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, 1998 Commission File No. 0-3681

MERCURY GENERAL CORPORATION
(Exact name of registrant as specified in its charter)

          California                                       95-221-1612
  (State or other jurisdiction                          (I.R.S. Employer
of incorporation or organization)                      Identification No.)


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

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

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

Title of Class                    Name of Exchange on Which Registered
--------------                    ------------------------------------
 Common Stock                           New York Stock Exchange

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

NONE

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ____

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]

The aggregate market value of the Registrant's voting stock held by non- affiliates of the Registrant at March 8, 1999, was approximately $888,043,000 (based upon the closing sales price of such date, as reported by the Wall Street Journal).

At March 8, 1999, the Registrant had issued and outstanding an aggregate of 54,684,438 shares of its Common Stock.

Documents Incorporated by Reference

Portions of the definitive proxy statement for the Annual Meeting of Shareholders of Registrant to be held on May 12, 1999 are incorporated herein by reference into Part III hereof.


Item 1. Business

General

Mercury General Corporation ("Mercury General") and its subsidiaries (collectively, "the Company") are engaged primarily in writing all risk classifications of automobile insurance in a number of states, principally California. During 1998, private passenger automobile insurance and commercial automobile insurance accounted for 91.7% and 4.1%, respectively, of the total Company's direct premiums written. The percentage of direct automobile premiums written during 1998 by state was 93.9% in California, 2.0% in Oklahoma, 1.3% in Texas, 1.0% in Georgia, 0.9% in Illinois, 0.8% in Florida and a negligible amount in Kansas. The Company also writes homeowners insurance, mechanical breakdown insurance, commercial and dwelling fire insurance and commercial property insurance. The non-automobile lines of insurance accounted for 4.2% of direct written premiums in 1998, of which approximately 50% was in commercial lines.

The Company offers automobile policyholders the following types of coverage: bodily injury liability, underinsured and uninsured motorist, property damage liability, comprehensive, collision and other hazards specified in the policy. The Company's published maximum limits of liability for bodily injury are $250,000 per person, $500,000 per accident and, for property damage, $250,000 per accident. Subject to special underwriting approval, the combined policy limits may be as high as $1,000,000 for vehicles written under the Company's commercial automobile plan. Under the majority of the Company's automobile policies, however, the limits of liability are $100,000 per person, $300,000 per accident and $50,000 for property damage or less.

In 1999, A.M. Best & Co. ("A.M. Best") assigned a rating of A+ (Superior) to all of the Company's insurance subsidiaries except American Mercury Insurance Company ("AMIC") and American Mercury Lloyds Insurance Company ("AML"). This is the second highest of the fifteen rating categories in the A.M. Best rating system, which range from A++ (Superior) to F (In Liquidation). AMIC and AML, which accounted for less than 6% of the Company's 1998 net written premiums, were rated A- (Excellent) in 1999 by A.M. Best.

The principal executive offices of Mercury General are located in Los Angeles, California. The home office of its California insurance subsidiaries and the Company's computer and operations center is located in Brea, California. The Company maintains branch offices in a number of locations in California as well as a branch office in Clearwater, Florida. The non-California subsidiaries maintain offices in Vernon Hills, Illinois, Atlanta, Georgia, Oklahoma City, Oklahoma and Cimarron, Kansas. The Company has approximately 2,200 employees.

Organization

Mercury General, an insurance holding company, is the parent of Mercury Casualty, a California automobile insurer founded in 1961 by George Joseph, its Chief Executive Officer. Its insurance operations in California are conducted through three California insurance company subsidiaries, Mercury Casualty Company

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("Mercury Casualty"), Mercury Insurance Company ("Mercury Insurance"), and California Automobile Insurance Company. Two subsidiaries, Mercury Insurance Company of Georgia and Mercury Insurance Company of Illinois, received authority in late 1989 to write automobile insurance in those two states. In 1992, Mercury Indemnity Company of Georgia and Mercury Indemnity Company of Illinois were formed to write preferred risk automobile insurance in those two states. Through the Company's first acquisition in December 1996, three additional subsidiaries were added to the group: American Fidelity Insurance Company, domiciled in Oklahoma; Cimarron Insurance Company, domiciled in Kansas; and AFI Management Company, Inc., a Texas corporation which serves as the attorney-in-fact for American Fidelity Lloyds Insurance Company, a Texas insurer. Accordingly, their operations are included in the consolidated financial statements of the Company effective December 1, 1996. During 1997, the names of American Fidelity Insurance Company and American Fidelity Lloyds Insurance Company were changed to American Mercury Insurance Company and American Mercury Lloyds Insurance Company, respectively. In June 1998, Cimarron Insurance Company was sold for cash. Cimarron's results, which are not material to the Company's operations, are included in the Company's 1998 operating results up to the sale date.

Mercury General furnishes management services to its California, Georgia, Illinois and Oklahoma subsidiaries. Mercury General, its subsidiaries, and AML are referred to as the "Company" unless the context indicates otherwise. Mercury General Corporation individually is referred to as "Mercury General." The term "California Companies" refers to Mercury Casualty, Mercury Insurance and California Automobile Insurance Company.

Underwriting

The Company sets its own automobile insurance premium rates, subject to rating regulations issued by the Insurance Commissioners of the applicable states. Automobile insurance rates on voluntary business in California have been subject to prior approval by the California Department of Insurance ("DOI") since November 1989. The Company uses its own extensive data base to establish rates and classifications. The California DOI has in effect rating factor regulations that influence the weight the Company ascribes to various classifications of data.

At December 31, 1998, "good drivers" (as defined by the California Insurance Code) accounted for approximately 74% of all voluntary private passenger automobile policies in force in California, while the higher risk categories accounted for approximately 26%. The renewal rate in California (the rate of acceptance of offers to renew) averages approximately 95%.

In October 1998, the Company began offering a monthly pay policy through its California Automobile Insurance Company subsidiary targeted at higher risk drivers who do not fall into existing risk classifications. An insignificant amount of this business was in-force at December 31, 1998.

The Company's Oklahoma and Texas private passenger automobile business in force, underwritten through AMI, is primarily standard and preferred risks. AMI

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began offering a non-standard policy during 1998 in Texas. The amount of non- standard policies in force at December 31, 1998 was insignificant.

The Company's Florida private passenger automobile business in force, underwritten by Mercury Casualty Company, is primarily standard and preferred risks.

Production and Servicing of Business

The Company sells its policies through more than 1,700 independent agents, of which approximately 800 are located in California, approximately 300 are located in Florida and approximately 540 others represent AMI in Oklahoma, Kansas and Texas. Approximately half of the agents in California have represented the Company for more than ten years. The agents, most of whom also represent one or more competing insurance companies, are independent contractors selected and appointed by the Company.

One agency produced approximately 19%, 18% and 17% during 1998, 1997 and 1996, respectively, of the Company's total direct premiums written. This agency was sold during 1998 to a large national broker. The buyer has informed the Company that they intend to continue producing business for the Company. No other agent accounted for more than 2% of direct premiums written.

The Company believes that its agents' compensation is higher than the industry average. During 1998 total commissions and bonuses incurred averaged 16.7% of direct premiums written. The Company is not responsible for any of its agents' expenses.

In April 1998, the Company began its first major radio and billboard advertising campaign in California to supplement its existing newspaper and direct mail advertising campaigns. The newspaper campaign has been in place since the fourth quarter 1995 and has met the Company's expectations. The cost of the newspaper program is primarily borne by the Company's agents. The cost of the radio and billboard campaign is primarily borne by the Company. Although the radio and billboard campaign have not met Company expectations, the Company intends to continue the program in the current competitive climate (See Competitive Conditions).

Claims

Claims operations are conducted by the Company. The claims staff in California, Georgia, Illinois, Florida and Oklahoma administers all claims and directs all legal and adjustment aspects of the claims process. The Company adjusts most claims without the assistance of outside adjusters.

Loss and Loss Adjustment Expense Reserves

The Company maintains reserves for the payment of losses and loss adjustment expenses for both reported and unreported claims. Loss reserves are

4

estimated based upon a case-by-case evaluation of the type of claim involved and the expected development of such claim. The amount of loss reserves and loss adjustment expense reserves for unreported claims are determined on the basis of historical information by line of insurance. Inflation is reflected in the reserving process through analysis of cost trends and reviews of historical reserving results.

The ultimate liability may be greater or lower than stated loss reserves. Reserves are closely monitored and are analyzed quarterly by the Company's actuarial consultants using new information on reported claims and a variety of statistical techniques. The Company does not discount to a present value that portion of its loss reserves expected to be paid in future periods. The Tax Reform Act of 1986 does, however, require the Company to discount loss reserves for Federal income tax purposes.

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The following table sets forth a reconciliation of beginning and ending reserves for losses and loss adjustment expenses, net of reinsurance deductions, as shown on the Company's consolidated financial statements for the periods indicated.

                                                            Year ended December 31,
                                                        ------------------------------
                                                         1998        1997       1996
                                                         ----        ----       ----
                                                            (Amounts in thousands)
Net reserves for losses and loss adjustment
 expenses,  beginning of year........................   $386,270   $311,754   $250,990
Reserves acquired from purchase of American
 Mercury Insurance Company...........................        --         --      24,231
Incurred losses and loss adjustment expenses:
      Provision for insured events of the
         current year................................    693,877    641,911    505,726
      Increase (decrease) in provision for
         Insured events of prior years...............     (9,409)    12,818     (3,868)
                                                          ------     ------     ------
         Total incurred losses and loss adjustment
           expenses..................................    684,468    654,729    501,858
                                                         -------    -------    -------

Payments:
      Losses and loss adjustment expenses attribu-
        table to insured events of the current
        year.........................................    437,612    373,823    298,099
      Losses and loss adjustment expenses attribu-
        table to insured events of prior years.......    247,310    206,390    167,226
                                                         -------    -------    -------
        Total payments...............................    684,922    580,213    465,325
                                                         -------    -------    -------

Net reserves for losses and loss adjustment
 expenses at the end of the period...................    385,816    386,270    311,754
Reinsurance recoverable..............................     20,160     22,791     24,931
                                                         -------    -------    -------
Gross liability at end of year.......................   $405,976   $409,061   $336,685
                                                         =======    =======    =======

The AMI purchase agreement includes an indemnification by the seller on the loss and loss adjustment expense reserves of AMI at the acquisition date, excluding the mechanical breakdown line, to avoid any impact on the Company's financial statements from any future adverse development on the acquisition date loss reserves.

Losses incurred in 1998 include approximately $0.5 million of adverse development related to acquisition date loss reserves of AMI. As per guidance provided by Financial Accounting Standards Board (FASB) release EITF D-54, the Company has recorded the effects of the reserve guarantee separately as a component of other receivables and other income rather than netting the effects directly against the loss reserve and loss expense accounts.

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The difference between the reserves reported in the Company's consolidated financial statements prepared in accordance with generally accepted accounting principles ("GAAP") and those reported in the statements filed with the Department of Insurance in accordance with statutory accounting principles ("SAP") is shown in the following table:

                                                     December 31,
                                          ---------------------------------
                                             1998          1997      1996
                                             ----          ----      ----
                                                (Amounts in thousands)
Reserves reported on a SAP basis.........$385,816      $386,270   $311,754
Reinsurance recoverable..................  20,160        22,791     24,931
                                         --------      --------   --------
Reserves reported on a GAAP basis........$405,976       409,061   $336,685
                                         ========      ========   ========

Under SAP reserves are stated net of reinsurance recoverable in contrast to GAAP where reserves are stated gross of reinsurance recoverable.

The following table represents the development of loss reserves for the period 1988 through 1998. The top line of the table shows the reserves at the balance sheet date net of reinsurance recoverable for each of the indicated years. This represents the estimated amount of losses and loss adjustment expenses for claims arising in all prior years that are unpaid at the balance sheet date, including losses that had been incurred but not yet reported to the Company. The upper portion of the table shows the cumulative amounts paid as of successive years with respect to that reserve liability. The lower portion of the table shows the re-estimated amount of the previously recorded reserves based on experience as of the end of each succeeding year, including cumulative payments made since the end of the respective year. The estimate changes as more information becomes known about the frequency and severity of claims for individual years. A redundancy (deficiency) exists when the original reserve estimate is greater (less) than the re-estimated reserves at December 31, 1998.

In evaluating the information in the table, it should be noted that each amount includes the effects of all changes in amounts for prior periods. This table does not present accident or policy year development data. Conditions and trends that have affected development of the liability in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based on this table.

                                                As of December 31,
                         ---------------------------------------------------------------------------------------------------
                        1988      1989     1990      1991      1992      1993     1994      1995      1996      1997    1998
                        ----      ----     ----      ----      ----      ----     ----      ----      ----      ----    ----
                                                               (Amounts in thousands)
Net reserves for
 losses and loss
 adjustment expenses. $241,037  $291,408 $301,354  $280,157  $239,203  $214,525  $223,392  $250,990  $311,754  $386,270 $385,816
Paid (cumulative)
 as of:
  One year later.....  139,874   167,850  181,781   151,866   135,188   143,272   145,664   167,226   206,390   247,310
  Two years later....  195,453   227,503  238,030   197,640   184,119   187,641   198,967   225,158   283,914
  Three years later..  218,335   249,371  254,884   213,824   197,371   204,606   214,403   248,894
  Four years later...  226,384   256,659  261,058   218,067   201,365   207,704   219,596
  Five years later...  229,168   259,147  263,011   220,057   202,383   209,930
  Six years later....  229,773   259,781  262,741   220,313   203,578
  Seven years later..  229,815   259,769  262,770   221,098
  Eight years later..  229,693   259,769  263,527
  Nine years later...  229,793   260,444
  Ten years later....  230,286

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                                                              As of December 31,
                        ----------------------------------------------------------------------------------------------------
                        1988      1989     1990      1991      1992      1993     1994      1995      1996      1997    1998
                        ----      ----     ----      ----      ----      ----     ----      ----      ----      ----    ----
                                                            (Amounts in thousands)
Net reserves re-estimated as of:
  One year later.....$230,249  $269,934  $285,212  $230,991  $204,479  $204,451  $216,684  $247,122  $324,572  $376,861
  Two years later.....233,607   269,652   265,618   218,404   204,999   207,089   222,861   254,920   329,210
  Three years later...234,757   259,635   259,624   220,620   203,452   210,838   221,744   257,958
  Four years later....228,909   256,694   264,259   221,118   204,603   210,890   222,957
  Five years later....228,326   260,365   264,127   221,264   203,705   211,192
  Six years later.....230,102   260,402   263,336   220,721   204,161
  Seven years later...229,998   260,098   263,045   220,974
  Eight years later...229,809   260,031   263,341
  Nine years later....229,882   260,233
  Ten years later.....230,081
Net Cumulative Redundancy
  (deficiency).......  10,956    31,175    38,013    59,183    35,042     3,333       435    (6,968)  (17,456)    9,409

                                                              As of December 31,
                            ----------------------------------------------------------------------------
                                               1992     1993     1994     1995     1996    1997     1998
                                               ----     ----     ----     ----     ----    ----     ----
                                            (Amounts in thousands)
Gross liability - end of year                240,183  215,301  227,499  253,546  336,685  409,061  405,976
Reinsurance recoverable                         (980)    (776)  (4,107)  (2,556) (24,931) (22,791) (20,160)
                                             -------  -------  -------  -------  -------  -------  -------
Net liability - end of year                  239,203  214,525  223,392  250,990  311,754  386,270  385,816
                                             =======  =======  =======  =======  =======  =======  =======
Gross re-estimated liability - latest        209,907  218,013  235,230  266,973  356,066  400,981
Re-estimated recoverable - latest             (5,746)  (6,821) (12,273)  (9,015) (26,856) (24,120)
                                             -------  -------  -------  -------  -------  -------
Net re-estimated liability - latest          204,161  211,192  222,957  257,958  329,210  376,861
                                             =======  =======  =======  =======  =======  =======
Gross cumulative redundancy (deficiency)      30,276   (2,712)  (7,731) (13,427) (19,381)   8,080
                                             =======  =======  =======  =======  =======  =======

For the calendar year 1997, the Company's previously estimated loss reserves produced a redundancy. The Company attributes the favorable loss development primarily to the effect of Proposition 213, a California initiative passed in November 1996 that prevents uninsured motorists, drunk drivers and fleeing felons from collecting awards for "pain and suffering." See Regulations -California Financial Responsibility Law. This new law produced an overall reduction in loss severity for calendar year 1997. In addition, a new law, effective January 1, 1997 requiring proof of insurance before registration of a motor vehicle resulted in a much smaller pool of uninsured motorists, thereby decreasing the frequency of uninsured motorists claims. See Regulations- California Financial Responsibility Law.

For the calendar years 1995 and 1996, the Company's previously estimated loss reserves produced deficiencies. These deficiencies relate to increases in the Company's ultimate estimates for loss adjustment expenses which are based principally on the Company's actual experience. The adverse development on such reserves reflects the increases in the legal expenses of defending the Company's insureds arising from the Company's policy of aggressively defending, including litigating, exaggerated bodily injury claims arising from minimal impact automobile accidents.

For the calendar years 1988 through 1994, the Company's previously estimated loss reserves produced redundancies. The Company attributes this favorable loss development to several factors. First, the Company had completed its development of a full complement of claims personnel early in this period. Second, during 1988, the California Supreme Court reversed what was known as the "Royal Globe" doctrine, which, since 1978, had permitted third party plaintiffs

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to sue insurers for alleged "bad faith" in resolving claims, even when the plaintiff had voluntarily agreed to a settlement. This doctrine had placed undue pressures on claims representatives to settle legitimate disputes at unfairly high settlement amounts. After the reversal of Royal Globe, the Company believes that it has been able to achieve fairer settlements, because both parties are in a more equal bargaining position. Third, during the years 1988 through 1990, the volume of business written in the Assigned Risk Program expanded substantially as rates were suppressed at grossly inadequate levels. Following the California Insurance Commissioner's approval of an 85% temporary rate increase in September 1990, the volume of assigned risk business has declined by nearly 80%. Many of the claims associated with the high volume of assigned risk business in the 1988-1990 period were later found to be fraudulent or grossly exaggerated and were settled in subsequent periods for substantially less than had been initially reserved.

Operating Ratios

Loss and Expense Ratios

Loss and underwriting expense ratios are used to interpret the underwriting experience of property and casualty insurance companies. Losses and loss adjustment expenses, on a statutory basis, are stated as a percentage of premiums earned because losses occur over the life of a policy. Underwriting expenses on a statutory basis are stated as a percentage of premiums written rather than premiums earned because most underwriting expenses are incurred when policies are written and are not spread over the policy period. The statutory underwriting profit margin is the extent to which the combined loss and underwriting expense ratios are less than 100%. The Company's loss ratio, expense ratio and combined ratio, and the private passenger automobile industry combined ratio, on a statutory basis, are shown in the following table. The Company's ratios include lines of insurance other than private passenger automobile written by Mercury Casualty and AMI. Since these other lines represent only a small percentage of premiums written, the Company believes its ratios can be compared to the industry ratios included in the table.

                                                  Year ended December 31,
                                        --------------------------------------------
                                         1998     1997      1996      1995     1994
                                         ----     ----      ----      ----     ----
Loss Ratio...........................    61.1%     63.5%     66.6%    67.8%    68.4%
Expense Ratio........................    26.3      24.7      24.0     24.0     24.6
                                         ----     -----      ----     ----     ----
Combined Ratio.......................    87.4%     88.2%     90.6%    91.8%    93.0%
                                         ====     =====      ====     ====     ====
Industry combined ratio (all
  writers) (1).......................    99.7%(2)  99.5%    101.0%   101.3%   101.3%
Industry combined ratio (excluding
  direct writers) (1)................     N.A.    100.1%    102.6%   102.0%   101.3%
------------------------------------

(1) Source: A.M. Best, Aggregates & Averages (1995 through 1998), for all property and casualty insurance companies (private passenger automobile line only, after policyholder dividends).
(2) Source: A.M. Best, "Best's Review, January 1999," "Review Preview." (N.A.) Not available.

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Premiums to Surplus Ratio

The following table shows, for the periods indicated, the insurance companies' statutory ratios of net premiums written to policyholders' surplus. While there is no statutory requirement applicable to the Company which establishes a permissible net premium writings to surplus ratio, widely recognized guidelines established by the National Association of Insurance Commissioners ("NAIC") indicate that this ratio should be no greater than 3 to 1.

                                                 Year ended December 31,
                                -----------------------------------------------------
                                1998       1997        1996       1995       1994
                                ----       ----        ----       ----       ----
                                    (Amounts in thousands, except ratios)
Net premiums written.....  $1,144,051   $1,086,241   $795,873   $636,590    $550,838
Policyholders' surplus...  $  767,223   $  679,359   $594,799   $479,114    $411,898
Ratio....................    1.5 to 1     1.6 to 1   1.3 to 1   1.3 to 1    1.3 to 1

Risk-Based Capital Requirements

In December 1993, the NAIC adopted a risk-based capital formula for casualty insurance companies which establishes recommended minimum capital requirements for casualty companies. The formula has been designed to capture the widely varying elements of risks undertaken by writers of different lines of insurance having differing risk characteristics, as well as writers of similar lines where differences in risk may be related to corporate structure, investment policies, reinsurance arrangements and a number of other factors. Based on the formula adopted by the NAIC, the Company has estimated the Risk- Based Capital Requirements of each of its insurance subsidiaries as of December 31, 1998. Each of the companies exceeded the highest level of minimum required capital.

Investments and Investment Results

The investments of the Company are made by the Company's Chief Investment Officer under the supervision of the Company's Board of Directors. The Company follows an investment policy which is regularly reviewed and revised. The Company's policy emphasizes investment grade, fixed income securities and maximization of after-tax yields. The Company does not invest with a view to achieving realized gains. However, sales of securities are undertaken, with resulting gains or losses, in order to enhance after-tax yield and keep the portfolio in line with current market conditions. Tax considerations are important in portfolio management, and have been made more so since 1986 when the alternative minimum tax was imposed on casualty companies. Changes in loss experience, growth rates and profitability produce significant changes in the Company's exposure to alternative minimum tax liability, requiring appropriate shifts in the investment asset mix between taxable bonds, tax-exempt bonds and equities in order to maximize after-tax yield. The optimum asset mix is subject to continuous review. At year-end, approximately 79% of the Company's portfolio, at market values, was invested in medium to long term, investment grade tax-exempt revenue and municipal bonds. The average Standard & Poor's rating of the

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Company's bond holdings was AA- at December 31, 1998.

The nominal average maturity of the bond portfolio, was 16.6 years at December 31, 1998, but the call-adjusted average maturity of the portfolio is shorter, approximately 7.3 years, because holdings are heavily weighted with high coupon issues which are expected to be called prior to maturity. The modified duration of the bond portfolio reflecting anticipated early calls was 5.8 years at December 31, 1998. Duration is a measure of how long it takes, on average, to receive all the cash flows produced by a bond, including reinvestment of interest. Because of its sensitivity to interest rates, it is a proxy for a bond's price volatility. The longer the duration, the greater the price volatility in relation to changes in interest rates.

Holdings of lower than investment grade bonds constitute approximately 1% of total investments. The Company continually evaluates the recoverability of its investment holdings. When a decline in value of fixed maturities or equity securities is considered other than temporary, a loss is recognized in the Consolidated Statement of Income. Equity holdings consist primarily of perpetual preferred stocks and relatively high yielding electric utility common stocks on which dividend income is partially tax-sheltered by the 70% corporate dividend exclusion.

The following table summarizes the investment results of the Company for the five years ended December 31, 1998.

                                                                 Year ended December 31,
                                                    --------------------------------------------------------------
                                                      1998(1)       1997(1)      1996(1)      1995        1994
                                                    -----------   -----------   ---------   ---------  -----------
                                                                 (Amounts in thousands)
Averaged invested assets (includes
 short-term cash investments).(2)................   $1,474,534    $1,262,925    $975,058    $827,861   $727,866
Net investment income:
       Before income taxes.......................       96,169        86,812      70,180      62,964     54,586
       After income taxes........................       87,199        77,917      63,371      57,035     49,787
Average annual return on investments:
       Before income taxes.......................          6.5%          6.9%        7.2%        7.6%       7.5%
       After income taxes........................          5.9%          6.2%        6.5%        6.9%       6.8%
Net realized investment gains
 (losses) after income taxes.....................       (2,552)        3,232      (2,062)        681     (6,485)
Net increase (decrease) in unrealized gains on
 all investments after income taxes..............   $    5,065    $   27,175    $ (6,271)   $ 37,960   $(36,503)

(1) Includes AMI for the month of December 1996 and the full years 1997 and 1998.
(2) Fixed maturities at cost, equities at market.

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

                                                              December 31,
                                 ----------------------------------------------------------------
                                        1998                  1997                 1996
                                 -------------------   -------------------   --------------------
                                   Amortized Market      Amortized Market      Amortized Market
                                  Cost      Value       Cost      Value       Cost       Value
                                 -------   ---------   --------   --------   --------  ----------
                                                         (Amounts in thousands)
Taxable Bonds.............   $   28,339  $   29,163  $   50,096 $   50,662   $  76,494  $   76,113
Tax-Exempt State and
 Municipal Bonds..........    1,174,630   1,251,475   1,021,259  1,085,613     781,586     808,761
Sinking Fund Preferred
 Stocks...................       42,471      44,270      76,239     78,711      66,713      69,234
                             ----------   ---------   ---------  ---------  ----------  ----------
   Total Fixed Maturity
    Investments...........    1,245,440   1,324,908   1,147,594  1,214,986     924,793     954,108

Equity Investments incl.
 Perpetual Preferred
 Stocks...................      220,449     219,745     169,943    173,522     148,264     148,112
Short-term Cash Invest-
 ments....................       45,992      45,992      59,740     59,740      66,067      66,067
                             ----------  ----------  ---------- ----------  ----------  ----------
Total Investments.........   $1,511,881  $1,590,645  $1,377,277 $1,448,248  $1,139,124  $1,168,287
                             ==========  ==========  ========== ==========  ==========  ==========

At December 31, 1998, the Company had a net unrealized gain on all investments of $78,764,000 before income taxes.

Competitive Conditions

The property and casualty insurance industry is highly competitive. The insurance industry consists of a large number of companies, many of which operate in more than one state, offering automobile, homeowners and commercial property insurance, as well as insurance coverage in other lines. Many of the Company's competitors have larger volumes of business and greater financial resources than the Company. Based on regularly published statistical compilations, the Company in 1998 was the sixth largest writer of private passenger automobile insurance in California. All of the insurance companies having greater shares of the California market sell insurance either directly or through exclusive agents, rather than through independent agents.

The property and casualty insurance industry is highly cyclical, character- ized by periods of high premium rates and shortages of underwriting capacity followed by periods of severe price competition and excess capacity. In the Company's view, competitive pressures have become more pronounced in the last several years. Some of the major writers in California have recently instituted rate cuts and most competitors have instituted one or more rate cuts over the last twenty-four months. In addition, many competitors have increased their marketing efforts.

Price and reputation for service are the principal means by which the Company competes with other automobile insurers. The Company believes that it has a good reputation for service, and it has, historically, been among the

12

lowest-priced insurers doing business in California according to surveys conducted by the California DOI. In the most recent survey conducted in 1998, the Company's rates for most classes of insureds were among the lowest available in most territories throughout the state. In addition to good service and competitive pricing, for those insurers dealing through independent agents, as the Company does, the marketing efforts of agents is a means of competition.

The current and future competitive climate for private passenger automobile insurance in California remains uncertain. All rates charged by private passenger automobile insurers are subject to the prior approval of the California Insurance Commissioner. New rating factor regulations have recently been issued and the filings required under those regulations have been approved. See "Regulation - Automobile Insurance Rating Factor Regulations."

The Company encounters similar competition in each state in which it operates outside California.

Reinsurance

The Company no longer maintains reinsurance for its liability coverage in California. Effective January 1, 1994, the Company terminated its liability reinsurance coverage with Employers Reinsurance Corporation ("ERC") because of rising premiums and under utilization of such coverage. The Company regularly evaluates the need for liability reinsurance.

The Company maintains property reinsurance under a treaty which was effective April 1, 1995 with National Reinsurance Corporation, which is rated A+ by A.M. Best. The treaty provides $900,000 coverage in excess of $100,000 for each risk subject to a maximum of $2,700,000 for any one occurrence. A second layer of coverage provides an additional $1,000,000 in excess of the first $1,000,000 per risk subject to a maximum of $2,000,000 for any one occurrence. This treaty was replaced with Swiss Re effective January 1, 1999. The new treaty provides $750,000 coverage in excess of $250,000 for each risk subject to a maximum of $2,250,000 for any one occurrence. A second layer of coverage provides an additional $1,000,000 in excess of the first $1,000,000 per risk.

The Company maintains treaty reinsurance with Swiss Re, effective October 1, 1998, where risks written under personal umbrella policies are ceded to Swiss Re on a 100% quota share basis. The maximum coverage is $5 million per risk.

Prior to 1998, the Company maintained catastrophe reinsurance for property and automobile physical damage business. Effective October 1, 1998, the Company did not renew this catastrophe reinsurance. The reinsurance program was not renewed because the Company believes it has adequate capitalization to absorb catastrophe losses in these lines. In addition, the Company expects a significant reduction in its catastrophe exposure from earthquakes due to the placement, beginning in the second quarter of 1998, of earthquake risks written in conjunction with homeowners policies, with the California Earthquake Authority (CEA). See Regulation - California Earthquake Authority.

13

ERC reinsures AMI through working layer treaties for property and casualty losses in excess of $200,000. For the years 1990 through 1996 the mechanical breakdown line of business was reinsured with Constitution Reinsurance Corporation through a quota-share treaty covering 50%-85% of the business written depending on the year the policy incepted. For policies effective on or after January 1, 1997, AMI is retaining the full exposure. AMI has other reinsurance treaties and facultative arrangements in place for various smaller lines of business.

If the reinsurers were unable to perform their obligations under the reinsurance treaty, the Company would be required, as primary insurer, to discharge all obligations to its insureds in their entirety.

Regulation

The Company's business in California is subject to regulation and supervision by the California DOI, which has broad regulatory, supervisory and administrative powers.

The powers of the California DOI primarily include the prior approval of insurance rates and rating factors and the establishment of standards of solvency which must be met and maintained. The regulation and supervision by the California DOI are designed principally for the benefit of policyholders and not for insurance company shareholders. The California DOI conducts periodic examinations of the Company's insurance subsidiaries. The last examination conducted of the California Companies was as of December 31, 1997. The reports on the results of that examination recommended no adjustments to the statutory financial statements as filed by the Company.

The insurance subsidiaries outside California, including AMI, are subject to the regulatory powers of the insurance departments of those states. Those powers are similar to the regulatory powers in California enumerated above. Generally, the regulations relate primarily to standards of solvency and are designed for the benefit of policyholders and not for insurance company shareholders.

In California, insurance rates have required prior approval since November 1989. Georgia and Kansas are also prior approval states, while Illinois only requires that rates be filed with the Department of Insurance prior to their use. Texas, Oklahoma and Florida have a modified version of prior approval laws. In all states, the insurance code provides that rates must not be "excessive, inadequate or unfairly discriminatory."

The Georgia DOI recently conducted an examination of Mercury Insurance Company of Georgia and Mercury Indemnity Company of Georgia as of December 31, 1997. While the audit was completed during the fall of 1998, the Georgia DOI has not yet issued the final examination reports. The Company does not anticipate any audit recommendations that would change the statutory financial statements as filed. The Illinois DOI conducted an examination of Mercury Insurance Company of Illinois and Mercury Indemnity Company of Illinois as of December 31, 1995.

14

The reports on that audit have recommended no changes to the statutory financial statements as filed. The states of Oklahoma, Kansas and Texas will also conduct periodic examinations of AMI.

The operations of the Company are dependent on the laws of the state in which it does business and changes in those laws can materially affect the revenue and expenses of the Company. The Company retains its own legislative advocates in California. The Company also makes financial contributions to officeholders and candidates. In 1998 and 1997, those contributions amounted to $1,137,000 and $96,000, 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.

Insurance Guarantee Association

In 1969, the California Insurance Guarantee Association (the "Association") was created pursuant to California law to provide for payment of claims for which insolvent insurers of most casualty lines are liable but which cannot be paid out of such insurers' assets. The Company is subject to assessment by the Association for its pro-rata share of such claims based on premiums written in the particular line in the year preceding the assessment by insurers writing that line of insurance in California. Such assessments are based upon estimates of losses to be incurred in liquidating an insolvent insurer. In a particular year, the Company cannot be assessed an amount greater than 1% of its premiums written in the preceding year. The only assessment imposed during the past five years was an immaterial amount in 1994. Assessments are recouped through a mandated surcharge to policyholders the year after the assessment. Insurance subsidiaries in the other states are subject to the provisions of similar insurance guaranty associations. No material assessments were imposed in the last five years in those states either.

Holding Company Act

The California Companies are subject to regulation by the California DOI pursuant to the provisions of the California Insurance Holding Company System Regulatory Act (the "Holding Company Act"). Pursuant to the Holding Company Act, the California DOI may examine the affairs of each company at any time. The Holding Company Act requires disclosure of any material transactions by or among the companies. Certain transactions and dividends defined to be of an "extraordinary" type may not be effected if the California DOI disapproves the transaction within 30 days after notice. Such transactions include, but are not limited to, sales, purchases, exchanges, loans and extensions of credit, and investments, in the net aggregate, involving more than the lesser of 3% of the Company's admitted assets or 25% of surplus as to policyholders, as of the preceding December 31. An extraordinary dividend is a dividend which, together with other dividends or distributions made within the preceding 12 months, exceeds the greater of 10% of the insurance company's policyholders' surplus as of the preceding December 31 or the insurance company's net income for the preceding calendar year. An insurance company is also required to notify the California DOI of any dividend after declaration, but prior to payment.

The Holding Company Act also provides that the acquisition or change of

15

"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 Insurance Commissioner. In general, a presumption of "control" arises from the ownership of voting securities and securities that are convertible into voting securities, which in the aggregate constitute 10% or more of the voting securities of a California insurance company or of a person that controls a California insurance company, such as Mercury General. A person seeking to acquire "control," directly or indirectly, of the Company must generally file with the Insurance Commissioner an application for change of control containing certain information required by statute and published regulations and provide a copy of the application to the Company. The Holding Company Act also effectively restricts the Company from consummating certain reorganizations or mergers without prior regulatory approval.

The insurance subsidiaries in Georgia, Illinois, Oklahoma and Texas are subject to holding company acts in those states, the provisions of which are substantially similar to those of the Holding Company Act. Regulatory approval was obtained from California, Oklahoma, Kansas and Texas before the acquisition of AMI was completed.

Assigned Risks

Automobile liability insurers in California are required to sell bodily injury liability, property damage liability, medical expense and uninsured motorist coverage to a proportionate number (based on the insurer's share of the California automobile casualty insurance market) of those drivers applying for placement as "assigned risks." Drivers seek placement as assigned risks because their driving records or other relevant characteristics, as defined by Proposition 103, make them difficult to insure in the voluntary market. During the last five years, approximately 0.7% of the direct automobile insurance premium written by the Company was for assigned risk business. In 1998, assigned risks represented 0.4% of total automobile direct premiums written and 0.5% of total automobile direct premium earned. Premium rates for assigned risk business are set by the California DOI. In October 1990, more stringent rules for gaining entry into the plan were approved, resulting in a substantial reduction in the number of assigned risks insured by the Company since 1991. Effective January 1, 1994, the California Insurance Code requires that rates established for the plan be adequate to support the plan's losses and expenses. The last rate increase approved by the Commissioner approximated 4.8% and became effective June 1, 1995. The Commissioner has approved a rate decrease of 28.3% effective February 1, 1999. The Company is prepared for an increase in the number of assignments based on the rate decrease. However, the magnitude of the increase in new assignments is difficult to predict because of the overall competitive climate of the voluntary insurance market.

Automobile Insurance Rating Factor Regulations

Commencing November 8, 1989, Proposition 103 required that property and casualty insurance rates must be approved by the Insurance Commissioner prior to their use, and that no rate shall be approved which is excessive, inadequate,

16

unfairly discriminatory or otherwise in violation of the provisions of the initiative. The proposition specified three 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, and (3) the number of years of driving experience of the insured. The new law also gave the Insurance Commissioner discretion to adopt other factors by regulation that have a substantial relationship to risk of loss. The new statute further provided 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, and most other insurers, historically charged different rates for residents of different geographical areas within California. The rates for urban areas, particularly in Los Angeles, have been generally substantially higher than for suburban and rural areas. The Company's geographical rate differentials have been derived by actuarial analysis of the claims costs in a given area.

In September 1996, the California Insurance Commissioner issued new permanent rating factor regulations which replaced emergency regulations which have been in use since their issuance in 1989. They required all automobile insurers in California to submit new rating plans complying with the regulations in early 1997. The Company submitted its new proposed rating plan on March 11, 1997.

The Company's plan, and the new plans of most other California automobile insurers, were approved by the Department in October 1997. The Company's plan became effective October 1, 1997. The rate changes resulting from implementation of the new plan did not have a material effect on the Company's competitive position or its profitability.

California Financial Responsibility Law

Effective January 1, 1997 California enacted a new law which requires proof of insurance for the registration (new or renewal) of a motor vehicle. It also provides for substantial penalties for failure to supply proof of insurance if one is stopped for a traffic violation. Media attention to the new law resulted in a surge of new business applications during the first half of 1997. The renewal experience of this new business has been similar to that of the Company's existing business.

