MERCURY GENERAL CORP - Annual Report: 2019 (Form 10-K)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

____________________________

FORM 10-K

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☒	Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Fiscal Year Ended December 31, 2019


☐	Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Transition Period from ___________ to ___________

Commission File No. 001-12257

____________________________

MERCURY GENERAL CORPORATION

(Exact name of registrant as specified in its charter)

____________________________



California		95-2211612
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

4484 Wilshire Boulevard
Los Angeles,	California	90010
(Address of principal executive offices)		(Zip Code)

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

____________________________

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



Title of Each Class	Trading Symbol(s)	Name of Each Exchange on Which Registered
Common Stock	MCY	New York Stock Exchange

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

None

____________________________

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒

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 ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.



Large accelerated filer	☒	Accelerated filer	☐
Non-accelerated filer	☐	Smaller reporting company	☐
Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒

The aggregate market value of the registrant’s common equity held by non-affiliates of the registrant at June 30, 2019 was $1,704,918,875 (which represents 27,278,702 shares of common equity held by non-affiliates multiplied by $62.50, the closing sales price on the New York Stock Exchange for such date, as reported by the Wall Street Journal).

At February 6, 2020, the registrant had issued and outstanding an aggregate of 55,357,691 shares of its Common Stock.

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Documents Incorporated by Reference

Certain information from the registrant’s definitive proxy statement for the 2020 Annual Meeting of Shareholders is incorporated herein by reference into Part III hereof.

MERCURY GENERAL CORPORATION

INDEX TO FORM 10-K



		Page
PART I

Item 1	Business	1
	General	1
	Website Access to Information	2
	Organization	2
	Production and Servicing of Business	3
	Underwriting	4
	Claims	4
	Loss and Loss Adjustment Expense Reserves and Reserve Development	4
	Statutory Accounting Principles	5
	Investments	6
	Competitive Conditions	7
	Reinsurance	8
	Regulation	10
	Information about the Company's Executive Officers	12
Item 1A	Risk Factors	13
Item 1B	Unresolved Staff Comments	25
Item 2	Properties	25
Item 3	Legal Proceedings	25
Item 4	Mine Safety Disclosures	25

PART II

Item 5	Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	26
Item 6	Selected Financial Data	28
Item 7	Management’s Discussion and Analysis of Financial Condition and Results of Operations	29
Item 7A	Quantitative and Qualitative Disclosures about Market Risks	50
Item 8	Financial Statements and Supplementary Data	52
Item 9	Changes in and Disagreements With Accountants on Accounting and Financial Disclosure	93
Item 9A	Controls and Procedures	93
Item 9B	Other Information	94

PART III

Item 10	Directors, Executive Officers, and Corporate Governance	95
Item 11	Executive Compensation	95
Item 12	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	95
Item 13	Certain Relationships and Related Transactions, and Director Independence	95
Item 14	Principal Accounting Fees and Services	95

PART IV

Item 15	Exhibits and Financial Statement Schedules	96

SIGNATURES		101
Financial Statement Schedules		S-1

PART I


Item 1.	Business

General

Mercury General Corporation ("Mercury General") and its subsidiaries (referred to herein collectively as the "Company") are primarily engaged in writing personal automobile insurance through 14 insurance subsidiaries (referred to herein collectively as the "Insurance Companies") in 11 states, principally California. The Company also writes homeowners, commercial automobile, commercial property, mechanical protection, and umbrella insurance. The Company's insurance policies are mostly sold through independent agents who receive a commission for selling policies. The Company believes that it has thorough underwriting and claims handling processes that, together with its agent relationships, provide the Company with competitive advantages.

The direct premiums written for the years ended December 31, 2019, 2018 and 2017 by state and line of insurance business were:

Year Ended December 31, 2019

(Dollars in thousands)



	Private Passenger Automobile			Homeowners			Commercial Automobile			Other Lines			Total
California	$	2,478,477		$	520,062		$	139,367		$	123,735		$	3,261,641		86.4	%
Other states ⁽¹⁾	342,005			78,478			77,960			14,506			512,949			13.6	%
Total	$	2,820,482		$	598,540		$	217,327		$	138,241		$	3,774,590		100.0	%
	74.6		%	15.9		%	5.8		%	3.7		%	100.0		%

Year Ended December 31, 2018

(Dollars in thousands)



	Private Passenger Automobile			Homeowners			Commercial Automobile			Other Lines			Total
California	$	2,346,403		$	458,065		$	120,234		$	114,838		$	3,039,540		85.6	%
Florida	126,756			7			14,149			114			141,026			4.0	%
Other states⁽¹⁾	230,417			66,838			64,069			9,027			370,351			10.4	%
Total	$	2,703,576		$	524,910		$	198,452		$	123,979		$	3,550,917		100.0	%
	76.1		%	14.8		%	5.6		%	3.5		%	100.0		%

Year Ended December 31, 2017

(Dollars in thousands)



	Private Passenger Automobile			Homeowners			Commercial Automobile			Other Lines			Total
California	$	2,117,882		$	404,645		$	102,204		$	109,779		$	2,734,510		84.1	%
Florida	140,288			4			17,089			680			158,061			4.9	%
Other states ⁽¹⁾	221,871			65,269			58,939			10,282			356,361			11.0	%
Total	$	2,480,041		$	469,918		$	178,232		$	120,741		$	3,248,932		100.0	%
	76.3		%	14.5		%	5.5		%	3.7		%	100.0		%

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⁽¹⁾	No individual state accounts for more than 4% of total direct premiums written.

The Company offers the following types of automobile coverage: collision, property damage, bodily injury ("BI"), comprehensive, personal injury protection ("PIP"), underinsured and uninsured motorist, and other hazards.

The Company offers the following types of homeowners coverage: dwelling, liability, personal property, fire, and other hazards.

The following table presents the Company's published maximum limits of coverage:



Insurance type	Published maximum limits of coverage
Private Passenger Automobile - bodily injury (BI)	$250,000 per person; $500,000 per accident ⁽¹⁾
Private Passenger Automobile (combined policy limits)	$500,000 per accident
Private Passenger Automobile - property damage	$250,000 per accident ⁽¹⁾
Commercial Automobile (combined policy limits)	$1,000,000 per accident
Homeowner property	no maximum ^{(2) (3)}
Homeowner liability	$1,000,000 ⁽³⁾
Umbrella liability	$5,000,000 ⁽⁴⁾

________

⁽¹⁾ The majority of the Company’s automobile policies have coverage limits that are equal to or less than $100,000 per person and $300,000 per accident for BI and $50,000 per accident for property damage.

⁽²⁾ The Company obtains facultative reinsurance coverage above the $5 million Company retention limit.

⁽³⁾ The majority of the Company’s homeowners policies have liability coverage limits of $300,000 or less, a replacement value of $500,000 or less, and a total insured value of $1,000,000 or less.

⁽⁴⁾ The majority of the Company’s umbrella policies have coverage limits of $1,000,000.

The principal executive offices of Mercury General are located in Los Angeles, California. The home office of the Insurance Companies and the information technology center are located in Brea, California. The Company also owns office buildings in Rancho Cucamonga and Folsom, California, which are used to support California operations and future expansion, and in Clearwater, Florida and in Oklahoma City, Oklahoma, which house Company employees and several third party tenants. The Company has approximately 4,500 employees. The Company maintains branch offices in a number of locations in California; Clearwater, Florida; Bridgewater, New Jersey; Oklahoma City, Oklahoma; and Austin and San Antonio, Texas.

Available Information

The Company’s website address is www.mercuryinsurance.com. The Company's website address is not intended to function as a hyperlink and the information contained on the Company’s website is not, and should not be considered part of, and is not incorporated by reference into, this Annual Report on Form 10-K. The Company makes available on its website its Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Proxy Statements, and amendments to such periodic reports and proxy statements (the "SEC Reports") filed with or furnished to the Securities and Exchange Commission (the "SEC") pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, 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. The SEC maintains a website at www.sec.gov that contains the SEC Reports that the Company has filed or furnished electronically with the SEC.

Organization

Mercury General, an insurance holding company, is the parent of Mercury Casualty Company, a California automobile insurer founded in 1961 by George Joseph, the Company’s Chairman of the Board of Directors.

Mercury General conducts its business through the following subsidiaries:



Insurance Companies	Formed or Acquired	A.M. Best Rating	Primary States
Mercury Casualty Company ("MCC")⁽¹⁾	1961	A	CA, AZ, NV, NY, VA
Mercury Insurance Company ("MIC")⁽¹⁾	1972	A	CA
California Automobile Insurance Company ("CAIC")⁽¹⁾	1975	A	CA
California General Underwriters Insurance Company, Inc. ("CGU")⁽¹⁾	1985	Non-rated	CA
Mercury Insurance Company of Illinois	1989	A	IL
Mercury Insurance Company of Georgia	1989	A	GA
Mercury Indemnity Company of Georgia	1991	A	GA
Mercury National Insurance Company	1991	A	IL
American Mercury Insurance Company	1996	A-	OK, CA, TX, VA
American Mercury Lloyds Insurance Company ("AML")	1996	A-	TX
Mercury County Mutual Insurance Company	2000	A-	TX
Mercury Insurance Company of Florida	2001	A	FL
Mercury Indemnity Company of America	2001	A	FL, NJ
Workmen’s Auto Insurance Company ("WAIC")⁽¹⁾	2015	Non-rated	CA



Non-Insurance Companies	Formed or Acquired	Purpose
Mercury Select Management Company, Inc.	1997	AML’s attorney-in-fact
Mercury Insurance Services LLC	2000	Management services to subsidiaries
AIS Management LLC	2009	Parent company of AIS and PoliSeek
Auto Insurance Specialists LLC ("AIS")	2009	Insurance agency
PoliSeek AIS Insurance Solutions, Inc. ("PoliSeek")	2009	Insurance agency
Animas Funding LLC ("AFL")	2013	Special purpose investment vehicle
Fannette Funding LLC ("FFL")	2014	Special purpose investment vehicle
Mercury Plus Insurance Services LLC	2018	Insurance agency

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⁽¹⁾	The term "California Companies" refers to MCC, MIC, CAIC, CGU, and WAIC.

Production and Servicing of Business

The Company sells its policies through a network of approximately 9,500 independent agents, its 100% owned insurance agencies, AIS and PoliSeek, and directly through internet sales portals. Approximately 1,870, 1,320, and 1,210 of the independent agents are located in California, Florida, and Texas, respectively. The independent agents and agencies are independent contractors selected and contracted by the Company and generally also represent competing insurance companies. Certain of these independent agencies are under the common ownership of a parent company; however, they each operate autonomously with their own contractual agreements with the Company and hence are accounted for as separate independent agencies. Excluding AIS and PoliSeek, independent agents and agencies collectively accounted for approximately 86% of the Company's direct premiums written in 2019 and no single independent agent or agency accounted for more than 1% of the Company’s direct premiums written during any of the last three years. AIS and PoliSeek represented the Company as independent agencies prior to their acquisition in 2009, and continue to act as independent agencies selling policies for a number of other insurance companies. Policies sold directly through the internet sales portals are assigned to and serviced by the Company's agents and agencies, including AIS and PoliSeek.

The Company believes that it compensates its agents above the industry average. Net commissions incurred in 2019 were approximately 15% of net premiums written.

The Company’s advertising budget is allocated among television, radio, newspaper, internet, and direct mailing media with the intent to provide the best coverage available within targeted 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 based upon the number of account leads generated by the advertising. The Company believes that its advertising program is important to generate leads,

create brand awareness, and remain competitive in the current insurance climate. In 2019, the Company incurred approximately $42 million in net advertising expense.

Underwriting

The Company sets its own automobile insurance premium rates, subject to rating regulations issued by the Department of Insurance or similar governmental agency of each state in which it is licensed to operate ("DOI"). Each state has different rate approval requirements. See "Regulation—Department of Insurance Oversight."

The Company offers standard, non-standard, and preferred private passenger automobile insurance in 11 states. The Company also offers homeowners insurance in 10 states, commercial automobile insurance in 8 states, and mechanical protection insurance in most states.

In California, "good drivers," as defined by the California Insurance Code, accounted for approximately 86% of the Company's California voluntary private passenger automobile policies-in-force at December 31, 2019, while higher risk categories accounted for approximately 14%. The Company's private passenger automobile renewal rate in California (the rate of acceptance of offers to renew) averaged approximately 96% in 2019, 2018, and 2017.

Claims

The Company conducts the majority of claims processing without the assistance of outside adjusters. The claims staff administers all claims and manages all legal and adjustment aspects of claims processing.

Loss and Loss Adjustment Expense Reserves ("Loss Reserves") and Reserve Development

The Company maintains loss reserves for both reported and unreported claims. Loss reserves for reported claims are estimated based upon a case-by-case evaluation of the type of claim involved and the expected development of such claims. Loss reserves for unreported claims are determined on the basis of historical information by line of insurance business. Inflation is reflected in the reserving process through analysis of cost trends and review of historical reserve settlement.

The Company’s ultimate liability may be greater or less than management estimates of reported loss reserves. The Company does not discount to a present value that portion of loss reserves expected to be paid in future periods. However, the Company is required to discount loss reserves for federal income tax purposes.

The following table provides a reconciliation of beginning and ending estimated reserve balances for the years indicated:

RECONCILIATION OF NET LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES



	Year Ended December 31,
	2019			2018			2017
	(Amounts in thousands)
Gross reserves at January 1⁽¹⁾	$	1,829,412		$	1,510,613		$	1,290,248
Less reinsurance recoverables on unpaid losses	(180,859		)	(64,001		)	(13,161		)
Net reserves at January 1⁽¹⁾	1,648,553			1,446,612			1,277,087
Incurred losses and loss adjustment expenses related to:
Current year	2,696,230			2,483,693			2,390,453
Prior years	9,794			93,096			54,431
Total incurred losses and loss adjustment expenses	2,706,024			2,576,789			2,444,884
Loss and loss adjustment expense payments related to:
Current year	1,651,550			1,543,828			1,550,789
Prior years	857,872			831,020			724,570
Total payments	2,509,422			2,374,848			2,275,359
Net reserves at December 31⁽¹⁾	1,845,155			1,648,553			1,446,612
Reinsurance recoverables on unpaid losses	76,100			180,859			64,001
Gross reserves at December 31⁽¹⁾	$	1,921,255		$	1,829,412		$	1,510,613

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⁽¹⁾	Under statutory accounting principles ("SAP"), reserves are stated net of reinsurance recoverables on unpaid losses whereas under U.S. generally accepted accounting principles ("GAAP"), reserves are stated gross of reinsurance recoverables on unpaid losses.

The increase in the provision for insured events of prior years in 2019 of approximately $9.8 million primarily resulted from higher than estimated defense and cost containment expenses in the California automobile line of insurance business, partially offset by favorable development on prior years’ loss and loss adjustment expense reserves, including catastrophe losses, in certain of the Company's other lines of insurance business.

The increase in the provision for insured events of prior years in 2018 of approximately $93.1 million primarily resulted from higher than estimated California automobile losses resulting from severity in excess of expectations for bodily injury claims as well as higher than estimated defense and cost containment expenses in the California automobile line of insurance business.

The increase in the provision for insured events of prior years in 2017 of approximately $54.4 million primarily resulted from higher than estimated losses in California automobile and property lines of business, which experienced loss severities in prior accident periods that were higher than previously estimated.

The Company recorded catastrophe losses net of reinsurance of approximately $53 million, $67 million, and $79 million in 2019, 2018, and 2017, respectively. Catastrophe losses due to events that occurred in 2019 totaled approximately $57 million, with no reinsurance benefits used for these losses, resulting primarily from wildfires and winter storms in California, a hurricane in Texas, and tornadoes and wind and hail storms in the Midwest. These losses were partially offset by favorable development of approximately $4 million on prior years' catastrophe losses, primarily from reductions in the Company's retained portion of losses on the Camp and Woolsey Fires in California under the Company's catastrophe reinsurance treaty, after accounting for the assignment of subrogation rights that occurred in the first quarter of 2019 and the re-estimation of reserves as part of normal reserving procedures. Catastrophe losses before reinsurance benefits totaled approximately $289 million in 2018, primarily resulting from wildfires in Northern and Southern California and weather-related catastrophes across several states. Catastrophe losses before reinsurance benefits totaled approximately $168 million in 2017, resulting primarily from wildfires in Northern and Southern California, severe rainstorms in California, and the impact of hurricanes in Texas, Florida and Georgia.

Statutory Accounting Principles

The Company’s results are reported in accordance with GAAP, which differ in some respects from amounts reported under SAP prescribed by insurance regulatory authorities. Some of the significant differences under GAAP are described below:


•	Policy acquisition costs such as commissions, premium taxes, and other costs that vary with and are primarily related to the successful acquisition of new and renewal insurance contracts, are capitalized and amortized on a pro rata basis over the period in which the related premiums are earned, whereas under SAP, these costs are expensed as incurred.

•

Certain assets are included in the consolidated balance sheets, whereas under SAP, such assets are designated as "nonadmitted assets," and charged directly against statutory surplus. These assets consist primarily of premium receivables that are outstanding for more than 90 days, deferred tax assets that do not meet statutory requirements for recognition, furniture, equipment, leasehold improvements, capitalized software, and prepaid expenses.


•	Amounts related to ceded reinsurance are shown gross as prepaid reinsurance premiums and reinsurance recoverables, whereas under SAP, these amounts are netted against unearned premium reserves and loss and loss adjustment expense reserves.


•	Fixed-maturity securities are reported at fair value, whereas under SAP, these securities are reported at amortized cost, or the lower of amortized cost, or fair value, depending on the specific type of security.


•	Equity securities are marked to market through the consolidated statements of operations, whereas under SAP, these securities are marked to market through unrealized gains and losses in surplus.

•

Goodwill is reported as the excess of cost of an acquired entity over the fair value of the underlying assets and assessed periodically for impairment. Intangible assets are amortized over their useful lives. Under SAP, goodwill is reported as the excess of cost of an acquired entity over the statutory book value and amortized over 10 years. Its carrying value is limited to 10% of adjusted surplus. Under SAP, intangible assets are not recognized.

•

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


•	Certain assessments paid to regulatory agencies that are recoverable from policyholders in future periods are expensed, whereas under SAP, these assessments are recorded as receivables.

Operating Ratios (SAP basis)

Loss and Expense Ratios

Loss and expense ratios are used to evaluate the underwriting experience of property and casualty insurance companies. Under SAP, losses and loss adjustment expenses are stated as a percentage of premiums earned because losses occur over the life of a policy, while underwriting expenses 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 expense ratios are less than 100%.

The following table presents, on a statutory basis, the Insurance Companies’ loss, expense and combined ratios, and the private passenger automobile industry combined ratio. The Insurance Companies’ ratios (Company-wide) include lines of insurance business other than private passenger automobile that accounted for 25.3% of direct premiums written in 2019; hence, the Company believes its combined ratio (for private passenger automobile only) is more comparable to the industry ratios.



	Year Ended December 31,
	2019		2018		2017		2016		2015
Loss ratio (Company-wide)	75.2	%	76.6	%	76.6	%	75.3	%	72.6	%
Expense ratio (Company-wide)	24.5	%	24.5	%	25.3	%	25.7	%	26.7	%
Combined ratio (Company-wide)⁽²⁾	99.7	%	101.0	%	101.9	%	101.0	%	99.3	%
Combined ratio (Company's private passenger automobile only)	98.2	%	99.5	%	99.3	%	100.8	%	99.3	%
Industry combined ratio (all writers)⁽¹⁾	N/A		97.3	%	102.2	%	106.0	%	104.1	%
Industry combined ratio (excluding direct writers)⁽¹⁾	N/A		97.8	%	99.9	%	99.7	%	100.2	%

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⁽¹⁾	Source: A.M. Best, Aggregates & Averages (2015 through 2018), for all property and casualty insurance companies (private passenger automobile line only, after policyholder dividends).


⁽²⁾	Combined ratio for 2018 does not sum due to rounding.

Premiums to Surplus Ratio

The following table presents the Insurance Companies’ statutory ratios of net premiums written to policyholders’ surplus. Guidelines established by the National Association of Insurance Commissioners (the "NAIC") indicate that this ratio should be no greater than 3 to 1.



	Year Ended December 31,
	2019		2018		2017		2016		2015
	(Amounts in thousands, except ratios)
Net premiums written	$	3,731,723	$	3,495,633	$	3,215,910	$	3,155,788	$	2,999,392
Policyholders’ surplus	$	1,539,998	$	1,471,547	$	1,589,226	$	1,441,571	$	1,451,950
Ratio	2.4 to 1		2.4 to 1		2.0 to 1		2.2 to 1		2.1 to 1

Investments

The Company’s investments are directed by the Chief Investment Officer under the supervision of the Investment Committee of the Board of Directors. The Company’s investment strategy emphasizes safety of principal and consistent income generation, within a total return framework. The investment strategy has historically focused on maximizing after-tax yield with a primary emphasis on maintaining a well diversified, investment grade, fixed income portfolio to support the underlying liabilities and achieve a return on capital and profitable growth. The Company believes that investment yield is maximized by selecting assets that perform favorably on a long-term basis and by disposing of certain assets to enhance after-tax yield and minimize the potential effect of downgrades and defaults. The Company believes that this strategy maintains the optimal investment performance necessary to sustain investment income over time. The Company’s portfolio management approach utilizes a market risk and asset allocation strategy as the primary basis for the allocation of interest sensitive, liquid and credit assets as well as for monitoring credit exposure and diversification requirements. Within the ranges set by the asset allocation strategy, tactical investment decisions are made in consideration of prevailing market conditions.

Tax considerations are important in portfolio management. The Company closely monitors the timing and recognition of capital gains and losses to maximize the realization of any deferred tax assets arising from capital losses. The Company had no capital loss carryforward at December 31, 2019.

Investment Portfolio

The following table presents the composition of the Company’s total investment portfolio:



	December 31,
	2019				2018				2017
	Cost⁽¹⁾		Fair Value		Cost⁽¹⁾		Fair Value		Cost⁽¹⁾		Fair Value
					(Amounts in thousands)
Taxable bonds	$	635,283	$	637,272	$	424,945	$	419,352	$	356,018	$	359,240
Tax-exempt state and municipal bonds	2,337,993		2,456,003		2,544,596		2,565,809		2,467,212		2,533,537
Total fixed maturities	2,973,276		3,093,275		2,969,541		2,985,161		2,823,230		2,892,777
Equity securities	648,282		724,751		544,082		529,631		474,197		537,240
Short-term investments	494,060		494,135		254,518		253,299		302,693		302,711
Total investments	$	4,115,618	$	4,312,161	$	3,768,141	$	3,768,091	$	3,600,120	$	3,732,728

__________


⁽¹⁾	Fixed maturities and short-term bonds at amortized cost; equities and other short-term investments at cost.

The Company applies the fair value option to all fixed maturity and equity securities and short-term investments at the time the eligible item is first recognized. For more detailed discussion on the Company's investment portfolio, including credit ratings, see "Liquidity and Capital Resources—C. Invested Assets" in "Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations" and Note 3. Investments, of the Notes to Consolidated Financial Statements in "Item 8. Financial Statements and Supplementary Data."

Investment Results

The following table presents the investment results of the Company for the most recent five years:



	Year Ended December 31,
	2019			2018			2017			2016			2015
				(Dollars in thousands)
Average invested assets at cost^{(1) (2)}	$	4,008,601		$	3,740,497		$	3,582,122		$	3,390,769		$	3,293,948
Net investment income⁽³⁾
Before income taxes	$	141,263		$	135,838		$	124,930		$	121,871		$	126,299
After income taxes	$	125,637		$	121,476		$	109,243		$	107,140		$	110,382
Average annual yield on investments⁽³⁾
Before income taxes	3.5		%	3.6		%	3.5		%	3.6		%	3.8		%
After income taxes	3.1		%	3.3		%	3.1		%	3.2		%	3.4		%
Net realized investment gains (losses) after income taxes	$	176,006		$	(105,481	)	$	54,373		$	(22,266	)	$	(54,474	)

__________


⁽¹⁾	Fixed maturities and short-term bonds at amortized cost; equities and other short-term investments at cost. Average invested assets at cost are based on the monthly amortized cost of the invested assets for each period.


⁽²⁾	At December 31, 2019, fixed maturity securities with call features totaled $2.7 billion at fair value and $2.6 billion at amortized cost.

⁽³⁾

During 2019, net investment income before and after income taxes increased primarily due to higher average invested assets. Average annual yield on investments before and after income taxes decreased primarily due to maturity and replacement of higher yielding investments purchased when market interest rates were higher with lower yielding investments, as a result of decreasing market interest rates.

Competitive Conditions

The Company operates in the highly competitive property and casualty insurance industry subject to competition on pricing, claims handling, consumer recognition, coverage offered and product features, customer service, and geographic coverage. Some of the Company’s competitors are larger and well-capitalized national companies that sell directly to consumers or have broad distribution networks of employed or captive agents.

Reputation for customer service and price are the principal means by which the Company competes with other insurers. In addition, the marketing efforts of independent agents can provide a competitive advantage. Based on the most recent regularly published statistical compilations of premiums written in 2018, the Company was the sixth largest writer of private passenger automobile insurance in California and the seventeenth largest in the United States.

The property and casualty insurance industry is highly cyclical, with alternating hard and soft market conditions. The Company has historically seen premium growth during hard market conditions. The Company believes that the automobile insurance industry is exiting a hard market with carriers generally raising rates at a slower pace than in 2017 and 2018, although this also depends on individual state profitability and the carriers’ growth appetite.

Reinsurance

For California homeowners policies, the Company has reduced its catastrophe exposure from earthquakes by placing earthquake risks directly with the California Earthquake Authority ("CEA"). However, the Company continues to have catastrophe exposure to fires following an earthquake. For more detailed discussion, see "Regulation—Insurance Assessments" below.

The Company is party to a Catastrophe Reinsurance Treaty ("Treaty") covering a wide range of perils that is effective through June 30, 2020. For the 12 months ending June 30, 2020, the Treaty provides $600 million of coverage on a per occurrence basis after covered catastrophe losses exceed the $40 million Company retention limit. The Treaty specifically excludes coverage for any Florida business and for California earthquake losses on fixed property policies such as homeowners, but does cover losses from fires following an earthquake. In addition, the Treaty excludes losses from wildfires on 89.5% of certain coverage layers of the Treaty.

Coverage on individual catastrophes provided for the 12 months ending June 30, 2020 under the Treaty is presented below in various layers:



	Catastrophe Losses and LAE
	In Excess of		Up to		Percentage of Coverage

	(Amounts in millions)
Retained	$	—	$	40	—	%
Layer of Coverage ⁽¹⁾	40		350		100
Layer of Coverage (wildfires are not covered for 89.5% of this layer)	350		400		100
Layer of Coverage	400		456		100
Layer of Coverage (wildfires are not covered for 89.5% of this layer)	456		500		100
Layer of Coverage ^{(1) (2)}	500		640		100

__________

⁽¹⁾ Layer of Coverage represents multiple actual treaty layers that are grouped for presentation purposes.

⁽²⁾ Additional $10 million in coverage was purchased and added to this layer effective January 1, 2020, which increased the coverage limit of this layer to $640 million from $630 million.

For the 12 months ended June 30, 2019, the Treaty provided $205 million of coverage on a per occurrence basis after covered catastrophe losses exceeded the $10 million Company retention limit. The Treaty specifically excluded coverage for any Florida business and for California earthquake losses on fixed property policies such as homeowners, but did cover losses from fires following an earthquake.

Coverage on individual catastrophes provided for the 12 months ended June 30, 2019 under the Treaty is presented below in various layers:



	Catastrophe Losses and LAE
	In Excess of		Up to		Percentage of Coverage

	(Amounts in millions)
Retained	$	—	$	10	—	%
Layer of Coverage ⁽¹⁾	10		200		100
Layer of Coverage	200		500		5

__________

⁽¹⁾ Layer of Coverage represents multiple actual treaty layers that are grouped for presentation purposes.

The annual premium for the Treaty is approximately $38 million for the 12 months ending June 30, 2020, as compared to $22 million for the 12 months ended June 30, 2019. The increase in the annual premium is primarily due to an increase in reinsurance coverage and rates as well as growth in the covered book of business. The Treaty provides for one full reinstatement of coverage limits, and reinstatement premiums are based on the amount of reinsurance benefits used by the Company and at 100% of the annual premium rate with some minor exceptions, up to the maximum reinstatement premium of approximately $38 million and $22 million if the full amount of benefit is used for the 12 months ending June 30, 2020 and 2019, respectively. The total amount of reinstatement premiums is recorded as ceded reinstatement premiums written at the time of the catastrophe event based on the total amount of reinsurance benefits expected to be used for the event, and such reinstatement premiums are recognized ratably over the remaining term of the Treaty as ceded reinstatement premiums earned.

The table below presents the combined total reinsurance premiums under the Treaty (annual premiums and reinstatement premiums) for the 12 months ending June 30, 2020 and 2019, respectively:



Treaty	Annual Premium		Reinstatement Premium ⁽¹⁾		Total Combined Premium ⁽¹⁾

	(Amounts in millions)
For the 12 months ending June 30, 2020	$	38	$	—	$	38
For the 12 months ended June 30, 2019	22		18		40

__________

⁽¹⁾ The reinstatement premium and the total combined premium for the treaty period ending June 30, 2020 are projected amounts to be paid based on the assumption that there will be no reinstatements occurring during this treaty period. The reinstatement premium and the total combined premium for the treaty period ended June 30, 2019 are the actual amounts paid.

The catastrophe events that occurred in 2019 caused approximately $57 million in losses to the Company, including a series of wildfires in California during the fourth quarter of 2019. However, no reinsurance benefits were available to the Company under the Treaty for these catastrophe losses, as none of the 2019 catastrophe events resulted in losses in excess of the Company’s per-occurrence retention limit under the Treaty of $10 million for the 12 months ended June 30, 2019 and $40 million for the 12 months ended June 30, 2020.

Two major catastrophe events that occurred in the fourth quarter of 2018, the Camp Fire in Northern California and the Woolsey Fire in Southern California, caused approximately $144 million and $44 million as of December 31, 2019, respectively, in losses to the Company, before reinsurance benefits. The combined loss to the Company from these two events, net of reinsurance benefits, totaled approximately $31 million, after accounting for the sale of subrogation rights to a third party (See Note 12. Loss and Loss Adjustment Expense Reserves of the Notes to Consolidated Financial Statements in "Item 8. Financial Statements and Supplementary Data" for more information on the sale), representing $20 million for the Company's initial reinsurance retention for the two catastrophe events, $10 million for each event, and approximately $11 million Company retention from the first layer of reinstated reinsurance limit previously used up. The Company recorded a total of approximately $15 million in ceded reinstatement premiums written and ceded reinstatement premiums earned for reinstatement of the reinsurance benefits used under the Treaty related to these two catastrophe events.

The Company incurred a total of approximately $22 million in losses as of December 31, 2019, before reinsurance benefits, resulting from the Carr Fire that occurred in Shasta County of Northern California in the third quarter of 2018. The loss to the Company, net of reinsurance benefits, was approximately $10 million, most of which is the Company's retention on the catastrophe event. The Company recorded approximately $3 million in ceded reinstatement premiums written and ceded reinstatement premiums earned for reinstatement of the reinsurance benefits used under the Treaty related to this catastrophe event.

The Company has reinsurance for PIP claims in Michigan through the Michigan Catastrophic Claims Association, a private non-profit unincorporated association created by the Michigan Legislature. The reinsurance covers losses in excess of $545,000 per person and has no maximum limit. Michigan law provides for unlimited lifetime coverage for medical costs caused by automobile accidents. The Company ceased writing personal automobile insurance in Michigan in 2016.

The Company carries a commercial umbrella reinsurance treaty and seeks facultative arrangements for large property risks. In addition, the Company has other reinsurance in force that is not material to the consolidated financial statements. If any reinsurers are unable to perform their obligations under a reinsurance treaty, the Company will be required, as primary insurer, to discharge all obligations to its policyholders in their entirety.

Regulation

The Insurance Companies are subject to significant regulation and supervision by insurance departments of the jurisdictions in which they are domiciled or licensed to operate business.

Department of Insurance Oversight

The powers of the DOI in each state primarily include the prior approval of insurance rates and rating factors and the establishment of capital and surplus requirements, solvency standards, restrictions on dividend payments and transactions with affiliates. DOI regulations and supervision are designed principally to benefit policyholders rather than shareholders.

California Proposition 103 (the "Proposition") requires that property and casualty insurance rates be approved by the California DOI 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 Proposition. 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 DOI to have a substantial relationship to risk of loss and are 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 Company’s rate plan operates under these rating factor regulations.

Insurance rates in California, Georgia, New York, New Jersey, and Nevada require prior approval from the state DOI, while insurance rates in Illinois, Texas, Virginia, and Arizona must only be filed with the respective DOI before they are implemented. Oklahoma and Florida have a modified version of prior approval laws. Insurance laws and regulations in all states in which the Company operates provide that rates must not be excessive, inadequate, or unfairly discriminatory.

The DOI in each state in which the Company operates is responsible for conducting periodic financial and market conduct examinations of the Insurance Companies in their states. Market conduct examinations typically review compliance with insurance statutes and regulations with respect to rating, underwriting, claims handling, billing, and other practices. For more detailed information on the Company’s current financial and market conduct examinations, see "Liquidity and Capital Resources—F. Regulatory Capital Requirements" in "Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations."

For a discussion of current regulatory matters in California, see "Regulatory and Legal Matters" in "Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations" and Note 18. Commitments and Contingencies, of the Notes to Consolidated Financial Statements in "Item 8. Financial Statements and Supplementary Data."

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 made direct financial contributions of approximately $122,000 and $120,000 to officeholders and candidates in 2019 and 2018, 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.

The Insurance Companies must comply with minimum capital requirements under applicable state laws and regulations. The risk-based capital ("RBC") formula is used by insurance regulators to monitor capital and surplus levels. It was designed to capture the widely varying elements of risks undertaken by writers of different lines of insurance business having differing risk characteristics, as well as writers of similar lines where differences in risk may be related to corporate structure, investment policies, reinsurance arrangements, and a number of other factors. The Company periodically monitors the RBC level of each of the Insurance Companies. As of December 31, 2019, 2018 and 2017, each of the Insurance Companies exceeded the minimum required

RBC level. For more detailed information, see "Liquidity and Capital Resources—F. Regulatory Capital Requirements" in "Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations."

Own Risk and Solvency Assessment

Insurance companies are required to file an Own Risk and Solvency Assessment ("ORSA") with the insurance regulators in their domiciliary states. The ORSA is required to cover, among many items, a company’s risk management policies, the material risks to which the company is exposed, how the company measures, monitors, manages and mitigates material risks, and how much economic and regulatory capital is needed to continue to operate in a strong and healthy manner. The ORSA is intended to be used by state insurance regulators to evaluate the risk exposure and quality of the risk management processes within insurance companies to assist in conducting risk-focused financial examinations and for determining the overall financial condition of insurance companies. The Company filed its most recent ORSA Summary Report with the California DOI in November 2019. Compliance with the ORSA requirements did not have a material impact on the Company's consolidated financial statements.

Insurance Assessments

The California Insurance Guarantee Association ("CIGA") was created to pay claims on behalf of insolvent property and casualty insurers. Each year, these claims are estimated by CIGA and the Company is assessed for its pro-rata share based on prior year California premiums written in the particular line. These assessments are currently limited to 2% of premiums written in the preceding year and are recouped through a mandated surcharge to policyholders in the year after the assessment. There were no CIGA assessments in 2019.

The CEA is a quasi-governmental organization that was established to provide a market for earthquake coverage to California homeowners. The Company places all new and renewal earthquake coverage offered with its homeowner policy directly with the CEA. The Company receives a small fee for placing business with the CEA, which is recorded as other revenue in the consolidated statements of operations. 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 3, 2019, the most recent date at which information was available, was $73.8 million. There was no assessment made in 2019.

The Insurance Companies in other states are also subject to the provisions of similar insurance guaranty associations. There were no material assessments or payments during 2019 in other states.

Holding Company Act

The California Companies are subject to California DOI regulation 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 affiliates within a holding company system. Some transactions require advance notice and may not be made if the California DOI disapproves the transaction within 30 days after notice. Such transactions include, but are not limited to, extraordinary dividends; management agreements, service contracts, and cost-sharing arrangements, and modifications thereto; all guarantees that are not quantifiable, or, if quantifiable, exceed the lesser of one-half of 1% of admitted assets or 10% of policyholders’ surplus as of the preceding December 31; derivative transactions or series of derivative transactions; reinsurance agreements or modifications thereto in which the reinsurance premium or a change in the insurer’s liabilities equals or exceeds 5% of the policyholders’ surplus as of the preceding December 31; 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 Companies’ admitted assets or 25% of statutory surplus as regards 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. The Holding Company Act also requires filing of an annual enterprise risk report identifying the material risks within the insurance holding company system.

California-domiciled insurance companies are also required to notify the California DOI of any dividend after declaration, but prior to payment. There are similar limitations imposed by other states on the Insurance Companies’ ability to pay dividends. As of December 31, 2019, the Insurance Companies are permitted to pay in 2020, without obtaining DOI approval for extraordinary dividends, $151 million in dividends to Mercury General, of which $125 million may be paid by the California Companies.

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 DOI. 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 DOI 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.

Each of the Insurance Companies is subject to holding company regulations in the state in which it is domiciled. These provisions are substantially similar to those of the Holding Company Act.

Assigned Risks

Automobile liability insurers in California are required to sell BI 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 the Proposition, make them difficult to insure in the voluntary market. In 2019, assigned risks represented less than 0.1% of total automobile direct premiums 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 programs similar to that of California. These programs are not a significant contributor to the business written in those states.

Information about the Company's Executive Officers

The following table presents certain information concerning the executive officers of the Company as of February 6, 2020:



Name	Age	Position
George Joseph	98	Chairman of the Board
Gabriel Tirador	55	President and Chief Executive Officer
Theodore R. Stalick	56	Senior Vice President and Chief Financial Officer
Christopher Graves	54	Vice President and Chief Investment Officer
Abby Hosseini	60	Vice President and Chief Information Officer
Victor G. Joseph	33	Vice President and Chief Underwriting Officer
Brandt N. Minnich	53	Vice President and Chief Marketing Officer
Randall R. Petro	56	Vice President and Chief Claims Officer
Jeffrey M. Schroeder	43	Vice President and Chief Product Officer
Heidi C. Sullivan	51	Vice President and Chief Human Capital Officer
Erik Thompson	51	Vice President, Advertising and Public Relations
Charles Toney	58	Vice President and Chief Actuary
Judy A. Walters	73	Vice President, Corporate Affairs and Secretary

Mr. George Joseph, Chairman of the Board of Directors, has served in this capacity since 1961. He held the position of Chief Executive Officer of the Company for 45 years from 1961 through 2006. Mr. Joseph has more than 50 years’ experience in the property and casualty insurance business.

Mr. Tirador, President and Chief Executive Officer, served as the Company’s assistant controller from 1994 to 1996. In 1997 and 1998, he served as the Vice President and Controller of the Automobile Club of Southern California. He rejoined the Company in 1998 as Vice President and Chief Financial Officer. He was appointed President and Chief Operating Officer in October 2001 and Chief Executive Officer in 2007. Mr. Tirador has over 25 years' experience in the property and casualty insurance industry and is an inactive Certified Public Accountant.

Mr. Stalick, Senior Vice President and Chief Financial Officer, joined the Company as Corporate Controller in 1997. He was appointed Chief Accounting Officer in October 2000 and Vice President and Chief Financial Officer in 2001. In July 2013, he was named Senior Vice President and Chief Financial Officer. Mr. Stalick is an inactive Certified Public Accountant.

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 1998, and named Vice President in 2001.

Mr. Hosseini, Vice President and Chief Information Officer, has been employed by the Company since 2008. He served as the Company's Chief Technology Officer for nine years and was appointed Vice President and Chief Information Officer in May 2018. Prior to 2008, he held various leadership positions in information technology, including Senior Vice President, Chief Technology Officer and Chief Information Officer at Option One, Inc. and Senior Vice President and Chief Information Officer at PeopleSupport, Inc.

Mr. Victor Joseph, Vice President and Chief Underwriting Officer has been employed by the Company in various capacities since 2009, and was appointed Vice President and Chief Underwriting Officer in July 2017. Mr. Victor Joseph is Mr. George Joseph’s son.

Mr. Minnich, Vice President and Chief Marketing Officer, joined the Company as an underwriter in 1989. In 2007, he joined Superior Access Insurance Services as Director of Agency Operations. In 2008 he rejoined the Company as an Assistant Product Manager, and in 2009, he was named Senior Director of Marketing, a role he held until appointed to his current position later in 2009. Mr. Minnich has over 30 years' experience in the property and casualty insurance industry and is a Chartered Property and Casualty Underwriter.

Mr. Petro, Vice President and Chief Claims Officer, has been employed by the Company in the Claims Department since 1987. Mr. Petro was appointed Vice President in March 2014, and named Chief Claims Officer in March 2015.

Mr. Schroeder, Vice President and Chief Product Officer, has been employed by the Company since 2010. Prior to his appointment as Vice President and Chief Product Officer, he served as President and Chief Operating Officer of WAIC. Prior to joining the Company, Mr. Schroeder was a Product Manager at 21st Insurance Company.

Ms. Sullivan, Vice President and Chief Human Capital Officer, joined the Company in 2012. Prior to joining the Company, she served as Senior Vice President, Human Capital for Arcadian Health Plan from 2008 to 2012. Prior to 2008, she held various leadership positions at Kaiser Permanente, Progressive Insurance, and Score Educational Centers.

Mr. Thompson, Vice President, Advertising and Public Relations, joined the Company as Director of Advertising in 2005, and was appointed Vice President, Advertising and Public Relations in October 2017. Prior to joining the Company, Mr. Thompson held various leadership positions in advertising, marketing, and public relations at several organizations, including Universal Studios, Inc., Turner, and Columbia TriStar Television.

Mr. Toney, Vice President and Chief Actuary, joined the Company in 1984 as a programmer/analyst. In 1994, he earned his Fellowship in the Casualty Actuarial Society and was appointed to his current position. In 2011, he became a board member of the Personal Insurance Federation of California. Mr. Toney is Mr. George Joseph’s nephew.

Ms. Walters, Vice President, Corporate Affairs and Secretary, 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 1998.


Item 1A.	Risk Factors

The Company’s business involves various risks and uncertainties in addition to the normal risks of business, some of which are discussed in this section. It should be noted that the Company’s business and that of other insurers may be adversely affected by a downturn in general economic conditions and other forces beyond the Company’s control. In addition, other risks and uncertainties not presently known or that the Company currently believes to be immaterial may also adversely affect the Company’s business. Any such risks or uncertainties, or any of the following risks or uncertainties, that develop into actual events could result in a material and adverse effect on the Company’s business, financial condition, results of operations, or liquidity.

The information discussed below should be considered carefully with the other information contained in this Annual Report on Form 10-K and the other documents and materials filed by the Company with the SEC, as well as news releases and other information publicly disseminated by the Company from time to time. The following risk factors are in no particular order.

Risks Related to the Company’s Business

The Company remains highly dependent upon California to produce revenues and operating profits.

For the year ended December 31, 2019, the Company generated approximately 86% of its direct automobile insurance premiums written in California. The Company’s financial results are subject to prevailing regulatory, legal, economic, demographic,

competitive, and other conditions in the states in which the Company operates and changes in any of these conditions could negatively impact the Company’s results of operations.

Mercury General is a holding company that relies on regulated subsidiaries for cash flows to satisfy its obligations.

As a holding company, Mercury General maintains no operations that generate cash flows sufficient to pay operating expenses, shareholders’ dividends, or principal or interest on its indebtedness. Consequently, Mercury General relies on the ability of the Insurance Companies, particularly the California Companies, to pay dividends for Mercury General to meet its obligations. The ability of the Insurance Companies to pay dividends is regulated by state insurance laws, which limit the amount of, and in certain circumstances may prohibit the payment of, cash dividends. Generally, these insurance regulations permit the payment of dividends only out of earned surplus in any year which, together with other dividends or distributions made within the preceding 12 months, do not exceed the greater of 10% of statutory surplus as of the end of the preceding year or the net income for the preceding year, with larger dividends payable only after receipt of prior regulatory approval. The inability of the Insurance Companies to pay dividends in an amount sufficient to enable the Company to meet its cash requirements at the holding company level could have a material adverse effect on the Company’s results of operations, financial condition, and its ability to pay dividends to its shareholders.

The Insurance Companies are subject to minimum capital and surplus requirements, and any failure to meet these requirements could subject the Insurance Companies to regulatory action.

The Insurance Companies are subject to risk-based capital standards and other minimum capital and surplus requirements imposed under the applicable laws of their states of domicile. The risk-based capital standards, based upon the Risk-Based Capital Model Act adopted by the NAIC, require the Insurance Companies to report their results of RBC calculations to state departments of insurance and the NAIC. If any of the Insurance Companies fails to meet these standards and requirements, the DOI regulating such subsidiary may require specified actions by the subsidiary.

The Company’s success depends on its ability to accurately underwrite risks and to charge adequate premiums to policyholders.

The Company’s financial condition, results of operations, and liquidity depend on its ability to underwrite and set premiums accurately for the risks it assumes. Premium rate adequacy is necessary to generate sufficient premium to offset losses, loss adjustment expenses, and underwriting expenses and to earn a profit. In order to price its products accurately, the Company must collect and properly analyze a substantial volume of data; develop, test, and apply appropriate rating formulae; closely monitor and timely recognize changes in trends; and project both severity and frequency of losses with reasonable accuracy. The Company’s ability to undertake these efforts successfully, and as a result, price accurately, is subject to a number of risks and uncertainties, including but not limited to:


•	availability of sufficient reliable data;


•	incorrect or incomplete analysis of available data;


•	uncertainties inherent in estimates and assumptions, generally;


•	selection and application of appropriate rating formulae or other pricing methodologies;


•	successful innovation of new pricing strategies;


•	recognition of changes in trends and in the projected severity and frequency of losses;


•	the Company’s ability to forecast renewals of existing policies accurately;


•	unanticipated court decisions, legislation or regulatory action;


•	ongoing changes in the Company’s claim settlement practices;


•	changes in operating expenses;


•	changing driving patterns;


•	extra-contractual liability arising from bad faith claims;


•	catastrophes, including those which may be related to climate change;


•	unexpected medical inflation; and


•	unanticipated inflation in automobile repair costs, automobile parts prices, and used car prices.

Such risks and uncertainties may result in the Company’s pricing being based on outdated, inadequate or inaccurate data, or inappropriate analyses, assumptions or methodologies, and may cause the Company to estimate incorrectly future changes in the frequency or severity of claims. As a result, the Company could underprice risks, which would negatively affect the Company’s margins, or it could overprice risks, which could reduce the Company’s volume and competitiveness. In either event, the Company’s financial condition, results of operations, and liquidity could be materially and adversely affected.

The Company’s insurance rates are subject to approval by the departments of insurance in most of the states in which the Company operates, and to political influences.

In five of the states in which it operates, including California, the Company must obtain the DOI’s prior approval of insurance rates charged to its customers, including any increases in those rates. If the Company is unable to receive approval of the rate changes it requests, or if such approval is delayed, the Company’s ability to operate its business in a profitable manner may be limited and its financial condition, results of operations, and liquidity may be adversely affected. Additionally, in California, the law allows for consumer groups to intervene in rate filings, which frequently causes delays in rate approvals and implementation of rate changes and can impact the rate that is ultimately approved.

From time to time, the automobile insurance industry comes under pressure from state regulators, legislators, and special interest groups to reduce, freeze, or set rates at levels that do not correspond with underlying costs, in the opinion of the Company’s management. The homeowners insurance business faces similar pressure, particularly as regulators in catastrophe-prone states seek an acceptable methodology to price for catastrophe exposure. In addition, various insurance underwriting and pricing criteria regularly come under attack by regulators, legislators, and special interest groups. The result could be legislation, regulations, or new interpretations of existing regulations that adversely affect the Company’s business, financial condition, and results of operations.

The effects of emerging claim and coverage issues on the Company’s business are uncertain and may have an adverse effect on the Company’s business.

As industry practices and legal, judicial, social, and other environmental conditions change, unexpected and unintended issues related to claims and coverage may emerge. These issues may adversely affect the Company’s business by either extending coverage beyond its underwriting intent or by increasing the number or size of claims. In some instances, these changes may not become apparent until sometime after the Company has issued insurance policies that are affected by the changes. As a result, the full extent of liability under the Company’s insurance policies may not be known for many years after a policy is issued.

Loss of, or significant restriction on, the use of credit scoring in the pricing and underwriting of personal lines products could reduce the Company’s future profitability.

The Company uses credit scoring as a factor in pricing and underwriting decisions where allowed by state law. Some consumer groups and regulators have questioned whether the use of credit scoring unfairly discriminates against some groups of people and are seeking to prohibit or restrict the use of credit scoring in underwriting and pricing. Laws or regulations that significantly curtail or regulate the use of credit scoring, if enacted in a large number of states in which the Company operates, could negatively impact the Company’s future results of operations.

If the Company cannot maintain its A.M. Best ratings, it may not be able to maintain premium volume in its insurance operations sufficient to attain the Company’s financial performance goals.

The Company’s ability to retain its existing business or to attract new business in its Insurance Companies is affected by its rating by A.M. Best. A.M. Best currently rates all of the Insurance Companies with sufficient operating history as either A (Excellent) or A- (Excellent). On January 28, 2020, A.M. Best affirmed the Financial Strength Rating ("FSR") of A (Excellent) with Stable outlook for the Company's A rated entities and A- (Excellent) with Stable outlook for the Company's A- rated entities. The Company believes that if it is unable to maintain its A.M. Best ratings within the A ratings range, it may face greater challenges to grow its premium volume sufficiently to attain its financial performance goals, which may adversely affect the Company’s business, financial condition, and results of operations. Two of the smaller Insurance Companies, California General Underwriters Insurance Company, Inc. and Workmen's Auto Insurance Company, are not rated by A.M. Best and the rating is not critical to the type of business they produce.

The Company may require additional capital in the future, which may not be available or may only be available on unfavorable terms.

The Company’s future capital requirements, including to fund future growth opportunities, depend on many factors, including its ability to underwrite new business successfully, its ability to establish premium rates and reserves at levels sufficient

to cover losses, the success of its expansion plans, the performance of its investment portfolio and its ability to obtain financing. The Company may seek to obtain financing through equity or debt issuances, or sales of all or a portion of its investment portfolio or other assets. The Company’s ability to obtain financing also depends on economic conditions affecting financial markets and financial strength and claims-paying ability ratings, which are assigned based upon an evaluation of the Company’s ability to meet its financial obligations. The Company’s current financial strength rating with Fitch and Moody's is A and A2, respectively. If the Company were to seek financing through the capital markets in the future, there can be no assurance that the Company would obtain favorable ratings from rating agencies. Any equity or debt financing, if available at all, may not be available on terms that are favorable to the Company. In the case of equity financing, the Company’s shareholders could experience dilution. In addition, such securities may have rights, preferences, and privileges that are senior to those of the Company’s current shareholders. If the Company cannot obtain adequate capital on favorable terms or at all, its business, financial condition, and results of operations could be adversely affected.

Changes in market interest rates, defaults on securities and tax considerations may have an adverse effect on the Company’s investment portfolio, which may adversely affect the Company’s financial results.

The Company’s financial results are affected, in part, by the performance of its investment portfolio. The Company’s investment portfolio contains interest rate sensitive-investments, such as municipal and corporate bonds. Increases in market interest rates may have an adverse impact on the value of the investment portfolio by decreasing the value of fixed income securities. Declining market interest rates could have an adverse impact on the Company’s investment income as it invests positive cash flows from operations and as it reinvests proceeds from maturing and called investments in new investments that could yield lower rates than the Company’s investments have historically generated. Defaults in the Company’s investment portfolio may produce operating losses and negatively impact the Company’s results of operations.

Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions, and other factors beyond the Company’s control. Market interest rates have been at historic lows for the last several years. Many observers, including the Company, believe that market interest rates will rise as the economy improves. Although the Company takes measures to manage the risks of investing in a changing interest rate environment, it may not be able to mitigate interest rate sensitivity effectively. The Company’s mitigation efforts include maintaining a high quality portfolio and managing the duration of the portfolio to reduce the effect of interest rate changes. Despite its mitigation efforts, a significant change in interest rates could have a material adverse effect on the Company’s financial condition and results of operations. Although the Company monitors the timing and recognition of capital gains and losses in an effort to maximize the realization of deferred tax assets arising from capital losses, no guaranty can be provided that such monitoring or the Company's tax strategies will be effective.

The Company’s valuation of financial instruments may include methodologies, estimates, and assumptions that are subject to differing interpretations and could result in changes to valuations that may materially adversely affect the Company’s financial condition or results of operations.

The Company employs a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date using the exit price. Accordingly, when market observable data are not readily available, the Company’s own assumptions are set to reflect those that market participants would be presumed to use in pricing the asset or liability at the measurement date. Assets and liabilities recorded on the consolidated balance sheets at fair value are categorized based on the level of judgment associated with the inputs used to measure their fair value and the level of market price observability.

During periods of market disruption, including periods of significantly changing interest rates, rapidly widening credit spreads, inactivity or illiquidity, it may be difficult to value certain of the Company’s securities if trading becomes less frequent and/or market data become less observable. There may be certain asset classes in historically active markets with significant observable data that become illiquid due to changes in the financial environment. In such cases, the valuations associated with such securities may rely more on management's judgment and include inputs and assumptions that are less observable or require greater estimation as well as valuation methods that are more sophisticated or require greater estimation. The valuations generated by such methods may be different from the value at which the investments ultimately may be sold. Further, rapidly changing and unprecedented credit and equity market conditions could materially impact the valuation of securities as reported within the Company’s consolidated financial statements, and the period-to-period changes in value could vary significantly. Decreases in value may have a material adverse effect on the Company’s financial condition or results of operations.

Changes in the method for determining London Interbank Offered Rate ("LIBOR") and the potential replacement of LIBOR may affect the Company's cost of capital, the value of its investment portfolio, and its net investment income.

On July 27, 2017, the U.K. Financial Conduct Authority (the “FCA”), which regulates LIBOR, announced that the FCA will no longer persuade or compel banks to submit rates for the calculation of LIBOR after 2021. This announcement indicates that the continuation of LIBOR on the current basis is not guaranteed after 2021, and LIBOR may be discontinued or modified by the end of 2021. The Federal Reserve Bank of New York began publishing the Secured Overnight Financing Rate (“SOFR”) in April 2018 as an alternative for LIBOR. SOFR is a broad measure of the cost of borrowing cash overnight collateralized by U.S. Treasury securities. A transition away from the widespread use of LIBOR to SOFR or another benchmark rate may occur over the course of the next few years.

The Company has exposure to LIBOR-based financial instruments, such as LIBOR-based securities held in its investment portfolio and its unsecured revolving credit facility. The discontinuance of LIBOR or changes or reforms to the determination or supervision of LIBOR may result in a sudden or prolonged increase or decrease in reported LIBOR, which could have an adverse impact on the market for LIBOR-based securities, the value of the Company's investment portfolio, and its net investment income. Additionally, if changes are made to the method of calculating LIBOR or LIBOR ceases to exist, the Company may need to renegotiate the terms of the credit agreement or agree upon a replacement index with the banks for its LIBOR-based unsecured revolving credit facility that expires on March 29, 2022.

Changes in the financial strength ratings of financial guaranty insurers issuing policies on bonds held in the Company’s investment portfolio may have an adverse effect on the Company’s investment results.

In an effort to enhance the bond rating applicable to certain bond issues, some bond issuers purchase municipal bond insurance policies from private insurers. The insurance generally guarantees the payment of principal and interest on a bond issue if the issuer defaults. By purchasing the insurance, the financial strength ratings applicable to the bonds are based on the credit worthiness of the insurer as well as the underlying credit of the bond issuer. These financial guaranty insurers are subject to DOI oversight. As the financial strength ratings of these insurers are reduced, the ratings of the insured bond issues correspondingly decrease. Although the Company has determined that the financial strength ratings of the underlying bond issues in its investment portfolio are within the Company’s investment policy without the enhancement provided by the insurance policies, any further downgrades in the financial strength ratings of these insurance companies or any defaults on the insurance policies written by these insurance companies may reduce the fair value of the underlying bond issues and the Company’s investment portfolio or may reduce the investment results generated by the Company’s investment portfolio, which could have a material adverse effect on the Company’s financial condition, results of operations, and liquidity.

Deterioration of the municipal bond market in general or of specific municipal bonds held by the Company may result in a material adverse effect on the Company’s financial condition, results of operations, and liquidity.

At December 31, 2019, approximately 57% of the Company’s total investment portfolio at fair value and approximately 79% of its total fixed maturity securities at fair value were invested in tax-exempt municipal bonds. With such a large percentage of the Company’s investment portfolio invested in municipal bonds, the performance of the Company’s investment portfolio, including the cash flows generated by the investment portfolio, is significantly dependent on the performance of municipal bonds. If the value of municipal bond markets in general or any of the Company’s municipal bond holdings deteriorates, the performance of the Company’s investment portfolio, financial condition, results of operations, and liquidity may be materially and adversely affected.

If the Company’s loss reserves are inadequate, its business and financial position could be harmed.

The process of establishing property and liability loss reserves is inherently uncertain due to a number of factors, including underwriting quality, the frequency and amount of covered losses, variations in claims settlement practices, the costs and uncertainty of litigation, and expanding theories of liability. While the Company believes that its actuarial techniques and databases are sufficient to estimate loss reserves, the Company’s approach may prove to be inadequate. If any of these contingencies, many of which are beyond the Company’s control, results in loss reserves that are not sufficient to cover its actual losses, the Company’s financial condition, results of operations, and liquidity may be materially and adversely affected.

There is uncertainty involved in the availability of reinsurance and the collectability of reinsurance recoverable.

The Company reinsures a portion of its potential losses on the policies it issues to mitigate the volatility of the losses on its financial condition and results of operations. The availability and cost of reinsurance is subject to market conditions, which are outside of the Company’s control. From time to time, market conditions have limited, and in some cases, prevented insurers from obtaining the types and amounts of reinsurance that they consider adequate for their business needs. As a result, the Company may not be able to successfully purchase reinsurance and transfer a portion of the Company’s risk through reinsurance arrangements.

In addition, as is customary, the Company initially pays all claims and seeks to recover the reinsured losses from its reinsurers. Although the Company reports as assets the amount of claims paid which the Company expects to recover from reinsurers, no assurance can be given that the Company will be able to collect from its reinsurers. If the amounts actually recoverable under the Company’s reinsurance treaties are ultimately determined to be less than the amount it has reported as recoverable, the Company may incur a loss during the period in which that determination is made.

The failure of any loss limitation methods employed by the Company could have a material adverse effect on its financial condition or results of operations.

Various provisions of the Company’s policies, such as limitations or exclusions from coverage which are intended to limit the Company’s risks, may not be enforceable in the manner the Company intends. In addition, the Company’s policies contain conditions requiring the prompt reporting of claims and the Company’s right to decline coverage in the event of a violation of that condition. While the Company’s insurance product exclusions and limitations reduce the Company’s loss exposure and help eliminate known exposures to certain risks, it is possible that a court or regulatory authority could nullify or void an exclusion or legislation could be enacted modifying or barring the use of such endorsements and limitations in a way that would adversely affect the Company’s loss experience, which could have a material adverse effect on its financial condition or results of operations.

The Company’s business is vulnerable to significant catastrophic property loss, which could have an adverse effect on its financial condition and results of operations.

The Company faces a significant risk of loss in the ordinary course of its business for property damage resulting from natural disasters, man-made catastrophes and other catastrophic events, particularly hurricanes, earthquakes, hail storms, explosions, tropical storms, rain storms, fires, mudslides, sinkholes, war, acts of terrorism, severe weather and other natural and man-made disasters. Such events typically increase the frequency and severity of automobile and other property claims. Because catastrophic loss events are by their nature unpredictable, historical results of operations may not be indicative of future results of operations, and the occurrence of claims from catastrophic events may result in substantial volatility in the Company’s financial condition and results of operations from period to period. Although the Company attempts to manage its exposure to such events, the occurrence of one or more major catastrophes in any given period could have a material and adverse impact on the Company’s financial condition and results of operations and could result in substantial outflows of cash as losses are paid.

The Company depends on independent agents who may discontinue sales of its policies at any time.

The Company sells its insurance policies primarily through a network of approximately 9,500 independent agents. The Company must compete with other insurance carriers for these agents’ business. Some competitors offer a larger variety of products, lower prices for insurance coverage, higher commissions, or more attractive non-cash incentives. To maintain its relationship with these independent agents, the Company must pay competitive commissions, be able to respond to their needs quickly and adequately, and create a consistently high level of customer satisfaction. If these independent agents find it preferable to do business with the Company’s competitors, it would be difficult to renew the Company’s existing business or attract new business. State regulations may also limit the manner in which the Company’s producers are compensated or incentivized. Such developments could negatively impact the Company’s relationship with these parties and ultimately reduce revenues.

The Company’s expansion plans may adversely affect its future profitability.

The Company intends to continue to expand its operations in several of the states in which the Company has operations and may expand into states in which it has not yet begun operations. The intended expansion will necessitate increased expenditures. The Company intends to fund these expenditures out of cash flows from operations. The expansion may not occur, or if it does occur, may not be successful in providing increased revenues or profitability. If the Company’s cash flows from operations are insufficient to cover the costs of the expansion, or if the expansion does not provide the benefits anticipated, the Company’s financial condition, results of operations, and ability to grow its business may be harmed.

Any inability of the Company to realize its deferred tax assets, if and when they arise, may have a material adverse effect on the Company’s financial condition and results of operations.

The Company recognizes deferred tax assets and liabilities for the future tax consequences related to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and for tax credits. The Company evaluates its deferred tax assets for recoverability based on available evidence, including assumptions about future profitability and capital gain generation. Although management believes that it is more likely than not that the deferred tax assets will be realized, some or all of the Company’s deferred tax assets could expire unused if the Company is unable to generate taxable income of an appropriate character and in a sufficient amount to utilize these tax benefits in the future. Any determination that the Company would not be able to realize all or a portion of its deferred tax assets in the future would result in a charge to earnings in the period in which the determination is made. This charge could have a material adverse effect on the Company’s results of

operations and financial condition. In addition, the assumptions used to make this determination are subject to change from period to period based on changes in tax laws or variances between the Company’s projected operating performance and actual results. As a result, significant management judgment is required in assessing the possible need for a deferred tax asset valuation allowance. The changes in the estimates and assumptions used in such assessments and decisions can materially affect the Company’s results of operations and financial condition.

The carrying value of the Company’s goodwill and other intangible assets could be subject to an impairment write-down.

At December 31, 2019, the Company’s consolidated balance sheets reflected approximately $43 million of goodwill and $11 million of other intangible assets. The Company evaluates whether events or circumstances have occurred that suggest that the fair values of its goodwill and other intangible assets are below their respective carrying values. The determination that the fair values of the Company’s goodwill and other intangible assets are less than their carrying values may result in an impairment write-down. An impairment write-down would be reflected as expense and could have a material adverse effect on the Company’s results of operations during the period in which it recognizes the expense. In the future, the Company may incur impairment charges related to goodwill and other intangible assets already recorded or arising out of future acquisitions.

The Company relies on its information technology systems to manage many aspects of its business, and any failure of these systems to function properly or any interruption in their operation could result in a material adverse effect on the Company’s business, financial condition, and results of operations.

The Company depends on the accuracy, reliability, and proper functioning of its information technology systems. The Company relies on these information technology systems to effectively manage many aspects of its business, including underwriting, policy acquisition, claims processing and handling, accounting, reserving and actuarial processes and policies, and to maintain its policyholder data. The Company has deployed, and continues to enhance, new information technology systems that are designed to manage many of these functions across the states in which it operates and the lines of insurance it offers. See "Overview—A. General—Technology" in "Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations." The failure of hardware or software that supports the Company’s information technology systems, the loss of data contained in the systems, or any delay or failure in the full deployment of the Company’s information technology systems could disrupt its business and could result in decreased premiums, increased overhead costs, and inaccurate reporting, all of which could have a material adverse effect on the Company’s business, financial condition, and results of operations.

In addition, despite system redundancy, the implementation of security measures, and the existence of a disaster recovery plan for the Company’s information technology systems, these systems are vulnerable to damage or interruption from:


•	earthquake, fire, flood and other natural disasters;


•	terrorist attacks and attacks by computer viruses, hackers, phishing, ransomware, or other exploits;


•	power loss in areas not covered by backup power generators;


•	unauthorized access; and


•	computer systems, internet, telecommunications or data network failure.

It is possible that a system failure, accident, or security breach could result in a material disruption to the Company’s business. In addition, substantial costs may be incurred to remedy the damages caused by these disruptions. Following implementation of information technology systems, the Company may from time to time install new or upgraded business management systems. To the extent that a critical system fails or is not properly implemented and the failure cannot be corrected in a timely manner, the Company may experience disruptions to the business that could have a material adverse effect on the Company’s results of operations.

Cyber security risks and the failure to maintain the confidentiality, integrity, and availability of internal or policyholder systems and data could result in damages to the Company’s reputation and/or subject it to expenses, fines or lawsuits.

The Company collects and retains large volumes of internal and policyholder data, including personally identifiable information, for business purposes including underwriting, claims and billing purposes, and relies upon the various information technology systems that enter, process, summarize and report such data. The Company also maintains personally identifiable information about its employees. The confidentiality and protection of the Company’s policyholder, employee and Company data are critical to the Company’s business. The Company’s policyholders and employees have a high expectation that the Company will adequately protect their personal information. The regulatory environment, as well as the requirements imposed by the payment card industry and insurance regulators, governing information, security and privacy laws is increasingly demanding and continues to evolve. Maintaining compliance with applicable information security and privacy regulations may increase the Company’s

operating costs and adversely impact its ability to market products and services to its policyholders. Furthermore, a penetrated or compromised information technology system or the intentional, unauthorized, inadvertent or negligent release or disclosure of data could result in theft, loss, fraudulent or unlawful use of policyholder, employee or Company data which could harm the Company’s reputation or result in remedial and other expenses, fines or lawsuits. Although the Company seeks to mitigate the impact and severity of potential cyber threats through cyber insurance coverage, not every risk or liability can be insured, and for risks that are insurable, the policy limits and terms of coverage reasonably obtainable in the market may not be sufficient to cover all actual losses or liabilities incurred. In addition, disputes with insurance carriers, including over policy terms, reservation of rights, the applicability of coverage (including exclusions), compliance with provisions (including notice) and/or the insolvency of one or more of our insurers, may significantly affect the amount or timing of recovery.

Changes in accounting standards issued by the Financial Accounting Standards Board (the "FASB") or other standard-setting bodies may adversely affect the Company’s consolidated financial statements.

The Company’s consolidated financial statements are subject to the application of GAAP, which is periodically revised and/or expanded. Accordingly, the Company is required to adopt new or revised accounting standards from time to time issued by recognized authoritative bodies, including the FASB. It is possible that future changes the Company is required to adopt could change the current accounting treatment that the Company applies to its consolidated financial statements and that such changes could have a material adverse effect on the Company’s financial condition and results of operations.

The Company’s disclosure controls and procedures may not prevent or detect acts of fraud.

The Company’s disclosure controls and procedures are designed to reasonably assure that information required to be disclosed in reports filed or submitted under the Securities Exchange Act of 1934, as amended, is accumulated and communicated to management and is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. The Company’s management, including its Chief Executive Officer and Chief Financial Officer, believe that any disclosure controls and procedures or internal controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, the Company cannot provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been prevented or detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by an unauthorized override of the controls. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and the Company cannot assure that any design will succeed in achieving its stated goals under all potential future conditions. Accordingly, because of the inherent limitations in a cost effective control system, misstatements due to error or fraud may occur and not be detected.

Failure to maintain an effective system of internal control over financial reporting may have an adverse effect on the Company’s stock price.

The Company is required to include in its Annual Report on Form 10-K a report by its management regarding the effectiveness of the Company’s internal control over financial reporting, which includes, among other things, an assessment of the effectiveness of the Company’s internal control over financial reporting as of the end of its fiscal year, including a statement as to whether or not the Company’s internal control over financial reporting is effective. This assessment must include disclosure of any material weaknesses in the Company’s internal control over financial reporting identified by management. Areas of the Company’s internal control over financial reporting may require improvement from time to time. If management is unable to assert that the Company’s internal control over financial reporting is effective now or in any future period, or if the Company’s independent auditors are unable to express an opinion on the effectiveness of those internal controls, investors may lose confidence in the accuracy and completeness of the Company’s financial reports, which could have an adverse effect on the Company’s stock price.

The ability of the Company to attract, develop and retain talented employees, managers and executives, and to maintain appropriate staffing levels, is critical to the Company’s success.

The Company is constantly hiring and training new employees and seeking to retain current employees. An inability to attract, retain and motivate the necessary employees for the operation and expansion of the Company’s business could hinder its ability to conduct its business activities successfully, develop new products and attract customers.

The Company’s success also depends upon the continued contributions of its executive officers, both individually and as a group. The Company’s future performance will be substantially dependent on its ability to retain and motivate its management team. The loss of the services of any of the Company’s executive officers could prevent the Company from successfully implementing its business strategy, which could have a material adverse effect on the Company’s business, financial condition, and results of operations.

Uncertain economic conditions may negatively affect the Company’s business and operating results.

Uncertain economic conditions could adversely affect the Company in the form of consumer behavior and pressure on its investment portfolio. Consumer behavior could include policy cancellations, modifications, or non-renewals, which may reduce cash flows from operations and investments, may harm the Company’s financial position, and may reduce the Insurance Companies’ statutory surplus. Uncertain economic conditions also may impair the ability of the Company’s customers to pay premiums as they become due, and as a result, the Company’s bad debt reserves and write-offs could increase. It is also possible that claims fraud may increase. The Company’s investment portfolios could be adversely affected as a result of financial and business conditions affecting the issuers of the securities in the Company’s investment portfolio. In addition, declines in the Company’s profitability could result in a charge to earnings for the impairment of goodwill, which would not affect the Company’s cash flows but could decrease its earnings, and could adversely affect its stock price.

The Company may be adversely affected if economic conditions result in either inflation or deflation. In an inflationary environment, established reserves may become inadequate and increase the Company’s loss ratio, and market interest rates may rise and reduce the value of the Company’s fixed maturity portfolio. The departments of insurance may not approve premium rate increases in time for the Company to adequately mitigate inflated loss costs. In a deflationary environment, some fixed maturity issuers may have difficulty meeting their debt service obligations and thereby reduce the value of the Company’s fixed maturity portfolio; equity investments may decrease in value; and policyholders may experience difficulties paying their premiums to the Company, which could adversely affect premium revenue.

Risks Related to the Company’s Industry

The private passenger automobile insurance industry is highly competitive, and the Company may not be able to compete effectively against larger or better-capitalized companies.

The Company competes with many property and casualty insurance companies selling private passenger automobile insurance in the states in which the Company operates. Many of these competitors are better capitalized than the Company, have higher A.M. Best ratings, and have a larger market share in the states in which the Company operates. The superior capitalization of the competitors may enable them to offer lower rates, to withstand larger losses, and to more effectively take advantage of new marketing opportunities. The Company’s competition may also become increasingly better capitalized in the future as the traditional barriers between insurance companies and banks and other financial institutions erode and as the property and casualty industry continues to consolidate. The Company’s ability to compete against these larger, better-capitalized competitors depends on its ability to deliver superior service and its strong relationships with independent agents.

The Company may undertake strategic marketing and operating initiatives to improve its competitive position and drive growth. If the Company is unable to successfully implement new strategic initiatives or if the Company’s marketing campaigns do not attract new customers, the Company’s competitive position may be harmed, which could adversely affect the Company’s business and results of operations. Additionally, in the event of a failure of any competitor, the Company and other insurance companies would likely be required by state law to absorb the losses of the failed insurer and would be faced with an unexpected surge in new business from the failed insurer’s former policyholders.

The Company may be adversely affected by changes in the private passenger automobile insurance industry.

Approximately 75% of the Company’s direct premiums written for the year ended December 31, 2019 were generated from private passenger automobile insurance policies. Adverse developments in the market for personal automobile insurance or the personal automobile insurance industry in general, whether related to changes in competition, pricing or regulations, could cause the Company’s results of operations to suffer. The property-casualty insurance industry is also exposed to the risks of severe weather conditions, such as rainstorms, snowstorms, hail and ice storms, hurricanes, tornadoes, wild fires, sinkholes, earthquakes and, to a lesser degree, explosions, terrorist attacks, and riots. The automobile insurance business is also affected by cost trends that impact profitability. Factors which negatively affect cost trends include inflation in automobile repair costs, automobile parts costs, new and used car valuations, medical costs, and changes in non-economic costs due to changes in the legal and regulatory environments. In addition, the advent of driverless cars and usage-based insurance could materially alter the way that automobile insurance is marketed, priced, and underwritten.

The Company cannot predict the impact that changing climate conditions, including legal, regulatory and social responses thereto, may have on its business.

Various scientists, environmentalists, international organizations, regulators and other commentators believe that global climate change has added, and will continue to add, to the unpredictability, frequency and severity of natural disasters (including,

but not limited to, hurricanes, tornadoes, freezes, droughts, other storms and fires) in certain parts of the world. In response, a number of legal and regulatory measures and social initiatives have been introduced in an effort to reduce greenhouse gas and other carbon emissions that may be chief contributors to global climate change. The Company cannot predict the impact that changing climate conditions, if any, will have on its business or its customers. It is also possible that the legal, regulatory and social responses to climate change could have a negative effect on the Company’s results of operations or financial condition.

