Mercury Insurance 2013 Annual Report Download - page 32

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During periods of market disruption, including periods of significantly changing interest rates, rapidly widening credit
spreads, inactivity or illiquidity, it may be difficult to value certain of the Company’s securities if trading becomes less frequent
and/or market data become less observable. There may be certain asset classes in historically active markets with significant
observable data that become illiquid due to changes in the financial environment. In such cases, the valuations associated with
such securities may rely more on management judgment and include inputs and assumptions that are less observable or require
greater estimation as well as valuation methods, which are more sophisticated or require greater estimation. The valuations generated
by such methods may be different from the value at which the investments ultimately may be sold. Further, rapidly changing and
unprecedented credit and equity market conditions could materially impact the valuation of securities as reported within the
Company’s consolidated financial statements, and the period-to-period changes in value could vary significantly. Decreases in
value may have a material adverse effect on the Company’s financial condition or results of operations.
Changes in the financial strength ratings of financial guaranty insurers issuing policies on bonds held in the Company’s
investment portfolio may have an adverse effect on the Company’s investment results.
In an effort to enhance the bond rating applicable to certain bond issues, some bond issuers purchase municipal bond
insurance policies from private insurers. The insurance generally guarantees the payment of principal and interest on a bond issue
if the issuer defaults. By purchasing the insurance, the financial strength ratings applicable to the bonds are based on the credit
worthiness of the insurer as well as the underlying credit of the bond issuer. These financial guaranty insurers are subject to DOI
oversight. As the financial strength ratings of these insurers are reduced, the ratings of the insured bond issues correspondingly
decrease. Although the Company has determined that the financial strength rating of the underlying bond issues in its investment
portfolio are within the Company’s investment policy without the enhancement provided by the insurance policies, any further
downgrades in the financial strength ratings of these insurance companies or any defaults on the insurance policies written by
these insurance companies may reduce the fair value of the underlying bond issues and the Company’s investment portfolio or
may reduce the investment results generated by the Company’s investment portfolio, which could have a material adverse effect
on the Company’s financial condition, results of operations, and liquidity.
Deterioration of the municipal bond market in general or of specific municipal bonds held by the Company may result
in a material adverse effect on the Company’s financial condition, results of operations, and liquidity.
At December 31, 2013, 70.6% of the Company’s total investment portfolio at fair value and 87.1% of its total fixed maturity
investments at fair value were invested in tax-exempt municipal bonds. With such a large percentage of the Company’s investment
portfolio invested in municipal bonds, the performance of the Company’s investment portfolio, including the cash flows generated
by the investment portfolio is significantly dependent on the performance of municipal bonds. If the value of municipal bond
markets in general or any of the Company’s municipal bond holdings deteriorate, the performance of the Company’s investment
portfolio, financial condition, results of operations, and liquidity may be materially and adversely affected.
If the Company’s loss reserves are inadequate, its business and financial position could be harmed.
The process of establishing property and liability loss reserves is inherently uncertain due to a number of factors, including
underwriting quality, the frequency and amount of covered losses, variations in claims settlement practices, the costs and uncertainty
of litigation, and expanding theories of liability. While the Company believes that its actuarial techniques and databases are
sufficient to estimate loss reserves, the Company’s approach may prove to be inadequate. If any of these contingencies, many of
which are beyond the Company’s control, results in loss reserves that are not sufficient to cover its actual losses, the Company’s
financial condition, results of operations, and liquidity may be materially adversely affected.
There is uncertainty involved in the availability of reinsurance and the collectability of reinsurance recoverable.
The Company reinsures a portion of its potential losses on the policies it issues to mitigate the volatility of the losses on its
financial condition and results of operations. The availability and cost of reinsurance is subject to market conditions, which are
outside of the Company’s control. From time to time, market conditions have limited, and in some cases, prevented insurers from
obtaining the types and amounts of reinsurance that they consider adequate for their business needs. As a result, the Company
may not be able to successfully purchase reinsurance and transfer a portion of the Company’s risk through reinsurance arrangements.
In addition, as is customary, the Company initially pays all claims and seeks to recover the reinsured losses from its reinsurers.
Although the Company reports as assets the amount of claims paid which the Company expects to recover from reinsurers, no
assurance can be given that the Company will be able to collect from its reinsurers. If the amounts actually recoverable under the
Company’s reinsurance treaties are ultimately determined to be less than the amount it has reported as recoverable, the Company
may incur a loss during the period in which that determination is made.