The home office of the California Companies and the Company's computer facilities are located in Brea, California in an 80,000 square foot office building owned by the Company.
Since December 1986, Mercury General's executive offices have been located in a 36,000
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. In 2001, the Company expanded into Virginia and New York.
In February 1994, the California Insurance Commissioner approved new rates which were designed to improve the Company's competitive position for new insureds. These rate changes, which became effective on May 1, 1994, provided for decreases in premium rates for new insureds. Several rate modifications were approved and made effective subsequent to May 1, 1994. A rate change made April 1, 1998, reduced rates by approximately 7% and was primarily made to improve Mercury's competitive position in the marketplace. On August 23, 2001, the Company increased premium rates by 6.9% on its non-standard line and on its non-good driver private passenger automobile line written by Mercury Casualty Company. The Company recently received approval for a 4.1% rate increase for private passenger automobile insurance in Mercury Insurance Company, which represents approximately 55% of Company-wide premiums written, and a 6.9% combined rate increase for private passenger automobile insurance in Mercury Casualty Company and California Automobile Insurance Company, which represent approximately 24% of Company-wide premiums written. These increases went into effect for all new and renewal California business as of March 1, 2002. Since March 31, 1994, Private Passenger Automobile policies in force in California have increased from approximately 300,000 to 828,000 at December 31, 2001, an annual rate of increase of approximately 14%. Policy count growth for the year 2001 was at a 7% rate, an improvement over 2000 when the rate was down negligibly from the prior year.
requires that each of the four factors be applied in decreasing order of importance.
The Company carries its fixed maturity and equity investments at market value as required for securities classified as "Available for Sale" by Statement of Financial Accounting Standards No. 115 (SFAS No. 115), "Accounting for Certain Investments in Debt and Equity Securities." In most cases, market valuations were drawn from trade data sources. In no case were any valuations made by the Company's management. Equity holdings, including non-sinking fund preferred stocks, are, with minor exceptions, actively traded on national exchanges, and were valued at the last transaction price on the balance sheet date. The Company constantly evaluates its investments for other than temporary declines and writes them off as realized losses through the Statement of Income, as required by SFAS No. 115, if the circumstances warrant. Temporary unrealized investment gains and losses are credited or charged directly to shareholders' equity as accumulated other comprehensive income, net of applicable taxes. It is possible that future information will become available about the Company's current investments that would require accounting for them as realized losses due to other than temporary declines in value. The financial statement effect would be to move the unrealized loss from accumulated other comprehensive income on the Balance Sheet to realized investment losses on the Statements of Income.
At December 31, 2001, the Company had on its books approximately $7.3 million in Goodwill related to the 1999 acquisition of Concord and approximately $9.3 million of intangible assets with indefinite useful lives related to the Elm acquisition.
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000 ---------------------------------------------------------------------
Premiums earned in 2001 of $1,380.6 million increased 10.5% and net premiums written in 2001 of $1,442.9 million increased 13.4% over amounts recorded in 2000. These premium increases were principally attributable to increased policy sales in the California automobile insurance lines as well as increased production in California homeowners insurance, Florida automobile insurance and Texas automobile insurance.
by Mercury Casualty Company. The Company recently received approval for a 4.1% rate increase for private passenger automobile insurance in Mercury Insurance Company, which represents approximately 55% of Company-wide premiums written, and a 6.9% combined rate increase for private passenger automobile insurance in Mercury Casualty Company and California Automobile Insurance Company, which represent approximately 24% of Company-wide premiums written. These increases go into effect for all new and renewal California business as of March 1, 2002. The Company plans to make additional filings for rate increases in California as well as other states. Despite the increases, the Company believes that its rates will remain competitive in the marketplace. During 2001, the Company continued its marketing efforts for name recognition and lead generation. The Company feels that its marketing effort combined with price and reputation make the Company very competitive in California.
The GAAP loss ratio in 2001 (loss and loss adjustment expenses related to premiums earned) was 73.2% compared with 72.2% in 2000. The less favorable loss ratio is primarily driven by higher loss ratios in the California automobile and homeowners lines of business which are partially offset by lower loss ratios in the Florida, Georgia and Illinois automobile lines of business.
Investment income in 2001 was $114.5 million, compared with $106.5 million in 2000. The after-tax yield on average investments of $1,828.5 million (cost basis) was 5.41%, compared with 5.56% on average investments of $1,710.2 million in 2000. The effective tax rate on investment income was 13.6% in 2001, compared to 10.6% in 2000. The higher tax rate and decrease in investment yields in 2001 reflect a shift in the mix of the Company's portfolio from non-taxable to taxable issues. Bonds matured and called in 2001 totaled $67.6 million, compared to $45.6 million in 2000. Approximately $120.4 million of bonds are expected to mature or be called in 2002.
Net income in 2001 was $105.3 million or $1.94 per share (diluted), compared with $109.4 million or $2.02 per share (diluted), in 2000. Diluted per share results are based on 54.4 million average shares in 2001 and 54.3 million shares in 2000. Basic per share results were $1.94 in 2001 and $2.02 in 2000.
