Business context and reporting period
Mercury General Corporation’s unaudited Form 10-Q covers the quarter and nine months ended September 30, 2018. The insurer primarily writes personal auto insurance through subsidiaries in 11 states, principally California; it also offers homeowners and other property and casualty products.
Key financial metrics
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net premiums earned | $858.1m | $801.2m | $2,500.2m | $2,388.6m |
| Total revenue | $894.8m | $858.4m | $2,563.4m | $2,558.7m |
| Net investment income | $38.2m | $31.0m | $104.5m | $94.1m |
| Realized investment gains (losses) | ($3.9m) | $20.7m | ($48.4m) | $66.3m |
| Net income | $58.6m | $46.5m | $76.2m | $125.1m |
| Diluted EPS | $1.06 | $0.84 | $1.38 | $2.26 |
| Combined ratio | 95.6% | 99.3% | 98.7% | 100.1% |
At September 30, 2018, total assets were $5.313bn, investments $3.904bn, cash $261.7m, total liabilities $3.579bn and shareholders’ equity $1.734bn. Debt carrying value was $371.6m, principally $375m of 4.40% senior notes due 2027; the $50m revolving facility was undrawn. Cash plus short-term investments totaled $524.5m. Nine-month operating cash flow was $325.2m, versus $276.5m in 2017; investing activities used $251.5m and financing activities used $103.4m. Dividends paid were $103.8m, or $1.875 per share.
Material changes versus prior comparable periods
- Q3 net premiums earned grew 7.1%; net premiums written grew 9.4%. Management attributed growth mainly to higher average premiums following rate increases and growth in California auto and homeowners policies. Reintroduced 12-month auto policies added an estimated $20m to Q3 written premiums, with no material Q3 earned-premium effect.
- Q3 net income rose about 26%, and the combined ratio improved to 95.6%. The nine-month combined ratio also improved, from 100.1% to 98.7%, but nine-month net income fell about 39%, primarily reflecting the swing from $66.3m of realized investment gains to $48.4m of losses.
- Net investment income increased in both periods as average invested assets and yields rose. Fair-value losses on fixed maturities were driven primarily by higher market interest rates: the nine-month change in fair value for fixed maturities was a loss of $68.2m.
- California auto and homeowners rate increases and policy growth lifted premiums. A 5% California private passenger auto rate increase became effective in March 2018. California represented 85.4% of direct premiums written in the first nine months.
Guidance, outlook, commentary, risks and unusual items
- The filing provides no specific earnings or premium guidance. Management said operating results and cash flows for the nine months are not necessarily indicative of full-year results and believes operating cash flow, cash and short-term investments, investment maturities, and available credit are adequate for liquidity needs without forced investment sales.
- Nine-month prior-year reserve development was unfavorable by $70.4m, versus $18.3m in 2017, mainly due to California auto bodily-injury severity and higher defense and cost-containment costs. Management cited more high-dollar claims, medical-cost inflation, and an aggressive plaintiff bar. Loss reserves were $1.580bn gross ($1.530bn net of reinsurance); management considers them adequate, but actual outcomes may differ.
- Catastrophe losses for the first nine months were approximately $34m gross and $24m net, compared with $59m gross in 2017. The Carr Fire accounted for $21m gross and $10m net. The catastrophe treaty generally covers losses above a $10m per-event retention, subject to stated limits and exclusions; its annual premium rose to about $22m from $19m.
- After quarter-end, Hurricane Michael was estimated to cause $4m–$8m of losses, to be recorded in Q4 2018. Management expected losses above the $10m retention to be reimbursed under the treaty.
- Market risks include interest-rate and equity-price movements. A 100- or 200-basis-point rate rise was estimated to reduce fixed-maturity fair value by $130.2m or $260.4m, respectively. The portfolio was heavily concentrated in municipal bonds; fixed maturities had an A+ weighted-average credit rating.
- A California regulatory penalty of $27.6m, previously paid, was returned with interest in 2017 after a court ruling vacated the order. The state appealed; the company had not recognized the approximately $31.4m returned amount as a gain and reported it in other liabilities at September 30, 2018. The related false-advertising proceeding was stayed pending the appeal.
- California tax examinations and proposed assessments for 2011–2013 remain unresolved; management did not expect their resolution to materially affect the financial statements. The company reported a $759,000 increase in unrecognized tax benefits during the nine months.
- Management identified customary insurance and market risks, including reserve-estimate uncertainty, catastrophe exposure, rate-approval and competitive pressures, inflation, investment-market changes, regulatory matters, and litigation. Disclosure controls were assessed as effective; no material change in internal control over financial reporting was reported.
Most important facts for investors to verify
- Whether California bodily-injury severity and the $70.4m adverse reserve development persist, and how subsequent reserve reviews affect earnings.
- Whether premium growth and the improved combined ratio continue after rate changes, policy growth, reinsurance costs, and catastrophe experience.
- How investment fair-value movements, especially interest-rate sensitivity and equity exposure, affect reported earnings and capital.
- The final Hurricane Michael losses and reinsurance recovery, as well as the terms, cost, and remaining capacity of catastrophe protection.
- The outcome of the California penalty appeal and tax assessments, including whether any amounts currently carried as liabilities change.
- Liquidity and capital indicators: cash and short-term investments of $524.5m, debt of $371.6m, and the reported 2.15-to-1 net-premiums-written-to-insurance-subsidiary-surplus ratio.