Mercury Insurance 2008 Annual Report Download - page 69

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Losses and Loss Adjustment Expenses
The liability for losses and loss adjustment expenses is based upon the accumulation of individual case estimates for
losses reported prior to the close of the accounting period, plus estimates, based upon past experience, of ultimate developed costs
which may differ from case estimates and estimates of unreported claims. The liability is stated net of anticipated salvage and
subrogation recoveries. The amount of reinsurance recoverable is included in other receivables.
Estimating loss reserves is a difficult process as there are many factors that can ultimately affect the final settlement of a
claim and, therefore, the reserve that is required. Changes in the regulatory and legal environment, results of litigation, medical
costs, the cost of repair materials or labor rates can impact ultimate claim costs. In addition, time can be a critical part of
reserving determinations since the longer the span between the occurrence of a loss and the payment or settlement of the claim,
the more variable the ultimate settlement amount can be. Accordingly, short-tail property damage claims tend to be more
reasonably predictable than long-tail liability claims. Management believes that the liability 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
for loss reserves are necessarily based upon estimates, the ultimate liability may be more or less than such provisions.
The Company analyzes loss reserves quarterly primarily using the incurred loss development, average severity and claim
count development methods described below. The Company also uses the paid loss development method to analyze loss
adjustment expense reserves and industry claims data as part of its reserve analysis. When deciding which method to use in
estimating its reserves, the Company and its actuaries evaluate the credibility of each method based on the maturity of the data
available and the claims settlement practices for each particular line of business or coverage within a line of business. When
establishing the reserve, the Company will generally analyze the results from all of the methods used rather than relying on one
method. While these methods are designed to determine the ultimate losses on claims under the Company’ s policies, there is
inherent uncertainty in all actuarial models since they use historical data to project outcomes. The Company believes that the
techniques it uses provide a reasonable basis in estimating loss reserves.
• The incurred loss development method analyzes historical incurred case loss (case reserves plus paid losses)
development to estimate ultimate losses. The Company applies development factors against current case incurred
losses by accident period to calculate ultimate expected losses. The Company believes that the incurred loss
development method provides a reasonable basis for evaluating ultimate losses, particularly in the Company’ s larger,
more established lines of business which have a long operating history.
• The claim count development method analyzes historical claim count development to estimate future incurred claim
count development for current claims. The Company applies these development factors against current claim counts
by accident period to calculate ultimate expected claim counts.
• The average severity method analyzes historical loss payments and/or incurred losses divided by closed claims and/or
total claims to calculate an estimated average cost per claim. From this, the expected ultimate average cost per claim
can be estimated. The average severity method coupled with the claim count development method provides
meaningful information regarding inflation and frequency trends that the Company believes is useful in establishing
reserves.
• The paid loss development method analyzes historical payment patterns to estimate the amount of losses yet to be
paid. The Company primarily uses this method for loss adjustment expenses because specific case reserves are
generally not established for loss adjustment expenses.
In states with little operating history where there is insufficient claims data to prepare a reserve analysis relying solely on
Company historical data, the Company generally projects ultimate losses using industry average loss data or expected loss ratios.
As the Company develops an operating history in these states, the Company will rely increasingly on the incurred loss
development and average severity and claim count development methods. The Company analyzes catastrophe losses separately
from non-catastrophe losses. For these losses, the Company determines claim counts based on claims reported and development
expectations from previous catastrophes and applies an average expected loss per claim based on reserves established by adjusters
and average losses on previous storms.
Goodwill
Goodwill represents the excess of amounts paid for acquiring businesses over the fair value of the net assets
acquired. The Company annually evaluates goodwill for impairment using widely accepted valuation techniques to estimate the
fair value of its reporting units. The Company also reviews its goodwill for impairment whenever events or changes in
circumstances indicate that it is more likely than not that the carrying amount of goodwill may exceed its implied fair
value. Goodwill impairment evaluations indicated no impairment at December 31, 2008.