Mercury General Corporation (NYSE: MCY) — 2020 Form 10-K
Reporting period: Fiscal year ended December 31, 2020; comparisons are primarily with FY2019. The filing also reports fourth-quarter results. Mercury is a property-and-casualty insurer focused on personal auto, operating in 11 states, principally California. About 86% of 2020 direct premiums written were in California; private passenger auto represented 70.3% of direct premiums written.
Financial results and position
| Metric | FY2020 | FY2019 | Change / context |
|---|---|---|---|
| Total revenue | $3.785 billion | $3.973 billion | Down 4.7%; investment gains were lower |
| Net premiums earned | $3.556 billion | $3.599 billion | Down 1.2%; includes about $128 million of COVID-related refunds and credits |
| Net income | $374.6 million | $320.1 million | Up 17.0% |
| Diluted EPS | $6.77 | $5.78 | Up 17.1% |
| GAAP combined ratio | 93.1% | 99.4% | Improved; below 100% indicates underwriting profit |
| Net investment income | $134.9 million | $141.3 million | Down as average investment yields declined |
| Net realized investment gains | $85.7 million | $222.8 million | Materially lower year over year |
| Operating cash flow | $605.6 million | $519.7 million | Up $85.9 million |
- FY2020 loss and loss-adjustment expenses were $2.395 billion, versus $2.706 billion in 2019. Lower auto claim frequency during pandemic restrictions improved the loss ratio, partly offset by higher severity, catastrophe losses and homeowners losses. Excluding prior-period reserve development and catastrophe losses, the loss ratio was 64.8%, versus 73.3%.
- Fourth-quarter 2020 net income was $166.7 million, or $3.01 per share, compared with $31.7 million, or $0.57 per share, in fourth-quarter 2019. The filing attributes the 2020 quarter primarily to underwriting profit and higher fair values of fixed-income and equity securities.
- At year-end, total investments were $4.729 billion, total assets $6.328 billion, shareholders’ equity $2.033 billion, and gross loss reserves $1.991 billion. Cash plus short-term investments totaled $724.1 million.
- Debt was $372.5 million carrying value ($375 million principal), consisting principally of 4.4% senior unsecured notes due 2027. The $50 million revolving facility was undrawn; the company reported compliance with its financial covenants.
- Insurance-company statutory surplus was $1.768 billion; all subsidiaries exceeded minimum risk-based capital requirements, with none below 350% of authorized-control-level RBC. Net premiums written to statutory surplus was 2.0:1.
Material changes, outlook and risks
- Premiums earned and written declined in part because of approximately $128 million in “Mercury Giveback” refunds and credits. California auto frequency fell with reduced driving, while severity rose amid a higher share of serious accidents and potential repair-cost and supply-chain pressures.
- Prior-year reserve development was unfavorable by approximately $23.0 million in 2020, mainly in homeowners and commercial auto, partly offset by favorable private-auto development. Management identifies 2020 California auto bodily-injury reserves and claim reporting as unusually uncertain; the filing’s sensitivity analyses show potentially material reserve variation.
- Catastrophe losses net of reinsurance were about $64 million in 2020. Approximately $69 million of 2020 catastrophe events generated no reinsurance recovery because individual events did not exceed the treaty retention. Wildfires, windstorms and severe weather remain significant exposures.
- Investments rose to $4.729 billion, but the portfolio is concentrated in municipal bonds: about 55% of total investments and 73% of fixed maturities at fair value. Lower reinvestment yields may constrain investment income; management estimates a 100- or 200-basis-point rate increase would reduce fixed-maturity fair value by $119.3 million or $238.7 million, respectively.
- Management intends in 2021 to stop accepting new and renewal commercial-auto business in Arizona, Georgia, Illinois and Nevada; the affected 2020 net premiums written were about $20 million. It also plans continued technology modernization and digital-service investment. No numerical earnings or revenue guidance is provided.
- Regulatory and legal matters include California rate oversight, residential-property nonrenewal moratoria in designated wildfire areas, and a California DOI notice of intent to pursue enforcement relating to findings from a prior market-conduct examination. Management does not expect pending legal or regulatory matters to have a material adverse effect, but outcomes can be uncertain.
- Other principal risks include California concentration, rate-approval delays, pricing and reserve-estimation error, catastrophe exposure, reinsurance collectability, investment-market and municipal-bond risk, COVID-19 effects, and cyber/technology disruption. The parent depends on regulated insurance subsidiaries for dividends; up to $222 million could be paid to Mercury General in 2021 without extraordinary-dividend approval.
Most important facts for investors to verify
- Whether reduced auto claim frequency persists or reverses, and how bodily-injury severity and late-reported claims affect 2020 and prior-year reserves.
- Whether California wildfire and other catastrophe losses remain within retention limits and whether current reinsurance pricing, limits and exclusions adequately protect the company.
- How premium volume, retention and underwriting profitability develop after refunds, rate actions and the planned commercial-auto exits.
- Whether investment income and realized gains can sustain earnings as yields remain low, given the municipal-bond and equity exposures.
- The status and potential financial consequences of California DOI enforcement proceedings, subsidiary dividend capacity, and the parent’s liquidity and debt obligations.
Audit and controls: KPMG issued an unqualified opinion on the consolidated financial statements and an unqualified opinion on internal control over financial reporting. Loss reserves were identified as a critical audit matter.