In November 1996 an initiative sponsored by the California Insurance Commissioner was overwhelmingly approved by the California voters. It provides that uninsured drivers who are injured in an automobile accident are able to recover only actual, out-of-pocket medical expenses and lost wages and are not entitled to receive awards for general damages, i.e., "pain and suffering." This restriction also applies to drunk drivers and fleeing felons. The law has helped in controlling loss costs.

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California Earthquake Authority

The California Earthquake Authority (CEA) is a Quasi-Governmental organization that was established to provide a market for earthquake coverage to California homeowners. During the second quarter of 1998, the Company began placing all new and renewal earthquake coverage offered with its homeowners policy through the California Earthquake Authority. The Company receives a small fee for placing business with the CEA.

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 Mercury Casualty Company's participation percentage, and recently published statistical information from the CEA, the Company, at December 31, 1998, estimates its assessment exposure to a "Northridge" - type earthquake to be approximately $3.2 million and its maximum total exposure to CEA assessments to be approximately $6.5 million.

Item 2. Properties

The home office of the California insurance subsidiaries and the Company's computer facilities are located in Brea, California in an 80,000 square foot office building owned by the Company.

Since December 1986, Mercury General's executive offices are located in a 36,000 square foot office building in Los Angeles, California, owned by Mercury Casualty. The Company occupies approximately 95% of the building and leases the remaining office space to others.

In October 1992, the Company purchased a 158,000 square foot office building in Brea, California. The Company occupies approximately 77% of the facility and leases the remaining office space to others.

The Company leases all of its other office space. Office location is not material to the Company's operations, and the Company anticipates no difficulty in extending these leases or obtaining comparable office space.

Item 3. Legal Proceedings

The Company is, from time to time, named as a defendant in various lawsuits incidental to its insurance business. In most of these actions, plaintiffs assert claims for punitive damages which are not insurable under California judicial decisions. The Company vigorously defends these actions, unless a reasonable settlement appears appropriate. The Company believes that adverse results, if any, in the actions currently pending should not have a material effect on the Company's operations or financial position.

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Item 4. Submission of Matters to a Vote of Security Holders

No matters were submitted to a vote of security holders by the Company during the fourth quarter of the fiscal year covered by this report.

EXECUTIVE OFFICERS OF THE COMPANY

The following table sets forth certain information concerning the executive officers of the Company as of March 16, 1999:

Name                     Age                    Position
----                     ---                    --------

George Joseph             77   Chairman of the Board and Chief
Executive Officer
Michael D. Curtius        48   President and Chief Operating Officer
Cooper Blanton, Jr.       72   Executive Vice President
Bruce E. Norman           50   Senior Vice President in charge of
                               Marketing
Joanna Y. Moore           43   Vice President and Chief Claims Officer
Kenneth G. Kitzmiller     52   Vice President in charge of Underwriting
Gabriel Tirador           34   Vice President and Chief Financial Officer
Judy A. Walters           52   Vice President - Corporate Affairs and
                               Secretary
Richard Glassman          41   Vice President - Information Systems

Mr. Joseph, Chief Executive Officer of the Company and Chairman of its Board of Directors, has served in those capacities since 1961. Mr. Joseph has more than 45 years experience in the property and casualty insurance business.

Mr. Curtius, President and Chief Operating Officer, has been employed by the Company since 1977. In October 1987, Mr. Curtius was named Vice President and Chief Claims Officer, and in August 1991 he was appointed Executive Vice President. He was elected President and Chief Operating Officer of Mercury General and the California Companies in May 1995 and elected to the Board of Directors of Mercury General and the California Companies in 1996. In December of 1996 he was appointed Vice Chairman of AMIC. Mr. Curtius has over 20 years of experience in the insurance industry.

Mr. Blanton, Executive Vice President, joined the Company in 1966 and supervised its underwriting activities from 1967 until September 1995. He was appointed Executive Vice President of Mercury Casualty and Mercury Insurance in 1983 and was named Executive Vice President of Mercury General in 1985. In May 1995 he was named President of the Georgia and Illinois insurance company subsidiaries and in February 1996 he was elected to the Board of Directors of those companies. In January 1999 he was named Chairman of the Board of AMIC. Mr. Blanton has over 40 years of experience in underwriting and other aspects of the property and casualty insurance business.

Mr. Norman, Senior Vice President in charge of Marketing, has been employed by the Company since 1971. Mr. Norman was named to this position in February 1999, and has been a Vice President since October 1985 and a Vice President of Mercury Casualty since 1983. Mr. Norman has supervised the selection and

19

training of agents and managed relations between agents and the Company since 1977. In February 1996 he was elected to the Board of Directors of the California Companies.

Ms. Moore, Vice President & Chief Claims Officer, joined the Company in the claims department in March 1981. She was named Vice President of Claims of Mercury General in August 1991 and has held her present position since July 1995.

Mr. Kitzmiller, Vice President in charge of Underwriting, has been employed by the Company in the underwriting department since 1972. In August 1991 he was appointed Vice President of Underwriting of Mercury General and has supervised the underwriting activities of the Company since early 1996.

Mr. Tirador, Vice President and Chief Financial Officer, served as the Company's assistant controller from March 1994 to December 1996. During January 1997 to February 1998 he served as the Vice President and Controller of the Automobile Club of Southern California. He rejoined the Company in February 1998 in his current capacity. Mr. Tirador has over twelve years experience in the property and casualty insurance industry and is a Certified Public Accountant.

Ms. Walters has been employed by the Company since 1967, and has served as its Secretary since 1982. Ms. Walters was named Vice President - Corporate Affairs in June 1998.

Mr. Glassman has been employed by Mercury since February 1993. In August 1995 he was appointed Assistant Vice President and assumed the position of Manager of Information Services, which he had been directing since earlier that year. In June 1998, Mr. Glassman was appointed Vice President - Information Systems. He has a vast background in technology, sales and marketing.

PART II

Item 5. Market for the Registrant's Common Equity and Related Security

Holder Matters

Price Range of Common Stock

The common stock is traded on the New York Stock Exchange (symbol: MCY). The following table shows the high and low sales prices per share in each quarter during the past two years as reported in the consolidated transaction reporting system. The quotations have been adjusted for a two-for-one stock split that was effective September 16, 1997.

1997                                           High                Low
                                               ----                ---

      1st Quarter.........................  $32.750              $26.125
      2nd Quarter.........................  $38.094              $29.250
      3rd Quarter.........................  $45.875              $36.000
      4th Quarter.........................  $55.500              $40.750

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1998                                           High                Low
                                               ----                ---
      1st Quarter.........................  $63.625              $46.000
      2nd Quarter.........................  $66.313              $58.250
      3rd Quarter.........................  $69.438              $36.563
      4th Quarter.........................  $45.625              $33.250

 1999
      1st Quarter (January 1 - March 8)...  $45.500              $32.938

Dividends

Following the public offering of its common stock in November 1985, the Company has paid regular quarterly dividends on its common stock. During 1998 and 1997, the Company paid dividends on its common stock of $0.70 per share and $0.58 per share, respectively. The 1997 per share amount is adjusted to reflect a two-for-one stock split in September 1997. On February 5, 1999, the Board of Directors declared a $.21 quarterly dividend ($.84 annually) payable on March 31, 1999 to stockholders of record on March 17, 1999.

The common stock dividend rate has been increased fifteen times since dividends were initiated in January, 1986, at an annual rate of $0.05, adjusted for the two-for-one stock splits in September 1992 and September 1997. For financial statement purposes, the Company records dividends on the declaration date. The Company expects to continue the payment of quarterly dividends. The continued payment and amount of cash dividends will depend upon, among other factors, the Company's operating results, overall financial condition, capital requirements and general business conditions.

As a holding company, Mercury General is largely dependent upon dividends from its subsidiaries to pay dividends to its shareholders. These subsidiaries are subject to state laws that restrict their ability to distribute dividends. The state laws permit a casualty insurance company to pay dividends and advances within any 12-month period, without any prior regulatory approval, in an amount up to the greater of 10% of statutory earned surplus at the preceding December 31, or net income for the calendar year preceding the date the dividend is paid. Under this test, the direct insurance subsidiaries of the Company are entitled to pay dividends to Mercury General during 1999 of up to approximately $98 million. See Note 10 of Notes to Consolidated Financial Statements and "Business -- Regulation -- Holding Company Act."

Shareholders of Record

The approximate number of holders of record of the Company's common stock as of March 8, 1999 was 255. The approximate number of beneficial holders as of March 8, 1999 was 9,197 according to the Bank of New York, the Company's transfer agent.

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Item 6. Selected Consolidated Financial Data

                                                                        Year ended December 31,
                                                       ----------------------------------------------------------
                                                        1998        1997         1996         1995        1994
                                                        ----        ----         ----         ----        ----
                                                             (Amounts in thousands, except per share data)
Income Data:
Premiums earned.....................................   $1,121,584   $1,031,280     $754,724     $616,326   $529,390
Net investment income...............................       96,169       86,812       70,180       62,964     54,586
Realized investment gains(losses)...................       (3,926)       4,973       (3,173)       1,048     (9,853)
Realized gain from sale of
  subsidiary                                                2,586           --           --           --         --
Other...............................................        5,710        4,881        3,233        3,341      3,123
                                                       ----------   ----------     --------     --------   --------

   Total Revenues...................................    1,222,123    1,127,946      824,964      683,679    577,246
                                                       ----------   ----------     --------     --------   --------
Losses and loss adjustment
  expenses..........................................      684,468      654,729      501,858      416,556    360,557
Policy acquisition costs............................      252,592      224,883      160,019      128,743    112,682
Other operating expenses............................       44,941       33,579       24,493       22,017     20,566
Interest............................................        4,842        4,976        2,004        2,040      1,025
                                                       ----------   ----------     --------     --------   --------
   Total Expenses...................................      986,843      918,167      688,374      569,356    494,830
                                                       ----------   ----------     --------     --------   --------
Income before income taxes..........................      235,280      209,779      136,590      114,323     82,416
Income taxes........................................       57,754       53,473       30,826       24,022     16,121
                                                       ----------   ----------     --------     --------   --------
   Net Income.......................................   $  177,526   $  156,306     $105,764     $ 90,301   $ 66,295
                                                       ==========   ==========     ========     ========   ========
Per Share Data:
Basic earnings per share *..........................   $     3.23   $     2.84     $   1.93     $   1.65   $   1.22
                                                       ==========   ==========     ========     ========   ========
Diluted earnings per share *........................         3.21         2.82         1.92         1.65       1.21
                                                       ==========   ==========     ========     ========   ========
Dividends paid *....................................   $      .70   $      .58     $    .48     $    .40   $    .35
                                                       ==========   ==========     ========     ========   ========
                                                                                 December 31,
                                                          ----------------------------------------------------------
                                                             1998         1997         1996         1995       1994
                                                             ----         ----         ----         ----       ----
                                                                  (Amounts in thousands, except per share data)
Balance Sheet Data:
Total investments...................................   $1,590,645   $1,448,248   $1,168,287     $923,194   $751,614
Premiums receivable.................................      107,950      104,216       83,748       58,902     48,741
Total assets........................................    1,877,025    1,725,532    1,419,927    1,081,656    911,693
Unpaid losses and loss
 adjustment expenses................................      405,976      409,061      336,685      253,546    227,499
Unearned premiums...................................      327,129      309,376      260,878      168,404    148,654
Notes payable.......................................       78,000       75,000       75,000       25,000     25,000
Deferred income tax
 liability (asset)..................................       22,639       19,722        6,349       10,158    (10,190)
Shareholders' equity................................      917,375      799,592      641,222      565,188    457,161
Book value per share*...............................        16.80        14.51        11.69        10.34       8.38

*Adjusted for a two-for-one stock split effective September 1997.

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Item 7. Management's Discussion and Analysis of Financial Condition and

Results of Operations

Overview

The operating results of property and casualty insurance companies are subject to significant fluctuations from quarter-to-quarter and from year-to- year due to the effect of competition on pricing, the frequency and severity of losses, including the effect of natural disasters on losses, general economic conditions, the general regulatory environment in those states in which an insurer operates, state regulation of premium rates and other factors such as changes in tax laws. The property and casualty industry has been highly cyclical, with periods of high premium rates and shortages of underwriting capacity followed by periods of severe price competition and excess capacity.

The Company operates primarily in the state of California, which was the only state it produced business in prior to 1990. The Company expanded its operations into Georgia and Illinois in 1990. With the acquisition of American Fidelity Insurance Group (AFI)in December 1996, now American Mercury Insurance Group (AMI), the Company expanded into the states of Oklahoma and Texas. The Company further expanded its operations into the state of Florida during 1998.

During 1998, approximately 92% of the Company's direct premiums written, including AMI, were derived from California.

In California, as in various other states, all property and casualty rates must be approved by the Insurance Commissioner before they can be used.

In February 1994, the California Insurance Commissioner approved new rates which were designed to improve the Company's competitive position for new insureds. These rate changes, which became effective on May 1, 1994, provided for decreases in premium rates for new insureds. Further rate modifications were approved and made effective on October 15, 1995, April 15, 1996, October 1, 1997, April 1, 1998 and November 15, 1998. The rate change made April 1, 1998 reduced rates by approximately 7% and was primarily made to improve Mercury's competitive position in the marketplace. Except for the April 1, 1998 rate change, the rate changes made over the last several years have been substantially revenue-neutral overall, with physical damage rates being increased and bodily injury liability rates decreased. The rate change made effective May 1, 1994 resulted in a substantial increase in new business being submitted to the Company. The subsequent rate modifications have allowed the Company to maintain ongoing growth in policy count. Since March 31, 1994, Private Passenger Automobile ("PPA") policies in force in California have increased from approximately 300,000 to 743,000 at December 31, 1998, an annual rate of increase of over 20%.

In September 1996, the California Insurance Commissioner issued new permanent rating factor regulations designed to implement the requirements that automobile insurance rates be determined by (1) driving safety record, (2) years of driving experience, (3) miles driven per year and (4) whatever optional factors are determined by the Insurance Commissioner to have a substantial

23

relationship to the risk of loss and adopted by regulation. The law further requires that each of the four factors be applied in decreasing order of importance.

The Company submitted a proposed rating plan in response to these regulations in March 1997. The Company's plan was approved by the California DOI and became effective October 1, 1997. Although the rate changes produced some minor dislocations, implementation of the new plan did not have a material effect on the Company's overall competitive position or its profitability.

Results of Operations

Year Ended December 31, 1998 Compared to Year Ended December 31, 1997

Premiums earned in 1998 of $1,121.6 million increased 8.8%, reflecting unit growth which was somewhat offset by reduced average premiums per policy. The reduction in average premium per policy was primarily the result of the 7% rate decrease taken for California business in April 1998. In addition, a large portion of the new California business written during 1997, which grew at a rate of 28.5% due to a new law requiring proof of insurance to register a car, qualified for a discount on renewal in 1998. Consequently, the average premium per policy declined in 1998 as compared to 1997.

Net premiums written in 1998 of $1,144.1 million increased 5.3% over a year earlier, continuing a growth trend which began in the second quarter of 1994. The Company increased its marketing efforts in April 1998, launching a fully integrated radio and billboard advertising program. Although the campaign has not met expectations, the Company believes continuing the advertising program is necessary in the current competitive climate. The California automobile insurance marketplace remains intensely competitive. Most of the major direct writers, who represent the Company's chief competition, have instituted one or more rate reductions over the last twenty-four months and many have significantly increased their marketing efforts.

The loss ratio in 1998 (loss and loss adjustment expenses related to premiums earned) was 61.0%, compared with 63.5% in 1997. The favorable loss experience is largely related to the effectiveness of Proposition 213, an initiative made effective January 1, 1997 which prohibits recovery of non- economic (pain and suffering) losses by uninsured motorists or drunk drivers injured in automobile accidents. The 7% rate reduction beginning on April 1, 1998 negatively affected the Company's loss ratio during a large portion of 1998. The full impact of the rate reduction on the Company's loss ratio will be felt in 1999 and succeeding periods.

The expense ratio (policy acquisition costs and other operating expenses related to premiums earned) was 26.6% in 1998 and 25.1% in 1997. The increase in the expense ratio was largely attributable to increased base commissions and profit-related bonuses to agents, expenses associated with the advertising program implemented in April 1998, and start up costs from the Company's entry into the Florida market.

24

Total losses and expenses in 1998, excluding interest expense of $4.8 million, were $982.0 million, resulting in an underwriting gain for the period of $139.6 million, compared with an underwriting gain of $118.1 million in 1997.

Investment income in 1998 was $96.2 million, compared with $86.8 million in 1997. The after-tax yield on average investments of $1,474.5 million (fixed maturities at cost, equities at market) was 5.91%, compared with 6.17% on average investments of $1,262.9 million in 1997. The effective tax rate on investment income was 9.3% in 1998, compared to 10.3% in 1997. The lower tax rate in 1998 reflects the benefits derived from replacing taxable issues held in the AMI investment portfolio, when purchased in December 1996, to non-taxable issues throughout the 1997 and 1998 fiscal years. The redemption of bonds acquired during higher interest periods has been a negative influence on realized yields in each of the last several years and is expected to continue in 1999. Bonds matured and called in 1998 totaled $65.3 million, compared with $54.0 million in 1997. Approximately $47 million of bonds are expected to mature or be called in 1999. Average yields being obtained during the first quarter of 1999 on new investments are 50 to 75 basis points lower than the average yield realized during 1998.

Realized investment losses in 1998 were $3.9 million, compared with realized gains of $5.0 million in 1997. The gains and losses in both years were principally incurred to enhance investment income on both fixed maturities and equity securities, including perpetual preferred stocks. The losses realized in 1998 were designed to utilize expiring capital gains tax benefits.

Realized gain from sale of subsidiaries of $2.6 million was derived from the sale for cash of Cimmaron Insurance Company, an inactive company acquired in the American Mercury Insurance Group purchase made in December 1996.

The income tax provision of $57.8 million in 1998 represented an effective tax rate of 24.5%, compared with an effective rate of 25.5% in 1997. The 1997 rate is higher primarily because the Company had a large non tax-deductible charge for ESOP compensation expense in 1997 that did not occur in 1998. ESOP compensation expense is calculated based on the current market value for the Company's stock multiplied by shares allocated to employees, however, only the Company's cost basis is deductible for tax purposes. The increase in the Company's share price on the shares allocated in 1997, which had been purchased in 1994, caused the large non-deductible charge that resulted in increasing the Company's effective tax rate in 1997. This situation did not occur in 1998 as the shares allocated to employees during 1998 had a similar cost and market value.

Net income in 1998 was $177.5 million or $3.23 per share, (basic), compared with $156.3 million, or $2.84 per share, (basic), in 1997. Basic per share results are based on 55.0 million average shares in 1998 and 55.0 million average shares in 1997. Diluted per share results were $3.21 in 1998 and $2.82 in 1997.

25

Year Ended December 31, 1997 Compared to Year Ended December 31, 1996

Premiums earned in 1997 of $1,031.3 million (including $65.1 million contributed by AMI) increased 36.6%, primarily reflecting unit growth and the fact that 1996 results only include one month of premiums from AMI. Without the impact of the AMI results, premiums earned increased 28.9%. Average premium per policy for the year declined slightly. Net premiums written in 1997 of $1,086.2 million (including $72.8 million contributed by AMI) increased 36.5% over a year earlier (28% excluding the impact of AMI results), continuing a growth trend which began in the second quarter of 1994. Growth in written premiums in California of 28.5% for all of 1997 was aided by a new California law that became effective January 1, 1997 which requires proof of insurance for the registration (new or renewal) of a motor vehicle. The greater part of the new business generated by the new law occurred in the first half of 1997, and provided for only the minimum liability coverage required by law. The average premium on this business was substantially less than that produced by full coverage policies, which constitute a majority of the Company's total premium volume.

The loss ratio in 1997 (loss and loss adjustment expenses related to premiums earned) was 63.5%, compared with 66.5% in 1996. The improvement in loss experience in 1997 is in large part related to the loss cost savings from the enactment of California Proposition 213 that became effective January 1, 1997. The 1997 loss ratio reflects deficiencies from unfavorable development on allocated loss adjustment expenses from prior periods. The initial estimates were based principally on the Company's actual experience and did not fully reflect the increases in the legal expenses of defending the Company's insureds arising from the Company's policy of aggressively defending, including litigating, exaggerated bodily injury claims arising from minimal impact automobile accidents.

The expense ratio (policy acquisition costs and other operating expenses related to premiums earned) was 25.1% in 1997 and 24.5% in 1996. The increase in the expense ratio in 1997 reflects increased provisions for profit-related bonuses to both agents and employees and the inclusion of the operating results of AMI for a full year.

Total losses and expenses in 1997, excluding interest expense of $5.0 million, were $913.2 million, resulting in an underwriting gain for the period of $118.1 million, compared with an underwriting gain of $68.4 million in 1996.

Investment income in 1997, including a contribution from AMI of $6.3 million, was $86.8 million, compared with $70.2 million in 1996. The after-tax yield on average investments of $1,262.9 million, including AMI, (fixed maturities at cost, equities at market) was 6.17%, compared with 6.50% on average investments of $975.1 million in 1996. The effective tax rate on investment income was 10.3% in 1997, compared with 9.7% in 1996. The effective tax rate was increased, and the effective after-tax yield was reduced slightly, by the inclusion of AMI for the full year 1997. The slightly higher tax rate on investment income in 1997 reflects an increase in the proportion of investment income derived from taxable bonds held by AMI and dividends on equities,

26

principally perpetual preferred stocks. The redemption of bonds acquired during higher interest periods has been a negative influence on realized yields in each of the last several years and will continue in 1998. Bonds matured and called in 1997 totaled $54.0 million, compared with $72.9 million in 1996.

Realized investment gains in 1997 were $5.0 million, compared with realized losses of $3.2 million in 1996. The gains and losses in both years reflect principally income-enhancing swaps of both fixed maturities and equity securities, including perpetual preferred stocks. The losses realized in 1996 were designed to utilize expiring capital gains tax benefits.

The income tax provision of $53.5 million in 1997 represented an effective tax rate of 25.5%, compared with an effective rate of 22.6% in 1996. The increase in the rate is largely attributable to the increased proportion of realized gains and the increase in underwriting gains, both of which are taxed at the full corporate rate of 35%, in contrast to investment income which consists primarily of tax-exempt interest and tax sheltered dividend income.

Net income in 1997 was $156.3 million, or $2.84 per share, (basic), compared with $105.8 million, or $1.93 per share, (basic), in 1996. Basic share results are based on 55.0 million average shares in 1997 and 54.8 million average shares in 1996, adjusted for a two-for-one stock split effective September 16, 1997. Diluted per share results, calculated in accordance with new accounting standards, were $2.82 in 1997 and $1.92 in 1996.

Liquidity and Capital Resources

Net cash provided from operating activities in 1998, was $192.1 million, while funds derived from the sale, redemption or maturity of investments was $941.5 million, of which approximately 79% was represented by the sale of equity securities. The amortized cost of fixed-maturity investments increased by $97.8 million during the year. Equity investments, including perpetual preferred stocks, increased by $50.5 million at cost, while short-term cash investments decreased by $13.7 million. The amortized cost of fixed-maturities available for sale that were sold, called or matured during the year was $195.2 million.

The market value of all investments held at market as "Available for Sale" exceeded the amortized cost of $1,511.9 million at December 31, 1998 by $78.8 million. That unrealized gain, reflected in shareholders' equity, as Accumulated Other Comprehensive Income, net of applicable tax effects, was $51.2 million at December 31, 1998 compared with an unrealized gain of $46.1 million at December 31, 1997. The increase in market values since December 31, 1997 reflects principally the substantial decline in intermediate and long term interest rates during 1998.

The Company's cash and short term investments totaled $47.9 million at December 31, 1998. Together with funds generated internally, such liquid assets are more than adequate to pay claims without the sale of long term investments.

Traditionally, it has been the Company's policy not to invest in high yield

27

or "junk" bonds. In 1995, the Company adopted a policy to place a small proportion of its investments in the taxable sector in bonds rated lower than investment grade, but not lower than Ba by Moody's or BB by Standard & Poor's. At December 31, 1998 bond holdings rated below investment grade totaled $13.6 million at market (cost $12.7 million), or 1% of total investments. The average rating of the $1,203 million bond portfolio (at amortized cost) was AA-, while the average effective maturity, giving effect to anticipated early call, approximates 7.3 years. The modified duration of the bond portfolio at year-end was 5.8 years, reflecting the heavy weighting of high coupon issues, including housing issues subject to sinking funds, and other issues which are pre-refunded or are expected to be called prior to their maturity. Duration measures the length of time it takes to receive all the cash flows produced by a bond, including reinvestment of interest. Because it measures four factors (maturity, coupon rate, yield and call terms) which determine sensitivity to changes in interest rates, modified duration is considered a much better indicator of price volatility than simple maturity alone. Bond holdings are broadly diversified geographically, and, within the tax-exempt sector, consist largely of high coupon revenue issues, many of which have been pre-refunded and escrowed with U.S. Treasuries. General obligation bonds of the large eastern cities have generally been avoided.

Holdings in the taxable sector consist largely of senior public utility issues. Fixed-maturity investments of $1,245.4 million (amortized cost), include $42.5 million (amortized cost) of sinking fund preferreds, principally utility issues. The market value of all fixed maturities exceeded cost by $79.5 million at December 31, 1998. The only securities held which may be considered derivatives are a small amount of adjustable rate preferred stocks.

Except for Company-occupied buildings, the Company has no direct investments in real estate and no holdings of mortgages secured by commercial real estate.

Equity holdings of $219.7 million at market (cost $220.4 million), including perpetual preferred issues, are largely confined to the public utility and banking sectors and represent about 24.0% of total shareholders' equity.

The Company had outstanding debt at December 31, 1998 of $78 million. Of this amount, $75 million has been borrowed under a three year revolving credit bank loan. The loan agreement requires the Company to meet numerous affirmative and negative covenants. The proceeds of the loan were used to repay a prior loan and to acquire AMI, with the balance contributed to the Company's new insurance subsidiaries. The loan agreement may be extended annually for additional periods of one year each to maintain the three year maturity date. The interest rate is variable and is optionally related to the Federal Funds rate, Bank of New York rate (prime rate) or the Eurodollar London Interbank rate (LIBOR). Based on the rates effective through February 22, 1999, LIBOR plus .40, the net interest cost on the loan approximates 5.65%.

The Company also maintains a $100 million line of credit, of which $3 million was drawn on at December 31, 1998 and is due October 31, 1999. The line

28

of credit may be used to fund the Company's stock repurchase program authorized by the Board of Directors in August 1998 as well as for general corporate purposes. The interest rate and loan covenants are the same as the Company's $75 million loan discussed above. The Company plans to extend the maturity date of this loan during 1999.

Under the stock repurchase program, the Company may purchase over a one- year period up to $200 million of Mercury General's common stock. The purchases may be made from time to time in the open market at the discretion of management. The program will be funded by the sale of lower yielding tax-exempt bonds, the proceeds of the $100 million credit facility and internal cash generation. During 1998, the Company purchased 580,000 shares of the common stock in the open market at an average price of $41.83. The shares purchased were retired.

In March 1994, the Company's Employee Stock Ownership Plan ("the Plan") purchased 322,000 shares of Mercury General's common stock in the open market at a price of $14.875 per share, adjusted for the two-for-one stock split effective September 16, 1997. The purchases were funded by a five year term bank loan of $5.0 million to the Plan which is guaranteed by the Company. The shares have been allocated to employees over the amortization period of the loan, with the initial allocation made in December 1994. The remaining balance of the loan of $2.0 million was retired in March 1998 with the proceeds of contributions to the Plan by the Company for the year 1997, and the remaining unallocated shares were credited to employees' ESOP balances at December 31, 1997. In August 1998, the Plan purchased 115,000 shares of Mercury General's common stock in the open market at a price of $43.05 per share. The purchases were funded by a five year term bank loan of $5 million to the Plan which is guaranteed by the Company. The shares are being allocated to the employees over a five-year period, with the initial allocation made in December 1998. Since dividends on unallocated shares held by the Plan are tax deductible if they are used for debt service, as are Company contributions to the Plan, the net, after-tax interest cost to the Company for the borrowed funds used for the Plan stock purchase is less than the effective rate of interest on the loan, which, in 1998 was 6.00%.

In December 1993, the NAIC adopted a risk-based capital formula for casualty insurance companies which establishes recommended minimum capital requirements for casualty companies. The formula has been designed to capture the widely varying elements of risks undertaken by writers of different lines of insurance having differing risk characteristics, as well as writers of similar lines where differences in risk may be related to corporate structure, investment policies, reinsurance arrangements and a number of other factors. The Company has estimated the Risk-Based Capital Requirements of each of its insurance subsidiaries as of December 31, 1998. Each of the companies' policyholders' surplus exceeded the highest level of minimum required capital.

As of December 31, 1998, the Company had no material commitments for capital expenditures.

The California Earthquake Authority (CEA) is a Quasi-Governmental organization that was established in 1996 to provide a market for earthquake

29

coverage to California homeowners. During the second quarter of 1998, the Company began placing all new and renewal earthquake coverage offered with its homeowners policy through the California Earthquake Authority. The Company receives a small fee for placing business with the CEA.

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 Mercury Casualty Company's participation percentage, and recently published statistical information from the CEA, the Company, at December 31, 1998, estimates its assessment exposure to a "Northridge" - type earthquake to be approximately $3.2 million and its maximum total exposure to CEA assessments to be approximately $6.5 million.

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 of the licensed insurance subsidiaries of $767.2 million at December 31, 1998, and net written premiums for the twelve months ended on that date of $1,144.1 million, the ratio of writings to surplus was approximately 1.5 to 1.

Year 2000

The Year 2000 issue is the result of computer programs being written using two digits rather than four digits to define the applicable year. Computer programs that have date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000, or as no date. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business operations.

In March of 1998, the Company completed the modifications necessary to its computer programs and systems for all of its "critical" systems for business written in California, Georgia, Illinois and Florida. Modifications were made to both hardware and software. The Company considers policy issuance, premium billing and collections and its claims systems as its critical systems. The modifications completed on the above critical systems represent approximately 94% of the Company's total premiums written.

The American Mercury Group, acquired by the Company in December 1996 and which represents approximately 6% of the Company's total premiums written, is in the process of completing the modifications necessary, including the conversion to new critical systems, to become Year 2000 compliant. The Company expects to have their critical systems to be Year 2000 compliant by the second quarter of 1999.

Other non-critical systems are already Year 2000 compliant or are in the process of being modified or converted to become Year 2000 compliant. The Company expects to have its non-critical systems to be Year 2000 compliant by the

30

second quarter of 1999.

The Company expensed approximately $475,000 in 1998 and $125,000 in 1997, primarily for internal labor costs, related to Year 2000 modifications. The Company expects to incur an amount less than what has previously been expensed for 1999. It is not possible to quantify the aggregate cost to the Company with respect to the Year 2000 problems, although the Company does not anticipate it will have a material adverse impact on its business.

While the Year 2000 considerations are not expected to materially impact the Company's internal operations, they may have a material effect on some of the Company's agents, suppliers and financial institutions with whom the Company conducts business, and thus indirectly affect the Company. The Company has commenced a program to ascertain the compliance status of those companies with whom the Company conducts material business. This program includes sending out questionnaires to our major business partners regarding their Year 2000 readiness. Based on the responses received to date, the Company does not anticipate any material impact on its operations or financial condition.

Mercury General is developing business resumption contingency plans specific to the Year 2000. Business resumption contingency plans address the actions that would be taken if critical business functions cannot be carried out in the normal manner upon entering the next century due to system or supplier failure.

Item 7A. Quantitative and Qualitative Disclosures about Market Risks

The Company is subject to various market risk exposures including interest rate risk and equity price risk. The following disclosure reflects estimates of future performance and economic conditions. Actual results may differ.

The Company invests its assets primarily in fixed maturity investments, which at December 31, 1998 comprised 83% of total investments at market value. Tax-exempt bonds represent 95% of the fixed maturity investments with the remaining amount consisting of sinking fund preferred stocks and taxable bonds. Equity securities, consisting primarily of preferred stocks, account for 14% of total investments at market. The remaining 3% of the investment portfolio consists of highly liquid short-term investments which are primarily U.S. Treasury backed overnight repurchase agreements and short-term money market funds.

The value of the fixed maturity portfolio is subject to interest rate risk. As market interest rates decrease, the value of the portfolio goes up with the opposite holding true in rising interest rate environments. A common measure of the interest sensitivity of fixed maturity assets is modified duration, a calculation that takes maturity, coupon rate, yield and call terms to calculate an average age of the expected cash flows. The longer the duration, the more sensitive the asset is to market interest rate fluctuations.

The Company has historically invested in fixed maturity investments with a goal towards maximizing after-tax yields and holding assets to the maturity or

31

call date. Since assets with longer maturity dates tend to produce higher current yields, the Company's investment philosophy has resulted in a portfolio with a moderate duration. This has exposed the portfolio to interest rate risk, which, in periods of falling interest rates, as was generally experienced over the last decade, resulted in substantial realized and unrealized gains on the portfolio holdings.

During 1998, lower market interest rates reduced the duration of the Company's fixed income portfolio. Bond investments made by the Company typically have call options attached, which reduce the duration of the asset as rates decline. Consequently, the average modified duration of the portfolio decreased from 6.1 years at December 31, 1997 to 5.8 years at December 31, 1998. Given a hypothetical parallel increase of 100 basis points in interest rates, the fair value of the fixed maturity portfolio would decrease by approximately $77.1 million.

The value of the equity investments consists of $47.8 million in common stocks and $171.9 million in non-sinking fund preferred stocks. The common stock equity assets are typically valued for future economic prospects as perceived by the market. The non-sinking fund preferred stocks are typically valued using credit spreads to U. S. Treasury benchmarks. This causes them to be comparable to fixed income securities in terms of interest rate risk.

The Company's primary strategy for equity investments is to maximize current income by accelerating the number of dividends collected on the overall funds employed. The Company times the purchase and sale of equity investments to coincide with quarterly dividend payment dates and minimum holding periods as required by the Internal Revenue Service. This timing strategy results in very short asset holding periods, often less than three months. The Company believes that this strategy coupled with the defensive nature of the assets involved reduces the risk, over time, of significant portfolio valuation fluctuations due to changes in market interest rates.

In general, credit spreads have widened in the non-sinking fund sector since the credit crisis of this past summer. The Company's non-sinking fund preferred stock assets were negatively affected by this market change. The duration of the Company's non-sinking fund preferred stocks is 8.5 years. This implies that an upward parallel shift in the yield curve by 100 basis points would reduce the asset value by approximately $14.7 million, everything else remaining the same.

The remainder of the equity portfolio, representing 3% of total investments at market value, consists primarily of public utility common stocks. These assets are defensive in nature and therefore have low volatility to changes in market price as measured by their Beta. Beta is a measure of a security's systematic (non-diversifiable) risk, which is the percentage change in an individual security's return for a 1% change in the return of the market. The average Beta for the Company's common stock holdings was 0.49. Based on a hypothetical 20% reduction in the overall value of the stock market, the fair value of the common stock portfolio would decrease by approximately $4.7 million.

32

Forward-looking statements

The foregoing discussion contains forward-looking statements regarding the Company, its business, prospects and results of operations that are subject to certain risks and uncertainties posed by factors and events that could cause the Company's actual business, prospects and results of operations to differ materially from the historical information contained herein and from those that may be expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, among others, the intense competition currently existing in the California automobile insurance markets, the success of the Company in integrating and profitably operating the business of AMI, and in expanding generally in Florida and other states outside of California, the impact of the Year 2000, the impact of the permanent rating factor regulations adopted by the California Insurance Commissioner for private passenger automobile policies issued in California and the level of investment yields obtainable in the Company's investment portfolio in comparison to recent yields, as well as the cyclical and general competitive nature of the property and casualty insurance industry and general uncertainties regarding loss reserve estimates and legislative and regulatory changes, particularly in California.

Quarterly Data

Summarized quarterly financial data for 1998 and 1997 is as follows (in thousands except per share data):

                                                    Quarter Ended
                                     --------------------------------------------
                                      March 31     June 30    Sept. 30   Dec. 31
                                     -----------   --------   --------   --------
1998
----
Earned premiums..................... $274,454      $278,768   $282,198   $286,164
Income before income taxes ......... $ 70,107      $ 67,966   $ 54,596   $ 42,611
Net income.......................... $ 51,414      $ 50,255   $ 41,442   $ 34,415
Basic earnings per share............ $    .93      $    .91   $    .75   $    .63
Diluted earnings per share.......... $    .93      $    .90   $    .75   $    .63
Dividends declared per share........ $   .175      $   .175   $   .175   $   .175

1997
----
Earned premiums..................... $235,579      $255,119   $267,212   $273,370
Income before income taxes.......... $ 39,870      $ 47,967   $ 55,198   $ 66,744
Net income.......................... $ 30,818      $ 35,893   $ 40,754   $ 48,841
Basic earnings per share............ $    .56      $    .65   $    .74   $    .89
Diluted earnings per share.......... $    .56      $    .65   $    .74   $    .88
Dividends declared per share......   $   .145      $   .145   $   .145   $   .145

33

Item 8. Financial Statements

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

                                                                           Page
Independent Auditors' Report............................................    35
Consolidated Financial Statements:
      Consolidated Balance Sheets as of December 31, 1998 and 1997......    36
      Consolidated Statements of Income for Each of the Years in the
      Three-Year Period Ended December 31, 1998.........................    37
      Consolidated Statements of Comprehensive Income for each of the
       Years in the Three-Year Period Ended December 31, 1998...........    38
      Consolidated Statements of Shareholders' Equity for Each of the
       Years in the Three-Year Period Ended December 31, 1998...........    39
      Consolidated Statements of Cash Flows for Each of the Years in
      the Three-Year Period Ended December 31, 1998.....................    40
      Notes to Consolidated Financial Statements........................    42

34

INDEPENDENT AUDITORS' REPORT

The Board of Directors
Mercury General Corporation:

We have audited the accompanying consolidated balance sheets of Mercury General Corporation and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income, comprehensive income, shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1998. 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 conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Mercury General Corporation and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1998, in conformity with generally accepted accounting principles.

