Mercury Insurance 2007 Annual Report Download - page 47

2007 MERCURYNOW 45
MANAGEMENT’S DISCUSSION & ANALYSIS
discounts for various deductible options and hurricane mitigation measures. The Company has made the rate filings required by the new law, and
is prepared to comply with all provisions as they become effective. The initial rate impact of the new law has not met the expectations of some
Florida governmental leaders, and the law may be subject to further enhancements. The Company is closely monitoring these developments.
In July 2007, the California DOI issued Orders to Show Cause and Statements of Charges and Accusations (the “OSCs”) alleging that the
Company has engaged in and continues to engage in claims handling acts and practices in violation of California Insurance Code sections 790
et seq and other regulations. The California DOI is seeking penalties for each violation. The California DOI is also seeking (a) a suspension of the
California Companies’ Certificates of Authority for a period not to exceed one year for acts in violation of Section 700(c) and 704 of the California
Insurance Code, (b) a finding that breaches of contract have occurred with a specification of the amount of actual damages sustained as a result
of the breaches and (c) restitution on behalf of those allegedly harmed by the acts alleged in the OSCs. On August 10, 2007, the Company filed a
Notice of Defense in response generally and specifically denied the allegations of the OSCs. A hearing on the matter is tentatively set for March
10-14, 2008. The Company does not believe that it has done anything to warrant any of the penalties or remedies sought by the California DOI.
In March 2006, the California DOI issued an Amended Notice of Non-Compliance (“NNC”) to the NNC originally issued in February 2004
alleging that the Company charged rates in violation of the California Insurance Code, willfully permitted its agents to charge broker fees in
violation of California law, and willfully misrepresented the actual price insurance consumers could expect to pay for insurance by the amount
of a fee charged by the consumer’s insurance broker. Through this action, the California DOI seeks to impose a fine for each policy in which the
Company allegedly permitted an agent to charge a broker fee, which the California DOI contends is the use of an unapproved rate, rating plan or
rating system. Further, the California DOI seeks to impose a penalty for each and every date on which the Company allegedly used a misleading
advertisement alleged in the NNC. Finally, based upon the conduct alleged, the California DOI also contends that the Company acted fraudulently
in violation of Section 704(a) of the California Insurance Code, which permits the California Commissioner of Insurance to suspend certificates
of authority for a period of one year. The Company filed a Notice of Defense in response to the NNC. The Company does not believe that it has
done anything to warrant a monetary penalty from the California DOI. The San Francisco Superior Court, in Robert Krumme, On Behalf Of The
General Public v. Mercury Insurance Company, Mercury Casualty Company, and California Automobile Insurance Company, denied plaintiff’s requests for
restitution or any other form of retrospective monetary relief based on the same facts and legal theory. The matter is currently in discovery and a
hearing before the administrative law judge has been scheduled to be held April 22, 2008.
The Company is not able to determine the impact of any of the legal and regulatory matters described above. It is possible that the impact of
some of the changes could adversely affect the Company and its operating results, however, the ultimate outcome is not expected to be material
to the Company’s financial position.
The California Franchise Tax Board (“FTB”) has audited the 1997 through 2002 and 2004 tax returns and accepted the 1997 through 2000
returns to be correct as filed. The Company received a notice of examination for the 2003 tax return from the FTB in January 2008. For the
Company’s 2001, 2002, and 2004 tax returns, the FTB has taken exception to the state apportionment factors used by the Company. Specifically,
the FTB has asserted that payroll and property factors from Mercury Insurance Services, LLC, a subsidiary of Mercury Casualty Company, that
are excluded from the Mercury General California Franchise tax return, should be included in the California apportionment factors. In addition,
for the 2004 tax return, the FTB has asserted that a portion of management fee expenses paid by Mercury Insurance Services, LLC should be
disallowed. Based on these assertions, the FTB has issued notices of proposed tax assessments for the 2001, 2002 and 2004 tax years totaling
approximately $5 million. The Company strongly disagrees with the position taken by the FTB and plans to formally appeal the assessments before
the California State Board of Equalization (“SBE”). An unfavorable ruling against the Company may have a material impact on the Company’s
results of operations in the period of such ruling. Management believes that the issue will ultimately be resolved in favor of the Company. However,
there can be no assurance that the Company will prevail on this matter.
The Company is also involved in proceedings incidental to its insurance business. See Note 10 of Notes to Consolidated Financial Statements
— Litigation.
Critical Accounting Estimates
RESERVES
The preparation of the Company’s consolidated financial statements requires judgment and estimates. The most significant is the estimate of loss
reserves as required by Statement of Financial Accounting Standards (“SFAS”) No. 60, “Accounting and Reporting by Insurance Enterprises”
(“SFAS No. 60”), and SFAS No. 5, “Accounting for Contingencies” (“SFAS No. 5”). Estimating loss reserves is a difficult process as many factors
can ultimately affect the final settlement of a claim and, therefore, the reserve that is required. Changes in the regulatory and legal environment,
results of litigation, medical costs, the cost of repair materials and labor rates, among other factors, can all impact ultimate claim costs. In addition,
time can be a critical part of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of a
claim, the more variable the ultimate settlement amount can be. Accordingly, short-tail claims, such as property damage claims, tend to be more
reasonably predictable than long-tail liability claims.
The Company does not calculate a range of loss reserve estimates but rather calculates a point estimate. There is inherent uncertainty with
estimates and this is particularly true with estimates for loss reserves. This uncertainty comes from many factors which may include changes in
claims reporting and settlement patterns, changes in the regulatory or legal environment, uncertainty over inflation rates and uncertainty for