Changes in federal or state tax laws could adversely affect the Company’s business, financial condition, results of operations, and liquidity.

The Company’s financial condition, results of operations, and liquidity are dependent in part on tax policy implemented at the federal and/or state level. For example, a significant portion of the Company’s investment portfolio consists of municipal securities that receive beneficial tax treatment under applicable federal tax law. The Company’s results are also subject to federal and state tax rules applicable to dividends received from its subsidiaries and its equity holdings. Additionally, changes in tax laws could have an adverse effect on deferred tax assets and liabilities included in the Company’s consolidated balance sheets and results of operations. The Company cannot predict whether any tax legislation will be enacted in the near future or whether any such changes to existing federal or state tax law would have a material adverse effect on the Company's financial condition and results of operations.

The insurance industry is subject to extensive regulation, which may affect the Company’s ability to execute its business plan and grow its business.

The Company is subject to extensive regulation and supervision by government agencies in each of the states in which its Insurance Companies are domiciled, sell insurance products, issue policies, or manage claims. Some states impose restrictions or require prior regulatory approval of specific corporate actions, which may adversely affect the Company’s ability to operate, innovate, obtain necessary rate adjustments in a timely manner or grow its business profitably. These regulations provide safeguards for policyholders and are not intended to protect the interests of shareholders. The Company’s ability to comply with these laws and regulations, and to obtain necessary regulatory action in a timely manner is, and will continue to be, critical to its success. Some of these regulations include:

Required Licensing. The Company operates under licenses issued by the DOI in the states in which the Company sells insurance. If a regulatory authority denies or delays granting a new license, the Company’s ability to enter that market quickly or offer new insurance products in that market may be substantially impaired. In addition, if the DOI in any state in which the Company currently operates suspends, non-renews, or revokes an existing license, the Company would not be able to offer affected products in that state.

Transactions Between Insurance Companies and Their Affiliates. Transactions between the Insurance Companies and their affiliates (including the Company) generally must be disclosed to state regulators, and prior approval of the applicable regulator is required before any material or extraordinary transaction may be consummated. State regulators may refuse to approve or delay approval of some transactions, which may adversely affect the Company’s ability to innovate or operate efficiently.

Regulation of Insurance Rates and Approval of Policy Forms. The insurance laws of most states in which the Company conducts business require insurance companies to file insurance rate schedules and insurance policy forms for review and approval. If, as permitted in some states, the Company begins using new rates before they are approved, it may be required to issue refunds or credits to the Company’s policyholders if the new rates are ultimately deemed excessive or unfair and disapproved by the applicable state regulator. In other states, prior approval of rate changes is required and there may be long delays in the approval process or the rates may not be approved. Accordingly, the Company’s ability to respond to market developments or increased costs in that state can be adversely affected.

Restrictions on Cancellation, Non-Renewal or Withdrawal. Most of the states in which the Company operates have laws and regulations that limit its ability to exit a market, or reduce risk by cancellation or non-renewal of individual policies. For example, these states may, for public policy reasons, limit an insurer’s ability to cancel and non-renew private passenger automobile or homeowners insurance policies. They may also prohibit the Company from withdrawing one or more lines of insurance business from the state unless prior approval is received from the state DOI. In some states, the regulations restricting withdrawal extend to significant reductions in the amount of insurance written, not only to a complete withdrawal. Laws and regulations that limit the Company’s ability to cancel and non-renew policies in some states or locations and that subject withdrawal plans to prior approval requirements may restrict the Company’s ability to control its risk exposure or exit unprofitable markets, which may harm its business and results of operations.

Other Regulations. The Company must also comply with regulations involving, among other matters:


•	the use of non-public consumer information and related privacy issues;


•	the use of credit history in underwriting and rating;


•	limitations on the ability to charge policy fees;


•	limitations on types and amounts of investments;


•	the payment of dividends;


•	the acquisition or disposition of an insurance company or of any company controlling an insurance company;


•	involuntary assignments of high-risk policies, participation in reinsurance facilities and underwriting associations, assessments and other governmental charges;


•	reporting with respect to financial condition;


•	periodic financial and market conduct examinations performed by state insurance department examiners; and


•	the other regulations discussed in this Annual Report on Form 10-K.

The failure to comply with these laws and regulations may also result in regulatory actions, fines and penalties, and in extreme cases, revocation of the Company’s ability to do business in that jurisdiction. In addition, the Company may face individual and class action lawsuits by insured and other parties for alleged violations of certain of these laws or regulations.

In addition, from time to time, the Company may support or oppose legislation or other amendments to insurance regulations in California or other states in which it operates. Consequently, the Company may receive negative publicity related to its support or opposition of legislative or regulatory changes that may have a material adverse effect on the Company’s financial condition, results of operations, and liquidity.

Regulation may become more restrictive in the future, which may adversely affect the Company’s business, financial condition, and results of operations.

No assurance can be given that states will not make existing insurance-related laws and regulations more restrictive in the future or enact new restrictive laws. New or more restrictive regulation in any state in which the Company conducts business could make it more expensive for it to continue to conduct business in these states, restrict the premiums the Company is able to charge or otherwise change the way the Company does business. In such events, the Company may seek to reduce its writings in or to withdraw entirely from these states. In addition, from time to time, the United States Congress and certain federal agencies investigate the current condition of the insurance industry to determine whether federal regulation is necessary. The Company cannot predict whether and to what extent new laws and regulations that would affect its business will be adopted, the timing of any such adoption and what effects, if any, they may have on the Company’s business, financial condition, and results of operations.

Assessments and other surcharges for guaranty funds, second-injury funds, catastrophe funds, and other mandatory pooling arrangements may reduce the Company’s profitability.

Virtually all states require insurers licensed to do business in their state to bear a portion of the loss suffered by some insured parties as the result of impaired or insolvent insurance companies. Many states also have laws that established second-injury funds to provide compensation to injured employees for aggravation of a prior condition or injury which are funded by either assessments based on paid losses or premium surcharge mechanisms. In addition, as a condition to the ability to conduct business in various states, the Insurance Companies must participate in mandatory property and casualty shared-market mechanisms or pooling arrangements, which provide various types of insurance coverage to individuals or other entities that otherwise are unable to purchase that coverage from private insurers. The effect of these assessments and mandatory shared-market mechanisms or changes in them could reduce the Company’s profitability in any given period or limit its ability to grow its business.

The insurance industry faces litigation risks, which, if resolved unfavorably, could result in substantial penalties and/or monetary damages, including punitive damages. In addition, insurance companies incur material expenses defending litigation and their results of operations or financial condition could be adversely affected if they fail to accurately project litigation expenses.

Insurance companies are subject to a variety of legal actions including breach of contract claims, tort claims, fraud and misrepresentation claims, employee benefit claims, and wage and hour claims. In addition, insurance companies incur and likely will continue to incur potential liability for claims related to the insurance industry in general and to the Company’s business in particular, such as those related to allegations for failure to pay claims, termination or non-renewal of coverage, interpretation of policy language, policy sales practices, reinsurance matters, and other similar matters. Such actions can also include allegations of fraud, misrepresentation, and unfair or improper business practices and can include claims for punitive damages.

Court decisions and legislative activity may increase exposures for any of the types of claims insurance companies face. There is a risk that insurance companies could incur substantial legal fees and expenses in any of the actions companies defend in excess of amounts budgeted for defense.

The Company and the Insurance Companies are named as defendants in a number of lawsuits. Those that management believes could have a material effect on the Company's consolidated financial statements are described more fully in "Overview—B. Regulatory and Legal Matters" in "Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations" and Note 18. Commitments and Contingencies, of the Notes to Consolidated Financial Statements in "Item 8. Financial Statements and Supplementary Data." Litigation, by its very nature, is unpredictable and the outcome of these cases is uncertain. The precise nature of the relief that may be sought or granted in any lawsuit is uncertain and may negatively impact the manner in which the Company conducts its business, which could materially increase the Company’s legal expenses and negatively impact the results of operations. In addition, potential litigation involving new claim, coverage, and business practice issues could adversely affect the Company’s business by changing the way policies are priced, extending coverage beyond its underwriting intent, or increasing the size of claims.

Risks Related to the Company’s Stock

The Company is controlled by a small number of shareholders who will be able to exert significant influence over matters requiring shareholder approval, including change of control transactions.

George Joseph and Gloria Joseph collectively own more than 50% of the Company’s common stock. Accordingly, George Joseph and Gloria Joseph have the ability to exert significant influence on the actions the Company may take in the future, including change of control transactions. From time to time, certain institutional investors also each own approximately between 2% and 7% of the Company's common stock. This concentration of ownership may conflict with the interests of the Company’s other shareholders and lenders.

Future equity or debt financing may affect the market price of the Company’s common stock and rights of the current shareholders, and the future exercise of options and granting of shares will result in dilution in the investment of the Company’s shareholders.

The Company may raise capital in the future through the issuance and sale of its common stock or debt securities. The Company cannot predict what effect, if any, such future financing will have on the market price of its common stock. Sales of substantial amounts of its common stock in the public market or issuance of substantial amounts of debt securities could adversely affect the market price of the Company’s outstanding common stock, and may make it more difficult for shareholders to sell common stock at a time and price that the shareholder deems appropriate. Furthermore, holders of some of the Company's securities may have rights, preferences, and privileges that are senior to those of the Company’s current shareholders. In addition, the Company has issued and may issue options to purchase shares of its common stock as well as restricted stock units ("RSUs") to incentivize its executives and key employees. In the event that any options to purchase common stock are exercised or any shares of common stock are issued when the RSUs vest, shareholders will suffer dilution in their investment.

Applicable insurance laws may make it difficult to effect a change of control of the Company or the sale of any of its Insurance Companies.

Before a person can acquire control of a U.S. insurance company or any holding company of a U.S. insurance company, prior written approval must be obtained from the DOI of the state where the insurer is domiciled. Prior to granting approval of an application to acquire control of the insurer or holding company, the state DOI will consider a number of factors relating to the acquirer and the transaction. These laws and regulations may discourage potential acquisition proposals and may delay, deter or prevent a change of control of the Company or the sale by the Company of any of its Insurance Companies, including transactions that some or all of the Company’s shareholders might consider to be desirable.

Although the Company has consistently paid increasing cash dividends in the past, it may not be able to pay or continue to increase cash dividends in the future.

The Company has consistently paid cash dividends since the public offering of its common stock in November 1985 and has consistently increased the dividend per share during that time. However, future cash dividends will depend upon a variety of factors, including the Company’s profitability, financial condition, capital needs, future prospects, and other factors deemed relevant by the Board of Directors. The Company’s ability to pay dividends or continue to increase the dividend per share may also be limited by the ability of the Insurance Companies to make distributions to the Company, which may be restricted by financial, regulatory or tax constraints, and by the terms of the Company’s debt instruments. In addition, there can be no assurance that the

Company will continue to pay dividends or increase the dividend per share even if the necessary financial and regulatory conditions are met and if sufficient cash is available for distribution.


Item 1B.	Unresolved Staff Comments

None.


Item 2.	Properties

The Company owns the following buildings which are mostly occupied by the Company’s employees. Space not occupied by the Company may be leased to independent third party tenants.



Location	Purpose	Size in Square Feet	Percent Occupied by the Company at December 31, 2019
Brea, CA	Home office and I.T. facilities (2 buildings)	236,000	100	%
Folsom, CA	Administrative and Data Center	88,000	100	%
Los Angeles, CA	Executive offices	41,000	95	%
Rancho Cucamonga, CA	Administrative	127,000	100	%
Clearwater, FL	Administrative	162,000	51	%
Oklahoma City, OK	Administrative	100,000	25	%

The Company leases additional office space for operations. Office location is not crucial to the Company’s operations, and the Company anticipates no difficulty in extending these leases or obtaining comparable office space. In addition, the Company owns 5.9 acres of land in Rancho Cucamonga, California.

The Company’s properties are well maintained, adequately meet its needs, and are being utilized for their intended purposes.


Item 3.	Legal Proceedings

The Company is, from time to time, named as a defendant in various lawsuits or regulatory actions incidental to its insurance business. The majority of lawsuits brought against the Company relate to insurance claims that arise in the normal course of business and are reserved for through the reserving process. For a discussion of the Company’s reserving methods, see "Overview-C. Critical Accounting Policies and Estimates" in "Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations" and Note 1. Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements in "Item 8. Financial Statements and Supplementary Data."

The Company also establishes reserves for non-insurance claims related lawsuits, regulatory actions, and other contingencies when the Company believes a loss is probable and is able to estimate its potential exposure. For loss contingencies believed to be reasonably possible, the Company also discloses the nature of the loss contingency and an estimate of the possible loss, range of loss, or a statement that such an estimate cannot be made. While actual losses may differ from the amounts recorded and the ultimate outcome of the Company’s pending actions is generally not yet determinable, the Company does not believe that the ultimate resolution of currently pending legal or regulatory proceedings, either individually or in the aggregate, will have a material adverse effect on its financial condition or cash flows.

In all cases, the Company vigorously defends itself unless a reasonable settlement appears appropriate. For a discussion of legal matters, see "Overview—B. Regulatory and Legal Matters" in "Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations" and Note 18. Commitments and Contingencies, of the Notes to Consolidated Financial Statements in "Item 8. Financial Statements and Supplementary Data," which is incorporated herein by reference.

There are no environmental proceedings arising under federal, state, or local laws or regulations to be discussed.


Item 4.	Mine Safety Disclosure

Not applicable.

PART II


Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information

The shares of the Company's common stock are listed and traded on the New York Stock Exchange (trading symbol: MCY).

The closing price of the Company’s common stock on February 6, 2020 was $49.09.

Holders

As of February 6, 2020, there were approximately 113 holders of record of the Company’s common stock.

Dividends

For financial statement purposes, the Company records dividends on the declaration date. The Company intends to continue paying quarterly dividends; however, the continued payment and amount of cash dividends will depend upon the Company’s operating results, overall financial condition, capital requirements, and general business conditions.

Holding Company Act

Pursuant to the Holding Company Act, California-domiciled insurance companies are required to notify the California DOI of any dividend after declaration, but prior to payment. There are similar limitations imposed by other states on the Insurance Companies’ ability to pay dividends. As of December 31, 2019, the Insurance Companies are permitted to pay in 2020, without obtaining DOI approval for extraordinary dividends, $151 million in dividends to Mercury General, of which $125 million may be paid by the California Companies.

For a discussion of certain restrictions on the payment of dividends to Mercury General by some of its insurance subsidiaries, see Note 13. Dividends, of the Notes to Consolidated Financial Statements in "Item 8. Financial Statements and Supplementary Data."

Performance Graph

The following graph compares the cumulative total shareholder returns on the Company’s common stock (trading symbol: MCY) with the cumulative total returns on the Standard and Poor’s 500 Composite Stock Price Index ("S&P 500 Index") and the Company’s industry peer group over the last five years. The graph assumes that $100 was invested on December 31, 2014 in each of the Company’s Common Stock, the S&P 500 Index and the industry peer group and the reinvestment of all dividends.



	2014		2015		2016		2017		2018		2019
Mercury General	$	100.00	$	86.19	$	116.59	$	108.16	$	109.98	$	108.63
Industry Peer Group	100.00		94.97		114.63		139.07		139.89		165.38
S&P 500 Index	100.00		101.38		113.51		138.29		132.23		173.86

The industry peer group consists of Alleghany Corporation, Allstate Corporation, American Financial Group, Arch Capital Group Ltd, Berkley (W.R.), Berkshire Hathaway 'B', Chubb Corporation, Cincinnati Financial Corporation, CNA Financial Corporation, Erie Indemnity Company, Hanover Insurance Group, Markel Corporation, Old Republic International, Progressive Corporation, RLI Corporation, Selective Insurance Group, Travelers Companies, Inc., and XL Group, plc.

Recent Sales of Unregistered Securities

None.

Share Repurchases

None.


Item 6.	Selected Financial Data

The following selected financial and operating data are derived from the Company’s audited consolidated financial statements. The selected financial and operating data should be read in conjunction with "Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations" and "Item 8. Financial Statements and Supplementary Data."



	Year Ended December 31,
	2019		2018			2017		2016			2015
			(Amounts in thousands, except per share data)
Income Data:
Net premiums earned	$	3,599,418	$	3,368,411		$	3,195,437	$	3,131,773		$	2,957,897
Net investment income	141,263		135,838			124,930		121,871			126,299
Net realized investment gains (losses)	222,793		(133,520		)	83,650		(34,255		)	(83,807		)
Other	9,044		9,275			11,945		8,294			8,911
Total revenues	3,972,518		3,380,004			3,415,962		3,227,683			3,009,300
Losses and loss adjustment expenses	2,706,024		2,576,789			2,444,884		2,355,138			2,145,495
Policy acquisition costs	602,085		572,164			555,350		562,545			539,231
Other operating expenses	269,305		244,630			233,475		235,314			250,839
Interest	17,035		17,036			15,168		3,962			3,168
Total expenses	3,594,449		3,410,619			3,248,877		3,156,959			2,938,733
Income (loss) before income taxes	378,069		(30,615		)	167,085		70,724			70,567
Income tax expense (benefit)	57,982		(24,887		)	22,208		(2,320		)	(3,912		)
Net income (loss)	$	320,087	$	(5,728	)	$	144,877	$	73,044		$	74,479
Per Share Data:
Basic earnings (loss) per share	$	5.78	$	(0.10	)	$	2.62	$	1.32		$	1.35
Diluted earnings (loss) per share	$	5.78	$	(0.10	)	$	2.62	$	1.32		$	1.35
Dividends paid per share	$	2.5125	$	2.5025		$	2.4925	$	2.4825		$	2.4725



	December 31,
	2019		2018		2017		2016		2015
			(Amounts in thousands, except per share data)
Balance Sheet Data:
Total investments	$	4,312,161	$	3,768,091	$	3,732,728	$	3,547,560	$	3,380,642
Total assets	5,889,157		5,433,729		5,101,323		4,788,718		4,628,645
Loss and loss adjustment expense reserves	1,921,255		1,829,412		1,510,613		1,290,248		1,146,688
Unearned premiums	1,355,547		1,236,181		1,101,927		1,074,437		1,049,314
Notes payable	372,133		371,734		371,335		320,000		290,000
Shareholders’ equity	1,799,502		1,617,684		1,761,387		1,752,402		1,820,885
Book value per share	32.51		29.23		31.83		31.70		33.01


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

Forward-looking Statements

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for certain forward-looking statements. Certain statements contained in this report are forward-looking statements based on the Company’s current expectations and beliefs concerning future developments and their potential effects on the Company. There can be no assurance that future developments affecting the Company will be those anticipated by the Company. Actual results may differ from those projected in the forward-looking statements. These forward-looking statements involve significant risks and uncertainties (some of which are beyond the control of the Company) and are subject to change based upon various factors, including but not limited to the following risks and uncertainties: changes in the demand for the Company’s insurance products, inflation and general economic conditions, including general market risks associated with the Company’s investment portfolio; the accuracy and adequacy of the Company’s pricing methodologies; catastrophes in the markets served by the Company; uncertainties related to estimates, assumptions and projections generally; the possibility that actual loss experience may vary adversely from the actuarial estimates made to determine the Company’s loss reserves in general; the Company’s ability to obtain and the timing of the approval of premium rate changes for insurance policies issued in states where the Company operates; legislation adverse to the automobile insurance industry or business generally that may be enacted in the states where the Company operates; the Company’s success in managing its business in non-California states; the presence of competitors with greater financial resources and the impact of competitive pricing and marketing efforts; the ability of the Company to successfully manage its claims organization outside of California; the Company's ability to successfully allocate the resources used in the states with reduced or exited operations to its operations in other states; changes in driving patterns and loss trends; acts of war and terrorist activities; court decisions and trends in litigation and health care and auto repair costs; and legal, cyber security, regulatory and litigation risks.

From time to time, forward-looking statements are also included in the Company’s quarterly reports on Form 10-Q and current reports on Form 8-K, in press releases, in presentations, on its web site, and in other materials released to the public. Investors are cautioned not to place undue reliance on any forward-looking statements, which speak only as of the date of this Annual Report on Form 10-K or, in the case of any document the Company incorporates by reference, any other report filed with the SEC or any other public statement made by the Company, the date of the document, report or statement. The Company undertakes no obligation to publicly update any forward-looking statements, whether as a result of new information or future events or otherwise.

OVERVIEW

A. General

The operating results of property and casualty insurance companies are subject to significant quarter-to-quarter and year-to-year fluctuations due to the effect of competition on pricing, the frequency and severity of losses, the effect of weather and natural disasters on losses, general economic conditions, the general regulatory environment in states in which an insurer operates, state regulation of insurance including premium rates, changes in fair value of investments, and other factors such as changes in tax laws. The property and casualty insurance 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 significant impact on the Company’s ability to grow and retain business.

The Company is headquartered in Los Angeles, California and writes primarily personal automobile lines of business selling policies through a network of independent agents, 100% owned insurance agents and direct channels, in 11 states: Arizona, California, Florida, Georgia, Illinois, Nevada, New Jersey, New York, Oklahoma, Texas, and Virginia. The Company also offers homeowners, commercial automobile, commercial property, mechanical protection, fire, and umbrella insurance. Private passenger automobile lines of insurance business accounted for approximately 75% of the $3.8 billion of the Company’s direct premiums written in 2019, and approximately 88% of the private passenger automobile premiums were written in California.

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

2019 Financial Performance Summary

The Company’s net income for the year ended December 31, 2019 was $320.1 million, or $5.78 per diluted share, compared to net (loss) of $(5.7) million, or $(0.10) per diluted share, for the same period in 2018. Included in net income (loss) was $141.3 million of pre-tax net investment income that was generated during 2019 on a portfolio of $4.3 billion, at fair value, at December 31,

2019, compared to $135.8 million of pre-tax net investment income that was generated during 2018 on a portfolio of $3.8 billion, at fair value, at December 31, 2018. Also included in net income (loss) were pre-tax net realized investment gains (losses) of $222.8 million and $(133.5) million in 2019 and 2018, respectively, and pre-tax catastrophe losses, net of reinsurance benefits and related reinstatement premiums earned, of approximately $65.3 million and $82.0 million in 2019 and 2018, respectively.

During 2019, the Company continued its marketing efforts to enhance name recognition and lead generation. The Company believes that its marketing efforts, combined with its ability to maintain relatively low prices and a strong reputation, make its insurance products competitive in California and in other states.

The Company believes its thorough underwriting process gives it an advantage over its competitors. The Company’s agent relationships and underwriting and claims processes are its most important competitive advantages.

The Company’s operating results and growth have allowed it to consistently generate positive cash flow from operations, which was approximately $520 million and $383 million in 2019 and 2018, respectively. Cash flow from operations has been used to pay shareholder dividends and help support growth.

Economic and Industry Wide Factors

•

Regulatory Uncertainty—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, restricting cancellation and non-renewal of insurance policies, and establishing minimum capital and surplus requirements. In many states, insurance commissioners may emphasize different agendas or interpret existing regulations differently than previous commissioners. 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.

•

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

•

Economic Conditions—The Company’s financial condition, results of operations, and liquidity may be negatively impacted by global, national and local economic conditions, such as recessions, increased levels of unemployment, inflation, and large fluctuations in interest rates. Further, volatility in global capital markets could adversely affect the Company’s investment portfolio. The Company is not able to predict the timing and effect of these factors, or their duration and severity.

•

Inflation—The largest cost component for automobile insurers is losses, which include medical, replacement automobile parts, and labor costs. There can be significant variation in the overall increases in medical cost inflation, and it is often years 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 may be higher or lower than anticipated.


•	Loss Frequency—Another component of overall loss costs is loss frequency, which is the number of claims per risk insured. Loss frequency trends are affected by many factors such as fuel prices, the economy, the prevalence of distracted driving, and collision avoidance and other technology in vehicles.

•

Underwriting Cycle and Competition—The property and casualty insurance industry is highly cyclical, with alternating hard and soft market conditions. The Company has historically seen significant premium growth during hard market conditions. The Company believes that the automobile insurance industry is exiting a hard market with carriers generally raising rates at a slower pace than in 2017 and 2018, although this also depends on individual state profitability and the carriers’ growth appetite.

Technology

The Company started an insurance platform modernization initiative in 2010 to migrate to Guidewire’s InsuranceSuite for its lines of business and states. Guidewire InsuranceSuite is a widely adopted industry-leading software for property and casualty insurance. The Company has completed the migration to InsuranceSuite for all of its claims processing, and for most of the states and lines of business in which the Company operates for its underwriting processing. Throughout 2019, the Company has made numerous enhancements to its information technology platforms to further improve agent experience and to promote cross selling

using our more modern and intuitive AgentCenter Portal. In addition, the Company implemented a new product offering for landlord insurance as well as new paperless eDelivery and customer portal capabilities and leveraged robotic process automation and automated rules engine for straight-through processing in 2019. The Company intends to continue to invest in modernization of its technology platforms, technologies for cross selling and new product offerings, and technology initiatives to enhance customer experience in 2020.

B. Regulatory and Legal Matters

The process for implementing rate changes varies by state. For more detailed information related to insurance rate approval, see "Item 1. Business—Regulation."

During 2019, the Company implemented rate changes in eleven states. In California, the following rate increases were approved by the California DOI for lines of business that exceeded 5% of the Company's total net premiums earned in 2019:


▪	In May 2019, the California DOI approved a 6.99% rate increase on the California homeowners line of insurance business, which represented approximately 12% of the Company's total net premiums earned in 2019. The Company implemented this rate increase in August 2019.


▪	In March 2019, the California DOI approved a 6.90% rate increase on MIC's private passenger automobile line of insurance business, which represented approximately 54% of the Company's total net premiums earned in 2019. The Company implemented this rate increase in May 2019.


▪	In January 2019, the California DOI approved a 6.90% rate increase on CAIC's private passenger automobile line of insurance business, which represented approximately 12% of the Company's total net premiums earned in 2019. The Company implemented this rate increase in March 2019.

In March 2006, the California DOI issued an Amended Notice of Non-Compliance to a Notice of Non-Compliance originally issued in February 2004 (as amended, “2004 NNC”) alleging that the Company charged rates in violation of the California Insurance Code, willfully permitted its agents to charge broker fees in violation of California law, and willfully misrepresented the actual price insurance consumers could expect to pay for insurance by the amount of a fee charged by the consumer's insurance broker. The California DOI sought to impose a fine for each policy on which the Company allegedly permitted an agent to charge a broker fee, to impose a penalty for each policy on which the Company allegedly used a misleading advertisement, and to suspend certificates of authority for a period of one year. In January 2012, the administrative law judge bifurcated the 2004 NNC between (a) the California DOI’s order to show cause (the “OSC”), in which the California DOI asserts the false advertising allegations and accusation, and (b) the California DOI’s notice of noncompliance (the “NNC”), in which the California DOI asserts the unlawful rate allegations. In February 2012, the administrative law judge (“ALJ”) submitted a proposed decision dismissing the NNC, but the Commissioner rejected the ALJ’s proposed decision. The Company challenged the rejection in Los Angeles Superior Court in April 2012, and the Commissioner responded with a demurrer. Following a hearing, the Superior Court sustained the Commissioner’s demurrer, based on the Company’s failure to exhaust its administrative remedies, and the Company appealed. The Court of Appeal affirmed the Superior Court's ruling that the Company was required to exhaust its administrative remedies, but expressly preserved for later appeal the legal basis for the ALJ’s dismissal: violation of the Company’s due process rights. Following an evidentiary hearing in April 2013, post-hearing briefs, and an unsuccessful mediation, the ALJ closed the evidentiary record on April 30, 2014. Although a proposed decision was to be submitted to the Commissioner on or before June 30, 2014, after which the Commissioner would have 100 days to accept, reject or modify the proposed decision, the proposed decision was not submitted until December 8, 2014. On January 7, 2015, the Commissioner adopted the ALJ’s proposed decision, which became the Commissioner’s adopted order (the "Order"). The decision and Order found that from the period July 1, 1996, through 2006, the Company’s "brokers" were actually operating as "de facto agents" and that the charging of "broker fees" by these producers constituted the charging of "premium" in excess of the Company's approved rates, and assessed a civil penalty in the amount of $27.6 million against the Company. On February 9, 2015, the Company filed a Writ of Administrative Mandamus and Complaint for Declaratory Relief (the “Writ”) in the Orange County Superior Court seeking, among other things, to require the Commissioner to vacate the Order, to stay the Order while the Superior Court action is pending, and to judicially declare as invalid the Commissioner’s interpretation of certain provisions of the California Insurance Code. Subsequent to the filing of the Writ, a consumer group petitioned and was granted the right to intervene in the Superior Court action. The Court did not order a stay, and the $27.6 million assessed penalty was paid in March 2015. The Company filed an amended Writ on September 11, 2015, adding an explicit request for a refund of the penalty, with interest.

the entire penalty amount within 120 days, plus prejudgment interest at the statutory rate of 7%. On January 12, 2017, the California DOI filed a notice of appeal of the Superior Court's judgment. While the appeal was pending, the California DOI returned the entire penalty amount plus accrued interest, a total of $30.9 million, to the Company in June 2017 in order to avoid accruing further interest. Because the matter had not been settled or otherwise finally resolved at the time, the Company did not recognize the $30.9 million as a gain in the consolidated statements of operations; instead, it recorded the $30.9 million plus interest earned in other liabilities in the consolidated balance sheets. The Company had filed a motion to dismiss the false advertising portion of the case based on the Superior Court's findings, but the ALJ denied that motion after the appeal was filed. The ALJ did, however, grant the Company's alternative request to stay further proceedings pending the final determination of the appeal. On May 7, 2019, the California Court of Appeal issued its decision reversing the Superior Court’s original judgment and directing the Superior Court to enter a new judgment in favor of the California DOI. The Company filed a petition for rehearing, which was denied, and subsequently filed a petition for review in the Supreme Court of California. Based on the decision of the California Court of Appeal, the Company accrued approximately $3 million in the second quarter of 2019, which represented an estimated amount of statutory interest the Company might be ordered to pay beyond the actual interest it had earned on the $30.9 million. The California Supreme Court denied the Company's petition for review on August 14, 2019, and the Commissioner's Order became final. On August 30, 2019, the Company paid approximately $35 million to the California DOI, which consisted of the $30.9 million received from the California DOI in June 2017 plus statutory interest.

On October 1, 2019, the Company and the California DOI entered into a settlement agreement resolving the case involving the 2004 NNC, along with the related false advertising action that had been stayed pending the outcome of that case. Pursuant to the settlement agreement, the Company paid an additional amount of approximately $6 million to the California DOI on October 2, 2019, bringing the total settlement amount to approximately $41.2 million, in full settlement of the entire case including the false advertising action. The Company has not admitted to any allegations raised in the case. As a result of the settlement, the Company recognized approximately $6 million of incremental expense in its consolidated statements of operations in the third quarter of 2019 relating to the settlement.

The Company is, from time to time, named as a defendant in various lawsuits or regulatory actions incidental to its insurance business. The majority of lawsuits brought against the Company relate to insurance claims that arise in the normal course of business and are reserved for through the reserving process. For a discussion of the Company’s reserving methods, see "Critical Accounting Policies and Estimates" below and Note 1. Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements in "Item 8. Financial Statements and Supplementary Data."

The Company establishes reserves for non-insurance claims related lawsuits, regulatory actions, and other contingencies when the Company believes a loss is probable and is able to estimate its potential exposure. For material loss contingencies believed to be reasonably possible, the Company also discloses the nature of the loss contingency and an estimate of the possible loss, range of loss, or a statement that such an estimate cannot be made. While actual losses may differ from the amounts recorded and the ultimate outcome of the Company’s pending actions is generally not yet determinable, the Company does not believe that the ultimate resolution of currently pending legal or regulatory proceedings, either individually or in the aggregate, will have a material adverse effect on its financial condition or cash flows.

In all cases, the Company vigorously defends itself unless a reasonable settlement appears appropriate. For a discussion of legal matters, see Note 18. Commitments and Contingencies—Litigation of the Notes to Consolidated Financial Statements in "Item 8. Financial Statements and Supplementary Data."

C. Critical Accounting Policies and Estimates

Loss and Loss Adjustment Expense Reserves ("Loss Reserves")

Preparation of the Company’s consolidated financial statements requires management’s judgment and estimates. The most significant is the estimate of loss reserves. Estimating loss reserves is a difficult process as many factors can ultimately affect the final settlement of a claim and, therefore, the loss reserve that is required. A key assumption in estimating loss reserves is the degree to which the historical data used to analyze reserves will be predictive of ultimate claim costs on incurred claims. Changes in the regulatory and legal environments, results of litigation, medical costs, the cost of repair materials, and labor rates, among other factors, can impact this assumption. In addition, time can be a critical part of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of a claim, the more variable the ultimate settlement amount could be. Accordingly, short-tail liability claims, such as property damage claims, tend to be more reasonably predictable than long-tail liability claims.

The Company calculates a loss reserve point estimate rather than a range. There is inherent uncertainty with estimates and this is particularly true with loss reserve estimates. This uncertainty comes from many factors which may include changes in claims

reporting and settlement patterns, changes in the regulatory and legal environments, uncertainty over inflation rates, and uncertainty for unknown items. The Company does not make specific provisions for these uncertainties, rather it considers them in establishing its loss reserve by looking at historical patterns and trends and projecting these out to current loss reserves. The underlying factors and assumptions that serve as the basis for preparing the loss reserve estimate include paid and incurred loss development factors, expected average costs per claim, inflation trends, expected loss ratios, industry data, and other relevant information.

The Company also engages independent actuarial consultants to review the Company’s loss reserves and to provide the annual actuarial opinions required under state statutory accounting requirements. The Company analyzes loss reserves quarterly primarily using the incurred loss, paid loss, average severity coupled with the claim count development methods, and the generalized linear model ("GLM") described below. When deciding among methods to use, the Company evaluates the credibility of each method based on the maturity of the data available and the claims settlement practices for each particular line of insurance business or coverage within a line of insurance business. The Company may also evaluate qualitative factors such as known changes in laws or legal rulings that could affect claims handling or other external environmental factors or internal factors that could affect the settlement of claims. When establishing the loss reserve, the Company generally analyzes the results from all of the methods used rather than relying on a single method. While these methods are designed to determine the ultimate losses on claims under the Company’s policies, there is inherent uncertainty in all actuarial models since they use historical data to project outcomes. The Company believes that the techniques it uses provide a reasonable basis in estimating loss reserves.

•

The incurred loss method analyzes historical incurred case loss (case reserves plus paid losses) development to estimate ultimate losses. The Company applies development factors against current case incurred losses by accident period to calculate ultimate expected losses. The Company believes that the incurred loss method provides a reasonable basis for evaluating ultimate losses, particularly in the Company’s larger, more established lines of insurance business which have a long operating history.


•	The paid loss method analyzes historical payment patterns to estimate the amount of losses yet to be paid.

•

The average severity method analyzes historical loss payments and/or incurred losses divided by closed claims and/or total claims to calculate an estimated average cost per claim. From this, the expected ultimate average cost per claim can be estimated. The average severity method coupled with the claim count development method provides meaningful information regarding inflation and frequency trends that the Company believes is useful in establishing loss reserves. The claim count development method analyzes historical claim count development to estimate future incurred claim count development for current claims. The Company applies these development factors against current claim counts by accident period to calculate ultimate expected claim counts.

•

The GLM determines an average severity for each percentile of claims that have been closed as a percentage of estimated ultimate claims. The average severities are applied to open claims to estimate the amount of losses yet to be paid. The GLM utilizes operational time, determined as a percentile of claims closed rather than a finite calendar period, which neutralizes the effect of changes in the timing of claims handling.

The Company analyzes catastrophe losses separately from non-catastrophe losses. For catastrophe losses, the Company generally determines claim counts based on claims reported and development expectations from previous catastrophes and applies an average expected loss per claim based on loss reserves established by adjusters and average losses on previous similar catastrophes. For catastrophe losses on individual properties that are expected to be total losses, the Company typically establishes reserves at the policy limits.

There are many factors that can cause variability between the ultimate expected loss and the actual developed loss. While there are certainly other factors, the Company believes that the following three items tend to create the most variability between expected losses and actual losses.

(1) Inflation

For the Company’s California automobile lines of insurance business, total reserves are comprised of the following:


•	BI reserves—approximately 75% of total reserves


•	Material damage ("MD") reserves, including collision and comprehensive property damage—approximately 10% of total reserves


•	Loss adjustment expense reserves—approximately 15% of total reserves.

Loss development on MD reserves is generally insignificant because MD claims are generally settled in a shorter period than BI claims. The majority of the loss adjustment expense reserves are estimated costs to defend BI claims, which tend to require longer periods of time to settle as compared to MD claims.

BI loss reserves are generally the most difficult to estimate because they take longer to close than other coverages. BI coverage in the Company’s policies includes injuries sustained by any person other than the insured, except in the case of uninsured or underinsured motorist BI coverage, which covers damages to the insured for BI caused by uninsured or underinsured motorists. BI payments are primarily for medical costs and general damages.

The following table presents the typical closure patterns of BI claims in the Company's California personal automobile insurance coverage:



	% of Total
	Claims Closed	Dollars Paid
BI claims closed in the accident year reported	38%	12%
BI claims closed one year after the accident year reported	78%	52%
BI claims closed two years after the accident year reported	93%	77%
BI claims closed three years after the accident year reported	98%	90%

BI claims closed in the accident year reported are generally the smaller and less complex claims that settle for approximately $5,000 to $6,000 on average, whereas the total average settlement, once all claims are closed in a particular accident year, is approximately $12,000 to $17,000. The Company creates incurred and paid loss triangles to estimate ultimate losses utilizing historical payment and reserving patterns and evaluates the results of this analysis against its frequency and severity analysis to establish BI loss reserves. The Company adjusts development factors to account for inflation trends it sees in loss severity. As a larger proportion of claims from an accident year are settled, there emerges a higher degree of certainty for the loss reserves established for that accident year. At December 31, 2019, the accident years that are most likely to develop are the 2017 through 2019 accident years; however, it is possible that older accident years could develop as well.

In general, the Company expects that historical claims trends will continue with costs tending to increase, which is generally consistent with historical data, and therefore the Company believes that it is reasonable to expect inflation to continue. Many potential factors can affect the BI inflation rate, including changes in claims handling process, changes in statutes and regulations, the number of litigated files, increased use of medical procedures such as MRIs and epidural injections, general economic factors, timeliness of claims adjudication, vehicle safety, weather patterns, social inflation, and gasoline prices, among other factors; however, the magnitude of the impact of such factors on the inflation rate is unknown.

The Company believes that it is reasonably possible that the California automobile BI severity could vary from recorded amounts by as much as 10%, 8%, and 6% for 2019, 2018, and 2017 accident years, respectively; however, the variation could be more or less than these amounts.

During the years 2015 through 2019, the changes in the loss severity amounts for the three preceding accident years from the prior year amounts (BI severity variance from prior year) have ranged as follows:



	High	Low
Immediate preceding accident year	1.4%	(5.1)%
Second preceding accident year	7.5%	(3.1)%
Third preceding accident year	5.2%	(2.9)%

The following table presents the effects on the California automobile BI loss reserves for the 2019, 2018, and 2017 accident years based on possible variations in the severity recorded; however, the variation could be more or less than these amounts:

California Automobile Bodily Injury Inflation Reserve Sensitivity Analysis



Accident Year	Number of Claims Expected		Actual Recorded Severity at 12/31/2019			Implied Inflation Rate Recorded ⁽¹⁾			(A) Pro-forma severity if actual severity is lower by 10% for 2019, 8% for 2018, and 6% for 2017		(B) Pro-forma severity if actual severity is higher by 10% for 2019, 8% for 2018, and 6% for 2017		Favorable loss development if actual severity is less than recorded (Column A)		Unfavorable loss development if actual severity is more than recorded (Column B)
2019	29,638	(2)	$	17,052	(2)	12.8	%	(2)	$	15,347	$	18,757	$	50,533,000	$	(50,533,000	)
2018	28,710	(2)	$	15,119	(2)	9.5	%	(2)	$	13,909	$	16,329	$	34,739,000	$	(34,739,000	)
2017	28,389	(2)	$	13,808	(2)	10.2	%	(2)	$	12,980	$	14,636	$	23,506,000	$	(23,506,000	)
2016	29,356	(2)	$	12,525	(2)	—			—		—		—		—
Total Loss Development—Favorable (Unfavorable)													$	108,778,000	$	(108,778,000	)

___________


⁽¹⁾	Implied inflation rate is calculated by dividing the difference between the current and prior year actual recorded severity by the prior year actual recorded severity. The Company believes that severity increases are caused by litigation, medical costs, inflation, and increased utilization of medical procedures.

⁽²⁾

During 2016, the Company implemented a claims strategy that reduced the number of small dollar settlements offered shortly after the claims were reported. This strategy reduced the total number of claims expected, which had the effect of increasing the actual recorded severity across the total claims population. There were fewer small dollar claims in the calculation of actual recorded severity for the 2016 through 2019 accident years compared to prior accident years. Consequently, the implied inflation rate recorded for these years are skewed upward due to this strategy change.

(2) Claim Count Development

The Company generally estimates ultimate claim counts for an accident period based on development of claim counts in prior accident periods. Typically, almost every claim is reported within one year following the end of an accident year and at that point the Company has a high degree of certainty as to the ultimate claim count. There are many factors that can affect the number of claims reported after an accident period ends. These factors include changes in weather patterns, a change in the number of litigated files, the number of automobiles insured, and whether the last day of the accident period falls on a weekday or a weekend. However, the Company is unable to determine which, if any, of the factors actually impact the number of claims reported and, if so, by what magnitude.

At December 31, 2019, there were 27,955 California automobile BI claims reported for the 2019 accident year and the Company estimates that these are expected to ultimately grow by approximately 6.0%. The Company believes that while actual development in recent years has ranged approximately from 4% to 7%, it is reasonable to expect that the range could be as great as between 0% and 10%. Actual development may be more or less than the expected range.

The following table presents the effects on loss development of different claim count within the broader possible range at December 31, 2019:

California Automobile Bodily Injury Claim Count Reserve Sensitivity Analysis



2019 Accident Year	Claims Reported	Amount Recorded at 12/31/2019 at Approximately 6.0% Claim Count Development		Total Expected Amount If Claim Count Development is 0%		Total Expected Amount If Claim Count Development is 10%
Claim count	27,955	29,638		27,955		30,751
Approximate average cost per claim	Not meaningful	$	17,052	$	17,052	$	17,052
Total dollars	Not meaningful	$	505,387,000	$	476,689,000	$	524,366,000
Total Loss Development—Favorable (Unfavorable)				$	28,698,000	$	(18,979,000	)

(3) Unexpected Losses From Older Accident Periods

Unexpected losses are generally not provided for in the current loss reserve because they are not known or expected and

tend to be unquantifiable. Once known, the Company establishes a provision for the losses, but it is not possible to provide any meaningful sensitivity analysis as to the potential size of any unexpected losses. These losses can be caused by many factors, including unexpected legal interpretations of coverage, ineffective claims handling, regulations extending claims reporting periods, assumption of unexpected or unknown risks, adverse court decisions as well as many unknown factors. During 2019, the Company did not incur any material unexpected losses related to claims from accident periods prior to 2016.

Unexpected losses are fairly infrequent but can have a large impact on the Company’s losses. To mitigate this risk, the Company has established claims handling and review procedures. However, it is still possible that these procedures will not prove entirely effective, and the Company may have material unexpected losses in future periods. It is also possible that the Company has not identified and established a sufficient loss reserve for all material unexpected losses occurring in the older accident years, even though a comprehensive claims file review was undertaken. The Company may experience additional development on these loss reserves.

Discussion of Losses and Loss Reserves and Prior Period Loss Development

At December 31, 2019 and 2018, the Company recorded its point estimate of approximately $1.92 billion and $1.83 billion ($1.85 billion and $1.65 billion, net of reinsurance), respectively, in loss and loss adjustment expense reserves, which included approximately $847 million and $823 million ($829 million and $751 million, net of reinsurance), respectively, of incurred-but-not-reported liabilities ("IBNR"). IBNR includes estimates, based upon past experience, of ultimate developed costs, which may differ from case estimates, unreported claims that occurred on or prior to December 31, 2019 and 2018, and estimated future payments for reopened 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; however, since the provisions are necessarily based upon estimates, the ultimate liability may be more or less than such provisions.

The Company evaluates its loss reserves quarterly. When management determines that the estimated ultimate claim cost requires a decrease for previously reported accident years, favorable development occurs and a reduction in losses and loss adjustment expenses is reported in the current period. If the estimated ultimate claim cost requires an increase for previously reported accident years, unfavorable development occurs and an increase in losses and loss adjustment expenses is reported in the current period. For 2019, the Company reported unfavorable development of approximately $10 million on the 2018 and prior accident years’ loss and loss adjustment expense reserves. The unfavorable development in 2019 was primarily attributable to higher than estimated defense and cost containment expenses in the California automobile line of insurance business, partially offset by favorable development on prior years’ loss and loss adjustment expense reserves, including catastrophe losses, in certain of the Company's other lines of insurance business.

The Company recorded catastrophe losses net of reinsurance of approximately $53 million in 2019. Catastrophe losses due to the catastrophe events that occurred during 2019 totaled approximately $57 million, with no reinsurance benefits used for these losses. The majority of the 2019 catastrophe losses resulted from wildfires and winter storms in California, a hurricane in Texas, and tornadoes and wind and hail storms in the Midwest. These losses were partially offset by favorable development of approximately $4 million on prior years' catastrophe losses, primarily from reductions in the Company's retained portion of losses on the Camp and Woolsey Fires under the Company's catastrophe reinsurance treaty, after accounting for the assignment of subrogation rights that occurred in the first quarter of 2019 and the re-estimation of reserves as part of normal reserving procedures.

Fair Value of Financial Instruments

Financial instruments recorded in the consolidated balance sheets include investments, note receivable, other receivables, total return swaps, accounts payable, options sold, and notes payable. The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Due to their short-term maturity, the carrying values of other receivables and accounts payable approximate their fair values. All investments are carried on the consolidated balance sheets at fair value, as described in Note 2. Financial Instruments, of the Notes to Consolidated Financial Statements in Item 8. "Financial Statements and Supplementary Data."

The Company’s financial instruments include securities issued by the U.S. government and its agencies, securities issued by states and municipal governments and agencies, certain corporate and other debt securities, equity securities, and exchange traded funds. 97.9% of the fair value of these financial instruments held at December 31, 2019 is based on observable market prices, observable pricing parameters, or is derived from such prices or parameters. The availability of observable market prices and pricing parameters can vary by financial instrument. Observable market prices and pricing parameters of a financial instrument, or a related financial instrument, are used to derive a price without requiring significant judgment. The Company’s fixed maturity and equity securities are classified as “trading” and carried at fair value as required when applying the fair value option, with changes in fair value reflected in net realized investment gains or losses in the consolidated statements of operations. The majority

of equity holdings, including non-redeemable preferred stocks, are actively traded on national exchanges or trading markets, and are valued at the last transaction price on the balance sheet date.

The Company may hold or acquire financial instruments that lack observable market prices or pricing parameters because they are less actively traded currently or in future periods. The fair value of such instruments is determined using techniques appropriate for each particular financial instrument. These techniques may involve some degree of judgment. The price transparency of the particular financial instrument will determine the degree of judgment involved in determining the fair value of the Company’s financial instruments. Price transparency is affected by a wide variety of factors, including the type of financial instrument, whether it is a new financial instrument and not yet established in the marketplace, and the characteristics particular to the transaction. Financial instruments for which actively quoted prices or pricing parameters are available or for which fair value is derived from actively quoted prices or pricing parameters will generally have a higher degree of price transparency. By contrast, financial instruments that are thinly traded or not quoted will generally have diminished price transparency. Even in normally active markets, the price transparency for actively quoted financial instruments may be reduced during periods of market dislocation. Alternatively, in thinly quoted markets, the participation of market makers willing to purchase and sell a financial instrument provides a source of transparency for products that otherwise are not actively quoted. For a further discussion, see Note 4. Fair Value Measurements, of the Notes to Consolidated Financial Statements in Item 8. "Financial Statements and Supplementary Data."

Income Taxes

At December 31, 2019, the Company’s deferred income taxes were in a net liability position mainly due to deferred tax liabilities generated by unrealized gains on securities held and deferred acquisition costs. These deferred tax liabilities were substantially offset by deferred tax assets resulting from unearned premiums, loss reserve discounting, and expense accruals. The Company assesses the likelihood that its deferred tax assets will be realized and, to the extent management does not believe these assets are more likely than not to be realized, a valuation allowance is established. Management’s recoverability assessment of the Company’s deferred tax assets which are ordinary in character takes into consideration the Company’s strong history of generating ordinary taxable income and a reasonable expectation that it will continue to generate ordinary taxable income in the future. Further, the Company has the capacity to recoup its ordinary deferred tax assets through tax loss carryback claims for taxes paid in prior years. Finally, the Company has various deferred tax liabilities that represent sources of future ordinary taxable income.

Management’s recoverability assessment with regard to its capital deferred tax assets is based on estimates of anticipated capital gains, tax-planning strategies available to generate future taxable capital gains, and the Company's capacity to absorb capital losses carried back to prior years, each of which would contribute to the realization of deferred tax benefits. The Company has significant unrealized gains in its investment portfolio that could be realized through asset dispositions, at management’s discretion. In addition, the Company expects to hold certain debt securities, which are currently in loss positions, to recovery or maturity. Management believes unrealized losses related to these debt securities, which represent a portion of the unrealized loss positions at period-end, are fully realizable at maturity. Management believes its long-term time horizon for holding these securities allows it to avoid any forced sales prior to maturity. Further, the Company has the capability to generate additional realized capital gains by entering into sale-leaseback transactions using one or more of its appreciated real estate holdings. Finally, the Company has the capacity to recoup capital deferred tax assets through tax capital loss carryback claims for taxes paid within permitted carryback periods.

The Company has the capability to implement tax planning strategies as it has a steady history of generating positive cash flows from operations and believes that its liquidity needs can be met in future periods without the forced sale of its investments. This capability assists management in controlling the timing and amount of realized losses generated during future periods. By prudent utilization of some or all of these strategies, management has the intent and believes that it has the ability to generate capital gains and minimize tax losses in a manner sufficient to avoid losing the benefits of its deferred tax assets. Management will continue to assess the need for a valuation allowance on a quarterly basis. Although realization is not assured, management believes it is more likely than not that the Company’s deferred tax assets will be realized.

The Company’s effective income tax rate can be affected by several factors. These generally include large changes in fully-taxable income including net realized investment gains or losses, tax-exempt investment income, nondeductible expenses, and periodically, non-routine tax items such as adjustments to unrecognized tax benefits related to tax uncertainties. The effective tax rate was 15.3% for 2019, compared to 81.3% for 2018. Tax-exempt investment income of approximately $82 million coupled with relatively large pre-tax income of approximately $378 million lowered the effective tax rate for 2019 to a rate moderately below the statutory tax rate of 21%, while tax-exempt investment income of approximately $86 million coupled with relatively small pre-tax loss of approximately $31 million increased the effective tax rate for 2018 to a rate much higher than the statutory tax rate of 21%.

As a result of enactment of the Tax Cuts and Jobs Act (the "Act") on December 22, 2017 that was effective for tax years beginning January 1, 2018, the Company made certain tax adjustments. For the years ended December 31, 2018 and 2019, the Company computed its current and deferred income taxes at the new corporate tax rate of 21%, compared to computing only deferred income taxes at 21% and current income taxes at the pre-enactment rate of 35% for the year ended December 31, 2017. The alternative minimum tax (“AMT”) credit, previously classified as deferred tax asset that was included in deferred income taxes in the Company’s consolidated balance sheets, was reclassified during 2017 to current income taxes receivable as a result of the Act. The Company expects to use the current income taxes receivable balance of approximately $24 million associated with the AMT credit as an offset against its federal tax obligations for tax year 2019.

The Company continues to assess other impacts that the Act may have on business and investment strategies as well as financial results in future years. There are complex factors at play, including the effect of insurance regulation, which will likely require the tax benefits to be passed on to consumers, and changing dynamics in the capital markets, which may result in a shift in the Company’s allocation between taxable and tax-exempt investments.

Contingent Liabilities

The Company has known, and may have unknown, potential liabilities which include claims, assessments, lawsuits, or regulatory fines and penalties relating to the Company’s business. The Company continually evaluates these potential liabilities and accrues for them and/or discloses them in the notes to the consolidated financial statements where required. The Company does not believe that the ultimate resolution of currently pending legal or regulatory proceedings, either individually or in the aggregate, will have a material adverse effect on its financial condition, results of operations, or cash flows. See "Regulatory and Legal Matters" above and Note 18. Commitments and Contingencies, of the Notes to Consolidated Financial Statements in "Item 8. Financial Statements and Supplementary Data."

RESULTS OF OPERATIONS

Year Ended December 31, 2019 Compared to Year Ended December 31, 2018

Revenues

Net premiums earned and net premiums written in 2019 increased 6.9% and 6.8%, respectively, from 2018. The increase in net premiums earned and net premiums written was primarily due to higher average premiums per policy arising from rate increases in the California private passenger automobile and homeowners lines of insurance business and growth in the number of homeowners policies written in California.

The Company, which predominantly offers six-month personal automobile insurance policies, reintroduced twelve-month personal automobile policies for new business in MIC, its largest insurance subsidiary, in March 2018. Twelve-month policies are generally sold for twice the price of six-month policies. MIC's net premiums written from twelve-month policies in 2019 and 2018 was approximately $354 million and $205 million, respectively.

Net premiums earned included ceded premiums earned of $56.7 million and $48.9 million in 2019 and 2018, respectively. Net premiums written included ceded premiums written of $43.8 million and $56.0 million in 2019 and 2018, respectively. The increase in ceded premiums earned resulted mostly from an increase in reinsurance coverage and rates, growth in the covered book of business, and an increase in reinstatement premiums following the Camp and Woolsey Fires in the fourth quarter of 2018 that caused higher losses than the wildfires in the fourth quarter of 2017. The decrease in ceded premiums written resulted mostly from an increase in ceded reinstatement premiums in the second half of 2018 following the major wildfires in Northern and Southern California, coupled with reductions in ceded reinstatement premiums in the first quarter of 2019 as a result of a decrease in estimated total losses and reinsurance benefits for the Camp and Woolsey Fires, as described further in Note 12. Loss and Loss Adjustment Expense Reserves of the Notes to Consolidated Financial Statements, partially offset by an increase in ceded premiums written due to higher reinsurance coverage and rates as well as growth in the covered book of business.

Net premiums earned, a GAAP measure, represents the portion of net premiums written that is recognized as revenue in the financial statements for the periods presented and earned on a pro-rata basis over the term of the policies. Net premiums written is a non-GAAP financial measure which represents the premiums charged on policies issued during a fiscal period less any applicable reinsurance. Net premiums written is a statutory measure designed to determine production levels.

The following is a reconciliation of total net premiums earned to net premiums written:



	Year Ended December 31,
	2019		2018
	(Amounts in thousands)
Net premiums earned	$	3,599,418	$	3,368,411
Change in net unearned premiums	132,305		127,222
Net premiums written	$	3,731,723	$	3,495,633

Expenses

Loss and expense ratios are used to interpret the underwriting experience of property and casualty insurance companies. The following table presents the Company's consolidated loss, expense, and combined ratios determined in accordance with GAAP:



	Year Ended December 31,
	2019		2018
Loss ratio	75.2	%	76.5	%
Expense ratio	24.2	%	24.2	%
Combined ratio	99.4	%	100.7	%

Loss ratio is calculated by dividing losses and loss adjustment expenses by net premiums earned. The Company’s loss ratio was affected by unfavorable development of approximately $10 million and $93 million on prior accident years’ loss and loss adjustment expense reserves for the years ended December 31, 2019 and 2018, respectively. The unfavorable development in 2019 was primarily attributable to higher than estimated defense and cost containment expenses in the California automobile line of insurance business, partially offset by favorable development on prior years’ loss and loss adjustment expense reserves, including catastrophe losses, in certain of the Company's other lines of insurance business, while the unfavorable development in 2018 was primarily attributable to higher than estimated California automobile losses resulting from severity in excess of expectations for bodily injury claims as well as higher than estimated defense and cost containment expenses in the California automobile line of insurance business. The 2019 loss ratio was also negatively impacted by a total of approximately $53 million of catastrophe losses, net of reinsurance benefits, primarily due to wildfires and winter storms in California, a hurricane in Texas, and tornadoes and wind and hail storms in the Midwest. The 2018 loss ratio was also negatively impacted by a total of approximately $67 million of catastrophe losses, net of reinsurance benefits, primarily due to wildfires in Northern and Southern California and weather-related catastrophes across several states. Excluding the effect of estimated prior periods’ loss development and catastrophe losses, the loss ratio was 73.3% and 71.7% for the years ended December 31, 2019 and 2018, respectively. The increase in the loss ratio primarily resulted from increased losses in the private passenger automobile line of insurance business in the states outside of California, and increased non-catastrophe losses in the California homeowners line of insurance business due to winter storms.

Expense ratio is calculated by dividing the sum of policy acquisition costs and other operating expenses by net premiums earned. The expense ratio for the year ended December 31, 2019 compared to the year ended December 31, 2018 was affected by a decrease in average policy acquisition cost as a result of a decrease in average commission rate, which was offset by costs related to the NNC and other operating expenses in 2019. For a discussion of the NNC, see Note 18. Commitments and Contingencies of the Notes to Consolidated Financial Statements in "Item 8. Financial Statements and Supplementary Data."

Combined ratio is equal to loss ratio plus expense ratio and is the key measure of underwriting performance traditionally used in the property and casualty insurance industry. A combined ratio under 100% generally reflects profitable underwriting results; a combined ratio over 100% generally reflects unprofitable underwriting results.

Income tax expense (benefit) was $58.0 million and $(24.9) million for the years ended December 31, 2019 and 2018, respectively. The $82.9 million increase in income tax expense was mainly due to a significant increase in pre-tax income of $408.7 million. Tax-exempt investment income, a component of total pre-tax income (loss), did not change significantly compared to the same period in 2018.

Investments

The following table presents the investment results of the Company:



	Year Ended December 31,
	2019			2018
	(Amounts in thousands)
Average invested assets at cost ⁽¹⁾	$	4,008,601		$	3,740,497
Net investment income ⁽²⁾
Before income taxes	$	141,263		$	135,838
After income taxes	$	125,637		$	121,476
Average annual yield on investments ⁽²⁾
Before income taxes	3.5		%	3.6		%
After income taxes	3.1		%	3.3		%
Net realized investment gains (losses)	$	222,793		$	(133,520	)

__________


⁽¹⁾	Fixed maturities and short-term bonds at amortized cost; equities and other short-term investments at cost. Average invested assets at cost are based on the monthly amortized cost of the invested assets for each period.


⁽²⁾	Net investment income before and after income taxes increased primarily due to higher average invested assets. Average annual yield on investments before and after income taxes decreased primarily due to maturity and replacement of higher yielding investments purchased when market interest rates were higher with lower yielding investments, as a result of decreasing market interest rates.

The following tables present the components of net realized investment gains (losses) included in net income:



	Year Ended December 31, 2019
	Gains (Losses) Recognized in Income
	Sales			Changes in fair value		Total
	(Amounts in thousands)
Net realized investment gains (losses):
Fixed maturity securities ⁽¹⁾⁽²⁾	$	1,347		$	104,379	$	105,726
Equity securities ⁽¹⁾⁽³⁾	19,322			90,920		110,242
Short-term investments ⁽¹⁾	(1,956		)	1,295		(661		)
Note receivable ⁽¹⁾	—			108		108
Total return swaps	1,039			—		1,039
Options sold	6,329			10		6,339
Total	$	26,081		$	196,712	$	222,793



	Year Ended December 31, 2018
	Gains (Losses) Recognized in Income
	Sales			Changes in fair value			Total
	(Amounts in thousands)
Net realized investment gains (losses):
Fixed maturity securities ⁽¹⁾⁽²⁾	$	(3,014	)	$	(53,927	)	$	(56,941	)
Equity securities ⁽¹⁾⁽³⁾	(2,187		)	(77,494		)	(79,681		)
Short-term investments ⁽¹⁾	(2,368		)	(1,237		)	(3,605		)
Note receivable ⁽¹⁾	—			(8		)	(8		)
Total return swaps	(132		)	(3,651		)	(3,783		)
Options sold	10,513			(15		)	10,498
Total	$	2,812		$	(136,332	)	$	(133,520	)

__________


⁽¹⁾	The changes in fair value of the investment portfolio and note receivable resulted from the application of the fair value option.


⁽²⁾	The increases in fair value of fixed maturity securities during 2019 were primarily due to decreases in market interest rates. The decreases in fair value of fixed maturity securities during 2018 were primarily due to increases in market interest rates.


⁽³⁾	The increases in fair value of equity securities during 2019 were primarily due to the overall improvement in equity markets. The decreases in fair value of equity securities during 2018 were primarily due to the overall decline in equity markets.

Net Income



	Year Ended December 31,
	2019		2018
	(Amounts in thousands, except per share data)
Net income (loss)	$	320,087	$	(5,728	)
Basic average shares outstanding	55,351		55,335
Diluted average shares outstanding	55,360		55,335
Basic Per Share Data:
Net income (loss)	$	5.78	$	(0.10	)
Net realized investment gains (losses), net of tax	$	3.18	$	(1.90	)
Diluted Per Share Data:
Net income (loss)	$	5.78	$	(0.10	)
Net realized investment gains (losses), net of tax	$	3.18	$	(1.90	)

Year Ended December 31, 2018 Compared to Year Ended December 31, 2017

See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" of the Company's Form 10-K for the year ended December 31, 2018 for a discussion of changes in its results of operations from the year ended December 31, 2017 to the year ended December 31, 2018.

LIQUIDITY AND CAPITAL RESOURCES

A. General

The Company is largely dependent upon dividends received from its insurance subsidiaries to pay debt service costs and to make distributions to its shareholders. Under current insurance law, the Insurance Companies are entitled to pay ordinary dividends of approximately $151 million in 2020 to Mercury General. The Insurance Companies paid Mercury General ordinary dividends of $114 million during 2019. As of December 31, 2019, Mercury General had approximately $184 million in investments and cash that could be utilized to satisfy its direct holding company obligations.

The principal sources of funds for the Insurance Companies are premiums, sales and maturity of invested assets, and dividend and interest income from invested assets. The principal uses of funds for the Insurance Companies are the payment of claims and related expenses, operating expenses, dividends to Mercury General, payment of debt and debt service costs, and the purchase of investments.

B. Cash Flows

The Company has generated positive cash flow from operations since the public offering of its common stock in November 1985. The Company does not attempt to match the duration and timing of asset maturities with those of liabilities; rather, it manages its portfolio with a view towards maximizing total return with an emphasis on after-tax income. With combined cash and short-term investments of $788.5 million at December 31, 2019 as well as a $50 million revolving credit facility, the Company believes its cash flow from operations is adequate to satisfy its liquidity requirements without the forced sale of investments. Investment maturities are also available to meet the Company’s liquidity needs. 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 or for future business expansion, through the sale of equity or debt securities or from credit facilities with lending institutions.

Net cash provided by operating activities for the year ended December 31, 2019 was $519.7 million, an increase of $136.2 million compared to the year ended December 31, 2018. The increase was primarily due to an increase in premium collections, partially offset by an increase in payments for losses and loss adjustment expenses and operating expenses. The Company utilized the cash provided by operating activities during the year ended December 31, 2019 primarily for the payment of dividends to its shareholders and net purchases of investment securities.

The following table presents the estimated fair value of fixed maturity securities at December 31, 2019 by contractual maturity in the next five years.



	Fixed Maturity Securities
	(Amounts in thousands)
Due in one year or less	$	93,758
Due after one year through two years	200,646
Due after two years through three years	196,258
Due after three years through four years	87,951
Due after four years through five years	75,954
	$	654,567

See "D. Debt" below for cash flow related to outstanding debt.

C. Invested Assets

Portfolio Composition

An important component of the Company’s financial results is the return on its investment portfolio. The Company’s investment strategy emphasizes safety of principal and consistent income generation, within a total return framework. The investment strategy has historically focused on maximizing after-tax yield with a primary emphasis on maintaining a well-diversified, investment grade, fixed income portfolio to support the underlying liabilities and achieve return on capital and profitable growth. The Company believes that investment yield is maximized by selecting assets that perform favorably on a long-term basis and by disposing of certain assets to enhance after-tax yield and minimize the potential effect of downgrades and defaults. The Company believes that this strategy enables the optimal investment performance necessary to sustain investment income over time. The Company’s portfolio management approach utilizes a market risk and consistent asset allocation strategy as the primary basis for the allocation of interest sensitive, liquid and credit assets as well as for determining overall below investment grade exposure and diversification requirements. Within the ranges set by the asset allocation strategy, tactical investment decisions are made in consideration of prevailing market conditions.

The following table presents the composition of the total investment portfolio of the Company at December 31, 2019:



	Cost⁽¹⁾		Fair Value
	(Amounts in thousands)
Fixed maturity securities:
U.S. government bonds	$	22,502	$	22,637
Municipal securities	2,435,346		2,554,208
Mortgage-backed securities	62,566		63,003
Corporate securities	233,730		235,565
Collateralized loan obligations	200,656		199,218
Other asset-backed securities	18,476		18,644
	2,973,276		3,093,275
Equity securities:
Common stock	498,514		586,367
Non-redeemable preferred stock	49,442		49,708
Private equity fund	1,137		1,203
Private equity funds measured at net asset value ⁽²⁾	99,189		87,473
	648,282		724,751
Short-term investments	494,060		494,135
Total investments	$	4,115,618	$	4,312,161

__________


⁽¹⁾	Fixed maturities and short-term bonds at amortized cost and equities and other short-term investments at cost.


⁽²⁾	The fair value is measured using the net asset value practical expedient. See Note 4. Fair Value Measurements of the Notes to Consolidated Financial Statements for additional information.

At December 31, 2019, 57.0% of the Company’s total investment portfolio at fair value and 79.4% of its total fixed maturity investments at fair value were invested in tax-exempt state and municipal bonds. Equity holdings consist of non-redeemable preferred stocks, dividend-bearing common stocks on which dividend income is partially tax-sheltered by the 50% corporate dividend received deduction, and private equity funds. At December 31, 2019, 93.3% of short-term investments consisted of highly rated short-duration securities redeemable on a daily or weekly basis.

Fixed Maturity Securities and Short-Term Investments

Fixed maturity securities include debt securities, which may have fixed or variable principal payment schedules, may be held for indefinite periods of time, and may be used as a part of the Company’s asset/liability strategy or sold in response to changes in interest rates, anticipated prepayments, risk/reward characteristics, liquidity needs, tax planning considerations, or other economic factors. Short-term investments include money market accounts, options, and short-term bonds that are highly rated short duration securities and redeemable within one year.

A primary exposure for the fixed maturity securities is interest rate risk. The longer the duration, the more sensitive the asset is to market interest rate fluctuations. As assets with longer maturity dates tend to produce higher current yields, the Company’s historical investment philosophy has resulted in a portfolio with a moderate duration. The Company's portfolio is heavily weighted in investment grade tax-exempt municipal bonds. Fixed maturity securities purchased by the Company typically have call options attached, which further reduce the duration of the asset as interest rates decline. The holdings, that are heavily weighted with high coupon issues, are expected to be called prior to maturity. 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. As it measures four factors (maturity, coupon rate, yield and call terms) which determine sensitivity to changes in interest rates, modified duration is considered a better indicator of price volatility than simple maturity alone.

The following table presents the maturities and durations of the Company's fixed maturity securities and short-term investments:



	December 31, 2019	December 31, 2018
	(in years)
Fixed Maturity Securities
Nominal average maturity:
excluding short-term investments	13.9	14.2
including short-term investments	12.0	13.1
Call-adjusted average maturities:
excluding short-term investments	4.6	4.9
including short-term investments	4.0	4.5
Modified duration reflecting anticipated early calls:
excluding short-term investments	3.7	4.3
including short-term investments	3.2	4.0
Short-Term Investments	—	—

Another exposure related to the fixed maturity securities is credit risk, which is managed by maintaining a weighted-average portfolio credit quality rating of A+, at fair value at December 31, 2019, consistent with the average rating at December 31, 2018. The Company’s municipal bond holdings, of which 96.2% were tax exempt, represented 82.6% of its fixed maturity portfolio at December 31, 2019, at fair value, and were broadly diversified geographically.

To calculate the weighted-average credit quality ratings as disclosed throughout this Annual Report on Form 10-K, individual securities were weighted based on fair value and a credit quality numeric score that was assigned to each security’s average of ratings assigned by nationally recognized securities rating organizations.

Taxable holdings consist principally of investment grade issues. At December 31, 2019, fixed maturity holdings rated below investment grade and non-rated bonds totaled $19.2 million and $37.8 million, respectively, at fair value, and represented 0.6% and 1.2%, respectively, of total fixed maturity securities. The majority of non-rated issues are a result of municipalities pre-funding and collateralizing those issues with U.S. government securities with an implicit AAA equivalent credit risk. At December 31, 2018, fixed maturity holdings rated below investment grade and non-rated bonds totaled $36.0 million and $76.4 million, respectively, at fair value, and represented 1.2% and 2.6%, respectively, of total fixed maturity securities.

Credit ratings for the Company's fixed maturity portfolio were stable in 2019, with 80.5% of fixed maturity securities at fair value experiencing no change in their overall rating. 14.4% and 5.1% of fixed maturity securities at fair value experienced upgrades and downgrades, respectively, in 2019. The majority of downgrades were slight and still within the investment grade portfolio in 2019.

The following table presents the credit quality ratings of the Company’s fixed maturity securities by security type at fair value:



	December 31, 2019
Security Type	AAA⁽¹⁾			AA⁽¹⁾			A⁽¹⁾			BBB⁽¹⁾			Non-Rated/Other ⁽¹⁾			Total Fair Value⁽¹⁾
	(Dollars in thousands)
U.S. government bonds:
Treasuries	$	22,637		$	—		$	—		$	—		$	—		$	22,637
Total	22,637			—			—			—			—			22,637
	100.0		%	—		%	—		%	—		%	—		%	100.0		%
Municipal securities:
Insured	37,251			148,960			96,797			57,951			3,754			344,713
Uninsured	92,424			647,895			1,244,430			187,214			37,532			2,209,495
Total	129,675			796,855			1,341,227			245,165			41,286			2,554,208
	5.1		%	31.2		%	52.4		%	9.6		%	1.7		%	100.0		%
Mortgage-backed securities:
Commercial	9,900			3,958			1,010			4,068			—			18,936
Agencies	1,443			—			—			—			—			1,443
Non-agencies:
Prime	14,292			25,030			115			76			756			40,269
Alt-A	—			815			—			744			796			2,355
Total	25,635			29,803			1,125			4,888			1,552			63,003
	40.6		%	47.3		%	1.8		%	7.8		%	2.5		%	100.0		%
Corporate securities:
Basic materials	—			—			—			571			2,802			3,373
Communications	—			—			183			350			—			533
Consumer, cyclical	—			9,970			—			10,792			976			21,738
Consumer, non-cyclical	—			10,602			445			10,458			—			21,505
Energy	—			—			2,401			22,758			4,405			29,564
Financial	—			33,253			71,485			26,046			1,004			131,788
Industrial	—			—			—			20,591			—			20,591
Utilities	—			—			6,473			—			—			6,473
Total	—			53,825			80,987			91,566			9,187			235,565
	—		%	22.8		%	34.4		%	38.9		%	3.9		%	100.0		%
Collateralized loan obligations:
Corporate	35,405			24,988			133,825			—			5,000			199,218
Total	35,405			24,988			133,825			—			5,000			199,218
	17.8		%	12.5		%	67.2		%	—		%	2.5		%	100.0		%

Other asset-backed securities	5,111			—			6,596			6,937			—			18,644
	27.4		%	—		%	35.4		%	37.2		%	—		%	100.0		%
Total	$	218,463		$	905,471		$	1,563,760		$	348,556		$	57,025		$	3,093,275
	7.1		%	29.3		%	50.5		%	11.3		%	1.8		%	100.0		%

__________


⁽¹⁾	Intermediate ratings are included at each level (e.g., AA includes AA+, AA and AA-).

U.S. Government Bonds

The Company had $22.6 million and $25.0 million, or 0.7% and 0.8% of its fixed maturity portfolio, at fair value, in U.S. government bonds at December 31, 2019 and 2018, respectively. At December 31, 2019, Moody's and Fitch ratings for U.S. government issued debt were Aaa and AAA, respectively, although a significant increase in government deficits and debt could lead to a downgrade. The Company understands that market participants continue to use rates of return on U.S. government debt

as a risk-free rate and have continued to invest in U.S. Treasury securities. The modified duration of the U.S. government bonds portfolio reflecting anticipated early calls was 1.0 years and 1.7 years at December 31, 2019 and 2018, respectively.

Municipal Securities

The Company had $2.55 billion and $2.62 billion, or 82.6% and 87.8% of its fixed maturity securities portfolio, at fair value, in municipal securities at December 31, 2019 and 2018, respectively, of which $344.7 million and $404.8 million, respectively, were insured by bond insurers. The underlying ratings for insured municipal bonds have been factored into the average rating of the securities by the rating agencies with no significant disparity between the absolute bond ratings and the underlying credit ratings as of December 31, 2019 and 2018.

