Mercury Insurance 2013 Annual Report Download - page 36

21
Challenging economic conditions may negatively affect the Company’s business and operating results.
Challenging economic conditions could adversely affect the Company in the form of consumer behavior and pressure on
its investment portfolio. Consumer behavior could include policy cancellations, modifications, or non-renewals, which may reduce
cash flows from operations and investments, may harm the Company’s financial position, and may reduce the Insurance Companies’
statutory surplus. Challenging economic conditions also may impair the ability of the Company’s customers to pay premiums as
they become due, and as a result, the Company’s bad debt reserves and write-offs could increase. It is also possible that claims
fraud may increase. The Company’s investment portfolios could be adversely affected as a result of financial and business conditions
affecting the issuers of the securities in the Company’s investment portfolio. In addition, declines in the Company’s profitability
could result in a charge to earnings for the impairment of goodwill, which would not affect the Company’s cash flow but could
decrease its earnings, and its stock price could be adversely affected.
The Company may be adversely affected if economic conditions result in either inflation or deflation. In an inflationary
environment, established reserves may become inadequate and increase the Company’s loss ratio, and market interest rates may
rise and reduce the value of the Company’s fixed maturity portfolio, while increasing interest expense on its LIBOR based debt.
The DOIs may not approve premium rate increases in time for the Company to adequately mitigate inflated loss costs. In a
deflationary environment, some fixed maturity issuers may have difficulty meeting their debt service obligations and thereby
reduce the value of the Company’s fixed maturity portfolio; equity investments may decrease in value; and policyholders may
experience difficulties paying their premiums to the Company, which could adversely affect premium revenue.
The Company’s business is vulnerable to significant losses related to sinkhole claims, which could have an adverse effect
on its results of operations.
In 2011, the Company began its withdrawal from the Florida homeowners market due to the high incidence of sinkhole
claims. While the Company has closed many sinkhole claims, and believes it has adequately reserved for the remaining open
claims, it remains possible for legal or legislative action to require opening closed claims that could impair profitability. The
Company completed its withdrawal from the Florida homeowners market in September 2012.
Risks Related to the Company’s Industry
The private passenger automobile insurance industry is highly competitive, and the Company may not be able to compete
effectively against larger or better-capitalized companies.
The Company competes with many property and casualty insurance companies selling private passenger automobile
insurance in the states in which the Company operates. Many of these competitors are better capitalized than the Company, have
higher A.M. Best ratings, and have a larger market share in the states in which the Company operates. The superior capitalization
of the competitors may enable them to offer lower rates, to withstand larger losses, and to more effectively take advantage of new
marketing opportunities. The Company’s competition may also become increasingly better capitalized in the future as the traditional
barriers between insurance companies and banks and other financial institutions erode and as the property and casualty industry
continues to consolidate. The Company’s ability to compete against these larger, better-capitalized competitors depends on its
ability to deliver superior service and its strong relationships with independent agents.
The Company may undertake strategic marketing and operating initiatives to improve its competitive position and drive
growth. If the Company is unable to successfully implement new strategic initiatives or if the Company’s marketing campaigns
do not attract new customers, the Company’s competitive position may be harmed, which could adversely affect the Company’s
business and results of operations. Additionally, in the event of a failure of any competitor, the Company and other insurance
companies would likely be required by state law to absorb the losses of the failed insurer and would be faced with an unexpected
surge in new business from the failed insurer’s former policyholders.
The Company may be adversely affected by changes in the private passenger automobile insurance industry.
79.1% of the Company’s direct written premiums for the year ended December 31, 2013 were generated from private
passenger automobile insurance policies. Adverse developments in the market for personal automobile insurance or the personal
automobile insurance industry in general, whether related to changes in competition, pricing or regulations, could cause the
Company’s results of operations to suffer. The property-casualty insurance industry is also exposed to the risks of severe weather
conditions, such as rainstorms, snowstorms, hail and ice storms, hurricanes, tornadoes, wild fires, sinkholes, earthquakes and, to
a lesser degree, explosions, terrorist attacks, and riots. The automobile insurance business is also affected by cost trends that impact
profitability. Factors which negatively affect cost trends include inflation in automobile repair costs, automobile parts costs, new
and used car valuations, medical costs, and changes in non-economic costs due to changes in the legal and regulatory environments.
In addition, the advent of driverless cars and usage-based insurance could materially alter the way that automobile insurance is
marketed, priced, and underwritten.