Mercury Insurance 2009 Annual Report Download - page 35

Rating agencies assign ratings based upon their evaluations of an insurance company’s ability to meet its
financial obligations. The Company’s financial strength ratings with Standard & Poor’s, Fitch, and Moody’s are
AA-, AA-, and Aa3, respectively; its respective debt ratings are A-, A, and A3. In 2009, the ratings were
affirmed by Standard & Poor’s, Fitch, and Moody’s, but the outlook for the ratings was changed from stable to
negative. Since these ratings are subject to continuous review, the Company cannot guarantee the continuation of
the favorable ratings. If the ratings were lowered significantly by any one of these agencies relative to those of
the Company’s competitors, its ability to market products to new customers and to renew the policies of current
customers could be harmed. A lowering of the ratings could also limit the Company’s access to the capital
markets or adversely affect pricing of new debt sought in the capital markets. These events, in turn, could have a
material adverse effect on the Company’s results of operations and liquidity.
Changes in market interest rates or defaults may have an adverse effect on the Company’s investment
portfolio, which may adversely affect the Company’s financial results.
The Company’s results are affected, in part, by the performance of its investment portfolio. The Company’s
investment portfolio contains interest rate sensitive-investments, such as municipal and corporate bonds.
Increases in market interest rates may have an adverse impact on the value of the investment portfolio by
decreasing realized capital gains on fixed income securities. Declining market interest rates could have an
adverse impact on the Company’s investment income as it invests positive cash flows from operations and as it
reinvests proceeds from maturing and called investments in new investments that could yield lower rates than the
Company’s investments have historically generated. Defaults in the Company’s investment portfolio may
produce operating losses and negatively impact the Company’s results of operations.
Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and
international economic and political conditions, and other factors beyond the Company’s control. Although the
Company takes measures to manage the risks of investing in a changing interest rate environment, it may not be
able to mitigate interest rate sensitivity effectively. The Company’s mitigation efforts include maintaining a high
quality portfolio and managing the duration of the portfolio to reduce the effect of interest rate changes. Despite
its mitigation efforts, a significant increase in interest rates could have a material adverse effect on the
Company’s financial condition and results of operations.
The Company’s valuation of financial instruments may include methodologies, estimations, and
assumptions that are subject to differing interpretations and could result in changes to valuations that may
materially adversely affect the Company’s financial condition or results of operations.
The Company employs a fair value hierarchy that prioritizes the inputs to valuation techniques used to
measure fair value. The fair value of a financial instrument is the amount that would be received to sell an asset
or paid to transfer a liability in an orderly transaction between market participants at the measurement date (the
exit price). Accordingly, when market observable data is not readily available, the Company’s own assumptions
are set to reflect those that market participants would be presumed to use in pricing the asset or liability at the
measurement date. Assets and liabilities recorded on the consolidated balance sheets at fair value are categorized
based on the level of judgment associated with the input used to measure their fair value and the level of market
price observability.
During periods of market disruption, including periods of significantly changing interest rates, rapidly
widening credit spreads, inactivity or illiquidity, it may be difficult to value certain of the Company’s securities if
trading becomes less frequent and/or market data becomes less observable. There may be certain asset classes in
historically active markets with significant observable data that become illiquid due to changes in the financial
environment. In such cases, the valuations associated with such securities may rely more on management
judgment and include inputs and assumptions that are less observable or require greater estimation as well as
valuation methods, which are more sophisticated or require greater estimation. The valuations generated by such
methods may be different from the value at which the investments ultimately may be sold. Further, rapidly
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