The interim consolidated financial statements include the accounts of Mercury General Corporation and its subsidiaries (referred to herein collectively as the “Company”). For the list of the Company’s subsidiaries, see Note 1. Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019. These interim 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. The financial data of the Company included herein are unaudited. In the opinion of management, all material adjustments of a normal recurring nature have been made to present fairly the Company’s financial position at June 30, 2020 and the results of operations and cash flows for the periods presented. All intercompany transactions and balances have been eliminated.

Certain financial information that is normally included in annual financial statements prepared in accordance with GAAP, but that is not required for interim reporting purposes, has been omitted from the accompanying interim consolidated financial statements and related notes. Readers are urged to review the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 for more complete descriptions and discussions. Operating results and cash flows for the six months ended June 30, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020.

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 revenues 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 the effects of matters that are inherently uncertain and will likely change in subsequent periods. The most significant assumptions in the preparation of these consolidated financial statements relate to reserves for losses and loss adjustment expenses. Actual results could differ from those estimates. See Note 1. Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.

Potentially dilutive securities representing approximately 67,500 shares of common stock were excluded from the computation of diluted income per common share for each of the three and six months ended June 30, 2020, because their effect would have been anti-dilutive. There were no potentially dilutive securities with anti-dilutive effect for the three and six months ended June 30, 2019.

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. Deferred policy acquisition cost amortization was $149.7 million and $148.6 million for the three months ended June 30, 2020 and 2019, respectively, and $306.2 million and $297.0 million for the six months ended June 30, 2020 and 2019, respectively. The Company does not defer advertising expenditures but expenses them as incurred. The Company recorded net advertising expense of approximately $9.2 million and $10.0 million for the three months ended June 30, 2020 and 2019, respectively, and $20.8 million and $23.6 million for the six months ended June 30, 2020 and 2019, respectively.

Unearned premiums and loss and loss adjustment expense reserves are stated in the accompanying consolidated financial statements before deductions for ceded reinsurance. Unearned premiums and loss and loss adjustment expense reserves that are ceded to reinsurers are carried in other assets and reinsurance recoverables, respectively, in the Company's consolidated balance sheets. Earned premiums are stated net of deductions for ceded reinsurance.

The Company is party to a Catastrophe Reinsurance Treaty (the "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 Company recognized ceded premiums earned of approximately $12 million and $16 million for the three months ended June 30, 2020 and 2019, respectively, and $26 million and $31 million for the six months ended June 30, 2020 and 2019, respectively, which are included in net premiums earned in its consolidated statements of operations. The Company recognized ceded losses and loss adjustment expenses of approximately $(15) million and $6 million for the three months ended June 30, 2020 and 2019, respectively, and $(16) million and $(52) million for the six months ended June 30, 2020 and 2019, respectively, which are included in losses and loss adjustment expenses in its consolidated statements of operations. The majority of the negative ceded losses and loss adjustment expenses for the three and six months ended June 30, 2020 resulted from anticipated reimbursements from Pacific Gas and Electric Corporation ("PG&E") to the Company for certain claims paid to its policyholders related to recent wildfires, in accordance with PG&E's Plan of Reorganization approved by the United States Bankruptcy Court. These expected 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 large negative ceded losses and loss adjustment expenses for the six months ended June 30, 2019 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 10. Loss and Loss Adjustment Expense Reserves for additional information.

The Company's revenue from contracts with customers is commission income earned from third-party insurers by its 100% owned insurance agencies, which amounted to approximately $4.5 million and $4.2 million, with related expenses of $3.2 million and $2.7 million, for the three months ended June 30, 2020 and 2019, respectively, and $9.2 million and $8.4 million, with related expenses of $6.2 million and $5.4 million, for the six months ended June 30, 2020 and 2019, respectively. All of 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 (see Note 13. Segment Information).

Other - Internal-Use Software (Subtopic 350-40), Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract," prospectively to all implementation costs incurred after the adoption date. Prior to the adoption date, such implementation costs were accounted for in a manner consistent with the guidance in ASU 2018-15. 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 capitalized implementation costs are amortized over the term of the hosting arrangement.

The balance of capitalized implementation costs for cloud computing arrangements, net of accumulated amortization, was $5.7 million and $4.4 million at June 30, 2020 and December 31, 2019, respectively, which is included in other assets in the Company's consolidated balance sheets. The accumulated amortization was $1.0 million and $0.3 million at June 30, 2020 and December 31, 2019, respectively. The amortization expense related to the capitalized implementation costs was $0.4 million and $0.7 million for the three and six months ended June 30, 2020, respectively, which is included in other operating expenses in the Company's consolidated statements of operations. The Company had no amortization expenses for the three and six months ended June 30, 2019.

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. 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 (see Note 4. Fair Value Option).

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 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 June 30, 2020. In addition, the Company has been offering 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. If future economic conditions, including the severity of job losses in the states in which the Company operates, were to be much worse than expected, the actual uncollectible amounts could be significantly greater than the allowance for credit losses on premiums receivable. 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 daily policy cancellations due to nonpayment of premiums and daily premium due date extensions granted to its insureds.


	Three Months Ended June 30,						Six Months Ended June 30,
	2020		2019		2020		2019

	(Amounts in thousands)
Beginning balance	$	10,000	$	1,321	$	1,445	$	1,458
Cumulative effect of adopting ASU 2016-13 for premiums receivable	—		—		1,855		—
Beginning balance, as adjusted	10,000		1,321		3,300		1,458
Provision during the period for expected credit losses ⁽¹⁾	719		331		8,888		1,894
Write-off amounts during the period	(885)		(680)		(2,543)		(2,550)
Recoveries during the period of amounts previously written off	166		227		355		397
Ending balance	$	10,000	$	1,199	$	10,000	$	1,199

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 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 June 30, 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 A- and A++ at June 30, 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.


	Three Months Ended June 30,						Six Months Ended June 30,
	2020		2019		2020		2019

	(Amounts in thousands)
Beginning balance	$	148	$	—	$	—	$	—
Cumulative effect of adopting ASU 2016-13 for reinsurance recoverables	—		—		159		—
Beginning balance, as adjusted	148		—		159		—
Provision during the period for expected credit losses	(60)		—		(71)		—
Write-off amounts during the period	—		—		—		—
Recoveries during the period of amounts previously written off	—		—		—		—
Ending balance	$	88	$	—	$	88	$	—

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.