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MERCURY GENERAL CORP - Annual Report: 2020 (Form 10-K)


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________ 
FORM 10-K
____________________________ 

☒    Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Fiscal Year Ended December 31, 2020
or
☐    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)
____________________________ 
California95-2211612
(State or other jurisdiction of
incorporation or organization)		(I.R.S. Employer
Identification No.)
4484 Wilshire Boulevard
Los Angeles, California90010
(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 ClassTrading Symbol(s)Name of Each Exchange on Which Registered
Common StockMCYNew 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 has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒

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, 2020 was $1,079,757,233 (which represents 26,497,110 shares of common equity held by non-affiliates multiplied by $40.75, the closing sales price on the New York Stock Exchange for such date, as reported by the Wall Street Journal).

At February 11, 2021, the registrant had issued and outstanding an aggregate of 55,357,691 shares of its Common Stock.
____________________________ 

Documents Incorporated by Reference
Certain information from the registrant’s definitive proxy statement for the 2021 Annual Meeting of Shareholders is incorporated herein by reference into Part III hereof.




MERCURY GENERAL CORPORATION
INDEX TO FORM 10-K
 
 Page
Item 1
Item 1A
Item 1B
Item 2
Item 3
Item 4
Item 5
Item 6
Item 7
Item 7A
Item 8
Item 9
Item 9A
Item 9B
Item 10
Item 11
Item 12
Item 13
Item 14
Item 15
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, 2020, 2019 and 2018 by state and line of insurance business were:

Year Ended December 31, 2020
(Dollars in thousands)
Private
Passenger  Automobile		HomeownersCommercial
Automobile		Other LinesTotal
California (1)
$2,266,115 $579,747 $161,619 $149,627 $3,157,108 86.4 %
Other states (2) (3)
302,819 99,194 79,169 15,871 497,053 13.6 %
Total$2,568,934 $678,941 $240,788 $165,498 $3,654,161 100.0 %
70.3 %18.6 %6.6 %4.5 %100.0 %

Year Ended December 31, 2019
(Dollars in thousands)
Private
Passenger  Automobile		HomeownersCommercial
Automobile		Other LinesTotal
California$2,478,477 $520,062 $139,367 $123,735 $3,261,641 86.4 %
Other states (3)
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		HomeownersCommercial
Automobile		Other LinesTotal
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 (3)
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 %
_____________
(1) California private passenger automobile and commercial automobile direct premiums written were reduced by approximately $112 million and $6 million, respectively, due to premium refunds and credits under the "Mercury Giveback" program associated with reduced driving during the COVID-19 pandemic.
(2) Other states private passenger automobile and commercial automobile direct premiums written were reduced by approximately $9 million and $1 million, respectively, due to premium refunds and credits, as described above.
(3) No individual state accounted for more than 4% of total direct premiums written.

1

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 typePublished maximum limits of coverage
Private Passenger Automobile - bodily injury (BI)
$500,000 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)
Commercial property
no maximum (2)
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 has a per-risk reinsurance treaty covering losses of $5 million in excess of $5 million, and facultative reinsurance coverage for losses above $10 million.
(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 commercial umbrella liability is 100% reinsured.

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 maintains branch offices in a number of locations in California; Clearwater, Florida; Bridgewater, New Jersey; Oklahoma City, Oklahoma; and Austin and San Antonio, Texas.

Human Capital

The Company had approximately 4,300 employees at December 31, 2020. The Company's employees are critical to its continued success, and it focuses significant attention on attracting and retaining talented and motivated individuals. The Company pays its employees fairly and competitively and offers a wide range of benefits regardless of gender, race or ethnicity. The Company benchmarks and sets pay ranges based on market data and considering such factors as employees' roles, experiences and performance, and the location of their job. Individual goals are set annually for each employee, and attainment of those goals is an element of the employee’s performance assessment. The Company regularly reviews its compensation practices, both in terms of its overall workforce and individual employees, to ensure its pay is fair and equitable.

The Company also reviews employee engagement and satisfaction surveys to monitor employee morale and receive feedback on a variety of issues, in order to improve the employee experience and identify opportunities to continually strengthen its culture. The Company devotes extensive resources to employee training and development, including tuition assistance for career-enhancing academic and professional programs. The Company recognizes that its success is based on the talents and dedication of those it employs, and it is highly invested in their success.

The Company is committed to hiring, developing and supporting a diverse and inclusive workplace. All of the Company's employees are expected to exhibit and promote honest, ethical and respectful conduct in the workplace, must adhere to a code of conduct that sets standards for appropriate behavior, and are required to take annual training on preventing, identifying, reporting and stopping any type of unlawful discrimination.

The Company sponsors a wellness program designed to enhance physical, financial and mental well-being for all of its employees, and encourages healthy behaviors through regular communications, educational sessions, voluntary progress tracking, wellness challenges, and other incentives. The Company implemented safety protocols and new procedures to protect
2

its employees and customers in response to the COVID-19 pandemic. This includes having the vast majority of its employees work from home, while implementing additional safety measures for employees continuing critical on-site work.

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 CompaniesFormed or
Acquired		A.M. Best
Rating		Primary States
Mercury Casualty Company ("MCC")(1)
1961ACA, AZ, NV, NY, VA
Mercury Insurance Company ("MIC")(1)
1972ACA
California Automobile Insurance Company ("CAIC")(1)
1975ACA
California General Underwriters Insurance Company, Inc. ("CGU")(1)
1985ACA
Mercury Insurance Company of Illinois 1989AIL, NJ
Mercury Insurance Company of Georgia1989AGA
Mercury Indemnity Company of Georgia1991AGA
Mercury National Insurance Company 1991AIL
American Mercury Insurance Company 1996A-OK, CA, TX, VA
American Mercury Lloyds Insurance Company ("AML")1996A-TX
Mercury County Mutual Insurance Company 2000A-TX
Mercury Insurance Company of Florida2001AFL
Mercury Indemnity Company of America2001AFL, NJ
Workmen’s Auto Insurance Company ("WAIC")(1)
2015Non-ratedCA
Non-Insurance CompaniesFormed or
Acquired		Purpose
Mercury Select Management Company, Inc.1997AML’s attorney-in-fact
Mercury Insurance Services LLC2000Management services to subsidiaries
AIS Management LLC 2009Parent company of AIS and PoliSeek
Auto Insurance Specialists LLC ("AIS")2009Insurance agency
PoliSeek AIS Insurance Solutions, Inc. ("PoliSeek")2009Insurance agency
Animas Funding LLC ("AFL")2013Special purpose investment vehicle
Fannette Funding LLC ("FFL")2014Special purpose investment vehicle
Mercury Plus Insurance Services LLC2018Insurance agency
_____________
(1)The term "California Companies" refers to MCC, MIC, CAIC, CGU, and WAIC.



3

Production and Servicing of Business
The Company sells its policies through a network of approximately 9,520 independent agents, its 100% owned insurance agencies, AIS and PoliSeek, and directly through internet sales portals. Approximately 1,800, 1,280, and 1,280 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 2020 and no single independent agent or agency accounted for more than 1.1% 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 2020 were approximately 16% 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 2020, the Company incurred approximately $38 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 87% of the Company's California voluntary private passenger automobile policies-in-force at December 31, 2020, while higher risk categories accounted for approximately 13%. The Company's private passenger automobile renewal rate in California (the rate of acceptance of offers to renew) averaged approximately 96% in 2020, 2019, and 2018.

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.





4

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,
 202020192018
 (Amounts in thousands)
Gross reserves at January 1(1)
$1,921,255 $1,829,412 $1,510,613 
Reinsurance recoverables on unpaid losses(76,100)(180,859)(64,001)
               Cumulative effect of adopting ASU 2016-13149 — — 
Reinsurance recoverables on unpaid losses, as adjusted(75,951)(180,859)(64,001)
Net reserves at January 1, as adjusted(1)
1,845,304 1,648,553 1,446,612 
Incurred losses and loss adjustment expenses related to:
Current year2,372,364 2,696,230 2,483,693 
Prior years22,979 9,794 93,096 
Total incurred losses and loss adjustment expenses2,395,343 2,706,024 2,576,789 
Loss and loss adjustment expense payments related to:
Current year1,366,661 1,651,550 1,543,828 
Prior years937,142 857,872 831,020 
Total payments2,303,803 2,509,422 2,374,848 
Net reserves at December 31(1)
1,936,844 1,845,155 1,648,553 
Reinsurance recoverables on unpaid losses54,460 76,100 180,859 
Gross reserves at December 31(1)
$1,991,304 $1,921,255 $1,829,412 
_____________ 
(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 2020 of approximately $23.0 million primarily resulted from higher than estimated losses and loss adjustment expenses in the homeowners and commercial automobile lines of insurance business, partially offset by favorable development in the private passenger automobile line of insurance business.

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 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 Company recorded catastrophe losses net of reinsurance of approximately $64 million, $53 million, and $67 million in 2020, 2019, and 2018, respectively. Catastrophe losses due to events that occurred in 2020 totaled approximately $69 million, with no reinsurance benefits used for these losses, resulting primarily from wildfires and windstorms in California and extreme weather events outside of California. These losses were partially offset by favorable development of approximately $5 million on prior years' catastrophe losses. Catastrophe losses before reinsurance benefits totaled approximately $57 million in 2019, primarily resulting 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. 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.

5

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%. 
6

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 29.7% of direct premiums written in 2020; hence, the Company believes its combined ratio (for private passenger automobile only) is more comparable to the industry ratios.
 Year Ended December 31,
 20202019 201820172016
Loss ratio (Company-wide)67.4 %75.2 %76.6 %76.6 %75.3 %
Expense ratio (Company-wide)26.2 %24.5 %24.5 %25.3 %25.7 %
Combined ratio (Company-wide)(2)
93.6 %99.7 %

101.0 %101.9 %101.0 %
Combined ratio (Company's private passenger automobile only)88.3 %98.2 %99.5 %99.3 %100.8 %
Industry combined ratio (all writers)(1)
N/A98.1 %97.3 %102.2 %106.0 %
Industry combined ratio (excluding direct writers)(1)
N/A97.3 %  97.8 %  99.9 %99.7 %
____________
(1)Source: A.M. Best, Aggregates & Averages (2016 through 2019), 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,
 20202019201820172016
 (Amounts in thousands, except ratios)
Net premiums written$3,611,543 $3,731,723 $3,495,633 $3,215,910 $3,155,788 
Policyholders’ surplus$1,768,103 $1,539,998 $1,471,547 $1,589,226 $1,441,571 
Ratio2.0 to 12.4 to 12.4 to 12.0 to 12.2 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, 2020.

7

Investment Portfolio
The following table presents the composition of the Company’s total investment portfolio:
 December 31,
 202020192018
 
Cost(1)
Fair Value
Cost(1)
Fair Value
Cost(1)
Fair Value
   (Amounts in thousands)  
Taxable bonds$936,762 $943,836 $635,283 $637,272 $424,945 $419,352 
Tax-exempt state and municipal bonds
2,451,656 2,605,974 2,337,993 2,456,003 2,544,596 2,565,809 
Total fixed maturities3,388,418 3,549,810 2,973,276 3,093,275 2,969,541 2,985,161 
Equity securities
695,150 803,851 648,282 724,751 544,082 529,631 
Short-term investments376,547 375,609 494,060 494,135 254,518 253,299 
Total investments$4,460,115 $4,729,270 $4,115,618 $4,312,161 $3,768,141 $3,768,091 
__________ 
(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,
 20202019201820172016
  (Dollars in thousands) 
Average invested assets at cost(1) (2)
$4,291,888 $4,008,601 $3,740,497 $3,582,122 $3,390,769 
Net investment income(3)
Before income taxes$134,858 $141,263 $135,838 $124,930 $121,871 
After income taxes$120,043 $125,637 $121,476 $109,243 $107,140 
Average annual yield on investments(3)
Before income taxes3.1 %3.5 %3.6 %3.5 %3.6 %
After income taxes2.8 %3.1 %3.3 %3.1 %3.2 %
Net realized investment gains (losses) after income taxes
$67,727 $176,006 $(105,481)$54,373 $(22,266)
 __________
(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, 2020, fixed maturity securities with call features totaled $3.1 billion at fair value and $3.0 billion at amortized cost.
(3)During 2020, net investment income before and after income taxes decreased primarily due to a lower average yield on investments, partially offset by higher average invested assets. Average annual yield on investments before and after income taxes decreased primarily due to the 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.
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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 2019, 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 in 2020 has generally experienced a significant softening of the market. Insurance carriers lowered rates to reflect lower loss frequencies as stay-at-home orders issued by the state and local governments following the COVID-19 pandemic led to a decrease in the number of accidents, 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 the assuming reinsurer under a Catastrophe Participation Reinsurance Contract ("Contract") effective through December 31, 2021. The Company reimburses a group of affiliates of a ceding company for a proportional share of a portfolio of catastrophe losses based on the premiums ceded to the Company under the Contract, to the extent the actual loss ratio exceeds the threshold loss ratio of 71%. The total assumed premium under the Contract is $7.5 million and $12.5 million for the years ending December 31, 2020 and 2021, respectively. The total possible amount of losses for the Company under the Contract is $18.8 million and $31.3 million for the years ending December 31, 2020 and 2021, respectively. If the actual loss ratio is less than the threshold loss ratio, the Company is eligible to receive a certain portion of the underwriting profit. The Company recorded $5.3 million in incurred losses under the Contract for the year ended December 31, 2020.

The Company is party to a Catastrophe Reinsurance Treaty ("Treaty") covering a wide range of perils that is effective through June 30, 2021. For the 12 months ending June 30, 2021, the Treaty provides $717 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. The Treaty provides for one full reinstatement of coverage limits with a minor exception at the top coverage layer and includes some additional minor territorial and coverage limits, as noted in the table below.

Coverage on individual catastrophes provided for the 12 months ending June 30, 2021 under the Treaty is presented below in various layers:

 Catastrophe Losses and LAE
In Excess ofUp toPercentage of Coverage
 (Amounts in millions)
Retained$— $40 — %
Layer of Coverage40 100 70 
Layer of Coverage (1)
100 400 100 
Layer of Coverage (1) (2) (3)
400 775 100 
__________ 
(1) Layer of Coverage represents multiple actual treaty layers that are grouped for presentation purposes.
(2) 13.4% of this layer covers only California wildfires and fires following an earthquake in California, and is not subject to reinstatement.
(3) 14% of this layer includes a territorial restriction covering California, Arizona and Nevada only.

For the 12 months ended June 30, 2020, the Treaty provided $600 million of coverage on a per occurrence basis after covered catastrophe losses exceeded the $40 million Company retention limit. The Treaty specifically excluded coverage for any Florida business and for California earthquake losses on fixed property policies such as homeowners, but did cover losses from fires following an earthquake. In addition, the Treaty excluded losses from wildfires on 89.5% of certain coverage layers of the Treaty as noted in the table below.
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Coverage on individual catastrophes provided for the 12 months ended June 30, 2020 under the Treaty is presented below in various layers:
 Catastrophe Losses and LAE
In Excess ofUp toPercentage of Coverage
 (Amounts in millions)
Retained$— $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 Coverage400 456 100 
Layer of Coverage (wildfires are not covered for 89.5% of this layer)456 500 100 
Layer of Coverage (1)
500 640 100 
__________ 
(1) Layer of Coverage represents multiple actual treaty layers that are grouped for presentation purposes.

The annual premium for the Treaty is approximately $50.3 million for the 12 months ending June 30, 2021, as compared to $38.0 million for the 12 months ended June 30, 2020. 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 ending June 30, 2021 provides for one full reinstatement of coverage limits and reinstatement premiums are based on the amount of reinsurance benefits used by the Company at 100% of the annual premium rate, with the exception of the reinstatement restriction noted in the table above, up to the maximum reinstatement premium of approximately $46 million if the full amount of benefit is used for the 12 months ending June 30, 2021. The Treaty ended June 30, 2020 provided for one full reinstatement of coverage limits, and reinstatement premiums were 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 if the full amount of benefit was used for the 12 months ended June 30, 2020.

