Mercury General Corporation — Q1 2016 Form 10-Q
Business context and period: Unaudited results cover the three months ended March 31, 2016, compared with Q1 2015. Mercury primarily writes personal automobile insurance through 14 subsidiaries in 13 states, principally California; it also writes homeowners and other property and casualty coverage.
Financial performance
| Metric | Q1 2016 | Q1 2015 |
|---|---|---|
| Net premiums earned | $767.1 million | $720.7 million |
| Total revenues | $823.9 million | $744.5 million |
| Net investment income | $29.7 million | $31.5 million |
| Net realized investment gains (losses) | $25.1 million | $(10.0) million |
| Income before taxes | $26.0 million | $29.9 million |
| Net income | $23.3 million | $26.2 million |
| Diluted EPS | $0.42 | $0.47 |
| Combined ratio | 103.9% | 99.1% |
Net premiums written increased 7.7% to $797.7 million; net premiums earned rose 6.4%. Total revenue increased 10.7%, driven chiefly by the swing in realized investment results, while net income declined about 10.9%. Net investment income fell as higher-yielding investments matured and were replaced in a low-rate environment; the reported annualized pre-tax yield decreased to 3.6% from 3.8%.
The loss ratio rose to 77.5% from 71.4%, reflecting about $40 million of unfavorable development on prior accident years and $8 million of catastrophe losses, primarily winter storms. The prior-year quarter had about $3 million of favorable development and $2 million of catastrophe losses. Excluding prior-period development and catastrophe losses, the loss ratio was 71.2% versus 71.5%. The expense ratio improved to 26.4% from 27.7%; underwriting nevertheless recorded a $29.8 million loss, versus a $6.8 million gain.
Cash, investments, debt and liquidity
- Operating cash flow was $45.7 million, compared with $11.5 million in Q1 2015. Investing cash flow was $(41.4) million and financing cash flow $(33.4) million; cash declined $29.1 million to $235.1 million.
- At March 31, cash and short-term investments totaled $390.3 million. Management said this, operating cash flow, investment maturities and $100 million of available capacity on its $250 million revolving facility were expected to meet liquidity needs without forced investment sales.
- Total investments were $3.43 billion; total assets were $4.69 billion. Total liabilities were $2.88 billion and shareholders’ equity was $1.81 billion.
- Notes payable totaled $290 million, unchanged from year-end: $140 million secured and $150 million drawn on the revolving facility. The company reported compliance with loan covenants. Insurance subsidiaries’ statutory surplus was $1.4 billion; net premiums written to surplus was 2.15:1.
- Dividends paid were $34.3 million. The quarterly dividend per share was $0.62, versus $0.6175 a year earlier.
Material changes, outlook and risks
- California rate increases: a 5.0% increase for Mercury Insurance’s private passenger auto business took effect in March 2016; a separate 6.9% increase was approved in April and was expected to take effect in June. Management attributed premium growth to higher average premiums and policy growth in several markets.
- After quarter-end, the company filed to exit Michigan and Pennsylvania, whose combined 2015 combined ratio was 137%. It expects to complete the run-off in 2017. On April 29, it also reduced its non-California claims workforce by about 100 employees and expects approximately $2 million of termination expense in Q2 2016.
- A California Department of Insurance order assessed a $27.6 million penalty relating to historical broker-fee and rate allegations. The company paid it in March 2015, disputes the findings, and is seeking reversal and a refund with interest; a court hearing was scheduled for June 13, 2016. Management says it does not expect pending proceedings to have a material adverse effect, but outcomes remain uncertain.
- Key exposures include uncertainty in loss reserves, competitive pricing and rate approvals, catastrophe and claims-cost trends, investment-market and interest-rate risk, and regulatory/legal matters. Loss reserves were about $1.17 billion, including approximately $469 million of IBNR. Management cautions that estimates may differ from ultimate outcomes.
- The investment portfolio was concentrated in municipal bonds: $2.53 billion, or 73.3% of total investments, at fair value. A hypothetical 100-basis-point rate increase was estimated to reduce bond portfolio fair value by $96.6 million. Management provided no general earnings guidance; it noted Q1 results are not necessarily indicative of full-year results.
- Management judged disclosure controls effective and reported no material change in internal control over financial reporting. The filing says previously disclosed risk factors had not materially changed.
Important facts for investors to verify
- Whether adverse reserve development, particularly for California and Florida auto liability and older accident years, continues or reverses.
- Whether approved California rate increases improve underwriting results and how the company’s reported combined ratio develops.
- Progress and costs of the Michigan and Pennsylvania exits and the non-California claims restructuring, including the expected Q2 charge.
- Outcome and timing of the California penalty appeal, including potential recovery of the $27.6 million payment and interest.
- Investment portfolio sensitivity to interest rates, credit downgrades and municipal-bond exposure, alongside liquidity and dividend funding.