Mercury Insurance 2013 Annual Report Download - page 48

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loss, or a statement that such an estimate cannot be made. While actual losses may differ from the amounts recorded and the
ultimate outcome of the Company’s pending actions is generally not yet determinable, 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.
In all cases, the Company vigorously defends itself unless a reasonable settlement appears appropriate. For a discussion of
legal matters, see Note 16 of Notes to Consolidated Financial Statements—Commitments and Contingencies—Litigation.
C. Critical Accounting Policies and Estimates
Reserves
Preparation of the Company’s consolidated financial statements requires judgment and estimates. The most significant is
the estimate of loss reserves. 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.
The Company calculates a loss reserve point estimate rather than a range. There is inherent uncertainty with estimates and
this is particularly true with estimates for loss reserves. This uncertainty comes from many factors which may include changes in
claims reporting and settlement patterns, changes in the regulatory or legal environment, uncertainty over inflation rates, and
uncertainty for unknown items. The Company does not make specific provisions for these uncertainties, rather it considers them
in establishing its reserve by looking at historical patterns and trends and projecting these out to current reserves. The underlying
factors and assumptions that serve as the basis for preparing the reserve estimate include paid and incurred loss development
factors, expected average costs per claim, inflation trends, expected loss ratios, industry data, and other relevant information.
The Company also engages an independent actuarial consultant to review the Company’s reserves and to provide the annual
actuarial opinions required under state statutory accounting requirements. The Company does not rely on the actuarial consultant
for GAAP reporting or periodic report disclosure purposes. 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 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 provides 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.