MERCURY GENERAL CORPORATION Forward-Looking Statements
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for certain forward-looking statements. Certain statements contained in this report are forward-looking statements based on the Company's current expectations and beliefs concerning future developments and their potential effects on the Company. There can be no assurance that future developments affecting the Company will be those anticipated by the Company. Actual results may differ from those projected in the forward-looking statements. These forward-looking statements involve significant risks and uncertainties (some of which are beyond the control of the Company) and are subject to change based upon various factors, including but not limited to the following risks and uncertainties: changes in the demand for the Company's insurance products, inflation and general economic conditions, including general market risks associated with the Company's investment portfolio; the accuracy and adequacy of the Company's pricing methodologies; catastrophes in the markets served by the Company; uncertainties related to estimates, assumptions and projections generally; the possibility that actual loss experience may vary adversely from the actuarial estimates made to determine the Company's loss reserves in general; the Company's ability to obtain and the timing of the approval of premium rate changes for insurance policies issued in the states where it operates; legislation adverse to the automobile insurance industry or business generally that may be enacted in the states where the Company operates; the Company's success in managing its business in non-California states; the presence of competitors with greater financial resources and the impact of competitive pricing and marketing efforts; the Company's ability to successfully manage its claims organization outside ofCalifornia ; the Company's ability to successfully allocate the resources used in the states with reduced or exited operations to its operations in other states; changes in driving patterns and loss trends; acts of war and terrorist activities; pandemics, epidemics, widespread health emergencies, or outbreaks of infectious diseases; court decisions and trends in litigation and health care and auto repair costs; and legal, cybersecurity, regulatory and litigation risks. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as the result of new information, future events or otherwise. For a more detailed discussion of some of the foregoing risks and uncertainties, see the Company's Annual Report on Form 10-K filed with theSecurities and Exchange Commission onFebruary 15, 2022 . OVERVIEW
A. General
The operating results of property and casualty insurance companies are subject to significant quarter-to-quarter and year-to-year fluctuations due to the effect of competition on pricing, the frequency and severity of losses, the effect of weather and natural disasters on losses, general economic conditions, the general regulatory environment in states in which an insurer operates, state regulation of insurance including premium rates, changes in fair value of investments, and other factors such as changes in tax laws. The property and casualty insurance industry has been highly cyclical, with periods of high premium rates and shortages of underwriting capacity followed by periods of severe price competition and excess capacity. These cycles can have a significant impact on the Company's ability to grow and retain business.
This section discusses some of the relevant factors that management considers in evaluating the Company's performance, prospects, and risks. It is not all-inclusive and is meant to be read in conjunction with the entirety of management's discussion and analysis, the Company's consolidated financial statements and notes thereto, and all other items contained within this Quarterly Report on Form 10-Q.
Note on COVID-19 and General Economic Conditions
InMarch 2020 , the outbreak of COVID-19 was recognized as a pandemic by theWorld Health Organization (the "WHO"), and the pandemic has had a notable impact on general economic conditions, including, but not limited to, the temporary closures of many businesses, "shelter in place" and other governmental orders, and reduced consumer spending. The Company is following guidelines established by theCenters for Disease Control , theWHO , and the state and local governments. The Company has taken a number of precautionary steps to safeguard its customers, business and employees from COVID-19. Most of the Company's employees have been working remotely, with only certain operationally critical employees working on site at various locations. InNovember 2021 , the Company extended its "work-from-home" policy indefinitely under the new "Mercury's My Workplace" policy, allowing most of its employees to work from anywhere in theU.S. beginningJanuary 2022 .
The Company's automobile line of insurance business began experiencing a significant decrease in loss frequency in March of 2020, and it remained lower than historical levels through the first half of 2021, although it began to increase as more
22
--------------------------------------------------------------------------------
Table of Contents
drivers returned to the road following the gradual reopening of businesses in
California and other states. After bottoming out in the second quarter of 2020,
loss frequency has been increasing and is near pre-pandemic levels, although it
declined slightly in the first quarter of 2022 mostly due to seasonal factors
and a temporary surge of the Omicron variant of COVID-19. The severity of
accidents, for both bodily injury and the cost to repair vehicles, has increased
following the outbreak of the COVID-19 pandemic, primarily due to a higher
percentage of high-speed serious accidents on less congested roads and freeways.
The costs to repair vehicles and treat bodily injuries may remain high due to
supply chain and labor force issues exacerbated by the high overall inflation
rate and the Russia -Ukraine war. Inflationary trends have accelerated to their
highest level since the 1980s with the most recent consumer price index increase
of 8.5%. Excessive inflation has led to significant increases in loss severities
related to vehicle repairs and bodily injuries. The COVID-19 pandemic also
created more uncertainty, and the total effect on losses occurring during the
COVID-19 era will not be known for several years. The Company expects more late
reported claims and a prolonged settlement period, particularly for bodily
injury claims. Many courts have been closed, and claimants may have been
reluctant to seek medical treatments due to the pandemic. The recent increases
in loss frequency combined with sustained high loss severity have negatively
impacted the Company's results of operations, and the Company has submitted
private passenger automobile rate filings in many states requesting rate
increases.
In March 2020 , the Federal Open Market Committee ("FOMC") of the Federal Reserve
unveiled a set of aggressive measures to cushion the economic impact of the
global COVID-19 crisis, including, among others, cutting the federal funds rate
by 100 basis points to a range of 0.00% to 0.25% and establishing a series of
emergency credit facilities in an effort to support the flow of credit in the
economy, easing liquidity pressure and calming market turmoil. While volatility
in the financial markets remains elevated, overall market liquidity concerns
have eased following the actions taken by the FOMC . However, the FOMC started
raising the federal funds rate in March 2022 as a response to inflationary
pressures. The ensuing increases in market interest rates resulted in
significant decreases in the fair values of the Company's fixed maturity
securities during the first quarter of 2022. The Company believes that it will
continue to have sufficient liquidity to support its business operations during
the COVID-19 crisis and beyond without the forced sale of investments, based on
its existing cash and short-term investments, future cash flows from operations,
and $75 million of undrawn credit in its unsecured credit facility.
The Company will continue to monitor the effects of the COVID-19 pandemic, the
legislative relief programs for the pandemic, the rising inflation and interest
rates and the Russia -Ukraine war. The extent of these effects on the Company's
business and financial results will depend largely on future developments,
including the duration and severity of the pandemic, the high inflation rate and
the war, most of which are highly uncertain and cannot be predicted.
B. Business
The Company is primarily engaged in writing personal automobile insurance
through 13 insurance subsidiaries ("Insurance Companies") in 11 states,
principally California . The Company also writes homeowners, commercial
automobile, commercial property, mechanical protection, and umbrella insurance.
The Company's insurance policies are mostly sold through independent agents who
receive a commission for selling policies. The Company believes that it has
thorough underwriting and claims handling processes that, together with its
agent relationships, provide the Company with competitive advantages.
The following tables present direct premiums written, by state and line of
insurance business, for the three months ended
Three Months Ended
(Dollars in thousands)
Private Commercial
Passenger Automobile Homeowners Automobile Other Lines (2) Total
California $ 567,202 $ 160,704 $ 49,872 $ 51,328 $ 829,106 81.4 %
Texas 23,180 24,680 12,351 1,557 61,768 6.1 %
Other states (1) 90,906 24,871 9,350 2,232 127,359 12.5 %
Total $ 681,288 $ 210,255 $ 71,573 $ 55,117 $ 1,018,233 100.0 %
66.9 % 20.7 % 7.0 % 5.4 % 100.0 %
23--------------------------------------------------------------------------------
Table of Contents
Three Months Ended
(Dollars in thousands)
Private Commercial
Passenger Automobile Homeowners Automobile Other Lines (2) Total
California $ 588,807 $ 140,140 $ 46,509 $ 44,048 $ 819,504 86.0 %
Other states (1) 77,689 30,079 22,357 3,728 133,853 14.0 %
Total $ 666,496 $ 170,219 $ 68,866 $ 47,776 $ 953,357 100.0 %
69.9 % 17.9 % 7.2 % 5.0 % 100.0 %
______________
(1) No individual state accounted for more than 5% of total direct premiums
written.
(2) No individual line of insurance business accounted for more than 5% of total
direct premiums written.
C. Regulatory and Legal Matters
The Department of Insurance ("DOI") in each state in which the Company operates is responsible for conducting periodic financial, market conduct, and rating and underwriting examinations of the Insurance Companies in their states. Market conduct examinations typically review compliance with insurance statutes and regulations with respect to rating, underwriting, claims handling, billing, and other practices.
The following table presents a summary of recent and upcoming examinations:
State Exam Type Exam Period Covered Status
CA, FL, GA, Coordinated Multi-state
IL, OK, TX Financial 2018-2021 Examination began in the second quarter of 2022.
During the course of and at the conclusion of the examinations, the examining DOI generally reports findings to the Company.
The Company is, from time to time, named as a defendant in various lawsuits or regulatory actions incidental to its insurance business. The majority of lawsuits brought against the Company relate to insurance claims that arise in the normal course of business and are reserved for through the reserving process. For a discussion of the Company's reserving methods, see the Company's Annual Report on Form 10-K for the year endedDecember 31, 2021 . The Company establishes reserves for non-insurance claims related lawsuits, regulatory actions, and other contingencies when the Company believes a loss is probable and is able to estimate its potential exposure. For loss contingencies believed to be reasonably possible, the Company also discloses the nature of the loss contingency and an estimate of the possible loss, range of loss, or a statement that such an estimate cannot be made. In addition, the Company accrues for anticipated legal defense costs associated with such lawsuits and regulatory actions. While actual losses may differ from the amounts recorded and the ultimate outcome of the Company's pending actions is generally not yet determinable, the Company does not believe that the ultimate resolution of currently pending legal or regulatory proceedings, either individually or in the aggregate, will have a material adverse effect on its financial condition or cash flows. In all cases, the Company vigorously defends itself unless a reasonable settlement appears appropriate. For a discussion of any additional regulatory or legal matters, see the Company's Annual Report on Form 10-K for the year endedDecember 31, 2021 , and Note 12. Contingencies of the Notes to Consolidated Financial Statements of this Quarterly Report.
D. Critical Accounting Estimates
Loss and Loss Adjustment Expense Reserves ("Loss Reserves")
Preparation of the Company's consolidated financial statements requires
management's judgment and estimates. The most significant is the estimate of
loss reserves. Estimating loss reserves is a difficult process as many factors
can ultimately affect the final settlement of a claim and, therefore, the loss
reserve that is required. A key assumption in estimating loss reserves is the
degree to which the historical data used to analyze reserves will be predictive
of ultimate claim costs on incurred claims. Changes in the regulatory and legal
environments, results of litigation, medical costs, the cost of repair
materials, and labor rates, among other factors, can impact this assumption. In
addition, time can be a critical part of reserving determinations
24
--------------------------------------------------------------------------------
Table of Contents
since the longer the span between the incidence of a loss and the payment or
settlement of a claim, the more variable the ultimate settlement amount could
be. Accordingly, short-tail claims, such as property damage claims, tend to be
more reasonably predictable than long-tail liability claims.
The Company calculates a loss reserve point estimate rather than a range. There
is inherent uncertainty with estimates and this is particularly true with loss
reserve estimates. This uncertainty comes from many factors which may include
changes in claims reporting and settlement patterns, changes in the regulatory
and legal environments, uncertainty over inflation rates, and uncertainty for
unknown items. The Company does not make specific provisions for these
uncertainties, rather it considers them in establishing its loss reserve by
reviewing historical patterns and trends and projecting these out to current
loss reserves. The underlying factors and assumptions that serve as the basis
for preparing the loss reserve estimate include paid and incurred loss
development factors, expected average costs per claim, inflation trends,
expected loss ratios, industry data, and other relevant information.
The Company also engages independent actuarial consultants to review the
Company's loss reserves and to provide the annual actuarial opinions under
statutory accounting principles as required by state regulation. The Company
analyzes loss reserves quarterly primarily using the incurred loss, paid loss,
average severity coupled with the claim count development methods, and the
generalized linear model ("GLM") described below. When deciding among methods to
use, the Company evaluates the credibility of each method based on the maturity
of the data available and the claims settlement practices for each particular
line of insurance business or coverage within a line of insurance business. The
Company may also evaluate qualitative factors such as known changes in laws or
legal rulings that could affect claims handling or other external environmental
factors or internal factors that could affect the settlement of claims. When
establishing the loss reserve, the Company will generally analyze the results
from all of the methods used rather than relying on a single method. While these
methods are designed to determine the ultimate losses on claims under the
Company's policies, there is inherent uncertainty in all actuarial models since
they use historical data to project outcomes. The Company believes that the
techniques it uses provide a reasonable basis in estimating loss reserves.
•The incurred loss method analyzes historical incurred case loss (case reserves
plus paid losses) development to estimate ultimate losses. The Company applies
development factors against current case incurred losses by accident period to
calculate ultimate expected losses. The Company believes that the incurred loss
method provides a reasonable basis for evaluating ultimate losses, particularly
in the Company's larger, more established lines of insurance business which have
a long operating history.
•The paid loss method analyzes historical payment patterns to estimate the amount of losses yet to be paid.
•The average severity method analyzes historical loss payments and/or incurred losses divided by closed claims and/or total claims to calculate an estimated average cost per claim. From this, the expected ultimate average cost per claim can be estimated. The average severity method coupled with the claim count development method provide meaningful information regarding inflation and frequency trends that the Company believes is useful in establishing loss reserves. The claim count development method analyzes historical claim count development to estimate future incurred claim count development for current claims. The Company applies these development factors against current claim counts by accident period to calculate ultimate expected claim counts. •The GLM determines an average severity for each percentile of claims that have been closed as a percentage of estimated ultimate claims. The average severities are applied to open claims to estimate the amount of losses yet to be paid. The GLM utilizes operational time, determined as a percentile of claims closed rather than a finite calendar period, which neutralizes the effect of changes in the timing of claims handling. The Company analyzes catastrophe losses separately from non-catastrophe losses. For catastrophe losses, the Company generally determines claim counts based on claims reported and development expectations from previous catastrophes and applies an average expected loss per claim based on loss reserves established by adjusters and average losses on previous similar catastrophes. For catastrophe losses on individual properties that are expected to be total losses, the Company typically establishes reserves at the policy limits. AtMarch 31, 2022 andDecember 31, 2021 , the Company recorded its point estimate of approximately$2.31 billion and$2.23 billion ($2.27 billion and$2.19 billion , net of reinsurance), respectively, in loss reserves, which included approximately$1.10 billion and$1.03 billion ($1.09 billion and$1.02 billion , net of reinsurance), respectively, of incurred but not reported loss reserves ("IBNR"). IBNR includes estimates, based upon past experience, of ultimate developed costs, which may differ from case estimates, unreported claims that occurred on or prior toMarch 31, 2022 andDecember 31, 2021 , and estimated future payments for reopened claims. Management believes that the liability for loss reserves is adequate to cover the ultimate net cost of losses and loss adjustment expenses incurred to date; however, since the provisions are necessarily based upon 25
--------------------------------------------------------------------------------
Table of Contents
estimates, the ultimate liability may be more or less than such provisions.
The Company evaluates its loss reserves quarterly. When management determines that the estimated ultimate claim cost requires a decrease for previously reported accident years, favorable development occurs and a reduction in losses and loss adjustment expenses is reported in the current period. If the estimated ultimate claim cost requires an increase for previously reported accident years, unfavorable development occurs and an increase in losses and loss adjustment expenses is reported in the current period.
For a further discussion of the Company's reserving methods, see the Company's
Annual Report on Form 10-K for the year ended
RESULTS OF OPERATIONS
Three Months Ended
Revenues
Net premiums earned and net premiums written for the three months endedMarch 31, 2022 increased 5.1% and 6.4%, respectively, from the corresponding period in 2021. The increase in net premiums earned and net premiums written for the three months endedMarch 31, 2022 compared to the corresponding period in 2021 was primarily due to higher average premiums per policy arising from rate increases in theCalifornia homeowners line of insurance business and increases in the number of policies written outside ofCalifornia , partially offset by a decrease in the number of private passenger automobile policies written inCalifornia . Net premiums earned included ceded premiums earned of$17.5 million and$15.5 million for the three months endedMarch 31, 2022 and 2021, respectively. Net premiums written included ceded premiums written of$17.6 million and$15.6 million for the three months endedMarch 31, 2022 and 2021, respectively. The increase in ceded premiums earned and ceded premiums written for the three months endedMarch 31, 2022 compared to the corresponding period in 2021 resulted mostly from higher reinsurance coverage and rates and growth in the covered book of business. Net premiums earned, a GAAP measure, represents the portion of net premiums written that is recognized as revenue in the financial statements for the periods presented and earned on a pro-rata basis over the term of the policies. Net premiums written is a non-GAAP financial measure which represents the premiums charged on policies issued during a fiscal period, net of any applicable reinsurance. Net premiums written is a statutory measure designed to determine production levels. The following is a reconciliation of net premiums earned to net premiums written: Three Months Ended March 31, 2022 2021 (Amounts in thousands) Net premiums earned$ 962,550 $ 915,922 Change in net unearned premiums 48,248 34,461 Net premiums written$ 1,010,798 $ 950,383 Expenses Loss and expense ratios are used to interpret the underwriting experience of property and casualty insurance companies. The following table presents the Insurance Companies' loss, expense, and combined ratios determined in accordance with GAAP: Three Months Ended March 31, 2022 2021 Loss ratio 85.4 % 68.4 % Expense ratio 24.1 % 25.1 % Combined ratio 109.5 % 93.5 %
Loss ratio is calculated by dividing losses and loss adjustment expenses by net premiums earned. The loss ratio for the
26
--------------------------------------------------------------------------------
Table of Contents
first quarter of 2022 and 2021 was affected by unfavorable development of
approximately $53 million and favorable development of approximately $1 million ,
respectively, on prior accident years' loss and loss adjustment expense
reserves. The unfavorable development for the first quarter of 2022 was
primarily attributable to higher than estimated losses and loss adjustment
expenses in the automobile and commercial property lines of insurance business,
partially offset by favorable development in the homeowners line of insurance
business. Inflationary trends have accelerated to their highest level in
decades, which has had a significant impact on the cost of auto parts and labor
as well as medical expenses for bodily injuries, and supply chain and labor
shortage issues have lengthened the time to repair vehicles. Bodily injury costs
are also under pressure from social inflation. These factors were major
contributors to the adverse reserve development in the automobile line of
insurance business. The favorable development for the first quarter of 2021 was
primarily attributable to lower than estimated losses and loss adjustment
expenses in the commercial property and private passenger automobile lines of
insurance business, mostly offset by unfavorable development in the commercial
automobile line of insurance business.
In addition, the 2022 loss ratio was negatively impacted by approximately $21
million of catastrophe losses, excluding unfavorable development of
approximately $1 million on prior years' catastrophe losses, primarily due to
winter storms in Texas and California . The 2021 loss ratio was negatively
impacted by approximately $39 million of catastrophe losses, excluding favorable
development of approximately $4 million on prior years' catastrophe losses,
primarily due to the deep freeze in Texas and Oklahoma and winter storms in
California .
Excluding the effect of estimated prior periods' loss development and
catastrophe losses, the loss ratio was 77.7% and 64.3% for the first quarter of
2022 and 2021, respectively. The increase in the loss ratio was primarily due to
an increase in loss frequency and severity in the automobile line of insurance
business, partially offset by higher average premiums per policy arising from
rate increases in the California homeowners line of insurance business. After
bottoming out in the second quarter of 2020, automobile loss frequency has been
increasing and is near pre-pandemic levels, although it declined slightly in the
first quarter of 2022 mostly due to seasonal factors and a temporary surge of
the Omicron variant of COVID-19. The inflationary pressures and the supply chain
and labor shortage issues discussed above have led to a significant increase in
automobile loss severity and increased losses and loss adjustment expenses for
the insured events of the current accident year for the three months ended March
31, 2022 compared to the corresponding period in 2021.
Expense ratio is calculated by dividing the sum of policy acquisition costs and
other operating expenses by net premiums earned. The expense ratio for the three
months ended March 31, 2022 decreased compared to the corresponding period in
2021. Higher average premiums per policy arising from rate increases in the
California homeowners line of insurance business contributed to the decrease in
the expense ratio. In addition, expenses for profitability-related accruals and
advertising decreased, partially offset by an increase in expense for allowance
for credit losses.
Combined ratio is equal to loss ratio plus expense ratio and is the key measure
of underwriting performance traditionally used in the property and casualty
insurance industry. A combined ratio under 100% generally reflects profitable
underwriting results, and a combined ratio over 100% generally reflects
unprofitable underwriting results.
Income tax (benefit) expense was $(56.2) million and $25.4 million for the three
months ended March 31, 2022 and 2021, respectively. The decrease in income tax
expense was primarily due to a $385.6 million decrease in total pre-tax income.
Tax-exempt investment income, a component of total pre-tax (loss) income,
remained relatively steady with the corresponding period in 2021.
The Company's effective income tax rate can be affected by several factors.
These generally include large changes in the composition of fully taxable income
including net realized investment gains or losses, tax-exempt investment income,
non-deductible expenses, and periodically, non-routine tax items such as
adjustments to unrecognized tax benefits related to tax uncertainties.
Tax-exempt investment income of approximately $17 million coupled with pre-tax
loss of approximately $253 million resulted in an effective tax rate of 22.2%,
above the statutory tax rate of 21%, for the three months ended March 31, 2022 ,
while tax-exempt investment income of approximately $19 million coupled with
pre-tax income of approximately $132 million resulted in an effective tax rate
of 19.2%, below the statutory rate, for the corresponding period in 2021.
27-------------------------------------------------------------------------------- Table of Contents Investments
The following table presents the investment results of the Company:
Three Months Ended March 31,
2022 2021
(Dollars in thousands)
Average invested assets at cost (1)
Net investment income (2)
Before income taxes $ 35,351 $ 32,279
After income taxes $ 30,921 $ 28,784
Average annual yield on investments
Before income taxes 2.9 % 2.9 %
After income taxes 2.5 % 2.5 %
Net realized investment (losses) gains
__________
(1) Fixed maturities and short-term bonds at amortized cost; equities and other short-term investments at cost. Average invested assets at cost are based on the monthly amortized cost of the invested assets for each period. (2) Higher net investment income before and after income taxes for the three months endedMarch 31, 2022 compared to the corresponding period in 2021 resulted largely from higher average invested assets.
The following tables present the components of net realized investment gains (losses) included in net income:
Three Months Ended
Gains (Losses) Recognized in Net Income
Changes in fair
Sales value Total
(Amounts in thousands)
Net realized investment gains (losses)
Fixed maturity securities (1)(2) $ (2,800) $ (157,929) $ (160,729)
Equity securities (1)(3) 5,562 (40,321) (34,759)
Short-term investments (1) (825) 2 (823)
Note receivable (1) - - -
Options sold 1,307 (82) 1,225
Total $ 3,244 $ (198,330) $ (195,086)
Three Months Ended March 31, 2021
Gains(Losses) Recognized in Net Income
Changes in
Sales fair value Total
(Amounts in thousands)
Net realized investment gains (losses)
Fixed maturity securities (1)(2) $ (3,247) $ (8,057) $ (11,304)
Equity securities (1)(3) 17,959 34,520 52,479
Short-term investments (1) 1 68 69
Note receivable (1) - (13) (13)
Options sold 370 90 460
Total $ 15,083 $ 26,608 $ 41,691 __________
(1)The changes in fair value of the investment portfolio and note receivable resulted from application of the fair value option. (2)The decreases in fair value of fixed maturity securities for the first quarter of 2022 and 2021 primarily resulted from
28
--------------------------------------------------------------------------------
Table of Contents
increases in market interest rates.
(3)The primary cause for the decrease in fair value of equity securities for the
first quarter of 2022 was the overall decline in equity markets. The primary
cause for the increase in fair value of equity securities for the first quarter
of 2021 was the overall improvement in equity markets.
Net (Loss) Income
Three Months Ended March 31,
2022 2021
(Amounts in thousands, except per share
data)
Net (loss) income $ (196,917) $ 106,995
Basic average shares outstanding 55,371 55,361
Diluted average shares outstanding 55,371 55,372
Basic Per Share Data:
Net (loss) income $ (3.56) $ 1.93
Net realized investment (losses) gains, net of tax $ (2.78) $ 0.59
Diluted Per Share Data:
Net (loss) income $ (3.56) $ 1.93
Net realized investment (losses) gains, net of tax $ (2.78) $ 0.59
LIQUIDITY AND CAPITAL RESOURCES
A. Cash Flows
The Company has generated positive cash flow from operations since the public
offering of its common stock in November 1985 . The Company does not attempt to
match the duration and timing of asset maturities with those of liabilities;
rather, it manages its portfolio with a view towards maximizing total return
with an emphasis on after-tax income. With combined cash and short-term
investments of $429.7 million at March 31, 2022 as well as $75 million of credit
available on the unsecured credit facility, the Company believes its cash flow
from operations is adequate to satisfy its liquidity requirements without the
forced sale of investments. Investment maturities are also available to meet the
Company's liquidity needs. However, the Company operates in a rapidly evolving
and often unpredictable business environment that may change the timing or
amount of expected future cash receipts and expenditures. Accordingly, there can
be no assurance that the Company's sources of funds will be sufficient to meet
its liquidity needs or that the Company will not be required to raise additional
funds to meet those needs or for future business expansion, through the sale of
equity or debt securities or from credit facilities with lending institutions.
Net cash provided by operating activities for the three months ended March 31,
2022 was $106.6 million , a decrease of $67.9 million compared to the
corresponding period in 2021. The decrease was primarily due to an increase in
payments for losses and loss adjustment expenses, partially offset by an
increase in premium collections and a decrease in payments for operating
expenses. The Company utilized the cash provided by operating activities during
the three months ended March 31, 2022 primarily for the net purchases of
investment securities and payment of dividends to its shareholders.
The following table presents the estimated fair value of fixed maturity
securities at March 31, 2022 by contractual maturity in the next five years:
Fixed Maturity Securities
(Amounts in thousands)
Due in one year or less $ 394,084
Due after one year through two years 177,773
Due after two years through three years 125,628
Due after three years through four years 193,077
Due after four years through five years 272,329
Total due within five years $ 1,162,891
29-------------------------------------------------------------------------------- Table of Contents B. Reinsurance
For
The Company is the assuming reinsurer under a Catastrophe Participation Reinsurance Contract (the "Contract") effective throughDecember 31, 2022 . The Company reimburses a group of affiliates of a ceding company for a proportional share of a portfolio of catastrophe losses based on the premiums ceded to the Company under the Contract, to the extent the actual loss ratio exceeds the threshold loss ratio of 73.5% and 71% for the 12 months endingDecember 31, 2022 and 2021, respectively. The total assumed premium under the Contract is$10.0 million and$12.5 million for the 12 months endingDecember 31, 2022 and 2021, respectively. The total possible amount of losses for the Company under the Contract is$25.0 million and$31.3 million for the 12 months endingDecember 31, 2022 and 2021, respectively. The Company recognized$2.5 million and$3.1 million in earned premiums and$2.4 million and$3.9 million in incurred losses under the Contract for the three months endedMarch 31, 2022 and 2021, respectively. The Company is the ceding party to a Catastrophe Reinsurance Treaty (the "Treaty") covering a wide range of perils that is effective throughJune 30, 2022 . For the 12 months endingJune 30, 2022 and 2021, the Treaty provides$792 million and$717 million of coverage, respectively, on a per occurrence basis after covered catastrophe losses exceed the$40 million Company retention limit. The Treaty specifically excludes coverage for anyFlorida business and forCalifornia earthquake losses on fixed property policies such as homeowners, but does cover losses from fires following an earthquake. The Treaty includes additional restrictions as noted in the tables below.
Coverage on individual catastrophes provided for the 12 months ending
Catastrophe Losses and LAE
Percentage of
In Excess of Up to Coverage
(Amounts in millions)
Retained $ - $ 40 - %
Layer of Coverage 40 100 70
Layer of Coverage (1) (2) 100 450 100
Layer of Coverage (1) (3) (4) (5) 450 850 100
__________
(1) Layer of Coverage represents multiple actual treaty layers that are grouped for presentation purposes. (2) 4.1% of this layer excludesTexas . (3) 11.9% of this layer excludesTexas . (4) 15.0% of this layer coversCalifornia ,Arizona andNevada only. (5) 12.7% of this layer covers onlyCalifornia wildfires and fires following an earthquake inCalifornia , and is not subject to reinstatement.
Coverage on individual catastrophes provided for the 12 months ended
Catastrophe Losses and LAE
Percentage of
In Excess of Up to Coverage
(Amounts in millions)
Retained $ - $ 40 - %
Layer of Coverage 40 100 70
Layer of Coverage (1) 100 400 100
Layer of Coverage (1) (2) (3) 400 775 100
__________
(1) Layer of Coverage represents multiple actual treaty layers that are grouped for presentation purposes. (2) 14.2% of this layer coversCalifornia ,Arizona andNevada only. (3) 13.4% of this layer covers onlyCalifornia wildfires and fires following an earthquake inCalifornia , and is not subject to reinstatement. 30 -------------------------------------------------------------------------------- Table of Contents The table below presents the combined total reinsurance premiums under the Treaty (annual premiums and reinstatement premiums) for the 12 months endingJune 30, 2022 and 2021, respectively: Annual Premium Reinstatement Premium Total Combined Treaty (1) (2) Premium (2) (Amounts in millions) For the 12 months ending June 30, 2022 $ 55 $ - $ 55 For the 12 months ended June 30, 2021 $ 50 $ - $ 50
__________
(1) The increase in the annual premium is primarily due to an increase in reinsurance coverage and rates and growth in the covered book of business. (2) The reinstatement premium and the total combined premium for the treaty period endingJune 30, 2022 are projected amounts to be paid based on the assumption that there will be no reinstatements occurring during this treaty period. The reinstatement premium for the treaty period endedJune 30, 2021 is zero, as there were no actual reinstatement premiums paid. The Treaty endingJune 30, 2022 and 2021 each provides for one full reinstatement of coverage limits. Reinstatement premiums are based on the amount of reinsurance benefits used by the Company at 100% of the annual premium rate, with the exception of the reinstatement restrictions noted in the tables above, up to the maximum reinstatement premium of approximately$51 million and$46 million if the full amount of benefit is used for the 12 months endingJune 30, 2022 and 2021, respectively. The total amount of reinstatement premiums is recorded as ceded reinstatement premiums written at the time of the catastrophe event based on the total amount of reinsurance benefits expected to be used for the event, and such reinstatement premiums are recognized ratably over the remaining term of the Treaty as ceded reinstatement premiums earned. The catastrophe events that occurred in 2022 caused approximately$21 million in losses to the Company, resulting primarily from winter storms inTexas andCalifornia . No reinsurance benefits were available under the Treaty for these losses as none of the 2022 catastrophe events individually resulted in losses in excess of the Company's per-occurrence retention limit of$40 million under the Treaty for the 12 months endingJune 30, 2022 . The catastrophe events that occurred in 2021 caused approximately$112 million in losses to the Company as ofMarch 31, 2022 , resulting primarily from the deep freeze and other extreme weather events inTexas andOklahoma , rainstorms, wildfires and winter storms inCalifornia , and the impact of Hurricane Ida inNew Jersey andNew York . No reinsurance benefits were available under the Treaty for these losses as none of the 2021 catastrophe events individually resulted in losses in excess of the Company's per-occurrence retention limit of$40 million under the Treaty for each of the 12 months endingJune 30, 2022 and 2021. The Company carries a commercial umbrella reinsurance treaty and a per-risk property reinsurance treaty, and seeks facultative arrangements for large property risks. In addition, the Company has other reinsurance in force that is not material to the consolidated financial statements. If any reinsurers are unable to perform their obligations under a reinsurance treaty, the Company will be required, as primary insurer, to discharge all obligations to its policyholders in their entirety.
C. Invested Assets
Portfolio Composition
An important component of the Company's financial results is the return on its
investment portfolio. The Company's investment strategy emphasizes safety of
principal and consistent income generation, within a total return framework. The
investment strategy has historically focused on maximizing after-tax yield with
a primary emphasis on maintaining a well-diversified, investment grade, fixed
income portfolio to support the underlying liabilities and achieve return on
capital and profitable growth. The Company believes that investment yield is
maximized by selecting assets that perform favorably on a long-term basis and by
disposing of certain assets to enhance after-tax yield and minimize the
potential effect of downgrades and defaults. The Company believes that this
strategy enables the optimal investment performance necessary to sustain
investment income over time. The Company's portfolio management approach
utilizes a market risk and consistent asset allocation strategy as the primary
basis for the allocation of interest sensitive, liquid and credit assets as well
as for determining overall below investment grade exposure and diversification
requirements. Within the ranges set by the asset allocation strategy, tactical
investment decisions are made in consideration of prevailing market conditions.
31--------------------------------------------------------------------------------
Table of Contents
The following table presents the composition of the total investment portfolio
of the Company at
Cost (1) Fair Value
(Amounts in thousands)
Fixed maturity securities:
U.S. government bonds $ 13,625 $ 13,477
Municipal securities 2,775,838 2,780,244
Mortgage-backed securities 156,697 151,840
Corporate securities 542,038 511,952
Collateralized loan obligations 315,041 314,193
Other asset-backed securities 192,625 187,973
3,995,864 3,959,679
Equity securities:
Common stock 573,516 779,229
Non-redeemable preferred stock 64,429 62,247
Private equity funds measured at net asset value (2) 131,989
104,539
769,934 946,015
Short-term investments 134,997 133,920
Total investments $ 4,900,795 $ 5,039,614
______________
(1) Fixed maturities and short-term bonds at amortized cost; equities and other
short-term investments at cost.
(2) The fair value is measured using the NAV practical expedient. See Note 5.
Fair Value Measurements of the Notes to Consolidated Financial Statements for
additional information.
At March 31, 2022 , 44.9% of the Company's total investment portfolio at fair
value and 57.1% of its total fixed maturity securities at fair value were
invested in tax-exempt state and municipal bonds. Equity holdings consist of
non-redeemable preferred stocks, dividend-bearing common stocks on which
dividend income is partially tax-sheltered by the 50% corporate dividend
received deduction, and private equity funds. At March 31, 2022 , 84.8% of
short-term investments consisted of highly rated short-duration securities
redeemable on a daily or weekly basis.
Fixed maturity securities include debt securities, which are mostly long-term
bonds and other debt with maturities of at least one year from purchase, and
which may have fixed or variable principal payment schedules, may be held for
indefinite periods of time, and may be used as a part of the Company's
asset/liability strategy or sold in response to changes in interest rates,
anticipated prepayments, risk/reward characteristics, liquidity needs, tax
planning considerations, or other economic factors. Short-term instruments
include money market accounts, options, and short-term bonds that are highly
rated short duration securities and redeemable within one year.
A primary exposure for the fixed maturity securities is interest rate risk. The
longer the duration, the more sensitive the asset is to market interest rate
fluctuations. As assets with longer maturity dates tend to produce higher
current yields, the Company's historical investment philosophy has resulted in a
portfolio with a moderate duration. The Company's portfolio is heavily weighted
in investment grade tax-exempt municipal bonds. Fixed maturity securities
purchased by the Company typically have call options attached, which further
reduce the duration of the asset as interest rates decline. The holdings that
are heavily weighted with high coupon issues, are expected to be called prior to
maturity. Modified duration measures the length of time it takes, on average, to
receive the present value of all the cash flows produced by a bond, including
reinvestment of interest. As it measures four factors (maturity, coupon rate,
yield and call terms) which determine sensitivity to changes in interest rates,
modified duration is considered a better indicator of price volatility than
simple maturity alone.
32
--------------------------------------------------------------------------------
Table of Contents
The following table presents the maturities and durations of the Company's fixed
maturity securities and short-term investments:
March 31, 2022 December 31, 2021
(in years)
Fixed Maturity Securities
Nominal average maturity:
excluding short-term investments 10.9 10.8
including short-term investments 10.6 10.4
Call-adjusted average maturity:
excluding short-term investments 4.9 4.6
including short-term investments 4.7 4.5
Modified duration reflecting anticipated early calls: excluding short-term investments
3.5 3.5
including short-term investments 3.4 3.4
Short-Term Investments - -
Another exposure related to the fixed maturity securities is credit risk, which
is managed by maintaining a weighted-average portfolio credit quality rating of
A+, at fair value, at March 31, 2022 , consistent with the average rating at
December 31, 2021 . The Company's municipal bond holdings, of which 81.3% were
tax exempt, represented 57.1% of its fixed maturity securities portfolio at
March 31, 2022 , at fair value, and are broadly diversified geographically. See
Part I-Item 3. Quantitative and Qualitative Disclosures About Market Risks for a
breakdown of municipal bond holdings by state.
To calculate the weighted-average credit quality ratings disclosed throughout
this Quarterly Report on Form 10-Q, individual securities were weighted based on
fair value and credit quality ratings assigned by nationally recognized
securities rating organizations.
Taxable holdings consist principally of investment grade issues. At March 31,
2022 , fixed maturity securities holdings rated below investment grade and
non-rated bonds totaled $7.0 million and $16.6 million , respectively, at fair
value, and represented 0.2% and 0.4%, respectively, of total fixed maturity
securities. The majority of non-rated issues are a result of municipalities
pre-funding and collateralizing those issues with U.S. government securities
with an implicit AAA equivalent credit risk. At December 31, 2021 , fixed
maturity securities holdings rated below investment grade and non-rated bonds
totaled $7.1 million and $17.3 million , respectively, at fair value, and
represented 0.2% and 0.4%, respectively, of total fixed maturity securities.
The overall credit ratings for the Company's fixed maturity securities portfolio
were relatively stable during the three months ended March 31, 2022 , with 97.5%
of fixed maturity securities at fair value experiencing no change in their
overall rating. 2.2% and 0.3% of fixed maturity securities at fair value
experienced upgrades and downgrades, respectively, during the three months ended
March 31, 2022 .
33--------------------------------------------------------------------------------
Table of Contents
The following table presents the credit quality ratings of the Company's fixed maturity securities by security type at fair value:
March 31, 2022
(Dollars in thousands)
Total Fair
Security Type AAA(1) AA(1) A(1) BBB(1) Non-Rated/Other(1) Value(1)
U.S. government bonds:
Treasuries $ 13,477 $ - $ - $ - $ - $ 13,477
Total 13,477 - - - - 13,477
100.0 % - % - % - % - % 100.0 %
Municipal securities:
Insured 64,040 267,363 94,274 39,909 2,463 468,049
Uninsured 101,833 806,523 1,205,580 180,464 17,795 2,312,195
Total 165,873 1,073,886 1,299,854 220,373 20,258 2,780,244
6.0 % 38.6 % 46.8 % 7.9 % 0.7 % 100.0 %
Mortgage-backed securities:
Commercial 13,507 10,071 - - - 23,578
Agencies 677 - - - - 677
Non-agencies:
Prime 16,940 102,794 5,848 - 500 126,082
Alt-A - 493 - 162 848 1,503
Total 31,124 113,358 5,848 162 1,348 151,840
20.4 % 74.7 % 3.9 % 0.1 % 0.9 % 100.0 %
Corporate securities:
Communications - 175 - 6,044 - 6,219
Consumer, cyclical - 1,883 - 68,230 - 70,113
Consumer, non-cyclical - 9,975 16,408 19,138 - 45,521
Energy - 6,009 3,716 41,686 - 51,411
Financial - 23,345 67,801 79,816 3,526 174,488
Industrial - - 52,394 76,751 - 129,145
Technology - - - 734 - 734
Utilities - - 19,075 15,246 - 34,321
Total - 41,387 159,394 307,645 3,526 511,952
- % 8.1 % 31.1 % 60.1 % 0.7 % 100.0 %
Collateralized loan obligations:
Corporate 30,251 89,801 194,141 - - 314,193
Total 30,251 89,801 194,141 - - 314,193
9.6 % 28.6 % 61.8 % - % - % 100.0 %
Other asset-backed securities 19,579 77,002 60,719 30,673 - 187,973
10.4 % 41.0 % 32.3 % 16.3 % - % 100.0 %
Total $ 260,304 $
1,395,434
$ 3,959,679 6.6 % 35.2 % 43.5 % 14.1 % 0.6 % 100.0 % _____________
(1)Intermediate ratings are included at each level (e.g., AA includes AA+, AA and AA-).
U.S. Government Bonds The Company had$13.5 million and$13.1 million , each representing 0.3% of its fixed maturity securities portfolio, at fair value, inU.S. government bonds atMarch 31, 2022 andDecember 31, 2021 , respectively. AtMarch 31, 2022 , Moody's and Fitch ratings forU.S. government-issued debt were Aaa andAAA , respectively, although a significant increase in government 34 -------------------------------------------------------------------------------- Table of Contents deficits and debt could lead to a downgrade. The Company understands that market participants continue to use rates of return onU.S. government debt as a risk-free rate and have continued to invest inU.S. Treasury securities. The modified duration of theU.S. government bonds portfolio reflecting anticipated early calls was 1.4 years and 0.9 years atMarch 31, 2022 andDecember 31, 2021 , respectively.Municipal Securities The Company had$2.78 billion and$2.84 billion , or 70.2% and 70.5% of its fixed maturity securities portfolio, at fair value, in municipal securities,$468.0 million and$424.1 million of which were insured, atMarch 31, 2022 andDecember 31, 2021 , respectively. The underlying ratings for insured municipal bonds have been factored into the average rating of the securities by the rating agencies with no significant disparity between the absolute securities ratings and the underlying credit ratings as ofMarch 31, 2022 andDecember 31, 2021 . AtMarch 31, 2022 andDecember 31, 2021 , 56.6% and 56.8%, respectively, of the insured municipal securities, at fair value, most of which were investment grade, were insured by bond insurers that provide credit enhancement and ratings reflecting the credit of the underlying issuers. AtMarch 31, 2022 andDecember 31, 2021 , the average rating of the Company's insured municipal securities was A+, which corresponded to the average rating of the investment grade bond insurers. The remaining 43.4% and 43.2% of insured municipal securities atMarch 31, 2022 andDecember 31, 2021 , respectively, were non-rated or below investment grade, and were insured by bond insurers that the Company believes did not provide credit enhancement. The modified duration of the municipal securities portfolio reflecting anticipated early calls was 3.2 years and 3.1 years atMarch 31, 2022 andDecember 31, 2021 , respectively. The Company considers the strength of the underlying credit as a buffer against potential market value declines which may result from future rating downgrades of the bond insurers. In addition, the Company has a long-term time horizon for its municipal bond holdings, which generally allows it to recover the full principal amounts upon maturity and avoid forced sales prior to maturity of bonds that have declined in market value due to the bond insurers' rating downgrades. Based on the uncertainty surrounding the financial condition of these insurers, it is possible that there will be future downgrades to below investment grade ratings by the rating agencies in the future, and such downgrades could impact the estimated fair value of municipal bonds.
AtMarch 31, 2022 andDecember 31, 2021 , substantially all of the mortgage-backed securities portfolio of$151.8 million and$137.0 million , or 3.8% and 3.4%, respectively, of the Company's fixed maturity securities portfolio, at fair value, was categorized as loans to "prime" residential and commercial real estate borrowers. The Company had holdings of$23.6 million and$25.2 million at fair value ($23.8 million and$25.1 million at amortized cost) in commercial mortgage-backed securities atMarch 31, 2022 andDecember 31, 2021 , respectively. The weighted-average rating of the entire mortgage-backed securities portfolio was AA at each ofMarch 31, 2022 andDecember 31, 2021 . The modified duration of the mortgage-backed securities portfolio reflecting anticipated early calls was 7.8 years and 7.9 years atMarch 31, 2022 andDecember 31, 2021 , respectively.
Corporate securities included in fixed maturity securities were as follows:
March
31, 2022
(Dollars in thousands)
Corporate securities at fair value $ 511,952 $ 523,853
Percentage of total fixed maturity securities portfolio 12.9 % 13.0 %
Modified duration 3.7 years 3.8 years
Weighted-average rating BBB+ BBB+
35
--------------------------------------------------------------------------------
Table of Contents
Collateralized Loan Obligations
Collateralized loan obligations included in fixed maturity securities were as
follows:
March 31, 2022 December 31, 2021
(Dollars in thousands)
Collateralized loan obligations at fair value $ 314,193 $ 314,153
Percentage of total fixed maturity securities portfolio 7.9 % 7.8 %
Modified duration 5.9 years 6.3 years
Weighted-average rating A+ AA-
Other Asset-Backed Securities
Other asset-backed securities included in fixed maturity securities were as
follows:
March 31, 2022 December 31, 2021
(Dollars in thousands)
Other asset-backed securities at fair value $ 187,973 $ 200,209
Percentage of total fixed maturity securities portfolio 4.7 % 5.0 %
Modified duration 3.5 years 2.6 years
Weighted-average rating AA- AA-
Equity Securities
Equity holdings of $946.0 million and $970.9 million at fair value, as of
March 31, 2022 and December 31, 2021 , respectively, consisted of non-redeemable
preferred stocks, common stocks on which dividend income is partially
tax-sheltered by the 50% corporate dividend received deduction, and private
equity funds. The Company had a net (loss) gain of $(40.3) million and $34.5
million due to changes in fair value of the Company's equity securities
portfolio for the three months ended March 31, 2022 and 2021, respectively. The
primary cause for the decrease in fair value of the Company's equity securities
portfolio for the three months ended March 31, 2022 was the overall decline in
equity markets. The primary cause for the increase in fair value of the
Company's equity securities portfolio for the three months ended March 31, 2021
was the overall improvement in equity markets.
The Company's common stock allocation is intended to enhance the return of and
provide diversification for the total portfolio. At March 31, 2022 , 18.8% of the
total investment portfolio at fair value was held in equity securities, compared
to 18.9% at December 31, 2021 .
D. Debt
OnMarch 8, 2017 , the Company completed a public debt offering issuing$375 million of senior notes. The notes are unsecured senior obligations of the Company with a 4.4% annual coupon payable onMarch 15 andSeptember 15 of each year commencingSeptember 15, 2017 . The notes mature onMarch 15, 2027 . The Company used the proceeds from the notes to pay off amounts outstanding under the existing loan and credit facilities and for general corporate purposes. The Company incurred debt issuance costs of approximately$3.4 million , inclusive of underwriters' fees. The notes were issued at a slight discount of 99.847% of par, resulting in the effective annualized interest rate including debt issuance costs of approximately 4.45%. OnMarch 29, 2017 , the Company entered into the 2017 Credit Agreement that provided for revolving loans of up to$50 million and was set to mature onMarch 29, 2022 . OnMarch 31, 2021 , the Company entered into the Amended and Restated Credit Agreement that amended and restated the 2017 Credit Agreement. The Amended and Restated Credit Agreement, among other things, extended the maturity date of the loan that was the subject of the 2017 Credit Agreement toMarch 31, 2026 , addedU.S. Bank as an additional lender, and increased the aggregate commitments by all the lenders to$75 million from$50 million under the 2017 Credit Agreement. The interest rates on borrowings under the credit facility are based on the Company's debt to total capital ratio and range from LIBOR plus 112.5 basis points when the ratio is under 20% to LIBOR plus 150.0 basis points when the ratio is greater than or equal to 30%. Commitment fees for the undrawn portions of the credit facility range from 12.5 basis points when the ratio is under 20% to 22.5 basis points when the ratio is greater than or equal to 30%. The debt to total capital ratio is expressed as a percentage of (a) consolidated debt to (b) consolidated shareholders' equity plus consolidated 36 -------------------------------------------------------------------------------- Table of Contents debt. The Company's debt to total capital ratio was 16.4% atMarch 31, 2022 , resulting in a 12.5 basis point commitment fee on the$75 million undrawn portion of the credit facility. As ofApril 28, 2022 , there have been no borrowings under this facility. The Company was in compliance with all of the financial covenants pertaining to minimum statutory surplus, debt to total capital ratio, and risk based capital ratio under the unsecured credit facility atMarch 31, 2022 .
For additional information on debt, see Note 11. Notes Payable of the Notes to Consolidated Financial Statements.
E. Regulatory Capital Requirements
Among other considerations, industry and regulatory guidelines suggest that the ratio of a property and casualty insurer's annual net premiums written to statutory policyholders' surplus should not exceed 3.0 to 1. Based on the combined surplus of all the Insurance Companies of$1.75 billion atMarch 31, 2022 , and net premiums written of$3.9 billion for the twelve months ended on that date, the ratio of net premiums written to surplus was 2.23 to 1 atMarch 31, 2022 .
© Edgar Online, source
