Mercury General Corporation — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020. Unaudited consolidated results. Mercury primarily writes personal auto insurance, with related property and casualty products, principally in California.
Financial performance
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net premiums earned | $811.9 million | $888.8 million | $1,734.5 million | $1,759.0 million |
| Total revenues | $1,005.8 million | $979.5 million | $1,714.2 million | $1,997.2 million |
| Net realized investment gains (losses) | $158.4 million | $53.3 million | $(92.9) million | $164.4 million |
| Net income | $228.2 million | $83.3 million | $89.0 million | $219.1 million |
| Diluted earnings per share | $4.12 | $1.50 | $1.61 | $3.96 |
| Combined ratio | 88.2% | 98.3% | 92.3% | 97.8% |
Q2 underwriting gain was $95.8 million, versus $15.2 million a year earlier. For the first half, underwriting gain was $133.6 million, versus $39.1 million. Combined ratios below 100% indicate underwriting profit. Q2 and half-year results reflect lower auto claim frequency, while reported net income also moved substantially with investment fair-value changes.
- Investment income: Net investment income was $34.2 million in Q2 and $68.7 million for the first half, slightly below the respective prior-year periods. First-half realized investment losses included a $74.4 million decline in equity-security fair value, following first-quarter market disruption; management said investment values substantially recovered in Q2.
- Cash flow: Six-month operating cash flow was $259.6 million, compared with $265.6 million. Investing activities used $222.1 million and financing activities used $69.8 million, primarily dividends. Cash ended the period at $262.2 million.
- Balance sheet and liquidity: Total assets were $5.92 billion and shareholders’ equity was $1.82 billion at June 30. Cash plus short-term investments totaled $597.8 million. Management cited the $50 million undrawn revolving facility and operating cash flow as additional liquidity.
- Debt: Notes payable were $372.3 million carrying value, representing $375 million of senior unsecured notes at 4.4%, due in 2027. The $50 million revolving credit facility was undrawn; debt-to-total-capital was 17.1%, and the company reported compliance with facility covenants.
- Dividends: The company paid $0.63 per share in Q2 and $1.26 per share in the first half.
Material changes and management commentary
- Net premiums earned fell 8.6% in Q2 and 1.4% in the first half versus 2019. Net premiums written fell 12.5% in Q2 and 4.3% in the first half. The company attributed the declines mainly to COVID-related refunds and credits and fewer California private passenger auto policies, partly offset by homeowners rate increases and policy growth.
- The Mercury Giveback program and related regulatory directives reduced premiums by approximately $106 million through June. The company expected to return a further approximately $22 million of July premiums in August, bringing expected total refunds and credits to about $128 million since the pandemic began. The July refunds were expected to reduce Q3 premiums earned and written by about $22 million.
- Auto claim frequency dropped beginning in mid-to-late March and remained low through Q2, but began increasing in June as driving resumed. Management noted higher accident severity, including serious high-speed crashes, and possible repair-cost pressure from labor and supply-chain disruptions. The duration of lower claim frequency was uncertain.
- For the first half, losses on prior accident years developed unfavorably by $27.5 million, mainly in commercial auto, homeowners, and Florida personal auto. The company reported approximately $18 million of catastrophe losses before about $4 million of favorable prior-catastrophe development.
- The allowance for credit losses on premiums receivable rose to $10 million at June 30 from $1.4 million at year-end, reflecting expected collection impacts from COVID-related economic conditions and customer payment grace periods. Management cautioned actual uncollectible amounts could be materially higher or lower.
- PG&E’s bankruptcy emergence and funding of a wildfire subrogation trust led Mercury to recognize about $16 million, net of fees, for expected recoveries on prior wildfire claims. Because the underlying losses had been ceded to reinsurers, the reported net benefit to Mercury before tax was approximately $2 million.
- The catastrophe reinsurance treaty effective through June 30, 2021 provides up to $717 million per occurrence above Mercury’s $40 million retention, subject to exclusions and limits. Its annual premium increased to approximately $50.3 million from $38.0 million for the prior treaty year.
- On July 31, 2020, the board authorized repurchases of up to $200 million of common stock over one year. The company gave no earnings or full-year financial guidance in the provided filing text.
Risks, contingencies, and other items
Key uncertainties include the course of the COVID-19 pandemic, premium collection and policy demand, claim frequency and severity, catastrophe exposure, reserve estimation, market and interest-rate volatility, and reinsurer creditworthiness. California accounted for 86.5% of first-half direct premiums written, creating geographic concentration. The company stated that pandemic-related business interruption claims are generally not covered under its policy terms and exclusions and that it does not believe it has material exposure; legal disputes and outcomes remain uncertain. Management did not expect pending legal or regulatory matters to materially adversely affect financial condition or cash flows.
Management said disclosure controls and procedures were effective and reported no material change in internal control over financial reporting during the quarter. The company adopted the expected-credit-loss accounting standard in January 2020, recording an approximately $2 million cumulative adjustment to opening retained earnings.
Important facts for investors to verify
- Whether auto claim frequency continued to rise after June, and how severity, repair costs, and any eventual normalization affect loss ratios.
- Actual policyholder refunds and credits, including the expected July refund, and their effects on earned premiums, written premiums, commissions, and Q3 results.
- Further changes in the premium-receivable credit allowance, collections, and policy cancellations as economic conditions evolve.
- Development of prior-year reserves, particularly commercial auto, homeowners, and Florida auto, and the adequacy of catastrophe reserves.
- Investment portfolio fair-value changes and income yields, given the significant effect of market movements on reported earnings.
- Timing and amount of PG&E wildfire trust recoveries, and the terms, exclusions, cost, and available limits of catastrophe reinsurance.
- Use of the newly authorized share-repurchase program and its funding in light of liquidity, catastrophe exposure, and capital needs.