Mercury General Corporation — Q3 2012 Form 10-Q
Business and reporting period. Unaudited results cover the three and nine months ended September 30, 2012, with balance-sheet comparisons to December 31, 2011. Mercury primarily writes personal automobile insurance through independent agents, chiefly in California, alongside homeowners, commercial auto and other lines. California represented 76.1% of direct premiums written in the first nine months.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net premiums earned | $646.1 million | $643.6 million | $1,919.1 million | $1,924.4 million |
| Total revenues | $731.8 million | $615.7 million | $2,102.2 million | $2,027.8 million |
| Net income (loss) | $66.2 million | $(3.8) million | $134.3 million | $111.7 million |
| Diluted earnings (loss) per share | $1.21 | $(0.07) | $2.45 | $2.04 |
| Combined ratio | 99.1% | 98.3% | 100.4% | 98.2% |
| Net cash from operating activities | Not presented by quarter | Not presented by quarter | $113.3 million | $166.1 million |
- Underwriting and premiums: Q3 net premiums written rose 3.4% year over year to $684.9 million; earned premiums increased 0.4%. Nine-month written premiums increased 2.0% to $1,996.8 million, while earned premiums declined 0.3%. The nine-month combined ratio exceeded 100%, indicating underwriting losses on the reported basis.
- Investment results: Net realized investment gains were $49.8 million in Q3 and $78.7 million year to date, versus losses of $66.9 million and $14.5 million, respectively, in 2011. Gains included fair-value increases in securities. Net investment income fell to $33.4 million in Q3 and $96.6 million year to date, from $35.5 million and $106.6 million, as higher-yielding investments matured and were replaced at lower rates.
- Cash, liquidity and capital: Cash was $188.2 million at September 30; cash plus short-term investments totaled $409.3 million. Operating cash flow was $113.3 million, down $52.8 million year over year; cash declined $23.2 million over the nine months. Total assets were $4.21 billion, total liabilities $2.32 billion, and shareholders’ equity $1.89 billion. Notes payable totaled $140 million, unchanged from year-end. Management reported compliance with loan covenants and stated liquidity was adequate, while noting funding needs could change.
- Dividends: $1.83 per share was paid in the first nine months, versus $1.80 in the prior-year period; Q3 dividends were $0.61 per share.
Material changes, outlook and risks
- Profit improved sharply in Q3, principally because investment results shifted from substantial realized losses to gains. For the nine months, net income rose despite slightly lower earned premiums and weaker investment income.
- Claims experience weakened: the nine-month loss ratio rose to 73.7% from 70.5%. The company reported approximately $33 million of unfavorable development on 2011 and prior accident-year reserves, mainly from higher California bodily-injury severity and more late-reported claims. It also recorded about $8 million of pre-tax Midwest wind and hail losses in Q2. Loss and loss adjustment expense reserves were $978.4 million, including $373.0 million of IBNR.
- On October 29, 2012, Hurricane Sandy made landfall. The company expected fourth-quarter losses but said their extent could not yet be determined.
- California approved an approximately 4% personal-auto rate increase, implemented October 26, 2012. A separate California homeowners rate proceeding remained unresolved, with further proceedings expected into 2013. The filing describes outstanding California DOI notices alleging rating, underwriting and related compliance violations; the company disputes the allegations and says it will defend itself. Management did not expect pending legal or regulatory matters to have a material adverse effect.
- Risks highlighted include loss-reserve estimation, competitive pricing, rate approvals and regulation, weather catastrophes, investment-market and interest-rate movements, credit exposure, litigation, and the ability to realize deferred tax assets. The portfolio had a weighted-average fixed-income rating of AA-; 5.1% of fixed maturities were below investment grade or non-rated. Management provided no specific earnings or revenue guidance.
Key facts for investors to verify
- Subsequent disclosures on Hurricane Sandy losses and their effect on Q4 underwriting results.
- Further development in California bodily-injury reserves, including whether unfavorable prior-year development continues.
- Progress and outcomes of California homeowners rate proceedings and the 2004 and 2010 DOI matters, including potential penalties.
- Whether premium growth and rate changes improve underwriting results, particularly given the nine-month combined ratio above 100%.
- Investment gains’ contribution to earnings versus recurring underwriting and investment income, and portfolio sensitivity to interest rates and equity markets.
- Operating cash flow, dividend coverage, and compliance with debt covenants as claims and investment cash flows evolve.