Mercury Insurance 2007 Annual Report Download - page 49

2007 MERCURYNOW 47
MANAGEMENT’S DISCUSSION & ANALYSIS
loss adjustment expense reserves make up approximately 25% of the total reserve. The BI reserves account for such a large portion of the total
because BI claims tend to close much slower than MD claims. The majority of the loss adjustment expense reserves consist of estimated costs to
defend BI claims, so those claims also tend to close more slowly than MD claims. Loss development on MD reserves is generally insignificant
because MD claims are closed quickly.
BI loss reserves are generally the most difficult to estimate because they take longer to close than most of the Company’s other coverages. The
Company’s BI policy covers injuries sustained by any person other than the insured, except in the case of uninsured motorist and underinsured
motorist BI coverage, which covers damages to the insured for BI caused by uninsured or underinsured motorists. BI payments are primarily for
medical costs and general damages.
The following table represents the typical closure patterns of BI claims in the California automobile insurance coverage:
% of Total
Claims Closed Dollars Paid
BI claims closed in the accident year reported 35% to 40% 15%
BI claims closed one year after the accident year reported 75% to 80% 60%
BI claims closed two years after the accident year reported 93% to 97% 90%
BI claims closed three years after the accident year reported 97% to 99% 98%
Claims that close during the initial accident year reported are generally the smaller, less complex claims that settle, on average, for approximately
$2,000 to $2,500 whereas the average settlement amount, once all claims are closed in a particular accident year, is approximately $7,500. The
Company creates incurred loss triangles to estimate ultimate losses utilizing historical reserving patterns and evaluates the results of this analysis
against its frequency and severity analysis to establish BI reserves. The Company will adjust development factors to account for inflation trends it
sees in loss severity. As a larger proportion of claims from an accident year are settled, there becomes a higher degree of certainty for the reserves
established for that accident year. Consequently, there is a decreasing likelihood of reserve development on any particular accident year, as those
periods age. The Company believes that the accident years that are most likely to develop in future years are the 2005 through 2007 accident years;
however, it is also possible that older accident years could develop as well.
In general, when establishing reserves, the Company expects that historical trends will continue. Furthermore, the Company believes that
costs tend to increase, which is generally consistent with historical data, and therefore the Company believes that it is more reasonable to expect
inflation than deflation. Many potential factors can affect the BI inflation rate, including: a reduction in litigated files, more timely handling of
claims, safer vehicles, and changes in weather patterns; however, whether these are the factors that actually impact the BI losses or the magnitude
of that impact is unknown.
The Company believes that it is reasonably possible that the California automobile BI inflation rate recorded for the 2007 accident year could
vary by as much as 7%, for 2006 as much as 5% and for 2005 as much as 4%. However, the actual variation could be more or less than such
estimates. The following table shows the effects on the 2005, 2006 and 2007 accident years’ California BI loss reserves based on those variations
in the severity recorded:
California Bodily Injury Inflation Reserve Sensitivity Analysis
(A) (B)
Pro-forma Pro-forma
severity if severity if Loss
actual actual Loss deficiency
severity is severity is redundancy if if actual
Ultimate Actual Implied lower by: 7% higher by 7% actual severity severity is
number of recorded inflation for 2007, 5% for 2007, 5% is less than more than
claims severity at rate for 2006 and for 2006 and recorded recorded
Accident year expected 12/31/07 recorded 4% for 2005 4% for 2005 (Column A) (Column B)
2007 35,638 $ 7,440 3.33% $ 6,919 $ 7,961 $ 18,567,000 $ (18,567,000)
2006 37,200 $ 7,200 1.44% $ 6,840 $ 7,560 $ 13,392,000 $ (13,392,000)
2005 36,667 $ 7,098 1.27% $ 6,814 $ 7,382 $ 10,413,000 $ (10,413,000)
2004 Not applicable $ 7,008
Total loss redundancy (deficiency) $ 42,372,000 $ (42,372,000)
The Company believes that inflation is more normative than deflation and expects a moderate inflation rate of approximately 3% to 4% to
continue. However, trends can change, so whether the Company’s inflation estimates will be in line with actual inflation is uncertain.