Mercury Insurance 2015 Annual Report Download - page 29

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Company monitors the timing and recognition of capital gains and losses and the generation of ordinary income in an effort to
maximize the realization of deferred tax assets arising from capital losses orAMT credit carryforwards, no guaranty can be provided
that such monitoring or the Company's tax strategies will be effective.
If interest rates rise, the Company’s debt service costs will increase.
Interest expense on the Company’s notes payable is directly tied to short-term LIBOR rates, which tend to move in
conjunction with the short-term bank borrowing rates (the "Fed Funds Rate") established by the Federal Reserve Bank. In December
2015, the Federal Reserve Bank increased the Fed Funds Rate by 0.25% for the first time since 2006 and many economists expect
additional rate increases in 2016. The interest expense on the Company's notes payable will increase if short-term LIBOR rates
experience increases. Higher interest expense could have an adverse impact on the Company's financial condition, results of
operations and liquidity.
The Company’s valuation of financial instruments may include methodologies, estimates, and assumptions that are
subject to differing interpretations and could result in changes to valuations that may materially adversely affect the Company’s
financial condition or results of operations.
The Company employs a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value.
The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date using the exit price. Accordingly, when market observable
data are not readily available, the Company’s own assumptions are set to reflect those that market participants would be presumed
to use in pricing the asset or liability at the measurement date. Assets and liabilities recorded on the consolidated balance sheets
at fair value are categorized based on the level of judgment associated with the input used to measure their fair value and the level
of market price observability.
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 become 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 consolidated 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 as well as the underlying credit of the bond issuer. 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, 2015, 72.9% of the Company’s total investment portfolio at fair value and 85.6% 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.