KPMG LLP

Los Angeles, California
February 12, 1999

35

PAGE>

MERCURY GENERAL CORPORATION
AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 1998 AND 1997

AMOUNTS EXPRESSED IN THOUSANDS, except share amounts

A S S E T S

                                                                  1998         1997
                                                                  ----         ----
Investments:
   Fixed maturities available for sale (amortized cost
    $1,245,440 in 1998 and $1,147,594 in 1997)..............   $1,324,908   $1,214,986
   Equity securities available for sale (cost $220,449 in
    1998 and $169,943 in 1997)..............................      219,745      173,522
   Short-term cash investments, at cost, which approxi-
    mates market............................................       45,992       59,740
                                                               ----------   ----------
              Total investments.............................    1,590,645    1,448,248
Cash........................................................        1,887        3,011
Receivables:
   Premiums receivable......................................      107,950      104,216
   Premium notes............................................       13,739       13,562
   Accrued investment income................................       22,356       21,895
   Other....................................................       24,884       26,476
                                                               ----------   ----------
                                                                  168,929      166,149
Deferred policy acquisition costs...........................       61,947       57,264
Fixed assets, net...........................................       31,901       30,493
Current income taxes recoverable............................        5,895           --
Other assets................................................       15,821       20,367
                                                               ----------   ----------
                                                               $1,877,025   $1,725,532
                                                               ==========   ==========

                      LIABILITIES AND SHAREHOLDERS' EQUITY

Losses and loss adjustment expenses.........................    $ 405,976     $409,061
Unearned premiums...........................................      327,129      309,376
Notes payable...............................................       78,000       75,000
Loss drafts payable.........................................       38,433       32,058
Accounts payable and accrued expenses.......................       53,196       50,742
Current income taxes payable................................           --        3,317
Deferred income taxes.......................................       22,639       19,722
Other liabilities...........................................       34,277       26,664
                                                               ----------   ----------
              Total liabilities.............................      959,650      925,940
                                                               ----------   ----------
Shareholders' equity:
   Common stock without par value or stated value.
    Authorized 70,000,000 shares; issued and outstanding
     54,684,438 shares in 1998 and 55,124,579 in 1997.......       48,830       47,412
   Accumulated other comprehensive income...................       51,196       46,131
   Unearned ESOP compensation...............................       (4,000)          --
Retained earnings...........................................      821,349      706,049
                                                               ----------   ----------
              Total shareholders' equity....................      917,375      799,592
                                                               ----------   ----------
   Commitments and contingencies............................   $1,877,025   $1,725,532
                                                               ==========   ==========

See accompanying notes to consolidated financial statements.

36

MERCURY GENERAL CORPORATION
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

Three years ended December 31, 1998

Amounts expressed in thousands, except per share data

                                                       1998         1997        1996
                                                       ----         ----        ----
Revenues:
  Earned premiums................................  $1,121,584    $1,031,280   $754,724
  Net investment income..........................      96,169        86,812     70,180
  Net realized investment gains (losses).........      (3,926)        4,973     (3,173)
  Net realized gain from sale of subsidiary......       2,586            --         --
  Other..........................................       5,710         4,881      3,233
                                                   ----------    ----------   --------
       Total revenues...........................    1,222,123     1,127,946    824,964
                                                   ----------    ----------   --------
Expenses:
  Losses and loss adjustment expenses............     684,468       654,729    501,858
  Policy acquisition costs.......................     252,592       224,883    160,019
  Other operating expenses.......................      44,941        33,579     24,493
  Interest.......................................       4,842         4,976      2,004
                                                   ----------    ----------   --------
       Total expenses............................     986,843       918,167    688,374
                                                   ----------    ----------   --------
  Income before income taxes.....................     235,280       209,779    136,590

Income taxes.....................................      57,754        53,473     30,826
                                                   ----------    ----------   --------
  Net income....................................   $  177,526    $  156,306   $105,764
                                                   ==========    ==========   ========
Basic earnings per share........................   $     3.23    $     2.84   $   1.93
                                                   ==========    ==========   ========
Diluted earnings per share......................   $     3.21    $     2.82   $   1.92
                                                   ==========    ==========   ========

See accompanying notes to consolidated financial statements.

37

MERCURY GENERAL CORPORATION
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Three Years ended December 31, 1998

Amounts expressed in thousands

                                                       1998        1997        1996
                                                     ---------   ---------   ---------

Net income                                           $177,526    $156,306    $105,764
Other comprehensive income, before tax:
   Unrealized gains (losses) on securities:
      Unrealized holding gains (losses) arising
       during period                                   12,397      44,185      (8,593)
      Less: reclassification adjustment for net
       gains included in net income                    (4,605)     (2,377)     (1,055)
                                                     --------    --------    --------
            Other comprehensive income (loss),
              before tax                                7,792      41,808      (9,648)
Income tax expense related to unrealized
 holding gains(losses) arising during period            4,339      15,465      (3,008)
Income tax benefit related to reclassification
 adjustment for gains included in net income           (1,612)       (832)       (369)
                                                     --------    --------    --------
Comprehensive income, net of tax                     $182,591    $183,481    $ 99,493
                                                     ========    ========    ========

See accompanying notes to Consolidated Financial Statements

38

MERCURY GENERAL CORPORATION
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

Three years ended December 31, 1998

Amounts expressed in thousands

                                                                                    1998       1997        1996
                                                                                   -------   ---------   ---------

Common stock, beginning of year................................................. $ 47,412    $ 42,644    $ 40,895
Proceeds of stock options exercised.............................................    1,216         999       1,104
Tax benefit on sales of incentive stock
 options........................................................................      748         401         220
Release of common stock by the ESOP.............................................      (30)      3,368         425
Purchase and retirement of common stock.........................................     (516)       --          --
                                                                                 --------    --------    --------
Common stock, end of year.......................................................   48,830      47,412      42,644
                                                                                 --------    --------    --------
Accumulated other comprehensive income, beginning
 of year........................................................................   46,131      18,956      25,227
Net increase (decrease) in other comprehensive
 income.........................................................................    5,065      27,175      (6,271)
                                                                                 --------    --------    --------
Accumulated other comprehensive income,
 end of year....................................................................   51,196      46,131      18,956
                                                                                 --------    --------    --------
Unearned ESOP compensation relating to common
 stock purchases by ESOP........................................................   (5,000)     (2,000)     (3,084)
Amortization of unearned ESOP compensation......................................    1,000       2,000       1,084
                                                                                 --------    --------    --------
Unearned ESOP compensation, end of year.........................................   (4,000)       --        (2,000)
                                                                                 --------    --------    --------

Retained earnings, beginning of year............................................  706,049     581,622     502,150
Purchase and retirement of common stock.........................................  (23,775)       --          --
Net income......................................................................  177,526     156,306     105,764
Dividends paid to shareholders..................................................  (38,451)    (31,879)    (26,292)
                                                                                 --------    --------    --------
Retained earnings, end of year..................................................  821,349     706,049     581,622
                                                                                 --------    --------    --------
       Total shareholders' equity............................................... $917,375    $799,592    $641,222
                                                                                 ========    ========    ========

See accompanying notes to consolidated financial statements.

39

MERCURY GENERAL CORPORATION
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

THREE YEARS ENDED DECEMBER 31, 1998
Amounts expressed in thousands

                                                                   1998         1997         1996
                                                                   ----         ----         ----
Cash flows from operating activities:
   Net income                                                   $ 177,526    $ 156,306    $ 105,764
   Adjustments to reconcile net income to net cash
    provided from operating activities:
    (Decrease) increase in unpaid losses and loss
       adjustment expenses                                         (3,085)      72,376       35,947
      Increase in unearned premiums                                17,753       48,498       42,276
      Increase in premium notes receivable                           (177)      (1,167)        (667)
      Increase in premiums receivable                              (3,734)     (20,468)     (15,460)
      Increase in deferred policy acquisition costs                (4,683)     (10,481)      (7,080)
      Increase in loss drafts payable                               6,375        3,026        5,179
       (Decrease) increase in accrued income taxes,
       excluding deferred tax on change in unrealized gain         (8,957)         469        1,016
      Increase in accounts payable and accrued
       expenses                                                     2,454       14,279        8,385
      Depreciation                                                  5,444        5,157        4,067
      Net realized investment (gains) losses                        3,926       (4,973)       3,173
      Net realized gain from sale of subsidiary                    (2,586)          --           --
      Bond accretion, net                                          (4,146)      (2,295)      (1,112)
      Other, net                                                    6,030        8,479       15,136
                                                                ---------    ---------    ---------
           Net cash provided from operating activities            192,140      269,206      196,624
Cash flows from investing activities:
   Fixed maturities available for sale:
      Purchases                                                  (295,723)    (362,932)    (243,779)
      Sales                                                       111,779       71,313       41,353
      Calls or maturities                                          84,445       72,515       91,834
   Equity securities available for sale:
      Purchases                                                  (800,620)    (608,260)    (437,128)
      Sales                                                       745,275      590,155      398,306
      Proceeds from sale of subsidiary less cash
       transferred                                                 11,018           --           --
   Purchase of AMI, less cash acquired                                              --      (33,629)
   Decrease (increase) in short-term cash investments, net         12,059        6,327      (32,077)
   Purchase of fixed assets                                        (7,164)      (6,854)      (5,971)
   Sale of fixed assets                                               444        1,165          167
                                                                ---------    ---------    ---------
            Net cash used in investing activities               $(138,487)   $(236,571)   $(220,924)

(Continued)

40

MERCURY GENERAL CORPORATION
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Continued)

                                                             1998        1997        1996
                                                           ---------   ---------   ---------
Cash flows from financing activities:
   Additions to notes payable                              $  3,000    $   --      $ 75,000
   Principal payments on notes payable                           --          --     (25,000)
   Payment of American Mercury Insurance Company
    indemnification holdback                                     --      (1,750)         --
   Dividends paid to shareholders                           (38,451)    (31,879)    (26,291)
   Proceeds from stock options exercised                      1,965       1,400       1,324
   Purchase and retirement of common stock                  (24,291)         --          --
   Net increase (decrease) of ESOP loan                       3,000      (1,000)         --
                                                           --------    --------    --------
            Net cash provided by (used in)
             financing activities                           (54,777)    (33,229)     25,033
                                                           --------    --------    --------

Net increase (decrease) in cash                              (1,124)       (594)        733
Cash:
   Beginning of the year                                      3,011       3,605       2,872
                                                           --------    --------    --------
   End of the year                                         $  1,887    $  3,011    $  3,605
                                                           ========    ========    ========

See accompanying notes to consolidated financial statements.

41

MERCURY GENERAL CORPORATION
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 1998 and 1997

(1) Significant Accounting Policies

Principles of Consolidation and Presentation

The Company is primarily engaged in the underwriting of private passenger automobile insurance in the state of California. In 1998 and 1997 over 90% of the net written premiums were from California.

The consolidated financial statements include the accounts of Mercury General Corporation (the Company or MGC) and its wholly-owned subsidiaries, Mercury Casualty Company, Mercury Insurance Company, California Automobile Insurance Company, California General Underwriters Insurance Company, Inc., Mercury Insurance Company of Georgia, Mercury Insurance Company of Illinois, Mercury Indemnity Company of Georgia and Mercury Indemnity Company of Illinois. Effective December 1, 1996 the financial statements also include newly acquired companies American Mercury Insurance Company (AMIC), Cimarron Insurance Company, Inc., AFI Management Company, Inc. (AFIMC), and American Mercury Lloyds Insurance Company (AML). AML is not owned by MGC, but is controlled by MGC through its attorney-in-fact, AFIMC. The acquisition is discussed further in Note 8. Effective for 1997 and 1998, the financial statements also include the newly formed company American Mercury MGA, Inc. (AMMGA), a wholly owned subsidiary of AMIC. The 1998 financial statements include the results of Cimarron Insurance Company through June 5, 1998, the date it was sold to an unrelated party. This sale is discussed further in Note 9. Collectively, the newly-acquired companies, including AML, are referred to as AMI. All of the subsidiaries as a group, including AML, but excluding AFIMC and AMMGA, are referred to as the Insurance Companies. The consolidated financial statements have been prepared in conformity with generally accepted accounting principles (GAAP) which differ in some respects from those filed in reports to insurance regulatory authorities. All significant intercompany balances and transactions have been eliminated.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and 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. The most significant assumptions in the preparation of these consolidated financial statements relate to loss and loss adjustment expenses. Actual results could differ from those estimates.

42

MERCURY GENERAL CORPORATION
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 1998 and 1997

(1) Significant Accounting Policies (Continued)

Investments

Fixed maturities available for sale include those securities that management intends to hold for indefinite periods, but which may be sold in response to changes in interest rates, tax planning considerations or other aspects of asset/liability management. Fixed maturities available for sale, which include bonds and sinking fund preferred stocks, are carried at market. Short-term investments are carried at cost, which approximates market. Investments in equity securities, which include common stocks and non-redeemable preferred stocks, are carried at market.

In most cases, the market valuations were drawn from standard trade data sources. In no case were any valuations made by the Company's management. Equity holdings, including non sinking fund preferred stocks, are, with minor exceptions, actively traded on national exchanges, and were valued at the last transaction price.

Temporary unrealized investment gains and losses on securities available for sale are credited or charged directly to shareholders' equity as accumulated other comprehensive income, net of applicable tax effects. When a decline in value of fixed maturities or equity securities is considered other than temporary, a loss is recognized in the consolidated statement of income. Realized gains and losses are included in the consolidated statements of income based upon the specific identification method.

Fair Value of Financial Instruments

Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments", and Statement of Financial Accounting Standards No. 119, "Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments", require disclosure of estimated fair value information about financial instruments, for which it is practicable to estimate that value. Under SFAS No. 115, the Company categorizes all of its investments in debt and equity securities as available for sale. Accordingly, all investments, including cash and short-term cash investments, are carried on the balance sheet at their fair value. The carrying amounts and fair values for investment securities are disclosed in Note 2 and were drawn from standard trade data sources such as market and broker quotes. The carrying value of receivables, accounts payable and other liabilities is equivalent to the estimated fair value of those items. The estimated fair value of notes payable equals their carrying value, which was based on borrowing rates currently available to the Company for bank loans with similar terms and maturities. The terms of the notes are discussed in Note 5.

43

MERCURY GENERAL CORPORATION
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 1998 and 1997

(1) Significant Accounting Policies (Continued)

Premium Income Recognition

Insurance premiums are recognized as income ratably over the term of the policies. Unearned premiums are computed on the monthly pro rata basis. Unearned premiums are stated gross of reinsurance deductions, with the reinsurance deduction recorded in other assets.

Net premiums written during 1998, 1997 and 1996 were $1,144,051,000, $1,086,241,000 and $795,873,000, respectively.

One agent produced direct premiums written of approximately 19%, 18% and 17% of the Company's total direct premiums written during 1998, 1997 and 1996, respectively. This agency was sold during 1998 to a large national broker. The buyer has informed the Company that they intend to continue producing business for the Company. No other agent accounted for more than 2% of direct premiums written.

Premium Notes

Premium notes receivable represent the balance due to the Company from policyholders who elect to finance their premiums over the policy term. The Company requires both a downpayment and monthly payments as part of its financing program. Premium finance fees are charged to policyholders who elect to finance premiums. The fees are charged at rates that vary with the amount of premium financed. Premium finance fees are recognized over the term of the premium note based upon the effective yield.

Deferred Policy Acquisition Costs

Acquisition costs related to unearned premiums, which consist of commissions, premium taxes and certain other underwriting costs, which vary directly with and are directly related to, the production of business, are deferred and amortized to income ratably over the terms of the policies. Deferred acquisition costs are limited to the amount which 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 the premiums are earned. The Company does not defer advertising expenses.

44

MERCURY GENERAL CORPORATION
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 1998 and 1997

(1) Significant Accounting Policies (Continued)

Losses and Loss Adjustment Expenses

The liability for losses and loss adjustment expenses is based upon the accumulation of individual case estimates for losses reported prior to the close of the accounting period, plus estimates, based upon past experience, of ultimate developed costs which may differ from case estimates and of unreported claims. The liability is stated net of anticipated salvage and subrogation recoveries. The amount of reinsurance recoverable is included in other receivables.

Estimating loss reserves is a difficult process as there are many factors that can ultimately affect the final settlement of a claim and, therefore, the reserve that is needed. Changes in the regulatory and legal environment, results of litigation, medical costs, the cost of repair materials and labor rates can all impact ultimate claim costs. In addition, time can be a critical part of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of the claim, the more variable the ultimate settlement amount can be. Accordingly, short-tail claims, such as property damage claims, tend to be more reasonably predictable than long-tail liability claims. Management believes that the liability for losses and loss adjustment expenses is adequate to cover the ultimate net cost of losses and loss adjustment expenses incurred to date. Since the provisions are necessarily based upon estimates, the ultimate liability may be more or less than such provisions.

Depreciation

Buildings and furniture and equipment are depreciated over 30-year and 5- year to 10-year periods, respectively, on a combination of straight-line and accelerated methods. Automobiles are depreciated over 5 years, using an accelerated method.

Earnings per Share

During 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings per Share", which requires presentation of basic and diluted earnings per share for all publicly traded companies effective for fiscal years ending after December 15, 1997. Note 15 contains the required disclosures which make up the calculation of basic and diluted earnings per share.

45

MERCURY GENERAL CORPORATION
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 1998 and 1997

(1) Significant Accounting Policies (Continued)

Comprehensive Income

Statement of Financial Accounting Standards No. 130 (SFAS No. 130), "Reporting Comprehensive Income," effective for fiscal years beginning after December 15, 1997 was adopted by the Company during 1998. The Company is reporting comprehensive income for the same periods presented on the Consolidated Statements of Income. The implementation of SFAS No. 130 had no effect on the financial position or results of operations of the Company.

Segment Reporting

Statement of Financial Accounting Standards No. 131 (SFAS No. 131), "Disclosures about Segments of an Enterprise and Related Information," became effective for fiscal years beginning after December 15, 1997. SFAS 131 establishes standards for the way information about operating segments is reported in financial statements. The Company does not have any operations that require disclosure as operating segments.

Recently Issued Accounting Standards

Statement of Position 98-1 (SOP 98-1), "Accounting For the Costs of Computer Software developed or obtained for Internal Use" is effective for financial statements beginning after December 15, 1998. SOP 98-1 requires that the cost of internally developed computer software be capitalized. The Company will implement this standard during the first quarter 1999 and is currently evaluating the impact that it will have on the Consolidated Financial Statements.

Income Taxes

Deferred income taxes result from temporary differences in the recognition of income and expense for tax and financial reporting purposes. The Company accounts for income taxes in accordance with SFAS 109, "Accounting for Income Taxes".

Reinsurance

In accordance with SFAS No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts," the liabilities for unearned premiums and unpaid losses are stated in the accompanying consolidated financial statements before deductions for ceded reinsurance. The ceded amounts are immaterial and are carried in other assets and other receivables. Earned premiums are stated net of deductions for ceded reinsurance.

46

MERCURY GENERAL CORPORATION
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 1998 and 1997

(1) Significant Accounting Policies (Continued)

The Insurance Companies, as primary insurers, would be required to pay losses in their entirety in the event that the reinsurers were unable to discharge their obligations under the reinsurance agreements.

Statements of Cash Flows

Interest paid during 1998, 1997, and 1996 was $4,494,000, $5,077,000, and $1,882,000, respectively. Income taxes paid were $65,984,000 in 1998, $52,611,000 in 1997, and $30,550,000 in 1996.

The subsidiary sold in 1998 consisted primarily of invested assets totaling $8,408,000 at the sale date.

In 1998, non-cash financing activities included receipt of $276,000 of common stock tendered at market value to exercise stock options.

The balance sheet of AMI at the acquisition date included the following assets: investments of $75,310,000, cash of $1,362,000, receivables of $44,418,000 and other assets of $31,124,000. Liabilities assumed in the acquisition included unearned premiums of $50,199,000, loss and loss adjustment expense reserves of $47,039,000 and other liabilities of $19,985,000.

On December 30, 1997, the Company paid $1,750,000 of principal plus $87,500 of interest to the seller of AMI. This amount represented repayment of a one year note which secured the seller's guaranty of the collectibility of certain assets of AMI.

Stock-Based Compensation

In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"), which is effective for fiscal years beginning after December 15, 1995. The Company accounts for stock-based compensation under the accounting methods prescribed by Accounting Principles Board (APB) Opinion No. 25, as allowed by SFAS No. 123. Disclosure of stock-based compensation determined in accordance with SFAS No. 123 is presented in Footnote
14. The adoption of this pronouncement did not have a material effect on the financial statements of the Company.

Reclassifications

Certain reclassifications have been made to the prior year balances to conform to the current year presentation.

47

MERCURY GENERAL CORPORATION
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 1998 and 1997

(2) Investments and Investment Income

A summary of net investment income is shown in the following table:

                                                                                 Year ended December 31,
                                                                                 (Amounts in thousands)
                                                                             -------------------------------
                                                                               1998       1997        1996
                                                                             --------   ---------   --------
Interest and dividends on fixed maturities................................   $75,602      $67,948    $55,132
Dividends on equity securities............................................    18,027       16,317     13,385
Interest on short-term cash investments...................................     3,460        3,321      2,126
                                                                             -------      -------    -------
  Total investment income.................................................    97,089       87,586     70,643
Investment expense........................................................       920          774        463
                                                                             -------      -------    -------
  Net investment income...................................................   $96,169      $86,812    $70,180
                                                                             =======      =======    =======

A summary of net realized investment gains (losses) is as follows:

                                                                                 Year ended December 31,
                                                                                 (Amounts in thousands)
                                                                             -------------------------------
                                                                               1998       1997        1996
                                                                             --------   ---------   --------
Net realized investment gains (losses):
  Fixed maturities........................................................   $   914      $1,400    $   963
  Equity securities.......................................................    (4,840)      3,573     (4,136)
                                                                             -------      ------    -------
                                                                             $(3,926)     $4,973    $(3,173)
                                                                             =======      ======    =======

Gross gains and losses realized on the sales of investments (excluding calls) are shown below:

                                                                                 Year ended December 31,
                                                                                 (Amounts in thousands)
                                                                             -------------------------------
                                                                               1998       1997        1996
                                                                             --------    --------   --------
Fixed maturities available for sale:
  Gross realized gains....................................................  $    394     $   849    $   515
  Gross realized losses...................................................      (370)       (389)    (1,237)
                                                                            --------     -------    -------
   Net....................................................................  $     24     $   460    $  (722)
                                                                            ========     =======    =======
Equity securities available for sale:
  Gross realized gains....................................................  $  9,452     $ 7,257    $ 2,925
  Gross realized losses...................................................   (14,166)     (3,565)    (7,115)
                                                                            --------     -------    -------
   Net....................................................................  $ (4,714)    $ 3,692    $(4,190)
                                                                            ========     =======    =======

48

MERCURY GENERAL CORPORATION
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 1998 and 1997

(2) Investments and Investment Income (Continued)

A summary of the net increase (decrease) in unrealized investment gains and losses less applicable income tax expense (benefit), is as follows:

                                                                                          Year ended December 31,
                                                                                           (Amounts in thousands)
                                                                                       ------------------------------
                                                                                         1998      1997       1996
                                                                                       --------   -------   ---------
Net increase (decrease) in net unrealized
 investment gains and losses:
   Fixed maturities available for sale..............................................   $12,076    $38,077    $(8,059)
   Income tax expense (benefit).....................................................     4,227     13,327     (2,821)
                                                                                       -------    -------    -------
                                                                                       $ 7,849    $24,750    $(5,238)
                                                                                       =======    =======    =======

   Equity securities...............................................................    $(4,283)   $ 3,731    $(1,589)
   Income tax expense (benefit)....................................................     (1,499)     1,306       (556)
                                                                                       -------    -------    -------
                                                                                       $(2,784)   $ 2,425    $(1,033)
                                                                                       =======    =======    =======

Accumulated unrealized gains and losses on securities available for sale follows:

                                                                                                  December 31,
                                                                                             (Amounts in thousands)
                                                                                           --------------------------
                                                                                             1998             1997
                                                                                           --------         --------
Fixed maturities available for sale:
  Unrealized gains..................................................................       $ 80,651         $ 68,718
  Unrealized losses.................................................................         (1,183)          (1,326)
  Tax effect........................................................................        (27,814)         (23,587)
                                                                                           --------         --------
                                                                                           $ 51,654         $ 43,805
                                                                                           --------         --------
Equity securities available for sale:
  Unrealized gains..................................................................       $  5,934         $  5,006
  Unrealized losses.................................................................         (6,638)          (1,427)
  Tax effect........................................................................            246           (1,253)
                                                                                           --------         --------
                                                                                           $   (458)        $  2,326
                                                                                           --------         --------
    Net unrealized investment gains (classified
     as accumulated other comprehensive income
     on the balance sheet)..........................................................       $ 51,196         $ 46,131
                                                                                           ========         ========

49

MERCURY GENERAL CORPORATION
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 1998 and 1997

(2) Investments and Investment Income (Continued)

The amortized costs and estimated market values of investments in fixed maturities available for sale as of December 31, 1998 are as follows:

                                                        Gross      Gross     Estimated
                                         Amortized  Unrealized  Unrealized     Market
                                            Cost        Gains      Losses      Value
                                         ----------   ---------   --------   ----------
                                                     (Amounts in thousands)
U.S. Treasury securities and
  obligations of U.S. government
  corporations and agencies...........   $   10,206     $   223     $    1   $   10,428
Obligations of states and political
  subdivisions........................    1,179,043      78,003        933    1,256,113
Public utilities......................          881          55         --          936
Corporate securities..................       12,839         336         14       13,161
Redeemable preferred stock............       42,471       2,034        235       44,270
                                         ----------     -------     ------   ----------
     Totals...........................   $1,245,440     $80,651     $1,183   $1,324,908
                                         ==========     =======     ======   ==========

The amortized costs and estimated market values of investments in fixed maturities available for sale as of December 31, 1997 are as follows:

                                                        Gross      Gross     Estimated
                                         Amortized  Unrealized  Unrealized     Market
                                            Cost        Gains      Losses      Value
                                         ----------   ---------   --------   ----------
                                                     (Amounts in thousands)
U.S. Treasury securities and
  obligations of U.S. government
  corporations and agencies...........   $   19,700     $   123     $   16  $    19,807
Obligations of states and political
  subdivisions........................    1,021,259      64,908        554    1,085,613
Public utilities......................       11,383         151          5       11,529
Corporate securities..................       19,013         324         11       19,326
Redeemable preferred stock............       76,239       3,212        740       78,711
                                         ----------     -------     ------   ----------
     Totals...........................   $1,147,594     $68,718     $1,326   $1,214,986
                                         ==========     =======     ======   ==========

Traditionally, it has been the Company's policy not to invest in high yield or non-investment grade bonds. In 1995, the Company adopted a policy allowing a small percentage of its investments to be placed in bonds rated lower than investment grade, but not lower than Ba by Moody's or BB by Standard & Poor's.

50

MERCURY GENERAL CORPORATION
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 1998 and 1997

(2) Investments and Investment Income (Continued)

At December 31, 1998 bond holdings rated below investment grade totaled approximately 1% of total investments. The average Standard and Poor's rating of the bond portfolio is AA-.

The amortized cost and estimated market value of fixed maturities available for sale at December 31, 1998, by contractual maturity, are shown below. 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
                                                     Amortized       Market
                                                       Cost          Value
                                                   -------------   ----------
                                                     (Amounts in thousands)
                                                   --------------------------
Fixed maturities available for sale:
   Due in one year or less .....................   $    4,671      $    4,774
   Due after one year through five years........       39,201          40,647
   Due after five years through ten years.......       66,971          70,750
   Due after ten years..........................    1,134,597       1,208,737
                                                   ----------      ----------
                                                   $1,245,440      $1,324,908
                                                   ==========      ==========

The Company utilizes repurchase agreements for investing funds overnight. All repurchase agreements utilized require U.S. Treasury securities or obligations of U.S. government corporations or agencies as collateral.

(3) Fixed Assets

A summary of fixed assets follows:

                                                December 31,
                                           (Amounts in thousands)
                                          -------------------------
                                            1998            1997
                                          --------       ----------
Land................................       $ 6,084        $  6,084
Buildings..........................         22,461          21,802
Furniture and equipment............         33,120          27,819
Leasehold improvements.............            410             391
                                          --------        --------
                                            62,075          56,096
Less accumulated depreciation......        (30,174)        (25,603)
                                          --------        --------
 Net fixed assets..................       $ 31,901        $ 30,493
                                          ========        ========

51

MERCURY GENERAL CORPORATION
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 1998 and 1997

(4) Deferred Policy Acquisition Costs

Policy acquisition costs incurred and amortized to income are as follows:

                                                     Years ended December 31,
                                                      (Amounts in thousands)
                                             ---------------------------------------
                                                 1998           1997         1996
                                             -----------     ----------   ----------
Balance, beginning of year.................  $  57,264       $  46,783    $  33,809
DAC acquired in purchase of AFI...........          --              --        5,850
Costs deferred during the year.............    257,275         235,364      167,143
Amortization charged to expense............   (252,592)       (224,883)    (160,019)
                                             ---------       ---------    ---------
Balance, end of year.......................  $  61,947       $  57,264    $  46,783
                                             =========       =========    =========

(5) Notes Payable

Notes payable at December 31, 1998 consist of two revolving credit facilities with a consortium of banks. A November 21, 1996 credit facility provides for an aggregate commitment of $75 million, of which $75 million has been drawn and is outstanding. The $75 million notes are due November 21, 2001. This due date may be extended annually for additional periods of one year to maintain the three-year maturity date. The other outstanding debt consists of a 364 day $100 million line of credit dated October 31, 1998. The outstanding draw on this line of credit is $3 million and is due on October 31, 1999.

The $75 million and $100 million credit facilities are subject to a commitment fee on the undrawn balances of 0.15% and 0.12%, respectively. In addition, the $100 million credit facility imposes a utilization fee of 0.05% on the outstanding debt of both lines of credit if the aggregate principal outstanding balance of both lines of credit exceeds 66 2/3% of the sum of the aggregate commitments. For both debts, the interest rate is variable and is optionally related to the Federal Funds rate, Bank of New York prime rate or the Eurodollar London Interbank rate (LIBOR). Based on the rates effective through February 22, 1999, the net interest cost on the loans at December 31, 1998 is approximately 5.65%.

The terms of the loan agreements include certain affirmative and negative covenants, all of which are met by the Company at December 31, 1998.

52

MERCURY GENERAL CORPORATION
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 1998 and 1997

(6) Income Taxes

The Company and its subsidiaries file a consolidated Federal income tax return.

The provision for income tax expense (benefit) consists of the following components:

                                                                      Year ended December 31,
                                                                      (Amounts in thousands)
                                                               -----------------------------------
                                                                 1998         1997         1996
                                                               --------     --------     --------
Federal
    Current..............................................      $  7,237     $ 54,447     $ 31,880
    Deferred.............................................           190       (1,265)      (1,139)
                                                               --------     --------     --------
                                                               $ 57,427     $ 53,182     $ 30,741
                                                               ========     ========     ========
State
    Current..............................................      $    327     $    291     $     85
    Deferred.............................................            --           --           --
                                                               --------     --------     --------
                                                               $    327     $    291     $     85
                                                               ========     ========     ========
Total
    Current..............................................      $ 57,564     $ 54,738     $ 31,965
    Deferred.............................................           190       (1,265)      (1,139)
                                                               --------     --------     --------
        Total............................................      $ 57,754     $ 53,473     $ 30,826
                                                               ========     ========     ========

The income tax provision reflected in the consolidated statements of income is less than the expected federal income tax on income before income taxes as shown in the table below:

                                                                       Year ended December 31,
                                                                        (Amounts in thousands)
                                                                  --------------------------------
                                                                     1998        1997         1996
                                                                  --------     --------     --------
Computed tax expense at 35% ................................      $ 82,348     $ 73,423     $ 47,807
Tax-exempt interest income..................................       (22,547)     (19,188)     (15,626)
Dividends received deduction................................        (5,437)      (5,389)      (4,949)
Reduction of losses incurred deduction for 15% of
 income on securities purchased after
 August 7, 1986.............................................         4,245        3,640        2,974
Other, net..................................................          (855)         987          620
                                                                  --------     --------     --------
     Income tax expense ....................................      $ 57,754     $ 53,473     $ 30,826
                                                                  ========     ========     ========

53

MERCURY GENERAL CORPORATION
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 1998 and 1997

(6) Income Taxes (Continued)

The "temporary differences" that give rise to a significant portion of the deferred tax asset (liability) relate to the following:

                                                                                            December 31,
                                                                                       (Amounts in thousands)
                                                                                   ------------------------------
                                                                                     1998       1997       1996
                                                                                   --------   --------   --------
Deferred tax assets
    Discounting of loss reserves and salvage
     and subrogation recoverable for tax
     purposes...................................................................  $  6,732   $  6,930   $  6,123
    Other deferred tax assets...................................................     1,389      1,085      1,358
                                                                                  --------   --------   --------
      Total gross deferred tax assets...........................................     8,121      8,015      7,481
       Less valuation allowance.................................................        --         --         --
                                                                                  --------   --------   --------
       Net deferred tax assets..................................................     8,121      8,015      7,481
                                                                                  --------   --------   --------

Deferred tax liabilities
    Tax liability on net unrealized gain on
     securities carried at market value.........................................   (27,567)   (24,840)   (10,207)
    Tax depreciation in excess of book
     depreciation...............................................................    (1,545)    (1,467)    (1,270)
    Accretion on bonds..........................................................    (1,467)    (1,061)      (784)
    Other deferred tax liabilities..............................................      (181)      (369)    (1,569)
                                                                                  --------   --------   --------
       Total gross deferred tax liabilities.....................................   (30,760)   (27,737)   (13,830)
                                                                                  --------   --------   --------
       Net deferred tax liabilities.............................................  $(22,639)  $(19,722)  $ (6,349)
                                                                                  ========   ========   ========

54

MERCURY GENERAL CORPORATION
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 1998 and 1997

(7) Reserves for Losses and Loss Adjustment Expenses

Activity in the reserves for losses and loss adjustment expenses is summarized as follows:

                                                     Year ended December 31,
                                                     (Amounts in thousands)
                                                  ------------------------------
                                                    1998        1997       1996
                                                  --------    --------   -------
Gross reserves for losses and loss
 adjustment expenses at beginning of year........$409,061     $336,685    $253,546
Less reinsurance recoverable..................... (22,791)     (24,931)     (2,556)
                                                 --------     --------    --------
Net reserves, beginning of year.................. 386,270      311,754     250,990

Reserves acquired in purchase of AMI.............      --           --      24,231

Incurred losses and loss adjustment expenses
 related to:
    Current year................................. 693,877      641,911     505,726
    Prior years..................................  (9,409)      12,818      (3,868)
                                                 --------     --------    --------
Total incurred losses and loss adjustment
 expenses........................................ 684,468      654,729     501,858
                                                 --------     --------    --------

Loss and loss adjustment expense payments
 related to:
    Current year................................. 437,612      373,823     298,099
    Prior years.................................. 247,310      206,390     167,226
                                                 --------     --------    --------
Total payments................................... 684,922      580,213     465,325
                                                 --------     --------    --------

Net reserves for losses and loss adjustment
 expenses at end of year.........................  385,816     386,270     311,754
Reinsurance recoverable..........................   20,160      22,791      24,931
                                                  --------    --------    --------
Gross reserves, end of year...................... $405,976    $409,061    $336,685
                                                  ========    ========    ========

Decreases in incurred losses relating to 1998 and 1996 reflects the favorable loss experience during these years attributable to a number of combined factors which have produced favorable frequency and severity trends.

Increase in incurred losses in 1997 relating to prior years reflects increases in the Company's estimates for loss adjustment expenses.

55

MERCURY GENERAL CORPORATION
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 1998 and 1997

(8) Acquisition of American Fidelity Insurance Company

Effective November 30, 1996 the Company acquired all of the issued and outstanding common stock of American Mercury Insurance Company, formerly American Fidelity Insurance Company, including its subsidiaries as described in Note 1, for $35.0 million. The acquisition was paid for in cash with funds raised by increasing the Company's notes payable under the bank credit agreement discussed in Note 5. On December 30, 1996 the Company contributed an additional $15.0 million to AMI. The acquisition was accounted for using the purchase method and resulted in a minimal amount of goodwill. The purchase agreement includes an indemnification by the seller on the loss and loss adjustment expense reserves of AMI at the acquisition date, excluding the mechanical breakdown line, to avoid any impact on the Company's financial statements from any future adverse development on the acquisition date loss reserves.

