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 ability of the Company 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 16, 2021 . 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
InMarch 2020 , the outbreak of COVID-19 was recognized as a pandemic by theWorld Health Organization (the "WHO"). 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 or orders issued by theCenters for Disease Control , theWHO and state and local governments. The Company has taken a number of precautionary steps to safeguard its business and employees from COVID-19, including activating its Business Continuity Plan. Most of the Company's employees have been working remotely, with only certain operationally critical employees working on site at various locations. The Company is monitoring and assessing the impact of the COVID-19 pandemic daily, including recommendations and orders issued by federal, state and local governments. The Company has recently extended its "work-from-home" policy for most of its employees toSeptember 2021 , and may further extend the policy, if necessary, based on the latest information on the pandemic's developments.
The Company's automobile line of business began experiencing a significant decrease in loss frequency in mid to late
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March of 2020, and it remained lower than the historical levels through the
first quarter of 2021, although it began to increase in June 2020 as more
drivers returned to the road following the gradual reopening of businesses in
California and other states. The reduction in automobile loss frequency was
primarily due to reduced driving during the pandemic. Due to the uncertainty
regarding COVID-19, it is unclear how long automobile loss frequency will remain
at these lower levels. Conversely, the severity of accidents, for both bodily
injury and the cost to repair vehicles, has increased primarily due to a higher
percentage of high-speed serious accidents on less congested roads and freeways.
The cost to repair vehicles may remain high due to supply chain and labor force
issues. 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. In addition, the Company's net premiums earned was negatively impacted
as a result of premium refunds and credits voluntarily issued to policyholders
by the Company or in compliance with the requests and directives from the
insurance regulators as well as premium reductions through reclassification of
loss exposures such as mileage reductions (see C. Regulatory and Legal Matters
below for additional details). COVID-19 is also impacting the ability of some of
the Company's policyholders to pay their insurance premiums, and the Company has
granted limited grace periods to those needing financial assistance.
Many businesses have been required by state and local governments to cease or
substantially reduce operations, and have suffered severe financial losses as a
result. Many of these businesses have submitted claims to their insurers under
the business interruption coverage of their commercial property policies,
resulting in coverage disputes in many states. While the Company does insure a
modest number of businesses with this business interruption coverage, these
pandemic-related losses are not covered under the Company's policy terms and
conditions. The Company's business interruption, or "business income" coverage,
requires a "direct physical loss" to the property that results in suspension of
operations, such as a fire or water loss. The coverage is not triggered under
the present circumstances. Most of the Company's policies also contain an
exclusion for losses caused directly or indirectly by "virus or bacteria." This
exclusion was adopted by many insurers after the SARS outbreak of 2003-2004,
upon recognition that such a pandemic could result in losses far exceeding the
capacity of individual insurers and the private insurance market as a whole. The
Company does not believe it has any material exposure to business interruption
claims.
Due to disruptions in the equity and fixed maturity securities markets following
the outbreak of the COVID-19 pandemic, the Company's investment portfolio
substantially declined in value during the quarter ended March 31, 2020 ;
however, its investment portfolio has recovered in value during the subsequent
quarters of 2020 and in 2021. In March 2020 , the Federal Open Market Committee
("FOMC") 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 . 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 revolving credit facility.
On March 27, 2020 , the President of the United States signed the Coronavirus
Aid, Relief, and Economic Security ("CARES") Act, a substantial tax-and-spending
package intended to provide economic stimulus to address the financial impact of
the COVID-19 pandemic. The CARES Act includes, among other items, cash payments
to individuals as well as emergency grants and forgivable loans to small
businesses, if they meet certain criteria. On March 11, 2021 , the President of
the United States signed the American Rescue Plan Act of 2021, a $1.9 trillion
COVID-19 relief bill, to provide additional relief to address the continued
impact of COVID-19 on the economy, public health, state and local governments,
individuals, and businesses. To the extent the Company's existing or potential
policyholders and business partners are aided by such relief programs, the
negative impact of the pandemic on its results of operations may be mitigated.
The Company will continue to monitor the impact of the COVID-19 pandemic, and
the effects of the CARES Act, the American Rescue Plan Act of 2021 and any
additional legislative relief. The extent of the impact of the pandemic on the
Company's business and financial results will depend largely on future
developments, including the duration of the pandemic, its impact on capital and
financial markets and the related impact on consumer confidence and spending,
the success of a broad vaccine rollout in the U. S. and around the world, and
the impact of actions taken in response, all of which are highly uncertain and
cannot be predicted. As the impact of the COVID-19 pandemic continues to evolve,
additional impacts may arise.
