Mercury Insurance 2012 Annual Report Download - page 82

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premiums are predominantly computed on a monthly pro-rata basis and are stated gross of reinsurance deductions, with the
reinsurance deduction recorded in other receivables. Net premiums written, a statutory measure designed to determine production
levels, were $2.65 billion, $2.58 billion, and $2.56 billion in 2012, 2011, and 2010, respectively.
No independent agent accounted for more than 2% of the Company’s direct premiums written during 2012, 2011, and 2010.
Losses and Loss Adjustment Expenses
Unpaid losses and loss adjustment expenses are determined in amounts estimated to cover incurred losses and loss adjustment
expenses and established based upon the Company’s assessment of claims pending and the development of prior years’ loss
liabilities. These amounts include liabilities based upon individual case estimates for reported losses and loss adjustment expenses
and estimates of such amounts that are IBNR. Changes in the estimated liability are charged or credited to operations as the losses
and loss adjustment expenses are reestimated. The liability is stated net of anticipated salvage and subrogation recoveries. The
amount of reinsurance recoverable is included in other receivables.
Estimating loss reserves is a difficult process as many factors can ultimately affect the final settlement of a claim and,
therefore, the reserve that is required. Changes in the regulatory and legal environment, results of litigation, medical costs, the
cost of repair materials, and labor rates, among other factors, can impact ultimate claim costs. In addition, time can be a critical
part of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of a claim,
the more variable the ultimate settlement amount could be. Accordingly, short-tail claims, such as property damage claims, tend
to be more reasonably predictable than long-tail liability claims, such as those involving the Company’s BI coverages. Management
believes that the liability for losses and loss adjustment expenses is adequate to cover the ultimate net cost of losses and loss
adjustment expenses incurred to date. Since the provisions for loss reserves are necessarily based upon estimates, the ultimate
liability may be more or less than such provisions.
The Company analyzes loss reserves quarterly primarily using the incurred loss, claim count development, and average
severity methods described below. The Company also uses the paid loss development method to analyze loss adjustment expense
reserves as part of its reserve analysis. When deciding among methods to use, the Company evaluates the credibility of each
method based on the maturity of the data available and the claims settlement practices for each particular line of business or
coverage within a line of business. When establishing the reserve, the Company will generally analyze the results from all of the
methods used rather than relying on a single method. While these methods are designed to determine the ultimate losses on claims
under the Company’s policies, there is inherent uncertainty in all actuarial models since they use historical data to project outcomes.
The Company believes that the techniques it uses provide a reasonable basis in estimating loss reserves.
• The incurred loss development method analyzes historical incurred case loss (case reserves plus paid losses)
development to estimate ultimate losses. The Company applies development factors against current case incurred losses
by accident period to calculate ultimate expected losses. The Company believes that the incurred loss development
method provides a reasonable basis for evaluating ultimate losses, particularly in the Company’s larger, more established
lines of business which have a long operating history.
• The average severity method analyzes historical loss payments and/or incurred losses divided by closed claims and/
or total claims to calculate an estimated average cost per claim. From this, the expected ultimate average cost per claim
can be estimated. The average severity method coupled with the claim count development method provide meaningful
information regarding inflation and frequency trends that the Company believes is useful in establishing reserves. The
claim count development method analyzes historical claim count development to estimate future incurred claim count
development for current claims. The Company applies these development factors against current claim counts by
accident period to calculate ultimate expected claim counts.
• The paid loss development method analyzes historical payment patterns to estimate the amount of losses yet to be paid.
The Company uses this method for losses and loss adjustment expenses.
The Company analyzes catastrophe losses separately from non-catastrophe losses. For catastrophe losses, the Company
determines claim counts based on claims reported and development expectations from previous catastrophes and applies an average
expected loss per claim based on reserves established by adjusters and average losses on previous similar catastrophes.
Derivative Financial Instruments
The Company accounts for all derivative instruments, other than those that meet the normal purchases and sales exception,
as either an asset or liability measured at fair value, which is based on information obtained from independent parties. In addition,
changes in fair value are recognized in earnings unless specific hedge accounting criteria are met. The Company’s derivative
instruments include interest rate swap agreements and were used to hedge the exposure to: