The Company’s executive offices are located in a 36,000 square foot office building in Los Angeles, California, owned by MCC. The Company occupies approximately 95% of the building and leases the remaining office space to others.
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 2003. It is uncertain how any regulatory changes implemented by the California insurance commissioner, or the insurance commissioner in any other state in which the Company operates, will be resolved and how it will impact the Company’s operations.
The Company also generates revenue from its investment portfolio, which was approximately $2.9 billion at the end of 2004. This investment portfolio generated nearly $110 million in pre-tax investment income during 2004. The portfolio is managed by Company personnel with a view towards maximizing after-tax yields and limiting interest rate and credit risk.
The Company currently underwrites personal automobile insurance in thirteen states: nine states entered into in previous years, California, Florida, Texas, Oklahoma, Georgia, Illinois, New York, Virginia and New Jersey, and four states entered during 2004, Arizona, Pennsylvania, Michigan and Nevada. The Company expects to continue its growth by expanding into new states in future years with the objective of achieving greater geographic diversification, so that non-California premiums eventually account for as much as half of the Company’s total premiums.
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. In management’s view, 2003 and 2004 were periods of very good results for companies underwriting automobile insurance. As a result, the automobile insurance market is presently extremely competitive with competitors reducing rates and increasing advertising expenditures. The Company expects this trend to continue in 2005 and consequently expects that the premium growth rate will likely decline from the levels seen in 2004 (17%) and 2003 (22%).
The California Insurance Commissioner (the “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 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.
On October 20, 2004, the Commissioner proposed regulations which require greater disclosure of the commissions that brokers may receive from insurance companies for selling insurance policies. The proposed regulations are designed to protect consumers from undisclosed commissions and would penalize any broker who places his or her own financial or other interest above that of a client. Under the proposed regulations, brokers and agents would be required to disclose “all material facts” regarding third party compensation. Brokers would also be required to provide their clients insurance quotes from the best available insurer. The Company believes that this proposed regulation, if enacted, will not have a material impact on its business since the Company is a leading provider of competitively-priced insurance in the California marketplace.
On June 25, 2003, the California State Board of Equalization (“SBE”) upheld Notices of Proposed Assessments (“NPAs”) issued against the Company for tax years 1993 through 1996. In these NPAs, 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 expenses were allocable to the Company’s tax-deductible dividends from such subsidiaries. The SBE decision also resulted in a smaller disallowance of the Company’s interest expense deductions than was proposed by the FTB in those years. The Company filed a petition for rehearing with the SBE and a rehearing was granted. The rehearing is expected to be held in the spring of 2005.
On September 29, 2004, California Governor Arnold Schwarzenegger signed into law Assembly Bill 263 (“AB 263”). The law resolves an issue raised by the FTB where they interpreted a legal ruling (“Ceridian”) to eliminate a dividends received deduction (“DRD”) taken by insurance companies. AB 263 provides for an 80% DRD for tax years 1997 through 2007 and an 85% DRD for tax years after 2007. The Company intends to refile its 1997 through 2003 tax returns based on the DRD established by AB 263. The tax liability for this item is included in the tax liabilities at December 31, 2004.
The Company is also involved in proceedings incidental to its insurance business. See “Item 3. Legal Proceedings,” and Note 10 of Notes to Consolidated Financial Statements.
The Company’s loss reserves estimated at December 31, 2003 produced a redundancy of $58 million which was reflected in the financial statements as a reduction to the 2004 calendar year incurred losses. The Company attributes most of this redundancy to a change in the inflation rate assumptions used to establish reserves on the bodily injury coverage for California private passenger automobile insurance on the 2002 and 2003 accident years.
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.
The loss ratio (GAAP basis) in 2004 (loss and loss adjustment expenses related to premiums earned) was 62.6% in 2004 compared with 67.7% in 2003. The lower loss ratio is largely attributable to improved loss frequency on automobile claims and California homeowners claims. Automobile loss frequencies can be affected by many factors including seasonal travel, weather and fluctuations in gasoline prices. The Florida hurricanes negatively impacted the 2004 loss ratio by 0.9% compared to the 0.7% negative impact that the Southern California firestorms had on the 2003 loss ratio. Furthermore, positive development on prior accident years reduced the 2004 loss ratio by 2.3% and adverse development on prior accident years increased the 2003 loss ratio by 0.2%.
