Mercury Insurance 2015 Annual Report Download - page 65

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53
and $10.4 million in private equity funds. Common stock equity assets are typically valued for future economic prospects as
perceived by the market.
Common stocks represented 8.3% of total investments at fair value. Beta is a measure of a security’s systematic (non-
diversifiable) risk, which is measured as the percentage change in an individual security’s return for a 1% change in the return of
the market.
Based on hypothetical reductions in the overall value of the stock market, the following table illustrates estimated reductions
in the overall value of the Company’s common stock portfolio at December 31, 2015 and 2014:
December 31,
2015 2014
(Amounts in thousands, except Average Beta)
Average Beta 0.89 0.98
Hypothetical reduction in the overall value of the stock market of 25% $ 62,359 $ 91,287
Hypothetical reduction in the overall value of the stock market of 50% $ 124,717 $ 182,573
Interest rate risk
Interest rate risk is the risk that the Company will incur a loss due to adverse changes in interest rates relative to the interest
rate characteristics of interest bearing assets and liabilities. The Company faces interest rate risk, as it invests substantial funds in
interest sensitive assets and issues interest sensitive liabilities. Interest rate risk includes risks related to changes in U.S. Treasury
yields and other key benchmarks, as well as changes in interest rates resulting from widening credit spreads and credit exposure
to collateralized securities.
The value of the fixed maturity portfolio at December 31, 2015, which represented 85.2% of total investments at fair value,
is subject to interest rate risk. As market interest rates decrease, the value of the portfolio increases and vice versa. A common
measure of the interest sensitivity of fixed maturity assets is modified duration, a calculation that utilizes maturity, coupon rate,
yield and call terms to calculate an average age of the expected cash flows generated by such assets. The longer the duration, the
more sensitive the asset is to market interest rate fluctuations.
The Company has historically invested in fixed maturity investments with a goal of maximizing after-tax yields and holding
assets to the maturity or call date. Since assets with longer maturities tend to produce higher current yields, the Company’s historical
investment philosophy resulted in a portfolio with a moderate duration. Bond investments made by the Company typically have
call options attached, which further reduce the duration of the asset as interest rates decline. The modified duration of the overall
bond portfolio reflecting anticipated early calls was 3.2 years at December 31, 2015 compared to 2.8 years and 3.9 years at
December 31, 2014 and 2013, respectively.
Given a hypothetical increase of 100 or 200 basis points in interest rates, the Company estimates that the fair value of its
bond portfolio at December 31, 2015 would decrease by $94.7 million or $189.4 million, respectively. Conversely, if interest rates
were to decrease, the fair value of the Company’s bond portfolio would rise, and it may cause a higher number of the Company’s
bonds to be called away. The proceeds from the called bonds would likely be reinvested at lower yields which would result in
lower overall investment income for the Company.