Mercury Insurance 2011 Annual Report Download - page 56

The Company’s operating results and growth have allowed it to consistently generate positive cash flow
from operations, which was approximately $159 million and $92 million in 2011 and 2010, respectively. Cash
flow from operations has been used to pay shareholder dividends, retire debt, and help support growth.
Economic and Industry Wide Factors
• Regulatory Uncertainty—The insurance industry is subject to strict state regulation and oversight and
is governed by the laws of each state in which each insurance company operates. State regulators
generally have substantial power and authority over insurance companies including, in some states,
approving rate changes and rating factors, and establishing minimum capital and surplus
requirements. In many states, insurance commissioners may emphasize different agendas or interpret
existing regulations differently than previous commissioners. The Company has a successful track
record of working with difficult regulations and new insurance commissioners. However, there is no
certainty that current or future regulations and the interpretation of those regulations by insurance
commissioners and the courts will not have an adverse impact on the Company.
• Cost Uncertainty—Because insurance companies pay claims after premiums are collected, the ultimate
cost of an insurance policy is not known until well after the policy revenues are earned. Consequently,
significant assumptions are made when establishing insurance rates and loss reserves. While insurance
companies use sophisticated models and experienced actuaries to assist in setting rates and establishing
loss reserves, there can be no assurance that current rates or current reserve estimates will be
adequate. Furthermore, there can be no assurance that insurance regulators will approve rate increases
when the Company’s actuarial analysis shows that they are needed.
•Economic Conditions—Though many businesses are still experiencing the slow recovery from the
severe economic recession, the recent sovereign debt crisis in Europe is leading to weaker global
economic growth, heightened financial vulnerabilities and some negative rating actions. The Company
is unable to predict the duration and severity of the current disruption in the financial markets and its
impact on the United States, and California, where the majority of the Company’s business is
produced. If economic conditions do not show improvement, there could be an adverse impact on the
Company’s financial condition, results of operations, and liquidity.
• Inflation—The largest cost component for automobile insurers is losses, which include medical costs,
replacement automobile parts, and labor costs. There can be significant variation in the overall
increases in medical cost inflation, and it is often a year or more after the respective fiscal period ends
before sufficient claims have closed for the inflation rate to be known with a reasonable degree of
certainty. Therefore, it can be difficult to establish reserves and set premium rates, particularly when
actual inflation rates may be higher or lower than anticipated.
•Loss Frequency—Another component of overall loss costs is loss frequency, which is the number of
claims per risk insured. There has been a long-term trend of declining loss frequency in the personal
automobile insurance industry. In recent years, the trend has shown increasing loss frequency;
however, the Company is unable to predict the trend of loss frequency in the future.
• Underwriting Cycle and Competition—The property and casualty insurance industry is highly cyclical,
with alternating hard and soft market conditions. The Company has historically seen significant
premium growth during hard markets. Premium growth rates in soft markets have ranged from slightly
positive to negative and were consistent in 2011.
Technology
In 2011, the Company continued to enhance its internet agency portal, Mercury First. Mercury First is a
single entry point for agents providing a broad suite of capabilities. One of its most powerful tools is a point of
sale (POS) system that allows agents to easily obtain and compare quotes and write new business. Mercury First
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