Mercury Insurance 2008 Annual Report Download - page 48

38
Contingent Liabilities
The Company has known, and may have unknown, potential liabilities that are evaluated using the criteria established by
SFAS No. 5. These include claims, assessments or lawsuits relating to the Company’s business. The Company continually
evaluates these potential liabilities and accrues for them or discloses them in the notes to the consolidated financial statements if
they meet the requirements stated in SFAS No. 5. While it is not possible to know with certainty the ultimate outcome of
contingent liabilities, an unfavorable result may have a material impact on the Company’s quarterly results of operations;
however, it is not expected to be material to the Company’s financial position. See also “Regulatory and Legal Matters” and Note
14 of Notes to Consolidated Financial Statements.
Results of Operations
Year Ended December 31, 2008 Compared to Year Ended December 31, 2007
Net premiums earned and net premiums written in 2008 decreased approximately 6.2% and 7.8%, respectively, from
2007. Net premiums written by the Company’s California operations were $2.2 billion in 2008, a 6.2% decrease from 2007. Net
premiums written by the Company’s non-California operations were $589.0 million in 2008, a 13.1% decrease from 2007. The
decrease in net premiums written is primarily due to a small decrease in the number of policies written and slightly lower average
premiums per policy reflecting the continuing soft market conditions.
Net premiums written is a non-GAAP financial measure which represents the premiums charged on policies issued
during a fiscal period less any applicable reinsurance. Net premiums written is a statutory measure designed to determine
production levels. Net premiums earned, the most directly comparable GAAP measure, represents the portion of net premiums
written that is recognized as income in the financial statements for the period presented and earned on a pro-rata basis over the
term of the policies. The following is a reconciliation of total Company net premiums written to net premiums earned:
2008 2007
Net premiums written 2,750,226$ 2,982,024$
Decrease in unearned premiu
m
58,613 11,853
Net premiums earned 2,808,839$ 2,993,877$
(Amounts in thousands)
The loss ratio (GAAP basis) (loss and loss adjustment expenses related to premiums earned) was 73.3% and 68.0% in
2008 and 2007, respectively. There was negative development of approximately $89 million and $19 million on prior accident
years’ loss reserves for 2008 and 2007, respectively. Excluding the effect of prior accident years’ loss development, the loss ratio
was 70.4% and 67.4% in 2008 and 2007, respectively. The increase in the loss ratio excluding the effect of prior accident years’
loss development is primarily due to higher severity in the California automobile lines of business which was partially offset by
lower frequency in the same lines.
The expense ratio (GAAP basis) (policy acquisition costs and other operating expenses related to premiums earned) was
28.5% and 27.4% in 2008 and 2007, respectively. The increase in the expense ratio largely reflects costs such as payroll, benefits,
and advertising that have not declined in proportion to the decline in premium volumes; an increase in technology-related
expenses; the establishment of the product management function; and approximately $2 million of AIS acquisition-related
expenses.
The combined ratio of losses and expenses (GAAP basis) is the key measure of underwriting performance traditionally
used in the property and casualty insurance industry. A combined ratio under 100% generally reflects profitable underwriting
results; and a combined ratio over 100% generally reflects unprofitable underwriting results. The combined ratio of losses and
expenses (GAAP basis) was 101.8% and 95.4% in 2008 and 2007, respectively. The Company’s underwriting performance
contributed $51.3 million of loss and $138.8 million of income to the Company’s results of operations before income tax benefit
and expense for 2008 and 2007, respectively.
Investment income was $151.3 million and $158.9 million in 2008 and 2007, respectively. The after-tax yield on
average investments (fixed maturities, equities and short-term investments valued at cost) was 3.9% and 4.0% in 2008 and 2007,
respectively, on average invested assets of $3.5 billion for each period. The slight decrease in after-tax yield is due to a decrease
in short-term interest rates.
Included in net (loss) income are net realized investment losses of $550.5 million in 2008 compared to net realized
investment gains of $20.8 million in 2007. Net realized investment losses of $550.5 million in 2008 include losses of $525.7
million due to changes in the fair value of total investments measured at fair value pursuant to SFAS No. 159. These losses,
primarily in fixed maturity securities, arise from the market value declines on the Company’s holdings during 2008 resulting from
ongoing downgrades of municipal bond insurers, widening credit spreads, economic downturn impacting municipalities and the
lack of liquidity in the market.