The home office of the California insurance subsidiaries and the Company's computer facilities are located in Brea, California in an 80,000 square foot office building owned by the Company.
The Company operates primarily in the state of California, which was the only state it produced business in prior to 1990. The Company expanded its operations into Georgia and Illinois in 1990. With the acquisition of American Fidelity Insurance Group ("AFI")in December 1996, now American Mercury Insurance Group ("AMI"), the Company expanded into the states of Oklahoma and Texas. The Company further expanded its operations into the state of Florida during 1998. Further expansion into Texas occurred with the Concord Insurance Services, Inc. transaction in December 1999 and the Mercury County Mutual Insurance Company ("MCM") transaction in September 2000.
The Company submitted a proposed rating plan in response to these regulations in March
1997. The Company's plan was approved by the California DOI and became effective October 1, 1997. Although the rate changes produced some minor dislocations, implementation of the new plan has not materially changed the Company's overall competitive position or its profitability.
The Company believes that downward pressure on premium rates due to highly competitive conditions in the California private passenger auto market has resulted in higher loss ratios. To improve loss ratios many California auto insurers have either filed for rate increases recently or will do so in the immediate future. The Company has filed for a 6.9% rate increase in both its non-standard automobile line and its private passenger automobile line written by Mercury Casualty Company in California. The combined premium volume for these two lines was $297.6 million in 2000 representing approximately 29% of the California private passenger business written in 2000. Despite the proposed increase, the Company believes that its rates will remain among the lowest in the market. During 2000, the Company continued its marketing efforts for name recognition and lead generation. The Company feels that its marketing effort combined with price and reputation for service make the Company very competitive in California.
Investment income in 2000 was $106.5 million compared with $99.4 million in 1999. The after-tax yield on average investments of $1,710.2 million (cost basis) was 5.56%, compared with 5.62% on average investments of $1,595.5 million in 1999. The effective tax rate on investment income in 2000 was 10.6%, compared with 9.8% in 1999. The higher tax rate in 2000 reflects a modest shift in the Company's portfolio mix from non-taxable to taxable issues. Bonds matured and called in 2000 totaled $45.6 million compared with $49.2 million in 1999. Approximately $22.9 million of bonds are expected to mature or be called in 2001.
Included in 1999 losses was a $6.0 million write-down of a preferred stock investment that became other than temporarily impaired during the third quarter.
The California private passenger automobile insurance marketplace continued to be extremely competitive which has placed downward pressure on rates. In April 1998, the Company reduced its average premium rate by 7%. Since 1999 was the first full year with the rate decrease in effect, average 1999 rates were lower than average 1998 rates. The Company has continued to increase its marketing efforts for both name recognition and lead generation purposes. Total amounts spent on advertising efforts during 1999 exceeded 1998 expenditures by approximately 70%.
Total losses and expenses in 1999, excluding interest expense of $5.0 million, were $1,107.2 million, resulting in an underwriting gain for the period of $81.1 million, compared with an underwriting gain of $139.6 million in 1998.
The higher tax rate in 1999 reflects a modest shift in the mix of the Company's equity investments from non-taxable to taxable issues. The redemption of bonds acquired during higher interest periods has been a negative influence on realized yields in each of the last several years. Bonds matured and called in 1999 totaled $49.2 million, compared to $65.3 million in 1998.
Net cash provided from operating activities in 2000, was $153.1 million, while funds derived from the sale, redemption or maturity of investments was $273.7 million, of which approximately 50% was represented by the sale of fixed maturities. The amortized cost of fixed-maturity investments increased by $110.1 million during the year. Equity investments, including perpetual preferred stocks, increased by $11.7 million at cost, while short-term cash investments decreased by $10.6 million. The amortized cost of fixed- maturities available for sale that were sold, called or matured during the year was $191.8 million.
The market value of all investments held at market as "Available for Sale" exceeded the amortized cost of $1,747.5 million at December 31, 2000 by $47.5 million. That unrealized gain, reflected in shareholders' equity, as Accumulated Other Comprehensive Income, net of applicable tax effects, was $30.9 million at December 31, 2000 compared with an unrealized loss of $39.5 million at December 31, 1999. The increase in market values since December 31, 1999 reflects principally the substantial decrease in intermediate and long term interest rates during 2000.
As of December 31, 2000, the average rating of the $1,444.0 million bond portfolio (at amortized cost) was AA-, while the average effective maturity, giving effect to anticipated early call provisions, approximates 9.4 years. The modified duration of the bond portfolio at year-end was 6.8 years. Duration measures the length of time it takes to receive all cash flows produced by a bond, including reinvestment of interest income. Because it measures four factors (maturity, coupon rate, yield and call terms) which determine sensitivity to changes in interest rates, modified duration is considered a much better indicator of price volatility than simple
Equity holdings of $252.5 million at market (cost $250.6 million), including perpetual preferred issues, are largely confined to the public utility and banking sectors and represent about 24.4% of total shareholders' equity.
The Company had outstanding debt at December 31, 2000 of $108 million. Of this amount, $75 million has been borrowed under a three year revolving credit bank loan and is due November 21, 2001. 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 AMI, with the balance contributed as capital to AMI. The loan agreement may be extended annually for additional periods of one year each to maintain the three year maturity date. Due to an increase in interest rate spreads in the loan syndication market during 1999 and 2000, the Company did not extend the maturity for an additional one year period. The Company will reevaluate refinancing or extending the current 2001 maturity date of this loan during 2001. 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 rates effective at December 31, 2000, the net interest cost on the loan approximates 6.96%.
The Company also maintains a $30 million line of credit, of which $27 million was drawn at December 31, 2000 and is due October 26, 2001. The line of credit may be used to fund the Company's stock repurchase program authorized by the Board of Directors in August 1998 as well as for general corporate purposes. The interest rate is variable and is optionally related to the Federal Funds rate or the Eurodollar London Interbank rate (LIBOR). Based on rates effective at December 31, 2000, the net interest cost on the loan approximates 7.51%. The loan covenants are similar to the Company's $75 million loan discussed above.
As part of the Elm County Mutual transaction the Company agreed to make annual $1 million payments to Employers Reinsurance Corporation over 7 years beginning September 30, 2001. At December 31, 2000, the Company is carrying a note payable for $5.4 million, which represents the discounted value of the seven annual payments using a 7% rate. An additional $500,000 note payable to Employers Reinsurance Corporation is due during the first quarter of 2001 and represents the remainder of the initial purchase price.
Under the stock repurchase program, the Company may purchase over a one-year period up to $200 million of Mercury General's common stock. The purchases may be made from time to time in the open market at the discretion of management. The program will be funded by the sale of
Upon the occurrence of a major seismic event, the CEA has the ability to assess participating companies for losses. These assessments are made after CEA capital has been expended and are based upon each company's participation percentage multiplied by the amount of the total assessment. Based upon the most current information provided by the CEA, the Company's maximum total exposure to CEA assessments at April 30,2000, is approximately $14.6 million.
insurer's annual net premiums written to statutory policyholders' surplus should not exceed 3.0 to 1. Based on the combined surplus of all of the Insurance Companies of $954.8 million at December 31, 2000, and net written premiums for the twelve months ended on that date of $1,272.4 million, the ratio of writings to surplus was approximately 1.3 to 1.
We have audited the accompanying consolidated balance sheets of Mercury General Corporation and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of income, comprehensive income, shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 2000. 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.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Mercury General Corporation and subsidiaries as of December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America.
The Company is primarily engaged in the underwriting of private passenger automobile insurance in the state of California. In 2000 and 1999 over 90% of the net written premiums were from California.
The consolidated financial statements include the accounts of Mercury General Corporation (the Company or MGC) 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, Mercury Indemnity Company of Illinois, American Mercury Insurance Company (AMIC), Cimarron Insurance Company, Inc., AFI Management Company, Inc. (AFIMC), American Mercury Lloyds Insurance Company (AML) and Mercury County Mutual Insurance Company (MCM). AML is not owned by MGC, but is controlled by MGC through its attorney-in-fact, AFIMC. MCM is not owned by the Company but is controlled through a management contract. American Mercury MGA, Inc. (AMMGA),is a wholly owned subsidiary of AMIC. The 1998 financial statements include the results of Cimarron Insurance Company through June 5, 1998, the date it was sold to an unrelated party. This sale is discussed further in Note 10. Effective October 31, 1999 the financial statements also include Concord Insurance Services, Inc., (Concord) a Texas insurance agency controlled by MGC. Concord is discussed further in Note 8. The results of MCM are included in the financial statements effective September 30, 2000. MCM is discussed further in Note 9. All of the subsidiaries as a group, including AML and MCM, but excluding AFIMC, AMMGA, and Concord, 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.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. The most significant assumptions in the preparation of these consolidated financial statements relate to loss and loss adjustment expenses. Actual results could differ from those estimates.
Net premiums written during 2000, 1999 and 1998 were $1,272,447,000, $1,206,171,000 and $1,144,051,000, respectively.
Buildings and furniture and equipment are depreciated over 30-year and 3- year to 10-year periods, respectively, on a combination of straight-line and accelerated methods. Automobiles are depreciated over 5 years, using an accelerated method.
Deferred income taxes result from temporary differences in the recognition of income and expense for tax and financial reporting purposes. The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109 (SFAS No. 109),"Accounting for Income Taxes".
In accordance with Statement of Financial Accounting Standards No. 113 (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 2000, 1999, and 1998 was $7,357,000, $4,758,000 and $4,494,000, respectively. Income taxes paid were $14,609,000 in 2000, $33,102,000 in 1999 and $65,984,000 in 1998.
At December 31, 2000, bond holdings rated below investment grade totaled approximately 1% of total investments. The average Standard and Poor's rating of the bond portfolio is AA-. The amortized cost and estimated market value of fixed maturities available for sale at December 31, 2000 by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Year ended December 31, (Amounts in thousands) -------------------------------- 2000 1999 1998 ---- ---- ---- Balance, beginning of year................. $ 63,975 $ 61,947 $ 57,264 Costs deferred during the year............. 275,808 269,427 257,275 Amortization charged to expense............ (268,657) (267,399) (252,592) --------- --------- --------- Balance, end of year....................... $ 71,126 $ 63,975 $ 61,947 ========= ========= =========
Deferred tax liabilities Deferred acquisition costs................... (27,623) (22,391) Tax liability on net unrealized gain on securities carried at market value.......... (16,623) -- Tax depreciation in excess of book depreciation................................ (1,167) (1,351) Accretion on bonds........................... (2,962) (2,008) Other deferred tax liabilities............... (1,292) (2,897) -------- -------- Total gross deferred tax liabilities....... (49,667) (28,647) -------- -------- Net deferred tax assets (liabilities)...... $ (8,336) $ 28,541 ======== ========
Year ended December 31, (Amounts in thousands) ------------------------- 2000 1999 1998 ---- ---- ---- Gross reserves for losses and loss adjustment expenses at beginning of year.. $434,843 $405,976 $409,061 Less reinsurance recoverable............... (16,043) (20,160) (22,791) -------- -------- -------- Net reserves, beginning of year............ 418,800 385,816 386,270
Loss and loss adjustment expense payments related to: Current year........................... 562,163 492,314 437,612 Prior years............................ 294,615 263,805 247,310 -------- -------- -------- Total payments............................. 856,778 756,119 684,922 -------- -------- --------
Increases in prior years incurred losses in 2000 a nd 1999 relate to increases in the severity estimates on bodily injury and p hysical damage coverages over what was originally recorded in the prior year. The increases in these claims relate to increased severity over what was recorded and are the result of inflationary trends in health care costs, auto parts and body shop labor costs.
In December 1999, the Company completed a transaction that, in effect, transferred control of Concord Insurance Services, Inc. ("Concord"), a Texas insurance agency headquartered in Houston, Texas, to the Company. The effective date of the transaction was October 31, 1999. Concords' results of operations, which are not material to the Company, are included in the Consolidated Financial Statements of the Company effective October 31, 1999.
The transaction was accounted for using the purchase method of accounting, and resulted in an immaterial amount of goodwill that is being amortized using the straight-line method over a ten-year period.
Effective September 30, 2000, the Company completed a transaction with Employers Reinsurance Corporation purchasing the authority and right to manage and control Elm County Mutual Insurance Company. Effective January 2, 2001, the name was changed to Mercury County Mutual Insurance Company ("MCM"). The results of operations of MCM, which are not material to the Company, are included in the consolidated financial statements of the Company effective September 30, 2000.
In June 1998, the Company sold its 100% interest in Cimarron Insurance Company for $11.1 million in cash. The Company realized a pre-tax gain of approximately $2.6 million on this transaction.
The Company has estimated the Risk-Based Capital Requirements of each of its insurance subsidiaries as of December 31, 2000 according to the formula issued by the NAIC. Each of the Companies' policyholders' surplus exceeded the highest level of minimum required capital.
The Company is obligated under various noncancellable lease agreements providing for office space and equipment rental that expire at various dates through the year 2008. Total rent expense under these lease agreements, all of which are operating leases, was $4,138,000, $3,320,000 and $2,074,000 for the years ended December 31, 2000, 1999 and 1998, respectively.
Rent Year Expense ---- ------- 2001.................... $3,814 2002.................... $2,837 2003.................... $1,889 2004.................... $1,675 2005.................... $1,311 Thereafter.............. $2,950
2000 1999 ---- ---- Allocated shares 46,000 23,000 Shares committed-to-be released 23,000 23,000 Unreleased shares 46,000 69,000 ---------- ---------- Total ESOP shares 115,000 115,000 ========== ========== Market value of unreleased shares at December 31, $2,018,000 $1,535,000 ========== ==========
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 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. At December 31, 2000 no awards other than options have been granted.