Mercury Insurance 2008 Annual Report Download - page 26

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The Company’s insurance subsidiaries are subject to minimum capital and surplus requirements, and any failure to
meet these requirements could subject the Company’s insurance subsidiaries to regulatory action.
The Company’s insurance subsidiaries are subject to risk-based capital standards and other minimum capital and surplus
requirements imposed under applicable laws of their state of domicile. The risk-based capital standards, based upon the Risk-
Based Capital Model Act adopted by the National Association of Insurance Commissioners, or NAIC, require the Company’s
insurance subsidiaries to report their results of risk-based capital calculations to state departments of insurance and the NAIC. If
any of the Company’s insurance subsidiaries fails to meet these standards and requirements, the Department of Insurance
regulating such subsidiary may require specified actions by the subsidiary.
There is uncertainty involved in the availability of reinsurance and the collectibility of reinsurance recoverables.
The Company reinsures a portion of its potential losses on the policies it issues to mitigate the volatility of the losses on
its financial condition and results of operations. The availability and cost of reinsurance is subject to market conditions, which are
outside of the Company’s control. From time to time, market conditions have limited, and in some cases prevented, insurers from
obtaining the types and amounts of reinsurance that they consider adequate for their business needs. As a result, the Company may
not be able to successfully purchase reinsurance and transfer a portion of the Company’s risk through reinsurance arrangements.
In addition, as is customary, the Company initially pays all claims and seeks to recover the reinsured losses from its reinsurers.
Although the Company reports as assets the amount of claims paid which the Company expects to recover from reinsurers, no
assurance can be given that the Company will be able to collect from its reinsurers. If the amounts actually recoverable under the
Company’s reinsurance treaties are ultimately determined to be less than the amount it has reported as recoverable, the Company
may incur a loss during the period in which that determination is made.
The Company depends on independent agents who may discontinue sales of its policies at any time.
The Company sells its insurance policies through approximately 4,700 independent agents and brokers. The Company
must compete with other insurance carriers for these agents’ and brokers’ business. Some competitors offer a larger variety of
products, lower prices for insurance coverage, higher commissions, or more attractive non-cash incentives. To maintain its
relationship with these independent agents, the Company must pay competitive commissions, be able to respond to their needs
quickly and adequately, and create a consistently high level of customer satisfaction. If these independent agents find it preferable
to do business with the Company’s competitors, it would be difficult to renew the Company’s existing business or attract new
business. State regulations may also limit the manner in which the Company’s producers are compensated or incentivized. Such
developments could negatively impact the Company’s relationship with these parties and ultimately reduce revenues.
Changes in market interest rates or defaults may have an adverse effect on the Company’s investment portfolio, which
may adversely affect the Company’s financial results.
The Company’s results are affected, in part, by the performance of its investment portfolio. The Company’s investment
portfolio contains interest rate sensitive-investments, such as municipal and corporate bonds. Increases in market interest rates
may have an adverse impact on the value of the investment portfolio by decreasing unrealized capital gains on fixed income
securities. Declining market interest rates could have an adverse impact on the Company’s investment income as it invests
positive cash flows from operations and as it reinvests proceeds from maturing and called investments in new investments that
could yield lower rates than the Company’s investments have historically generated. Defaults in the Company’s investment
portfolio may produce operating losses and reduce the Company’s capital and surplus.
Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international
economic and political conditions and other factors beyond the Company’s control. Although the Company takes measures to
manage the risks of investing in a changing interest rate environment, it may not be able to mitigate interest rate sensitivity
effectively. The Company’s mitigation efforts include maintaining a high quality portfolio and managing the duration of the
portfolio to reduce the effect of interest rate changes on book value. Despite its mitigation efforts, a significant increase in interest
rates could have a material adverse effect on the Company’s book value.