Mercury Insurance 2012 Annual Report Download - page 59

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The Company has the capability to implement tax planning strategies as it has a steady history of generating positive cash
flow from operations, as well as the reasonable expectation that its cash flow needs can be met in future periods without the forced
sale of its investments. This capability assists management in controlling the timing and amount of realized losses it generates
during future periods. By prudent utilization of some or all of these strategies, management believes that it has the ability and
intent to generate capital gains, and minimize tax losses, in a manner sufficient to avoid losing the benefits of its deferred tax
assets. Management will continue to assess the need for a valuation allowance on a quarterly basis. Although realization is not
assured, management believes it is more likely than not that the Company’s deferred tax assets will be realized.
The Company’s effective income tax rate can be affected by several factors. These generally include tax exempt investment
income, non-deductible expenses, and periodically, non-routine tax items such as adjustments to unrecognized tax benefits related
to tax uncertainties. The effective tax rate for 2012 was 13.6%, compared to 22.0% for 2011. The decrease in the effective tax rate
is mainly due to a decrease in taxable income relative to tax exempt investment income. The Company’s effective tax rate for the
year ended December 31, 2012 was lower than the statutory tax rate primarily as a result of tax exempt investment income earned.
Goodwill and Other Intangible Assets
Goodwill and other intangible assets arise from business acquisitions and consist of the excess of the cost of the acquisitions
over the tangible and intangible assets acquired and liabilities assumed and identifiable intangible assets acquired. The Company
annually evaluates goodwill and other intangible assets for impairment. The Company also reviews its goodwill and other intangible
assets for impairment whenever events or changes in circumstances indicate that it is more likely than not that the carrying amount
of goodwill and other intangible assets may exceed the implied fair value. As of December 31, 2012, the fair value of the Company’s
reporting units exceeded their carrying value.
Contingent Liabilities
The Company has known, and may have unknown, potential liabilities which include claims, assessments, lawsuits, or
regulatory fines and penalties relating to the Company’s business. The Company continually evaluates these potential liabilities
and accrues for them and/or discloses them in the notes to the consolidated financial statements where required. The Company
does not believe that the ultimate resolution of currently pending legal or regulatory proceedings, either individually or in the
aggregate, will have a material adverse effect on its financial condition, results of operations, or cash flows. See also “Regulatory
and Legal Matters” and Note 16 of Notes to Consolidated Financial Statements.
For a discussion of recently issued accounting standards, see Note 1 of Notes to Consolidated Financial Statements.
RESULTS OF OPERATIONS
Year Ended December 31, 2012 Compared to Year Ended December 31, 2011
Revenues
Net premiums earned and net premiums written in 2012 increased 0.3% and 3.0%, respectively, from 2011. Net premiums
written by the Company's California operations and non-California operations increased by $73.3 million and $3.1 million,
respectively, from 2011. The increase in net premiums written is primarily due to an increase in the number of policies-in-force
and slightly higher average premiums per policy. The increase in average premiums per policy partially reflects a modest shift for
the California personal automobile line from six-month policies to twelve-month policies. Premiums on twelve-month policies
are typically twice that of six-month policies. For 2012, fewer than 5% of California personal automobile policies were written
on a twelve-month basis and more than 95% were written on a six-month basis, whereas in 2011, fewer than 1% of the California
personal automobile policies were written on a twelve-month basis and over 99% were written on a six-month basis. In addition,
the Company increased private passenger automobile insurance rates in twelve states outside California and grew its homeowners
business in several states outside of California during 2012.
Net premiums written is a non-GAAP financial measure which represents the premiums charged on policies issued during
a fiscal period less any applicable reinsurance. Net premiums written is a statutory measure designed to determine production
levels. Net premiums earned, the most directly comparable GAAP measure, represents the portion of net premiums written that
is recognized as revenue in the financial statements for the period presented and earned on a pro-rata basis over the term of the
policies. The following is a reconciliation of total net premiums written to net premiums earned: