Mercury Insurance 2013 Annual Report Download - page 49

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There are many factors that can cause variability between the ultimate expected loss and the actual developed loss. While
there are certainly other factors, the Company believes that the following three items tend to create the most variability between
expected losses and actual losses.
(1) Inflation
For the Company’s California automobile lines of business, total reserves are comprised of the following:
• BI reserves—approximately 60% of total reserves
• Material damage (MD) reserves, including collision and comprehensive property damage—approximately 20%
of total reserves
• Loss adjustment expenses reserves—approximately 20% of total reserves.
Loss development on MD reserves is generally insignificant because MD claims are generally settled in a shorter period
than BI claims. The majority of the loss adjustment expense reserves are estimated costs to defend BI claims, which tend to require
longer periods of time to settle as compared to MD claims.
BI loss reserves are generally the most difficult to estimate because they take longer to close than other coverages. BI
coverage in the Company’s policies includes injuries sustained by any person other than the insured, except in the case of uninsured
or underinsured motorist BI coverage, which covers damages to the insured for BI caused by uninsured or underinsured motorists.
BI payments are primarily for medical costs and general damages.
The following table presents the typical closure patterns of BI claims in the California automobile insurance coverage:
% of Total
Claims Closed Dollars Paid
BI claims closed in the accident year reported 42% 14%
BI claims closed one year after the accident year reported 80% 55%
BI claims closed two years after the accident year reported 94% 81%
BI claims closed three years after the accident year reported 99% 95%
BI claims closed in the accident year reported are generally the smaller and less complex claims that settle for approximately
$3,000 to $3,500, on average, whereas the total average settlement, once all claims are closed in a particular accident year, is
approximately $8,500 to $10,000. The Company creates incurred and paid loss triangles to estimate ultimate losses utilizing
historical payment and reserving patterns and evaluates the results of this analysis against its frequency and severity analysis to
establish BI reserves. The Company adjusts development factors to account for inflation trends it sees in loss severity. As a larger
proportion of claims from an accident year are settled, there becomes a higher degree of certainty for the reserves established for
that accident year. Consequently, there is a decreasing likelihood of reserve development on any particular accident year, as those
periods age. At December 31, 2013, the Company believes that the accident years that are most likely to develop are the 2011
through 2013 accident years; however, it is possible that older accident years could develop as well.
In general, the Company expects that historical claims trends will continue with costs tending to increase, which is generally
consistent with historical data, and therefore the Company believes that it is reasonable to expect inflation to continue. The Company
is experiencing inflation at a rate that is higher than in recent years. Many potential factors can affect the BI inflation rate, including
changes in claims handling process, statutes and regulations, the number of litigated files, increased use of medical procedures
such as MRIs and epidural injections, general economic factors, timeliness of claims adjudication, vehicle safety, weather patterns,
and gasoline prices, among other factors; however, the magnitude of such impact on the inflation rate is unknown.
The Company believes that it is reasonably possible that the California automobile BI severity could vary from recorded
amounts by as much as 10%, 5%, and 3% for 2013, 2012, and 2011, respectively. For example, at December 31, 2013, the loss
severity for the amounts recorded at December 31, 2012 changed by (2.2)%, 2.1%, and 1.4% for the 2012, 2011, and 2010 accident
years, respectively. Comparatively, at December 31, 2012, the loss severity for the amounts recorded at December 31, 2011
increased by 7.0%, 2.5%, and 0.3% for the 2011, 2010, and 2009 accident years, respectively. The following table presents the
effects on the 2013, 2012, and 2011 accident year California BI loss reserves based on possible variations in the severity recorded;
however, the variation could be more or less than these amounts.