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, 2021 and 2020, respectively:
TreatyAnnual Premium
 Reinstatement Premium (1)
Total Combined Premium (1)
 (Amounts in millions)
For the 12 months ending June 30, 2021$50 $— $50 
For the 12 months ended June 30, 202038 — 38 
__________ 
(1) The reinstatement premium and the total combined premium for the treaty period ending June 30, 2021 are projected amounts to be paid based on the assumption that there will be no reinstatements occurring during this treaty period. The reinstatement premium for the treaty period ended June 30, 2020 is zero, as there were no actual reinstatement premiums paid.

The catastrophe events that occurred in 2020 caused approximately $69 million in losses to the Company, including a series of California wildfires in the second half of 2020, with no reinsurance benefits used under the Treaty for these losses as none of the 2020 catastrophe events resulted in losses in excess of the Company’s per-occurrence retention limit under the Treaty of $40 million for each of the 12 months ending June 30, 2020 and 2021.

The catastrophe events that occurred in 2019 caused approximately $54 million in losses to the Company as of December 31, 2020, including a series of California wildfires in 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.

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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, Oklahoma, and Arizona must only be filed with the respective DOI before they are implemented. Florida has a modified version of use and file 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 $131,000 and $122,000 to officeholders and candidates in 2020 and 2019, 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, 2020, 2019 and 2018, each of the Insurance Companies exceeded the minimum
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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 2020. 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 material CIGA assessments in 2020.

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 28, 2020, the most recent date at which information was available, was $78.0 million. There was no assessment made in 2020.

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 2020 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, 2020, the Insurance Companies are permitted to pay in 2021, without obtaining DOI approval for extraordinary dividends, $222 million in dividends to Mercury General, of which $196 million may be paid by the California Companies.
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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 2020, 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 11, 2021:
NameAgePosition
George Joseph99Chairman of the Board
Gabriel Tirador56President and Chief Executive Officer
Theodore R. Stalick57Senior Vice President and Chief Financial Officer
Christopher Graves55Vice President and Chief Investment Officer
Abby Hosseini61Vice President and Chief Information Officer
Victor G. Joseph34Vice President and Chief Underwriting Officer
Brandt N. Minnich54Vice President and Chief Marketing Officer
Randall R. Petro57Vice President and Chief Claims Officer
Jeffrey M. Schroeder44Vice President and Chief Product Officer
Heidi C. Sullivan52Vice President and Chief Human Capital Officer
Erik Thompson52Vice President, Advertising and Public Relations
Charles Toney59Vice President and Chief Actuary
Judy A. Walters74Vice 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
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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 a 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.















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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.

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, 2020, 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;
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•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,
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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 February 4, 2021, 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. One of the smaller Insurance Companies, Workmen's Auto Insurance Company, is not rated by A.M. Best and the rating is not critical to the type of business it produces.

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
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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, 2020, approximately 55% of the Company’s total investment portfolio at fair value and approximately 73% 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.
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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 9,520 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.

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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, 2020, 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.

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.





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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 70% of the Company’s direct premiums written for the year ended December 31, 2020 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.



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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.

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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
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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 Technology and Cybersecurity

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),
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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.

Risks Related to the COVID-19 Pandemic and Other Widespread Health Emergencies

Pandemics, epidemics, widespread health emergencies, or outbreaks of infectious diseases could disrupt the Company's business and adversely affect its results of operations and financial condition.

The Company's operations may be subject to disruptions due to the occurrence of public health emergencies, such as the COVID-19 pandemic, or other similar unexpected events, some of which may be intensified by the effects of a government response to such an event. In March 2020, the outbreak of COVID-19 was recognized as a pandemic by the World Health Organization and shortly thereafter, the President of the United States declared a National Emergency. While still evolving, the COVID-19 pandemic has caused significant economic and financial turmoil both in the United States and globally.

The implementation of restrictions by federal, state and local authorities to slow the spread of COVID-19 could disrupt the Company's business and operations. As providers of essential services, the Company may be required to continue to provide services to its policyholders regardless of the ability of certain policyholders affected by COVID-19 to make timely payments for such services, due to the moratoriums issued by the DOIs of certain states on the cancellation or non-renewal of insurance policies for the non-payment of premiums. The inability to collect, or delays in collecting payments for services provided could have a material adverse effect on the Company's business, results of operations or financial condition. In addition, the DOIs of certain states have issued and may continue to issue directives requiring insurers to refund a portion of premiums to their policyholders due to reduced driving and business activities during the pandemic, which could adversely impact the Company's financial condition, operating results and cash flows.

The COVID-19 pandemic has caused, and could continue to cause, substantial disruptions to the Company's employees, distribution channels involving a network of independent agents, and policyholders due to factors such as self-isolation, travel limitations, and business restrictions, among others, which could result in significant declines in its premiums. Although the Company has activated its Business Continuity Plan and most of its employees are able to work remotely, there can be no assurance that the Plan will adequately mitigate the risks of business disruptions and interruptions. In addition, the Company relies on various third party service providers for certain functions of its operations, including, but not limited to, technology support, legal services and office supplies. The Company's operations could be negatively impacted by disruptions at these service providers caused by the pandemic. The COVID-19 pandemic has caused, and could continue to cause, labor shortages in the automobile repair industry and disruptions to the automotive parts supply chain, resulting in delays in automobile repairs and/or higher repair costs, which could adversely impact the Company's results of operations. These effects, individually or in the aggregate, could adversely impact the Company's business, financial condition, operating results and cash flows, and such adverse impacts may be material.

Market disruptions and dislocations caused by the COVID-19 pandemic or other similar events, leading to instability in the global credit markets, could have additional adverse effects on the Company's business and results of operations, including, but not limited to, substantial realized and unrealized losses on its investment portfolio, reduced liquidity, and increased uncertainty in its ability to raise capital. Market volatility may also make it more difficult to value certain of the Company's investments if trading becomes less frequent. In addition, these adverse conditions could heighten the credit risk of some of the Company's reinsurers, and could negatively impact their ability to pay for the losses under certain reinsurance agreements.

The United States and many other countries around the world have experienced a resurgence of the pandemic in the fall and winter of 2020. While it is not possible at this time to estimate the duration of the COVID-19 pandemic and the ultimate impact it could have on the Company's business, the continued spread of COVID-19 and the measures taken by certain countries, as well as measures taken by state and local governments in the United States, could adversely impact the Company's business, results of operations or financial condition. The extent to which the COVID-19 pandemic further impacts the Company's business will depend on future developments, including the duration and spread of COVID-19, the acceptance and effectiveness of vaccines, and the impact of COVID-19 and related containment and mitigation measures on its policyholders and employees, all of which are highly uncertain, unpredictable and outside its control.

General Risk Factors

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,
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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 over 5% 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.

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
26

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.

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.
LocationPurposeSize in
Square Feet
Percent Occupied by
the Company at
December 31, 2020
Brea, CAHome office and I.T. facilities (2 buildings)236,000 100 %
Folsom, CAAdministrative and Data Center88,000 100 %
Los Angeles, CAExecutive offices41,000 95 %
Rancho Cucamonga, CAAdministrative127,000 100 %
Clearwater, FLAdministrative162,000 51 %
Oklahoma City, OKAdministrative100,000 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.

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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 Disclosures
Not applicable.
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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 11, 2021 was $56.50.
Holders
As of February 11, 2021, there were approximately 122 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, 2020, the Insurance Companies are permitted to pay in 2021, without obtaining DOI approval for extraordinary dividends, $222 million in dividends to Mercury General, of which $196 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."

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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, 2015 in each of the Company’s Common Stock, the S&P 500 Index and the industry peer group and the reinvestment of all dividends.
 
mcy-20201231_g1.jpg
201520162017201820192020
Mercury General$100.00 $135.27 $125.49 $127.60 $126.04 $143.31 
Industry Peer Group100.00 120.71 146.44 147.30 174.14 179.66 
S&P 500 Index100.00 111.96 136.40 130.42 171.49 203.04 

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.
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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,
 20202019201820172016
  (Amounts in thousands, except per share data) 
Income Data:
Net premiums earned (1)
$3,555,635 $3,599,418 $3,368,411 $3,195,437 $3,131,773 
Net investment income134,858 141,263 135,838 124,930 121,871 
Net realized investment gains (losses)85,731 222,793 (133,520)83,650 (34,255)
Other8,287 9,044 9,275 11,945 8,294 
Total revenues3,784,511 3,972,518 3,380,004 3,415,962 3,227,683 
Losses and loss adjustment expenses2,395,343 2,706,024 2,576,789 2,444,884 2,355,138 
Policy acquisition costs627,788 602,085 572,164 555,350 562,545 
Other operating expenses285,831 269,305 244,630 233,475 235,314 
Interest17,048 17,035 17,036 15,168 3,962 
Total expenses3,326,010 3,594,449 3,410,619 3,248,877 3,156,959 
Income (loss) before income taxes458,501 378,069 (30,615)167,085 70,724 
Income tax expense (benefit)83,894 57,982 (24,887)22,208 (2,320)
Net income (loss)$374,607 $320,087 $(5,728)$144,877 $73,044 
Per Share Data:
Basic earnings (loss) per share$6.77 $5.78 $(0.10)$2.62 $1.32 
Diluted earnings (loss) per share$6.77 $5.78 $(0.10)$2.62 $1.32 
Dividends paid per share$2.5225 $2.5125 $2.5025 $2.4925 $2.4825 
__________ 
(1) Net premiums earned for 2020 was reduced by approximately $128 million due to premium refunds and credits under the "Mercury Giveback" program associated with reduced driving during the COVID-19 pandemic.
 
 December 31,
 20202019201820172016
  (Amounts in thousands, except per share data) 
Balance Sheet Data:
Total investments$4,729,270 $4,312,161 $3,768,091 $3,732,728 $3,547,560 
Total assets6,328,246 5,889,157 5,433,729 5,101,323 4,788,718 
Loss and loss adjustment expense reserves1,991,304 1,921,255 1,829,412 1,510,613 1,290,248 
Unearned premiums1,405,873 1,355,547 1,236,181 1,101,927 1,074,437 
Notes payable372,532 372,133 371,734 371,335 320,000 
Shareholders’ equity2,032,597 1,799,502 1,617,684 1,761,387 1,752,402 
Book value per share36.72 32.51 29.23 31.83 31.70 
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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; pandemics, epidemics, widespread health emergencies, or outbreaks of infectious diseases; 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 70% of the $3.7 billion of the Company’s direct premiums written in 2020, and approximately 88% of the private passenger automobile premiums were written in California. 

In 2021, the Company intends to cease accepting new business and renewing existing policies for the commercial automobile line of insurance business in Arizona, Georgia, Illinois and Nevada. The commercial automobile line of insurance business in those states has been volatile and challenged the Company’s objective of growing the business profitably. The Company plans to focus resources on the states and lines of insurance business with better opportunities for sustainable growth. The combined net premiums written in 2020 for the commercial automobile line of insurance business in those states was approximately $20 million.

This section discusses some of the relevant factors that management considers in evaluating the Company’s
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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.

2020 Financial Performance Summary
The Company’s net income for the year ended December 31, 2020 was $374.6 million, or $6.77 per diluted share, compared to $320.1 million, or $5.78 per diluted share, for the same period in 2019. Included in net income was $134.9 million of pre-tax net investment income that was generated during 2020 on a portfolio of $4.7 billion, at fair value, at December 31, 2020, compared to $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. Also included in net income were pre-tax net realized investment gains of $85.7 million and $222.8 million in 2020 and 2019, respectively, and pre-tax catastrophe losses, net of reinsurance benefits and related reinstatement premiums earned, of approximately $60.9 million and $65.3 million in 2020 and 2019, respectively.

During 2020, 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 $606 million and $520 million in 2020 and 2019, 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, collision avoidance and other technology in vehicles, and stay-at-home orders issued by state and local governments due to the pandemic.
•Underwriting Cycle and Competition—The property and casualty insurance industry is highly cyclical, with alternating hard and soft market conditions. The Company believes that the automobile insurance industry in 2020
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has generally experienced a significant softening of the market. Insurance carriers lowered rates to reflect lower loss frequencies as stay-at-home orders issued by the state and local governments following the COVID-19 pandemic led to a decrease in the number of accidents, although this also depends on individual state profitability and the carriers' growth appetite.

Technology

In 2020, the Company continued its insurance platform modernization initiative to migrate its lines of insurance business to Guidewire’s InsuranceSuite, 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 many of the states and lines of insurance business in which the Company operates for its underwriting processing. The Company expects to complete the migration for the remaining states and lines of insurance business, including the policy and billing centers of the California private passenger automobile line of insurance business, over the next few years. In addition, the Company implemented a new product offering for Commercial Multi-Peril insurance, and improved paperless eDelivery as well as customer portal and billing self-service capabilities in 2020.

Since March of 2020, the Company has been leveraging its information technology capabilities to enable all of its employees to work from home using mobile and collaborative technologies. The Company's other technology accomplishments in 2020 include: completion of major enhancements to its core network infrastructure and application systems, including a major Guidewire software upgrade which leverages new feature enhancements and adds capacity and performance; implementation of omni-channel customer service; development of a mobile application; and deployment of major technology enhancements to its customer portal, and several other technologies, such as computer vision and machine learning for photo-based estimation, mobile appraisal and business rules engine, Usage-Based Insurance, Robotic Process Automation, and enhancements to its cloud-based business analytics capabilities.

In 2021, the Company intends to continue to invest in modernization of its technology platforms, and deploy advanced technologies for enhanced digital customer experience, cross selling and customer relationship management, which will improve its customer acquisition process based on direct-to-consumer and agent distribution models.

Note on COVID-19
 
In March 2020, the outbreak of COVID-19 was recognized as a pandemic by the World Health Organization (the "WHO"), and the outbreak has become increasingly widespread in the United States, including in the markets in which the Company operates. The pandemic has had a notable impact on general economic conditions, including, but not limited to, the temporary closures of many businesses, “shelter in place” and other governmental orders, and reduced consumer spending. The Company is following guidelines established by the Centers for Disease Control, the WHO and orders issued by the state and local governments in which the Company operates. The Company has taken a number of precautionary steps to safeguard its business and employees from COVID-19, including activating its Business Continuity Plan. Most of the Company's employees have been working remotely, with only certain operationally critical employees working on site at various locations. The Company is monitoring and assessing the impact of the COVID-19 pandemic daily, including recommendations and orders issued by federal, state and local governments. In September 2020, the Company extended its "work-from-home" policy for most of its employees to June 2021, and may further extend the policy, if necessary, based on the latest information on the pandemic's developments.

The Company’s automobile line of business began experiencing a significant decrease in loss frequency in mid to late March, and it remained lower than the historical levels through the end of 2020, although it began to increase in June and the second half of 2020 as more drivers returned to the road following the gradual reopening of businesses in California and other states. The reduction in auto loss frequency was primarily due to reduced driving resulting from the shelter-in-place orders issued by state and local governments. Due to the uncertainty regarding COVID-19, it is unclear how long auto loss frequency will remain at these lower levels. Conversely, the severity of accidents, for both bodily injury and the cost to repair vehicles, has increased primarily due to a higher percentage of high-speed serious accidents on less congested roads and freeways. The cost to repair vehicles may remain high due to supply chain and labor force issues. In addition, the Company's net premiums earned was negatively impacted as a result of premium refunds and credits voluntarily issued to policyholders by the Company, and also in compliance with the requests and directives from the California Insurance Commissioner (see B. Regulatory and Legal Matters below for additional details) and other insurance regulators in other states. COVID-19 is also impacting the ability of some of the Company’s policyholders to pay their insurance premiums, and the Company has granted limited grace periods to those needing financial assistance.

Many businesses have been required by state and local governments to cease or substantially reduce operations, and have
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suffered severe financial losses as a result. Many of these businesses have submitted claims to their insurers under the business interruption coverage of their commercial property policies, resulting in coverage disputes in many states. While the Company does insure a modest number of businesses with this business interruption coverage, these pandemic-related losses are not covered under the Company's policy terms and conditions. The Company’s business interruption, or “business income” coverage, requires a “direct physical loss” to the property that results in suspension of operations, such as a fire or water loss. The coverage is not triggered under the present circumstances. Most of the Company’s policies also contain an exclusion for losses caused directly or indirectly by “virus or bacteria.” This exclusion was adopted by many insurers after the SARS outbreak of 2003-2004, upon recognition that such a pandemic could result in losses far exceeding the capacity of individual insurers and the private insurance market as a whole. The Company does not believe it has any material exposure to business interruption claims.

Due to disruptions in the equity and fixed maturity securities markets following the outbreak of the COVID-19 pandemic, the Company's investment portfolio substantially declined in value during the quarter ended March 31, 2020. Such decline in the fair value of the Company's investment portfolio has recovered during the subsequent quarters of 2020. In March 2020, the Federal Open Market Committee (“FOMC”) unveiled a set of aggressive measures to cushion the economic impact of the global COVID-19 crisis, including, among others, cutting the federal funds rate by 100 basis points to a range of 0.00% to 0.25% and establishing a series of emergency credit facilities in an effort to support the flow of credit in the economy, easing liquidity pressure and calming market turmoil. While volatility in the financial markets remains elevated, overall market liquidity concerns have eased following the actions taken by the FOMC. The Company believes that it will continue to have sufficient liquidity to support its business operations during the COVID-19 crisis and beyond without the forced sale of investments, based on its existing cash and short-term investments, future cash flows from operations, and $50 million of undrawn credit in its revolving credit facility.

On March 27, 2020, the President of the United States signed the Coronavirus Aid, Relief, and Economic Security ("CARES") Act, a substantial tax-and-spending package intended to provide additional economic stimulus to address the financial impact of the COVID-19 pandemic. The CARES Act includes, among other items, cash payments to individuals as well as emergency grants and forgivable loans to small businesses, if they meet certain criteria. On December 27, 2020, the President signed an additional round of COVID-19 relief legislation. To the extent the Company's existing or potential policyholders, both individuals and businesses, and its independent agents are aided by such relief programs, the negative impact of the pandemic on its results of operations due to the reduced premiums written or increased uncollectible premiums is mitigated.

The Company will continue to monitor the impact of the COVID-19 pandemic, and the effects of the CARES Act and any future rounds of such relief legislation. The extent of the impact of the pandemic on the Company's business and financial results will depend largely on future developments, including the duration of the pandemic, its impact on capital and financial markets and the related impact on consumer confidence and spending, the success of efforts to contain it such as broad vaccine rollout, and the impact of actions taken in response, all of which are highly uncertain and cannot be predicted. As the impact of the COVID-19 pandemic continues to evolve, additional impacts may arise.
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 2020, the Company implemented rate changes in ten 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 2020:

▪In each of February and July 2020, the California DOI approved a 6.99% rate increase on the California homeowners line of insurance business, which represented approximately 14% of the Company's total net premiums earned in 2020. The Company implemented the February rate increase in April 2020 and the July rate increase in October 2020.

On April 13, 2020, the California Insurance Commissioner issued Bulletin 2020-3 ordering insurers to make an initial premium adjustment within 120 days from the date of the Bulletin 2020-3 to adversely impacted California policyholders for the months of March and April 2020. The Commissioner granted insurers flexibility in determining how to quickly and fairly process the premium refunds. On May 15, 2020, the California Insurance Commissioner issued Bulletin 2020-4 extending the directives in Bulletin 2020-3 through May 31, 2020. The Bulletin 2020-8, originally issued on June 25, 2020 and amended on December 3, 2020, extended the previous directives of Bulletin 2020-3 and Bulletin 2020-4 through June 30, 2020, as well as any months subsequent to June 2020 because the COVID-19 pandemic continued to result in projected loss exposures remaining overstated or misclassified. The total amount of premiums returned to the Company's policyholders through refunds
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or credits in 2020 was approximately $128 million. The Company's net premiums earned was reduced by approximately $128 million for the twelve months ended December 31, 2020 as a result of these premium refunds and credits.

In July 2019, the governor of California signed a bill that created a $21 billion fund (the "California Wildfire Fund") to help PG&E and the state's other investor-owned utility companies cover liabilities arising from future wildfires caused by their equipment. The bill requires investor-owned utility companies to put up half of the money in the California Wildfire Fund. The other half comes from surcharges paid by ratepayers across the state. In order to access the California Wildfire Fund, PG&E had to emerge from its bankruptcy proceedings by June 30, 2020. On July 1, 2020, PG&E made an announcement that it emerged out of bankruptcy and made an initial deposit of approximately $5 billion to the California Wildfire Fund. It is expected that the Company and other insurers will be reimbursed for some portion of the claims paid for its policyholders if it is determined that a wildfire is caused by equipment failure. The announcement also confirmed that PG&E has funded the Subrogation Trust Fund with $11 billion, which was set up to reimburse insurance companies and other entities that paid claims by individuals and businesses related to wildfires in recent past years. The Company received approximately $23 million, net of fees, in 2020 from the Subrogation Trust Fund. However, the subrogation recovery recognized was for losses and loss adjustment expenses previously ceded to the Company’s reinsurers, and therefore the recovery did not reduce losses and loss adjustment expenses net of reinsurance. The benefit to the Company, net of reinsurance and before taxes, was approximately $3 million, representing a reduction to reinstatement premiums previously recognized.

In November and December 2020, the California Insurance Commissioner issued a mandatory moratorium on cancellations and non-renewals of policies of residential property insurance after the declaration of a state of emergency through Bulletins 2020-11, 2020-12 and 2020-13. These Bulletins list declarations of a state of emergency issued by the California Governor in August, September and November 2020, along with the ZIP Codes within and adjacent to the fire perimeters in counties subject to each state of emergency. The mandatory moratorium prohibits insurers from canceling or refusing to renew a policy of residential property insurance for a property located in any ZIP Code listed in these Bulletins for one year after the declaration of a state of emergency and in effect at the time of the declared emergency, based solely on the fact that the insured structure is located in an area in which a fire has occurred. The Company will comply with these Bulletins and does not believe that these Bulletins will have a material adverse impact on its financial condition or cash flows.

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.
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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
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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 ClosedDollars Paid
BI claims closed in the accident year reported40%13%
BI claims closed one year after the accident year reported77%51%
BI claims closed two years after the accident year reported92%77%
BI claims closed three years after the accident year reported97%89%

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 $15,000 to $20,000. 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, 2020, the accident years that are most likely to develop are the 2018 through 2020 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.

During 2020, the Company experienced a decrease in loss frequency primarily resulting from the shelter-in-place orders issued by state and local governments in response to the COVID-19 pandemic. In addition, the COVID-19 pandemic created greater uncertainty in the reserve estimates: A greater number of large claims may emerge from the 2020 accident year compared to the prior accident years as claimants may be reluctant to go to a medical provider due to the pandemic but subsequently seek monetary compensation to ease the economic hardship attributable to the pandemic. A lower percentage of minor accidents with lower average severity experienced during the pandemic are likely to push the total average severity higher. There is reduced subrogation potential due to increased single-vehicle accidents during 2020. Automobile parts and labor costs will be higher if further supply shortages emerge due to the prolonged pandemic. Based on these factors and uncertainty attributable to the pandemic, the reserve estimates for the 2020 accident year are subject to a greater degree of variability.

The Company believes that it is reasonably possible that the California automobile BI severity could vary from recorded amounts by as much as 12%, 8%, and 6% for 2020, 2019, and 2018 accident years, respectively; however, the variation could be more or less than these amounts.





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During the years 2016 through 2020, 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:
 HighLow
Immediate preceding accident year1.4%(5.1)%
Second preceding accident year7.5%(3.1)%
Third preceding accident year5.2%(2.9)%

The following table presents the effects on the California automobile BI loss reserves for the 2020, 2019, and 2018 accident years based on possible variations in the severity recorded; however, the actual variations 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
12/31/2020
Implied
Inflation Rate
Recorded (1)
(A) Pro-forma
severity if actual
severity is lower by
12% for 2020,
8% for 2019, and
6% for 2018		(B) Pro-forma
severity if actual
severity is higher by
12% for 2020,
8% for 2019, and
6% for 2018		Favorable loss
development if
actual severity is
less than recorded
(Column A)		Unfavorable loss
development if
actual severity is
more than recorded
(Column B)
202019,896 (2)$20,557 (2)23.5 %(2)$18,090 $23,024 $49,083,000 $(49,083,000)
201929,526 $16,649 9.7 %$15,317 $17,981 $39,329,000 $(39,329,000)
201828,685 $15,171 11.0 %$14,261 $16,081 $26,103,000 $(26,103,000)
201728,358 $13,670 — — — — — 
Total Loss Development—Favorable (Unfavorable) $114,515,000 $(114,515,000)
___________
(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 2020, the Company experienced a significant reduction in loss frequency resulting from the shelter-in-place orders issued by state and local governments in response to the COVID-19 pandemic, which led to the smaller number of claims expected for the 2020 accident year compared to the prior accident years. Conversely, a higher percentage of high-speed serious accidents on less congested roads combined with a lower percentage of minor accidents had the effect of increasing the actual recorded severity across the total claims population. Consequently, the implied inflation rate recorded for the 2020 accident year is skewed upward.

(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.

The COVID-19 pandemic created greater uncertainty in the claims count development for the 2020 accident year. The Company believes that the reduced services for non-critical cases at medical facilities and fear of infection during the pandemic combined with the economic hardship caused by the pandemic are likely to increase the late reporting of claims seeking settlement for monetary compensation. At December 31, 2020, there were 17,829 California automobile BI claims reported for the 2020 accident year, and while actual development in recent years has ranged approximately from 3% to 7%, the Company estimates that the BI claims for the 2020 accident year are expected to ultimately grow by approximately 11.6%, as it expects an increase in late reporting of claims given the high level of uncertainty in claims reporting patterns associated with the COVID-19 pandemic. The Company further believes that it is reasonable to expect that the range of the development for the 2020 accident year is subject to greater variability due to uncertainty related to the pandemic and could be as great as between 0% and 20%. However, actual development may be more or less than the expected range.


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The following table presents the effects on loss development of different claim counts within the broader possible range at December 31, 2020:

California Automobile Bodily Injury Claim Count Reserve Sensitivity Analysis
2020 Accident YearClaims ReportedAmount Recorded
at 12/31/2020 at  Approximately 11.6%
Claim Count
Development		Total Expected
Amount If Claim
Count Development is
0%		Total Expected
Amount If Claim
Count Development is
20%
Claim count17,829 19,896 17,829 21,395 
Approximate average cost per claimNot meaningful$20,557 $20,557 $20,557 
Total dollarsNot meaningful$409,002,000 $366,511,000 $439,817,000 
Total Loss Development—Favorable (Unfavorable)$42,491,000 $(30,815,000)

(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 2020, the Company did not incur any material unexpected losses related to claims from accident periods prior to 2017.

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, 2020 and 2019, the Company recorded its point estimate of approximately $1.99 billion and $1.92 billion ($1.94 billion and $1.85 billion, net of reinsurance), respectively, in loss and loss adjustment expense reserves, which included approximately $885 million and $847 million ($864 million and $829 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, 2020 and 2019, 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 2020, the Company reported unfavorable development of approximately $23 million on the 2019 and prior accident years’ loss and loss adjustment expense reserves. The unfavorable development in 2020 was primarily attributable to higher than estimated losses and loss adjustment expenses in the homeowners and commercial automobile lines of insurance business, partially offset by favorable development in the private passenger automobile line of insurance business.

The Company recorded catastrophe losses net of reinsurance of approximately $64 million in 2020. Catastrophe losses due to the catastrophe events that occurred during 2020 totaled approximately $69 million, with no reinsurance benefits used for these losses. The majority of the 2020 catastrophe losses resulted from wildfires and windstorms in California and extreme weather events outside of California. These losses were partially offset by favorable development of approximately $5 million on prior years' catastrophe losses.



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Fair Value of Financial Instruments
Financial instruments recorded in the consolidated balance sheets include investments, note receivable, other receivables, 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. 98.3% of the fair value of these financial instruments held at December 31, 2020 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, 2020, 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.
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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. Tax-exempt investment income of approximately $78 million coupled with pre-tax income of approximately $459 million resulted in an effective tax rate of 18.3%, below the statutory tax rate of 21%, in 2020, and tax-exempt investment income of approximately $82 million coupled with pre-tax income of approximately $378 million resulted in an effective tax rate of 15.3% in 2019.

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, 2020 Compared to Year Ended December 31, 2019

Revenues

Net premiums earned and net premiums written in 2020 decreased 1.2% and 3.2%, respectively, from 2019. The Company's net premiums earned and written in 2020 were each reduced by approximately $128 million due to premium refunds and credits to its eligible policyholders associated with the "Mercury Giveback" program for reduced driving and business activities following the outbreak of the COVID-19 pandemic. The decrease in net premiums earned and net premiums written was primarily due to these premium refunds and credits and to a decline in the number of private passenger automobile policies written in California, partially offset by higher average premiums per policy arising from rate increases in the California homeowners line of insurance business and growth in the number of homeowners policies written in California.

Net premiums earned included ceded premiums earned of $56.2 million and $56.7 million in 2020 and 2019, respectively. Net premiums written included ceded premiums written of $50.6 million and $43.8 million in 2020 and 2019, respectively. The increase in ceded premiums written resulted mostly from higher reinsurance coverage, higher rates, and 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.








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The following is a reconciliation of total net premiums earned to net premiums written:
Year Ended December 31,
20202019
 (Amounts in thousands)
Net premiums earned$3,555,635 $3,599,418 
Change in net unearned premiums55,908 132,305 
Net premiums written$3,611,543 $3,731,723 

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,
20202019
Loss ratio67.4 %75.2 %
Expense ratio25.7 %24.2 %
Combined ratio
93.1 %99.4 %
    
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 $23 million and $10 million on prior accident years’ loss and loss adjustment expense reserves for the years ended December 31, 2020 and 2019, respectively. The unfavorable development in 2020 was primarily attributable to higher than estimated losses and loss adjustment expenses in the homeowners and commercial automobile lines of insurance business, partially offset by favorable development in the private passenger automobile line of insurance business, while 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 in certain of the Company's other lines of insurance business.

The 2020 loss ratio was negatively impacted by a total of approximately $64 million of catastrophe losses, net of reinsurance benefits, primarily due to wildfires and windstorms in California and extreme weather events outside of California. 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.

Excluding the effect of estimated prior periods’ loss development and catastrophe losses, the loss ratio was 64.8% and 73.3% for the years ended December 31, 2020 and 2019, respectively. The decrease in the loss ratio was primarily due to a significant decrease in loss frequency in the private passenger automobile line of insurance business stemming from the substantial decrease in overall driving following the "stay-at-home" orders issued in response to the COVID-19 pandemic in the states where the Company operates, partially offset by premium refunds and credits under the "Mercury Giveback" program as described above, an increase in loss severity in the private passenger automobile line of insurance business, and higher losses in the homeowners line of insurance business.

Expense ratio is calculated by dividing the sum of policy acquisition costs and other operating expenses by net premiums earned. The increase in the expense ratio is largely due to premium refunds and credits as described above, without a corresponding decrease in policy acquisition costs and other operating expenses. The Company did not recoup commissions from its agents on the premiums returned to its eligible policyholders under the "Mercury Giveback" program. In addition, an increase in allowance for credit losses on premiums receivable, reflecting heightened credit risk for certain of the Company's policyholders as a result of the economic downturn caused by the COVID-19 pandemic, contributed to an increase in the expense ratio.

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 was $83.9 million and $58.0 million for the years ended December 31, 2020 and 2019, respectively. The $25.9 million increase in income tax expense was mainly due to a significant increase in pre-tax income of $80.4 million.
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Tax-exempt investment income, a component of total pre-tax income, remained relatively steady with the same period in 2019.
Investments
The following table presents the investment results of the Company:
Year Ended December 31,
20202019
 (Amounts in thousands)
Average invested assets at cost (1)
$4,291,888 $4,008,601 
Net investment income (2)
Before income taxes$134,858 $141,263 
After income taxes$120,043 $125,637 
Average annual yield on investments (2)
Before income taxes3.1 %3.5 %
After income taxes2.8 %3.1 %
Net realized investment gains (losses)$85,731 $222,793 
__________ 
(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 decreased primarily due to a lower average yield on investments, partially offset by higher average invested assets. Average annual yield on investments before and after income taxes decreased primarily due to the 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, 2020
Gains (Losses) Recognized in Income
 Sales
Changes in fair value
Total
 (Amounts in thousands)
Net realized investment gains (losses):
Fixed maturity securities (1)(2)
$(2,412)$41,394 $38,982 
Equity securities (1)(3)
(4,543)32,232 27,689 
Short-term investments (1)
(2,292)(1,014)(3,306)
Note receivable (1)
— 60 60 
Options sold22,322 (16)22,306 
Total$13,075 $72,656 $85,731 

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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 swaps1,039 — 1,039 
Options sold6,329 10 6,339 
Total$26,081 $196,712 $222,793 
__________ 
(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 in 2020 and 2019 were primarily due to decreases in market interest rates.
(3)The increases in fair value of equity securities in 2020 and 2019 were primarily due to the overall improvement in equity markets.

Net Income
 Year Ended December 31,
20202019
 (Amounts in thousands, except per share data)
Net income$374,607 $320,087 
Basic average shares outstanding55,358 55,351 
Diluted average shares outstanding55,358 55,360 
Basic Per Share Data:
Net income$6.77 $5.78 
Net realized investment gains, net of tax$1.22 $3.18 
Diluted Per Share Data:
Net income$6.77 $5.78 
Net realized investment gains, net of tax$1.22 $3.18 


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

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, 2019 for a discussion of changes in its results of operations from the year ended December 31, 2018 to the year ended December 31, 2019.


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 $222 million in 2021 to Mercury General. The Insurance Companies paid Mercury General ordinary dividends of $121 million during 2020. As of December 31, 2020, Mercury General had approximately $140 million in investments and cash that could be utilized to satisfy its direct holding company obligations.

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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 $724.1 million at December 31, 2020 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, 2020 was $605.6 million, an increase of $85.9 million compared to the year ended December 31, 2019. The increase was primarily due to a decrease in payments for losses and loss adjustment expenses, partially offset by a decrease in collections from reinsurers on reinsurance recoverables, an increase in payments for income taxes and a decrease in premium collections net of premium refunds. The Company utilized the cash provided by operating activities during the year ended December 31, 2020 primarily for the net purchases of investment securities and payment of dividends to its shareholders.

The following table presents the estimated fair value of fixed maturity securities at December 31, 2020 by contractual maturity in the next five years.
 Fixed Maturity Securities
 (Amounts in thousands)
Due in one year or less$246,708 
Due after one year through two years376,850 
Due after two years through three years213,301 
Due after three years through four years52,459 
Due after four years through five years50,457 
$939,775 

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.

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The following table presents the composition of the total investment portfolio of the Company at December 31, 2020:
Cost(1)
Fair Value
 (Amounts in thousands)
Fixed maturity securities:
U.S. government bonds $13,756 $13,816 
Municipal securities2,632,559 2,791,212 
Mortgage-backed securities91,527 93,264 
Corporate securities240,486 241,366 
Collateralized loan obligations256,558 256,891 
Other asset-backed securities153,532 153,261 
3,388,418 3,549,810 
Equity securities:
Common stock563,394 691,782 
Non-redeemable preferred stock31,430 32,660 
Private equity funds measured at net asset value (2)
100,326 79,409 
695,150 803,851 
Short-term investments 376,547 375,609 
Total investments$4,460,115 $4,729,270 
 __________
(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, 2020, 55.1% of the Company’s total investment portfolio at fair value and 73.4% 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, 2020, 92.8% 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.
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The following table presents the maturities and durations of the Company's fixed maturity securities and short-term investments:
December 31, 2020December 31, 2019
(in years)
Fixed Maturity Securities
Nominal average maturity:
excluding short-term investments11.713.9
including short-term investments10.612.0
Call-adjusted average maturities:
excluding short-term investments4.14.6
including short-term investments3.74.0
Modified duration reflecting anticipated early calls:
excluding short-term investments3.43.7
including short-term investments3.03.2
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, 2020, consistent with the average rating at December 31, 2019. The Company’s municipal bond holdings, of which 93.4% were tax exempt, represented 78.6% of its fixed maturity portfolio at December 31, 2020, 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, 2020, fixed maturity holdings rated below investment grade and non-rated bonds totaled $25.5 million and $38.4 million, respectively, at fair value, and represented 0.7% and 1.1%, 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, 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.

Credit ratings for the Company's fixed maturity portfolio were stable in 2020, with 91.4% of fixed maturity securities at fair value experiencing no change in their overall rating. 2.6% and 6.0% of fixed maturity securities at fair value experienced upgrades and downgrades, respectively, in 2020.

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The following table presents the credit quality ratings of the Company’s fixed maturity securities by security type at fair value:
 December 31, 2020
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$13,816 $— $— $— $— $13,816 
Total13,816 — — — — 13,816 
100.0 %— %— %— %— %100.0 %
Municipal securities:
Insured37,331 175,732 109,690 52,061 2,221 377,035 
Uninsured97,709 783,290 1,274,639 218,587 39,952 2,414,177 
Total135,040 959,022 1,384,329 270,648 42,173 2,791,212 
4.8 %34.4 %49.6 %9.7 %1.5 %100.0 %
Mortgage-backed securities:
Commercial6,787 5,162 1,493 4,134 — 17,576 
Agencies1,094 — — — — 1,094 
Non-agencies:
Prime24,841 40,396 6,726 57 621 72,641 
Alt-A— 642 — 611 700 1,953 
Total32,722 46,200 8,219 4,802 1,321 93,264 
35.2 %49.5 %8.8 %5.1 %1.4 %100.0 %
Corporate securities:
Basic materials— — — 399 2,736 3,135 
Communications— — 191 482 — 673 
Consumer, cyclical— 2,575 7,477 5,593 4,975 20,620 
Consumer, non-cyclical— 10,361 14,263 11,995 — 36,619 
Energy— — 2,286 18,088 2,000 22,374 
Financial— 12,514 87,152 30,061 3,270 132,997 
Industrial— 450 2,055 15,753 — 18,258 
Utilities— — 6,690 — — 6,690 
Total— 25,900 120,114 82,371 12,981 241,366 
— %10.7 %49.8 %34.1 %5.4 %100.0 %
Collateralized loan obligations:
Corporate79,860 24,260 151,771 — 1,000 256,891 
Total79,860 24,260 151,771 — 1,000 256,891 
31.1 %9.4 %59.1 %— %0.4 %100.0 %
Other asset-backed securities58,000 77,000 11,884 — 6,377 153,261 
37.8 %50.2 %7.8 %— %4.2 %100.0 %
Total$319,438 $1,132,382 $1,676,317 $357,821 $63,852 $3,549,810 
9.0 %31.9 %47.2 %10.1 %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 $13.8 million and $22.6 million, or 0.4% and 0.7% of its fixed maturity portfolio, at fair value, in U.S. government bonds at December 31, 2020 and 2019, respectively. At December 31, 2020, 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
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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 at December 31, 2020 and 2019.
Municipal Securities
The Company had $2.79 billion and $2.55 billion, or 78.6% and 82.6% of its fixed maturity securities portfolio, at fair value, in municipal securities at December 31, 2020 and 2019, respectively, of which $377.0 million and $344.7 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, 2020 and 2019.

At December 31, 2020 and 2019, respectively, 59.9% and 65.5% 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, 2020 and 2019, the average rating of the Company’s insured municipal securities was A+, which corresponded to the average rating of the investment grade bond insurers. The remaining 40.1% and 34.5% of insured municipal securities at December 31, 2020 and 2019, 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 3.4 years and 3.7 years at December 31, 2020 and 2019, 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, 2020 and 2019, respectively, the mortgage-backed securities portfolio of $93.3 million and $63.0 million, or 2.6% and 2.0% of the Company's fixed maturity securities portfolio, at fair value, was categorized as loans to "prime" borrowers, except for $2.0 million and $2.4 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 $17.6 million and $18.9 million, at fair value, in commercial mortgage-backed securities at December 31, 2020 and 2019, respectively.

The weighted-average rating of the Company’s Alt-A mortgage-backed securities was BBB- at December 31, 2020 and 2019. The weighted-average rating of the entire mortgage backed securities portfolio was AA at December 31, 2020 and 2019. The modified duration of the mortgage-backed securities portfolio reflecting anticipated early calls was 6.4 years and 3.1 years at December 31, 2020 and 2019, respectively.
Corporate Securities
At December 31, 2020 and 2019, respectively, the company had corporate securities of $241.4 million and $235.6 million, or 6.8% and 7.6% of its fixed maturity securities portfolio, at fair value. The weighted-average rating was A- at December 31, 2020 and 2019. The modified duration reflecting anticipated early calls was 1.7 years and 2.0 years at December 31, 2020 and 2019, respectively.
Collateralized Loan Obligations

The Company had collateralized loan obligations of $256.9 million and $199.2 million, which represented 7.2% and 6.4% of its fixed maturity securities portfolio, at fair value, at December 31, 2020 and 2019, respectively. The weighted-average rating was AA- and A+ at December 31, 2020 and 2019, respectively. The modified duration reflecting anticipated early calls was 4.8 years and 5.2 years at December 31, 2020 and 2019, respectively.



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Other Asset-Backed Securities

The Company had other asset-backed securities of $153.3 million and $18.6 million, which represented 4.3% and 0.6% of its fixed maturity securities portfolio, at fair value, at December 31, 2020 and 2019, respectively. The weighted-average rating was AA+ and A at December 31, 2020 and 2019, respectively. The modified duration reflecting anticipated early calls was 1.6 years and 1.8 years at December 31, 2020 and 2019, respectively.
Equity Securities
Equity holdings of $803.9 million and $724.8 million, at fair value, as of December 31, 2020 and 2019, 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 due to changes in fair value of the Company’s equity portfolio were $32.2 million and $90.9 million in 2020 and 2019, respectively. The primary cause for the increase in fair value of the Company's equity securities in 2020 and 2019 was the overall improvement in equity markets.
The Company’s common stock allocation is intended to enhance the return of and provide diversification for the total portfolio. At December 31, 2020, 17.0% of the total investment portfolio, at fair value, was held in equity securities, compared to 16.8% at December 31, 2019.

The following table presents the equity security portfolio by industry sector at December 31, 2020 and 2019:
 December 31,
 20202019
 CostFair ValueCostFair Value
  (Amounts in thousands) 
Equity securities:
Basic materials$7,520 $8,262 $9,528 $10,058 
Communications28,970 34,806 26,130 29,516 
Consumer, cyclical60,604 78,822 49,816 52,470 
Consumer, non-cyclical64,067 77,071 47,427 55,526 
Energy51,338 37,163 57,459 54,615 
Financial81,602 102,924 100,720 121,642 
Funds143,947 137,143 141,405 139,517 
Industrial59,084 76,348 45,132 55,135 
Technology97,190 145,023 65,280 89,681 
Utilities100,828 106,289 105,385 116,591 
$695,150 $803,851 $648,282 $724,751 

D. Debt
Notes payable consist of the following:
December 31,
LenderInterest RateExpiration20202019
(Amounts in thousands)
Senior unsecured notes(1)
Publicly traded4.40%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 amount375,000 375,000 
Less unamortized discount and debt issuance costs(3)
2,468 2,867 
Total$372,532 $372,133 
__________
(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
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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 15.6% at December 31, 2020, resulting in a 15 basis point commitment fee on the $50 million undrawn portion of the credit facility. As of February 16, 2021, 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, 2020.

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 2020, the Company made capital expenditures, including capitalized software, of approximately $40.0 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, 2020, 2019 and 2018, 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 350% of the authorized control level RBC as of December 31, 2020, 2019 and 2018. 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 $1.77 billion at December 31, 2020 and net premiums written in 2020 of $3.6 billion, the ratio of premiums written to surplus was 2.04 to 1.

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 2020. Compliance with the ORSA requirements did not have a material impact on the Company's consolidated financial statements.

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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.

The following table presents a summary of recent examinations:
StateExam TypePeriod Under ReviewStatus
CAPremium Tax2015 to 2018Desk audit was completed in the first quarter of 2021 with no additional taxes due.
TXPremium and Maintenance Tax2016 to 2019Desk audit was completed in the fourth quarter of 2020 with no additional taxes due.
CAMarket Conduct2014Final report of examination was adopted by the DOI on November 6, 2019.

During the course of and at the conclusion of these examinations, the examining DOI generally reports findings to the Company. On October 30, 2020, the Company received notice from the DOI that the market conduct examination report mentioned above was being reviewed for potential further action in connection with some of the findings in the report. Subsequently, the DOI gave the Company notice of its intent to proceed with an enforcement action for the alleged violations in the report. The Company will have the opportunity to resolve the alleged violations before a Notice of Noncompliance is formally filed with the DOI.

OFF-BALANCE SHEET ARRANGEMENTS

As of December 31, 2020, 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, 2020 are summarized as follows:
Contractual Obligations (4)
Payments Due By Period
Total20212022202320242025Thereafter
   (Amounts in thousands)  
Debt (including interest)(1)
$482,250 $16,500 $16,500 $16,500 $16,500 $16,500 $399,750 
Lease obligations(2)
49,295 15,992 13,361 8,717 5,010 3,230 2,985 
Loss and loss adjustment expense reserves(3)
1,991,304 1,246,658 350,486 172,729 102,932 52,391 66,108 
Total contractual obligations$2,522,849 $1,279,150 $380,347 $197,946 $124,442 $72,121 $468,843 
__________ 
(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, 2020 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, office equipment, and electronic data processing 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, 2020. 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 $6.2 million related to uncertainty in tax settlements as the Company is unable to reasonably estimate the timing and amount of related future payments.
53

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, 2020, 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, 2019.
The following table presents municipal securities by state in descending order of holdings at fair value at December 31, 2020:
StatesFair ValueAverage Rating
(Amounts in thousands)
Texas$354,628 AA-
Florida268,190 A+
Illinois226,499 A
New York193,317 A+
California181,772 AA-
Other states1,566,806 A+
Total$2,791,212 

At December 31, 2020, 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 26.6% of the Company’s fixed maturity portfolio at December 31, 2020. 1.5% of the Company’s taxable fixed maturity securities were comprised of U.S. government bonds, which were rated AAA at December 31, 2020. 2.2% of the Company’s taxable fixed maturity securities, representing 0.6% of its total fixed maturity portfolio, were rated below investment grade at December 31, 2020. 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, 2020, the Company’s primary objective for common equity investments was current income. The fair
54

value of the equity investments consisted of $691.8 million in common stocks, $32.7 million in non-redeemable preferred stocks, and $79.4 million in private equity funds. Common stocks are typically valued for future economic prospects as perceived by the market.
Common stocks represented 14.6% of total investments at fair value at December 31, 2020. 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, 2020 and 2019:
December 31,
20202019
(Amounts in thousands, except Average Beta)
Average Beta1.11 0.83 
Hypothetical reduction of 25% in the overall value of the stock market $191,970 $121,671 
Hypothetical reduction of 50% in the overall value of the stock market $383,939 $243,342 

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, 2020, which represented 75.1% of total investments at December 31, 2020, 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 3.0 years at December 31, 2020. 
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, 2020 would decrease by $119.3 million and $238.7 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.

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Item 8.Financial Statements and Supplementary Data

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
 Page
Consolidated Financial Statements:
56

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, 2020 and 2019, the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes and financial statement schedules I, II, and 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, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2020, 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, 2020, 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 16, 2021 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 judgments. 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.

Loss and loss adjustment expense reserves
As discussed in Notes 1 and 12 to the consolidated financial statements, the Company estimates loss and loss adjustment expense reserves (loss reserves) to cover incurred losses and loss adjustment expenses. 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, 2020, the loss and loss adjustment expense reserves balance was $1.99 billion, which included catastrophe losses of $64 million.

