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 outside parties.
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, insurance commissioners may emphasize different agendas or interpret existing regulations differently than previous commissioners. The Company has a successful track record of working with difficult regulations and new insurance commissioners. However, there is no certainty that current or future regulations, and the interpretation of those regulations by insurance commissioners and the courts will not have an adverse impact on the Company.
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 significant variation in the overall increases 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 low single digit inflation rates on bodily injury coverages for its major California personal automobile lines for the 2005 accident year. The inflation rate for this accident year 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.
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 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 announced improved operating results in 2004 and throughout 2005. This typically signals a softening in the market, and consequently, the Company experienced a decline in the rate of growth of its policies in force in California during 2005.
The Company believes that it has a more thorough underwriting process which gives the Company an advantage over its competitors. The Company views its agent relationships and underwriting process as one of its primary competitive advantages because it allows the Company to charge lower prices yet realize better margins.
A major regulatory change could make it more difficult for the Company to generate new business.
To the extent it is within the Company’s control, the Company seeks to manage these risks in order to mitigate the effect that major events would have on the Company’s financial position.
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, 2004 and 2005 were periods of very good results for companies underwriting automobile insurance. As a result, the automobile insurance market is extremely competitive. The Company expects this trend to continue in 2006.
The process for implementing rate changes varies by state, with California, Georgia, New York, New Jersey, Pennsylvania and Nevada requiring prior approval from the DOI before a rate can be implemented. Illinois, Texas, Virginia, Arizona and Michigan 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.
The California DOI 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
Persistency discounts are discounts to consumers based on the number of consecutive years the consumer has had insurance coverage. In 1990, following the enactment of Proposition 103 and its prior approval requirement for insurance premiums in California, the California DOI issued regulations permitting persistency as a rating factor. The regulations, however, provided no definition of persistency. Following a 1994 market conduct examination of the Company, the California DOI determined that the Company’s persistency discount, awarded only to consumers previously insured by the Company or its agents and brokers (so-called “loyalty” persistency), was unfairly discriminatory. In response, in 1995 the Company obtained approval for a persistency discount awarded to insureds with continuous coverage with any insurer-what has come to be called “portable” persistency. This discount was consistently reapproved until 2002 when the California DOI, under then Commissioner Harry Low took the position that only “loyalty” persistency-that is, the kind of persistency discount the Company awarded prior to 1995-was allowable under Proposition 103.
In 2003, the California DOI required all insurers offering persistency discounts to eliminate their portability. However, Senate Bill 841 (“SB 841”), enacted in 2003, amended the California Insurance Code to allow portable persistency discounts. SB 841 was challenged in the courts and on September 27, 2005 was overturned in a decision by the California Court of Appeal in The Foundation for Taxpayer and Consumer Rights, et al. v. Garamendi. The Company’s petition for review of this decision was denied by the California Supreme Court in January 2006. Consequently, the Company has filed and received approval for a revenue neutral rate change eliminating persistency which effectively increases the rates charged to some insureds moderately and lowers rates for all others. Since the new rates went in effect, the Company has seen an increase in the number of new applications. However, it is not yet possible to determine if this will have a material impact on the Company or its operations.
The potential net exposure on the franchise tax issues for 1993 through 1996, after federal tax benefit, amounts to approximately $15 million, which includes a potential tax amnesty interest penalty of approximately $4 million. The amnesty penalty relates to a revenue enhancement provision contained in the California Tax Amnesty legislation requiring taxpayers with tax assessments for tax years 2002 and prior, whether or not disputed, to pay amounts due by March 31, 2005 or risk paying an additional penalty amount equal to 50% of the interest computed on the original assessment for the period beginning with the due date of the return and ending on March 31, 2005. These amounts would be due should the Company not prevail on the underlying tax issues.
The Company believes that the deduction of the expenses related to management services provided to its insurance company subsidiaries is appropriate. The Company has established a tax liability of approximately $1 million for the franchise tax issues related to the tax years 1993 through 1996. An unfavorable ruling against the Company in the rehearing may have a material impact on the Company’s quarterly results of operations.
As a result of California Assembly Bill 263 (“AB263”), the Company paid approximately $3.5 million in California franchise taxes for the tax years 1997 through 2003 during 2005. AB263 resolved an issue raised by the FTB where they interpreted a legal ruling to eliminate a dividends received deduction (“DRD”) taken by companies on dividends received from their insurance subsidiaries. AB263 provides for an 80% DRD for tax years 1997 through 2007 and an 85% DRD for tax years after 2007.
The Company performs its own loss reserve analysis and also engages the services of independent actuaries to assist in the estimation of loss reserves. The Company and the actuaries 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, 2005, the Company recorded its point estimate of approximately $1,023 million in loss and loss adjustment expense reserves which includes approximately $277 million of incurred but not reported (“IBNR”) loss reserves. IBNR includes estimates, based upon past experience, of ultimate developed costs which may differ from case estimates, unreported claims which occurred on or prior to December 31, 2005 and estimated future payments for reopened-claims 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.
For the year ended December 31, 2005, the Company had positive development of approximately $46.5 million on the 2004 and prior year loss and loss adjustment expense reserves which at December 31, 2004 totaled $901 million. The Company attributes more than half of this redundancy to a change in the inflation rate assumptions used to establish bodily injury coverage reserves for the California automobile insurance lines of business for the 2003 and 2004 accident years. The redundancies, related to changes in bodily injury inflation rate changes on the 2004 and 2003 accident years, were approximately $23 million and $5 million, respectively.
In addition, approximately one third of the positive development on the reserves established at December 31, 2004 relates to a reduction in the loss adjustment expense reserves for the California automobile insurance lines of business. During the year ended December 31, 2005, there was a decrease in the expenditures to outside legal counsel for the defense of personal automobile claims in California. This led to a reduction in the ultimate expense amount expected to be paid out and therefore a redundancy in the reserves established at December 31, 2004. The Company believes that many factors could be contributing to the reduction in payments to outside legal counsel. These include cost savings from the usage of more flat fee billing arrangements with outside counsel, faster closure rates of bodily injury liability cases and a decrease in bodily injury claims frequency due to factors such as improvements made in vehicle safety.
The change in these inflation assumptions accounted for approximately $41 million of the decrease in the expected ultimate loss on the reserves established at December 31, 2003. Each percentage point change in the inflation rate assumption accounts for approximately $2.5 million of the redundancy on the 2002 accident year losses and approximately $5 million on the 2003 accident year losses.
The remainder of the redundancy for the 2003 accident year primarily occurred in the Company’s California homeowners and Florida personal automobile lines of business. California homeowners had approximately $6 million in reserve redundancy and Florida personal automobile had approximately $8 million in reserve redundancy.
At December 31, 2004, the Company assumed bodily injury inflation rates of approximately 1% on the 2004 accident year for the California automobile lines of business. The Company estimates that each percentage point change in the inflation rate assumption would impact the 2002 through 2004 accident years by approximately $2.5 million individually with a compounding effect if adjusted for multiple accident years. For example, if all years were changed to 2%, 2002 would be affected by $2.5 million, 2003 by $5 million and 2004 by $7.5 million for a total of approximately $15 million.
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 or trading markets, 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 consolidated 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 part of accumulated other comprehensive income (loss), 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 (loss) on the consolidated balance sheet to realized investment losses on the consolidated statement of income.
Premiums earned in 2005 of $2,847.7 million increased 12.6% from the corresponding period in 2004. Net premiums written in 2005 of $2,950.5 million increased 11.5% over amounts written in 2004. The premium increases were principally attributable to increased policy sales. During 2005, the Company had no rate increases in California and implemented automobile rate increases in three of the twelve non-California states.
