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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



FORM 10-K



ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934



For the Fiscal Year Ended December 31, 2003

Commission File No. 0-3681



MERCURY GENERAL CORPORATION

(Exact name of registrant as specified in its charter)



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|California                                                     |  | 95-221-1612                         
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|4484 Wilshire Boulevard, Los Angeles, California               |  | 90010                               
|(Address of principal executive offices)                       |  | (Zip Code)                          



Registrants telephone
number, including area code: (323) 937-1060



Securities registered
pursuant to Section 12(b) of the Act



|               |  |                                     
|-------------- |  | ------------------------------------
|Title of Class |  | Name of Exchange on Which Registered
|Common Stock   |  | New York Stock Exchange             



Securities registered pursuant
to Section 12(g) of the Act



NONE



Indicate by check mark whether the Registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past
90 days.  Yes  x    No   ̈



Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form
10-K.  x



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the
Act).  Yes  x    No   ̈



The aggregate market value of the Registrants voting and non-voting common equity
held by non-affiliates of the Registrant at June 30, 2003 was approximately $1,184,000,000 (based upon the closing sales price on the New York Stock Exchange for such date, as reported by the Wall Street Journal).



At February 13, 2004, the Registrant had issued and outstanding an aggregate of
54,425,128 shares of its Common Stock.



Documents Incorporated by
Reference



Portions of the definitive proxy statement for the Annual
Meeting of Shareholders of Registrant to be held on May 12, 2004 are incorporated herein by reference into Part III hereof.



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Item 1.    Business



General



Mercury General Corporation (Mercury General) and its subsidiaries (collectively, the Company) are engaged primarily in writing all risk
classifications of automobile insurance in a number of states, principally California. During 2003, private passenger automobile insurance and commercial automobile insurance accounted for 87.4% and 4.0%, respectively, of the Companys total
gross premiums written. The percentage of gross automobile insurance premiums written during 2003 by state was 84.0% in California, 7.2% in Florida, 4.5% in Texas, 1.2% in Oklahoma, 0.9% in Illinois, 0.8% in Georgia and 1.4% in all other states. The
Company also writes homeowners insurance, mechanical breakdown insurance, commercial and dwelling fire insurance and commercial property insurance. The non-automobile lines of insurance accounted for 8.6% of gross written premiums in 2003, of which
approximately 12% was in commercial lines.



The Company offers automobile
policyholders the following types of coverage: bodily injury liability, underinsured and uninsured motorist, personal injury protection, property damage liability, comprehensive, collision and other hazards. The Companys published maximum
limits of liability for bodily injury are $250,000 per person, $500,000 per accident and, for property damage, $250,000 per accident. Subject to special underwriting approval, the combined policy limits may be as high as $1,000,000 for vehicles
written under the Companys commercial automobile plan. However, under the majority of the Companys automobile policies, the limits of liability are equal to or less than $100,000 per person, $300,000 per accident and $50,000 for property
damage.



In 2003, all of the Companys subsidiaries actively writing
insurance, except American Mercury Insurance Company (AMI) and American Mercury Lloyds Insurance Company (AML), maintained a rating of A+ (Superior) by A.M. Best & Co. (A.M. Best). This is the second highest
of the fifteen rating categories in the A.M. Best rating system, which range from A++ (Superior) to F (In Liquidation). Each of AMI and AML, which accounted for approximately 5% of the Companys 2003 net written premiums, maintained an A.M.
Best rating of A- (Excellent).



The principal executive offices of
Mercury General are located in Los Angeles, California. The home office of its California insurance subsidiaries and the Companys computer and operations center is located in Brea, California. During 2003, the Company opened a new 130,000
square foot office building in Rancho Cucamonga, California which is used to support the Companys recent growth and future expansion. The Company maintains branch offices in a number of locations in California as well as branch offices in
Richmond, Virginia, Latham, New York, Vernon Hills, Illinois, Atlanta, Georgia, Clearwater, Florida, Oklahoma City, Oklahoma, and Austin, Dallas, Fort Worth, Houston and San Antonio, Texas. The Company has approximately 3,800 employees.



Website Access to Information



The internet address for the Companys website is www.mercuryinsurance.com. The Company makes available on its website its Annual
Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to such reports (the SEC Reports) filed or furnished to the SEC pursuant to Federal securities laws as soon as reasonably practicable
after each SEC Report is filed with, or furnished to the SEC. In addition, copies of the SEC Reports are available, without charge, upon written request to the Companys Chief Financial Officer, Mercury General Corporation, 4484 Wilshire
Boulevard, Los Angeles, California 90010.



Organization



Mercury General, an insurance holding company, is the parent of Mercury Casualty
Company (Mercury Casualty or MCC), a California automobile insurer founded in 1961 by George Joseph, Mercury Generals Chief Executive Officer. Including MCC, Mercury General has eighteen subsidiaries. The Companys
insurance operations in California are conducted through three California insurance company subsidiaries, Mercury Casualty, Mercury Insurance Company (Mercury Insurance or MIC), and California Automobile Insurance Company (Cal
Auto). The Company formed two subsidiaries, Mercury Insurance Company of Georgia (MICGA) and Mercury Insurance



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Company of Illinois (MICIL) in 1989 to write automobile insurance and added Mercury Indemnity Company of Georgia (MIDGA) and Mercury Indemnity
Company of Illinois (MIDIL) in 1992 to write preferred risk automobile insurance in Georgia and Illinois. In December 1996, the Company acquired American Mercury Insurance Company (formerly, American Fidelity Insurance Company) and AFI
Management Company, Inc. (AFIMC), a Texas corporation which serves as the attorney-in-fact for American Mercury Lloyds Insurance Company (formerly, American Fidelity Lloyds Insurance Company), a Texas insurer.



In December 1999, the Company acquired control of Concord Insurance Services, Inc.
(Concord), a Texas insurance agency headquartered in Houston, Texas. In September 2000, the Company acquired the authority and right to manage and control Elm County Mutual Insurance Company, a mutual insurance company organized under
Chapter 17 of the Texas Insurance Code. The acquisition was made through the purchase of a management agreement from Employers Reinsurance Corporation. Effective January 2, 2001, Elm County Mutual Insurance Companys name was changed to Mercury
County Mutual Insurance Company (MCM). In 2001, the Company expanded its operations into Virginia and New York. In December 2001, the Company received authority to write automobile insurance in the state of Florida through two newly
established companies, Mercury Insurance Company of Florida (MICFL) and Mercury Indemnity Company of Florida (MIDFL). In January 2002, MICFL commenced writing new business as well as renewing business that was previously
written through MCC in Florida.



In 2003, MIDFL changed its name to
Mercury Indemnity Company of America (MIDAM) and in August 2003 commenced writing new business in the state of New Jersey through a network of brokers.



Management services are provided to Mercury Generals subsidiaries by Mercury Insurance Services, LLC (MISLLC), a
subsidiary of Mercury Casualty. Mercury General and its subsidiaries are referred to collectively as the Company unless the context indicates otherwise. Mercury General Corporation individually is referred to as Mercury
General. All of the subsidiaries as a group, excluding AFIMC, MISLLC and Concord, are referred to as the Insurance Companies. The term California Companies refers to Mercury Casualty, Mercury Insurance and Cal Auto.



Underwriting



The Company sets its own automobile insurance premium rates, subject to rating regulations issued by the Insurance Commissioners of
the applicable states. Automobile insurance rates on voluntary business in California are subject to prior approval by the California Department of Insurance (DOI). The Company uses its own extensive data base to establish rates and
classifications. The California DOI has in effect rating factor regulations that influence the weight the Company ascribes to various classifications of data.



At December 31, 2003, good drivers (as defined by the California Insurance Code) accounted for approximately 77% of all voluntary private passenger
automobile policies in force in California, while the higher risk categories accounted for approximately 23%. The private passenger automobile renewal rate in California (the rate of acceptance of offers to renew) averages approximately 96%. The
Company also offers homeowners insurance to California residents.



In
states outside of California, the Company offers non-standard, standard and preferred private passenger automobile insurance. In addition the Company offers homeowners insurance in Florida, Illinois, Oklahoma and Georgia. Private passenger
automobile policies in force for non-California operations represent approximately 15% of total private passenger automobile policies in force at December 31, 2003.



Production and Servicing of Business



The Company sells its policies through more than 3,300 independent agents and brokers, of which approximately 1,000 are located in each of California and Florida
and approximately 400 represent AMI in Oklahoma and Texas. The remainder are located in Georgia, Illinois, Texas, New York, New Jersey and Virginia. Over half of



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the agents and brokers in California have represented the Company for more than ten years. The agents and brokers, most of whom also represent one or more competing
insurance companies, are independent contractors selected and appointed by the Company.



Other than one broker that produced approximately 16%, 16% and 17% during 2003, 2002, and 2001, respectively, of the Companys total direct premiums written, no agent or broker accounted for more than 2% of direct premiums
written.



The Company believes that it compensates its agents and brokers
above the industry average. During 2003, total commissions and bonuses incurred were 17.0% of net premiums written.



The Companys advertising budget is allocated among television, newspaper, internet and direct mailing media to provide the best coverage available within
defined media markets. While the majority of these advertising costs are borne by the Company, a portion of these costs are reimbursed by the Companys agents and brokers based upon the number of account leads generated by the advertising. The
Company believes that its advertising program is important to create brand awareness and to remain competitive in the current insurance climate and intends to maintain or possibly expand the current level of advertising in 2004 (See Competitive
Conditions).



Claims



Claims operations are conducted by the Company. The claims staff administers all
claims and directs all legal and adjustment aspects of the claims process. The Company adjusts most claims without the assistance of outside adjusters.



Loss and Loss Adjustment Expense Reserves



The Company maintains reserves for the payment of losses and loss adjustment expenses for both reported and unreported claims. Loss reserves are estimated based
upon a case-by-case evaluation of the type of claim involved and the expected development of such claim. The amount of loss reserves and loss adjustment expense reserves for unreported claims are determined on the basis of historical information by
line of insurance. Inflation is reflected in the reserving process through analysis of cost trends and reviews of historical reserving results.



The ultimate liability may be greater or less than stated loss reserves. Reserves are closely monitored and are analyzed quarterly by the Companys actuarial
consultants using current information on reported claims and a variety of statistical techniques. The Company does not discount to a present value that portion of its loss reserves expected to be paid in future periods. The Tax Reform Act of 1986
does, however, require the Company to discount loss reserves for Federal income tax purposes.



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The following table sets forth a reconciliation of beginning and ending reserves for losses and loss adjustment
expenses, net of reinsurance deductions, as shown on the Companys consolidated financial statements for the periods indicated:



|                                                                                       |  |                         |           |      |   |           |  |   |          
|-------------------------------------------------------------------------------------- |  | ----------------------- | --------- | ---- | - | --------- |  | - | ---------
|                                                                                       |  | Year ended December 31,
|                                                                                       |  | 2003                    |           | 2002 |   | 2001     
|                                                                                       |  | (Amounts in thousands) 
|Net reserves for losses and loss adjustment expenses, beginning of year                |  | $                       | 664,889   |      | $ | 516,592   |  | $ | 463,803  
|Incurred losses and loss adjustment expenses:                                          |  |                         |           |      |   |           |  |   |          
|Provision for insured events of the current year                                       |  |                         | 1,447,986 |      |   | 1,242,060 |  |   | 993,510  
|Increase in provision for insured events of prior years                                |  |                         | 4,065     |      |   | 26,183    |  |   | 16,929   
|                                                                                       |  |                         |           |      |   |           |  |   |          
|Total incurred losses and loss adjustment expenses                                     |  |                         | 1,452,051 |      |   | 1,268,243 |  |   | 1,010,439
|                                                                                       |  |                         |           |      |   |           |  |   |          
|Payments:                                                                              |  |                         |           |      |   |           |  |   |          
|Losses and loss adjustment expenses attributable to insured events of the current year |  |                         | 892,658   |      |   | 759,165   |  |   | 636,007  
|Losses and loss adjustment expenses attributable to insured events of prior years      |  |                         | 438,126   |      |   | 360,781   |  |   | 321,643  
|                                                                                       |  |                         |           |      |   |           |  |   |          
|Total payments                                                                         |  |                         | 1,330,784 |      |   | 1,119,946 |  |   | 957,650  
|                                                                                       |  |                         |           |      |   |           |  |   |          
|Net reserves for losses and loss adjustment expenses at the end of the period          |  |                         | 786,156   |      |   | 664,889   |  |   | 516,592  
|Reinsurance recoverable                                                                |  |                         | 11,771    |      |   | 14,382    |  |   | 18,334   
|                                                                                       |  |                         |           |      |   |           |  |   |          
|Gross liability at end of year                                                         |  | $                       | 797,927   |      | $ | 679,271   |  | $ | 534,926  
|                                                                                       |  |                         |           |      |   |           |  |   |          



The increase in the provision
for insured events of prior years in 2003 relates largely to an increase in the ultimate liability for physical damage and collision claims over what was originally estimated. For 2002 and 2001, the increase largely relates to an increase in the
ultimate liability for bodily injury, physical damage and collision claims over what was originally estimated. The increases in these claims relate to increased severity over what was originally recorded and are the result of inflationary trends in
health care costs, auto parts and body shop labor costs.



In October
2003, the Southern California region was devastated by sweeping fire storms. The Company has estimated that its pre-tax loss exposure resulting from these fire storms is approximately $16 million.



The difference between the reserves reported in the Companys consolidated
financial statements prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) and those reported in the statements filed with the DOI in accordance with statutory accounting principles
(SAP) is shown in the following table:



|                                  |  |                        |         |      |   |         |  |   |        
|--------------------------------- |  | ---------------------- | ------- | ---- | - | ------- |  | - | -------
|                                  |  | December 31,          
|                                  |  | 2003                   |         | 2002 |   | 2001   
|                                  |  | (Amounts in thousands)
|Reserves reported on a SAP basis  |  | $                      | 786,156 |      | $ | 664,889 |  | $ | 516,592
|Reinsurance recoverable           |  |                        | 11,771  |      |   | 14,382  |  |   | 18,334 
|                                  |  |                        |         |      |   |         |  |   |        
|Reserves reported on a GAAP basis |  | $                      | 797,927 |      | $ | 679,271 |  | $ | 534,926
|                                  |  |                        |         |      |   |         |  |   |        



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Under SAP, reserves are stated net of reinsurance recoverable in contrast to GAAP where reserves are stated gross
of reinsurance recoverable.



The following table represents the
development of loss reserves for the period 1993 through 2003. The top line of the table shows the reserves at the balance sheet date, net of reinsurance recoverable for each of the indicated years. This represents the estimated amount of losses and
loss adjustment expenses for claims arising in all prior years that are unpaid at the balance sheet date, including an estimate for losses that had been incurred but not yet reported to the Company. The upper portion of the table shows the
cumulative amounts paid as of successive years with respect to that reserve liability. The middle portion of the table shows the re-estimated amount of the previously recorded reserves based on experience as of the end of each succeeding year,
including cumulative payments made since the end of the respective year. The estimate changes as more information becomes known about the frequency and severity of claims for individual years. The bottom line shows the redundancy (deficiency) that
exists when the original reserve estimates are greater (less) than the re-estimated reserves at December 31, 2003.



In evaluating the information in the table, it should be noted that each amount includes the effects of all changes in amounts for prior periods. This table does
not present accident or policy year development data. Conditions and trends that have affected development of the liability in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate future
redundancies or deficiencies based on this table.



|                                                     |  |                        |         |      |   |         |      |  |   |         |   |  |      |         |   |      |   |         |      |  |   |         |   |  |      |         |   |      |   |         |      |  |   |         |   |  |   |         |   |  |   |        
|---------------------------------------------------- |  | ---------------------- | ------- | ---- | - | ------- | ---- |  | - | ------- | - |  | ---- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | - |  | ---- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | - |  | - | ------- | - |  | - | -------
|                                                     |  | As of December 31,    
|                                                     |  | 1993                   |         | 1994 |   |         | 1995 |  |   | 1996    |   |  | 1997 |         |   | 1998 |   |         | 1999 |  |   | 2000    |   |  | 2001 |         |   | 2002 |   |         | 2003
|                                                     |  | (Amounts in thousands)
|Net reserves for losses and loss adjustment expenses |  | $                      | 214,525 |      | $ | 223,392 |      |  | $ | 250,990 |   |  | $    | 311,754 |   |      | $ | 386,270 |      |  | $ | 385,816 |   |  | $    | 418,800 |   |      | $ | 463,803 |      |  | $ | 516,592 |   |  | $ | 664,889 |   |  | $ | 786,156
|Paid (cumulative) as of:                             |  |                        |         |      |   |         |      |  |   |         |   |  |      |         |   |      |   |         |      |  |   |         |   |  |      |         |   |      |   |         |      |  |   |         |   |  |   |         |   |  |   |        
|One year later                                       |  |                        | 143,272 |      |   | 145,664 |      |  |   | 167,226 |   |  |      | 206,390 |   |      |   | 247,310 |      |  |   | 263,805 |   |  |      | 294,615 |   |      |   | 321,643 |      |  |   | 360,781 |   |  |   | 438,126 |   |  |   |        
|Two years later                                      |  |                        | 187,641 |      |   | 198,967 |      |  |   | 225,158 |   |  |      | 291,552 |   |      |   | 338,016 |      |  |   | 366,908 |   |  |      | 403,378 |   |      |   | 431,498 |      |  |   | 491,243 |   |  |   |         |   |  |   |        
|Three years later                                    |  |                        | 204,606 |      |   | 214,403 |      |  |   | 248,894 |   |  |      | 316,505 |   |      |   | 369,173 |      |  |   | 395,574 |   |  |      | 429,787 |   |      |   | 462,391 |      |  |   |         |   |  |   |         |   |  |   |        
|Four years later                                     |  |                        | 207,704 |      |   | 219,596 |      |  |   | 253,708 |   |  |      | 324,337 |   |      |   | 379,233 |      |  |   | 402,000 |   |  |      | 439,351 |   |      |   |         |      |  |   |         |   |  |   |         |   |  |   |        
|Five years later                                     |  |                        | 209,930 |      |   | 220,852 |      |  |   | 255,688 |   |  |      | 329,109 |   |      |   | 381,696 |      |  |   | 405,910 |   |  |      |         |   |      |   |         |      |  |   |         |   |  |   |         |   |  |   |        
|Six years later                                      |  |                        | 210,281 |      |   | 221,771 |      |  |   | 257,041 |   |  |      | 329,825 |   |      |   | 383,469 |      |  |   |         |   |  |      |         |   |      |   |         |      |  |   |         |   |  |   |         |   |  |   |        
|Seven years later                                    |  |                        | 210,767 |      |   | 222,912 |      |  |   | 256,654 |   |  |      | 330,883 |   |      |   |         |      |  |   |         |   |  |      |         |   |      |   |         |      |  |   |         |   |  |   |         |   |  |   |        
|Eight years later                                    |  |                        | 211,655 |      |   | 222,492 |      |  |   | 257,292 |   |  |      |         |   |      |   |         |      |  |   |         |   |  |      |         |   |      |   |         |      |  |   |         |   |  |   |         |   |  |   |        
|Nine years later                                     |  |                        | 211,212 |      |   | 223,113 |      |  |   |         |   |  |      |         |   |      |   |         |      |  |   |         |   |  |      |         |   |      |   |         |      |  |   |         |   |  |   |         |   |  |   |        
|Ten years later                                      |  |                        | 211,968 |      |   |         |      |  |   |         |   |  |      |         |   |      |   |         |      |  |   |         |   |  |      |         |   |      |   |         |      |  |   |         |   |  |   |         |   |  |   |        
|Net reserves re-estimated as of:                     |  |                        |         |      |   |         |      |  |   |         |   |  |      |         |   |      |   |         |      |  |   |         |   |  |      |         |   |      |   |         |      |  |   |         |   |  |   |         |   |  |   |        
|One year later                                       |  |                        | 204,451 |      |   | 216,684 |      |  |   | 247,122 |   |  |      | 324,572 |   |      |   | 376,861 |      |  |   | 393,603 |   |  |      | 442,437 |   |      |   | 480,732 |      |  |   | 542,775 |   |  |   | 668,954 |   |  |   |        
|Two years later                                      |  |                        | 207,089 |      |   | 222,861 |      |  |   | 254,920 |   |  |      | 329,210 |   |      |   | 378,057 |      |  |   | 407,047 |   |  |      | 449,094 |   |      |   | 481,196 |      |  |   | 549,262 |   |  |   |         |   |  |   |        
|Three years later                                    |  |                        | 210,838 |      |   | 221,744 |      |  |   | 257,958 |   |  |      | 327,749 |   |      |   | 383,588 |      |  |   | 410,754 |   |  |      | 446,242 |   |      |   | 483,382 |      |  |   |         |   |  |   |         |   |  |   |        
|Four years later                                     |  |                        | 210,890 |      |   | 222,957 |      |  |   | 257,196 |   |  |      | 329,339 |   |      |   | 386,522 |      |  |   | 409,744 |   |  |      | 449,325 |   |      |   |         |      |  |   |         |   |  |   |         |   |  |   |        
|Five years later                                     |  |                        | 211,192 |      |   | 221,947 |      |  |   | 256,395 |   |  |      | 332,570 |   |      |   | 385,770 |      |  |   | 410,982 |   |  |      |         |   |      |   |         |      |  |   |         |   |  |   |         |   |  |   |        
|Six years later                                      |  |                        | 210,739 |      |   | 221,942 |      |  |   | 257,692 |   |  |      | 332,939 |   |      |   | 386,883 |      |  |   |         |   |  |      |         |   |      |   |         |      |  |   |         |   |  |   |         |   |  |   |        
|Seven years later                                    |  |                        | 210,719 |      |   | 223,215 |      |  |   | 258,743 |   |  |      | 333,720 |   |      |   |         |      |  |   |         |   |  |      |         |   |      |   |         |      |  |   |         |   |  |   |         |   |  |   |        
|Eight years later                                    |  |                        | 211,845 |      |   | 224,276 |      |  |   | 259,467 |   |  |      |         |   |      |   |         |      |  |   |         |   |  |      |         |   |      |   |         |      |  |   |         |   |  |   |         |   |  |   |        
|Nine years later                                     |  |                        | 212,902 |      |   | 225,019 |      |  |   |         |   |  |      |         |   |      |   |         |      |  |   |         |   |  |      |         |   |      |   |         |      |  |   |         |   |  |   |         |   |  |   |        
|Ten years later                                      |  |                        | 213,809 |      |   |         |      |  |   |         |   |  |      |         |   |      |   |         |      |  |   |         |   |  |      |         |   |      |   |         |      |  |   |         |   |  |   |         |   |  |   |        
|Net cumulative redundancy (deficiency)               |  |                        | 716     |      |   | (1,627  | )    |  |   | (8,477  | ) |  |      | (21,966 | ) |      |   | (613    | )    |  |   | (25,166 | ) |  |      | (30,525 | ) |      |   | (19,579 | )    |  |   | (32,670 | ) |  |   | (4,065  | ) |  |   |        



6



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|                                         |  |                        |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |  
|---------------------------------------- |  | ---------------------- | - |  | ------- | - |  | ------- | - |  | ------- | - |  | ------- | - |  | ------- | - |  | ------- | - |  | ------- | - |  | ------- | - |  | ------- | -
|                                         |  | As of December 31,     |  
|                                         |  | 1994                   |   |  | 1995    |   |  | 1996    |   |  | 1997    |   |  | 1998    |   |  | 1999    |   |  | 2000    |   |  | 2001    |   |  | 2002    |   |  | 2003    |  
|                                         |  | (Amounts in thousands) |  
|Gross liabilityend of year              |  | 227,499                |   |  | 253,546 |   |  | 336,685 |   |  | 409,061 |   |  | 405,976 |   |  | 434,843 |   |  | 492,220 |   |  | 534,926 |   |  | 679,271 |   |  | 797,927 |  
|Reinsurance recoverable                  |  | (4,107                 | ) |  | (2,556  | ) |  | (24,931 | ) |  | (22,791 | ) |  | (20,160 | ) |  | (16,043 | ) |  | (28,417 | ) |  | (18,334 | ) |  | (14,382 | ) |  | (11,771 | )
|                                         |  |                        |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |  
|Net liabilityend of year                |  | 223,392                |   |  | 250,990 |   |  | 311,754 |   |  | 386,270 |   |  | 385,816 |   |  | 418,800 |   |  | 463,803 |   |  | 516,592 |   |  | 664,889 |   |  | 786,156 |  
|                                         |  |                        |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |  
|Gross re-estimated liabilitylatest      |  | 237,895                |   |  | 269,136 |   |  | 361,338 |   |  | 411,868 |   |  | 432,696 |   |  | 466,610 |   |  | 512,462 |   |  | 567,321 |   |  | 683,145 |   |  |         |  
|Re-estimated recoverablelatest          |  | (12,876                | ) |  | (9,669  | ) |  | (27,618 | ) |  | (24,985 | ) |  | (21,714 | ) |  | (17,285 | ) |  | (29,080 | ) |  | (18,059 | ) |  | (14,191 | ) |  |         |  
|                                         |  |                        |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |  
|Net re-estimated liabilitylatest        |  | 225,019                |   |  | 259,467 |   |  | 333,720 |   |  | 386,883 |   |  | 410,982 |   |  | 449,325 |   |  | 483,382 |   |  | 549,262 |   |  | 668,954 |   |  |         |  
|                                         |  |                        |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |  
|Gross cumulative redundancy (deficiency) |  | (10,396                | ) |  | (15,590 | ) |  | (24,653 | ) |  | (2,807  | ) |  | (26,720 | ) |  | (31,767 | ) |  | (20,242 | ) |  | (32,395 | ) |  | (3,874  | ) |  |         |  
|                                         |  |                        |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |   |  |         |  



For calendar years 1998 through
2002, the Companys previously estimated loss reserves produced a deficiency which was reflected in the following years incurred losses. The Company attributes a large portion of the deficiency to an increase in the ultimate liability for
bodily injury, physical damage and collision claims over what was originally estimated. The increases in these claims relate to increased severity over what was originally recorded and are the result of inflationary trends in health care costs, auto
parts and body shop labor costs.



Throughout the 1990s average
bodily injury costs decreased until 1998 when they began to rise. Since individual losses for this coverage tend to develop slower than they do for the collision or physical damage line, it is difficult for the actuaries to identify such a change in
trend until well after the year has closed. Furthermore, once the Company knows it is in an inflationary trend, it is difficult to determine the magnitude of the inflation due to the slower developing nature of the bodily injury claims.



During 2002, the Company increased the bodily injury severity inflation rate that it
recorded for the 2001 and 2002 accident years from approximately 4% to approximately 8% on its California automobile lines which contributed significantly to the Companys total adverse development on 2001 and prior accident years. During 2003,
the Company increased the 2001 bodily injury severity inflation rate again to approximately 9%, reduced the 2002 rate to approximately 6% and recorded 2003 severity inflation at approximately 7%. Management monitors inflation trends closely and
adjusts assumptions based on its best estimate from the information available at the time. Future information will become available which could change managements assumptions.



For calendar year 1997, the Companys previously estimated loss reserves produced a small deficiency indicating that the Company
was reasonably accurate in establishing the initial reserve for that year.



For calendar years 1995 and 1996, the Companys previously estimated loss reserves produced deficiencies. These deficiencies relate to increases in the Companys ultimate estimates for loss adjustment expenses, which are based
principally on the Companys actual experience. The adverse development on such reserves reflects the increases in the legal expenses of defending the Companys insureds arising from the Companys policy of aggressively defending,
including litigating, exaggerated bodily injury claims arising from minimal impact automobile accidents.



For calendar years 1994 and 1993, the Companys previously estimated loss reserve produced a small deficiency and a small redundancy, respectively, indicating
that the Company was reasonably accurate in establishing the initial reserve for those years.



Operating Ratios



Loss and Expense Ratios



Loss and underwriting expense ratios are used to interpret the
underwriting experience of property and casualty insurance companies. Losses and loss adjustment expenses, on a statutory basis, are stated as a



7



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percentage of premiums earned because losses occur over the life of a policy. Underwriting expenses on a statutory basis are stated as a percentage of premiums written
rather than premiums earned because most underwriting expenses are incurred when policies are written and are not spread over the policy period. The statutory underwriting profit margin is the extent to which the combined loss and underwriting
expense ratios are less than 100%. The Companys loss ratio, expense ratio and combined ratio, and the private passenger automobile industry combined ratio, on a statutory basis, are shown in the following table. The Companys ratios
include lines of insurance other than private passenger automobile. Since these other lines represent only a small percentage of premiums written, the Company believes its ratios can be compared to the industry ratios included in the table.



|                                                      |  |                         |      |  |       |   |  |       |   |  |       |   |  |       |  
|----------------------------------------------------- |  | ----------------------- | ---- |  | ----- | - |  | ----- | - |  | ----- | - |  | ----- | -
|                                                      |  | Year ended December 31, |     
|                                                      |  | 2003                    |      |  | 2002  |   |  | 2001  |   |  | 2000  |   |  | 1999  |  
|Loss Ratio                                            |  | 67.7                    | %    |  | 72.8  | % |  | 73.2  | % |  | 72.2  | % |  | 66.5  | %
|Expense Ratio                                         |  | 25.9                    |      |  | 25.6  |   |  | 26.0  |   |  | 26.4  |   |  | 26.5  |  
|                                                      |  |                         |      |  |       |   |  |       |   |  |       |   |  |       |  
|Combined Ratio                                        |  | 93.6                    | %    |  | 98.4  | % |  | 99.2  | % |  | 98.6  | % |  | 93.0  | %
|                                                      |  |                         |      |  |       |   |  |       |   |  |       |   |  |       |  
|Industry combined ratio (all writers)(1)              |  | 99.1                    | %(2) |  | 103.7 | % |  | 107.4 | % |  | 108.0 | % |  | 102.6 | %
|Industry combined ratio (excluding direct writers)(1) |  | (N.A.                   | )    |  | 103.7 | % |  | 106.0 | % |  | 108.7 | % |  | 102.4 | %

---

|(1) |  | Source: A.M. Best, Aggregates & Averages (1999 through 2003), for all property and casualty insurance companies (private passenger automobile line only, after policyholder
dividends).
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Source: A.M. Best, Bests Review, January 2004, Review Preview.
|--- |  | -------------------------------------------------------------------

|(N.A.) |  | Not available.
|------ |  | --------------



Under GAAP, the loss ratio is computed in the same manner as under statutory accounting, but the expense ratio is determined by matching underwriting expenses to the period over which net premiums were earned, rather than to
the period that net premiums were written. The following table sets forth the Companys loss ratio, expense ratio and combined ratio determined in accordance with GAAP for the last five years.



|               |  |                         |   |  |      |   |  |      |   |  |      |   |  |      |  
|-------------- |  | ----------------------- | - |  | ---- | - |  | ---- | - |  | ---- | - |  | ---- | -
|               |  | Year ended December 31, |  
|               |  | 2003                    |   |  | 2002 |   |  | 2001 |   |  | 2000 |   |  | 1999 |  
|Loss Ratio     |  | 67.7                    | % |  | 72.8 | % |  | 73.2 | % |  | 72.2 | % |  | 66.5 | %
|Expense Ratio  |  | 26.3                    |   |  | 26.0 |   |  | 26.4 |   |  | 26.3 |   |  | 26.8 |  
|               |  |                         |   |  |      |   |  |      |   |  |      |   |  |      |  
|Combined Ratio |  | 94.0                    | % |  | 98.8 | % |  | 99.6 | % |  | 98.5 | % |  | 93.3 | %
|               |  |                         |   |  |      |   |  |      |   |  |      |   |  |      |  



Premiums to Surplus Ratio



The following table shows, for the periods indicated, the
Insurance Companies statutory ratios of net premiums written to policyholders surplus. Widely recognized guidelines established by the National Association of Insurance Commissioners (NAIC) indicate that this ratio should be
no greater than 3 to 1.



|                       |  |                                       |           |      |   |           |  |      |           |      |   |           |  |   |          
|---------------------- |  | ------------------------------------- | --------- | ---- | - | --------- |  | ---- | --------- | ---- | - | --------- |  | - | ---------
|                       |  | Year ended December 31,              
|                       |  | 2003                                  |           | 2002 |   | 2001      |  | 2000 |           | 1999
|                       |  | (Amounts in thousands, except ratios)
|Net premiums written   |  | $                                     | 2,268,778 |      | $ | 1,865,046 |  | $    | 1,442,886 |      | $ | 1,272,447 |  | $ | 1,206,171
|Policyholders surplus |  | $                                     | 1,169,427 |      | $ | 1,014,935 |  | $    | 1,045,104 |      | $ | 954,753   |  | $ | 853,794  
|Ratio                  |  |                                       | 1.9 to 1  |      |   | 1.8 to 1  |  |      | 1.4 to 1  |      |   | 1.3 to 1  |  |   | 1.4 to 1 



Risk Based Capital



The NAIC employs a risk-based capital formula for casualty
insurance companies which establishes recommended minimum capital requirements for casualty companies. The formula was designed to capture the widely varying elements of risks undertaken by writers of different lines of insurance having differing
risk characteristics, as well as writers of similar lines where differences in risk may be related to corporate structure,



8



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investment policies, reinsurance arrangements and a number of other factors. Based on the formula adopted by the NAIC, the Company has calculated the Risk-Based
Capital Requirements of each of the Insurance Companies as of December 31, 2003. Each of the companies exceeded the highest level of minimum required capital.



Statutory Accounting Principles



The Companys results are reported in accordance with GAAP, which differ from amounts reported in accordance with SAP as prescribed by insurance regulatory
authorities. Specifically, under GAAP:



| |  |  | Policy acquisition costs such as commissions, premium taxes and other variable costs incurred in connection with writing new and renewal business are capitalized and amortized on a pro rata
basis over the period in which the related premiums are earned, rather than expensed as incurred, as required by SAP.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Certain assets are included in the consolidated balance sheets whereas, under SAP, such assets are designated as nonadmitted assets, and charged directly against statutory
surplus. These assets consist primarily of premium receivables that are outstanding over 90 days, federal deferred tax assets in excess of statutory limitations, furniture, equipment, leasehold improvements and prepaid expenses.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Amounts related to ceded reinsurance are shown gross as prepaid reinsurance premiums and reinsurance recoverables, rather than netted against unearned premium reserves and loss and loss
adjustment expense reserves, respectively, as required by SAP.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Fixed maturities securities, which are classified as available-for-sale, are reported at current market values, rather than at amortized cost, or the lower of amortized cost or market,
depending on the specific type of security, as required by SAP.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Equity securities are reported at quoted market values which may differ from the NAIC market values as required by SAP.
| | - |  | -----------------------------------------------------------------------------------------------------------------------



| |  |  | Costs for application computer software developed or obtained for internal use are capitalized and amortized over their useful life, rather then expensed as incurred, as required by SAP.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The differing treatment of income and expense items results in a corresponding difference in federal income tax expense. Changes in deferred income taxes are reflected as an item of income
tax benefit or expense, rather than recorded directly to surplus as regards policyholders, as required by SAP. Admittance testing may result in a charge to unassigned surplus for non-admitted portions of deferred tax assets. Under GAAP reporting, a
valuation allowance may be recorded against the deferred tax asset and reflected as an expense.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Investments and Investment Results



The
investments of the Company are directed by the Companys Chief Investment Officer under the supervision of the Companys Board of Directors. The Company follows an investment policy which is regularly reviewed and revised. The
Companys policy emphasizes investment grade, fixed income securities and maximization of after-tax yields and places certain restrictions to limit portfolio concentrations and market exposure. Sales of securities are undertaken, with resulting
gains or losses, in order to enhance after-tax yield and keep the portfolio in line with current market conditions. Tax considerations are important in portfolio management, and have been made more so since 1986 when the alternative minimum tax
(AMT) was imposed on casualty companies. Changes in loss experience, growth rates and profitability produce significant changes in the Companys exposure to AMT liability, requiring appropriate shifts in the investment asset mix
between taxable bonds, tax-exempt bonds and equities in order to maximize after-tax yield.



9



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The following table sets forth the composition of the investment portfolio of the Company at the dates indicated:



|                                                    |  |                        |           |                  |   |                  |  |       |           |      |   |           |  |   |           |  |   |          
|--------------------------------------------------- |  | ---------------------- | --------- | ---------------- | - | ---------------- |  | ----- | --------- | ---- | - | --------- |  | - | --------- |  | - | ---------
|                                                    |  | December 31,          
|                                                    |  | 2003                   |           | 2002             |   | 2001            
|                                                    |  | Amortized Market       |           | Amortized Market |   | Amortized Market
|                                                    |  | Cost                   |           | Value            |   | Cost             |  | Value |           | Cost |   | Value    
|                                                    |  | (Amounts in thousands)
|Taxable bonds                                       |  | $                      | 350,750   |                  | $ | 356,181          |  | $     | 198,994   |      | $ | 185,643   |  | $ | 283,991   |  | $ | 271,925  
|Tax-exempt state and municipal bonds                |  |                        | 1,492,873 |                  |   | 1,576,606        |  |       | 1,352,616 |      |   | 1,433,242 |  |   | 1,260,485 |  |   | 1,298,637
|Sinking fund preferred stocks                       |  |                        | 12,460    |                  |   | 12,522           |  |       | 14,150    |      |   | 13,986    |  |   | 15,704    |  |   | 15,871   
|                                                    |  |                        |           |                  |   |                  |  |       |           |      |   |           |  |   |           |  |   |          
|Total fixed maturity investments                    |  |                        | 1,856,083 |                  |   | 1,945,309        |  |       | 1,565,760 |      |   | 1,632,871 |  |   | 1,560,180 |  |   | 1,586,433
|Equity investments incl. perpetual preferred stocks |  |                        | 223,113   |                  |   | 264,393          |  |       | 233,297   |      |   | 230,981   |  |   | 277,925   |  |   | 277,787  
|Short-term cash investments                         |  |                        | 329,812   |                  |   | 329,812          |  |       | 286,806   |      |   | 286,806   |  |   | 71,951    |  |   | 71,951   
|                                                    |  |                        |           |                  |   |                  |  |       |           |      |   |           |  |   |           |  |   |          
|Total investments                                   |  | $                      | 2,409,008 |                  | $ | 2,539,514        |  | $     | 2,085,863 |      | $ | 2,150,658 |  | $ | 1,910,056 |  | $ | 1,936,171
|                                                    |  |                        |           |                  |   |                  |  |       |           |      |   |           |  |   |           |  |   |          



The Company continually
evaluates the recoverability of its investment holdings. When a decline in value of fixed maturities or equity securities is considered other than temporary, the Company writes the security down to fair value by recognizing a loss in the
Consolidated Statement of Income. The Company recognized losses of $9.1 million in 2003 and $71.7 million in 2002 of investment write-downs considered to be other than temporarily impaired. Declines in value considered to be temporary are charged as
unrealized losses to shareholders equity as accumulated other comprehensive income. At December 31, 2003, the Company had a net unrealized gain on all investments of $130.5 million before income taxes which is comprised of unrealized gains of
$140.8 million offset by unrealized losses of $10.3 million. Of these unrealized losses, approximately $7.7 million relate to fixed maturities which are current on their debt servicing obligations. The remaining unrealized losses of approximately
$2.6 million relate to equity securities. The Company has concluded that the gross unrealized losses of $10.3 million at December 31, 2003 were temporary in nature. However, facts and circumstances may change which could result in a decline in
market value considered to be other than temporary.



At year-end,
approximately 62% of the Companys total investment portfolio, at market values, and 81% of its total fixed maturity investments, at market values, were invested in medium term, investment grade tax-exempt revenue and municipal bonds. Shorter
duration sinking fund preferred stocks and collateralized mortgage obligations represented approximately 6.9% of the Companys total investment portfolio, at market values, and 8.9% of its total fixed maturity investments, at market value, at
December 31, 2003. The average Standard & Poors rating of the Companys bond holdings was AA at December 31, 2003.



The nominal average maturity of the overall bond portfolio which includes collateralized mortgage obligations and short-term cash investments was 12.2 years at
December 31, 2003 which reflects a heavier portfolio mix in medium term, investment grade tax-exempt revenue and municipal bonds. The call-adjusted average maturity of the overall bond portfolio was shorter, approximately 4.8 years, because holdings
are heavily weighted with high coupon issues which are expected to be called prior to maturity. The modified duration of the overall bond portfolio reflecting anticipated early calls was 3.8 years at December 31, 2003 which includes collateralized
mortgage obligations with modified durations of approximately 0.9 years and short-term cash investments 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. Because it measures four factors (maturity, coupon rate, yield and call terms) which determine sensitivity to changes in interest rates, modified duration is



10



---

considered a much better indicator of price volatility than simple maturity alone. The longer the duration, the greater the price volatility in relation to changes in
interest rates. Holdings of lower than investment grade bonds constitute approximately 2% of total assets.



Equity holdings consist of perpetual preferred stocks and dividend-bearing common stocks on which dividend income is partially tax-sheltered by the 70% corporate
dividend exclusion. At year end, short-term cash investments consisted of highly rated short duration securities redeemable on a daily or weekly basis. This component of the portfolio was increased by management when longer term investment
opportunities were considered unattractive as a result of the current interest rate environment.



The Company writes covered call options through listed exchanges and over the counter with the intent of generating additional income or return on capital. The
total investment under the covered call program in 2003 was approximately $30 million. The Company as a writer of an option bears the market risk of an unfavorable change in the price of the security underlying the written option. The Board of
Directors has authorized the Companys management to commence selling put options in 2004 and to increase its option writing program up to $40 million.



The following table summarizes the investment results of the Company for the five years ended December 31, 2003:



|                                                                                          |  |                         |           |     |         |   |           |         |  |   |           |   |  |      |           |   |  |   |           |     
|----------------------------------------------------------------------------------------- |  | ----------------------- | --------- | --- | ------- | - | --------- | ------- |  | - | --------- | - |  | ---- | --------- | - |  | - | --------- | ----
|                                                                                          |  | Year ended December 31, |          
|                                                                                          |  | 2003(1)                 |           |     | 2002(1) |   |           | 2001(1) |  |   | 2000(1)   |   |  | 1999 |          
|                                                                                          |  | (Amounts in thousands)  |          
|Averaged invested assets (includes short-term cash investments(2))                        |  | $                       | 2,310,966 |     |         | $ | 2,035,279 |         |  | $ | 1,828,455 |   |  | $    | 1,710,176 |   |  | $ | 1,595,466 |     
|Net investment income:                                                                    |  |                         |           |     |         |   |           |         |  |   |           |   |  |      |           |   |  |   |           |     
|Before income taxes                                                                       |  |                         | 104,520   |     |         |   | 113,083   |         |  |   | 114,511   |   |  |      | 106,466   |   |  |   | 99,374    |     
|After income taxes                                                                        |  |                         | 93,318    |     |         |   | 99,071    |         |  |   | 98,909    |   |  |      | 95,154    |   |  |   | 89,598    |     
|Average annual yield on investments:                                                      |  |                         |           |     |         |   |           |         |  |   |           |   |  |      |           |   |  |   |           |     
|Before income taxes                                                                       |  |                         | 4.5       | %   |         |   | 5.6       | %       |  |   | 6.3       | % |  |      | 6.2       | % |  |   | 6.2       | %   
|After income taxes                                                                        |  |                         | 4.0       | %   |         |   | 4.9       | %       |  |   | 5.4       | % |  |      | 5.6       | % |  |   | 5.6       | %   
|Net realized investment gains (losses) after income taxes                                 |  |                         | 7,285     | (3) |         |   | (45,768   | )(3)    |  |   | 4,233     |   |  |      | 2,564     |   |  |   | (7,754    | )(3)
|Net increase (decrease) in un-realized gains/losses on all investments after income taxes |  | $                       | 42,693    |     |         | $ | 25,165    |         |  | $ | (13,896   | ) |  | $    | 70,342    |   |  | $ | (90,667   | )   

---

|(1) |  | Includes MCM for the last three months of 2000 and the full year in 2001, 2002 and 2003.
|--- |  | ----------------------------------------------------------------------------------------

|(2) |  | Fixed maturities and equities at cost.
|--- |  | --------------------------------------

|(3) |  | Includes investment write-downs, net of tax benefit, that the Company considered to be other than temporary of $3.9 million in 1999, $46.6 million in 2002 and $5.9 million in 2003. There were
no investment write-downs in 2000 and 2001.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Competitive Conditions



The property and casualty insurance industry is highly competitive.
The insurance industry consists of a large number of companies, many of which operate in more than one state, offering automobile, homeowners and commercial property insurance, as well as insurance coverage in other lines. Many of the Companys
competitors have larger volumes of business and greater financial resources than the Company. Based on the most recent regularly published statistical compilations, the Company in 2002 was the sixth largest writer of private passenger automobile
insurance in California. All of the Companys competitors having greater shares of the California market sell insurance either directly and/or through exclusive agents, rather than through independent agents and brokers.



11



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The property and casualty insurance industry is highly cyclical, characterized by periods of high premium rates and
shortages of underwriting capacity (hard market) followed by periods of severe price competition and excess capacity (soft market). In the Companys view, the overall profitability of the California marketplace during
the 1996 through 1998 time period created a favorable environment for automobile insurance writers. Many major automobile insurers attempted to capitalize on the favorable climate by increasing their marketing efforts and reducing rates in attempts
to capture more business. These industry wide rate reductions and increased severity trends on bodily injury, collision and physical damage coverages contributed to the deterioration of industry loss ratios in the years 1999 through 2002 (See
Operating RatiosLoss and Expense Ratios). Many of the Companys major competitors have announced better results in 2003 which typically signals a softening in the market, and consequently, the Company expects that it will be more
difficult to grow in 2004, particularly in California. The Company expects to offset some of the expected reduction in growth through expansion into new states.



Price and reputation for service are the principal means by which the Company competes with other automobile insurers. The Company believes that it has a good
reputation for service, and it has, historically, been among the lowest-priced insurers doing business in California according to surveys conducted by the California DOI. In addition to good service and competitive pricing, for those insurers
dealing through independent agents or brokers, as the Company does, the marketing efforts of agents and brokers is also a means of competition.



All rates charged by private passenger automobile insurers are subject to the prior approval of the California DOI. (See RegulationAutomobile Insurance Rating
Factor Regulations).



The Company encounters similar competition in each
state and each line of business in which it operates outside California.



Reinsurance



The Company maintains property reinsurance under a treaty with
Swiss Re, which is rated A++ by A.M. Best, effective January 1, 1999. Prior to October 1, 2002, the treaty provided $750,000 coverage in excess of $250,000 for each risk subject to a maximum of $2,250,000 for any one occurrence. A second layer of
coverage provides an additional $1,000,000 in excess of the first $1,000,000 per risk. Effective March 1, 2002, a third layer of coverage provides an additional $3,000,000 in excess of the first $2,000,000 for coverage which exceeds $2,000,000 in
insured value. On October 1, 2002, the first layer of the treaty was amended from $750,000 in excess of $250,000 to $500,000 in excess of $500,000. Effective January 1, 2004, the first layer of the treaty was amended to $250,000 in excess of
$750,000 and a fourth layer of $5,000,000 in excess of $5,000,000 was added.



This treaty was utilized during 2003 for the Southern California fire storms in October. At December 31, 2003, the Company estimates its total reinsurance recovery from losses caused by the fires will be approximately $1.5 million.



The Company has in place a treaty reinsurance agreement with Swiss Re,
where risks written under personal umbrella policies are ceded to Swiss Re on a quota share basis. Prior to May 1, 2003 the treaty was on a 100% quota share basis and provided $4 million coverage in excess of $1 million for each risk. Effective May
1, 2003, the treaty was replaced with a 33% quota share agreement for umbrella policies with coverage amounts up to but not exceeding $2 million. Consequently, there is no reinsurance on the portion of umbrella policy limits over $2 million.



The Company does not maintain catastrophe reinsurance for property and
automobile physical damage business because the Company believes it has adequate capitalization to absorb catastrophe losses in these lines. The Company periodically reviews its requirements for catastrophic reinsurance particularly in areas that
are prone to catastrophes such as Florida and California. For California, the Company has reduced its catastrophe exposure from earthquakes due to the placement of earthquake risks, written in conjunction with California homeowners policies, with
the California Earthquake Authority. (See RegulationCalifornia Earthquake Authority). Although the Companys catastrophe exposure to earthquakes has been reduced, the Company continues to have catastrophe exposure for fire following an
earthquake.



12



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The Employers Reinsurance Corporation (ERC) reinsures AMI through working layer treaties for
property and casualty losses in excess of $500,000 up to $4 million. AMI has other reinsurance treaties and facultative arrangements in place for various smaller lines of business.



All new business written by MCM is ceded to either MCC or AMI. MCM continues to maintain reinsurance treaties with several different
reinsurers covering policies prior to January 1, 2001. The Company also holds a formal guarantee from ERC which reimburses MCM if any of the reinsurers fail to satisfy their obligations under their respective reinsurance agreements.



If the reinsurers were unable to perform their obligations under the reinsurance
treaty, the Company would be required, as primary insurer, to discharge all obligations to its insureds in their entirety.



Regulation



The Companys business in California is subject to regulation and supervision by the California DOI, which has broad regulatory, supervisory and administrative powers.



The powers of the California DOI primarily include the prior approval of insurance
rates and rating factors and the establishment of capital and surplus requirements and standards of solvency which must be met and maintained, restrictions on dividend payments and transactions with affiliates. The regulation and supervision by the
California DOI are designed principally for the benefit of policyholders and not for insurance company shareholders.



The California DOIs Market Conduct Division is responsible for conducting periodic examinations of companies to ensure compliance with California Insurance
Code and California Code of Regulations with respect to rating, underwriting and claims handling practices. The most recent examination covered the underwriting and rating practices applied to its homeowners multiple peril, personal automobile,
commercial multiple peril and commercial automobile insurance of the California Companies and AMI during the period January 1, 1999 through December 31, 2001. The report on the examination is pending finalization by the California DOI. The
California DOI is conducting a periodic financial examination of the Companys California domiciled insurance subsidiaries for the period January 1, 2001 through December 31, 2003.



In February 2004, the Department of Insurance issued a Notice of Non-Compliance (NNC) to the California Companies. The NNC
alleges that the California Companies willfully misrepresented the actual price insurance consumers could expect to pay for insurance by the amount of a one-time fee charged by the consumers insurance broker. The NNC carries penalties which
include fines for each policy issued whose premium including the broker fee exceeded the premium level approved by the Department of Insurance and fines for each comparative advertisement used in print media that failed to disclose the broker fees
amongst other things. The California Companies are preparing a Notice of Defense in advance of an administrative hearing which will be based primarily on the same grounds formed by the Companys defense in the Robert Krumme case. The outcome of
this matter is uncertain and the impact to the Company cannot be determined at the present time (See Item 3. Legal Proceedings).



The insurance subsidiaries outside California are subject to the regulatory powers of the insurance departments of those states. Those powers are similar to the
regulatory powers in California enumerated above. Generally, the regulations relate primarily to standards of solvency and are designed for the benefit of policyholders and not of insurance company shareholders.



In California, Georgia, New York and New Jersey, insurance rates require prior approval
from the State DOI, while Illinois, Texas and Virginia only require that rates be filed with the DOI. Oklahoma and Florida have a modified version of prior approval laws. In all states, the insurance code provides that rates must not be
excessive, inadequate or unfairly discriminatory.



13



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The California DOI required all insurers offering persistency discounts to make class plan filings by January 15,
2003, removing the portability of these discounts. Persistency discounts represent discounts on policy rates extended to consumers based upon the number of consecutive years that the consumers carried insurance coverage. These class plans were never
implemented because Senate Bill 841 was enacted during 2003 amending the California Insurance Code to allow insurers to offer products with portable persistency discounts. In January 2004, this legislation was overturned through judicial proceedings
in the Los Angeles Superior Court. The Company intervened in the original proceedings and intends to seek appellate review of this ruling. The outcome of such action is uncertain. The changes made during the class plan filing indicated that removing
persistency discounts is revenue neutral for the Companys existing business. The removal of persistency discounts could have an impact on the Companys price competitiveness in attracting new business and would cause many existing
customers rates to change. However, this impact, if any, is undeterminable.



The Georgia DOI conducted an examination of MICGA and MIDGA as of December 31, 2000. The exam resulted in no adjustments or material findings. The Illinois DOI conducted an examination of MICIL and MIDIL as of December 31, 2000. The reports
on that examination are not yet available. The Oklahoma DOI conducted an examination of AMI as of December 31, 2001. The exam resulted in no material findings or recommendations. The State of Texas conducted an examination of MCM in the fall of
2002. The exam resulted in no adjustments or material findings. The State of Florida conducted examinations of MICFL and MIDFL (now MIDAM) for the period August 27, 2001 through December 31, 2002. The report on examination is pending finalization.



The operations of the Company are dependent on the laws of the state in
which it does business and changes in those laws can materially affect the revenue and expenses of the Company. The Company retains its own legislative advocates in California. The Company also makes financial contributions to officeholders and
candidates. In 2003 and 2002, those contributions amounted to $789,600 and $726,950, respectively. The Company believes in supporting the political process and intends to continue to make such contributions in amounts which it determines to be
appropriate.



Insurance Guarantee Association



The California Insurance Guarantee Association (the Association) was
created to provide for payment of claims for which insolvent insurers of most casualty lines are liable but which cannot be paid out of such insurers assets. The Company is subject to assessment by the Association for its pro-rata share of
such claims based on premiums written in the particular line in the year preceding the assessment by insurers writing that line of insurance in California. Insurance subsidiaries in the other states are also subject to the provisions of similar
insurance guaranty associations. Such assessments are based upon estimates of losses to be incurred in liquidating an insolvent insurer. In a particular year, the Company cannot be assessed an amount greater than 2% of its premiums written in the
preceding year. Assessments are recouped through a mandated surcharge to policyholders the year after the assessment. The Company accounts for assessments in accordance with AICPA Statement of Position 97-3 (SOP 97-3), which requires the
recognition of a liability when an assessment is levied or information is available indicating that an assessment is probable. In addition, SOP 97-3 prohibits the recognition of an asset for recoveries related to new business or renewal of short
duration policies. There were no assessments levied against the Company during 2003.



Holding Company Act



The California
Companies are subject to regulation by the California DOI pursuant to the provisions of the California Insurance Holding Company System Regulatory Act (the Holding Company Act). The California DOI may examine the affairs of each of the
California Companies at any time. The Holding Company Act requires disclosure of any material transactions among the companies. Certain transactions and dividends defined to be of an extraordinary type may not be effected if the
California DOI disapproves the transaction within 30 days after notice. Such transactions include, but are not limited to, certain reinsurance transactions and sales, purchases, exchanges, loans and extensions of credit, and investments, in the net
aggregate, involving more than the lesser of



14



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3% of the respective California Companys admitted assets or 25% of surplus as to policyholders, as of the preceding December 31. An extraordinary dividend is a
dividend which, together with other dividends or distributions made within the preceding 12 months, exceeds the greater of 10% of the insurance companys statutory policyholders surplus as of the preceding December 31 or the insurance
companys statutory net income for the preceding calendar year. An insurance company is also required to notify the California DOI of any dividend after declaration, but prior to payment.



The Holding Company Act also provides that the acquisition or change of
control of a California domiciled insurance company or of any person who controls such an insurance company cannot be consummated without the prior approval of the Insurance Commissioner. In general, a presumption of control
arises from the ownership of voting securities and securities that are convertible into voting securities, which in the aggregate constitute 10% or more of the voting securities of a California insurance company or of a person that controls a
California insurance company, such as Mercury General. A person seeking to acquire control, directly or indirectly, of the Company must generally file with the Insurance Commissioner an application for change of control containing
certain information required by statute and published regulations and provide a copy of the application to the Company. The Holding Company Act also effectively restricts the Company from consummating certain reorganizations or mergers without prior
regulatory approval.



The insurance subsidiaries in Florida, Georgia,
Illinois, Oklahoma and Texas are subject to holding company acts in those states, the provisions of which are substantially similar to those of the Holding Company Act. Regulatory approval was obtained from California, Oklahoma and Texas before the
acquisition of AMI was completed. Approval was granted by Texas for the transaction in which the Company acquired control of MCM.



Assigned Risks



Automobile liability insurers in California are required to sell bodily injury liability, property damage liability, medical expense and uninsured motorist coverage
to a proportionate number (based on the insurers share of the California automobile casualty insurance market) of those drivers applying for placement as assigned risks. Drivers seek placement as assigned risks because their
driving records or other relevant characteristics, as defined by Proposition 103, make them difficult to insure in the voluntary market. Premium rates for assigned risk business are set by the California DOI. In October 1990, more stringent rules
for gaining entry into the Assigned Risk Program were approved, resulting in a substantial reduction in the number of assigned risks insured by the Company since 1991. Since January 1, 1994, the California Insurance Code has required that rates
established for this program be adequate to support this programs losses and expenses. The Commissioner approved a rate decrease of 28.3% effective February 1, 1999. Effective November 1, 2003, the Commissioner approved a rate increase of
15.5% on new and renewal assigned risk business. While the number of assignments has increased in each of 2001, 2002 and 2003, the total assignments were not material. In 2003, assigned risks represented 0.2% of total automobile direct premiums
written and 0.2% of total automobile direct premium earned. The Company attributes the low level of assignments to the competitive voluntary market.



Automobile Insurance Rating Factor Regulations



California Proposition 103 requires that property and casualty insurance rates be approved by the Insurance Commissioner prior to their use, and that no rate be
approved which is excessive, inadequate, unfairly discriminatory or otherwise in violation of the provisions of the initiative. The proposition specifies four statutory factors required to be applied in decreasing order of importance in
determining rates for private passenger automobile insurance: (1) the insureds driving safety record, (2) the number of miles the insured drives annually, (3) the number of years of driving experience of the insured and (4) whatever optional
factors are determined by the Insurance Commissioner to have a substantial relationship to risk of loss and adopted by regulation. The statute further provides that insurers are required to give at least a 20% discount to good drivers,
as defined, from rates that would otherwise be charged to such drivers and that no insurer may refuse to insure a good driver.



15



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The California Insurance Commissioner uses rating factor regulations which are designed to implement the
Proposition 103 guidelines. The Companys rate plan was approved by the California Insurance Commissioner and operates under these rating factor regulations.



The Company, and most other insurers charge different rates for residents of different geographical areas within California. The
Companys geographical rate differentials have been derived by actuarial analysis of the claims costs in a given area. The rates for urban areas, particularly in Los Angeles, have been generally higher than for suburban and rural areas. The
California Insurance Commissioner is conducting townhall meetings to discuss modifying how territory is used as a rating factor. The outcome of this matter is uncertain and the impact to the Company can not be determined at this time.



California Financial Responsibility Law



California requires proof of insurance for the registration (new or renewal) of a
motor vehicle. It also provides for substantial penalties for failure to supply proof of insurance if a driver is stopped for a traffic violation. In addition, California provides that uninsured drivers who are injured in an automobile accident are
able to recover only actual, out-of-pocket medical expenses and lost wages and are not entitled to receive awards for general damages, i.e., pain and suffering. This restriction also applies to drunk drivers and fleeing felons. The law
has helped in controlling loss costs.



Third Party Bad
Faith Legislation



Recent initiatives
in California to reinstate third party bad faith lawsuits have been unsuccessful. If such legislation is enacted, it could have a significant detrimental effect on the Companys operating results. This would particularly be the case
if the Company had difficulty in implementing rate increases to compensate for increased loss costs.



California Earthquake Authority



The California Earthquake Authority (CEA) is a quasi-governmental organization that was established to provide a market for earthquake coverage to
California homeowners. Since 1998, the Company places all new and renewal earthquake coverage offered with its homeowners policy through the California Earthquake Authority. The Company receives a small fee for placing business with the CEA.



Upon the occurrence of a major seismic event, the CEA has the ability to
assess participating companies for losses. These assessments are made after CEA capital has been expended and are based upon each companys participation percentage multiplied by the amount of the total assessment. Based upon the most recent
information provided by the CEA, the Companys maximum total exposure to CEA assessments at April 17, 2003, is approximately $38.9 million.



Terrorism Risk Insurance Act of 2002



On November 26, 2002, the federal government enacted the Terrorism Risk Insurance Act of 2002 (the Act), which established a temporary Federal program
that provides for a system of shared public and private compensation for insured commercial property and casualty losses resulting from acts of terrorism, as defined within the Act. The Terrorism Insurance Program (the Program) requires
all commercial property and casualty insurers licensed in the United States to participate. The Program provides that in the event of a terrorist attack, as defined, resulting in insurance industry losses exceeding $5 million, the U.S. government
will provide funding to the insurance industry on an annual aggregate basis of 90% of covered losses up to $100 billion. Each insurance company is subject to a deductible based upon a percentage of the previous years direct earned premium;
with the percentage increasing each year. The Program required insurers to notify in-force commercial policyholders by February 24, 2003 that coverage for terrorism acts is provided and the cost for this coverage. The Company is



16



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required to offer this coverage at each subsequent renewal even if the policyholder elected to exclude this coverage in the previous policy period. The Program became
effective upon enactment and runs through December 31, 2005.



The Company
writes a limited amount of commercial property policies and does not write policies on properties considered to be a target of terrorist activities such as airports, hotels, large office structures, amusement parks, landmark defined structures or
other public facilities. In addition, there is not a high concentration of commercial policies in any one area where increased exposure to terrorist threats exist. Consequently, the Company believes its exposure relating to acts of terrorism is low
and consequently, few policyholders will buy this coverage.



EXECUTIVE
OFFICERS OF THE COMPANY



The following table sets forth certain
information concerning the executive officers of the Company as of February 13, 2004:



|                      |  |     |  |                                                  
|--------------------- |  | --- |  | -------------------------------------------------
|Name                  |  | Age |  | Position                                         
|George Joseph         |  | 82  |  | Chairman of the Board and Chief Executive Officer
|Gabriel Tirador       |  | 39  |  | President and Chief Operating Officer            
|Cooper Blanton, Jr.   |  | 77  |  | Executive Vice President                         
|Bruce E. Norman       |  | 55  |  | Senior Vice PresidentMarketing                  
|Joanna Y. Moore       |  | 48  |  | Vice President and Chief Claims Officer          
|Kenneth G. Kitzmiller |  | 57  |  | Vice PresidentUnderwriting                      
|Theodore R. Stalick   |  | 40  |  | Vice President and Chief Financial Officer       
|Judy A. Walters       |  | 57  |  | Vice PresidentCorporate Affairs and Secretary   
|Christopher Graves    |  | 38  |  | Vice President and Chief Investment Officer      
|Charles Toney         |  | 42  |  | Vice President and Chief Actuary                 
|Maria Fitzpatrick     |  | 46  |  | Vice President and Chief Information Officer     
|Peter Simon           |  | 44  |  | Vice President and Chief Technology Officer      



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Mr. Joseph, Chief Executive Officer of the Company and Chairman of its Board of Directors, has served in those
capacities since 1961. Mr. Joseph has more than 45 years experience in the property and casualty insurance business.



Mr. Tirador, President and Chief Operating Officer, served as the Companys assistant controller from March 1994 to December 1996. During January 1997 to
February 1998 he served as the Vice President and Controller of the Automobile Club of Southern California. He rejoined the Company in February 1998 as Vice President and Chief Financial Officer. He was appointed President and Chief Operating
Officer in October 2001. Mr. Tirador has over fifteen years experience in the property and casualty insurance industry and is a Certified Public Accountant.



Mr. Blanton, Executive Vice President, joined the Company in 1966 and supervised its underwriting activities from 1967 until September 1995. He was appointed
Executive Vice President of Mercury Casualty and Mercury Insurance in 1983 and was named Executive Vice President of Mercury General in 1985. In May 1995, he was named President of the Georgia and Illinois insurance company subsidiaries and in
February 1996 he was elected to the Board of Directors of those companies. In January 1999, he was named Chairman of the Board of AMIC and President in April 2000. Mr. Blanton has over 40 years of experience in underwriting and other aspects of the
property and casualty insurance business.



Mr. Norman, Senior Vice
President in charge of Marketing, has been employed by the Company since 1971. Mr. Norman was named to his current position in February 1999, and has been a Vice President since October 1985 and a Vice President of Mercury Casualty since 1983. Mr.
Norman has supervised the selection and training of agents and managed relations between agents and the Company since 1977. In February 1996, he was elected to the Board of Directors of each of the California Companies.



Ms. Moore, Vice President and Chief Claims Officer, joined the Company in the claims
department in March 1981. She was named Vice President of Claims of Mercury General in August 1991 and has held her present position since July 1995.



Mr. Kitzmiller, Vice President in charge of Underwriting, has been employed by the Company in the underwriting department since 1972. In August 1991, he was
appointed Vice President of Underwriting of Mercury General and has supervised the underwriting activities of the Company since early 1996.



Mr. Stalick, Vice President and Chief Financial Officer, joined the Company as Corporate Controller in June 1997. In October 2000, he was named Chief Accounting
Officer, a role he held until appointed to his current position in October 2001. Mr. Stalick is a Certified Public Accountant.



Ms. Walters has been employed by the Company since 1967, and has served as its Secretary since 1982. Ms. Walters was named Vice PresidentCorporate
Affairs in June 1998.



Mr. Graves, Vice President and Chief Investment
Officer, has been employed by the Company in the investment department since 1986. Mr. Graves was appointed Chief Investment Officer in June 1998, and named Vice President in April 2001.



Mr. Toney, Vice President and Chief Actuary, joined the Company in May 1984 as a programmer/analyst. In 1994 he earned his Fellowship
in the Casualty Actuarial Society and was appointed to his current position.



Ms. Fitzpatrick, Vice President and Chief Information Officer, joined the Company in February 2004, and is responsible for information technology operations. Prior to joining Mercury, she served as the Senior Vice PresidentChief
Information Officer for Pacificare Health Systems from 2000 to 2003 and Vice President of Systems Development at Pacificare Health Systems since 1996.



Mr. Simon, Vice President and Chief Technology Officer, has been employed by the Company since 1980. He was appointed to his current position in 2003. Prior to this
appointment, Mr. Simon served as a Vice President in the Information Systems Department since December 1999.



18



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Item 2.    Properties



The home office of the California Companies and the Companys computer facilities are located in Brea, California in 238,000
square feet of office space owned by the Company.



The Companys
executive offices are located in a 36,000 square foot office building in Los Angeles, California, owned by Mercury Casualty. The Company occupies approximately 95% of the building and leases the remaining office space to others.



In September 2003, the Company opened a new 130,000 square foot office building in
Rancho Cucamonga, California. The Company capitalized approximately $24 million in costs to construct this facility including land of approximately $6 million. This space is used to support the Companys recent growth and future expansion. Any
space in the building that is not occupied by the Company may be leased to outside parties.



The Company leases all of its other office space. Office location is not material to the Companys operations, and the Company anticipates no difficulty in extending these leases or obtaining comparable office space.



Item 3.    Legal Proceedings



The Company is, from time to time, named as a defendant in various lawsuits incidental
to its insurance business. In most of these actions, plaintiffs assert claims for punitive damages which are not insurable under judicial decisions. The Company has established reserves for lawsuits which the Company is able to estimate its
potential exposure and the likelihood that the court will rule against the Company is probable. The Company vigorously defends these actions, unless a reasonable settlement appears appropriate. The Company believes that adverse results, if any, in
the actions currently pending should not have a material effect on the Companys operations or financial position.



In Robert Krumme, On Behalf Of The General Public vs. Mercury Insurance Company, Mercury Casualty Company, and California Automobile Insurance Company
(Superior Court for the City and County of San Francisco), initially filed June 30, 2000, the plaintiff has asserted an unfair trade practices claim under Section 17200 of the California Business and Professions Code. Specifically, the case involves
a dispute over the legality of broker fees (generally less than $100 per policy) charged by independent brokers who sell the Companys products to consumers that purchase insurance policies written by the California Companies. The plaintiff
asserts that the brokers who sell the Companys products should not charge broker fees and that the Company benefits from these fees and should be liable for them. The plaintiff sought an elimination of the broker fees and restitution of
previously paid broker fees. In April 2003, the court ruled that the brokers involved in the suit were in fact agents of the Company; however, the court also held that the Company was not responsible for retroactive restitution. The court issued an
injunction on May 16, 2003 that prevents Mercury from either (a) selling auto or homeowners insurance through any producer that is not appointed as an agent under Insurance Code, Section 1704, (b) selling auto or homeowners insurance through any
producer that charges broker fees and (c) engaging in comparative rate advertising and failing to disclose the possibility that a broker fee may be charged. Mercury has appealed, which has the effect of staying all but the advertising aspects of the
courts injunction. The Companys appeal is based on the fact that the broker fees are subject to directand, if they could be attributed to Mercury, exclusiveregulation by the Insurance Commissioner. The law allows a broker to
perform agent functions without giving up broker status. In the past, the Insurance Commissioner never found broker fees were either being improperly charged or attributable to Mercury. However, in February 2004, the Department of Insurance issued a
Notice of Non-Compliance (NNC) to the California Companies based on this litigations outcome. The NNC alleges that the California Companies willfully misrepresented the actual price insurance consumers could expect to pay for
insurance by the amount of a one-time fee charged by the consumers insurance broker. The California Companies are preparing a Notice of Defense in advance of an administrative hearing which will be based on the same grounds forming the
Companys defense in the Robert Krumme case. The impact of this NNC as it relates to this case can not be determined at the present time. However, the Company intends to continue to vigorously defend this case.



19



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In Sheila Leivas, Individually And On Behalf Of All Others Similarly Situated vs. Mercury Insurance Company
(Orange County Superior Court), filed July 12, 2002, the Company is defending a suit involving a dispute over premium retained by the Company during a time when the plaintiff was not covered following a voluntary cancellation of the policy and prior
to reinstatement of the policy. The plaintiffs motion seeking to have the case certified as a class action was denied without prejudice. The court also overruled plaintiffs Demurrer to Mercurys cross complaint, thereby allowing
Mercury to proceed with its action for the return of premium owed to Mercury if plaintiffs action proceeds. The Company intends to continue to vigorously defend this case.



Dan ODell, individually and on behalf of others similarly situated v. Mercury Insurance Company, Mercury General
Corporation (Los Angeles Superior Court), filed July 12, 2002, involves a dispute over whether Mercurys use of certain automated database vendors to help determine the value of total loss claims is proper. In 2003, the court granted
Mercurys motion to stay the action pending compliance with a contractual arbitration provision. After completion of the arbitration which should occur in June 2004, Mercury and its attorneys intend to challenge the pleadings and seek a
dismissal.



In Marissa Goodman, on her own behalf and on behalf of all
others similarly situated v. Mercury Insurance Company (Los Angeles Superior Court), filed June 16, 2002, the plaintiff is challenging the Companys use of certain automated database vendors to assist in valuing claims for medical payments.
The plaintiff is seeking to have the case certified as a class action. As with the ODell case above, and the other cases in the coordinated proceedings, plaintiff alleges that these automated databases systematically undervalue medical
payment claims to the detriment of insureds. The plaintiff is seeking actual and punitive damages. Similar lawsuits have been filed against other insurance carriers in the industry. The case has been coordinated with two other similar cases, and
also with ten other cases relating to total loss claims. The Company and the other defendants were successful on demurrer. Plaintiffs were given leave to file amended complaints, which are expected in 2004.The Company intends to vigorously
defend this lawsuit jointly with the other defendants in the coordinated proceedings.



The Company is also involved in proceedings relating to assessments and rulings made by the California Franchise Tax Board. (See Item 7. Managements Discussion and Analysis of Financial Conditions and Results of
OperationsGeneral, and Note 6 of Notes to Consolidated Financial Statements.)



Item 4.    Submission of Matters to a Vote of Security Holders



No matters were submitted to a vote of security holders by the Company during the fourth quarter of the fiscal year covered by this report.



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PART II



Item 5.    Market for the Registrants Common Equity, Related Security Holder Matters and Issuer Purchase of Equity
Securities



Price Range of Common Stock



The common stock is traded on the New York Stock Exchange (symbol: MCY). The following
table shows the high and low sales prices per share in each quarter during the past two years as reported in the consolidated transaction reporting system.



|            |  |      |       |     |   |      
|----------- |  | ---- | ----- | --- | - | -----
|            |  | High |       | Low
|2002        |  |      |       |     |   |      
|1st Quarter |  | $    | 46.85 |     | $ | 39.21
|2nd Quarter |  | $    | 51.15 |     | $ | 45.01
|3rd Quarter |  | $    | 48.55 |     | $ | 39.25
|4th Quarter |  | $    | 46.10 |     | $ | 37.25
|            |  |     
|            |  | High |       | Low
|2003        |  |      |       |     |   |      
|1st Quarter |  | $    | 39.05 |     | $ | 33.50
|2nd Quarter |  | $    | 48.59 |     | $ | 37.82
|3rd Quarter |  | $    | 47.40 |     | $ | 42.05
|4th Quarter |  | $    | 50.30 |     | $ | 44.78



The closing price of the
Companys common stock on February 13, 2004 was $48.83.



Dividends



Following the public offering of its common
stock in November 1985, the Company has paid regular quarterly dividends on its common stock. During 2003 and 2002, the Company paid dividends on its common stock of $1.32 per share and $1.20 per share, respectively. On January 30, 2004, the Board
of Directors declared a $0.37 quarterly dividend payable on March 31, 2004 to stockholders of record on March 15, 2004.



The common stock dividend rate has been increased twenty times since dividends were initiated in January, 1986, at an annual rate of $0.05, adjusted for the
two-for-one stock splits in September 1992 and September 1997. For financial statement purposes, the Company records dividends on the declaration date. The Company expects to continue the payment of quarterly dividends; however, the continued
payment and amount of cash dividends will depend upon, among other factors, the Companys operating results, overall financial condition, capital requirements and general business conditions.



As a holding company, Mercury General is largely dependent upon dividends from its
subsidiaries to pay dividends to its shareholders. These subsidiaries are subject to state laws that restrict their ability to distribute dividends. The state laws permit a casualty insurance company to pay dividends and advances within any 12-month
period, without any prior regulatory approval, in an amount up to the greater of 10% of statutory earned surplus at the preceding December 31, or statutory net income for the calendar year preceding the date the dividend is paid. Under this test,
the direct insurance subsidiaries of the Company are entitled to pay dividends to Mercury General during 2004 of up to approximately $121 million. (See Item 1. BusinessRegulationHolding Company Act, and Note 9 of Notes to Consolidated
Financial Statements). Mercury General is contesting a recent FTB ruling which disallows the dividend-received deductions from all insurance holding companies, regardless of domicile. The ultimate outcome of this matter could affect future dividend
policy (See Item 7. Managements Discussion and Analysis of Financial Conditions and Results of OperationsGeneral, and Note 6 of Notes to Consolidated Financial Statements).



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Shareholders of Record



The approximate number of holders of record of the Companys common stock as of February 13, 2004 was 229. The approximate number of beneficial holders as of
February 13, 2004 was 7,300.



Item 6.    Selected Consolidated
Financial Data



|                                           |  |                                               |           |      |   |           |      |  |   |           |   |      |   |           |  |   |           |  
|------------------------------------------ |  | --------------------------------------------- | --------- | ---- | - | --------- | ---- |  | - | --------- | - | ---- | - | --------- |  | - | --------- | -
|                                           |  | Year ended December 31,                       |          
|                                           |  | 2003                                          |           | 2002 |   |           | 2001 |  |   | 2000      |   | 1999 |  
|                                           |  | (Amounts in thousands, except per share data) |          
|Income Data:                               |  |                                               |           |      |   |           |      |  |   |           |   |      |   |           |  |   |           |  
|Earned premiums                            |  | $                                             | 2,145,047 |      | $ | 1,741,527 |      |  | $ | 1,380,561 |   |      | $ | 1,249,259 |  | $ | 1,188,307 |  
|Net investment income                      |  |                                               | 104,520   |      |   | 113,083   |      |  |   | 114,511   |   |      |   | 106,466   |  |   | 99,374    |  
|Net realized investment gains (losses)     |  |                                               | 11,207    |      |   | (70,412   | )    |  |   | 6,512     |   |      |   | 3,944     |  |   | (11,929   | )
|Other                                      |  |                                               | 4,743     |      |   | 2,073     |      |  |   | 5,396     |   |      |   | 6,349     |  |   | 4,924     |  
|                                           |  |                                               |           |      |   |           |      |  |   |           |   |      |   |           |  |   |           |  
|Total Revenues                             |  |                                               | 2,265,517 |      |   | 1,786,271 |      |  |   | 1,506,980 |   |      |   | 1,366,018 |  |   | 1,280,676 |  
|                                           |  |                                               |           |      |   |           |      |  |   |           |   |      |   |           |  |   |           |  
|Losses and loss adjustment expenses        |  |                                               | 1,452,051 |      |   | 1,268,243 |      |  |   | 1,010,439 |   |      |   | 901,781   |  |   | 789,103   |  
|Policy acquisition costs                   |  |                                               | 473,314   |      |   | 378,385   |      |  |   | 301,670   |   |      |   | 268,657   |  |   | 267,399   |  
|Other operating expenses                   |  |                                               | 91,295    |      |   | 74,875    |      |  |   | 62,335    |   |      |   | 59,733    |  |   | 50,675    |  
|Interest                                   |  |                                               | 3,056     |      |   | 4,100     |      |  |   | 7,727     |   |      |   | 7,292     |  |   | 4,960     |  
|                                           |  |                                               |           |      |   |           |      |  |   |           |   |      |   |           |  |   |           |  
|Total Expenses                             |  |                                               | 2,019,716 |      |   | 1,725,603 |      |  |   | 1,382,171 |   |      |   | 1,237,463 |  |   | 1,112,137 |  
|                                           |  |                                               |           |      |   |           |      |  |   |           |   |      |   |           |  |   |           |  
|Income before income taxes                 |  |                                               | 245,801   |      |   | 60,668    |      |  |   | 124,809   |   |      |   | 128,555   |  |   | 168,539   |  
|Income taxes                               |  |                                               | 61,480    |      |   | (5,437    | )    |  |   | 19,470    |   |      |   | 19,189    |  |   | 34,830    |  
|                                           |  |                                               |           |      |   |           |      |  |   |           |   |      |   |           |  |   |           |  
|Net Income                                 |  | $                                             | 184,321   |      | $ | 66,105    |      |  | $ | 105,339   |   |      | $ | 109,366   |  | $ | 133,709   |  
|                                           |  |                                               |           |      |   |           |      |  |   |           |   |      |   |           |  |   |           |  
|Per Share Data:                            |  |                                               |           |      |   |           |      |  |   |           |   |      |   |           |  |   |           |  
|Basic earnings per share                   |  | $                                             | 3.39      |      | $ | 1.22      |      |  | $ | 1.94      |   |      | $ | 2.02      |  | $ | 2.45      |  
|                                           |  |                                               |           |      |   |           |      |  |   |           |   |      |   |           |  |   |           |  
|Diluted earnings per share                 |  | $                                             | 3.38      |      | $ | 1.21      |      |  | $ | 1.94      |   |      | $ | 2.02      |  | $ | 2.44      |  
|                                           |  |                                               |           |      |   |           |      |  |   |           |   |      |   |           |  |   |           |  
|Dividends paid                             |  | $                                             | 1.32      |      | $ | 1.20      |      |  | $ | 1.06      |   |      | $ | .96       |  | $ | .84       |  
|                                           |  |                                               |           |      |   |           |      |  |   |           |   |      |   |           |  |   |           |  
|                                           | 
|                                           |  | December 31,                                  |          
|                                           |  | 2003                                          |           | 2002 |   |           | 2001 |  |   | 2000      |   | 1999 |  
|                                           |  | (Amounts in thousands, except per share data) |          
|Balance Sheet Data:                        |  |                                               |           |      |   |           |      |  |   |           |   |      |   |           |  |   |           |  
|Total investments                          |  | $                                             | 2,539,514 |      | $ | 2,150,658 |      |  | $ | 1,936,171 |   |      | $ | 1,794,961 |  | $ | 1,575,465 |  
|Premiums receivable                        |  |                                               | 231,277   |      |   | 186,446   |      |  |   | 143,612   |   |      |   | 123,070   |  |   | 115,654   |  
|Total assets                               |  |                                               | 3,119,766 |      |   | 2,645,296 |      |  |   | 2,316,540 |   |      |   | 2,142,263 |  |   | 1,906,367 |  
|Unpaid losses and loss adjustment expenses |  |                                               | 797,927   |      |   | 679,271   |      |  |   | 534,926   |   |      |   | 492,220   |  |   | 434,843   |  
|Unearned premiums                          |  |                                               | 663,004   |      |   | 545,485   |      |  |   | 421,342   |   |      |   | 365,579   |  |   | 340,846   |  
|Notes payable                              |  |                                               | 124,714   |      |   | 128,859   |      |  |   | 129,513   |   |      |   | 107,889   |  |   | 92,000    |  
|Deferred income tax liability (asset)      |  |                                               | 17,808    |      |   | (17,004   | )    |  |   | (1,252    | ) |      |   | 8,336     |  |   | (28,541   | )
|Shareholders equity                       |  |                                               | 1,255,503 |      |   | 1,098,786 |      |  |   | 1,069,711 |   |      |   | 1,032,905 |  |   | 909,591   |  
|Book value per share                       |  |                                               | 23.07     |      |   | 20.21     |      |  |   | 19.72     |   |      |   | 19.08     |  |   | 16.73     |  



22



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Item 7.    Managements Discussion and Analysis of Financial Condition and Results of Operations



Overview



Mercury General Corporation and its subsidiaries (collectively, the Company) is headquartered in Los Angeles, California
and operates primarily as a personal automobile insurer selling policies through a network of independent agents and brokers in nine states. The Company also offers homeowners insurance, mechanical breakdown insurance, commercial and dwelling fire
insurance, umbrella insurance, commercial automobile and commercial property insurance. The private passenger automobile lines of insurance accounted for approximately 88% of the $2.3 billion of the Companys gross written premiums in 2003,
with 84% of the private passenger automobile premiums written in California.



This overview discusses some of the relevant factors that management considers in evaluating the Companys performance, prospects and risks. It is not all-inclusive and is meant to be read in conjunction with the entirety of the
management discussion and analysis, the Companys financial statements and notes thereto and all other items contained within the report on this Annual Report on Form 10-K.



Economic and Industry Wide Factors



| |  |  | RegulatoryThe insurance industry is subject to strict state regulation and oversight and is governed by the laws of each state in which each insurance company operates. State regulators
generally have substantial power and authority over insurance companies including, in some states, approving rate changes and rating factors and establishing minimum capital and surplus requirements. In many states, the insurance commissioner is an
elected office and newly-elected commissioners may emphasize different agendas or interpret existing regulations differently than previous commissioners. In California, the Companys largest market, the current commissioner took office in
January of 2003. He has made changes more actively than the previous commissioner in the way automobile insurance is regulated in California. It is uncertain how any regulatory changes implemented by the California insurance commissioner, or the
insurance commissioner in any other state in which Mercury operates, will be resolved and how it will impact the Companys operations.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Cost uncertaintyBecause insurance companies pay claims after premiums are collected, the ultimate cost of an insurance policy is not known until well after the policy revenues are
earned. Consequently, significant assumptions are made when establishing insurance rates and loss reserves. While insurance companies use sophisticated models and experienced actuaries to assist in setting rates and establishing loss reserves, there
can be no assurance that current rates or current reserve estimates will be adequate. Furthermore, there can be no assurance that insurance regulators will approve rate increases when the Companys actuarial analysis shows that they are needed.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | InflationThe largest cost component for automobile insurers are losses which include medical costs and replacement automobile parts and labor repair costs. There has recently been a
significant increase in medical cost inflation and it is often a year or more after the respective fiscal period ends before sufficient claims have closed for the inflation rate to be known with a reasonable degree of certainty. Therefore, it can be
difficult to establish reserves and set premium rates, particularly when actual inflation rates are higher or lower than anticipated. The Company currently estimates mid to high single digit inflation rates on bodily injury coverages for its major
California personal automobile lines for the 2002 and 2003 accident years. The inflation rate for these accident years is the most difficult to estimate because there remain many open claims. Should actual inflation be higher the Company could be
under reserved for its losses and profit margins would be lower.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Loss FrequencyAnother component of overall loss costs is loss frequency, which is the number of claims per risks insured. There has been a long-term trend of declining loss frequency in
the personal automobile insurance industry, which has benefited the industry as a whole. However, it is unknown if loss frequency in the future will continue to decline, remain flat or increase.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Underwriting Cycle and CompetitionThe property and casualty insurance industry is highly cyclical, with periods of rising premium rates and shortages of underwriting
capacity (hard market) followed by
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



23



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| | periods of substantial price competition and excess capacity (soft market). The Company has historically seen premium growth in excess of 20% during hard
markets, whereas premium growth rates during soft markets have historically been in the single digits. Many of the Companys major competitors have announced better operating results in 2003, which typically signals a softening in the market,
and consequently, the Company expects that its policies in force will be difficult to grow in 2004, particularly in California. The Company expects to offset some of this expected reduction in growth through expansion into new states.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Revenues, Income and Cash Generation



The Company generates its revenues through the sale of
insurance policies, primarily covering personal automobile and homeowners. These policies are sold through independent agents and brokers who receive a commission (on average 17%) for selling and servicing the policies.



The Company believes that the relationship with its brokers and agents along with a
more thorough underwriting process gives the Company an advantage over its competitors. The Company views this as one of its primary competitive advantages because it allows the Company to charge lower prices yet realize better margins.



The Company also generates revenue from its investment portfolio, which was
approximately $2.5 billion at the end of 2003. This investment portfolio generated $105 million in pre-tax investment income during 2003. The portfolio is managed by Company personnel with a view towards maximizing after-tax yields and limiting
interest rate and credit risk.



The Companys results and growth
have allowed it to consistently generate positive cash flow from operations, which was $444 million in 2003. The Companys cash flow from operations has exceeded $100 million every year since 1994 and has been positive for over 20 years. Cash
flows from operations has been used to pay shareholder dividends and to help support growth.



Opportunities, Challenges and Risks



The Company currently underwrites personal automobile insurance in nine states; California, Florida, Texas, Oklahoma, Georgia, Illinois, New York, Virginia and beginning in August of 2003, New Jersey. The Company believes that there are
opportunities to expand its business into additional states and expects to begin writing business in Arizona and possibly other states by the end of 2004. The Company expects to continue this growth by expanding into new states in future years with
the objective for non-California premiums to eventually account for as much as half of the Companys total premiums.



There are, however, challenges and risks involved in entering each new state, including establishing adequate rates without any operating history in the state,
working with a new regulatory regime, hiring and training competent personnel, building adequate systems and finding qualified agents to represent the Company. The Company has entered five new states during the past six years and believes that it
has sufficient expertise to manage these challenges and risks to continue its expansion into additional new states.



The Company is also subject to some risks inherent to its business, which might include but are not limited to the following:



| |  |  | A catastrophe, such as a major wildfire, earthquake or hurricane can cause a significant amount of loss to the Company in a very short period of time.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | A major regulatory change, such as the reinstatement of third party bad faith lawsuits could cause a dramatic increase in loss costs.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------



| |  |  | A sharp upward increase in market interest rates or an equity market crash could cause a significant loss to our investment portfolio.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------



24



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To the extent that is within the Companys control, the Company manages these risks and believes that it has
established adequate controls to mitigate the effect that major events would have on the Companys financial position.



The Company is currently developing a Next Generation (NextGen) computer system to replace its existing legacy systems that currently reside on Hewlett
Packard 3000 mainframe computers. The NextGen system is being designed to be a multi-state, multi-line system that is expected to enable the Company to enter new states more rapidly, as well as respond to legislative and regulatory changes more
easily than the Companys current system. The NextGen project is in the development phase and is not expected to be in operation until 2005 or 2006. The NextGen system is expected to cost approximately $20 million and to provide a significant
positive benefit to the Company.



General



The operating results of property and casualty insurance companies are subject to
significant fluctuations from quarter-to-quarter and from year-to-year due to the effect of competition on pricing, the frequency and severity of losses, including the effect of natural disasters on losses, general economic conditions, the general
regulatory environment in those states in which an insurer operates, state regulation of premium rates and other factors such as changes in tax laws. The property and casualty industry has been highly cyclical, with periods of high premium rates and
shortages of underwriting capacity followed by periods of severe price competition and excess capacity. These cycles can have a large impact on the ability of the Company to grow and retain business.



The Company operates primarily in the state of California, which was the only state it
produced business in prior to 1990. The Company expanded its operations into Georgia and Illinois in 1990. With the acquisition of American Fidelity Insurance Group (AFI) in December 1996, now American Mercury Insurance Company
(AMI), the Company expanded into the states of Oklahoma and Texas. The Company expanded its operations into the state of Florida during 1998 and further expansion into Texas occurred with the Concord Insurance Services, Inc. transaction
in December 1999 and the Mercury County Mutual Insurance Company (MCM) transaction in September 2000. In 2001, the Company expanded into Virginia and New York. The Company expanded its operations into New Jersey during 2003.



During 2003, approximately 83% of the Companys total net premiums written were
derived from California.



Implementing rate changes varies by state with
California, Georgia, New York and New Jersey requiring prior approval from the DOI before a rate can be implemented. Illinois, Texas and Virginia only require that rates be filed with the DOI, while Oklahoma and Florida have a modified version of
prior approval laws. In all states, the insurance code provides that rates must not be excessive, inadequate or unfairly discriminatory.



Effective June 23, 2003, the Company implemented a 3.8% rate increase for new and renewal California private passenger automobile insurance written by Mercury
Insurance Company (MIC), which represents approximately 47% of company-wide premiums written, and a 6.9% combined rate increase for new and renewal California private passenger automobile insurance written by Mercury Casualty Company
(MCC) and California Automobile Insurance Company (Cal Auto), which represent approximately 26% of company-wide premiums written. During 2003, the Company also implemented automobile insurance rate increases in four of the
eight non-California states.



Despite the increases, the Company believes
that its rates will remain competitive in the marketplace. During 2003, the Company continued its marketing efforts for name recognition and lead generation. The Company believes that its marketing effort combined with price and reputation makes the
Company very competitive in California.



Since December 31, 2001, the
Companys private passenger automobile policies in force in California have experienced an average annual growth rate of approximately 12% with a growth rate of 8% in 2003. The Companys non-California private passenger automobile policies
in force have experienced an average annual



25



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growth rate of approximately 32% since December 31, 2001 with a growth rate of 23% in 2003. Management believes the increase is due in large part to a hard insurance
market, the Companys expansion into new states, favorable competitive rates, a good reputation and a highly visible and targeted advertising strategy.



The California Insurance Commissioner uses rating factor regulations requiring automobile insurance rates to be determined by (1) driving safety record, (2) miles
driven per year, (3) years of driving experience and (4) whatever optional factors are determined by the Insurance Commissioner to have a substantial relationship to the risk of loss and adopted by regulation. The regulations further require
that each of the four factors be applied in decreasing order of importance.



The California Insurance Commissioner is conducting townhall meetings to discuss modifying territory as a rating factor. The outcome of this matter is uncertain and the impact to the Company can not be determined at this time.



The California DOI required all insurers offering persistency discounts to make
class plan filings by January 15, 2003, removing the portability of these discounts. Persistency discounts represent discounts on policy rates extended to consumers based upon the number of consecutive years that the consumers carried insurance
coverage. These class plans were never implemented because Senate Bill 841 was enacted during 2003 amending the California Insurance Code to allow insurers to offer products with portable persistency discounts. However, in January 2004, this
legislation was overturned through judicial proceedings in the Los Angeles Superior Court. The Company intervened in the original proceedings and intends to seek appellate review of this ruling. The outcome of such action is uncertain. The changes
made during the class plan filing indicated that removing persistency discounts is revenue neutral for the Companys existing business. The removal of persistency discounts could have an impact on the Companys price competitiveness in
attracting new business and would cause many existing customers rates to change. However, this impact, if any, is undeterminable.



On June 25, 2003, the California State Board of Equalization (SBE) upheld Notices of Proposed Assessment (NPAs) issued against the Company
for tax years 1993 through 1996. In the NPAs, the California Franchise Tax Board (FTB) disallowed a portion of the Companys expenses related to management services provided to its insurance company subsidiaries on grounds
that such portion was allocable to the Companys tax-deductible dividends from such subsidiaries. The total tax liability and interest on the management fee expenses amount to approximately $14 million (approximately $7 million tax liability
plus $7 million of interest through December 31, 2003). The potential net liability, after federal tax benefit, amounts to approximately $9 million.



The Company continues to believe that its deduction of the expenses related to management services provided to it subsidiaries is meritorious and will continue to
defend it vigorously before the SBE and, if necessary, the courts. The Company has filed a Petition for Rehearing with the SBE based both on procedural and substantive grounds, and both the Company and the FTB have filed briefs relating to the
Petition. The SBE is expected to consider the matter in March 2004.



The
SBE decision on the NPAs for tax years 1993 through 1996 also resulted in a smaller disallowance of the Companys interest expense deductions than was proposed by the FTB in those years. The Company has decided not to continue to
challenge this issue and has established a small accrual for the tax liability and related interest.



As a result of the court ruling in Ceridian vs. Franchise Tax Board, the FTB has issued NPAs for tax years 1997 through 2000 disallowing all Dividend
Received Deductions (DRD) taken by the Company for those tax years. The ruling in Ceridian vs. Franchise Tax Boardheld the statute permitting the tax deductibility of dividends received from wholly-owned insurance subsidiaries
unconstitutional because it discriminated against out-of-state holding companies. The FTB interpretation of the ruling concludes that the discriminatory sections of the statute are not severable and the entire statute is invalid. As a result, the
FTBs position in the NPAs is that all dividends received by the Company from its insurance company subsidiaries are subject to California franchise taxes. The DRD



26



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disallowance could result in approximately $17 million of additional California state franchise taxes plus $8 million of related interest through December 31, 2003.
The potential net liability, after federal tax benefit, amounts to approximately $16 million.



Management intends to vigorously challenge these potential tax liabilities on 2001 and future inter-company dividends. However, if the Companys challenges are ineffective or the issue is not resolved favorably with the
State of California, additional state taxes of approximately 9% (6% after the federal tax benefit of deducting state taxes) could be owed on dividends Mercury General receives from its insurance subsidiaries. While the Company intends to continue
paying dividends to its shareholders, an unsatisfactory conclusion to the inter-company dividend issue could affect future dividend policy.



The Company is closely following the progress of legislation that if enacted would resolve the issues on expense disallowance and eliminate the uncertainty created
by the court ruling in Ceridian vs. Franchise Tax Board for all tax years through December 31, 2003. Without a legislative solution, years of future litigation may be required to determine the ultimate outcome of the expense disallowance and
DRD issues. Because of the uncertainty surrounding these issues, it is difficult to predict the ultimate amount the Company may be required to pay, if anything. Consistent with the proposed legislation and the Companys expectations of a
legislative solution, the Company has established a tax contingency reserve of approximately $3 million, net of federal tax benefits, for all California franchise tax issues including the disallowance of expenses and DRD issues.



The Company is also involved in proceedings incidental to its insurance business (See
Item 3. Legal Proceedings, and Note 11 of Notes to Consolidated Financial Statements).



Critical Accounting Policies



The preparation of the
Companys financial statements requires judgment and estimates. The most significant is the estimate of loss reserves as required by Statement of Financial Accounting Standards No. 60, Accounting and Reporting by Insurance
Enterprises (SFAS No. 60) and Statement of Financial Accounting Standards No. 5, Accounting for Contingencies (SFAS No. 5). Estimating loss reserves is a difficult process as there are many factors that can
ultimately affect the final settlement of a claim and, therefore, the reserve that is needed. Changes in the regulatory and legal environment, results of litigation, medical costs, the cost of repair materials and labor rates can all 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 the claim, the more variable the ultimate settlement amount can be.
Accordingly, short-tail claims, such as property damage claims, tend to be more reasonably predictable than long-tail liability claims. Inflation is reflected in the reserving process through analysis of cost trends and reviews of historical
reserving results.



The Company performs its own loss reserve analysis
and also engages the services of an independent actuary to assist in the estimation of loss reserves. The Company and the actuary do not calculate a range of loss reserve estimates but rather calculate a point estimate. Management reviews the
underlying factors and assumptions that serve as the basis for preparing the reserve estimate. These include paid and incurred loss development factors, expected average costs per claim, inflation trends, expected loss ratios, industry data and
other relevant information. At December 31, 2003, the Company recorded $797.9 million in loss and loss adjustment expense reserves. 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. Since the provisions are necessarily based upon estimates, the ultimate liability may be more or less than such provision.



The Company complies with the SFAS No. 60 definition of how insurance enterprises should recognize revenue on insurance policies
written. The Companys insurance premiums are recognized as income ratably over the term of the policies. Unearned premiums are carried as a liability on the balance sheet and are computed on a monthly pro-rata basis. The Company evaluates its
unearned premiums periodically for premium deficiencies by comparing the sum of expected claim costs, unamortized acquisition costs and maintenance costs to related



27



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unearned premiums. To the extent that any of the Companys lines of business become substantially unprofitable, then a premium deficiency reserve may be required.
The Company does not expect this to occur on any of its significant lines of business.



The Company carries its fixed maturity and equity investments at market value as required for securities classified as Available for Sale by Statement of Financial Accounting Standards No. 115, Accounting for
Certain Investments in Debt and Equity Securities (SFAS No. 115). In most cases, market valuations were drawn from trade data sources. In no case were any valuations made by the Companys management. Equity holdings, including
non-sinking fund preferred stocks, are, with minor exceptions, actively traded on national exchanges, and were valued at the last transaction price on the balance sheet date. The Company constantly evaluates its investments for other than temporary
declines and writes them off as realized losses through the Statement of Income, as required by SFAS No. 115 when recovery of the net book value appears doubtful. Temporary unrealized investment gains and losses are credited or charged directly to
shareholders equity as accumulated other comprehensive income, net of applicable taxes. It is possible that future information will become available about the Companys current investments that would require accounting for them as
realized losses due to other than temporary declines in value. The financial statement effect would be to move the unrealized loss from accumulated other comprehensive income on the Balance Sheet to realized investment losses on the Statement of
Income.



The Company may have certain known and unknown potential
liabilities that are evaluated using the criteria established by SFAS No. 5. These include claims, assessments or lawsuits incidental to our business. The Company continually evaluates these potential liabilities and accrues for them or discloses
them in the financial statement footnotes if they meet the requirements stated in SFAS No. 5. While it is not possible to know with certainty the ultimate outcome of contingent liabilities, management does not expect them to have a material effect
on the consolidated operations or financial position.



Statement of
Financial Accounting Standards SFAS No. 141, Business Combinations (SFAS No. 141) and Statement of Financial Accounting Standards SFAS No. 142, Goodwill and Other Intangible Assets (SFAS No. 142)
became effective January 1, 2002. SFAS No. 141 requires companies to apply the purchase method of accounting for all business combinations initiated after June 30, 2001 and prohibits the use of the pooling-of-interest method. SFAS No. 142 changes
the method by which companies may recognize intangible assets in purchase business combinations and generally requires identifiable intangible assets to be recognized separately from goodwill. In addition, it eliminates the amortization of all
existing and newly acquired goodwill on a prospective basis and requires companies to assess goodwill for impairment, at least annually, based on the fair value of the reporting unit.



At December 31, 2003, the Company had on its books approximately $7.3 million in goodwill related to the 1999 acquisition of Concord
and approximately $5.2 million of intangible assets with indefinite useful lives related to the MCM acquisition.



As required by SFAS No. 142, the Company has assessed these assets and determined that they are not impaired. Furthermore, as required by SFAS No. 142, the Company
did not amortize these assets after 2001. Total amortization expense in 2001 related to these assets was $1.9 million.



Results of Operations



Year Ended December 31, 2003 Compared to Year Ended December 31, 2002



Premiums earned in 2003 of $2,145.0 million increased 23.2% from the corresponding period in 2002. Net premiums written in 2003 of
$2,268.8 million increased 21.6% over amounts written in 2002. The premium increases were principally attributable to increased policy sales and rate increases in the California, Florida and Texas automobile lines and the California homeowners
insurance lines of business.



Net premiums written is a non-GAAP
financial measure which represents the premiums charged on policies issued during a fiscal period less any reinsurance. Net premiums written is a statutory measure used to determine



28



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production levels. Net premiums earned, the most directly comparable GAAP measure, represents the portion of premiums written that are recognized as income in the
financial statements for the period presented and earned on a pro-rata basis over the term of the policies. The following is a reconciliation of total Company net premiums written to net premiums earned (000s) for the years ended December 31, 2003
and 2002, respectively:



|                              |  |      |           |      |   |          
|----------------------------- |  | ---- | --------- | ---- | - | ---------
|                              |  | 2003 |           | 2002
|Net premiums written          |  | $    | 2,268,778 |      | $ | 1,865,046
|Increase in unearned premiums |  |      | 123,731   |      |   | 123,519  
|                              |  |      |           |      |   |          
|Earned premiums               |  | $    | 2,145,047 |      | $ | 1,741,527
|                              |  |      |           |      |   |          



The loss ratio (GAAP basis) in
2003 (loss and loss adjustment expenses related to premiums earned) was 67.7% in 2003 compared with 72.8% in 2002. The lower loss ratio is largely attributable to recent rate increases and improved loss frequency on automobile claims as well as
California homeowners claims. Automobile loss frequencies can be affected by many factors including seasonal travel, weather and fluctuations in gasoline prices. The Southern California firestorms negatively impacted the loss ratio by 0.7% in 2003.
Furthermore, adverse development on prior accident years increased the 2003 loss ratio by 0.2% and the 2002 loss ratio by 1.5%.



The expense ratio (GAAP basis) in 2003 (policy acquisition costs and other operating expenses related to premiums earned) was 26.3% compared with 26.0% in 2002. The
increase in the expense ratio is primarily due to higher profitability related bonus accruals.



The combined ratio of losses and expenses (GAAP basis) is the key measure of underwriting performance traditionally used in the property and casualty insurance industry. A combined ratio under 100% generally reflects profitable
underwriting results; a combined ratio over 100% generally reflects unprofitable underwriting results. The combined ratio of losses and expenses (GAAP basis) was 94.0% in 2003 compared with 98.8% in 2002 which indicates that the Companys
underwriting performance contributed $128.4 million to the Companys income before income taxes of $245.8 million during 2003 versus contributing $20.0 million to the Companys income before income tax of $60.7 million in 2002.



Investment income in 2003 was $104.5 million, compared with $113.1 million in 2002.
The after-tax yield on average investments of $2,311.0 million (cost basis) was 4.04%, compared with 4.87% on average investments of $2,035.3 million (cost basis) in 2002. The effective tax rate on investment income was 10.7% in 2003, compared to
12.4% in 2002. The lower tax rate in 2003 reflects a shift in the mix of the Companys portfolio from taxable to non-taxable issues. Bonds matured and called in 2003 totaled $444.4 million, compared to $120.5 million in 2002. Assuming market
interest rates remain the same, the Company expects approximately $430 million of bonds to mature or be called in 2004. The proceeds will be reinvested into securities meeting the Companys investment profile.



Net realized investment gains in 2003 were $11.2 million, compared with net realized
losses of $70.4 million in 2002. Included in the net realized investment gains (losses) are investment write-downs of $9.1 million in 2003 and $71.7 million in 2002 that the Company considered to be other-than-temporarily impaired. The investment
write-downs were on investments primarily in the telecommunications and energy sectors and are discussed further under Liquidity and Capital Resources.



The income tax provision of $61.5 million in 2003 represented an effective tax rate of 24.5% which compares with an effective tax rate of 14.7% in 2002 after
excluding the effect of net realized investment gains (losses) in both years. The higher rate is primarily attributable to the increased proportion of underwriting income which is taxed at the full corporate rate of 35% in contrast with investment
income which includes tax exempt interest and tax sheltered dividend income.



Net income in 2003 was $184.3 million or $3.38 per share (diluted), compared with $66.1 million or $1.21 per share (diluted), in 2002. Diluted per share results are based on 54.5 million average shares in 2003 and 2002. Basic



29



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per share results were $3.39 in 2003 and $1.22 in 2002. Included in net income in 2003 are realized gains, net of income tax expense, of $0.13 per share (diluted and
basic) which positively impacted the 2003 results compared to realized losses, net of income tax benefit, of $0.84 per share (diluted and basic) which negatively impacted the 2002 results,



Year Ended December 31, 2002 Compared to Year Ended December 31, 2001



Premiums earned in 2002 of $1,741.5 million increased 26.1% and
net premiums written in 2002 of $1,865.0 million increased 29.3% over amounts recorded in 2001. These premium increases were principally attributable to increased policy sales and rate increases in the California automobile insurance lines,
California homeowners insurance, Florida automobile insurance and Texas automobile insurance.



During 2002, the California private passenger automobile insurance marketplace experienced rising premium rates. The Company and virtually all of its competitors filed and implemented rate increases, which helped spur the
Companys premium growth during the year.



The GAAP loss ratio in
2002 (loss and loss adjustment expenses related to premiums earned) was 72.8% compared with 73.2% in 2001. The lower loss ratio was primarily driven by rate increases which were partially offset by rising loss severity trends and adverse loss
development from prior periods.



The GAAP expense ratio (policy
acquisition costs and other operating expenses related to premiums earned) was 26.0% in 2002 and 26.4% in 2001. While expenses generally increased in 2002, the increase was at a slightly lower rate than the increase in premium volume. The majority
of expenses vary directly with premiums.



Total losses and expenses in
2002, excluding interest expense of $4.1 million, were $1,721.5 million, resulting in an underwriting gain (premiums earned less total losses and expenses excluding interest) for the period of $20.0 million, compared with an underwriting gain of
$6.1 million in 2001.



Investment income in 2002 was $113.1 million,
compared with $114.5 million in 2001. The after-tax yield on average investments of $2,035.3 million (cost basis) was 4.87%, compared with 5.41% on average investments of $1,828.5 million (cost basis) in 2001. The effective tax rate on investment
income was 12.4% in 2002, compared to 13.6% in 2001. The lower tax rate in 2002 reflects a shift in the mix of the Companys portfolio from taxable to non-taxable issues. Bonds matured and called in 2002 totaled $120.5 million, compared to
$67.6 million in 2001.



Net realized investment losses in 2002 were $70.4
million, compared with net realized gains of $6.5 million in 2001. Included in the net realized investment losses for 2002 are $71.7 million of investment write-downs that the Company considered to be other-than-temporarily impaired. The investment
write-downs were on investments primarily in the telecommunications and energy sectors. There were no investment write-downs in 2001.



The income tax benefit of $5.4 million in 2002 is primarily due to realized losses recognized on securities deemed to be other than temporarily impaired. Excluding
the effect of net realized gains (losses) from both 2002 and 2001 results in an effective tax rate of 14.7% in 2002 compared with an effective tax rate of 14.5% in 2001.



Net income in 2002 was $66.1 million or $1.21 per share (diluted), compared with $105.3 million or $1.94 per share (diluted), in 2001.
Diluted per share results are based on 54.5 million average shares in 2002 and 54.4 million shares in 2001. Basic per share results were $1.22 in 2002 and $1.94 in 2001.



Liquidity and Capital Resources



Mercury General is largely dependent upon dividends received from its insurance subsidiaries to pay debt service costs and to make distributions to its
shareholders. Under current insurance law, Mercury Generals insurance subsidiaries are entitled to pay, without extraordinary approval, dividends of approximately $121 million



30



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in 2004. The actual amount of dividends paid from insurance subsidiaries to Mercury General during 2003 was $76 million. As of December 31, 2003, Mercury General also
had approximately $31 million in fixed maturity securities, equity securities and cash that can be utilized to satisfy its direct holding company obligations.



The principal sources of funds for Mercury Generals insurance subsidiaries are premiums, sales and maturity of invested assets and dividend and interest
income from invested assets. The principal uses of funds for Mercury Generals insurance subsidiaries are the payment of claims and related expenses, operating expenses, dividends to Mercury General and the purchase of investments. Mercury
Generals insurance subsidiaries generate substantial positive cash flows, particularly when the Company experiences growth, from operations as premiums are typically received in advance of the time when claim payments are required. Cash and
short term cash investments increased by nearly $67 million as the Company has managed its portfolio to a shorter portfolio duration as a result of the current interest rate environment.



Net cash provided from operating activities in 2003 was $444.5 million, an increase of $101.9 million over the same period in 2002.
This increase was primarily due to the growth in premiums reflecting increases in both policy sales and rates partially offset by an increase in loss and loss adjustment expenses paid in 2003. The Company has utilized the cash provided from
operating activities primarily to increase its investment in fixed maturity securities, the construction of an additional office facility during 2003, the purchase and development of information technology and the payment of dividends to its
shareholders. Excess cash was invested in short-term cash investments. Funds derived from the sale, redemption or maturity of fixed maturity investments of $564.7 million, were primarily reinvested by the Company in high grade fixed maturity
securities.



The Companys cash and short-term cash investment
portfolio totaled $366.8 million at December 31, 2003. Together with cash flows from operations, the Company believes that such liquid assets are adequate to satisfy its liquidity requirements without the forced sale of investments. However, the
Company operates in a rapidly evolving and often unpredictable business environment that may change the timing or amount of expected future cash receipts and expenditures. Accordingly, there can be no assurance that the Companys sources of
funds will be sufficient to meet its liquidity needs or that the Company will not be required to raise additional funds to meet those needs, including future business expansion, through the sale of equity or debt securities or from credit facilities
with lending institutions.



The market value of all investments
(fixed-maturities and equities) held at market as Available for Sale exceeded amortized cost of $2,409.0 million at December 31, 2003 by $130.5 million. That net unrealized gain of $130.5 million, reflected in shareholders equity,
net of applicable tax effects, was $84.8 million at December 31, 2003, compared with a net unrealized gain of $42.1 million of December 31, 2002. The increase in unrealized gains is largely due to an increase in the market value of bond holdings
resulting from the current interest rate environment and the partial recovery in value of previously written down equity securities.



At December 31, 2003, the average rating of the $1,932.8 million bond portfolio at market (amortized cost $1,843.6 million) was AA, the same average rating at
December 31, 2002. Bond holdings are broadly diversified geographically, within the tax-exempt sector. California state bonds represent 4.7% of the total bond portfolio and carry a net unrealized gain of $2.5 million at December 31, 2003. Holdings
in the taxable sector consist principally of investment grade issues. At December 31, 2003, bond holdings rated below investment grade totaled $52.8 million at market (cost $53.3 million) representing approximately 2% of total investments. This
compares to approximately $50.1 million at market (cost $68.8 million) representing 2.3% of total investments at December 31, 2002.



31



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The following table sets forth the composition of the investment portfolio of the Company as of December 31, 2003:



|                                      |  |                        |           |              |   |          
|------------------------------------- |  | ---------------------- | --------- | ------------ | - | ---------
|                                      |  | Amortized cost         |           | Market value
|                                      |  | (Amounts in thousands)
|Fixed maturity securities:            |  |                        |           |              |   |          
|U.S. government bonds and agencies    |  | $                      | 258,442   |              | $ | 258,692  
|Municipal bonds                       |  |                        | 1,502,974 |              |   | 1,588,398
|Corporate bonds                       |  |                        | 82,207    |              |   | 85,697   
|Redeemable preferred stock            |  |                        | 12,460    |              |   | 12,522   
|                                      |  |                        |           |              |   |          
|                                      |  | $                      | 1,856,083 |              | $ | 1,945,309
|                                      |  |                        |           |              |   |          
|Equity securities:                    |  |                        |           |              |   |          
|Common Stock:                         |  |                        |           |              |   |          
|Public utilities                      |  | $                      | 63,810    |              | $ | 78,447   
|Banks, trusts and insurance companies |  |                        | 5,841     |              |   | 7,682    
|Industrial and other                  |  |                        | 67,852    |              |   | 86,753   
|Non-redeemable preferred stock        |  |                        | 85,610    |              |   | 91,511   
|                                      |  |                        |           |              |   |          
|                                      |  | $                      | 223,113   |              | $ | 264,393  
|                                      |  |                        |           |              |   |          



The Company writes covered call
options through listed exchanges and over the counter with the intent of generating additional income or return on capital. The total investment under the covered call program in 2003 was approximately $30 million. The Company as a writer of an
option bears the market risk of an unfavorable change in the price of the security underlying the written option. The Board of Directors has authorized the Companys management to commence selling put options in 2004 and to increase its option
writing program up to $40 million.



The Company monitors its investments
closely. If an unrealized loss is determined to be other than temporary it is written off as a realized loss through the Consolidated Statement of Income. The Companys methodology of assessing other than temporary impairments is based on
security-specific analysis as of the balance sheet date and considers various factors including the length of time and the extent to which the fair value has been less than the cost, the financial condition and the near term prospects of the issuer,
whether the debtor is current on its contractually obligated interest and principal payments, and the Companys intent to hold the investment for a period of time sufficient to allow the Company to recover its costs.



During 2003, the Company recognized approximately $11.2 million in net realized gains
from the disposal (sale, call or maturity) of securities which is comprised of realized gains of $27.0 million offset by realized losses of $15.8 million. These realized losses were derived from the disposal of securities with a total amortized cost
of approximately $232.5 million. Approximately $3.8 million of the $15.8 million total realized loss relates to securities held as of December 2002 with no loss on any one individual security exceeding $0.3 million.



The Company recognized $9.1 million and $71.7 million in realized losses as other than
temporary declines to its investment securities during 2003 and 2002, respectively. Of the $9.1 million write-down recognized in 2003, approximately $6.5 million relates to fixed maturity securities for a single company that filed for bankruptcy
protection in July 2003. At such time, the Company liquidated its investment and recognized an impairment loss equal to the difference between the net proceeds on liquidation and the amortized cost of the investment. The balance of the write-down
recognized relates to four equity securities whose book value materially exceeded market value for more than six consecutive months and the Company considered it unlikely that the market value would recover.



At December 31, 2003, the Company had a net unrealized gain on all investments of
$130.5 million before income taxes which is comprised of unrealized gains of $140.8 million offset by unrealized losses of $10.3 million.



32



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Unrealized losses represent 0.4% of total investments at amortized cost. Of these unrealized losses, approximately $7.7 million relate to fixed maturity investments
and the remaining $2.6 million relate to equity securities. Approximately $9.2 million of the unrealized losses are represented by a large number of individual securities with unrealized losses of less than 20% of each securitys amortized
cost. Of these, the most significant unrealized losses relate to one corporate bond and one municipal bond with unrealized losses of approximately $0.6 million and $0.5 million, respectively, representing market value declines of 11% and 18% of
amortized cost. The remaining $1.1 million represents unrealized losses that exceed 20% of amortized costs and are discussed further below. The Company has concluded that the gross unrealized losses of $10.3 million at December 31, 2003 were
temporary in nature. However, facts and circumstances may change which could result in a decline in market value considered to be other than temporary.



The following table presents the aging of pre-tax unrealized losses on investments that exceed 20% of amortized costs as of December 31, 2003:



|                                                 |  |                            |       |           |   |     |            |  |               |   |  |   |      
|------------------------------------------------ |  | -------------------------- | ----- | --------- | - | --- | ---------- |  | ------------- | - |  | - | -----
|                                                 |  | Aging of Unrealized Losses
|                                                 |  | AmortizedCost              |       | 0-6Months |   |     | 6-12Months |  | Over 12Months
|                                                 |  | (Amounts in thousands)    
|Fixed Maturities:                                |  |                            |       |           |   |     |            |  |               |   |  |   |      
|Investment grade                                 |  | $                          |      |           | $ |    |            |  | $             |  |  | $ |     
|Non-Investment grade                             |  |                            | 3,366 |           |   |    |            |  |               |  |  |   | 1,062
|Equity securities                                |  |                            |      |           |   |    |            |  |               |  |  |   |     
|                                                 |  |                            |       |           |   |     |            |  |               |   |  |   |      
|Total                                            |  | $                          | 3,366 |           | $ |    |            |  | $             |  |  | $ | 1,062
|                                                 |  |                            |       |           |   |     |            |  |               |   |  |   |      
|Aged unrealized losses as a % of amortized cost: |  |                            |       |           |   |     |            |  |               |   |  |   |      
|                                                 |  |                            |       |          
|Non-Investment grade securities                  |  |                            |       |           |   |     |            |  |               |   |  |   |      
|20-50% below amortized cost                      |  |                            |       |           |   | 100 | %          |  |               |   |  |   |      
|Over 50% below amortized cost                    |  |                            |       |           |   |    |            |  |               |   |  |   |      
|Equity securities                                |  |                            |       |           |   |     |            |  |               |   |  |   |      
|20-50% below amortized cost                      |  |                            |       |           |   |    |            |  |               |   |  |   |      
|Over 50% below amortized cost                    |  |                            |       |           |   |    |            |  |               |   |  |   |      



The unrealized losses of $1.1
million on non-investment grade fixed maturity securities (in table above) relate to a single bond obligation of a major airline which are supported by gate lease revenues at the Dallas-Fort Worth (DFW) airport. Given the status of DFW
as the third busiest airport in the world, the Company believes that these gates are of vital strategic importance to the airlines. The airline is current on their interest obligations for these bonds. The Company has the ability and intent to hold
securities with unrealized losses until they recover their value. In the future, information may come to light or circumstances may change that would cause the Company to write-down or sell these securities for a realized loss.



The amortized cost and estimated market value of fixed maturities available for sale
with unrealized losses exceeding 20% of amortized cost as of December 31, 2003 by contractual maturity are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations
with or without call or prepayment penalties.



|                                       |  |                        |       |                       |   |      
|-------------------------------------- |  | ---------------------- | ----- | --------------------- | - | -----
|                                       |  | Amortized Cost         |       | EstimatedMarket Value
|                                       |  | (Amounts in thousands)
|Fixed maturities available for sale:   |  |                        |       |                       |   |      
|Due in one year or less                |  | $                      |      |                       | $ |     
|Due after one year through five years  |  |                        |      |                       |   |     
|Due after five years through ten years |  |                        |      |                       |   |     
|Due after ten years                    |  | $                      | 3,366 |                       | $ | 2,304



33



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On August 7, 2001, the Company completed a public debt offering issuing $125 million of senior notes payable under
a $300 million shelf registration filed with the SEC in July 2001. The notes are unsecured, senior obligations of the Company with a 7.25% annual coupon payable on August 15 and February 15 each year commencing February 15, 2002. These notes mature
on August 15, 2011. The Company used the proceeds from the senior notes to retire amounts payable under existing revolving credit facilities, which were terminated. Effective January 2, 2002, the Company entered into an interest rate swap of its
fixed rate obligation on the senior notes for a floating rate of LIBOR plus 107 basis points. The swap significantly reduced interest expense in 2002 and 2003, but does expose the Company to higher interest expense in future periods, should LIBOR
rates increase. The effective annualized interest rate in 2003 was 2.2%. The swap is accounted for as a fair value hedge under SFAS No. 133 (See Item 7A. Quantitative and Qualitative Disclosures About Market Risk).



Under the Companys stock repurchase program, the Company may purchase over a
one-year period up to $200 million of Mercury Generals common stock. The purchases may be made from time to time in the open market at the discretion of management. The program will be funded by dividends received from the Companys
insurance subsidiaries that generate cash flow through the sale of lower yielding tax-exempt bonds and internal cash generation. Since the inception of the program in 1998, the Company has purchased 1,266,100 shares of common stock at an average
price of $31.36. The shares purchased were retired. No stock was purchased in 2003.



The NAIC utilizes a risk-based capital formula for casualty insurance companies which establishes a hypothetical minimum capital level that is compared to the Companys actual capital level. The formula has been designed
to capture the widely varying elements of risks undertaken by writers of different lines of insurance having differing risk characteristics, as well as writers of similar lines where differences in risk may be related to corporate structure,
investment policies, reinsurance arrangements and a number of other factors. The Company has calculated the Risk-Based Capital Requirements of each of its insurance subsidiaries as of December 31, 2003. Each of the Insurance Companies
policyholders surplus exceeded the highest level of minimum required capital.



The Company has no direct investments in real estate and no holdings of mortgages secured by commercial real estate.



During 2002, the Company was notified that the Hewlett Packard 3000 (HP 3000) mainframe system that the Company utilizes for its core insurance
applications will no longer be supported by Hewlett Packard after December 2006. Although mainframe system support will be available through other information technology service providers, the Company formed a team of experienced information
technology employees to design and develop the Companys legacy replacement strategy. The project is currently in the development stage and the Company has estimated the cost of this project to be approximately $20 million.



The Company has obligations to make future payments under contracts and credit-related
financial instruments and commitments. At December 31, 2003, certain long-term aggregate contractual obligations and credit-related commitments are summarized as follows:



|                              |  |                        |         |               |   |           |  |           |        |               |   |        |  |   |        
|----------------------------- |  | ---------------------- | ------- | ------------- | - | --------- |  | --------- | ------ | ------------- | - | ------ |  | - | -------
|                              |  | Payments Due by Period
|Contractual Obligations       |  | Total                  |         | Within 1 year |   | 1-3 years |  | 4-5 years |        | After 5 years
|                              |  | (Amounts in thousands)
|Debt (including interest)     |  | $                      | 194,103 |               | $ | 9,063     |  | $         | 27,188 |               | $ | 18,125 |  | $ | 139,727
|Capital Lease Obligations     |  |                        | 1,324   |               |   | 1,124     |  |           | 200    |               |   |       |  |   |       
|Operating Leases              |  |                        | 23,309  |               |   | 5,688     |  |           | 14,400 |               |   | 3,151  |  |   | 70     
|                              |  |                        |         |               |   |           |  |           |        |               |   |        |  |   |        
|Total Contractual Obligations |  | $                      | 218,736 |               | $ | 15,875    |  | $         | 41,788 |               | $ | 21,276 |  | $ | 139,797
|                              |  |                        |         |               |   |           |  |           |        |               |   |        |  |   |        



The amount of interest included
in the Companys debt obligations was calculated using the fixed rate of 7.25% on the senior notes issued August 2001. The Company is party to an interest rate swap of its fixed rate obligations on its senior notes for a floating rate of six
month LIBOR plus 107 basis points. Using the effective



34



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annual interest rate of 2.2% in 2003, the total contractual obligations on debt would be $146 million with $2.8 million due within 1 year, $8.2 million due between 1
and 3 years, $5.5 million due in years 4 and 5 and $129.5 million due beyond 5 years. However, interest rates are currently at a 40 year low and are likely to rise in the future.



The Company places all new and renewal earthquake coverage offered with its homeowners policy through the California Earthquake
Authority (CEA). The Company receives a small fee for placing business with the CEA.



Upon the occurrence of a major seismic event, the CEA has the ability to assess participating companies for losses. These assessments are made after CEA capital has
been expended and are based upon each companys participation percentage multiplied by the amount of the total assessment. Based upon the most current information provided by the CEA, the Companys maximum total exposure to CEA assessments
at April 17, 2003 is approximately $38.9 million.



Industry and
regulatory guidelines suggest that the ratio of a property and casualty insurers annual net premiums written to statutory policyholders surplus should not exceed 3.0 to 1. Based on the combined surplus of all of the Insurance Companies
of $1,169.4 million at December 31, 2003, and net written premiums for the twelve months ended on that date of $2,268.8 million, the ratio of premium writings to surplus was approximately 1.9 to 1.



Item 7A.    Quantitative and Qualitative Disclosures about Market Risks



The Company is subject to various market risk exposures including
interest rate risk and equity price risk. The following disclosure reflects estimates of future performance and economic conditions. Actual results may differ.



The Company invests its assets primarily in fixed maturity investments, which at December 31, 2003 comprised 77% of total investments at market value. Tax-exempt
bonds represent 81% of the fixed maturity investments with the remaining amount consisting of sinking fund preferred stocks and taxable bonds. Equity securities account for 10% of total investments at market. The remaining 13% of the investment
portfolio consists of highly liquid short-term investments which are primarily short-term money market funds.



The value of the fixed maturity portfolio is subject to interest rate risk. As market interest rates decrease, the value of the portfolio goes up with the opposite
holding true in rising interest rate environments. A common measure of the interest sensitivity of fixed maturity assets is modified duration, a calculation that takes maturity, coupon rate, yield and call terms to calculate an average age of the
expected cash flows. The longer the duration, the more sensitive the asset is to market interest rate fluctuations.



The Company historically invested in fixed maturity investments with a goal towards maximizing after-tax yields and holding assets to the maturity or call date.
Since assets with longer maturity dates tend to produce higher current yields, the Companys investment philosophy resulted in a portfolio with a moderate duration. However, due to the current interest rate environment, management believes it
prudent to reduce the duration of the Companys bond portfolio. Bond investments made by the Company typically have call options attached, which further reduce the duration of the asset as interest rates decline. Consequently, the modified
duration of the bond portfolio declined from 4.4 years at December 31, 2002 to 3.8 years at December 31, 2003. Given a hypothetical parallel increase of 100 basis points in interest rates, the fair value of the bond portfolio would decrease by
approximately $85 million.



At December 31, 2003, approximately 8% of the
fixed maturity portfolio includes U.S. government agency collateralized mortgage obligations (CMOs) with AAA ratings from Standard & Poors. The Company invests in CMOs to strategically increase its current cash flows from
investments. The average duration and effective maturity for these securities are 0.9 years and 1.0 years, respectively. The Company does not expect that its investments in CMOs to grow beyond 10% of its total investment portfolio.



At December 31, 2003, the Companys strategy for common equity investments is an
active strategy which focuses on current income with a secondary focus on capital appreciation. The value of the common equity



35



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investments consists of $172.9 million in common stocks and $91.5 million in non-sinking fund preferred stocks. The common stock equity assets are typically valued for
future economic prospects as perceived by the market. The non-sinking fund preferred stocks are typically valued using credit spreads to U. S. Treasury benchmarks. This causes them to be comparable to fixed income securities in terms of interest
rate risk.



Throughout 2003, non-sinking fund preferred stocks were not
actively traded by the market, though lower interest rates intrinsically benefit their market values. At December 31, 2003, the duration on the Companys non-sinking fund preferred stock portfolio was 11.9 years. This implies that an upward
parallel shift in the yield curve by 100 basis points would reduce the asset value at December 31, 2003 by approximately $11 million, everything else remaining the same.



The common equity portfolio, representing approximately 7% of total investments at market value, consists primarily of public utility
common stocks. These assets are theoretically defensive in nature and therefore have low volatility to changes in market price as measured by their Beta. Beta is a measure of a securitys systematic (non-diversifiable) risk, which is the
percentage change in an individual securitys return for a 1% change in the return of the market. The average Beta for the Companys common stock holdings was 0.77. Based on a hypothetical 20% reduction in the overall value of the stock
market, the fair value of the common stock portfolio would decrease by approximately $27 million.



Effective January 2, 2002, the Company entered into an interest rate swap of its fixed rate obligation on its $125 million fixed rate senior notes for a floating
rate. The interest rate swap has the effect of hedging the fair value of the senior notes.



New Accounting Standards



In April 2003, the Financial
Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities (SFAS No. 149). SFAS No. 149 amends and
clarifies accounting for derivative instruments and improves financial reporting by requiring that contracts with comparable characteristics be accounted for similarly. The amendments to SFAS No. 133 fall principally into three categories:
amendments related to SFAS No. 133 implementation issues, amendments clarifying the definition of a derivative instrument, and amendments relating to the definition of expected cash flows contained in FASB Concepts Statement No. 7 Using Cash
Flow Information and Present Value in Accounting Measurements. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003. SFAS No. 149 does not alter current valuation or disclosures. The implementation of SFAS No.
149 did not have a material impact on the Companys consolidated financial statements.



In May 2003, the FASB issued Statement of Financial Accounting Standard No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (SFAS No. 150). SFAS No.
150 addresses certain financial instruments that, under previous guidelines, could be accounted for as equity, but now must be classified as liabilities in the statement of financial position. These financial instruments include: 1) mandatorily
redeemable financial instruments, 2) obligations to repurchase the issuers equity shares by transferring assets, and 3) obligations to issue a variable number of shares. SFAS No. 150 is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The implementation of SFAS No. 150 did not have a material impact on the Companys consolidated financial
statements.



Forward-looking statements



Certain statements in this report on Form 10-K that are not historical fact constitute
forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements may address, among other things,
our strategy for growth, business development, regulatory approvals, market position, expenditures,



36



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financial results and reserves. Forward-looking statements are not guarantees of performance and are subject to important factors and events that could cause our
actual business, prospects and results of operations to differ materially from the historical information contained in this Form 10-K and from those that may be expressed or implied by the forward-looking statements. Factors that could cause or
contribute to such differences include, among others: the competition currently existing in the California automobile insurance markets, our success in expanding our business in states outside of California, the impact of potential third party
bad-faith legislation, changes in laws or regulations, the outcome of tax position challenges by the California FTB, and decisions of courts, regulators and governmental bodies, particularly in California, our ability to obtain and the
timing of the approval of the California Insurance Commissioner for premium rate changes for private passenger automobile policies issued in California and similar rate approvals in other states where we do business, our success in integrating and
profitably operating the businesses we have acquired, the level of investment yields we are able to obtain with our investments in comparison to recent yields and the market risk associated with our investment portfolio, the cyclical and general
competitive nature of the property and casualty insurance industry and general uncertainties regarding loss reserve or other estimates, the accuracy and adequacy of the Companys pricing methodologies, uncertainties related to assumptions and
projections generally, inflation and changes in economic conditions, changes in driving patterns and loss trends, acts of war and terrorist activities, court decisions and trends in litigation and health care and auto repair costs, and other
uncertainties, all of which are difficult to predict and many of which are beyond our control. GAAP prescribes when a Company may reserve for particular risks including litigation exposures. Accordingly, results for a given reporting period could be
significantly affected if and when a reserve is established for a major contingency. Reported results may therefore appear to be volatile in certain periods. The Company undertakes no obligation to publicly update any forward-looking statements,
whether as a result of new information or future events or otherwise. Investors are cautioned not to place undue reliance on any forward-looking statements, which speak only as of the date of this Form 10-K or, in the case of any document we
incorporate by reference, the date of that document. Investors also should understand that it is not possible to predict or identify all factors and should not consider the risks set forth above to be a complete statement of all potential risks and
uncertainties. If the expectations or assumptions underlying our forward-looking statements prove inaccurate or if risks or uncertainties arise, actual results could differ materially from those predicted in any forward-looking statements.



Quarterly Data



Summarized quarterly financial data for 2003 and 2002 is as follows (in thousands except per share data):



|                                  |  |               |         |         |   |         |          |  |         |         |  |   |        
|--------------------------------- |  | ------------- | ------- | ------- | - | ------- | -------- |  | ------- | ------- |  | - | -------
|                                  |  | Quarter Ended
|                                  |  | March 31      |         | June 30 |   |         | Sept. 30 |  | Dec. 31
|2003                              |  |               |         |         |   |         |          |  |         |         |  |   |        
|Earned premiums                   |  | $             | 500,666 |         | $ | 525,072 |          |  | $       | 546,638 |  | $ | 572,671
|Income before income taxes        |  | $             | 54,771  |         | $ | 57,060  |          |  | $       | 67,663  |  | $ | 66,307 
|Net income                        |  | $             | 42,108  |         | $ | 43,372  |          |  | $       | 49,615  |  | $ | 49,226 
|Basic earnings per share          |  | $             | .77     |         | $ | .80     |          |  | $       | .91     |  | $ | .90    
|Diluted earnings per share        |  | $             | .77     |         | $ | .80     |          |  | $       | .91     |  | $ | .90    
|Dividends declared per share      |  | $             | .33     |         | $ | .33     |          |  | $       | .33     |  | $ | .33    
|                                  |  |               |         |        
|2002                              |  |               |         |         |   |         |          |  |         |         |  |   |        
|Earned premiums                   |  | $             | 386,637 |         | $ | 418,146 |          |  | $       | 455,467 |  | $ | 481,277
|Income (loss) before income taxes |  | $             | 34,838  |         | $ | (7,563  | )        |  | $       | 16,677  |  | $ | 16,716 
|Net income                        |  | $             | 28,954  |         | $ | 1,301   |          |  | $       | 18,520  |  | $ | 17,330 
|Basic earnings per share          |  | $             | .53     |         | $ | .02     |          |  | $       | .34     |  | $ | .33    
|Diluted earnings per share        |  | $             | .53     |         | $ | .02     |          |  | $       | .34     |  | $ | .32    
|Dividends declared per share      |  | $             | .30     |         | $ | .30     |          |  | $       | .30     |  | $ | .30    



37



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Item 8.    Financial Statements



INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



|                                                                                                                       |  |     
|---------------------------------------------------------------------------------------------------------------------- |  | ----
|                                                                                                                       |  | Page
|Independent Auditors Report                                                                                           |  | 39  
|                                                                                                                       | 
|Consolidated Financial Statements:                                                                                     |  |     
|                                                                                                                       | 
|Consolidated Balance Sheets as of December 31, 2003 and 2002                                                           |  | 40  
|                                                                                                                       | 
|Consolidated Statements of Income for Each of the Years in the Three-Year Period Ended December 31, 2003               |  | 41  
|                                                                                                                       | 
|Consolidated Statements of Comprehensive Income for Each of the Years in the Three-Year Period Ended December 31, 2003 |  | 42  
|                                                                                                                       | 
|Consolidated Statements of Shareholders Equity for Each of the Years in the Three-Year Period Ended December 31, 2003 |  | 43  
|                                                                                                                       | 
|Consolidated Statements of Cash Flows for Each of the Years in the Three-Year Period Ended December 31, 2003           |  | 44  
|                                                                                                                       | 
|Notes to Consolidated Financial Statements                                                                             |  | 45  



38



---

INDEPENDENT AUDITORS REPORT



The Board of Directors

Mercury General Corporation:



We have audited the accompanying consolidated balance sheets of Mercury General Corporation and subsidiaries as of December 31, 2003
and 2002, and the related consolidated statements of income, comprehensive income, shareholders equity and cash flows for each of the years in the three-year period ended December 31, 2003. These consolidated financial statements are the
responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.



We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.



In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Mercury General Corporation and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year
period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.



KPMG LLP



Los Angeles, California

February 2, 2004



39



---

MERCURY GENERAL CORPORATION

AND SUBSIDIARIES



CONSOLIDATED BALANCE SHEETS



DECEMBER 31, 2003 AND 2002

Amounts expressed in
thousands, except share amounts



|                                                                                                      |  |      |           |      |   |          
|----------------------------------------------------------------------------------------------------- |  | ---- | --------- | ---- | - | ---------
|ASSETS                                                                                                |  |      |           |     
|                                                                                                      |  | 2003 |           | 2002
|Investments:                                                                                          |  |      |           |      |   |          
|Fixed maturities available for sale (amortized cost $1,856,083 in 2003 and $1,565,760 in 2002)        |  | $    | 1,945,309 |      | $ | 1,632,871
|Equity securities available for sale (cost $223,113 in 2003 and $233,297 in 2002)                     |  |      | 264,393   |      |   | 230,981  
|Short-term cash investments, at cost, which approximates market                                       |  |      | 329,812   |      |   | 286,806  
|                                                                                                      |  |      |           |      |   |          
|Total investments                                                                                     |  |      | 2,539,514 |      |   | 2,150,658
|Cash                                                                                                  |  |      | 36,964    |      |   | 13,191   
|Receivables:                                                                                          |  |      |           |      |   |          
|Premiums receivable                                                                                   |  |      | 231,277   |      |   | 186,446  
|Premium notes                                                                                         |  |      | 22,620    |      |   | 21,761   
|Accrued investment income                                                                             |  |      | 26,585    |      |   | 26,203   
|Other                                                                                                 |  |      | 18,612    |      |   | 25,035   
|                                                                                                      |  |      |           |      |   |          
|                                                                                                      |  |      | 299,094   |      |   | 259,445  
|Deferred policy acquisition costs                                                                     |  |      | 132,059   |      |   | 107,485  
|Fixed assets, net                                                                                     |  |      | 79,286    |      |   | 61,619   
|Deferred income taxes                                                                                 |  |      |          |      |   | 17,004   
|Other assets                                                                                          |  |      | 32,849    |      |   | 35,894   
|                                                                                                      |  |      |           |      |   |          
|Total assets                                                                                          |  | $    | 3,119,766 |      | $ | 2,645,296
|                                                                                                      |  |      |           |      |   |          
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                  |  |      |           |     
|Losses and loss adjustment expenses                                                                   |  | $    | 797,927   |      | $ | 679,271  
|Unearned premiums                                                                                     |  |      | 663,004   |      |   | 545,485  
|Notes payable                                                                                         |  |      | 124,714   |      |   | 128,859  
|Loss drafts payable                                                                                   |  |      | 79,960    |      |   | 64,346   
|Accounts payable and accrued expenses                                                                 |  |      | 99,389    |      |   | 61,270   
|Current income tax                                                                                    |  |      | 11,441    |      |   | 6,654    
|Deferred income taxes                                                                                 |  |      | 17,808    |      |   |         
|Other liabilities                                                                                     |  |      | 70,020    |      |   | 60,625   
|                                                                                                      |  |      |           |      |   |          
|Total liabilities                                                                                     |  |      | 1,864,263 |      |   | 1,546,510
|                                                                                                      |  |      |           |      |   |          
|Commitments and contingencies                                                                         |  |      |           |      |   |          
|Shareholders equity:                                                                                 |  |      |           |      |   |          
|Common stock without par value or stated value:                                                       |  |      |           |      |   |          
|Authorized 70,000,000 shares; issued and outstanding 54,424,128 shares in 2003 and 54,361,698 in 2002 |  |      | 57,453    |      |   | 55,933   
|Accumulated other comprehensive income                                                                |  |      | 84,833    |      |   | 42,140   
|Retained earnings                                                                                     |  |      | 1,113,217 |      |   | 1,000,713
|                                                                                                      |  |      |           |      |   |          
|Total shareholders equity                                                                            |  |      | 1,255,503 |      |   | 1,098,786
|                                                                                                      |  |      |           |      |   |          
|Total liabilities and shareholders equity.                                                           |  | $    | 3,119,766 |      | $ | 2,645,296
|                                                                                                      |  |      |           |      |   |          



See accompanying notes to
consolidated financial statements.



40



---

MERCURY GENERAL CORPORATION

AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF INCOME



Three years ended December 31, 2003

Amounts expressed in
thousands, except per share data



|                                       |  |      |           |      |   |           |      |  |   |          
|-------------------------------------- |  | ---- | --------- | ---- | - | --------- | ---- |  | - | ---------
|                                       |  | 2003 |           | 2002 |   |           | 2001
|Revenues:                              |  |      |           |      |   |           |      |  |   |          
|Earned premiums                        |  | $    | 2,145,047 |      | $ | 1,741,527 |      |  | $ | 1,380,561
|Net investment income                  |  |      | 104,520   |      |   | 113,083   |      |  |   | 114,511  
|Net realized investment gains (losses) |  |      | 11,207    |      |   | (70,412   | )    |  |   | 6,512    
|Other                                  |  |      | 4,743     |      |   | 2,073     |      |  |   | 5,396    
|                                       |  |      |           |      |   |           |      |  |   |          
|Total revenues                         |  |      | 2,265,517 |      |   | 1,786,271 |      |  |   | 1,506,980
|                                       |  |      |           |      |   |           |      |  |   |          
|Expenses:                              |  |      |           |      |   |           |      |  |   |          
|Losses and loss adjustment expenses    |  |      | 1,452,051 |      |   | 1,268,243 |      |  |   | 1,010,439
|Policy acquisition costs               |  |      | 473,314   |      |   | 378,385   |      |  |   | 301,670  
|Other operating expenses               |  |      | 91,295    |      |   | 74,875    |      |  |   | 62,335   
|Interest                               |  |      | 3,056     |      |   | 4,100     |      |  |   | 7,727    
|                                       |  |      |           |      |   |           |      |  |   |          
|Total expenses                         |  |      | 2,019,716 |      |   | 1,725,603 |      |  |   | 1,382,171
|                                       |  |      |           |      |   |           |      |  |   |          
|Income before income taxes             |  |      | 245,801   |      |   | 60,668    |      |  |   | 124,809  
|Income tax expense (benefit)           |  |      | 61,480    |      |   | (5,437    | )    |  |   | 19,470   
|                                       |  |      |           |      |   |           |      |  |   |          
|Net income                             |  | $    | 184,321   |      | $ | 66,105    |      |  | $ | 105,339  
|                                       |  |      |           |      |   |           |      |  |   |          
|Basic earnings per share               |  | $    | 3.39      |      | $ | 1.22      |      |  | $ | 1.94     
|                                       |  |      |           |      |   |           |      |  |   |          
|Diluted earnings per share             |  | $    | 3.38      |      | $ | 1.21      |      |  | $ | 1.94     
|                                       |  |      |           |      |   |           |      |  |   |          







See accompanying notes to consolidated financial statements.



41



---

MERCURY GENERAL CORPORATION

AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME



Three Years ended December 31, 2003

Amounts expressed in thousands



|                                                                                                              |  |      |         |   |      |   |         |      |  |   |         |  
|------------------------------------------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                                              |  | 2003 |         |   | 2002 |   |         | 2001 | 
|Net income                                                                                                    |  | $    | 184,321 |   |      | $ | 66,105  |      |  | $ | 105,339 |  
|Other comprehensive income (loss), before tax:                                                                |  |      |         |   |      |   |         |      |  |   |         |  
|Unrealized gains (losses) on securities:                                                                      |  |      |         |   |      |   |         |      |  |   |         |  
|Unrealized holding gains (losses) arising during period                                                       |  |      | 71,502  |   |      |   | (30,623 | )    |  |   | (16,854 | )
|Less: reclassification adjustment for net losses (gains) included innet income                                |  |      | (5,790  | ) |      |   | 69,303  |      |  |   | (4,524  | )
|                                                                                                              |  |      |         |   |      |   |         |      |  |   |         |  
|Other comprehensive income (loss), before tax                                                                 |  |      | 65,712  |   |      |   | 38,680  |      |  |   | (21,378 | )
|Income tax expense (benefit) related to unrealized holding gains (losses) arising during period               |  |      | 25,046  |   |      |   | (10,741 | )    |  |   | (5,899  | )
|Income tax expense (benefit) related to reclassification adjustment for (gains) losses included in net income |  |      | (2,027  | ) |      |   | 24,256  |      |  |   | (1,583  | )
|                                                                                                              |  |      |         |   |      |   |         |      |  |   |         |  
|Comprehensive income, net of tax                                                                              |  | $    | 227,014 |   |      | $ | 91,270  |      |  | $ | 91,443  |  
|                                                                                                              |  |      |         |   |      |   |         |      |  |   |         |  







See accompanying notes to consolidated financial statements.



42



---

MERCURY GENERAL CORPORATION

AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY



Three years ended December 31, 2003

Amounts expressed in thousands



|                                                                  |  |      |           |   |      |   |           |      |  |   |           |  
|----------------------------------------------------------------- |  | ---- | --------- | - | ---- | - | --------- | ---- |  | - | --------- | -
|                                                                  |  | 2003 |           |   | 2002 |   |           | 2001 | 
|Common stock, beginning of year                                   |  | $    | 55,933    |   |      | $ | 53,955    |      |  | $ | 52,162    |  
|Proceeds of stock options exercised                               |  |      | 1,331     |   |      |   | 1,581     |      |  |   | 1,344     |  
|Tax benefit on sales of incentive stock options                   |  |      | 189       |   |      |   | 389       |      |  |   | 587       |  
|Release of common stock by the ESOP                               |  |      |          |   |      |   | 8         |      |  |   | (138      | )
|                                                                  |  |      |           |   |      |   |           |      |  |   |           |  
|Common stock, end of year                                         |  |      | 57,453    |   |      |   | 55,933    |      |  |   | 53,955    |  
|                                                                  |  |      |           |   |      |   |           |      |  |   |           |  
|Accumulated other comprehensive income, beginning of year         |  |      | 42,140    |   |      |   | 16,975    |      |  |   | 30,871    |  
|Net increase (decrease) in other comprehensive income, net of tax |  |      | 42,693    |   |      |   | 25,165    |      |  |   | (13,896   | )
|                                                                  |  |      |           |   |      |   |           |      |  |   |           |  
|Accumulated other comprehensive income, end of year               |  |      | 84,833    |   |      |   | 42,140    |      |  |   | 16,975    |  
|                                                                  |  |      |           |   |      |   |           |      |  |   |           |  
|Unearned ESOP compensation, beginning of year                     |  |      |          |   |      |   | (1,000    | )    |  |   | (2,000    | )
|Amortization of unearned ESOP compensation                        |  |      |          |   |      |   | 1,000     |      |  |   | 1,000     |  
|                                                                  |  |      |           |   |      |   |           |      |  |   |           |  
|Unearned ESOP compensation, end of year                           |  |      |          |   |      |   |          |      |  |   | (1,000    | )
|                                                                  |  |      |           |   |      |   |           |      |  |   |           |  
|Retained earnings, beginning of year                              |  |      | 1,000,713 |   |      |   | 999,781   |      |  |   | 951,872   |  
|Net income                                                        |  |      | 184,321   |   |      |   | 66,105    |      |  |   | 105,339   |  
|Dividends paid to shareholders                                    |  |      | (71,817   | ) |      |   | (65,173   | )    |  |   | (57,430   | )
|                                                                  |  |      |           |   |      |   |           |      |  |   |           |  
|Retained earnings, end of year                                    |  | $    | 1,113,217 |   |      | $ | 1,000,713 |      |  |   | 999,781   |  
|                                                                  |  |      |           |   |      |   |           |      |  |   |           |  
|Total shareholders equity                                        |  | $    | 1,255,503 |   |      | $ | 1,098,786 |      |  | $ | 1,069,711 |  
|                                                                  |  |      |           |   |      |   |           |      |  |   |           |  





See accompanying notes to consolidated financial statements.



43



---

MERCURY GENERAL CORPORATION

AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF CASH FLOWS



Three Years Ended December 31, 2003

Amounts expressed
in thousands



|                                                                                                  |  |      |          |   |      |   |          |      |  |   |          |  
|------------------------------------------------------------------------------------------------- |  | ---- | -------- | - | ---- | - | -------- | ---- |  | - | -------- | -
|                                                                                                  |  | 2003 |          |   | 2002 |   |          | 2001 | 
|Cash flows from operating activities:                                                             |  |      |          |   |      |   |          |      |  |   |          |  
|Net income                                                                                        |  | $    | 184,321  |   |      | $ | 66,105   |      |  | $ | 105,339  |  
|Adjustments to reconcile net income to net cash provided from operating activities:               |  |      |          |   |      |   |          |      |  |   |          |  
|Depreciation                                                                                      |  |      | 16,126   |   |      |   | 10,233   |      |  |   | 8,477    |  
|Net realized investment (gains) losses                                                            |  |      | (11,207  | ) |      |   | 70,412   |      |  |   | (6,512   | )
|Bond amortization (accretion), net                                                                |  |      | 2,883    |   |      |   | (6,982   | )    |  |   | (9,229   | )
|Increase in premium notes receivable                                                              |  |      | (859     | ) |      |   | (4,505   | )    |  |   | (3,051   | )
|Increase in premiums receivable                                                                   |  |      | (44,831  | ) |      |   | (42,834  | )    |  |   | (20,542  | )
|Increase (decrease) in reinsurance recoveries                                                     |  |      | 2,736    |   |      |   | (955     | )    |  |   | 19,335   |  
|Increase in deferred policy acquisition costs                                                     |  |      | (24,574  | ) |      |   | (24,045  | )    |  |   | (12,314  | )
|Increase in unpaid losses and loss adjustment expenses                                            |  |      | 118,656  |   |      |   | 144,345  |      |  |   | 42,706   |  
|Increase in unearned premiums                                                                     |  |      | 117,519  |   |      |   | 124,143  |      |  |   | 55,763   |  
|Increase in premiums collected in advance                                                         |  |      | 7,305    |   |      |   | 7,558    |      |  |   | 6,922    |  
|Increase in loss drafts payable                                                                   |  |      | 15,614   |   |      |   | 10,717   |      |  |   | 3,675    |  
|Decrease (increase) in accrued income taxes, excluding deferred tax on change in unrealized gain. |  |      | 16,601   |   |      |   | (27,003  | )    |  |   | (1,209   | )
|Increase in accounts payable and accrued expenses                                                 |  |      | 38,119   |   |      |   | 14,632   |      |  |   | 6,923    |  
|Other, net                                                                                        |  |      | 6,043    |   |      |   | 741      |      |  |   | 3,169    |  
|                                                                                                  |  |      |          |   |      |   |          |      |  |   |          |  
|Net cash provided from operating activities                                                       |  |      | 444,452  |   |      |   | 342,562  |      |  |   | 199,452  |  
|Cash flows from investing activities:                                                             |  |      |          |   |      |   |          |      |  |   |          |  
|Fixed maturities available for sale:                                                              |  |      |          |   |      |   |          |      |  |   |          |  
|Purchases                                                                                         |  |      | (854,883 | ) |      |   | (480,335 | )    |  |   | (341,471 | )
|Sales                                                                                             |  |      | 122,212  |   |      |   | 327,464  |      |  |   | 186,949  |  
|Calls or maturities                                                                               |  |      | 442,465  |   |      |   | 119,460  |      |  |   | 71,758   |  
|Equity securities available for sale:                                                             |  |      |          |   |      |   |          |      |  |   |          |  
|Purchases                                                                                         |  |      | (217,681 | ) |      |   | (207,535 | )    |  |   | (90,067  | )
|Sales                                                                                             |  |      | 228,588  |   |      |   | 216,565  |      |  |   | 64,450   |  
|Decrease (increase) in receivable from securities                                                 |  |      | 6,709    |   |      |   | (1,246   | )    |  |   | 167      |  
|Increase in short-term cash investments                                                           |  |      | (43,006  | ) |      |   | (214,855 | )    |  |   | (38,974  | )
|Purchase of fixed assets                                                                          |  |      | (35,015  | ) |      |   | (29,389  | )    |  |   | (18,095  | )
|Sale of fixed assets                                                                              |  |      | 1,418    |   |      |   | 2,241    |      |  |   | 563      |  
|                                                                                                  |  |      |          |   |      |   |          |      |  |   |          |  
|Net cash used in investing activities                                                             |  | $    | (349,193 | ) |      | $ | (267,630 | )    |  | $ | (164,720 | )
|Cash flows from financing activities:                                                             |  |      |          |   |      |   |          |      |  |   |          |  
|Net proceeds from issuance of senior notes                                                        |  | $    |         |   |      | $ |         |      |  | $ | 123,309  |  
|Net payments under credit arrangements                                                            |  |      |         |   |      |   | (1,000   | )    |  |   | (103,039 | )
|Dividends paid to shareholders                                                                    |  |      | (71,817  | ) |      |   | (65,173  | )    |  |   | (57,430  | )
|Proceeds from stock options exercised                                                             |  |      | 1,331    |   |      |   | 1,581    |      |  |   | 1,344    |  
|Payments on ESOP loan                                                                             |  |      | (1,000   | ) |      |   | (1,000   | )    |  |   | (1,000   | )
|                                                                                                  |  |      |          |   |      |   |          |      |  |   |          |  
|Net cash used in financing activities                                                             |  |      | (71,486  | ) |      |   | (65,592  | )    |  |   | (36,816  | )
|                                                                                                  |  |      |          |   |      |   |          |      |  |   |          |  
|Net increase (decrease) in cash                                                                   |  |      | 23,773   |   |      |   | 9,340    |      |  |   | (2,084   | )
|Cash:                                                                                             |  |      |          |   |      |   |          |      |  |   |          |  
|Beginning of the year                                                                             |  |      | 13,191   |   |      |   | 3,851    |      |  |   | 5,935    |  
|                                                                                                  |  |      |          |   |      |   |          |      |  |   |          |  
|End of the year                                                                                   |  | $    | 36,964   |   |      | $ | 13,191   |      |  | $ | 3,851    |  
|                                                                                                  |  |      |          |   |      |   |          |      |  |   |          |  



See accompanying notes to
consolidated financial statements.



44



---

MERCURY GENERAL CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



December
31, 2003 and 2002



(1)    Significant Accounting Policies



Principles of Consolidation and Presentation



The Company is primarily engaged in the underwriting of private passenger automobile
insurance in the state of California. In 2003, 2002 and 2001, over 83% of total net written premiums were from California.



The consolidated financial statements include the accounts of Mercury General Corporation (the Company) and its wholly-owned subsidiaries, Mercury Casualty Company,
Mercury Insurance Company, California Automobile Insurance Company, California General Underwriters Insurance Company, Inc., Mercury Insurance Company of Georgia, Mercury Insurance Company of Illinois, Mercury Insurance Company of Florida, Mercury
Indemnity Company of Georgia, Mercury Indemnity Company of Illinois, Mercury Indemnity Company of Florida (changed in 2003 to Mercury Indemnity Company of America), Mercury Insurance Services, LLC (MISLLC), American Mercury Insurance Company (AMIC),
AFI Management Company, Inc. (AFIMC), American Mercury Lloyds Insurance Company (AML) and Mercury County Mutual Insurance Company (MCM). American Mercury MGA, Inc. (AMMGA), is a wholly owned subsidiary of AMIC. AML is not owned by the Company, but
is controlled by the Company through its attorney-in-fact, AFIMC. MCM is not owned by the Company but is controlled through a management contract and therefore its results are included in the financial statements. MCM is discussed further in Note 8
of the Notes to Consolidated Financial Statements. The financial statements also include Concord Insurance Services, Inc., (Concord) a Texas insurance agency owned by the Company. All of the subsidiaries as a group, including AML and MCM, but
excluding AFIMC, AMMGA, MISLLC and Concord, are referred to as the Insurance Companies. The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP) which
differ in some respects from those filed in reports to insurance regulatory authorities. All significant intercompany balances and transactions have been eliminated.



The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. The most significant assumptions in
the preparation of these consolidated financial statements relate to loss and loss adjustment expenses. Actual results could differ from those estimates.



Investments



Fixed maturities available for sale include those securities that management intends to hold for indefinite periods, but which may be sold in response to changes in
interest rates, tax planning considerations or other aspects of asset/liability management. Fixed maturities available for sale, which include bonds and sinking fund preferred stocks, are carried at market. Investments in equity securities, which
include common stocks and non-redeemable preferred stocks, are carried at market. Short-term cash investments are carried at cost, which approximates market.



In most cases, the market valuations were drawn from standard trade data sources. In no case were any valuations made by the Companys management. Equity
holdings, including non-sinking fund preferred stocks, are, with minor exceptions, actively traded on national exchanges, and were valued at the last transaction price on the balance sheet date.



Temporary unrealized investment gains and losses on securities available for sale are
credited or charged directly to shareholders equity as accumulated other comprehensive income, net of applicable tax effects. When a decline in value of fixed maturities or equity securities is considered other than temporary, a loss is
recognized in



45



---

MERCURY GENERAL CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



December 31, 2003 and 2002



the consolidated statements of income. Realized gains and losses are included in the consolidated statements of income based upon the specific identification method.



The Company writes covered call options through listed exchanges and
over-the-counter. When the Company writes an option, an amount equal to the premium received by the Company is recorded as a liability and is subsequently adjusted to the current fair value of the option written. Premiums received from writing
options that expire unexercised are treated by the Company on the expiration date as realized gains from investments. If a call option is exercised, the premium is added to the proceeds from the sale of the underlying security or currency in
determining whether the Company has realized a gain or loss. The Company as writer of an option bears the market risk of an unfavorable change in the price of the security underlying the written option.



Fair Value of Financial Instruments



Under Statement of Financial Accounting Standards No. 115, Accounting for
Certain Investments in Debt and Equity Securities (SFAS No. 115), the Company categorizes all of its investments in debt and equity securities as available for sale. Accordingly, all investments, including cash and short-term cash
investments, are carried on the balance sheet at their fair value. The carrying amounts and fair values for investment securities are disclosed in Note 2 of the Notes to Consolidated Financial Statements and were drawn from standard trade data
sources such as market and broker quotes. The carrying value of receivables, accounts payable and other liabilities is equivalent to the estimated fair value of those items. The notes payable are carried at their book value which is calculated as
the principal less unamortized discount on the senior debt. The terms of the note are discussed in Note 5 of the Notes to Consolidated Financial Statements.



Goodwill and Other Intangible Assets



Goodwill and other intangible assets represent the excess of the purchase price of acquired businesses over the fair value of net assets acquired using the purchase
method of accounting. Included in the Companys balance sheet are goodwill of $7.3 million and other intangible assets of $5.2 million. The Company adopted the provisions of SFAS No. 142, Goodwill and Other Intangible Assets, as of
January 1, 2002. The goodwill and other intangible assets were determined to have an indefinite useful life and in accordance with SFAS No. 142 are not amortized, but tested for impairment annually. The fair value of goodwill and other intangibles
are measured annually based upon projected discounted operating cash flows using a market rate of interest to discount the cash flows. No impairment was recorded at December 31, 2003. Prior to January 2002, the Company amortized these assets over
their expected useful lives and recorded amortization expense for goodwill and other intangible assets of $1.9 million in 2001.



Premium Income Recognition



Insurance premiums are recognized as income ratably over the term of the policies. Unearned premiums are computed on a monthly pro rata basis. Unearned premiums are
stated gross of reinsurance deductions, with the reinsurance deduction recorded in other assets.



Net premiums written during 2003, 2002 and 2001 were $2,268,778,000, $1,865,046,000 and $1,442,886,000, respectively.



One broker produced direct premiums written of approximately 16%, 16% and 17% of the
Companys total direct premiums written during 2003, 2002 and 2001, respectively. No other agent or broker accounted for more than 2% of direct premiums written.



46



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MERCURY GENERAL CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



December 31, 2003 and 2002



Premium Notes



Premium notes receivable represent the balance due to the Company from policyholders who elect to finance their premiums over the policy term. The Company
requires both a downpayment and monthly payments as part of its financing program. Premium finance fees are charged to policyholders who elect to finance premiums. The fees are charged at rates that vary with the amount of premium financed. Premium
finance fees are recognized over the term of the premium note based upon the effective yield.



Deferred Policy Acquisition Costs



Acquisition costs related to unearned premiums, which consist of commissions, premium taxes and certain other underwriting costs, which vary directly with and are directly related to the production of business, are deferred and amortized to
expense ratably over the terms of the policies. Deferred acquisition costs are limited to the amount which will remain after deducting from unearned premiums and anticipated investment income the estimated losses and loss adjustment expenses and the
servicing costs that will be incurred as the premiums are earned. The Company does not defer advertising expenses.



Losses and Loss Adjustment Expenses



The liability for losses and loss adjustment expenses is based upon the accumulation of individual case estimates for losses reported prior to the close of the
accounting period, plus estimates, based upon past experience, of ultimate developed costs which may differ from case estimates and of unreported claims. The liability is stated net of anticipated salvage and subrogation recoveries. The amount of
reinsurance recoverable is included in other receivables.



Estimating
loss reserves is a difficult process as there are many factors that can ultimately affect the final settlement of a claim and, therefore, the reserve that is needed. Changes in the regulatory and legal environment, results of litigation, medical
costs, the cost of repair materials and labor rates can all 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
the claim, the more variable the ultimate settlement amount can be. Accordingly, short-tail claims, such as property damage claims, tend to be more reasonably predictable than long-tail liability 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. Since the provisions are necessarily based upon estimates, the ultimate liability may be more or less than such
provisions.



Depreciation



Buildings and furniture and equipment are stated at cost and depreciated over 30-year
and 3-year to 10-year periods, respectively, on a combination of straight-line and accelerated methods. Automobiles are depreciated over 5 years, using an accelerated method.



Earnings per Share



Earnings per share is presented in accordance with the provisions of Statement of Financial Accounting Standards No. 128, Earnings per Share, which
requires presentation of basic and diluted earnings per share for all publicly traded companies. Note 14 of the Notes to Consolidated Financial Statements contains the required disclosures which make up the calculation of basic and diluted earnings
per share.



47



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MERCURY GENERAL CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



December 31, 2003 and 2002



Segment Reporting



Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information
(SFAS No. 131), establishes standards for the way information about operating segments is reported in financial statements. The Company does not have any operations that require separate disclosure as operating segments.



Income Taxes



The Company recognizes deferred tax assets and liabilities for temporary differences between the financial reporting basis and the tax
basis of the Companys assets and liabilities and expected benefits of utilizing net operating loss and credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or settled. The impact on deferred taxes of changes in tax rates and laws, if any, are applied to the years during which temporary differences are expected to be settled and
reflected in the financial statements in the period enacted.



Reinsurance



Liabilities for unearned premiums and
unpaid losses are stated in the accompanying consolidated financial statements before deductions for ceded reinsurance. The ceded amounts are immaterial and are carried in other assets and other receivables. Earned premiums are stated net of
deductions for ceded reinsurance.



The Insurance Companies, as primary
insurers, would be required to pay losses in their entirety in the event that the reinsurers were unable to discharge their obligations under the reinsurance agreements.



Supplemental Cash Flow Information



Interest paid during 2003, 2002 and 2001, was $3,087,000, $6,435,000 and $4,610,000, respectively. Income taxes paid were $44,697,000 in 2003, $21,154,000 in 2002
and $20,089,000 in 2001.



The tax benefit realized on stock options
exercised and included in cash provided from operations in 2003, 2002 and 2001 was $189,000, $389,000 and $587,000, respectively.



In 2003, notes payable with a discounted value of $4,315,000 was canceled in accordance with terms of a Purchase and Sale Agreement between the Company and
Employers Reinsurance Corporation (See Note 8 in Notes to Consolidated Financial Statements).



Stock-Based Compensation



The Company
accounts for stock-based compensation under the accounting methods prescribed by Accounting Principles Board (APB) Opinion No. 25, as allowed by Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation and amended by SFAS No. 148, Accounting for Stock-Based CompensationTransition and Disclosure. Disclosure of stock-based compensation determined in accordance with SFAS No. 148 is presented in Note 13 in Notes to
Consolidated Financial Statements.



Reclassifications



Certain reclassifications have been made to the prior year balances to conform to
the current year presentation.



48



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MERCURY GENERAL CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



December 31, 2003 and 2002



Recently Issued Accounting Standards



In April 2003, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard No. 149,
Amendment of Statement 133 on Derivative Instruments and Hedging Activities (SFAS No. 149). SFAS No. 149 amends and clarifies accounting for derivative instruments and improves financial reporting by requiring that
contracts with comparable characteristics be accounted for similarly. The amendments to SFAS No. 133 fall principally into three categories: amendments related to SFAS No. 133 implementation issues, amendments clarifying the definition of a
derivative instrument, and amendments relating to the definition of expected cash flows contained in FASB Concepts Statement No. 7 Using Cash Flow Information and Present Value in Accounting Measurements. SFAS No. 149 is effective for
contracts entered into or modified after June 30, 2003. SFAS No. 149 does not alter current valuation or disclosures. The implementation of SFAS No. 149 did not have a material impact on the Companys consolidated financial statements.



In May 2003, the FASB issued Statement of Financial Accounting Standard
No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (SFAS No. 150). SFAS No. 150 addresses certain financial instruments that, under previous guidelines, could be
accounted for as equity, but now must be classified as liabilities in the statement of financial position. These financial instruments include: 1) mandatorily redeemable financial instruments, 2) obligations to repurchase the issuers
equity shares by transferring assets, and 3) obligations to issue a variable number of shares. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first
interim period beginning after June 15, 2003. The implementation of SFAS No. 150 did not have a material impact on the Companys consolidated financial statements.



(2)    Investments and Investment Income



A summary of net investment income is shown in the following table:



|                                           |  |                         |         |      |   |         |  |   |        
|------------------------------------------ |  | ----------------------- | ------- | ---- | - | ------- |  | - | -------
|                                           |  | Year ended December 31,
|                                           |  | 2003                    |         | 2002 |   | 2001   
|                                           |  | (Amounts in thousands) 
|Interest and dividends on fixed maturities |  | $                       | 87,586  |      | $ | 95,124  |  | $ | 95,187 
|Dividends on equity securities             |  |                         | 14,752  |      |   | 15,478  |  |   | 17,080 
|Interest on short-term cash investments    |  |                         | 3,339   |      |   | 2,951   |  |   | 3,295  
|                                           |  |                         |         |      |   |         |  |   |        
|Total investment income                    |  |                         | 105,677 |      |   | 113,553 |  |   | 115,562
|Investment expense                         |  |                         | 1,157   |      |   | 470     |  |   | 1,051  
|                                           |  |                         |         |      |   |         |  |   |        
|Net investment income                      |  | $                       | 104,520 |      | $ | 113,083 |  | $ | 114,511
|                                           |  |                         |         |      |   |         |  |   |        



A summary of net realized
investment gains (losses) is as follows:



|                                        |  |                         |        |      |   |         |      |  |   |      
|--------------------------------------- |  | ----------------------- | ------ | ---- | - | ------- | ---- |  | - | -----
|                                        |  | Year ended December 31,
|                                        |  | 2003                    |        | 2002 |   |         | 2001
|                                        |  | (Amounts in thousands) 
|Net realized investment gains (losses): |  |                         |        |      |   |         |      |  |   |      
|Fixed maturities                        |  | $                       | 3,198  |      | $ | (34,550 | )    |  | $ | 4,561
|Equity securities                       |  |                         | 8,009  |      |   | (35,862 | )    |  |   | 1,951
|                                        |  |                         |        |      |   |         |      |  |   |      
|                                        |  | $                       | 11,207 |      | $ | (70,412 | )    |  | $ | 6,512
|                                        |  |                         |        |      |   |         |      |  |   |      



49



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MERCURY GENERAL CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



December 31, 2003 and 2002



Gross gains and losses realized on the sales of investments (excluding calls and other than temporarily
impaired securities) are shown below:



|                                      |  |                         |        |   |      |   |         |      |  |   |        |  
|------------------------------------- |  | ----------------------- | ------ | - | ---- | - | ------- | ---- |  | - | ------ | -
|                                      |  | Year ended December 31, |       
|                                      |  | 2003                    |        |   | 2002 |   |         | 2001 | 
|                                      |  | (Amounts in thousands)  |       
|Fixed maturities available for sale:  |  |                         |        |   |      |   |         |      |  |   |        |  
|Gross realized gains                  |  | $                       | 4,529  |   |      | $ | 11,807  |      |  | $ | 5,558  |  
|Gross realized losses                 |  |                         | (1,161 | ) |      |   | (12,894 | )    |  |   | (1,608 | )
|                                      |  |                         |        |   |      |   |         |      |  |   |        |  
|Net                                   |  | $                       | 3,368  |   |      | $ | (1,087  | )    |  | $ | 3,950  |  
|                                      |  |                         |        |   |      |   |         |      |  |   |        |  
|Equity securities available for sale: |  |                         |        |   |      |   |         |      |  |   |        |  
|Gross realized gains                  |  | $                       | 15,216 |   |      | $ | 7,622   |      |  | $ | 5,205  |  
|Gross realized losses                 |  |                         | (4,128 | ) |      |   | (6,561  | )    |  |   | (2,760 | )
|                                      |  |                         |        |   |      |   |         |      |  |   |        |  
|Net                                   |  | $                       | 11,088 |   |      | $ | 1,061   |      |  | $ | 2,445  |  
|                                      |  |                         |        |   |      |   |         |      |  |   |        |  



A summary of the net increase
(decrease) in unrealized investment gains and losses less applicable income tax expense (benefit), is as follows:



|                                                                       |  |                         |        |      |   |        |      |  |   |         |  
|---------------------------------------------------------------------- |  | ----------------------- | ------ | ---- | - | ------ | ---- |  | - | ------- | -
|                                                                       |  | Year ended December 31, |       
|                                                                       |  | 2003                    |        | 2002 |   |        | 2001 | 
|                                                                       |  | (Amounts in thousands)  |       
|Net increase (decrease) in net unrealized investment gains and losses: |  |                         |        |      |   |        |      |  |   |         |  
|Fixed maturities available for sale                                    |  | $                       | 22,114 |      | $ | 40,858 |      |  | $ | (19,324 | )
|Income tax expense (benefit)                                           |  |                         | 7,740  |      |   | 14,300 |      |  |   | (6,763  | )
|                                                                       |  |                         |        |      |   |        |      |  |   |         |  
|                                                                       |  | $                       | 14,374 |      | $ | 26,558 |      |  | $ | (12,561 | )
|                                                                       |  |                         |        |      |   |        |      |  |   |         |  
|Equity securities                                                      |  | $                       | 43,598 |      | $ | (2,178 | )    |  | $ | (2,055  | )
|Income tax expense (benefit)                                           |  |                         | 15,279 |      |   | (785   | )    |  |   | (720    | )
|                                                                       |  |                         |        |      |   |        |      |  |   |         |  
|                                                                       |  | $                       | 28,319 |      | $ | (1,393 | )    |  | $ | (1,335  | )
|                                                                       |  |                         |        |      |   |        |      |  |   |         |  



50



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MERCURY GENERAL CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



December 31, 2003 and 2002



Accumulated unrealized gains and losses on securities available for sale is as follows:



|                                                                                                            |  |                        |         |   |      |   |         |  
|----------------------------------------------------------------------------------------------------------- |  | ---------------------- | ------- | - | ---- | - | ------- | -
|                                                                                                            |  | December 31,           |        
|                                                                                                            |  | 2003                   |         |   | 2002 |  
|                                                                                                            |  | (Amounts in thousands) |        
|Fixed maturities available for sale:                                                                        |  |                        |         |   |      |   |         |  
|Unrealized gains                                                                                            |  | $                      | 96,884  |   |      | $ | 94,032  |  
|Unrealized losses                                                                                           |  |                        | (7,658  | ) |      |   | (26,921 | )
|Tax effect                                                                                                  |  |                        | (31,229 | ) |      |   | (23,488 | )
|                                                                                                            |  |                        |         |   |      |   |         |  
|                                                                                                            |  | $                      | 57,997  |   |      | $ | 43,623  |  
|                                                                                                            |  |                        |         |   |      |   |         |  
|Equity securities available for sale:                                                                       |  |                        |         |   |      |   |         |  
|Unrealized gains                                                                                            |  | $                      | 43,885  |   |      | $ | 8,860   |  
|Unrealized losses                                                                                           |  |                        | (2,605  | ) |      |   | (11,176 | )
|Tax effect                                                                                                  |  |                        | (14,444 | ) |      |   | 833     |  
|                                                                                                            |  |                        |         |   |      |   |         |  
|                                                                                                            |  | $                      | 26,836  |   |      | $ | (1,483  | )
|                                                                                                            |  |                        |         |   |      |   |         |  
|Net unrealized investment gains (classified as accumulated other comprehensive income on the balance sheet) |  | $                      | 84,833  |   |      | $ | 42,140  |  
|                                                                                                            |  |                        |         |   |      |   |         |  



The amortized costs and
estimated market values of investments in fixed maturities available for sale as of December 31, 2003 are as follows:



|                                                                                      |  |                        |           |                        |   |                         |  |                        |       |  |   |          
|------------------------------------------------------------------------------------- |  | ---------------------- | --------- | ---------------------- | - | ----------------------- |  | ---------------------- | ----- |  | - | ---------
|                                                                                      |  | Amortized Cost         |           | Gross Unrealized Gains |   | Gross Unrealized Losses |  | Estimated Market Value
|                                                                                      |  | (Amounts in thousands)
|U.S. Treasury securities and obligations of U.S. government corporations and agencies |  | $                      | 258,442   |                        | $ | 1,714                   |  | $                      | 1,464 |  | $ | 258,692  
|Obligations of states and political subdivisions                                      |  |                        | 1,502,974 |                        |   | 90,674                  |  |                        | 5,250 |  |   | 1,588,398
|Corporate securities                                                                  |  |                        | 82,207    |                        |   | 4,162                   |  |                        | 672   |  |   | 85,697   
|Redeemable preferred stock                                                            |  |                        | 12,460    |                        |   | 334                     |  |                        | 272   |  |   | 12,522   
|                                                                                      |  |                        |           |                        |   |                         |  |                        |       |  |   |          
|Totals                                                                                |  | $                      | 1,856,083 |                        | $ | 96,884                  |  | $                      | 7,658 |  | $ | 1,945,309
|                                                                                      |  |                        |           |                        |   |                         |  |                        |       |  |   |          



The amortized costs and
estimated market values of investments in fixed maturities available for sale as of December 31, 2002 are as follows:



|                                                                                      |  |                        |           |                        |   |                         |  |                        |        |  |   |          
|------------------------------------------------------------------------------------- |  | ---------------------- | --------- | ---------------------- | - | ----------------------- |  | ---------------------- | ------ |  | - | ---------
|                                                                                      |  | Amortized Cost         |           | Gross Unrealized Gains |   | Gross Unrealized Losses |  | Estimated Market Value
|                                                                                      |  | (Amounts in thousands)
|U.S. Treasury securities and obligations of U.S. government corporations and agencies |  | $                      | 84,644    |                        | $ | 1,492                   |  | $                      | 56     |  | $ | 86,080   
|Obligations of states and political subdivisions                                      |  |                        | 1,361,852 |                        |   | 89,005                  |  |                        | 7,856  |  |   | 1,443,001
|Corporate securities                                                                  |  |                        | 105,114   |                        |   | 3,245                   |  |                        | 18,555 |  |   | 89,804   
|Redeemable preferred stock                                                            |  |                        | 14,150    |                        |   | 290                     |  |                        | 454    |  |   | 13,986   
|                                                                                      |  |                        |           |                        |   |                         |  |                        |        |  |   |          
|Totals                                                                                |  | $                      | 1,565,760 |                        | $ | 94,032                  |  | $                      | 26,921 |  | $ | 1,632,871
|                                                                                      |  |                        |           |                        |   |                         |  |                        |        |  |   |          



51



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MERCURY GENERAL CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



December 31, 2003 and 2002



The following table illustrates the gross unrealized losses included in the Companys investment portfolio
and the fair value of those securities, aggregated by investment category. The table also illustrates the length of time that they have been in a continuous unrealized loss position as of December 31, 2003.



|                                                                                      |  |                        |       |                   |   |                   |  |            |       |                   |   |            |  |   |        |  |   |        
|------------------------------------------------------------------------------------- |  | ---------------------- | ----- | ----------------- | - | ----------------- |  | ---------- | ----- | ----------------- | - | ---------- |  | - | ------ |  | - | -------
|                                                                                      |  | Less than 12 months    |       | 12 months or more |   | Total            
|                                                                                      |  | Unrealized Losses      |       | Fair Value        |   | Unrealized Losses |  | Fair Value |       | Unrealized Losses |   | Fair Value
|                                                                                      |  | (Amounts in thousands)
|U.S. Treasury Securities and obligations of U.S. government corporations and agencies |  | $                      | 1,464 |                   | $ | 139,162           |  | $          |      |                   | $ |           |  | $ | 1,464  |  | $ | 139,162
|Obligations of states and political subdivisions                                      |  |                        | 2,589 |                   |   | 165,636           |  |            | 2,661 |                   |   | 27,809     |  |   | 5,250  |  |   | 193,445
|Corporate securities                                                                  |  |                        | 106   |                   |   | 19,388            |  |            | 566   |                   |   | 4,631      |  |   | 672    |  |   | 24,019 
|Redeemable Preferred Stock                                                            |  |                        | 10    |                   |   | 1,248             |  |            | 262   |                   |   | 5,780      |  |   | 272    |  |   | 7,028  
|                                                                                      |  |                        |       |                   |   |                   |  |            |       |                   |   |            |  |   |        |  |   |        
|Subtotal, debt securities                                                             |  | $                      | 4,169 |                   | $ | 325,434           |  | $          | 3,489 |                   | $ | 38,220     |  | $ | 7,658  |  | $ | 363,654
|Equity Securities                                                                     |  |                        | 1,817 |                   |   | 63,310            |  |            | 788   |                   |   | 26,217     |  |   | 2,605  |  |   | 89,527 
|                                                                                      |  |                        |       |                   |   |                   |  |            |       |                   |   |            |  |   |        |  |   |        
|Total temporarily impaired securities                                                 |  | $                      | 5,986 |                   | $ | 388,744           |  | $          | 4,277 |                   | $ | 64,437     |  | $ | 10,263 |  | $ | 453,181
|                                                                                      |  |                        |       |                   |   |                   |  |            |       |                   |   |            |  |   |        |  |   |        



The Company monitors its
investments closely. If an unrealized loss is determined to be other than temporary it is written off as a realized loss through the Consolidated Statement of Income. The Companys methodology of assessing other than temporary impairments is
based on security-specific analysis as of the balance sheet date and considers various factors including the length of time and the extent to which the fair value has been less than the cost, the financial condition and the near term prospects of
the issuer, whether the debtor is current on its contractually obligated interest and principal payments, and the Companys intent to hold the investment for a period of time sufficient to allow the Company to recover its costs.



At December 31, 2003, the Company had a net unrealized gain on all investments of
$130.5 million before income taxes which is comprised of gross unrealized gains of $140.8 million offset by gross unrealized losses of $10.3 million. Gross unrealized losses represent 2.2% of amortized cost for those securities in a gross unrealized
loss position and 0.4% of total investments at amortized cost. The Companys investment portfolio includes approximately 300 securities in a gross unrealized loss position. Of this amount, 15 securities account for over 50% of the gross
unrealized losses. The most significant gross unrealized losses in this group relate to a $1.1 million gross unrealized loss for a single bond obligation of a major airline which is supported by gate lease revenues at the Dallas-Fort Worth
(DFW) airport and to one corporate bond and one municipal bond with unrealized losses of approximately $0.6 million and $0.5 million, respectively, representing market value declines of 11% and 18%, respectively, of amortized cost. All
of the bond issuers are current on their interest obligations. The remaining 50% of gross unrealized losses represents a large number of securities whose gross unrealized losses average approximately $18,000 per security and 1.3% of their amortized
cost.



52



---

MERCURY GENERAL CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



December 31, 2003 and 2002



At December 31, 2003, bond holdings rated below investment grade were approximately 2% of total investments.
The average Standard and Poors rating of the bond portfolio was AA. The amortized cost and estimated market value of fixed maturities available for sale at December 31, 2003 by contractual maturity, are shown below. Expected maturities will
differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.



|                                       |  |                        |           |                        |   |          
|-------------------------------------- |  | ---------------------- | --------- | ---------------------- | - | ---------
|                                       |  | Amortized Cost         |           | Estimated Market Value
|                                       |  | (Amounts in thousands)
|Fixed maturities available for sale:   |  |                        |           |                        |   |          
|Due in one year or less                |  | $                      | 40,716    |                        | $ | 40,712   
|Due after one year through five years  |  |                        | 72,693    |                        |   | 75,908   
|Due after five years through ten years |  |                        | 338,299   |                        |   | 358,624  
|Due after ten years                    |  |                        | 1,404,375 |                        |   | 1,470,065
|                                       |  |                        |           |                        |   |          
|                                       |  | $                      | 1,856,083 |                        | $ | 1,945,309
|                                       |  |                        |           |                        |   |          



(3)    Fixed Assets



A summary of fixed assets follows:



|                              |  |                        |         |   |      |   |         |  
|----------------------------- |  | ---------------------- | ------- | - | ---- | - | ------- | -
|                              |  | December 31,           |        
|                              |  | 2003                   |         |   | 2002 |  
|                              |  | (Amounts in thousands) |        
|Land                          |  | $                      | 12,308  |   |      | $ | 12,305  |  
|Buildings                     |  |                        | 46,362  |   |      |   | 30,359  |  
|Furniture and equipment       |  |                        | 90,292  |   |      |   | 75,161  |  
|Leasehold improvements        |  |                        | 1,603   |   |      |   | 1,283   |  
|                              |  |                        |         |   |      |   |         |  
|                              |  |                        | 105,565 |   |      |   | 119,108 |  
|Less accumulated depreciation |  |                        | (71,279 | ) |      |   | (57,489 | )
|                              |  |                        |         |   |      |   |         |  
|Net fixed assets              |  | $                      | 79,286  |   |      | $ | 61,619  |  
|                              |  |                        |         |   |      |   |         |  



(4)    Deferred Policy
Acquisition Costs



Policy acquisition costs incurred and amortized
are as follows:



|                                |  |                         |          |   |      |   |          |      |  |   |          |  
|------------------------------- |  | ----------------------- | -------- | - | ---- | - | -------- | ---- |  | - | -------- | -
|                                |  | Year ended December 31, |         
|                                |  | 2003                    |          |   | 2002 |   |          | 2001 | 
|                                |  | (Amounts in thousands)  |         
|Balance, beginning of year      |  | $                       | 107,485  |   |      | $ | 83,440   |      |  | $ | 71,126   |  
|Costs deferred during the year  |  |                         | 497,888  |   |      |   | 402,430  |      |  |   | 313,984  |  
|Amortization charged to expense |  |                         | (473,314 | ) |      |   | (378,385 | )    |  |   | (301,670 | )
|                                |  |                         |          |   |      |   |          |      |  |   |          |  
|Balance, end of year            |  | $                       | 132,059  |   |      | $ | 107,485  |      |  | $ | 83,440   |  
|                                |  |                         |          |   |      |   |          |      |  |   |          |  



(5)    Notes Payable



The Company had outstanding debt at December 31, 2003 of $124.7
million. Included in the total debt is the proceeds from an August 7, 2001 public debt offering where the Company issued $125 million of senior notes



53



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MERCURY GENERAL CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



December 31, 2003 and 2002



payable under a $300 million shelf registration filed with the SEC in July 2001. The notes are unsecured, senior obligations of the Company with a 7.25% annual coupon
payable on August 15 and February 15 each year. The notes mature on August 15, 2011. The Company incurred debt issuance costs of approximately $1.3 million, inclusive of underwriters fees. These costs are deferred and then amortized as a
component of interest expense over the term of the notes. The notes were issued at a slight discount at 99.723%, making the effective annualized interest rate including debt issuance costs approximately 7.44%. At December 31, 2003, the book value of
the debt was $124.7 million and the fair market value was $140.4 million.



Effective January 2, 2002, the Company entered into an interest rate swap of its fixed rate obligation on the senior notes for a floating rate of LIBOR plus 107 basis points. The swap agreement terminates on August 15, 2011 and includes an
early termination option exercisable by either party on the fifth anniversary or each subsequent anniversary by providing sufficient notice, as defined. The swap significantly reduced interest expense in 2002 and 2003, but does expose the Company to
higher interest expense in future periods, should LIBOR rates increase. The effective annualized interest rate in 2003 was 2.2%. The swap is accounted for as a fair value hedge under SFAS No. 133.



As part of the Mercury County Mutual Insurance Company (MCM) transaction,
the Company agreed to make annual $1 million payments to Employers Reinsurance Corporation (ERC) over 7 years beginning September 30, 2001. At December 31, 2002, the Company was carrying a note payable for $4.2 million, which represented
the discounted value of the five remaining annual payments using a 7% rate. In June 2003, the enactment of legislation in Texas triggered a provision in the acquisition agreement with ERC relieving the Company of further obligation to pay ERC
additional consideration. Notes payable has been reduced by $4.3 million representing the discounted value of the future annual installments. The Company has also reduced the carrying value of the intangible asset that originated from the
acquisition of MCM by $4.3 million. No gain or loss has been recognized from this transaction. See Note 8 to Notes to Consolidated Financial Statements.



(6)    Income Taxes



The Company and its subsidiaries file a consolidated Federal income tax return. The provision for income tax expense (benefit) consists of the following components:



|         |  |                         |        |      |   |         |      |  |   |        |  
|-------- |  | ----------------------- | ------ | ---- | - | ------- | ---- |  | - | ------ | -
|         |  | Year ended December 31, |       
|         |  | 2003                    |        | 2002 |   |         | 2001 | 
|         |  | (Amounts in thousands)  |       
|Federal  |  |                         |        |      |   |         |      |  |   |        |  
|Current  |  | $                       | 49,299 |      | $ | 23,593  |      |  | $ | 21,377 |  
|Deferred |  |                         | 11,606 |      |   | (29,271 | )    |  |   | (2,546 | )
|         |  |                         |        |      |   |         |      |  |   |        |  
|         |  | $                       | 60,905 |      | $ | (5,678  | )    |  | $ | 18,831 |  
|         |  |                         |        |      |   |         |      |  |   |        |  
|State    |  |                         |        |      |   |         |      |  |   |        |  
|Current  |  | $                       | 374    |      | $ | 237     |      |  | $ | 196    |  
|Deferred |  |                         | 201    |      |   | 4       |      |  |   | 443    |  
|         |  |                         |        |      |   |         |      |  |   |        |  
|         |  | $                       | 575    |      | $ | 241     |      |  | $ | 639    |  
|         |  |                         |        |      |   |         |      |  |   |        |  
|Total    |  |                         |        |      |   |         |      |  |   |        |  
|Current  |  | $                       | 49,673 |      | $ | 23,830  |      |  | $ | 21,573 |  
|Deferred |  |                         | 11,807 |      |   | (29,267 | )    |  |   | (2,103 | )
|         |  |                         |        |      |   |         |      |  |   |        |  
|Total    |  | $                       | 61,480 |      | $ | (5,437  | )    |  | $ | 19,470 |  
|         |  |                         |        |      |   |         |      |  |   |        |  



54



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MERCURY GENERAL CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



December 31, 2003 and 2002



The income tax provision reflected in the consolidated statements of income is less than the expected federal
income tax on income before income taxes as shown in the table below:



|                                                                                                      |  |                         |         |   |      |   |         |      |  |   |         |  
|----------------------------------------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                                      |  | Year ended December 31, |        
|                                                                                                      |  | 2003                    |         |   | 2002 |   |         | 2001 | 
|                                                                                                      |  | (Amounts in thousands)  |        
|Computed tax expense at 35%                                                                           |  | $                       | 86,030  |   |      | $ | 21,234  |      |  | $ | 43,683  |  
|Tax-exempt interest income                                                                            |  |                         | (26,967 | ) |      |   | (27,656 | )    |  |   | (25,694 | )
|Dividends received deduction                                                                          |  |                         | (2,734  | ) |      |   | (3,065  | )    |  |   | (3,054  | )
|Reduction of losses incurred deduction for 15% of income on securities purchased after August 7, 1986 |  |                         | 4,322   |   |      |   | 4,689   |      |  |   | 4,272   |  
|Other, net                                                                                            |  |                         | 829     |   |      |   | (639    | )    |  |   | 263     |  
|                                                                                                      |  |                         |         |   |      |   |         |      |  |   |         |  
|Income tax expense (benefit)                                                                          |  | $                       | 61,480  |   |      | $ | (5,437  | )    |  | $ | 19,470  |  
|                                                                                                      |  |                         |         |   |      |   |         |      |  |   |         |  



The temporary differences that
give rise to a significant portion of the deferred tax asset (liability) relate to the following:



|                                                                                      |  |                        |          |   |      |   |         |  
|------------------------------------------------------------------------------------- |  | ---------------------- | -------- | - | ---- | - | ------- | -
|                                                                                      |  | December 31,           |         
|                                                                                      |  | 2003                   |          |   | 2002 |  
|                                                                                      |  | (Amounts in thousands) |         
|Deferred tax assets                                                                   |  |                        |          |   |      |   |         |  
|20% of net unearned premium                                                           |  | $                      | 47,670   |   |      | $ | 39,009  |  
|Discounting of loss reserves and salvage and subrogation recoverable for tax purposes |  |                        | 16,957   |   |      |   | 13,734  |  
|Write-down of impaired investments                                                    |  |                        | 18,281   |   |      |   | 24,423  |  
|Other deferred tax assets                                                             |  |                        | 2,247    |   |      |   | 10,006  |  
|                                                                                      |  |                        |          |   |      |   |         |  
|Total gross deferred tax assets                                                       |  |                        | 85,155   |   |      |   | 87,172  |  
|                                                                                      |  |                        |          |   |      |   |         |  
|Deferred tax liabilities                                                              |  |                        |          |   |      |   |         |  
|Deferred acquisition costs                                                            |  |                        | (51,433  | ) |      |   | (41,662 | )
|Tax liability on net unrealized gain on securities carried at market value            |  |                        | (45,673  | ) |      |   | (22,654 | )
|Tax depreciation in excess of book depreciation                                       |  |                        | (169     | ) |      |   | (555    | )
|Accretion on bonds                                                                    |  |                        | (57      | ) |      |   | (47     | )
|Other deferred tax liabilities                                                        |  |                        | (5,631   | ) |      |   | (5,250  | )
|                                                                                      |  |                        |          |   |      |   |         |  
|Total gross deferred tax liabilities                                                  |  |                        | (102,963 | ) |      |   | (70,168 | )
|                                                                                      |  |                        |          |   |      |   |         |  
|Net deferred tax (liabilities) assets                                                 |  | $                      | (17,808  | ) |      | $ | 17,004  |  
|                                                                                      |  |                        |          |   |      |   |         |  



Realization of deferred tax
assets is dependent on generating sufficient taxable income prior to their expiration. Although realization is not assured, management believes it is more likely than not that the deferred tax assets will be realized.



On June 25, 2003, the California State Board of Equalization (SBE) upheld
Notices of Proposed Assessment (NPAs) issued against the Company for tax years 1993 through 1996. In the NPAs, the California Franchise Tax Board (FTB) disallowed a portion of the Companys expenses related to
management services provided to its insurance company subsidiaries on grounds that such portion was allocable to the Companys tax-deductible dividends from such subsidiaries. The total tax liability and interest on the management fee expenses
amount to approximately $14 million (approximately $7 million tax liability plus $7 million of interest through December 31, 2003). The potential net liability, after federal tax benefit, amounts to approximately $9 million.



55



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MERCURY GENERAL CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



December 31, 2003 and 2002



The Company continues to believe that its deduction of the expenses related to management services provided to
it subsidiaries is meritorious and will continue to defend it vigorously before the SBE and, if necessary, the courts. The Company has filed a Petition for Rehearing with the SBE based both on procedural and substantive grounds, and both the Company
and the FTB have filed briefs relating to the Petition. The SBE is expected to consider the matter in March 2004.



The SBE decision on the NPAs for tax years 1993 through 1996 also resulted in a smaller disallowance of the Companys interest expense deductions than
was proposed by the FTB in those years. The Company has decided not to continue to challenge this issue and has established a small accrual for the tax liability and related interest.



As a result of the court ruling in Ceridian vs. Franchise Tax Board, the FTB has issued NPAs for tax years 1997 through 2000
disallowing all Dividend Received Deductions (DRD) taken by the Company for those tax years. The ruling in Ceridian vs. Franchise Tax Boardheld the statute permitting the tax deductibility of dividends received from wholly-owned insurance
subsidiaries unconstitutional because it discriminated against out-of-state holding companies. The FTB interpretation of the ruling concludes that the discriminatory sections of the statute are not severable and the entire statute is invalid. As a
result, the FTBs position in the NPAs is that all dividends received by the Company from its insurance company subsidiaries are subject to California franchise taxes. The DRD disallowance could result in approximately $17 million of additional
California state franchise taxes plus $8 million of related interest through December 31, 2003. The potential net liability, after federal tax benefit, amounts to approximately $16 million.



Management intends to vigorously challenge these potential tax liabilities on 2001 and
future inter-company dividends. However, if the Companys challenges are ineffective or the issue is not resolved favorably with the State of California, additional state taxes of approximately 9% (6% after the federal tax benefit of deducting
state taxes) could be owed on dividends Mercury General receives from its insurance subsidiaries. While the Company intends to continue paying dividends to its shareholders, an unsatisfactory conclusion to the inter-company dividend issue could
affect future dividend policy.



The Company is closely following the
progress of legislation that if enacted would resolve the issues on expense disallowance and eliminate the uncertainty created by the court ruling in Ceridian vs. Franchise Tax Board for all tax years through December 31, 2003. Without a
legislative solution, years of future litigation may be required to determine the ultimate outcome of the expense disallowance and DRD issues. Because of the uncertainty surrounding these issues, it is difficult to predict the ultimate amount the
Company may be required to pay, if anything. Consistent with the proposed legislation and the Companys expectations of a legislative solution, the Company has established a tax contingency reserve of approximately $3 million, net of federal
tax benefits, for all California franchise tax issues including the disallowance of expenses and DRD issues.



56



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MERCURY GENERAL CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



December 31, 2003 and 2002



(7)    Reserves for Losses and Loss Adjustment Expenses



Activity in the reserves for losses and loss adjustment expenses is summarized as
follows:



|                                                                            |  |                         |           |   |      |   |           |      |  |   |           |  
|--------------------------------------------------------------------------- |  | ----------------------- | --------- | - | ---- | - | --------- | ---- |  | - | --------- | -
|                                                                            |  | Year ended December 31, |          
|                                                                            |  | 2003                    |           |   | 2002 |   |           | 2001 | 
|                                                                            |  | (Amounts in thousands)  |          
|Gross reserves for losses and loss adjustment expenses at beginning of year |  | $                       | 679,271   |   |      | $ | 534,926   |      |  | $ | 492,220   |  
|Less reinsurance recoverable                                                |  |                         | (14,382   | ) |      |   | (18,334   | )    |  |   | (28,417   | )
|                                                                            |  |                         |           |   |      |   |           |      |  |   |           |  
|Net reserves, beginning of year                                             |  |                         | 664,889   |   |      |   | 516,592   |      |  |   | 463,803   |  
|Incurred losses and loss adjustment expenses related to:                    |  |                         |           |   |      |   |           |      |  |   |           |  
|Current year                                                                |  |                         | 1,447,986 |   |      |   | 1,242,060 |      |  |   | 993,510   |  
|Prior years                                                                 |  |                         | 4,065     |   |      |   | 26,183    |      |  |   | 16,929    |  
|                                                                            |  |                         |           |   |      |   |           |      |  |   |           |  
|Total incurred losses and loss adjustment expenses                          |  |                         | 1,452,051 |   |      |   | 1,268,243 |      |  |   | 1,010,439 |  
|                                                                            |  |                         |           |   |      |   |           |      |  |   |           |  
|Loss and loss adjustment expense payments related to:                       |  |                         |           |   |      |   |           |      |  |   |           |  
|Current year                                                                |  |                         | 892,658   |   |      |   | 759,165   |      |  |   | 636,007   |  
|Prior years                                                                 |  |                         | 438,126   |   |      |   | 360,781   |      |  |   | 321,643   |  
|                                                                            |  |                         |           |   |      |   |           |      |  |   |           |  
|Total payments                                                              |  |                         | 1,330,784 |   |      |   | 1,119,946 |      |  |   | 957,650   |  
|                                                                            |  |                         |           |   |      |   |           |      |  |   |           |  
|Net reserves for losses and loss adjustment expenses at end of year         |  |                         | 786,156   |   |      |   | 664,889   |      |  |   | 516,592   |  
|Reinsurance recoverable                                                     |  |                         | 11,771    |   |      |   | 14,382    |      |  |   | 18,334    |  
|                                                                            |  |                         |           |   |      |   |           |      |  |   |           |  
|Gross reserves, end of year                                                 |  | $                       | 797,927   |   |      | $ | 679,271   |      |  | $ | 534,926   |  
|                                                                            |  |                         |           |   |      |   |           |      |  |   |           |  



The increase in the provision
for insured events of prior years in 2003 relates largely to an increase in the ultimate liability for physical damage and collision claims over what was originally estimated. For 2002 and 2001, the increase largely relates to an increase in the
ultimate liability for bodily injury, physical damage and collision claims over what was originally estimated. The increases in these claims relate to increased severity over what was originally recorded and are the result of inflationary trends in
health care costs, auto parts and body shop labor costs.



(8)    Mercury County Mutual Insurance Company Transaction



The Company conducts business in Texas through Mercury County Mutual Insurance Company (MCM), a Texas county mutual insurance company that the Company
manages and controls under the authority of a management contract acquired from Employers Reinsurance Corporation (ERC) effective September 30, 2000. Under the terms of the acquisition agreement, the Company agreed to pay additional
consideration in the aggregate amount of $7 million payable in annual installments of $1 million provided no statutes were enacted that eliminate or substantially reduce the preferential underwriting and rate treatment afforded county mutual
insurance companies.



In June 2003, legislation was enacted in Texas that
calls for sweeping changes in the regulation of rates and forms for property and casualty insurance companies, including the elimination of the rate freedom afforded to county mutual insurance companies. The enactment of this legislation triggered a
provision in the acquisition agreement with ERC relieving the Company of further obligation to pay ERC additional consideration. Notes payable



57



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MERCURY GENERAL CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



December 31, 2003 and 2002



has been reduced by $4.3 million representing the discounted value of the future annual installments. The Company has also reduced the carrying value of the intangible
asset that originated from the acquisition of MCM by $4.3 million. No gain or loss has been recognized from this transaction.



(9)    Dividend Restrictions



The Insurance Companies are subject to the financial capacity guidelines established by their domiciliary states. The payment of dividends from statutory unassigned
surplus of the Insurance Companies is restricted, subject to certain statutory limitations. For 2004, the direct insurance subsidiaries of the Company are permitted to pay approximately $121 million in dividends to the Company without the prior
approval of the Commissioner of Insurance of the state of domicile. The above statutory regulations may have the effect of indirectly limiting the ability of the Company to pay dividends. During 2003 and 2002, the Insurance Companies paid dividends
to Mercury General Corporation of $76.0 million and $75.0 million, respectively.



(10)    Statutory Balances and Accounting Practices



The Insurance Companies prepare their statutory financial statements in accordance with accounting practices prescribed or permitted by the various state insurance departments. Prescribed statutory accounting practices include
primarily those published as statements of Statutory Accounting Principles by the National Association of Insurance Commissioners (NAIC), as well as state laws, regulations, and general administrative rules. Permitted statutory accounting practices
encompass all accounting practices not so prescribed. As of December 31, 2003, there were no material permitted statutory accounting practices utilized by the Insurance Companies.



The Insurance Companies statutory net income, as reported to regulatory authorities, was $168,118,000, $14,792,000 and
$93,720,000 for the years ended December 31, 2003, 2002 and 2001, respectively. The statutory policyholders surplus of the Insurance Companies, as reported to regulatory authorities, as of December 31, 2003 and 2002 was $1,169,427,000 and
$1,014,935,000, respectively.



The Company has estimated the Risk-Based
Capital Requirements of each of the Insurance Companies as of December 31, 2003 according to the formula issued by the NAIC. Each of the Insurance Companies policyholders surplus exceeded the highest level of minimum required capital.



(11)    Commitments and Contingencies



The Company is obligated under various noncancellable lease agreements providing for
office space and equipment rental that expire at various dates through the year 2010. Total rent expense under these lease agreements, all of which are operating leases, was $6,150,000, $4,815,000 and $4,428,000 for the years ended December 31,
2003, 2002 and 2001, respectively.



The annual rental commitments,
expressed in thousands, are shown as follows:



|           |  |              |      
|---------- |  | ------------ | -----
|Year       |  | Rent Expense
|2004       |  | $            | 5,688
|2005       |  | $            | 5,410
|2006       |  | $            | 4,653
|2007       |  | $            | 4,337
|2008       |  | $            | 2,901
|Thereafter |  | $            | 320  



58



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MERCURY GENERAL CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



December 31, 2003 and 2002



The Company is, from time to time, named as a defendant in various lawsuits incidental to its insurance
business. In most of these actions, plaintiffs assert claims for punitive damages which are not insurable under judicial decisions. The Company has established reserves for lawsuits which the Company is able to estimate its potential exposure and
the likelihood that the court will rule against the Company is probable. The Company vigorously defends these actions, unless a reasonable settlement appears appropriate. The Company believes that adverse results, if any, in the actions currently
pending should not have a material effect on the Companys operations or financial position.



In Robert Krumme, On Behalf Of The General Public vs. Mercury Insurance Company, Mercury Casualty Company, and California Automobile Insurance Company
(Superior Court for the City and County of San Francisco), initially filed June 30, 2000, the plaintiff has asserted an unfair trade practices claim under Section 17200 of the California Business and Professions Code. Specifically, the case involves
a dispute over the legality of broker fees (generally less than $100 per policy) charged by independent brokers who sell the Companys products to consumers that purchase insurance policies written by the California Companies. The plaintiff
asserts that the brokers who sell the Companys products should not charge broker fees and that the Company benefits from these fees and should be liable for them. The plaintiff sought an elimination of the broker fees and restitution of
previously paid broker fees. In April 2003, the court ruled that the brokers involved in the suit were in fact agents of the Company; however, the court also held that the Company was not responsible for retroactive restitution. The court issued an
injunction on May 16, 2003 that prevents Mercury from either (a) selling auto or homeowners insurance through any producer that is not appointed as an agent under Insurance Code, Section 1704, (b) selling auto or homeowners insurance through any
producer that charges broker fees and (c) engaging in comparative rate advertising and failing to disclose the possibility that a broker fee may be charged. Mercury has appealed, which has the effect of staying all but the advertising aspects of the
courts injunction. The Companys appeal is based on the fact that the broker fees are subject to directand, if they could be attributed to Mercury, exclusiveregulation by the Insurance Commissioner. The law allows a broker to
perform agent functions without giving up broker status. In the past, the Insurance Commissioner never found broker fees were either being improperly charged or attributable to Mercury. However, in February 2004, the Department of Insurance issued a
Notice of Non-Compliance (NNC) to the California Companies based on this litigations outcome. The NNC alleges that the California Companies willfully misrepresented the actual price insurance consumers could expect to pay for
insurance by the amount of a one-time fee charged by the consumers insurance broker. The California Companies are preparing a Notice of Defense in advance of an administrative hearing which will be based on the same grounds forming the
Companys defense in the Robert Krumme case. The impact of this NNC as it relates to this case can not be determined at the present time. However, the Company intends to continue to vigorously defend this case.



In Sheila Leivas, Individually And On Behalf Of All Others Similarly Situated vs.
Mercury Insurance Company (Orange County Superior Court), filed July 12, 2002, the Company is defending a suit involving a dispute over premium retained by the Company during a time when the plaintiff was not covered following a voluntary
cancellation of the policy and prior to reinstatement of the policy. The plaintiffs motion seeking to have the case certified as a class action was denied without prejudice. The court also overruled plaintiffs Demurrer to Mercurys
cross complaint, thereby allowing Mercury to proceed with its action for the return of premium owed to Mercury if plaintiffs action proceeds. The Company intends to continue to vigorously defend this case.



Dan ODell, individually and on behalf of others similarly situated v. Mercury
Insurance Company, Mercury General Corporation (Los Angeles Superior Court), filed July 12, 2002, involves a dispute over whether Mercurys use of certain automated database vendors to help determine the value of total loss claims is
proper. In 2003, the court granted Mercurys motion to stay the action pending compliance with a contractual arbitration provision. After completion of the arbitration which should occur in June 2004, Mercury and its attorneys intend to
challenge the pleadings and seek a dismissal.



59



---

MERCURY GENERAL CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



December 31, 2003 and 2002



In Marissa Goodman, on her own behalf and on behalf of all others similarly situated v. Mercury Insurance
Company (Los Angeles Superior Court), filed June 16, 2002, the plaintiff is challenging the Companys use of certain automated database vendors to assist in valuing claims for medical payments. The plaintiff is seeking to have the case
certified as a class action. As with the ODell case above, and the other cases in the coordinated proceedings, plaintiff alleges that these automated databases systematically undervalue medical payment claims to the detriment of
insureds. The plaintiff is seeking actual and punitive damages. Similar lawsuits have been filed against other insurance carriers in the industry. The case has been coordinated with two other similar cases, and also with ten other cases relating to
total loss claims. The Company and the other defendants were successful on demurrer. Plaintiffs were given leave to file amended complaints, which are expected in 2004.The Company intends to vigorously defend this lawsuit jointly with the
other defendants in the coordinated proceedings.



The Company is also
involved in proceedings relating to assessments and rulings made by the California Franchise Tax Board. (See Item 7. Managements Discussion and Analysis of Financial Conditions and Results of OperationsGeneral, and Note
6 of Notes to Consolidated Financial Statements.)



(12)    Profit Sharing Plan



The
Company, at the option of the Board of Directors, may make annual contributions to an employee profit sharing plan. The contributions are not to exceed the greater of the Companys net income for the plan year or its retained earnings at that
date. In addition, the annual contributions may not exceed an amount equal to 15% of the compensation paid or accrued during the year to all participants under the plan. The annual contribution was $1,500,000, $1,500,000 and $1,300,000 for plan
years ended December 31, 2003, 2002 and 2001, respectively.



The Profit
Sharing Plan also includes an option for employees to make salary deferrals under Section 401(k) of the Internal Revenue Code. Company matching contributions, at a rate set by the Board of Directors, totaled $2,235,000, $2,030,000 and $1,787,000 for
the plan years ended December 31, 2003, 2002 and 2001.



For 2003, the
Profit Sharing plan includes an employee stock ownership plan (ESOP) that covers substantially all employees. The Board of Directors authorized the plan to purchase $1 million of the Companys common stock in the open market for
allocation to the plan participants. The Company recognized the $1 million as compensation expense in 2003.



Prior to 2003, the Profit Sharing Plan included a leveraged ESOP that covers substantially all employees. The Company made annual contributions to the ESOP equal to
the ESOPs debt service less dividends received by the ESOP. Dividends received by the ESOP on unallocated shares were used to pay debt service and the ESOP shares serve as collateral for its debt. As the debt is repaid, shares are released
from collateral and allocated to employees, based on the proportion of debt service paid in the year. The Company accounts for its leveraged ESOP in accordance with Statement of Position 93-6.



The debt of the leveraged ESOP, which was $0 and $1,000,000 at December 31, 2003 and
2002 respectively, is recorded in the balance sheet as other liabilities. The shares pledged as collateral are reported as unearned ESOP compensation in the shareholders equity section of the balance sheet. As shares are committed to be
released from collateral, the Company reports compensation expense equal to the market price of the shares, and reduces unearned ESOP compensation by the original cost of the shares. The difference between the market price and cost of the shares is
charged to common stock. As shares are committed to be released from collateral, the shares become outstanding for earnings-per-share computations. Dividends on allocated ESOP shares are recorded as a reduction of retained earnings; dividends on
unallocated ESOP shares are recorded as a reduction of accrued interest. ESOP compensation expense was $1,009,000 and $862,000 in 2002 and 2001, respectively.



60



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MERCURY GENERAL CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



December 31, 2003 and 2002



(13)    Common Stock



Dividends paid per-share in 2003, 2002 and 2001 were $1.32, $1.20 and $1.06, respectively and dividends paid in total in 2003, 2002
and 2001 were $71,817,000, $65,173,000 and $57,430,000, respectively.



The Company adopted a stock option plan in October 1985 (the 1985 Plan) under which 5,400,000 shares were reserved for issuance. Options granted during 1985 were exercisable immediately. Subsequent options granted become
exercisable 20% per year beginning one year from the date granted. All options were granted at the market price on the date of the grant and expire in 10 years.



In May 1995, the Company adopted the 1995 Equity Participation Plan (the 1995 Plan) which succeeds the 1985 Plan. Under the 1995 Plan, 5,400,000
shares of Common Stock are authorized for issuance upon exercise of options, stock appreciation rights and other awards, or upon vesting of restricted or deferred stock awards. During 1995, the Company granted incentive stock options under both the
1995 Plan and the 1985 Plan. The options granted become exercisable 20% per year beginning one year from the date granted and were granted at the market price on the date of the grant. The options expire in 10 years. At December 31, 2003 no awards
other than options have been granted.



As explained in Note 1, the
Company applies APB No. 25 in accounting for its stock option plan. Accordingly, no compensation cost has been recognized in the Consolidated Statements of Income.



The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition
of SFAS No. 123:



|                                                                                                                                           |  |                                          |         |   |      |   |        |      |  |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------------ |  | ---------------------------------------- | ------- | - | ---- | - | ------ | ---- |  | - | ------- | -
|                                                                                                                                           |  | Year Ended December 31,                  |        
|                                                                                                                                           |  | 2003                                     |         |   | 2002 |   |        | 2001 | 
|                                                                                                                                           |  | (Amounts in thousands, except per share) |        
|Net income, as reported                                                                                                                    |  | $                                        | 184,321 |   |      | $ | 66,105 |      |  | $ | 105,339 |  
|Deduct: Total stock based employee compensation expense determined under fair value based method for all awards, net of related tax
effect |  |                                          | (560    | ) |      |   | (485   | )    |  |   | (459    | )
|                                                                                                                                           |  |                                          |         |   |      |   |        |      |  |   |         |  
|Proforma net income                                                                                                                        |  | $                                        | 183,761 |   |      | $ | 65,620 |      |  | $ | 104,880 |  
|                                                                                                                                           |  |                                          |         |   |      |   |        |      |  |   |         |  
|Earnings per share:                                                                                                                        |  |                                          |         |   |      |   |        |      |  |   |         |  
|Basicas reported                                                                                                                          |  | $                                        | 3.39    |   |      | $ | 1.22   |      |  | $ | 1.94    |  
|                                                                                                                                           |  |                                          |         |   |      |   |        |      |  |   |         |  
|Basicpro forma                                                                                                                            |  | $                                        | 3.38    |   |      | $ | 1.21   |      |  | $ | 1.93    |  
|                                                                                                                                           |  |                                          |         |   |      |   |        |      |  |   |         |  
|Dilutedas reported                                                                                                                        |  | $                                        | 3.38    |   |      | $ | 1.21   |      |  | $ | 1.94    |  
|                                                                                                                                           |  |                                          |         |   |      |   |        |      |  |   |         |  
|Dilutedpro forma                                                                                                                          |  | $                                        | 3.37    |   |      | $ | 1.21   |      |  | $ | 1.93    |  
|                                                                                                                                           |  |                                          |         |   |      |   |        |      |  |   |         |  



Calculations of the fair value
under the method prescribed by SFAS No. 123 were made using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 2003, 2002 and 2001: dividend yield of 2.8 percent in 2003, 3.2 percent in 2002 and
2.4 percent for 2001, expected volatility of 35.0 percent in 2003, 33.6 percent in 2002 and 34.2 percent in 2001 and expected lives of 6 years for all years. The risk-free interest rates used were 3.2 percent for options granted in 2003, 4.4 percent
for options granted during 2002 and 4.9 percent for the options granted during 2001.



61



---

MERCURY GENERAL CORPORATION AND SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



December 31, 2003 and 2002



A summary of the status of the Companys plans as of December 31, 2003, 2002 and 2001 and changes during
the years ending on those dates is presented below:



|                                                               |  |        |         |      |                              |      |        |  |   |                              |   |        |   |        |                              |   |         |   |  |   |       
|-------------------------------------------------------------- |  | ------ | ------- | ---- | ---------------------------- | ---- | ------ |  | - | ---------------------------- | - | ------ | - | ------ | ---------------------------- | - | ------- | - |  | - | ------
|                                                               |  | 2003   |         | 2002 |                              | 2001
|                                                               |  | Shares |         |      | WeightedAverageExercisePrice |      | Shares |  |   | WeightedAverageExercisePrice |   | Shares |   |        | WeightedAverageExercisePrice
|Outstanding at beginning of year                               |  |        | 582,950 |      |                              | $    | 31.118 |  |   | 580,800                      |   |        | $ | 27.739 |                              |   | 538,675 |   |  | $ | 23.104
|Granted during the year                                        |  |        | 32,500  |      |                              |      | 39.856 |  |   | 87,000                       |   |        |   | 41.497 |                              |   | 125,500 |   |  |   | 39.912
|Exercised during the year                                      |  |        | (62,480 | )    |                              |      | 21.307 |  |   | (84,850                      | ) |        |   | 18.629 |                              |   | (83,375 | ) |  |   | 16.118
|Canceled or expired                                            |  |        | (5,000  | )    |                              |      | 41.335 |  |   |                             |   |        |   |       |                              |   |        |   |  |   |      
|                                                               |  |        |         |      |                              |      |        |  |   |                              |   |        |   |        |                              |   |         |   |  |   |       
|Outstanding at end of year                                     |  |        | 547,970 |      |                              |      | 32.662 |  |   | 582,950                      |   |        |   | 31.118 |                              |   | 580,800 |   |  |   | 27.739
|                                                               |  |        |         |      |                              |      |        |  |   |                              |   |        |   |        |                              |   |         |   |  |   |       
|Options exercisable at year-end                                |  |        | 331,090 |      |                              |      |        |  |   | 313,690                      |   |        |   |        |                              |   | 328,460 |   |  |   |       
|Weighted-average fair value of options granted during the year |  | $      | 11.40   |      |                              |      |        |  | $ | 11.79                        |   |        |   |        |                              | $ | 12.96   |   |  |   |       



The following table summarizes
information regarding the stock options outstanding at December 31, 2003:



|                         |  |                                |  |                                          |  |                              |        |                                |         |                              |   |       
|------------------------ |  | ------------------------------ |  | ---------------------------------------- |  | ---------------------------- | ------ | ------------------------------ | ------- | ---------------------------- | - | ------
|Range of Exercise Prices |  | Number Outstanding at 12/31/03 |  | Weighted Avg. Remaining Contractual Life |  | Weighted Avg. Exercise Price |        | Number Exercisable at 12/31/03 |         | Weighted Avg. Exercise Price
|$15.00 to 15.9375        |  | 57,420                         |  | 1.38                                     |  | $                            | 15.505 |                                | 57,420  |                              | $ | 15.505
|$21.75 to 29.77          |  | 168,050                        |  | 4.52                                     |  |                              | 24.336 |                                | 133,470 |                              |   | 24.030
|$31.22 to 48.5314        |  | 322,500                        |  | 7.26                                     |  |                              | 40.055 |                                | 140,200 |                              |   | 39.802
|                         |  |                                |  |                                          |  |                              |        |                                |         |                              |   |       
|$15.00 to 48.5314        |  | 547,970                        |  | 5.80                                     |  |                              | 32.662 |                                | 331,090 |                              |   | 29.230
|                         |  |                                |  |                                          |  |                              |        |                                |         |                              |   |       



(14)    Earnings Per
Share



A reconciliation of the numerator and denominator used in the
basic and diluted earnings per share calculation is presented below:



|                                                                  |  |                   |         |                              |        |                 |   |                   |  |                                 |        |                  |        |                    |   |                                |  |                 |         |  |        |  |   |     
|----------------------------------------------------------------- |  | ----------------- | ------- | ---------------------------- | ------ | --------------- | - | ----------------- |  | ------------------------------- | ------ | ---------------- | ------ | ------------------ | - | ------------------------------ |  | --------------- | ------- |  | ------ |  | - | ----
|                                                                  |  | 2003              |         | 2002                         |        | 2001           
|                                                                  |  | (000s)           |         | (000s)                      |        |                 |   | (000s)           |  | (000s)                         |        |                  |        | (000s)            |   | (000s)                        |  |                
|                                                                  |  | Income(Numerator) |         | WeightedShares(Denomi-nator) |        | Per-ShareAmount |   | Income(Numerator) |  | Weighted Shares (Denomi- nator) |        | Per-Share Amount |        | Income (Numerator) |   | Weighted Shares (Denomi-nator) |  | Per-ShareAmount
|                                                                  |  |                   |         |                              |        |                 |   |                   | 
|Basic EPS                                                         |  |                   |         |                              |        |                 |   |                   |  |                                 |        |                  |        |                    |   |                                |  |                 |         |  |        |  |   |     
|Income available to common stockholders                           |  | $                 | 184,321 |                              | 54,402 |                 | $ | 3.39              |  | $                               | 66,105 |                  | 54,314 |                    | $ | 1.22                           |  | $               | 105,339 |  | 54,182 |  | $ | 1.94
|Effect of dilutive securities:                                    |  |                   |         |                              |        |                 |   |                   |  |                                 |        |                  |        |                    |   |                                |  |                 |         |  |        |  |   |     
|Options                                                           |  |                   |        |                              | 145    |                 |   |                   |  |                                 |       |                  | 188    |                    |   |                                |  |                 |        |  | 200    |  |   |     
|                                                                  |  |                   |         |                              |        |                 |   |                   | 
|Diluted EPS                                                       |  |                   |         |                              |        |                 |   |                   |  |                                 |        |                  |        |                    |   |                                |  |                 |         |  |        |  |   |     
|Income available to common stockholders after assumed conversions |  | $                 | 184,321 |                              | 54,547 |                 | $ | 3.38              |  | $                               | 66,105 |                  | 54,502 |                    | $ | 1.21                           |  | $               | 105,339 |  | 54,382 |  | $ | 1.94
|                                                                  |  |                   |         |                              |        |                 |   |                   |  |                                 |        |                  |        |                    |   |                                |  |                 |         |  |        |  |   |     



The diluted weighted shares
excludes incremental shares of 133,000, 8,000 and 104,000 for 2003, 2002 and 2001, respectively. These shares are excluded due to their antidilutive effect.



