Since December 1986, Mercury General's executive offices are located in a 36,000 sq. ft. office building, in Los Angeles, owned by Mercury Casualty Company. The Company occupies approximately 95% of the building and leases the remaining office space to others.
In October 1992 the Company purchased a 158,000 square foot office building in Brea, California. The Company occupies approximately 43% of the facility and leases the remaining office space to others.
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995 ---------------------------------------------------------------------
Total losses and expenses in 1996, excluding interest expense of $2.0 million, were $686.4 million, resulting in an underwriting gain for the period of $68.4 million, compared with an underwriting gain of $49.0 million in 1995.
the inclusion of AFI for the month of December 1996. The effective tax rate on investment income in 1996, excluding AFI, was 9.6%, and the after-tax yield was 6.56%. The slightly higher tax rate on investment income in 1996 reflects an increase in the proportion of investment income derived from dividends on equities, principally perpetual preferred stocks. The redemption of bonds acquired during higher interest periods has been a negative influence on realized yields in each of the last several years and will continue in 1997. Bonds matured and called in 1996 totaled $72.9 million, compared with $71.0 million in 1995, and approximately $48.6 million of calls and maturities are expected in 1997. Average yields being obtained during the first quarter of 1997 on new investments are some 50 basis points lower than the average yield realized in 1996.
Realized investment losses in 1996 were $3.2 million, compared with realized gains of $1.0 million in 1995. The 1996 losses reflect principally yield-enhancing swaps of both fixed maturities and equity securities, including perpetual preferred stocks, designed to utilize expiring capital gains tax benefits. The 1995 gains arose in part from the early redemption of fixed- maturity investments.
The income tax provision of $30.8 million in 1996 represented an effective tax rate of 22.6%, compared with an effective rate of 21.0%, in 1995. The increase in the rate is attributable principally to the greater contribution from underwriting gains, which are fully taxable and increased by $19.4 million during 1996, whereas the predominantly tax-free investment income increased $7.2 million.
Net income in 1996 was $105.8 million, or $3.86 per share, compared with $90.3 million, or $3.31 per share, in 1995. Per share results are based on 27.4 million average shares in 1996 and $27.3 million average shares in 1995.
Realized investment gains in 1995 were $1.0 million, compared with realized losses of $9.9 million in 1994. The 1994 losses reflect principally yield- enhancing swaps of both fixed maturities and equity securities, including perpetual preferred stocks, undertaken to recapture capital gains taxes paid in prior years. The 1995 gains arose in part from the early redemption of fixed- maturity investments.
The income tax provision of $24.0 million in 1995 represented an effective tax rate of 21.0%, compared with an effective rate of 19.6%, in 1994. The increase in the rate is attributable principally to the realization of capital gains in 1995, in contrast to the realization of losses in 1994.
Net income in 1995 was $90.3 million, or $3.31 per share, compared with $66.3 million, or $2.43 per share, in 1994. Per share results are based on 27.3 million average shares in both years.
The loss ratio in 1994 was 68.1%, compared with 61.0% in 1993. The higher loss ratio in 1994 reflects a much smaller contribution from favorable loss reserve development from prior periods and a reduction in the estimate of salvage and subrogation recoverable for prior accident years. The major earthquake which struck Southern California on January 17, 1994 resulted in net loss claims, after reinsurance recoveries, of approximately $1.2 million, which added less than 0.25% to the 1994 loss ratio. Earthquake losses were immaterial as the Company writes only a small amount of homeowners' insurance. Approximately one half of
the net earthquake losses incurred were related to the Company's principal line, automobile insurance, while the other half was related to the homeowners' line.
Total losses and expenses, excluding interest expense of $1,025,000, were $493.8 million, resulting in an underwriting gain for the period of $35.6 million, compared with an underwriting gain of $66.6 million in 1993.
Net income in 1994 was $66.3 million, or $2.43 per share, compared with $96.2 million, or $3.52 per share, in 1993. Per share results are based on 27.3 million average shares in 1994 and 27.4 million average shares in 1993.
Net cash provided from operating activities in 1996, including $9.7 million from AFI, was $196.6 million, while funds derived from the sale, redemption or maturity of investments was $531.5 million, of which approximately 75% was represented by the sale of equity securities. The amortized cost of fixed- maturity investments increased by $182.4 million during the year. Equity investments, including perpetual preferred stocks, increased by $34.8 million at cost, and short-term cash investments increased by $37.6 million. The amortized cost of fixed-maturities available for sale that were sold, called or matured during the year was $133.2 million.
