Mercury Insurance 2008 Annual Report Download - page 50

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Net investment income was $158.9 million and $151.1 million in 2007 and 2006, respectively. The after-tax yield on
average investments (fixed maturities, equities and short-term investments valued at cost) was 4.0% on average invested assets of
$3.5 billion and 3.8% on average invested assets of $3.3 billion in 2007 and 2006, respectively. The effective tax rate on
investment income was 13.3% and 15.5% in 2007 and 2006, respectively. The lower tax rate in 2007 reflected a shift in the mix
of the Company’s portfolio from taxable to non-taxable securities. Proceeds from bonds which matured or were called totaled
$311.7 million and $522.2 million in 2007 and 2006, respectively. The proceeds were mostly reinvested into securities meeting
the Company’s investment profile.
Net realized investment gains were $20.8 million and $15.4 million in 2007 and 2006, respectively. Included in the net
realized investment gains were investment write-downs of $22.7 million and $2.0 million in 2007 and 2006, respectively, that the
Company considered to be other-than-temporarily impaired. In addition, net realized investment gains included approximately
$1.4 million loss and $0 in 2007 and 2006, respectively, related to the change in the fair value of hybrid financial instruments, and
approximately $2.0 million gain and $0 in 2007 and 2006, respectively, related to the change in the fair value of trading securities.
The income tax provision for 2006 of $97.6 million was impacted significantly by a $15 million income tax charge
relating to the Notices of Proposed Assessments for the tax years 1993 through 1996 (the “NPAs”) that were upheld by the
California State Board of Equalization. Excluding the effect of this income tax charge resulted in an effective tax rate of 24.5%
and 26.4% in 2007 and 2006, respectively. The lower rate in 2007 was primarily attributable to an increased proportion of tax-
exempt investment income including tax sheltered dividend income, in contrast to taxable investment income and underwriting
income.
Net income was $237.8 million or $4.34 per share (diluted) and $214.8 million or $3.92 per share (diluted) in 2007 and
2006, respectively. Diluted per share results were based on a weighted average of 54.8 million shares and 54.8 million shares in
2007 and 2006, respectively. Basic per share results were $4.35 and $3.93 in 2007 and 2006, respectively. Included in net
income were net realized investment gains, net of income tax expense, of $0.25 and $0.18 per share (diluted and basic) in 2007
and 2006, respectively.
Liquidity and Capital Resources
General
The Company is largely dependent upon dividends received from its insurance subsidiaries to pay debt service costs and
to make distributions to its shareholders. Under current insurance law, the Insurance Companies are entitled to pay, without
extraordinary approval, ordinary dividends of approximately $136.7 million in 2009. Extraordinary dividends, as defined by the
DOI, require DOI extraordinary approval. Actual ordinary dividends paid from the Insurance Companies to Mercury General
during 2008 were $140 million. As of December 31, 2008, Mercury General also had approximately $67 million in investments
and cash that could be utilized to satisfy its direct holding company obligations.
The principal sources of funds for the Insurance Companies are premiums, sales and maturity of invested assets and
dividend and interest income from invested assets. The principal uses of funds for the Insurance Companies are the payment of
claims and related expenses, operating expenses, dividends to Mercury General and the purchase of investments.
Cash Flows
The Company has generated positive cash flow from operations for over twenty consecutive years. Because of the
Company’s long track record of positive operating cash flows, it does not attempt to match the duration and timing of asset
maturities with those of liabilities. Rather, the Company manages its portfolio with a view towards maximizing total return with
an emphasis on after-tax income. With combined cash and short-term investments of $240.2 million at December 31, 2008, the
Company believes its cash flow from operations is adequate to satisfy its liquidity requirements without the forced sale of
investments. However, the Company operates in a rapidly evolving and often unpredictable business environment that may
change the timing or amount of expected future cash receipts and expenditures. Accordingly, there can be no assurance that the
Company’s sources of funds will be sufficient to meet its liquidity needs or that the Company will not be required to raise
additional funds to meet those needs, including future business expansion, through the sale of equity or debt securities or from
credit facilities with lending institutions.
Net cash provided from operating activities in 2008 was $63.5 million, a decrease of $152.6 million over the same period
in 2007. This decrease was primarily due to the slowdown in growth of premiums reflecting softening market conditions in
personal automobile insurance coupled with an increase in loss and loss adjustment expenses paid in 2008 compared with the
same period in 2007. The Company has utilized the cash provided from operating activities primarily for the purchase and
development of information technology such as the NextGen and Mercury First computer systems and the payment of dividends
to its shareholders. Funds derived from the sale, redemption or maturity of fixed maturity investments of $786.5 million, were
primarily reinvested by the Company in high grade fixed maturity securities.