Mercury Insurance 2007 Annual Report Download - page 56

54 MERCURYNOW 2007
MANAGEMENT’S DISCUSSION & ANALYSIS
The Company monitors its investments closely. If an unrealized loss is determined to be other than temporary, it is written off as a realized
loss through the consolidated statements of income. The Company’s assessment of other-than-temporary impairments is security-specific as of the
balance sheet date and considers various factors including the length of time and the extent to which the fair value has been lower than the cost,
the financial condition and the near-term prospects of the issuer, whether the debtor is current on its contractually obligated interest and principal
payments, and the Company’s intent to hold the securities until they mature or recover their value. The Company recognized $22.7 million and
$2.0 million in realized losses as other-than-temporary declines to its investment securities during 2007 and 2006, respectively.
During the second half of 2007 and subsequent to December 31, 2007, the investment market has experienced substantial volatility as a result
of uncertainty in the credit markets. As a result, some asset classes have had liquidity and/or valuation issues including mortgage-backed securities
(“CMO”), privately insured municipal bonds, and adjustable rate short-term securities.
The entire CMO portfolio consists of loans to prime borrowers except for approximately $20 million (amortized cost and fair value) of Alt-
A CMO’s. Alt-A mortgages are generally home loans made to individuals that have credit scores as high as prime borrowers, but provide less
documentation of their finances on their credit applications. All of the Company’s Alt-A CMO’s are currently rated AAA and the overall rating
of the entire CMO portfolio is AAA.
The Company had approximately $2.5 billion at fair value in municipal bonds at December 31, 2007. Approximately half of the municipal
bonds do not carry insurance from bond insurers and have an average rating of AA. The other half of the municipal bond positions are insured by
bond insurers. The following bond insurers each insured more than one percent of the Company’s municipal bond portfolio at December 31, 2007:
MBIA-17.0%, FSA-11.3%, AMBAC-9.0%, FGIC-7.2%, and XLCA-1.7%. All of these insurers maintained investment grade ratings at December
31, 2007 and, although some of the insurers have been downgraded subsequent to year-end, they all continue to maintain investment grade ratings
as of February 20, 2008. However, based on the uncertainty surrounding the financial condition of these insurers, it is possible that they will be
downgraded to a below investment grade rating by the rating agencies in the future, and such downgrades could impact the estimated fair value
of municipal bonds.
At December 31, 2007, the average rating of the insured portion of the Company’s municipal bond portfolio was AAA. For insured bonds that
have underlying ratings, the average underlying rating is AA-. There is also approximately $200 million of insured bonds that carry no official
underlying rating. The Company considers bonds that carry no underlying rating as being investment grade since it is an underwriting policy
of the “AAA” mono-line insurers that the issuer qualifies as an investment grade credit in order to get the bond insurer’s rating. The Company
considers the strength of the underlying credit as a buffer against potential market value declines which may result from future rating downgrades
of the bond insurers. In addition, the Company has a long-term time horizon for its municipal bond holdings which allows us to recover the full
principle amounts upon maturity, rather than forced sales of bonds prior to maturity that have declined in market values due to bond insurer
rating downgrades.
The Company owned less than $100 million of adjustable rate short-term securities, including auction rate securities, at December 31, 2007
but subsequently exited substantially all of the asset class at par without gain or loss. The Company continuously monitors the market and may
invest in such securities in the future.
DEBT
On August 7, 2001, the Company completed a public debt offering issuing $125 million of senior notes. The notes are unsecured, senior obligations
of the Company with a 7.25% annual coupon payable on August 15 and February 15 each year commencing February 15, 2002. These notes mature
on August 15, 2011. The Company used the proceeds from the senior notes to retire amounts payable under existing revolving credit facilities,
which were terminated. Effective January 2, 2002, the Company entered into an interest rate swap of its fixed rate obligation on the senior notes
for a floating rate of LIBOR plus 107 basis points. The swap significantly reduced the interest expense in 2007 and 2006 when the effective interest
rate was 6.4% and 6.6%, respectively. However, if the LIBOR interest rate increases in the future, the Company will incur higher interest expense
in the future. The swap is designated as a fair value hedge under SFAS No. 133.
SHARE REPURCHASES
Under the Company’s stock repurchase program, the Company may purchase over a one-year period up to $200 million of Mercury General’s
common stock. The purchases may be made from time to time in the open market at the discretion of management. The program will be funded
by dividends received from the Company’s insurance subsidiaries that generate cash flow through the sale of lower yielding tax-exempt bonds and
internal cash generation. Since the inception of the program in 1998, the Company has purchased 1,266,100 shares of common stock at an average
price of $31.36. The purchased shares were retired. No stock has been purchased since 2000.