Mercury General Corporation — Q1 2011 Form 10-Q
Reporting period: Three months ended March 31, 2011; balance-sheet comparisons are to December 31, 2010. The unaudited consolidated statements cover Mercury General and its subsidiaries. The company primarily writes automobile insurance, operating mainly in California, with business in other states and additional insurance lines.
Financial results and key metrics
| Metric | Q1 2011 | Q1 2010 / prior date |
|---|---|---|
| Total revenue | $705.5 million | $699.8 million |
| Net premiums earned | $638.5 million | $640.6 million |
| Net premiums written | $658.2 million | $652.5 million |
| Net investment income | $35.1 million | $35.9 million |
| Net realized investment gains | $28.7 million | $22.0 million |
| Income before tax | $76.9 million | $81.3 million |
| Net income | $58.2 million | $61.2 million |
| Diluted EPS | $1.06 | $1.12 |
| Loss / expense / combined ratios | 69.9% / 28.3% / 98.2% | 67.2% / 29.1% / 96.3% |
| Operating cash flow | $35.6 million | $32.9 million |
| Total assets / shareholders’ equity | $4.209 billion / $1.821 billion | $4.203 billion / $1.795 billion at Dec. 31, 2010 |
- Revenue rose about 0.8%, while net income fell about 4.8%. Earned premiums declined about 0.3%; written premiums increased about 0.9%, reflecting slightly more policies and modestly higher average premiums.
- Underwriting remained profitable by the reported combined ratio, which was below 100%, but deteriorated 1.9 percentage points year over year. The loss ratio increased while the expense ratio improved.
- Prior-year reserve development was about $1 million unfavorable in Q1 2011, compared with about $20 million favorable in Q1 2010. Excluding prior-period development, the reported loss ratios were 69.8% and 70.3%, respectively.
- Investment gains supported earnings: $28.7 million of net realized gains included $20.9 million from fair-value changes, principally a $30.4 million equity-security gain partly offset by a $9.5 million fixed-maturity loss. Investment income and the reported pretax yield were lower and unchanged, respectively: $35.1 million and 4.6% versus $35.9 million and 4.6%.
- Cash and short-term investments totaled $445.9 million at quarter-end; cash alone was $334.3 million. Operating cash flow was positive, and investing activities provided $149.7 million, while financing activities used $32.4 million, mainly for dividends. Dividends paid were $32.9 million; declared dividends were $0.60 per share.
- Notes payable were $265.6 million, down from $267.2 million at year-end. The balance includes $125 million of unsecured senior notes due August 15, 2011, a $120 million credit facility due January 1, 2012, and an $18 million bank loan. The company said it intended to use cash and short-term investments to repay the senior notes and expected to extend, refinance, or retire the credit facility. It reported compliance with debt covenants.
Material changes, outlook and management commentary
- In January 2011, the company announced a workforce reduction of about 165 employees, primarily in California claims operations. It recorded approximately $4 million of severance expense in Q1 and expected annual savings of about $11 million beginning in Q2.
- The company is withdrawing from Florida homeowners insurance and expected to complete the withdrawal by September 2012. It had established a premium deficiency reserve for that business at December 31, 2010.
- No specific earnings or revenue guidance was provided. Management cautioned that one quarter’s results are not necessarily indicative of full-year results and noted that insurance results can fluctuate with pricing, claim frequency and severity, catastrophes, regulation, and investment values.
- Loss and loss-adjustment reserves were $990.7 million, including about $310.9 million of incurred-but-not-reported reserves. Management considered the reserve estimate adequate, while acknowledging actual ultimate costs could differ.
- California DOI matters include 2004 and 2010 notices alleging rating, underwriting, and related compliance violations. The company denied the allegations and said it would defend them; possible penalties and operational changes remain uncertain. Management did not expect the matters to be material to financial position, though an adverse ruling could materially affect results in the quarter decided. Other lawsuits and regulatory proceedings also carry potential quarterly earnings exposure.
- The investment portfolio was $3.026 billion at fair value and concentrated in municipal bonds: 76.2% of total investments and 91.6% of fixed maturities. The fixed-maturity portfolio’s average credit rating was AA-. Management disclosed modeled sensitivity to a 25% or 50% fall in common-stock values of $119.7 million or $239.4 million, and to a parallel 100- or 200-basis-point interest-rate increase of $124.1 million or $248.2 million in fixed-maturity fair value.
- About $58.4 million of collateralized debt obligations were classified as Level 3 fair-value assets, requiring significant unobservable inputs. The company reported no auction-rate securities at March 31, 2011; it held $1.6 million at year-end.
Most important facts for investors to verify
- Whether underwriting performance and reserve development improve or worsen, particularly given the higher reported loss and combined ratios and the uncertainty inherent in loss reserves.
- Whether the planned $125 million senior-note repayment and the January 2012 credit-facility decision proceed as stated, and whether liquidity remains sufficient.
- The eventual outcomes, penalties, and any required business changes related to the California DOI notices and other litigation or regulatory matters.
- Whether the Florida homeowners withdrawal and expected workforce cost savings occur on schedule and deliver the anticipated financial effects.
- How investment-market movements, municipal-bond credit changes, and Level 3 valuations affect realized gains, reported earnings, and portfolio values.