At December 31, 2019 and 2018, respectively, 65.5% and 62.6% of the insured municipal securities, at fair value, most of which were investment grade, were insured by bond insurers that provide credit enhancement in addition to the ratings reflected by the financial strength of the underlying issuers. At December 31, 2019 and 2018, the average rating of the Company’s insured municipal securities was A+, which corresponds to the average rating of the investment grade bond insurers. The remaining 34.5% and 37.4% of insured municipal securities at December 31, 2019 and 2018, respectively, were insured by non-rated or below investment grade bond insurers that the Company believes did not provide credit enhancement. The modified duration of the municipal securities portfolio reflecting anticipated early calls was 3.7 years and 4.4 years at December 31, 2019 and 2018, respectively.

The Company considers the strength of the underlying credit as a buffer against potential market value declines which may result from future rating downgrades of the bond insurers. In addition, the Company has a long-term time horizon for its municipal bond holdings, which generally allows it to recover the full principal amounts upon maturity and avoid forced sales prior to maturity of bonds that have declined in market value due to the bond insurers’ rating downgrades. Based on the uncertainty surrounding the financial condition of these insurers, it is possible that there will be additional downgrades to below investment grade ratings by the rating agencies in the future, and such downgrades could impact the estimated fair value of those municipal bonds.

Mortgage-Backed Securities

At December 31, 2019 and 2018, respectively, the mortgage-backed securities portfolio of $63.0 million and $31.0 million, or 2.0% and 1.0% of the Company's fixed maturity securities portfolio, at fair value, was categorized as loans to "prime" borrowers, except for $2.4 million and $3.2 million, at fair value, of Alt-A mortgages. Alt-A mortgage backed securities are at fixed or variable rates and include certain securities that are collateralized by residential mortgage loans issued to borrowers with credit profiles stronger than those of sub-prime borrowers, but do not qualify for prime financing terms due to high loan-to-value ratios or limited supporting documentation. The Company had holdings of $18.9 million and $24.8 million, at fair value, in commercial mortgage-backed securities at December 31, 2019 and 2018, respectively.

The weighted-average rating of the Company’s Alt-A mortgage-backed securities was BBB- and BB at December 31, 2019 and December 31, 2018, respectively. The weighted-average rating of the entire mortgage backed securities portfolio was AA at December 31, 2019, compared to A+ at December 31, 2018. The modified duration of the mortgage-backed securities portfolio reflecting anticipated early calls was 3.1 years and 4.0 years at December 31, 2019 and 2018, respectively.

Corporate Securities

At December 31, 2019 and 2018, respectively, the company had corporate securities of $235.6 million and $105.5 million, or 7.6% and 3.5% of its fixed maturity securities portfolio, at fair value. The weighted-average rating was A- and BBB at December 31, 2019 and 2018, respectively. The modified duration reflecting anticipated early calls was 2.0 years and 2.4 years at December 31, 2019 and 2018, respectively.

Collateralized Loan Obligations

The Company had collateralized loan obligations of $199.2 million and $165.8 million, which represented 6.4% and 5.6% of its fixed maturity securities portfolio, at fair value, at December 31, 2019 and 2018, respectively. The weighted-average rating was A+ at December 31, 2019 and 2018. The modified duration reflecting anticipated early calls was 5.2 years and 5.5 years at December 31, 2019 and 2018, respectively.

Other Asset-Backed Securities

The Company had other asset-backed securities of $18.6 million and $37.8 million, which represented 0.6% and 1.3% of

its fixed maturity securities portfolio, at fair value, at December 31, 2019 and 2018, respectively. The weighted-average rating was A and A+ at December 31, 2019 and 2018, respectively. The modified duration reflecting anticipated early calls was 1.8 years and 2.1 years at December 31, 2019 and 2018, respectively.

Equity Securities

Equity holdings of $724.8 million and $529.6 million, at fair value, as of December 31, 2019 and 2018, respectively, consisted of non-redeemable preferred stocks, common stocks on which dividend income is partially tax-sheltered by the 50% corporate dividend received deduction, and private equity funds. The net gains (losses) due to changes in fair value of the Company’s equity portfolio were $90.9 million and $(77.5) million in 2019 and 2018, respectively. The primary cause for the increase in the fair value of the Company's equity securities was the overall improvement in equity markets in 2019.

The Company’s common stock allocation is intended to enhance the return of and provide diversification for the total portfolio. At December 31, 2019, 16.8% of the total investment portfolio, at fair value, was held in equity securities, compared to 14.1% at December 31, 2018.

The following table presents the equity security portfolio by industry sector at December 31, 2019 and 2018:



	December 31,
	2019				2018
	Cost		Fair Value		Cost		Fair Value
			(Amounts in thousands)
Equity securities:
Basic materials	$	9,528	$	10,058	$	15,321	$	14,657
Communications	26,130		29,516		29,268		29,646
Consumer, cyclical	49,816		52,470		35,028		32,722
Consumer, non-cyclical	47,427		55,526		30,189		31,672
Energy	57,459		54,615		56,397		44,444
Financial	100,720		121,642		85,405		86,362
Funds	141,405		139,517		110,177		106,463
Industrial	45,132		55,135		40,730		42,649
Technology	65,280		89,681		47,873		45,677
Utilities	105,385		116,591		93,694		95,339
	$	648,282	$	724,751	$	544,082	$	529,631

D. Debt

Notes payable consist of the following:



				December 31,
	Lender	Interest Rate	Expiration	2019		2018
				(Amounts in thousands)

Senior unsecured notes⁽¹⁾	Publicly traded	4.40%	March 15, 2027	$	375,000	$	375,000
Unsecured credit facility⁽²⁾	Bank of America and Wells Fargo Bank	LIBOR plus 112.5-162.5 basis points	March 29, 2022	—		—
Total principal amount				375,000		375,000
Less unamortized discount and debt issuance costs⁽³⁾				2,867		3,266
Total				$	372,133	$	371,734

__________

⁽¹⁾

On March 8, 2017, the Company completed a public debt offering issuing $375 million of senior notes. The notes are unsecured senior obligations of the Company, with a 4.4% annual coupon payable on March 15 and September 15 of each year commencing September 15, 2017. These notes mature on March 15, 2027. The Company used the proceeds from the notes to pay off the total outstanding balance of $320 million under the existing loan and credit facility agreements and terminated the agreements on March 8, 2017. The remainder of the proceeds from the notes was used for general corporate purposes. The Company incurred debt issuance costs of approximately $3.4 million, inclusive of underwriters' fees. The

notes were issued at a slight discount of 99.847% of par, resulting in the effective annualized interest rate, including debt issuance costs, of approximately 4.45%.

⁽²⁾

On March 29, 2017, the Company entered into an unsecured credit agreement that provides for revolving loans of up to $50 million and matures on March 29, 2022. The interest rates on borrowings under the credit facility are based on the Company's debt to total capital ratio and range from LIBOR plus 112.5 basis points when the ratio is under 15% to LIBOR plus 162.5 basis points when the ratio is greater than or equal to 25%. Commitment fees for the undrawn portions of the credit facility range from 12.5 basis points when the ratio is under 15% to 22.5 basis points when the ratio is greater than or equal to 25%. The debt to total capital ratio is expressed as a percentage of (a) consolidated debt to (b) consolidated shareholders' equity plus consolidated debt. The Company's debt to total capital ratio was 17.2% at December 31, 2019, resulting in a 15 basis point commitment fee on the $50 million undrawn portion of the credit facility. As of February 6, 2020, there have been no borrowings under this facility.

⁽³⁾

The unamortized discount and debt issuance costs are associated with the publicly traded $375 million senior unsecured notes. These are amortized to interest expense over the life of the notes, and the unamortized balance is presented in the Company's consolidated balance sheets as a direct deduction from the carrying amount of the debt. The unamortized debt issuance cost of approximately $0.1 million associated with the $50 million five-year unsecured revolving credit facility maturing on March 29, 2022 is included in other assets in the Company's consolidated balance sheets and amortized to interest expense over the term of the credit facility.

The Company was in compliance with all of its financial covenants pertaining to minimum statutory surplus, debt to total capital ratio, and RBC ratio under the unsecured credit facility at December 31, 2019.

For a further discussion, see Note 8. Notes Payable, of the Notes to Consolidated Financial Statements in "Item 8. Financial Statements and Supplementary Data."

E. Capital Expenditures

In 2019, the Company made capital expenditures, including capitalized software, of approximately $40.1 million primarily related to information technology.

F. Regulatory Capital Requirements

The Insurance Companies must comply with minimum capital requirements under applicable state laws and regulations. The RBC formula is used by insurance regulators to monitor capital and surplus levels. It was designed to capture the widely varying elements of risks undertaken by writers of different lines of insurance business having differing risk characteristics, as well as writers of similar lines where differences in risk may be related to corporate structure, investment policies, reinsurance arrangements, and a number of other factors. The Company periodically monitors the RBC level of each of the Insurance Companies. As of December 31, 2019, 2018 and 2017, each of the Insurance Companies exceeded the minimum required RBC level, as determined by the NAIC and adopted by the state insurance regulators. None of the Insurance Companies’ RBC ratios were less than 400% of the authorized control level RBC as of December 31, 2019, 2018 and 2017. Generally, an RBC ratio of 200% or less would require some form of regulatory or company action.

Among other considerations, industry and regulatory guidelines suggest that the ratio of a property and casualty insurer’s annual net premiums written to statutory policyholders’ surplus should not exceed 3.0 to 1. Based on the combined surplus of all the Insurance Companies of $1.54 billion at December 31, 2019 and net premiums written in 2019 of $3.7 billion, the ratio of premiums written to surplus was 2.42 to 1.

The following table presents a summary of recent examinations:



State	Exam Type	Period Under Review	Status
CA,FL,GA,IL,OK,TX	Coordinated Multi-state Financial	2014 to 2017	Received final reports from all six states.
CA	Rating and Underwriting	2014	Received final report.

During the course of and at the conclusion of these examinations, the examining DOI generally reports findings to the Company, and none of the findings reported to date are expected to be material to the Company’s financial position.

OFF-BALANCE SHEET ARRANGEMENTS

As of December 31, 2019, the Company had no off-balance sheet arrangements as defined under Regulation S-K 303(a)(4) and the instructions thereto.

CONTRACTUAL OBLIGATIONS

The Company’s significant contractual obligations at December 31, 2019 are summarized as follows:



Contractual Obligations ⁽⁴⁾			Payments Due By Period
	Total		2020		2021		2022		2023		2024		Thereafter
					(Amounts in thousands)
Debt (including interest)⁽¹⁾	$	498,750	$	16,500	$	16,500	$	16,500	$	16,500	$	16,500	$	416,250
Lease obligations⁽²⁾	51,343		14,458		12,259		9,910		6,439		3,533		4,744
Loss and loss adjustment expense reserves⁽³⁾	1,921,255		1,224,272		334,363		165,174		99,067		49,484		48,895
Total contractual obligations	$	2,471,348	$	1,255,230	$	363,122	$	191,584	$	122,006	$	69,517	$	469,889

__________

⁽¹⁾

The Company’s debt contains various terms, conditions and covenants which, if violated by the Company, would result in a default and could result in the acceleration of the Company’s payment obligations. Amounts differ from the balances presented on the consolidated balance sheets as of December 31, 2019 because the debt amounts above include interest, calculated at the stated 4.4% coupon rate, and exclude the discount and issuance costs of the debt.


⁽²⁾	The Company is obligated under various non-cancellable lease agreements providing for office space, automobiles, and office equipment that expire at various dates through the year 2028.

⁽³⁾

Loss and loss adjustment expense reserves represents an estimate of amounts necessary to settle all outstanding claims, including IBNR as of December 31, 2019. The Company has estimated the timing of these payments based on its historical experience and expectation of future payment patterns. However, the timing of these payments may vary significantly from the amounts shown above. The ultimate cost of losses may vary materially from recorded amounts which are the Company’s best estimates. The Company believes that cash flows from operations and existing cash and investments are sufficient to meet these obligations despite the uncertainty in payment patterns. For more detailed information on the Company's liquidity and cash flows, see "Liquidity and Capital Resources—B. Cash Flows" in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations."


⁽⁴⁾	The table excludes liabilities of $7.2 million related to uncertainty in tax settlements as the Company is unable to reasonably estimate the timing and amount of related future payments.

Item 7A. Quantitative and Qualitative Disclosures about Market Risks

The Company is subject to various market risk exposures primarily due to its investing and borrowing activities. Primary market risk exposures are changes in interest rates, equity prices, and credit risk. Adverse changes to these rates and prices may occur due to changes in the liquidity of a market, or to changes in market perceptions of creditworthiness and risk tolerance. The following disclosure reflects estimates of future performance and economic conditions. Actual results may differ.

Overview

The Company’s investment policies define the overall framework for managing market and investment risks, including accountability and controls over risk management activities, and specify the investment limits and strategies that are appropriate given the liquidity, surplus, product profile, and regulatory requirements of the Company's subsidiaries. Executive oversight of investment activities is conducted primarily through the Company’s investment committee. The Company’s investment committee focuses on strategies to enhance after-tax yields, mitigate market risks, and optimize capital to improve profitability and returns.

The Company manages exposures to market risk through the use of asset allocation, duration, and credit ratings. Asset allocation limits place restrictions on the total amount of funds that may be invested within an asset class. Duration limits on the fixed maturity securities portfolio place restrictions on the amount of interest rate risk that may be taken. Comprehensive day-to-day management of market risk within defined tolerance ranges occurs as portfolio managers buy and sell within their respective markets based upon the acceptable boundaries established by investment policies.

Credit Risk

Credit risk results from uncertainty in a counterparty’s ability to meet its obligations. Credit risk is managed by maintaining a high credit quality fixed maturity securities portfolio. As of December 31, 2019, the estimated weighted-average credit quality rating of the fixed maturity securities portfolio was A+, at fair value, consistent with the average rating at December 31, 2018.

The following table presents municipal securities by state in descending order of holdings at fair value at December 31, 2019:



States	Fair Value		Average Rating
	(Amounts in thousands)
Texas	$	379,269	AA-
Florida	246,104		A+
Illinois	212,290		A
Pennsylvania	151,084		A+
New York	158,754		A+
Other states	1,406,707		A+
Total	$	2,554,208

At December 31, 2019, the municipal securities portfolio was broadly diversified among the states and the largest holdings were in populous states such as Texas and Florida. These holdings were further diversified primarily among cities, counties, schools, public works, hospitals, and state general obligations. The Company seeks to minimize overall credit risk and ensure diversification by limiting exposure to any particular issuer.

Taxable fixed maturity securities represented 20.6% of the Company’s fixed maturity portfolio at December 31, 2019. 3.6% of the Company’s taxable fixed maturity securities were comprised of U.S. government bonds, which were rated AAA at December 31, 2019. 1.7% of the Company’s taxable fixed maturity securities, representing 0.3% of its total fixed maturity portfolio, were rated below investment grade at December 31, 2019. Below investment grade issues are considered "watch list" items by the Company, and their status is evaluated within the context of the Company’s overall portfolio and its investment policy on an aggregate risk management basis, as well as their ability to recover their investment on an individual issue basis.

Equity Price Risk

Equity price risk is the risk that the Company will incur losses due to adverse changes in the equity markets.

At December 31, 2019, the Company’s primary objective for common equity investments was current income. The fair value of the equity investments consisted of $586.4 million in common stocks, $49.7 million in non-redeemable preferred stocks, and $88.7 million in private equity funds. Common stocks are typically valued for future economic prospects as perceived by the market.

Common stocks represented 13.6% of total investments at fair value at December 31, 2019. Beta is a measure of a security’s systematic (non-diversifiable) risk, which is measured as the percentage change in an individual security’s return for a 1% change in the return of the market.

Based on hypothetical reductions in the overall value of the stock market, the following table illustrates estimated reductions in the overall value of the Company’s common stock portfolio at December 31, 2019 and 2018:



	December 31,
	2019		2018
	(Amounts in thousands, except Average Beta)
Average Beta	0.83		0.78
Hypothetical reduction of 25% in the overall value of the stock market	$	121,671	$	84,040
Hypothetical reduction of 50% in the overall value of the stock market	$	243,342	$	168,080

Interest Rate Risk

Interest rate risk is the risk that the Company will incur a loss due to adverse changes in interest rates relative to the interest rate characteristics of interest bearing assets and liabilities. The Company faces interest rate risk, as it invests a substantial amount of funds in interest sensitive assets and issues interest sensitive liabilities. Interest rate risk includes risks related to changes in U.S. Treasury yields and other key benchmarks, as well as changes in interest rates resulting from widening credit spreads and credit exposure to collateralized securities.

The fixed maturity portfolio at December 31, 2019, which represented 71.7% of total investments at December 31, 2019, at fair value, is subject to interest rate risk. As market interest rates decrease, the value of the portfolio increases and vice versa. A common measure of the interest sensitivity of fixed maturity assets is modified duration, a calculation that utilizes maturity, coupon rate, yield and call terms to calculate an average age to receive the present value of all the cash flows produced by such assets, including reinvestment of interest. The longer the duration, the more sensitive the asset is to market interest rate fluctuations.

The Company has historically invested in fixed maturity securities with a goal of maximizing after-tax yields and holding assets to the maturity or call date. Since assets with longer maturities tend to produce higher current yields, the Company’s historical investment philosophy resulted in a portfolio with a moderate duration. Fixed maturity securities purchased by the Company typically have call options attached, which further reduce the duration of the asset as interest rates decline. The modified duration of the overall fixed maturity securities portfolio reflecting anticipated early calls was 3.2 years at December 31, 2019, and 4.0 years at December 31, 2018 and 2017.

If interest rates were to rise by 100 and 200 basis points, the Company estimates that the fair value of its fixed maturity securities portfolio at December 31, 2019 would decrease by $113.0 million and $226.0 million, respectively. Conversely, if interest rates were to decrease, the fair value of the Company’s fixed maturity securities portfolio would rise, and it may cause a higher number of the Company’s fixed maturity securities to be called away. The proceeds from the called fixed maturity securities would likely be reinvested at lower yields, which would result in lower overall investment income for the Company.


Item 8.	Financial Statements and Supplementary Data

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



	Page
Reports of Independent Registered Public Accounting Firm	53

Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 2019 and 2018	56
Consolidated Statements of Operations for the Years Ended December 31, 2019, 2018, and 2017	57
Consolidated Statements of Shareholders’ Equity for the Years Ended December 31, 2019, 2018, and 2017	58
Consolidated Statements of Cash Flows for the Years Ended December 31, 2019, 2018, and 2017	59
Notes to Consolidated Financial Statements	60

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders and Board of Directors

Mercury General Corporation:

Opinion on the Consolidated Financial Statements

We have audited the accompanying consolidated balance sheets of Mercury General Corporation and subsidiaries (the Company) as of December 31, 2019 and 2018, the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the years in the three‑year period ended December 31, 2019 and the related notes and financial statement schedules I, II, IV (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the years in the three‑year period ended December 31, 2019, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 12, 2020 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

Basis for Opinion

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

Critical Audit Matter

The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgment. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.

Assessment of the estimation of the loss and loss adjustment expense reserves

As discussed in Notes 1 and 12 to the consolidated financial statements, the Company’s estimation of the loss and loss adjustment expense reserves (loss reserves) is based on generally accepted actuarial methods (methods). Specifically, loss reserves are established based on the Company’s assessment of claims pending and the development of prior years’ loss liabilities. As of December 31, 2019, the loss and loss adjustment expense reserve balance was $1.92 billion.

We identified the assessment of the estimation of loss reserves as a critical audit matter. Specialized actuarial skills and knowledge were needed to evaluate the Company’s estimate of future claims payment and reporting patterns based on observed historical patterns. Subjective auditor judgment was required to assess the Company’s selection of the methods and assumptions, such as paid and incurred loss development factors, used to estimate loss reserves.

The primary procedures we performed to address this critical audit matter included the following. We tested certain internal controls over the Company’s loss reserve process, including controls over the selection of methods and assumptions used in the estimate of loss reserves. We also involved actuarial professionals with specialized skills and knowledge who assisted in:


•	Assessing the Company’s methodology for estimating loss reserves by comparing it to generally accepted

actuarial methods;


•	Evaluating the Company’s estimates for certain lines of business by performing independent analyses of loss reserves using the Company’s underlying historical claims data;


•	Evaluating the results of the Company’s estimates for the remaining lines of business in comparison to the internal experience and related industry trends;


•	Developing a range of reserves based on actuarial methodologies in order to evaluate the Company’s total recorded loss reserves; and


•	Evaluating the year-over-year movements of the Company’s recorded loss reserves within the developed range.

/s/ KPMG LLP

We have served as the Company’s auditor since 1963.

Los Angeles, California

February 12, 2020

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders and Board of Directors

Mercury General Corporation:

Opinion on Internal Control Over Financial Reporting

We have audited Mercury General Corporation and subsidiaries’ (the Company) internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2019 and 2018, the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2019, and the related notes and financial statement schedules I, II, and IV (collectively, the consolidated financial statements), and our report dated February 12, 2020 expressed an unqualified opinion on those consolidated financial statements.

Basis for Opinion

The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

Definition and Limitations of Internal Control Over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ KPMG LLP

Los Angeles, California

February 12, 2020

MERCURY GENERAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands)



	December 31,
	2019		2018
ASSETS
Investments, at fair value:
Fixed maturity securities (amortized cost $2,973,276; $2,969,541)	$	3,093,275	$	2,985,161
Equity securities (cost $648,282; $544,082)	724,751		529,631
Short-term investments (cost $494,060; $254,518)	494,135		253,299
Total investments	4,312,161		3,768,091
Cash	294,398		314,291
Receivables:
Premiums	604,871		555,038
Accrued investment income	40,107		45,373
Other	6,464		6,132
Total receivables	651,442		606,543
Reinsurance recoverables	78,774		221,088
Deferred policy acquisition costs	233,166		215,131
Fixed assets, net	168,986		153,023
Operating lease right-of-use assets	44,909		—
Current income taxes	7,642		38,885
Deferred income taxes	—		13,339
Goodwill	42,796		42,796
Other intangible assets, net	10,636		15,534
Other assets	44,247		45,008
Total assets	$	5,889,157	$	5,433,729
LIABILITIES AND SHAREHOLDERS’ EQUITY
Loss and loss adjustment expense reserves	$	1,921,255	$	1,829,412
Unearned premiums	1,355,547		1,236,181
Notes payable	372,133		371,734
Accounts payable and accrued expenses	143,318		115,071
Operating lease liabilities	47,996		—
Deferred income taxes	27,964		—
Other liabilities	221,442		263,647
Total liabilities	4,089,655		3,816,045
Commitments and contingencies
Shareholders’ equity:
Common stock without par value or stated value:
Authorized 70,000 shares; issued and outstanding 55,358; 55,340	98,828		98,026
Retained earnings	1,700,674		1,519,658
Total shareholders’ equity	1,799,502		1,617,684
Total liabilities and shareholders’ equity	$	5,889,157	$	5,433,729

See accompanying Notes to Consolidated Financial Statements.

MERCURY GENERAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)



	Year Ended December 31,
	2019		2018			2017
Revenues:
Net premiums earned	$	3,599,418	$	3,368,411		$	3,195,437
Net investment income	141,263		135,838			124,930
Net realized investment gains (losses)	222,793		(133,520		)	83,650
Other	9,044		9,275			11,945
Total revenues	3,972,518		3,380,004			3,415,962
Expenses:
Losses and loss adjustment expenses	2,706,024		2,576,789			2,444,884
Policy acquisition costs	602,085		572,164			555,350
Other operating expenses	269,305		244,630			233,475
Interest	17,035		17,036			15,168
Total expenses	3,594,449		3,410,619			3,248,877
Income (loss) before income taxes	378,069		(30,615		)	167,085
Income tax expense (benefit)	57,982		(24,887		)	22,208
Net income (loss)	$	320,087	$	(5,728	)	$	144,877
Net income (loss) per share:
Basic	$	5.78	$	(0.10	)	$	2.62
Diluted	$	5.78	$	(0.10	)	$	2.62

See accompanying Notes to Consolidated Financial Statements.

MERCURY GENERAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(in thousands)



	Year Ended December 31,
	2019			2018			2017
Common stock, beginning of year	$	98,026		$	97,523		$	95,529
Proceeds of stock options exercised	701			358			2,102
Reclassification of restricted stock units from equity to liability award	—			—			(168		)
Share-based compensation expense	123			145			60
Withholding tax on stock options exercised	(22		)	—			—
Common stock, end of year	98,828			98,026			97,523
Retained earnings, beginning of year	1,519,658			1,663,864			1,656,873
Net income (loss)	320,087			(5,728		)	144,877
Dividends paid to shareholders	(139,071		)	(138,478		)	(137,886		)
Retained earnings, end of year	1,700,674			1,519,658			1,663,864
Total shareholders’ equity	$	1,799,502		$	1,617,684		$	1,761,387

See accompanying Notes to Consolidated Financial Statements.

MERCURY GENERAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)



	Year Ended December 31,
	2019			2018			2017
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)	$	320,087		$	(5,728	)	$	144,877
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	64,730			58,791			55,343
Net realized investment (gains) losses	(222,793		)	133,520			(83,650		)
Increase in premiums receivable	(49,832		)	(80,979		)	(14,908		)
Decrease (increase) in reinsurance recoverables	142,314			(164,739		)	(43,043		)
Gain on sale of fixed assets	—			—			(3,078		)
Changes in current and deferred income taxes	72,545			(13,898		)	(3,010		)
(Increase) decrease in deferred policy acquisition costs	(18,035		)	(16,980		)	2,675
Increase in loss and loss adjustment expense reserves	91,843			318,799			220,365
Increase in unearned premiums	119,366			134,254			27,490
Increase (decrease) in accounts payable and accrued expenses	26,493			6,586			(4,178		)
Share-based compensation	123			145			60
Other, net	(27,163		)	13,663			42,462
Net cash provided by operating activities	519,678			383,434			341,405
CASH FLOWS FROM INVESTING ACTIVITIES
Fixed maturity securities available for sale in nature:
Purchases	(491,795		)	(706,224		)	(734,397		)
Sales	136,560			189,306			100,709
Calls or maturities	316,860			334,626			575,735
Equity securities available for sale in nature:
Purchases	(1,174,759		)	(1,026,827		)	(831,310		)
Sales	1,088,701			954,755			679,571
Calls	—			—			7,100
Changes in securities payable and receivable	(2,536		)	4,035			(44,740		)
(Increase) decrease in short-term investments	(240,391		)	45,747			73,005
Purchase of fixed assets	(40,088		)	(27,959		)	(19,443		)
Sale of fixed assets	—			—			6,239
Other, net	6,247			10,105			1,934
Net cash used in investing activities	(401,201		)	(222,436		)	(185,597		)
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends paid to shareholders	(139,071		)	(138,478		)	(137,886		)
Proceeds from stock options exercised	701			358			2,162
Net proceeds from issuance of senior notes	—			—			371,011
Payoff of principal on loan and credit facilities	—			—			(320,000		)
Net cash used in financing activities	(138,370		)	(138,120		)	(84,713		)
Net (decrease) increase in cash	(19,893		)	22,878			71,095
Cash:
Beginning of year	314,291			291,413			220,318
End of year	$	294,398		$	314,291		$	291,413
SUPPLEMENTAL CASH FLOW DISCLOSURE
Interest paid	$	16,586		$	16,586		$	9,863
Income taxes (refunded) paid, net	$	(14,564	)	$	(10,989	)	$	25,218

See accompanying Notes to Consolidated Financial Statements.

MERCURY GENERAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Summary of Significant Accounting Policies

General

Mercury General Corporation ("Mercury General") and its subsidiaries (referred to herein collectively as the "Company") are primarily engaged in writing personal automobile insurance through 14 Insurance Companies in 11 states, principally California. The Company also writes homeowners, commercial automobile, commercial property, mechanical protection, fire, and umbrella insurance. The private passenger automobile line of insurance business was more than 74% of the Company’s direct premiums written in 2019, 2018, and 2017, and approximately 88%, 87%, and 85% of the private passenger automobile premiums were written in California in 2019, 2018, and 2017, respectively. Premiums written represents the premiums charged on policies issued during a fiscal period, which is a statutory measure designed to determine production levels.

Consolidation and Basis of Presentation

The consolidated financial statements include the accounts of Mercury General Corporation and its subsidiaries:



Insurance Companies

Mercury Casualty Company ("MCC")		Mercury National Insurance Company
Mercury Insurance Company ("MIC")		American Mercury Insurance Company
California Automobile Insurance Company ("CAIC")		American Mercury Lloyds Insurance Company⁽¹⁾
California General Underwriters Insurance Company, Inc.		Mercury County Mutual Insurance Company⁽²⁾
Mercury Insurance Company of Illinois		Mercury Insurance Company of Florida
Mercury Insurance Company of Georgia		Mercury Indemnity Company of America
Mercury Indemnity Company of Georgia		Workmen's Auto Insurance Company ("WAIC")

Non-Insurance Companies

Mercury Select Management Company, Inc.		AIS Management LLC
Mercury Insurance Services LLC		Auto Insurance Specialists LLC
Animas Funding LLC ("AFL")⁽³⁾		PoliSeek AIS Insurance Solutions, Inc.
Fannette Funding LLC ("FFL")⁽³⁾		Mercury Plus Insurance Services LLC

__________


⁽¹⁾	American Mercury Lloyds Insurance Company is not owned but is controlled by the Company through its attorney-in-fact, Mercury Select Management Company, Inc.


⁽²⁾	Mercury County Mutual Insurance Company is not owned but is controlled by the Company through a management contract.


⁽³⁾	Special purpose investment vehicle.

The consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles ("GAAP"), which differ in some respects from those filed in reports to insurance regulatory authorities. All intercompany transactions and balances have been eliminated.

Certain prior period amounts have been reclassified to conform with the current period presentation.

The Company did not have other comprehensive income (loss) in 2019, 2018 and 2017.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. These estimates require the Company to apply complex assumptions and judgments, and often the Company must make estimates about effects of matters that are inherently uncertain and will likely change in subsequent periods. The most significant assumptions in the preparation of these consolidated financial statements relate to reserves for losses and loss adjustment expenses. Actual results could differ from those estimates.

Investments

The Company applies the fair value option to all fixed maturity and equity securities and short-term investments at the time an eligible item is first recognized. The primary reasons for electing the fair value option were simplification and cost benefit considerations as well as the expansion of the use of fair value measurement by the Company consistent with the long-term measurement objectives of the Financial Accounting Standards Board (the "FASB") for accounting for financial instruments. See Note 2. Financial Instruments for additional information on the fair value option.

Gains and losses due to changes in fair value for items measured at fair value pursuant to application of the fair value option are included in net realized investment gains (losses) in the Company's consolidated statements of operations, while interest and dividend income on investment holdings are recognized on an accrual basis on each measurement date and are included in net investment income in the Company's consolidated statements of operations.

Fixed maturity securities include debt securities, which may have fixed or variable principal payment schedules, may be held for indefinite periods of time, and may be used as a part of the Company’s asset/liability strategy or sold in response to changes in interest rates, anticipated prepayments, risk/reward characteristics, liquidity needs, tax planning considerations, or other economic factors. Premiums and discounts on fixed maturities are amortized using first call date and are adjusted for anticipated prepayments. Premiums and discounts on mortgage-backed securities are adjusted for anticipated prepayment using the retrospective method, with the exception of some beneficial interests in securitized financial assets, which are accounted for using the prospective method.

Equity securities consist of non-redeemable preferred stocks, common stocks on which dividend income is partially tax-sheltered by the 50% corporate dividend received deduction, and private equity funds.

Short-term investments include money market accounts, options, and short-term bonds that are highly rated short duration securities and redeemable within one year.

In the normal course of investing activities, the Company either forms or enters into relationships with variable interest entities ("VIEs"). A VIE is an entity that either has investors that lack certain essential characteristics of a controlling financial interest, such as simple majority kick-out rights, or lacks sufficient funds to finance its own activities without financial support provided by other entities. The Company performs ongoing qualitative assessments of the VIEs to determine whether the Company has a controlling financial interest in the VIE and therefore is the primary beneficiary. The Company is deemed to have a controlling financial interest when it has both the ability to direct the activities that most significantly impact the economic performance of the VIE and the obligation to absorb losses or right to receive benefits from the VIE that could potentially be significant to the VIE. Based on the Company's assessment, if it determines it is the primary beneficiary, the Company consolidates the VIE in its consolidated financial statements.

The Company forms special purpose investment vehicles to facilitate its investment activities involving derivative instruments such as total return swaps, or limited partnerships or limited liability companies such as private equity funds. These special purpose investment vehicles are consolidated VIEs as the Company has determined it is the primary beneficiary of such VIEs. Creditors have no recourse against the Company in the event of default by these VIEs. The Company had no implied or unfunded commitments to these VIEs at December 31, 2019 and 2018. The Company's financial or other support provided to these VIEs and its loss exposure are limited to its collateral and original investment.

The Company invests, directly or indirectly through its consolidated VIEs, in limited partnerships or limited liability companies such as private equity funds. These investments are non-consolidated VIEs as the Company has determined it is not the primary beneficiary. The Company's maximum exposure to loss is limited to the total carrying value that is included in equity securities in the Company's consolidated balance sheets. At December 31, 2019 and 2018, the Company had no outstanding unfunded commitments to these VIEs whereby the Company may be called by the VIEs during the commitment period to fund the purchase of new investments and the expenses of the VIEs.

Securities on Deposit

As required by statute, the Company’s insurance subsidiaries have securities deposited with the departments of insurance or similar governmental agencies in the states in which they are licensed to operate with fair values totaling $16 million and $15 million at December 31, 2019 and 2018, respectively.

Deferred Policy Acquisition Costs

Deferred policy acquisition costs consist of commissions paid to outside agents, premium taxes, salaries, and certain other underwriting costs that are incremental or directly related to the successful acquisition of new and renewal insurance contracts and are amortized over the life of the related policy in proportion to premiums earned. Deferred policy acquisition costs are limited to the amount that will remain after deducting from unearned premiums and anticipated investment income, the estimated losses and loss adjustment expenses, and the servicing costs that will be incurred as premiums are earned. The Company’s deferred policy acquisition costs are further limited by excluding those costs not directly related to the successful acquisition of insurance contracts. The Company does not defer advertising expenditures but expenses them as incurred.

The table below presents a summary of deferred policy acquisition cost amortization and net advertising expense:



	Year Ended December 31,
	2019		2018		2017
	(Amounts in millions)
Deferred policy acquisition cost amortization	$	602.1	$	572.2	$	555.4
Net advertising expense	42.2		40.9		37.4

Fixed Assets

Fixed assets are stated at historical cost less accumulated depreciation and amortization. The useful life for buildings is 30 to 40 years. Furniture, equipment, and purchased software are depreciated on a combination of straight-line and accelerated methods over 3 to 7 years. The Company has capitalized certain consulting costs, payroll, and payroll-related costs for employees related to computer software developed for internal use, which are amortized on a straight-line method over the estimated useful life of the software, generally not exceeding 7 years. In accordance with applicable accounting standards, capitalization ceases no later than the point at which a computer software project is substantially complete and ready for its intended use. Leasehold improvements are amortized over the shorter of the useful life of the assets or the life of the associated lease.

The Company periodically assesses long-lived assets or asset groups including building and equipment, for recoverability when events or changes in circumstances indicate that their carrying amounts may not be recoverable. If the Company identifies an indicator of impairment, the Company assesses recoverability by comparing the carrying amount of the asset to the sum of the undiscounted cash flows expected to result from the use and the eventual disposal of the asset. An impairment loss is recognized when the carrying amount is not recoverable and is measured as the excess of carrying value over fair value. There were no impairment charges during 2019, 2018, and 2017.

Goodwill and Other Intangible Assets

Goodwill and other intangible assets arise as a result of business acquisitions and consist of the excess of the cost of the acquisitions over the tangible and intangible assets acquired and liabilities assumed and identifiable intangible assets acquired. Identifiable intangible assets consist of the value of customer relationships, trade names, software and technology, and favorable leases, which are all subject to amortization, and an insurance license which is not subject to amortization.

The Company evaluates goodwill and other intangible assets for impairment annually or whenever events or changes in circumstances indicate that it is more likely than not that the carrying amount of goodwill and other intangible assets may exceed their implied fair values. The Company qualitatively determines whether, more likely than not, the fair value exceeds the carrying amount of a reporting unit. There are numerous assumptions and estimates underlying the qualitative assessments including future earnings, long-term strategies, and the Company’s annual planning and forecasting process. If these planned initiatives do not accomplish the targeted objectives, the assumptions and estimates underlying the qualitative assessments could be adversely affected and have a material effect upon the Company’s financial condition and results of operations. In addition, the Company evaluates other intangible assets using methods similar to those used for goodwill described above. As of December 31, 2019 and 2018, goodwill and other intangible impairment assessments indicated that there was no impairment.

