Mercury General Corporation — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018; unaudited consolidated results. Mercury primarily writes personal auto insurance, with operations in 11 states and substantial concentration in California.
Financial performance
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Net premiums earned | $834.0 million | $797.7 million | $1,642.0 million | $1,587.4 million |
| Total revenue | $885.4 million | $852.8 million | $1,668.6 million | $1,700.4 million |
| Income before taxes | $73.2 million | $68.8 million | $13.5 million | $99.4 million |
| Net income | $60.2 million | $51.6 million | $17.6 million | $78.6 million |
| Diluted earnings per share | $1.09 | $0.93 | $0.32 | $1.42 |
| Net realized investment gains (losses) | $14.3 million | $21.2 million | ($44.4 million) | $45.6 million |
| Combined ratio | 96.9% | 97.8% | 100.3% | 100.4% |
Q2 net income rose about 17% year over year, while first-half net income fell about 78%, primarily reflecting the swing in investment results: first-half net realized losses included $50.0 million of adverse fair-value changes, chiefly from rising interest rates on fixed maturities and declines in energy and consumer equities. First-half net investment income increased to $66.3 million from $63.1 million.
First-half net premiums written increased 8.1% to $1.740 billion; direct premiums written increased 8.7% to $1.756 billion. Management attributed premium growth mainly to rate increases and growth in California auto and homeowners policies. Reintroduced 12-month auto policies contributed an estimated $23 million to first-half net premiums written, with no material first-half earned-premium effect. The California private-passenger auto rate increase of 5% took effect in March 2018.
Cash, liquidity, debt and capital
- Operating cash flow was $184.1 million in the first half, compared with $174.7 million in 2017. Investing activities used $162.6 million and dividends used $69.2 million; cash declined $47.7 million to $243.8 million.
- Cash plus short-term investments totaled $514.3 million at June 30. Management said operating cash flow, investment maturities and an undrawn revolving facility supported liquidity without forced investment sales, while noting future funding needs cannot be assured.
- Total investments were $3.834 billion; total assets were $5.204 billion and shareholders’ equity was $1.710 billion. Notes payable were $371.5 million, consisting principally of $375 million of 4.40% senior unsecured notes due 2027, net of unamortized costs. The $50 million revolver was undrawn; the company reported covenant compliance.
- Quarterly dividends were $0.625 per share; first-half dividends totaled $69.2 million. Insurer net-premiums-written-to-surplus ratio was 2.13:1, versus the cited industry guideline of 3:1.
Material changes, outlook and risks
- First-half combined ratio remained above 100% at 100.3%, indicating an underwriting loss, despite a slight improvement from 100.4% in 2017. Q2 combined ratio improved to 96.9%.
- Prior-year reserve development was unfavorable by $63.9 million in the first half, versus $14.2 million in 2017. Management cited higher-than-expected California auto bodily-injury severity and defense and cost-containment expenses. It also reported more high-dollar claims and rising medical and settlement costs. Catastrophe losses were $11 million in the first half, down from $40 million.
- The investment portfolio was concentrated in municipal bonds: $2.62 billion, or 88.7% of fixed maturities. Portfolio credit quality averaged A+. Management estimated that a 100- or 200-basis-point rate increase would reduce fixed-maturity fair value by $128.4 million or $256.8 million, respectively.
- A July 2018 Carr Fire was a subsequent event. The company could not yet estimate total losses; reported claims could approach or exceed the $10 million retention. Management expected covered losses above retention to be reimbursed under the treaty, subject to reinstatement premiums.
- A California regulatory appeal remains pending over a $27.6 million penalty previously paid and later refunded with interest. The company has not recognized the approximately $31.3 million refund and accrued interest as a gain; it remains recorded in other liabilities pending appeal. Management does not expect pending proceedings to materially harm its financial position or cash flows.
- No earnings guidance was provided. Management cautioned that results are subject to competition, rate approvals, catastrophe experience, reserve-estimate uncertainty, investment-market movements, regulation and litigation. It stated first-half results are not necessarily indicative of full-year results.
Important facts for investors to verify
- Whether California bodily-injury severity and unfavorable reserve development persist, and the adequacy of loss reserves.
- Premium retention, rate approvals and profitability as policy growth and 12-month auto policies affect written versus earned premiums.
- Investment fair-value sensitivity, particularly municipal-bond exposure and the effects of further interest-rate or equity-market changes.
- Ultimate Carr Fire losses, reinsurance recovery and any reinstatement premiums.
- Outcome of the California penalty appeal and timing of any recognition of the refunded amount.
- Liquidity and dividend capacity if underwriting losses, catastrophe claims or investment volatility increase.