Mercury General Corporation — Q3 2013 Form 10-Q
Business context and reporting period. The unaudited filing covers the quarter and nine months ended September 30, 2013, compared with the same 2012 periods. Mercury primarily writes personal automobile insurance through subsidiaries in 13 states, principally California, and also writes homeowners, commercial auto, commercial property and other lines. Figures below are in millions of dollars unless noted.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net premiums earned | $678.9 | $646.1 | $2,017.3 | $1,919.1 |
| Total revenue | $728.7 | $731.8 | $2,111.4 | $2,102.2 |
| Net investment income | $30.9 | $33.4 | $93.7 | $96.6 |
| Net realized investment gains (losses) | $16.2 | $49.8 | $(7.2) | $78.7 |
| Net income | $39.6 | $66.2 | $96.8 | $134.3 |
| Diluted earnings per share | $0.72 | $1.21 | $1.76 | $2.45 |
| Combined ratio | 99.2% | 99.1% | 98.6% | 100.4% |
| Operating cash flow | Not separately presented for the quarter | $169.7 | $113.3 |
Net premiums written increased 2.9% in Q3 and 3.2% year to date. Management attributed the growth primarily to higher average premiums, including rate increases, and, year to date, more policies in force. The nine-month combined ratio improved below 100%, indicating underwriting profitability for that period; Q3 remained near 100%. Nine-month favorable prior-year reserve development was approximately $2 million, versus approximately $33 million unfavorable development in 2012.
Investment income and yields declined: the nine-month pre-tax annualized yield was 4.1%, compared with 4.3% in 2012. The company reported $7.2 million of nine-month realized investment losses, including fair-value losses on fixed maturities that exceeded gains on equities. The 2012 comparison included substantial realized gains. Q3 investment gains were $16.2 million, also below the prior-year quarter.
Financial position, liquidity and capital
- At September 30, total assets were $4,340.5 million and shareholders’ equity was $1,840.2 million, compared with $4,189.7 million and $1,842.5 million, respectively, at December 31, 2012.
- Cash was $250.1 million; cash plus short-term investments totaled $501.5 million. The investment portfolio was $3,126.3 million at fair value.
- Notes payable were $180.0 million, up from $140.0 million at year-end, including a new $40 million borrowing under the company’s $200 million unsecured revolving credit facility. $160 million remained available. The company reported compliance with loan covenants.
- Operating cash flow for the first nine months rose to $169.7 million. Investing activities used $18.5 million and financing activities used $59.3 million, including $101.0 million of shareholder dividends. Cash increased by $91.9 million to $250.1 million.
- Insurance-company statutory surplus was $1.5 billion; the trailing-twelve-month net-premiums-written-to-surplus ratio was 1.8 to 1. Dividends paid were $1.8375 per share for the nine-month period.
Material changes, outlook and risks
- Earnings comparison: Net income fell 40% in Q3 and 28% for the first nine months year over year. Lower realized investment results were a major factor. For nine months, pre-tax income also reflected approximately $16 million of catastrophe losses and approximately $10 million of first-quarter office consolidation and severance costs.
- Claims and costs: Management reported approximately $16 million of catastrophe losses in the first nine months of 2013, versus approximately $9 million in 2012. A California auto-body repair regulation effective March 2013 may increase repair-parts costs; the full effect was not yet known. Loss reserves were approximately $1.0 billion, including $396.1 million of incurred-but-not-reported reserves. Management considers reserves adequate but notes actual outcomes may differ from estimates.
- Rates and regulatory matters: A mandated California homeowners rate reduction was implemented in Q2 2013, and the company challenged the decision. A stipulated 8.26% homeowners rate increase was agreed to but remained subject to final regulatory approval. California DOI noncompliance matters from 2004 and 2010 remained unresolved; Mercury denied the allegations and did not expect a material financial impact. Management likewise did not expect pending proceedings overall to materially adversely affect the company.
- Reinsurance and investment strategy: A catastrophe treaty effective July 1, 2013 provides $100 million of per-occurrence coverage after a $100 million company retention, subject to stated exclusions; annual premium is $4.25 million. The investment portfolio is concentrated in municipal bonds: 68.1% of total investments and 83.9% of fixed maturities were in tax-exempt state and municipal bonds. Management cited interest-rate, equity-market and credit risks.
- New transaction: A consolidated investment vehicle entered a three-year total return swap in August 2013 with approximately $80 million notional exposure, paying LIBOR plus 120 basis points and secured by approximately $40 million of U.S. Treasuries. The filing describes potential reduction of the position following significant market-value erosion and an option to add capital or terminate.
- Guidance: The filing provides no numerical earnings or premium guidance. Management cautioned that interim results are not necessarily indicative of full-year results. Key stated uncertainties include competition, pricing and rate approvals, claims severity and reserve estimates, weather events, investment returns and interest rates, regulation and litigation, and realization of deferred tax assets.
Most important facts for investors to verify
- Whether premium growth and underwriting margins persist, particularly as California rate changes and repair-cost rules affect claims.
- Whether loss reserves, including IBNR, remain adequate and how catastrophe claims and prior-year development evolve.
- How much reported earnings are affected by investment fair-value movements versus recurring underwriting and investment income.
- Developments in the California homeowners rate proceeding and the 2004 and 2010 DOI matters.
- Performance, collateral requirements and downside exposure of the new total return swap, and continued covenant compliance and liquidity availability.