Mercury General Corporation — Q2 2016 Form 10-Q
Business and period: Property-and-casualty insurer focused on personal automobile insurance, principally in California, with related homeowners, commercial, and other lines. This unaudited filing covers the quarter and six months ended June 30, 2016; comparisons are to 2015.
Financial performance
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Net premiums earned | $779.3 million | $731.5 million | $1,546.4 million | $1,452.3 million |
| Net income | $48.9 million | $9.6 million | $72.2 million | $35.8 million |
| Diluted EPS | $0.88 | $0.17 | $1.31 | $0.65 |
| Net realized investment gains (losses) | $45.4 million | $(39.3) million | $70.4 million | $(49.3) million |
| Combined ratio | 101.7% | 98.5% | 102.8% | 98.8% |
Premium growth reflected higher average premiums per policy, primarily from California private-auto rate increases. Net premiums written rose 6.6% in Q2 and 7.1% in the first half. Underwriting was unprofitable in both 2016 periods: first-half pre-tax underwriting loss was $43.2 million, versus a $17.5 million underwriting gain in first-half 2015. Net income benefited materially from investment fair-value gains, reversing prior-year losses; net investment income declined slightly to $61.1 million for the first half from $63.2 million.
For Q2, the loss ratio was 76.4% versus 71.2%; the expense ratio improved to 25.4% from 27.3%. For the first half, the loss ratio rose to 76.9% from 71.3%, while the expense ratio improved to 25.9% from 27.5%. Excluding prior-year reserve development and catastrophe losses, the first-half loss ratio was 71.7%, versus 71.0%.
Cash, balance sheet, and capital
- First-half operating cash flow was $101.7 million, up from $73.2 million. Investing activities used $65.0 million; financing activities used $67.6 million, including $68.5 million of dividends. Cash declined $30.9 million to $233.3 million.
- At June 30, total investments were $3.49 billion; cash plus short-term investments were $414.6 million. Management cited $100 million of unused availability on its $250 million revolving credit facility.
- Total assets were $4.72 billion, total liabilities $2.90 billion, and shareholders’ equity $1.82 billion. Notes payable remained $290 million: $140 million secured and $150 million unsecured. The company reported compliance with loan covenants.
- Statutory insurer surplus was $1.4 billion; trailing-twelve-month net premiums written to surplus was 2.19:1. The quarterly dividend was $0.62 per share.
Material changes, outlook, and risks
- Reserve deterioration: First-half unfavorable development on 2015 and prior accident years was approximately $62 million, including $46 million related to 2014 and prior years. Much of the deterioration arose from California and Florida auto liability claims. Management considers reserves adequate, but ultimate losses may differ from estimates.
- Catastrophes and restructuring: First-half catastrophe losses were about $19 million, primarily from severe winter storms in Texas and northern California. A claims-operations restructuring outside California reduced the workforce by about 100 and generated an approximately $2 million Q2 charge, primarily in loss and loss-adjustment expenses.
- State exits: Mercury stopped accepting new business in Michigan and Pennsylvania in May 2016, began issuing non-renewal notices in June, and expects to complete run-off in 2017. The exits follow weak profitability in those states.
- Investment sensitivity: Municipal bonds made up 71.9% of the investment portfolio at fair value. Management estimated that a 100- or 200-basis-point interest-rate increase would reduce bond-portfolio fair value by $98.3 million or $196.6 million, respectively. Lower rates could also reduce reinvestment yields.
- Legal and tax matters: The company paid a $27.6 million California DOI penalty in March 2015 and is seeking reversal and a refund; the court hearing occurred in June 2016, with no decision reported in this filing. The company is also disputing California tax assessments and is under FTB examination; management did not expect these matters to materially affect results.
- Ratings: On June 15, 2016, A.M. Best affirmed insurer ratings but changed the outlook for A+-rated entities from Stable to Negative. Management expected to work toward restoring a Stable outlook in the 2017 ratings cycle.
- Guidance: No quantified earnings or premium guidance is provided. Management cautions that interim results are not necessarily indicative of full-year results.
Key investor verification points
- Track whether California and Florida auto liability reserve estimates stabilize, particularly for older accident years.
- Separate recurring underwriting performance from investment fair-value gains when assessing earnings quality.
- Monitor loss trends, catastrophe exposure, and the combined ratio after the Michigan and Pennsylvania exits.
- Follow the California DOI penalty appeal and California FTB tax matters for changes in potential outcomes.
- Check A.M. Best outlook developments, investment portfolio valuation and rate sensitivity, and liquidity after dividends and investment purchases.