Mercury Insurance 2010 Annual Report Download - page 29

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During periods of market disruption, including periods of significantly changing interest rates, rapidly
widening credit spreads, inactivity or illiquidity, it may be difficult to value certain of the Company’s securities if
trading becomes less frequent and/or market data becomes less observable. There may be certain asset classes in
historically active markets with significant observable data that become illiquid due to changes in the financial
environment. In such cases, the valuations associated with such securities may rely more on management
judgment and include inputs and assumptions that are less observable or require greater estimation as well as
valuation methods, which are more sophisticated or require greater estimation. The valuations generated by such
methods may be different from the value at which the investments ultimately may be sold. Further, rapidly
changing and unprecedented credit and equity market conditions could materially impact the valuation of
securities as reported within the Company’s financial statements, and the period-to-period changes in value could
vary significantly. Decreases in value may have a material adverse effect on the Company’s financial condition
or results of operations.
Changes in the financial strength ratings of financial guaranty insurers issuing policies on bonds held in
the Company’s investment portfolio may have an adverse effect on the Company’s investment results.
In an effort to enhance the bond rating applicable to certain bond issues, some bond issuers purchase
municipal bond insurance policies from private insurers. The insurance generally guarantees the payment of
principal and interest on a bond issue if the issuer defaults. By purchasing the insurance, the financial strength
ratings applicable to the bonds are based on the credit worthiness of the insurer rather than the underlying credit
of the bond issuer. Several financial guaranty insurers that have issued insurance policies covering bonds held by
the Company have experienced financial strength rating downgrades due to risk exposures on insurance policies
that guarantee mortgage debt and related structured products. These financial guaranty insurers are subject to
DOI oversight. As the financial strength ratings of these insurers are reduced, the ratings of the insured bond
issues correspondingly decrease. Although the Company has determined that the financial strength rating of the
underlying bond issues in its investment portfolio are within the Company’s investment policy without the
enhancement provided by the insurance policies, any further downgrades in the financial strength ratings of these
insurance companies or any defaults on the insurance policies written by these insurance companies may reduce
the fair value of the underlying bond issues and the Company’s investment portfolio or may reduce the
investment results generated by the Company’s investment portfolio, which could have a material adverse effect
on the Company’s financial condition, results of operations, and liquidity.
Deterioration of the municipal bond market in general or of specific municipal bonds held by the
Company may result in a material adverse effect on the Company’s financial condition, results of operations,
and liquidity.
At December 31, 2010, 77.0% of the Company’s total investment portfolio at fair value and 91.6% of its
total fixed maturity investments at fair value were invested in tax-exempt municipal bonds. With such a large
percentage of the Company’s investment portfolio invested in municipal bonds, the performance of the
Company’s investment portfolio, including the cash flows generated by the investment portfolio is significantly
dependent on the performance of municipal bonds. If the value of municipal bond markets in general or any of
the Company’s municipal bond holdings deteriorate, the performance of the Company’s investment portfolio,
financial condition, results of operations, and liquidity may be materially and adversely affected.
If the Company’s loss reserves are inadequate, its business and financial position could be harmed.
The process of establishing property and liability loss reserves is inherently uncertain due to a number of
factors, including underwriting quality, the frequency and amount of covered losses, variations in claims
settlement practices, the costs and uncertainty of litigation, and expanding theories of liability. While the
Company believes that improved actuarial techniques and databases have assisted in estimating loss reserves, the
Company’s methods may prove to be inadequate. If any of these contingencies, many of which are beyond the
Company’s control, results in loss reserves that are not sufficient to cover its actual losses, the Company’s
financial condition, results of operations, and liquidity may be materially adversely affected.
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