Mercury Insurance 2011 Annual Report Download - page 78

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Credit risk
Credit risk is 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, 2011, the estimated weighted-
average credit quality rating of the fixed maturities portfolio was AA-, at fair value, consistent with the average
rating at December 31, 2010. 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 92.9% of its fixed maturity
portfolio at December 31, 2011, at fair value, are broadly diversified geographically. 99.7% 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, 2011:
States Fair Value Average Rating
(Amounts in thousands)
Texas .............. $337,678 AA-
California ........... 265,731 A+
Florida ............. 176,959 A+
Illinois .............. 159,642 A
Washington .......... 132,233 AA-
Other states .......... 1,199,032 A+
Total ............... $2,271,275
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 7.4% of the Company’s fixed maturity portfolio. 17.8% 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, 2011. 38.3% of the Company’s
taxable fixed maturity securities, representing 2.8% of the total fixed maturity portfolio, were rated below
investment grade. Below investment grade issues are considered “watch list” items by the Company, and their
status is evaluated within the context of the Company’s overall portfolio and its investment policy on an
aggregate risk management basis, as well as their ability to recover their investment on an individual issue basis.
Equity price risk
Equity price risk is the risk that the Company will incur losses due to adverse changes in the general levels
of the equity markets.
At December 31, 2011, the Company’s primary objective for common equity investments is current
income. The fair value of the equity investments consists of $359.0 million in common stocks, $11.4 million in
non-redeemable preferred stocks, and $10.0 million in a partnership interest in a private credit fund. Common
stock equity assets are typically valued for future economic prospects as perceived by the market. The Company
invests more in the energy and utility sector relative to the S&P 500 Index.
Common stocks represent 11.7% of total investments at fair value. Beta is a measure of a security’s
systematic (non-diversifiable) risk, which is the percentage change in an individual security’s return for a 1%
change in the return of the market. The average Beta for the Company’s common stock holdings was 1.18 at
December 31, 2011. Based on a hypothetical 25% or 50% reduction in the overall value of the stock market, the
Company estimates that the fair value of the common stock portfolio would decrease by $105.9 million or
$211.8 million, respectively.
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