Mercury Insurance 2011 Annual Report Download - page 72

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During 2011, the Company recognized $58.4 million in net realized investment gains, which include gains
of $54.1 million related to fixed maturity securities and losses of $4.9 million related to equity securities.
Included in the gains and losses were $62.1 million in gains due to changes in the fair value of the Company’s
fixed maturity portfolio and $30.9 million in losses due to changes in the fair value of the Company’s equity
security portfolio, as a result of applying the fair value option.
During 2010, the Company recognized $57.1 million in net realized investment gains, which include gains
of $5.9 million and $46.5 million related to fixed maturity securities and equity securities, respectively. Included
in the gains were $1.0 million and $45.7 million in gains due to changes in the fair value of the Company’s fixed
maturity portfolio and equity security portfolio, respectively, as a result of applying the fair value option.
Fixed Maturity Securities
Fixed maturity securities include debt securities, 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. A primary exposure for the fixed maturity
securities is interest rate risk. The longer the duration, the more sensitive the asset is to market interest rate
fluctuations. As assets with longer maturity dates tend to produce higher current yields, the Company’s historical
investment philosophy has resulted in a portfolio with a moderate duration. The nominal average maturities of
the overall bond portfolio were 11.8 years at both December 31, 2011 and 2010 (10.8 years and 11.3 years,
respectively, including all short-term instruments). The portfolio is heavily weighted in investment grade
tax-exempt municipal bonds. Fixed maturity investments purchased by the Company typically have call options
attached, which reduce the duration of the asset as interest rates decline. The call-adjusted average maturities of
the overall bond portfolio were 4.5 years and 6.3 years (4.1 years and 6.0 years including all short-term
instruments) at December 31, 2011 and 2010, respectively, related to holdings which are heavily weighted with
high coupon issues that are expected to be called prior to maturity. The modified durations of the overall bond
portfolio reflecting anticipated early calls were 3.7 years and 4.7 years, (3.3 years and 4.5 years including all
short-term instruments), including collateralized mortgage obligations with a modified duration of 2.4 years and
2.2 years at December 31, 2011 and 2010, respectively, and short-term bonds that carry no duration. Modified
duration measures the length of time it takes, on average, to receive the present value of all the cash flows
produced by a bond, including reinvestment of interest. As it measures four factors (maturity, coupon rate, yield,
and call terms) which determine sensitivity to changes in interest rates, modified duration is considered a better
indicator of price volatility than simple maturity alone.
Another exposure related to the fixed maturity securities is credit risk, which is managed by maintaining a
weighted-average portfolio credit quality rating of AA-, at fair value, consistent with the average rating at
December 31, 2010. To calculate the weighted-average credit quality ratings as disclosed throughout this Annual
Report on Form 10-K, individual securities were weighted based on fair value and a credit quality numeric score
that was assigned to each rating grade. Tax-exempt bond holdings are broadly diversified geographically.
Taxable holdings consist principally of investment grade issues. At December 31, 2011, fixed maturity holdings
rated below investment grade and non-rated bonds totaled $95.8 million and $17.2 million, respectively, at fair
value, and represented 3.9% and 0.7%, respectively, of total fixed maturity securities. At December 31, 2010,
below investment grade and non-rated fixed maturity holdings totaled $139.4 million and $34.9 million,
respectively, at fair value, and represented 5.3% and 1.3%, respectively, of total fixed maturity securities.
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