Mercury General Corporation — Q1 2019 Form 10-Q
Business context and period. Unaudited results for the three months ended March 31, 2019, compared with Q1 2018. Mercury writes personal auto and related property and casualty insurance through subsidiaries in 11 states, principally California; property and casualty is its main reportable segment.
Key financial results
| Metric | Q1 2019 | Q1 2018 |
|---|---|---|
| Net premiums earned | $870.2 million | $808.1 million |
| Total revenues | $1,017.7 million | $783.2 million |
| Net realized investment gains (losses) | $111.1 million | $(58.7) million |
| Net income (loss) | $135.9 million | $(42.6) million |
| Diluted earnings (loss) per share | $2.45 | $(0.77) |
| Operating cash flow | $174.7 million | $78.4 million |
- Net premiums earned increased 7.7%; management attributed growth primarily to higher average premiums from California auto rate increases and growth in California homeowners policies. Direct premiums written rose 6.1% to $922.1 million.
- Underwriting improved: the combined ratio was 97.3%, versus 103.8%; underwriting gain was $23.9 million, compared with a $30.5 million loss. The loss ratio was 72.4% versus 78.2%, and the expense ratio was 24.8% versus 25.5%.
- Excluding prior-year loss development and catastrophe losses, the loss ratio was 71.7% versus 71.8%. Prior-year reserves had $1.4 million of unfavorable development in Q1 2019, compared with $42.7 million in Q1 2018.
- Investment income increased to $34.2 million from $31.5 million. Most of the year-over-year earnings swing came from investment fair-value changes: gains in 2019 followed losses in 2018. The filing reports that Q1 2019 gains primarily reflected lower interest rates and improved equity markets.
- At March 31, 2019, total investments were $4.06 billion, cash was $270.1 million, total assets were $5.61 billion, and shareholders’ equity was $1.72 billion. Cash plus short-term investments totaled $637.5 million.
- Debt was $371.8 million carrying value, principally $375 million of 4.40% senior notes due 2027. The $50 million revolving credit facility was undrawn; debt-to-total-capital was 17.9%. The company reported compliance with facility covenants.
- Operating cash flow rose $96.3 million year over year, primarily due to increased premium collections, partly offset by higher paid losses and expenses. Investing activities used $184.6 million; dividends used $34.7 million. The quarterly dividend was $0.6275 per share.
Changes, outlook, risks and unusual items
- Rates and premiums: California approved a 6.9% private passenger auto rate increase for Mercury Insurance Company in March, expected to take effect in May 2019. A separate 6.9% increase for California Automobile Insurance Company took effect in March.
- Wildfire reinsurance: Sale of subrogation rights and reserve re-estimation for the Camp and Woolsey Fires and 2017 Southern California fires benefited Q1 pretax results by approximately $10 million. The company estimated these events’ total gross losses at approximately $208 million and net losses at approximately $40 million at quarter-end.
- The catastrophe treaty in force through June 30, 2019 provides up to $205 million per occurrence above a $10 million retention, subject to terms and exclusions. Prior catastrophe claims had exhausted the reinstated limit on the first layer; remaining protection for another event during the treaty period is reduced. Florida business and California earthquake losses on fixed-property policies are excluded.
- Legal contingency: The company is appealing a California insurance regulator matter concerning alleged broker fees. Although a court had ordered repayment of a $27.6 million penalty and the state returned $30.9 million including interest, the appeal remained pending. Approximately $31.8 million, including interest earned, remained recorded in other liabilities rather than recognized as a gain.
- Other risks: Management identifies uncertainty in loss-reserve estimates, catastrophes, pricing and rate approvals, competitive conditions, claims severity, investment-market movements, credit and interest-rate risk, and legal and regulatory matters. The company stated that it expects no material adverse effect from currently pending legal or regulatory proceedings. It provided no specific earnings guidance; it cautioned that quarterly results are not necessarily indicative of full-year results.
- The company adopted lease accounting on January 1, 2019, recording operating lease assets of $41.3 million and liabilities of $43.4 million; no cumulative-effect adjustment was recorded.
Most important facts for investors to verify
- How much of Q1’s $135.9 million profit reflects recurring underwriting and investment income versus $111.1 million of realized investment gains.
- Whether California rate increases are implemented as expected and sustain premium growth without weakening retention or increasing claim costs.
- Further development in auto and catastrophe reserves, including the final net cost of recent California wildfires.
- Renewal terms and available catastrophe coverage after the June 30, 2019 treaty expiration, including catastrophe exposure retained by Mercury.
- Outcome and potential financial consequences of the California DOI appeal and the continued treatment of the $31.8 million liability.
- Investment portfolio exposure to market movements: municipal bonds represented 87.6% of fixed maturities, and management estimated a 100-basis-point rate rise would reduce fixed-maturity fair value by $129.2 million.