Premium Revenue Recognition

Premium revenue is recognized on a pro-rata basis over the terms of the policies in proportion to the amount of insurance protection provided. Premium revenue includes installment and other fees for services which are recognized in the periods in which the services are rendered. Unearned premiums represent the portion of the written premium related to the unexpired policy term. Unearned premiums are predominantly computed monthly on a pro-rata basis and are stated gross of reinsurance deductions,

with the reinsurance deduction recorded in other assets. The Company evaluates its unearned premiums periodically for premium deficiencies by comparing the sum of expected claim costs, unamortized acquisition costs and maintenance costs, partially offset by investment income, to related unearned premiums. To the extent that any of the Company’s lines of insurance business become unprofitable, a premium deficiency reserve may be required. Net premiums written, a statutory measure designed to determine production levels, were $3.73 billion, $3.50 billion, and $3.22 billion in 2019, 2018, and 2017, respectively.

Losses and Loss Adjustment Expenses

Unpaid losses and loss adjustment expenses are determined in amounts estimated to cover incurred losses and loss adjustment expenses and established based upon the Company’s assessment of claims pending and the development of prior years’ loss liabilities. These amounts include liabilities based upon individual case estimates for reported losses and loss adjustment expenses and estimates of such amounts that are incurred but not reported. Changes in the estimated liability are charged or credited to operations as the losses and loss adjustment expenses are re-estimated. The liability is stated net of anticipated salvage and subrogation recoveries, and gross of reinsurance recoverables on unpaid losses.

Estimating loss reserves is a difficult process as many factors can ultimately affect the final settlement of a claim and, therefore, the loss reserve that is required. A key assumption in estimating loss reserves is the degree to which the historical data used to analyze reserves will be predictive of ultimate claim costs on incurred claims. Changes in the regulatory and legal environments, results of litigation, medical costs, the cost of repair materials, and labor rates, among other factors, can impact this assumption. In addition, time can be a critical part of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of a claim, the more variable the ultimate settlement amount could be. Accordingly, short-tail claims, such as property damage claims, tend to be more reasonably predictable than long-tail liability claims, such as those involving the Company’s bodily injury ("BI") coverages. 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. However, since the provisions for loss reserves are necessarily based upon estimates, the ultimate liability may be more or less than such provisions.

The Company analyzes loss reserves quarterly primarily using the incurred loss, paid loss, average severity coupled with the claim count development methods, and the generalized linear model ("GLM") described below. When deciding among methods to use, the Company evaluates the credibility of each method based on the maturity of the data available and the claims settlement practices for each particular line of insurance business or coverage within a line of insurance business. The Company may also evaluate qualitative factors such as known changes in laws or legal ruling that could affect claims handling or other external environmental factors or internal factors that could affect the settlement of claims. When establishing the loss reserve, the Company will generally analyze the results from all of the methods used rather than relying on a single method. While these methods are designed to determine the ultimate losses on claims under the Company’s policies, there is inherent uncertainty in all actuarial models since they use historical data to project outcomes. The Company believes that the techniques it uses provide a reasonable basis in estimating loss reserves.

•


•	The paid loss method analyzes historical payment patterns to estimate the amount of losses yet to be paid.

•

catastrophes. For catastrophe losses on individual properties that are expected to be total losses, the Company typically establishes reserves at the policy limits.

Derivative Financial Instruments

The Company accounts for all derivative instruments, other than those that meet the normal purchases and sales exception, as either an asset or liability, measured at fair value, which is based on information obtained from independent parties. In addition, changes in fair value are recognized in earnings unless specific hedge accounting criteria are met. The Company’s derivative instruments include total return swaps and options sold. See Note 9. Derivative Financial Instruments.

Earnings Per Share

Basic earnings per share excludes dilution and reflects net income divided by the weighted average shares of common stock outstanding during the periods presented. Diluted earnings per share is based on the weighted average shares of common stock and potential dilutive securities outstanding during the periods presented. At December 31, 2019 and 2018, potential dilutive securities consisted of outstanding stock options. See Note 17. Earnings Per Share, for the required disclosures relating to the calculation of basic and diluted earnings per share.

Income Taxes

Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial reporting basis and the respective tax basis of the Company’s assets and liabilities, and expected benefits of utilizing net operating loss, capital loss, and tax-credit carryforwards. The Company assesses the likelihood that its deferred tax assets will be realized and, to the extent management does not believe these assets are more likely than not to be realized, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates or laws is recognized in earnings in the period that includes the enactment date.

At December 31, 2019, the Company’s deferred income taxes were in a net liability position, which included a combination of ordinary and capital deferred tax benefits and expenses. In assessing the Company's ability to realize deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon generating sufficient taxable income of the appropriate character within the carryback and carryforward periods available under the tax law. Management considers the reversal of deferred tax liabilities, projected future taxable income of an appropriate nature, and tax-planning strategies in making this assessment. The Company believes that through the use of prudent tax planning strategies and the generation of capital gains, sufficient income will be realized in order to maximize the full benefits of its deferred tax assets. Although realization is not assured, management believes that it is more likely than not that the Company’s deferred tax assets will be realized.

Reinsurance

Liabilities for unearned premiums and unpaid losses are stated in the accompanying consolidated financial statements before deductions for ceded reinsurance. Unpaid losses and unearned premiums that are ceded to reinsurers are carried in reinsurance recoverables and other assets, respectively, in the Company's consolidated balance sheets. Earned premiums are stated net of deductions for ceded reinsurance.

The Company is party to a Catastrophe Reinsurance Treaty ("Treaty") covering a wide range of perils that is effective through June 30, 2020. The Treaty provides $600 million of coverage on a per occurrence basis after covered catastrophe losses exceed the $40 million Company retention limit. The Treaty specifically excludes coverage for any Florida business and for California earthquake losses on fixed property policies, such as homeowners, but does cover losses from fires following an earthquake. In addition, the Treaty provides for one full reinstatement of coverage limits and excludes losses from wildfires on certain coverage layers of the Treaty.

The Company recognized ceded premiums earned of approximately $57 million, $49 million, and $27 million in 2019, 2018, and 2017, respectively, which are included in net premiums earned in its consolidated statements of operations, and ceded losses and loss adjustment expenses of approximately $(71) million, $257 million, and $90 million in 2019, 2018, and 2017, respectively, which are included in losses and loss adjustment expenses in its consolidated statements of operations. The negative ceded losses and loss adjustment expenses in 2019 primarily resulted from the re-estimation of the catastrophe loss reserves, including estimated subrogation, on the 2018 Camp and Woolsey Fires and the 2017 Southern California wildfires, which have previously been ceded to reinsurers under the Treaty, in conjunction with the sale of the Company's subrogation rights during the

first quarter of 2019. The re-estimation primarily benefited the Company's reinsurers. See Note 12. Loss and Loss Adjustment Expense Reserves for additional information.

The Insurance Companies, as primary insurers, are required to pay losses to the extent reinsurers are unable to discharge their obligations under the reinsurance agreements.

Share-Based Compensation

Share-based compensation expenses for all stock options granted or modified are based on their estimated grant-date fair values. The Company recognizes these compensation costs on a straight-line basis over the requisite service period of the award, which is the option vesting term of four years. The Company estimates forfeitures expected to occur in determining the amount of compensation cost to be recognized in each period. The fair value of stock option awards is estimated using the Black-Scholes option pricing model with the grant-date assumptions and weighted-average fair values.

The fair value of each restricted stock unit ("RSU") grant is determined based on the market price on the grant date for awards classified as equity and on each reporting date for awards classified as liability. Compensation cost is recognized based on management’s best estimate of the performance goals that will be achieved at the end of the performance period, taking into account expected forfeitures. If the minimum performance goals are not expected to be met, no compensation cost is recognized and any recognized compensation cost would be reversed. See Note 16. Share-Based Compensation for additional disclosures.

Revenue from Contracts with Customers

The Company's revenue from contracts with customers that are in scope of Topic 606 represents the commission income that the Company's 100% owned insurance agencies, Auto Insurance Specialists LLC ("AIS") and PoliSeek AIS Insurance Solutions, Inc. ("Poliseek"), earned from third-party insurers. The Company's commission income from third-party insurers was approximately $16.3 million and $16.0 million representing approximately 0.4% and 0.5% of the consolidated total revenue, for the years ended December 31, 2019 and 2018, respectively, with related expenses of approximately $10.5 million for each of the years ended December 31, 2019 and 2018. Due to the immateriality of the Company's commission income and its related expenses to the overall consolidated financial statements, the commission income, net of related expenses, is included in other revenues in the Company's consolidated statements of operations, and in other income of the Property and Casualty business segment in the Company's segment reporting in accordance with Topic 280, Segment Reporting (see Note 20. Segment Information).

AIS and PoliSeek are primarily engaged in the marketing and sales of insurance policies in private passenger automobile, commercial automobile and homeowners lines of business. Their revenues primarily consist of commission income received from property and casualty insurers. The primary performance obligation of AIS and Poliseek in return for the commission income from the insurers is to complete the sale of the policy and deliver the control of the policy to the insurer prior to the policy effective date. The total revenue from the sale of a policy is recognized when the sale is complete and the policy is effective as all the material aspects of the performance obligation are satisfied and the insurer is deemed to obtain control of the insurance policy at that time. The commission income is constrained such that the revenue is recognized only to the extent that the commission income received is not likely to be returned to the insurers due to policy cancellations. Any commission income not received when the sale is complete is recognized as commission income receivable, which is included in other receivables in the Company's consolidated balance sheets. Commission income receivable at December 31, 2019 and 2018 was approximately $1.2 million.

A refund liability is recorded for the expected amount of the commission income that has to be returned to the insurers based on estimated policy cancellations. The refund liability is computed for the entire portfolio of contracts as a practical expedient, using the expected value method based on all relevant information, including historical data. The refund liability at December 31, 2019 and 2018 was approximately $0.7 million, which was included in other liabilities in the Company's consolidated balance sheets.

As of December 31, 2019 and 2018, the Company had no contract assets, contract liabilities, capitalized costs to obtain or fulfill a contract, or remaining performance obligations associated with unrecognized revenues.

Recently Issued Accounting Standards

In August 2018, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2018-15, "Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40), Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract." ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software under Subtopic 350-40. This ASU also requires an entity

to expense the capitalized implementation costs of a hosting arrangement that is a service contract over the term of the hosting arrangement and present such expense in the same line item in the statement of income as the fees associated with the hosting element (service) of the arrangement and classify payments for capitalized implementation costs in the statement of cash flows in the same manner as payments made for fees associated with the hosting element. The entity is also required to present the capitalized implementation costs in the statement of financial position in the same line item that a prepayment for the fees of the associated hosting arrangement would be presented. ASU 2018-15 became effective for the Company on January 1, 2020 and did not have any material impact on its consolidated financial statements and related disclosures.

In August 2018, the FASB issued ASU 2018-13, "Fair Value Measurement (Topic 820), Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement." The amendments in this ASU require certain existing disclosure requirements in Topic 820 to be modified or removed, and certain new disclosure requirements to be added to the Topic. In addition, this ASU allows entities to exercise more discretion when considering fair value measurement disclosures. ASU 2018-13 became effective for the Company on January 1, 2020 and did not have any material impact on its consolidated financial statements and related disclosures.

In January 2017, the FASB issued ASU 2017-04, "Intangibles - Goodwill and Other (Topic 350), Simplifying the Test for Goodwill Impairment." ASU 2017-04 removes the requirement to compare the implied fair value of goodwill with its carrying amount as part of Step 2 of the goodwill impairment test and requires an entity to recognize an impairment charge for the amount by which the carrying amount of a reporting unit exceeds its fair value. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. ASU 2017-04 became effective for the Company on January 1, 2020 and did not have any material impact on its consolidated financial statements and related disclosures.

In June 2016, the FASB issued ASU 2016-13, "Financial Instruments - Credit Losses (Topic 326)." The amendments in this ASU replace the "incurred loss" methodology for recognizing credit losses with a methodology that reflects expected credit losses and requires consideration of a broader range of information including past events, current conditions and reasonable and supportable forecasts that affect the collectibility of reported amounts of financial assets that are not accounted for at fair value through net income, such as loans, certain debt securities, trade receivables, net investment in leases, off-balance sheet credit exposures and reinsurance recoverables. Under the current GAAP incurred loss methodology, recognition of the full amount of credit losses is generally delayed until the loss is probable of occurring. Current GAAP restricts the ability to record credit losses that are expected, but do not yet meet the probability threshold. Subsequently, the FASB has issued an additional ASUs on Topic 326 that do not change the core principle of the guidance in ASU 2016-13 but clarify or certain aspects of it. ASU 2016-13 and the additional ASUs on Topic 326 became effective for the Company on January 1, 2020. The Company adopted this ASU using a modified retrospective transition method by recognizing the cumulative-effect adjustment of approximately $2 million to retained earnings at January 1, 2020. The cumulative-effect adjustment primarily resulted from reestimating credit losses on the outstanding balances of the Company's reinsurance recoverables and premiums receivables at the adoption date of the new standard. The Company will make the required disclosures under Topic 326, starting with its consolidated financial statements that include the initial adoption date.

2. Financial Instruments

Financial instruments recorded in the consolidated balance sheets include investments, note receivable, other receivables, options sold, total return swaps, accounts payable, and notes payable. Due to their short-term maturity, the carrying values of other receivables and accounts payable approximate their fair values. All investments are carried at fair value in the consolidated balance sheets.

The following table presents the fair values of financial instruments:



	December 31,
	2019		2018
	(Amounts in thousands)
Assets
Investments	$	4,312,161	$	3,768,091
Note receivable	5,665		5,557
Liabilities
Total return swaps	—		4,851
Options sold	77		3
Unsecured notes	394,279		362,674

Investments

The Company applies the fair value option to all fixed maturity and equity securities and short-term investments at the time an eligible item is first recognized. The cost of investments sold is determined on a first-in and first-out method and realized gains and losses are included in net realized investment gains (losses) in the Company's consolidated statements of operations. See Note 3. Investments for additional information.

Note Receivable

Note receivable was recognized as part of the sale of land in August 2017 (See Note 5. Fixed Assets for additional information on the sale transaction). The Company elected to apply the fair value option to this security at the time it was first recognized. The fair value of note receivable is included in other assets in the Company's consolidated balance sheets, while the changes in fair value of note receivable are included in net realized investment gains (losses) in the Company's consolidated statements of operations.

Options Sold

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

Total Return Swaps

The fair values of the total return swaps reflect the estimated amounts that, upon termination of the contracts, would be received for selling an asset or paid to transfer a liability in an orderly transaction, based on models using inputs, such as interest rate yield curves and credit spreads, observable for substantially the full term of the contract.

Unsecured Notes

The fair value of the Company’s publicly traded $375 million unsecured notes at December 31, 2019 and 2018 was obtained from a third party pricing service.

For additional disclosures regarding methods and assumptions used in estimating fair values, see Note 4. Fair Value Measurements.

3. Investments

The following table presents gains (losses) due to changes in fair value of investments that are measured at fair value pursuant to application of the fair value option:



	Year Ended December 31,
	2019		2018			2017
	(Amounts in thousands)
Fixed maturity securities	$	104,379	$	(53,927	)	$	50,403
Equity securities	90,920		(77,494		)	37,486
Short-term investments	1,295		(1,237		)	38
Total gains (losses)	$	196,594	$	(132,658	)	$	87,927

The following table presents gross gains (losses) realized on the sales of investments:



	Year Ended December 31,
	2019								2018								2017
	(Amounts in thousands)
	Gross Realized Gains		Gross Realized Losses			Net			Gross Realized Gains		Gross Realized Losses			Net			Gross Realized Gains		Gross Realized Losses			Net
Fixed maturity securities	$	2,413	$	(1,066	)	$	1,347		$	549	$	(3,563	)	$	(3,014	)	$	604	$	(2,701	)	$	(2,097	)
Equity securities	47,411		(28,089		)	19,322			43,420		(45,607		)	(2,187		)	20,835		(23,048		)	(2,213		)
Short-term investments	177		(2,133		)	(1,956		)	61		(2,429		)	(2,368		)	21		(20		)	1

Contractual Maturity

At December 31, 2019, fixed maturity holdings rated below investment grade and non-rated comprised 1.3% of total investments at fair value. Additionally, the Company owns securities that are credit enhanced by financial guarantors that are subject to uncertainty related to market perception of the guarantors’ ability to perform. Determining the estimated fair value of municipal bonds could become more difficult should markets for these securities become illiquid.

The following table presents the estimated fair values of the Company's fixed maturity securities at December 31, 2019 by contractual maturity. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.



	Estimated Fair Value
	(Amounts in thousands)
Fixed maturity securities:
Due in one year or less	$	105,929
Due after one year through five years	548,638
Due after five years through ten years	287,005
Due after ten years	2,151,703
Total	$	3,093,275

Investment Income

The following table presents a summary of net investment income:



	Year Ended December 31,
	2019			2018			2017
	(Amounts in thousands)
Fixed maturity securities	$	102,254		$	102,198		$	102,790
Equity securities	32,233			30,496			18,554
Short-term investments	12,381			8,789			8,753
Total investment income	$	146,868		$	141,483		$	130,097
Less: investment expense	(5,605		)	(5,645		)	(5,167		)
Net investment income	$	141,263		$	135,838		$	124,930

4. Fair Value Measurements

The Company employs a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date using the exit price. Accordingly, when market observable data are not readily available, the Company’s own assumptions are set to reflect those that market participants would be presumed to use in pricing the asset or liability at the measurement date. Assets and liabilities recorded at fair value on the consolidated balance sheets are categorized based on the level of judgment associated with inputs used to measure their fair value and the level of market price observability, as follows:



Level 1	Unadjusted quoted prices are available in active markets for identical assets or liabilities as of the reporting date.



Level 2	Pricing inputs are other than quoted prices in active markets, which are based on the following:
	a. Quoted prices for similar assets or liabilities in active markets;
	b. Quoted prices for identical or similar assets or liabilities in non-active markets; or
	c. Either directly or indirectly observable inputs as of the reporting date.



Level 3	Pricing inputs are unobservable and significant to the overall fair value measurement, and the determination of fair value requires significant management judgment or estimation.

In certain cases, inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. Thus, a Level 3 fair value measurement may include inputs that are observable (Level 1 or Level 2) and unobservable (Level 3). The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and consideration of factors specific to the asset or liability.

The Company uses prices and inputs that are current as of the measurement date, including during periods of market disruption. In periods of market disruption, the ability to observe prices and inputs may be reduced for many instruments. This condition could cause an instrument to be reclassified from Level 1 to Level 2, or from Level 2 to Level 3. The Company recognizes transfers between levels at either the actual date of the event or a change in circumstances that caused the transfer.

Summary of Significant Valuation Techniques for Financial Assets and Financial Liabilities

The Company’s fair value measurements are based on the market approach, which utilizes market transaction data for the same or similar instruments.

The Company obtained unadjusted fair values on 97.9% of its investment portfolio from an independent pricing service. For a private equity fund that was classified as Level 3 and included in equity securities at December 31, 2019 and 2018, the Company obtained specific unadjusted broker quotes based on net fund value and, to a lesser extent, unobservable inputs from at least one knowledgeable outside security broker to determine the fair value. The fair value of the private equity fund was $1.2 million and $1.4 million at December 31, 2019 and 2018, respectively.

Level 1 measurements—Fair values of financial assets and financial liabilities are obtained from an independent pricing service, and are based on unadjusted quoted prices for identical assets or liabilities in active markets. Additional pricing services and closing exchange values are used as a comparison to ensure that reasonable fair values are used in pricing the investment portfolio.

U.S. government bonds/Short-term bonds: Valued using unadjusted quoted market prices for identical assets in active markets.

Common stock: Comprised of actively traded, exchange listed U.S. and international equity securities and valued based on unadjusted quoted prices for identical assets in active markets.

Money market instruments: Valued based on unadjusted quoted prices for identical assets in active markets.

Options sold: Comprised of free-standing exchange listed derivatives that are actively traded and valued based on quoted prices for identical instruments in active markets.

Level 2 measurements—Fair values of financial assets and financial liabilities are obtained from an independent pricing service or outside brokers, and are based on prices for similar assets or liabilities in active markets or valuation models whose inputs are observable, directly or indirectly, for substantially the full term of the asset or liability. Additional pricing services are used as a comparison to ensure reliable fair values are used in pricing the investment portfolio.

Municipal securities: Valued based on models or matrices using inputs such as quoted prices for identical or similar assets in active markets.

Mortgage-backed securities: Comprised of securities that are collateralized by residential and commercial mortgage loans and valued based on models or matrices using multiple observable inputs, such as benchmark yields, reported trades and broker/dealer quotes, for identical or similar assets in active markets. The Company had holdings of $18.9 million and $24.8 million in commercial mortgage-backed securities at December 31, 2019 and 2018, respectively.

Corporate securities/Short-term bonds: Valued based on a multi-dimensional model using multiple observable inputs, such as benchmark yields, reported trades, broker/dealer quotes and issue spreads, for identical or similar assets in active markets.

Non-redeemable preferred stock: Valued based on observable inputs, such as underlying and common stock of same issuer and appropriate spread over a comparable U.S. Treasury security, for identical or similar assets in active markets.

Total return swaps: Valued based on multi-dimensional models using inputs such as interest rate yield curves, underlying debt/credit instruments and the appropriate benchmark spread for similar assets in active markets, observable for substantially the full term of the contract.

Collateralized loan obligations ("CLOs"): Valued based on underlying debt instruments and the appropriate benchmark spread for similar assets in active markets.

Other asset-backed securities: Comprised of securities that are collateralized by non-mortgage assets, such as automobile loans, valued based on models or matrices using multiple observable inputs, such as benchmark yields, reported trades and broker/dealer quotes, for identical or similar assets in active markets.

Note receivable: Valued based on observable inputs, such as benchmark yields, and considering any premium or discount for the differential between the stated interest rate and market interest rates, based on quoted market prices of similar instruments.

Level 3 measurements—Fair values of financial assets are based on inputs that are both unobservable and significant to the overall fair value measurement, including any items in which the evaluated prices obtained elsewhere were deemed to be of a distressed trading level.

Private equity fund: Private equity fund that is not measured at net asset value ("NAV") is valued based on underlying investments of the fund or assets similar to such investments in active markets, taking into consideration specific unadjusted broker quotes based on net fund value and unobservable inputs from at least one knowledgeable outside security broker related to liquidity assumptions.

Fair value measurement using NAV practical expedient - The fair values of private equity funds measured at net asset value are determined using NAV as advised by the external fund managers and the third party administrators. The NAV of the Company's limited partnership or limited liability company interest in such a fund is based on the manager's and the administrator's valuation of the underlying holdings in accordance with the fund's governing documents and GAAP. In accordance with applicable accounting guidance, private equity funds measured at fair value using the NAV practical expedient are not classified in the fair value hierarchy. The strategy of these funds is to provide current income to investors by investing mainly in secured loans, CLOs or CLO issuers, and equity interests in vehicles established to purchase and warehouse loans. The Company has made all of its capital contributions in such funds and had no outstanding unfunded commitments at December 31, 2019 with respect to the funds. The underlying assets of the funds are expected to be liquidated over the period of approximately one to 10 years from December 31, 2019. In addition, the Company does not have the ability to redeem or withdraw from the funds, or to sell, assign, pledge or transfer its investment, without the consent from the General Partner or Managers of each fund, but will receive distributions based on the liquidation of the underlying assets and the interest proceeds from the underlying assets.

The Company’s financial instruments at fair value are reflected in the consolidated balance sheets on a trade-date basis. Related unrealized gains or losses are recognized in net realized investment gains or losses in the consolidated statements of operations. Fair value measurements are not adjusted for transaction costs.

The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring basis, and indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair values:



	December 31, 2019
	Level 1		Level 2		Level 3		Total
	(Amounts in thousands)
Assets
Fixed maturity securities:
U.S. government bonds	$	22,637	$	—	$	—	$	22,637
Municipal securities	—		2,554,208		—		2,554,208
Mortgage-backed securities	—		63,003		—		63,003
Corporate securities	—		235,565		—		235,565
Collateralized loan obligations	—		199,217		—		199,217
Other asset-backed securities	—		18,645		—		18,645
Total fixed maturity securities	22,637		3,070,638		—		3,093,275
Equity securities:
Common stock	586,367		—		—		586,367
Non-redeemable preferred stock	—		49,708		—		49,708
Private equity fund	—		—		1,203		1,203
Private equity funds measured at net asset value ⁽¹⁾							87,473
Total equity securities	586,367		49,708		1,203		724,751
Short-term investments:
Short-term bonds	2,822		30,080		—		32,902
Money market instruments	461,233		—		—		461,233
Total short-term investments	464,055		30,080		—		494,135
Other assets:
Note receivable	—		5,665		—		5,665
Total assets at fair value	$	1,073,059	$	3,156,091	$	1,203	$	4,317,826
Liabilities
Other liabilities:
Options sold	77		—		—		77
Total liabilities at fair value	$	77	$	—	$	—	$	77



	December 31, 2018
	Level 1		Level 2		Level 3		Total
	(Amounts in thousands)
Assets
Fixed maturity securities:
U.S. government bonds	$	25,003	$	—	$	—	$	25,003
Municipal securities	—		2,620,132		—		2,620,132
Mortgage-backed securities	—		30,952		—		30,952
Corporate securities	—		105,524		—		105,524
Collateralized debt obligations	—		165,789		—		165,789
Other asset-backed securities	—		37,761		—		37,761
Total fixed maturity securities	25,003		2,960,158		—		2,985,161
Equity securities:
Common stock	430,973		—		—		430,973
Non-redeemable preferred stock	—		31,433		—		31,433
Private equity fund	—		—		1,445		1,445
Private equity fund measured at net asset value ⁽¹⁾							65,780
Total equity securities	430,973		31,433		1,445		529,631
Short-term investments:
Short-term bonds	31,472		16,784		—		48,256
Money market instruments	205,043		—		—		205,043
Total short-term investments	236,515		16,784		—		253,299
Other assets:
Note receivable	—		5,557		—		5,557
Total assets at fair value	$	692,491	$	3,013,932	$	1,445	$	3,773,648
Liabilities
Other liabilities:
Total return swaps	$	—	$	4,851	$	—	$	4,851
Options sold	3		—		—		3
Total liabilities at fair value	$	3	$	4,851	$	—	$	4,854

__________

⁽¹⁾ The fair value is measured using the NAV practical expedient; therefore, it is not categorized within the fair value hierarchy. The fair value amount is presented in this table to permit reconciliation of the fair value hierarchy to the amounts presented in the Company's consolidated balance sheets.

The following table presents a summary of changes in fair value of Level 3 financial assets:



	Private Equity Fund
	Year Ended December 31,
	2019			2018
	(Amounts in thousands)
Beginning balance	$	1,445		$	1,481
Net realized gains (losses) included in earnings	101			(36		)
Settlements	(343		)	—
Ending balance	$	1,203		$	1,445
The amount of total gains (losses) for the period included in earnings attributable to assets still held at December 31	$	93		$	(36	)

There were no transfers between Levels 1, 2, and 3 of the fair value hierarchy in 2019 and 2018.

At December 31, 2019 and 2018, the Company did not have any nonrecurring fair value measurements of nonfinancial assets or nonfinancial liabilities.

Financial Instruments Disclosed, But Not Carried, at Fair Value

The following tables present the carrying value and fair value of the Company’s financial instruments disclosed, but not carried, at fair value, and the level within the fair value hierarchy at which such instruments are categorized:



	December 31, 2019
	Carrying Value		Fair Value		Level 1		Level 2		Level 3

	(Amounts in thousands)
Liabilities
Notes payable:
Unsecured notes	$	372,133	$	394,279	$	—	$	394,279	$	—



	December 31, 2018
	Carrying Value		Fair Value		Level 1		Level 2		Level 3

	(Amounts in thousands)
Liabilities
Notes payable:
Unsecured notes	$	371,734	$	362,674	$	—	$	362,674	$	—

Unsecured Notes

The fair value of the Company’s publicly traded $375 million unsecured notes at December 31, 2019 and 2018 was based on the spreads above the risk-free yield curve. These spreads are generally obtained from the new issue market, secondary trading and broker-dealer quotes. See Note 8. Notes Payable for additional information on unsecured notes.

5. Fixed Assets

The following table presents the components of fixed assets:



	December 31,
	2019			2018
	(Amounts in thousands)
Land	$	18,152		$	18,144
Buildings and improvements	140,567			138,238
Furniture and equipment	70,355			123,021
Capitalized software	244,425			222,903
Leasehold improvements	7,547			9,986
	481,046			512,292
Less: accumulated depreciation and amortization	(312,060		)	(359,269		)
Fixed assets, net	$	168,986		$	153,023

Depreciation expense, including amortization of leasehold improvements, was $23.2 million, $19.9 million, and $21.2 million for 2019, 2018, and 2017, respectively.

In August 2017, the Company completed the sale of approximately six acres of land located in Brea, California (the "Property"), for a total sale price of approximately $12.2 million. Approximately $5.7 million of the total sale price was received in the form of a promissory note (the "Note") and the remainder in cash. The Note is secured by a first trust deed and an assignment of rents on the Property, and bears interest at an annual rate of 3.5%, payable in monthly installments. The Note matures in August 2020, and its fair value is included in other assets in the Company's consolidated balance sheets. Only the cash portion of the total sale price of the Property, excluding the Note, is reported in the Company's consolidated statements of cash flows. Interest earned on the Note is recognized in other revenues in the Company's consolidated statements of operations. The Company recognized a gain of approximately $3.3 million on the sale transaction, which is included in other revenues in its consolidated statements of operations.

6. Deferred Policy Acquisition Costs

Deferred policy acquisition costs were as follows:



	December 31,
	2019			2018			2017
	(Amounts in thousands)
Balance, beginning of year	$	215,131		$	198,151		$	200,826
Policy acquisition costs deferred	620,120			589,144			552,675
Amortization	(602,085		)	(572,164		)	(555,350		)
Balance, end of year	$	233,166		$	215,131		$	198,151

7. Leases

The Company adopted ASU 2016-02, "Leases (Topic 842)," which supersedes the guidance in Accounting Standards Codification ("ASC") 840, "Leases," on January 1, 2019, using a modified retrospective transition, with the cumulative-effect adjustment to the opening balance of retained earnings as of the effective date (the "effective date method"). Under the effective date method, financial results reported in periods prior to 2019 are unchanged. In addition, the Company elected the package of practical expedients permitted under the transition guidance within the new standard, which allowed the Company not to reassess (a) whether arrangements contain leases, (b) lease classification and (c) initial direct costs. Adoption of the new standard resulted in the recognition of operating lease right-of-use ("ROU") assets and operating lease liabilities of approximately $41 million and $43 million, respectively, at the adoption date for the Company's operating leases. The difference of approximately $2 million between the operating lease ROU assets and operating lease liabilities represents reclassification of deferred rent liability (the difference between the straight-line rent expenses and paid rent amounts under the leases) to operating lease ROU assets from other liabilities at the adoption date. The Company did not have any cumulative-effect adjustment as a result of the adoption.

The Company has operating leases for office space for insurance operations and administrative functions, automobiles for certain employees and general uses, and office equipment such as printers and computers. As of December 31, 2019, the Company's leases had remaining terms ranging from less than 1 year to approximately 8 years. These leases may contain provisions for periodic adjustments to rates and charges applicable under such lease agreements. These rates and charges also may vary with the Company's level of use. Certain of these leases include one or more options to renew or early terminate, and the exercise of these options is at the Company's sole discretion. Certain leases also include options to purchase the leased property. The Company's lease agreements do not contain any residual value guarantees.

The Company determines if an arrangement is a lease at inception. Operating leases are included in operating lease ROU assets and operating lease liabilities in the Company's consolidated balance sheets. ROU assets represent the Company's right to use an underlying asset for the lease term and lease liabilities represent its obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at the lease commencement date based on the estimated present value of lease payments over the lease term.

The Company uses its estimated incremental borrowing rate for office space and office equipment leases, which is derived from information available at the lease commencement date, in determining the present value of lease payments, as the rate implicit in the lease is not readily available for such leases. The Company gives consideration to its recent debt issuances as well as publicly available data for instruments with similar characteristics when calculating its incremental borrowing rates. For automobile leases, the Company uses the rate implicit in the lease at the lease commencement date in determining the present value of lease payments, as the readily-determinable implicit rate is provided in such leases. The Company's lease terms include options to extend or terminate the lease when it is reasonably certain that it will exercise that option. The Company does not use the short-term lease exemption practical expedient and records all leases on the balance sheets, including leases with a term of twelve months or less. The Company accounts for the lease and non-lease components as a single lease component for all of its leases. Lease expense for scheduled lease payments is recognized on a straight-line basis over the lease term.

The components of lease expense were as follows:



		Year Ended
Lease Cost	Classification	December 31, 2019
		(Amounts in thousands)
Operating lease cost ⁽¹⁾	Other operating expenses	$	15,146
Variable lease cost ⁽¹⁾	Other operating expenses	2,196
Total lease cost		$	17,342

__________

⁽¹⁾ Includes short-term leases, which are immaterial.

Supplemental balance sheet information related to leases was as follows:



	December 31, 2019
	(Amounts in thousands)
Operating lease ROU assets	$	44,909
Operating lease liabilities	47,996

Weighted-average lease term and discount rate were as follows:



	December 31, 2019
Weighted-average remaining lease term (in years):
Operating leases	4.4

Weighted-average discount rate:
Operating leases	3.02	%

Supplemental cash flow and other information related to leases was as follows:



	Year Ended
	December 31, 2019
	(Amounts in thousands)
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases	$	14,289

ROU assets obtained in exchange for lease liabilities:
Operating leases	15,372

Maturities of lease liabilities as of December 31, 2019 were as follows:



Year	Operating Leases
	(Amounts in thousands)
2020	14,458
2021	12,259
2022	9,910
2023	6,439
2024	3,533
2025 and thereafter	$	4,744
Total lease payments	$	51,343
Less: Imputed interest	3,347
Total lease obligations	$	47,996

As of December 31, 2019, the Company had additional operating lease commitments that have not yet commenced of

approximately $2 million with each lease term ranging from approximately 1 year to 3 years. These operating leases will commence in 2020.

Disclosures related to periods prior to adoption of ASC Topic 842

Total rent expense recognized under the Company's various lease agreements was $14.9 million and $14.8 million for 2018 and 2017, respectively. The following table presents future minimum commitments for operating leases as of December 31, 2018:



Year Ending December 31,	Operating Leases
	(Amounts in thousands)
2019	$	12,812
2020	11,547
2021	8,732
2022	6,972
2023	3,659
Thereafter	1,966

8. Notes Payable

The following table presents information about the Company's notes payable:



				December 31,
	Lender	Interest Rate	Expiration	2019		2018
				(Amounts in thousands)
Senior unsecured notes⁽¹⁾	Publicly traded	4.40%	March 15, 2027	$	375,000	$	375,000
Unsecured credit facility⁽²⁾	Bank of America and Wells Fargo Bank	LIBOR plus 112.5-162.5 basis points	March 29, 2022	—		—
Total principal amount				375,000		375,000
Less unamortized discount and debt issuance costs⁽³⁾				2,867		3,266
Total				$	372,133	$	371,734

__________

⁽¹⁾

⁽²⁾

⁽³⁾

The unamortized discount and debt issuance costs are associated with the publicly traded $375 million senior unsecured notes. These are amortized to interest expense over the life of the notes, and the unamortized balance is presented in the Company's consolidated balance sheets as a direct deduction from the carrying amount of the debt. The unamortized debt issuance costs of approximately $0.1 million associated with the $50 million five-year unsecured revolving credit facility maturing on March 29, 2022 are included in other assets in the Company's consolidated balance sheets and amortized to interest expense over the term of the credit facility.

The Company was in compliance with all of its financial covenants pertaining to minimum statutory surplus, debt to total capital ratio, and risk based capital ("RBC") ratio under the unsecured credit facility at December 31, 2019.

Debt maturities for each of the next five years and thereafter as of December 31, 2019 are as follows:



Maturity	Amounts
	(in thousands)
2020	$	—
2021	—
2022	—
2023	—
2024	—
Thereafter	375,000
Total	$	375,000

9. Derivative Financial Instruments

The Company is exposed to certain risks relating to its ongoing business operations. The primary risks managed by using derivative instruments are equity price risk and interest rate risk. Equity contracts (options sold) on various equity securities are intended to manage the price risk associated with forecasted purchases or sales of such securities.

The Company also enters into derivative contracts to enhance returns on its investment portfolio.

On February 13, 2014, Fannette Funding LLC ("FFL"), a special purpose investment vehicle, formed by and consolidated into the Company, entered into a total return swap agreement with Citibank. The agreement had an initial term of one year, subject to periodic renewal. In July 2018, the agreement was renewed through January 24, 2020. During the fourth quarter of 2019, the underlying obligations were liquidated and the total return swap agreement between FFL and Citibank was terminated. Under the agreement, FFL received the income equivalent on underlying obligations due to Citibank and paid to Citibank interest on the outstanding notional amount of the underlying obligations. The total return swap was secured by approximately $31 million of U.S. Treasuries as collateral, which were included in short-term investments on the consolidated balance sheets. The Company paid interest equal to LIBOR plus 128 basis points prior to the renewal of the agreement in January 2018, LIBOR plus 120 basis points subsequent to the January 2018 renewal through July 2018, and LIBOR plus105 basis points subsequent to the July 2018 renewal until December 2019, on approximately $100 million of underlying obligations as of December 31, 2018.

On August 9, 2013, Animas Funding LLC ("AFL"), a special purpose investment vehicle, formed and consolidated by the Company, entered into a three-year total return swap agreement with Citibank, which was renewed through February 17, 2018. During June and July 2017, the underlying obligations were liquidated and the total return swap agreement between AFL and Citibank was terminated on. Under the agreement, AFL received the income equivalent on underlying obligations due to Citibank and paid to Citibank interest on the outstanding notional amount of the underlying obligations. The total return swap was secured by approximately $40 million of U.S. Treasuries as collateral, which were included in short-term investments on the consolidated balance sheets. The Company paid interest equal to LIBOR plus 135 basis points prior to the amendment of the agreement in January 2017 and LIBOR plus 128 basis points subsequent to the amendment until July 2017, on approximately $152 million of underlying obligations as of December 31, 2016.

The following tables present the location and amounts of derivative fair values in the consolidated balance sheets and derivative gains or losses in the consolidated statements of operations:



	Liability Derivatives
	December 31, 2019		December 31, 2018
	(Amounts in thousands)
Options sold - Other liabilities	$	77	$	3
Total return swaps - Other liabilities	—		4,851
Total derivatives	$	77	$	4,854



	Gains (Losses) Recognized in Income
	Year Ended December 31,
	2019		2018			2017
	(Amounts in thousands)
Total return swaps - Net realized investment gains (losses)	$	1,039	$	(3,783	)	$	(2,137	)
Options sold - Net realized investment gains (losses)	6,339		10,498			2,291
Total	$	7,378	$	6,715		$	154

Most options sold consist of covered calls. The Company writes covered calls on underlying equity positions held as an enhanced income strategy that is permitted for the Company’s insurance subsidiaries under statutory regulations. The Company manages the risk associated with covered calls through strict capital limitations and asset diversification throughout various industries. For additional disclosures regarding equity contracts, see Note 4. Fair Value Measurements for additional disclosures regarding options sold.

10. Goodwill and Other Intangible Assets

Goodwill

There were no changes in the carrying amount of goodwill during 2019 and 2018. Goodwill is reviewed annually for impairment and more frequently if potential impairment indicators exist. No impairment indicators were identified during 2019 and 2018. All of the Company's goodwill is associated with the Property and Casualty business segment (See Note 20. Segment Information for additional information on the reportable business segment).

Other Intangible Assets

The following table presents the components of other intangible assets:



	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount		Useful Lives
	(Amounts in thousands)							(in years)
As of December 31, 2019
Customer relationships	$	53,213	$	(52,319	)	$	894	11
Trade names	15,400		(7,058		)	8,342		24
Technology	4,300		(4,300		)	—		10
Insurance license	1,400		—			1,400		Indefinite
Total intangible assets, net	$	74,313	$	(63,677	)	$	10,636

As of December 31, 2018
Customer relationships	$	53,048	$	(47,897	)	$	5,151	11
Trade names	15,400		(6,417		)	8,983		24
Technology	4,300		(4,300		)	—		10
Insurance license	1,400		—			1,400		Indefinite
Total intangible assets, net	$	74,148	$	(58,614	)	$	15,534

Other intangible assets are reviewed annually for impairment and more frequently if potential impairment indicators exist. No impairment indicators were identified during 2019 and 2018.

Other intangible assets with definite useful lives are amortized on a straight-line basis over their useful lives. Other intangible assets amortization expense was $5.1 million, $5.5 million, and $5.4 million for the years ended December 31, 2019, 2018, and 2017, respectively. None of the intangible assets with definite useful lives are anticipated to have a residual value.

The following table presents the estimated future amortization expense related to other intangible assets as of December 31, 2019:



Year Ending December 31,	Amortization Expense
	(Amounts in thousands)
2020	$	922
2021	902
2022	878
2023	714
2024	686
Thereafter	5,134
Total	$	9,236

11. Income Taxes

Income tax provision

The Company and its subsidiaries file a consolidated federal income tax return. The income tax expense (benefit) consisted of the following components:



	Year Ended December 31,
	2019			2018			2017
	(Amounts in thousands)
Federal
Current	$	18,109		$	14,190		$	10,898
Deferred	40,413			(39,244		)	10,934
	$	58,522		$	(25,054	)	$	21,832
State
Current	$	(1,430	)	$	1,982		$	955
Deferred	890			(1,815		)	(579		)
	$	(540	)	$	167		$	376
Total
Current	$	16,679		$	16,172		$	11,853
Deferred	41,303			(41,059		)	10,355
Total	$	57,982		$	(24,887	)	$	22,208

As a result of the Tax Cuts and Jobs Act of 2017 (the "Act"), the Company’s deferred tax assets and liabilities were measured using the new corporate tax rate of 21% at December 31, 2019, 2018 and 2017. For the years ended December 31, 2019 and 2018, the Company measured its current income taxes using the new corporate tax rate of 21%, rather than the pre-enactment corporate tax rate of 35%. Additionally in 2018, as a result of a determination made by the Office of Management and Budget, the Company reversed the previously recorded provisional 6.6% sequestration reduction to its alternative minimum tax (“AMT”) credit that originally resulted from repeal of the corporate AMT and reclassification of AMT credit carryforwards to current taxes receivable as a refundable credit.

In computing taxable income, property and casualty insurers reduce underwriting income by losses and loss adjustment expenses incurred. The amount of the deduction for losses incurred associated with unpaid losses is discounted at the interest rates and for the loss payment patterns prescribed by the U.S. Treasury. The Act changes the prescribed interest rates to rates based on corporate bond yield curves and extends the applicable time periods for the loss payment pattern. These changes are effective for tax years beginning after 2017 and are subject to a transition rule that spreads the additional tax payments from the amount determined by applying these changes versus the previous calculated amount over the subsequent eight years beginning in 2018. The Company recorded a total deferred tax liability adjustment of approximately $8.6 million at December 31, 2018 related to the changes in discounting of unpaid losses included in the Act based on the guidance published in 2018 by the Internal Revenue Service. As of December 31, 2019, the balance of the deferred tax liability related to changes in discounting of unpaid losses was $6.7 million.

The following table presents a reconciliation of the tax expense (benefit) based on the statutory rate to the Company's actual tax expense (benefit) in the consolidated statements of operations:



	Year Ended December 31,
	2019			2018			2017
	(Amounts in thousands)
Computed tax expense (benefit) at 21% for 2019 and 2018 and 35% for 2017	$	79,394		$	(6,429	)	$	58,480
Tax-exempt interest income	(12,909		)	(13,507		)	(26,038		)
Dividends received deduction	(1,276		)	(1,082		)	(2,296		)
State tax (benefit) expense	(869		)	439			158
Nondeductible expenses	526			390			348
Change in federal tax contingency reserve	(2,588		)	—			—
Cumulative impact from change in federal tax rate	—			—			(11,449		)
(Reversal in 2018) reduction of AMT credit carryforward due to sequestration in 2017	—			(4,088		)	4,088
Other, net	(4,296		)	(610		)	(1,083		)
Income tax expense (benefit)	$	57,982		$	(24,887	)	$	22,208

Deferred Income Taxes

Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial reporting basis and the respective tax basis of the Company’s assets and liabilities, and expected benefits of utilizing net operating loss, capital loss, and tax-credit carryforwards. The ultimate realization of deferred tax assets is dependent upon generating sufficient taxable income of the appropriate character within the carryback and carryforward periods available under the tax law. Management considers the reversal of deferred tax liabilities, projected future taxable income of an appropriate nature, and tax-planning strategies in making this assessment. The Company believes that through the use of prudent tax planning strategies and the generation of capital gains, sufficient income will be realized in order to maximize the full benefits of its deferred tax assets.

The following table presents the significant components of the Company’s net deferred tax assets and liabilities:



	December 31,
	2019			2018
	(Amounts in thousands)
Deferred tax assets:
20% of net unearned premiums	$	58,448		$	52,644
Discounting of loss reserves and salvage and subrogation recoverable for tax purposes	12,769			9,245
Write-down of impaired investments	314			356
Expense accruals	8,099			7,019
Tax asset on net unrealized loss on securities carried at fair value	—			1,055
Other deferred tax assets	3,348			3,257
Total gross deferred tax assets	82,978			73,576

Deferred tax liabilities:
Deferred policy acquisition costs	(48,964		)	(45,178		)
Tax liability on net unrealized gain on securities carried at fair value	(41,273		)	—
Tax depreciation in excess of book depreciation	(8,105		)	(4,594		)
Undistributed earnings of insurance subsidiaries	(2,855		)	(3,017		)
Tax amortization in excess of book amortization	(3,264		)	(2,729		)
Other deferred tax liabilities	(6,481		)	(4,719		)
Total gross deferred tax liabilities	(110,942		)	(60,237		)

Net deferred tax (liabilities) assets	$	(27,964	)	$	13,339

Uncertainty in Income Taxes

The Company recognizes tax benefits related to positions taken, or expected to be taken, on its tax returns, only if the positions are "more-likely-than-not" sustainable. Once this threshold has been met, the Company’s measurement of its expected tax benefits is recognized in its financial statements.

There was a $4.6 million decrease to the total amount of unrecognized tax benefits related to tax uncertainties during 2019. The decrease was the result of tax positions taken regarding research and development federal tax credits and state tax apportionment issues based on management’s judgment and latest information available. The Company does not expect any changes in unrecognized tax benefits to have a material impact on its consolidated financial statements within the next 12 months.

The Company and its subsidiaries file income tax returns with the Internal Revenue Service and the taxing authorities of various states. Tax years that remain subject to examination by major taxing jurisdictions are 2016 through 2018 for federal taxes and 2011 through 2018 for California state taxes. For tax years 2003 through 2010, the Company achieved a resolution with the California Franchise Tax Board (“FTB”) in December 2017 and paid a $4.6 million negotiated settlement amount in accordance with the settlement agreement provided by the FTB and signed by the Company. The settlement agreement was approved by the California attorney general in 2018. The Company believes that resolution of tax years 2003 through 2010 has the potential to establish guidance for future audit assessments proposed by the FTB for future tax years.

The Company is currently under examination by the FTB for tax years 2011 through 2016. For tax years 2011 through 2013, the FTB issued Notices of Proposed Assessments ("NPAs") to the Company, for which the Company submitted a formal protest in 2018. If a reasonable settlement is not reached, the Company intends to pursue other options, including a formal hearing with the FTB, an appeal with the California Office of Tax Appeals, or litigation in Superior Court. For tax years 2014 through 2016, the Company received Audit Issue Presentation Sheets (“AIPS”) related to the Company’s California apportionment factor. The Company accepted the proposed adjustments in December 2019.

The Company believes that the resolution of these examinations and assessments will not have a material impact on the consolidated financial statements.

The following table presents a reconciliation of the beginning and ending balances of unrecognized tax benefits:



	December 31,
	2019			2018
	(Amounts in thousands)
Balance at January 1	$	10,615		$	9,674
Additions (reductions) based on tax positions related to:
Current year	—			662
Prior years	(4,564		)	279
Balance at December 31	$	6,051		$	10,615

If unrecognized tax benefits were recognized, $7.2 million and $11.5 million, including accrued interest, penalties and federal tax benefit related to unrecognized tax benefits, would impact the Company’s effective tax rate at December 31, 2019 and 2018, respectively.

The Company recognizes interest and penalties related to unrecognized tax benefits as a part of income taxes. The Company recognized an accrued net expense (benefit) related to interest and penalty of approximately $(0.1) million, $0.5 million, and $(1.1) million for the years ended December 31, 2019, 2018 and 2017, respectively. The net benefit for the years ended 2019 and 2017 is largely due to reversal of accrued interest and penalty following the recent updates from the FTB for tax years 2014 through 2016, and the settlement with the FTB for tax years 2003 through 2010, respectively. The Company carried an accrued interest and penalty balance of approximately $2.8 million and $2.9 million at December 31, 2019 and 2018, respectively.

12. Loss and Loss Adjustment Expense Reserves

The following table presents the activity in loss and loss adjustment expense reserves:



	Year Ended December 31,
	2019			2018			2017
	(Amounts in thousands)
Gross reserves at January 1	$	1,829,412		$	1,510,613		$	1,290,248
Less reinsurance recoverables on unpaid losses	(180,859		)	(64,001		)	(13,161		)
Net reserves at January 1	1,648,553			1,446,612			1,277,087
Incurred losses and loss adjustment expenses related to:
Current year	2,696,230			2,483,693			2,390,453
Prior years	9,794			93,096			54,431
Total incurred losses and loss adjustment expenses	2,706,024			2,576,789			2,444,884
Loss and loss adjustment expense payments related to:
Current year	1,651,550			1,543,828			1,550,789
Prior years	857,872			831,020			724,570
Total payments	2,509,422			2,374,848			2,275,359
Net reserves at December 31	1,845,155			1,648,553			1,446,612
Reinsurance recoverables on unpaid losses	76,100			180,859			64,001
Gross reserves at December 31	$	1,921,255		$	1,829,412		$	1,510,613

The increase in the provision for insured events of prior years in 2017 of approximately $54.4 million primarily resulted from higher than estimated losses in California automobile and property lines, which experienced higher loss severity on liability coverages including bodily injury and property damage and higher loss adjustment expenses than previously estimated.

The Company recorded catastrophe losses net of reinsurance of approximately $53 million, $67 million, and $79 million in 2019, 2018, and 2017, respectively. Catastrophe losses due to the catastrophe events that occurred in 2019 totaled approximately $57 million, with no reinsurance benefits used for these losses, resulting primarily from wildfires and winter storms in California, a hurricane in Texas, and tornadoes and wind and hail storms in the Midwest. These losses were partially offset by favorable development of approximately $4 million on prior years' catastrophe losses, primarily from reductions in the Company's retained portion of losses on the Camp and Woolsey Fires, as described further below. Catastrophe losses before reinsurance benefits totaled approximately $289 million in 2018, primarily resulting from wildfires in Northern and Southern California and weather-related catastrophes across several states. Catastrophe losses before reinsurance benefits totaled approximately $168 million in 2017, resulting primarily from wildfires in Northern and Southern California, severe rainstorms in California, and the impact of hurricanes in Texas, Florida and Georgia.

During the first quarter of 2019, the Company completed the sale of its subrogation rights related to the 2018 Camp and Woolsey Fires and the 2017 Thomas Fire (which was a component of the "2017 Southern California fires") to a third party. The Company’s reinsurers were the primary beneficiaries of this transaction, as they had absorbed most of the losses under the terms of the Treaty. The Company re-estimated its gross and net losses from the 2018 Camp and Woolsey Fires and the 2017 Southern California fires in conjunction with this sale, and its total gross losses from these catastrophes, after accounting for the assignment of subrogation rights and adjustments made to claims reserves as part of normal reserving procedures, were approximately $208 million, and its total net losses, after reinsurance benefits, were approximately $40 million at March 31, 2019. The Company benefited by approximately $10 million, before taxes, in the first quarter of 2019 from the sale of the subrogation rights, including adjustments made to the associated claims as a result of normal reserving procedures, reductions in the Company's retained portion of losses on the Camp and Woolsey Fires, and reduced reinstatement premiums recognized.

The following is information about incurred and paid claims development as of December 31, 2019, net of reinsurance, as well as cumulative claim frequency and the total of incurred-but-not-reported liabilities plus expected development on reported claims included within the net incurred claims amounts for our two major product lines: automobile and homeowners lines of business. As the information presented is for these two major product lines only, the total incurred and paid claims development shown below does not correspond to the aggregate development presented in the table above, which is for all product lines and includes unallocated claims adjustment expenses. The cumulative number of reported claims represents open claims, claims closed with payment, and claims closed without payment. It does not include an estimated amount for unreported claims. The number of claims is measured by claim event (such as a car accident or storm damage) and an individual claim event may result in more than one reported claim. The Company considers a claim that does not result in a liability as a claim closed without payment.

The information about incurred and paid claims development for the years ended December 31, 2010 to 2018 is presented as unaudited supplementary information.



Incurred Losses and Allocated Loss Adjustment Expenses, Net of Reinsurance (Automobile Insurance)																					As of December 31, 2019
																					Total of Incurred But Not Reported Liabilities Plus Expected Development on Reported Claims		Cumulative Number of Reported Claims
Accident Year	For the Years Ended December 31,
Accident Year	2010⁽¹⁾		2011⁽¹⁾		2012⁽¹⁾		2013⁽¹⁾		2014⁽¹⁾		2015⁽¹⁾		2016⁽¹⁾		2017⁽¹⁾		2018⁽¹⁾		2019
	(Amounts in thousands)																				(Amounts in thousands)
2010	$	1,367,547	$	1,357,750	$	1,364,307	$	1,374,638	$	1,379,336	$	1,381,056	$	1,386,105	$	1,388,077	$	1,388,055	$	1,388,086	$	43	184
2011			1,343,919		1,367,000		1,380,557		1,388,363		1,393,878		1,398,518		1,405,112		1,401,178		1,401,151		73		181
2012					1,424,754		1,408,222		1,409,104		1,414,878		1,426,735		1,436,034		1,438,250		1,439,660		493		181
2013							1,448,567		1,431,058		1,447,881		1,458,421		1,464,071		1,468,294		1,468,237		1,149		185
2014									1,467,175		1,454,366		1,473,545		1,486,322		1,498,504		1,501,075		3,469		180
2015											1,551,105		1,588,443		1,610,839		1,634,435		1,645,950		9,132		170
2016													1,672,853		1,669,642		1,713,696		1,731,997		22,097		154
2017															1,703,857		1,727,277		1,741,825		58,648		149
2018																	1,781,817		1,773,502		139,022		146
2019																			1,916,269		438,858		140
																	Total		$	16,007,752

__________

⁽¹⁾The information for the years 2010 to 2018 is presented as unaudited supplemental information.



Cumulative Paid Losses and Allocated Loss Adjustment Expenses, Net of Reinsurance (Automobile Insurance)
	For the Years Ended December 31,
Accident Year	2010⁽¹⁾		2011⁽¹⁾		2012⁽¹⁾		2013⁽¹⁾		2014⁽¹⁾		2015⁽¹⁾		2016⁽¹⁾		2017⁽¹⁾		2018⁽¹⁾		2019
	(Amounts in thousands)
2010	$	908,954	$	1,143,984	$	1,268,142	$	1,335,871	$	1,365,464	$	1,375,799	$	1,384,333	$	1,387,835	$	1,388,140	$	1,388,322
2011			926,983		1,152,459		1,277,808		1,347,082		1,378,920		1,391,101		1,394,684		1,400,441		1,400,958
2012					955,647		1,194,648		1,304,511		1,372,828		1,409,911		1,422,705		1,434,956		1,438,686
2013							974,445		1,217,906		1,340,724		1,413,999		1,447,004		1,460,352		1,464,277
2014									967,481		1,231,413		1,358,472		1,432,472		1,476,944		1,490,366
2015											1,040,253		1,336,223		1,466,368		1,560,480		1,614,188
2016													1,094,006		1,395,199		1,554,217		1,656,192
2017															1,076,079		1,399,202		1,561,850
2018																	1,082,127		1,417,637
2019																			1,134,859
																	Total		$	14,567,335
							All outstanding liabilities before 2010, net of reinsurance												(557		)
							Loss and allocated loss adjustment expense reserves, net of reinsurance												$	1,439,861

__________

⁽¹⁾The information for the years 2010 to 2018 is presented as unaudited supplemental information.



Incurred Losses and Allocated Loss Adjustment Expenses, Net of Reinsurance (Homeowners' Insurance)																					As of December 31, 2019
																					Total of Incurred But Not Reported Liabilities Plus Expected Development on Reported Claims		Cumulative Number of Reported Claims
Accident Year	For the Years Ended December 31,
Accident Year	2010⁽¹⁾		2011⁽¹⁾		2012⁽¹⁾		2013⁽¹⁾		2014⁽¹⁾		2015⁽¹⁾		2016⁽¹⁾		2017⁽¹⁾		2018⁽¹⁾		2019
	(Amounts in thousands)																				(Amounts in thousands)
2010	$	165,727	$	157,566	$	160,983	$	160,472	$	160,206	$	160,015	$	159,608	$	159,662	$	159,720	$	159,652	$	1	21
2011			167,414		170,623		170,052		169,600		169,390		169,621		170,126		170,334		170,174		75		23
2012					196,063		188,010		190,376		191,548		192,057		191,804		192,905		192,790		6		25
2013							191,903		188,915		188,026		186,795		187,165		188,014		187,147		42		23
2014									199,298		202,621		203,218		202,513		204,986		208,003		3,259		25
2015											234,800		234,881		233,501		236,855		238,652		1,978		24
2016													250,691		259,489		259,497		259,708		2,092		24
2017															309,491		295,163		288,322		4,310		30
2018																	311,798		308,361		15,686		25
2019																			359,643		64,136		28
																	Total		$	2,372,452

__________

⁽¹⁾The information for the years 2010 to 2018 is presented as unaudited supplemental information.



Cumulative Paid Losses and Allocated Loss Adjustment Expenses, Net of Reinsurance (Homeowners' Insurance)
	For the Years Ended December 31,
Accident Year	2010⁽¹⁾		2011⁽¹⁾		2012⁽¹⁾		2013⁽¹⁾		2014⁽¹⁾		2015⁽¹⁾		2016⁽¹⁾		2017⁽¹⁾		2018⁽¹⁾		2019
	(Amounts in thousands)
2010	$	95,057	$	137,628	$	149,084	$	155,191	$	156,853	$	158,053	$	158,943	$	159,268	$	159,435	$	159,491
2011			111,909		153,845		162,870		166,375		167,806		168,621		168,914		169,757		169,899
2012					128,618		175,029		182,756		188,121		190,373		190,649		191,660		192,362
2013							133,528		174,295		180,858		183,860		185,168		186,132		186,494
2014									139,615		186,996		194,605		198,758		202,193		203,333
2015											163,196		213,994		224,178		230,480		234,683
2016													173,537		234,215		245,878		253,919
2017															217,900		269,254		278,341
2018																	213,038		271,534
2019																			240,240
																	Total		$	2,190,296
							All outstanding liabilities before 2010, net of reinsurance												576
							Loss and allocated loss adjustment expense reserves, net of reinsurance												$	182,731

__________

⁽¹⁾The information for the years 2010 to 2018 is presented as unaudited supplemental information.

The following is unaudited supplementary information about average historical claims duration as of December 31, 2019.



Average Annual Percentage Payout of Incurred Claims by Age, Net of Reinsurance

Years	1		2		3		4		5		6		7		8		9		10
Automobile insurance	63.6	%	17.4	%	8.6	%	5.2	%	2.6	%	0.9	%	0.5	%	0.3	%	0.9	%	—	%



Average Annual Percentage Payout of Incurred Claims by Age, Net of Reinsurance

Years	1		2		3		4		5		6		7		8		9		10
Homeowners insurance	67.6	%	22.4	%	4.4	%	2.6	%	1.2	%	0.5	%	0.4	%	0.4	%	0.5	%	—	%

The reconciliation of the net incurred and paid claims development tables to the liability for claims and claim adjustment expenses in the consolidated balance sheets is as follows:

Reconciliation of the Disclosure of Incurred and Paid Claims Development

to the Loss and Loss Adjustment Expense Reserves



	December 31, 2019
	(Amounts in thousands)
Net outstanding liabilities
Automobile insurance	$	1,439,861
Homeowners' insurance	182,731
WAIC automobile insurance	16,576
Other short-duration insurance lines	106,002
Loss and loss adjustment expense reserves, net of reinsurance recoverables on unpaid losses	1,745,170
Reinsurance recoverables on unpaid losses
Automobile insurance	22,060
Homeowners' insurance	52,317
Other short-duration insurance lines	1,723
Total reinsurance recoverables on unpaid losses	76,100
Insurance lines other than short-duration	629
Unallocated claims adjustment expenses	99,356
	99,985
Total gross loss and loss adjustment expense reserves	$	1,921,255

13. Dividends

The following table presents shareholder dividends paid:



	Year Ended December 31,
	2019		2018		2017
	(Amounts in thousands, except per share data)
Total paid	$	139,071	$	138,478	$	137,886
Per share paid	$	2.5125	$	2.5025	$	2.4925

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. As of December 31, 2019, the insurance subsidiaries of the Company are permitted to pay approximately $151 million in dividends in 2020 to Mercury General without the prior approval of the DOI of domiciliary states. The above statutory regulations may have the effect of indirectly limiting the ability of the Company to pay shareholder dividends. During 2019, 2018, and 2017, the Insurance Companies paid Mercury General ordinary dividends of $114 million, $135 million, and $109 million, respectively.

On February 7, 2020, the Board of Directors declared a $0.6300 quarterly dividend payable on March 31, 2020 to shareholders of record on March 17, 2020.

14. Statutory Balances and Accounting Practices

The Insurance Companies prepare their statutory-basis financial statements in conformity with accounting practices prescribed or permitted by the insurance departments of their domiciliary states. Prescribed statutory accounting practices primarily include those published as statements of statutory accounting principles by the National Association of Insurance Commissioners

(the "NAIC"), as well as state laws, regulations, and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. As of December 31, 2019, there were no material permitted statutory accounting practices utilized by the Insurance Companies.

The following table presents the statutory net income, and statutory capital and surplus of the Insurance Companies, as reported to regulatory authorities:



	Year Ended December 31,
	2019		2018		2017
	(Amounts in thousands)
Statutory net income⁽¹⁾	$	135,670	$	81,935	$	117,376
Statutory capital and surplus	$	1,539,998	$	1,471,547	$	1,589,226

__________


⁽¹⁾	Statutory net income reflects differences from GAAP net income, including changes in the fair value of the investment portfolio as a result of the application of the fair value option.

15. Profit Sharing Plan and Annual Cash Bonuses

The Company’s employees are eligible to become members of the Profit Sharing Plan (the "Plan"). The Company, at the option of the Board of Directors, may make annual contributions to the Plan, and the contributions are not to exceed the greater of the Company’s net income for the plan year or its retained earnings at that date. In addition, the annual contributions may not exceed an amount equal to 15% of the compensation paid or accrued during the year to all participants under the Plan. No contributions were made in the past three years.

The Plan includes an option for employees to make salary deferrals under Section 401(k) of the Internal Revenue Code. The matching contributions, at a rate set by the Board of Directors, totaled $9.9 million, $9.0 million, and $8.6 million for 2019, 2018, and 2017, respectively.

The Plan also includes an employee stock ownership plan that covers substantially all employees. The Board of Directors authorizes the Plan to purchase the Company’s common stock in the open market for allocation to the Plan participants. No purchases were made during the past three years.

The Company also provides company-wide annual cash bonuses to all eligible employees based on performance criteria for each recipient and for the Company as a whole. The Company performance goals were based on the Company's premium growth and combined ratio. The Company did not pay any company-wide annual cash bonuses to all eligible employees in 2019, 2018, and 2017.

16. Share-Based Compensation

In February 2015, the Company adopted the 2015 Incentive Award Plan (the "2015 Plan"), replacing the 2005 Equity Incentive Plan (the "2005 Plan") which expired in January 2015. The 2015 Plan was approved at the Company's Annual Meeting of Shareholders in May 2015. A maximum of 4,900,000 shares of common stock under the 2015 Plan are authorized for issuance upon exercise of stock options, stock appreciation rights and other awards, or upon vesting of RSU or deferred stock awards. As of December 31, 2019, the Company had 70,000 stock options granted and outstanding and 4,830,000 shares of common stock available for future grant under the 2015 Plan.

The following table presents a summary of cash received, compensation costs recognized and excess tax expense (benefit), related to the Company's share-based awards:



	Year Ended December 31,
	2019			2018		2017
	(Amounts in thousands)
Cash received from stock option exercises	$	701		$	358	$	2,162
Compensation cost, all share-based awards	123			145		60
Excess tax (benefit) expense, all share-based awards	(7		)	4		8

Stock Option Awards

Stock option awards become exercisable at a rate of 25% per year beginning one year from the date granted, are granted at the closing price of the Company's stock on the date of grant, and expire after 10 years.

In February 2018, the Compensation Committee of the Company's Board of Directors awarded a total of 80,000 stock options to four senior executives under the 2015 Plan which will vest over the four-year requisite service period. 10,000 of these stock options were forfeited in February 2019 following the departure of a senior executive. The fair values of these stock options were estimated on the date of grant using a closed-form option valuation model (Black-Scholes). No stock options were awarded in 2019 and 2017 under the 2015 Plan.

The following table provides the assumptions used in the calculation of grant-date fair values of these stock options based on the Black-Scholes option pricing model:



Weighted-average grant-date fair value	$	8.09
Expected volatility	33.18		%
Risk-free interest rate	2.62		%
Expected dividend yield	5.40		%
Expected term in months	72

Expected volatility is based on historical volatility of the Company’s stock over the term of the stock options. The Company estimated the expected term of stock options, which represents the period of time that stock options granted are expected to be outstanding, by using historical exercise patterns and post-vesting termination behavior. The risk free interest rate is determined based on U.S. Treasury yields with equivalent remaining terms in effect at the time of the grant.

The following table presents a summary of the stock option activity for the year ended December 31, 2019:



	Shares		Weighted-Average Exercise Price		Weighted-Average Remaining Contractual Term (Years)	Aggregate Intrinsic Value (in 000’s)
Outstanding at January 1, 2019	99,500		$	42.77
Exercised	(22,000	)	$	41.92
Canceled or expired	(10,000	)	$	43.01
Outstanding at December 31, 2019	67,500		$	43.01	8.1	$	376
Exercisable at December 31, 2019	15,000		$	43.01	8.1	$	84

The aggregate intrinsic values in the table above represent the total pre-tax intrinsic value (the difference between the Company’s closing stock price and the stock option exercise price, multiplied by the number of in-the-money stock options) that would have been received by the stock option holders had all stock options been exercised on December 31, 2019. The aggregate intrinsic values of stock options exercised were $217,064, $42,000, and $371,000 for 2019, 2018, and 2017, respectively. The total fair value of stock options vested during 2019, 2018, and 2017 was $141,584, $0, and $142,000, respectively.

The following table presents information regarding stock options outstanding at December 31, 2019:



	Options Outstanding				Options Exercisable
Range of Exercise Prices	Number of Options	Weighted-Average Remaining Contractual Life (Years)	Weighted- Average Exercise Price		Number of Options	Weighted- Average Exercise Price
$43.01	67,500	8.1	$	43.01	15,000	$	43.01

As of December 31, 2019, the Company had $0.3 million of unrecognized compensation expense related to stock options awarded under the 2015 Plan, which will be recognized ratably over the remaining vesting period of approximately 2.1 years.

Restricted Stock Unit Awards

Under the 2015 Plan and 2005 Plan, the Compensation Committee of the Company’s Board of Directors granted performance-based vesting RSU awards to the Company’s senior management and key employees prior to 2017. No RSUs were awarded in 2019, 2018, and 2017 under the 2015 Plan.

The following table presents a summary of RSU awards activity, based on target vesting, during the years indicated:



	Year Ended December 31,
	2019				2018				2017
	Shares		Weighted- Average Fair Value per Share		Shares		Weighted- Average Fair Value per Share		Shares		Weighted- Average Fair Value per Share
Outstanding at January 1	75,250		$	53.49	169,000		$	53.66	271,000		$	51.09
Vested	—		$	—	—		$	—	(82,000	)	$	45.17
Forfeited/Canceled	(6,000	)	$	53.49	(8,000	)	$	53.49	(20,000	)	$	53.62
Expired	(69,250	)	$	53.49	(85,750	)	$	53.80	—		$	—
Outstanding at December 31	—		$	—	75,250		$	53.49	169,000		$	53.66

The RSU awards vested at the end of a three-year performance period beginning with the year of the grant, and then only if, and to the extent that, the Company’s performance during the performance period achieved the threshold established by the Compensation Committee of the Company’s Board of Directors. Performance thresholds were based on the Company’s cumulative underwriting income, annual underwriting income, and net earned premium growth. Shares were forfeited or canceled when employees were no longer employed by the Company. Expired shares represent shares that did not meet the vesting requirements.

The fair value of each RSU grant was determined based on the closing price of the Company's common stock on the grant date for awards classified as equity and on each reporting date for awards classified as a liability. Compensation cost is recognized based on management’s best estimate of the performance goals that will be achieved. If the minimum performance goals are not met, no compensation cost will be recognized and any recognized compensation cost would be reversed.

In February 2019, based on certification by the Compensation Committee of the Company's Board of Directors of the results of the three-year performance period ended December 31, 2018, all of the outstanding RSUs granted in 2016 expired unvested because the Company did not meet the minimum three-year performance threshold.

In March 2018, based on certification by the Compensation Committee of the Company's Board of Directors of the results of the three-year performance period ended December 31, 2017, all of the outstanding RSUs granted in 2015 expired unvested because the Company did not meet the minimum three-year performance threshold.

In March 2017, a total of approximately $3.6 million was paid upon vesting of 61,445 RSUs awarded in 2014 resulting from the attainment of performance goals above the target threshold during the three-year performance period ended December 31, 2016.

At December 31, 2016, the Company determined that it was probable that the Company's Board of Directors would modify the payment method for the vested 2014 grant awards and pay for the vested awards in cash in lieu of shares of the Company's common stock. As a result, the 2014 grants were reclassified from equity to liability awards at December 31, 2016. $3.4 million of the amount previously recognized in additional paid-in capital for the 2014 grant awards was reclassified to other liabilities in

the consolidated balance sheets at December 31, 2016. Additional $0.2 million was reclassified from additional paid-in capital to other liabilities at the vesting date of February 28, 2017 for the 2014 grant awards, based on the additional amount of awards vested from December 31, 2016 to the vesting date.

17. Earnings Per Share

The following table presents a reconciliation of the numerators and denominators of the basic and diluted earnings per share calculations:



	Year Ended December 31,
	2019					2018							2017
	Income (Numerator)		Weighted Shares (Denominator)	Per-Share Amount		Loss (Numerator)			Weighted Shares (Denominator)	Per-Share Amount			Income (Numerator)		Weighted Shares (Denominator)	Per-Share Amount
	(Amounts and numbers in thousands, except per-share data)
Basic EPS
Income (loss) available to common stockholders	$	320,087	55,351	$	5.78	$	(5,728	)	55,335	$	(0.10	)	$	144,877	55,316	$	2.62
Effect of dilutive securities:
Options	—		9			—			—				—		11
Diluted EPS
Income (loss) available to common stockholders after assumed conversions	$	320,087	55,360	$	5.78	$	(5,728	)	55,335	$	(0.10	)	$	144,877	55,327	$	2.62

Potentially dilutive securities representing approximately 0, 78,500, and 0 shares of common stock for 2019, 2018, and 2017, respectively, were excluded from the computation of diluted earnings (loss) per common share because their effect would have been anti-dilutive. For the year ended December 31, 2018, the dilutive impact of incremental shares was excluded as the Company generated a net loss.

18. Commitments and Contingencies

Operating Leases

The Company is obligated under various non-cancellable lease agreements providing for office space, automobiles, and office equipment that expire at various dates through the year 2028. See Note 7. Leases for additional information on leases and future lease payments for operating leases as of December 31, 2019.

California Earthquake Authority ("CEA")

The CEA is a quasi-governmental organization that was established to provide a market for earthquake coverage to California homeowners. The Company places all new and renewal earthquake coverage offered with its homeowners policies directly with the CEA. The Company receives a small fee for placing business with the CEA, which is recorded as other income in the consolidated statements of operations. 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 3, 2019, the most recent date at which information was available, was approximately $73.8 million. There was no assessment made in 2019.

