Mercury Insurance 2010 Annual Report Download - page 45

The Company believes that it has a thorough underwriting process that gives the Company an advantage
over its competitors. The Company views its agent and broker relationships and underwriting process as one of
its primary competitive advantages because it allows the Company to charge lower rates yet realize better
margins than many competitors.
The Company’s operating results and growth have allowed it to consistently generate positive cash flow
from operations, which was approximately $92 million and $189 million in 2010 and 2009, respectively. Cash
flow from operations has been used to pay shareholder dividends and to help support growth.
Economic and Industry Wide Factors
• Regulatory Uncertainty—The insurance industry is subject to strict state regulation and oversight and
is governed by the laws of each state in which each insurance company operates. State regulators
generally have substantial power and authority over insurance companies including, in some states,
approving rate changes and rating factors, and establishing minimum capital and surplus
requirements. In many states, insurance commissioners may emphasize different agendas or interpret
existing regulations differently than previous commissioners. The Company has a successful track
record of working with difficult regulations and new insurance commissioners. However, there is no
certainty that current or future regulations and the interpretation of those regulations by insurance
commissioners and the courts will not have an adverse impact on the Company.
• Cost Uncertainty—Because insurance companies pay claims after premiums are collected, the ultimate
cost of an insurance policy is not known until well after the policy revenues are earned. Consequently,
significant assumptions are made when establishing insurance rates and loss reserves. While insurance
companies use sophisticated models and experienced actuaries to assist in setting rates and establishing
loss reserves, there can be no assurance that current rates or current reserve estimates will be
adequate. Furthermore, there can be no assurance that insurance regulators will approve rate increases
when the Company’s actuarial analysis shows that they are needed.
• Economic Conditions—While many economists believe that the severe economic recession is over
compared to 2008 and 2009, they expect the recovery to be slow with many businesses experiencing
the effects of the downturn for years to come. The Company is unable to predict the duration and
severity of the continued disruption in the financial markets in the United States, and in California,
where the majority of the Company’s business is produced. If economic conditions do not show
significant improvement, the adverse impact on the Company’s financial condition, results of
operations, and liquidity may continue.
• Inflation—The largest cost component for automobile insurers is losses, which include medical costs,
replacement automobile parts, and labor costs. There can be significant variation in the overall
increases in medical cost inflation, and it is often a year or more after the respective fiscal period ends
before sufficient claims have closed for the inflation rate to be known with a reasonable degree of
certainty. Therefore, it can be difficult to establish reserves and set premium rates, particularly when
actual inflation rates may be higher or lower than anticipated.
•Loss Frequency—Another component of overall loss costs is loss frequency, which is the number of
claims per risk insured. There has been a long-term trend of declining loss frequency in the personal
automobile insurance industry. In recent years, the trend has shown increasing loss frequency;
however, the Company is unable to predict the trend of loss frequency in the future.
• Underwriting Cycle and Competition—The property and casualty insurance industry is highly cyclical,
with alternating hard and soft market conditions. The Company has historically seen premium growth
in excess of 20% during hard markets. Premium growth rates in soft markets have ranged from slightly
positive to negative and were negative 2.2% in 2010. Many in the industry have experienced declining
profitability since 2007. Since 2009, many of the Company’s largest competitors have increased rates
on both private passenger auto insurance and homeowners insurance. Rate increases generally indicate
that the market is hardening.
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