Mercury General Corporation — Q2 2011 Form 10-Q
Business context and reporting period. The unaudited filing covers the quarter and six months ended June 30, 2011, compared with the corresponding 2010 periods. Mercury primarily writes automobile insurance through 13 insurance subsidiaries, with California representing 75.5% of premiums written in the first half of 2011.
Financial results and position
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net premiums earned | $642.3m | $642.7m | $1,280.8m | $1,283.3m |
| Total revenues | $706.5m | $653.7m | $1,412.1m | $1,353.5m |
| Income before taxes | $75.6m | $15.4m | $152.5m | $96.6m |
| Net income | $57.3m | $17.8m | $115.5m | $79.0m |
| Diluted earnings per share | $1.04 | $0.32 | $2.11 | $1.44 |
| Net realized investment gains (losses) | $23.8m | ($27.7m) | $52.5m | ($5.7m) |
- Underwriting: Q2 loss ratio was 70.3% versus 68.4%; expense ratio 27.7% versus 30.6%; combined ratio 98.0% versus 99.0%. First-half combined ratio was 98.1% versus 97.7%. Ratios below 100% indicate underwriting profit.
- Premium production: First-half net premiums written rose 0.9% to $1,294.5m, while earned premiums declined 0.2%. Management attributed written-premium growth to slightly more policies and higher average premiums.
- Investment income: First-half net investment income was $71.1m versus $72.4m; pretax annualized portfolio yield was 4.7% in both periods. The reported earnings improvement was substantially aided by the swing in realized investment results.
- Cash flow: First-half operating cash flow was $93.1m versus $52.0m. Cash increased to $305.1m from $181.4m at year-end. Cash plus short-term investments totaled $443.7m. Dividends paid were $65.8m.
- Balance sheet at June 30: Total assets were $4,246.5m; investments $3,117.6m; total liabilities $2,400.9m; shareholders’ equity $1,845.6m. Notes payable were $263.9m. Loss and loss-adjustment reserves were $981.0m, including approximately $324.1m of IBNR.
- Capital and liquidity: Insurance subsidiaries’ combined statutory surplus was $1.4bn; trailing 12-month premiums written to surplus were 1.8:1. Management said operating cash flow and liquidity were adequate, while noting funding needs could change.
Material changes and management commentary
- Net income increased year over year in both reported periods, but comparisons were materially influenced by investment fair-value and realized gains in 2011 versus losses in 2010. In Q2 2011, fixed-maturity fair-value gains were partly offset by equity losses; first-half gains reflected appreciation in both fixed maturities and equities.
- First-half unfavorable development on 2010 and prior-year loss reserves was approximately $10m, compared with approximately $22m favorable development in the prior-year period. Management cited higher California bodily-injury claim severity and more late-reported claims. Excluding prior-period development, the first-half loss ratio was broadly stable at 69.3% versus 69.5%.
- Lower consulting, advertising, and IT spending reduced the expense ratio. The 2010 comparison also included $12.1m of contributions supporting a California legislative initiative.
- Florida homeowners operations had a premium-deficiency reserve at year-end 2010. The company was withdrawing from that market and expected to complete the withdrawal by September 2012.
- No specific earnings or premium guidance is provided. Management cautions that first-half results are not necessarily indicative of full-year results.
Debt, risks, and contingencies
- A $125m, 7.25% senior note matured August 15, 2011. Mercury intended to use part of an authorized $270m extraordinary dividend from a subsidiary to repay it. A $120m credit facility matured January 1, 2012; management expected to extend, refinance, or repay it using cash, operations, or investment sales. An additional $18m bank loan is disclosed. The company reported compliance with applicable debt covenants at June 30.
- California DOI matters include 2004 and 2010 Notices of Non-Compliance alleging rating, underwriting, and broker-fee violations. The company denied the allegations and intended to defend them; it said outcomes were not expected to materially affect financial position, but effects on results cannot be determined and an adverse ruling could affect quarterly earnings.
- Other risks include uncertain loss-reserve estimates, competitive pricing and rate approvals, litigation and regulatory actions, catastrophe and claims-cost trends, investment-market movements, and the concentration of premiums and municipal-bond holdings. The company reported approximately $2.4bn of municipal securities and $55.7m of collateralized debt obligations.
- Market sensitivity disclosures: a hypothetical 100-basis-point rate increase would reduce bond-portfolio fair value by about $110.5m; a 25% decline in the stock market would reduce common-stock portfolio fair value by about $122.9m.
Most important facts for investors to verify
- Whether subsequent results confirm that the $10m reserve deterioration, especially California bodily-injury severity and late-reported claims, was contained.
- How much earnings depend on volatile investment gains, and whether underwriting remains profitable without those gains.
- Repayment or refinancing of the August 2011 senior note and the January 2012 credit facility, including the subsidiary dividend funding.
- Developments and potential financial consequences of the California DOI proceedings and the Florida homeowners withdrawal.
- Investment portfolio exposures, including municipal bond credit and insurer support, lower-rated holdings, and sensitivity to interest-rate and equity-market changes.