Mercury General Corporation — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019; unaudited consolidated results. Mercury primarily writes personal auto insurance, principally in California, and also offers homeowners and other property and casualty products.
Financial performance and position
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net premiums earned | $888.8 million | $834.0 million | $1,759.0 million | $1,642.0 million |
| Total revenue | $979.5 million | $885.4 million | $1,997.2 million | $1,668.6 million |
| Net income | $83.3 million | $60.2 million | $219.1 million | $17.6 million |
| Diluted EPS | $1.50 | $1.09 | $3.96 | $0.32 |
| Combined ratio | 98.3% | 96.9% | 97.8% | 100.3% |
| Net realized investment gains (losses) | $53.3 million | $14.3 million | $164.4 million | ($44.4 million) |
- Premium growth reflected higher average premiums, including California rate increases, and growth in California auto and homeowners policies. Six-month net premiums earned grew 7.1%; net premiums written grew 6.5%.
- Six-month underwriting results improved to a $39.1 million gain from a $4.6 million loss. The combined ratio fell to 97.8% from 100.3%, as the loss ratio improved to 73.2% from 75.4% and the expense ratio to 24.6% from 24.9%. Q2 underwriting remained profitable, but its combined ratio worsened year over year.
- Investment performance substantially influenced reported earnings: six-month realized gains were $164.4 million, mainly fair-value increases in fixed maturities and equities. The 2018 comparison included $44.4 million of realized losses. Q2 gains were $53.3 million versus $14.3 million.
- Net investment income was $69.2 million for the first half, up from $66.3 million; average annual pretax yield declined to 3.5% from 3.6%, which management attributed primarily to reinvestment at lower market yields.
- Operating cash flow was $265.6 million for the first half, versus $184.1 million. Investing activities used $270.7 million and financing activities used $68.9 million, including $69.5 million of dividends. Cash ended at $240.3 million, down from $314.3 million at year-end.
- At June 30, total assets were $5.72 billion, shareholders’ equity $1.77 billion, and investments $4.17 billion. Debt carrying value was $371.9 million, primarily $375 million of 4.40% senior notes due 2027. The $50 million revolving facility was undrawn; the company reported compliance with its financial covenants.
- Cash and short-term investments totaled $602.5 million. Management said operating cash flow, available credit, and investment maturities were expected to meet liquidity needs without forced investment sales.
- Dividends paid were $0.6275 per share in Q2 and $1.2550 per share for the first half.
Material developments, outlook, and risks
- California approved auto rate increases of 6.90% for two subsidiaries, implemented in March and May 2019. A 6.99% California homeowners increase was approved in May and was expected to take effect in August.
- Loss reserves increased by $10.8 million for prior accident years in the first half, primarily due to higher-than-estimated California auto defense and cost-containment expenses, partly offset by favorable homeowners reserve changes. Management emphasizes that reserve estimates are uncertain and actual ultimate claims may differ.
- The sale of subrogation rights related to the Camp and Woolsey Fires and 2017 Southern California fires led to reserve re-estimation and an approximately $10 million pretax first-quarter benefit. Reinsurance recoverables and ceded losses were also affected; reinsurers were the primary beneficiaries of the transaction.
- The catastrophe treaty through June 30, 2020 provides up to $590 million per occurrence above a $40 million company retention, subject to exclusions, including Florida business, California earthquake losses on fixed-property policies, and wildfire exclusions on specified layers. Annual treaty premium rose to approximately $38 million from $22 million for the prior treaty year.
- A longstanding California DOI rate and broker-fee matter remains unresolved. After the Court of Appeal reversed a judgment favorable to Mercury in May 2019, the company sought California Supreme Court review. Mercury had recorded approximately $31.9 million in other liabilities for the refunded penalty and interest, and accrued about $3 million in Q2 for estimated additional statutory interest. The company said it did not expect the false-advertising proceeding to be material to its financial position.
- Other principal exposures include catastrophe severity, pricing and regulatory approvals, competitive conditions, claims inflation and reserve adequacy, investment market movements, and reinsurer performance. Mercury did not provide specific earnings or premium guidance; it cautioned that interim results are not necessarily indicative of full-year results.
Key facts for investors to verify
- How much of the first-half earnings increase came from recurring underwriting and investment income versus fair-value-driven realized investment gains.
- Whether California rate increases and policy growth offset claims severity, catastrophe costs, and higher reinsurance expense.
- Subsequent development of auto and wildfire reserves, including the effects of the subrogation-rights sale and reinsurance recoverables.
- Outcome and potential additional interest or costs in the California DOI litigation and related proceedings.
- Investment portfolio exposure to equity markets, interest rates, municipal credit, and the treaty’s wildfire and geographic exclusions.