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B. Business
The Company is primarily engaged in writing personal automobile insurance
through 14 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 March 31, 2021 and 2020:
Three Months Ended
(Dollars in thousands)
Private Commercial
Passenger Automobile Homeowners Automobile Other Lines 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 %
Three Months Ended
(Dollars in thousands)
Private Commercial
Passenger Automobile Homeowners Automobile Other Lines Total
California $ 626,999 $ 127,887 $ 40,863 $ 34,329 $ 830,078 86.7 %
Other states (1) 83,387 19,629 20,843 4,007 127,866 13.3 %
Total $ 710,386 $ 147,516 $ 61,706 $ 38,336 $ 957,944 100.0 %
74.2 % 15.4 % 6.4 % 4.0 % 100.0 %
______________(1) No individual state 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 Period Covered Status
Desk audit was completed in the first quarter
CA Premium Tax 2015 to 2018 of 2021 with no additional taxes due.
Premium and Maintenance Desk audit was completed in the fourth quarter
TX Tax 2016 to 2019 of 2020 with no additional taxes due.
Final report of examination was adopted by the
CA Market Conduct 2014 DOI on November 6, 2019.
During the course of and at the conclusion of the examinations, the examining
DOI generally reports findings to the Company. On October 30, 2020 , the Company
received notice from the California DOI that the market conduct examination
report mentioned above was being reviewed for potential further action in
connection with some of the findings in the report. Subsequently, the California
DOI gave the Company notice of its intent to proceed with an enforcement action
for the alleged violations in the report. The Company will have the opportunity
to resolve the alleged violations before a Notice of Noncompliance is formally
filed with the California DOI.
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OnApril 13, 2020 , the California Insurance Commissioner issued Bulletin 2020-3 ordering insurers to make an initial premium adjustment within 120 days from the date of the Bulletin 2020-3 to adversely impactedCalifornia policyholders for the months of March andApril 2020 . The Commissioner granted insurers flexibility in determining how to quickly and fairly process the premium refunds. OnMay 15, 2020 , the California Insurance Commissioner issued Bulletin 2020-4 extending the directives in Bulletin 2020-3 throughMay 31, 2020 . Bulletin 2020-8, originally issued onJune 25, 2020 and amended onDecember 3, 2020 , extended the previous directives of Bulletin 2020-3 and Bulletin 2020-4 throughJune 30, 2020 , as well as any months subsequent toJune 2020 because the COVID-19 pandemic continued to result in projected loss exposures remaining overstated or misclassified. OnMarch 11, 2021 , theCalifornia Insurance Commissioner issued Bulletin 2021-03 directingCalifornia insurance companies to do more to return additional premium relief commensurate with continuing reductions in the exposure to loss for particular lines of insurance and to communicate with their policyholders about how they will return premiums as well as options available to reduce their ongoing premiums. The Company believes that the amounts returned to-date, including the mileage reductions on individual policies, have provided appropriate and material relief to its policyholders. The total amount of premiums returned to the Company's policyholders through refunds or credits is approximately$128 million , which reduced its net premiums earned for 2020. The Company has also worked with its agents and policyholders to reclassify exposures on an individual policy basis, including reducing mileage on approximately 250,000 vehicles since the pandemic began. The mileage reductions have significantly reduced premiums on those individual policies in a manner consistent with the Company's filed and approved rates. Additionally, the Company withdrew its private passenger automobile rate filings requesting rate increases that were pending before the pandemic.
In
InJuly 2019 , the governor ofCalifornia signed a bill that created a$21 billion fund (the "California Wildfire Fund ") to help then bankrupt Pacific Gas and Electric Company ("PG&E") and the state's other investor-owned utility companies cover liabilities arising from future wildfires caused by their equipment. The bill requires investor-owned utility companies to fund half of theCalifornia Wildfire Fund . The other half is to be funded by surcharges paid by ratepayers across the state. OnJuly 1, 2020 , PG&E made an announcement that it emerged out of bankruptcy and made an initial deposit of approximately$5 billion to theCalifornia Wildfire Fund . It is expected that the Company and other insurers will be reimbursed for some portion of the claims paid for its policyholders if it is determined that a wildfire is caused by equipment failure. The announcement also confirmed that PG&E funded theSubrogation Trust Fund with$11 billion , which was set up to reimburse insurance companies and other entities that paid claims by individuals and businesses related to wildfires that occurred in the recent past years prior toJuly 1, 2020 . The Company received approximately$23 million , net of fees, in 2020 from theSubrogation Trust Fund . However, the subrogation recovery recognized was for losses and loss adjustment expenses previously ceded to the Company's reinsurers, and therefore the recovery did not reduce losses and loss adjustment expenses net of reinsurance. The benefit to the Company, net of reinsurance and before taxes, was approximately$3 million , representing a reduction to reinstatement premiums previously recognized. 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, 2020 . 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. 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 legal matters, see the Company's Annual Report on Form 10-K for the year endedDecember 31, 2020 , and Note 12. Contingencies of the Notes to Consolidated Financial Statements of this Quarterly Report. 27
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D. Critical Accounting Policies and 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 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
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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.