The Company's cash and short term investments totaled $69.7 million at December 31, 1996. Together with funds generated internally, such liquid assets are more than adequate to pay claims without the sale of long term investments.
Holdings in the taxable sector consist largely of senior public utility issues. Fixed-maturity investments of $924.8 million, including $68.5 million held by AFI, (at amortized cost) include $66.7 million of sinking fund preferreds, principally utility issues. The market value of all fixed maturities exceeded cost by $29.3 at December 31, 1996. The only securities held which may be considered derivatives are a small amount of adjustable rate preferred stocks.
The only significant debt of the Company at December 31, 1996 was a three year, $75,000,000 revolving credit bank loan. The loan agreement requires the Company to meet numerous affirmative and negative covenants. The proceeds of the loan were used to repay a prior loan and to acquire American Fidelity Insurance Company, with the balance contributed to the Company's new insurance subsidiaries. The loan agreement may be extended annually for additional periods
of one year each to maintain the three year maturity date. The interest rate is variable and is optionally related to the Federal Funds Rate, Bank of New York Rate (prime rate) or the Eurodollar London Interbank Rate (LIBOR). Based on the rates effective through June 25, 1997, LIBOR plus .50, the net interest cost on the loan approximates 6.08%.
The foregoing discussion contains forward-looking statements regarding the Company, its business, prospects and results of operations that are subject to certain risks and uncertainties posed by factors and events that could cause the Company's actual business, prospects and results of operations to differ materially from the historical information contained herein and from those that may be expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, among others, the success of the Company in integrating and profitably operating the business of AFI, the impact of the permanent rating factor regulations recently adopted by the California Insurance Commissioner for private passenger automobile policies issued in California and the level of investment yields obtainable in the
We have audited the accompanying consolidated balance sheets of Mercury General Corporation and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of income, shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
The Company is primarily engaged in the underwriting of private passenger automobile insurance in the state of California.
The consolidated financial statements include the accounts of Mercury General Corporation (the Company) and its wholly-owned subsidiaries, Mercury Casualty Company, Mercury Insurance Company, California Automobile Insurance Company, California General Underwriters Insurance Company, Inc., Mercury Insurance Company of Georgia, Mercury Insurance Company of Illinois, Mercury Indemnity Company of Georgia and Mercury Indemnity Company of Illinois. Effective December 1, 1996 the financial statements also include newly acquired companies American Fidelity Insurance Company, Cimarron Insurance Company, Inc., AFI Management Company, Inc. (AFIMC), and American Fidelity Lloyds Insurance Company (AFL). AFL is not owned by MGC, but is controlled by MGC through its attorney-in-fact, AFIMC. The acquisition is discussed further in Note 8. Collectively, the newly-acquired companies, including AFL, are referred to as AFI. All of the subsidiaries as a group, including AFL, but excluding AFIMC, are referred to as the Insurance Companies. The consolidated financial statements have been prepared in conformity with generally accepted accounting principles (GAAP) which differ in some respects from those filed in reports to insurance regulatory authorities. All significant intercompany balances and transactions have been eliminated.
Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments", and Statement of Financial Accounting Standards No. 119, "Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments", require disclosure of estimated fair value information about financial instruments, for which it is practicable to estimate that value. Under SFAS No. 115, the Company categorizes all of its investments in debt and equity securities as available for sale. Accordingly, all investments, including cash and short-term cash investments, are carried on the balance sheet at their fair value. The carrying amounts and fair values for investment securities are disclosed in Note 2 and were drawn from standard trade data sources such as market and broker quotes. The estimated fair value is equivalent to the carrying value of receivables, accounts payable and other liabilities. The estimated fair value of notes payable equals their carrying value, which was based on borrowing rates currently available to the Company for bank loans with similar terms and maturities. The terms of the notes are discussed in Note 5.
Net premiums written during 1996, 1995 and 1994 were $795,873,000, $636,590,000 and $550,838,000, respectively.
