Mercury Insurance 2009 Annual Report Download - page 85

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MERCURY GENERAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Investments
Effective January 1, 2008, the Company elected to apply the fair value option to all available-for-sale, fixed
maturities, equity securities, and short-term investments existing at the time of adoption, and similar securities
acquired subsequently unless otherwise noted at the time when the eligible item is first recognized. The primary
reasons for electing the fair value option were simplification and cost-benefit considerations as well as expansion
of use of fair value measurement consistent with the long-term measurement objectives of the FASB for
accounting for financial instruments. Gains and losses due to changes in fair value for items measured at fair
value pursuant to election of the fair value option are included in net realized investment gains (losses) in the
Company’s consolidated statements of operations. Interest and dividend income on the investment holdings are
recognized on an accrual basis on each measurement date and are included in net investment income in the
Company’s consolidated statements of operations. See Note 2 for additional information regarding the fair value
option.
Prior to the adoption of the fair value option, when a decline in value of fixed maturities or equity securities
was considered other than temporary, a loss was recognized in the consolidated statements of operations.
Realized capital gains and losses were included in the consolidated statements of operations based upon the
specific identification method.
Fixed maturity securities include debt securities and redeemable preferred stocks, which may have fixed or
variable principal payment schedules, may be held for indefinite periods of time, and may be used as a part of the
Company’s asset/liability strategy or sold in response to changes in interest rates, anticipated prepayments, risk/
reward characteristics, liquidity needs, tax planning considerations, or other economic factors. Prior to the
election of the fair value option, these securities were carried at fair value with the corresponding unrealized
gains (losses), net of deferred income taxes, reported in accumulated other comprehensive income. Premiums
and discounts on fixed maturities are amortized using first call date and are adjusted for anticipated prepayments.
Premiums and discounts on mortgage-backed securities are adjusted for anticipated prepayment using the
retrospective method, with the exception of some beneficial interests in securitized financial assets, which are
accounted for using the prospective method.
Equity securities consist of non-redeemable preferred stocks and common stocks on which dividend income
is partially tax-sheltered by the 70% corporate dividend exclusion. Prior to the election of the fair value option,
changes in fair value of these securities, net of deferred income taxes, were reflected as unrealized gains and
losses in accumulated other comprehensive income.
Short-term investments include money market accounts, options, and short-term bonds which are highly
rated short duration securities redeemable within one year.
The Company writes covered call options through listed and over-the-counter exchanges. When the
Company writes an option, an amount equal to the premium received by the Company is recorded as a liability
and is subsequently adjusted to the current fair value of the option written. Premiums received from writing
options that expire unexercised are treated by the Company on the expiration date as realized gains from
investments. If a call option is exercised, the premium is added to the proceeds from the sale of the underlying
security or currency in determining whether the Company has realized a gain or loss. The Company, as writer of
an option, bears the market risk of an unfavorable change in the price of the security underlying the written
option. Liabilities for covered call options of $1.0 million and $2.8 million were included in other liabilities at
December 31, 2009 and 2008, respectively.
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