Mercury Insurance 2015 Annual Report Download - page 76

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used rather than relying on a single method. While these methods are designed to determine the ultimate losses on claims under
the Company’s policies, there is inherent uncertainty in all actuarial models since they use historical data to project outcomes.
The Company believes that the techniques it uses provide a reasonable basis in estimating loss reserves.
• The incurred loss development method analyzes historical incurred case loss (case reserves plus paid losses)
development to estimate ultimate losses. The Company applies development factors against current case incurred losses
by accident period to calculate ultimate expected losses. The Company believes that the incurred loss development
method provides a reasonable basis for evaluating ultimate losses, particularly in the Company’s larger, more established
lines of insurance business which have a long operating history.
• The average severity method analyzes historical loss payments and/or incurred losses divided by closed claims and/
or total claims to calculate an estimated average cost per claim. From this, the expected ultimate average cost per claim
can be estimated. The average severity method coupled with the claim count development method provide meaningful
information regarding inflation and frequency trends that the Company believes is useful in establishing loss reserves.
The claim count development method analyzes historical claim count development to estimate future incurred claim
count development for current claims. The Company applies these development factors against current claim counts
by accident period to calculate ultimate expected claim counts.
• The paid loss development method analyzes historical payment patterns to estimate the amount of losses yet to be paid.
The Company uses this method for losses and loss adjustment expenses.
The Company analyzes catastrophe losses separately from non-catastrophe losses. For catastrophe losses, the Company
determines claim counts based on claims reported and development expectations from previous catastrophes and applies an average
expected loss per claim based on loss reserves established by adjusters and average losses on previous similar catastrophes.
Derivative Financial Instruments
The Company accounts for all derivative instruments, other than those that meet the normal purchases and sales exception,
as either an asset or liability, measured at fair value, which is based on information obtained from independent parties. In addition,
changes in fair value are recognized in earnings unless specific hedge accounting criteria are met. The Company’s derivative
instruments include total return swaps and options sold. See Note 8. Derivative Financial Instruments.
Earnings Per Share
Basic earnings per share excludes dilution and reflects net income divided by the weighted average shares of common stock
outstanding during the periods presented. Diluted earnings per share is based on the weighted average shares of common stock
and potential dilutive securities outstanding during the periods presented. At December 31, 2015 and 2014, potential dilutive
securities consisted of outstanding stock options and restricted stock units ("RSUs") granted from the Company's 2013 Long Term
Incentive Plan. See Note 16. Earnings Per Share,for the required disclosures relating to the calculation of basic and diluted earnings
per share.
Income Taxes
Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between
the financial reporting basis and the respective tax basis of the Company’s assets and liabilities, and expected benefits of utilizing
net operating loss, capital loss, and tax-credit carryforwards. The Company assesses the likelihood that its deferred tax assets will
be realized and, to the extent management does not believe these assets are more likely than not to be realized, a valuation allowance
is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities
of a change in tax rates or laws is recognized in earnings in the period that includes the enactment date.
At December 31, 2015, the Company’s deferred income taxes were in a net asset position, which included a combination
of ordinary and capital deferred tax benefits. In assessing the Company's ability to realize deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization
of deferred tax assets is dependent upon generating sufficient taxable income of the appropriate character within the carryback
and carryforward periods available under the tax law. Management considers the reversal of deferred tax liabilities, projected
future taxable income of an appropriate nature, and tax-planning strategies in making this assessment. The Company believes that
through the use of prudent tax planning strategies and the generation of capital gains, sufficient income will be realized in order
to maximize the full benefits of its deferred tax assets. Although realization is not assured, management believes that it is more
likely than not that the Company’s deferred tax assets will be realized.