Mercury Insurance 2007 Annual Report Download - page 53

2007 MERCURYNOW 51
MANAGEMENT’S DISCUSSION & ANALYSIS
Results of Operations
YEAR ENDED DECEMBER 31, 2007 COMPARED TO YEAR ENDED DECEMBER 31, 2006
Premiums earned in 2007 decreased 0.1% from the corresponding period in 2006. Net premiums written in 2007 decreased 2.1% from the
corresponding period in 2006. The premium decreases were principally attributable to a decrease in the number of policies written by the Company’s
non-California operations, mostly in New Jersey and Florida, which are experiencing significant competition. The decrease is partially offset by
a slight increase in the average premium collected per policy. During 2007, the Company implemented no rate changes in California. In states
outside of California, the Company implemented automobile rate increases in two states, automobile rate decreases in four states, and homeowners
rate decreases in one state during 2007.
Net premiums written is a non-GAAP financial measure which represents the premiums charged on policies issued during a fiscal period
less any effects of reinsurance. Net premiums written is a statutory measure used to determine production levels. Net premiums earned, the most
directly comparable GAAP measure, represents the portion of premiums written that are recognized as income in the financial statements for the
period presented and earned on a pro-rata basis over the term of the policies. The following is a reconciliation of total Company net premiums
written to net premiums earned for the years ended December 31, 2007 and 2006, respectively:
Amounts in thousands 2007 2006
Net premiums written $ 2,982,024 $ 3,044,774
Decrease (increase) in unearned premiums 11,853 (47,751)
Earned premiums $ 2,993,877 $ 2,997,023
The loss ratio (GAAP basis) in 2007 (loss and loss adjustment expenses related to premiums earned) was 68.0% compared with 67.5% in 2006.
There was negative development of approximately $20 million on prior accident years’ loss reserves in both 2007 and 2006. Excluding the effect
of prior accident years’ loss development, the loss ratio was 67.4% in 2007 and 66.8% in 2006. The Southern California fire storms negatively
impacted the loss ratio by approximately 0.8% in 2007.
The expense ratio (GAAP basis) in 2007 (policy acquisition costs and other operating expenses related to premiums earned) was 27.4%
compared with 27.5% in 2006. The majority of expenses vary directly with premiums.
The combined ratio of losses and expenses (GAAP basis) is the key measure of underwriting performance traditionally used in the property
and casualty insurance industry. A combined ratio under 100% generally reflects profitable underwriting results; a combined ratio over 100%
generally reflects unprofitable underwriting results. The combined ratio of losses and expenses (GAAP basis) was 95.4% in 2007 compared with
95.0% in 2006.
Net investment income in 2007 was $158.9 million compared with $151.1 million in 2006. The after-tax yield on average investments of
$3,468.4 million (cost basis) was 4.0%, compared with 3.8% on average investments of $3,325.4 million (cost basis) in 2006. The effective tax rate
on investment income was 13.3% in 2007, compared to 15.5% in 2006. The lower tax rate in 2007 reflects a shift in the mix of the Company’s
portfolio from taxable to non-taxable securities. Proceeds from bonds which matured or were called in 2007 totaled $311.7 million, compared to
$522.2 million in 2006. The proceeds were mostly reinvested into securities meeting the Company’s investment profile.
Net realized investment gains in 2007 were $20.8 million, compared with net realized investment gains of $15.4 million in 2006. Included
in the net realized investment gains are investment write-downs of $22.7 million in 2007 and $2.0 million in 2006 that the Company considered
to be other-than-temporarily impaired. In addition, net realized investment gains include approximately $1.4 million loss in 2007 and $0 in 2006
related to the change in the fair value of hybrid financial instruments, and approximately $2.0 million gain in 2007 and $0 in 2006 related to the
change in the fair value of trading securities.
The income tax provision for 2006 of $97.6 million was impacted significantly by a $15 million income tax charge relating to the Notices of
Proposed Assessments for the tax years 1993 through 1996 (the “NPAs”) that were upheld by the California State Board of Equalization. Excluding
the effect of this income tax charge results in an effective tax rate of 26.4% in 2006 compared with an effective rate of 24.5% in 2007. The lower
rate in 2007 is primarily attributable to an increased proportion of tax-exempt investment income including tax sheltered dividend income, in
contrast to taxable investment income and underwriting income.
Net income in 2007 was $237.8 million or $4.34 per share (diluted) compared with $214.8 million or $3.92 per share (diluted) in 2006. Diluted
per share results are based on a weighted average of 54.8 million shares in 2007 and 54.8 million shares in 2006. Basic per share results were
$4.35 in 2007 and $3.93 in 2006. Included in net income are net realized investment gains, net of income tax expense, of $0.25 and $0.18 per share
(diluted and basic) in 2007 and 2006, respectively.