Mercury General Corporation — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013; financial statements are unaudited. Mercury primarily writes personal automobile insurance through subsidiaries in 13 states, principally California, and also writes homeowners and other property and casualty lines.
Financial performance
| Metric | Q1 2013 | Q1 2012 / comparison |
|---|---|---|
| Net premiums earned | $662.6 million | $635.8 million; up 4.2% |
| Total revenues | $740.2 million | $722.7 million |
| Net investment income | $31.2 million | $31.5 million |
| Net realized investment gains | $44.1 million | $52.7 million |
| Income before taxes | $91.0 million | $102.0 million |
| Net income | $66.5 million | $73.4 million; down about 9.4% |
| Diluted EPS | $1.21 | $1.34 |
| Loss / expense / combined ratios | 70.5% / 27.4% / 97.9% | 70.8% / 26.8% / 97.6% |
| Operating cash flow | $58.2 million | $34.7 million |
| Dividends paid | $33.6 million | $33.5 million |
Net premiums written rose 4.9% to $690.5 million. Management attributed growth mainly to more policies in force and higher average premiums, including the October 2012 California auto rate increase. California represented 78.0% of direct premiums written in Q1 2013, versus 76.3% a year earlier.
The underwriting combined ratio remained below 100%, indicating underwriting profitability, but increased 0.3 percentage point. Approximately $10 million of pretax office-closure and severance costs contributed 0.5 point to the expense ratio and 1.0 point to the loss-adjustment-expense portion of the loss ratio. The filing reports about $3 million of favorable prior-year reserve development, largely from Florida and New Jersey. Management’s point estimate for loss and loss-adjustment reserves was about $1.0 billion, including $408.5 million of IBNR reserves.
Financial position, liquidity, and investments
- At March 31, total assets were $4.27 billion, total liabilities $2.40 billion, and shareholders’ equity $1.88 billion.
- Cash was $185.0 million and short-term investments $152.1 million, or $337.1 million combined. Operating cash flow increased year over year, primarily reflecting higher premium collections and lower operating expenses and tax payments, partly offset by increased paid losses.
- Notes payable totaled $140 million, unchanged from year-end. The company reported compliance with its loan covenants. Insurance-company statutory surplus was $1.51 billion; the trailing-12-month net-premiums-written-to-surplus ratio was 1.8 to 1.
- Total investments at fair value were $3.20 billion. Municipal bonds were $2.19 billion and represented 67.8% of the portfolio; the fixed-maturity portfolio’s weighted-average credit rating was AA-. Equity securities were 16.8% of the portfolio at fair value.
- Investment gains were market-sensitive: Q1 2013 included $54.0 million of fair-value gains on equities, partly offset by $10.4 million of fair-value losses on fixed maturities. Net investment income and pretax yield edged down year over year, which management attributed primarily to replacing higher-yielding investments with lower-yielding securities in the low-rate environment.
Material changes, outlook, and risks
- In January 2013, Mercury announced a net workforce reduction of about 135 employees, under 3% of its workforce, and consolidated certain claims and underwriting operations into hubs in Florida, New Jersey, and Texas. Management expects approximately $12 million in annual savings; the filing does not provide a timeline for realizing those savings.
- No specific earnings or revenue guidance is provided. Management cautions that quarterly results are not necessarily indicative of full-year results.
- California approved an auto-body repair regulation effective March 2013. Management said the full effect was unknown but likely to increase automobile repair-parts costs.
- California auto rate filings remained pending: a 6.9% increase for CAIC filed in October 2012 and a 6% increase for MIC filed in February 2013. Mercury was also challenging a California homeowners rate order recommending an approximately 5.5% reduction; a stay hearing was scheduled for May 5, 2013.
- California DOI notices of non-compliance concerning rating, underwriting, broker fees, and advertising remained in dispute. The company denied the allegations and said it intended to defend itself; management did not expect the matters to materially affect financial position, though outcomes were not certain.
- Key disclosed risks include competition and pricing, loss-reserve estimation, claims inflation and severity, weather and catastrophe losses, regulatory approval of rates, litigation and regulatory outcomes, investment-market and interest-rate changes, and the realization of deferred tax assets. Management said pending proceedings were not expected to have a material adverse effect. The filing also notes ongoing federal and California tax examinations.
- Interest-rate sensitivity analysis estimated that a 100- or 200-basis-point increase would reduce the fair value of the bond portfolio by $89.3 million or $178.6 million, respectively. A 25% or 50% decline in the overall stock market was estimated to reduce common-stock portfolio fair value by $134.1 million or $268.2 million.
Investor verification priorities
- Track whether premium and policy growth persists and whether pending California auto rate increases are approved.
- Monitor the California homeowners rate dispute and the potential cost impact of the auto-body repair regulation.
- Assess reserve adequacy, particularly given the uncertainty inherent in loss estimates and the reported favorable prior-year development.
- Verify whether the operational consolidation delivers the projected annual savings and how costs affect subsequent expense ratios.
- Evaluate investment-gain volatility, low reinvestment yields, and portfolio sensitivity to interest-rate and equity-market movements.
- Follow the disputed California regulatory matters and tax examinations, including any changes to management’s assessment of potential financial exposure.