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

The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls related to the Company’s reserving process. This
57

included controls related to 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 Company’s estimates for the remaining lines of business in comparison to internal experience and related industry trends

• developing a range of reserves based on actuarial methodologies and comparing to the Company’s total recorded loss reserves

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


/s/    KPMG LLP

We have served as the Company’s auditor since 1963.
Los Angeles, California
February 16, 2021
58

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, 2020, 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, 2020, 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, 2020 and 2019, the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes and financial statement schedules I, II, and IV (collectively, the consolidated financial statements), and our report dated February 16, 2021 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 16, 2021
59


MERCURY GENERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands) 
 December 31,
 20202019
ASSETS
Investments, at fair value:
Fixed maturity securities (amortized cost $3,388,418; $2,973,276)
$3,549,810 $3,093,275 
Equity securities (cost $695,150; $648,282)
803,851 724,751 
Short-term investments (cost $376,547; $494,060)
375,609 494,135 
Total investments4,729,270 4,312,161 
Cash348,479 294,398 
Receivables:
Premiums599,070 606,316 
      Allowance for credit losses on premiums receivable(10,000)(1,445)
                   Premiums receivable, net of allowance for credit losses589,070 604,871 
Accrued investment income42,985 40,107 
Other10,730 6,464 
Total receivables642,785 651,442 
Reinsurance recoverables48,579 78,774 
 Allowance for credit losses on reinsurance recoverables(91)— 
             Reinsurance recoverables, net of allowance for credit losses48,488 78,774 
Deferred policy acquisition costs246,994 233,166 
Fixed assets, net178,923 168,986 
Operating lease right-of-use assets40,554 44,909 
Current income taxes— 7,642 
Goodwill42,796 42,796 
Other intangible assets, net11,322 10,636 
Other assets38,635 44,247 
Total assets$6,328,246 $5,889,157 
LIABILITIES AND SHAREHOLDERS’ EQUITY
Loss and loss adjustment expense reserves$1,991,304 $1,921,255 
Unearned premiums1,405,873 1,355,547 
Notes payable372,532 372,133 
Accounts payable and accrued expenses194,421 143,318 
Operating lease liabilities43,825 47,996 
Current income taxes10,426 — 
Deferred income taxes41,132 27,964 
Other liabilities236,136 221,442 
Total liabilities4,295,649 4,089,655 
Commitments and contingencies
Shareholders’ equity:
Common stock without par value or stated value:
Authorized 70,000 shares; issued and outstanding 55,358; 55,358
98,970 98,828 
Retained earnings1,933,627 1,700,674 
Total shareholders’ equity2,032,597 1,799,502 
Total liabilities and shareholders’ equity$6,328,246 $5,889,157 
See accompanying Notes to Consolidated Financial Statements.
60

MERCURY GENERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
 Year Ended December 31,
 202020192018
Revenues:
Net premiums earned$3,555,635 $3,599,418 $3,368,411 
Net investment income134,858 141,263 135,838 
Net realized investment gains (losses)85,731 222,793 (133,520)
Other8,287 9,044 9,275 
Total revenues3,784,511 3,972,518 3,380,004 
Expenses:
Losses and loss adjustment expenses2,395,343 2,706,024 2,576,789 
Policy acquisition costs627,788 602,085 572,164 
Other operating expenses285,831 269,305 244,630 
Interest17,048 17,035 17,036 
Total expenses3,326,010 3,594,449 3,410,619 
Income (loss) before income taxes458,501 378,069 (30,615)
Income tax expense (benefit)83,894 57,982 (24,887)
Net income (loss)$374,607 $320,087 $(5,728)
Net income (loss) per share:
Basic$6.77 $5.78 $(0.10)
Diluted$6.77 $5.78 $(0.10)



See accompanying Notes to Consolidated Financial Statements.
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MERCURY GENERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(in thousands)
 Year Ended December 31,
 202020192018
Common stock, beginning of year$98,828 $98,026 $97,523 
Proceeds of stock options exercised— 701 358 
Share-based compensation expense142 123 145 
Withholding tax on stock options exercised— (22)— 
Common stock, end of year98,970 98,828 98,026 
Retained earnings, beginning of year1,700,674 1,519,658 1,663,864 
       Cumulative effect of adopting ASU 2016-13 (Note1)(2,014)— — 
Retained earnings, beginning of year, as adjusted1,698,660 1,519,658 1,663,864 
Net income (loss)374,607 320,087 (5,728)
Dividends paid to shareholders(139,640)(139,071)(138,478)
Retained earnings, end of year1,933,627 1,700,674 1,519,658 
Total shareholders’ equity, end of year$2,032,597 $1,799,502 $1,617,684 
See accompanying Notes to Consolidated Financial Statements.
62

MERCURY GENERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
 Year Ended December 31,
 202020192018
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)$374,607 $320,087 $(5,728)
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization68,463 64,730 58,791 
Net realized investment (gains) losses(85,731)(222,793)133,520 
Decrease (increase) in premiums receivable13,946 (49,832)(80,979)
Decrease (increase) in reinsurance recoverables30,127 142,314 (164,739)
Changes in current and deferred income taxes31,236 72,545 (13,898)
Increase in deferred policy acquisition costs(13,828)(18,035)(16,980)
Increase in loss and loss adjustment expense reserves70,049 91,843 318,799 
Increase in unearned premiums50,326 119,366 134,254 
Increase in accounts payable and accrued expenses51,988 26,493 6,586 
Share-based compensation142 123 145 
Other, net14,291 (27,163)13,663 
      Net cash provided by operating activities605,616 519,678 383,434 
CASH FLOWS FROM INVESTING ACTIVITIES
Fixed maturity securities available for sale in nature:
Purchases(878,213)(491,795)(706,224)
Sales168,087 136,560 189,306 
Calls or maturities250,878 316,860 334,626 
Equity securities available for sale in nature:
Purchases(1,230,785)(1,174,759)(1,026,827)
Sales1,174,540 1,088,701 954,755 
Calls3,880 — — 
Changes in securities payable and receivable873 (2,536)4,035 
Decrease (increase) in short-term investments 118,830 (240,391)45,747 
Purchase of fixed assets(39,953)(40,088)(27,959)
Other, net 20,577 6,247 10,105 
Net cash used in investing activities(411,286)(401,201)(222,436)
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends paid to shareholders(139,640)(139,071)(138,478)
Proceeds from stock options exercised— 701 358 
Payments on finance lease obligations(609)— — 
Net cash used in financing activities(140,249)(138,370)(138,120)
Net increase (decrease) in cash54,081 (19,893)22,878 
Cash:
Beginning of year294,398 314,291 291,413 
End of year$348,479 $294,398 $314,291 
SUPPLEMENTAL CASH FLOW DISCLOSURE
Interest paid$16,599 $16,586 $16,586 
Income taxes paid (refunded), net$52,659 $(14,564)$(10,989)
See accompanying Notes to Consolidated Financial Statements.
63

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 70% of the Company’s direct premiums written in 2020, 2019, and 2018, and approximately 88%, 88%, and 87% of the private passenger automobile premiums were written in California in 2020, 2019, and 2018, 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 2020, 2019 and 2018.
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
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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.

From time to time, 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, 2020 and 2019. 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 entities 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 of its investment that is included in equity securities in the Company's consolidated balance sheets. At December 31, 2020 and 2019, 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 $15 million and $16 million at December 31, 2020 and 2019, respectively.
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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,
202020192018
(Amounts in millions)
Deferred policy acquisition cost amortization
$627.8 $602.1 $572.2 
Net advertising expense
37.7 42.2 40.9 
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 2020, 2019, and 2018.
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, 2020 and 2019, 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
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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 $3.61 billion, $3.73 billion, and $3.50 billion in 2020, 2019, and 2018, respectively. The Company's net premiums written in 2020 were reduced by approximately $128 million due to premium refunds and credits to its eligible policyholders associated with the "Mercury Giveback" program for reduced driving and business activities following the outbreak of the COVID-19 pandemic.
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 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
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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.

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. 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, 2020 and 2019, 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, 2020, 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. Reinsurance recoverables on unpaid losses are estimated based upon assumptions consistent with those used in establishing the liabilities related to the underlying contracts. Most of the Company's reinsurance premiums are recognized ratably over the contract period to the extent coverage remains available. Net premiums earned and losses and loss adjustment expenses are stated net of deductions for ceded reinsurance.

The Company is the assuming reinsurer under a Catastrophe Participation Reinsurance Contract ("Contract") effective through December 31, 2021. The Company reimburses up to $31 million in losses for a proportional share of a portfolio of catastrophe losses under the Contract, to the extent the actual loss ratio exceeds the threshold loss ratio of 71%. If the actual loss ratio is less than the threshold loss ratio, the Company is eligible to receive a certain portion of the underwriting profit.

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The Company is party to a Catastrophe Reinsurance Treaty ("Treaty") covering a wide range of perils that is effective through June 30, 2021. The Treaty provides $717 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. The Treaty provides for one full reinstatement of coverage limits with a minor exception at the top coverage layer, and includes some additional minor territorial and coverage limits.

The effect of reinsurance on property and casualty premiums written and earned was as follows:

Year Ended December 31,
202020192018
 (Amounts in thousands)
Premiums Written
Direct $3,624,965 $3,742,627 $3,524,186 
Ceded(50,630)(43,785)(55,973)
Assumed8,012 919 689 
     Net$3,582,347 $3,699,761 $3,468,902 
Premiums Earned
Direct$3,574,898 $3,626,857 $3,386,192 
Ceded(56,212)(56,725)(48,941)
Assumed8,067 910 665 
     Net$3,526,753 $3,571,042 $3,337,916 

The Company recognized ceded premiums earned of approximately $56 million, $57 million, and $49 million in 2020, 2019, and 2018, respectively, which are included in net premiums earned in its consolidated statements of operations, and ceded losses and loss adjustment expenses of approximately $(28) million, $(71) million, and $257 million in 2020, 2019, and 2018, 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 2020 were mainly due to the reimbursements from Pacific Gas and Electric Corporation ("PG&E") Subrogation Trust Fund to the Company for certain claims paid to its policyholders related to wildfires in recent past years, in accordance with PG&E's Plan of Reorganization approved by the United States Bankruptcy Court. These loss recoveries from PG&E were ceded to the Company's reinsurers as the original losses had previously been ceded to its reinsurers under the Treaty. 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 had 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.



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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 $18.0 million, $16.3 million and $16.0 million, with related expenses of approximately $11.8 million, $10.5 million and $10.5 million, for the years ended December 31, 2020, 2019 and 2018, respectively. 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, 2020 and 2019 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, 2020 and 2019 was approximately $0.9 million and $0.7 million, respectively, which was included in other liabilities in the Company's consolidated balance sheets.

As of December 31, 2020 and 2019, the Company had no contract assets, contract liabilities, capitalized costs to obtain or fulfill a contract, or remaining performance obligations associated with unrecognized revenues.

Capitalized Implementation Costs for Cloud Computing Arrangements

On January 1, 2020, the Company adopted 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," on a prospective basis, which provides guidance that requires capitalizing and amortizing certain of the implementation costs. The majority of the Company's cloud computing arrangements relate to service contracts with third parties that host the Company's data and computing infrastructure that are used in providing services to and supporting transactions with its existing or potential policyholders and insurance agents.

The balance of capitalized implementation costs for cloud computing arrangements, net of accumulated amortization, was $4.8 million and $4.4 million at December 31, 2020 and December 31, 2019, respectively, which is included in other assets in the Company's consolidated balance sheets. The accumulated amortization was $2.1 million and $0.3 million at December 31, 2020 and December 31, 2019, respectively. The total amortization expense related to such capitalized implementation costs was $1.8 million and $0.3 million for the years ended December 31, 2020 and 2019, respectively, which is included in other operating expenses in the Company's consolidated statements of operations. The Company had no amortization expenses related to such capitalized implementation costs for the year ended December 31, 2018.

Allowance for Credit Losses

On January 1, 2020, the Company adopted ASU 2016-13, Financial Instruments - Credit Losses (Topic 326) along with certain additional ASUs on Topic 326 using a modified retrospective transition method, and recognized the cumulative-effect adjustment of approximately $2 million to the beginning retained earnings of 2020. The cumulative-effect adjustment primarily resulted from re-estimating credit losses on the outstanding balances of the Company's premiums receivable and reinsurance recoverables at the adoption date. Topic 326 replaces the "incurred loss" methodology for recognizing credit losses with a methodology that reflects expected credit losses for financial assets that are not accounted for at fair value through net income.
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The Company's investment portfolio, not including accrued investment income, was not affected by Topic 326 as it applies the fair value option to all of its investments.

Premiums Receivable

The majority of the Company's premiums receivable are short-term in nature and are due within a year, consistent with the policy term of its insurance policies sold. Generally, premiums are collected prior to providing risk coverage, minimizing the Company's exposure to credit risk. The Company monitors the credit risk associated with premiums receivable, taking into consideration the fact that credit risk is reduced by the Company's right to offset loss payments and unearned premiums against premiums receivable. The Company has established an allowance for uncollectible premiums receivable related to credit risk, and the estimated allowance is reviewed quarterly and adjusted as appropriate based on evaluations of balances due from insureds, management’s experience, historical data, current economic conditions, and reasonable and supportable forecasts of future economic conditions that affect the collectibility of the reported amounts. In estimating an allowance for uncollectible premiums receivable, the Company assesses customer balances and write-offs by state, line of business, and the year the premiums were written, leveraging its current process for analyzing uncollectibility of premiums receivable. This allowance is based on historical write-off percentages adjusted for the effects of current trends and reasonable and supportable forecasts, as well as expected recoveries of amounts written off.

Evaluating the current trends or economic conditions that impact the Company's ability to collect premiums receivable and projecting those into the remaining life of premiums receivable in order to develop a reasonable and supportable forecast of the ultimate collectibility involve significant judgment and assumptions about future economic conditions. The Company believes that the sustained high unemployment rate resulting from the outbreak of a novel strain of coronavirus (“COVID-19”) will lead to significant uncollectible amounts over the life of the premiums receivable balances outstanding at December 31, 2020. In addition, the Company has offered payment grace periods upon request from customers, which adds an element of uncertainty to the collectibility. Actual uncollectible amounts could be considerably more or less than the estimate. The Company monitors the overall credit risk of premiums receivable by regularly reviewing macroeconomic indicators such as unemployment and interest rates, regulatory developments such as restrictions on cancellation of policies for nonpayment of premiums, and insurance policy specific indicators such as trends in policy cancellations.

The following table presents a summary of changes in allowance for credit losses on premiums receivable:
 Year Ended December 31,
 202020192018
 
Beginning balance$1,445 $1,458 1,258 
     Cumulative effect of adopting ASU 2016-131,855 — — 
Beginning balance, as adjusted 3,300 1,458 1,258 
     Provision during the period for expected credit losses 10,294 6,162 6,463 
Write-off amounts during the period(4,406)(7,000)(6,908)
Recoveries during the period of amounts previously written off 812 825 645 
Ending balance $10,000 $1,445 $1,458 

Reinsurance Recoverables

Reinsurance recoverables are balances due to the Company from its reinsurers for paid and unpaid losses and loss adjustment expenses. A credit exposure exists with respect to these balances to the extent that any reinsurer is unable to meet its obligations. The Company has established an allowance for uncollectible reinsurance recoverables related to credit risk, and changes in the allowance are presented as a component of losses and loss adjustment expenses in the Company's consolidated statements of operations. The Company reviews the allowance quarterly and adjusts it as necessary to reflect changes in estimates of uncollectible balances. The Company evaluates the financial condition of its reinsurers and monitors concentration risk to minimize its exposure to significant losses from individual reinsurers. The Company attempts to mitigate its credit risk related to reinsurance by entering into reinsurance arrangements with reinsurers that have high credit ratings and by obtaining collateral as necessary. The primary method of obtaining collateral is through letters of credit.

Generally, the Company uses a default analysis to estimate uncollectible reinsurance recoverables. The primary components of the default analysis are reinsurance recoverable balances by reinsurer, net of collateral and any liabilities held by
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the Company subject to a right of offset, and future default factors used to estimate the probability that the reinsurer may be unable to meet its future obligations in full. The determination of the future default factor is based on a historical default factor published by a major rating agency applicable to the particular financial strength rating class. Application of future default factors also requires considerable judgment and assumptions, such as timing of loss payments and duration of the outstanding recoverable balances. Based on its past experiences with major catastrophes, the Company assumed that the majority of the reinsurance recoverable balances on unpaid losses outstanding at December 31, 2020 will be billed and collected or written off over the course of the next 5 years, and that the outstanding reinsurance recoverable balances on paid losses will be collected or written off within a year.

AM Best's Financial Strength Ratings of the Company's reinsurers ranged between B++ and A++ at December 31, 2020. While a ratings downgrade would result in an increase in provision for uncollectible reinsurance recoverables and a charge to earnings in that period, a downgrade in and of itself does not imply that the Company will be unable to collect all of the reinsurance recoverables from the reinsurers in question. To the extent the creditworthiness of the Company's reinsurers were to deteriorate due to an adverse event affecting the reinsurance industry, such as a large number of major catastrophes, actual uncollectible amounts could be significantly greater than the allowance for uncollectible reinsurance recoverables. The Company monitors credit risk by reviewing the credit ratings of its reinsurers, adequacy of letters of credit, and broader industry risks such as catastrophes impacting our reinsurers.

The following table presents a summary of changes in allowance for credit losses on reinsurance recoverables:
 Year Ended December 31,
 202020192018
 
Beginning balance$— $— $— 
     Cumulative effect of adopting ASU 2016-13159 — — 
Beginning balance, as adjusted 159 — — 
     Provision during the period for expected credit losses (68)— — 
Write-off amounts during the period— — — 
Recoveries during the period of amounts previously written off — — — 
Ending balance$91 $— $— 

Accrued Interest Receivables

The Company made certain accounting policy elections for its accrued interest receivables on the adoption date of Topic 326 as allowed: a) an election to present accrued interest receivable balances separately from the associated financial assets on the balance sheet, and b) an election not to measure an allowance for credit losses on accrued interest receivable amounts and instead write off uncollectible accrued interest amounts in a timely manner by reversing interest income.

As a general policy, the Company writes off the accrued interest receivable balance when it receives a default notice or when the scheduled interest payment is not received, unless management determines that the default is temporary considering all of the relevant information. The Company believes that for the majority of its investment securities, writing off the uncollectible interest receivable balance within a year from the due date is considered timely. In all cases, the Company writes off the accrued interest receivable immediately if management determines that it is not reasonably expected that the payment will be received. The Company did not have any cumulative-effect adjustment as a result of adopting Topic 326 for its accrued interest receivables. The Company's accrued interest receivable balances are included in accrued investment income receivables in its consolidated balance sheets. There were no accrued interest receivable amounts considered uncollectible or written off for the years ended December 31, 2020, 2019 and 2018.

Recently Issued Accounting Standards

In March 2020, the Financial Accounting Standards Board ("FASB") issued ASU 2020-04, "Reference Rate Reform (Topic 848), Facilitation of the Effects of Reference Rate Reform on Financial Reporting." ASU 2020-04 provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The amendments in this ASU apply only to contracts, hedging relationships, and other transactions that reference LIBOR or other interbank offered rates expected to be discontinued because of reference rate reform. ASU 2020-04 is effective for all entities as of March 12, 2020 through December 31, 2022. The Company expects to apply the
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optional expedients in this ASU to its unsecured credit facility that references LIBOR (see Note 8), when the facility is modified with a replacement rate before LIBOR expires. The Company does not expect any material impact on its consolidated financial statements and related disclosures resulting from applying this ASU.

2. Financial Instruments
Financial instruments recorded in the consolidated balance sheets include investments, note receivable, other receivables, options sold, accounts payable, and unsecured 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,
 20202019
 (Amounts in thousands)
Assets
Investments$4,729,270 $4,312,161 
Note receivable5,725 5,665 
Liabilities
Options sold — 77 
Unsecured notes 415,253 394,279 
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 and unrealized 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.

Unsecured Notes

The fair value of the Company’s publicly traded $375 million unsecured notes at December 31, 2020 and 2019 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.



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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,
 202020192018
 (Amounts in thousands)
Fixed maturity securities$41,394 $104,379 $(53,927)
Equity securities32,232 90,920 (77,494)
Short-term investments(1,014)1,295 (1,237)
       Total gains (losses)$72,612 $196,594 $(132,658)

The following table presents gross gains (losses) realized on the sales of investments:
 Year Ended December 31,
 202020192018
 (Amounts in thousands)
 Gross
Realized
Gains		Gross
Realized
Losses		NetGross
Realized
Gains		Gross
Realized
Losses		NetGross
Realized
Gains		Gross
Realized
Losses		Net
Fixed maturity securities$1,884 $(4,296)$(2,412)$2,413 $(1,066)$1,347 $549 $(3,563)$(3,014)
Equity securities75,591 (80,134)(4,543)47,411 (28,089)19,322 43,420 (45,607)(2,187)
Short-term investments146 (2,438)(2,292)177 (2,133)(1,956)61 (2,429)(2,368)
Contractual Maturity
At December 31, 2020, 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, 2020 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$246,708 
Due after one year through five years693,068 
Due after five years through ten years540,052 
Due after ten years2,069,982 
Total$3,549,810 
















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Investment Income
The following table presents a summary of net investment income:
 Year Ended December 31,
 202020192018
 (Amounts in thousands)
Fixed maturity securities$100,166 $102,254 $102,198 
Equity securities37,598 32,233 30,496 
Short-term investments2,822 12,381 8,789 
Total investment income$140,586 $146,868 $141,483 
Less: investment expense(5,728)(5,605)(5,645)
Net investment income$134,858 $141,263 $135,838 

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 1Unadjusted quoted prices are available in active markets for identical assets or liabilities as of the reporting date.
Level 2Pricing 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 3Pricing 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 98.3% 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, 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 at December 31, 2019. The Company reclassified this fund from Level 3 to private equity funds measured at net asset value ("NAV") at March 31, 2020, due to the use of the practical expedient based on NAV in measuring the fair value of the fund.

Level 1 measurements—Fair values of financial assets and financial liabilities are obtained from an independent pricing
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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 $17.6 million and $18.9 million in commercial mortgage-backed securities at December 31, 2020 and 2019, 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.

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 was not measured at NAV was 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 two of the three such funds with a fair value of approximately $78.2 million at December 31, 2020 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 strategy of the other such fund with a fair value of approximately $1.2 million at December 31, 2020 is to achieve favorable long-term financial returns and measurable positive social and environmental returns by investing in privately held technology, healthcare, specialty consumer goods and service companies. The Company has made all of its capital contributions in such funds and had no outstanding
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unfunded commitments at December 31, 2020 with respect to the funds. The underlying assets of the funds are expected to be liquidated over the period of approximately one year to nine years from December 31, 2020. 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, 2020
 Level 1Level 2Level 3Total
 (Amounts in thousands)
Assets
Fixed maturity securities:
U.S. government bonds $13,816 $— $— $13,816 
Municipal securities— 2,791,212 — 2,791,212 
Mortgage-backed securities — 93,264 — 93,264 
Corporate securities— 241,366 — 241,366 
Collateralized loan obligations— 256,891 — 256,891 
Other asset-backed securities— 153,261 — 153,261 
Total fixed maturity securities13,816 3,535,994 — 3,549,810 
Equity securities:
Common stock691,782 — — 691,782 
Non-redeemable preferred stock— 32,660 — 32,660 
Private equity funds measured at net asset value (1)
79,409 
Total equity securities691,782 32,660 — 803,851 
Short-term investments:
Short-term bonds21,999 4,929 — 26,928 
Money market instruments348,676 — — 348,676 
Other5 — — 5 
Total short-term investments370,680 4,929 — 375,609 
Other assets:
Note receivable
— 5,725 — 5,725 
Total assets at fair value$1,076,278 $3,579,308 $— $4,734,995 

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 December 31, 2019
 Level 1Level 2Level 3Total
 (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 debt obligations— 199,217 — 199,217 
Other asset-backed securities— 18,645 — 18,645 
Total fixed maturity securities22,637 3,070,638 — 3,093,275 
Equity securities:
Common stock586,367 — — 586,367 
Non-redeemable preferred stock— 49,708 — 49,708 
Private equity fund— — 1,203 1,203 
Private equity fund measured at net asset value (1)
87,473 
Total equity securities586,367 49,708 1,203 724,751 
Short-term investments:
Short-term bonds2,822 30,080 — 32,902 
Money market instruments461,233 — — 461,233 
Total short-term investments464,055 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 sold77 — — 77 
Total liabilities at fair value$77 $— $— $77 
__________ 
(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,
 20202019
(Amounts in thousands)
Beginning balance$1,203 $1,445 
Net realized (losses) gains included in earnings(1)101 
Settlements— (343)
Transfer out (1)
(1,202)— 
Ending balance$— $1,203 
The amount of total gains for the period included in earnings attributable to assets still held at December 31$— $93 
__________ 
(1) The private equity fund was reclassified from Level 3 to private equity funds measured at net asset value due to the use of the NAV practical expedient in measuring the fair value of the fund at March 31, 2020.

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There were no transfers between Levels 1, 2, and 3 of the fair value hierarchy in 2020 and 2019. A private equity fund was reclassified from Level 3 to private equity funds measured at net asset value at March 31, 2020, as described above.

At December 31, 2020 and 2019, 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, 2020
 Carrying ValueFair ValueLevel 1Level 2Level 3
 (Amounts in thousands)
Liabilities
Notes payable:
Unsecured notes$372,532 $415,253 $— $415,253 $— 
 December 31, 2019
 Carrying ValueFair ValueLevel 1Level 2Level 3
 (Amounts in thousands)
Liabilities
Notes payable:
Unsecured notes$372,133 $394,279 $— $394,279 $— 

Unsecured Notes
The fair value of the Company’s publicly traded $375 million unsecured notes at December 31, 2020 and 2019 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,
 20202019
 (Amounts in thousands)
Land$18,152 $18,152 
Buildings and improvements139,274 140,567 
Furniture and equipment46,450 70,355 
Capitalized software254,066 244,425 
Leasehold improvements7,004 7,547 
464,946 481,046 
Less: accumulated depreciation and amortization(286,023)(312,060)
Fixed assets, net$178,923 $168,986 

Depreciation expense, including amortization of leasehold improvements, was $28.0 million, $23.2 million, and $19.9 million for 2020, 2019, and 2018, 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 was originally set to mature on August 31, 2020. Effective August 1, 2020, the maturity date was extended to August 31, 2021,
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with no change in the annual interest rate. The fair value of the Note is included in other assets in the Company's consolidated balance sheets, and interest earned on the Note is recognized in other revenues in the Company's consolidated statements of operations.

6. Deferred Policy Acquisition Costs
Deferred policy acquisition costs were as follows:
 December 31,
 202020192018
 (Amounts in thousands)
Balance, beginning of year$233,166 $215,131 $198,151 
Policy acquisition costs deferred641,616 620,120 589,144 
Amortization(627,788)(602,085)(572,164)
Balance, end of year$246,994 $233,166 $215,131 

7. Leases

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. In addition, the Company has finance leases for electronic data processing ("EDP") equipment. As of December 31, 2020, the Company's leases had remaining terms ranging from less than 1 year to approximately 7 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 adopted ASU 2016-02, "Leases (Topic 842)," on January 1, 2019, using a modified retrospective transition method. Under this transition method, its financial results reported in periods prior to 2019 were unchanged.

The Company determines if an arrangement is a lease at inception. Right-of-use ("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. Lease 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 leases for office space, office equipment and EDP equipment, 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 leases for office space, automobiles, and office equipment, while it accounts for the lease components separately from the non-lease components for EDP equipment leases.











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The components of lease cost along with its classification on the Company's consolidated statements of operations were as follows:
Year Ended December 31,
Lease CostClassification20202019
(Amounts in thousands)
Operating lease cost (1)
Other operating expenses$15,814 $15,146 
Finance lease cost:
     Amortization of assetsOther operating expenses338 — 
     Interest on lease liabilitiesInterest expense13 — 
Variable lease cost (1)
Other operating expenses1,697 2,196 
Total lease cost17,862 17,342 
__________ 
(1) Includes short-term leases, which are immaterial.

Total rent expense recognized under the Company's various operating lease agreements was $14.9 million for the year ended December 31, 2018.

The components of lease assets and liabilities along with their classification on the Company's consolidated balance sheets were as follows:
December 31,
Lease Assets and LiabilitiesClassification20202019
(Amounts in thousands)
Operating lease assetsOperating lease right-of-use assets$40,554 $44,909 
Operating lease liabilitiesOperating lease liabilities43,825 47,996 
Finance lease assetsOther assets3,107 — 
Finance lease liabilitiesOther liabilities2,836 — 

Weighted-average lease term and discount rate were as follows:
December 31,
20202019
Weighted-average remaining lease term (in years):
      Operating leases3.84.4
      Finance leases 5.1— 

Weighted-average discount rate:
      Operating leases2.82 %3.02 %
      Finance leases
0.82 %— 














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Supplemental cash flow and other information related to leases was as follows:
Year Ended December 31,
20202019
 (Amounts in thousands)
Cash paid for amounts included in the measurement of lease liabilities:
      Operating cash flows from operating leases$15,539 $14,289 
      Operating cash flows from finance leases13 — 
      Financing cash flows from finance leases609 — 
 
ROU assets obtained in exchange for lease liabilities:
      Operating leases8,673 15,372 
      Finance leases3,047 — 

Maturities of lease liabilities as of December 31, 2020 were as follows:
YearOperating LeasesFinance Leases
 (Amounts in thousands)
202115,370 622 
202212,739 622 
20238,095 622 
20244,388 622 
20252,832 398 
2026 and thereafter$2,985 $— 
          Total lease payments$46,409 $2,886 
Less: Imputed interest2,584 50 
          Total lease obligations$43,825 $2,836 

As of December 31, 2020, the Company had additional lease commitments that have not yet commenced of approximately $5 million with each lease term ranging from approximately 3 years to 4 years. These leases will commence in 2021.

8. Notes Payable

The following table presents information about the Company's notes payable:
December 31,
LenderInterest RateExpiration20202019
(Amounts in thousands)
Senior unsecured notes(1)
Publicly traded4.40%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 amount375,000 375,000 
Less unamortized discount and debt issuance costs(3)
2,468 2,867 
Total$372,532 $372,133 
__________
(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
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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 15.6% at December 31, 2020, resulting in a 15 basis point commitment fee on the $50 million undrawn portion of the credit facility. As of February 16, 2021, 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 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, 2020.

Debt maturities for each of the next five years and thereafter as of December 31, 2020 are as follows:
MaturityAmounts
(in thousands)
2021$— 
2022— 
2023— 
2024— 
2025— 
Thereafter375,000 
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 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.





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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, 2020December 31, 2019
 (Amounts in thousands)
Options sold - Other liabilities$— $77 
Total derivatives$— $77 
 
 Gains (Losses) Recognized in Income
 Year Ended December 31,
202020192018
 (Amounts in thousands)
Total return swaps - Net realized investment gains (losses) $— $1,039 $(3,783)
Options sold - Net realized investment gains (losses)22,306 6,339 10,498 
Total$22,306 $7,378 $6,715 

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 2020 and 2019. No accumulated goodwill impairment losses existed at December 31, 2020 and 2019. Goodwill is reviewed annually for impairment and more frequently if potential impairment indicators exist. No impairment indicators were identified during 2020 and 2019. The Company considered the potential impact of the COVID-19 pandemic on the market factors affecting the fair values of the reporting units in its annual impairment review in 2020 and determined such factors did not indicate a goodwill impairment for any of the reporting units with goodwill. 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, 2020
Customer relationships$54,862 $(52,640)$2,222 11
Trade names15,400 (7,700)7,700 24
Technology4,300 (4,300)— 10
Insurance license1,400 — 1,400 Indefinite
Total intangible assets, net$75,962 $(64,640)$11,322 
As of December 31, 2019
Customer relationships$53,213 $(52,319)$894 11
Trade names15,400 (7,058)8,342 24
Technology4,300 (4,300)— 10
Insurance license1,400 — 1,400 Indefinite
Total intangible assets, net$74,313 $(63,677)$10,636 
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Other intangible assets are reviewed annually for impairment and more frequently if potential impairment indicators exist. No impairment indicators were identified during 2020 and 2019.

Other intangible assets with definite useful lives are amortized on a straight-line basis over their useful lives. Other intangible assets amortization expense was $1.0 million, $5.1 million, and $5.5 million for the years ended December 31, 2020, 2019 and 2018, 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, 2020:
Year Ending December 31,Amortization Expense
 (Amounts in thousands)
2021$1,067 
20221,043 
2023879 
2024851 
2025807 
Thereafter5,275 
Total$9,922 

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,
 202020192018
 (Amounts in thousands)
Federal
Current$69,554 $18,109 $14,190 
Deferred12,340 40,413 (39,244)
$81,894 $58,522 $(25,054)
State
Current$1,172 $(1,430)$1,982 
Deferred828 890 (1,815)
$2,000 $(540)$167 
Total
Current$70,726 $16,679 $16,172 
Deferred13,168 41,303 (41,059)
Total$83,894 $57,982 $(24,887)
 
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 Tax Cuts and Jobs Act of 2017 (the "Act") changed the prescribed interest rates to rates based on corporate bond yield curves and extended 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, 2020 and 2019, the balance of the deferred tax liability related to changes in discounting of unpaid losses was $5.6 million, and $6.7 million, respectively.

