Mercury General Corporation — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015; unaudited consolidated results. Mercury primarily writes personal auto insurance, principally in California, and also offers homeowners, commercial auto, and other insurance through independent agents.
Financial performance and position
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net premiums earned | $731.5 million | $697.9 million | $1,452.3 million | $1,381.6 million |
| Total revenues | $726.2 million | $807.0 million | $1,470.7 million | $1,570.0 million |
| Income before tax | $4.5 million | $136.4 million | $34.4 million | $238.5 million |
| Net income | $9.6 million | $95.0 million | $35.8 million | $167.6 million |
| Diluted EPS | $0.17 | $1.73 | $0.65 | $3.05 |
| Combined ratio | 98.5% | 96.0% | 98.8% | 96.3% |
Premium growth reflected higher average premiums, including California auto rate increases, and growth in selected homeowner and auto business. Net realized investment results swung from gains of $76.2 million in Q2 2014 and $122.9 million in the first half of 2014 to losses of $39.3 million and $49.3 million, respectively, in 2015. The 2015 losses primarily reflected fair-value declines in fixed maturities as interest rates rose and in equities, particularly utility shares. These investment swings were the main reason total revenue and earnings fell despite higher earned premiums.
Underwriting remained profitable by combined-ratio measure, but deteriorated year over year. Higher catastrophe losses, rising claim frequency and severity in California private auto, and increased advertising costs contributed. Catastrophe losses were approximately $7 million in Q2 and $10 million in the first half. Favorable prior-year reserve development was approximately $2 million in Q2 and $5 million in the first half; the first-half benefit was mainly from California personal auto and was partly offset by adverse development elsewhere.
Net investment income was $31.7 million in Q2 and $63.2 million in the first half, up from the comparable periods, primarily because average invested assets increased. Before-tax portfolio yield was 3.9% for Q2 versus 3.9%, and 3.8% for the first half versus 4.0%.
At June 30, 2015, total assets were $4.586 billion, investments were $3.360 billion, shareholders’ equity was $1.848 billion, and cash was $274.8 million. Cash plus short-term investments totaled approximately $428.3 million. Loss and loss-adjustment reserves were $1.114 billion, including approximately $438 million of IBNR reserves. Notes payable totaled $290 million, unchanged from year-end. The company reported $100 million available under its $250 million revolving facility and compliance with loan covenants. Insurance subsidiaries’ combined statutory surplus was $1.5 billion; trailing premiums-written-to-surplus was 2.0:1.
For the first half, operating cash flow was $73.2 million, down from $128.4 million; investing cash flow used $22.4 million, and financing cash flow used $65.9 million, including $68.1 million of dividends. Cash declined $15.1 million to $274.8 million. Dividends paid were $0.6175 per share in Q2 and $1.2350 per share for the half.
Material changes, outlook, and risks
- California DOI-approved rate increases: 6.4% on preferred private passenger auto, implemented in May 2015, and 6.9% on standard private passenger auto, scheduled for August 2015. These lines represented approximately 50% and 15% of company net premiums earned, respectively.
- WAIC was acquired on January 2, 2015. It contributed $12.8 million of revenue and a $2.8 million net loss for the first half. Mercury paid $8 million, with $2 million held in escrow, and contributed $15 million of capital to WAIC.
- The California DOI’s $27.6 million penalty in a long-running rate-practices matter was accrued in Q4 2014 and paid in March 2015. Mercury is challenging the order in court and seeks to recover the penalty plus interest; a hearing was expected in Q1 2016. The separate false-advertising allegations remain unresolved. Mercury also settled a separate 2010 notice for $1 million, paid in 2015.
- Management gave no numerical earnings or premium guidance. It said operating cash flow, liquid investments, maturities, and available credit were expected to meet liquidity needs without forced investment sales, while cautioning that business conditions could change. The catastrophe reinsurance treaty provides $100 million per occurrence above a $100 million retention, excludes Florida, and runs through June 30, 2016; renewal terms were to be negotiated.
- Key stated risks include uncertain loss reserves and claim-cost trends, competition and pricing, rate-approval timing, catastrophe exposure, investment and interest-rate volatility, municipal-bond credit risk, regulatory and legal matters, tax challenges, and execution of information-technology initiatives. The company reported its disclosure controls were effective and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether California auto rate increases improve premium growth and underwriting results, and how claim frequency and severity evolve.
- Investment portfolio valuation and earnings sensitivity: the filing estimates a $80 million reduction in bond fair value for a 100-basis-point rate increase and $160 million for 200 basis points.
- Loss-reserve adequacy, including IBNR estimates, catastrophe losses, and the direction of prior-year development.
- Progress and potential financial outcomes of the California DOI litigation, including possible recovery of the $27.6 million penalty and the unresolved false-advertising matter.
- WAIC’s subsequent performance and the recoverability of the $2 million escrow; liquidity, dividends, and debt-facility availability.