Mercury General Corporation — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012. Mercury is primarily a personal automobile insurer, operating through 13 insurance subsidiaries and selling mostly through independent agents. California generated 76.3% of direct premiums written.
Financial performance
| Metric | Q1 2012 | Q1 2011 |
|---|---|---|
| Net premiums written | $658.3 million | $658.2 million |
| Net premiums earned | $635.8 million | $638.5 million |
| Total revenue | $722.7 million | $705.5 million |
| Net investment income | $31.5 million | $35.1 million |
| Net realized investment gains | $52.7 million | $28.7 million |
| Net income | $73.4 million; $1.34 per diluted share | $58.2 million; $1.06 per diluted share |
| Combined ratio | 97.6% | 98.2% |
| Operating cash flow | $34.7 million | $35.6 million |
Net income increased 26%, although the improvement included higher fair-value investment gains: $49.3 million in Q1 2012 versus $20.9 million in Q1 2011. The gains reflected higher market values for equities and fixed maturities. Net investment income and average annual pretax yield fell, with the company citing the replacement of maturing higher-yielding assets with lower-yielding investments. Excluding prior-period reserve development, the loss ratio was 69.8% in both periods; the expense ratio improved to 26.8% from 28.3%, mainly due to cost reductions.
Financial position and liquidity
- At March 31, total assets were $4.14 billion, shareholders’ equity $1.90 billion, and investments $3.12 billion. Cash was $204.7 million; cash plus short-term investments totaled $431.9 million.
- Notes payable were $140 million, unchanged from year-end 2011. The company reported compliance with its debt covenants.
- Operating cash flow was nearly flat year over year. Cash declined $6.7 million during the quarter, after $33.5 million of dividends paid. Dividends were $0.61 per share, versus $0.60.
- Insurance subsidiaries had $1.5 billion of statutory surplus; the premium writings-to-surplus ratio was 1.7 to 1, below the cited industry guideline of 3.0 to 1.
Material changes, outlook and risks
- Premiums written were essentially unchanged, while earned premiums declined modestly. The combined ratio improved, but remained sensitive to claims experience and reserve estimates.
- Q1 included approximately $6 million of unfavorable development on 2011 and prior accident-year reserves, mainly due to higher average severity and more late-reported California bodily injury claims. Loss reserves were $954.4 million, including $344.9 million of incurred-but-not-reported reserves.
- The company expected to complete its withdrawal from the Florida homeowners market by September 2012. A $1.2 million premium deficiency reserve remained for that business.
- No numerical earnings or premium guidance was provided. Management cautioned that first-quarter results are not necessarily indicative of full-year results. It cited competition, pricing and regulatory approvals, claim severity and frequency, weather and catastrophe losses, investment-market changes, low reinvestment yields, and tax and legal uncertainties among key risks.
- California DOI proceedings remain significant: the Commissioner rejected an administrative law judge’s proposed dismissal of unlawful-rate allegations in the 2004 matter, and the company challenged that rejection in court. A separate 2010 notice alleges rating and underwriting noncompliance. The company denies the allegations and expects no material financial effect, but the outcomes are unresolved.
- Other disclosed exposures include IRS and California tax examinations, including proposed California assessments for 2003–2006, and investment-market sensitivity. Management estimated that a 100-basis-point rise in interest rates could reduce fixed-maturity fair value by $88.1 million; a 25% fall in equity markets could reduce common-stock fair value by $110.7 million.
Key facts for investors to verify
- Whether the reserve estimates remain adequate, particularly for California bodily injury claims and late-reported losses.
- How much earnings growth is repeatable from underwriting and operations versus fair-value investment gains.
- Progress and financial effects of the Florida homeowners withdrawal, including any remaining exposure or costs.
- Developments and potential penalties in the California DOI proceedings, and outcomes of the federal and state tax examinations.
- Investment portfolio valuation and credit exposures, including municipal bonds, below-investment-grade holdings, collateralized debt obligations, and the impact of market or rate changes.