Mercury General Corporation — Q2 2012 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2012. The company primarily writes personal automobile insurance, with California representing 76.1% of first-half direct premiums written. Financial statements are unaudited.
Financial performance
- Q2 revenue: $647.7 million, down from $706.5 million in Q2 2011. Net premiums earned were $637.2 million, down 0.8%; net investment income was $31.7 million, down from $36.0 million.
- Q2 earnings: Net loss of $5.3 million, or $0.10 per diluted share, versus net income of $57.3 million, or $1.04 per diluted share, a year earlier. A $23.8 million net realized investment loss contrasted with a $23.8 million gain in Q2 2011.
- First-half revenue and earnings: Revenue was $1.370 billion versus $1.412 billion. Net income was $68.1 million, or $1.24 per diluted share, versus $115.5 million, or $2.11 per share. Net premiums earned declined 0.6% to $1.273 billion.
- Underwriting: Q2 loss, expense and combined ratios were 78.0%, 26.5% and 104.5%, respectively, compared with 70.3%, 27.7% and 98.0%. First-half ratios were 74.4%, 26.7% and 101.1%, versus 70.1%, 28.0% and 98.1%. Combined ratios above 100% indicate underwriting losses.
- Cash flow: First-half operating cash flow was $49.4 million, down from $93.1 million, primarily reflecting higher income tax payments. Investing activities used $35.5 million; dividends used $67.0 million. Cash ended at $160.5 million, compared with $211.4 million at year-end 2011.
- Balance sheet and liquidity: Total assets were $4.120 billion and shareholders’ equity $1.861 billion at June 30. Cash plus short-term investments totaled $339.8 million. Investments were $3.113 billion. Management said operating cash flow and investment maturities were expected to meet liquidity needs without forced investment sales, while noting future funding needs cannot be assured.
- Debt and capital: Notes payable totaled $140 million, unchanged from year-end. The company reported compliance with loan covenants. Insurance-company statutory surplus was $1.5 billion; trailing 12-month premiums written to surplus was 1.8:1, below the cited 3.0:1 guideline.
Material changes and management commentary
- First-half net premiums written rose 1.3% to $1.312 billion, while earned premiums fell slightly. Management attributed written-premium growth to more policies and modestly higher average premiums; the shift toward annual California auto policies was largely offset by reduced renewals after a revised rating plan.
- Unfavorable development on 2011 and prior accident-year reserves was approximately $29 million in the first half, including $23 million in Q2. Management cited higher California bodily-injury severity and more late-reported claims. Q2 also included about $8 million of Midwest wind and hail losses.
- First-half net realized investment gains were $28.9 million, down from $52.5 million. Q2 equity-market losses, particularly in energy holdings, outweighed gains in fixed maturities. First-half fixed-maturity gains were supported by municipal bonds.
- Net investment income and yield declined as maturing higher-yield investments were replaced in a low-interest-rate environment. First-half pre-tax annualized yield was 4.2%, versus 4.7% in 2011.
- The investment portfolio was concentrated in municipal bonds: 72.5% of total investments and 90.8% of fixed maturities at fair value. The fixed-maturity portfolio’s weighted-average credit rating was AA-; below-investment-grade and non-rated holdings were $131.8 million, or 5.3% of fixed maturities.
Outlook, risks and contingencies
- The filing provides no specific earnings or revenue guidance. Management cautioned that first-half results are not necessarily indicative of full-year results.
- Key risks include loss-reserve estimation, claim severity and frequency, weather events, pricing and renewal trends, competition, regulatory approval of rate changes, investment yield and market values, interest rates, credit quality, and California legal and regulatory developments.
- California Department of Insurance proceedings remain pending. The 2004 matter includes allegations concerning rates and broker fees; an administrative law judge’s proposed dismissal of unlawful-rate allegations was rejected by the Insurance Commissioner, and the company challenged that rejection in court. A hearing on false-advertising allegations was scheduled for September 14, 2012. The separate 2010 notice alleges rating and underwriting noncompliance. The company denies the allegations and does not expect the matters to have a material financial effect; it has accrued estimated defense costs.
- Federal and California tax examinations were ongoing. Management said the proposed California assessments and examinations were not expected to materially affect the financial statements.
- Management 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 bodily-injury reserve development continues, and how actual claims compare with the $978.3 million loss-reserve estimate, including $371.4 million of IBNR.
- Subsequent underwriting ratios, catastrophe losses, policy renewal trends and the effect of the revised California rating plan.
- Developments and potential outcomes in the 2004 and 2010 California DOI proceedings, including any penalties or required practice changes.
- Investment portfolio performance, equity exposure to energy stocks, municipal-bond and below-investment-grade credit quality, and reinvestment yields.
- Operating cash generation, dividend coverage, liquidity, and continued compliance with debt covenants.