Mercury Insurance 2007 Annual Report Download - page 69

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2007 MERCURYNOW 67
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company writes covered call options through listed and over-the-counter exchanges. When the Company writes an option, an amount
equal to the premium received by the Company is recorded as a liability and is subsequently adjusted to the current fair value of the option
written. Premiums received from writing options that expire unexercised are treated by the Company on the expiration date as realized gains from
investments. If a call option is exercised, the premium is added to the proceeds from the sale of the underlying security or currency in determining
whether the Company has realized a gain or loss. The Company, as writer of an option, bears the market risk of an unfavorable change in the price
of the security underlying the written option.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Under SFAS No. 115, the Company categorizes all of its investments in debt securities and the majority of equity securities as available-for-sale. The
remaining equity securities are categorized as trading. Accordingly, all investments, including cash and short-term investments, are carried on the
balance sheet at their fair value. The carrying amounts and fair values for investment securities are disclosed in Note 2 of Notes to Consolidated
Financial Statements and were drawn from standard trade data sources such as market and broker quotes. The carrying value of receivables,
accounts payable and accrued expenses and other liabilities is equivalent to the estimated fair value of those items.
PREMIUM INCOME RECOGNITION
Insurance premiums are recognized as income ratably over the term of the policies, that is, in proportion to the amount of insurance protection
provided. Unearned premiums are computed on a monthly pro rata basis. Unearned premiums are stated gross of reinsurance deductions, with the
reinsurance deduction recorded in other assets and other receivables. Net premiums of $2.98 billion, $3.04 billion, and $2.95 billion were written
in 2007, 2006 and 2005, respectively.
One broker produced direct premiums written of approximately 14%, 13% and 14% of the Company’s total direct premiums written during
2007, 2006 and 2005, respectively. No other agent or broker accounted for more than 2% of direct premiums written.
PREMIUM NOTES
Premium notes receivable represent the balance due to the Company from policyholders who elect to finance their premiums over the policy
term. The Company requires both a down payment and monthly payments as part of its financing program. Premium finance fees are charged
to policyholders who elect to finance premiums. The fees are charged at rates that vary with the amount of premium financed. Premium finance
fees are recognized over the term of the premium note based upon the effective yield.
DEFERRED POLICY ACQUISITION COSTS
Acquisition costs related to unearned premiums, which consist of commissions, premium taxes and certain other underwriting costs, and which
vary directly with and are directly related to the production of business, are deferred and amortized to expense ratably over the terms of the policies.
Deferred acquisition costs are limited to the amount which will remain after deducting from unearned premiums and anticipated investment
income the estimated losses and loss adjustment expenses and the servicing costs that will be incurred as the premiums are earned. The Company
does not defer advertising expenses.
LOSSES AND LOSS ADJUSTMENT EXPENSES
The liability for losses and loss adjustment expenses is based upon the accumulation of individual case estimates for losses reported prior to the
close of the accounting period, plus estimates, based upon past experience, of ultimate developed costs which may differ from case estimates and
estimates of unreported claims. The liability is stated net of anticipated salvage and subrogation recoveries. The amount of reinsurance recoverable
is included in other receivables.
Estimating loss reserves is a difficult process as there are many factors that can ultimately affect the final settlement of a claim and, therefore,
the reserve that is required. Changes in the regulatory and legal environment, results of litigation, medical costs, the cost of repair materials or