Net investment income in 2005 was $122.6 million compared with $109.7 million in 2004. The after-tax yield on average investments of $3,058.1 million (cost basis) was 3.5%, compared with 3.6% on average investments of $2,662.2 million (cost basis) in 2004. The effective tax rate on investment income was 13.8% in 2005, compared to 12.6% in 2004. The higher tax rate in 2005 reflects a shift in the mix of the Company’s portfolio from non-taxable to taxable securities. Proceeds from bonds which matured or were called in 2005 totaled $409.5 million, compared to $363.4 million in 2004. Assuming market interest rates remain at current levels, the Company expects approximately $520 million of bonds to mature or be called in 2006. The Company expects to reinvest any proceeds into securities meeting the Company’s investment profile.
Premiums earned in 2004 of $2,528.6 million increased 17.9% from the corresponding period in 2003. Net premiums written in 2004 of $2,646.7 million increased 16.7% over amounts written in 2003. The premium increases were principally attributable to increased policy sales in the California, Florida and New Jersey automobile lines of business and the California homeowners line of business.
Through the Insurance Companies, the Company has generated positive cash flow from operations for over twenty consecutive years, in excess of $100 million every year since 1994 and over $400 million for each of the past three years. 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 $355.8 million at December 31, 2005, 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.
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. The Company recognized $2.2 million and $0.9 million in realized losses as other-than-temporary declines to its investment securities during 2005 and 2004, respectively.
At December 31, 2005, the Company had a net unrealized gain on all investments of $102.6 million before income taxes which is comprised of unrealized gains of $122.7 million offset by unrealized losses of $20.1 million. Unrealized losses represent 0.6% of total investments at amortized cost. Of these unrealized losses, approximately $14.6 million relate to fixed maturity investments and the remaining $5.5 million relate to equity securities. Approximately $18.1 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 $0.8 million and $0.5 million, respectively, representing market value declines of 6% and 16% of amortized cost. The remaining $2.0 million represents unrealized losses that exceed 20% of amortized costs, the majority of which have been in an unrealized loss position for less than twelve months. The Company has concluded that the gross unrealized losses of $20.1 million at December 31, 2005 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, 2005:
The unrealized losses of $2.0 million in the table above include two municipal bonds with losses of $0.1 million and $0.3 million and four equity securities whose individual losses range from $0.1 million to $0.3 million. Based upon the Company’s analysis of these securities which includes the status of debt servicing for the municipal bonds and third party analyst estimates for the equity securities, the unrealized losses for these securities are treated as temporary declines.
During 2005, the Company recognized approximately $18.3 million in net realized gains from the disposal (sale, call or maturity) of securities which is comprised of realized gains of $29.3 million offset by realized losses of $11.0 million. These realized losses were derived from the disposal of securities with a total amortized cost of
approximately $323.0 million. Of the total realized losses, approximately $4.5 million relates to securities held as of December 2004 with an average realized loss of approximately $19,000 and no loss on any one individual security exceeding $0.2 million.
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, 2005, 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 7, 2006 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.
In our opinion, management’s assessment that Mercury General Corporation maintained effective internal control over financial reporting as of December 31, 2005, 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, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
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 the consolidated statements of income. Realized gains and losses are included in the consolidated statements of income based upon the specific identification method.
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 consolidated balance sheets are goodwill of $7.3 million and other intangible assets of $5.2 million. The goodwill and other intangible assets were determined to have an indefinite useful life and in accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” are not amortized, but tested for impairment annually or more frequently if circumstances indicate potential impairment. The fair values 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 during the three years ended December 31, 2005.
Net premiums written during 2005, 2004 and 2003 were $2,950,523,000, $2,646,704,000 and $2,268,778,000, respectively.
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 occurrence 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 for loss reserves are necessarily based upon estimates, the ultimate liability may be more or less than such provisions.
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. Capitalized software is capitalized in accordance with Statement of Position 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use” and amortized on a straight-line method over the estimated useful life of the software, generally not exceeding five years. Leasehold improvements are stated at cost and amortized over the life of the associated lease.
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 13 of the Notes to Consolidated Financial Statements contains the required disclosures which make up the calculation of basic and diluted earnings per share.
The Insurance Companies, as primary insurers, will be required to pay losses in their entirety in the event that the reinsurers are unable to discharge their obligations under the reinsurance agreements.
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 2005, 2004 and 2003: dividend yield of 3.0% in 2005, 2.5% in 2004 and 2.8% for 2003, expected volatility of 26.4% in 2005, 29.4% in 2004 and 35.0% in 2003 and expected lives of 6 years for all years. The risk-free interest rates used were 4.0% for options granted in 2005, 3.9% for options granted during 2004 and 3.2% for the options granted during 2003.
In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections” (“SFAS No. 154”). SFAS No. 154 establishes, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to a newly adopted accounting principle. The statement will be effective for the Company for all accounting changes and any error corrections occurring after January 1, 2006.
There were no other accounting standards issued as of March 7, 2006 that are expected to have a material impact on the Company’s consolidated financial statements.
The amortized costs and estimated market values of investments in fixed maturities available for sale as of December 31, 2005 are as follows:
$14.6 million relate to fixed maturity investments and the remaining $5.5 million relate to equity securities. Approximately $18.1 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 $0.8 million and $0.5 million, respectively, representing market value declines of 6% and 16% of amortized cost, the majority of which have been in an unrealized loss position for less than twelve months. The remaining $2.0 million represents unrealized losses that exceed 20% of amortized costs. Based upon the Company’s analysis of these securities which includes the status of debt servicing for the municipal bonds and third party analyst estimates for the equity securities, the Company has concluded that the gross unrealized losses of $20.1 million at December 31, 2005 are temporary in nature. However, facts and circumstances may change which could result in a decline in market value considered to be other than temporary.
interpreted a legal ruling to eliminate a dividends received deduction (“DRD”) taken by companies on dividends received from their insurance subsidiaries. AB263 provides for an 80% DRD for tax years 1997 through 2007 and an 85% DRD for tax years after 2007.
On June 25, 2003, the California State Board of Equalization (“SBE”) upheld Notices of Proposed Assessments issued against the Company for tax years 1993 through 1996 in which the 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 relating to these franchise tax issues and a rehearing was granted and held on July 1, 2005. At the rehearing, additional briefings were requested before the SBE would rule on the matter. These briefings were filed with the SBE and another rehearing is scheduled for March 28, 2006.
The California FTB has audited the 1997 through 2002 tax returns and they accepted the 1997 through 2000 returns to be correct as filed. For the 2001 and 2002 tax returns, the FTB has taken exception to the state apportionment factors used by the Company. Specifically, the FTB has asserted that payroll and property factors from Mercury Insurance Services, LLC, a subsidiary of Mercury Casualty Company that is excluded from the Mercury General California Franchise tax return, should be included in the California apportionment factors. Based on this assertion, the FTB issued notices of proposed tax assessments in January 2006 for the 2001 and 2002 tax years totaling approximately $1 million. The Company strongly disagrees with the position taken by the FTB and plans to formally appeal the assessments before the SBE. An unfavorable ruling against the Company may have a material impact on the Company’s quarterly results of operations. Management believes that the issue will ultimately be resolved in favor of the Company. However, there can be no assurance that the Company will prevail in this matter.
During 2005, the state of Florida was struck by several hurricanes. The Company estimated that its pre-tax losses resulting from these hurricanes is approximately $27 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 $22 million incurred from hurricanes in 2004.
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 2006, the direct insurance subsidiaries of the Company are permitted to pay approximately $248 million in dividends to the Company without the prior approval of the Department of
Insurance (“DOI”) 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 2005 and 2004, the Insurance Companies paid dividends to Mercury General Corporation of $134.0 million and $99.0 million, respectively.
The Insurance Companies’ statutory net income, as reported to regulatory authorities, was $253,810,000, $270,466,000 and $168,118,000 for the years ended December 31, 2005, 2004 and 2003, respectively. The statutory policyholders’ surplus of the Insurance Companies, as reported to regulatory authorities, as of December 31, 2005 and 2004 was $1,487,574,000 and $1,361,072,000, respectively.
The Company has estimated the risk-based capital requirements of each of the Insurance Companies as of December 31, 2005 according to the formula issued by the NAIC. Each of the Insurance Companies’ policyholders’ surplus exceeded the highest level of minimum required capital.
In February 2004, the California DOI issued a Notice of Non-Compliance (“NNC”) based on the trial court ruling in the Robert Krumme litigation. The NNC alleges that the Company 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 Company filed a Notice of Defense which is based on the same grounds that formed the Company’s defense in the Robert Krumme case as well as what the San Francisco Superior Court appeared to regard as the California DOI’s acquiescence in our practices. The Company does not believe that it has done anything to warrant a monetary penalty from the California DOI. If a monetary penalty is imposed, the Company is unable to estimate the ultimate amount of any monetary penalty, and therefore no reserve for the potential monetary penalty has been established in the consolidated financial statements.
Sam Donabedian, individually and on behalf of those similarly situated v. Mercury Insurance Company, filed his original action on April 20, 2001 in the Los Angeles Superior Court, asserting, among other things, a claim that the Company’s calculation of persistency discounts to determine premiums is an unfair business practice, a violation of the California Consumer Legal Remedies Act (“CLRA”) and a breach of the covenant of good faith and fair dealing. The Company originally prevailed on a Demurrer to the Complaint and the case was dismissed; however, the California Court of Appeal reversed the trial court’s ruling, deciding that the California Insurance Commissioner does not have the exclusive right to review the calculation of insurance rates/premiums. After filing two additional pleadings, on June 28, 2005, the Plaintiff filed a Fourth Amended Complaint, asserting claims for violation of California Business & Professions Code Section 17200 and breach of the covenant of good faith and fair dealing (the CLRA claim previously had been dismissed with prejudice). Plaintiff again sought injunctive relief,
unspecified restitution and monetary damages as well as punitive damages and attorneys’ fees and costs. Without leave of court, the Plaintiff has attempted to state claims for breach of contract and fraud. The Company filed a Demurrer and Motion to Strike certain portions of the Plaintiff’s Fourth Amended Complaint. Following the hearing on September 19, 2005, the Court took the matter under submission. On June 9, 2005, the trial court also permitted a Complaint in Intervention by The Foundation for Taxpayer and Consumer Rights which alleges that the Company’s calculation of persistency discounts constitutes a violation of Insurance Code Section 1861.02(a) and (c) and the Company has filed an answer to that pleading. No trial date has been scheduled and the Plaintiff has not filed a motion to certify the putative class.
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 has filed a motion seeking class action certification to include all of the Company’s insureds from 1998 to the present who presented a medical payments claim, had the claim reduced using the computer program and whose claim did not reach the policy limits for medical payments. No date has been set for this motion. As with the O’Dell case above, and the other cases in the coordinated proceedings, the Plaintiff alleges that these automated databases systematically undervalue medical payment claims to the detriment of insureds. The Plaintiff is seeking unspecified 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 Court denied the Company’s Motion for Summary Judgment holding that there is an issue of fact as to whether Ms. Goodman sustained any damages as a result of the Company’s handling of her medical payments claim. A trial
In May 1995, the Company adopted the 1995 Equity Participation Plan (the “1995 Plan”) which succeeded a prior 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 prior 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.
In May 2005, the Company adopted the 2005 Equity Incentive Award Plan (the “2005 Plan”) which succeeds the 1995 Plan. Under the 2005 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 2005, the Company granted incentive stock options under both the 2005 Plan and the 1995 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, 2005 no awards other than options have been granted.
The diluted weighted shares excludes incremental shares of 19,000, 8,000 and 133,000 for 2005, 2004 and 2003, respectively. These shares are excluded due to their antidilutive effect.