Mercury Insurance 2010 Annual Report Download - page 93

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MERCURY GENERAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
7. Derivative Financial Instruments
The Company is exposed to certain risks relating to its ongoing business operations. The primary risks
managed by derivative instruments are equity price risk and interest rate risk. Equity contracts on various equity
securities are intended to manage the price risk associated with forecasted purchases or sales of such securities.
Interest rate swaps are intended to manage interest rate risk associated with the Company’s loans with fixed or
floating rates.
On February 6, 2009, the Company entered into an interest rate swap of its floating LIBOR rate on the $120
million credit facility, which was used for the acquisition of AIS, resulting in a 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 statement of operations
in the period of change.
Effective January 2, 2002, the Company entered into an interest rate swap on the $125 million senior notes
for a floating rate of LIBOR plus 107 basis points. The swap agreement terminates on August 15, 2011. The
swap is designated as a fair value hedge and qualifies for the shortcut method as the hedge is deemed to have no
ineffectiveness. The fair market value of the interest rate swap was $4.2 million and $8.5 million as of
December 31, 2010 and 2009, respectively, and has been recorded in other assets in the consolidated balance
sheets with a corresponding increase in notes payable. The Company includes the gain or loss on the hedged item
in the same line item, other revenue, as the offsetting loss or gain on the related interest rate swaps as follows:
Income Statement Classification
Year Ended December 31,
2010 2009 2008
Gain (Loss)
on Swap
Gain (Loss)
on Loan
Gain (Loss)
on Swap
Gain (Loss)
on Loan
Gain (Loss)
on Swap
Gain (Loss)
on Loan
(Amounts in thousands)
Other revenue .................... $(4,232) $4,232 $(5,922) $5,922 $5,175 $(5,175)
On March 3, 2008, the Company entered into an interest rate swap of its floating LIBOR rate on the $18
million bank loan for a fixed rate of 4.25%. The swap agreement terminates on March 1, 2013. The swap is
designated as a cash flow hedge. The fair market value of the interest rate swap was $1.1 million and $0.9 million
as of December 31, 2010 and 2009, respectively, and has been reported as a component of other comprehensive
income (loss) and amortized into earnings over the term of the hedged transaction. The interest rate swap was
determined to be highly effective, and no amount of ineffectiveness was recorded in earnings during 2010, 2009,
or 2008.
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