Mercury Insurance 2007 Annual Report Download - page 57

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2007 MERCURYNOW 55
MANAGEMENT’S DISCUSSION & ANALYSIS
CAPITAL EXPENDITURES
The Company has no direct investment in real estate that it does not utilize for operations. In October 2007, the Company completed the acquisition
of a 4.25 acre parcel of land in Brea, California. The purchase price of $7.5 million includes issuing a $4.5 million promissory note due in April
2009. The land is adjacent to the property currently owned by the Company and will be used for future expansion. Also in October 2007, the
Company agreed to acquire an 88,300 square foot office building in Folsom, California for approximately $18.4 million. The Company intends
to finance the transaction through a bank credit facility. The transaction is expected to close on February 29, 2008. The building will be used to
house the Company’s northern California employees when the existing lease expires on the building that they currently occupy.
The Company is in the process of implementing its NextGen computer system to replace its existing underwriting, billings, claims and
commissions legacy systems. The NextGen system has been successfully implemented in Virginia, New York, Florida, and California. The
Company expects to implement NextGen in the majority of its other states by the end of 2008. The total capital expenditure incurred on the
NextGen project since it began in 2002 was approximately $40 million as of December 31, 2007. In 2006, the Company embarked on another
information technology project, Internet Business Strategy (“IBS”). IBS will provide the Company’s agents and brokers with an improved ability
to access resources relevant to writing and maintaining their book of business. It will also provide potential customers and existing customers with
the ability to obtain a quote and self-services through the internet. IBS is planned to be rolled out in phases starting in the first quarter of 2008.
The Company expects to complete the rollout by the end of 2008. The total capital expenditure incurred on the IBS project since it began in 2006
was approximately $20 million as of December 31, 2007. The development and implementation of these two projects are expected to provide a
positive benefit to the Company for an extended future period.
CONTRACTUAL OBLIGATIONS
The Company has obligations to make future payments under contracts and credit-related financial instruments and commitments. At December
31, 2007, certain long-term aggregate contractual obligations and credit-related commitments are summarized as follows:
Payments Due by Period
Amounts in thousands Total Within 1 year 1-3 years 4-5 years After 5 years
Contractual Obligations
Debt (including interest) $ 162,324 $ 9,063 $ 22,625 $ 130,636 $ —
Lease obligations 33,170 9,890 18,770 4,510 —
Losses and loss adjustment expenses 1,103,915 710,373 356,425 36,542 575
Total Contractual Obligations $ 1,299,409 $ 729,326 $ 397,820 $ 171,688 $ 575
Notes to Contractual Obligations Table:
The amount of interest included in the Company’s debt obligations was calculated using the fixed rate of 7.25% on the senior notes. The
Company is party to an interest rate swap of its fixed rate obligations on its senior notes for a floating rate of six month LIBOR plus 107 basis
points. Using the effective annual interest rate of 6.4% in 2007, the total contractual obligations on debt would be $158 million with $8 million
due within 1 year, $20 million due between 1 and 3 years, and $130 million due in year 4.
The Company’s outstanding debt contains various terms, conditions and covenants which, if violated by the Company, would result in
a default and could result in the acceleration of the Company’s payment obligations thereunder.
Unlike many other forms of contractual obligations, loss and loss adjustment expenses do not have definitive due dates and the ultimate
payment dates are subject to a number of variables and uncertainties. As a result, the total loss and loss adjustment expense payments to be
made by period, as shown above, are estimates.
The table excludes FIN No. 48 liabilities of $5 million related to uncertainty in tax settlements because the Company is unable to reasonably
estimate the timing of related future payments.
REGULATORY CAPITAL REQUIREMENT
The NAIC utilizes a risk-based capital formula for casualty insurance companies which establishes recommended minimum capital requirements
that are compared to the Company’s actual capital level. The formula was designed to capture the widely varying elements of risks undertaken by
writers of different lines of insurance having differing risk characteristics, as well as writers of similar lines where differences in risk may be related
to corporate structure, investment policies, reinsurance arrangements and a number of other factors. The Company has calculated the risk-based
capital requirements of each of the Insurance Companies as of December 31, 2007. The policyholders’ statutory surplus of each of the Insurance
Companies exceeded the highest level of minimum required capital.