MERCURY GENERAL CORP - Annual Report: 2004 (Form 10-K)

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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, 2004

Commission File No. 001-12257

MERCURY GENERAL CORPORATION

(Exact name of registrant as specified in its charter)

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

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

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, 2004 was approximately $1,294,000,000 (based upon the closing sales price on the New York Stock Exchange for such date, as reported by the Wall Street Journal).

At February 28, 2005, the Registrant had issued and outstanding an aggregate of 54,539,318 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 11, 2005 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 2004, private passenger automobile insurance and commercial automobile insurance accounted for 86.6% and 4.2%, respectively, of the Company’s total gross premiums written. The percentage of gross automobile insurance premiums written during 2004 by state was 76.2% in California, 9.6% in Florida, 4.6% in New Jersey, 4.3% in Texas and 5.3% 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 9.2% of gross premiums written in 2004, of which approximately 59% was in the homeowners line.

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 2004, all of the Company’s subsidiaries actively writing insurance, except American Mercury Insurance Company (“AMI”), American Mercury Lloyds Insurance Company (“AML”) and Mercury Indemnity Company of America (“MIDAM”) 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). AMI and AML, which accounted for approximately 5% of the Company’s 2004 net premiums written, maintained an A.M. Best rating of A- (Excellent). MIDAM, which writes business in New Jersey, is currently not rated due to insufficient operating experience.

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. The Company opened a 130,000 square foot office building in Rancho Cucamonga, California in September 2003, which is used to support the Company’s recent growth and future expansion. The Company purchased a 157,000 square foot office building in St. Petersburg, Florida in January 2005, which currently houses the East Region corporate office. 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 4,300 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 with or furnished to the Securities and Exchange Commission (“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 (“MCC”), a California automobile insurer founded in 1961 by George Joseph, Mercury General’s Chief Executive Officer.

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Including MCC, Mercury General has eighteen subsidiaries. The Company’s insurance operations are conducted through the following insurance company subsidiaries:

Mercury Select Management Company, Inc. (“MSMC”), a Texas corporation serves as the attorney-in-fact for AML. The Company operates Concord Insurance Services, Inc. (“Concord”), a Texas insurance agency headquartered in Houston, Texas. MCM, a mutual insurance company organized under Chapter 17 of the Texas Insurance Code, is managed and controlled by the Company through a management agreement.

Management services are provided to Mercury General’s subsidiaries by Mercury Insurance Services, LLC (“MISLLC”), a subsidiary of MCC. 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 MSMC, MISLLC and Concord, are referred to as the “Insurance Companies.” The term “California Companies” refers to MCC, MIC and CAIC.

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 database 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, 2004, “good drivers” (as defined by the California Insurance Code) accounted for approximately 78% of all voluntary private passenger automobile policies in force in California, while higher risk categories accounted for approximately 22%. The private passenger automobile renewal rate in California (the rate of acceptance of offers to renew) averages approximately 96%. The Company also offers homeowners, commercial property and commercial automobile and mechanical breakdown insurance in California.

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In states outside of California, the Company offers non-standard, standard and preferred private passenger automobile insurance. Private passenger automobile policies in force for non-California operations represented approximately 24% of total private passenger automobile policies in force at December 31, 2004. In addition the Company offers mechanical breakdown insurance in all states outside of California and homeowners insurance in Florida, Illinois, Oklahoma and Georgia.

Production and Servicing of Business

The Company sells its policies through more than 4,200 independent agents and brokers, of which approximately 1,000 are located in each of California and Florida. The remainder are located in Georgia, Illinois, Texas, Oklahoma, New York, New Jersey, Virginia, Pennsylvania, Arizona, Nevada and Michigan. Over half of 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 contracted by the Company.

Other than one broker that produced approximately 14%, 16% and 16% during 2004, 2003, and 2002, respectively, of the Company’s 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 2004, total commissions incurred were approximately 17% 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 independent 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 it intends to maintain or possibly expand the current level of advertising in 2005. During 2004, the Company incurred approximately $26 million in advertising expense. “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 Company’s 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:

The decrease in the provision for insured events of prior years in 2004 relates largely to a decrease in the estimated inflation rates on the 2002 and 2003 accident years on bodily injury coverage for California automobile insurance. For 2003 and 2002, 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.

During the third quarter of 2004, the state of Florida was ravaged by four hurricanes. The Company has 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 pre-tax losses of approximately $16 million incurred from the California firestorms in 2003.

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:

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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 1994 through 2004. 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 amount represents the estimated 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, 2004.

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.

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The Company’s loss reserves estimated at December 31, 2003 produced a redundancy of approximately $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.

At year-end 2003, the Company had assumed bodily injury severity inflation on California private passenger automobile insurance of 9% on the 2001 accident year, 6% on the 2002 accident year and 7% on the 2003 accident year. At year-end 2004, these assumptions were reduced to 8% for 2001, 1% for 2002 and 1% for 2003. The Company reduced the inflation rate assumptions based on factors that emerged during 2004 including moderating to decreasing average amounts paid on closed claims in the 2003 and 2004 accident years and increased certainty in reserve amounts that comes through the passage of time as more claims from an accident period are closed.

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 effect is greater on the latter accident year because the lowering of the rate for accident year 2002 has a compounding effect on accident year 2003.

The remainder of the redundancy on the 2003 accident year primarily occurred in the Company’s California homeowners line of business and Florida personal automobile line of business. California homeowners had approximately $6 million in reserve redundancy and Florida personal automobile had approximately $8 million in reserve redundancy.

For calendar year 2002, the Company’s previously estimated loss reserves produced a small redundancy which was reflected in the following years losses. This redundancy was primarily the result of changing bodily injury severity inflation assumptions for the 2002 accident year as discussed above.

For calendar years 1998 through 2001, 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.

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.

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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 year 1994, the Company’s previously estimated loss reserve produced a small deficiency indicating that the Company was reasonably accurate in establishing the initial reserve for that year.

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 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.

(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.

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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.

Risk-Based Capital

The NAIC employs a risk-based capital formula for casualty insurance companies that 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, 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, 2004. Each of the Insurance Companies’ policyholders’ surplus 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:

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Investments and Investment Results

The Company’s investments 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 that 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.

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

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. Declines in value considered to be temporary are charged as unrealized losses to shareholders’ equity as accumulated other comprehensive income. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources,” and Note 2 of Notes to Consolidated Financial Statements.

At year-end, approximately 58% of the Company’s total investment portfolio, at market values, and 76% of its total fixed maturity investments, at market values, were invested in investment grade tax-exempt revenue and municipal bonds. Shorter duration sinking fund preferred stocks and collateralized mortgage obligations represented approximately 8.7% of the Company’s total investment portfolio, at market values, and 11.4% of its total fixed maturity investments, at market values, at December 31, 2004. The average Standard & Poor’s rating of the Company’s bond holdings was AA at December 31, 2004. Holdings of lower than investment grade bonds constitute approximately 1.7% of total invested assets.

The nominal average maturity of the overall bond portfolio, including collateralized mortgage obligations and short-term cash investments, was 11.3 years at December 31, 2004, which reflects a heavier portfolio mix in investment grade tax-exempt revenue and municipal bonds. The call-adjusted average maturity of the overall bond

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portfolio was shorter, approximately 4.0 years, because holdings are heavily weighted with high coupon issues that are expected to be called prior to maturity. The modified duration of the overall bond portfolio reflecting anticipated early calls was 3.2 years at December 31, 2004, including collateralized mortgage obligations with modified durations of approximately 1.6 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 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.

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 2004 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 following table summarizes the investment results of the Company for the five years ended December 31, 2004:

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

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have larger volumes of business and greater financial resources than the Company. Based on the most recent regularly published statistical compilations of premiums written, the Company in 2003 was the third largest writer of private passenger automobile insurance in California. All of the Company’s competitors having greater shares of the California market sell insurance through exclusive agents, rather than through independent agents and brokers.

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 management’s view, 2003 and 2004 were periods of very good results for companies underwriting automobile insurance. As a result, many competitors have recently begun reducing rates and increasing advertising expenditures. The Company expects this to continue in 2005 and consequently the premium growth rate will likely decline from the levels seen in 2004 (17%) and 2003 (22%).

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

Effective January 8, 2005, the Company terminated a property per risk reinsurance treaty that had been in place with Swiss Re since January 1999, and replaced it with a similar treaty with Employers Reinsurance Corporation (“ERC”), which is rated A by A.M. Best. The new treaty, which covers commercial property and homeowners, provides first layer coverage of $250,000 in excess of $750,000 for each risk, second layer coverage of $1,000,000 in excess of $1,000,000 per risk and third layer coverage of $3,000,000 in excess of $2,000,000 per risk.

The Swiss Re treaty was terminated on a cut off basis meaning that Swiss Re will remain liable for losses occurring prior to the date of termination. The Swiss Re treaty provides first layer coverage of $250,000 in excess of $750,000, second layer coverage of $1,000,000 in excess of $1,000,000, third layer coverage of $3,000,000 in excess of $2,000,000 and fourth layer coverage of $5,000,000 in excess of $5,000,000.

Prior to October 1, 2004, the Company had in place a treaty reinsurance agreement with Swiss Re, where risks written under personal umbrella policies were 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. Effective October 1, 2004, the umbrella coverage was terminated. The Company has chosen to end the treaty on a run-off basis meaning that the treaty will remain active for one year after the termination date with policies incepting September 30, 2004 and prior being covered per the treaty terms. Policies incepting on October 1, 2004 and after will not have any reinsurance coverage.

At December 31, 2004, the Company did not maintain catastrophe insurance but has determined that such coverage is warranted for certain coverages written in Florida and Georgia. Effective April 1, 2005, the Company expects to enter into a property catastrophe excess of loss reinsurance agreement that will cover all property and automobile physical damage (comprehensive peril only) coverages in those two states. The treaty is with a group of reinsurers and Lloyd’s underwriters and has two layers. The first layer provides coverage of $30,000,000 in excess

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of $70,000,000 and the second layer is for $50,000,000 in excess of $100,000,000. For all layers, the Company will retain 5% of the limit. Policies written in all other states do not have catastrophe coverage, as the Company believes it has adequate capitalization to absorb catastrophe losses in those states. The Company periodically reviews its requirements for catastrophic reinsurance particularly in areas that are prone to catastrophes.

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.

ERC reinsures AMI through working layer treaties for property and casualty losses in excess of $500,000 up to $3 million. AMI has other reinsurance treaties and facultative arrangements in place for various smaller lines of business.

MCM maintains 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 any reinsurers are unable to perform their obligations under the reinsurance treaty, the Company will 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, the establishment of capital and surplus requirements and standards of solvency, restrictions on dividend payments and transactions with affiliates. The regulations of 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 the California Insurance Code and the California Code of Regulations with respect to rating, underwriting and claims handling practices. The most recent examination covered a compliance review of the activities of the Company’s Special Investigation Unit commencing in October 2004. The report on the examination is pending finalization by the California DOI.

In February 2004, the California DOI issued a Notice of Non-Compliance (“NNC”) to the California Companies based on the trial court ruling in the Robert Krumme litigation. 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 filed a Notice of Defense which is based on the same grounds that formed the Company’s defense in the Robert Krumme case. The administrative proceeding has been stayed at the California DOI’s request until a resolution is reached on the Robert Krumme case. Settlement negotiations have commenced in order to resolve the matter, including reimbursement of costs to the DOI and the payment of a monetary penalty. No specific discussions have taken place regarding the amount of any monetary penalty, except that the DOI has indicated that a monetary penalty would be required. The Company does not believe that it has done anything to warrant a monetary penalty from the California DOI. 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. See “Item 3. Legal Proceedings.”

The Insurance Companies outside California are subject to the regulatory powers of the DOIs of the various states in which they operate. 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.

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In California, Georgia, New York, New Jersey, Pennsylvania and Nevada, insurance rates require prior approval from the State DOI, while Illinois, Texas, Virginia, Arizona and Michigan 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.”

Persistency discounts predate the Proposition 103 rate regulations. They represent discounts on policy rates extended to consumers based on the number of consecutive years insurance coverage has existed. In 1990, in response to Proposition 103’s allowance of optional rating factors promulgated by the California Insurance Commissioner (the “Commissioner”), the Commissioner issued regulations permitting persistency as a rating factor under the new rate regulations. No further definition of persistency discount was provided. In 1994, the Commissioner conducted a market conduct examination of the Company, after which he indicated he believed Mercury’s persistency discount, then awarded only to consumers serviced by the Company’s agents and brokers, was unfairly discriminatory. In response to that examination, in 1995 the Company filed, and secured 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 by the Commissioner until 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.

The California DOI required all insurers offering persistency discounts to make class plan filings by January 15, 2003, removing the portability of the persistency discounts. 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 expects appellate review of this ruling to be heard in the second quarter of 2005. The outcome of such action is uncertain; however, in the meantime, the Company is allowed to maintain its existing portable persistency discounts. 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.

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.

The California DOI conducted a financial examination of the California Companies as of December 31, 2003. The exam resulted in no material findings or recommendations. The state of Florida conducted financial examinations of MIC FL and MIDAM as of December 31, 2002 and again as of December 31, 2003 as required by Florida statute for a start-up company. The exam as of December 31, 2002 resulted in no material findings or recommendations. The report on examination for the period ending December 31, 2003 is pending finalization. The Georgia DOI is conducting a financial examination of MIC GA and MID GA as of December 31, 2003. The report is not yet available.

The operations of the Company are dependent on the laws of the states 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 2004 and 2003, those contributions amounted to $534,800 and $789,600, 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.

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During 2004, the Company spent substantial management time and resources in anticipation of the attestation by its independent auditor of management’s report with respect to its internal controls over financial reporting as required by Section 404 (“SOX 404”) of the Sarbanes-Oxley Act of 2002. As part of its readiness preparation, the Company engaged the services of consultants from a large international consulting firm and consultants from a Big Four accounting firm. The Company estimates that its total expenditures will be approximately $2 million (including audit fees) relating to the readiness preparation and the attestation by its independent auditor of management’s report of its internal controls over financial reporting. The Company expects SOX 404 related costs will be lower in 2005.

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. 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. Insurance subsidiaries in the other states are also subject to the provisions of similar insurance guaranty associations. 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 material assessments levied against the Company during 2004.

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 3% of the respective California Company’s admitted assets or 25% of statutory 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 California 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 California 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.

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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 California DOI approved a rate decrease of 28.3% effective February 1, 1999. The California DOI approved rate increases of 15.5% and 10.3% on new and renewal assigned risk business effective November 1, 2003 and November 19, 2004, respectively. While the number of the Company’s assignments increased in 2002 and 2003, its total assignments decreased slightly in 2004. In 2004, 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. Many of the other states in which the Company conducts business offer similar programs to that of California. These programs are not a significant contributor to the business written in those states.

Automobile Insurance Rating Factor Regulations

California Proposition 103 requires that property and casualty insurance rates be approved by the California 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 California 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.”

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.

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.

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 CEA. The Company receives a small fee for placing business with the CEA.

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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 29, 2004, is approximately $47 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 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, the Company does not insure 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. Less than five percent of the Company’s commercial property policyholders purchased this coverage in 2004.

EXECUTIVE OFFICERS OF THE COMPANY

The following table sets forth certain information concerning the executive officers of the Company as of February 15, 2005:

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 50 years’ experience in the property and casualty insurance business.

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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 15 years experience in the property and casualty insurance industry and is a Certified Public Accountant.

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 MCC 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.

Mr. Dougherty, Vice President—Eastern Region, joined the Company in 1998 where he served as the General Manager for the Company’s Florida operations. He was named to his current position in April 2004. In this position, Mr. Dougherty is responsible for all aspects of the Company’s operations east of the Mississippi River. As General Manager of the Florida operations, Mr. Dougherty was responsible for the marketing, underwriting and claims functions within Florida.

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. 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. Kitzmiller, Vice President—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 California underwriting activities of the Company since early 1996.

Mr. McCathron, Vice President—Western Region, joined the Company in the underwriting department in 1993. He was named to his current position in April 2004. In this position, Mr. McCathron is responsible for all aspects of the Company’s operations west of the Mississippi River, excluding California. Mr. McCathron has served in various positions and responsibilities since joining the Company.

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

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.

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. 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.

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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 MCC. The Company occupies approximately 95% of the building and leases the remaining office space to others.

The Company owns a 130,000 square foot office building in Rancho Cucamonga, California that opened in September 2003. 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.

In January 2005, the Company purchased a 157,000 square foot office building in St. Petersburg, Florida. This building currently houses the Company’s East Region corporate offices and seven outside tenants. In the future, the Company plans to expand into the spaces occupied by the outside tenants as their lease terms end.

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 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

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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.

In February 2004, the California DOI issued a Notice of Non-Compliance (“NNC”) to the California Companies based on the trial court ruling in the Robert Krumme litigation. 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 filed a Notice of Defense which is based on the same grounds that formed the Company’s defense in the Robert Krumme case. The administrative proceeding has been stayed at the California DOI’s request until a resolution is reached on the Robert Krumme case. Settlement negotiations have commenced in order to resolve the matter including reimbursement of costs to the DOI and the payment of a monetary penalty. No specific discussions have taken place regarding the amount of monetary penalty, except that the DOI has indicated that a monetary penalty would be required. The Company does not believe that it has done anything to warrant a monetary penalty from the California DOI. 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.

Sam Donabedian, individually, and on behalf of those similarly situated vs. Mercury Insurance Company (Los Angeles Superior Court), filed April 20, 2001, involves a dispute over insurance rates/premiums charged to the plaintiff and the legality of persistency discounts. The action was dismissed when the Company’s Demurrer to the plaintiff’s First Amended Complaint was sustained without leave to amend. The dismissal of this case was appealed and then overruled by an Appellate Court on the basis that there are factual issues as to whether the persistency discounts as applied comply with the Company’s class plan and the California Insurance Code. The California Supreme Court declined to grant review. The plaintiff filed a Second Amended Complaint in December 2004, which specifically alleges that the Company violated California Business and Professional Code 17200 et seq. and California Civil Code Section 1750 et seq. and that it breached the implied covenant of good faith and fair dealing. The Second Amended Complaint seeks relief in the form of an injunction to cease the alleged unfair business acts, notification to policyholders of the alleged acts, unspecified restitution and monetary damages including punitive damages and unspecified attorney’s fees and costs. The plaintiff filed a Third Amended Complaint in February 2005 which was substantially the same as the Second Amended Complaint. The Company filed Demurrers to the Amended Complaints. A hearing is scheduled for April 22, 2005. No trial date has been scheduled and the Plaintiff has not filed a motion seeking to certify the putative class. The Company intends to vigorously defend this case. Since the case is in its early stages, the Company is not able to determine the potential outcome of this matter and potential liability exposure.

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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 the Company’s use of certain automated database vendors to help determine the value of total loss claims is proper. The plaintiff (along with plaintiffs in other coordinated cases against other insurers) is seeking class certification and unspecified damages for breach of contract and bad faith, including punitive damages, restitution, an injunction preventing us from using valuation software and unspecified attorneys’ fees and costs. In 2003, the court granted the Company’s motion to stay the action pending compliance with a contractual arbitration provision. The arbitration was completed in August 2004 and the award in the Company’s favor has been confirmed by the court in January 2005. Based upon the arbitration result and other defenses, the Company intends to challenge the pleadings and seek dismissal. The Company is not able to evaluate the likelihood of an unfavorable outcome or to estimate a range of potential loss in the event of an unfavorable outcome at the present time.

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 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 Company and the other defendants were successful on demurrer. The plaintiffs filed a Second Amended Complaint on June 28, 2004 which was substantially the same as the original complaint. The Company has answered the Second Amended Complaint and will file a Motion for Summary Judgment as to the claims of Ms. Goodman. The Company expects the Motion to be heard in May 2005. The Company is not able to evaluate the likelihood of an unfavorable outcome or to estimate a range of potential loss in the event of an unfavorable outcome at the present time. 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 Company’s 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.

The closing price of the Company’s common stock on February 28, 2005 was $54.86.

Dividends

Since the public offering of its common stock in November 1985, the Company has paid regular quarterly dividends on its common stock. During 2004 and 2003, the Company paid dividends on its common stock of $1.48 per share and $1.32 per share, respectively. On January 28, 2005, the Board of Directors declared a $0.43 quarterly dividend payable on March 31, 2005 to stockholders of record on March 15, 2005.

The common stock dividend rate has increased at least once each year since dividends were initiated in January, 1986. 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. For example, California 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 the state restrictions, the direct insurance subsidiaries of the Company are entitled to pay dividends to Mercury General during 2005 of up to approximately $235 million without prior regulatory approval. See “Item 1. Business—Regulation—Holding Company Act,” and Note 8 of Notes to Consolidated Financial Statements. Assembly Bill 263, signed into law in September 2004, established a dividend received deduction of 80% for tax years 1997 through 2007 and an 85% dividend received deduction after 2007 on the dividends the Company receives from its insurance company subsidiaries. The effect of this law on the Company will be to create a tax liability on dividends paid from the insurance subsidiaries to Mercury General. The amount of this liability is not expected to be significant.

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Shareholders of Record

The approximate number of holders of record of the Company’s common stock as of February 28, 2005 was 209. The approximate number of beneficial holders as of February 28, 2005 was 11,000.

Item 6.    Selected Consolidated Financial Data