Regulatory Matters

and accusation, and (b) the California DOI’s notice of noncompliance (the “NNC”), in which the California DOI asserts the unlawful rate allegations. In February 2012, the administrative law judge (“ALJ”) submitted a proposed decision dismissing the NNC, but the Commissioner rejected the ALJ’s proposed decision. The Company challenged the rejection in Los Angeles Superior Court in April 2012, and the Commissioner responded with a demurrer. Following a hearing, the Superior Court sustained the Commissioner’s demurrer, based on the Company’s failure to exhaust its administrative remedies, and the Company appealed. The Court of Appeal affirmed the Superior Court's ruling that the Company was required to exhaust its administrative remedies, but expressly preserved for later appeal the legal basis for the ALJ’s dismissal: violation of the Company’s due process rights. Following an evidentiary hearing in April 2013, post-hearing briefs, and an unsuccessful mediation, the ALJ closed the evidentiary record on April 30, 2014. Although a proposed decision was to be submitted to the Commissioner on or before June 30, 2014, after which the Commissioner would have 100 days to accept, reject or modify the proposed decision, the proposed decision was not submitted until December 8, 2014. On January 7, 2015, the Commissioner adopted the ALJ’s proposed decision, which became the Commissioner’s adopted order (the "Order"). The decision and Order found that from the period July 1, 1996, through 2006, the Company’s "brokers" were actually operating as "de facto agents" and that the charging of "broker fees" by these producers constituted the charging of "premium" in excess of the Company's approved rates, and assessed a civil penalty in the amount of $27.6 million against the Company. On February 9, 2015, the Company filed a Writ of Administrative Mandamus and Complaint for Declaratory Relief (the “Writ”) in the Orange County Superior Court seeking, among other things, to require the Commissioner to vacate the Order, to stay the Order while the Superior Court action is pending, and to judicially declare as invalid the Commissioner’s interpretation of certain provisions of the California Insurance Code. Subsequent to the filing of the Writ, a consumer group petitioned and was granted the right to intervene in the Superior Court action. The Court did not order a stay, and the $27.6 million assessed penalty was paid in March 2015. The Company filed an amended Writ on September 11, 2015, adding an explicit request for a refund of the penalty, with interest.

On August 12, 2016, the Superior Court issued its ruling on the Writ, for the most part granting the relief sought by the Company. The Superior Court found that the Commissioner and the California DOI did commit due process violations, but declined to dismiss the case on those grounds. The Superior Court also agreed with the Company that the broker fees at issue were not premium, and that the penalties imposed by the Commissioner were improper, and therefore vacated the Order imposing the penalty. The Superior Court entered final judgment on November 17, 2016, issuing a writ requiring the Commissioner to refund the entire penalty amount within 120 days, plus prejudgment interest at the statutory rate of 7%. On January 12, 2017, the California DOI filed a notice of appeal of the Superior Court's judgment. While the appeal was pending, the California DOI returned the entire penalty amount plus accrued interest, a total of $30.9 million, to the Company in June 2017 in order to avoid accruing further interest. Because the matter had not been settled or otherwise finally resolved at the time, the Company did not recognize the $30.9 million as a gain in the consolidated statements of operations; instead, it recorded the $30.9 million plus interest earned in other liabilities in the consolidated balance sheets. The Company had filed a motion to dismiss the false advertising portion of the case based on the Superior Court's findings, but the ALJ denied that motion after the appeal was filed. The ALJ did, however, grant the Company's alternative request to stay further proceedings pending the final determination of the appeal. On May 7, 2019, the California Court of Appeal issued its decision reversing the Superior Court’s original judgment and directing the Superior Court to enter a new judgment in favor of the California DOI. The Company filed a petition for rehearing, which was denied, and subsequently filed a petition for review in the Supreme Court of California. Based on the decision of the California Court of Appeal, the Company accrued approximately $3 million in the second quarter of 2019, which represented an estimated amount of statutory interest the Company might be ordered to pay beyond the actual interest it had earned on the $30.9 million. The California Supreme Court denied the Company's petition for review on August 14, 2019, and the Commissioner's Order became final. On August 30, 2019, the Company paid approximately $35 million to the California DOI, which consisted of the $30.9 million received from the California DOI in June 2017 plus statutory interest.

On October 1, 2019, the Company and the California DOI entered into a settlement agreement resolving the case involving the 2004 NNC, along with the related false advertising action that had been stayed pending the outcome of that case. Pursuant to the settlement agreement, the Company paid an additional amount of approximately $6 million to the California DOI on October 2, 2019, bringing the total settlement amount to approximately $41.2 million, in full settlement of the entire case including the false advertising action; the Company has not admitted to any allegations raised in the case. As a result of the settlement, the Company recognized approximately $6 million of incremental expense in its consolidated statements of operations in the third quarter of 2019 relating to the settlement.

Litigation

In all cases, the Company vigorously defends itself unless a reasonable settlement appears appropriate.

The Company is also involved in proceedings relating to assessments and rulings made by the FTB. See Note 11. Income Taxes.

There are no environmental proceedings arising under federal, state, or local laws or regulations to be discussed.

19. Quarterly Financial Information (Unaudited)

The following table presents summarized quarterly financial data for 2019 and 2018:



	Quarter Ended
	March 31			June 30		September 30			December 31
	(Amounts in thousands, except per share data)
2019
Net premiums earned	$	870,245		$	888,776	$	915,012		$	925,384
Change in fair value of financial instruments pursuant to the fair value option	104,227			50,281		24,021			18,173
Income before income taxes	167,169			101,595		80,840			28,465
Net income	135,867			83,250		69,282			31,688
Basic earnings per share	2.46			1.50		1.25			0.57
Diluted earnings per share	2.45			1.50		1.25			0.57
Dividends paid per share	0.6275			0.6275		0.6275			0.6300

2018
Net premiums earned	$	808,084		$	833,959	$	858,135		$	868,233
Change in fair value of financial instruments pursuant to the fair value option	(58,532		)	8,793		(12,907		)	(70,020		)
(Loss) income before income taxes	(59,699		)	73,246		70,286			(114,448		)
Net (loss) income	(42,607		)	60,180		58,578			(81,879		)
Basic (loss) earnings per share	(0.77		)	1.09		1.06			(1.48		)
Diluted (loss) earnings per share	(0.77		)	1.09		1.06			(1.48		)
Dividends paid per share	0.6250			0.6250		0.6250			0.6275

Net income for 2019 was primarily attributable to net premiums earned, net realized investment gains, partially offset by operating expenses and losses and loss adjustment expenses, including catastrophe losses and unfavorable development on prior accident years' loss and loss adjustment expense reserves. The primary causes of the net income for the fourth quarter of 2019 were the increases in the fair values of the Company’s fixed maturity and equity securities due to decreases in market interest rates and the overall improvement in equity markets.

Net income for 2018 was primarily attributable to net premiums earned, net investment income and income tax benefit on pre-tax loss, partially offset by net realized investment losses, operating expenses and losses and loss adjustment expenses, including catastrophe losses and unfavorable development on prior accident years' loss and loss adjustment expense reserves. The primary causes of the net loss for the fourth quarter of 2018 were the decreases in the fair values of the Company’s fixed maturity and equity securities due to the rising market interest rates and the overall decline in equity markets.

20. Segment Information

The Company is primarily engaged in writing personal automobile insurance and provides related property and casualty insurance products to its customers through 14 subsidiaries in 11 states, principally in California.

The Company has one reportable business segment - the Property and Casualty business segment.

The Company’s Chief Operating Decision Maker evaluates operating results based on pre-tax underwriting results which is calculated as net premiums earned less (a) losses and loss adjustment expenses and (b) underwriting expenses (policy acquisition costs and other operating expenses).

Expenses are allocated based on certain assumptions that are primarily related to premiums and losses. The Company’s net investment income, net realized investment gains (losses), other income, and interest expense are excluded in evaluating pre-tax underwriting profit. The Company does not allocate its assets, including investments, or income taxes in evaluating pre-tax underwriting profit.

Property and Casualty Lines

The Property and Casualty business segment offers several insurance products to the Company’s individual customers and small business customers. These insurance products are: private passenger automobile, which is the Company’s primary business, and related insurance products such as homeowners, commercial automobile and commercial property. These insurance products are primarily sold to the Company’s individual customers and small business customers, which increases retention of the Company’s private personal automobile client base. The insurance products comprising the Property and Casualty business segment are sold through the same distribution channels, mainly through independent and 100% owned insurance agents, and go through a similar underwriting process.

Other Lines

The Other business segment represents net premiums written and earned from an operating segment that does not meet the quantitative thresholds required to be considered a reportable segment. This operating segment offers automobile mechanical protection warranties which are primarily sold through automobile dealerships and credit unions.

The following table presents operating results by reportable segment for the years ended:



	Year Ended December 31,
	2019							2018								2017
	Property & Casualty		Other		Total			Property & Casualty			Other		Total			Property & Casualty			Other		Total
	(Amounts in millions)
Net premiums earned	$	3,571.0	$	28.4	$	3,599.4		$	3,337.9		$	30.5	$	3,368.4		$	3,160.9		$	34.5	$	3,195.4
Less:
Losses and loss adjustment expenses	2,692.7		13.3		2,706.0			2,562.0			14.8		2,576.8			2,427.8			17.1		2,444.9
Underwriting expenses	857.3		14.1		871.4			802.7			14.1		816.8			773.1			15.6		788.7
Underwriting gain (loss)	21.0		1.0		22.0			(26.8		)	1.6		(25.2		)	(40.0		)	1.8		(38.2		)
Investment income					141.3								135.8								124.9
Net realized investment gains (losses)					222.8								(133.5		)						83.7
Other income					9.0								9.3								11.9
Interest expense					(17.0		)						(17.0		)						(15.2		)
Pre-tax income (loss)					$	378.1							$	(30.6	)						$	167.1
Net income (loss)					$	320.1							$	(5.7	)						$	144.9

The following table presents the Company’s net premiums earned and direct premiums written by line of insurance business for the years ended:



	Year Ended December 31,
	2019						2018						2017
	Property & Casualty		Other		Total		Property & Casualty		Other		Total		Property & Casualty		Other		Total
	(Amounts in millions)
Private passenger automobile	$	2,756.5	$	—	$	2,756.5	$	2,602.1	$	—	$	2,602.1	$	2,473.8	$	—	$	2,473.8
Homeowners	514.8		—		514.8		459.4		—		459.4		431.6		—		431.6
Commercial automobile	208.7		—		208.7		190.1		—		190.1		171.9		—		171.9
Other	91.0		28.4		119.4		86.3		30.5		116.8		83.6		34.5		118.1
Net premiums earned	$	3,571.0	$	28.4	$	3,599.4	$	3,337.9	$	30.5	$	3,368.4	$	3,160.9	$	34.5	$	3,195.4

Private passenger automobile	$	2,820.5	$	—	$	2,820.5	$	2,703.6	$	—	$	2,703.6	$	2,480.0	$	—	$	2,480.0
Homeowners	598.5		—		598.5		524.9		—		524.9		469.9		—		469.9
Commercial automobile	217.3		—		217.3		198.5		—		198.5		178.2		—		178.2
Other	106.3		32.0		138.3		97.2		26.7		123.9		92.9		27.9		120.8
Direct premiums written	$	3,742.6	$	32.0	$	3,774.6	$	3,524.2	$	26.7	$	3,550.9	$	3,221.0	$	27.9	$	3,248.9


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

None


Item 9A.	Controls and Procedures

Evaluation of Disclosure Controls and Procedures

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

As required by Securities and Exchange Commission Rule 13a-15(b), the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the period covered by this Annual Report on Form 10-K. Based on the foregoing, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective at the reasonable assurance level.

Management’s Report on Internal Control Over Financial Reporting

The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control system was designed to provide reasonable assurance to the Company’s management and Board of Directors regarding the preparation and fair presentation of published financial statements.

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2019. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework (2013). Based upon its assessment, the Company’s management believes that, as of December 31, 2019, the Company’s internal control over financial reporting is effective based on these criteria.

KPMG LLP, the independent registered public accounting firm that audited the consolidated financial statements included in this 2019 Annual Report on Form 10-K, has issued an audit report on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2019, which is included herein.

Changes in Internal Control over Financial Reporting

There has been no change in the Company’s internal control over financial reporting during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. The Company’s process for evaluating controls and procedures is continuous and encompasses constant improvement of the design and effectiveness of established controls and procedures and the remediation of any deficiencies which may be identified during this process.


Item 9B.	Other Information

None

PART III


Item 10.	Directors, Executive Officers, and Corporate Governance


Item 11.	Executive Compensation


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


Item 13.	Certain Relationships and Related Transactions, and Director Independence


Item 14.	Principal Accounting Fees and Services

Information regarding executive officers of the Company is included in Part I. For other information called for by Items 10, 11, 12, 13 and 14, reference is made to the Company’s definitive proxy statement for its Annual Meeting of Shareholders, which will be filed with the SEC within 120 days after December 31, 2019 and which is incorporated herein by reference.

PART IV


Item 15.	Exhibits and Financial Statement Schedules

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

1. Financial Statements: The Consolidated Financial Statements for the year ended December 31, 2019 are contained herein as listed in the Index to Consolidated Financial Statements on page 52.

2. Financial Statement Schedules:

Report of Independent Registered Public Accounting Firm

Schedule I—Summary of Investments—Other than Investments in Related Parties

Schedule II—Condensed Financial Information of Registrant

Schedule IV—Reinsurance

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

3. Exhibits



Form 10-K Exhibit No.	Description of Exhibit	If Incorporated by Reference, Documents with Which Exhibit was Previously Filed with the SEC
3.1	Articles of Incorporation of the Company, as amended to date.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 1997, and is incorporated herein by this reference.
3.2	Amended and Restated Bylaws of the Company.	This document was filed as an exhibit to Registrant’s Form 10-Q for the quarterly period ended September 30, 2007, and is incorporated herein by this reference.
3.3	First Amendment to Amended and Restated Bylaws of the Company.	This document was filed as an exhibit to Registrant’s Form 8-K filed with the Securities and Exchange Commission on August 4, 2008, and is incorporated herein by this reference.
3.4	Second Amendment to Amended and Restated Bylaws of the Company.	This document was filed as an exhibit to Registrant’s Form 8-K filed with the Securities and Exchange Commission on February 25, 2009, and is incorporated herein by this reference.
3.5	Third Amendment to Amended and Restated Bylaws of the Company.	This document was filed as an exhibit to Registrant’s Form 8-K filed with the Securities and Exchange Commission on May 11, 2018, and is incorporated herein by this reference.
4.1	Shareholders’ Agreement dated as of October 7, 1985 among the Company, George Joseph and Gloria Joseph.	This document was filed as an exhibit to Registrant’s Registration Statement on Form S-1, File No. 33-899, and is incorporated herein by this reference. (Not available on the SEC website. Filed prior to the SEC Edgar filing mandate).
4.2	Indenture, dated as of March 8, 2017, between Mercury General Corporation and Wilmington Trust, National Association.	This document was filed as an exhibit to Registrant’s Form 8-K, filed with the Securities and Exchange Commission on March 8, 2017, and is incorporated herein by this reference.
4.3	First Supplemental Indenture, dated as of March 8, 2017, between Mercury General Corporation and Wilmington Trust, National Association.	This document was filed as an exhibit to Registrant’s Form 8-K, filed with the Securities and Exchange Commission on March 8, 2017, and is incorporated herein by this reference.
4.4	Description of Registrant's Securities Registered Pursuant to Section 12 of the Securities Exchange Act of 1934	Filed herewith.



10.1*	Profit Sharing Plan, as Amended and Restated as of March 11, 1994.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 1993, and is incorporated herein by this reference. (Not available on the SEC website. Filed prior to the SEC Edgar filing mandate).
10.2*	Amendment 1994-I to the Mercury General Corporation Profit Sharing Plan.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 1994, and is incorporated herein by this reference. (Not available on the SEC website. Filed prior to the SEC Edgar filing mandate).
10.3*	Amendment 1994-II to the Mercury General Corporation Profit Sharing Plan.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 1994, and is incorporated herein by this reference. (Not available on the SEC website. Filed prior to the SEC Edgar filing mandate).
10.4*	Amendment 1996-I to the Mercury General Corporation Profit Sharing Plan.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 1996, and is incorporated herein by this reference.
10.5*	Amendment 1997-I to the Mercury General Corporation Profit Sharing Plan.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 1996, and is incorporated herein by this reference.
10.6*	Amendment 1998-I to the Mercury General Corporation Profit Sharing Plan.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 1997, and is incorporated herein by this reference.
10.7*	Amendment 1999-I to the Mercury General Corporation Profit Sharing Plan.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 1999, and is incorporated herein by this reference.
10.8*	Amendment 1999-II to the Mercury General Corporation Profit Sharing Plan.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 1999, and is incorporated herein by this reference.
10.9*	Amendment 2001-I to the Mercury General Corporation Profit Sharing Plan.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 2001, and is incorporated herein by this reference.
10.10*	Amendment 2002-1 to the Mercury General Corporation Profit Sharing Plan.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 2002, and is incorporated herein by this reference.
10.11*	Amendment 2002-2 to the Mercury General Corporation Profit Sharing Plan.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 2002, and is incorporated herein by this reference.
10.12*	Amendment 2003-1 to the Mercury General Corporation Profit Sharing Plan.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 2004, and is incorporated herein by this reference.
10.13*	Amendment 2004-1 to the Mercury General Corporation Profit Sharing Plan.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 2004, and is incorporated herein by this reference.
10.14*	Amendment 2006-1 to the Mercury General Corporation Profit Sharing Plan.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 2007, and is incorporated herein by this reference.
10.15*	Amendment 2006-2 to the Mercury General Corporation Profit Sharing Plan.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 2006, and is incorporated herein by this reference.
10.16*	Amendment 2007-1 to the Mercury General Corporation Profit Sharing Plan.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 2007, and is incorporated herein by this reference.
10.17*	Amendment 2008-1 to the Mercury General Corporation Profit Sharing Plan.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 2008, and is incorporated herein by this reference.
10.18*	Amendment 2008-2 to the Mercury General Corporation Profit Sharing Plan.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 2008, and is incorporated herein by this reference.



10.19*	Amendment 2009-1 to the Mercury General Corporation Profit Sharing Plan.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 2009, and is incorporated herein by this reference.
10.20*	Amendment 2009-2 to the Mercury General Corporation Profit Sharing Plan.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 2009, and is incorporated herein by this reference.
10.21*	Amendment 2011-1 to the Mercury General Corporation Profit Sharing Plan.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 2011, and is incorporated herein by this reference.
10.22*	Amendment 2013-1 to the Mercury General Corporation Profit Sharing Plan.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 2013, and is incorporated herein by this reference.
10.23*	Amendment 2014-1 to the Mercury General Corporation Profit Sharing Plan.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 2014, and is incorporated herein by this reference.
10.24*	Amendment 2014-2 to the Mercury General Corporation Profit Sharing Plan.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 2014, and is incorporated herein by this reference.
10.25*	Amendment 2015-1 to the Mercury General Corporation Profit Sharing Plan.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 2015, and is incorporated herein by this reference.
10.26*	Amendment 2015-2 to the Mercury General Corporation Profit Sharing Plan.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 2015, and is incorporated herein by this reference.
10.27*	Amendment 2017-1 to the Mercury General Corporation Profit Sharing Plan.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 2017, and is incorporated herein by this reference.
10.28*	Amendment 2019-1 to the Mercury General Corporation Profit Sharing Plan.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 2018, and is incorporated herein by this reference.
10.29	Management Agreement effective January 1, 2001 between Mercury Insurance Services, LLC and Mercury Casualty Company, Mercury Insurance Company, California Automobile Insurance Company and California General Insurance Company.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 2000, and is incorporated herein by this reference.
10.30	Expense Reimbursement and Services Agreement effective January 1, 2001 between Mercury Insurance Services, LLC and American Mercury Insurance Company.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 2000, and is incorporated herein by this reference.
10.31	Management Agreement effective January 1, 2001 between Mercury Insurance Services, LLC and Mercury Insurance Company of Georgia.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 2000, and is incorporated herein by this reference.
10.32	Management Agreement effective January 1, 2001 between Mercury Insurance Services, LLC and Mercury Indemnity Company of Georgia.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 2000, and is incorporated herein by this reference.
10.33	Management Agreement effective January 1, 2001 between Mercury Insurance Services, LLC and Mercury Insurance Company of Illinois.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 2000, and is incorporated herein by this reference.
10.34	Management Agreement effective January 1, 2001 between Mercury Insurance Services, LLC and Mercury Indemnity Company of Illinois.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 2000, and is incorporated herein by this reference.
10.35	Management Agreement effective January 1, 2002 between Mercury Insurance Services, LLC and Mercury Insurance Company of Florida and Mercury Indemnity Company of Florida.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 2001, and is incorporated herein by this reference.
10.36	Management Agreement dated January 22, 1997 between Mercury County Mutual Insurance Company and Mercury Insurance Services, LLC.	This document was filed as an exhibit to Registrant’s Form 10-K for the fiscal year ended December 31, 2006, and is incorporated herein by this reference.



10.37*	Mercury General Corporation Senior Executive Incentive Bonus Plan.	This document was filed as an exhibit to Registrant’s Form 8-K filed with the Securities and Exchange Commission on May 10, 2013, and is incorporated herein by this reference.
10.38*	Amended and Restated Mercury General Corporation 2005 Equity Incentive Award Plan.	This document was filed as an exhibit to the Registrant’s Form 8-K filed with the Securities and Exchange Commission on November 1, 2010, and is incorporated herein by this reference.
10.39*	Form of Incentive Stock Option Agreement under the Mercury General Corporation 2005 Equity Incentive Award Plan.	This document was filed as an exhibit to Registrant’s Form 8-K filed with the Securities and Exchange Commission on May 16, 2005, and is incorporated herein by this reference.
10.40*	Form of Restricted Stock Unit Award Agreement under the Mercury General Corporation 2005 Equity Incentive Award Plan.	This document was filed as an exhibit to Registrant’s Form 8-K filed with the Securities and Exchange Commission on October 5, 2010, and is incorporated herein by this reference.
10.41*	Mercury General Corporation Annual Incentive Plan.	This document was filed as an exhibit to Registrant’s Form 8-K filed with the Securities and Exchange Commission on May 2, 2011, and is incorporated herein by this reference.
10.42*	Mercury General Corporation 2015 Incentive Award Plan	This document was filed as an exhibit to Registrant’s Form S-8 filed with the Securities and Exchange Commission on February 20, 2015 (File No. 333-202204), and is incorporated herein by this reference.
10.43*	Form of Restricted Stock Unit Agreement under the Mercury General Corporation 2015 Incentive Award Plan	This document was filed as an exhibit to Registrant’s Form S-8 filed with the Securities and Exchange Commission on February 20, 2015 (File No. 333-202204), and is incorporated herein by this reference.
10.44*	Form of Stock Option Agreement under the Mercury General Corporation 2015 Incentive Award Plan	This document was filed as an exhibit to Registrant’s Form S-8 filed with the Securities and Exchange Commission on February 20, 2015 (File No. 333-202204), and is incorporated herein by this reference.
10.45*	Form of Restricted Stock Unit Agreement under the Mercury General Corporation 2015 Incentive Award Plan (2016 and later version).	This document was filed as an exhibit to Registrant’s Form 8-K filed with the Securities and Exchange Commission on March 23, 2016, and is incorporated herein by this reference.
10.46	Credit Agreement, dated as of March 29, 2017, by and among Mercury General Corporation, Bank of America, as Administrative Agent, and the Lenders party thereto.	This document was filed as an exhibit to Registrant’s Form 8-K filed with the Securities and Exchange Commission on April 3, 2017, and is incorporated herein by this reference.
10.47*	Separation Agreement and General Release, effective May 24, 2018, by and between Allan Lubitz and Mercury Insurance Services, LLC.	This document was filed as an exhibit to Registrant's Form 10-Q for the quarterly period ended June 30, 2018, and is incorporated herein by this reference.
21.1	Subsidiaries of the Company	Filed herewith.
23.1	Consent of Independent Registered Public Accounting Firm.	Filed herewith.
31.1	Certification of Registrant’s Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.	Filed herewith.
31.2	Certification of Registrant’s Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.	Filed herewith.
32.1	Certification of Registrant’s Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002. This certification is being furnished solely to accompany this Annual Report on Form 10-K and is not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and is not to be incorporated by reference into any filing of the Company.	Filed herewith.



32.2	Certification of Registrant’s Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002. This certification is being furnished solely to accompany this Annual Report on Form 10-K and is not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and is not to be incorporated by reference into any filing of the Company.	Filed herewith.
101.INS	XBRL Instance Document-the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.SCH	XBRL Taxonomy Extension Schema Document
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document
101.LAB	XBRL Taxonomy Extension Label Linkbase Document
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document

*	Denotes management contract or compensatory plan or arrangement.

100

SIGNATURES

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




MERCURY GENERAL CORPORATION

BY	/S/ GABRIEL TIRADOR
	Gabriel Tirador
	President and Chief Executive Officer

February 12, 2020

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



Signature	Title	Date

/S/ GEORGE JOSEPH George Joseph	Chairman of the Board	February 12, 2020

/S/ GABRIEL TIRADOR Gabriel Tirador	President and Chief Executive Officer and Director (Principal Executive Officer)	February 12, 2020

/S/ THEODORE R. STALICK Theodore R. Stalick	Senior Vice President and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)	February 12, 2020

/S/ GEORGE G. BRAUNEGG George G. Braunegg	Director	February 12, 2020

/S/ RAMONA L. CAPPELLO Ramona L. Cappello	Director	February 12, 2020

/S/ JAMES G. ELLIS James G. Ellis	Director	February 12, 2020

/S/ JOSHUA E. LITTLE Joshua E. Little	Director	February 12, 2020

/S/ MARTHA E. MARCON Martha E. Marcon	Director	February 12, 2020

101

SCHEDULE I

MERCURY GENERAL CORPORATION AND SUBSIDIARIES SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 2019

Type of Investment	Cost		Fair Value		Amounts in the Balance Sheet
	(Amounts in thousands)
Fixed maturity securities:
U.S. government bonds	$	22,502	$	22,637	$	22,637
Municipal securities	2,435,346		2,554,208		2,554,208
Mortgage-backed securities	62,566		63,003		63,003
Corporate securities	233,730		235,565		235,565
Collateralized loan obligations	200,656		199,218		199,217
Other asset-backed securities	18,476		18,644		18,645
Total fixed maturity securities	2,973,276		3,093,275		3,093,275
Equity securities:
Common stock	498,514		586,367		586,367
Non-redeemable preferred stock	49,442		49,708		49,708
Private equity fund	1,137		1,203		1,203
Private equity funds measured at net asset value ⁽¹⁾	99,189		87,473		87,473
Total equity securities	648,282		724,751		724,751
Short-term investments	494,060		494,135		494,135
Total investments	$	4,115,618	$	4,312,161	$	4,312,161

__________


⁽¹⁾	The fair value is measured using the NAV practical expedient. See Note 4. Fair Value Measurements of the Notes to Consolidated Financial Statements for additional information.

See accompanying Report of Independent Registered Public Accounting Firm

S-1

SCHEDULE I, Continued

MERCURY GENERAL CORPORATION AND SUBSIDIARIES SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 2018

Type of Investment	Cost		Fair Value		Amounts in the Balance Sheet
	(Amounts in thousands)
Fixed maturity securities:
U.S. government bonds	$	25,131	$	25,003	$	25,003
Municipal securities	2,599,056		2,620,132		2,620,132
Mortgage-backed securities	30,640		30,952		30,952
Corporate securities	107,479		105,524		105,524
Collateralized loan obligations	169,626		165,789		165,789
Other asset-backed securities	37,609		37,761		37,761
Total fixed maturity securities	2,969,541		2,985,161		2,985,161
Equity securities:
Common stock	438,504		430,973		430,973
Non-redeemable preferred stock	34,429		31,433		31,433
Private equity fund	1,481		1,445		1,445
Private equity fund measured at net asset value ⁽¹⁾	69,668		65,780		65,780
Total equity securities	544,082		529,631		529,631
Short-term investments	254,518		253,299		253,299
Total investments	$	3,768,141	$	3,768,091	$	3,768,091

__________


⁽¹⁾	The fair value is measured using the NAV practical expedient. See Note 4. Fair Value Measurements of the Notes to Consolidated Financial Statements for additional information.

See accompanying Report of Independent Registered Public Accounting Firm

S-2

SCHEDULE II

MERCURY GENERAL CORPORATION CONDENSED FINANCIAL INFORMATION OF REGISTRANT BALANCE SHEETS

	December 31,
	2019		2018
	(Amounts in thousands)
ASSETS
Investments, at fair value:
Equity securities (cost $81,802; $110,279)	$	114,668	$	119,037
Short-term investments (cost $29,356; $3,166)	29,356		3,166
Investment in subsidiaries	2,008,163		1,850,582
Total investments	2,152,187		1,972,785
Cash	39,766		24,140
Accrued investment income	90		161
Amounts receivable from affiliates	244		1,172
Current income taxes	—		—
Income tax receivable from affiliates	9,192		19,225
Other assets	312		446
Total assets	$	2,201,791	$	2,017,929
LIABILITIES AND SHAREHOLDERS’ EQUITY
Notes payable	$	372,133	$	371,734
Accounts payable and accrued expenses	17		25
Amounts payable to affiliates	22		3,082
Income tax payable to affiliates	4,106		580
Current income taxes	14,052		17,773
Deferred income taxes	7,059		1,691
Other liabilities	4,900		5,360
Total liabilities	402,289		400,245
Commitments and contingencies
Shareholders’ equity:
Common stock	98,828		98,026
Retained earnings	1,700,674		1,519,658
Total shareholders’ equity	1,799,502		1,617,684
Total liabilities and shareholders’ equity	$	2,201,791	$	2,017,929

See accompanying notes to condensed financial information.

See accompanying Report of Independent Registered Public Accounting Firm

S-3

SCHEDULE II, Continued

MERCURY GENERAL CORPORATION CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF OPERATIONS

	Year Ended December 31,
	2019		2018			2017
	(Amounts in thousands)
Revenues:
Net investment income	$	3,735	$	4,661		$	4,090
Net realized investment gains (losses)	31,682		(10,797		)	19,279
Other	5		2			—
Total revenues	35,422		(6,134		)	23,369
Expenses:
Other operating expenses	2,592		2,343			1,918
Interest	17,036		17,036			14,856
Total expenses	19,628		19,379			16,774
Income (loss) before income taxes and equity in net income of subsidiaries	15,794		(25,513		)	6,595
Income tax expense (benefit)	2,816		(5,144		)	1,572
Income (loss) before equity in net income of subsidiaries	12,978		(20,369		)	5,023
Equity in net income of subsidiaries	307,109		14,641			139,854
Net income (loss)	$	320,087	$	(5,728	)	$	144,877

See accompanying notes to condensed financial information.

See accompanying Report of Independent Registered Public Accounting Firm

S-4

SCHEDULE II, Continued

MERCURY GENERAL CORPORATION CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF CASH FLOWS

	Year Ended December 31,
	2019			2018			2017
	(Amounts in thousands)
Cash flows from operating activities:
Net cash used in operating activities	$	(5,392	)	$	(16,108	)	$	(14,503	)
Cash flows from investing activities:
Capital contribution to subsidiaries	(125		)	(541		)	(140,125		)
Capital distribution from subsidiaries	30,069			—			—
Distributions received from special purpose entities	5,153			5,998			5,243
Dividends received from subsidiaries	114,431			135,000			109,000
Fixed maturity securities available for sale in nature:
Sales	—			—			1,614
Equity securities available for sale in nature
Purchases	(39,966		)	(22,286		)	(22,406		)
Sales	74,663			33,052			18,876
Calls	—			—			4,000
(Increase) decrease in short-term investments	(25,213		)	18,065			(20,607		)
Other, net	376			605			310
Net cash provided by (used in) investing activities	159,388			169,893			(44,095		)
Cash flows from financing activities:
Dividends paid to shareholders	(139,071		)	(138,478		)	(137,886		)
Proceeds from stock options exercised	701			358			2,162
Net proceeds from issuance of senior notes	—			—			371,011
Payoff of principal on loan and credit facilities	—			—			(180,000		)
Net cash (used in) provided by financing activities	(138,370		)	(138,120		)	55,287
Net increase (decrease) in cash	15,626			15,665			(3,311		)
Cash:
Beginning of year	24,140			8,475			11,786
End of year	$	39,766		$	24,140		$	8,475
SUPPLEMENTAL CASH FLOW DISCLOSURE
Interest paid	$	16,586		$	16,586		$	9,435
Income taxes (refunded) paid, net	$	(12,391	)	$	4,296		$	346

See accompanying notes to condensed financial information.

See accompanying Report of Independent Registered Public Accounting Firm

S-5

MERCURY GENERAL CORPORATION

CONDENSED FINANCIAL INFORMATION OF REGISTRANT

NOTES TO CONDENSED FINANCIAL INFORMATION

The accompanying condensed financial information should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements included in this report.

Distributions received from Special Purpose Entities

On August 9, 2013, Animas Funding LLC ("AFL"), a special purpose investment vehicle, formed and consolidated by the Company, entered into a three-year total return swap agreement with Citibank, which was renewed for an additional one-year term through February 17, 2018. During June and July 2017, the underlying obligations were liquidated and the total return swap agreement between AFL and Citibank was terminated on. Under the agreement, AFL received the income equivalent on underlying obligations due to Citibank and paid to Citibank interest on the outstanding notional amount of the underlying obligations. The total return swap was secured by approximately $40 million of U.S. Treasuries as collateral, which were included in short-term investments on the consolidated balance sheets. The Company paid interest equal to LIBOR plus 135 basis points prior to the amendment of the agreement in January 2017 and LIBOR plus 128 basis points subsequent to the amendment until July 2017, on approximately $152 million of underlying obligations as of December 31, 2016.

Distributions of $5.2 million and $6.0 million were received in 2019 and 2018, respectively, from these special purpose entities.

Dividends received from Subsidiaries

Dividends of $114,431,433, $135,000,000 and $109,000,000 were received by Mercury General from its 100% owned insurance subsidiaries in 2019, 2018 and 2017, respectively, and are recorded as a reduction to investment in subsidiaries.

Capitalization of Insurance Subsidiaries

Mercury General made capital contributions to its insurance subsidiaries of $125,000, $540,619 and $140,125,000 in 2019, 2018 and 2017, respectively. In addition, Mercury General received a capital distribution from one of its insurance subsidiaries of $30,068,567 in 2019.

Notes Payable

On March 8, 2017, Mercury General completed a public debt offering issuing $375 million of senior notes. The notes are unsecured senior obligations of Mercury General, with a 4.4% annual coupon payable on March 15 and September 15 of each year commencing September 15, 2017. These notes mature on March 15, 2027. The Company used the proceeds from the notes to pay off the total outstanding balance of $320 million under the existing loan and credit facility agreements and terminated the agreements on March 8, 2017. The remainder of the proceeds from the notes was used for general corporate purposes. Mercury General incurred debt issuance costs of approximately $3.4 million, inclusive of underwriters' fees. The notes were issued at a slight discount of 99.847% of par, resulting in the effective annualized interest rate, including debt issuance costs, of approximately 4.45%.

See accompanying Report of Independent Registered Public Accounting Firm

S-6

Commitments and Contingencies

On March 29, 2017, Mercury General entered into an unsecured credit agreement that provides for revolving loans of up to $50 million and matures on March 29, 2022. The interest rates on borrowings under the credit facility are based on the Company's debt to total capital ratio and range from LIBOR plus 112.5 basis points when the ratio is under 15% to LIBOR plus 162.5 basis points when the ratio is greater than or equal to 25%. Commitment fees for the undrawn portions of the credit facility range from 12.5 basis points when the ratio is under 15% to 22.5 basis points when the ratio is greater than or equal to 25%. The debt to total capital ratio is expressed as a percentage of (a) consolidated debt to (b) consolidated shareholders' equity plus consolidated debt. The Company's debt to total capital ratio was 17.2% at December 31, 2019, resulting in a 15 basis point commitment fee on the $50 million undrawn portion of the credit facility. As of February 6, 2020, there have been no borrowings under this facility.

Federal Income Taxes

The Company files a consolidated federal income tax return for the following entities:



Mercury Casualty Company		Mercury County Mutual Insurance Company
Mercury Insurance Company		Mercury Insurance Company of Florida
California Automobile Insurance Company		Mercury Indemnity Company of America
California General Underwriters Insurance Company, Inc.		Mercury Select Management Company, Inc.
Mercury Insurance Company of Illinois		Mercury Insurance Services LLC
Mercury Insurance Company of Georgia		AIS Management LLC
Mercury Indemnity Company of Georgia		Auto Insurance Specialists LLC
Mercury National Insurance Company		PoliSeek AIS Insurance Solutions, Inc.
American Mercury Insurance Company		Animas Funding LLC
American Mercury Lloyds Insurance Company		Fannette Funding LLC
Workmen's Auto Insurance Company		Mercury Plus Insurance Services LLC

The method of allocation between the companies is subject to an agreement approved by the Board of Directors. Allocation is based upon separate return calculations with current credit for net losses incurred by the insurance subsidiaries to the extent it can be used in the current consolidated return.

See accompanying Report of Independent Registered Public Accounting Firm

S-7

SCHEDULE IV MERCURY GENERAL CORPORATION AND SUBSIDIARIES REINSURANCE THREE YEARS ENDED DECEMBER 31, Property and Liability Insurance Earned Premiums

	2019			2018			2017
	(Amounts in thousands)
Direct amounts	$	3,655,233		$	3,416,687		$	3,221,493
Ceded to other companies	(56,725		)	(48,941		)	(26,881		)
Assumed	910			665			825
Net amounts	$	3,599,418		$	3,368,411		$	3,195,437

See accompanying Report of Independent Registered Public Accounting Firm

S-8