AMI writes property and casualty insurance, primarily in Oklahoma and Texas, where the companies are domiciled. Its primary lines are automobile and mechanical breakdown insurance. The results of operations for the month of December 1996 and all of 1997 and 1998, with the exception of Cimarron, which is discussed in Note 9, are included in the consolidated financial statements of the Company.

The following unaudited proforma consolidated results of operations show 1996 results, as though the acquisition occurred on January 1, 1996 (Amounts in thousands except per share date):

Revenues                                  $891,243
Pretax operating income                   $136,912
Income before income taxes                $133,691
Basic earnings per share                  $   1.89
Diluted earnings per share                $   1.88

(9) Sale of Subsidiary

In June 1998, the Company sold its 100% interest in Cimarron Insurance Company for $11.1 million in cash. The Company realized a pre-tax gain of approximately $2.6 million on this transaction.

Cimarron ceased writing new business in 1997 and all renewal business was underwritten and retained by American Mercury Insurance Company. The consolidated results for 1998 include $0.2 million of revenue and $0.1 million of net income from the operations of Cimarron up the sale date of June 5, 1998.

56

MERCURY GENERAL CORPORATION
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 1998 and 1997

(10) Dividend Restrictions

The Insurance Companies are subject to the financial capacity guidelines established by the Office of the Commissioner of Insurance of their domiciliary states. The payment of dividends from statutory unassigned surplus of the Insurance Companies is restricted, subject to certain statutory limitations. For the year 1999, the direct insurance subsidiaries of the Company are permitted to pay approximately $98 million in dividends to the Company without the prior approval of the Commissioner of Insurance of the state of domicile. The above statutory regulations may have the effect of indirectly limiting the ability of the Company to pay dividends.

(11) Statutory Balances and Accounting Practices

The Insurance Companies prepare their statutory financial statements in accordance with accounting practices prescribed or permitted by the various state insurance departments. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners (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, 1998, there were no material permitted statutory accounting practices utilized by the Insurance Companies. During 1998, the NAIC approved the codification of statutory accounting practices. Codification will become effective in the year 2001 if it is adopted by the states. If adopted, it will result in changes to the accounting policies that insurance enterprises use to prepare their statutory financial statements.

The Insurance Companies' statutory net income, as reported to regulatory authorities, was $173,473,000, $147,255,000, and $97,979,000 for the years ended December 31, 1998, 1997 and 1996, respectively. The statutory policyholders' surplus of the Insurance Companies, as reported to regulatory authorities, as of December 31, 1998 and 1997 was $767,223,000 and $679,359,000, respectively.

The Company has estimated the Risk-Based Capital Requirements of each of its insurance subsidiaries as of December 31, 1998 according to the formula issued by the NAIC. Each of the companies' policyholders' surplus exceeded the highest level of minimum required capital.

57

MERCURY GENERAL CORPORATION
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 1998 and 1997

(12) Commitments and Contingencies

The Company is obligated under various noncancellable lease agreements providing for office space and equipment rental that expire at various dates through the year 2008. Total rent expense under these lease agreements, all of which are operating leases, was $2,074,000, $1,885,000 and $1,583,000 for the years ended December 31, 1998, 1997 and 1996, respectively.

Mercury Casualty Company will receive minimum future rentals on various noncancellable operating leases on a building in Brea, California. The annual rental commitments, expressed in thousands, are shown as follows:

                          Rent          Rent
Year                     Expense       Income
----                     -------       ------
1999.................... $3,059      $  (295)
2000.................... $2,758      $  (100)
2001.................... $2,329      $    --
2002.................... $1,642      $    --
2003............         $  952      $    --
Thereafter.............. $4,670      $    --

The Company and its subsidiaries are defendants in various lawsuits generally incidental to their business. In most of these actions, plaintiffs assert claims for exemplary and punitive damages which are not insurable under California judicial decisions. The Company vigorously defends these actions, unless a reasonable settlement appears appropriate. Management does not expect the ultimate disposition of these lawsuits to have a material effect on the Company's consolidated operations or financial position.

(13) Profit Sharing Plan

The Company, at the option of the Board of Directors, may make annual con- tributions to an employee profit sharing plan. 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. The annual contribution was $1,100,000 for the plan year ended December 31, 1998 and $1,000,000 for each plan year ended December 31, 1997 and 1996.

The Profit Sharing Plan also includes an option for employees to make salary deferrals under Section 401(k) of the Internal Revenue Code. Company matching

58

MERCURY GENERAL CORPORATION
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 1998 and 1997

(13) Profit Sharing Plan (Continued)

contributions, at a rate set by the Board of Directors, totaled $1,648,000, $1,349,000, and $955,000 for the plan years ended December 31, 1998, 1997 and 1996.

Effective March 11, 1994 the Profit Sharing Plan also includes a leveraged employee stock ownership plan (ESOP) that covers substantially all employees. The Company makes annual contributions to the ESOP equal to the ESOP's debt service less dividends received by the ESOP. Dividends received by the ESOP on unallocated shares are used to pay debt service and the ESOP shares serve as collateral for its debt. As the debt is repaid, shares are released from collateral and allocated to employees, based on the proportion of debt service paid in the year. The Company accounts for its ESOP in accordance with Statement of Position 93-6. Accordingly, the debt of the ESOP, which was $5,000,000, $2,000,000 and $3,000,000 at December 31, 1998, 1997 and 1996, respectively, is recorded in the balance sheet as other liabilities. The shares pledged as collateral are reported as unearned ESOP compensation in the shareholders' equity section of the balance sheet. As shares are committed to be released from collateral, the Company reports compensation expense equal to the current market price of the shares, and reduces unearned ESOP compensation by the original cost of the shares. The difference between the market price and cost of the shares is charged to common stock. As shares are committed to be released from collateral, the shares become outstanding for earnings-per-share computations. Dividends on allocated ESOP shares are recorded as a reduction of retained earnings; dividends on unallocated ESOP shares are recorded as a reduction of accrued interest. ESOP compensation expense was $970,000, $5,368,000 and $1,509,000 in 1998, 1997 and 1996, respectively. The ESOP shares as of December 31 were as follows:

                                               1998      1997
                                               ----      ----
Allocated shares                                --       193,200
Shares committed-to-be released               23,000     128,800
Unreleased shares                             92,000       --
                                          ----------     -------
Total ESOP shares                            115,000     322,000
                                          ==========     =======
Market value of unreleased shares at
 December 31,                             $4,031,000       --
                                          ==========     =======

(14) Common Stock

In September 1997, the common stock of the Company was split two-for-one. All share information has been adjusted accordingly.

59

MERCURY GENERAL CORPORATION
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 1998 and 1997

(14) Common Stock (Continued)

The Company adopted a stock option plan in October 1985 (the "1985 Plan") under which 5,400,000 shares were reserved for issuance. Options granted during 1985 were exercisable immediately. Subsequent options granted become exercisable 20% per year beginning one year from the date granted. All options were granted at the market price on the date of the grant and expire in 10 years.

In May 1995 the Company adopted The 1995 Equity Participation Plan (the "1995 Plan") which succeeds the Company's 1985 Plan. Under the 1995 Plan, 5,400,000 shares of Common Stock are authorized for issuance upon exercise of options, stock appreciation rights and other awards, or upon vesting of restricted or deferred stock awards. During 1995, the Company granted incentive stock options under both the 1995 Plan and the 1985 Plan. The options granted become exercisable 20% per year beginning one year from the date granted and were granted at the market price on the date of the grant. The options expire in 10 years. At December 31, 1998 no awards other than options have been granted.

As explained in Note 1, the Company applies APB Opinion No. 25 in accounting for its stock option plan. Accordingly, no compensation cost has been recognized in the Statements of Income. Had compensation cost for the Company's Plans been determined based on the fair value at the grant dates consistent with the method of SFAS No. 123, the Company's net income would have been reduced by $454,000, $363,000 and $295,000 in 1998, 1997 and 1996, respectively, and earnings per share (basic and diluted) would have been reduced by .01 in 1998, would have remained the same in 1997, and been reduced by .01 (basic and diluted) in 1996. Calculations of the fair value under the method prescribed by SFAS No. 123 were made using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 1998, 1997 and 1996:
dividend yield of 2.0 percent for all years, expected volatility of 32.7 percent in 1998 and 30 percent for 1997 and 1996 and expected lives of 7 years for all years. The risk-free interest rates used were 5.4 percent for the options granted during 1998, 6.4 percent for the options granted during 1997 and 5.5 and 6.4 percent for the options granted during 1996.

60

MERCURY GENERAL CORPORATION
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 1998 and 1997

(14) Common Stock (Continued)

A summary of the status of the Company's plans as of December 31, 1998, 1997 and 1996 and changes during the years ending on those dates is presented below:

                                                  1998                   1997                  1996
                                          --------------------   --------------------   --------------------
                                                      Weighted               Weighted               Weighted
                                                      Average                Average                Average
                                                      Exercise               Exercise               Exercise
                                           Shares      Price      Shares      Price      Shares      Price
                                          ---------   --------   ---------   --------   ---------   --------
Outstanding at beginning of year           629,621     $16.269    717,350     $14.452    724,650     $12.117
Granted during the year                     73,000      45.385     45,000      27.406    120,000      23.078
Exercised during the year                 (144,475)     10.329   (116,729)      8.553   (122,500)      7.713
Canceled or expired                        (19,000)     51.484    (16,000)     21.750     (4,800)     13.500
                                          --------               --------               --------
Outstanding at end of year                 539,146      20.575    629,621      16.269    717,350      14.452
                                          ========               ========               ========

Options exercisable at year-end            265,146                277,021                268,150

Weighted-average fair value of
 options granted during the year          $  16.37                $  9.91                 $ 8.11

The following table summarizes information regarding the stock options outstanding at December 31, 1998:

                         Number        Weighted Avg.    Weighted Avg.     Number      Weighted Avg.
Range of               Outstanding      Remaining         Exercise      Exercisable     Exercise
Exercise Prices        at 12/31/98   Contractual Life       Price       at 12/31/98       Price
--------------------   -----------   ----------------   -------------   -----------   -------------
$15.00 to 15.9375      346,846             5.75            $15.451        222,846        $15.399
$21.75 to 27.40063     138,300             7.55             24.577         42,300         23.919
$42.3091 to 44.8209     54,000             9.69             43.239            --             --
                       -------                                            -------
$15.00 to 44.8209      539,146             6.61             20.575        265,146         16.758
                       =======                                            =======

(15) Earnings Per Share

A reconciliation of the numerator and denominator, adjusted for a two-for-one stock split effective September 1997, used in the basic and diluted earnings per share calculation is presented below:

                                        1998                           1997                            1996
                           ----------------------------  --------------------------------   --------------------------------
                           (000's)    (000's)             (000's)     (000's)                (000's)    (000's)
                                     Weighted                        Weighted                           Weighted
                           Income     Shares              Income     Shares                   Income    Shares
                          (Numera-   (Denomi-  Per-Share  (Numera-  (Denomi-  Per-Share      (Numera-  (Denomi-    Per-Share
                            tor)      nator)    Amount      tor)      nator)     Amount        tor)      nator)      Amount
                          ---------   -------   ------   ---------   -------   ----------   ----------   --------   ---------
Basic EPS
---------
Income available to
 common stockholders      $177,526    55,003     $3.23   $156,306    54,997       $2.84       $105,764     54,794      $1.93

Effect of dilutive
 securities
     Options                  --         351                 --         386                       --          304

Diluted EPS
-----------
Income available to
 common stockholders
 after assumed
 conversions              $177,526    55,354     $3.21   $156,306    55,383       $2.82       $105,764     55,098    $1.92
                          ========    ======     =====   ========    ======       =====       ========     ======    =====

61

Item 9. Changes in and Disagreements with Accountants on Accounting and

Financial Disclosure

None.

PART III

Item 10. Directors and Executive Officers of the Registrant

Item 11. Executive Compensation

Item 12. Security ownership of Certain Beneficial Owners and Management

Item 13. Certain Relationships and Related Transactions

Information regarding executive officers of the Company is included in Part
I. For this and other information called for by Items 10, 11, 12 and 13, reference is made to the Company's definitive proxy statement for its Annual Meeting of Shareholders, to be held on May 12, 1999, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1998, and which is incorporated herein by reference.

PART IV

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K

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

1. Financial Statements: The Consolidated Financial Statements for the year ended December 31, 1998 are contained herein as listed in the Index to Consolidated Financial Statements on page 34.

2. Financial Statement Schedules:

Title

Independent Auditors' Report on Financial Statement Schedules 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.

62

3. Exhibits:

 3.1&&   Articles of Incorporation of the Company, as amended to date.
 3.2@@   By-laws of the Company, as amended to date.
 4.1*    Shareholders' Agreement dated as of October 7, 1985 among the
         Company, George Joseph and Gloria Joseph.
10.1&&   Form of Agency Contract.
10.2#    Management Agreement, as amended, effective July 1, 1992, among
         the Company, Mercury Casualty Company, Mercury Insurance Company
         and California Automobile Insurance Company.
10.3##   Profit Sharing Plan, as Amended and Restated as of March 11,
         1994.
10.4##   ESOP Feature Trust Agreement between the Company and Wells Fargo
         Bank, N.A., as Trustee, effective March 1, 1994.
10.5##   ESOP Loan Agreement between Union Bank and Wells Fargo Bank,
         N.A., as Trustee, of the Mercury General Corporation ESOP
         Feature Trust dated as of March 11, 1994.
10.6##   Continuing Guaranty, dated as of March 11, 1994, executed by
         Mercury General Corporation in favor of Union Bank.
10.7**   Amendment 1994-I to the Mercury General Corporation Profit
         Sharing Plan.
10.8**   Amendment 1994-II to the Mercury General Corporation Profit
         Sharing Plan.
10.9&    Amendment 1996-I to the Mercury General Corporation Profit
         Sharing Plan.
10.10&   Amendment 1997-I to the Mercury General Corporation Profit
         Sharing Plan.
10.11&&  Amendment 1998-I to the Mercury General Corporation Profit
         Sharing Plan.
10.12&   Revolving Credit Agreement by and among Mercury General
         Corporation, the Lenders Party Thereto and The Bank of New York,
         as Agent dated as of November 21, 1996.
10.13**  Property Per Risk Excess of Loss Reinsurance Agreement between
         National Reinsurance Corporation and Mercury Casualty Company,
         effective April 1, 1995.
10.14**  Endorsement No. 1 to the Property Per Risk Excess of Loss
         Agreement effective April 1, 1995.
10.15@@  Endorsement No. 2 to the Property Per Risk Excess of Loss
         Agreement effective April 1, 1995.
10.16@@  Endorsement No. 3 to the Property Per Risk Excess of Loss
         Agreement effective April 1, 1995.
10.17&&  Property Excess Catastrophe Reinsurance Agreement effective
         September 1, 1996.
10.18@@  Management Agreement effective January 1, 1995 between the
         Company and Mercury Insurance Company of Illinois.
10.19@@  Management Agreement effective January 1, 1995 between the
         Company and Mercury Indemnity Company of Illinois.
10.20@@  Management Agreement effective January 1, 1995 between the
         Company and Mercury Insurance Company of Georgia.
10.21@@  Management Agreement effective January 1, 1995 between the

63

         Company and Mercury Indemnity Company of Georgia.
10.22@   The 1995 Equity Participation Plan.
10.23&   Stock Purchase Agreement between Mercury General Corporation as
         Purchaser and AFC as Seller dated November 15, 1996.
10.24&&  Management Agreement effective January 1, 1997 between the
         Company and American Mercury Insurance Company, AFI Management
         Co., Inc. and Cimarron Insurance Company.
10.25    Amendment to Revolving Credit Agreement by and among Mercury
         General Corporation, the Lender Party thereto and The Bank of
         New York, as Agent, dated as of November 21, 1996.
10.26    Revolving Credit Agreement by and among Mercury General
         Corporation, the Lender Party thereto and The Bank of New York,
         as Agent, dated as of October 30, 1998.
21.1     Subsidiaries of the Company.
23.1     Accountants' Consent.
27.1     Financial Data Schedule

* 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.

# This document was filed as an exhibit to Registrant's Form 10-K for the fiscal year ended December 31, 1992, and is incorporated herein by this reference.

## 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.

** 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.

@ This document was filed as an exhibit to Registrant's Form S-8 filed on March 8, 1996 and is incorporated herein by this reference.

@@ This document was filed as an exhibit to Registrant's Form 10-K for the fiscal year ended December 31, 1995, and is incorporated herein by this reference.

& This document was filed as an exhibit to Registrant's Form 10-K for the fiscal year ended December 31, 1996 and is incorporated herein by this reference.

&& This document was filed as an exhibit to Registrant's Form 10-K for the fiscal year ended December 31, 1997 and is incorporated herein by this reference.

(b) Reports on Form 8-K:
None

64

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         GEORGE JOSEPH
  -------------------------------------
           George Joseph
     Chief Executive Officer and
       Chairman of the Board

March 8, 1999

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

      Signature                       Title                        Date
      ---------                       -----                        ----
                                 Chief Executive Officer
                                          and
                                   Chairman of the Board
    GEORGE JOSEPH                (Principal Executive Officer)  March 8, 1999
-----------------------------
    George Joseph

                                   Vice President and
                                 Chief Financial Officer
    GABRIEL TIRADOR             (Principal Financial Officer)   March 8, 1999
-----------------------------
    Gabriel Tirador


    NATHAN BESSIN                       Director                March 8, 1999
--------------------------
    Nathan Bessin


    BRUCE A. BUNNER                     Director                March 8, 1999
--------------------------
    Bruce A. Bunner


    MICHAEL D. CURTIUS                  Director                March 8, 1999
--------------------------
    Michael D. Curtius

65

        Signature                          Title                Date
        ---------                          -----                ----


   RICHARD E. GRAYSON                    Director            March 8, 1999
-------------------------
   Richard E. Grayson


     GLORIA JOSEPH                       Director            March 8, 1999
------------------------
     Gloria Joseph


    CHARLES MCCLUNG                      Director            March 8, 1999
------------------------
    Charles McClung


    DONALD P. NEWELL                     Director            March 8, 1999
------------------------
    Donald P. Newell


  DONALD R. SPUEHLER                     Director            March 8, 1999
------------------------
  Donald R. Spuehler

66

INDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULES

The Board of Directors
Mercury General Corporation:

Under date of February 12, 1999, we reported on the consolidated balance sheets of Mercury General Corporation and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income, comprehensive income, shareholders' equity and cash flows for each of the years in the three- year period ended December 31, 1998, as contained in the annual report on Form 10-K for the year 1998. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related financial statement schedules as listed under Item 14(a)2. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits.

In our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

KPMG LLP

Los Angeles, California
February 12, 1999

S-1

SCHEDULE I

MERCURY GENERAL CORPORATION

SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTS IN RELATED PARTIES

December 31, 1998

Amounts in Thousands

                                                                             Amount at
                                                                            which shown
                                                                              in the
Type of Investment                                  Cost        Value      balance sheet
------------------                               ----------   ----------   -------------
Fixed maturities available for sale
    Bonds:
      U.S. Government.........................   $   10,206   $   10,428      $   10,428
      States, Municipalities..................    1,179,043    1,256,113       1,256,113
      Public utilities........................          881          936             936
      All other corporate bonds...............       12,839       13,161          13,161
    Redeemable preferred stock................       42,471       44,270          44,270
                                                 ----------   ----------      ----------

      Total fixed maturities available for
        sale..................................    1,245,440    1,324,908       1,324,908
                                                 ----------   ----------      ----------

Equity securities:
    Common stocks:
      Public utilities........................       38,260       40,650          40,650
      Banks, trust and insurance companies....        1,666        1,813           1,813
      Industrial, Miscellaneous and
       all other..............................        5,233        5,372           5,372
    Nonredeemable preferred stocks............      175,290      171,910         171,910
                                                 ----------   ----------      ----------

      Total equity securities available for
        sale..................................      220,449      219,745         219,745
                                                 ----------   ----------      ----------

Short-term investments........................       45,992                       45,992
                                                 ----------                   ----------

     Total investments.....................      $1,511,881                   $1,590,645
                                                 ==========                   ==========

S-2

SCHEDULE I

MERCURY GENERAL CORPORATION

SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTS IN RELATED PARTIES

December 31, 1997

Amounts in Thousands

                                                                             Amount at
                                                                            which shown
                                                                              in the
Type of Investment                                  Cost        Value      balance sheet
------------------                               ----------   ----------   -------------
Fixed maturities available for sale
    Bonds:
      U.S. Government.........................   $   19,700   $   19,807      $   19,807
      States, Municipalities..................    1,021,259    1,085,614       1,085,614
      Public utilities........................       11,383       11,529          11,529
      All other corporate bonds...............       19,013       19,326          19,326
    Redeemable preferred stock................       76,239       78,710          78,710
                                                 ----------   ----------      ----------

      Total fixed maturities available for
        sale..................................    1,147,594    1,214,986       1,214,986
                                                 ----------   ----------      ----------

Equity securities:
    Common stocks:
      Public utilities........................       25,020       29,144          29,144
      Banks, trust and insurance companies....          567          552             552
      Industrial, Miscellaneous and
       all other..............................        1,962        1,980           1,980
    Nonredeemable preferred stocks............      142,394      141,846         141,846
                                                 ----------   ----------      ----------

      Total equity securities available for
        sale..................................      169,943      173,522         173,522
                                                 ----------   ----------      ----------

Short-term investments........................       59,740                       59,740
                                                 ----------                   ----------

     Total investments........................   $1,377,277                   $1,448,248
                                                 ==========                   ==========

S-3

SCHEDULE II
MERCURY GENERAL CORPORATION

CONDENSED FINANCIAL INFORMATION OF REGISTRANT

BALANCE SHEETS

December 31, 1998 and 1997

Amounts in thousands

ASSETS

                                                         1998            1997
                                                      ---------        --------
Investments:
 Fixed maturities available for sale (amortized
  cost $1,002 in 1998 and $2,914 in 1997).........   $      980        $  2,888
 Equity securities, available for sale (cost
  $22,885 in 1998 and $28,398 in 1997)............       22,274          28,555
 Short-term cash investments......................        9,189           6,705
 Investment in subsidiaries.......................      979,695         849,608
                                                     ----------        --------
   Total investments..............................    1,012,138         887,756

Amounts due from affiliates.......................        8,544           5,452
Income taxes......................................        3,693           3,144
Other assets......................................        1,963           1,863
                                                     ----------        --------
                                                     $1,026,338        $898,215
                                                     ==========        ========

                      LIABILITIES AND SHAREHOLDERS' EQUITY

Notes payable.....................................      $78,000        $ 75,000
Accounts payable and accrued expenses..............      22,353          18,594
Other liabilities..................................       8,610           5,029
                                                     ----------        --------
       Total liabilities...........................     108,963          98,623
                                                     ----------        --------
Shareholders' equity:
    Common stock...................................      48,830          47,412
    Accumulated other comprehensive income.........      51,196          46,131
    Unearned ESOP compensation.....................      (4,000)           --
    Retained earnings..............................     821,349         706,049
                                                     ----------        --------
              Total shareholders' equity...........     917,375         799,592
                                                     ----------        --------
                                                     $1,026,338        $898,215
                                                     ==========        ========

See notes to condensed financial information

S-4

SCHEDULE II, Continued

MERCURY GENERAL CORPORATION

CONDENSED FINANCIAL INFORMATION OF REGISTRANT

STATEMENTS OF INCOME

Three years ended December 31, 1998

Amounts in thousands

                                                        1998        1997           1996
                                                        ----        ----           ----
Revenues:
  Net investment income.........................    $  1,956       $  2,139       $  1,489
  Management fee income from subsidiaries.......     186,387        162,352        118,657
  Other.........................................          94            --               8
                                                    --------       --------       --------
      Total revenues............................     188,437        164,491        120,154
                                                                   --------       --------
Expenses:
  Loss adjustment expenses......................     115,242        102,889         79,934
  Policy acquisition costs......................      33,550         31,543         20,345
  Other operating expenses......................      38,815         28,454         19,336
  Interest......................................       4,839          4,972          2,004
                                                    --------       --------       --------

      Total expenses............................     192,446        167,858        121,619
                                                    --------       --------       --------
  Loss before income taxes and equity in net
   income of subsidiaries.......................      (4,009)        (3,367)        (1,465)

Income tax benefit..............................      (2,010)          (528)          (536)
                                                    --------       --------       --------
  Loss before equity in net income
   of subsidiaries..............................      (1,999)        (2,839)          (929)

Equity in net income of subsidiaries............     179,525        159,145        106,693
                                                    --------       --------       --------
      Net income................................    $177,526       $156,306       $105,764
                                                    ========       ========       ========

See notes to condensed financial information.

S-5

SCHEDULE II, Continued

MERCURY GENERAL CORPORATION

CONDENSED FINANCIAL INFORMATION OF REGISTRANT

STATEMENTS OF CASH FLOWS

Three Years ended December 31, 1998

Amounts in thousands

                                                       1998         1997        1996
                                                    ---------    ---------   ----------
Cash flows from operating activities:
  Net cash provided from operating activities......  $ 52,908    $ 40,097    $ 32,510

Cash flows from investing activities:
  Acquisition of American Mercury Insurance
   Company.........................................      --          --       (34,991)
  Capital contribution to subsidiaries.............      --          --       (15,000)
  Fixed maturities, at market:
    Purchases......................................    (2,700)     (3,556)       (807)
    Sales..........................................     3,849       2,398         475
    Calls or maturities............................       731       1,234       1,072
  Equity securities:
    Purchases......................................   (75,180)    (71,446)    (47,597)
    Sales..........................................    79,852      59,786      42,934
    Calls..........................................       222         358        --
  (Increase) decrease in short term cash
  investments, net.................................    (2,484)      1,385      (3,344)
  Other, net.......................................      --          --          --
                                                        ------    --------    --------
      Net cash provided by (used) in investing
       activities..................................     4,290      (9,841)    (57,258)

Cash flows from financing activities:
  Additions to notes payable.......................     3,000        --        75,000

  Principal payments on notes payable..............      --          --       (25,000)

  Payment of AMI indemnification holdback..........                (1,750)       --
  Dividends paid to shareholders...................   (38,452)    (31,879)    (26,291)
  Purchase and retirement of common stock..........   (24,291)       --          --
  Stock options exercised..........................     1,964       1,400       1,324
                                                        ------    --------    --------
     Net cash provided by (used) in financing
      activities...................................   (57,779)    (32,229)     25,033

Net increase (decrease) in cash....................      (581)     (1,973)        285
Cash:
  Beginning of the year............................    (3,029)     (1,056)     (1,340)
                                                        ------    --------    --------
  End of the year .................................  $ (3,610)   $ (3,029)   $ (1,055)
                                                      =======     ========    ========

See notes to condensed financial information.

S-6

SCHEDULE II, Continued

MERCURY GENERAL CORPORATION

CONDENSED FINANCIAL INFORMATION OF REGISTRANT

NOTES TO CONDENSED FINANCIAL INFORMATION

December 31, 1998 and 1997

The accompanying condensed financial information should be read in conjunction with the consolidated financial statements and notes included in this statement.

Management Fee Income

Under a management agreement, the Company performs management services which include all underwriting and claims servicing functions for its subsidiaries. The Company is compensated by monthly reimbursement of expenses incurred.

Dividends Received From Subsidiaries

Dividends of $55,000,000, $33,500,000, and $27,700,000 were received by the Company from its wholly-owned subsidiaries in 1998, 1997 and 1996, respectively, and are recorded as a reduction to Investment in Subsidiaries.

Cash Overdraft

At December 31, 1998 and 1997, the Company had cash overdrafts of $3,610,000 and $3,029,000, respectively which are classified in "other liabilities" in the accompanying condensed balance sheet.

S-7

SCHEDULE IV

MERCURY GENERAL CORPORATION

REINSURANCE

Three years ended December 31, 1998

Amounts in thousands

                                              Ceded to
                                     Gross      other                  Net
                                     amount   companies   Assumed     amount
                                     ------   ---------  ---------    ------
Property and Liability insurance
   1998......................... $1,130,597   $14,352     $5,339    $1,121,584
   1997......................... $1,055,114   $24,241     $  407    $1,031,280
   1996......................... $  757,447   $ 3,138     $  415    $  754,724

S-8

EXHIBIT INDEX

 3.1&&      Articles of Incorporation of the Company, as amended to date.
 3.2@@      By-laws of the Company, as amended to date.
 4.1*       Shareholders' Agreement dated as of October 7, 1985 among the
            Company, George Joseph and Gloria Joseph.
10.1&&      Form of Agency Contract.
10.2#       Management Agreement, as amended, effective July 1, 1992,
            among the Company, Mercury Casualty Company, Mercury
            Insurance Company and California Automobile Insurance
            Company.
10.3##      Profit Sharing Plan, as Amended and Restated as of March 11,
            1994.
10.4##      ESOP Feature Trust Agreement between the Company and Wells
            Fargo Bank, N.A., as Trustee, effective March 1, 1994.
10.5##      ESOP Loan Agreement between Union Bank and Wells Fargo Bank,
            N.A., as Trustee, of the Mercury General Corporation ESOP
            Feature Trust dated as of March 11, 1994.
10.6##      Continuing Guaranty, dated as of March 11, 1994, executed by
            Mercury General Corporation in favor of Union Bank.
10.7**      Amendment 1994-I to the Mercury General Corporation Profit
            Sharing Plan.
10.8**      Amendment 1994-II to the Mercury General Corporation Profit
            Sharing Plan.
10.9&       Amendment 1996-I to the Mercury General Corporation Profit
            Sharing Plan.
10.10&      Amendment 1997-I to the Mercury General Corporation Profit
            Sharing Plan.
10.11&&     Amendment 1998-I to the Mercury General Corporation Profit
            Sharing Plan.
10.12&      Revolving Credit Agreement by and among Mercury General
            Corporation, the Lenders Party Thereto and The Bank of New
            York, as Agent dated as of November 21, 1996.
10.13**     Property Per Risk Excess of Loss Reinsurance Agreement
            between National Reinsurance Corporation and Mercury Casualty
            Company, effective April 1, 1995.
10.14**     Endorsement No. 1 to the Property Per Risk Excess of Loss
            Agreement effective April 1, 1995.
10.15@@     Endorsement No. 2 to the Property Per Risk Excess of Loss
            Agreement effective April 1, 1995.
10.16@@     Endorsement No. 3 to the Property Per Risk Excess of Loss
            Agreement effective April 1, 1995.
10.17&&     Property Excess Catastrophe Reinsurance Agreement effective
            September 1, 1996.
10.18@@     Management Agreement effective January 1, 1995 between the
            Company and Mercury Insurance Company of Illinois.
10.19@@     Management Agreement effective January 1, 1995 between the
            Company and Mercury Indemnity Company of Illinois.
10.20@@     Management Agreement effective January 1, 1995 between the
            Company and Mercury Insurance Company of Georgia.
10.21@@     Management Agreement effective January 1, 1995 between the

75

            Company and Mercury Indemnity Company of Georgia.
10.22@      The 1995 Equity Participation Plan.
10.23&      Stock Purchase Agreement between Mercury General Corporation
            as Purchaser and AFC as Seller dated November 15, 1996.
10.24&&     Management Agreement effective January 1, 1997 between the
            Company and American Mercury Insurance Company, AFI
            Management Co., Inc. and Cimarron Insurance Company.
10.25       Amendment to Revolving Credit Agreement by and among Mercury
            General Corporation, the Lender Party thereto and The Bank of
            New York, as Agent, dated as of November 21, 1996.
10.26       Revolving Credit Agreement by and among Mercury General
            Corporation, the Lender Party thereto and The Bank of New
            York, as Agent, dated as of October 30, 1998.
21.1        Subsidiaries of the Company.
23.1        Accountants' Consent.
27.1        Financial Data Schedule.

* 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.

# This document was filed as an exhibit to Registrant's Form 10-K for the fiscal year ended December 31, 1992, and is incorporated herein by this reference.

## 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.

** 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.

@ This document was filed as an exhibit to Registrant's Form S-8 filed on March 8, 1996 and is incorporated herein by this reference.

@@ This document was filed as an exhibit to Registrant's Form 10-K for the fiscal year ended December 31, 1995, and is incorporated herein by this reference.

& This document was filed as an exhibit to Registrant's Form 10-K for the fiscal year ended December 31, 1996 and is incorporated herein by this reference.

&& This document was filed as an exhibit to Registrant's Form 10-K for the fiscal year ended December 31, 1997 and is incorporated herein by this reference.

(b) Reports on Form 8-K:
None

76

AMENDMENT AND
RESTATEMENT
OF
CREDIT AGREEMENT

AMENDMENT AND RESTATEMENT (this "Amendment"), dated as of December 31, 1998, of the CREDIT AGREEMENT, dated as of November 21, 1996, by and among MERCURY GENERAL CORPORATION, a California corporation (the "Borrower"), the lenders party thereto (collectively, together with their respective assigns, the "Lenders", and each a "Lender") and THE BANK OF NEW YORK, as agent for the Lenders (in such capacity, the "Agent"), as amended by Amendment No. 1, dated as of February 20, 1998, Amendment No. 2, dated as of July 14, 1998 and Amendment No. 3, dated as of October 30, 1998 (the "Agreement").

RECITALS

1. Except as otherwise provided herein, capitalized terms used herein that are not herein defined shall have the meanings ascribed thereto by the Agreement.

2. The parties to the Agreement desire to amend and restate the Agreement to the extent set forth herein upon the terms and conditions herein contained.

Therefore, in consideration of the RECITALS and the terms and conditions herein contained, and of other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, it is agreed that the Agreement be and the same hereby is amended and restated in its entirety so as to read as presently set forth therein with the exception that the definition of "Maturity Date" set forth in Section 1.1 thereof shall read as follows:

"Maturity Date": November 21, 2001 (or any date subsequent thereto resulting from an extension of the Maturity Date pursuant to Section 2.17), or such earlier date on which the Notes shall become due and payable, whether by acceleration or otherwise.

A. This Amendment shall not be effective until such time (the "Restatement Effective Date") as each of the following conditions precedent has been fulfilled:

1. This Amendment.

The Agent shall have received counterparts of this Amendment executed by a duly authorized officer of the Borrower and the Agent and consented to by all of the Lenders.

2. Fees and Expenses of Special Counsel.

The fees and expenses of Special Counsel in connection with the preparation, negotiation and closing of this Amendment shall have been paid.

3. Compliance.

After giving effect to this Amendment, (a) the Borrower shall be in compliance with all of the terms, covenants and conditions of the Loan Documents as amended hereby, (b) there shall exist no Default or Event of Default and (c) the representations and warranties contained in the Loan Documents shall be true and correct with the same effect as though such representations and warranties had been made on the Restatement Effective Date.

B. The Borrower hereby reaffirms and admits the validity and enforceability of the Loan Documents and all of its obligations thereunder, agrees and admits that it has no defenses to or offsets against any of its obligations under the Loan Documents, and represents and warrants that there exists no Default or Event of Default and that the representations and warranties contained in the Loan Documents are true and correct on and as of the date hereof.

C. In all other respects the Loan Documents shall remain in full force and effect, and no amendment of any term or condition of the Agreement herein contained shall be deemed to be an amendment of any other term or condition contained in the Agreement or any other Loan Document or constitute a waiver of any Default or Event of Default.

D. This Amendment may be executed in any number of counterparts all of which, taken together, shall constitute one Amendment. In making proof of this Amendment, it shall only be necessary to produce the counterpart executed and delivered by the party to be charged.

E. THIS AMENDMENT IS BEING EXECUTED AND DELIVERED IN, AND IS INTENDED TO BE PERFORMED IN, THE STATE OF NEW YORK AND SHALL


BE CONSTRUED AND ENFORCEABLE IN ACCORDANCE WITH, AND BE GOVERNED BY, THE INTERNAL LAWS OF THE STATE OF NEW YORK, WITHOUT REGARD TO PRINCIPLES OF CONFLICT OF LAWS.

The Borrower and the Agent have caused this Amendment to be duly executed as of the date first above written.


MERCURY GENERAL CORPORATION

By:

Name:
Title:

THE BANK OF NEW YORK, individually and as Agent

By:
Name:
Title:

CONSENTED TO:

UNION BANK OF CALIFORNIA, N.A.

By:
Name:
Title:

THE FIRST NATIONAL BANK OF CHICAGO

By:
Name:
Title:


REVOLVING CREDIT AGREEMENT

by and among

MERCURY GENERAL CORPORATION,

THE LENDERS PARTY HERETO,

AND

THE BANK OF NEW YORK, AS AGENT

UNION BANK OF CALIFORNIA, AS CO-AGENT

AND

FIRST NATIONAL BANK OF CHICAGO, AS CO-AGENT

WITH

BNY CAPITAL MARKETS, INC.