85

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,
 202020192018
 (Amounts in thousands)
Computed tax expense (benefit) at 21%$96,285 $79,394 $(6,429)
Tax-exempt interest income(12,270)(12,909)(13,507)
Dividends received deduction(1,335)(1,276)(1,082)
State tax (benefit) expense 1,678 (869)439 
Nondeductible expenses983 526 390 
Change in federal tax contingency reserve— (2,588)— 
Reversal of AMT credit reduction (1)
— — (4,088)
Other, net(1,447)(4,296)(610)
Income tax expense (benefit) $83,894 $57,982 $(24,887)
__________ 
(1) As a result of a determination made by the Office of Management and Budget in 2018, the Company reversed the previously recorded provisional 6.6% sequestration reduction to its alternative minimum tax (“AMT”) credit, which originally resulted from repeal of the corporate AMT and reclassification of AMT credit carryforwards to current taxes receivable as a refundable credit.
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.


























86

The following table presents the significant components of the Company’s net deferred tax assets and liabilities:
 December 31,
 20202019
 (Amounts in thousands)
Deferred tax assets:
20% of net unearned premiums$61,067 $58,448 
Discounting of loss reserves and salvage and subrogation recoverable for tax purposes15,090 12,769 
Write-down of impaired investments293 314 
Expense accruals14,432 8,099 
Other deferred tax assets6,401 3,348 
Total gross deferred tax assets97,283 82,978 
Deferred tax liabilities:
Deferred policy acquisition costs(51,869)(48,964)
Tax liability on net unrealized gain on securities carried at fair value(56,531)(41,273)
Tax depreciation in excess of book depreciation(12,632)(8,105)
Undistributed earnings of insurance subsidiaries(3,382)(2,855)
Tax amortization in excess of book amortization(4,666)(3,264)
Other deferred tax liabilities(9,335)(6,481)
Total gross deferred tax liabilities(138,415)(110,942)
Net deferred tax liabilities$(41,132)$(27,964)

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 $1.4 million decrease to the total amount of unrecognized tax benefits related to tax uncertainties during 2020. The decrease was the result of a payment of an assessment related to a California Franchise Tax Board (“FTB”) audit for tax years 2014 through 2016. 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 2017 through 2019 for federal taxes, and 2011 through 2013 and 2017 through 2019 for California state taxes. For tax years 2014 through 2016, the Company received Notices of Proposed Assessments (“NPAs”) related to the Company’s California apportionment factor and paid the total assessment with interest to the FTB in the third quarter of 2020. For tax years 2011 through 2013, the Company received NPAs and submitted a formal protest to the FTB in 2018. For tax years 2017 through 2019, the FTB initiated its examination in the fourth quarter of 2020.

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

87

The following table presents a reconciliation of the beginning and ending balances of unrecognized tax benefits:
December 31,
20202019
 (Amounts in thousands)
Balance at January 1$6,051 $10,615 
Additions (reductions) based on tax positions related to:
     Current year— — 
     Prior years (1,417)(4,564)
Balance at December 31$4,634 $6,051 

If unrecognized tax benefits were recognized, $6.2 million and $7.2 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, 2020 and 2019, 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 $0.2 million, $(0.1) million, and $0.5 million for the years ended December 31, 2020, 2019 and 2018, respectively. The net benefit for the year ended 2019 was largely due to the reversal of accrued interest and penalty following the updates from the FTB for tax years 2014 through 2016. The Company carried an accrued interest and penalty balance of approximately $3.1 million and $2.8 million at December 31, 2020 and 2019, 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,
 202020192018
 (Amounts in thousands)
Gross reserves at January 1$1,921,255 $1,829,412 $1,510,613 
Reinsurance recoverables on unpaid losses(76,100)(180,859)(64,001)
             Cumulative effect of adopting ASU 2016-13 149 — — 
Reinsurance recoverables on unpaid losses, as adjusted(75,951)(180,859)(64,001)
Net reserves at January 1, as adjusted1,845,304 1,648,553 1,446,612 
Incurred losses and loss adjustment expenses related to:
Current year2,372,364 2,696,230 2,483,693 
Prior years22,979 9,794 93,096 
Total incurred losses and loss adjustment expenses2,395,343 2,706,024 2,576,789 
Loss and loss adjustment expense payments related to:
Current year1,366,661 1,651,550 1,543,828 
Prior years937,142 857,872 831,020 
Total payments2,303,803 2,509,422 2,374,848 
Net reserves at December 311,936,844 1,845,155 1,648,553 
Reinsurance recoverables on unpaid losses54,460 76,100 180,859 
Gross reserves at December 31$1,991,304 $1,921,255 $1,829,412 

The increase in the provision for insured events of prior years in 2020 of approximately $23.0 million primarily resulted from higher than estimated losses and loss adjustment expenses in the homeowners and commercial automobile lines of insurance business, partially offset by favorable development in the private passenger automobile line of insurance business.

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 in certain of the Company's other lines of insurance business.

88

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 Company recorded catastrophe losses net of reinsurance of approximately $64 million, $53 million, and $67 million in 2020, 2019, and 2018, respectively. Catastrophe losses due to the catastrophe events that occurred in 2020 totaled approximately $69 million, with no reinsurance benefits used for these losses, resulting primarily from wildfires and windstorms in California and extreme weather events outside of California. These losses were partially offset by favorable development of approximately $5 million on prior years' catastrophe losses. Catastrophe losses before reinsurance benefits totaled approximately $57 million in 2019, 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. Catastrophe losses before reinsurance benefits totaled approximately $289 million in 2018, resulting primarily from wildfires in Northern and Southern California and weather-related catastrophes across several states.

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, 2020, 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, 2011 to 2019 is presented as unaudited supplementary information.

89

Incurred Losses and Allocated Loss Adjustment Expenses, Net of Reinsurance (Automobile Insurance)As of December 31, 2020
Total of Incurred But Not Reported Liabilities Plus Expected Development on Reported ClaimsCumulative Number of Reported Claims
Accident YearFor the Years Ended December 31,
2011(1)
2012(1)
2013(1)
2014(1)
2015(1)
2016(1)
2017(1)
2018(1)
2019(1)
2020
(Amounts in thousands)(Amounts in thousands)
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 $1,401,543 $59 181
20121,424,754 1,408,222 1,409,104 1,414,878 1,426,735 1,436,034 1,438,250 1,439,660 1,440,537 116 181
20131,448,567 1,431,058 1,447,881 1,458,421 1,464,071 1,468,294 1,468,237 1,468,747 816 185
20141,467,175 1,454,366 1,473,545 1,486,322 1,498,504 1,501,075 1,501,713 718 180
20151,551,105 1,588,443 1,610,839 1,634,435 1,645,950 1,649,170 4,577 170
20161,672,853 1,669,642 1,713,696 1,731,997 1,732,410 8,206 155
20171,703,857 1,727,277 1,741,825 1,733,425 22,626 149
20181,781,817 1,773,502 1,785,071 60,829 146
20191,916,269 1,911,268 165,108 147
20201,514,551 407,969 85
Total$16,138,435 
__________ 
(1) The information for the years 2011 to 2019 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
2011(1)
2012(1)
2013(1)
2014(1)
2015(1)
2016(1)
2017(1)
2018(1)
2019(1)
2020
(Amounts in thousands)
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 $1,401,592 
2012955,647 1,194,648 1,304,511 1,372,828 1,409,911 1,422,705 1,434,956 1,438,686 1,440,482 
2013974,445 1,217,906 1,340,724 1,413,999 1,447,004 1,460,352 1,464,277 1,466,356 
2014967,481 1,231,413 1,358,472 1,432,472 1,476,944 1,490,366 1,496,814 
20151,040,253 1,336,223 1,466,368 1,560,480 1,614,188 1,634,780 
20161,094,006 1,395,199 1,554,217 1,656,192 1,699,069 
20171,076,079 1,399,202 1,561,850 1,648,328 
20181,082,127 1,417,637 1,588,049 
20191,134,859 1,494,342 
2020825,398 
Total$14,695,210 
All outstanding liabilities before 2011, net of reinsurance(531)
Loss and allocated loss adjustment expense reserves, net of reinsurance$1,442,694 
__________ 
(1) The information for the years 2011 to 2019 is presented as unaudited supplemental information.
90

Incurred Losses and Allocated Loss Adjustment Expenses, Net of Reinsurance (Homeowners' Insurance)As of December 31, 2020
Total of Incurred But Not Reported Liabilities Plus Expected Development on Reported ClaimsCumulative Number of Reported Claims
Accident YearFor the Years Ended December 31,
2011(1)
2012(1)
2013(1)
2014(1)
2015(1)
2016(1)
2017(1)
2018(1)
2019(1)
2020
(Amounts in thousands)(Amounts in thousands)
2011$167,414 $170,623 $170,052 $169,600 $169,390 $169,621 $170,126 $170,334 $170,174 $170,402 $167 23
2012196,063 188,010 190,376 191,548 192,057 191,804 192,905 192,790 193,002 120 25
2013191,903 188,915 188,026 186,795 187,165 188,014 187,147 187,683 142 23
2014199,298 202,621 203,218 202,513 204,986 208,003 208,743 592 25
2015234,800 234,881 233,501 236,855 238,652 239,941 2,950 24
2016250,691 259,489 259,497 259,708 260,496 1,821 24
2017309,491 295,163 288,322 289,869 2,702 30
2018311,798 308,361 310,695 9,704 25
2019359,643 366,139 17,580 30
2020420,257 77,396 26
Total$2,647,227 
__________ 
(1) The information for the years 2011 to 2019 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
2011(1)
2012(1)
2013(1)
2014(1)
2015(1)
2016(1)
2017(1)
2018(1)
2019(1)
2020
(Amounts in thousands)
2011$111,909 $153,845 $162,870 $166,375 $167,806 $168,621 $168,914 $169,757 $169,899 $169,958 
2012128,618 175,029 182,756 188,121 190,373 190,649 191,660 192,362 192,454 
2013133,528 174,295 180,858 183,860 185,168 186,132 186,494 186,816 
2014139,615 186,996 194,605 198,758 202,193 203,333 207,524 
2015163,196 213,994 224,178 230,480 234,683 235,971 
2016173,537 234,215 245,878 253,919 256,642 
2017217,900 269,254 278,341 283,311 
2018213,038 271,534 286,658 
2019240,240 324,953 
2020271,208 
Total$2,415,495 
All outstanding liabilities before 2011, net of reinsurance1,457 
Loss and allocated loss adjustment expense reserves, net of reinsurance$233,189 
__________ 
(1) The information for the years 2011 to 2019 is presented as unaudited supplemental information.

The following is unaudited supplementary information about average historical claims duration as of December 31, 2020.
Average Annual Percentage Payout of Incurred Claims by Age, Net of Reinsurance
Years12345678910
Automobile insurance62.6 %17.6 %8.7 %5.2 %2.6 %1.0 %0.5 %0.3 %0.1 %— %
Average Annual Percentage Payout of Incurred Claims by Age, Net of Reinsurance
Years12345678910
Homeowners insurance67.9 %21.9 %4.1 %2.3 %1.2 %0.4 %0.7 %0.3 %0.1 %— %

91

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, 2020
(Amounts in thousands)
Net outstanding liabilities
Automobile insurance$1,442,694 
Homeowners' insurance233,189 
WAIC automobile insurance13,903 
Other short-duration insurance lines130,291 
Loss and loss adjustment expense reserves, net of reinsurance recoverables on unpaid losses1,820,077 
Reinsurance recoverables on unpaid losses
Automobile insurance18,187 
Homeowners' insurance35,214 
Other short-duration insurance lines1,059 
Total reinsurance recoverables on unpaid losses54,460 
Insurance lines other than short-duration676 
Unallocated claims adjustment expenses116,091 
116,767 
Total gross loss and loss adjustment expense reserves$1,991,304 

13. Dividends
The following table presents shareholder dividends paid:
Year Ended December 31,
202020192018
 (Amounts in thousands, except per share data)
Total paid$139,640 $139,071 $138,478 
Per share paid$2.5225 $2.5125 $2.5025 

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, 2020, the insurance subsidiaries of the Company are permitted to pay approximately $222 million in dividends in 2021 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 2020, 2019, and 2018, the Insurance Companies paid Mercury General ordinary dividends of $121 million, $114 million, and $135 million, respectively.

On February 12, 2021, the Board of Directors declared a $0.6325 quarterly dividend payable on March 31, 2021 to shareholders of record on March 17, 2021.

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, 2020, there were no material permitted statutory accounting practices utilized by the Insurance Companies.

92

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,
 202020192018
 (Amounts in thousands)
Statutory net income(1)
$283,928 $135,670 $81,935 
Statutory capital and surplus$1,768,103 $1,539,998 $1,471,547 
 __________
(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.

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, 2020, 2019 and 2018, 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 350% of the authorized control level RBC as of December 31, 2020, 2019 and 2018. Generally, an RBC ratio of 200% or less would require some form of regulatory or company action.

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 $11.2 million, $9.9 million, and $9.0 million for 2020, 2019, and 2018, 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 paid a total of $11.6 million of company-wide annual cash bonuses to all its eligible employees in 2020. The Company did not pay any company-wide annual cash bonuses to all eligible employees in 2019 and 2018.

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, 2020, 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.

93

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,
202020192018
(Amounts in thousands)
Cash received from stock option exercises$— $701 $358 
Compensation cost, all share-based awards142 123 145 
Excess tax (benefit) expense, all share-based awards— (7)4 

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 2020 and 2019 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 volatility33.18 %
Risk-free interest rate2.62 %
Expected dividend yield5.40 %
Expected term in months72

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, 2020:
SharesWeighted-Average
Exercise Price		Weighted-Average
Remaining Contractual Term
(Years)		Aggregate
Intrinsic Value
(in 000’s)
Outstanding at January 1, 202067,500$43.01 
Exercised— $— 
Canceled or expired— $— 
Outstanding at December 31, 202067,500$43.01 7.1$621 
Exercisable at December 31, 202032,500$43.01 7.1$299 

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, 2020. The aggregate intrinsic value of stock options exercised in 2019 and 2018 was $217,064 and $42,000, respectively. There were no stock options exercised in 2020. The total fair value of stock options vested in each of 2020 and 2019 was $141,584. There were no stock options vested in 2018.



94

The following table presents information regarding stock options outstanding at December 31, 2020:
 Options OutstandingOptions Exercisable
Range of Exercise PricesNumber of
Options		Weighted-Average
Remaining
Contractual Life
(Years)		Weighted-
Average  Exercise
Price		Number of
Options		Weighted-
Average  Exercise
Price
$43.0167,5007.1$43.01 32,500$43.01 

As of December 31, 2020, the Company had $0.2 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 1.1 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 2020, 2019, and 2018 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,
 202020192018
 SharesWeighted-
Average Fair
Value per Share		SharesWeighted-
Average  Fair
Value per Share		SharesWeighted-
Average  Fair
Value per Share
Outstanding at January 1—$— 75,250$53.49 169,000$53.66 
Vested— $— — $— — $— 
Forfeited/Canceled— $— (6,000)$53.49 (8,000)$53.49 
Expired— $— (69,250)$53.49 (85,750)$53.80 
Outstanding at December 31— $— —$— 75,250$53.49 

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 was recognized based on management’s best estimate of the performance goals that would be achieved at the end of the performance period, taking into account expected forfeitures. If the minimum performance goals were not met, no compensation cost was recognized and any recognized compensation cost was 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.







