Mercury Insurance 2008 Annual Report Download - page 46

36
For 2008, the Company had negative development of approximately $89 million on the 2007 and prior accident years’
loss and loss adjustment expense reserves which at December 31, 2007 totaled approximately $1,104 million.
The primary causes of the negative loss development were:
(1) The estimates for California Bodily Injury Severities and California Defense and Cost Containment reserves
established at December 31, 2007 were too low causing adverse development of approximately $45 million. During the
year, the Company experienced a lengthening of the pay-out period for claims that are settled after the first year and a
large increase in the average amounts paid on closed claims. The Company believes that the lengthening of the pay-out
periods may be attributable to a law passed in California several years ago that extended the statute for filing claims from
one year to two years. Initial indications, when the law was passed, were that the law would have little impact on
development patterns and therefore it was not factored into the Company’s reserve estimates. In hindsight, claims
payouts 2 to 4 years after the period-end have increased thereby affecting the loss reserve estimates. The Company
believes that this trend was factored into its reserve estimate at year-end 2008.
(2) The Company had approximately $30 million of adverse development on its New Jersey reserves established at
December 31, 2007. Due to short operating history and rapid growth in that state, the Company had limited internal
historical claims information to estimate BI, PIP and related loss adjustment expense reserves as of December 31,
2007. Consequently, the Company relied substantially on industry data to help set these reserves. During 2008, the
reserve indications using the Company’s own historical data rather than industry data led to increases in estimates for
both PIP losses and loss adjustment expenses. In particular, loss severities experienced by the Company data for the PIP
coverage developed into amounts larger than industry data suggested. The Company is now using its own historical data,
rather than industry data to set New Jersey loss reserves. Management believes that, over time this will lead to less
variation in reserve estimates.
Premiums
The Company complies with SFAS No. 60, “Accounting and Reporting by Insurance Enterprises,” in recognizing
revenue on insurance policies written. The Company’s 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 carried as a liability on the
balance sheet and are computed on a monthly pro-rata basis. The Company evaluates its unearned premiums periodically for
premium deficiencies by comparing the sum of expected claim costs, unamortized acquisition costs and maintenance costs to
related unearned premiums, net of investment income. To the extent that any of the Company’s lines of business become
substantially unprofitable, a premium deficiency reserve may be required. The Company does not expect this to occur on any of
its significant lines of business. At December 31, 2008, a premium deficiency reserve of $639,000 was established for New
Jersey operations after anticipating 4% investment income.
Investments
Beginning January 1, 2008, all of the Company’s fixed maturity and equity investments are classified as “trading” and
carried at fair value as required by SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS
No. 115”), as amended, and SFAS No. 159. Prior to January 1, 2008, the Company’s fixed maturity and equity investment
portfolios were classified either as “available for sale” or “trading” and carried at fair value under SFAS No. 115, as
amended. The Company adopted SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”) and SFAS No. 159 as of January
1, 2008. Equity holdings, including non-sinking fund preferred stocks, are, with minor exceptions, actively traded on national
exchanges or trading markets, and were valued at the last transaction price on the balance sheet date. Changes in fair value of the
investments are reflected in net realized investment gains or losses in the consolidated statements of operations as required under
SFAS No. 115, as amended, and SFAS No. 159.
For equity securities, the net loss due to changes in fair value in 2008 was approximately 52.6% of fair value at
December 31, 2008. The primary cause of the losses in fair value of equity securities was the overall decline in the stock markets,
which saw a decline of approximately 38.5% in the S&P 500 index in 2008. The underperformance of the Company’s equities
was primarily due to the large allocation to energy related stocks, which experienced a decline in value more severe than that of
the overall stock market. For fixed maturity securities, the net loss due to changes in fair value was approximately 9.9% of fair
value in 2008. The Company believes that the primary causes of the majority of the losses in fair value of fixed maturity
securities were ongoing downgrades of municipal bond insurers, widening credit spreads, and reduced market liquidity.