Mercury General Corporation — Q2 2021 Form 10-Q
Business context and period. Mercury General writes personal automobile and related property and casualty insurance through subsidiaries in 11 states, principally California. This unaudited filing covers the quarter and six months ended June 30, 2021; comparisons are with the corresponding 2020 periods.
Key financial results
| Metric | Q2 2021 | Q2 2020 | First half 2021 | First half 2020 |
|---|---|---|---|---|
| Net premiums earned | $926.8 million | $811.9 million | $1,842.7 million | $1,734.5 million |
| Total revenue | $1,018.8 million | $1,005.8 million | $2,011.9 million | $1,714.2 million |
| Net income | $109.2 million | $228.2 million | $216.2 million | $89.0 million |
| Diluted earnings per share | $1.97 | $4.12 | $3.90 | $1.61 |
| Combined ratio | 94.9% | 88.2% | 94.2% | 92.3% |
Underwriting and margins. Q2 underwriting gain was $47.6 million, down from $95.8 million; first-half underwriting gain was $107.3 million, versus $133.6 million. Q2 loss ratio rose to 70.9% from 61.0%, while the expense ratio improved to 23.9% from 27.2%. First-half loss and expense ratios were 69.7% and 24.5%, respectively, versus 66.1% and 26.2%. Combined ratios remained below 100%, indicating underwriting profitability.
Investment results. Net investment income was $31.0 million in Q2 and $63.2 million for the first half, down from $34.2 million and $68.7 million. Average annual pre-tax yields fell to 2.7% in Q2 and 2.8% in the first half, from 3.2% and 3.3%. Net realized investment gains were $58.8 million in Q2 and $100.5 million in the first half; the prior-year first half had a $92.9 million realized loss. Fair-value changes in securities materially affected earnings.
Cash flow, balance sheet and liquidity. First-half operating cash flow was $317.2 million, up from $259.6 million. Cash was $378.6 million at June 30; cash plus short-term investments was approximately $787.1 million. Total investments were $5.04 billion, total assets $6.70 billion, and shareholders’ equity $2.18 billion. Loss and LAE reserves were $2.09 billion, versus $1.99 billion at year-end 2020. Debt carrying value was $372.7 million, consisting principally of $375 million of 4.4% senior notes due 2027. The $75 million revolving facility was undrawn; the company reported covenant compliance and a 14.7% debt-to-total-capital ratio. First-half dividends paid were $70.0 million.
Material changes and management commentary
- Premium growth benefited substantially from comparison with 2020’s Mercury Giveback refunds and credits. Excluding those prior-year amounts, net premiums earned increased 1.0% in Q2 and 0.1% for the first half; net premiums written increased 3.5% and 1.5%, respectively. Homeowners growth and rate increases contributed, while private passenger auto policy counts declined.
- Auto claim frequency, which fell during pandemic restrictions, increased again in Q2 2021. Management also cited elevated accident severity and repair costs, potential supply-chain and labor pressures, and uncertainty around delayed bodily-injury claims. It warned that further frequency increases or persistently high severity could materially worsen results and might prompt auto rate filings.
- First-half catastrophe losses from 2021 events were approximately $64 million; $60 million was the net catastrophe-loss impact after favorable prior-year catastrophe development. The events included the Texas and Oklahoma freeze and California winter storms. No treaty recovery applied because no single event exceeded the $40 million retention.
- Prior-year reserve development was favorable by $15.4 million in the first half, principally in commercial property and private passenger auto, partly offset by unfavorable commercial auto development. Reserve adequacy remains inherently uncertain.
- California approved a 6.99% homeowners rate increase, implemented in June 2021. A planned standardization of coverage and transfer of eligible California “Good Drivers” between subsidiaries, expected in Q4 2021, is projected to reduce annual California private passenger auto premiums by approximately $25 million over 24 months.
- The company’s catastrophe treaty provides up to $792 million per occurrence after the $40 million retention through June 30, 2022, subject to exclusions and other terms. The company also assumes catastrophe risk under a separate contract, with potential 2021 losses of up to $31.3 million.
- No earnings guidance was provided. Management said liquidity should be adequate without forced investment sales, but noted that business conditions and future cash flows remain uncertain. It extended most employees’ work-from-home policy through January 2022.
- After the quarter, the board extended its authorization to repurchase up to $200 million of common stock for one year; no shares had been repurchased under the authorization. The company also extended the maturity of its $5.7 million land-sale note receivable to August 2022.
Risks, contingencies and unusual items
Key risks include catastrophe exposure, claims inflation and reserve-estimation uncertainty, changing auto driving and loss trends, regulated rate approvals, competition, investment-market and interest-rate movements, and COVID-19-related uncertainty. A 100- or 200-basis-point rise in rates was estimated to reduce fixed-maturity fair value by $121.8 million or $243.5 million, respectively. The equity portfolio also exposes earnings and capital to market declines.
The California DOI indicated it may pursue enforcement related to findings from a 2014 market-conduct examination; the company said it could resolve alleged violations before a formal notice is filed. California tax examinations and assessments remain matters to monitor, though management did not expect their resolution to materially affect financial position. The company stated that pending legal and regulatory matters were not expected to have a material adverse effect. It reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether auto claim frequency and severity continue to rise, and the effect on loss ratios and reserve development.
- How much reported premium growth reflects underlying policy and rate trends versus the comparison with 2020 premium refunds and credits.
- Catastrophe-loss experience, treaty coverage and retention effects, and the terms and exposure of the assumed catastrophe contract.
- The impact of California’s homeowners rate increase and planned auto coverage standardization and policyholder transfers.
- Investment portfolio sensitivity to interest rates and equity markets, including the earnings volatility from fair-value changes.
- Developments in the California DOI enforcement matter, tax examinations, and other legal contingencies.