At March 31, 2021 and December 31, 2020 , the Company recorded its point estimate
of approximately $2.04 billion and $1.99 billion ($1.99 billion and $1.94
billion , net of reinsurance), respectively, in loss reserves, which included
approximately $919.3 million and $885.5 million ($898.0 million and $864.5
million , 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 to March 31, 2021 and December 31, 2020 , 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 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 December 31, 2020 .
Fair Value of Financial Instruments
Financial instruments recorded in the consolidated balance sheets include investments, note receivable, other receivables, accounts payable, options sold, and unsecured notes payable. The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Due to their short-term maturity, the carrying values of other receivables and accounts payable approximate their fair values. All investments are carried on the consolidated balance sheets at fair value, as described in Note 3. Financial Instruments of the Notes to Consolidated Financial Statements. The Company's financial instruments include securities issued by theU.S. government and its agencies, securities issued by states and municipal governments and agencies, certain corporate and other debt securities, equity securities, and exchange traded funds. AtMarch 31, 2021 , 98.4% of the fair value of these financial instruments is based on observable market prices, observable market parameters, or is derived from such prices or parameters. The availability of observable market prices and pricing parameters can vary by financial instrument. Observable market prices and pricing parameters of a financial instrument, or a related financial instrument, are used to derive a price without requiring significant judgment. The Company's fixed maturity and equity securities are classified as "trading" and carried at fair value as required when applying the fair value option, with changes in fair value reflected in net realized investment gains or losses in the consolidated statements of operations. The majority of equity holdings, including non-redeemable preferred stocks, are actively traded on national exchanges or trading markets, and are valued at the last transaction price on the balance sheet date. The Company may hold or acquire financial instruments that lack observable market prices or market parameters because they are less actively traded currently or in future periods. The fair value of such instruments is determined using techniques appropriate for each particular financial instrument. These techniques may involve some degree of judgment. The price transparency of the particular financial instrument will determine the degree of judgment involved in determining the fair value of the Company's financial instruments. Price transparency is affected by a wide variety of factors, including the type of financial instrument, whether it is a new financial instrument and not yet established in the marketplace, and the characteristics particular to the transaction. Financial instruments for which actively quoted prices or pricing parameters are available or for which fair value is derived from actively quoted prices or pricing parameters will generally have a higher degree of price transparency. By contrast, financial instruments that are thinly traded or not quoted will generally have diminished price transparency. Even in normally active markets, the price transparency for actively quoted instruments may be reduced during periods of market dislocation. Alternatively, in thinly quoted markets, the participation of market makers willing to purchase and sell a financial instrument provides a source of transparency for products that otherwise are not actively quoted.
Income Taxes
AtMarch 31, 2021 , the Company's deferred income taxes were in a net liability position mainly due to deferred tax liabilities generated by unrealized gains on securities held. These deferred tax liabilities were substantially offset by deferred tax assets resulting from unearned premiums, loss reserve discounting, and expense accruals. The Company assesses the 29 -------------------------------------------------------------------------------- Table of Contents likelihood that its deferred tax assets will be realized and, to the extent management does not believe these assets are more likely than not to be realized, a valuation allowance is established. Management's recoverability assessment of the Company's deferred tax assets which are ordinary in character takes into consideration the Company's strong history of generating ordinary taxable income and a reasonable expectation that it will continue to generate ordinary taxable income in the future. Further, the Company has the capacity to recoup its ordinary deferred tax assets through tax loss carryback claims for taxes paid in prior years. Finally, the Company has various deferred tax liabilities that represent sources of future ordinary taxable income. Management's recoverability assessment with regard to its capital deferred tax assets is based on estimates of anticipated capital gains, tax-planning strategies available to generate future taxable capital gains, and the Company's capacity to absorb capital losses carried back to prior years, each of which would contribute to the realization of deferred tax benefits. The Company has significant unrealized gains in its investment portfolio that could be realized through asset dispositions, at management's discretion. In addition, the Company expects to hold certain debt securities, which are currently in loss positions, to recovery or maturity. Management believes unrealized losses related to these debt securities, which represent a portion of the unrealized loss positions at period-end, are fully realizable at maturity. Management believes its long-term time horizon for holding these securities allows it to avoid any forced sales prior to maturity. Further, the Company has the capability to generate additional realized capital gains by entering into sale-leaseback transactions using one or more of its appreciated real estate holdings. Finally, the Company has the capacity to recoup capital deferred tax assets through tax capital loss carryback claims for taxes paid within permitted carryback periods. The Company has the capability to implement tax planning strategies as it has a steady history of generating positive cash flows from operations and believes that its liquidity needs can be met in future periods without the forced sale of its investments. This capability assists management in controlling the timing and amount of realized losses generated during future periods. By prudent utilization of some or all of these strategies, management has the intent and believes that it has the ability to generate capital gains and minimize tax losses in a manner sufficient to avoid losing the benefits of its deferred tax assets. Management will continue to assess the need for a valuation allowance on a quarterly basis. Although realization is not assured, management believes it is more likely than not that the Company's deferred tax assets will be realized. The Company's effective income tax rate can be affected by several factors. These generally include large changes in 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$19 million coupled with pre-tax income of approximately$132 million resulted in an effective tax rate of 19.2%, below the statutory tax rate of 21%, for the three months endedMarch 31, 2021 , and tax-exempt investment income of approximately$19 million coupled with pre-tax loss of approximately$181 million resulted in an effective tax rate of 23.0%, above the statutory rate of 21%, for the corresponding period in 2020.
Contingent Liabilities
The Company has known, and may have unknown, potential liabilities which include
claims, assessments, lawsuits, or regulatory fines and penalties relating to the
Company's business. The Company continually evaluates these potential
liabilities and accrues for them and/or discloses them in the notes to the
consolidated financial statements where required. 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. See "Regulatory and
Legal Matters" above and Note 12. Contingencies of the Notes to Consolidated
Financial Statements.
RESULTS OF OPERATIONS
Three Months Ended
Revenues
Net premiums earned and net premiums written for the three months endedMarch 31, 2021 decreased 0.7% and 0.4%, respectively, from the corresponding period in 2020. The decrease in net premiums earned and net premiums written was primarily due to a decrease in the number of private passenger automobile policies written, combined with lower average premiums per policy in the private passenger automobile line of insurance business arising from a decrease in average mileage driven associated with reduced driving during the COVID-19 pandemic, partially offset by higher average premiums per policy arising from rate increases in theCalifornia homeowners line of insurance business and growth in the number of homeowners policies written. 30 -------------------------------------------------------------------------------- Table of Contents Net premiums earned included ceded premiums earned of$15.5 million and$13.7 million for the three months endedMarch 31, 2021 and 2020, respectively. Net premiums written included ceded premiums written of$15.6 million and$11.4 million for the three months endedMarch 31, 2021 and 2020, respectively. The increase in ceded premiums earned and ceded premiums written for the three months endedMarch 31, 2021 compared to the corresponding period in 2020 resulted mostly from higher reinsurance coverage and rates and growth in the covered book of business. Net premiums earned, a GAAP measure, represents the portion of net premiums written that is recognized as revenue in the financial statements for the periods presented and earned on a pro-rata basis over the term of the policies. Net premiums written is a non-GAAP financial measure which represents the premiums charged on policies issued during a fiscal period, net of any applicable reinsurance. Net premiums written is a statutory measure designed to determine production levels. The following is a reconciliation of net premiums earned to net premiums written: Three Months Ended March 31, 2021 2020 (Amounts in thousands) Net premiums earned$ 915,922 $ 922,574
Change in net unearned premiums 34,461 31,642
Net premiums written $ 950,383 $
954,216
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,
2021 2020
Loss ratio 68.4 % 70.6 %
Expense ratio 25.1 % 25.3 %
Combined ratio 93.5 % 95.9 %
Loss ratio is calculated by dividing losses and loss adjustment expenses by net
premiums earned. The loss ratio for the first quarter of 2021 and 2020 was
affected by favorable development of approximately $1 million and unfavorable
development of approximately $15 million , respectively, on prior accident years'
loss and loss adjustment expense reserves. 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. The unfavorable
development for the first quarter of 2020 was primarily attributable to higher
than estimated losses and loss adjustment expenses in the homeowners and
commercial automobile lines of insurance business.
In addition, 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 . The 2020 loss ratio was
negatively impacted by approximately $4 million of catastrophe losses, excluding
favorable development of approximately $2 million on prior years' catastrophe
losses, primarily due to windstorms in California and Oklahoma .
Excluding the effect of estimated prior periods' loss development and
catastrophe losses, the loss ratio was 64.3% and 68.6% for the first quarter of
2021 and 2020, respectively. The decrease in the loss ratio was primarily due to
a decrease in loss frequency in the private passenger automobile line of
insurance business resulting from reduced driving during the COVID-19 pandemic
that started in March 2020 , partially offset by an increase in loss severity in
the private passenger automobile line of insurance business and lower average
premiums per policy in the private passenger automobile line of insurance
business arising from a decrease in average mileage driven during the pandemic.
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, 2021 decreased slightly compared to the corresponding
period in 2020. A decrease in expenses for advertising and allowance for credit
losses on premiums receivable was partially offset by
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Table of Contents an increase in expenses for agents' contingent commissions and employees' bonuses.
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 expense (benefit) was$25.4 million and$(41.5) million for the three months endedMarch 31, 2021 and 2020, respectively. The increase in income tax expense was primarily due to a$313 million increase in total pre-tax income. Tax-exempt investment income, a component of total pre-tax income (loss), remained relatively steady with the corresponding period in 2020.
Investments
The following table presents the investment results of the Company:
Three Months Ended March 31,
2021 2020
(Dollars in thousands)
Average invested assets at cost (1)
Net investment income (2)
Before income taxes $ 32,279 $ 34,495
After income taxes $ 28,784 $ 30,533
Average annual yield on investments (2)
Before income taxes 2.9 % 3.3 %
After income taxes 2.5 % 2.9 %
Net realized investment gains (losses)
__________
(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) Lower net investment income before and after income taxes for the three months endedMarch 31, 2021 compared to the corresponding period in 2020 resulted largely from a lower average yield on investments, partially offset by higher average invested assets. Average annual yield on investments before and after income taxes for the three months endedMarch 31, 2021 decreased compared to the corresponding period in 2020, primarily due to the maturity and replacement of higher yielding investments purchased when market interest rates were higher with lower yielding investments, as a result of decreasing market interest rates.
The following tables present the components of net realized investment gains (losses) included in net income (loss):
Three
Months Ended
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
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Three Months Ended
Gains (Losses) Recognized in Net Loss
Changes in fair
Sales value Total
(Amounts in thousands)
Net realized investment gains (losses)
Fixed maturity securities (1)(2) $ (627) $ (50,013) $ (50,640)
Equity securities (1)(3) (11,316) (186,373) (197,689)
Short-term investments (1) (99) (4,637) (4,736)
Note receivable (1) - 33 33
Options sold 1,986 (274) 1,712
Total $ (10,056) $ (241,264) $ (251,320)
__________
(1)The changes in fair value of the investment portfolio and note receivable
resulted from application of the fair value option.
(2)The decrease in fair value of fixed maturity securities for the first quarter
of 2021 primarily resulted from increases in market interest rates. The decrease
in fair value of fixed maturity securities for the first quarter of 2020
primarily resulted from the overall market disruptions and dislocations
following the COVID-19 outbreak.
(3)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. The primary
cause for the decrease in fair value of equity securities for the first quarter
of 2020 was the overall market disruptions and dislocations following the
COVID-19 outbreak.
Net Income (Loss)
Three Months Ended March 31,
2021 2020
(Amounts in thousands, except per share
data)
Net income (loss) $ 106,995 $ (139,204)
Basic average shares outstanding 55,361 55,358
Diluted average shares outstanding 55,372 55,358
Basic Per Share Data:
Net income (loss) $ 1.93 $ (2.51)
Net realized investment gains (losses), net of tax $ 0.59 $ (3.58)
Diluted Per Share Data:
Net income (loss) $ 1.93 $ (2.51)
Net realized investment gains (losses), net of tax $ 0.59 $ (3.58)
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 $886.5 million at March 31, 2021 as well as $75 million of credit
available on a $75 million revolving 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.
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Net cash provided by operating activities for the three months endedMarch 31, 2021 was$174.5 million , an increase of$77.4 million compared to the corresponding period in 2020. The increase was primarily due to a decrease in payments for losses and loss adjustment expenses, partially offset by a decrease in collections from reinsurers on reinsurance recoverables and a decrease in premium collections. The Company utilized the cash provided by operating activities during the three months endedMarch 31, 2021 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
Fixed Maturity Securities
(Amounts in thousands)
Due in one year or less $ 347,861
Due after one year through two years 367,216
Due after two years through three years 149,428
Due after three years through four years 69,565
Due after four years through five years 82,855
Total due within five years $ 1,016,925
B. Reinsurance
For California homeowners policies, the Company has reduced its catastrophe
exposure from earthquakes by placing earthquake risks directly with the
California Earthquake Authority ("CEA"). However, the Company continues to have
catastrophe exposure to fires following an earthquake.
The Company is the assuming reinsurer under a Catastrophe Participation
Reinsurance Contract (the "Contract") effective through December 31, 2021 . 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 71%. The total assumed premium under the Contract is
$7.5 million and $12.5 million for the years ending December 31, 2020 and 2021,
respectively. The total possible amount of losses for the Company under the
Contract is $18.8 million and $31.3 million for the years ending December 31,
2020 and 2021, respectively. If the actual loss ratio is less than the threshold
loss ratio, the Company is eligible to receive a certain portion of the
underwriting profit. The Company recorded $3.9 million and $1.3 million in
incurred losses, and $3.1 million and $1.9 million in earned premiums, under the
Contract for the three months ended March 31, 2021 and 2020, respectively.
The Company is party to a Catastrophe Reinsurance Treaty (the "Treaty") covering
a wide range of perils that is effective through June 30, 2021 . For the 12
months ending June 30, 2021 , the Treaty provides $717 million of coverage on a
per occurrence basis after covered catastrophe losses exceed the $40 million
Company retention limit. The Treaty specifically excludes coverage for any
Florida business and for California earthquake losses on fixed property policies
such as homeowners, but does cover losses from fires following an earthquake.
The Treaty includes additional territorial and coverage restrictions as noted in
the table 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) 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) 13.4% of this layer covers onlyCalifornia wildfires and fires following an earthquake inCalifornia , and is not subject to reinstatement. (3) 14% of this layer includes a territorial restriction coveringCalifornia ,Arizona andNevada only. 34
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For the 12 months endedJune 30, 2020 , the Treaty provided$600 million of coverage on a per occurrence basis after covered catastrophe losses exceeded the$40 million Company retention limit. The Treaty specifically excluded coverage for anyFlorida business and forCalifornia earthquake losses on fixed property policies such as homeowners, but did cover losses from fires following an earthquake. In addition, the Treaty excluded losses from wildfires on 89.5% of certain coverage layers of the Treaty as noted in the table below.
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 (1) 40 350 100Layer of Coverage (wildfires not covered for 89.5% of this layer)
350 400 100
Layer of Coverage 400 456 100
Layer of Coverage (wildfires not covered for 89.5% of
this layer) 456 500 100
Layer of Coverage (1) 500 640 100
__________(1) Layer of Coverage represents multiple actual treaty layers that are grouped for presentation purposes.
The annual premium for the Treaty is approximately$50.3 million for the 12 months endingJune 30, 2021 , as compared to$38.0 million for the 12 months endedJune 30, 2020 . The increase in the annual premium is primarily due to an increase in reinsurance coverage and rates as well as growth in the covered book of business. The Treaty endingJune 30, 2021 provides for one full reinstatement of coverage limits and 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 restriction noted in the table above, up to the maximum reinstatement premium of approximately$46 million if the full amount of benefit is used for the 12 months endingJune 30, 2021 . The Treaty endedJune 30, 2020 provided for one full reinstatement of coverage limits, and reinstatement premiums were based on the amount of reinsurance benefits used by the Company and at 100% of the annual premium rate with some minor exceptions, up to the maximum reinstatement premium of approximately$38 million if the full amount of benefit was used for the 12 months endedJune 30, 2020 . 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 table below presents the combined total reinsurance premiums under the
Treaty (annual premiums and reinstatement premiums) for the 12 months ending
Reinstatement Premium Total Combined
Treaty Annual Premium (1) Premium (1)
(Amounts in millions)
For the 12 months ending June 30, 2021 $ 50 $ - $ 50
For the 12 months ended June 30, 2020 $ 38 $ - $ 38
__________
(1) The reinstatement premium and the total combined premium for the treaty period endingJune 30, 2021 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, 2020 is zero, as there were no actual reinstatement premiums paid. The catastrophe events that occurred during the three months endedMarch 31, 2021 caused approximately$39 million in losses to the Company, resulting primarily from deep freeze inTexas andOklahoma and winter storms inCalifornia . No reinsurance benefits were available under the Treaty for these losses as none of the 2021 catastrophe events resulted in losses in excess of the Company's per-occurrence retention limit under the Treaty of$40 million for the 12 months endingJune 30, 2021 . 35
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The catastrophe events that occurred in 2020 caused approximately$67 million in losses to the Company as ofMarch 31, 2021 , resulting primarily from wildfires and windstorms inCalifornia and extreme weather events outside ofCalifornia . No reinsurance benefits were available under the Treaty for these losses as none of the 2020 catastrophe events resulted in losses in excess of the Company's per-occurrence retention limit under the Treaty of$40 million for each of the 12 months endingJune 30, 2020 and 2021. The Company carries a commercial umbrella 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. The following table presents the composition of the total investment portfolio of the Company atMarch 31, 2021 : Cost (1) Fair Value (Amounts in thousands) Fixed maturity securities: U.S. government bonds$ 13,742 $ 13,792 Municipal securities 2,679,407 2,825,589 Mortgage-backed securities 81,708 82,878 Corporate securities 222,788 226,376 Collateralized loan obligations 265,235 267,569 Other asset-backed securities 171,282 171,292 3,434,162 3,587,496 Equity securities: Common stock 535,625 700,168 Non-redeemable preferred stock 31,429
32,326
Private equity funds measured at net asset value (2) 100,326
78,108
667,380 810,602
Short-term investments 548,975 548,104
Total investments $ 4,650,517 $ 4,946,202
______________
(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, 2021 , 51.9% of the Company's total investment portfolio at fair
value and 71.6% 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, 2021 , 95.0% of
short-term investments consisted of highly
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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.
The following table presents the maturities and durations of the Company's fixed
maturity securities and short-term investments:
March 31, 2021 December 31, 2020
(in years)
Fixed Maturity Securities
Nominal average maturity:
excluding short-term investments 11.3 11.7
including short-term investments 9.8 10.6
Call-adjusted average maturity:
excluding short-term investments 4.1 4.1
including short-term investments 3.5 3.7
Modified duration reflecting anticipated early calls: excluding short-term investments
3.4 3.4
including short-term investments 2.9 3.0
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, 2021 , consistent with the average rating at
December 31, 2020 . The Company's municipal bond holdings, of which 90.9% were
tax exempt, represented 71.6% of its fixed maturity securities portfolio at
March 31, 2021 , 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,
2021 , fixed maturity securities holdings rated below investment grade and
non-rated bonds totaled $19.9 million and $74.1 million , respectively, at fair
value, and represented 0.6% and 2.1%, 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, 2020 , fixed
maturity securities holdings rated below investment grade and non-rated bonds
totaled $25.5 million and $38.4 million , respectively, at fair value, and
represented 0.7% and 1.1%, respectively, of total fixed maturity securities.
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The overall credit ratings for the Company's fixed maturity securities portfolio
were relatively stable during the three months ended March 31, 2021 , with 97.4%
of fixed maturity securities at fair value experiencing no change in their
overall rating. 0.6% and 2.0% of fixed maturity securities at fair value
experienced upgrades and downgrades, respectively, during the three months ended
March 31, 2021 .
The following table presents the credit quality ratings of the Company's fixed
maturity securities by security type at fair value:
March 31, 2021
(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 $ 13,792 $ - $ - $ - $ - $ 13,792
Total 13,792 - - - - 13,792
100.0 % - % - % - % - % 100.0 %
Municipal securities:
Insured 36,874 175,001 108,846 52,228 2,208 375,157
Uninsured 115,759 793,144 1,317,397 184,670 39,462 2,450,432
Total 152,633 968,145 1,426,243 236,898 41,670 2,825,589
5.4 % 34.3 % 50.4 % 8.4 % 1.5 % 100.0 %
Mortgage-backed securities:
Commercial 5,738 6,450 1,496 4,124 - 17,808
Agencies 960 - - - - 960
Non-agencies:
Prime 23,002 38,542 86 49 593 62,272
Alt-A - 628 - 582 628 1,838
Total 29,700 45,620 1,582 4,755 1,221 82,878
35.8 % 55.1 % 1.9 % 5.7 % 1.5 % 100.0 %
Corporate securities:
Basic materials - - - 399 2,712 3,111
Communications - - 188 478 - 666
Consumer, cyclical - 2,570 7,385 11,268 - 21,223
Consumer, non-cyclical - 10,280 14,139 11,882 - 36,301
Energy - - 2,246 14,819 555 17,620
Financial - 18,214 76,264 19,763 8,984 123,225
Industrial - 446 2,022 15,317 - 17,785
Utilities - - 6,445 - - 6,445
Total - 31,510 108,689 73,926 12,251 226,376
- % 13.9 % 48.0 % 32.7 % 5.4 % 100.0 %
Collateralized loan obligations:
Corporate 72,304 26,103 156,918 - 12,244 267,569
Total 72,304 26,103 156,918 - 12,244 267,569
27.0 % 9.8 % 58.6 % - % 4.6 % 100.0 %
Other asset-backed securities 58,000 77,000 11,334 18,292 6,666 171,292
33.9 % 44.9 % 6.6 % 10.7 % 3.9 % 100.0 %
Total $ 326,429 $
1,148,378
$ 3,587,496 9.1 % 32.0 % 47.5 % 9.3 % 2.1 % 100.0 % ______________
(1)Intermediate ratings are included at each level (e.g., AA includes AA+, AA and AA-).
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U.S. Government Bonds
The Company had $13.8 million , or 0.4% of its fixed maturity securities
portfolio, at fair value, in U.S. government bonds at each of March 31, 2021 and
December 31, 2020 . At March 31, 2021 , Moody's and Fitch ratings for U.S.
government-issued debt were Aaa and AAA , respectively, although a significant
increase in government deficits and debt could lead to a downgrade. The Company
understands that market participants continue to use rates of return on U.S.
government debt as a risk-free rate and have continued to invest in U.S.