AS LEAD ARRANGER


$100,000,000


Dated as of October 30, 1998


TABLE OF CONTENTS

ARTICLE 1           DEFINITIONS AND PRINCIPLES OF CONSTRUCTION ..............   1
 Section 1.1        Definitions .............................................   1
 Section 1.2        Principles of Construction ..............................  13
ARTICLE 2           AMOUNT AND TERMS OF LOANS ...............................  14
 Section 2.1        Loans ...................................................  14
 Section 2.2        Notes ...................................................  14
 Section 2.3        Procedure for Borrowing .................................  15
 Section 2.4        Termination or Reduction of Aggregate Commitments .......  16
 Section 2.5        Prepayments of the Loans ................................  16
 Section 2.6        Conversions and Continuations ...........................  17
 Section 2.7        Interest Rate and Payment Dates .........................  18
 Section 2.8        Taxes ...................................................  19
 Section 2.9        Substituted Interest Rate ...............................  21
 Section 2.10       Illegality ..............................................  22
 Section 2.11       Increased Costs .........................................  22
 Section 2.12       Capital Adequacy ........................................  23
 Section 2.13       Lending Offices .........................................  24
 Section 2.14       Indemnification for Loss ................................  24
 Section 2.15       Option to Fund ..........................................  25
 Section 2.16       Use of Proceeds .........................................  25
 Section 2.17       Extension of Maturity Date ..............................  25
 Section 2.18       Agent's Records .........................................  26
 Section 2.19       Mitigation of Taxes and Costs ...........................  26

ARTICLE 3           FEES; PAYMENTS ..........................................  27
 Section 3.1        Commitment Fee ..........................................  27
 Section 3.2        Pro Rata Treatment and Application of Principal Payments.  27
ARTICLE 4           REPRESENTATIONS AND WARRANTIES ..........................  28
 Section 4.1        Subsidiaries ............................................  28


 Section 4.2        Existence and Power .....................................  28
 Section 4.3        Authority ...............................................  28
 Section 4.4        Binding Agreement .......................................  28
 Section 4.5        Litigation ..............................................  28
 Section 4.6        Required Consents .......................................  29
 Section 4.7        No Conflicting Agreements ...............................  29
 Section 4.8        Compliance with Applicable Laws .........................  29
 Section 4.9        Taxes ...................................................  29
 Section 4.10       Governmental Regulations ................................  30
 Section 4.11       Federal Reserve Regulations; Use of Loan Proceeds .......  30
 Section 4.12       Plans ...................................................  30
 Section 4.13       Financial Statements ....................................  30
 Section 4.14       Property ................................................  31
 Section 4.15       Licenses, Franchises, Etc ...............................  31
 Section 4.16       Environmental Matters ...................................  31
 Section 4.17       Labor Relations .........................................  32
 Section 4.18       Burdensome Obligations ..................................  32
 Section 4.19       No Misrepresentation ....................................  33
 Section 4.20       Year 2000 ...............................................  33
ARTICLE 5           CONDITIONS TO FIRST LOANS ...............................  33
 Section 5.1        Evidence of Action ......................................  33
 Section 5.2        This Agreement ..........................................  34
 Section 5.3        Notes ...................................................  34
 Section 5.4        Approvals ...............................................  34
 Section 5.5        Opinion of Counsel to the Borrower ......................  34
 Section 5.6        Opinion of Special Counsel ..............................  34
 Section 5.7        Payment of Fees .........................................  34
 Section 5.8        Other Documents .........................................  35
ARTICLE 6           CONDITIONS OF LENDING - ALL LOANS .......................  35
 Section 6.1        Compliance ..............................................  35
 Section 6.2        Loan Closings ...........................................  35


 Section 6.3        Borrowing Request .......................................  35
 Section 6.4        Other Documents .........................................  35
ARTICLE 7           AFFIRMATIVE COVENANTS ...................................  36
 Section 7.1        Financial Statements ....................................  36
 Section 7.2        Certificates; Other Information .........................  37
 Section 7.3        Legal Existence .........................................  38
 Section 7.4        Taxes ...................................................  38
 Section 7.5        Insurance ...............................................  38
 Section 7.6        Payment of Indebtedness and Performance of Obligations ..  39
 Section 7.7        Condition of Property ...................................  39
 Section 7.8        Observance of Legal Requirements ........................  39
 Section 7.9        Inspection of Property; Books and Records; Discussions ..  39
 Section 7.10       Authorizations ..........................................  39
 Section 7.11       Adjusted Net Worth ......................................  40
 Section 7.12       GAAP Net Worth ..........................................  40
 Section 7.13       Leverage Ratio ..........................................  40
 Section 7.14       Interest Coverage Ratio .................................  40
 Section 7.15       Year 2000 Covenant ......................................  40
ARTICLE 8           NEGATIVE COVENANTS ......................................  40
 Section 8.1        Indebtedness of Subsidiaries ............................  41
 Section 8.2        Liens ...................................................  41
 Section 8.3        Mergers, Acquisitions and Dispositions ..................  42
 Section 8.4        Line of Business ........................................  42
 Section 8.5        Articles of Incorporation and By-laws ...................  42
 Section 8.6        Fiscal Year .............................................  42
 Section 8.7        Transactions with Affiliates ............................  42
 Section 8.8        Issuance of Additional Stock by Subsidiaries ............  43
 Section 8.9        Reinsurance Agreements ..................................  43
 Section 8.10       Adoption of Pension Plans ...............................  43
ARTICLE 9           DEFAULT .................................................  43
 Section 9.1        Events of Default .......................................  43


ARTICLE 10          THE AGENT ...............................................  46
 Section 10.1       Appointment .............................................  46
 Section 10.2       Delegation of Duties ....................................  47
 Section 10.3       Exculpatory Provisions ..................................  47
 Section 10.4       Reliance by Agent .......................................  47
 Section 10.5       Notice of Default .......................................  48
 Section 10.6       Non-Reliance on Agent and Other Lenders .................  48
 Section 10.7       Indemnification .........................................  49
 Section 10.8       Agent in Its Individual Capacity ........................  49
 Section 10.9       Successor Agent .........................................  49
ARTICLE 11          OTHER PROVISIONS ........................................  50
 Section 11.1       Amendments and Waivers ..................................  50
 Section 11.2       Notices .................................................  51
 Section 11.3       No Waiver; Cumulative Remedies ..........................  52
 Section 11.4       Survival of Representations and Warranties ..............  52
 Section 11.5       Payment of Expenses and Taxes ...........................  52
 Section 11.6       Assignments and Participations ..........................  53
 Section 11.7       Counterparts ............................................  55
 Section 11.8       Adjustments; Set-off ....................................  55
 Section 11.9       Construction ............................................  56
 Section 11.10      Indemnity ...............................................  56
 Section 11.11      Governing Law ...........................................  57
 Section 11.12      Headings Descriptive ....................................  57
 Section 11.13      Severability ............................................  57
 Section 11.14      Integration .............................................  57
 Section 11.15      Consent to Jurisdiction .................................  57
 Section 11.16      Service of Process ......................................  58
 Section 11.17      No Limitation on Service or Suit ........................  58
 Section 11.18      WAIVER OF TRIAL BY JURY .................................  58


EXHIBITS

Exhibit A           List of Commitments
Exhibit B           Form of Note
Exhibit C           Form of Borrowing Request
Exhibit D           Form of Assignment and Acceptance Agreement
Exhibit E           Form of Opinion of Counsel to the Borrower
Exhibit F           Form of Opinion of Special Counsel
Exhibit G           Form of Notice of Conversion/Continuation

SCHEDULES

Schedule 1.1        List of Lending Offices
Schedule 4.1        List of Subsidiaries
Schedule 4.5        List of Litigation
Schedule 8.1        List of Existing Indebtedness
Schedule 8.2        List of Existing Liens


REVOLVING CREDIT AGREEMENT, dated as of October 30, 1998, by and among MERCURY GENERAL CORPORATION, a California corporation (the "Borrower"), the lenders party hereto (collectively, together with their respective assigns, the "Lenders", and each a "Lender") and THE BANK OF NEW YORK, as agent for the Lenders (in such capacity, the "Agent").

ARTICLE 1 DEFINITIONS AND PRINCIPLES OF CONSTRUCTION

Section 1.1 Definitions

As used in this Agreement, terms defined in the preamble have the meanings therein indicated, and the following terms have the following meanings:

"ABR Advances": the Loans (or any portions thereof) at such time as they (or such portions) are made and/or being maintained at a rate of interest based upon the Alternate Base Rate.

"Accountants": KPMG Peat Marwick (or any successor thereto), or such other firm of certified public accountants of recognized national standing selected by the Borrower and reasonably satisfactory to the Agent.

"Acquisition": with respect to any Person, the purchase or other acquisition by such Person, by any means whatsoever (including by devise, bequest, gift, through a dividend or otherwise and whether in a single transaction or in a series of related transactions), of (i) the Capital Stock of, or other equity securities of, any other Person if, immediately thereafter, such other Person would be either a Subsidiary of such Person or otherwise under the control of such Person, (ii) any business, going concern or division or segment thereof, or (iii) the Property of any other Person other than in the ordinary course of business, provided, however, that no acquisition of all or substantially all of the assets of such other Person shall be deemed to be in the ordinary course of business.

"Adjusted Net Worth": at any date of determination, the sum of all amounts which would be included under shareholders' equity on a Consolidated balance sheet of the Borrower determined in accordance with GAAP (without adjusting the value of securities held by the Borrower or its Subsidiaries to market value as contemplated under FASB 115 for securities designated as "available for sale").

"Advance": an ABR Advance or a Eurodollar Advance, as the case may be.

"Affected Advance": defined in Section 2.9.

"Affected Principal Amount": in the event that (i) the Borrower shall fail for any reason to borrow, convert or continue after it shall have notified the Agent of its intent to do so in any instance in which it shall have requested a Eurodollar Advance, an amount equal to the principal amount of such Eurodollar Advance; (ii) a Eurodollar Advance shall terminate pursuant to the provisions hereof prior to the last day of the Interest Period applicable thereto, an amount equal to the principal amount of such Eurodollar Advance; and
(iii) the Borrower shall prepay or repay all


or any part of the principal amount of a Eurodollar Advance prior to the last day of the Interest Period applicable thereto, an amount equal to the principal amount of such Eurodollar Advance so prepaid or repaid.

"Affiliate": as to any Person, any other Person which, directly or indirectly, is in control of, is controlled by, or is under common control with, such Person. For purposes of this definition, control of a Person shall mean the power, direct or indirect, (i) to vote 5% or more of the securities or other interests having ordinary voting power for the election of directors or other managing Persons thereof or (ii) to direct or cause the direction of the management and policies of such Person, whether by contract or otherwise.

"Aggregate Commitments": on any date, the sum of all Commitments on such date.

"Agreement": this Revolving Credit Agreement, as the same may be amended, supplemented or otherwise modified from time to time.

"Alternate Base Rate": on any date, a rate of interest per annum equal to the higher of (i) the Federal Funds Rate in effect on such date plus 1/2 of 1% or (ii) the BNY Rate in effect on such date.

"Annual Statements": defined in Section 4.13(b).

"Applicable Insurance Code": with respect to any Insurance Subsidiary, the insurance code of any jurisdiction where such Insurance Subsidiary is domiciled or is conducting an insurance business, as in effect from time to time and including any successor code or statute thereto, together with the regulations issued thereunder.

"Applicable Insurance Regulatory Authority": with respect to any Insurance Subsidiary, the insurance department or similar Governmental Authority located in the jurisdiction in which such Insurance Subsidiary is domiciled and, to the extent that it has any regulatory authority over such Insurance Subsidiary, in each other jurisdiction in which such Insurance Subsidiary is licensed.

"Applicable Lending Office": in respect of any Lender, (i) in the case of such Lender's ABR Advances, its Domestic Lending Office and (ii) in the case of such Lender's Eurodollar Advances, its Eurodollar Lending Office.

"Applicable Margin": (i) with respect to the unpaid principal balance of ABR Advances, the applicable percentage set forth below in the column entitled "ABR Advances", (ii) with respect to the unpaid principal balance of Eurodollar Advances, the applicable percentage set forth below in the column entitled "Eurodollar Advances", and (iii) with respect to the Commitment Fee, the applicable percentage set forth below in the column entitled "Commitment Fee"; in each case opposite the applicable Pricing Level:

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                          ABR      Eurodollar    Commitment
Pricing Level          Advances     Advances         Fee
--------------------   ---------   -----------   -----------

Pricing Level I               0%       0.4000%        .1200%
Pricing Level II              0%       0.4500%        .1200%
Pricing Level III             0%       0.5750%        .1200%
Pricing Level IV              0%       0.6500%        .1200%

"Assignment and Acceptance Agreement": an assignment and acceptance agreement executed by an assignor and an assignee pursuant to which the assignor assigns to the assignee all or any portion of such assignor's Notes and Commitment, substantially in the form of Exhibit D.

"Assignment Fee": defined in Section 11.6(b).

"Authorized Signatory": as to (i) any Person which is a corporation, the chairman of the board, the president, any vice president, the chief financial officer or any other duly authorized officer (acceptable to the Agent) of such Person and (ii) any Person which is not a corporation, the general partner or other managing Person thereof.

"Benefited Lender": defined in Section 11.8.

"BNY": The Bank of New York.

"BNY Rate": a rate of interest per annum equal to the rate of interest publicly announced in New York City by BNY from time to time as its prime commercial lending rate, such rate to be adjusted automatically (without notice) on the effective date of any change in such publicly announced rate.

"Borrowing Date": any Business Day specified in a Borrowing Request as a date on which the Borrower requests the Lenders to make Loans.

"Borrowing Request": a request for Loans in the form of Exhibit C.

"Business Day": for all purposes other than as set forth in clause
(ii) below, (i) any day other than a Saturday, Sunday or a day on which commercial banks located in New York City and Los Angeles are authorized or required by law or other governmental action to close and (ii) with respect to all notices and determinations in connection with, and payments of principal and interest on, Eurodollar Advances, any day which is a Business Day described in clause (i) above and which is also a day on which dealings in foreign currency and exchange and Eurodollar funding between banks may be carried on in London, England.

"Capital Lease Obligations": with respect to any Person, the obligations of such Person with respect to leases which, in accordance with GAAP, are required to be capitalized on the financial statements of such Person.

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"Code": the Internal Revenue Code of 1986, as amended from time to time, or any successor thereto, and the rules and regulations issued thereunder, as from time to time in effect.

"Commitment": in respect of any Lender, such Lender's undertaking during the Commitment Period to make Loans, subject to the terms and conditions hereof, in an aggregate outstanding principal amount not exceeding the amount set forth next to the name of such Lender in Exhibit A under the heading "Commitments", as such amount may be reduced pursuant to Section 2.4.

"Commitment Fee": defined in Section 3.1.

"Commitment Period": the period from the Effective Date until the Business Day immediately preceding the Maturity Date.

"Commitment Percentage": as to any Lender, the percentage set forth opposite the name of such Lender in Exhibit A under the heading "Commitment Percentage".

"Compensatory Interest Payment": defined in Section 2.7(c).

"Consolidated": the Borrower and its Subsidiaries which are consolidated for financial reporting purposes.

"Consolidated Statutory Capital and Surplus": at any date the consolidated statutory capital and surplus of the Borrower and its Subsidiaries determined as of such date in accordance with SAP.

"Consolidating": the Borrower and its Subsidiaries taken separately.

"Contingent Obligation": as to any Person (the "secondary obligor"), any obligation, without duplication, of such secondary obligor (i) guaranteeing or in effect guaranteeing any return on any investment made by another Person, or (ii) guaranteeing or in effect guaranteeing any indebtedness, lease, dividend or other obligation ("primary obligation") of any other Person (the "primary obligor") in any manner, whether directly or indirectly, including, without limitation, any obligation of such secondary obligor, whether contingent, (A) to purchase any such primary obligation or any Property constituting direct or indirect security therefor, (B) to advance or supply funds (x) for the purchase or payment of any such primary obligation or (y) to maintain working capital or equity capital of the primary obligor or otherwise to maintain the net worth or solvency of the primary obligor, (C) to purchase Property, securities or services primarily for the purpose of assuring the beneficiary of any such primary obligation of the ability of the primary obligor to make payment of such primary obligation, (D) otherwise to assure or hold harmless the beneficiary of such primary obligation against loss in respect thereof, and (E) in respect of the liabilities of any partnership in which such secondary obligor is a general partner, except to the extent that such liabilities of such partnership are nonrecourse to such secondary obligor and its separate Property, provided, however, that the term "Contingent Obligation" shall not include (1) amounts potentially

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owed on or with respect to insurance policies issued or sold in the ordinary course of business, (2) premiums for any such policies, to the extent attributable to a period after a particular date upon which Contingent Obligations are being determined or (3) the indorsement of instruments for deposit or collection in the ordinary course of business. The amount of any Contingent Obligation of a Person shall be deemed to be an amount equal to the stated or determinable amount of the primary obligation in respect of which such Contingent Obligation is made or, if not stated or determinable, the maximum reasonably anticipated liability in respect thereof as determined by such Person in good faith.

"Control Person": defined in Section 2.12.

"Conversion/Continuation Date": the date on which (i) a Eurodollar Advance is converted to an ABR Advance, (ii) the date on which an ABR Advance is converted to a Eurodollar Advance or (iii) the date on which a Eurodollar Advance is continued as a new Eurodollar Advance.

"Default": any event or condition which constitutes an Event of Default or which, with the giving of notice, the lapse of time, or any other condition, would, unless cured or waived, become an Event of Default.

"Disposition": with respect to any Person, any sale, ceding, assignment, transfer or other disposition by such Person, by any means, of (a) any Operating Entity, or (b) any other Property of such Person, provided, however, that the term "Disposition" shall not include any sale, ceding, assignment, transfer or other disposition by a Person that is a corporation (i) to a wholly-owned Subsidiary of that Person or (ii) as a dividend to that Person's shareholders.

"Dollars" and "$": lawful currency of the United States of America.

"Domestic Lending Office": in respect of any Lender, initially, the office or offices of such Lender designated as such on Schedule 1.1; thereafter, such other office of such Lender through which it shall be making or maintaining ABR Advances, as reported by such Lender to the Agent and the Borrower.

"EBITDA": for any period, net income of the Borrower and its Non- Insurance Subsidiaries for such period, determined on a Consolidated basis in accordance with GAAP, plus the sum of, without duplication, (i) Interest Expense, (ii) provision for income taxes of the Borrower and its Non-Insurance Subsidiaries and (iii) depreciation, amortization and other non-cash charges of the Borrower and its Non-Insurance Subsidiaries, each to the extent deducted in determining such net income for such period.

"Effective Date": October 30, 1998.

"Employee Benefit Plan": an employee benefit plan within the meaning of Section 3(3) of ERISA maintained, sponsored or contributed to by the Borrower, any of its Subsidiaries or any ERISA Affiliate.

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"Environmental Laws": any and all federal, state and local laws relating to the environment, the use, storage, transporting, manufacturing, handling, discharge, disposal or recycling of hazardous substances, materials or pollutants or industrial hygiene, and including, without limitation, (i) the Comprehensive Environmental Response, Compensation and Liability Act, as amended, 42 USCA (S)9601 et seq.; (ii) the Resource Conservation and Recovery

Act of 1976, as amended, 42 USCA (S)6901 et seq.; (iii) the Toxic Substance

Control Act, as amended, 15 USCA (S)2601 et. seq.; (iv) the Water Pollution

Control Act, as amended, 33 USCA (S)1251 et. seq.; (v) the Clean Air Act, as

amended, 42 USCA (S)7401 et seq.; (vi) the Hazardous Material Transportation Act, as amended, 49 USCA (S)1801 et seq. and (vii) all rules, regulations,

judgments, decrees, injunctions and restrictions thereunder and any analogous state law.

"ERISA": the Employee Retirement Income Security Act of 1974, as amended from time to time, and the rules and regulations issued thereunder, as from time to time in effect.

"ERISA Affiliate": when used with respect to an Employee Benefit Plan, ERISA, the PBGC or a provision of the Code pertaining to employee benefit plans, any Person that is a member of any group of organizations within the meaning of Sections 414(b), (c), (m) or (o) of the Code of which the Borrower or any of its Subsidiaries is a member.

"Eurodollar Advances": collectively, the Loans (or any portions thereof) at such time as they (or such portions) are made and/or being maintained at a rate of interest based upon the Eurodollar Rate.

"Eurodollar Lending Office": in respect of any Lender, initially, the office, branch or affiliate of such Lender designated as such on Schedule 1.1 (or, if no such office branch or affiliate is specified, its Domestic Lending Office); thereafter, such other office, branch or affiliate of such Lender through which it shall be making or maintaining Eurodollar Advances, as reported by such Lender to the Agent and the Borrower.

"Eurodollar Rate": with respect to the Interest Period applicable to any Eurodollar Advance, a rate of interest per annum, as determined by the Agent, obtained by dividing (and then rounding to the nearest 1/16 of 1% or, if there is no nearest 1/16 of 1%, then to the next higher 1/16 of 1%):

(a) the rate, as reported by BNY to the Agent, quoted by BNY to leading banks in the interbank eurodollar market as the rate at which BNY is offering Dollar deposits in an amount equal approximately to the Eurodollar Advance of BNY to which such Interest Period shall apply for a period equal to such Interest Period, as quoted at approximately 11:00 A.M. two Business Days prior to the first day of such Interest Period, by

(b) a number equal to 1.00 minus the aggregate of the then stated maximum rates during such Interest Period of all reserve requirements (including, without limitation, marginal, emergency, supplemental and special reserves), expressed as a decimal, established by the Board of Governors of the Federal Reserve System and any other banking

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authority to which BNY and other major United States money center banks are subject, in respect of eurocurrency funding (currently referred to as "Eurocurrency liabilities" in Regulation D of the Board of Governors of the Federal Reserve System) or in respect of any other category of liabilities including deposits by reference to which the interest rate on Eurodollar Advances is determined or any category of extensions of credit or other assets which includes loans by non-domestic offices of any Lender to United States Residents. Such reserve requirements shall include, without limitation, those imposed under such Regulation D. Eurodollar Advances shall be deemed to constitute Eurocurrency liabilities and as such shall be deemed to be subject to such reserve requirements without benefit of credits for proration, exceptions or offsets which may be available from time to time to any Lender under such Regulation D. The Eurodollar Rate shall be adjusted automatically on and as of the effective date of any change in any such reserve requirement.

"Event of Default": any of the events specified in Section 9.1, provided that any requirement for the giving of notice, the lapse of time, or any other condition has been satisfied.

"Extension Request": defined in Section 2.17.

"Federal Funds Rate": for any day, a rate per annum (expressed as a decimal, rounded upwards, if necessary, to the next higher 1/100 of 1%), equal to the weighted average of the rates on overnight federal funds transactions with members of the Federal Reserve System arranged by federal funds brokers on such day, as published by the Federal Reserve Bank of New York on the Business Day next succeeding such day, provided that (i) if the day for which such rate is to be determined is not a Business Day, the Federal Funds Rate for such day shall be such rate on such transactions on the next preceding Business Day as so published on the next succeeding Business Day, and (ii) if such rate is not so published for any day, the Federal Funds Rate for such day shall be the average of the quotations for such day on such transactions received by BNY as determined by BNY and reported to the Agent.

"Financial Statements": defined in Section 4.13(a).

"GAAP": generally accepted accounting principles as from time to time in effect in the United States.

"GAAP Net Worth": at any date of determination, the sum of all amounts which would be included under shareholders' equity on a Consolidated balance sheet of the Borrower determined in accordance with GAAP.

"Governmental Authority": any nation or government, any state or other political subdivision thereof, any entity exercising executive, legislative, judicial, regulatory or administrative functions of or pertaining to government and any court or arbitrator (including, without limitation, any Applicable Insurance Regulatory Authority).

"Hazardous Substance": any hazardous or toxic substance, material or waste, including, but not limited to, (i) those substances, materials, and wastes listed in the United States Department of Transportation Hazardous Materials Table (49 CFR 172.101) or by the

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Environmental Protection Agency as hazardous substances (40 CFR Part 302) and amendments thereto and replacements therefor and (ii) any substance, pollutant or material defined as, or designated in, any Environmental Law as a "hazardous substance," "toxic substance," "hazardous material," "hazardous waste," "restricted hazardous waste," "pollutant," "toxic pollutant" or words of similar import.

"Highest Lawful Rate": as to any Lender, the maximum rate of interest, if any, that at any time or from time to time may be contracted for, taken, charged or received by such Lender on the Notes held thereby or which may be owing to such Lender pursuant to this Agreement and the other Loan Documents under the laws applicable to such Lender and this transaction.

"Indebtedness": as to any Person, at a particular time, all items which constitute, without duplication, (i) indebtedness for borrowed money or the deferred purchase price of Property (other than trade payables and accrued expenses incurred in the ordinary course of business), (ii) indebtedness evidenced by notes, bonds, debentures or similar instruments, (iii) obligations with respect to any conditional sale or title retention agreement, (iv) indebtedness arising under acceptance facilities and the amount available to be drawn under all letters of credit issued for the account of such Person and, without duplication, all drafts drawn thereunder to the extent such Person shall not have reimbursed the issuer in respect of the issuer's payment of such drafts, (v) all liabilities secured by any Lien on any Property owned by such Person even though such Person has not assumed or otherwise become liable for the payment thereof (other than carriers', warehousemen's, mechanics', repairmen's or other like non-consensual statutory Liens arising in the ordinary course of business), (vi) obligations under Capital Lease Obligations and (vii) Contingent Obligations; provided that, for purposes of this definition, (a) "Indebtedness" shall not include obligations in respect of interest rate caps, collars, swaps or other similar agreements, and (b) Indebtedness under clauses
(iii) or (v) shall be taken at the lesser of the principal amount of such Indebtedness and the value of the property subject to the Lien referred to therein.

"Indemnified Person": defined in Section 11.10.

"Insurance Subsidiary": each Subsidiary of the Borrower set forth on Schedule 4.1 under the heading "Engaged in an Insurance Business."

"Intellectual Property": all copyrights, trademarks, servicemarks, patents, trade names and service names.

"Interest Coverage Ratio": at any date of determination, the ratio of
(i) the sum of (x) EBITDA of the Borrower and its Non-Insurance Subsidiaries for the immediately preceding four fiscal quarters of the Borrower plus (y) the

greater of (1) 10% of Statutory Surplus of the Insurance Subsidiaries at such date of determination and (2) Statutory Net Income of the Insurance Subsidiaries for the immediately preceding four fiscal quarters of the Borrower to (ii) Interest Expense for the immediately preceding four fiscal quarters of the Borrower.

"Interest Expense": for any period, the sum of, without duplication, all interest and commitment fees (adjusted to give effect to all interest rate swap, cap or other interest rate hedging

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arrangements and fees and expenses paid in connection with the same, all as determined in accordance with GAAP), paid or accrued in respect of all Indebtedness of the Borrower and its Subsidiaries determined on a Consolidated basis in accordance with GAAP during such period.

"Interest Payment Date": (i) as to any ABR Advance, the last day of each March, June, September and December commencing on the first of such days to occur after such ABR Advance is made or any Eurodollar Advance is converted to an ABR Advance, (ii) as to any Eurodollar Advance in respect of which the Borrower has selected an Interest Period of one, two or three months, the last day of such Interest Period, and (iii) as to any Eurodollar Advance in respect of which the Borrower has selected an Interest Period of six months, the day which is three months after the first day of such Interest Period and the last day of such Interest Period.

"Interest Period": with respect to any Eurodollar Advance requested by the Borrower, the period commencing on, as the case may be, the Borrowing Date or Conversion/Continuation Date with respect to such Eurodollar Advance and ending one, two, three or six months thereafter, as selected by the Borrower in its irrevocable Borrowing Request or its irrevocable Notice of Conversion/Continuation, provided, however, that (i) if any Interest Period would otherwise end on a day which is not a Business Day, such Interest Period shall be extended to the next succeeding Business Day unless the result of such extension would be to carry such Interest Period into another calendar month, in which event such Interest Period shall end on the immediately preceding Business Day, (ii) any Interest Period that begins on the last Business Day of a calendar month (or on a day for which there is no numerically corresponding day in the calendar month at the end of such Interest Period) shall end on the last Business Day of a calendar month and (iii) the Borrower shall select Interest Periods so as not to have more than five different Interest Periods outstanding at any one time for all Loans.

"Leverage Ratio": as of any date, the ratio of (a) Consolidated Indebtedness of the Borrower on such date, to (b) the sum of (i) Consolidated Indebtedness of the Borrower on such date, plus (ii) Adjusted Net Worth on such date.

"Lien": any mortgage, pledge, hypothecation, assignment, deposit or preferential arrangement, encumbrance, lien (statutory or other), or other security agreement or security interest of any kind or nature whatsoever, including, without limitation, any conditional sale or other title retention agreement and any capital or financing lease having substantially the same economic effect as any of the foregoing.

"Loan Documents": collectively, this Agreement and the Notes.

"Loan" and "Loans": defined in Section 2.1.

"Margin Stock": any "margin stock", as defined in Regulation U of the Board of Governors of the Federal Reserve System, as the same may be amended or supplemented from time to time.

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"Material Adverse Change": a material adverse change in (i) the financial condition, operations, business, prospects or Property of the Borrower and its Subsidiaries taken as a whole, (ii) the ability of the Borrower to perform its obligations under the Loan Documents or (iii) the ability of the Agent and the Lenders to enforce the Loan Documents, including, without limitation, as a result of a change of law since December 31, 1997.

"Material Adverse Effect": a material adverse effect on (i) the financial condition, operations, business, prospects or Property of the Borrower and its Subsidiaries taken as a whole, (ii) the ability of the Borrower to perform its obligations under the Loan Documents or (iii) the ability of the Agent and the Lenders to enforce the Loan Documents, including, without limitation, as a result of a change of law since December 31, 1997.

"Maturity Date": October 29, 1999 (or any date subsequent thereto resulting from an extension of the Maturity Date pursuant to Section 2.17), or such earlier date on which the Notes shall become due and payable, whether by acceleration or otherwise.

"Multiemployer Plan": a Pension Plan which is a multiemployer plan as defined in Section 4001(a)(3) of ERISA.

"NAIC": the National Association of Insurance Commissioners, or any association or Governmental Authority successor to the functions thereof.

"1996 Revolving Credit": the Revolving Credit Agreement, dated as of November 21, 1996, by and among the Borrower, the lenders party thereto and BNY as agent.

"Non-Insurance Subsidiary": each Subsidiary of the Borrower set forth on Schedule 4.1 under the heading "Not Engaged in an Insurance Business."

"Note" and "Notes": defined in Section 2.2.

"Notice of Conversion/Continuation": a notice substantially in the form of Exhibit G.

"Operating Entity": (a) any Person, (b) any business or operating unit of a Person which is, or could be, operated separate and apart from the other businesses and operations of such Person, or (c) any other line of business or business segment.

"Pension Plan": at any date of determination, any Employee Benefit Plan (including a Multiemployer Plan), the funding requirements of which (under
Section 302 of ERISA or Section 412 of the Code) are, or at any time within the six years immediately preceding such date, were in whole or in part, the responsibility of the Borrower, any of its Subsidiaries or any ERISA Affiliate.

"Permitted Liens": Liens permitted to exist under Section 8.2.

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"Person": any individual, firm, partnership, joint venture, corporation, limited liability company, association, business enterprise, joint stock company, unincorporated association, trust, Governmental Authority or any other entity, whether acting in an individual, fiduciary, or other capacity, and for the purpose of the definition of "ERISA Affiliate", a trade or business.

"Pricing Level I": any time when the Leverage Ratio is less than or equal to .10:1.00.

"Pricing Level II": any time when the Leverage Ratio is greater than .10:1.00, but less than or equal to .15:1.00.

"Pricing Level III": any time when the Leverage Ratio is greater than .15:1.00, but less than or equal to .25:1.00.

"Pricing Level IV": any time when the Leverage Ratio is greater than .25:1.00

"Property": all types of real, personal, tangible, intangible or mixed property.

"Real Property": all real property owned or leased by the Borrower or any of its Subsidiaries.

"Reinsurance Agreement": any agreement, contract, treaty, certificate or other arrangement under which any Insurance Subsidiary agrees to transfer or cede to another insurer all or part of the liabilities assumed, or the assets held, by such Insurance Subsidiary under one or more policies of insurance (including, without limitation, any agreement, contract, treaty, certificate or other arrangement that is treated as such by any Applicable Insurance Regulatory Authority of such Insurance Subsidiary).

"Remaining Interest Period": (i) in the event that the Borrower shall fail for any reason to borrow a Loan in respect of which it shall have requested a Eurodollar Advance or convert an Advance to, or continue an Advance as, a Eurodollar Advance after it shall have notified the Agent of its intent to do so, a period equal to the Interest Period that the Borrower elected in respect of such Eurodollar Advance; or (ii) in the event that a Eurodollar Advance shall terminate pursuant to the provisions hereof prior to the last day of the Interest Period applicable thereto, a period equal to the remaining portion of such Interest Period if such Interest Period had not been so terminated; or
(iii) in the event that the Borrower shall prepay or repay all or any part of the principal amount of a Eurodollar Advance prior to the last day of the Interest Period applicable thereto, a period equal to the period from and including the date of such prepayment or repayment to but excluding the last day of such Interest Period.

"Reporting Insurance Subsidiary": on any date, each Insurance Subsidiary which, as of the end of the fiscal quarter immediately preceding such date, (i) had a Statutory Surplus of at least 5% of consolidated Statutory Surplus of the Insurance Subsidiaries at the end of such fiscal quarter or (ii) accounted for at least 5% of consolidated net premiums written by the Insurance

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Subsidiaries for the 4 fiscal quarters immediately preceding such date.

"Required Lenders": at any time when no Loans are outstanding, Lenders having Commitments (or if no Commitments then exist, Lenders having Commitments on the last day on which Commitments did exist) equal to at least 66 2/3% of the aggregate Commitments of all the Lenders, and at any time when Loans are outstanding, Lenders holding Notes having an unpaid principal balance equal to at least 66 2/3% of the aggregate Loans outstanding.

"Restricted Payment": as to any Person (i) any dividend or other distribution, direct or indirect, on account of any shares of any class of Stock or other equity interest in such Person now or hereafter outstanding (other than a dividend payable solely in shares of such Stock to the holders of such shares) and (ii) any redemption, retirement, sinking fund or similar payment, purchase or other acquisition, direct or indirect, of any shares of any class of Stock or other equity interest in such Person now or hereafter outstanding.

"SAP": with respect to each Insurance Subsidiary, statutory accounting principles in effect from time to time prescribed or permitted by the Applicable Insurance Regulatory Authority in the preparation of the financial statements of such Subsidiary.

"SEC": the Securities and Exchange Commission or any Governmental Authority succeeding to the functions thereof.

"Special Counsel": Emmet, Marvin & Martin, LLP, special counsel to the Agent.

"Statutory Net Income": with respect to the Insurance Subsidiaries for any period, the consolidated statutory net income of the Insurance Subsidiaries for such period computed in accordance with SAP and consistent with that reported on line 16, page 4, column 1 of the Summary of Operations Statement in the Annual Statement.

"Statutory Surplus": with respect to the Insurance Subsidiaries at any date of determination, the consolidated statutory surplus of the Insurance Subsidiaries on such date computed in accordance with SAP and consistent with that reported on line 25, page 3, column 1 of the Liabilities, Surplus and Other Funds Statement in the Annual Statement.

"Stock": as to any Person, all shares, interests, partnership interests, limited liability company interests, participations, rights in or other equivalents (however designated) of such Person's equity (however designated) and any rights, warrants or options exchangeable for or convertible into such shares, interests, participations, rights or other equity.

"Subsidiary": as to any Person, any corporation, association, partnership, limited liability company, joint venture or other business entity of which such Person or any Subsidiary of such Person, directly or indirectly, either (i) in respect of a corporation, owns or controls more than 50% of the outstanding Stock having ordinary voting power to elect a majority of the board of directors or similar managing body, irrespective of whether a class or classes shall or might have voting power by reason of the happening of any contingency, or (ii) in respect of an association,

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partnership, limited liability company, joint venture or other business entity, is entitled to share in more than 50% of the profits and losses, however determined.

"Tax": any present or future tax, levy, impost, duty, charge, fee, deduction or withholding of any nature and whatever called, by a Governmental Authority, on whomsoever and wherever imposed, levied, collected, withheld or assessed.

"Tax on the Overall Net Income": as to any Person, a Tax imposed by the jurisdiction in which that Person's principal office (and/or, in the case of a Lender, its Domestic Lending Office) is located or by any political subdivision or taxing authority thereof or in which that Person is deemed to be doing business on all or part of the net income, profits or gains of that Person (whether worldwide, or only insofar as such income, profits or gains are considered to arise in or to relate to a particular jurisdiction, or otherwise).

"United States": the United States of America (including the States thereof and the District of Columbia).

"Unqualified Amount": defined in Section 2.7(c).

"Utilization Fee": defined in Section 3.3.

"Year 2000 Issue": defined in Section 4.20.

Section 1.2 Principles of Construction

(a) All terms defined in a Loan Document shall have the meanings given such terms therein when used in the other Loan Documents or any certificate, opinion or other document made or delivered pursuant thereto, unless otherwise defined therein.

(b) As used in the Loan Documents and in any certificate, opinion or other document made or delivered pursuant thereto, accounting terms not defined in Section 1.1, and accounting terms partly defined in Section 1.1, to the extent not defined, shall have the respective meanings given to them under GAAP, or, to the extent that such terms apply solely to one or more Insurance Subsidiaries, given to them under SAP.

(c) The phrase "may not" is prohibitive and not permissive.

(d) Unless the context otherwise requires, words in the singular number include the plural, and words in the plural include the singular.

(e) Unless specifically provided in a Loan Document to the contrary, references to a time shall refer to New York City time.

(f) Unless specifically provided in a Loan Document to the contrary, in the computation of periods of time from a specified date to a later specified date, the word "from"

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means "from and including" and the words "to" and "until" each means "to but excluding".

(g) References in any Loan Document to a fiscal period shall refer to that fiscal period of the Borrower.

