Mercury Insurance 2007 Annual Report Download - page 45

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2007 MERCURYNOW 43
MANAGEMENT’S DISCUSSION & ANALYSIS
REVENUES, INCOME AND CASH GENERATION
The Company generates its revenues through the sale of insurance policies, primarily covering personal automobiles and homeowners. These
policies are sold through independent agents and brokers who receive a commission on average of 17% of net premiums written for selling and
servicing the policies.
During 2007, the Company continued its marketing efforts for name recognition and lead generation. The Company believes that its marketing
efforts, combined with its ability to maintain relatively low prices and a strong reputation make the Company very competitive in California and
in other states. During 2007, the Company incurred approximately $28 million in advertising expenses.
The Company believes that it has a thorough underwriting process that gives the Company an advantage over its competitors. The Company
views its agent relationships and underwriting process as one of its primary competitive advantages because it allows the Company to charge lower
prices yet realize better margins than many of its competitors.
The Company also generates revenue from its investment portfolio, which was approximately $3.6 billion at the end of 2007. This investment
portfolio generated approximately $159 million in pre-tax investment income during 2007. The portfolio is managed by Company personnel with
a view towards maximizing after-tax yields and limiting interest rate and credit risk.
The Company’s operating results and growth have allowed it to consistently generate positive cash flow from operations, which was approximately
$222 million in 2007. The Company’s cash flow from operations has exceeded $100 million every year since 1994 and has been positive for over
20 years. Cash flow from operations has been used to pay shareholder dividends and to help support growth.
OPPORTUNITIES, CHALLENGES AND RISKS
The Company currently underwrites personal automobile insurance in thirteen states: Arizona, California, Florida, Georgia, Illinois, Michigan,
Nevada, New Jersey, New York, Oklahoma, Pennsylvania, Texas and Virginia. The Company expects to continue its growth by expanding into
new states in future years with the objective of achieving greater geographic diversification, so that non-California premiums eventually account
for as much as half of the Company’s total premiums.
There are, however, challenges and risks involved in entering each new state, including establishing adequate rates without any operating
history in the state, working with a new regulatory regime, hiring and training competent personnel, building adequate systems and finding
qualified agents to represent the Company. The Company does not expect to enter into any new states until after the end of 2008.
The Company is also subject to risks inherent in its business, which include but are not limited to the following:
• A catastrophe, such as a major wildfire, earthquake or hurricane, could cause a significant amount of loss to the Company in a very short period
of time.
• A major regulatory change could make it more difficult for the Company to generate new business or reduce the profitability of the Company’s
existing business.
• A sharp upward increase in market interest rates or a downturn in securities markets could cause a significant loss in the value of the Company’s
investment portfolio.
To the extent it is within the Company’s control, the Company seeks to manage these risks in order to mitigate the effect that major events
would have on the Company’s financial position.
TECHNOLOGY
The Company is currently implementing its NextGen computer system to replace its existing underwriting, billings, claims and commissions
legacy systems that currently reside on Hewlett Packard 3000 mainframe computers. The NextGen system is designed to be a multi-state, multi-
line system that is expected to enable the Company to enter new states more rapidly, as well as respond to legislative and regulatory changes more
easily than the Company’s current systems. The NextGen system is initially being deployed for the personal automobile line of business and has
been successfully implemented in Virginia, New York, Florida, and California. The Company expects to implement NextGen in Georgia, Illinois,
and Texas by the end of 2008.