Mercury General Corporation — Q2 2013 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2013. Amounts below are in millions of dollars except per-share data and ratios. The company primarily writes personal automobile insurance through subsidiaries in 13 states, principally California; it also writes homeowners and other insurance lines.
Financial results and position
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net premiums earned | $675.8 | $637.2 | $1,338.4 | $1,273.1 |
| Net investment income | $31.7 | $31.7 | $62.8 | $63.2 |
| Net realized investment gains (losses) | $(67.4) | $(23.8) | $(23.4) | $28.9 |
| Net income (loss) | $(9.3) | $(5.3) | $57.2 | $68.1 |
| EPS, basic and diluted | $(0.17) | $(0.10) | $1.04 | $1.24 |
| Combined ratio | 98.7% | 104.5% | 98.3% | 101.1% |
Q2 underwriting improved to a combined ratio below 100%, while investment losses drove the quarterly net loss. For the six-month period, premiums and underwriting results grew, but lower investment gains/losses contributed to lower net income. Q2 net premiums written rose 1.8%; six-month net premiums written rose 3.4%. Management attributed premium growth mainly to more policies in force and higher average premiums, including California private passenger auto’s 4% rate increase effective October 2012 and rate increases in other states.
- Underwriting: Q2 loss and expense ratios were 72.1% and 26.7%; six-month ratios were 71.3% and 27.1%. Prior-year reserve development was approximately zero in Q2 2013 versus $23 million unfavorable in Q2 2012; for the half, it was $3 million favorable versus $29 million unfavorable. Catastrophe losses were approximately $13 million in Q2 and $14 million for the half, versus about $8 million in each comparable 2012 period.
- Cash flow: Six-month operating cash flow was $96.5 million, versus $49.4 million in 2012. Investing activities used $8.6 million and financing activities used $65.7 million, including $67.3 million of dividends. Cash ended at $180.3 million, up $22.1 million from year-end.
- Liquidity and debt: Cash plus short-term investments totaled $345.9 million at June 30. Notes payable were $140 million, unchanged from year-end; the company reported compliance with loan covenants. A new $200 million, five-year revolving credit facility was signed July 2, 2013; no amounts had been drawn as of July 30. Insurance subsidiaries’ statutory surplus was $1.5 billion, and trailing 12-month written premiums to surplus was 1.8:1.
- Balance sheet: Total assets were $4.23 billion, total liabilities $2.40 billion, and shareholders’ equity $1.83 billion at June 30. Loss and loss adjustment expense reserves were $1.01 billion, including $391.3 million of IBNR reserves. Management described its reserve estimate as adequate but noted actual ultimate losses may differ.
- Investments and margins: The portfolio’s fair value was $3.18 billion, including $2.48 billion of fixed maturities; 66.8% of total investments were tax-exempt municipal bonds. Six-month pretax investment yield was 4.1%, down from 4.2%, principally as higher-yielding securities matured and were replaced at lower yields.
Material changes, outlook, and risks
- Q2 fixed-maturity and equity fair-value declines were approximately $59.6 million and $19.0 million, respectively; management linked fixed-income weakness primarily to rising interest rates and equity declines to market movements. For the six months, fixed-maturity fair-value losses were partly offset by equity fair-value gains.
- The expense ratio increased for the six-month period, partly reflecting approximately $10 million in first-quarter office closure and severance costs from consolidating claims and underwriting operations outside California into hub locations.
- No specific earnings or premium guidance is provided. Management cautions that six-month results are not necessarily indicative of full-year results. It expects operating cash flow and available liquidity to meet requirements, while noting there is no assurance funding sources will always be sufficient.
- Key exposures include competitive pricing, claim frequency and severity, inflation in medical and repair costs, catastrophe and weather losses, premium-rate regulation, reserve-estimation uncertainty, investment market and interest-rate risk, and the ability to realize deferred tax assets. A hypothetical 100-basis-point interest-rate increase was estimated to reduce bond-portfolio fair value by $90.6 million; a 25% decline in the stock market was estimated to reduce common-stock value by $124.9 million.
- California homeowners regulators’ rate order reduced rates by approximately 5.5%; Mercury implemented the reduction in Q2 while challenging the decision, with a hearing scheduled for November 1, 2013. A California auto-body repair regulation effective March 2013 may increase repair-part costs; the impact was not yet clear.
- Regulatory matters include California DOI notices alleging rating, underwriting, broker-fee, and advertising violations (the 2004 and 2010 matters). The company denies the allegations, intends to defend itself, and does not expect resolution to materially affect its financial position. It has accrued defense costs; ultimate outcomes and potential penalties remain uncertain.
- A catastrophe reinsurance treaty effective July 1, 2013 provides $100 million per-occurrence coverage after a $100 million company retention, subject to stated exclusions; annual premium is $4.25 million.
Important facts for investors to verify
- Whether premium growth and combined ratios remain favorable, and how California rate actions and repair-cost regulation affect underwriting.
- Whether reserve development, particularly in California bodily-injury claims, remains consistent with management’s estimates; monitor IBNR and catastrophe losses.
- How interest rates, equity markets, and municipal-bond credit conditions affect reported earnings and portfolio values.
- Developments in California DOI proceedings, the homeowners rate-order challenge, and tax examinations; the filing does not quantify a clear potential loss for these matters.
- Availability and terms of the new revolving facility, cash generation, dividend payments, and the company’s ability to maintain liquidity without selling investments.