Mercury Insurance 2009 Annual Report Download - page 57

ultimate average cost per claim can be estimated. The average severity method coupled with the claim
count development method provide 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 uses this method for losses and loss adjustment expenses.
The Company analyzes catastrophe losses separately from non-catastrophe losses. For catastrophe 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 similar catastrophes.
There are many factors that can cause variability between the ultimate expected loss and the actual
developed loss. While there are certainly other factors, the Company believes that the following three items tend
to create the most variability between expected losses and actual losses.
(1) Inflation
For the Company’s California automobile lines of business, total reserves are comprised of the following:
• BI reserves—approximately 65%
• Material damage (MD) reserves, including collision and comprehensive property damage—
approximately 10%
• Loss adjustment expenses reserves—approximately 25%.
Loss development on MD reserves is generally insignificant because MD claims are generally settled in a
shorter period than BI reserves. The majority of the loss adjustment expenses reserves are estimated costs to
defend BI claims, which tend to require longer periods of time to settle as compared to MD claims.
BI loss reserves are generally the most difficult to estimate because they take longer to close than other
coverages. BI coverage in the Company’s policies includes injuries sustained by any person other than the
insured, except in the case of uninsured or underinsured motorist BI coverage, which covers damages to the
insured for BI caused by uninsured or underinsured motorists. BI payments are primarily for medical costs and
general damages.
The following table represents the typical closure patterns of BI claims in the California automobile
insurance coverage:
% of Total
Claims Closed Dollars Paid
BI claims closed in the accident year reported .............. 35%to40% 15%
BI claims closed one year after the accident year reported .... 75%to80% 60%
BI claims closed two years after the accident year reported . . . 93% to 95% 85%
BI claims closed three years after the accident year reported . . 96% to 98% 96%
BI claims closed in the accident year reported are generally the smaller and less complex claims that settle
for approximately $2,500 to $3,000, on average, whereas the total average settlement, once all claims are closed
in a particular accident year, is approximately $7,500 to $9,000. The Company creates incurred and paid loss
triangles to estimate ultimate losses utilizing historical payment and reserving patterns and evaluates the results
of this analysis against its frequency and severity analysis to establish BI reserves. The Company adjusts
development factors to account for inflation trends it sees in loss severity. As a larger proportion of claims from
an accident year are settled, there becomes a higher degree of certainty for the reserves established for that
accident year. Consequently, there is a decreasing likelihood of reserve development on any particular accident
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