ARTICLE 2 AMOUNT AND TERMS OF LOANS

Section 2.1 Loans

Subject to the terms and conditions hereof, each Lender severally agrees to make revolving credit loans (each a "Loan" and, as the context may

require, collectively with all other Loans of such Lender and with the Loans of all other Lenders, the "Loans") to the Borrower from time to time during the Commitment Period, provided, however, that immediately after giving effect thereto (i) the outstanding principal balance of such Lender's Loans would not exceed such Lender's Commitment, and (b) the aggregate outstanding principal balance of all Lenders' Loans would not exceed the Aggregate Commitments. During the Commitment Period, the Borrower may borrow, prepay in whole or in part and reborrow under the Aggregate Commitments, all in accordance with the terms and conditions of this Agreement.

Section 2.2 Notes

The Loans made by a Lender shall be evidenced by a promissory note of the Borrower, substantially in the form of Exhibit B, with appropriate insertions therein as to date and principal amount (each, as indorsed or modified from time to time, a "Note" and, collectively with the Notes of all other Lenders, the "Notes"), payable to the order of such Lender for the account of its Applicable Lending Office and representing the obligation of the Borrower to pay the lesser of (a) the original amount of the Commitment of such Lender and (b) the aggregate unpaid principal balance of all Loans made by such Lender, with interest thereon as prescribed in Section 2.7. Each Note shall (i) be dated the first Borrowing Date, (ii) be stated to mature on the Maturity Date and
(iii) bear interest from the date thereof on the unpaid principal balance thereof at the applicable interest rate or rates per annum determined as provided in Section 2.7. Interest on each Note shall be payable as specified in
Section 2.7.

Section 2.3 Procedure for Borrowing

(a) The Borrower may borrow under the Aggregate Commitments on any Business Day during the Commitment Period, provided, however, that the Borrower shall notify the Agent (by telephone or fax) no later than: 12:00 Noon three Business Days prior to the requested Borrowing Date, in the case of Eurodollar Advances, and 12:00 Noon, one Business Day prior to the requested Borrowing Date, in the case of ABR Advances, specifying in each case (i) the aggregate principal amount to be borrowed under the Aggregate Commitments, (ii) the requested Borrowing Date, (iii) whether such borrowing is to consist of one or more Eurodollar Advances, ABR Advances, or a combination thereof and (iv) if the borrowing is to consist of one or more Eurodollar Advances, the length of the Interest Period for each such

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Eurodollar Advance, provided, however, that no Interest Period selected in respect of any Loan shall end after the Maturity Date. If the Borrower fails to give timely notice in connection with a request for a Eurodollar Advance, the Borrower shall be deemed to have elected that such Advance shall be made as an ABR Advance. Each such notice shall be irrevocable and confirmed immediately by delivery to the Agent of a Borrowing Request. Each Advance shall be in an aggregate principal amount equal to $3,000,000 or such amount plus a whole multiple of $1,000,000 in excess thereof, or, if less, the unused amount of the Aggregate Commitments.

(b) Upon receipt of each notice of borrowing from the Borrower, the Agent shall promptly notify each Lender thereof. Subject to its receipt of the notice referred to in the preceding sentence, (i) each Lender will make the amount of its Commitment Percentage of each borrowing available to the Agent for the account of the Borrower at the office of the Agent set forth in Section 11.2 not later than 2:00 PM on the relevant Borrowing Date requested by the Borrower, in funds immediately available to the Agent at such office. The amounts so made available to the Agent on such Borrowing Date will then, subject to the satisfaction of the terms and conditions of this Agreement, as determined by the Agent, be made available on such date to the Borrower by the Agent at the office of the Agent specified in Section 11.2 by crediting the account of the Borrower on the books of such office with the aggregate of said amounts received by the Agent.

(c) Unless the Agent shall have received prior notice from a Lender (by telephone or otherwise, such notice to be promptly confirmed by fax or other writing) that such Lender will not make available to the Agent such Lender's Commitment Percentage of the Loans requested by the Borrower, the Agent may assume that such Lender has made such share available to the Agent on the Borrowing Date in accordance with this Section, provided that such Lender received notice of the proposed borrowing from the Agent, and the Agent may, in reliance upon such assumption, make available to the Borrower on the Borrowing Date a corresponding amount. If and to the extent such Lender shall not have so made its Commitment Percentage of such Loans available to the Agent, such Lender and the Borrower severally agree to pay to the Agent forthwith on demand such corresponding amount (to the extent not previously paid by the other), together with interest thereon for each day from the date such amount is made available to the Borrower to the date such amount is paid to the Agent, at a rate per annum equal to, in the case of the Borrower, the applicable interest rate set forth in Section 2.7 for ABR Advances, and, in the case of such Lender, the Federal Funds Rate in effect on each such day (as determined by the Agent). Such payment by the Borrower, however, shall be without prejudice to its rights against such Lender. If such Lender shall pay to the Agent such corresponding amount, such amount so paid shall constitute such Lender's Loan as part of the Loans for purposes of this Agreement, which Loan shall be deemed to have been made by such Lender on the Borrowing Date applicable to such Loans.

(d) If a Lender makes a new Loan on a Borrowing Date on which the Borrower is to repay a Loan from such Lender, such Lender shall apply the proceeds of such new Loan to make such repayment, and only the excess of the proceeds of such new Loan over the Loan being repaid need be made available to the Agent.

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(e) Notices of borrowing given by telephone shall be deemed given when made by telephone and the Agent and the Lenders may rely thereon whether such notice is confirmed by the delivery of a Borrowing Request.

Section 2.4 Termination or Reduction of Aggregate Commitments

(a) Voluntary Reductions. The Borrower shall have the right, upon at least three Business Days' prior written notice to the Agent, at any time to terminate the Aggregate Commitments or from time to time to permanently reduce the Aggregate Commitments, provided, however, that any such reduction shall be in the amount of $3,000,000 (or such lesser available amount of the Facility) or $3,000,000 plus a whole multiple of $1,000,000 in excess thereof.

(b) In General. Reductions of the Aggregate Commitments shall be applied pro rata according to the Commitment of each Lender. Simultaneously with each reduction of the Aggregate Commitments under this Section, the Borrower shall pay the Commitment Fee accrued on the amount by which the Aggregate Commitments have been reduced and prepay the Loans as required by Section 2.5(b).

Section 2.5 Prepayments of the Loans

(a) Voluntary Prepayments. The Borrower may, at its option, prepay the Loans without premium or penalty, in full at any time or in part from time to time by notifying the Agent in writing at least one Business Day prior to the proposed prepayment date, in the case of Loans consisting of ABR Advances and at least three Business Days prior to the proposed prepayment date, in the case of Loans consisting of Eurodollar Advances, in each case specifying whether the Loans to be prepaid consist of ABR Advances, Eurodollar Advances, or a combination thereof, the amount to be prepaid and the date of prepayment. Such notice shall be irrevocable and the amount specified in such notice shall be due and payable on the date specified, together with accrued interest to the date of such payment on the amount prepaid. Upon receipt of such notice, the Agent shall promptly notify each Lender thereof. Each partial prepayment of the Loans pursuant to this subsection shall be in an aggregate principal amount of $3,000,000 (or any smaller outstanding balance of the Loans) or $3,000,000 plus a whole multiple of $1,000,000 in excess thereof. After giving effect to any partial prepayment with respect to Eurodollar Advances which were made (whether as the result of a borrowing or a conversion) on the same date and which had the same Interest Period, the outstanding principal amount of such Eurodollar Advances shall exceed (subject to Section 2.6) $3,000,000 or such amount plus a whole multiple of $1,000,000 in excess thereof.

(b) Mandatory Prepayments of Loans Relating to Reductions of the Aggregate Commitments. Simultaneously with each reduction of the Aggregate Commitments under Section 2.4, the Borrower shall prepay the Loans by the amount, if any, by which the aggregate unpaid principal balance of the Loans exceeds the amount of the Aggregate Commitments as so reduced.

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(c) In General. If any prepayment is made in respect of any Eurodollar Advance, in whole or in part, prior to the last day of the applicable Interest Period, the Borrower agrees to indemnify the Lenders in accordance with
Section 2.14.

Section 2.6 Conversions and Continuations

(a) The Borrower may elect from time to time to convert Eurodollar Advances to ABR Advances by giving the Agent at least one Business Day's prior irrevocable notice of such election (confirmed by the delivery of a Notice of Conversion/Continuation), specifying the amount to be so converted, provided, that any such conversion of Eurodollar Advances shall only be made on the last day of the Interest Period applicable thereto. In addition, the Borrower may elect from time to time to (i) convert ABR Advances to Eurodollar Advances and
(ii) to continue Eurodollar Advances by selecting a new Interest Period therefor, in each case by giving the Agent at least three Business Days' prior irrevocable notice of such election (confirmed by the delivery of a Notice of Conversion/Continuation), in the case of a conversion to, or continuation of, Eurodollar Advances, specifying the amount to be so converted and the initial Interest Period relating thereto, provided that any such conversion of ABR Advances to Eurodollar Advances shall only be made on a Business Day and any such continuation of Eurodollar Advances shall only be made on the last day of the Interest Period applicable to the Eurodollar Advances which are to be continued as such new Eurodollar Advances. The Agent shall promptly provide the Lenders with a copy of each such Notice of Conversion/Continuation. ABR Advances and Eurodollar Advances may be converted or continued pursuant to this Section in whole or in part, provided that conversions of ABR Advances to Eurodollar Advances, or continuations of Eurodollar Advances shall be in an aggregate principal amount of $3,000,000 or such amount plus a whole multiple of $1,000,000 in excess thereof.

(b) Notwithstanding anything in this Section to the contrary, no ABR Advance may be converted to a Eurodollar Advance and no Eurodollar Advance may be continued, if the Borrower or the Agent has knowledge that an Event of Default has occurred and is continuing either (i) at the time the Borrower shall notify the Agent of its election to convert or continue or (ii) on the requested Conversion/Continuation Date. In such event, such ABR Advance shall be automatically continued as an ABR Advance, or such Eurodollar Advance shall be automatically converted to an ABR Advance on the last day of the Interest Period applicable to such Eurodollar Advance. If an Event of Default shall have occurred and be continuing, the Agent shall, at the request of the Required Lenders, notify the Borrower (by telephone or otherwise) that all, or such lesser amount as the Required Lenders shall designate, of the outstanding Eurodollar Advances shall be automatically converted to ABR Advances, in which event such Eurodollar Advances shall be automatically converted to ABR Advances on the date such notice is given.

(c) No Interest Period selected in respect of conversion or continuation of any Eurodollar Advance shall end after the Maturity Date.

(d) Each conversion or continuation of a Eurodollar Advance shall be effected by each Lender by applying the proceeds of its new Eurodollar Advance to its Eurodollar Advances (or portion thereof) being converted or continued (it being understood that such

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conversion or continuation shall not constitute a borrowing for purposes of Sections 4, 5 or 6).

(e) Notices in respect of a conversion or continuation given by telephone shall be deemed given when made by telephone and the Agent and the Lenders may rely thereon whether such notice is confirmed by the delivery of a Notice of Conversion/Continuation.

Section 2.7 Interest Rate and Payment Dates

(a) Prior to Maturity. Except as otherwise provided in Section 2.7(b), prior to maturity, the Loans shall bear interest on the outstanding principal balance thereof at the applicable interest rate or rates per annum set forth below:

  LOANS                         RATE
  -----                         ----

Made as ABR            Alternate Base Rate plus the
Advances               Applicable Margin.

Made as Eurodollar     Eurodollar Rate for the
Advances               applicable Interest Period
                       plus the Applicable Margin.

(b) Event of Default. After the occurrence and during the continuance of a Default or an Event of Default under Section 9.1(a) or (b), the outstanding principal balance of the Loans shall bear interest at a rate per annum equal to 2% plus the rate which would otherwise be applicable under
Section 2.7(a), and any overdue interest or other amount payable under the Loan Documents shall bear interest at a rate per annum equal to the Alternate Base Rate plus the Applicable Margin plus 2%. All such interest shall be payable on demand.

(c) In General. Interest on (i) ABR Advances to the extent based on the BNY Rate shall be calculated on the basis of a 365 or 366-day year (as the case may be), and (ii) ABR Advances to the extent based on the Federal Funds Rate and on Eurodollar Advances shall be calculated on the basis of a 360-day year, in each case, for the actual number of days elapsed, including the first day but excluding the last. Except as otherwise provided in Section 2.7(b), interest shall be payable in arrears on each Interest Payment Date and upon each payment (including prepayment) of the Loans. Any change in the interest rate on the Loans resulting from a change in the Alternate Base Rate or reserve requirements shall become effective as of the opening of business on the day on which such change shall become effective. The Agent shall, as soon as practicable, notify the Borrower and the Lenders of the effective date and the amount of each such change in the BNY Rate, but any failure to so notify shall not in any manner affect the obligation of the Borrower to pay interest on the Loans in the amounts and on the dates required. Each determination of the Alternate Base Rate or a Eurodollar Rate by the Agent pursuant to this Agreement shall be conclusive and binding on the Borrower absent manifest error. At no time shall the interest rate payable on the Loans, together with the Commitment Fee and all other amounts payable under the Loan Documents, to the extent the same are construed to constitute

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interest, exceed the Highest Lawful Rate. If in respect of a ny period during the term of this Agreement, any amount paid hereunder, to the extent the same shall (but for the provisions of this Section) constitute or be deemed to constitute interest, would exceed the maximum amount of interest permitted by the Highest Lawful Rate during such period (such amount being hereinafter referred to as an "Unqualified Amount"), then (i) such Unqualified Amount shall be applied or shall be deemed to have been applied as a prepayment of the Loans, and (ii) if in any subsequent period during the term of this Agreement, all amounts payable hereunder in respect of such period which constitute or shall be deemed to constitute interest shall be less than the maximum amount of interest permitted by the Highest Lawful Rate during such period, then the Borrower shall pay to the Lenders in respect of such period an amount (each a "Compensatory Interest Payment") equal to the lesser of (x) a sum which, when added to all such amounts, would equal the maximum amount of interest permitted by the Highest Lawful Rate during such period, and (y) an amount equal to the Unqualified Amount less all other Compensatory Interest Payments made in respect thereof. The Borrower acknowledges that to the extent interest payable on ABR Advances is based on the BNY Rate, such Rate is only one of the bases for computing interest on loans made by the Lenders, and by basing interest payable on ABR Advances on the BNY Rate, the Lenders have not committed to charge, and the Borrower has not in any way bargained for, interest based on a lower or the lowest rate at which the Lenders may now or in the future make loans to other borrowers.

Section 2.8 Taxes

(a) Payments to Be Free and Clear. Provided that all documentation, if any, then required to be delivered by any Lender or the Agent pursuant to subsection (c) below has been delivered, all sums payable by the Borrower under the Loan Documents shall be paid free and clear of and (except to the extent required by law) without any deduction or withholding on account of any Tax (other than a Tax on the Overall Net Income of any Lender (for which payment need not be free and clear but no deduction or withholding shall be made unless then required by applicable law)) imposed, levied, collected, withheld or assessed by or within the United States or any political subdivision in or of the United States or any other jurisdiction from or to which a payment is made by or on behalf of the Borrower or by any federation or organization of which the United States or any such jurisdiction is a member at the time of payment.

(b) Grossing-up of Payments. If the Borrower or any other Person is required by law to make any deduction or withholding on account of any such Tax from any sum paid or payable by the Borrower to the Agent or any Lender under any of the Loan Documents:

(i) The Borrower shall notify the Agent and such Lender of any such requirement or any change in any such requirement as soon as the Borrower becomes aware of it;

(ii) The Borrower shall pay any such Tax before the date on which penalties attach thereto, such payment to be made (if the liability to pay is imposed on the Borrower) for its own account or (if that liability is imposed on the Agent or such Lender, as the case may be) on behalf of and in the name of the Agent or such Lender;

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(iii) the sum payable by the Borrower to the Agent or a Lender in respect of which the relevant deduction, withholding or payment is required shall be increased to the extent necessary to ensure that, after the making of that deduction, withholding or payment, the Agent or such Lender, as the case may be, receives on the due date therefor a net sum equal to what it would have received had no such deduction, withholding or payment been required or made; and

(iv) within 30 days after paying any sum from which it is required by law to make any deduction or withholding, and within 30 days after the due date of payment of any Tax which it is required by clause (b) above to pay, the Borrower shall deliver to the Agent and the applicable Lender evidence satisfactory to the other affected parties of such deduction, withholding or payment and of the remittance thereof to the relevant Governmental Authority; provided that no such additional amount shall be required to be paid to any Lender under clause (iii) above except to the extent that any change after the date hereof (in the case of each Lender listed on the signature pages hereof) or after the date of the Assignment and Acceptance Agreement pursuant to which such Lender became a Lender (in the case of each other Lender) in any such requirement for a deduction, withholding or payment as is specified therein shall result in an increase in the rate of such deduction, withholding or payment from that in effect at the date of this Agreement or at the date of such Assignment and Acceptance, as the case may be, in respect of payments to such Lender.

(c) U.S. Tax Certificates. Each Lender that is organized under the laws of any jurisdiction other than the United States shall deliver to the Agent for transmission to the Borrower, on or prior to the Effective Date (in the case of each Lender listed on the signature pages hereof) or on the effective date of the Assignment and Acceptance Agreement pursuant to which it becomes a Lender (in the case of each other Lender), and at such other times as may be necessary in the determination of the Borrower or the Agent (each in the reasonable exercise of its discretion), such certificates, documents or other evidence, properly completed and duly executed by such Lender (including, without limitation, Internal Revenue Service Form 1001 or Form 4224 or any other certificate or statement of exemption required by Treasury Regulations Section 1.1441-4(a) or Section 1.1441-6(c) or any successor thereto) to establish that such Lender is not subject to deduction or withholding of United States federal income tax under Section 1441 or 1442 of the Code or otherwise (or under any comparable provisions of any successor statute) with respect to any payments to such Lender of principal, interest, fees or other amounts payable under any of the Loan Documents. The Borrower shall not be required to pay any additional amount to any such Lender under subsection (b)(iii) above if such Lender shall have failed to satisfy the requirements of the immediately preceding sentence; provided that if such Lender shall have satisfied such requirements on the Effective Date (in the case of each Lender listed on the signature pages hereof) or on the effective date of the Assignment and Acceptance Agreement pursuant to which it became a Lender (in the case of each other Lender), nothing in this subsection shall relieve the Borrower of its obligation to pay any additional amounts pursuant to subsection (b)(iii) above in the event that, as a result of any change in applicable law, such Lender is no longer properly entitled to deliver certificates, documents or

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other evidence at a subsequent date establishing the fact that such Lender is not subject to withholding as described in the immediately preceding sentence.

(d) Tax Refund. If any Lender or the Agent, as applicable, receives a refund (whether by way of direct payment or by offset) of any Tax for which a payment has been made pursuant to subsection 2.8(b)(ii) which, in the reasonable good faith judgment of such Lender or Agent, as the case may be, is allocable to such payment made under subsection 2.8(B)(ii), the amount of such refund (together with any interest received thereon) shall be paid to the Borrower to the extent payment has been made in full pursuant to subsection 2.8(b)(ii).

Section 2.9 Substituted Interest Rate

In the event that (i) the Agent shall have determined (which determination shall be conclusive and binding upon the Borrower) that by reason of circumstances affecting the interbank eurodollar market either adequate and reasonable means do not exist for ascertaining the Eurodollar Rate applicable pursuant to Section 2.7 or (ii) the Required Lenders shall have notified the Agent that they have determined (which determination shall be conclusive and binding on the Borrower) that the applicable Eurodollar Rate will not adequately and fairly reflect the cost to such Lenders of maintaining or funding loans bearing interest based on such Eurodollar Rate, with respect to any portion of the Loans that the Borrower has requested be made as Eurodollar Advances or Eurodollar Advances that will result from the requested conversion or continuation of any portion of the Advances into or of Eurodollar Advances (each, an "Affected Advance"), the Agent shall promptly notify the Borrower and the Lenders (by telephone or otherwise, to be promptly confirmed in writing) of such determination, on or, to the extent practicable, prior to the requested Borrowing Date or Conversion/Continuation Date for such Affected Advances. If the Agent shall give such notice, (a) any Affected Advances shall be made as ABR Advances, (b) the Advances (or any portion thereof) that were to have been converted to or continued as Affected Advances shall be converted to or continued as ABR Advances and (c) any outstanding Affected Advances shall be converted, on the last day of the then current Interest Period with respect thereto, to ABR Advances. Until any notice under clauses (i) or (ii), as the case may be, of this Section has been withdrawn by the Agent (by notice to the Borrower promptly upon either (x) the Agent having determined that such circumstances affecting the interbank eurodollar market no longer exist and that adequate and reasonable means do exist for determining the Eurodollar Rate pursuant to Section 2.7 or (y) the Agent having been notified by such Required Lenders that circumstances no longer render the Advances (or any portion thereof) Affected Advances, no further Eurodollar Advances shall be required to be made by the Lenders, nor shall the Borrower have the right to convert or continue all or any portion of the Loans to Eurodollar Advances.

Section 2.10 Illegality

Notwithstanding any other provisions herein, if any law, regulation, treaty or directive, or any change therein or in the interpretation or application thereof, shall make it unlawful for any Lender to make or maintain its Eurodollar Advances as contemplated by this Agreement, (i) the commitment of such Lender hereunder to make Eurodollar Advances or convert ABR Advances to Eurodollar Advances shall forthwith be suspended and (ii) such Lender's Loans

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then outstanding as Eurodollar Advances affected hereby, if any, shall be converted automatically to ABR Advances on the last day of the then current Interest Period applicable thereto or within such earlier period as required by law. If the commitment of any Lender with respect to Eurodollar Advances is suspended pursuant to this Section and such Lender shall notify the Agent and the Borrower that it is once again legal for such Lender to make or maintain Eurodollar Advances, such Lender's commitment to make or maintain Eurodollar Advances shall be reinstated.

Section 2.11 Increased Costs

In the event that any law, regulation, treaty or directive hereafter enacted, promulgated, approved or issued or any change in any presently existing law, regulation, treaty or directive therein or in the interpretation or application thereof by any Governmental Authority charged with the administration thereof or compliance by any Lender (or any corporation directly or indirectly owning or controlling such Lender) with any request or directive from any central bank or other Governmental Authority:

(a) does or shall subject any Lender to any Taxes of any kind whatsoever with respect to any Eurodollar Advances or its obligations under this Agreement to make Eurodollar Advances, or change the basis of taxation of payments to any Lender of principal, interest or any other amount payable hereunder in respect of its Eurodollar Advances, including any Taxes required to be withheld from any amounts payable under the Loan Documents (except for imposition of, or change in the rate of, Tax on the Overall Net Income of such Lender or its Applicable Lending Office for any of such Advances by the jurisdiction in which such Lender is incorporated or has its principal office or such Applicable Lending Office, including, in the case of Lenders incorporated in any State of the United States, such tax imposed by the United States); or

(b) does or shall impose, modify or make applicable any reserve, special deposit, compulsory loan, assessment, increased cost or similar requirement against assets held by, or deposits of, or advances or loans by, or other credit extended by, or any other acquisition of funds by, any office of such Lender in respect of its Eurodollar Advances which is not otherwise included in the determination of a Eurodollar Rate;

(c) and the result of any of the foregoing is to increase the cost to such Lender of making, renewing, converting, continuing or maintaining its Eurodollar Advances or its commitment to make such Eurodollar Advances, or to reduce any amount receivable hereunder in respect of its Eurodollar Advances, then, in any such case, the Borrower shall pay such Lender, upon its demand, any additional amounts necessary to compensate such Lender for such additional cost or reduction in such amount receivable which such Lender deems to be material as determined by such Lender; provided, however, that nothing in this Section shall require the Borrower to indemnify the Lenders with respect to withholding Taxes for which the Borrower has no obligation under Section 2.8 or any other increased costs, expenses, Taxes or other matters incurred by a Lender more than 90 days prior to the date that such Lender delivers notice to the Borrower of such increased cost, expense, tax or matter. A statement setting forth the

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calculations of any additional amounts payable pursuant to the foregoing sentence submitted by a Lender to the Borrower shall be conclusive absent manifest error.

Section 2.12 Capital Adequacy

If the amount of capital required or expected to be maintained by any Lender or any Person directly or indirectly owning or controlling such Lender (each a "Control Person"), shall be affected by (i) the introduction or phasing in of any law, rule or regulation after the Effective Date, (ii) any change after the Effective Date in the interpretation of any existing law, rule or regulation by any central bank or United States or foreign Governmental Authority charged with the administration thereof or (iii) compliance by such Lender or such Control Person with any directive, guideline or request from any central bank or United States or foreign Governmental Authority (whether or not having the force of law) promulgated or made after the Effective Date, and such Lender shall have determined that such introduction, phasing in, change or compliance shall have had or will thereafter have the effect of reducing (A) the rate of return on such Lender's or such Control Person's capital, or (B) the asset value to such Lender or such Control Person of the Loans made or maintained by such Lender, in either case to a level below that which such Lender or such Control Person could have achieved or would thereafter be able to achieve but for such introduction, phasing in, change or compliance (after taking into account such Lender's or such Control Person's policies regarding capital adequacy) by an amount deemed by such Lender to be material to such Lender or Control Person, then, within ten days after demand by such Lender, accompanied by a statement setting forth the calculations of any additional amount payable under this Section, which statement shall be conclusive absent manifest error, the Borrower shall pay to such Lender or such Control Person such additional amount or amounts as shall be sufficient to compensate such Lender or such Control Person, as the case may be, for such reduction, provided, however, that nothing in this Section shall require the Borrower to compensate any Lender for any such reduction arising more than 90 days prior to the date that such Lender delivers notice thereof to the Borrower.

Section 2.13 Lending Offices

Each Lender shall have the right at any time and from time to time to transfer its Loans to a different office, provided that such Lender shall promptly notify the Agent and the Borrower of any such change of office. Such office shall thereupon become such Lender's Domestic Lending Office or Eurodollar Lending Office, as the case may be, provided, however, that no such Lender shall be entitled to receive any greater amount under Sections 2.9, 2.11 and 2.12 as a result of a transfer of any such Loans to a different office of such Lender than it would be entitled to immediately prior thereto unless such claim would have arisen even if such transfer had not occurred.

Section 2.14 Indemnification for Loss

Notwithstanding anything contained herein to the contrary, if the Borrower shall fail to borrow or convert or continue on a Borrowing Date or Conversion/Continuation Date after it shall have given notice to do so in which it shall have requested a Eurodollar Advance, or if a

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Eurodollar Advance shall be terminated or suspended pursuant to the provisions hereof prior to the last day of the Interest Period applicable thereto, or if, while a Eurodollar Advance is outstanding, any repayment or prepayment of such Eurodollar Advance is made for any reason (including, without limitation, as a result of acceleration, illegality or an assignment pursuant to Section 2.19(b)) on a date which is prior to the last day of the Interest Period applicable thereto, the Borrower agrees to indemnify each Lender against, and to pay on demand directly to such Lender, any loss or expense suffered by such Lender as a result of such failure to borrow, convert or continue, termination, repayment or prepayment, including, without limitation, an amount, if greater than zero, equal to:

A x (B-C) x D

360

where:

"A" equals such Lender's Commitment Percentage of the Affected Principal Amount;

"B" equals the Eurodollar Rate (expressed as a decimal) applicable to such Eurodollar Advances;

"C" equals the applicable Eurodollar Rate (expressed as a decimal) in effect on or about the first day of the applicable Remaining Interest Period, based on the applicable rates offered or bid, as the case may be, on or about such date, for deposits in an amount equal approximately to such Lender's Commitment Percentage of the Affected Principal Amount with an Interest Period equal approximately to the applicable Remaining Interest Period, as determined by such Lender;

"D" equals the number of days from and including the first day of the applicable Remaining Interest Period to but excluding the last day of such Remaining Interest Period;

and any other out-of-pocket loss or expense (including any internal processing charge customarily charged by such Lender) suffered by such Lender in connection with such Eurodollar Advance, including, without limitation, in liquidating or employing deposits acquired to fund or maintain the funding of its Commitment Percentage of the Affected Principal Amount, or redeploying funds prepaid or repaid, in amounts which correspond to its Commitment Percentage of the Affected Principal Amount. Each determination by the Agent or a Lender pursuant to this
Section shall be conclusive and binding on the Borrower absent manifest error.

Section 2.15 Option to Fund

Each Lender has indicated that, if the Borrower elects to borrow or convert or continue to Eurodollar Advances, such Lender may wish to purchase one or more deposits in order to fund or maintain its funding of its Eurodollar Advances during the Interest Period in question; it being understood that the provisions of this Agreement relating to such funding are included only for the purpose of determining the rate of interest to be paid on such Eurodollar Advances and for purposes of determining amounts owning under Sections 2.11, 2.12 and 2.14. Each Lender shall be entitled to fund and maintain its funding of all or any part of each Eurodollar Advance made by it in

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any manner it sees fit, but all such determinations shall be made as if such Lender had actually funded and maintained its funding of such Eurodollar Advance during the applicable Interest Period through the purchase of deposits in an amount equal to such Eurodollar Advance and having a maturity corresponding to such Interest Period. The obligations of the Borrower under Sections 2.8, 2.9, 2.10, 2.11 and 2.12 shall survive the termination of the Aggregate Commitments, the payment of the Notes and all other amounts payable under the Loan Documents.

Section 2.16 Use of Proceeds

The Borrower agrees that the proceeds of the Loans shall be used solely for its general corporate purposes not inconsistent with the provisions hereof, including, without limitation, the purchase and retirement of outstanding common stock of the Borrower (but not the purchase or carrying of any other Margin Stock) and the provision by Borrower to its Subsidiaries of funds for use in connection with the business, operations and general corporate purposes of such Subsidiaries. Notwithstanding anything to the contrary contained herein, the Borrower further agrees that no part of the proceeds of any Loan will be used, directly or indirectly, for a purpose which violates any law, rule or regulation of any Governmental Authority, including the provisions of Regulations T, U or X of the Board of Governors of the Federal Reserve System, as amended.

Section 2.17 Extension of Maturity Date

Provided that no Default or Event of Default shall exist, the Borrower may request that the Maturity Date be extended for additional periods of 364 days each by giving written notice thereof (each an "Extension Request") to the Agent at any time during the period which is not more than 60 days nor less than 30 days prior to any then current Maturity Date and, upon receipt of each such notice, the Agent shall promptly notify each Lender thereof. The then current Maturity Date shall not be extended unless and until each Lender, in its sole and absolute discretion, shall have consented, in writing, to such request, in which event such then existing Maturity Date shall be extended to the date occurring 364 days from the date of the last such consent, provided, however, that if such date is not a Business Day, such extended Maturity Date shall be the immediately preceding Business Day. In the event that any Lender shall not have granted its consent to an Extension Request, the then current Maturity Date shall remain in effect. Each Lender shall endeavor to respond to each Extension Request by no later than 15 days following the receipt by such Lender from the Agent of notice of such Extension Request, provided that each Lender which shall have failed so to respond by such time shall be deemed not to have consented thereto.

Section 2.18 Agent's Records

The Agent's records regarding the amount of each Loan, each payment by the Borrower of principal and interest on the Loans and other information relating to the Loans shall be presumptively correct absent manifest error.

Section 2.19 Mitigation of Taxes and Costs

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(a) Each Lender agrees that, if requested by the Borrower after the occurrence of an event or the existence of a condition that would require the Borrower to make payments to such Lender under Section 2.8, 2.11 or 2.12, it will, to the extent not inconsistent with such Lender's internal policies, use reasonable efforts (subject to overall policy considerations of such Lender) (i) to make, fund or maintain the Commitments or Loans of such lender through another lending office of such Lender, or (ii) take such other reasonable measures, if as a result the additional amounts that would otherwise be required to be paid by the Borrower with respect to such Lender pursuant to said Sections would be materially reduced and if, as determined by such Lender in its sole discretion, the making, funding or maintaining of such Commitments or Loans through such other lending office or in accordance with such other measures, as the case may be, would not otherwise adversely affect such Commitments or Loans or the interests or such Lender.

(b) If the Borrower becomes obligated to pay additional amounts described in Section 2.8, 2.11 or 2.12 as a result of any condition described in such Sections and payment of such amount is demanded by any Lender, then, provided that no Default or Event of Default shall exist, the Borrower may, on ten Business Days' prior written notice to the Agent and such Lender, cause such Lender to (and such Lender shall) assign all of its rights and obligations under this Agreement to a Lender or other bank selected by the Borrower and acceptable to the Agent for a purchase price equal to the outstanding principal amount of such Lender's Loans and all accrued interest and fees thereon, provided that in no event shall the assigning Lender be required to pay or surrender to such purchasing Lender or other bank any of the fees received by such assigning Lender pursuant to this Agreement. The Borrower shall remain obligated to pay to such assigning Lender all additional amounts required to be paid by the Borrower pursuant to such Sections had there been no such assignment.

ARTICLE 3 FEES; PAYMENTS

Section 3.1 Commitment Fee

The Borrower agrees to pay to the Agent, for the account of the Lenders in accordance with each Lender's Commitment Percentage, a fee (the "Commitment Fee"), during the Commitment Period, equal to the Applicable Margin times the excess of (a) the Aggregate Commitments (excluding the amount of any cancelled or reduced portion of the Aggregate Commitments for which the Commitment Fee was paid upon each such cancellation or reduction under Section 2.4(b)) over (b) the average daily sum of the outstanding principal balance of the Loans. The Commitment Fee shall be payable quarterly in arrears on the last day of each March, June, September and December of each year, commencing on the first such day following the Effective Date, and ending on the date that the Aggregate Commitments shall expire or otherwise terminate. The Commitment Fee shall be calculated on the basis of a 360-day year for the actual number of days elapsed.

Section 3.2 Pro Rata Treatment and Application of Principal Payments

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Each payment, including each prepayment, of principal and interest on the Loans and of the Commitment Fee shall be made by the Borrower to the Agent at its office set forth in Section 11.2 in funds immediately available to the Agent at such office by 2:00 P.M. on the due date for such payment, and, promptly upon receipt thereof by the Agent, shall be remitted by the Agent in like funds as received, to the Lenders according to the Commitment Percentage of each Lender, in the case of the Commitment Fee, and pro rata according to the aggregate outstanding principal balance of the Loans, in the case of principal and interest due thereon. The failure of the Borrower to make any such payment by such time shall not constitute a default hereunder, provided that such payment is made on such due date, but any such payment made after 2:00 P.M. on such due date shall be deemed to have been made on the next Business Day for the purpose of calculating interest on amounts outstanding on the Loans. If any payment hereunder or under the Notes shall be due and payable on a day which is not a Business Day, the due date thereof (except as otherwise provided in the definition of Interest Period) shall be extended to the next Business Day and (except with respect to payments in respect of the Commitment Fee) interest shall be payable at the applicable rate specified herein during such extension. If any payment is made with respect to any Eurodollar Advance prior to the last day of the applicable Interest Period, the Borrower shall indemnify each Lender in accordance with Section 2.14.

Section 3.3 Utilization Fee

The Borrower agrees to pay to the Agent, for the account of each Lender a fee (the "Utilization Fee") equal to 0.05% of the amount of each such Lender's Loans made when, after giving effect thereto, the aggregate principal balance of all Loans outstanding hereunder and under the 1996 Revolving Credit would exceed 66 2/3% of the sum of the Aggregate Commitments, as such term is defined hereunder and under the 1996 Revolving Credit.

ARTICLE 4 REPRESENTATIONS AND WARRANTIES

In order to induce the Agent and the Lenders to enter into this Agreement and to make the Loans, the Borrower makes the following representations and warranties to the Agent and each Lender:

Section 4.1 Subsidiaries

The Borrower has only the Insurance Subsidiaries and Non-Insurance Subsidiaries set forth on Schedule 4.1.

Section 4.2 Existence and Power

Each of the Borrower and its Subsidiaries is duly organized or formed and validly existing in good standing under the laws of the jurisdiction of its incorporation or formation, has all requisite power and authority to own its Property and to carry on its business as now conducted, and is in good standing and authorized to do business as a foreign corporation in each jurisdiction in which the nature of the business conducted therein or the Property owned therein makes such

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qualification necessary, except where such failure to qualify could not reasonably be expected to have a Material Adverse Effect.

Section 4.3 Authority

The Borrower has full corporate power and authority to enter into, execute, deliver and perform the terms of the Loan Documents and to make the borrowings contemplated thereby all of which have been duly authorized by all proper and necessary corporate or other applicable action and are in full compliance with its Articles of Incorporation and By-Laws.

Section 4.4 Binding Agreement

The Loan Documents constitute the valid and legally binding obligations of the Borrower, enforceable in accordance with their respective terms, except as such enforceability may be limited by applicable bankruptcy, insolvency, reorganization or other similar laws now or hereafter in effect relating to or affecting the rights and remedies of creditors' generally and by general principles of equity, regardless of whether enforcement is sought in an action at law or a proceeding in equity, and the discretion of the court before which any action or proceeding therefor may be brought.

Section 4.5 Litigation

Except as set forth on Schedule 4.5, there are no actions, suits or proceedings at law or in equity or by or before any Governmental Authority (whether purportedly on behalf of the Borrower or any its Subsidiaries) pending or, to the knowledge of the Borrower, threatened against the Borrower or any of its Subsidiaries or any of their respective Properties or rights, which (i) could reasonably be expected to have a Material Adverse Effect, (ii) call into question the validity or enforceability of any of the Loan Documents, or (iii) could reasonably be expected to result in the rescission, termination or cancellation of any material license, franchise, right, permit or similar authorization held by the Borrower or any of its Subsidiaries.

