Mercury Insurance 2013 Annual Report Download - page 60

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45
finances on a sustainable path and secure the AAA ratings. Standard and Poor’s affirmed the U.S. Treasury’s short-term credit
rating of AAA indicating that the short-term capacity of the U.S. to meet its financial commitment on its outstanding obligations
is strong. The Company understands that market participants continue to use rates of return on U.S. government debt as a risk-
free rate and have continued to invest in U.S. Treasury securities.
(1) Municipal Securities
The Company had $2.2 billion at fair value and amortized cost in municipal bonds at December 31, 2013, of which $1.0
billion were insured by bond insurers. For insured municipal bonds that have underlying ratings, the average underlying rating
was A+ at December 31, 2013.
At December 31, 2013, the bond insurers providing credit enhancement were Assured Guaranty Corporation and National
Public Finance Guarantee Corporation, which covered approximately 25% of the insured municipal securities. The average rating
of the Company’s insured municipal bonds by these bond insurers was A, with an underlying rating of A-. Most of the insured
bonds' ratings were investment grade and reflected the credit of underlying issuer. 8.6% of the remaining insured bonds are non-
rated or below investment grade, and the Company does not believe that these insurers provide credit enhancement to the municipal
bonds that they insure.
The Company considers the strength of the underlying credit as a buffer against potential market value declines which may
result from future rating downgrades of the bond insurers. In addition, the Company has a long-term time horizon for its municipal
bond holdings which generally allows it to recover the full principal amounts upon maturity and avoid forced sales prior to maturity
of bonds that have declined in market value due to the bond insurers’ rating downgrades. Based on the uncertainty surrounding
the financial condition of these insurers, it is possible that there will be additional downgrades to below investment grade ratings
by the rating agencies in the future, and such downgrades could impact the fair value of municipal bonds.
(2) Mortgage-Backed Securities
The mortgage-backed securities portfolio is categorized as loans to “prime” borrowers except for $7.0 million and $8.2
million ($6.3 million and $7.3 million at amortized cost) of Alt-A mortgages at December 31, 2013 and 2012, respectively. Alt-
A mortgage backed securities are at fixed or variable rates and include certain securities that are collateralized by residential
mortgage loans issued to borrowers with credit profiles stronger than those of sub-prime borrowers, but do not qualify for prime
financing terms due to high loan-to-value ratios or limited supporting documentation. The Company had holdings of $21.9 million
and $4.3 million ($21.8 million and $4.2 million at amortized cost) in commercial mortgage-backed securities at December 31,
2013 and 2012, respectively.
The weighted-average rating of the Company’s Alt-A mortgage-backed securities was B+ and the weighted-average rating
of the entire mortgage backed securities portfolio was BBB+ as of December 31, 2013.
(3) Corporate Securities
Included in fixed maturity securities are $264.7 million and $155.6 million of corporate securities, which had durations of
3.4 and 1.8 years, at December 31, 2013 and 2012, respectively. The weighted-average rating was BBB as of December 31, 2013
and 2012.
(4) Collateralized Debt Obligations
Included in fixed maturities securities are collateralized debt obligations of $4.3 million and $42.8 million, which represent
0.1% and 1.3% of the total investment portfolio and had durations of 0.01 years and 0.47 years, at December 31, 2013 and 2012,
respectively.
Equity Securities
Equity holdings consist of non-redeemable preferred stocks, common stocks on which dividend income is partially tax-
sheltered by the 70% corporate dividend received deduction, and a partnership interest in a private credit fund. The net gains in
2013 due to changes in fair value of the Company’s equity portfolio were $56.8 million. The primary cause of the increase in the
value of the Company’s equity securities was the overall improvement in the equity markets.
The Company’s common stock allocation is intended to enhance the return of and provide diversification for the total
portfolio. At December 31, 2013, 8.9% of the total investment portfolio at fair value was held in equity securities, compared to
15.0% at December 31, 2012. During the second half of 2013, the Company sold a significant portion of its equity portfolio to