Mercury Insurance 2013 Annual Report Download - page 51

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though a comprehensive claims file review was undertaken. The Company may experience additional development on these
reserves.
Discussion of losses and loss reserves and prior period loss development at December 31, 2013
At December 31, 2013 and 2012, the Company recorded its point estimate of approximately $1,039 million and $1,036
million, respectively, in losses and loss adjustment expense liabilities, which include $409.2 million and $408.9 million,
respectively, of IBNR loss reserves. IBNR includes estimates, based upon past experience, of ultimate developed costs, which
may differ from case estimates, unreported claims that occurred on or prior to December 31, 2013 and estimated future payments
for reopened claims. 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; however, since the provisions are necessarily based upon
estimates, the ultimate liability may be more or less than such provisions.
During 2013, the Company recorded catastrophe losses of approximately $17 million which were primarily due to tornadoes
in Oklahoma and severe storms in the Midwest and the Southeast regions during the second quarter.
The Company evaluates its reserves quarterly. When management determines that the estimated ultimate claim cost requires
a decrease for previously reported accident years, favorable development occurs and a reduction in losses and loss adjustment
expenses is reported in the current period. If the estimated ultimate claim cost requires an increase for previously reported accident
years, unfavorable development occurs and an increase in losses and loss adjustment expenses is reported in the current period.
For 2013, the Company reported unfavorable development of approximately $3 million on the 2012 and prior accident years’
losses and loss adjustment expense reserves, which at December 31, 2012 totaled approximately $1,036 million. The unfavorable
development in 2013 is largely from Florida claims that were re-opened from prior years due to a state supreme court ruling that
was adverse to the insurance industry.
Investments
The Company’s fixed maturity and equity investments are classified as “trading” and carried at fair value as required when
applying the fair value option, with changes in fair value reflected in net realized investment gains or losses in the consolidated
statements of operations. The majority of equity holdings, including non-redeemable fund preferred stocks, is actively traded on
national exchanges or trading markets, and is valued at the last transaction price on the balance sheet dates.
Fair Value of Financial Instruments
The financial instruments recorded in the consolidated balance sheets include investments, receivables, a total return swap,
interest rate swaps, accounts payable, equity contracts, and secured and unsecured notes payable. The fair value of a financial
instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market
participants at the measurement date. Due to their short-term maturity, the carrying values of receivables and accounts payable
approximate their fair market values. All investments are carried on the consolidated balance sheets at fair value, as disclosed in
Note 1 of Notes to Consolidated Financial Statements.
The Company’s financial instruments include securities issued by the U.S. government and its agencies, securities issued
by states and municipal governments and agencies, certain corporate and other debt securities, equity securities, and exchange
traded funds. 99.5% of the fair value of financial instruments held at December 31, 2013 is based on observable market prices,
observable market parameters, or is derived from such prices or parameters. The availability of observable market prices and
pricing parameters can vary by financial instrument. Observable market prices and pricing parameters of a financial instrument,
or a related financial instrument, are used to derive a price without requiring significant judgment.
The Company may hold or acquire financial instruments that lack observable market prices or market parameters because
they are less actively traded currently or in future periods. The fair value of such instruments is determined using techniques
appropriate for each particular financial instrument. These techniques may involve some degree of judgment. The price transparency
of the particular financial instrument will determine the degree of judgment involved in determining the fair value of the Company’s
financial instruments. Price transparency is affected by a wide variety of factors, including, for example, the type of financial
instrument, whether it is a new financial instrument and not yet established in the marketplace, and the characteristics particular
to the transaction. Financial instruments for which actively quoted prices or pricing parameters are available or for which fair
value is derived from actively quoted prices or pricing parameters will generally have a higher degree of price transparency. By
contrast, financial instruments that are thinly traded or not quoted will generally have diminished price transparency. Even in
normally active markets, the price transparency for actively quoted instruments may be reduced during periods of market
dislocation. Alternatively, in thinly quoted markets, the participation of market makers willing to purchase and sell a financial