Mercury General Corporation — Q3 2019 Form 10-Q
Business context and period. Insurer primarily writing personal auto insurance, with related homeowners and commercial lines, in 11 states, principally California. This unaudited report covers the quarter and nine months ended September 30, 2019; comparisons are with the corresponding 2018 periods.
Key financial results
- Third quarter: Net premiums earned rose 6.6% to $915.0 million; total revenues increased 10.3% to $987.3 million. Net income was $69.3 million, or $1.25 per diluted share, versus $58.6 million, or $1.06, a year earlier.
- First nine months: Net premiums earned increased 7.0% to $2.674 billion; total revenues were $2.985 billion versus $2.563 billion. Net income was $288.4 million, or $5.21 per diluted share, compared with $76.2 million, or $1.38.
- Investment results: Net investment income was $36.4 million in Q3 (down from $38.2 million) and $105.6 million for nine months (up from $104.5 million). Net realized investment gains were $33.3 million for Q3 versus a $3.9 million loss, and $197.7 million for nine months versus a $48.4 million loss. These gains included substantial fair-value increases, particularly on fixed maturities and equities, and materially contributed to reported earnings.
- Underwriting and margins: The Q3 combined ratio rose to 98.6% from 95.6%; the loss ratio increased to 74.4% from 71.6%, while the expense ratio was 24.2% versus 24.0%. For nine months, the combined ratio improved to 98.1% from 98.7%, with loss and expense ratios of 73.6% and 24.5%, respectively. Ratios below 100% indicate underwriting profit.
- Cash flow and liquidity: Nine-month operating cash flow was $413.6 million, up from $325.2 million. Cash was $315.4 million at September 30; cash plus short-term investments totaled $736.9 million. The $50 million revolving credit facility was undrawn, and management said operating cash flow and available liquidity were expected to meet requirements without forced investment sales.
- Balance sheet and debt: Total assets were $5.873 billion and shareholders’ equity was $1.803 billion at September 30. Notes payable had a $372.0 million carrying value, representing $375 million of 4.40% senior unsecured notes due in 2027. The company reported a 17.2% debt-to-total-capital ratio and compliance with credit-facility covenants.
- Dividends: The company paid $0.6275 per share in Q3 and $1.8825 per share for the first nine months of 2019.
Changes versus prior comparable periods
- Premium growth was attributed mainly to higher average premiums following California auto and homeowners rate increases, growth in California homeowners policies, and increased sales of 12-month auto policies. Nine-month direct premiums written rose to $2.865 billion from $2.673 billion.
- Q3 underwriting weakened: increased auto losses and severity, particularly in California private passenger auto, more than offset rate benefits. Nine-month underwriting results improved overall, but the loss ratio excluding catastrophe losses and prior-year development rose to 72.5% from 70.3%.
- Nine-month net income benefited from the shift in realized investment results from a loss to a large gain. Excluding after-tax realized investment gains, diluted earnings per share were $2.39 for nine months in 2019 versus $2.07 in 2018 (derived from reported EPS less disclosed per-share investment gains or losses).
- Prior-year reserve development was unfavorable by $10.3 million for nine months in 2019, compared with $70.4 million in 2018. The 2019 increase mainly reflected higher California auto defense and cost-containment expenses, partly offset by favorable development in other lines.
Outlook, commentary, risks and unusual items
- The filing gives no specific earnings or revenue guidance. Management cautions that results fluctuate with competition and pricing, claims frequency and severity, catastrophes, regulation, investment-market changes, and reserve estimates; nine-month results are not necessarily indicative of full-year results.
- California rate increases implemented in 2019 included 6.90% increases on specified private-passenger-auto books and a 6.99% homeowners increase. Their effect on future pricing, retention and claims margins remains important.
- Catastrophe reinsurance through June 30, 2020 provides up to $590 million per occurrence after a $40 million retention, but excludes Florida business and California earthquake losses on fixed-property policies and excludes most wildfire losses on certain layers. The annual treaty premium rose to approximately $38 million from $22 million for the prior treaty year.
- October 2019 California wildfires were a subsequent event. Claims had been received, but the company said it could not yet reasonably estimate total losses; it did not expect net losses after reinsurance to be material to financial position.
- A California regulatory matter was settled after quarter-end. The company paid approximately $35 million on August 30, 2019 and an additional approximately $6 million on October 2, bringing the settlement to approximately $41.2 million. The company recorded approximately $6 million of incremental Q3 expense; it made no admission of the allegations.
- Key exposures include uncertainty in loss reserves, rising claim severity and defense costs, catastrophe losses and reinsurance recoverability, California regulatory and litigation matters, and market risks. A 100- or 200-basis-point rise in interest rates was estimated to reduce fixed-maturity fair value by $120.7 million or $241.4 million, respectively. A 25% or 50% market decline was estimated to reduce common-stock portfolio value by $112.2 million or $224.5 million.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- How much future earnings depend on investment fair-value movements versus recurring investment income and underwriting profit.
- Whether auto and homeowners rate increases keep pace with claim severity, expenses and competition, and whether the combined ratio remains below 100%.
- Subsequent estimates and reinsurance recoveries for the October 2019 California wildfires, including treaty exclusions and retention.
- Development of California auto loss reserves and the adequacy of recorded reserves as claims mature.
- Cash and statutory capital after the approximately $41.2 million California settlement, dividend payments and catastrophe-related costs.