62



---

Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure



None.



Item 9A.    Disclosure Controls and Procedures



The Company maintains disclosure controls and procedures designed to ensure that information required to be disclosed in the
Companys reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms, and that such
information is accumulated and communicated to the Companys management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating
the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily
was required to apply its judgment in evaluating the cost benefit relationship of possible controls and procedures.



As required by Securities and Exchange Commission Rule 13a-15(b), the Company carried out an evaluation, under the supervision and with the participation of the
Companys management, including the Companys Chief Executive Officer and the Companys Chief Financial Officer, of the effectiveness of the design and operation of the Companys disclosure controls and procedures as of the end
of the quarter covered by this report. Based on the foregoing, the Companys Chief Executive Officer and Chief Financial Officer concluded that the Companys disclosure controls and procedures were effective at the reasonable assurance
level.



There has been no change in the Companys internal controls
over financial reporting during the Companys most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect the Companys internal controls over financial reporting.



PART III



Item 10.    Directors and Executive Officers of the Registrant



Item 11.    Executive Compensation



Item 12.    Security ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters



Item 13.    Certain
Relationships and Related Transactions



Item 14.    Principal
Accountant Fees and Services



Information regarding executive
officers of the Company is included in Part I. For this and other information called for by Items 10, 11, 12, 13 and 14 reference is made to the Companys definitive proxy statement for its Annual Meeting of Shareholders, to be held on May 12,
2004, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 2003, and which is incorporated herein by reference.



PART IV



Item 15.    Exhibits, Financial Statement Schedules and Reports on Form 8-K



(a)  The following documents are filed as a part of this report:



1.    Financial Statements:  The Consolidated Financial Statements for the year ended December 31, 2003 are contained herein as
listed in the Index to Consolidated Financial Statements on page 38.



63



---

2.    Financial Statement Schedules:



| |  |                                                                            
| |  | ---------------------------------------------------------------------------
| |  | Title                                                                      
| |  | Independent Auditors Report on Financial Statement Schedules              
| |  | Schedule ISummary of InvestmentsOther than Investments in Related Parties
| |  | Schedule IICondensed Financial Information of Registrant                  
| |  | Schedule IVReinsurance                                                    



All other schedules are omitted
as the required information is inapplicable or the information is presented in the Consolidated Financial Statements or Notes thereto.



3.    Exhibits:



|          |  |                                                                                                                                                                                                                                              
|--------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|          | 
|3.1(1)    |  | Articles of Incorporation of the Company, as amended to date.                                                                                                                                                                                
|          | 
|3.2(2)    |  | By-laws of the Company, as amended to date.                                                                                                                                                                                                  
|          | 
|4.1(3)    |  | Shareholders Agreement dated as of October 7, 1985 among the Company, George Joseph and Gloria Joseph.                                                                                                                                      
|          | 
|4.2(4)    |  | Indenture between the Company and Bank One Trust Company, N.A., as Trustee dated as of June 1, 2001.                                                                                                                                         
|          | 
|4.3(5)    |  | Officers Certificate establishing the Companys 7.25% Senior Notes due 2011 as a series of securities under the Indenture dated as of June
1, 2001 between Mercury General Corporation and Bank One Trust Company, N.A.                     
|          | 
|10.1(1)   |  | Form of Agency Contract.                                                                                                                                                                                                                     
|          | 
|10.2(6)   |  | Profit Sharing Plan, as Amended and Restated as of March 11, 1994.                                                                                                                                                                           
|          | 
|10.3(7)   |  | Amendment 1994-I to the Mercury General Corporation Profit Sharing Plan.                                                                                                                                                                     
|          | 
|10.4(7)   |  | Amendment 1994-II to the Mercury General Corporation Profit Sharing Plan.                                                                                                                                                                    
|          | 
|10.5(8)   |  | Amendment 1996-I to the Mercury General Corporation Profit Sharing Plan.                                                                                                                                                                     
|          | 
|10.6(8)   |  | Amendment 1997-I to the Mercury General Corporation Profit Sharing Plan.                                                                                                                                                                     
|          | 
|10.7(1)   |  | Amendment 1998-I to the Mercury General Corporation Profit Sharing Plan.                                                                                                                                                                     
|          | 
|10.8(9)   |  | Amendment 1999-I and Amendment 1999-II to the Mercury General Corporation Profit Sharing Plan.                                                                                                                                               
|          | 
|10.9(12)  |  | Amendment 2001-I to the Mercury General Corporation Profit Sharing Plan.                                                                                                                                                                     
|          | 
|10.10(13) |  | Amendment 2002-1 to the Mercury General Corporation Profit Sharing Plan.                                                                                                                                                                     
|          | 
|10.11(13) |  | Amendment 2002-2 to the Mercury General Corporation Profit Sharing Plan.                                                                                                                                                                     
|          | 
|10.12(10) |  | The 1995 Equity Participation Plan.                                                                                                                                                                                                          
|          | 
|10.13(8)  |  | Stock Purchase Agreement between Mercury General Corporation as Purchaser and AFC as Seller dated November 15, 1996.                                                                                                                         
|          | 
|10.14(9)  |  | Multiple Line Excess of Loss Reinsurance Agreement between Swiss Reinsurance America Corporation and Mercury Casualty Company, effective January 1,
1999.                                                                                    
|          | 
|10.15(9)  |  | Multiple Line Excess of Loss Reinsurance Agreement between Swiss Reinsurance America Corporation and American Mercury Insurance Company, effective
January 1, 2000.                                                                          
|10.16(11) |  | Management agreement effective January 1, 2001 between Mercury Insurance Services LLC and Mercury Casualty Company, Mercury Insurance Company,
California Automobile Insurance Company and California General Underwriters Insurance Company.
|          | 
|10.17(11) |  | Management Agreement effective January 1, 2001 between Mercury Insurance Services LLC and American Mercury Insurance Company.                                                                                                                
|          | 
|10.18(11) |  | Management Agreement effective January 1, 2001 between Mercury Insurance Services LLC and Mercury Insurance Company of Georgia.                                                                                                              



64



---

|          |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|--------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.19(11) |  | Management Agreement effective January 1, 2001 between Mercury Insurance Services LLC and Mercury Indemnity Company of Georgia.                                                                                                                                                                                                                                                                                                                                    
|          | 
|10.20(11) |  | Management Agreement effective January 1, 2001 between Mercury Insurance Services LLC and Mercury Insurance Company of Illinois.                                                                                                                                                                                                                                                                                                                                   
|          | 
|10.21(11) |  | Management Agreement effective January 1, 2001 between Mercury Insurance Services LLC and Mercury Indemnity Company of Illinois.                                                                                                                                                                                                                                                                                                                                   
|          | 
|10.22(12) |  | Management Agreement effective January 1, 2002 between Mercury Insurance Services LLC and Mercury Insurance Company of Florida and Mercury Indemnity
Company of Florida.                                                                                                                                                                                                                                                                                           
|          | 
|21.1      |  | Subsidiaries of the Company.                                                                                                                                                                                                                                                                                                                                                                                                                                       
|          | 
|23.1      |  | Accountants Consent.                                                                                                                                                                                                                                                                                                                                                                                                                                              
|          | 
|31.1      |  | Certifications of Registrants Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002                                                                                                                                                                                                                                                                                                                       
|          | 
|32.1      |  | Certifications of Registrants Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as created by Section 906
of the Sarbanes-Oxley Act of 2002. These certifications are being furnished solely to accompany this Annual Report on Form 10-K and are not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and are not to be
incorporated by reference into any filing of the Company.

---

|(1) |  | This document was filed as an exhibit to Registrants Form 10-K for the fiscal year ended December 31, 1997 and is incorporated herein by this reference.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) |  | This document was filed as an exhibit to Registrants Form 8-K filed on September 14, 1999 and is incorporated herein by this reference.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------



|(3) |  | This document was filed as an exhibit to Registrants Registration Statement on Form S-1, File No. 33-899, and is incorporated herein by this reference.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------



|(4) |  | This document was filed as an exhibit to Registrants Form S-3 filed on June 4, 2001 and is incorporated herein by this reference.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------



|(5) |  | This document was filed as an exhibit to Registrants Form 8-K filed on August 6, 2001 and is incorporated herein by this reference.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------



|(6) |  | This document was filed as an exhibit to Registrants Form 10-K for the fiscal year ended December 31, 1993, and is incorporated herein by this reference.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------



|(7) |  | This document was filed as an exhibit to Registrants Form 10-K for the fiscal year ended December 31, 1994, and is incorporated herein by this reference.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------



|(8) |  | This document was filed as an exhibit to Registrants Form 10-K for the fiscal year ended December 31, 1996 and is incorporated herein by this reference.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------



|(9) |  | This document was filed as an exhibit to Registrants Form 10-K for the fiscal year ended December 31, 1999 and is incorporated herein by this reference.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------



|(10) |  | This document was filed as an exhibit to Registrants Form S-8 filed on March 8, 1996 and is incorporated herein by this reference.
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------



|(11) |  | This document was filed as an exhibit to Registrants Form 10-K for the fiscal year ended December 31, 2000 and is incorporated herein by this reference.
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------



|(12) |  | This document was filed as an exhibit to Registrants Form 10-K for the fiscal year ended December 31, 2001 and is incorporated herein by this reference.
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------



|(13) |  | This document was filed as an exhibit to Registrants Form 10-K for the fiscal year ended December 31, 2002 and is incorporated herein by this reference.
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------



(b)    Reports on Form 8-K:



None



65



---

SIGNATURES



Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.



MERCURY GENERAL CORPORATIONBy

/s/    GEORGE
JOSEPHGeorge Joseph Chairman of the Board and ChiefExecutive Officer




February
24, 2004



Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.



|                                              |  |                                                                                                           |  |                  
|--------------------------------------------- |  | --------------------------------------------------------------------------------------------------------- |  | -----------------
|Signature                                     |  | Title                                                                                                     |  | Date             
|                                              |  |                                                                                                          
|/s/    GEORGE
JOSEPHGeorge Joseph             |  | Chairman of the Board and Chief Executive Officer (Principal Executive Officer)                           |  | February 24, 2004
|                                              |  |                                                                                                          
|/s/    GABRIEL
TIRADORGabriel Tirador         |  | President and Chief Operating Officer Director                                                            |  | February 24, 2004
|                                              |  |                                                                                                          
|/s/    THEODORE R.
STALICKTheodore R. Stalick |  | Vice President and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) |  | February 24, 2004
|                                              |  |                                                                                                          
|/s/    NATHAN
BESSINNathan Bessin             |  | Director                                                                                                  |  | February 24, 2004
|                                              |  |                                                                                                          
|Bruce A. Bunner                               |  | Director                                                                                                  |  | February 24, 2004
|                                              |  |                                                                                                          
|/s/    MICHAEL D.
CURTIUSMichael D. Curtius   |  | Director                                                                                                  |  | February 24, 2004
|                                              |  |                                                                                                          
|/s/    RICHARD E.
GRAYSONRichard E. Grayson   |  | Director                                                                                                  |  | February 24, 2004
|                                              |  |                                                                                                          
|/s/    CHARLES
MCCLUNGCharles
McClung         |  | Director                                                                                                  |  | February 24, 2004
|                                              |  |                                                                                                          
|/s/    DONALD P.
NEWELLDonald P. Newell       |  | Director                                                                                                  |  | February 24, 2004
|                                              |  |                                                                                                          
|/s/    DONALD R.
SPUEHLERDonald R. Spuehler   |  | Director                                                                                                  |  | February 24, 2004



66



---

INDEPENDENT AUDITORS REPORT ON FINANCIAL STATEMENT SCHEDULES



The Board of Directors

Mercury General Corporation:



Under date of February 2, 2004 we reported on the consolidated balance sheets of Mercury General Corporation and subsidiaries as of December 31, 2003 and 2002, and
the related consolidated statements of income, comprehensive income, shareholders equity and cash flows for each of the years in the three-year period ended December 31, 2003, as contained in the annual report on Form 10-K for the year 2003.
In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related financial statement schedules as listed under Item 15(a)2. These financial statement schedules are the responsibility of the
Companys management. Our responsibility is to express an opinion on these financial statement schedules based on our audits.



In our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present
fairly, in all material respects, the information set forth therein.



KPMG LLP



Los Angeles, California

February 2, 2004



S-1



---

SCHEDULE I



MERCURY GENERAL CORPORATION



SUMMARY OF INVESTMENTS

OTHER THAN INVESTMENTS IN RELATED
PARTIES



December 31, 2003



|                                           |  |                      |           |       |   |                                            |  |   |          
|------------------------------------------ |  | -------------------- | --------- | ----- | - | ------------------------------------------ |  | - | ---------
|Type of Investment                         |  | Cost                 |           | Value |   | Amount at which shown in the balance sheet
|                                           |  | Amounts in thousands
|Fixed maturities available for sale        |  |                      |           |       |   |                                            |  |   |          
|Bonds:                                     |  |                      |           |       |   |                                            |  |   |          
|U.S. Government                            |  | $                    | 258,442   |       | $ | 258,692                                    |  | $ | 258,692  
|States, municipalities                     |  |                      | 1,502,974 |       |   | 1,588,398                                  |  |   | 1,588,398
|All other corporate bonds                  |  |                      | 82,207    |       |   | 85,697                                     |  |   | 85,697   
|Redeemable preferred stock                 |  |                      | 12,460    |       |   | 12,522                                     |  |   | 12,522   
|                                           |  |                      |           |       |   |                                            |  |   |          
|Total fixed maturities available for sale  |  |                      | 1,856,083 |       |   | 1,945,309                                  |  |   | 1,945,309
|                                           |  |                      |           |       |   |                                            |  |   |          
|Equity securities:                         |  |                      |           |       |   |                                            |  |   |          
|Common stocks:                             |  |                      |           |       |   |                                            |  |   |          
|Public utilities                           |  |                      | 63,810    |       |   | 78,447                                     |  |   | 78,447   
|Banks, trust and insurance companies       |  |                      | 5,841     |       |   | 7,682                                      |  |   | 7,682    
|Industrial, miscellaneous and all other    |  |                      | 67,852    |       |   | 86,753                                     |  |   | 86,753   
|Nonredeemable preferred stocks             |  |                      | 85,610    |       |   | 91,511                                     |  |   | 91,511   
|Total equity securities available for sale |  |                      | 223,113   |       |   | 264,393                                    |  |   | 264,393  
|                                           |  |                      |           |       |   |                                            |  |   |          
|Short-term investments                     |  |                      | 329,812   |       |   |                                            |  |   | 329,812  
|                                           |  |                      |           |       |   |                                            |  |   |          
|Total investments                          |  | $                    | 2,409,008 |       |   |                                            |  | $ | 2,539,514
|                                           |  |                      |           |       |   |                                            |  |   |          



S-2



---

SCHEDULE I



MERCURY GENERAL CORPORATION



SUMMARY OF INVESTMENTS

OTHER THAN INVESTMENTS IN RELATED
PARTIES(Continued)



December 31, 2002



|                                           |  |                      |           |       |   |                                           |  |   |          
|------------------------------------------ |  | -------------------- | --------- | ----- | - | ----------------------------------------- |  | - | ---------
|Type of Investment                         |  | Cost                 |           | Value |   | Amount atwhich shown in the balance sheet
|                                           |  | Amounts in thousands
|Fixed maturities available for sale        |  |                      |           |       |   |                                           |  |   |          
|Bonds:                                     |  |                      |           |       |   |                                           |  |   |          
|U.S. Government                            |  | $                    | 84,644    |       | $ | 86,080                                    |  | $ | 86,080   
|States, municipalities                     |  |                      | 1,361,852 |       |   | 1,443,001                                 |  |   | 1,443,001
|All other corporate bonds                  |  |                      | 105,114   |       |   | 89,804                                    |  |   | 89,804   
|Redeemable preferred stock                 |  |                      | 14,150    |       |   | 13,986                                    |  |   | 13,986   
|                                           |  |                      |           |       |   |                                           |  |   |          
|Total fixed maturities available for sale  |  |                      | 1,565,760 |       |   | 1,632,871                                 |  |   | 1,632,871
|                                           |  |                      |           |       |   |                                           |  |   |          
|Equity securities:                         |  |                      |           |       |   |                                           |  |   |          
|Common stocks:                             |  |                      |           |       |   |                                           |  |   |          
|Public utilities                           |  |                      | 77,936    |       |   | 79,263                                    |  |   | 79,263   
|Banks, trust and insurance companies       |  |                      | 6,112     |       |   | 6,970                                     |  |   | 6,970    
|Industrial, miscellaneous and all other    |  |                      | 19,541    |       |   | 20,185                                    |  |   | 20,185   
|Nonredeemable preferred stocks             |  |                      | 129,139   |       |   | 123,994                                   |  |   | 123,994  
|Other investments                          |  |                      | 569       |       |   | 569                                       |  |   | 569      
|                                           |  |                      |           |       |   |                                           |  |   |          
|Total equity securities available for sale |  |                      | 233,297   |       |   | 230,981                                   |  |   | 230,981  
|                                           |  |                      |           |       |   |                                           |  |   |          
|Short-term investments                     |  |                      | 286,806   |       |   |                                           |  |   | 286,806  
|                                           |  |                      |           |       |   |                                           |  |   |          
|Total investments                          |  | $                    | 2,085,863 |       |   |                                           |  | $ | 2,150,658
|                                           |  |                      |           |       |   |                                           |  |   |          



S-3



---

SCHEDULE II



MERCURY GENERAL CORPORATION



CONDENSED FINANCIAL INFORMATION OF REGISTRANT



BALANCE SHEETS



December 31, 2003 and 2002



|                                                                                       |  |                      |           |      |   |          
|-------------------------------------------------------------------------------------- |  | -------------------- | --------- | ---- | - | ---------
|                                                                                       |  | 2003                 |           | 2002
|                                                                                       |  | Amounts in thousands
|ASSETS                                                                                 |  |                      |           |     
|Investments:                                                                           |  |                      |           |      |   |          
|Fixed maturities available for sale (amortized cost $2,162 in 2003 and $4,642 in 2002) |  | $                    | 2,304     |      | $ | 5,186    
|Equity securities, available for sale (cost $16,206 in 2003 and $22,120 in 2002)       |  |                      | 20,019    |      |   | 21,755   
|Short-term cash investments                                                            |  |                      | 8,499     |      |   | 9,253    
|Investment in subsidiaries                                                             |  |                      | 1,343,385 |      |   | 1,188,422
|                                                                                       |  |                      |           |      |   |          
|Total investments                                                                      |  |                      | 1,374,207 |      |   | 1,224,616
|                                                                                       |  |                     
|Amounts due from affiliates                                                            |  |                      | 139       |      |   | 1,965    
|Income taxes                                                                           |  |                      | 6,074     |      |   | 1,041    
|Other assets                                                                           |  |                      | 1,465     |      |   | 2,390    
|                                                                                       |  |                      |           |      |   |          
|Total assets                                                                           |  | $                    | 1,381,885 |      | $ | 1,230,012
|                                                                                       |  |                      |           |      |   |          
|LIABILITIES AND SHAREHOLDERS EQUITY                                                   |  |                      |           |     
|Notes payable                                                                          |  | $                    | 124,714   |      | $ | 128,859  
|Accounts payable and accrued expenses                                                  |  |                      | 1,186     |      |   | 1,366    
|Other liabilities                                                                      |  |                      | 482       |      |   | 1,001    
|                                                                                       |  |                      |           |      |   |          
|Total liabilities                                                                      |  |                      | 126,382   |      |   | 131,226  
|                                                                                       |  |                      |           |      |   |          
|Shareholders equity:                                                                  |  |                      |           |      |   |          
|Common stock                                                                           |  |                      | 57,453    |      |   | 55,933   
|Accumulated other comprehensive income                                                 |  |                      | 84,833    |      |   | 42,140   
|Retained earnings                                                                      |  |                      | 1,113,217 |      |   | 1,000,713
|                                                                                       |  |                      |           |      |   |          
|Total shareholders equity                                                             |  |                      | 1,255,503 |      |   | 1,098,786
|                                                                                       |  |                      |           |      |   |          
|Total liabilities and shareholders equity                                             |  | $                    | 1,381,885 |      | $ | 1,230,012
|                                                                                       |  |                      |           |      |   |          





See accompanying notes to condensed financial information



S-4



---

SCHEDULE II



MERCURY GENERAL CORPORATION



CONDENSED FINANCIAL INFORMATION OF REGISTRANT(Continued)



STATEMENTS OF INCOME



Three years ended December 31, 2003



|                                                                  |  |                      |         |   |      |   |         |      |  |   |         |  
|----------------------------------------------------------------- |  | -------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                  |  | 2003                 |         |   | 2002 |   |         | 2001 | 
|                                                                  |  | Amounts in thousands |        
|Revenues:                                                         |  |                      |         |   |      |   |         |      |  |   |         |  
|Net investment income                                             |  | $                    | 2,097   |   |      | $ | 2,698   |      |  | $ | 3,133   |  
|Other                                                             |  |                      | 876     |   |      |   | (8,865  | )    |  |   | (273    | )
|                                                                  |  |                      |         |   |      |   |         |      |  |   |         |  
|Total revenues (expenses)                                         |  |                      | 2,973   |   |      |   | (6,167  | )    |  |   | 2,860   |  
|                                                                  |  |                      |         |   |      |   |         |      |  |   |         |  
|Expenses:                                                         |  |                      |         |   |      |   |         |      |  |   |         |  
|Other operating expenses                                          |  |                      | 2,490   |   |      |   | 1,945   |      |  |   | 1,528   |  
|Interest                                                          |  |                      | 3,056   |   |      |   | 4,100   |      |  |   | 7,727   |  
|                                                                  |  |                      |         |   |      |   |         |      |  |   |         |  
|Total expenses                                                    |  |                      | 5,546   |   |      |   | 6,045   |      |  |   | 9,255   |  
|                                                                  |  |                      |         |   |      |   |         |      |  |   |         |  
|Loss before income taxes and equity in net income of subsidiaries |  |                      | (2,573  | ) |      |   | (12,212 | )    |  |   | (6,395  | )
|Income tax benefit                                                |  |                      | (2,276  | ) |      |   | (5,114  | )    |  |   | (2,355  | )
|                                                                  |  |                      |         |   |      |   |         |      |  |   |         |  
|Loss before equity in net income of subsidiaries                  |  |                      | (297    | ) |      |   | (7,098  | )    |  |   | (4,040  | )
|Equity in net income of subsidiaries                              |  |                      | 184,618 |   |      |   | 73,203  |      |  |   | 109,379 |  
|                                                                  |  |                      |         |   |      |   |         |      |  |   |         |  
|Net income                                                        |  | $                    | 184,321 |   |      | $ | 66,105  |      |  | $ | 105,339 |  
|                                                                  |  |                      |         |   |      |   |         |      |  |   |         |  





See accompanying notes to condensed financial information.





S-5



---

SCHEDULE II



MERCURY GENERAL CORPORATION



CONDENSED FINANCIAL INFORMATION OF REGISTRANT(Continued)



STATEMENTS OF CASH FLOWS



Three Years ended December 31, 2003





|                                                        |  |                      |         |   |      |   |          |      |  |   |          |  
|------------------------------------------------------- |  | -------------------- | ------- | - | ---- | - | -------- | ---- |  | - | -------- | -
|                                                        |  | 2003                 |         |   | 2002 |   |          | 2001 | 
|                                                        |  | Amounts in thousands |        
|Cash flows from operating activities:                   |  |                      |         |   |      |   |          |      |  |   |          |  
|Net cash (used in) provided by operating activities     |  | $                    | (3,985  | ) |      | $ | 1,798    |      |  | $ | 5,922    |  
|Cash flows from investing activities:                   |  |                      |         |   |      |   |          |      |  |   |          |  
|Capital contribution to controlled entity               |  |                      | (11,500 | ) |      |   | (8,000   | )    |  |   | (12,000  | )
|Dividends from subsidiaries                             |  |                      | 76,000  |   |      |   | 75,000   |      |  |   | 60,000   |  
|Fixed maturities, at market:                            |  |                      |         |   |      |   |          |      |  |   |          |  
|Purchases                                               |  |                      |        |   |      |   |         |      |  |   | (6,087   | )
|Sales                                                   |  |                      | 2,860   |   |      |   |         |      |  |   |         |  
|Calls or maturities                                     |  |                      | 8       |   |      |   | 3        |      |  |   | 23       |  
|Equity securities:                                      |  |                      |         |   |      |   |          |      |  |   |          |  
|Purchases                                               |  |                      | (3,619  | ) |      |   | (144,107 | )    |  |   | (3,507   | )
|Sales                                                   |  |                      | 8,595   |   |      |   | 137,414  |      |  |   | 2,187    |  
|Calls                                                   |  |                      | 1,450   |   |      |   | 4,060    |      |  |   | 802      |  
|Decrease (increase) in short term cash investments, net |  |                      | 754     |   |      |   | 44       |      |  |   | (5,811   | )
|                                                        |  |                      |         |   |      |   |          |      |  |   |          |  
|Net cash provided by investing activities               |  |                      | 74,548  |   |      |   | 64,414   |      |  |   | 35,607   |  
|Cash flows from financing activities:                   |  |                      |         |   |      |   |          |      |  |   |          |  
|Net proceeds from issuance of senior notes              |  |                      |        |   |      |   |         |      |  |   | 123,309  |  
|Net payments under credit arrangements                  |  |                      |        |   |      |   | (1,000   | )    |  |   | (103,039 | )
|Dividends paid to shareholders                          |  |                      | (71,817 | ) |      |   | (65,173  | )    |  |   | (57,430  | )
|Stock options exercised                                 |  |                      | 1,331   |   |      |   | 1,581    |      |  |   | 1,344    |  
|Net decrease of ESOP loan                               |  |                      |        |   |      |   | (1,000   | )    |  |   | (1,000   | )
|                                                        |  |                      |         |   |      |   |          |      |  |   |          |  
|Net cash used in financing activities                   |  |                      | (70,486 | ) |      |   | (65,592  | )    |  |   | (36,816  | )
|Net increase in cash                                    |  |                      | 77      |   |      |   | 620      |      |  |   | 4,713    |  
|Cash:                                                   |  |                      |         |   |      |   |          |      |  |   |          |  
|Beginning of the year                                   |  |                      | (59     | ) |      |   | (679     | )    |  |   | (5,392   | )
|                                                        |  |                      |         |   |      |   |          |      |  |   |          |  
|End of the year                                         |  | $                    | 18      |   |      | $ | (59      | )    |  | $ | (679     | )
|                                                        |  |                      |         |   |      |   |          |      |  |   |          |  





See accompanying notes to condensed financial information.





S-6



---

SCHEDULE II



MERCURY GENERAL CORPORATION



CONDENSED FINANCIAL INFORMATION OF REGISTRANT(Continued)



NOTES TO CONDENSED FINANCIAL INFORMATION



December 31, 2003 and 2002



The accompanying condensed financial information should be read in conjunction with the consolidated financial statements and notes included in this statement.



Dividends Received From Subsidiaries



Dividends of $76,000,000, $75,000,000 and $60,000,000 were received by the Company
from its wholly-owned subsidiaries in 2003, 2002 and 2001, respectively, and are recorded as a reduction to Investment in Subsidiaries.



At December 31, 2002, the Company had cash overdrafts of $59,000 which are classified in other liabilities in the accompanying condensed balance sheet.
At December 31, 2003, the Company did not have any cash overdrafts.



Capitalization of
Subsidiaries



In 2002, the Company contributed $8 million to Mercury
Insurance Company of Florida. In 2003, an additional $4,000,000 was contributed to Mercury Insurance Company of Florida and $7,500,000 was contributed to Mercury Indemnity Company of America.



Statements of Cash Flow



In 2003, notes payable with a discounted value of $4,315,000 was canceled in accordance with terms of a Purchase and Sale Agreement
between the Company and Employers Reinsurance Corporation.



Mercury County
Mutual Insurance Company Transaction



The Company conducts business
in Texas through Mercury County Mutual Insurance Company (MCM), a Texas county mutual insurance company that the Company manages and controls under the authority of a management contract acquired from Employers Reinsurance Corporation
(ERC) effective September 30, 2000. Under the terms of the acquisition agreement, the Company agreed to pay additional consideration in the aggregate amount of $7 million payable in annual installments of $1 million provided no statutes
are enacted that eliminate or substantially reduce the preferential underwriting and rate treatment afforded county mutual insurance companies.



In June 2003, legislation was enacted in Texas that calls for sweeping changes in the regulation of rates and forms for property and casualty insurance companies,
including the elimination of the rate freedom afforded to county mutual insurance companies. The enactment of this legislation triggered a provision in the acquisition agreement with ERC relieving the Company of further obligation to pay ERC
additional consideration. Notes payable has been reduced by $4.3 million representing the discounted value of the future annual installments. The Company has also reduced the carrying value of the intangible asset that originated from the
acquisition of MCM by $4.3 million. No gain or loss has been recognized from this transaction.



S-7



---

SCHEDULE IV



MERCURY GENERAL CORPORATION



REINSURANCE



Three years ended December 31, 2003



|                                                 |  |                      |           |                          |   |         |  |            |        |  |   |          
|------------------------------------------------ |  | -------------------- | --------- | ------------------------ | - | ------- |  | ---------- | ------ |  | - | ---------
|                                                 |  | Direct amount        |           | Ceded to other companies |   | Assumed |  | Net amount
|                                                 |  | Amounts in thousands
|Property and Liability insurance earned premiums |  |                      |           |                          |   |         |  |            |        |  |   |          
|2003                                             |  | $                    | 2,151,598 |                          | $ | 7,650   |  | $          | 1,099  |  | $ | 2,145,047
|2002                                             |  | $                    | 1,748,645 |                          | $ | 8,866   |  | $          | 1,748  |  | $ | 1,741,527
|2001                                             |  | $                    | 1,374,988 |                          | $ | 7,233   |  | $          | 12,806 |  | $ | 1,380,561



S-8