Treasury securities. The modified duration of the U.S. government bonds
portfolio reflecting anticipated early calls was 0.8 years and 1.0 years at
March 31, 2021 and December 31, 2020 , respectively.
The Company had$2.83 billion and$2.79 billion , or 78.8% and 78.6%, of its fixed maturity securities portfolio, at fair value, in municipal securities,$375.2 million and$377.0 million of which were insured, atMarch 31, 2021 andDecember 31, 2020 , 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, 2021 andDecember 31, 2020 . AtMarch 31, 2021 andDecember 31, 2020 , 60.1% and 59.9%, 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, 2021 andDecember 31, 2020 , 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 39.9% and 40.1% of insured municipal securities atMarch 31, 2021 andDecember 31, 2020 , 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 3.4 years at each ofMarch 31, 2021 andDecember 31, 2020 . 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, 2021 andDecember 31, 2020 , the mortgage-backed securities portfolio of$82.9 million and$93.3 million , or 2.3% and 2.6%, respectively, of the Company's fixed maturity securities portfolio, at fair value, was categorized as loans to "prime" residential and commercial real estate borrowers, except for$1.8 million and$2.0 million , respectively, at fair value ($1.8 million and$1.9 million at amortized cost) of Alt-A mortgages. Alt-A mortgage-backed securities are at fixed or variable rates and include certain securities that are collateralized by residential mortgage loans issued to borrowers with credit profiles stronger than those of sub-prime borrowers, but do not qualify for prime financing terms due to high loan-to-value ratios or limited supporting documentation. The Company had holdings of$17.8 million and$17.6 million at fair value ($17.3 million and$17.2 million at amortized cost) in commercial mortgage-backed securities atMarch 31, 2021 andDecember 31, 2020 , respectively. The weighted-average rating of the Company's Alt-A mortgage-backed securities was BBB- at each ofMarch 31, 2021 andDecember 31, 2020 . The weighted-average rating of the entire mortgage-backed securities portfolio was AA at each ofMarch 31, 2021 andDecember 31, 2020 . The modified duration of the mortgage-backed securities portfolio reflecting anticipated early calls was 5.8 years and 6.4 years atMarch 31, 2021 andDecember 31, 2020 , respectively. 39
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Corporate securities included in fixed maturity securities were as follows:
March
31, 2021
(Amounts in thousands)
Corporate securities at fair value $ 226,376 $ 241,366
Percentage of total fixed maturity securities portfolio 6.3 % 6.8 %
Modified duration 2.1 years 1.7 years
Weighted-average rating A- A-
Collateralized Loan Obligations
Collateralized loan obligations included in fixed maturity securities were as
follows:
March 31, 2021 December 31, 2020
(Amounts in thousands)
Collateralized loan obligations at fair value $ 267,569 $ 256,891
Percentage of total fixed maturity securities portfolio 7.5 % 7.2 %
Modified duration 4.9 years 4.8 years
Weighted-average rating AA- AA-
Other Asset-Backed Securities
Other asset-backed securities included in fixed maturity securities were as
follows:
March 31, 2021 December 31, 2020
(Amounts in thousands)
Other asset-backed securities at fair value $ 171,292 $ 153,261
Percentage of total fixed maturity securities portfolio 4.8 % 4.3 %
Modified duration 0.6 years 1.6 years
Weighted-average rating AA AA+
Equity Securities
Equity holdings of $810.6 million and $803.9 million at fair value, as of
March 31, 2021 and December 31, 2020 , 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 gain (loss) of $34.5 million and $(186.4)
million due to changes in fair value of the Company's equity securities
portfolio for the three months ended March 31, 2021 and 2020, respectively. 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 primary cause for the decrease in fair value of the
Company's equity securities portfolio for the three months ended March 31, 2020
was the overall market disruptions and dislocations resulting from the COVID-19
outbreak.
The Company's common stock allocation is intended to enhance the return of and
provide diversification for the total portfolio. At March 31, 2021 , 16.4% of the
total investment portfolio at fair value was held in equity securities, compared
to 17.0% at December 31, 2020 .
D. Debt
On March 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 on March 15 and September 15 of each
year commencing September 15, 2017 . The notes mature on March 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
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99.847% of par, resulting in the effective annualized interest rate including
debt issuance costs of approximately 4.45%.
On March 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 on March
29, 2022 . On March 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 to March 31,
2026 , added U.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 debt. The
Company's debt to total capital ratio was 15.1% at March 31, 2021 , resulting in
a 12.5 basis point commitment fee on the $75 million undrawn portion of the
credit facility. As of April 29, 2021 , 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 at March 31, 2021 .
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$1.87 billion atMarch 31, 2021 , and net premiums written of$3.6 billion for the twelve months ended on that date, the ratio of net premiums written to surplus was 1.93 to 1 atMarch 31, 2021 .
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