MERCURY GENERAL CORP annual report, FY2022

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Mercury General Corporation — 2022 Form 10-K

Business context and reporting period. This annual report covers the fiscal year ended December 31, 2022. Mercury General writes personal auto and other property-and-casualty insurance in 11 states, principally California. About 64% of 2022 direct premiums written came from private passenger auto, and California generated 80.8% of direct premiums written across all lines.

Financial performance and position

  • Premiums and revenue: Net premiums earned were $3.952 billion, up 5.6% from 2021; net premiums written were $3.978 billion, up 3.2%. Total GAAP revenue was $3.643 billion, down from $3.993 billion, chiefly reflecting investment losses.
  • Earnings: Net loss was $512.7 million, or $9.26 per diluted share, versus net income of $247.9 million, or $4.48 per share, in 2021. The 2022 pretax loss was $670.7 million. Results included $488.1 million of pretax net realized investment losses, compared with $111.7 million of gains in 2021.
  • Underwriting and margins: The GAAP combined ratio rose to 108.7% from 98.3%; above 100% generally indicates an underwriting loss. Loss ratio increased to 85.1% from 73.8%, while expense ratio improved to 23.6% from 24.5%. Excluding prior-year reserve development and catastrophe losses, the loss ratio was 81.3%, versus 71.5%.
  • Investment income and portfolio: Net investment income rose to $168.4 million from $129.7 million, with pretax yield increasing to 3.4% from 2.8%. Investments at fair value totaled $4.911 billion, down from $5.143 billion. Fixed maturities were $4.088 billion and equities $699.6 million at year-end. Fair-value losses reflected higher interest rates and falling equity markets.
  • Cash flow and liquidity: Operating cash flow was $352.6 million, down from $501.6 million. Cash and short-term investments totaled $412.7 million. Management said liquidity, operating cash flows, and available credit should meet needs without forced investment sales; the company had $175 million undrawn under its revolving facility at year-end.
  • Debt and capital: Debt carrying value was $398.3 million, including $375 million of 4.40% senior notes due 2027 and a $25 million revolving-facility draw. Shareholders’ equity fell to $1.522 billion from $2.140 billion. Insurance subsidiaries’ statutory surplus was $1.502 billion, down from $1.827 billion; each subsidiary exceeded minimum RBC requirements, with no ratio below 330% of authorized-control-level RBC.
  • Reserves and dividends: Gross loss and loss-adjustment-expense reserves increased to $2.585 billion from $2.226 billion; 2022 prior-year development was unfavorable by $47.3 million. Shareholder dividends paid were $105.5 million, or $1.905 per share, versus $140.2 million, or $2.5325 per share, in 2021.

Material changes versus 2021

  • Premium growth did not offset sharply higher claims costs and investment-market losses. Losses and loss-adjustment expenses increased to $3.362 billion from $2.760 billion.
  • Current-year auto losses worsened as claim severity and frequency rose. Inflation in vehicle parts, repair labor, and medical costs, supply-chain delays, and social inflation contributed to higher losses and adverse reserve development.
  • Net catastrophe losses were approximately $102 million, broadly similar to approximately $104 million in 2021. 2022 events included Winter Storm Elliott, other severe weather, California winter storms, and Hurricane Ian; the reported catastrophe losses did not exceed treaty retentions, so no treaty recoveries were used.
  • The company reduced its quarterly dividend during 2022, the first annual per-share reduction since 1985. It also reduced its workforce by approximately 40 employees in October, recording about $3 million in one-time costs and anticipating approximately $6 million in annual savings.
  • The revolving credit facility was expanded from $75 million to $200 million, its maturity extended to November 2026, and its reference rate changed from LIBOR to Term SOFR. The company dissolved its Florida insurance subsidiary, MICFL, in November 2022.

Outlook, commentary, risks and contingencies

  • Rates and profitability: Management said it filed for auto rate increases in multiple states and was taking non-rate actions to improve profitability. In January 2023, California approved 6.9% private-auto rate increases for MIC and CAIC, planned for implementation in March 2023; the company also planned to seek another 6.9% increase. California had approved no rate increases in 2022 for lines representing more than 5% of 2022 net premiums earned. Rate approvals and implementation timing remain uncertain.
  • Near-term catastrophe item: The company estimated approximately $35 million of losses from California atmospheric-river storms in January 2023, to be recorded in the first quarter of 2023.
  • Reinsurance: The catastrophe treaty effective through June 30, 2023 provided up to $936 million per occurrence after a $60 million retention, subject to exclusions and other terms. Florida business was excluded. Treaty premium for the period ending June 2023 was projected at $74 million, versus $55 million for the prior treaty period, primarily due to higher coverage, rates, and covered-business growth.
  • Regulatory matters: California’s Department of Insurance stated in November 2022 that approximately $52 million of additional pandemic premium refunds should be provided. Mercury disputes the basis for further refunds; the amount, if any, ultimately payable is not reasonably estimable. A separate California DOI notice alleges rating and underwriting compliance violations and seeks penalties; the company disputes the allegations, and the outcome and potential amount are not estimable.
  • Other risks: Results are exposed to inflation, claim-frequency and severity trends, reserve-estimation uncertainty, catastrophes, reinsurance availability and collectability, interest-rate and equity-market changes, and concentration in California. Insurance-rate regulation, competition, litigation, and cybersecurity are also material risks. Municipal bonds represented about 49.7% of the total investment portfolio at fair value.
  • Other outlook: Management expected 2023 capital expenditures to be at a level similar to 2022’s $35.5 million and planned continued technology-platform modernization. The company expected quarterly dividends to continue, but future declarations and amounts remain at the board’s discretion.
  • Audit and controls: KPMG issued unqualified opinions on the financial statements and internal control over financial reporting. Loss reserves were identified as a critical audit matter. Management reported effective disclosure controls and internal controls.

Investor verification priorities

  1. Track California rate approvals, implementation, and the effect of rate actions on policy counts, earned premiums, and underwriting results.
  2. Monitor auto loss severity and frequency, inflation, and reserve development—particularly for 2020–2022 accident years and bodily-injury claims.
  3. Follow the California DOI refund request and rating-and-underwriting proceeding, including any settlement, hearing, penalty, or additional refund exposure.
  4. Assess investment portfolio fair values, realized results, interest-rate sensitivity, municipal-bond exposure, and whether operating cash flow remains adequate.
  5. Review catastrophe losses and reinsurance protection, including treaty renewals, retentions, exclusions, cost, and recoverability.
  6. Evaluate statutory surplus, RBC levels, debt and credit-facility usage, subsidiary dividend capacity, and the sustainability of shareholder dividends.