Mercury Insurance 2013 Annual Report Download - page 58

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43
million and $9.2 million in gains due to changes in the fair value of the Company’s fixed maturity and equity security portfolio,
respectively, as a result of applying the fair value accounting option.
Fixed Maturity Securities and Short-Term Investments
Fixed maturity securities include debt securities, which may have fixed or variable principal payment schedules, may be
held for indefinite periods of time, and may be used as a part of the Company’s asset/liability strategy or sold in response to changes
in interest rates, anticipated prepayments, risk/reward characteristics, liquidity needs, tax planning considerations, or other
economic factors. Short-term investments include money market accounts, options, and short-term bonds that are highly rated
short duration securities and redeemable within one year.
A primary exposure for the fixed maturity securities is interest rate risk. The longer the duration, the more sensitive the
asset is to market interest rate fluctuations. As assets with longer maturity dates tend to produce higher current yields, the Company’s
historical investment philosophy has resulted in a portfolio with a moderate duration. The nominal average maturities of the overall
bond portfolio were 13.3 years and 12.2 years (12.1 years and 11.0 years including all short-term instruments) at December 31,
2013 and 2012, respectively. The portfolio is heavily weighted in investment grade tax-exempt municipal bonds. Fixed maturity
investments purchased by the Company typically have call options attached, which further reduce the duration of the asset as
interest rates decline. The call-adjusted average maturities of the overall bond portfolio were 5.2 years and 3.7 years (4.7 years
and 3.3 years including all short-term instruments) at December 31, 2013 and 2012, respectively, related to holdings which are
heavily weighted with high coupon issues that are expected to be called prior to maturity. The modified durations of the overall
bond portfolio reflecting anticipated early calls were 3.9 years and 3.1 years, (3.6 years and 2.8 years including all short-term
instruments), including collateralized mortgage obligations with a modified duration of 2.3 years and 3.2 years at December 31,
2013 and 2012, respectively, and short-term bonds that carry no duration. Modified duration measures the length of time it takes,
on average, to receive the present value of all the cash flows produced by a bond, including reinvestment of interest. As it measures
four factors (maturity, coupon rate, yield, and call terms) which determine sensitivity to changes in interest rates, modified duration
is considered a better indicator of price volatility than simple maturity alone.
Another exposure related to the fixed maturity securities is credit risk, which is managed by maintaining a weighted-average
portfolio credit quality rating of AA-, at fair value, consistent with the average rating at December 31, 2012. To calculate the
weighted-average credit quality ratings as disclosed throughout this Annual Report on Form 10-K, individual securities were
weighted based on fair value and a credit quality numeric score that was assigned to each rating grade. Tax-exempt bond holdings
are broadly diversified geographically. Taxable holdings consist principally of investment grade issues. At December 31, 2013,
fixed maturity holdings rated below investment grade and non-rated bonds totaled $35.0 million and $13.1 million, respectively,
at fair value, and represented 1.4% and 0.5%, respectively, of total fixed maturity securities. At December 31, 2012, fixed maturity
holdings rated below investment grade and non-rated bonds totaled $41.4 million and $47.4 million, respectively, at fair value,
and represented 1.7% and 2.0%, respectively, of total fixed maturity securities.
The following table presents the credit quality ratings of the Company’s fixed maturity portfolio by security type at
December 31, 2013 at fair value. The Company’s estimated credit quality ratings are based on the average of ratings assigned by
nationally recognized securities rating organizations. Credit ratings for the Company’s fixed maturity portfolio were stable as
compared to the prior year, with 83.1% of fixed maturity securities at fair value experiencing no change in their overall rating.
9.3% of fixed maturity securities at fair value experienced downgrades, partially offset by 7.6% in credit upgrades. A majority of
the downgrades were slight and still within the investment grade portfolio, except for $7.4 million at fair value that were downgraded
to below investment grade during 2013.