Mercury General Corporation — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. Mercury primarily writes personal auto insurance through subsidiaries in 13 states, principally California; it also writes homeowners and other property and casualty lines. Figures below are unaudited.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net premiums earned | $697.9 million | $675.8 million | $1,381.6 million | $1,338.4 million |
| Total revenue | $807.0 million | $642.6 million | $1,570.0 million | $1,382.7 million |
| Net income (loss) | $95.0 million | $(9.3) million | $167.6 million | $57.2 million |
| Diluted earnings (loss) per share | $1.73 | $(0.17) | $3.05 | $1.04 |
| Combined ratio | 96.0% | 98.7% | 96.3% | 98.3% |
| Net investment income | $30.9 million | $31.7 million | $61.1 million | $62.8 million |
| Net realized investment gains (losses) | $76.2 million | $(67.4) million | $122.9 million | $(23.4) million |
Q2 loss and expense ratios were 69.2% and 26.8%, respectively; six-month ratios were 69.5% and 26.8%. Net premiums written rose 5.0% in both periods, while earned premiums increased 3.3% in Q2 and 3.2% year to date. Management attributed written-premium growth mainly to higher average premiums following California auto and homeowners rate increases. Q2 net income included $0.90 per share of after-tax realized investment gains; the six-month amount was $1.45 per share.
Cash, investments, debt and capital
- Operating cash flow was $128.4 million for the first half, versus $96.5 million a year earlier. Investing activities used $148.9 million; financing activities provided $12.5 million. Cash ended the period at $258.5 million.
- At June 30, total investments were $3.39 billion, total assets $4.56 billion, and shareholders’ equity $1.92 billion. Cash plus short-term investments totaled $487.9 million.
- Notes payable rose to $270 million from $190 million at year-end, including $130 million drawn under the unsecured revolving facility. The company reported covenant compliance and $70 million of remaining availability on its $200 million facility.
- Insurance subsidiaries’ combined statutory surplus was $1.5 billion; trailing-12-month net premiums written to surplus was 1.9:1.
Material changes, outlook and risks
- The sharp year-over-year earnings swing primarily reflects investment-market fair-value movements: 2014 realized gains contrasted with 2013 losses. Net investment income and yields declined modestly, which management attributed to replacing maturing higher-yield investments with lower-yield securities.
- Underwriting improved: the six-month combined ratio fell to 96.3% from 98.3%. Results included about $8 million of favorable prior-year reserve development and $6 million of catastrophe losses in 2014; the comparable period had about $3 million favorable development and $14 million catastrophe losses.
- California preferred private passenger auto rates increased 6.0% and homeowners rates 8.26%, both effective January 2014. The catastrophe treaty renewed effective July 1, 2014, providing $100 million per occurrence above a $100 million company retention, subject to stated exclusions and limits; annual premium is $4.8 million.
- No specific earnings or premium guidance was provided. Management cautioned that interim results are not necessarily indicative of full-year results and cited competition, pricing and rate approvals, loss trends and reserve estimates, catastrophe exposure, investment and interest-rate risk, regulatory changes, and tax uncertainties as factors that could affect results.
- Loss and loss-adjustment reserves were approximately $1.05 billion, including about $426 million of IBNR. Management considers reserves adequate, but ultimate claim costs may differ from estimates. Reserve estimates are a key judgment area.
- California DOI matters remain pending: the company awaits an administrative decision on the 2004 notice of non-compliance; the 2010 notice alleges rating and underwriting violations. The company denies the allegations and says resolution is not expected to be material, but outcomes are uncertain. California tax examinations and proposed assessments for 2003–2006 are also outstanding; management does not expect a material impact.
- Investment exposures include a large municipal-bond concentration and market sensitivity. A hypothetical 100-basis-point rate increase was estimated to reduce bond fair value by $83.7 million; a 200-basis-point increase by $167.4 million. A 25% decline in the stock market was estimated to reduce common-stock value by about $100.5 million.
Key facts for investors to verify
- How much of earnings growth is attributable to investment gains versus recurring underwriting performance, and whether fair-value gains persist.
- Whether premium growth and the sub-100% combined ratio are sustainable after rate changes, reserve development, and catastrophe losses.
- Reserve adequacy and subsequent development, particularly given the scale of IBNR and inherent estimation uncertainty.
- Exposure and potential outcomes from the California DOI proceedings and state tax examinations.
- Investment-portfolio sensitivity, credit quality, liquidity, and the effect of higher debt and the total-return-swap exposures.