Mercury Insurance 2008 Annual Report Download - page 24

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The Company’s success depends on its ability to accurately underwrite risks and to charge adequate premiums to
policyholders.
The Company’s financial condition, liquidity and results of operations depend on the Company’s ability to underwrite
and set premiums accurately for the risks it faces. Premium rate adequacy is necessary to generate sufficient premium to offset
losses, loss adjustment expenses and underwriting expenses and to earn a profit. In order to price its products accurately, the
Company must collect and properly analyze a substantial volume of data; develop, test and apply appropriate rating formulae;
closely monitor and timely recognize changes in trends; and project both severity and frequency of losses with reasonable
accuracy. The Company’s ability to undertake these efforts successfully, and as a result, price accurately, is subject to a number of
risks and uncertainties, including, without limitation:
• availability of sufficient reliable data;
• incorrect or incomplete analysis of available data;
• uncertainties inherent in estimates and assumptions, generally;
• selection and application of appropriate rating formulae or other pricing methodologies;
• successful innovation of new pricing strategies;
• recognition of changes in trends and in the projected severity and frequency of losses;
• the Company’s ability to forecast renewals of existing policies accurately;
• unanticipated court decisions, legislation or regulatory action;
• ongoing changes in the Company’s claim settlement practices;
• changes in operating expenses;
• changing driving patterns;
• extra-contractual liability arising from bad faith claims;
• weather catastrophes;
• unexpected medical inflation; and
• unanticipated inflation in auto repair costs, auto parts prices and used car prices.
Such risks may result in the Company’s pricing being based on outdated, inadequate or inaccurate data or inappropriate
analyses, assumptions or methodologies, and may cause the Company to estimate incorrectly future changes in the frequency or
severity of claims. As a result, the Company could underprice risks, which would negatively affect the Company’s margins, or it
could overprice risks, which could reduce the Company’s volume and competitiveness. In either event, the Company’s operating
results, financial condition and cash flow could be materially adversely affected.
The effects of emerging claim and coverage issues on the Company’s business are uncertain and may have an adverse
effect on the Company’s business.
As industry practices and legal, judicial, social and other environmental conditions change, unexpected and unintended
issues related to claims and coverage may emerge. These issues may adversely affect the Company’s business by either extending
coverage beyond its underwriting intent or by increasing the number or size of claims. In some instances, these changes may not
become apparent until some time after the Company has issued insurance policies that are affected by the changes. As a result, the
full extent of liability under the Company’s insurance policies may not be known for many years after a policy is issued.
The Company’s private passenger insurance rates are subject to prior approval by the departments of insurance in
most of the states in which the Company operates, and to political influences.
In most of the states in which the Company operates, it must obtain prior approval from the state department of insurance
of the private passenger insurance rates charged to its customers, including any increases in those rates. If the Company is unable
to receive approval of the rate increases it requests, the Company’s ability to operate its business in a profitable manner may be
limited and its liquidity, financial condition and results of operations may be adversely affected.
From time to time, the private passenger auto insurance industry comes under pressure from state regulators, legislators
and special interest groups to reduce, freeze or set rates at levels that do not correspond with underlying costs, in the opinion of
the Company’s management. The homeowners insurance business faces similar pressure, particularly as regulators in catastrophe-
prone states seek an acceptable methodology to price for catastrophe exposure. In addition, various insurance underwriting and
pricing criteria regularly come under attack by regulators, legislators and special interest groups. The result could be legislation or
regulations that would adversely affect the Company’s business, financial condition and results of operations.
The Company remains highly dependent upon California and several other key states to produce revenues and
operating profits.
For the year ended December 31, 2008, the Company generated approximately 79.4% of its direct automobile insurance
premiums written in California, 6.7% in Florida and 3.5% in New Jersey. The Company’s financial results are therefore subject to
prevailing regulatory, legal, economic, demographic, competitive and other conditions in these states and changes in any of these
conditions could negatively impact the Company’s results of operations.