Mercury General Corporation — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015; balance-sheet comparisons are with December 31, 2014. The company primarily writes personal automobile insurance, principally in California, alongside homeowners, commercial auto, and other coverages. California accounted for 81.6% of Q1 direct premiums written.
Financial performance
| Metric | Q1 2015 | Q1 2014 / comparison |
|---|---|---|
| Net premiums earned | $720.7 million | $683.7 million; up 5.4% |
| Net premiums written | $740.5 million | $724.7 million; up 2.2% |
| Total revenues | $744.5 million | $763.0 million |
| Net investment income | $31.5 million | $30.2 million |
| Net realized investment losses (gains) | $(10.0) million | $46.7 million gain |
| Net income / diluted EPS | $26.2 million / $0.47 | $72.6 million / $1.32 |
| Loss / expense / combined ratio | 71.4% / 27.7% / 99.1% | 69.7% / 26.9% / 96.6% |
| Operating cash flow | $11.5 million | $49.4 million |
Net income fell 64% year over year. The main driver was the shift from substantial realized investment gains in 2014 to realized losses in 2015, including declines in energy-related equity holdings. Underwriting remained profitable by the combined-ratio measure, but the ratio deteriorated 2.5 percentage points. Management attributed the higher loss ratio mainly to rising frequency and severity in California personal auto; higher advertising expense, following a national campaign launched in 2015, contributed to the higher expense ratio. Q1 included about $2 million of catastrophe losses and about $3 million of favorable prior-year reserve development.
Average annual investment yield was 3.8% before tax versus 3.9% a year earlier. Investment income increased with higher average invested assets, while yield declined as older, higher-yielding investments matured and were replaced. Dividends paid were $0.6175 per share, versus $0.6150.
Financial position, liquidity, and debt
At March 31, 2015, total assets were $4.62 billion, total liabilities $2.75 billion, and shareholders’ equity $1.87 billion. Investments totaled $3.44 billion and cash was $234.6 million. Loss and loss adjustment expense reserves were $1.11 billion, including approximately $440 million of incurred-but-not-reported reserves. Notes payable totaled $290 million, unchanged from year-end; the company reported compliance with its debt covenants.
Cash and short-term investments totaled $408.2 million. The company reported $100 million available under its $250 million revolving facility and stated it expected operating cash flow, investment maturities, and available credit to meet liquidity needs without forced investment sales. Operating cash flow declined $38.0 million year over year, mainly because of higher claim and expense payments, including payment of the California DOI penalty. Investing used $34.1 million; financing used $32.7 million, including $34.1 million of shareholder dividends. Cash ended the quarter at $234.6 million, down $55.3 million from year-end.
Material changes, outlook, and risks
- Premium growth reflected higher average premiums per policy, primarily from California auto and homeowners rate increases. A 6.4% increase for California preferred private passenger auto was approved for implementation in May 2015. A 6.9% increase for California standard private passenger auto was filed and awaited approval.
- The company acquired Workmen’s Auto Insurance Company (WAIC) on January 2, 2015. It paid $8 million, with $2 million held in escrow and deducted in calculating $6 million of fair-value consideration, and contributed $15 million of capital to WAIC. WAIC contributed $6.9 million of revenue and a $2.0 million net loss in Q1.
- The company paid a $27.6 million penalty assessed in the California DOI’s 2004 Notice of Non-Compliance. It is challenging the order in court and seeks to have it vacated and recover the penalty; outcome and recovery are uncertain. Separately, a 2010 California DOI notice was settled for $1 million, paid in March 2015.
- No quantified full-year earnings or premium guidance is provided in the filing. The company cautions that quarterly results are affected by competition, claim frequency and severity, weather and catastrophe losses, reserve estimates, investment-market changes, regulation, and other factors; Q1 results are not necessarily indicative of full-year results.
- The catastrophe reinsurance treaty provides up to $100 million per occurrence after a $100 million retention, excludes Florida, and expires June 30, 2015; the company intended to negotiate renewal terms. Investment risks include interest-rate, equity-price, and credit exposure. A hypothetical 100-basis-point rate increase was estimated to reduce bond portfolio fair value by $92.2 million.
- Loss reserves require significant estimates. The company said pending proceedings were not expected to have a material adverse effect, but actual outcomes may differ. It was also under California tax examination for 2003–2013; management did not expect the proposed assessments to have a material financial impact.
Important facts for investors to verify
- Whether California rate approvals and implementation improve premium growth enough to offset rising auto claim frequency and severity.
- Whether the investment portfolio’s realized losses and equity exposure, particularly energy holdings, persist or reverse.
- Reserve adequacy and the sustainability of favorable prior-year development, including the effect of adverse development in other states.
- The outcome and potential recovery in the $27.6 million California 2004 NNC court challenge, as well as any related legal costs.
- WAIC’s future underwriting performance and the status of its escrow and acquired claims reserves.
- Renewal terms for catastrophe reinsurance and the company’s liquidity and dividend capacity if operating cash flow remains weak.