Mercury General Corporation — Q3 2016 Form 10-Q
Business and period: Property-and-casualty insurer, primarily personal auto, operating in 11 states through 14 insurance subsidiaries, principally in California. This unaudited report covers the quarter and nine months ended September 30, 2016; comparisons are with the same 2015 periods.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net premiums earned | $790.9m | $745.5m | $2,337.3m | $2,197.8m |
| Total revenue | $808.2m | $752.4m | $2,490.1m | $2,223.1m |
| Net investment income | $30.4m | $30.9m | $91.4m | $94.1m |
| Net realized investment gains (losses) | $(15.5)m | $(26.3)m | $55.0m | $(75.6)m |
| Net income | $26.9m | $15.3m | $99.1m | $51.1m |
| Diluted EPS | $0.49 | $0.28 | $1.79 | $0.93 |
| Combined ratio | 98.1% | 99.2% | 101.2% | 98.9% |
- Q3 underwriting was profitable, with a reported segment underwriting gain of $15.3m, versus $6.1m a year earlier. Nine-month underwriting produced a $27.9m loss, versus a $23.6m gain in 2015; favorable investment gains drove much of the increase in year-to-date net income.
- Nine-month net premiums written increased 6.0%; management attributed premium growth primarily to higher average premiums per policy following California auto rate increases. Q3 net premiums earned rose 6.1%.
- Q3 loss and expense ratios were 72.9% and 25.2%, respectively. The nine-month loss ratio rose to 75.5% from 71.9%, while the expense ratio improved to 25.7% from 27.0%.
- Nine-month operating cash flow was $209.6m, versus $148.7m. Investing used $142.8m and financing used $101.1m, including $102.8m of dividends. Cash ended the period at $229.9m, down from $264.2m at year-end 2015.
Financial position and liquidity
- At September 30, 2016, total investments were $3.55bn, total assets $4.80bn, shareholders’ equity $1.82bn, and total liabilities $2.99bn.
- Debt was $290m, unchanged from year-end 2015: $140m secured and $150m unsecured. The company reported compliance with all loan covenants.
- Cash plus short-term investments totaled $436.7m. Management also cited $100m available under its $250m revolving facility and stated operating cash flow, investment maturities, and available liquidity were expected to meet requirements without forced investment sales; it cautioned that future needs and receipts may change.
- Insurance-subsidiary statutory surplus was $1.44bn; trailing 12-month net premiums written to surplus was 2.17:1. The investment portfolio was concentrated in municipal bonds, which represented 72.4% of total investments at fair value.
Changes, outlook, and risks
- Loss reserves: Nine-month unfavorable prior-accident-year development was approximately $69m, mainly from California and Florida auto liability. Catastrophe losses were approximately $23m, primarily severe storms in Texas and Northern California and the Southern California Sand Fire. Management said reserves were adequate, but ultimate outcomes may differ from estimates.
- Investment volatility: Nine-month realized gains improved substantially versus 2015, while Q3 recorded investment losses. Net investment income and annualized yield declined slightly as higher-yielding investments matured and were replaced at lower rates. A hypothetical 100- or 200-basis-point rate increase was estimated to reduce bond portfolio fair value by $105.6m or $211.1m.
- Operations: The company began exiting Michigan and Pennsylvania in 2016 after difficulty achieving profitable growth; runoff was expected to be completed in 2017. A claims-operations restructuring reduced the workforce by about 100 employees and resulted in an approximately $2m second-quarter charge.
- Rates and ratings: California regulators approved 5.0% and 6.9% auto rate increases for two subsidiaries, implemented in March and June 2016. An additional 6.9% increase was pending approval. A.M. Best affirmed ratings in June but moved the outlook for A+ rated entities from Stable to Negative; management said it was working to restore a Stable outlook in the next rating cycle, expected in 2017.
- Contingency: A California Superior Court ruling in August 2016 vacated the regulator’s $27.6m penalty related to broker fees and found, among other matters, that the fees were not premium. The company had paid and accrued the penalty in 2015 but had not recognized a reversal or potential refund, including interest, because the decision remained appealable. Management expected remand for refund and a new order, subject to appeal.
- The company disclosed ongoing California tax examinations and settlement discussions concerning proposed assessments for 2003–2010; management did not expect a material financial-statement impact. Other key risks include reserve estimation, competitive pricing, catastrophe losses, regulatory approvals, investment-market exposure, and the A.M. Best outlook. No formal earnings guidance is provided in the filing; management cautioned that nine-month results are not necessarily indicative of full-year results.
Most important facts for investors to verify
- Whether adverse reserve development continues, particularly in California and Florida auto liability, and how loss trends affect the combined ratio.
- The appeal and remand status of the $27.6m California penalty and whether any refund or interest is ultimately recognized.
- Approval and earned impact of the pending California rate increase, and whether pricing keeps pace with claim severity and costs.
- Progress and financial effects of the Michigan and Pennsylvania runoff and the claims restructuring.
- Any change in A.M. Best ratings or outlook, and the effect of interest-rate, municipal-credit, and equity-market movements on investments and liquidity.