95

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,
 202020192018
 Income
(Numerator)		Weighted
Shares
(Denominator)		Per-Share
Amount		Income
(Numerator)		Weighted
Shares
(Denominator)		Per-Share
Amount		Loss
(Numerator)		Weighted
Shares
(Denominator)		Per-Share
Amount
 (Amounts and numbers in thousands, except per-share data)
Basic EPS
Income (loss) available to common stockholders$374,607 55,358 $6.77 $320,087 55,351 $5.78 $(5,728)55,335 $(0.10)
Effect of dilutive securities:
Options— — — 9 — — 
Diluted EPS
Income (loss) available to common stockholders after assumed conversions$374,607 55,358 $6.77 $320,087 55,360 $5.78 $(5,728)55,335 $(0.10)

Potentially dilutive securities representing approximately 67,500, 0, and 78,500 shares of common stock for 2020, 2019, and 2018, 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

Leases
The Company is obligated under various non-cancellable lease agreements providing for office space, automobiles, office equipment, and EDP equipment that expire at various dates through the year 2028. See Note 7. Leases for additional information on leases and future lease payments as of December 31, 2020.
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 28, 2020, the most recent date at which information was available, was approximately $78.0 million. There was no assessment made in 2020.
Regulatory Matters
On April 13, 2020, the California Insurance Commissioner issued Bulletin 2020-3 ordering insurers to make an initial premium adjustment within 120 days from the date of the Bulletin 2020-3 to adversely impacted California policyholders for the months of March and April 2020. The Commissioner granted insurers flexibility in determining how to quickly and fairly process the premium refunds. On May 15, 2020, the California Insurance Commissioner issued Bulletin 2020-4 extending the directives in Bulletin 2020-3 through May 31, 2020. The Bulletin 2020-8, originally issued on June 25, 2020 and amended on December 3, 2020, extended the previous directives of Bulletin 2020-3 and Bulletin 2020-4 through June 30, 2020, as well as any months subsequent to June 2020 because the COVID-19 pandemic continued to result in projected loss exposures remaining overstated or misclassified. The total amount of premiums returned to the Company's policyholders through refunds or credits in 2020 was approximately $128 million. The Company's net premiums earned was reduced by approximately $128 million for the twelve months ended December 31, 2020 as a result of these premium refunds and credits.

In November and December 2020, the California Insurance Commissioner issued a mandatory moratorium on
96

cancellations and non-renewals of policies of residential property insurance after the declaration of a state of emergency through Bulletins 2020-11, 2020-12 and 2020-13. These Bulletins list declarations of a state of emergency issued by the California Governor in August, September and November 2020, along with the ZIP Codes within and adjacent to the fire perimeters in counties subject to each state of emergency. The mandatory moratorium prohibits insurers from canceling or refusing to renew a policy of residential property insurance for a property located in any ZIP Code listed in these Bulletins for one year after the declaration of a state of emergency and in effect at the time of the declared emergency, based solely on the fact that the insured structure is located in an area in which a fire has occurred. The Company will comply with these Bulletins and does not believe that these Bulletins will have a material adverse impact on its financial condition or cash flows.
Litigation
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 Note 1. Summary of Significant Accounting Policies.

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.

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
































97

19. Quarterly Financial Information (Unaudited)
The following table presents summarized quarterly financial data for 2020 and 2019:
 
 Quarter Ended
 March 31June 30September 30 December 31
 (Amounts in thousands, except per share data)
2020
Net premiums earned$922,574 $811,897 $899,304   $921,860 
Change in fair value of financial instruments pursuant to the fair value option(240,990)166,829 58,865 87,968 
(Loss) income before income taxes(180,705)285,466 146,631 207,110 
Net (loss) income(139,204)228,211 118,857 166,743 
Basic (loss) earnings per share (2.51)4.12 2.15 3.01 
Diluted (loss) earnings per share
(2.51)4.12 2.15 3.01 
Dividends paid per share0.6300 0.6300 0.6300   0.6325 
2019
Net premiums earned$870,245 $888,776 $915,012   $925,384 
Change in fair value of financial instruments pursuant to the fair value option104,227 50,281 24,021 18,173 
Income before income taxes167,169 101,595 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 share0.6275 0.6275 0.6275   0.6300 

Net income for 2020 was primarily attributable to net premiums earned, net investment income, and net realized investment gains, partially offset by losses and loss adjustment expenses, including catastrophe losses and unfavorable development on prior accident years' loss and loss adjustment expense reserves, and operating expenses. Major factors contributing to net income for the fourth quarter of 2020 were underwriting profit and increases in the fair values of the Company’s fixed maturity and equity securities due to the overall improvement in fixed maturity and equity markets.

Net income for 2019 was primarily attributable to net premiums earned, net realized investment gains, and net investment income, 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. Main factors contributing to 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.

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.
98

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,
202020192018
 Property & CasualtyOtherTotalProperty & CasualtyOtherTotalProperty & CasualtyOtherTotal
(Amounts in millions)
Net premiums earned$3,526.8 $28.8 $3,555.6 $3,571.0 $28.4 $3,599.4 $3,337.9 $30.5 $3,368.4 
Less:
Losses and loss adjustment expenses2,381.5 13.8 2,395.3 2,692.7 13.3 2,706.0 2,562.0 14.8 2,576.8 
Underwriting expenses899.1 14.6 913.7 857.3 14.1 871.4 802.7 14.1 816.8 
Underwriting gain (loss) 246.2 0.4 246.6 21.0 1.0 22.0 (26.8)1.6 (25.2)
Investment income134.9 141.3 135.8 
Net realized investment gains (losses) 85.7 222.8 (133.5)
Other income8.3 9.0 9.3 
Interest expense(17.0)(17.0)(17.0)
Pre-tax income (loss) $458.5 $378.1 $(30.6)
Net income (loss) $374.6 $320.1 $(5.7)




















99

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,
 202020192018
 Property & CasualtyOtherTotalProperty & CasualtyOtherTotalProperty & CasualtyOtherTotal
(Amounts in millions)
Private passenger automobile$2,591.3 $— $2,591.3 $2,756.5 $— $2,756.5 $2,602.1 $— $2,602.1 
Homeowners601.3 — 601.3 514.8 — 514.8 459.4 — 459.4 
Commercial automobile225.6 — 225.6 208.7 — 208.7 190.1 — 190.1 
Other108.6 28.8 137.4 91.0 28.4 119.4 86.3 30.5 116.8 
Net premiums earned$3,526.8 $28.8 $3,555.6 $3,571.0 $28.4 $3,599.4 $3,337.9 $30.5 $3,368.4 
Private passenger automobile$2,569.0 $— $2,569.0 $2,820.5 $— $2,820.5 $2,703.6 $— $2,703.6 
Homeowners678.9 — 678.9 598.5 — 598.5 524.9 — 524.9 
Commercial automobile240.8 — 240.8 217.3 — 217.3 198.5 — 198.5 
Other136.3 29.2 165.5 106.3 32.0 138.3 97.2 26.7 123.9 
Direct premiums written$3,625.0 $29.2 $3,654.2 $3,742.6 $32.0 $3,774.6 $3,524.2 $26.7 $3,550.9 


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.
100


The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2020. 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, 2020, 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 2020 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, 2020, 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.

The Company has not experienced any material impact to its internal controls over financial reporting due to the COVID-19 pandemic. The Company will continually monitor and assess the COVID-19 situation with respect to its internal controls to minimize the impact of the pandemic on their design and operating effectiveness.


Item 9B.Other Information
None
101

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, 2020 and which is incorporated herein by reference.
102

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, 2020 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 ExhibitIf Incorporated by Reference, Documents with Which Exhibit was Previously Filed with the SEC
3.1
3.2
3.3
3.4
3.5
4.1Shareholders’ 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
4.3
4.4
103

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*
10.5*
10.6*
10.7*
10.8*
10.9*
10.10*
10.11*
10.12*
10.13*
10.14*
10.15*
10.16*
10.17*
10.18*
104

10.19*
10.20*
10.21*
10.22*
10.23*
10.24*
10.25*
10.26*
10.27*
10.28*
10.29*Filed herewith.
10.30
10.31
10.32
10.33
10.34
10.35
10.36
10.37
105

10.38*
10.39*
10.40*
10.41*
10.42*
10.43*
10.44*
10.45*
10.46*
10.47
10.48
10.49
10.50
10.51*
21.1
 
23.1Filed herewith.
31.1Filed herewith.
106

31.2Filed herewith.
32.1Filed herewith.
32.2Filed herewith.
101.INSXBRL 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.SCHXBRL Taxonomy Extension Schema Document
101.CALXBRL Taxonomy Extension Calculation Linkbase Document
101.DEFXBRL Taxonomy Extension Definition Linkbase Document
101.LABXBRL Taxonomy Extension Label Linkbase Document
101.PREXBRL Taxonomy Extension Presentation Linkbase Document
*Denotes management contract or compensatory plan or arrangement.

107

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 16, 2021

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.
SignatureTitle Date
/S/    GEORGE JOSEPH       
George Joseph
Chairman of the Board February 16, 2021
/S/    GABRIEL TIRADOR         
Gabriel Tirador
President and Chief Executive Officer and Director (Principal Executive Officer) February 16, 2021
/S/    THEODORE R. STALICK  
Theodore R. Stalick
Senior Vice President and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) February 16, 2021
/S/    GEORGE G. BRAUNEGG  
George G. Braunegg
Director February 16, 2021
/S/    RAMONA L. CAPPELLO  
Ramona L. Cappello
Director February 16, 2021
/S/    JAMES G. ELLIS
James G. Ellis
DirectorFebruary 16, 2021
/S/    JOSHUA E. LITTLE
Joshua E. Little
Director February 16, 2021
/S/    MARTHA E. MARCON
Martha E. Marcon
Director February 16, 2021
108

SCHEDULE I
 
MERCURY GENERAL CORPORATION AND SUBSIDIARIES
SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 2020
Type of InvestmentCostFair ValueAmounts in the
Balance Sheet
 (Amounts in thousands)
Fixed maturity securities:
U.S. government bonds$13,756 $13,816 $13,816 
Municipal securities2,632,559 2,791,212 2,791,212 
Mortgage-backed securities91,527 93,264 93,264 
Corporate securities240,486 241,366 241,366 
Collateralized loan obligations256,558 256,891 256,891 
Other asset-backed securities153,532 153,261 153,261 
Total fixed maturity securities3,388,418 3,549,810 3,549,810 
Equity securities:
Common stock563,394 691,782 691,782 
Non-redeemable preferred stock31,430 32,660 32,660 
Private equity funds measured at net asset value (1)
100,326 79,409 79,409 
Total equity securities695,150 803,851 803,851 
Short-term investments376,547 375,609 375,609 
Total investments$4,460,115 $4,729,270 $4,729,270 
__________ 
(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, 2019
Type of InvestmentCostFair ValueAmounts in the
Balance Sheet
 (Amounts in thousands)
Fixed maturity securities:
U.S. government bonds $22,502 $22,637 $22,637 
Municipal securities2,435,346 2,554,208 2,554,208 
Mortgage-backed securities62,566 63,003 63,003 
Corporate securities233,730 235,565 235,565 
Collateralized loan obligations200,656 199,218 199,217 
Other asset-backed securities18,476 18,644 18,645 
Total fixed maturity securities2,973,276 3,093,275 3,093,275 
Equity securities:
Common stock498,514 586,367 586,367 
Non-redeemable preferred stock49,442 49,708 49,708 
Private equity fund1,137 1,203 1,203 
Private equity fund measured at net asset value (1)
99,189 87,473 87,473 
Total equity securities648,282 724,751 724,751 
Short-term investments494,060 494,135 494,135 
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-2

SCHEDULE II

MERCURY GENERAL CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS
 December 31,
 20202019
 (Amounts in thousands)
ASSETS
Investments, at fair value:
Equity securities (cost $75,099; $81,802)
$110,596 $114,668 
Short-term investments (cost $4,269; $29,356)
4,269 29,356 
Investment in subsidiaries2,285,417 2,008,163 
Total investments2,400,282 2,152,187 
Cash24,652 39,766 
Accrued investment income20 90 
Amounts receivable from affiliates250 244 
Income tax receivable from affiliates5,862 9,192 
Other assets221 312 
Total assets$2,431,287 $2,201,791 
LIABILITIES AND SHAREHOLDERS’ EQUITY
Notes payable$372,532 $372,133 
Accounts payable and accrued expenses— 17 
Amounts payable to affiliates30 22 
Income tax payable to affiliates2,724 4,106 
Current income taxes10,074 14,052 
Deferred income taxes8,470 7,059 
Other liabilities4,860 4,900 
Total liabilities398,690 402,289 
Commitments and contingencies
Shareholders’ equity:
Common stock98,970 98,828 
Retained earnings1,933,627 1,700,674 
Total shareholders’ equity2,032,597 1,799,502 
Total liabilities and shareholders’ equity$2,431,287 $2,201,791 
 















SCHEDULE II, Continued
See accompanying notes to condensed financial information.
See accompanying Report of Independent Registered Public Accounting Firm
S-3



MERCURY GENERAL CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF OPERATIONS
 Year Ended December 31,
 202020192018
 (Amounts in thousands)
Revenues:
Net investment income$3,323 $3,735 $4,661 
Net realized investment gains (losses)9,575 31,682 (10,797)
Other— 5 2 
Total revenues12,898 35,422 (6,134)
Expenses:
Other operating expenses3,054 2,592 2,343 
Interest17,035 17,036 17,036 
Total expenses20,089 19,628 19,379 
(Loss) income before income taxes and equity in net income of subsidiaries(7,191)15,794 (25,513)
Income tax expense (benefit)600 2,816 (5,144)
(Loss) income before equity in net income of subsidiaries(7,791)12,978 (20,369)
Equity in net income of subsidiaries382,398 307,109 14,641 
Net income (loss)$374,607 $320,087 $(5,728)





















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,
 202020192018
 (Amounts in thousands)
Cash flows from operating activities:
Net cash used in operating activities$(17,339)$(5,392)$(16,108)
Cash flows from investing activities:
Capital contribution to subsidiaries(30,000)(125)(541)
Capital distribution from subsidiaries— 30,069 — 
Distributions received from special purpose entities12,129 5,153 5,998 
Dividends received from subsidiaries121,000 114,431 135,000 
Equity securities available for sale in nature
Purchases(54,571)(39,966)(22,286)
Sales67,965 74,663 33,052 
Decrease (increase) in short-term investments25,088 (25,213)18,065 
Other, net254 376 605 
Net cash provided by investing activities141,865 159,388 169,893 
Cash flows from financing activities:
Dividends paid to shareholders(139,640)(139,071)(138,478)
Proceeds from stock options exercised— 701 358 
Net cash used in financing activities(139,640)(138,370)(138,120)
Net (decrease) increase in cash(15,114)15,626 15,665 
Cash:
Beginning of year39,766 24,140 8,475 
End of year$24,652 $39,766 $24,140 
SUPPLEMENTAL CASH FLOW DISCLOSURE
Interest paid $16,586 $16,586 $16,586 
Income taxes (refunded) paid, net $(20,552)$(12,391)$4,296 
 



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 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 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.

Distributions of $12.1 million and $5.2 million were received in 2020 and 2019, respectively, from these special purpose entities.
Dividends received from Subsidiaries

Dividends of $121,000,000, $114,431,433 and $135,000,000 were received by Mercury General from its 100% owned insurance subsidiaries in 2020, 2019 and 2018, 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 $30,000,000, $125,000 and $540,619 in 2020, 2019 and 2018, respectively. In addition, Mercury General received a capital distribution from its insurance subsidiaries of $0, $30,068,567 and $0 in 2020, 2019 and 2018, respectively.
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%.
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 15.6% at December 31, 2020, resulting in a 15 basis point commitment fee on the $50 million undrawn portion of the credit facility. As of February 16, 2021, there have been no borrowings under this facility.

See accompanying Report of Independent Registered Public Accounting Firm
S-6

Federal Income Taxes

The Company files a consolidated federal income tax return for the following entities:
 
Mercury Casualty CompanyMercury County Mutual Insurance Company
Mercury Insurance CompanyMercury Insurance Company of Florida
California Automobile Insurance CompanyMercury Indemnity Company of America
California General Underwriters Insurance Company, Inc.Mercury Select Management Company, Inc.
Mercury Insurance Company of IllinoisMercury Insurance Services LLC
Mercury Insurance Company of GeorgiaAIS Management LLC
Mercury Indemnity Company of GeorgiaAuto Insurance Specialists LLC
Mercury National Insurance CompanyPoliSeek AIS Insurance Solutions, Inc.
American Mercury Insurance CompanyAnimas Funding LLC
American Mercury Lloyds Insurance CompanyFannette Funding LLC
Workmen's Auto Insurance CompanyMercury 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
202020192018
 (Amounts in thousands)
Direct amounts$3,603,780 $3,655,233 $3,416,687 
Ceded to other companies(56,212)(56,725)(48,941)
Assumed8,067 910 665 
Net amounts$3,555,635 $3,599,418 $3,368,411 
 
See accompanying Report of Independent Registered Public Accounting Firm
S-8