Mercury General Corporation — 2012 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2012. This is an annual report, not a standalone fourth-quarter filing; quarterly figures below are unaudited. Mercury is primarily a personal auto insurer, operating in 13 states, with 80.6% of 2012 direct premiums written in private passenger auto and California representing 76.5% of total direct premiums written.
Financial performance and position
| Metric | 2012 | 2011 |
|---|---|---|
| Net premiums earned | $2,574.9 million | $2,566.1 million |
| Total revenues | $2,783.4 million | $2,777.3 million |
| Net investment income | $131.9 million | $140.9 million |
| Net realized investment gains | $66.4 million | $58.4 million |
| Net income / diluted EPS | $116.9 million / $2.13 | $191.2 million / $3.49 |
| Combined ratio (GAAP) | 102.8% | 98.5% |
| Cash from operating activities | $148.1 million | $158.5 million |
| Total investments / total assets | $3,180.1 million / $4,189.7 million | $3,062.4 million / $4,070.0 million |
| Notes payable / shareholders’ equity | $140.0 million / $1,842.5 million | $140.0 million / $1,857.5 million |
Net premiums written increased 3.0% to $2,651.7 million, while earned premiums rose 0.3%. The 102.8% combined ratio indicates underwriting losses before investment results. Year-end cash was $158.2 million; cash plus short-term investments was $452.8 million. Management said operating cash flow and investment maturities were expected to meet liquidity needs without forced investment sales, while noting that future needs could change. Insurance subsidiaries had $1.441 billion of statutory capital and surplus and a 1.8-to-1 net-premiums-written-to-surplus ratio. The company reported compliance with debt covenants and statutory capital requirements.
Material changes and operating drivers
- Net income declined 38.9%, primarily as losses and loss-adjustment expenses rose to $1,961.4 million from $1,829.2 million. The loss ratio increased to 76.2% from 71.3%; expense ratio improved to 26.6% from 27.2%.
- Prior-year reserve development was unfavorable by approximately $42 million, versus $18 million in 2011. Management attributed the 2012 development principally to higher severity and more late-reported California bodily-injury claims, particularly for 2010 and 2011 accident years.
- Catastrophe losses were approximately $39 million in 2012, mainly from Hurricane Sandy and Midwest wind and hail, compared with $18 million in 2011. California auto frequency and severity also rose.
- Investment income fell as higher-yielding securities matured or were replaced with lower-yielding investments. Realized investment gains increased, including $45.5 million from fair-value changes under the company’s fair-value option.
- Year-end loss and loss-adjustment expense reserves were $1,036.1 million, including approximately $409 million of IBNR reserves. California auto bodily-injury reserve sensitivity analysis showed a possible approximately $48.1 million favorable or unfavorable impact from specified severity assumptions for 2010–2012 accident years.
- Unaudited fourth-quarter net loss was $17.4 million, or $0.32 per diluted share, on $655.8 million of earned premiums. Management cited Sandy and seasonal California losses and declines in municipal and equity security values. The second quarter also recorded a net loss of $5.3 million.
Outlook, commentary, risks and unusual items
- No specific earnings or revenue guidance was provided. Management said it expected no entry into new states in 2013, while continuing to pursue growth and stating that the market may be hardening.
- A California private passenger auto rate increase of approximately 4% took effect in October 2012. Additional California auto and homeowners rate increases were filed or planned and remained subject to regulatory approval. The homeowners filing followed a contested rate proceeding; the company disagreed with a proposed reduction and expected a final ruling.
- Mercury completed its withdrawal from Florida homeowners in September 2012, citing sinkhole-claim exposure. It also ceased writing California commercial taxi business in 2011. Run-off claims from both businesses contributed to adverse reserve development.
- In January 2013, Mercury announced consolidation of non-California claims and underwriting operations into Florida, New Jersey and Texas hubs, with a workforce reduction of approximately 135 employees. It expected $8–$13 million of pretax office-closure and severance costs in the first quarter of 2013.
- Key risks include California and other state concentration; rate-approval delays and insurance regulation; reserve uncertainty, bodily-injury inflation and claim frequency; catastrophe exposure; competition; investment-market and interest-rate sensitivity; and reliance on subsidiary dividends. Municipal bonds comprised 67.4% of total investments at fair value, and a hypothetical 100-basis-point rate increase was estimated to reduce bond portfolio fair value by $75.4 million.
- California DOI proceedings allege rating, underwriting, broker-fee and advertising violations in separate 2004 and 2010 notices. Mercury denied the allegations and said it intended to defend itself; it did not expect the ultimate resolution to materially affect its financial position. The California Franchise Tax Board was also examining tax years 2003–2010 and had issued proposed assessments for 2003–2006; management did not expect a material impact. The filing states that pending proceedings generally were not expected to have a material adverse effect.
- The company’s maximum disclosed exposure to California Earthquake Authority assessments was approximately $52.2 million, based on information available at April 1, 2012; no assessment was made in 2012. Reinsurer performance is a risk because Mercury remains responsible to policyholders if reinsurers fail to pay.
- Shareholders received $2.4425 per share in dividends during 2012. The board declared a $0.6125 quarterly dividend in February 2013. Up to approximately $154.6 million of ordinary subsidiary dividends could be paid to the parent in 2013 without extraordinary-dividend approval, subject to applicable requirements.
- KPMG issued unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Whether California bodily-injury severity and late-reported claims continue to drive adverse reserve development, and how the 2012 accident years mature.
- The outcome and timing of California rate approvals and the pending DOI notices, including any required operational changes, penalties or restrictions.
- Whether the company can restore underwriting profitability after a 102.8% combined ratio, given catastrophe losses, rising claim frequency and severity, and the timing of approved rate changes.
- Whether municipal-bond concentration, interest-rate movements and lower reinvestment yields materially affect investment income, portfolio values or liquidity.
- Actual costs and savings from the 2013 office consolidation, and the company’s continuing ability to fund shareholder dividends from regulated subsidiary distributions.