Mercury General Corporation — 2013 Form 10-K
Business context and reporting period. The filing covers the fiscal year ended December 31, 2013; it is an annual report, not a standalone fourth-quarter filing. Mercury General is a property-and-casualty insurer writing primarily personal auto insurance through 13 insurance subsidiaries in 13 states. California accounted for 78.7% of 2013 direct premiums written, and private passenger auto represented 79.1% of total direct premiums written.
Key financial metrics
| Metric | 2013 | 2012 |
|---|---|---|
| Net premiums earned | $2,698.2 million | $2,574.9 million |
| Net premiums written | $2,729.0 million | $2,651.7 million |
| Total revenues | $2,821.0 million | $2,783.4 million |
| Net investment income | $124.5 million | $131.9 million |
| Net realized investment gains (losses) | $(11.4) million | $66.4 million |
| Net income | $112.1 million | $116.9 million |
| Diluted EPS | $2.04 | $2.13 |
| GAAP combined ratio | 99.6% | 102.8% |
| Cash flow from operations | $209.8 million | $148.1 million |
Balance sheet and liquidity at year-end 2013: Total assets were $4.315 billion, investments at fair value $3.158 billion, cash $266.5 million, notes payable $190.0 million, and shareholders’ equity $1.822 billion. Cash plus short-term investments totaled $582.3 million. A $200 million revolving facility had $50 million drawn, leaving $150 million available. The company reported compliance with loan covenants. The Insurance Companies’ statutory policyholders’ surplus was $1.529 billion, with net premiums written to surplus of 1.8 to 1.
Dividends paid were $134.8 million, or $2.4525 per share. The board declared a further quarterly dividend of $0.615 per share, payable March 31, 2014. The holding company depends on regulated insurance subsidiaries for dividends; subsidiaries could pay approximately $260.2 million to the parent in 2014 without extraordinary-dividend approval.
Material changes versus the prior comparable period
- Net premiums earned rose 4.8% and net premiums written rose 2.9%, mainly reflecting higher average premiums following California and other state rate increases.
- Net income declined to $112.1 million from $116.9 million. The year-over-year comparison was substantially affected by a shift from $66.4 million of realized investment gains in 2012 to $11.4 million of realized losses in 2013.
- Underwriting performance improved: the GAAP combined ratio fell to 99.6% from 102.8%. The loss ratio improved to 72.7% from 76.2%; the expense ratio was 26.9% versus 26.6%.
- Prior-year reserve development was unfavorable by approximately $3 million in 2013, compared with approximately $42 million in 2012. The 2013 development was mainly from reopened Florida claims following an adverse state supreme court ruling.
- Operating cash flow increased to $209.8 million from $148.1 million. Notes payable increased by $50 million, reflecting borrowing under the new unsecured revolving credit facility.
- The company reduced equity holdings during the second half of 2013; equities were 8.9% of investments at fair value at year-end, versus 15.0% a year earlier. Fixed-maturity fair value declined, principally amid weakness in municipal bond markets.
Fourth-quarter information
Unaudited fourth-quarter 2013 net income was $15.4 million, or $0.28 per share, compared with a net loss of $17.4 million, or $0.32 per share, in fourth-quarter 2012. Fourth-quarter 2013 net premiums earned were $680.9 million. Results in both periods were affected by investment fair-value movements and catastrophe or other claim costs.
Outlook, commentary, risks and unusual items
- Management did not expect to enter new states during 2014. It anticipated approximately $12 million of annual future savings from consolidating non-California claims and underwriting operations; the consolidation generated about $10 million of pretax closure and severance costs in first-quarter 2013.
- An 8.26% California homeowners rate increase took effect in January 2014. The company also challenged in court issues arising from an earlier California homeowners rate proceeding. Rate approvals, particularly in California, remain subject to regulatory review and potential delays.
- 2013 catastrophe losses were approximately $17 million, primarily from tornadoes and severe storms. The catastrophe reinsurance treaty in effect July 2013–June 2014 provided $100 million per occurrence above a $100 million company retention, with specified exclusions.
- Loss reserves were approximately $1.039 billion, including $409.2 million of IBNR reserves. Management cautioned that actual claim costs may differ materially from estimates, especially for California bodily-injury claims. Its sensitivity analysis indicated possible reserve impacts of approximately $51.8 million from specified severity variations and about $14–15 million from the illustrated 2013 claim-count range.
- Investment income and fair values face interest-rate and credit risks. Municipal bonds were 70.6% of the total investment portfolio at fair value; a hypothetical 100-basis-point rate increase was estimated to reduce bond-portfolio fair value by $101.9 million.
- California DOI notices from 2004 and 2010 allege insurance-law violations; the company disputes the allegations and says it will defend them. Proceedings remained unresolved, and the company did not expect a material effect, but potential outcomes were uncertain. California tax examinations and proposed assessments for 2003–2006 were also pending; management likewise did not expect a material financial-statement impact.
- The company’s maximum stated potential California Earthquake Authority assessment exposure was $60.4 million, based on information available at April 1, 2013; no assessment was made in 2013. Other key risks include California concentration, rate adequacy and regulation, claims inflation and reserve uncertainty, catastrophe losses, municipal-bond exposure, and the ability to collect reinsurance.
The financial statements and internal control over financial reporting received unqualified audit opinions from KPMG. Management and the auditor concluded internal control over financial reporting was effective as of December 31, 2013.
Important facts for investors to verify
- Whether premium growth and the improved combined ratio persist after the effects of rate increases, catastrophe losses, and reserve development.
- Whether California bodily-injury severity, late-reported claims, and reopened Florida claims require further reserve strengthening.
- The investment portfolio’s municipal-bond concentration, fair-value sensitivity to interest rates, and realized investment results.
- The status and potential financial consequences of the California DOI proceedings and California tax matters.
- Holding-company liquidity, subsidiary dividend capacity, debt maturities and facility availability, and the sustainability of shareholder dividends.
- Whether the projected operating savings materialize and whether the January 2014 California homeowners rate increase adequately addresses claims costs.