Mercury Insurance 2008 Annual Report Download - page 45

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As a result of the lack of sufficient operating history prior to 2008, the Company relied on industry loss data to determine
the ultimate losses for the BI and PIP coverage’s in New Jersey. The reserve approach utilized for New Jersey in 2007 assumed
that there would not be significantly more development on the 2004 accident year claims, due to the maturity of those claims, and
that the relationship between Company loss data and industry loss data in accident years 2005, 2006 and 2007 will be similar to
that experienced in accident year 2004.
In 2008, it became apparent that the Company results were turning out differently than estimates derived by the industry
results. In particular, loss severities for the PIP coverage were developing into larger amounts than the industry data
suggested. With the passage of 2008, the loss data began to mature and the Company began utilizing its own historical loss
patterns to determine the reserves. While management believes that this has led to a more reliable reserve estimate, there is still a
great deal of potential variability in the reserves. This is particularly true with PIP and BI losses which often take years to settle.
At December 31, 2008 the Company estimates that in New Jersey, for every 10% increase on recorded BI and PIP loss
severities for the 2006, 2007 and 2008 accident years, an additional loss reserve of approximately $20 million would be required,
with the converse holding true if the loss severities recorded were reduced. As these accident years continue to mature, there is
likely to be additional development, however, it is uncertain whether this development will be positive or negative.
4. Unexpected large individual losses or groups of losses arising from older accident periods typically caused by an
event that is not reflected in the historical company data used to establish reserves.
These types of losses are generally not provided for in the current reserve because they are not known or expected and
tend to be unquantifiable. Once known, the Company establishes a provision for the losses. Consequently, it is not possible to
provide any meaningful sensitivity analysis as to the potential size of any unexpected losses. These losses can be caused by many
factors, including unexpected legal interpretations of coverage, ineffective claims handling, regulation extending claims reporting
periods, assumption of unexpected or unknown risks, adverse court decisions as well as many unknown factors. Conversely, it is
possible to experience positive reserve development when one or more of these factors prove to be beneficial to the Company.
One instance when there were large unanticipated losses arising from older accident periods was in 2006 from extra-
contractual losses in Florida. Typically, extra-contractual claims are those that settle for more than the policy limits because the
original claim was denied, thus exposing the Company to losses greater than the policy limits. Claims may be denied for various
reasons, including material misrepresentations made by the insured on the policy application or insureds that have violated
prohibitions in the insurance contract or when there is fraud involved. These types of losses are fairly infrequent but can amount
to millions of dollars per claim, especially if the injured party sustained a serious physical injury. Consequently, these claims can
have a large impact on the Company’s losses. During 2006, the Company had extra-contractual losses that settled for amounts
much greater than the policy limits and much greater than expected. As a result of these settlements, the Company, during the
second quarter of 2006, reevaluated its exposure to extra-contractual claims in Florida and increased its reserve estimates for prior
accident years.
To mitigate this specific risk, during 2006 the Company established new claims handling and review procedures in
Florida, as well as in other states, that are intended to reduce the risk of receiving extra-contractual claims. Consequently, the
Company does not expect that Florida extra-contractual claims will continue to have a significant impact on the financial
statements or reserves in the future. However, it is possible that these procedures will not prove entirely effective and the
Company may continue to have material extra-contractual losses. It is also possible that the Company has not identified and
established a sufficient reserve for all of the extra-contractual losses occurring in the older accident years, even though a
comprehensive claims file review was undertaken, or that the Company will experience additional development on these reserves.
Discussion of loss reserves and prior period loss development at December 31, 2008
At December 31, 2008 and 2007, the Company recorded its point estimate of approximately $1,134 million and $1,104
million, respectively, in loss and loss adjustment expense reserves which includes approximately $385 and $322 million,
respectively, of incurred but not reported (“IBNR”) loss reserves. IBNR includes estimates, based upon past experience, of
ultimate developed costs which may differ from case estimates, unreported claims which occurred on or prior to December 31,
2008 and estimated future payments for reopened-claims reserves. Management believes that the liability established at
December 31, 2008 for losses and loss adjustment expenses is adequate to cover the ultimate net cost of losses and loss adjustment
expenses incurred to date. Since the provisions are necessarily based upon estimates, the ultimate liability may be more or less
than such provisions.
The Company reevaluates its reserves quarterly. When management determines that the estimated ultimate claim cost
requires reduction for previously reported accident years, positive development occurs and a reduction in losses and loss
adjustment expenses is reported in the current period. If the estimated ultimate claim cost requires an increase for previously
reported accident years, negative development occurs and an increase in losses and loss adjustment expenses is reported in the
current period.