Mercury General Corporation — Q3 2015 Form 10-Q
Business and period. Property-and-casualty insurer focused primarily on personal auto, operating in 13 states, principally California, and distributing mostly through independent agents. This unaudited report covers the quarter and nine months ended September 30, 2015; balance-sheet comparisons are with December 31, 2014. Amounts below are in millions except per-share data and ratios.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net premiums earned | $745.5 | $705.2 | $2,197.8 | $2,086.8 |
| Total revenues | $752.4 | $720.0 | $2,223.1 | $2,290.0 |
| Net investment income | $30.9 | $32.6 | $94.1 | $93.7 |
| Net realized investment losses (gains) | $(26.3) | $(20.1) | $(75.6) | $102.8 |
| Net income | $15.3 | $31.3 | $51.1 | $198.9 |
| Diluted earnings per share | $0.28 | $0.57 | $0.93 | $3.62 |
| Combined ratio | 99.2% | 96.7% | 98.9% | 96.4% |
| Operating cash flow | Not presented by quarter | $148.7 | $199.5 |
Balance sheet and liquidity
- At September 30, total assets were $4,646.6 million, total investments $3,348.4 million, cash $295.2 million, and shareholders’ equity $1,829.5 million.
- Loss and loss-adjustment reserves were $1,131.6 million, up from $1,091.8 million at year-end 2014; unearned premiums were $1,063.3 million, up from $999.8 million.
- Debt was unchanged at $290.0 million: $140.0 million secured and $150.0 million under an unsecured facility. The company reported covenant compliance and $100 million available under its $250 million revolving facility.
- Cash plus short-term investments totaled approximately $458 million. Nine-month dividends paid were $102.2 million, or $1.8525 per share.
Material changes and management commentary
- Premium growth: net premiums written increased 8.2% in Q3 and 5.1% year to date; earned premiums rose 5.7% and 5.3%, respectively. Management attributed growth mainly to higher average premiums following California auto rate increases and policy growth in homeowners and out-of-state auto.
- Underwriting results weakened versus both comparison periods. Q3 loss ratio increased to 73.2% from 69.8%; year-to-date it rose to 71.9% from 69.6%. Management cited loss frequency and severity, California homeowners and auto loss costs, higher catastrophe losses year to date, and less favorable prior-year reserve development. Expense ratio was 26.0% in Q3 versus 26.9%, but 27.0% year to date versus 26.8%, partly reflecting increased advertising.
- Investment results were a significant earnings swing: nine-month net realized investment results moved from a $102.8 million gain in 2014 to a $75.6 million loss in 2015. The company cited market interest-rate increases and declines in equity values. Q3 net investment income and investment yield also declined modestly as older, higher-yielding holdings matured and were replaced.
- Operating cash flow declined $50.8 million year over year to $148.7 million, primarily due to increased paid losses and expenses, including the California DOI penalty, partly offset by higher premium collections.
- California approved auto rate increases of 6.4% for preferred business (implemented May 2015) and 6.9% for standard business (implemented August 2015).
- On January 2, 2015, Mercury acquired Workmen’s Automobile Insurance Company. WAIC contributed $18.5 million revenue and a $3.6 million net loss for the nine-month period.
Outlook, risks and unusual items
- No numerical earnings or premium guidance is provided. Management cautions that nine-month results are not necessarily indicative of full-year results.
- Key exposures include competitive pricing, insurance-rate regulation, claim frequency and severity, catastrophe losses, reserve-estimation uncertainty, investment-market volatility, interest rates, and the ability to realize deferred tax assets. Management reported approximately $11 million of catastrophe losses and $3 million favorable development on prior accident years for the first nine months; Q3 included approximately $1 million of catastrophe losses and $2 million unfavorable development.
- The company paid a $27.6 million California DOI penalty in March 2015 concerning alleged historical rate and broker-fee violations, while challenging the order in court and seeking recovery. A hearing was scheduled for March 14, 2016. A separate 2010 DOI notice was settled for $1 million, paid in 2015. Management said pending legal and regulatory matters were not expected to have a material adverse effect, but outcomes remain uncertain.
- The California Franchise Tax Board is examining tax years 2003–2013; proposed adjustments for 2003–2010 were protested, and settlement discussions were ongoing. Management did not expect a material financial-statement impact from the examinations.
- Investment portfolio risks include concentration in municipal bonds (72.9% of investments at fair value), equity price exposure, and interest-rate sensitivity. A hypothetical 100- or 200-basis-point rate increase was estimated to reduce bond portfolio fair value by $82.6 million or $165.1 million, respectively.
Key facts investors should verify
- Whether California auto rate increases translate into sustained premium growth and offset rising claim frequency, severity, and catastrophe costs.
- Reserve adequacy and subsequent development, particularly given the $1.13 billion reserve balance and uncertainty inherent in long-tail claims.
- Resolution and potential recovery of the $27.6 million California DOI penalty, plus progress in the separate tax examination.
- Drivers and persistence of realized investment losses, portfolio valuation changes, and sensitivity to interest rates and equity markets.
- Liquidity and capital position after dividends, claims payments, and ongoing investment needs; the filing reports $100 million of undrawn revolver capacity.