The expense ratio (GAAP basis) in 2004 (policy acquisition costs and other operating expenses related to premiums earned) was 26.6% compared with 26.3% in 2003. The increase in the expense ratio is primarily due to an increase in advertising expense and profitability related bonuses.
Investment income in 2004 was $109.7 million compared with $104.5 million in 2003. The after-tax yield on average investments of $2,662.2 million (cost basis) was 3.6%, compared with 4.0% on average investments of $2,311.0 million (cost basis) in 2003. The effective tax rate on investment income was 12.6% in 2004, compared to 10.7% in 2003. The higher tax rate in 2004 reflects a shift in the mix of the Company’s portfolio from non-taxable to taxable securities. Proceeds from the sale of bonds which matured or were called in 2004 totaled $363.4 million, compared to $442.5 million in 2003. Assuming market interest rates remain the same, the Company expects approximately $583 million of bonds to mature or be called in 2005. The proceeds will be reinvested into securities meeting the Company’s investment profile.
Net income in 2004 was $286.2 million or $5.24 per share (diluted) compared with $184.3 million or $3.38 per share (diluted), in 2003. Diluted per share results are based on 54.6 million average shares in 2004 and 54.5 million average shares in 2003. Basic per share results were $5.25 in 2004 and $3.39 in 2003. Included in net income are net realized investment gains, net of income tax expense, of $0.30 and $0.13 per share (diluted and basic) in 2004 and 2003, respectively.
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.
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 rate increases implemented in 2003 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 loss reserves 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.
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.
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, the Insurance Companies are entitled to pay, without extraordinary approval, dividends of approximately $235 million in 2005. The actual amount of dividends paid from the Insurance Companies to Mercury General during 2004 was $99 million. As of December 31, 2004, 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.
Through the Insurance Companies, the Company has generated positive cash flow from operations for over twenty consecutive years and in excess of $100 million every year since 1994. During this same period, the Company has not been required to liquidate any of its fixed maturity investments to settle claims or other liabilities.
Because of the Company’s long track record of positive operating cash flows, it does not attempt to match the duration and timing of asset maturities with those of liabilities. Rather, the Company manages its portfolio with a view towards maximizing total return with an emphasis on after-tax income. Combined with cash and short term investments of $445.1 million at December 31, 2004, the Company believes its cash flows from operations 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.
Net cash provided from operating activities in 2004 was $468.7 million, an increase of $24.2 million over the same period in 2003. 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 2004. The Company has utilized the cash provided from operating activities primarily to increase its investment in fixed maturity securities, the purchase and development of information technology such as the Next Generation computer system 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 $760.2 million, were primarily reinvested by the Company in high grade fixed maturity securities.
The market value of all investments held at market as “Available for Sale” exceeded amortized cost of $2,796.9 million at December 31, 2004 by $124.2 million. That net unrealized gain, reflected in shareholders’ equity, net of applicable tax effects, was $80.5 million at December 31, 2004, compared with $84.8 million at December 31, 2003.
At December 31, 2004, the Company had a net unrealized gain on all investments of $124.2 million before income taxes which is comprised of unrealized gains of $135.5 million offset by unrealized losses of $11.3 million. Unrealized losses represent 0.4% of total investments at amortized cost. Of these unrealized losses, approximately $8.8 million relate to fixed maturity investments and the remaining $2.5 million relate to equity securities. Approximately $10.6 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 two municipal bonds with unrealized losses of approximately $0.6 million and $0.4 million, respectively, representing market value declines of 19% and 16% of amortized cost. The remaining $0.7 million represents unrealized losses that exceed 20% of amortized costs. The Company has concluded that the gross unrealized losses of $11.3 million at December 31, 2004 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.
During 2004, the Company recognized approximately $26.0 million in net realized gains from the disposal (sale, call or maturity) of securities which is comprised of realized gains of $33.1 million offset by realized losses of $7.1 million. These realized losses were derived from the disposal of securities with a total amortized cost of approximately $207.9 million. Of the total realized losses, approximately $4.5 million relates to securities held as of December 2003 with an average realized loss of approximately $15,000 and no loss on any one individual security exceeding $0.4 million.
