Mercury General Corporation — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011; compared with the corresponding 2010 periods. The company primarily writes personal automobile insurance, principally in California, through independent agents and brokers.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net premiums earned | $643.6m | $642.6m | $1,924.4m | $1,925.9m |
| Total revenue | $615.7m | $766.8m | $2,027.8m | $2,120.2m |
| Net income (loss) | $(3.8)m | $96.8m | $111.7m | $175.8m |
| Diluted EPS | $(0.07) | $1.77 | $2.04 | $3.21 |
| Combined ratio | 98.3% | 98.0% | 98.2% | 97.8% |
- Net premiums written were $662.3m for Q3, up 1.2%, and $1,956.8m for nine months, up 1.0%. The company attributed the growth mainly to slightly more policies and higher average premiums; earned premiums were nearly flat.
- Q3 loss ratio rose to 71.2% from 68.6%, while the expense ratio improved to 27.0% from 29.4%. Nine-month ratios were 70.5% and 27.7%, respectively. Combined ratios remained below 100%, indicating underwriting profitability under the company’s stated measure.
- Investment income was $35.5m in Q3 and $106.6m for nine months, modestly below 2010. Net realized investment results swung from gains of $86.4m to losses of $66.9m in Q3, and from gains of $80.8m to losses of $14.5m for nine months. The 2011 losses principally reflected declines in equity market values, partly offset by gains in fixed maturities.
- Nine-month operating cash flow was $170.8m, versus $99.4m in 2010. Cash at period end was $209.8m; cash plus short-term investments was $458.6m. The company said operating cash flow and investment maturities should meet liquidity needs, while noting funding needs could change.
- At September 30, total assets were $4.10bn, shareholders’ equity $1.81bn, and notes payable $138m, down from $267.2m at year-end 2010. The company retired $125m of 7.25% senior notes at maturity and extended its $120m credit facility to January 2015. On October 4, it refinanced an $18m loan with a $20m loan due January 2015. It reported compliance with loan covenants.
- Dividends paid were $0.60 per share in Q3 and $1.80 per share for nine months. Nine-month dividends paid totaled $98.7m.
Changes, outlook, and risks
- Profit fell sharply year over year, particularly in Q3, primarily because investment results shifted from substantial realized gains in 2010 to losses in 2011. Underwriting ratios also weakened modestly; for the nine months, unfavorable prior-year reserve development replaced favorable development in 2010.
- For the first nine months, prior-year loss reserves developed unfavorably by about $11m, largely from higher average severities and more late-reported California bodily-injury claims. Recorded loss and loss-adjustment reserves were $978.7m, including $331.8m of IBNR. Management considered reserves adequate, but actual outcomes may differ.
- California approved a revenue-neutral personal-auto classification plan scheduled for implementation in December 2011. It will lower rates for some risks and raise them for others; management warned of a possible short-term decline in renewals but could not quantify it. The plan is intended to improve risk-based pricing and competitiveness.
- The company was withdrawing from Florida homeowners insurance and expected to complete the exit by September 2012. It had established a premium-deficiency reserve for that operation at year-end 2010.
- California DOI proceedings remain unresolved: the 2010 Notice of Non-Compliance alleges rating and underwriting violations; the 2004 matter concerns rates, broker fees, and advertising. The company disputes the allegations and intends to defend itself. Management did not expect the ultimate resolution to materially affect financial condition, results, or cash flows; no clear potential penalty amount is provided in this filing.
- Investment risks include equity-price exposure and a large municipal-bond concentration: municipal securities were $2.29bn, and 75.2% of the total portfolio was in tax-exempt state and municipal bonds. Level 3 assets included $43.9m of collateralized debt obligations. Management reported a hypothetical 25% decline in the stock market would reduce common-stock fair value by $90m; a 100-basis-point rate increase would reduce bond fair value by $91.7m.
- Management provided no earnings or revenue forecast. It cautioned that results are sensitive to competition and pricing, claim frequency and severity, reserve estimates, weather and catastrophes, regulation and litigation, investment markets and yields, and tax matters. Hurricane Irene and Georgia tornadoes contributed approximately $4m and $3m of catastrophe losses, respectively, during the nine-month period.
Investor verification priorities
- Track California bodily-injury claim severity, late-reported claims, and subsequent reserve development.
- Review equity-market exposure and realized/unrealized investment results, including the valuation and credit risks in municipal bonds and CDOs.
- Monitor developments and potential financial exposure in the California DOI proceedings.
- Assess retention, pricing effects, and policy growth following the December 2011 California auto-classification plan, alongside progress on the Florida homeowners exit.
- Confirm liquidity, debt maturities, covenant compliance, and the sustainability of dividends relative to operating cash flow.