Section 4.6 Required Consents

Except for information filings required to be made in the ordinary course of business which are not a condition to the Borrower's performance under the Loan Documents, no consent, authorization or approval of, filing with, notice to, or exemption by, stockholders, any Governmental Authority or any other Person is required to authorize, or is required in connection with the execution, delivery and performance of the Loan Documents or is required as a condition to the validity or enforceability of the Loan Documents.

Section 4.7 No Conflicting Agreements

Neither the Borrower nor any of its Subsidiaries is in default under any mortgage, indenture, contract or agreement to which it is a party or by which it or any of its Property is bound, the effect of which default could reasonably be expected to have a Material Adverse Effect. The

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execution, delivery or carrying out of the terms of the Loan Documents will not constitute a default under, or result in the creation or imposition of, or obligation to create, any Lien upon any Property of the Borrower or any of its Subsidiaries or result in a breach of or require the mandatory repayment of or other acceleration of payment under or pursuant to the terms of any such mortgage, indenture, contract or agreement.

Section 4.8 Compliance with Applicable Laws

Neither the Borrower nor any of its Subsidiaries is in default with respect to any judgment, order, writ, injunction, decree or decision of any Governmental Authority which default could reasonably be expected to have a Material Adverse Effect. Each of the Borrower and its Subsidiaries is complying in all material respects with all statutes, regulations, rules and orders applicable to the Borrower or such Subsidiary of all Governmental Authorities, including, without limitation, all Applicable Insurance Codes and Environmental Laws, a violation of which could reasonably be expected to have a Material Adverse Effect.

Section 4.9 Taxes

Each of the Borrower and its Subsidiaries has filed or caused to be filed all tax returns required to be filed and has paid, or has made adequate provision for the payment of, all taxes shown to be due and payable on said returns or in any assessments made against it (other than those being contested as required under Section 7.4) which would be material to the Borrower or any of its Subsidiaries, and no tax Liens have been filed with respect thereto. The charges, accruals and reserves on the books of the Borrower and each of its Subsidiaries with respect to all federal, state, local and other taxes are, to the best knowledge of the Borrower, adequate for the payment of all such taxes, and the Borrower knows of no unpaid assessment which is due and payable against it or any of its Subsidiaries or any claims being asserted which could reasonably be expected to have a Material Adverse Effect, except such thereof as are being contested as required under Section 7.4, and for which adequate reserves have been set aside in accordance with GAAP.

Section 4.10 Governmental Regulations

Neither the Borrower nor any of its Subsidiaries is subject to regulation under the Investment Company Act of 1940, as amended, the Public Utility Holding Company Act of 1935, as amended, or the Federal Power Act, and neither the Borrower nor any of its Subsidiaries is subject to any statute or regulation which prohibits or restricts the incurrence of Indebtedness under the Loan Documents, including, without limitation, statutes or regulations relative to common or contract carriers or to the sale of electricity, gas, steam, water, telephone, telegraph or other public utility services.

Section 4.11 Federal Reserve Regulations; Use of Loan Proceeds

Neither the Borrower nor any of its Subsidiaries is engaged principally, or as one of its important activities, in the business of extending credit for the purpose of purchasing or carrying any Margin Stock. No part of the proceeds of the Loans will be used, directly or indirectly,

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for a purpose which violates any law, rule or regulation of any Governmental Authority, including, without limitation, the provisions of Regulations T, U or X of the Board of Governors of the Federal Reserve System, as amended. No part of the proceeds of the Loans will be used, directly or indirectly, to purchase or carry Margin Stock or to extend credit to others for the purpose of purchasing or carrying Margin Stock, other than any shares of outstanding stock of the Borrower that are purchased by the Borrower using the proceeds of the Loans, which shares shall be returned to the status of authorized and unissued shares and retired. The Borrower understands that the Lenders, in good faith, are not relying upon such shares as collateral in extending or maintaining the Loans.

Section 4.12 Plans

Neither the Borrower nor any Subsidiary has a Pension Plan on the Effective Date.

Section 4.13 Financial Statements

(a) The Borrower has heretofore delivered to the Agent and the Lenders copies of its Form 10-K for the fiscal year ending December 31, 1997, containing the audited Consolidated Balance Sheets of the Borrower and its Subsidiaries as of December 31, 1997 and December 31, 1996, and the related Consolidated Statements of Income, Retained Earnings and Cash Flows for the three year periods ending December 31, 1997, and its Form 10-Q for the fiscal quarter ended June 30, 1998, containing the unaudited Consolidated Balance Sheet of the Borrower and its Subsidiaries for such fiscal quarter, together with the related Consolidated Statements of Income, Retained Earnings and Cash Flows for the fiscal quarter then ended (with the applicable related notes and schedules, the "Financial Statements"). The Financial Statements fairly present the Consolidated financial condition and results of the operations of the Borrower and its Subsidiaries as of the dates and for the periods indicated therein and have been prepared in conformity with GAAP. Except as reflected in the Financial Statements or in the footnotes thereto, neither the Borrower nor any of its Subsidiaries has any obligation or liability of any kind (whether fixed, accrued, Contingent, unmatured or otherwise) which, in accordance with GAAP, should have been shown in the Financial Statements and was not. Since December 31, 1997, the Borrower and each of its Subsidiaries has conducted its business only in the ordinary course and there has been no Material Adverse Change.

(b) The Borrower has heretofore delivered to the Lenders copies of the consolidated Annual Statements, as of December 31, 1997, of each of Mercury Casualty Company and American Mercury Insurance Company (together with the related notes and schedules thereto, the "Annual Statements"). The Annual Statements fairly present the financial condition and results of operations of the Insurance Subsidiaries included therein as of the dates and for the periods indicated therein and have been prepared in accordance with SAP.

Section 4.14 Property

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Each of the Borrower and its Subsidiaries has good and marketable title to all of its Property, title to which is material to the Borrower or such Subsidiary, subject to no Liens except Permitted Liens.

Section 4.15 Licenses, Franchises, Etc.

Each of the Borrower and its Subsidiaries possesses or has the right to use all licenses, franchises, Intellectual Property, and other rights as are material and necessary for the conduct of its business, and with respect to which it is in compliance, with no known conflict with the valid rights of others which could reasonably be expected to have a Material Adverse Effect. No event has occurred which permits or, to the best knowledge of the Borrower, after notice or the lapse of time or both, or any other condition, could reasonably be expected to permit, the revocation or termination of any such license, franchise, Intellectual Property, or other right which revocation or termination could reasonably be expected to have a Material Adverse Effect.

Section 4.16 Environmental Matters

(a) The Borrower and each of its Subsidiaries is in compliance in all material respects with the requirements of all applicable Environmental Laws, a violation of which could reasonably be expected to have a Material Adverse Effect.

(b) No Hazardous Substances have been generated or manufactured on, transported to or from, treated at, stored at or discharged from any Real Property in violation of any Environmental Laws which violation could reasonably be expected to have a Material Adverse Effect; no Hazardous Substances have been discharged into subsurface waters under any Real Property in violation of any Environmental Laws which violation could reasonably be expected to have a Material Adverse Effect; no Hazardous Substances have been discharged from any Real Property on or into Property or waters (including subsurface waters) adjacent to any Real Property in violation of any Environmental Laws which violation could reasonably be expected to have a Material Adverse Effect; and there are not now, nor ever have been, on any Real Property any underground or above ground storage tanks containing Hazardous Substances.

(c) Neither the Borrower nor any of its Subsidiaries (i) has received notice (written or oral) or otherwise learned of any claim, demand, suit, action, proceeding, event, condition, report, directive, Lien, violation, non-compliance or investigation indicating or concerning any potential or actual liability (including, without limitation, potential liability for enforcement, investigatory costs, cleanup costs, government response costs, removal costs, remedial costs, natural resources damages, Property damages, personal injuries or penalties) arising in connection with: (x) any non-compliance with or violation of the requirements of any applicable Environmental Laws, or (y) the presence of any Hazardous Substance on any Real Property (or any Real Property previously owned by the Borrower or any of its Subsidiaries) or the release or threatened release of any Hazardous Substance into the environment, (ii) to the knowledge of the Borrower has any threatened or actual liability in connection with the presence of any Hazardous Substance on any Real Property (or any Real Property previously owned by the Borrower or any of its Subsidiaries) or the release or threatened release of any Hazardous

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Substance into the environment, (iii) has received notice of any federal or state investigation evaluating whether any remedial action is needed to respond to the presence of any Hazardous Substance on any Real Property (or any Real Property previously owned by the Borrower or any of its Subsidiaries) or a release or threatened release of any Hazardous Substance into the environment for which the Borrower or any of its Subsidiaries is or may be liable, or (iv) has received notice that the Borrower or any of its Subsidiaries is or may be liable to any Person under any Environmental Law.

(d) To the knowledge of the Borrower no Real Property is located in an area identified by the Secretary of Housing and Urban Development as an area having special flood hazards.

Section 4.17 Labor Relations

There are no material controversies pending between the Borrower or any of its Subsidiaries and any of their respective employees, which could reasonably be expected to have a Material Adverse Effect.

Section 4.18 Burdensome Obligations

Neither the Borrower nor any of its Subsidiaries is a party to or bound by any license, franchise, agreement, deed, lease or other instrument, or subject to any restriction which, in the opinion of the management of the Borrower or such Subsidiary is so unusual or burdensome, in the context of its business, as in the foreseeable future might materially and adversely affect or impair the revenue or cash flows of the Borrower or such Subsidiary or the ability of the Borrower to perform its obligations under the Loan Documents. The Borrower does not presently anticipate that future expenditures by the Borrower or any of its Subsidiaries needed to meet the provisions of federal or state statutes, orders, rules or regulations will be so burdensome as to result in a Material Adverse Effect or Material Adverse Change.

Section 4.19 No Misrepresentation

No representation or warranty contained in any Loan Document and no certificate or report furnished or to be furnished by the Borrower or any of its Subsidiaries in connection with the transactions contemplated thereby, contains or will contain a misstatement of material fact, or, to the best knowledge of the Borrower, omits or will omit to state a material fact required to be stated in order to make the statements therein contained not misleading in the light of the circumstances under which made.

Section 4.20 Year 2000

The Borrower and its Subsidiaries have reviewed the effect of the Year 2000 Issue on the computer software, hardware and firmware systems and equipment containing embedded microchips used or relied upon in the conduct of their businesses (including systems and equipment supplied by others or with which such computer systems interface). The costs to the

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Borrower and its Subsidiaries of any reprogramming required as a result of the Year 2000 Issue to permit the proper functioning of such systems and equipment and the proper processing of data, and the testing of such reprogramming, and of the reasonably foreseeable consequences of the Year 2000 Issue to the Borrower and its Subsidiaries (including reprogramming errors and the failure of systems or equipment supplied by others) are not reasonably expected to result in an Event of Default or to have a material adverse effect on the business, assets, operations, prospects or financial condition of the Borrower and its Subsidiaries. The term "Year 2000 Issue" means the failure of computer software, hardware and firmware systems and equipment containing embedded computer chips to properly receive, transmit, process, manipulate, store, retrieve, retransmit or in any other way utilize data and information due to the occurrence of the year 2000 or the inclusion of dates on or after January 1, 2000.

ARTICLE 5 CONDITIONS TO FIRST LOANS

In addition to the conditions precedent set forth in Section 6, the obligation of each Lender to make its first Loan shall be subject to the fulfillment of the following conditions precedent:

Section 5.1 Evidence of Action

The Agent shall have received a certificate, dated the first Borrowing Date, of the Secretary or Assistant Secretary of the Borrower (i) attaching a true and complete copy of the resolutions of its Board of Directors and of all documents evidencing other necessary corporate action (in form and substance satisfactory to the Agent) taken by it to authorize the Loan Documents and the transactions contemplated thereby, (ii) attaching a true and complete copy of its Articles of Incorporation and By-Laws, (iii) setting forth the incumbency of its officer or officers who may sign the Loan Documents, including therein a signature specimen of such officer or officers and (iv) attaching a certificate of good standing of the Secretary of State of the State of California and of each other jurisdiction in which it is qualified to do business.

Section 5.2 This Agreement

The Agent shall have received counterparts of this Agreement signed by each of the parties hereto (or receipt by the Agent from a party hereto of a fax signature page signed by such party which shall have agreed to promptly provide the Agent with originally executed counterparts hereof).

Section 5.3 Notes

The Agent shall have received the Notes, duly executed by an Authorized Signatory of the Borrower.

Section 5.4 Approvals

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The Agent shall have received a certificate of an Authorized Signatory of the Borrower to the effect that all approvals and consents of all Persons required to be obtained in connection with the consummation of the transactions contemplated by the Loan Documents have been duly obtained and are in full force and effect, and that all required notices have been given and all required waiting periods have expired.

Section 5.5 Opinion of Counsel to the Borrower

The Agent shall have received an opinion of Latham & Watkins, counsel to the Borrower, addressed to the Agent, the Lenders and Special Counsel, and dated the first Borrowing Date, substantially in the form of Exhibit E, and covering such additional matters as the Required Lenders may reasonably request. It is understood that such opinion is being delivered to the Agent and the Lenders upon the direction of the Borrower and that the Agent and the Lenders may and will rely upon such opinion.

Section 5.6 Opinion of Special Counsel

The Agent shall have received an opinion of Special Counsel, addressed to the Agent and the Lenders and dated the first Borrowing Date substantially in the form of Exhibit F.

Section 5.7 Payment of Fees

The Borrower shall have paid to the Agent and the Lenders all fees and expenses which it shall have agreed to pay, to the extent such fees and expenses shall have become payable on or prior to the Effective Date, and shall have paid the reasonable fees and disbursements of Special Counsel which the Borrower is obligated to pay in accordance with Section 11.5 and which shall have accrued up to the Effective Date.

Section 5.8 Other Documents

The Agent shall have received such other documents (including financial statements and projections), each in form and substance reasonably satisfactory to the Agent, as the Agent shall reasonably require in connection with the making of the first Loans.

ARTICLE 6 CONDITIONS OF LENDING - ALL LOANS

The obligation of each Lender to make any Loan is subject to the satisfaction of the following conditions precedent as of the date of such Loan:

Section 6.1 Compliance

On each Borrowing Date and after giving effect to the Loans to be made thereon, (i) the Borrower shall be in compliance with all of the terms, covenants and conditions thereof, (ii) there shall exist no Default or Event of Default, (iii) the representations and warranties contained in

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the Loan Documents shall be true and correct with the same effect as though such representations and warranties had been made on such Borrowing Date (except that Schedules 4.1 and 4.5 shall have been updated, as appropriate, in order to make the representations and warranties expressed in Sections 4.1 and 4.5 true and correct as of such Borrowing Date) and (iv) the aggregate outstanding principal balance of the Loans will not exceed the Aggregate Commitments. Each borrowing by the Borrower shall constitute a certification by the Borrower as of such Borrowing Date that each of the foregoing matters is true and correct in all respects.

Section 6.2 Loan Closings

All documents required by the provisions of this Agreement to be executed or delivered to the Agent on or before the applicable Borrowing Date shall have been executed and shall have been delivered at the office of the Agent set forth in Section 11.2 on or before such Borrowing Date.

Section 6.3 Borrowing Request

The Agent shall have received a Borrowing Request duly executed by an Authorized Signatory of the Borrower.

Section 6.4 Concerning Regulation U

If required by Regulation U, the Agent shall have received for each Lender an appropriately completed Form FR U-1.

Section 6.5 Other Documents

The Agent shall have received such other documents as the Agent or the Lenders shall reasonably request.

ARTICLE 7 AFFIRMATIVE COVENANTS

The Borrower agrees that, so long as this Agreement is in effect, any Loan remains outstanding and unpaid, or any other amount is owing under any Loan Document to any Lender or the Agent, the Borrower shall:

Section 7.1 Financial Statements

Maintain, and cause each Subsidiary to maintain, a standard system of accounting in accordance with GAAP and, with respect to each Insurance Subsidiary, SAP, and furnish to the Agent and each Lender:

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(a) As soon as available and, in any event, within 105 days after the close of each fiscal year, a copy of (x) the Borrower's 10-K in respect of such fiscal year, and (y) (i) the Borrower's Consolidated Balance Sheet as of the end of such fiscal year, and (ii) the related Consolidated Statements of Income and Shareholders' Equity and Cash Flows, as of and through the end of such fiscal year, setting forth in each case in comparative form the corresponding figures in respect of the previous fiscal year, all in reasonable detail, and accompanied by a report of the Borrower's auditors, which report shall be unqualified as to scope of audit and going concern or similar or other qualification and shall state that (A) such auditors audited such financial statements, (B) such audit was made in accordance with generally accepted auditing standards in effect at the time and provides a reasonable basis for such opinion, and (C) said financial statements have been prepared in accordance with GAAP;

(b) After request by the Agent therefor, simultaneously with the delivery of the certified statements required by clause (a) above, copies of a statement of the Borrower's auditors (i) confirming the computations by the Borrower (which computations shall accompany such statement and shall be in reasonable detail) with respect to the Borrower's compliance with Sections 7.11, 7.12, 7.13, and 7.14, and (ii) stating that, in making the examination necessary for their audit of the financial statements of the Borrower for such fiscal year, nothing came to their attention that caused them to believe that any Default or an Event of Default existed on the date of such statements;

(c) As soon as available, and in any event within 60 days after the end of each of the first three fiscal quarters of each fiscal year, a copy of (x) the Borrower's 10-Q in respect of such fiscal quarter, and (y) (i) the Borrower's Consolidated Balance Sheet as of the end of such quarter, and (ii) the related Consolidated Statements of Income Shareholders' Equity and Cash Flows for (A) such quarter, and (B) the period from the beginning of the then current fiscal year to the end of such quarter, in each case in comparable form with the prior fiscal year, all in reasonable detail and prepared in accordance with GAAP (without footnotes and subject to year-end audit adjustments);

(d) Simultaneously with the delivery of the financial statements required by clauses (a) and (c) above, a certificate of the chief financial officer of the Borrower certifying that no Default or Event of Default shall have occurred or be continuing or, if so, specifying in such certificate all such Defaults and Events of Default, and setting forth computations in reasonable detail demonstrating compliance with Sections 7.11, 7.12, 7.13, and 7.14;

(e) As soon as practicable after the filing thereof but in any case no later than 105 days after the close of each fiscal year of the Borrower and 60 days after the close of each fiscal quarter of the Borrower, copies of each annual and quarterly statutory statement filed by the Borrower or any Reporting Insurance Subsidiary with the department of insurance of the state of domicile of each Reporting Insurance Subsidiary or any other Governmental Authority;

(f) Promptly upon receipt thereof, copies of any audit reports and management letters delivered in connection with the statements referred to in
Section 7.1(a); and

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(g) From time to time, such other information regarding the financial position or business of the Borrower and the Subsidiaries, as either Agent, at the request of any Lender, may reasonably request.

Section 7.2 Certificates; Other Information

Furnish to the Agent and each Lender:

(a) Prompt written notice if: (i) the Borrower becomes aware that any Indebtedness of the Borrower or any of its Subsidiaries is declared or shall become due and payable prior to its stated maturity, or is called and not paid when due, (ii) the Borrower becomes aware that a default shall have occurred under any note (other than the Notes), or the holder of any such note, or other evidence of Indebtedness, certificate or security evidencing any such Indebtedness or any obligee with respect to any other Indebtedness of the Borrower or any of its Subsidiaries has the right to declare any such Indebtedness due and payable prior to its stated maturity, or (iii) the Borrower becomes aware that there shall occur and be continuing a Default or an Event of Default or a Material Adverse Change;

(b) Promptly following the Borrower becoming aware of the same, written notice of: (i) any citation, summons, subpoena, order to show cause or other document naming the Borrower or any of its Subsidiaries a party to any proceeding before any Governmental Authority which could reasonably be expected to have a Material Adverse Effect or which calls into question the validity or enforceability of any of the Loan Documents, and include with such notice a copy of such citation, summons, subpoena, order to show cause or other document, (ii) any lapse or other termination of any material license, Intellectual Property, permit, franchise or other authorization issued to the Borrower or any of its Subsidiaries by any Person or Governmental Authority, and (iii) any refusal by any Person or Governmental Authority to renew or extend any such material license, Intellectual Property, permit, franchise or other authorization, which lapse, termination, refusal or dispute could reasonably be expected to have a Material Adverse Effect;

(c) Promptly upon becoming available, copies of all regular or periodic reports (including, without limitation, current reports on Form 8-K) which the Borrower or any Subsidiary may now or hereafter be required to file with or deliver to the SEC, and copies of all material news releases and proxy statements sent to stockholders;

(d) Prompt written notice of any order, notice, claim or proceeding received by, or brought against, the Borrower or any of its Subsidiaries, or with respect to any of the Real Property, under any Environmental Law.

(e) Such other information as the Agent or any Lender shall reasonably request from time to time.

Section 7.3 Legal Existence

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Maintain, and cause each of its Subsidiaries so to maintain, its corporate existence, in good standing in the jurisdiction of its incorporation and in each other jurisdiction in which the failure so to do could reasonably be expected to have a Material Adverse Effect.

Section 7.4 Taxes

Pay and discharge when due, and cause each of its Subsidiaries so to do, all Taxes, assessments and governmental charges, license fees and levies upon, or with respect to the Borrower or such Subsidiary and all Taxes upon the income, profits and Property of the Borrower and its Subsidiaries, which if unpaid, could reasonably be expected to have a Material Adverse Effect or become a Lien on the Property of the Borrower or such Subsidiary (other than a Lien described in Section 8.2(i)), unless and to the extent only that such Taxes, assessments, charges, license fees and levies shall be contested in good faith and by appropriate proceedings diligently conducted by the Borrower or such Subsidiary and, provided, that the Borrower shall give the Agent prompt notice of such contest and that such reserve or other appropriate provision as shall be required by the Accountants in accordance with GAAP shall have been made therefor.

Section 7.5 Insurance

Maintain, and cause each of its Subsidiaries to maintain, with financially sound and reputable insurance companies insurance on all its Property in at least such amounts and against at least such risks (but including in any event public liability, property damage, workers' compensation and business interruption coverage) as are usually insured against in the same general area by companies engaged in the same or a similar business; and furnish to the Agent, upon written request, full information as to the insurance carried.

Section 7.6 Payment of Indebtedness and Performance of Obligations

Pay and discharge when due, and cause each of its Subsidiaries to pay and discharge, all lawful Indebtedness, obligations and claims for labor, materials and supplies or otherwise which, if unpaid, might (i) have a Material Adverse Effect, or (ii) become a Lien upon Property of the Borrower or any of its Subsidiaries other than a Permitted Lien, unless and to the extent only that the validity of such Indebtedness, obligation or claim shall be contested in good faith and by appropriate proceedings diligently conducted by the Borrower or such Subsidiary, provided that the Borrower shall give the Agent prompt notice of any such contest and that such reserve or other appropriate provision as shall be required by the Accountants in accordance with GAAP shall have been made therefor.

Section 7.7 Condition of Property

At all times, maintain, protect and keep in good repair, working order and condition (ordinary wear and tear excepted), and cause each of its Subsidiaries so to do, all Property necessary to the operation of the Borrower's or such Subsidiary's business.

Section 7.8 Observance of Legal Requirements

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Observe and comply in all respects, and cause each of its Subsidiaries so to do, with all laws, ordinances, orders, judgments, rules, regulations, licenses, certifications, franchises, permits, directions and requirements of all Governmental Authorities, which now or at any time hereafter may be applicable to it, a violation of which could reasonably be expected to have a Material Adverse Effect, except such thereof as shall be contested in good faith and by appropriate proceedings diligently conducted by the Borrower or such Subsidiary, provided that the Borrower shall give the Agent prompt notice of such contest and that such reserve or other appropriate provision as shall be required by the Accountants in accordance with GAAP shall have been made therefor.

Section 7.9 Inspection of Property; Books and Records; Discussions

Keep proper books of record and account in which full, true and correct entries in conformity with GAAP and all requirements of law shall be made of all dealings and transactions in relation to its business and activities and permit representatives of the Agent and any Lender to visit its offices, to inspect any of its Property and examine and make copies or abstracts from any of its books and records at any reasonable time and as often as may reasonably be desired, and to discuss the business, operations, prospects, licenses, Property and financial condition of the Borrower and its Subsidiaries with the officers thereof and the Accountants.

Section 7.10 Authorizations

Maintain and cause each of its Subsidiaries to maintain, in full force and effect, all licenses, copyrights, patents, trademarks, trade names, franchises, permits, applications, reports, and other authorizations and rights, which, if not so maintained, would individually or in the aggregate have a Material Adverse Effect.

Section 7.11 Adjusted Net Worth

As of any date of determination, have Adjusted Net Worth of not less than the sum of (a) $500,000,000, plus (b) 50% of the Consolidated net income (but not less than zero) for each full fiscal quarter ended during the period commencing on July 1, 1998 and ending on such date of determination.

Section 7.12 GAAP Net Worth

As of any date of determination, have GAAP Net Worth of not less than the sum of (a) $475,000,000, plus (b) 50% of the Consolidated net income (but not less than zero) for each full fiscal quarter ended during the period commencing on July 1, 1998 and ending on such date of determination.

Section 7.13 Leverage Ratio

Maintain at all times a Leverage Ratio of not more than 0.30:1.00.

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Section 7.14 Interest Coverage Ratio

Maintain at all times an Interest Coverage Ratio greater than 2.50:1.00.

Section 7.15 Year 2000 Covenant

The Borrower shall take, and shall cause each of its Subsidiaries to take, all necessary action to complete in all material respects by June 30, 1999, the reprogramming of computer software, hardware and firmware systems and equipment containing embedded microchips owned or operated by or for the Borrower and its Subsidiaries or used or relied upon in the conduct of their businesses (including systems and equipment supplied by others or with which such systems of the Borrower or any of its Subsidiaries interface) required as a result of the Year 2000 Issue to permit the proper functioning of such computer systems and other equipment and the testing of such systems and equipment, as so reprogrammed. At the request of the Agent, the Borrower shall provide, and shall cause each of its Subsidiaries to provide, to the Agent reasonable assurance of compliance with the preceding sentence.

ARTICLE 8 NEGATIVE COVENANTS

The Borrower agrees that, so long as this Agreement is in effect, any Loan remains outstanding and unpaid, or any other amount is owing under any Loan Document to any Lender or the Agent, the Borrower shall not, directly or indirectly:

Section 8.1 Indebtedness of Subsidiaries

Permit any Subsidiary of the Borrower to create, incur, assume or suffer to exist any liability for Indebtedness, except (i) Indebtedness existing on the date hereof as set forth on Schedule 8.1, but not any increases in the amount thereof, (ii) Indebtedness secured by Liens on Real Property acquired by such Subsidiary after the Effective Date and (iii) Indebtedness (not in excess of $25,000,000 aggregate principal amount at any time outstanding) secured by Liens permitted under Section 8.2(xi), provided that after giving effect to any Indebtedness permitted under clauses (ii) and (iii) above, the Borrower is in compliance with the provisions of Sections 7.13, 7.14 and 8.2(vii).

Section 8.2 Liens

Create, incur, assume or suffer to exist any Lien upon any of its Property, whether now owned or hereafter acquired, or permit any of its Subsidiaries so to do, except (i) Liens for Taxes, assessments or similar charges incurred in the ordinary course of business which are not delinquent or which are being contested in accordance with Section 7.4, provided that enforcement of such Liens is stayed pending such contest, (ii) Liens in connection with workers' compensation, unemployment insurance or other social security obligations (but not ERISA), (iii) deposits or pledges to secure bids, tenders, contracts (other than contracts for the payment of money), leases, statutory obligations, surety and appeal bonds and other obligations of like nature arising in the

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ordinary course of business, (iv) zoning ordinances, easements, rights of way, minor defects, irregularities, and other similar restrictions affecting real Property which do not materially adversely affect the value of such real Property or the financial condition of the Borrower or such Subsidiary or impair its use for the operation of the business of the Borrower or such Subsidiary,
(v) Liens arising by operation of law such as mechanics', materialmen's, carriers', warehousemen's liens incurred in the ordinary course of business which are not delinquent or which are being contested in accordance with Section 7.6, provided that enforcement of such Liens is stayed pending such contest,
(vi) Liens arising out of judgments or decrees aggregating $5,000,000 or less in existence less than 30 days after the entry thereof or which are being contested in accordance with Section 7.6, provided that enforcement of such Liens is stayed pending such contest or the payment of which is covered by insurance as to which the carrier has acknowledged liability in writing, (vii) Liens on Real Property of any Subsidiary of the Borrower acquired after the Effective Date to secure Indebtedness permitted by Section 8.1(ii), incurred in connection with the acquisition of such Property, provided that each such Lien is limited to such Property so acquired, (viii) Liens on Property of the Borrower and its Subsidiaries existing on the Effective Date as set forth on Schedule 8.2 as renewed from time to time, but not any increases in the amounts secured thereby,
(ix) purchase money security interests in personal property, provided that each such Lien is limited to such Property so purchased, (x) banker's liens arising in the ordinary course of business and (xi) Liens on real property owned by Subsidiaries of the Borrower securing Indebtedness permitted under Section 8.1(iii), provided that such Liens are limited to the real property so owned.

Section 8.3 Mergers, Acquisitions and Dispositions

Consolidate or merge into or with any Person, or make any Acquisition or Disposition, or enter into any binding agreement to do any of the foregoing which is not contingent on obtaining the consent of the Required Lenders, or permit any Subsidiary of the Borrower to do any of the foregoing, except that (a) a Subsidiary of the Borrower may consolidate and merge with another wholly-owned Subsidiary of the Borrower, if (i) immediately before and after giving effect thereto no Default or Event of Default shall or would exist and (ii) any such consolidation or merger would not cause any Applicable Insurance Regulatory Authority to restrict the ability of any Insurance Subsidiary to pay dividends or otherwise make distributions to the Borrower or any of its Subsidiaries in any manner, and (b) the Borrower may make Acquisitions and Dispositions, if (i) the aggregate consolidated amount of any Capital Stock or Property so acquired in any calendar year (determined on the basis of the fair market value of any Capital Stock or Property acquired), or the aggregate Consolidated amount of any assets sold, leased or otherwise disposed of in any calendar year (determined on the basis of the fair market value of any assets so sold, leased or disposed of) would not exceed 15% of the Borrower's Consolidated Statutory Capital and Surplus as of the end of the immediately preceding calendar year, (ii) an Event of Default would not exist before or after giving effect thereto and (iii) any such Acquisition or Disposition would not cause any Applicable Insurance Regulatory Authority to restrict the ability of any Insurance Subsidiary to pay dividends or otherwise make distributions to the Borrower or any of its Subsidiaries in any manner, provided, however, that the foregoing shall not limit Dispositions of investment securities as part of the management of a securities portfolio of the Borrower or any of its Subsidiaries.

Section 8.4 Line of Business

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Engage, or permit any Subsidiary of the Borrower to engage, in any material respect in any business other than a business in which the Borrower or any Subsidiary is engaged in on the Effective Date and any other business reasonably related thereto.

Section 8.5 Articles of Incorporation and By-laws

Amend or otherwise modify its Articles of Incorporation or By-Laws in any way which would adversely affect the interests of the Agent and the Lenders under any of the Loan Documents, or permit any of its Subsidiaries so to do.

Section 8.6 Fiscal Year

Change its fiscal year from that in effect on the Effective Date, or permit any of its Subsidiaries so to do.

Section 8.7 Transactions with Affiliates

Become, or permit any Subsidiary to become, a party to any transaction with any Affiliate of the Borrower on a basis less favorable to the Borrower or such Subsidiary in any material respect than if such transaction were not with an Affiliate of the Borrower other than (A) advances made to employees of the Borrower or any Subsidiary in the ordinary course of business in connection with their employment, (B) transactions in which the aggregate rental value, remuneration or other consideration (including the value of a loan) together with the aggregate rental value, remuneration or other consideration (including the value of a loan) of all such other transactions consummated in the year during which such transaction is proposed to be consummated, does not exceed $5,000,000, (C) management or similar agreements entered among the Borrower and any Subsidiaries in the ordinary course of business, (D) transactions effected pursuant to the agreement, date October 7, 1985, by and among the Borrower, George Joseph and Gloria Joseph with respect to the ownership by George Joseph and Gloria Joseph of the Borrower's Common Stock, (E) payments to officers or directors of the Borrower or any Subsidiaries in the ordinary course of their employment, (F) dividends otherwise permitted by this Agreement or (G) the provision by the Borrower to its Subsidiaries of funds as contemplated by Section 2.16.

Section 8.8 Issuance of Additional Stock by Subsidiaries

Permit any of its Subsidiaries to issue, directly or indirectly, any additional Stock or other equity interests of such Subsidiary, other than to the Borrower or to a wholly-owned Subsidiary of the Borrower.

Section 8.9 Reinsurance Agreements

Permit any Insurance Subsidiary to enter into a treaty to cede any of its obligations to any reinsurer that could reasonably be expected to have a Material Adverse Effect.

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Section 8.10 Adoption of Pension Plans

Adopt a Pension Plan, or permit any Subsidiary so to do, unless this Agreement is amended, in form and substance satisfactory to the Required Lenders, to insert the customary provisions with respect thereto.

ARTICLE 9 DEFAULT

Section 9.1 Events of Default

The following shall each constitute an "Event of Default" hereunder:

(a) The failure of the Borrower to pay any installment of principal on any Note on the date when due and payable; or

(b) The failure of the Borrower to pay any installment of interest or any other fees or expenses payable under any Loan Document or otherwise to the Agent with respect to the loan facilities established hereunder within three Business Days after the date when due and payable; or

(c) The use of the proceeds of any Loan in a manner inconsistent with or in violation of Section 2.16; or

(d) The failure of the Borrower to observe or perform any covenant or agreement contained in Sections 7.11, 7.12, 7.13, 7.14 or Section 8; or

(e) The failure to observe or perform any other term, covenant, or agreement contained in any Loan Document and such failure shall have continued unremedied for a period of 30 days after the earlier of the Borrower becoming aware of such failure and the receipt by the Borrower of notice of such failure from the Agent; or

(f) Any representation or warranty made in any Loan Document or in any certificate, report, opinion (other than an opinion of counsel) or other document delivered or to be delivered pursuant thereto, shall prove to have been incorrect or misleading (whether because of misstatement or omission) in any material respect when made; or

(g) Obligations of the Borrower (other than its obligations under the Notes) or any of its Subsidiaries, whether as principal, guarantor, surety or other obligor, for the payment of any Indebtedness or operating leases in excess of $5,000,000 in the aggregate (i) shall become or shall be declared to be due and payable prior to the expressed maturity thereof, or (ii) shall not be paid when due or within any grace period for the payment thereof, or (iii) any holder of any such obligation shall have the right to declare such obligation due and payable prior to the expressed maturity thereof; or

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(h) The Borrower or any of its Subsidiaries shall (i) suspend or discontinue its business, (ii) make an assignment for the benefit of creditors,
(iii) generally not be paying its debts as such debts become due, (iv) admit in writing its inability to pay its debts as they become due, (v) file a voluntary petition in bankruptcy, (vi) become insolvent (however such insolvency shall be evidenced), (vii) file any petition or answer seeking for itself any reorganization, arrangement, composition, readjustment of debt, liquidation or dissolution or similar relief under any present or future statute, law or regulation of any jurisdiction, (viii) petition or apply to any tribunal for any receiver, custodian or any trustee for any substantial part of its Property,
(ix) be the subject of any such proceeding filed against it which remains undismissed for a period of 45 days, (x) file any answer admitting or not contesting the material allegations of any such petition filed against it or any order, judgment or decree approving such petition in any such proceeding, (xi) seek, approve, consent to, or acquiesce in any such proceeding, or in the appointment of any trustee, receiver, sequestrator, custodian, liquidator, or fiscal agent for it, or any substantial part of its Property, or an order is entered appointing any such trustee, receiver, sequestrator, custodian, liquidator or fiscal agent and such order remains in effect for 45 days, (xii) any conservatorship or similar proceeding is commenced in respect of the Borrower or any Reporting Insurance Subsidiary by or on behalf of the California Department of Insurance or the department of insurance of any other state of domicile having jurisdiction or (xiii) take any formal action for the purpose of effecting any of the foregoing or looking to the liquidation or dissolution of the Borrower or such Subsidiary; or

(i) An order for relief is entered under the United States bankruptcy laws or any other decree or order is entered by a court having jurisdiction (i) adjudging the Borrower or any of its Subsidiaries bankrupt or insolvent, (ii) approving as properly filed a petition seeking reorganization, liquidation, arrangement, adjustment or composition of or in respect of the Borrower or any of its Subsidiaries under the United States bankruptcy laws or any other applicable Federal or state law, (iii) appointing a receiver, liquidator, assignee, trustee, custodian, sequestrator (or other similar official) of the Borrower or any of its Subsidiaries or of any substantial part of the Property thereof, or (iv) ordering the winding up or liquidation of the affairs of the Borrower or any of its Subsidiaries, and any such decree or order continues unstayed and in effect for a period of 45 days; or

(j) Judgments or decrees against the Borrower or any of its Subsidiaries aggregating in excess of $5,000,000 shall remain unpaid, unstayed, undischarged, unbonded and undismissed for a period of 30 days unless the payment thereof is covered in full by insurance as to which the carrier has acknowledged liability in writing; or

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(k) After the Effective Date (1) Any Person (other than George Joseph or Gloria Joseph), acting alone or with a group of Persons acting in concert, (i) shall have or acquire beneficial ownership of securities (or options therefor) having 20% or more of the ordinary voting power of the Borrower, or (ii) shall possess, directly or indirectly, the power to direct or cause the direction of the management and policies of the Borrower, whether through the ownership of voting securities, by contract or otherwise, or (2) directors of the Borrower constituting that percentage necessary to approve corporate action shall not have been directors on the date hereof or directors designated or approved by directors on the date hereof; or

(l) Any license, franchise, permit, right, approval or agreement of the Borrower or any Subsidiary to own or operate any Operating Entity owned or operated by the Borrower or such Subsidiary (i) is not renewed, or is suspended or revoked and (ii) the non-renewal, suspension or revocation thereof would have a Material Adverse Effect; or

(m) Any Loan Document shall cease, for any reason, to be in full force and effect or the Borrower shall so assert in writing or shall disavow any of its obligations thereunder; or

(n) An event of default shall occur and be continuing under the 1996 Revolving Credit.

Upon the occurrence of an Event of Default or at any time thereafter during the continuance thereof, (a) if such event is an Event of Default specified in clause (h) or (i) above, the Aggregate Commitments shall immediately and automatically terminate and the Loans, all accrued and unpaid interest thereon and all other amounts owing under the Loan Documents shall immediately become due and payable and the Agent may, and, upon the direction of the Required Lenders shall, exercise any and all remedies and other rights provided in the Loan Documents, and (b) if such event is any other Event of Default, any or all of the following actions may be taken: (i) with the consent of the Required Lenders, the Agent may, and upon the direction of the Required Lenders shall, by notice to the Borrower, declare the Aggregate Commitments to be terminated forthwith, whereupon the Aggregate Commitments shall immediately terminate, and (ii) with the consent of the Required Lenders, the Agent may, and upon the direction of the Required Lenders shall, by notice of default to the Borrower, declare the Loans, all accrued and unpaid interest thereon, and all other amounts owing under the Loan Documents to be due and payable forthwith, whereupon the same shall immediately become due and payable, and the Agent may, and upon the direction of the Required Lenders shall, exercise any and all remedies and other rights provided pursuant to the Loan Documents. Except as otherwise provided in this Section, presentment, demand, protest and all other notices of any kind are hereby expressly waived. To the fullest extent not prohibited by applicable law, the Borrower hereby further expressly waives and covenants not to assert any appraisement, valuation, stay, extension, redemption or similar laws, now or at any time hereafter in force which might delay, prevent or otherwise impede the performance or enforcement of any Loan Document.

In the event that the Aggregate Commitments shall have been terminated or the Notes shall have been declared due and payable pursuant to the provisions of this Section, any funds received by the Agent and the Lenders from or on behalf of the Borrower shall be applied by

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the Agent and the Lenders in liquidation of the Loans and the obligations of the Borrower under the Loan Documents in the following manner and order: (i) first, to the payment of interest on, and then the principal portion of, any Loans which the Agent may have advanced on behalf of any Lender for which the Agent has not then been reimbursed by such Lender or the Borrower; (ii) second, to the payment of any fees or expenses due the Agent from the Borrower, (iii) third, to reimburse the Agent and the Lenders for any expenses (to the extent not paid pursuant to clause (ii) above) due from the Borrower pursuant to the provisions of Section 11.5; (iv) fourth, to the payment of accrued Commitment Fees and all other fees, expenses and amounts due under the Loan Documents (other than principal and interest on the Notes); (v) fifth, to the payment of interest due on the Notes; (vi) sixth, to the payment of principal outstanding on the Notes; and (vii) seventh, to the payment of any other amounts owing to the Agent and the Lenders under any Loan Document.

ARTICLE 10 THE AGENT

Section 10.1 Appointment

Each Lender hereby irrevocably designates and appoints BNY as the Agent of such Lender under the Loan Documents and each such Lender hereby irrevocably authorizes BNY, as the Agent for such Lender, to take such action on its behalf under the provisions of the Loan Documents and to exercise such powers and perform such duties as are expressly delegated to the Agent by the terms of the Loan Documents, together with such other powers as are reasonably incidental thereto. Notwithstanding any provision to the contrary elsewhere in any Loan Document, the Agent shall not have any duties or responsibilities other than those expressly set forth therein, or any fiduciary relationship with any Lender, and no implied covenants, functions, responsibilities, duties, obligations or liabilities shall be read into the Loan Documents or otherwise exist against the Agent.

Section 10.2 Delegation of Duties

The Agent may execute any of its duties under the Loan Documents by or through agents or attorneys-in-fact and shall be entitled to rely upon the advice of counsel concerning all matters pertaining to such duties.

Section 10.3 Exculpatory Provisions

Neither the Agent nor any of its officers, directors, employees, agents, attorneys-in-fact or affiliates shall be (i) liable for any action lawfully taken or omitted to be taken by it or such Person under or in connection with the Loan Documents (except the Agent for its own gross negligence or willful misconduct), or (ii) responsible in any manner to any of the Lenders for any recitals, statements, representations or warranties made by the Borrower or any officer thereof contained in the Loan Documents or in any certificate, report, statement or other document referred to or provided for in, or received by the Agent under or in connection with, the Loan Documents or for the value, validity, effectiveness, genuineness, perfection, enforceability or sufficiency of any of the Loan Documents or for any failure of the Borrower or any other Person to perform its

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obligations thereunder. The Agent shall not be under any obligation to any Lender to ascertain or to inquire as to the observance or performance of any of the agreements contained in, or conditions of, the Loan Documents, or to inspect the properties, books or records of the Borrower. The Agent shall not be under any liability or responsibility whatsoever, as Agent, to the Borrower or any other Person as a consequence of any failure or delay in performance, or any breach, by any Lender of any of its obligations under any of the Loan Documents.

Section 10.4 Reliance by Agent

The Agent shall be entitled to rely, and shall be fully protected in relying, upon any writing, resolution, notice, consent, certificate, affidavit, opinion, letter, cablegram, telegram, fax, telex or teletype message, statement, order or other document or conversation believed by it to be genuine and correct and to have been signed, sent or made by the proper Person or Persons and upon advice and statements of legal counsel (including, without limitation, counsel to the Borrower), independent accountants and other experts selected by the Agent. The Agent may treat each Lender, or the Person designated in the last notice filed with it under this Section, as the holder of all of the interests of such Lender in its Loans and in its Note until written notice of transfer, signed by such Lender (or the Person designated in the last notice filed with the Agent) and by the Person designated in such written notice of transfer, in form and substance satisfactory to the Agent, shall have been filed with the Agent. The Agent shall not be under any duty to examine or pass upon the validity, effectiveness, enforceability, perfection or genuineness of the Loan Documents or any instrument, document or communication furnished pursuant thereto or in connection therewith, and the Agent shall be entitled to assume that the same are valid, effective and genuine, have been signed or sent by the proper parties and are what they purport to be. The Agent shall be fully justified in failing or refusing to take any action under the Loan Documents unless it shall first receive such advice or concurrence of the Required Lenders as it deems appropriate. The Agent shall in all cases be fully protected in acting, or in refraining from acting, under the Loan Documents in accordance with a request or direction of the Required Lenders, and such request or direction and any action taken or failure to act pursuant thereto shall be binding upon all the Lenders and all future holders of the Notes.

Section 10.5 Notice of Default

The Agent shall not be deemed to have knowledge or notice of the occurrence of any Default or Event of Default unless the Agent has received written notice thereof from a Lender or the Borrower. In the event that the Agent receives such a notice, the Agent shall promptly give notice thereof to the Lenders and the Borrower. The Agent shall take such action with respect to such Default or Event of Default as shall be directed by the Required Lenders, provided, however, that unless and until the Agent shall have received such directions, the Agent may (but shall not be obligated to) take such action, or refrain from taking such action, with respect to such Default or Event of Default as it shall deem to be in the best interests of the Lenders.

Section 10.6 Non-Reliance on Agent and Other Lenders

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Each Lender expressly acknowledges that neither the Agent nor any of its respective officers, directors, employees, agents, attorneys-in-fact or affiliates has made any representations or warranties to it and that no act by the Agent hereinafter, including any review of the affairs of the Borrower, shall be deemed to constitute any representation or warranty by the Agent to any Lender. Each Lender represents to the Agent that it has, independently and without reliance upon the Agent or any other Lender, and based on such documents and information as it has deemed appropriate, made its own evaluation of and investigation into the business, operations, Property, financial and other condition and creditworthiness of the Borrower and made its own decision to enter into this Agreement. Each Lender also represents that it will, independently and without reliance upon the Agent or any other Lender, and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit analysis, evaluations and decisions in taking or not taking action under any Loan Document, and to make such investigation as it deems necessary to inform itself as to the business, operations, Property, financial and other condition and creditworthiness of the Borrower. Except for notices, reports and other documents expressly required to be furnished to the Lenders by the Agent hereunder, the Agent shall not have any duty or responsibility to provide any Lender with any credit or other information concerning the business, operations, Property, financial and other condition or creditworthiness of the Borrower which may come into the possession of the Agent or any of its officers, directors, employees, agents, attorneys-in-fact or affiliates.

Section 10.7 Indemnification

Each Lender agrees to indemnify and reimburse the Agent in its capacity as such (to the extent not promptly reimbursed by the Borrower and without limiting the obligation of the Borrower to do so), pro rata according to the outstanding principal balance of the Loans (or at any time when no Loans are outstanding, according to its Commitment Percentage), from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind whatsoever including, without limitation, any amounts paid to the Lenders (through the Agent) by the Borrower pursuant to the terms of the Loan Documents, that are subsequently rescinded or avoided, or must otherwise be restored or returned) which may at any time (including, without limitation, at any time following the payment of the Notes) be imposed on, incurred by or asserted against the Agent in any way relating to or arising out of the Loan Documents or any other documents contemplated by or referred to therein or the transactions contemplated thereby or any action taken or omitted to be taken by the Agent under or in connection with any of the foregoing; provided, however, that no Lender shall be liable for the payment of any portion of such liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements to the extent resulting solely from the finally adjudicated gross negligence or willful misconduct of the Agent. Without limitation of the foregoing, each Lender agrees to reimburse the Agent promptly upon demand for its pro rata share of any unpaid fees owing to the Agent, and any costs and expenses (including, without limitation, reasonable fees and expenses of counsel) payable by the Borrower under Section 11.5, to the extent that the Agent has not been paid such fees or has not be reimbursed for such costs and expenses by the Borrower. The failure of any Lender to reimburse the Agent promptly upon demand for its pro rata share of any amount required to be by the Lenders to the Agent as provided in this
Section shall not relieve any other Lender of its obligation hereunder to reimburse the Agent for its pro rata share

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of such amount, but no Lender shall be responsible for the failure of other Lender to reimburse the Agent for such other Lender's pro rata share of such amount. The agreements in this Section shall survive the payment of all amounts payable under the Loan Documents.

Section 10.8 Agent in Its Individual Capacity

BNY and its respective affiliates may make loans to, accept deposits from, issue letters of credit for the account of, and generally engage in any kind of business with, the Borrower as though BNY were not Agent hereunder. With respect to the Commitment made or renewed by BNY and the Notes issued to BNY, BNY shall have the same rights and powers under the Loan Documents as any Lender and may exercise the same as though it were not the Agent, and the terms "Lender" and "Lenders" shall in each case include BNY.

Section 10.9 Successor Agent

If at any time the Agent deems it advisable, in its sole discretion, it may submit to each of the Lenders a written notice of its resignation as Agent under the Loan Documents, such resignation to be effective upon the earlier of (i) the written acceptance of the duties of the Agent under the Loan Documents by a successor Agent and (ii) on the 30th day after the date of such notice. Upon any such resignation, the Required Lenders shall have the right to appoint from among the Lenders a successor Agent. If no successor Agent shall have been so appointed by the Required Lenders and accepted such appointment in writing within 30 days after the retiring Agent's giving of notice of resignation, then the retiring Agent may, on behalf of the Lenders, appoint a successor Agent, which successor Agent shall be a commercial bank organized under the laws of the United States of America or any State thereof and having a combined capital, surplus, and undivided profits of at least $100,000,000. Upon the acceptance of any appointment as Agent hereunder by a successor Agent, such successor Agent shall thereupon succeed to and become vested with all the rights, powers, privileges and duties of the retiring Agent, and the retiring Agent's rights, powers, privileges and duties as Agent under the Loan Documents shall be terminated. The Borrower and the Lenders shall execute such documents as shall be necessary to effect such appointment. After any retiring Agent's resignation as Agent, the provisions of the Loan Documents shall inure to its benefit as to any actions taken or omitted to be taken by it while it was Agent under the Loan Documents. If at any time there shall not be a duly appointed and acting Agent, the Borrower agrees to make each payment due under the Loan Documents directly to the Lenders entitled thereto during such time.

ARTICLE 11 OTHER PROVISIONS

Section 11.1 Amendments and Waivers

With the written consent of the Required Lenders, the Agent and the Borrower may, from time to time, enter into written amendments, supplements or modifications of the Loan Documents and, with the consent of the Required Lenders, the Agent on behalf of the Lenders may execute and deliver to any such parties a written instrument waiving or a consent to a departure

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from, on such terms and conditions as the Agent may specify in such instrument, any of the requirements of the Loan Documents or any Default or Event of Default and its consequences; provided, however, that:

(a) no such amendment, supplement, modification, waiver or consent shall, without the consent of all of the Lenders, (i) increase the Commitments of any Lender or the Aggregate Commitments, (ii) extend the Maturity Date; (iii) decrease the rate, or extend the time of payment, of interest of, or change or forgive the principal amount of, or change the pro rata allocation of payments under, any Note or change or forgive the payment of any fees, (iv) change the provisions of Sections 2.11, 2.12, 2.13, 2.14, 2.15, 5, 6, 11.1 or 11.6(a), or release any security interest or collateral, except to the extent that such release is specifically provided for in any Loan Document, or release any guarantor under any guarantee or (v) change the definition of Required Lenders; and

(b) without the written consent of the Agent, no such amendment, supplement, modification or waiver shall amend, modify or waive any provision of
Section 10 or otherwise change any of the rights or obligations of the Agent hereunder or under the Loan Documents.

Any such amendment, supplement, modification or waiver shall apply equally to each of the Lenders and shall be binding upon the parties to the applicable Loan Document, the Lenders, the Agent and all future holders of the Notes. In the case of any waiver, the parties to the applicable Loan Document, the Lenders and the Agent shall be restored to their former position and rights hereunder and under the outstanding Notes and other Loan Documents to the extent provided for in such waiver, and any Default or Event of Default waived shall not extend to any subsequent or other Default or Event of Default, or impair any right consequent thereon. The Loan Documents may not be amended orally or by any course of conduct.

Section 11.2 Notices

All notices, requests and demands to or upon the respective parties to Loan Documents to be effective shall be in writing and, unless otherwise expressly provided therein, shall be deemed to have been duly given or made when delivered by hand, or when deposited in the mail, first-class postage prepaid, or, in the case of notice by fax, when sent, addressed as follows in the case of the Borrower or the Agent, at the Domestic Lending Office, in the case of each Lender, or to such other addresses as to which the Agent may be hereafter notified by the respective parties thereto or any future holders of the Notes:

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The Borrower:

Mercury General Corporation
4484 Wilshire Boulevard
Los Angeles, California 90010 Attention: Gabriel Tirador,
Chief Financial Officer Telephone: (213) 857-7150
Fax: (213) 857-7116

The Agent:

The Bank of New York
One Wall Street
Agency Function Administration 18th Floor
New York, New York 10286

Attention:   Patricia A. Hylton
Telephone:  (212) 635-4975
Fax:        (212) 635-6365 or 6366 or 6367

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with a copy to:

The Bank of New York
One Wall Street
17th Floor
New York, New York 10286
Attention: Lizanne T. Eberle
Vice President
Telephone: (212) 635-6475
Fax: (212) 809-9520,

except that any notice, request or demand by the Borrower to or upon the Agent or the Lenders pursuant to Sections 2.3 or 2.6 shall not be effective until received. Any party to a Loan Document may rely on signatures of the parties thereto which are transmitted by fax or other electronic means as fully as if originally signed.

Section 11.3 No Waiver; Cumulative Remedies

No failure to exercise and no delay in exercising, on the part of the Agent or any Lender, any right, remedy, power or privilege under any Loan Document shall operate as a waiver thereof; nor shall any single or partial exercise of any right, remedy, power or privilege under any Loan Document preclude any other or further exercise thereof or the exercise of any other right, remedy, power or privilege. The rights, remedies, powers and privileges under the Loan Documents are cumulative and not exclusive of any rights, remedies, powers and privileges provided by law.

Section 11.4 Survival of Representations and Warranties

All representations and warranties made under the Loan Documents and in any document, certificate or statement delivered pursuant thereto or in connection therewith shall survive the execution and delivery of the Loan Documents.

Section 11.5 Payment of Expenses and Taxes

The Borrower agrees, promptly upon presentation of a statement or invoice therefor, and whether any Loan is made (i) to pay or reimburse the Agent for all its out-of-pocket costs and expenses reasonably incurred in connection with the development, preparation and execution of, the Loan Documents and the syndication thereof and any amendment, supplement or modification thereto (whether or not executed), any documents prepared in connection therewith and the consummation of the transactions contemplated thereby, including, without limitation, the reasonable fees and disbursements of Special Counsel, (ii) to pay or reimburse the Agent and the Lenders for all of their respective costs and expenses, including, without limitation, reasonable fees and disbursements of counsel, reasonably incurred in connection with (A) any Default or Event of Default and any enforcement or collection proceedings resulting therefrom or in connection with the negotiation of any restructuring or "work-out" (whether consummated or not) of the obligations of the Borrower under any of the Loan Documents, (B) the enforcement of this Section and (C) any

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appraisal required in connection with any real Property at any time in the future taken as collateral security for any obligations under the Loan Documents, (iii) to pay, indemnify, and hold each Lender and the Agent harmless from and against, any and all recording and filing fees and any and all liabilities with respect to, or resulting from any delay in paying, stamp, excise and other similar taxes, if any, which may be payable or determined to be payable in connection with the execution and delivery of, or consummation of any of the transactions contemplated by, or any amendment, supplement or modification of, or any waiver or consent under or in respect of, the Loan Documents and any such other documents, and (iv) to pay, indemnify and hold each Lender and the Agent and each of their respective officers, directors and employees harmless from and against any and all other liabilities, obligations, claims, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind or nature whatsoever (including, without limitation, reasonable counsel fees and disbursements) with respect to the enforcement and performance of the Loan Documents, the use of the proceeds of the Loans and the enforcement and performance of the provisions of any subordination agreement in favor of the Agent and the Lenders (all the foregoing, collectively, the "indemnified liabilities") and, if and to the extent that the foregoing indemnity may be unenforceable for any reason, the Borrower agrees to make the maximum payment permitted or not prohibited under applicable law; provided, however, that the Borrower shall have no obligation hereunder to pay indemnified liabilities to the Agent or any Lender arising from the finally adjudicated gross negligence or willful misconduct of the Agent or such Lender or claims between one indemnified party and another indemnified party. The agreements in this Section shall survive the termination of the Aggregate Commitments and the payment of all amounts payable under the Loan Documents.

Section 11.6 Assignments and Participations

(a) The Loan Documents shall be binding upon and inure to the benefit of the Borrower, the Lenders, the Agent, all future holders of the Notes and their respective successors and assigns, except that the Borrower may not assign, delegate or transfer any of its rights or obligations under the Loan Documents without the prior written consent of the Agent and each Lender.

(b) Each Lender shall have the right at any time, upon written notice to the Agent of its intent to do so, to sell, assign, transfer or negotiate all or any part of such Lender's rights and obligations under the Loan Documents to one or more of its affiliates, to one or more of the other Lenders (or to affiliates of such other Lenders) or, with the prior written consent of the Borrower (which consent shall not be unreasonably withheld or delayed and shall not be required upon the occurrence and during the continuance of an Event of Default), to sell, assign, transfer or negotiate all or any part of such Lender's rights and obligations under the Loan Documents to any other bank, insurance company, pension fund, mutual fund or other financial institution, provided that (i) each such sale, assignment, transfer or negotiation (other than sales, assignments, transfers or negotiations (x) to affiliates of such Lender or (y) of a Lender's entire interest) shall be in a minimum amount of $5,000,000 and (ii) there shall be paid to the Agent by the assigning Lender (or the Borrower, in the case of an assignment pursuant to Section 2.19(b)) a fee (the "Assignment Fee") of $3,500. For each assignment, the parties to such assignment shall execute and deliver to the Agent for its acceptance and recording an Assignment and Acceptance

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Agreement. Upon such execution, delivery, acceptance and recording by the Agent, from and after the effective date specified in such Assignment and Acceptance Agreement, the assignee thereunder shall be a party hereto and, to the extent provided in such Assignment and Acceptance Agreement, the assignor Lender thereunder shall be released from its obligations under the Loan Documents. Subject to Borrower's right to consent or not to consent to such an assignment as set forth above, the Borrower agrees upon written request of the Agent and at the Borrower's expense to execute and deliver (1) to such assignee, Notes, dated the effective date of such Assignment and Acceptance Agreement, in an aggregate principal amount equal to the Loans assigned to, and Commitments assumed by, such assignee and (2) to such assignor Lender, Notes, dated the effective date of such Assignment and Acceptance Agreement, in an aggregate principal amount equal to the balance of such assignor Lender's Loans and Commitments, if any, and each assignor Lender shall cancel and return to the Borrower its existing Notes. Upon any such sale, assignment or other transfer, the Commitments and the Commitment Percentages set forth in Exhibit A shall be adjusted accordingly by the Agent and a new Exhibit A shall be distributed by the Agent to the Borrower and each Lender.

(c) Each Lender may grant participations in all or any part of its Loans, its Note and its Commitment to one or more banks, insurance companies, financial institutions, pension funds or mutual funds, provided that (i) such Lender's obligations under the Loan Documents shall remain unchanged, (ii) such Lender shall remain solely responsible to the other parties to the Loan Documents for the performance of such obligations and (iii) the Borrower, the Agent and the other Lenders shall continue to deal solely and directly with such Lender in connection with such Lender's rights and obligations under the Loan Documents, (iv) the voting rights of any holder of any participation shall be limited to decisions that only do any of the following: (A) subject the participant to any additional obligation, (B) reduce the principal of, or interest on the Notes or any fees or other amounts payable hereunder, (C) postpone any date fixed for the payment of principal of, or interest on the Notes or any fees or other amounts payable hereunder, (D) release any security interest or collateral, except to the extent that such release is specifically provided for in any Loan Document or (E) release any guarantor under any guarantee. The Borrower acknowledges and agrees that any such participant shall for purposes of Sections 2.9, 2.11, 2.12 and 2.15 be deemed to be a "Lender"; provided, however, the Borrower shall not, at any time, be obligated to pay any participant in any interest of any Lender hereunder any sum in excess of the sum which the Borrower would have been obligated to pay to such Lender in respect of such interest had such Lender not sold such participation.

(d) If any (i) assignment is made pursuant to subsection (b) above or (ii) any participation is granted pursuant to subsection (c) above, shall be made to any Person that is not a U.S. Person, such Person shall furnish such certificates, documents or other evidence to the Borrower and the Agent, in the case of clause (i) and to the Borrower and the Lender which sold such participation in the case of clause (ii), as shall be required by Section 2.9(c).

(e) No Lender shall, as between and among the Borrower, the Agent and such Lender, be relieved of any of its obligations under the Loan Documents as a result of any sale, assignment, transfer or negotiation of, or granting of participations in, all or any part of its Loans, its Commitment or its Note, except that a Lender shall be relieved of its obligations to the

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extent of any such sale, assignment, transfer, or negotiation of all or any part of its Loans, its Commitment or its Note pursuant to subsection (b) above.

(f) Notwithstanding anything to the contrary contained in this Section, any Lender may at any time or from time to time assign all or any portion of its rights under the Loan Documents to a Federal Reserve Bank, provided that any such assignment shall not release such assignor from its obligations thereunder.

Section 11.7 Counterparts

Each Loan Document (other than the Notes) may be executed by one or more of the parties thereto on any number of separate counterparts and all of said counterparts taken together shall be deemed to constitute one and the same document. It shall not be necessary in making proof of any Loan Document to produce or account for more than one counterpart signed by the party to be charged. A counterpart of any Loan Document or to any document evidencing, and of any an amendment, modification, consent or waiver to or of any Loan Document transmitted by fax shall be deemed to be an originally executed counterpart. A set of the copies of the Loan Documents signed by all the parties thereto shall be deposited with each of the Borrower and the Agent. Any party to a Loan Document may rely upon the signatures of any other party thereto which are transmitted by fax or other electronic means to the same extent as if originally signed.

Section 11.8 Adjustments; Set-off

(a) If any Lender (a "Benefited Lender") shall at any time receive any payment of all or any part of its Loans, or interest thereon, or receive any collateral in respect thereof (whether voluntarily or involuntarily, by set-off, pursuant to events or proceedings of the nature referred to in Section 9.1 (h) or (i), or otherwise) in a greater proportion than any such payment to and collateral received by any other Lender in respect of such other Lender's Loans, or interest thereon, such Benefited Lender shall purchase for cash from each of the other Lenders such portion of each such other Lender's Loans, and shall provide each of such other Lenders with the benefits of any such collateral, or the proceeds thereof, as shall be necessary to cause such Benefited Lender to share the excess payment or benefits of such collateral or proceeds ratably with each of the Lenders, provided, however, that if all or any portion of such excess payment or benefits is thereafter recovered from such Benefited Lender, such purchase shall be rescinded, and the purchase price and benefits returned, to the extent of such recovery, but without interest. The Borrower agrees that each Lender so purchasing a portion of another Lender's Loans may exercise all rights of payment (including, without limitation, rights of set-off, to the extent not prohibited by law) with respect to such portion as fully as if such Lender were the direct holder of such portion.

(b) In addition to any rights and remedies of the Lenders provided by law, upon the occurrence of an Event of Default and the acceleration of the obligations owing in connection with the Loan Documents, or at any time upon the occurrence and during the continuance of an Event of Default, under Section 9.1(a) or (b), each Lender shall have the right, without prior notice to the Borrower, any such notice being expressly waived by the Borrower to the extent not

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prohibited by applicable law, to set-off and apply against any indebtedness, whether matured or unmatured, of the Borrower to such Lender, any amount owing from such Lender to the Borrower, at, or at any time after, the happening of any of the above-mentioned events. To the extent not prohibited by applicable law, the aforesaid right of set-off may be exercised by such Lender against the Borrower or against any trustee in bankruptcy, custodian, debtor in possession, assignee for the benefit of creditors, receiver, or execution, judgment or attachment creditor of the Borrower, or against anyone else claiming through or against the Borrower or such trustee in bankruptcy, custodian, debtor in possession, assignee for the benefit of creditors, receiver, or execution, judgment or attachment creditor, notwithstanding the fact that such right of set-off shall not have been exercised by such Lender prior to the making, filing or issuance, or service upon such Lender of, or of notice of, any such petition, assignment for the benefit of creditors, appointment or application for the appointment of a receiver, or issuance of execution, subpoena, order or warrant. Each Lender agrees promptly to notify the Borrower and the Agent after any such set-off and application made by such Lender, provided that the failure to give such notice shall not affect the validity of such set-off and application.

Section 11.9 Construction

The Borrower represents that it has been represented by counsel in connection with the Loan Documents and the transactions contemplated thereby and that the principle that agreements are to be construed against the draftsman shall be inapplicable.

Section 11.10 Indemnity

The Borrower agrees to indemnify and hold harmless the Agent and each Lender and their respective affiliates, directors, officers, employees, attorneys and agents (each an "Indemnified Person") from and against any loss, cost, liability, damage or expense (including the reasonable fees and disbursements of counsel of such Indemnified Person, including all local counsel hired by any such counsel) incurred by such Indemnified Person in investigating, preparing for, defending against, or providing evidence, producing documents or taking any other action in respect of, any commenced or threatened litigation, administrative proceeding or investigation under any federal securities law or any other statute of any jurisdiction, or any regulation, or at common law or otherwise, which is alleged to arise out of or is based upon (i) any untrue statement or alleged untrue statement of any material fact by the Borrower in any document or schedule executed or filed with any Governmental Authority by or on behalf of the Borrower; (ii) any omission or alleged omission to state any material fact required to be stated in such document or schedule, or necessary to make the statements made therein, in light of the circumstances under which made, not misleading; (iii) any acts, practices or omissions or alleged acts, practices or omissions of the Borrower or its agents relating to the use of the proceeds of any or all borrowings made by the Borrower which are alleged to be in violation of Section 2.14, or in violation of any federal securities law or of any other statute, regulation or other law of any jurisdiction applicable thereto; or (iv) any acquisition or proposed acquisition by the Borrower of all or a portion of the Stock, or all or a portion of the assets, of any Person whether such Indemnified Person is a party thereto. The indemnity set forth herein shall be in addition to any other obligations or liabilities of the Borrower to each Indemnified Person under the Loan Documents or at common law or

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otherwise, and shall survive any termination of the Loan Documents, the expiration of the Commitments and the payment of all indebtedness of the Borrower under the Loan Documents, provided that the Borrower shall have no obligation under this Section to an Indemnified Person with respect to any of the foregoing to the extent found in a final judgment of a court having jurisdiction to have resulted primarily out of the gross negligence or wilful misconduct of such Indemnified Person or arising solely from claims between one such Indemnified Person and another such Indemnified Person.

Section 11.11 Governing Law

The Loan Documents and the rights and obligations of the parties thereunder shall be governed by, and construed and interpreted in accordance with, the internal laws of the State of New York, without regard to principles of conflict of laws.

Section 11.12 Headings Descriptive

Section headings have been inserted in the Loan Documents for convenience only and shall not be construed to be a part thereof.

Section 11.13 Severability

Every provision of the Loan Documents is intended to be severable, and if any term or provision thereof shall be invalid, illegal or unenforceable for any reason, the validity, legality and enforceability of the remaining provisions thereof shall not be affected or impaired thereby, and any invalidity, illegality or unenforceability in any jurisdiction shall not affect the validity, legality or enforceability of any such term or provision in any other jurisdiction.

Section 11.14 Integration

All exhibits to a Loan Document shall be deemed to be a part thereof. Except for agreements between the Agent and the Borrower with respect to certain fees, the Loan Documents embody the entire agreement and understanding among the Borrower, the Agent and the Lenders with respect to the subject matter thereof and supersede all prior agreements and understandings among the Borrower, the Agent and the Lenders with respect to the subject matter thereof.

Section 11.15 Consent to Jurisdiction

The Borrower hereby irrevocably submits to the jurisdiction of any New York State or Federal court sitting in the City of New York over any suit, action or proceeding arising out of or relating to the Loan Documents. The Borrower hereby irrevocably waives, to the fullest extent permitted or not prohibited by law, any objection which it may now or hereafter have to the laying of the venue of any such suit, action or proceeding brought in such a court and any claim that any such suit, action or proceeding brought in such a court has been brought in an inconvenient forum. The Borrower hereby agrees that a final judgment in any such suit, action or proceeding brought in such a court, after all appropriate appeals, shall be conclusive and binding upon it.

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Section 11.16 Service of Process

The Borrower hereby irrevocably consents to the service of process in any suit, action or proceeding by sending the same by first class mail, return receipt requested or by overnight courier service, to the address of the Borrower set forth in Section 11.2. The Borrower hereby agrees that any such service (i) shall be deemed in every respect effective service of process upon it in any such suit, action, or proceeding, and (ii) shall to the fullest extent enforceable by law, be taken and held to be valid personal service upon and personal delivery to it.

Section 11.17 No Limitation on Service or Suit

Nothing in the Loan Documents or any modification, waiver, consent or amendment thereto shall affect the right of the Agent or any Lender to serve process in any manner permitted by law or limit the right of the Agent or any Lender to bring proceedings against the Borrower in the courts of any jurisdiction or jurisdictions in which the Borrower may be served.

Section 11.18 WAIVER OF TRIAL BY JURY

THE AGENT, THE LENDERS AND THE BORROWER HEREBY KNOWINGLY, VOLUNTARILY AND INTENTIONALLY WAIVE ANY RIGHT IT MAY HAVE TO A TRIAL BY JURY IN RESPECT OF ANY LITIGATION ARISING OUT OF, UNDER OR IN CONNECTION WITH THE LOAN DOCUMENTS OR THE TRANSACTIONS CONTEMPLATED THEREIN. FURTHER, THE BORROWER HEREBY CERTIFIES THAT NO REPRESENTATIVE OR AGENT OF THE AGENT, OR THE LENDERS, OR COUNSEL TO THE AGENT OR THE LENDERS, HAS REPRESENTED, EXPRESSLY OR OTHERWISE, THAT THE AGENT OR THE LENDERS WOULD NOT, IN THE EVENT OF SUCH LITIGATION, SEEK TO ENFORCE THIS WAIVER OF RIGHT TO JURY TRIAL PROVISION. THE BORROWER ACKNOWLEDGES THAT THE AGENT AND THE LENDERS HAVE BEEN INDUCED TO ENTER INTO THIS AGREEMENT BY, INTER ALIA, THE PROVISIONS OF THIS SECTION.

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TO EVIDENCE THE FOREGOING, the parties hereto have caused this Agreement to be duly executed and delivered by their proper and duly authorized officers as of the day and year first above written.

MERCURY GENERAL CORPORATION

By:______________________________
Name:____________________________
Title:___________________________


THE BANK OF NEW YORK,
Individually and as Agent

By:______________________________
Name:____________________________
Title:___________________________


UNION BANK OF CALIFORNIA, N.A.,
as Co-Agent

By:______________________________
Name:____________________________
Title:___________________________


THE FIRST NATIONAL BANK OF
CHICAGO, as Co-Agent

By:______________________________
Name:____________________________
Title:___________________________


THE CHASE MANHATTAN BANK

By:______________________________
Name:____________________________
Title:___________________________


FLEET NATIONAL BANK

By:______________________________
Name:____________________________
Title:___________________________


CREDIT LYONNAIS NEW YORK BRANCH

By:______________________________
Name:____________________________
Title:___________________________

By:______________________________
Name:____________________________

Title:___________________________


Exhibit 21.1

SUBSIDIARIES - MERCURY GENERAL CORPORATION

Mercury Casualty Company (100% owned)
Mercury Insurance Company (100% owned by Mercury Casualty Company) California General Underwriters Insurance Company, Inc. (100% owned by Mercury Casualty Company)
California Automobile Insurance Company (100% owned) Mercury Insurance Company of Georgia (100% owned by California Automobile Insurance Company)
Mercury Indemnity Company of Georgia (100% owned) Mercury Insurance Company of Illinois (100% owned) Mercury Indemnity Company of Illinois (100% owned by Mercury Insurance Company of Illinois)
American Mercury Insurance Company (100% owned) American Mercury Lloyds Insurance Company * AFI Management Company, Inc. (100% owned by American Fidelity Ins. Company) ** American Mercury MGA, Inc.(100% owned by American Mercury Insurance Company)

* Controlled by Mercury General Corporation through its attorney-in-fact, AFI Management Company, Inc.

** Attorney-in-fact for American Fidelity Lloyds Insurance Co., whose results

are consolidated with Mercury General Corporation.


The Board of Directors
Mercury General Corporation

We consent to incorporation by reference in the registration statement No. 333- 01583 on Form S-8 of Mercury General Corporation of our reports dated February 12, 1999, relating to the consolidated balance sheets of Mercury General Corporation and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income, comprehensive income, shareholders' equity, and cash flows and related schedules for each of the years in the three-year period ended December 31, 1998, which reports appear in the December 31, 1998 annual report on Form 10-K of Mercury General Corporation.

KPMG LLP

Los Angeles, California
March 19, 1999

Exhibit 23.1


ARTICLE 7
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM MERCURY GENERAL CORPORATION AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
MULTIPLIER: 1,000


PERIOD TYPE YEAR
FISCAL YEAR END DEC 31 1998
PERIOD START JAN 01 1998
PERIOD END DEC 31 1998
DEBT HELD FOR SALE 1,324,908
DEBT CARRYING VALUE 0
DEBT MARKET VALUE 0
EQUITIES 219,745
MORTGAGE 0
REAL ESTATE 0
TOTAL INVEST 1,590,645
CASH 1,887
RECOVER REINSURE 0
DEFERRED ACQUISITION 61,947
TOTAL ASSETS 1,877,025
POLICY LOSSES 405,976
UNEARNED PREMIUMS 327,129
POLICY OTHER 0
POLICY HOLDER FUNDS 0
NOTES PAYABLE 78,000
PREFERRED MANDATORY 0
PREFERRED 0
COMMON 48,830
OTHER SE 868,545
TOTAL LIABILITY AND EQUITY 1,877,025
PREMIUMS 1,121,584
INVESTMENT INCOME 96,169
INVESTMENT GAINS (1,340)
OTHER INCOME 5,710
BENEFITS 684,468
UNDERWRITING AMORTIZATION 252,592
UNDERWRITING OTHER 44,941
INCOME PRETAX 235,280
INCOME TAX 57,754
INCOME CONTINUING 177,526
DISCONTINUED 0
EXTRAORDINARY 0
CHANGES 0
NET INCOME 177,526
EPS PRIMARY 3.23
EPS DILUTED 3.21
RESERVE OPEN 386,270
PROVISION CURRENT 693,877
PROVISION PRIOR (9,409)
PAYMENTS CURRENT 437,612
PAYMENTS PRIOR 247,310
RESERVE CLOSE 385,816
CUMULATIVE DEFICIENCY 9,409