Consolidated Statements of Income for Each of the Years in the Three-Year Period Ended December 31, 2004
Consolidated Statements of Comprehensive Income for Each of the Years in the Three-Year Period Ended December 31, 2004
Consolidated Statements of Shareholders’ Equity for Each of the Years in the Three-Year Period Ended December 31, 2004
Consolidated Statements of Cash Flows for Each of the Years in the Three-Year Period Ended December 31, 2004
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, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 11, 2005 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting as set forth in Item 9a, that Mercury General Corporation maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Mercury General Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
In our opinion, management’s assessment that Mercury General Corporation maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Mercury General Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Mercury General Corporation and subsidiaries as of December 31, 2004 and 2003, 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, 2004, and our report dated March 11, 2005 expressed an unqualified opinion on those consolidated financial statements.
The Company operates as a private passenger automobile insurer selling policies through a network of independent agents and brokers in thirteen states. The Company also offers homeowners insurance, commercial automobile and property insurance, mechanical breakdown insurance, commercial and dwelling fire insurance and umbrella insurance. The private passenger automobile lines of insurance exceeded 87% of the Company’s net premiums written in 2004, 2003 and 2002, with approximately 76%, 84% and 86% of the private passenger automobile premiums written in the state of California during 2004, 2003 and 2002, respectively.
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 National Insurance Company (formerly known as Mercury Indemnity Company of Illinois), Mercury Indemnity Company of America (formerly known as Mercury Indemnity Company of Florida), Mercury Insurance Services, LLC (MISLLC), American Mercury Insurance Company (AMIC), Mercury Select Management Company, Inc. (MSMC) (formerly known as AFI Management Company, Inc.), 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, MSMC. MCM is not owned by the Company, but is controlled through a management contract and therefore its results are included in the consolidated financial statements. The consolidated 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 MSMC, 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.
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. Fixed maturities at amortized cost to first call date are adjusted for anticipated prepayments. Mortgage-backed securities at amortized cost are adjusted for anticipated prepayment
using the prospective method. 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.
One broker produced direct premiums written of approximately 14%, 16% and 16% of the Company’s total direct premiums written during 2004, 2003 and 2002, respectively. No other agent or broker accounted for more than 2% of direct premiums written.
Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an Enterprise and Related Information,” 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.
In 2003, notes payable with a discounted value of $4,315,000 were canceled in accordance with terms of a Purchase and Sale Agreement between the Company and Employers Reinsurance Corporation.
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” (“SFAS No. 123”) and amended by SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure”.
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:
Accumulated unrealized gains and losses on securities available for sale is as follows:
The amortized costs and estimated market values of investments in fixed maturities available for sale as of December 31, 2004 are as follows:
The amortized costs and estimated market values of investments in fixed maturities available for sale as of December 31, 2003 are as follows:
The Company had outstanding debt at December 31, 2004 of $124.7 million. The debt consists of the proceeds from an August 7, 2001 public debt offering where the Company issued $125 million of senior notes payable under a $300 million shelf registration filed with the Securities and Exchange Commission 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, 2004, the book value of the debt was $124.7 million and the fair market value was $141.3 million based upon quotations received from securities dealers.
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, 2003 and 2004, but does expose the Company to higher interest expense in future periods, should LIBOR rates increase. The effective annualized interest rate in 2004 was 3.3%. The swap is accounted for as a fair value hedge under Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities.”
The temporary differences that give rise to a significant portion of the deferred tax asset (liability) relate to the following:
The Company believes that the deduction of the expenses related to management services provided to its insurance company subsidiaries is meritorious and that this is further supported by the SBE’s decision to grant a rehearing on the matter. The potential net liability on the franchise tax issues in 1993 through 1996, after federal tax benefit, amounts to approximately $9 million. The Company has recorded a tax liability of approximately $1 million for the issues related to these tax years.
On September 29, 2004, California Governor Arnold Schwarzenegger signed into law Assembly Bill 263 (“AB 263”). The law resolves an issue raised by the FTB where they interpreted a legal ruling (“Ceridian”) to eliminate a dividends received deduction (“DRD”) taken by insurance companies. AB 263 provides for an 80% DRD for tax
During the third quarter of 2004, the state of Florida was ravaged by four hurricanes. The Company estimated that its pre-tax losses resulting from these hurricanes is approximately $22 million. The estimate is based upon the total number of claims reported and the number of unreported claims anticipated as a result of the hurricanes. This compares with the pre-tax losses of approximately $16 million incurred from the California firestorms in 2003.
