Mercury General Corporation — FY2017 Form 10-K
Business and reporting period. Mercury General is a property-and-casualty insurer focused on personal automobile insurance, operating through 14 insurance subsidiaries in 11 states. California is the core market: it represented 84% of direct premiums written, and approximately 85% of private-passenger auto premiums were written there. The filing covers the fiscal year ended December 31, 2017; quarterly figures below identify fourth-quarter results where relevant.
Financial performance and position
| Metric | 2017 | 2016 | Change / context |
|---|---|---|---|
| Total revenue | $3.416 billion | $3.228 billion | Up 5.8% |
| Net premiums earned | $3.195 billion | $3.132 billion | Up 2.0% |
| Net income | $144.9 million | $73.0 million | Diluted EPS was $2.62 versus $1.32 |
| Net investment income | $124.9 million | $121.9 million | Income increased, while pretax investment yield eased to 3.5% from 3.6% |
| Net realized investment gains (losses) | $83.7 million | ($34.3 million) | Major contributor to higher earnings |
| Operating cash flow | $341.4 million | $291.7 million | Up $49.7 million |
| GAAP combined ratio | 101.2% | 100.7% | Above 100% indicates underwriting loss |
| Assets / shareholders’ equity | $5.101 billion / $1.761 billion | $4.789 billion / $1.752 billion | At December 31 |
| Investments | $3.733 billion | $3.548 billion | At fair value; heavily weighted toward municipal bonds |
| Notes payable | $371.3 million | $320.0 million | $375 million principal of senior notes issued in 2017 |
Net income for fourth-quarter 2017 was $19.8 million, or $0.36 per diluted share, compared with a $26.1 million net loss, or $0.47 per diluted share, in fourth-quarter 2016. Management attributed the 2017 quarter’s result in part to higher fair values of fixed-maturity and equity securities and a $7.4 million tax benefit related to the Tax Cuts and Jobs Act.
Cash was $291.4 million and short-term investments were $302.7 million at year-end. The company also had an undrawn $50 million revolving credit facility. Insurance subsidiaries had statutory policyholders’ surplus of $1.589 billion; their premiums-written-to-surplus ratio was 2.0 to 1, and each insurer’s RBC ratio exceeded 400% of authorized control-level RBC. These statutory measures are distinct from consolidated GAAP equity.
Material changes versus 2016
- Net income nearly doubled, but the improvement was substantially influenced by the swing in realized investment results from a $34.3 million loss to an $83.7 million gain.
- Net premiums earned grew 2.0%, mainly from higher average premiums following rate increases and growth in California homeowners policies. Direct premiums written increased to $3.249 billion from $3.172 billion.
- The GAAP loss ratio rose to 76.5% from 75.2%; the expense ratio improved to 24.7% from 25.5%. The combined ratio therefore rose to 101.2% from 100.7%.
- Prior-year reserve development remained adverse, though it moderated: $54.4 million of unfavorable development in 2017 versus $85.4 million in 2016, primarily reflecting higher-than-estimated California automobile and property losses in 2017.
- Catastrophe losses net of reinsurance increased to approximately $79 million from $27 million, primarily from California wildfires and rainstorms, Hurricane Harvey, and Hurricane Irma.
- Debt financing changed: the company issued $375 million of 4.4% senior unsecured notes due in 2027, repaid $320 million under prior facilities, and established a new $50 million revolver. Interest expense rose to $15.2 million from $4.0 million.
Outlook, commentary, risks, and unusual items
- Outlook and rates: The filing provides no quantified earnings or revenue guidance. Management said the insurance market appeared to be hardening, with carriers generally raising rates, and intended to continue expansion and marketing efforts. A 6.9% California auto rate increase for CAIC took effect in May 2017; a 6.9% homeowners increase took effect in August 2017. A 5.0% increase for MIC’s California auto business was approved in January 2018 and was expected to take effect in March 2018. Rate approvals and timing remain subject to regulation.
- Catastrophes and reinsurance: Fourth-quarter California wildfires generated about $109 million of gross losses; reinsurance reduced the combined net loss from the two events to the company’s $20 million retention. The company also recorded about $12 million in ceded reinstatement premiums. The catastrophe treaty ran through June 30, 2018, excluded Florida business and California earthquake losses on fixed property, and had reduced remaining first-layer coverage following treaty use.
- Reserves: Gross loss and loss-adjustment-expense reserves grew to $1.511 billion from $1.290 billion. Management emphasizes that reserve estimates are uncertain; it identified 2015–2017 accident years as more likely to develop and disclosed sensitivity to bodily-injury claim severity and claim counts. It also recorded about $15 million of losses from adverse legal outcomes on three older claims.
- Concentration and investment exposure: California and personal auto dominate the business. Municipal bonds represented 67.9% of the investment portfolio at fair value; management disclosed exposure to interest rates, municipal credit conditions, equity prices, and valuation uncertainty. A 100-basis-point rate increase was estimated to reduce fixed-maturity fair value by $127.4 million.
- Tax and legal matters: The 2017 Tax Act produced a provisional $7.4 million net tax benefit; tax balances were remeasured at the new 21% federal corporate rate, and the company reported a $57.9 million AMT credit receivable. A California DOI appeal concerns a previously assessed $27.6 million penalty. The state returned $30.9 million, including accrued interest, but the company has not recognized it as a gain while the appeal remains pending; approximately $31.1 million including earned interest was recorded in other liabilities at year-end.
- Holding-company liquidity: Mercury General depends on regulated insurance subsidiaries for dividends. Those subsidiaries could pay up to $167 million to the parent in 2018 without extraordinary-dividend approval, including $134 million from California companies. Restrictions on subsidiary distributions could affect parent-company debt service and shareholder dividends.
- Other risks: Rate regulation, competition, inflation and repair/medical costs, reinsurance collectability, cybersecurity and systems reliability, and catastrophe severity could materially affect results. A.M. Best affirmed ratings in 2017 but maintained a Negative outlook for A+ rated entities; management said it was working to return the outlook to Stable.
The company paid $2.4925 per share in dividends during 2017 and declared a $0.625 quarterly dividend in February 2018. KPMG issued unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- How much of 2017’s earnings improvement is repeatable underwriting or investment income versus fair-value-driven realized gains and the one-time tax benefit?
- Whether California auto and property loss severity, adverse reserve development, and catastrophe losses persist, and how actual claims compare with disclosed reserve sensitivities.
- The status and remaining protection of the catastrophe reinsurance treaty after wildfire claims and reinstatement premiums, including renewal terms after June 30, 2018.
- The outcome of the California DOI appeal and whether the $31.1 million liability can ultimately be recognized as income or must be repaid.
- Whether statutory capital, subsidiary dividend capacity, and parent liquidity remain adequate alongside debt service and the dividend policy.
- How the municipal-heavy investment portfolio performs under changing interest rates, credit conditions, and market valuations, and how tax-law changes affect investment allocation and future earnings.