Mercury Insurance 2012 Annual Report Download - page 51

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The Company is headquartered in Los Angeles, California and operates primarily as a personal automobile insurer selling
policies through a network of independent agents in thirteen states. The Company also offers homeowners, commercial automobile
and property, mechanical breakdown, fire, and umbrella insurance. Private passenger automobile lines of insurance accounted for
80.6% of the $2.7 billion of the Company’s direct premiums written in 2012. 78.0% of the private passenger automobile premiums
were written in California. The Company also operates in Arizona, Florida, Georgia, Illinois, Michigan, Nevada, New Jersey, New
York, Oklahoma, Pennsylvania, Texas, and Virginia.
The Company expects to continue its growth by expanding into new states in the future to achieve greater geographic
diversification. There are challenges and risks involved in entering each new state, including establishing adequate rates without
any operating history in the state, working with a new regulatory regime, hiring and training competent personnel, building adequate
systems, and finding qualified agents to represent the Company. The Company does not expect to enter into any new states during
2013.
This section discusses some of the relevant factors that management considers in evaluating the Company’s performance,
prospects, and risks. It is not all-inclusive and is meant to be read in conjunction with the entirety of management’s discussion
and analysis, the Company’s consolidated financial statements and notes thereto, and all other items contained within this Annual
Report on Form 10-K.
2012 Financial Performance Summary
The Company’s net income for the year ended December 31, 2012 decreased to $116.9 million, or $2.13 per diluted share,
from $191.2 million, or $3.49 per diluted share, for the same period in 2011. Approximately $132 million in pre-tax investment
income was generated during 2012 on a portfolio of approximately $3.2 billion at fair value at December 31, 2012, compared to
$141 million pre-tax investment income during 2011 on a portfolio of approximately $3.1 billion at fair value at December 31,
2011. Included in net income are net realized investment gains of $66.4 million and $58.4 million in 2012 and 2011, respectively.
Net realized investment gains include gains of $45.5 million and $31.3 million in 2012 and 2011, respectively, due to changes in
the fair value of total investments pursuant to application of the fair value accounting option.
During 2012, the Company continued its marketing efforts to enhance name recognition and lead generation. The Company
believes that its marketing efforts, combined with its ability to maintain relatively low prices and a strong reputation, make the
Company very competitive in California and in other states.
The Company believes its thorough underwriting process gives it an advantage over competitors. The Company views its
agent relationships and underwriting process as one of its primary competitive advantages because it allows the Company to charge
lower rates yet realize better margins than many competitors.
The Company’s operating results and growth have allowed it to consistently generate positive cash flow from operations,
which was approximately $148 million and $159 million in 2012 and 2011, respectively. Cash flow from operations has been used
to pay shareholder dividends 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. 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—Many businesses are experiencing a slow recovery from the severe economic recession, and
economic uncertainty is expected to continue in 2013 due in large part to continuing political disagreements in
Washington that may cause businesses and consumers to hold back spending. Further, the sovereign debt crisis in
Europe continues to lead to weaker global economic growth, heightened financial vulnerabilities and some negative