Estimating loss reserves is a difficult process as there are many factors that can ultimately affect the final settlement of a claim and, therefore, the reserve that is needed. Changes in the law, results of litigation, medical costs, the cost of repair materials and labor rates can all impact ultimate claim costs. 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 the claim, the more variable the ultimate settlement amount can be. Accordingly, short-tail claims, such as property damage claims, tend to be more reasonably predictable than long-tail liability claims. Management believes that
In accordance with SFAS No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts," the liabilities for unearned premiums and unpaid losses are stated in the accompanying consolidated financial statements before deductions for ceded reinsurance. The ceded amounts are immaterial and are carried in other assets and other receivables. Earned premiums are stated net of deductions for ceded reinsurance.
Interest paid during 1996, 1995, and 1994 was $1,882,000, $1,970,000, and $1,001,000, respectively. Income taxes paid were $30,550,000 in 1996, $18,954,000 in 1995, and $19,315,000 in 1994.
Notes payable at December 31, 1996 consists of three unsecured notes payable under a credit agreement dated November 21, 1996. The combined principal amount on the notes of $75,000,000 is payable on November 21, 1999. The loan agreement may be extended annually for additional periods of one year each to maintain the three year maturity date. The interest rate is variable and is optionally related to the Federal Funds rate, Bank of New York prime rate or the Eurodollar London Interbank rate (LIBOR). Based on the rates effective through June 25, 1997, the net interest cost on the loan at December 31, 1996 is approximately 6.08%.
Decreases in incurred losses relating to prior years reflects the favorable loss experience during these years attributable to a number of combined factors which have produced favorable frequency and severity trends in recent years. In addition, actuarial assumptions based on historical trends have proved to be conservative.
Effective November 30, 1996 the Company acquired all of the issued and outstanding common stock of American Fidelity Insurance Company, including its subsidiaries as described in Note 1, for $35.0 million. The acquisition was paid for in cash with funds raised by increasing the Company's notes payable under the bank credit agreement discussed in Note 5. On December 30, 1996 the Company contributed an additional $15.0 million to AFI. The acquisition was accounted for using the purchase method and resulted in a minimal amount of negative goodwill. The purchase agreement includes an indemnification by the seller on the loss and loss adjustment expense reserves of AFI at the acquisition date, excluding the mechanical breakdown line, to avoid any impact on the Company's financial statements from any future adverse development on the acquisition date loss reserves.
AFI writes property and casualty insurance, primarily in Oklahoma, Kansas and Texas, where the companies are domiciled. Its primary lines are automobile and mechanical breakdown insurance. The results of operations for the month of December are included in the consolidated financial statements of the Company.
The Insurance Companies are subject to the financial capacity guidelines established by the Office of the Commissioner of Insurance of their domicile states. The payment of dividends from statutory unassigned surplus of the Insurance Companies is restricted, subject to certain statutory limitations. For the year 1997, the direct insurance subsidiaries of the Company are permitted to pay approximately $61,471,000 in dividends to the Company without the prior approval of the Commissioner of Insurance of the state of domicile.
The Company has estimated the Risk-Based Capital Requirements of each of its insurance subsidiaries as of December 31, 1996 according to the formula issued by the NAIC. Each of the companies' policyholders' surplus exceeded the highest level of recommended capital requirements.
Company will receive minimum future rentals on various noncancellable operating leases on a building in Brea, California. The annual rental commitments, expressed in thousands, are shown as follows:
The Company and its subsidiaries are defendants in various lawsuits generally incidental to their business. In most of these actions, plaintiffs assert claims for exemplary and punitive damages which are not insurable under California judicial decisions. The Company vigorously defends these actions, unless a reasonable settlement appears appropriate. Management does not expect the ultimate disposition of these lawsuits to have a material effect on the Company's consolidated operations or financial position.
The Company adopted a stock option plan in October 1985 (the "1985 Plan") under which 2,700,000 shares were reserved for issuance. Options granted during 1985 were exercisable immediately. Subsequent options granted become exercisable 20% per year beginning one year from the date granted. All options were granted at the market price on the date of the grant and expire in 10 years.
In May 1995 the Company adopted The 1995 Equity Participation Plan (the "1995 Plan") which succeeds the Company's 1985 Plan. Under the 1995 Plan, 2,700,000 shares of Common Stock are authorized for issuance upon exercise of options, stock appreciation rights and other awards, or upon vesting of restricted or deferred stock awards. During 1995, the Company granted incentive stock options under both the 1995 Plan and the 1985 Plan. The options granted during 1996, 1995 and 1994 become exercisable 20% per year beginning one year from the date granted and were granted at the market price on the date of the grant. The options expire in 10 years.
The following table summarizes information regarding the stock options outstanding at December 31, 1996: