Mercury Insurance 2008 Annual Report Download - page 43

33
Claims that close during the initial accident year reported are generally the smaller, less complex claims that settle, on
average, for approximately $2,000 to $2,500 whereas the average settlement, once all claims are closed in a particular accident
year, is approximately $7,500 to $9,000. The Company creates incurred loss triangles to estimate ultimate losses utilizing
historical reserving patterns and evaluates the results of this analysis against its frequency and severity analysis to establish BI
reserves. The Company adjusts development factors to account for inflation trends it sees in loss severity. As a larger proportion
of claims from an accident year are settled, there becomes a higher degree of certainty for the reserves established for that accident
year. Consequently, there is a decreasing likelihood of reserve development on any particular accident year, as those periods
age. The Company believes that the accident years that are most likely to develop are the 2006 through 2008 accident years;
however it is also possible that older accident years could develop as well.
In general, when establishing reserves, the Company expects that historical trends will continue. Furthermore, the
Company believes that costs tend to increase, which is generally consistent with historical data, and therefore the Company
believes that it is more reasonable to expect inflation than deflation. Many potential factors can affect the BI inflation rate,
including: changes in statutes and regulations, an increase or reduction in litigated files, general economic factors, more timely
handling of claims, safer vehicles, changes in weather patterns, and gasoline prices; however, whether these are the factors that
actually impacted the BI losses, and the magnitude of that impact is unknown.
The Company believes that it is reasonably possible that the California automobile BI inflation rate could vary from
recorded amounts by as much as 7%, 5% and 4% for 2008, 2007 and 2006, respectively. However, the variation could be more or
less than these amounts. As a comparison, at December 31, 2008 the actual variation for the amounts recorded at December 31,
2007 was 5.6%, 3.7% and 1.5% for the 2007, 2006 and 2005 accident years, respectively. The following table shows the effects
on the 2008, 2007 and 2006 accident year California BI loss reserves based on possible variations in the severity recorded:
California Bodily Injury Inflation Reserve Sensitivity Analysis
Accident
Year
Number of Claims
Expected (a)
Actual
Recorded
Severity
at
12/31/08
Implied
Inflation
Rate
Recorded
(A) Pro-forma
severity if
actual severity
is lower by:
7% for 2008,
5% for 2007
and 4% for
2006
(B) Pro-forma
severity if
actual severity
is higher by:
7% for 2008,
5% for 2007
and 4% for
2006
Loss
redundancy if
actual severity
is less than
recorded
(Column A)
Loss
development if
actual severity is
more than
recorded
(Column B)
2008 31,737 $ 8,831 12.4% $ 8,213 $ 9,449 $ 19,613,000 $ (19,613,000)
2007 35,716 $ 7,856 5.2% $ 7,463 $ 8,249 $ 14,036,000 $ (14,036,000)
2006 36,999 $ 7,465 3.6% $ 7,166 $ 7,764 $ 11,062,000 $ (11,062,000)
2005 Not Applicable $ 7,204
Total Loss Redundancy (Development) $ 44,711,000 $ (44,711,000)
(a) The recent downward trend in the total number of claims reported is reflective of declining loss frequencies and a decline in
the number of insurance policies issued.
During 2008, the Company experienced a large increase in the average cost paid on claims that closed within the 2008
accident period. Only between 35% and 40% of the claims close in the first year, however the averages are still an indicator that
inflation is increasing at a higher rate than in previous recent accident periods. As a result, the Company adjusted inflation rate
assumptions upwards for the 2008 accident year, as compared to 2007. The Company is uncertain as to what is driving the larger
than normal inflation increases but, as shown in the table above, it is not unusual for the rate to vary from period to period.