Mercury Insurance 2009 Annual Report Download - page 23

For the years 2005 through 2007, the Company experienced unfavorable development of approximately $99
million to $120 million on prior accident years’ losses and loss adjustment expenses reserves. The unfavorable
development from these years relates primarily to increases in loss severity estimates and loss adjustment
expense estimates for the California BI coverage as well as increases in the provision for losses in New Jersey
and Florida. Reserves from these years showed further unfavorable development after December 31, 2008
primarily as a result of re-estimates of the 2005 and 2006 accident year loss reserves in New Jersey and
re-estimates of the 2005 and 2006 accident year loss adjustment expenses reserves in New Jersey and California.
For 2004, the unfavorable development relates to an increase in the Company’s prior accident years’ loss
estimates for personal automobile insurance in Florida and New Jersey. In addition, an increase in estimates for
loss severity for the 2004 accident year reserves for California and New Jersey automobile lines of business
contributed to the deficiencies.
For 2003, the favorable development largely relates to lower inflation than originally expected on the BI
coverage reserves for the California automobile line of insurance. In addition, the Company experienced a
reduction in expenditures to outside legal counsel for the defense of personal automobile claims in California.
This led to a reduction in the ultimate expense amount expected to be paid out and therefore favorable
development in the reserves at December 31, 2003, partially offset by unfavorable development in the Florida
and New Jersey automobile lines of business.
For years 1999 through 2002, the Company’s previously estimated loss reserves produced deficiencies that
were reflected in the subsequent years’ incurred losses. The Company attributes a large portion of the
unfavorable development to increases in the ultimate liability for BI, physical damage, and collision claims over
what was originally estimated. The increases in these losses relate to increased severity over what was originally
recorded and are the result of inflationary trends in health care costs, auto parts, and body shop labor costs.
Statutory Accounting Principles
The Company’s results are reported in accordance with GAAP, which differ in some respects from amounts
reported under SAP prescribed by insurance regulatory authorities. Some of the significant differences under
GAAP are described below:
• Policy acquisition costs such as commissions, premium taxes, and other costs that vary with and are
primarily related to the acquisition of new and renewal insurance contracts, are capitalized and
amortized on a pro rata basis over the period in which the related premiums are earned, rather than
expensed as incurred, as required by SAP.
• Certain assets are included in the consolidated balance sheets whereas, under SAP, such assets
are designated as “nonadmitted assets,” and charged directly against statutory surplus. These assets
consist primarily of premium receivables outstanding more than 90 days, deferred tax assets that do not
meet statutory requirements for recognition, furniture, equipment, leasehold improvements, capitalized
software, and prepaid expenses.
• Amounts related to ceded reinsurance are shown gross as prepaid reinsurance premiums and
reinsurance recoverables, rather than netted against unearned premium reserves and losses and loss
adjustment expenses reserves, respectively, as required by SAP.
• Fixed-maturity securities are reported at fair value rather than at amortized cost, or the lower of
amortized cost or fair value, depending on the specific type of security as required by SAP.
• The differing treatment of income and expense items results in a corresponding difference in federal
income tax expense. Changes in deferred income taxes are reflected as an item of income tax benefit or
expense, rather than recorded directly to statutory surplus as regards policyholders, as required by
SAP. Admittance testing under SAP may result in a charge to unassigned surplus for non-admitted
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