Mercury Insurance 2010 Annual Report Download - page 67

Download and view the complete annual report

Please find page 67 of the 2010 Mercury Insurance annual report below. You can navigate through the pages in the report by either clicking on the pages listed below, or by using the keyword search tool below to find specific information within the annual report.

Page out of 126

  • 1
  • 2
  • 3
  • 4
  • 5
  • 6
  • 7
  • 8
  • 9
  • 10
  • 11
  • 12
  • 13
  • 14
  • 15
  • 16
  • 17
  • 18
  • 19
  • 20
  • 21
  • 22
  • 23
  • 24
  • 25
  • 26
  • 27
  • 28
  • 29
  • 30
  • 31
  • 32
  • 33
  • 34
  • 35
  • 36
  • 37
  • 38
  • 39
  • 40
  • 41
  • 42
  • 43
  • 44
  • 45
  • 46
  • 47
  • 48
  • 49
  • 50
  • 51
  • 52
  • 53
  • 54
  • 55
  • 56
  • 57
  • 58
  • 59
  • 60
  • 61
  • 62
  • 63
  • 64
  • 65
  • 66
  • 67
  • 68
  • 69
  • 70
  • 71
  • 72
  • 73
  • 74
  • 75
  • 76
  • 77
  • 78
  • 79
  • 80
  • 81
  • 82
  • 83
  • 84
  • 85
  • 86
  • 87
  • 88
  • 89
  • 90
  • 91
  • 92
  • 93
  • 94
  • 95
  • 96
  • 97
  • 98
  • 99
  • 100
  • 101
  • 102
  • 103
  • 104
  • 105
  • 106
  • 107
  • 108
  • 109
  • 110
  • 111
  • 112
  • 113
  • 114
  • 115
  • 116
  • 117
  • 118
  • 119
  • 120
  • 121
  • 122
  • 123
  • 124
  • 125
  • 126

Item 7A. Quantitative and Qualitative Disclosures about Market Risks
The Company is subject to various market risk exposures primarily due to its investing and borrowing
activities. Primary market risk exposures are changes in interest rates, equity prices, and credit risk. Adverse
changes to these rates and prices may occur due to changes in the liquidity of a market, or to changes in market
perceptions of credit worthiness and risk tolerance. The following disclosure reflects estimates of future
performance and economic conditions. Actual results may differ.
Overview
The Company’s investment policies define the overall framework for managing market and investment
risks, including accountability and controls over risk management activities, and specify the investment limits
and strategies that are appropriate given the liquidity, surplus, product profile, and regulatory requirements of the
subsidiaries. Executive oversight of investment activities is conducted primarily through the Company’s
investment committee. The Company’s investment committee focuses on strategies to enhance after-tax yields,
mitigate market risks, and optimize capital to improve profitability and returns.
The Company manages exposures to market risk through the use of asset allocation, duration, and credit
ratings. Asset allocation limits place restrictions on the total funds that may be invested within an asset class.
Duration limits on the fixed maturities portfolio place restrictions on the amount of interest rate risk that may be
taken. Comprehensive day-to-day management of market risk within defined tolerance ranges occurs as portfolio
managers buy and sell within their respective markets based upon the acceptable boundaries established by
investment policies.
Credit risk
Credit risk is risk due to uncertainty in a counterparty’s ability to meet its obligations. Credit risk is
managed by maintaining a high credit quality fixed maturities portfolio. As of December 31, 2010, the weighted-
average credit quality rating of the fixed maturities portfolio was AA-, at fair value, consistent with
December 31, 2009. Historically, the ten-year default rate per Moody’s for AA rated municipal bonds has been
less than 1%. The Company’s municipal bond holdings, which represent 91.8% of its fixed maturity portfolio at
December 31, 2010, at fair value, are broadly diversified geographically. 99.8% of municipal bond holdings are
tax-exempt. The following table presents municipal bond holdings by state in descending order of holdings at fair
value at December 31, 2010:
States Amounts
Average
Rating
(Amounts in thousands)
Texas .............. $ 360,273 AA-
California ........... 265,871 A+
Florida ............. 200,182 A+
Illinois .............. 146,397 A+
Washington .......... 141,155 AA-
Other states .......... 1,321,335 A+
Total ............... $2,435,213
The portfolio is broadly diversified among the states and the largest holdings are in populous states such as
Texas and California. These holdings are further diversified primarily among cities, counties, schools, public
works, hospitals and state general obligations. Credit risk is addressed by limiting exposure to any particular
issuer to ensure diversification.
Taxable fixed maturity securities represent 8.4% of the Company’s fixed maturity portfolio. 18.7% of the
Company’s taxable fixed maturity securities were comprised of U.S. government bonds and agencies and
mortgage-backed securities (agencies), which were rated AAA at December 31, 2010. 40.9% of the Company’s
taxable fixed maturity securities, representing 3.4% of the total fixed maturity portfolio, were rated below
57