Mercury General Corporation — Q2 2017 Form 10-Q
Business and period: Property-and-casualty insurer focused on personal automobile insurance, principally in California, with operations in 11 states. This unaudited report covers the three and six months ended June 30, 2017; comparisons are with 2016.
Financial performance
| Metric | Q2 2017 | Q2 2016 | First half 2017 | First half 2016 |
|---|---|---|---|---|
| Net premiums earned | $797.7 million | $779.3 million | $1,587.4 million | $1,546.4 million |
| Total revenue | $852.8 million | $858.0 million | $1,700.4 million | $1,681.9 million |
| Net income | $51.6 million | $48.9 million | $78.6 million | $72.2 million |
| Diluted EPS | $0.93 | $0.88 | $1.42 | $1.31 |
| Combined ratio | 97.8% | 101.7% | 100.4% | 102.8% |
- Premium growth reflected higher average premiums, including California auto rate increases; Q2 also benefited from growth in California homeowners policies. First-half net premiums earned increased 2.7%.
- Q2 underwriting gain was $17.8 million, versus a $13.4 million loss a year earlier. First-half underwriting loss narrowed to $6.9 million from $43.2 million.
- Investment income rose modestly, to $31.9 million in Q2 and $63.1 million for the first half. Net realized investment gains declined to $21.2 million in Q2 from $45.4 million, and to $45.6 million for the first half from $70.4 million. The filing attributes the Q2 comparison mainly to lower equity-market fair-value gains.
- Q2 loss and expense ratios improved to 73.8% and 24.0%, respectively. First-half ratios were 75.3% and 25.1%. Excluding catastrophe losses and prior-year reserve development, the loss ratio was 71.3% for Q2 and 71.9% for the first half.
Financial position, cash flow and debt
- At June 30, total assets were $4.94 billion, total liabilities $3.18 billion, and shareholders’ equity $1.76 billion. Cash was $261.4 million; short-term investments were $280.0 million.
- Operating cash flow for the first half was $174.7 million, up from $105.8 million in 2016. Investing activities used $117.0 million; financing activities used $16.7 million. Dividends paid were $68.9 million.
- Debt carrying value was $371.1 million. In March, the company issued $375 million of 4.40% senior notes due 2027 and used proceeds to repay $320 million of prior facilities and for general corporate purposes. It also established a $50 million revolving facility, undrawn as of July 27. Debt-to-total-capital was 17.5% and the company reported compliance with financial covenants.
- Management cited $541.5 million in cash and short-term investments plus the undrawn $50 million revolver as available liquidity, and said operating cash flow was adequate for liquidity needs, while noting funding needs could change.
- Statutory policyholders’ surplus was $1.58 billion; the net-premiums-written-to-surplus ratio was 2.01 to 1.
Material changes, outlook and risks
- First-half catastrophe losses were approximately $40 million, versus $19 million in 2016, mainly from severe California rainstorms and storms and tornadoes in Oklahoma and Texas. Unfavorable prior-year reserve development was $14.2 million, principally from higher-than-estimated California property losses, compared with $62.0 million in 2016.
- California regulators approved a 6.9% private-passenger-auto rate increase effective May 2017 and a 6.9% homeowners increase effective August 2017. The filing provides no earnings or full-year quantitative guidance; management cautions that interim results are not necessarily indicative of full-year results.
- Catastrophe exposure is partly protected by a reinsurance treaty renewed through June 30, 2018, providing up to $205 million per occurrence after a $10 million company retention, subject to stated limits and exclusions. Florida business and California earthquake losses on fixed property are excluded; earthquake-following fires are covered.
- A California regulatory penalty previously paid by the company was returned with interest, totaling $30.9 million in June. Because the state appealed the judgment, the company recorded the amount as a liability rather than a gain. Further proceedings on a related false-advertising matter are stayed pending the appeal.
- Key risks include loss-reserve estimation, severe weather, rate approvals and competition, investment-market and interest-rate movements, credit exposure, and legal or regulatory outcomes. The filing reports no material change to the risk factors in the 2016 Form 10-K. Disclosure controls were deemed effective.
Investor facts to verify
- Whether California property-loss experience, catastrophe claims, and prior-year reserve development worsen or improve in subsequent quarters.
- Whether approved rate increases take effect as expected and support premium growth without adverse retention or competitive effects.
- Investment-gain volatility, portfolio valuation and credit quality; sensitivity disclosed for a 100-basis-point rate increase was a $126.5 million decline in bond-portfolio fair value.
- Outcome of the state appeal concerning the $30.9 million refund and any resulting accounting treatment or further liability.
- Reinsurance coverage, exclusions and cost, along with liquidity, debt and covenant compliance.