Business context and reporting period
Mercury General Corporation filed this Form 10-K for the fiscal year ended December 31, 2018. It primarily writes personal auto insurance through subsidiaries in 11 states, with California accounting for about 85% of direct premiums written. Personal auto represented about 76% of direct premiums written; distribution is primarily through independent agents.
Financial and operating results
- Revenue and premiums: Total revenue was $3.380 billion, down 1.1% from $3.416 billion in 2017. Net premiums earned rose 5.4% to $3.368 billion; net premiums written increased 8.7% to $3.496 billion, driven by rate increases and policy growth, especially in California.
- Profit: The company recorded a net loss of $5.7 million, or $0.10 per diluted share, versus net income of $144.9 million, or $2.62 per share, in 2017. The change primarily reflected $133.5 million in net realized investment losses, versus $83.7 million in gains a year earlier. Pre-tax loss was $30.6 million; income tax benefit was $24.9 million.
- Fourth quarter: Q4 net loss was $81.9 million, or $1.48 per diluted share, compared with net income of $19.8 million, or $0.36 per share, in Q4 2017. Q4 2018 pre-tax loss was $114.4 million. The filing attributes the quarter’s loss primarily to declines in fixed-income and equity fair values.
- Underwriting and margins: The GAAP combined ratio improved to 100.7% from 101.2%; underwriting remained unprofitable overall. Loss ratio was 76.5% and expense ratio 24.2%. Excluding catastrophe losses and prior-year reserve development, the loss ratio improved to 71.7% from 72.3%.
- Claims and reserves: Loss and loss adjustment expense reserves rose to $1.829 billion from $1.511 billion. Prior-year reserve development was unfavorable by $93.1 million, mainly from greater-than-expected California auto bodily-injury severity and defense costs.
- Cash flow and liquidity: Operating cash flow was $383.4 million, up from $341.4 million. Cash was $314.3 million; cash plus short-term investments totaled $567.6 million. Management said operating cash flow and available liquidity were adequate for requirements without forced investment sales.
- Investments: The portfolio was $3.768 billion at fair value. Net investment income increased to $135.8 million from $124.9 million, and pre-tax yield rose to 3.6% from 3.5%. About 68% of portfolio fair value was in tax-exempt municipal bonds.
- Debt and capital: Notes payable were $371.7 million, primarily $375 million of 4.4% senior unsecured notes due in 2027. A $50 million revolving facility was undrawn. Shareholders’ equity was $1.618 billion, down from $1.761 billion. Statutory insurer surplus was $1.472 billion; statutory net income was $81.9 million.
- Dividends: Dividends paid totaled $2.5025 per share. Insurance subsidiaries could pay up to $145 million in ordinary dividends to the parent in 2019 without extraordinary-dividend approval.
Material changes versus 2017
- Premium growth accelerated, but total revenue and earnings fell as investment fair-value changes swung from gains to losses.
- Catastrophe losses before reinsurance increased to about $289 million from $168 million; net catastrophe losses were about $67 million versus $79 million in 2017.
- Unfavorable prior-year reserve development increased to $93.1 million from $54.4 million.
- The combined ratio improved by 0.5 percentage point, chiefly reflecting a lower expense ratio and better underlying loss ratio, though still above 100%.
- Invested assets and investment income grew, while shareholders’ equity declined.
Outlook, commentary, risks and unusual items
- Management characterized the auto insurance market as hard, with insurers generally raising rates, but provided no formal earnings or revenue guidance.
- California DOI approved a 6.9% rate increase for CAIC private passenger auto in January 2019, expected to take effect in March 2019. A 5.0% increase for MIC took effect in March 2018. Rate approvals and timing remain subject to regulation.
- The Camp and Woolsey fires generated approximately $249 million of pre-reinsurance losses; combined net losses were about $37 million. The Carr Fire produced about $10 million of net losses. These events used the treaty’s available reinstated first-layer limit; further catastrophe losses before the treaty expires June 30, 2019 could leave the company retaining more losses.
- California concentration, catastrophe exposure, rate adequacy and approval delays, bodily-injury severity and reserve uncertainty, competition, and municipal-bond and interest-rate exposure are material risks. A 100-basis-point rise in rates was estimated to reduce fixed-maturity fair value by $128.6 million.
- A.M. Best downgraded the company’s A+ rated entities to A in December 2018, with a stable outlook; A- rated entities were affirmed. The filing reports all insurers above regulatory minimum RBC levels, but CAIC was below a credit-facility RBC covenant threshold and received a waiver; it remained above the regulatory minimum.
- A California DOI appeal remains pending regarding a previously assessed $27.6 million penalty. The company received $30.9 million, including interest, in 2017, but continues to carry approximately $31.6 million as a liability pending appeal. Management does not expect pending legal and regulatory matters to materially affect financial position or cash flows.
- The 2018 tax benefit included effects of the 21% federal corporate tax rate and tax adjustments. Management considered deferred tax assets more likely than not to be realized; the outcome depends on future taxable income and tax-planning actions.
- KPMG issued unqualified opinions on the financial statements and internal control over financial reporting; management also concluded disclosure controls were effective.
Important facts for investors to verify
- Whether California auto rate changes and policy growth are sufficient to offset bodily-injury severity, reserve strengthening, and regulatory limits.
- Further development of the $1.829 billion loss reserve, particularly California auto claims and wildfire losses.
- Renewal terms and remaining catastrophe protection after exhaustion of the treaty’s reinstated first layer.
- Investment portfolio exposure to municipal credit, equity-market movements, and interest-rate changes, and the effect of fair-value swings on earnings.
- CAIC’s covenant waiver status, statutory capital and dividend capacity, and the holding company’s reliance on subsidiary dividends.
- Outcome of the California DOI appeal and the treatment of the $31.6 million liability.