Mercury Insurance 2007 Annual Report Download - page 48

46 MERCURYNOW 2007
MANAGEMENT’S DISCUSSION & ANALYSIS
unknown items. The Company does not make specific provisions for these uncertainties, rather it considers them in establishing its reserve by
looking at historical patterns and trends and projecting these out to current reserves. The underlying factors and assumptions that serve as the
basis for preparing the reserve estimate include paid and incurred loss development factors, expected average costs per claim, inflation trends,
expected loss ratios, industry data and other relevant information.
The Company also engages independent actuarial consultants to review the Company’s reserves and to provide the annual actuarial opinions
required under state statutory accounting requirements. The Company does not rely on actuarial consultants for GAAP reporting or periodic
report disclosure purposes.
The Company analyzes loss reserves quarterly primarily using the incurred loss development, average severity and claim count development
methods described below. The Company also uses the paid loss development method to analyze loss adjustment expense reserves and industry
claims data as part of its reserve analysis. When deciding which method to use in estimating its reserves, the Company evaluates the credibility of
each method based on the maturity of the data available and the claims settlement practices for each particular line of business or coverage within
a line of business. When establishing the reserve, the Company will generally analyze the results from all of the methods used rather than relying
on one 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 business which have a long operating history.
• 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 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 reserves.
• The paid loss development method analyzes historical payment patterns to estimate the amount of losses yet to be paid. The Company primarily
uses this method for loss adjustment expenses because specific case reserves are generally not established for loss adjustment expenses.
In states with little operating history where there are insufficient claims data to prepare a reserve analysis relying solely on Company historical
data, the Company generally projects ultimate losses using industry average loss data or expected loss ratios. As the Company develops an operating
history in these states, the Company will rely increasingly on the incurred loss development and average severity and claim count development
methods. The Company analyzes catastrophe losses separately from non-catastrophe losses. For these 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 reserves established by adjusters and average losses on previous similar catastrophes.
There are many factors that can cause variability between the ultimate expected loss and the actual developed loss. Because the actual loss
for a particular accident period is unknown until all claims have settled for that period, the Company must estimate the ultimate expected loss.
While there are certainly other factors, the Company believes the following items tend to create the most variability between expected losses and
actual losses:
1) Variability in inflation expectations — particularly on coverages that take longer to settle such as the California automobile bodily injury
coverage.
2) Variability in the number of claims reported subsequent to a period-end relating to that period — particularly on coverages that take longer to
settle such as the California automobile bodily injury coverage.
3) Variability between Company loss experience and industry averages for those lines of business where the Company is relying on industry averages
to establish reserves.
4) Unexpected large individual losses or groups of losses arising from older accident periods typically caused by an event that is not reflected in
the historical company data used to establish reserves.
These items are discussed in detail below.
1. INFLATION VARIABILITY — CALIFORNIA AUTOMOBILE LINES OF BUSINESS
For the Company’s California automobile lines of business, the bodily injury (BI) reserves make up approximately 65% of the total reserve;
material damage, including collision, comprehensive, and property damage (MD) reserves make up approximately 10% of the total reserve; and