Mercury Insurance 2009 Annual Report Download - page 60

(3) Unexpected Large Losses From Older Accident Periods
Unexpected large losses are generally not provided for in the current reserve because they are not known or
expected and tend to be unquantifiable. Once known, the Company establishes a provision for the losses, but it is
not possible to provide any meaningful sensitivity analysis as to the potential size of any unexpected
losses. These losses can be caused by many factors, including unexpected legal interpretations of coverage,
ineffective claims handling, regulation extending claims reporting periods, assumption of unexpected or
unknown risks, adverse court decisions as well as many unknown factors.
Unexpected large losses are fairly infrequent but can have a large impact on the Company’s losses. To
mitigate this specific risk the Company has established claims handling and review procedures. However, it is
still possible that these procedures will not prove entirely effective and the Company may have material
unexpected large losses in future periods. It is also possible that the Company has not identified and established a
sufficient reserve for all of unexpected large losses occurring in the older accident years, even though a
comprehensive claims file review was undertaken, or that the Company will experience additional development
on these reserves.
Discussion of loss reserves and prior period loss development at December 31, 2009
At December 31, 2009 and 2008, the Company recorded its point estimate of approximately $1,053 million
and $1,134 million, respectively, in losses and loss adjustment expenses liabilities which include approximately
$340 and $385 million, respectively, of IBNR loss reserves. IBNR includes estimates, based upon past
experience, of ultimate developed costs which may differ from case estimates, unreported claims which occurred
on or prior to December 31, 2009 and estimated future payments for reopened 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; however, since the provisions are necessarily based upon estimates, the
ultimate liability may be more or less than such provisions.
The Company evaluates its reserves quarterly. When management determines that the estimated ultimate
claim cost requires a decrease for previously reported accident years, favorable development occurs and a
reduction in losses and loss adjustment expenses is reported in the current period. If the estimated ultimate claim
cost requires an increase for previously reported accident years, unfavorable development occurs and an increase
in losses and loss adjustment expenses is reported in the current period. For 2009, the Company reported
favorable development of approximately $58 million on the 2008 and prior accident years’ losses and loss
adjustment expenses reserves which at December 31, 2008 totaled approximately $1.1 billion. The favorable
development in 2009 is largely the result of re-estimates of accident year 2008 and 2007 California BI losses
which have experienced both lower average severities and fewer late reported claims (claim count development)
than were originally estimated at December 31, 2008. In addition, there was favorable development from a
recovery of approximately $5 million related to losses incurred on 2007 wildfires.
Premiums
The Company’s insurance premiums are recognized as income ratably over the term of the policies, that is,
in proportion to the amount of insurance protection provided. Unearned premiums are carried as a liability on the
balance sheet and are computed on a monthly pro-rata basis. The Company evaluates its unearned premiums
periodically for premium deficiencies by comparing the sum of expected claim costs, unamortized acquisition
costs, and maintenance costs to related unearned premiums, net of investment income. To the extent that any of
the Company’s lines of business become substantially unprofitable, a premium deficiency reserve may be
required. The Company does not expect this to occur on any of its significant lines of business. At December 31,
2009 and 2008, the Company established premium deficiency reserves for New Jersey operations of $0 and
$639,000, respectively, after anticipating 4.5% and 4.4% investment income in 2009 and 2008, respectively.
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