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 2005, the direct insurance subsidiaries of the Company are permitted to
pay approximately $235 million in dividends to the Company without the prior approval of the Insurance Commissioner 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 2004 and 2003, the Insurance Companies paid dividends to Mercury General Corporation of $99.0 million and $76.0 million, respectively.
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, 2004, there were no material permitted statutory accounting practices utilized by the Insurance Companies.
The Company is obligated under various noncancellable lease agreements providing for office space and equipment rental that expire at various dates through the year 2012. Total rent expense under these lease agreements was $6,921,000, $6,150,000 and $4,815,000 for the years ended December 31, 2004, 2003 and 2002, respectively.
In January 2005, the Company completed the acquisition of a 157,000 square foot office building which houses the Company’s Eastern Region operations that the Company previously leased. The purchase price of $24,888,000 includes the assumption of a secured promissory note in the amount of $11,250,000. Under the terms of the note, interest only is payable quarterly at a rate based on LIBOR. The terms of the note also contain restrictions for prepayment which includes penalties for partial or complete prepayment. The note matures on August 1, 2008 at which time the principal and any outstanding interest is due and payable.
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 in cases where the Company is able to estimate its potential exposure and it is probable that the court will rule against the Company. The Company vigorously defends actions against it, 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 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 asserted 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 the Company 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. The Company appealed, which had the effect of staying all but the advertising aspects of the court’s injunction. After the trial court decision, the Company changed its comparative rate advertising and now discloses the possibility that broker fees may be charged. In October 2004, the California Court of Appeals upheld the judgment of the trial court and denied the Company’s request for rehearing. On January 19, 2005, the California Supreme Court denied the Company’s petition to review the decision rendered by the California Court of Appeals.
Following the decision by the California Supreme Court not to review the California Court of Appeals’ ruling, representatives of the Company held discussions with representatives of the plaintiffs and of the California DOI regarding changes to the Company’s business practices that have been or may be implemented in response to the case. As a result of these discussions, a stipulation was filed jointly by the plaintiffs and the company to extend the stay of the trial court’s injunction that was in place during the appeals process. The Company filed a Motion to Vacate the trial court’s injunction on the basis that the Company has implemented material changes in its relationship with broker-agents. A hearing is scheduled on March 24, 2005 in the Superior Court of the State of California regarding the Company’s Motion to Vacate. The Company is unable to estimate the impact, if any, should it be required to appoint its brokers as agents.
be required. The Company is unable to estimate the ultimate amount of the monetary penalty therefore no adjustment for the potential monetary penalty is recorded in the financial statements.
In Kate Steinbeck vs. Mercury Insurance Company, Mercury Casualty Company, and California Automobile Insurance Company (Orange County Superior Court), filed October 7, 2004, the plaintiff alleges that billing service fees charged in connection with installment payments made by insureds constitute premium and that Section 381 of the California Insurance Code bars the charging of premium not specified in the policy. The Complaint states claims for breach of contract, violations of the California Unfair Competition Law, violation of the California Consumer Legal Remedies Act, and common count claims for unjust enrichment and money had and received under this theory. The Complaint also seeks class action status, unspecified damages and restitution, injunctive relief, and unspecified attorneys’ fees. On January 19, 2005, the Company filed a Demurrer to the Complaint seeking its dismissal with prejudice for failure to state a claim and a Motion to Strike Certain Allegations in the Complaint. The latter motion seeks to strike the class and representative allegations in the Complaint in the event the Demurrer is not sustained with prejudice as to all of the plaintiff’s alleged individual causes of actions. The Demurrer and Motion to Strike are currently scheduled to be heard in April 2005. The Company believes that its actions are in compliance with both industry practice and California law and intends to vigorously defend this case. The Company can not predict the ultimate outcome at this stage of the proceedings.
The Plan 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 $2,841,000, $2,235,000 and $2,030,000 for the plan years ended December 31, 2004, 2003 and 2002, respectively.
The Plan also 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 $1,000,000 as compensation expense in 2004, 2003 and 2002, 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, 2004 no awards other than options have been granted.
A summary of the status of the Company’s plans as of December 31, 2004, 2003 and 2002 and changes during the years ending on those dates is presented below: