Mercury General Corporation — Q1 2018 Form 10-Q
Business and period: Insurer primarily writing personal automobile coverage through 14 subsidiaries in 11 states, principally California. This unaudited report covers the three months ended March 31, 2018; comparisons are with Q1 2017 unless noted.
Financial results and position
| Metric | Q1 2018 | Q1 2017 / comparison |
|---|---|---|
| Net premiums earned | $808.1 million | $789.8 million; up 2.3% |
| Total revenue | $783.2 million | $847.5 million; down 7.6% |
| Net investment income | $31.5 million | $31.2 million |
| Net realized investment gains (losses) | $(58.7) million | $24.5 million |
| Net income (loss) | $(42.6) million; $(0.77) per diluted share | $27.0 million; $0.49 per diluted share |
| Loss / expense / combined ratios | 78.2% / 25.5% / 103.8% | 76.8% / 26.3% / 103.1% |
| Operating cash flow | $78.4 million | $74.2 million |
| Cash and short-term investments | $535.3 million at March 31 | Includes $290.1 million cash |
| Debt | $371.4 million carrying value | $375 million principal, 4.40% senior notes due 2027 |
| Total assets / shareholders’ equity | $5.13 billion / $1.68 billion at March 31 | At December 31: $5.10 billion / $1.76 billion |
| Dividend paid per share | $0.625 | $0.6225 |
The underwriting combined ratio above 100% indicates an underwriting loss; segment underwriting loss was $30.5 million. Net premiums written rose 6.1% to $861.3 million. California accounted for 85.1% of direct premiums written. Management attributed premium growth mainly to higher average premiums following rate increases and growth in California auto and homeowners policies.
Operating cash flow exceeded the prior-year period by $4.1 million, primarily reflecting higher premium collections, partly offset by higher claim payments. Investing activities used $45.1 million; dividends used $34.6 million. The company reported $50 million available under its undrawn revolving credit facility and said operating cash flow and investment maturities should meet liquidity needs without forced investment sales.
Material changes and management commentary
- Net loss primarily reflected $58.7 million of net realized investment losses, driven mainly by fair-value declines in fixed maturities as market interest rates rose and in equities amid market declines. The company applies the fair value option, with changes recognized in earnings.
- Loss ratio increased to 78.2% from 76.8%. The quarter included about $42.7 million of unfavorable prior-year reserve development, mainly from California auto bodily-injury severity, versus $4.1 million unfavorable development in Q1 2017. Excluding prior-year development and catastrophe losses, the loss ratio improved to 71.8% from 72.5%.
- Catastrophe losses were approximately $9 million, versus $30 million in Q1 2017. Q1 2018 events primarily involved California winter storms and mudslides and winter storms on the Atlantic Seaboard.
- California approved a 5% private passenger auto rate increase in January, effective March 2018. No quantitative earnings or full-year guidance is provided. Management cautions that quarterly results are not necessarily indicative of full-year results.
- The 2017 wildfire losses totaled approximately $109 million before reinsurance and $20 million net of reinsurance; the company also recorded $12 million of ceded reinstatement premiums. The catastrophe treaty runs through June 30, 2018, with certain first-layer capacity reduced after prior recoveries.
Risks, contingencies, and unusual items
- Loss reserving remains a key estimate and risk. Management noted increasing high-dollar California bodily-injury claims, medical costs, procedures, alleged traumatic brain injuries, and aggressive plaintiff litigation; ultimate claim costs may differ from estimates.
- The portfolio is exposed to interest-rate and equity-market changes. A 100- or 200-basis-point rise in rates was estimated to reduce fixed-maturity fair value by $130.7 million or $261.3 million, respectively. Municipal bonds made up 88.5% of fixed maturities; portfolio average credit quality was A+.
- In a California regulatory matter, a $27.6 million penalty previously paid was returned with interest in 2017 after a court vacated the order. The appeal remained pending; approximately $31.2 million, including interest, remained recorded as a liability rather than income. Further false-advertising proceedings were stayed pending the appeal.
- California tax examinations and proposed assessments for 2011–2013 remain under protest; the company said it did not expect resolution to materially affect its financial statements. The 2017 tax-law adjustments remained provisional during the measurement period.
- The company reported compliance with credit-facility financial covenants. Its statutory net-premiums-written-to-surplus ratio was 2.10 to 1, compared with industry guidance cited in the filing of no more than 3.0 to 1.
- Management identified competition, rate-approval timing, catastrophe exposure, claims trends, reserve-estimate uncertainty, investment-market volatility, regulation, and litigation among the risks to future results. It reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether California auto bodily-injury severity and unfavorable reserve development continue, and how these trends affect the combined ratio.
- Whether the recent rate increases and policy growth offset claim-cost inflation and underwriting losses.
- How much investment fair-value volatility affects reported earnings, and whether the company’s investment and tax assumptions remain appropriate.
- The status and potential financial outcome of the California DOI appeal and related proceedings, including the recorded $31.2 million liability.
- Renewal terms and remaining catastrophe-reinsurance protection after June 30, 2018, including reinsurance counterparty performance.
- Liquidity and capital needs, dividend sustainability, and the company’s ability to meet obligations without selling investments under adverse market conditions.