Mercury Insurance 2007 Annual Report Download - page 51

2007 MERCURYNOW 49
MANAGEMENT’S DISCUSSION & ANALYSIS
in accident years 2005, 2006 and 2007 will be similar to that experienced in accident year 2004. At December 31, 2007, the Company recorded
average BI loss severities that were higher than those from the industry loss data. For every 10% that recorded BI loss severities are increased on
the 2005, 2006 and 2007 accident years, an additional loss reserve of approximately $8 million would be required, with the converse holding true
if the loss severities recorded were reduced. As the claims from the 2005, 2006 and 2007 accident years continue to mature, there is likely to be
additional development, however, it is uncertain whether this development will be positive or adverse.
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 types of losses are generally not provided for in the current reserve because they are not known or expected and tend to be unquantifiable.
Once they become known, the Company establishes a provision for the losses. Consequently, it is not possible to provide any meaningful sensitivity
analysis as to the potential size of any unexpected losses. These losses can be caused by many factors, including unexpected legal interpretations of
coverage, ineffective claims handling, new regulations extending claims reporting periods, assumption of unexpected or unknown risks, adverse
court decisions as well as many unknown factors. Conversely, it is possible to experience positive reserve development when one or more of these
factors prove to be beneficial to the Company.
One instance of unanticipated large losses arising from older accident periods was in 2006 from extra-contractual losses in Florida. Typically,
extra-contractual claims settle for more than the policy limits because the original claim was denied, exposing the Company to losses greater than
the policy limits. Claims may be denied for various reasons, including material misrepresentation made by the insured on the policy application,
violation of prohibitions in the insurance contract by the insured, or fraud. These types of losses are fairly infrequent but can amount to millions
of dollars per claim, especially if the injured party sustained a serious injury such as a loss of a limb or paralysis. Consequently, these claims can
have a large impact on the Company’s losses. During 2006, the Company had extra-contractual claims that settled for amounts much greater than
the policy limits and much greater than expected. As a result of these settlements, the Company, during the second quarter of 2006, reevaluated
its exposure to extra-contractual claims in Florida and increased its reserve estimates for prior accident years.
To mitigate this specific risk, during 2006 the Company established new claims handling and review procedures in Florida, as well as in
other states, that are intended to reduce the risk of receiving extra-contractual claims. Consequently, the Company does not expect that Florida
extra-contractual claims will continue to have a significant impact on the financial statements or reserves in the future. However, it is possible that
these procedures will not prove entirely effective and the Company may continue to have material extra-contractual losses. It is also possible that
the Company has not identified and established sufficient reserves for all of the extra-contractual losses occurring in the older accident years, even
though a comprehensive claims file review was undertaken, or that the Company will experience additional development on these reserves.
DISCUSSION OF LOSS RESERVES AND PRIOR PERIOD LOSS DEVELOPMENT AT DECEMBER 31, 2007
At December 31, 2007 and 2006, respectively, the Company recorded its point estimate of approximately $1,104 and $1,089 million, respectively in
loss and loss adjustment expense reserves which includes approximately $322 and $306 million, respectively of incurred but not reported (“IBNR”)
loss reserves. IBNR includes estimates, based upon past experience, of ultimate developed costs which may differ from case estimates, unreported
claims which occurred on or prior to December 31, 2007 and estimated future payments for reopened-claims reserves. Management believes that
the liability established at December 31, 2007 for losses and loss adjustment expenses is adequate to cover the ultimate net cost of losses and loss
adjustment expenses incurred to date. Since the provisions are necessarily based upon estimates, the ultimate liability may be more or less than
such provision.
The Company reevaluates its reserves quarterly. When management determines that the estimated ultimate claim cost requires reduction for
previously reported accident years, positive development occurs and a reduction in losses and loss adjustment expenses is reported in the current
period. If the estimated ultimate claim cost requires an increase for previously reported accident years, negative development occurs and an increase
in losses and loss adjustment expenses is reported in the current period.
For 2007, the Company had negative development of approximately $20 million on the 2006 and prior accident years’ loss and loss adjustment
expense reserves which at December 31, 2006 totaled approximately $1.1 billion. The negative development related to California operations was
approximately $25 million, which was offset by positive development of approximately $5 million related to operations outside of California. See
also Note 7 of Notes to Consolidated Financial Statements.
CALIFORNIA DEVELOPMENT
Of the $25 million in adverse development recorded for California, approximately $13 million relates to adverse development on the bodily injury
reserves established at December 31, 2006. Of that $13 million, approximately $4 million relates to an increase in the ultimate number of claims
reported that exceeded the Company’s original estimate and approximately $9 million relates to increases in the Company’s loss severity estimates
from the amount that was recorded at December 31, 2006.