Mercury General Corporation — 2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. Although the request identifies 2019 Q4, this filing is an annual report; quarterly figures are noted separately. Mercury General is a property-and-casualty insurer focused on personal auto, principally in California, with homeowners and other insurance lines.
Financial performance and position
- Revenue and premiums: Total revenue was $3.97 billion, up from $3.38 billion in 2018. Net premiums earned rose 6.9% to $3.60 billion; net premiums written increased 6.8% to $3.73 billion. Management attributed premium growth mainly to rate increases and California homeowners policy growth.
- Profit: Net income was $320.1 million ($5.78 diluted EPS), versus a $5.7 million loss ($0.10 per share) in 2018. Pre-tax income was $378.1 million. The 2019 result included $222.8 million in net realized investment gains, compared with $133.5 million in losses in 2018; investment fair-value changes contributed substantially to the swing.
- Underwriting and margins: The GAAP combined ratio improved to 99.4% from 100.7%; below 100% generally indicates underwriting profitability. The statutory company-wide combined ratio was 99.7%, while the private passenger auto statutory ratio was 98.2%. Excluding catastrophe losses and prior-year reserve development, the loss ratio increased to 73.3% from 71.7%.
- Cash flow: Operating cash flow was $519.7 million, up from $383.4 million. Cash and short-term investments totaled $788.5 million at year-end. Shareholder dividends paid were $139.1 million, or $2.5125 per share.
- Investments: Investments at fair value were $4.31 billion, up from $3.77 billion. Net investment income was $141.3 million versus $135.8 million, while the pre-tax portfolio yield declined to 3.5% from 3.6%. Municipal bonds represented 57.0% of the investment portfolio’s fair value.
- Reserves: Gross loss and loss-adjustment-expense reserves were $1.92 billion, up from $1.83 billion; $847 million was incurred-but-not-reported. Prior-year reserve development was unfavorable by $9.8 million in 2019, versus $93.1 million unfavorable in 2018.
- Debt and capital: Notes payable were $372.1 million, comprising $375 million principal of 4.4% senior unsecured notes due 2027, net of discount and issuance costs. The $50 million revolving facility was undrawn. Statutory policyholder surplus was $1.54 billion; net premiums written to surplus was 2.4:1. Each insurance subsidiary exceeded minimum RBC requirements, with none below 400% of authorized-control-level RBC.
Material changes versus 2018
- Net income recovered from a small loss to $320.1 million, driven in large part by the reversal from investment losses to substantial investment gains, alongside premium growth and improved underwriting results.
- Net premiums earned increased 6.9%. California remained the core market, accounting for 86.4% of direct premiums written overall; approximately 88% of private-auto premiums were written in California.
- Catastrophe losses net of reinsurance were approximately $53 million, compared with $67 million in 2018. 2019 catastrophe events generated about $57 million of losses with no reinsurance recovery; favorable prior-catastrophe development partly offset them.
- Reinsurance recoverables on unpaid losses fell to $76.1 million from $180.9 million. The catastrophe treaty effective through June 30, 2020 increased coverage to $600 million above a $40 million per-occurrence retention, with specified exclusions; the annual premium increased to approximately $38 million from $22 million.
- Operating lease assets and liabilities were recognized in 2019 under the new lease accounting standard; adoption had no material financial-statement impact.
Outlook, commentary, risks and unusual items
- Outlook: No specific earnings or revenue guidance is provided. Management said the auto insurance industry was exiting a hard market, with insurers generally raising rates more slowly than in 2017 and 2018. The company planned continued investment in technology, customer experience, cross-selling and new products in 2020.
- Rates and concentration: California rate changes require prior regulatory approval under Proposition 103, which can delay or constrain pricing actions. California auto rate increases of 6.90% were implemented for two subsidiaries in 2019, and a 6.99% homeowners increase was implemented in August. Geographic concentration leaves results exposed to California regulation, competition, claims trends and catastrophe conditions.
- Catastrophes and reinsurance: Wildfires, winter storms and other severe weather affected 2019 results. Treaty protection has exclusions, including for Florida business and specified wildfire layers; the insurer remains responsible to policyholders if reinsurers fail to pay.
- Reserving uncertainty: Management identifies loss-reserve estimation as its most significant accounting estimate. California auto bodily-injury severity and claim-count development are key sensitivities; the filing presents possible reserve sensitivity of about $108.8 million favorable or unfavorable from severity variations for selected accident years.
- Investment and market exposure: Earnings are exposed to equity prices, interest rates and credit conditions. A 100- or 200-basis-point rate increase was estimated to reduce fixed-maturity fair value by $113 million or $226 million, respectively. Lower rates may reduce reinvestment yields. Municipal bonds comprise a substantial share of the portfolio.
- Regulatory settlement: A long-running California Department of Insurance matter concerning broker fees and advertising was settled in October 2019 for approximately $41.2 million in total. The company recorded about $6 million of incremental third-quarter expense and stated it did not admit the allegations.
- Liquidity and dividends: Mercury General relies on regulated insurance subsidiaries for holding-company cash. Subsidiaries could pay up to $151 million in ordinary dividends to the parent in 2020 without extraordinary-dividend approval; $114 million was paid in 2019. The board declared a $0.63 quarterly dividend in February 2020. Dividend continuation is not assured.
- Audit and controls: The auditor issued unqualified opinions on the financial statements and internal control over financial reporting. Loss-reserve estimation was identified as a critical audit matter.
Important facts for investors to verify
- How much of reported earnings reflects recurring underwriting and investment income versus fair-value-driven realized investment gains.
- Whether California auto bodily-injury severity and reserve development remain controlled, and how the latest accident years mature.
- The scope, exclusions, cost and renewal terms of catastrophe reinsurance, especially wildfire exposure and retention levels.
- Whether premium growth and rate approvals keep pace with claims inflation as the insurance market softens.
- The investment portfolio’s sensitivity to municipal-bond credit deterioration, equity declines and lower reinvestment yields.
- Insurance-subsidiary dividend capacity and its effect on parent-company debt service and shareholder dividends.