Mercury General Corporation — 2014 Form 10-K
Reporting period: Fiscal year ended December 31, 2014. This is an annual filing, not a standalone fourth-quarter report. Mercury primarily writes personal automobile insurance through subsidiaries in 13 states, with California representing 80.9% of 2014 direct premiums written.
Financial performance
| Metric | 2014 | 2013 | Change / context |
|---|---|---|---|
| Net premiums earned | $2.796 billion | $2.698 billion | Up 3.6% |
| Total revenues | $3.012 billion | $2.821 billion | Up 6.8%; includes large investment gains |
| Net income | $177.9 million | $112.1 million | Up 58.7% |
| Diluted EPS | $3.23 | $2.04 | Up $1.19 |
| Net cash from operations | $246.5 million | $209.8 million | Up $36.7 million |
| Combined ratio, GAAP | 98.8% | 99.6% | Below 100% indicates underwriting profit |
- Net premiums written rose 4.1% to $2.841 billion, primarily reflecting higher average premiums following California auto and homeowners rate increases.
- Net investment income was $125.7 million, versus $124.5 million. Average pre-tax yield declined to 3.9% from 4.1% as lower-yielding investments replaced maturing higher-yielding holdings.
- Net realized investment gains were $81.2 million, compared with an $11.4 million loss in 2013. Much of the year-over-year earnings improvement therefore reflected investment valuation and realization results, not solely underwriting.
- Reported loss and expense ratios were 71.0% and 27.7%, respectively. The expense ratio included the $27.6 million California regulatory penalty; excluding that charge, management reported a 26.8% expense ratio. Excluding catastrophe losses and prior-year reserve development, the loss ratio was 70.7%, versus 72.0% in 2013.
- Fourth-quarter 2014 net premiums earned were $709.4 million; the quarter recorded a $21.0 million net loss, or $0.38 per diluted share, versus $15.4 million net income in fourth-quarter 2013. The 2014 quarterly loss reflected the penalty, falling equity values, and California rainstorm losses.
Balance sheet, debt and liquidity
- At year-end, total assets were $4.600 billion, shareholders’ equity was $1.875 billion, and investments at fair value totaled $3.404 billion.
- Notes payable increased to $290 million from $190 million. The company had $289.9 million of cash and $372.5 million of short-term investments; management reported $100 million available under its $250 million revolving facility.
- Operating cash flow was positive for more than 20 consecutive years, according to management. In 2014, operating cash funded dividends and investments; cash from operations increased partly because of higher premium collections and lower paid losses.
- Insurance subsidiaries’ statutory policyholders’ surplus was $1.438 billion, down from $1.529 billion. Net premiums written to statutory surplus was 2.0:1, within the cited 3.0:1 guideline. Each subsidiary exceeded regulatory minimum RBC requirements, although CAIC’s 386% RBC ratio was below a loan-covenant threshold; the company obtained a waiver and contributed $10 million to CAIC.
- Shareholder dividends paid were $2.4625 per share in 2014. The board declared a $0.6175 quarterly dividend in February 2015. Subsidiaries could pay approximately $177.5 million in ordinary dividends to the parent in 2015 without extraordinary-dividend approval.
Material changes versus 2013
- Underwriting improved: the GAAP combined ratio fell to 98.8% from 99.6%, helped by a lower loss ratio and favorable prior-year reserve development of about $3 million; 2013 had about $3 million of unfavorable development.
- Investment gains swung to $81.2 million from a loss of $11.4 million, including gains in fixed maturities but fourth-quarter declines in equity values, particularly energy holdings.
- Other operating expenses increased to $249.4 million from $219.5 million, including the regulatory penalty. The 2013 comparison included approximately $10 million of office consolidation and severance costs.
- Debt rose by $100 million, primarily from additional unsecured-facility borrowings. The company extended certain facility maturities and increased the unsecured revolver capacity from $200 million to $250 million.
- California remained the core market; direct premiums written grew to $2.853 billion from $2.737 billion. California homeowners and commercial auto premiums also increased, while some non-California personal auto rates were reduced.
Outlook, risks and unusual items
- No specific earnings or premium-growth guidance is provided. The company described market conditions as mixed and emphasized that results depend on competition, rate approvals, claims trends, and catastrophe experience.
- Management said it launched a national advertising campaign in 2015 and expected advertising spending of up to $48 million, compared with $23.1 million in 2014. Further Guidewire system deployments were planned for 2015, including California personal auto claims processing.
- The California Insurance Commissioner adopted a proposed decision assessing a $27.6 million civil penalty in the long-running 2004 Notice of Non-Compliance matter. The company accrued the full amount in 2014, disputes the allegations and penalty, and said it intends to defend itself or seek a reasonable settlement. The separate 2010 notice alleges other rating and underwriting noncompliance.
- The company identifies reserve adequacy as a major uncertainty. California bodily-injury severity and claim counts may differ from estimates; management cited potential combined unfavorable development of about $54.5 million under specified severity sensitivities for 2012–2014 accident years, and a 2014 claim-count sensitivity range with approximately $16.4 million of unfavorable development at the high end.
- Catastrophe losses were approximately $11 million in 2014, versus $17 million in 2013. The company also disclosed maximum potential California Earthquake Authority assessments of approximately $62.5 million based on the latest available information; no assessment was made in 2014. Its catastrophe treaty provides $100 million per occurrence after a $100 million retention, excludes Florida, and was effective through June 30, 2015.
- Investment risks include concentration in municipal bonds: 66.6% of total investments at fair value and 86.6% of fixed maturities were tax-exempt municipal securities. A hypothetical 100- or 200-basis-point rate increase was estimated to reduce bond-portfolio fair value by $75.8 million or $151.6 million, respectively.
- On January 2, 2015, Mercury acquired California non-standard auto insurer WAIC for $8 million, with $2 million held in escrow, and contributed $15 million of capital after closing. Purchase accounting remained under review.
- KPMG gave unqualified opinions on the consolidated financial statements and internal control over financial reporting; management also concluded disclosure controls were effective.
Key facts for investors to verify
- Review the status and possible ultimate cost of the $27.6 million California penalty, including the company’s challenge and any resolution of the 2004 and 2010 matters.
- Assess whether the improvement in underwriting persists after separating investment gains, the penalty, catastrophe losses, and prior-year reserve development.
- Monitor California auto bodily-injury severity, claim-count development, and reserve adequacy, particularly for 2012–2014 accident years.
- Check CAIC’s RBC covenant compliance after the waiver and capital contribution, alongside statutory surplus and subsidiary dividend capacity.
- Evaluate municipal-bond concentration and interest-rate sensitivity, as well as debt levels and available holding-company liquidity.
- Verify WAIC integration, the final acquisition accounting and reserve assessment, and the expected 2015 advertising and technology spending.