Mercury Insurance 2009 Annual Report Download - page 53

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Effective January 1, 2009, the Company acquired AIS with the expectation that the acquisition would result
in various benefits including enhanced revenue and profits, greater market presence and development, and
enhancements to the Company’s product portfolio and customer base. In 2009, the AIS operations were fully
integrated into the Company.
The Company’s operating results and growth have allowed it to consistently generate positive cash flow
from operations, which was approximately $189 million and $65 million in 2009 and 2008, respectively. Cash
flow from operations has been used to pay shareholder dividends and to help support growth.
Economic and Industry Wide Factors
• Regulatory Uncertainty—The insurance industry is subject to strict state regulation and oversight and
is governed by the laws of each state in which each insurance company operates. State regulators
generally have substantial power and authority over insurance companies including, in some states,
approving rate changes and rating factors, and establishing minimum capital and surplus
requirements. In many states, insurance commissioners may emphasize different agendas or interpret
existing regulations differently than previous commissioners. The Company has a successful track
record of working with difficult regulations and new insurance commissioners. However, there is no
certainty that current or future regulations and the interpretation of those regulations by insurance
commissioners and the courts will not have an adverse impact on the Company.
• Cost Uncertainty—Because insurance companies pay claims after premiums are collected, the ultimate
cost of an insurance policy is not known until well after the policy revenues are earned. Consequently,
significant assumptions are made when establishing insurance rates and loss reserves. While insurance
companies use sophisticated models and experienced actuaries to assist in setting rates and establishing
loss reserves, there can be no assurance that current rates or current reserve estimates will be
adequate. Furthermore, there can be no assurance that insurance regulators will approve rate increases
when the Company’s actuarial analysis shows that they are needed.
• Market Volatility—In 2008 and early 2009, the prolonged and severe disruptions in the public debt and
equity markets, including widening of credit spreads, bankruptcies, and government intervention in a
number of large financial institutions, resulted in significant fluctuations in the Company’s investment
portfolio. While many economists believe that the severe economic recession is over, they expect the
recovery to be slow with many businesses feeling the effects of the downturn for years to come. The
Company is unable to predict the duration and severity of the current disruption in the financial
markets in the United States. As a result, depending on market conditions, the Company may incur
substantial additional losses in future periods, which could have a material adverse impact on its results
of operations, equity, business and insurer financial strength, and debt ratings.
• Inflation—The largest cost component for automobile insurers is losses, which include medical costs,
replacement automobile parts, and labor costs. There can be significant variation in the overall
increases in medical cost inflation, and it is often a year or more after the respective fiscal period ends
before sufficient claims have closed for the inflation rate to be known with a reasonable degree of
certainty. Therefore, it can be difficult to establish reserves and set premium rates, particularly when
actual inflation rates may be higher or lower than anticipated.
•Loss Frequency—Another component of overall loss costs is loss frequency, which is the number of
claims per risk insured. There has been a long-term trend of declining loss frequency in the personal
automobile insurance industry, but the Company is unable to predict the trend of loss frequency in the
future.
• Underwriting Cycle and Competition—The property and casualty insurance industry is highly cyclical,
with alternating hard and soft market conditions. The Company has historically seen premium growth
in excess of 20% during hard markets. Premium growth rates in soft markets have been from slightly
35