Mercury Insurance 2009 Annual Report Download - page 72

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collateral requirement to be greater than the loan amount. The collateral requirement is calculated as the fair
market value of the municipal bonds held as collateral multiplied by the advance rates, which vary based on the
credit quality and duration of the assets held and range between 75% and 100% of the fair value of each bond.
The loan matures on January 1, 2012 with interest payable at a floating rate of LIBOR plus 125 basis points. On
February 6, 2009, the Company entered into an interest rate swap of its floating LIBOR rate on the loan for a
fixed rate of 1.93%, resulting in a total fixed rate of 3.18%. The purpose of the swap is to offset the variability of
cash flows resulting from the variable interest rate. The swap is not designated as a hedge and changes in the fair
value are adjusted through the consolidated statements of operations in the period of change.
In February 2008, the Company acquired an 88,300 square foot office building in Folsom, California for
approximately $18.4 million. The Company financed the transaction through an $18 million bank loan that is
secured by municipal securities held as collateral. The loan matures on March 1, 2013 with interest payable
quarterly at an annual floating rate of LIBOR plus 50 basis points. On March 3, 2008, the Company entered into
an interest rate swap of a floating LIBOR rate on the loan for a fixed rate of 3.75%, resulting in a total fixed rate
of 4.25%. The swap agreement terminates on March 1, 2013. The swap is designated as a cash flow hedge
wherein the effective portion of the gain or loss on the derivative is reported as a component of other
comprehensive income and reclassified into earnings in the same period or periods during which the hedged
transaction affects earnings.
On August 7, 2001, the Company completed a public debt offering issuing $125 million of senior notes. The
notes are unsecured, senior obligations of the Company with a 7.25% annual coupon payable on August 15 and
February 15 each year commencing February 15, 2002. These notes mature on August 15, 2011. The Company
used the proceeds from the senior notes to retire amounts payable under existing revolving credit facilities, which
were terminated. Effective January 2, 2002, the Company entered into an interest rate swap of a 7.25% fixed rate
obligation on the senior notes for a floating rate of LIBOR plus 107 basis points. The swap significantly reduced
the interest expense in 2009 and 2008 when the effective interest rate was 1.6% and 3.3%, respectively.
However, if the LIBOR interest rate increases in the future, the Company will incur higher interest expense in the
future. The swap is designated as a fair value hedge and qualifies for the shortcut method wherein the gain or loss
on the derivative, and the offsetting loss or gain on the hedged item attributable to the hedged risk, are
recognized in current earnings.
E. Capital Expenditures
The NextGen software project began in 2002 and the total capital investment is approximately $41 million
as of December 31, 2009. The Mercury First software project began in 2006 and the total capital investment is
approximately $31 million as of December 31, 2009. Although the majority of the related software development
costs have been expended, there will be some Mercury First development and implementation costs in the future.
In accordance with applicable accounting standards, capitalization ceases no later than the point at which
computer software project development is substantially complete and ready for its intended use. NextGen is
currently in the implementation stage with all remaining expenditures recorded as other operating expenses.
F. Regulatory Capital Requirement
The Insurance Companies must comply with minimum capital requirements under applicable state laws and
regulations, and must have adequate reserves for claims. The minimum statutory capital requirements differ by
state and are generally based on balances established by statute, a percentage of annualized premiums, a
percentage of annualized loss, or RBC requirements. The RBC requirements are based on guidelines established
by the NAIC. The RBC formula was designed to capture the widely varying elements of risks undertaken by
writers of different lines of insurance having differing risk characteristics, as well as writers of similar lines
where differences in risk may be related to corporate structure, investment policies, reinsurance arrangements,
and a number of other factors. At December 31, 2009, the Insurance Companies had sufficient capital to exceed
the highest level of minimum required capital.
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