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999 ---------------------------------------------------------------------
Total losses and expenses in 2000, excluding interest expense of $7.3 million, were $1,230.2 million, resulting in an underwriting gain (premiums earned less total losses and expenses excluding interest) for the period of $19.1 million compared with an underwriting gain of $81.1 million in 1999.
The income tax provision of $19.2 million in 2000 represented an effective rate of 14.9%, compared with an effective rate of 20.7% in 1999. The lower rate in 2000 is primarily attributable to the increased proportion of investment income which consists primarily of tax-exempt interest and tax sheltered dividend income in contrast to underwriting income which is taxed at the full corporate rate of 35%.
The Company's unrestricted cash and short term investments totaled $72.8 million at December 31, 2001. Together with funds generated internally, such liquid assets are adequate to pay claims without the sale of long term investments.
As of December 31, 2001, the average Standard & Poor's rating of the $1,544.5 million bond portfolio (at amortized cost) was A, while the average effective maturity, giving effect to anticipated early call provisions, approximates 8.8 years. The modified duration of the bond portfolio at year-end was 6.5 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 maturity alone. Bond holdings are broadly diversified geographically and by obligor. Traditionally, it has been the Company's policy not to invest in high yield or "junk" bonds. At December 31, 2001 bond holdings rated below investment grade totaled $39.1 million at market (cost $40.2 million), or less than 2% of total assets. A decrease in the portfolio's average rating from AA- at December 31, 2000 to A at December 31, 2001 reflects some downgrades in the Company's existing holdings as well as the fact that a larger percentage of the portfolio is invested in corporate bonds which generally have lower ratings than municipal issues.
Fixed maturity investments of $1,560.2 million (amortized cost), include $15.7 million (amortized cost) of sinking fund preferred stocks, principally utility issues. The market value of all fixed maturities exceeded cost by $26.3 million at December 31, 2001.
Except for Company-occupied buildings and land to be utilized for Company office space, the Company has no direct investments in real estate and no holdings of mortgages secured by commercial real estate.
On August 7, 2001, the Company completed a public debt offering issuing $125 million of senior notes payable under a $300 million shelf registration filed with the SEC in July 2001. The notes are unsecured, senior obligations of the Company with a 7.25% annual coupon payable on August 15 and February 15 each year commencing February 15, 2002. These notes mature on August 15, 2011. The Company incurred debt issuance costs of approximately $1.3 million, inclusive of underwriter's fees. These costs are deferred and then amortized as a component of interest expense over the term of the notes. The notes were issued at a slight discount at 99.723%, making the effective annualized interest rate including debt issuance costs approximately 7.44%.
Prior to the issuance of the senior notes, the Company used short-term floating rate bank debt as part of its capital structure. Effective January 2, 2002, the Company entered into an interest rate swap of its fixed rate obligation on the senior notes for a floating rate of LIBOR plus 107 basis points. The Company believes that the swap will significantly reduce interest expense in 2002, but does expose it to higher interest expense in future periods, should LIBOR rates increase. The swap will be accounted for as a fair value hedge under SFAS No. 133. See
Independent Auditors' Report ............................................ 36 Consolidated Financial Statements: Consolidated Balance Sheets as of December 31, 2001 and 2000 ..... 37 Consolidated Statements of Income for Each of the Years in the Three-Year Period Ended December 31, 2001 ....................... 38 Consolidated Statements of Comprehensive Income for each of the Years in the Three-Year Period Ended December 31, 2001 .......... 39 Consolidated Statements of Shareholders' Equity for Each of the Years in the Three-Year Period Ended December 31, 2001 .......... 40 Consolidated Statements of Cash Flows for Each of the Years in the Three-Year Period Ended December 31, 2001 ................... 41 Notes to Consolidated Financial Statements ....................... 43
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, 2001 and 2000, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America.
2001 2000 1999 ---------- ---------- ---------- Revenues: Earned premiums ...................... $1,380,561 $1,249,259 $1,188,307 Net investment income ................ 114,511 106,466 99,374 Net realized investment gains (losses) 6,512 3,944 (11,929) Other ................................ 5,396 6,349 4,924 ---------- ---------- ----------
Expenses: Losses and loss adjustment expenses .. 1,010,439 901,781 789,103 Policy acquisition costs ............. 301,670 268,657 267,399 Other operating expenses ............. 62,335 59,733 50,675 Interest ............................. 7,727 7,292 4,960 ---------- ---------- ----------
Basic earnings per share ............... $ 1.94 $ 2.02 $ 2.45 ========== ========== ==========
Diluted earnings per share ............. $ 1.94 $ 2.02 2.44 ========== ========== ==========
One broker produced direct premiums written of approximately 17%, 18% and 19% of the Company's total direct premiums written during 2001, 2000 and 1999, respectively. No other agent or broker accounted for more than 2% of direct premiums written.
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.
Statement of Financial Accounting Standards No. 133, (SFAS No. 133) "Accounting for Derivative Instruments and Hedging Activities" became effective for fiscal years beginning after June 15, 1999. Statement of Financial Accounting Standards No. 137 (SFAS No. 137), "Accounting for Derivative Instruments and Hedging Activities-Deferral of the Effective Date of FASB Statement No. 133" defers the effective date of SFAS 133 to fiscal years beginning after June 15, 2000. The Company adopted this new Standard on January 1, 2001 and it had no impact on the Consolidated Financial Statements.
At December 31, 2001, the cash balance includes $3,000,000 of restricted cash related to the Concord transaction (See Note 8).
Interest paid during 2001, 2000, and 1999 was $4,610,000, $7,357,000 and $4,758,000, respectively. Income taxes paid were $20,089,000 in 2001, $14,609,000 in 2000 and $33,102,000 in 1999.
The tax benefit realized on stock options exercised and included in cash provided from operations in 2001, 2000 and 1999 was $588,000, $550,000 and $152,000, respectively.
Year ended December 31, (Amounts in thousands) ------------------------------ 2001 2000 1999 -------- -------- -------- Interest and dividends on fixed maturities ... $ 95,187 $ 86,644 $ 78,559 Dividends on equity securities ............... 17,080 17,136 18,885 Interest on short-term cash investments ...... 3,295 3,380 2,840 -------- -------- -------- Total investment income ............... 115,562 107,160 100,284 Investment expense ........................... 1,051 694 910 -------- -------- -------- Net investment income ................. $114,511 $106,466 $ 99,374 ======== ======== ========
Equity securities available for sale: Gross realized gains .................. $ 5,205 $ 5,259 $ 5,506 Gross realized losses ................. (2,760) (1,621) (11,536) ------- ------- -------- Net ............................. $ 2,445 $ 3,638 $ (6,030) ======= ======= ========
Equity securities ..................... $ (2,055) $ 30,930 $ (28,309) Income tax expense (benefit) .......... (720) 10,825 (9,909) -------- -------- --------- $ (1,335) $ 20,105 $ (18,400) ======== ======== =========
December 31, (Amounts in thousands) 2001 2000 -------- -------- Fixed maturities available for sale: Unrealized gains ...................... $ 56,541 $ 60,318 Unrealized losses ..................... (30,288) (14,741) Tax effect ............................ (9,188) (15,952) -------- -------- $ 17,065 $ 29,625 ======== ========
The amortized costs and estimated market values of investments in fixed maturities available for sale as of December 31, 2001 are as follows:
At December 31, 2001, bond holdings rated below investment grade totaled approximately 1.7% of total investments. The average Standard and Poor's rating of the bond portfolio was A. The amortized cost and estimated market value of fixed maturities available for sale at December 31, 2001 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.
Estimated Amortized Market Cost Value ---------- ---------- (Amounts in thousands) ----------------------- Fixed maturities available for sale: Due in one year or less ....................... $ 2,392 $ 2,459 Due after one year through five years ......... 89,275 90,451 Due after five years through ten years ........ 267,464 262,046 Due after ten years ........................... 1,201,049 1,231,477 ---------- ---------- $1,560,180 $1,586,433 ========== ==========
Land ....................................... $ 10,524 $ 6,084 Buildings .................................. 25,088 23,291 Furniture and equipment .................... 56,880 46,666 Leasehold improvements ..................... 415 598 -------- -------- 92,907 76,639 Less accumulated depreciation .............. (48,459) (41,431) -------- -------- Net fixed assets ........................... $ 44,448 $ 35,208 ======== ========
The Company had outstanding debt at December 31, 2001 of $129.5 million. Included in the total debt is the proceeds from an August 7, 2001, public debt offering where the Company issued $125 million of senior notes payable under a $300 million shelf registration filed with the SEC in July 2001. The notes are unsecured, senior obligations of the Company with a 7.25% annual coupon payable on August 15 and February 15 each year commencing February 15, 2002. The notes mature on August 15, 2011. The Company incurred debt issuance costs of approximately $1.3 million, inclusive of underwriter's fees. These costs are deferred and then amortized as a component of interest expense over the term of the notes. The notes were issued at a slight discount at 99.723%, making the effective annualized interest rate including debt issuance costs
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, 2001, the Company was carrying a note payable for $4.8 million, which represents the discounted value of the six remaining annual payments using a 7% rate.
Prior to the $125 million senior note issuance, the Company had $75 million payable under a revolving credit facility due November 21, 2001 and $27 million payable under a $30 million revolving credit facility due October 26, 2001. The interest rate on these two loans was variable and through August 7, 2001 was priced off of the Eurodollar London Interbank Rate (LIBOR) making the effective interest rate 5.77% and 5.78%, respectively. On August 7, 2001, the Company repaid the entire balance of both the $75 million and $27 million borrowings with proceeds received from the $125 million senior note issuance. The Company also terminated the $75 million revolving credit facility. The $30 million facility that expired on October 26, 2001 was not renewed.
Year ended December 31, (Amounts in thousands) ------------------------------ 2001 2000 1999 -------- -------- -------- Federal Current ............... $ 21,377 $ 20,270 $ 36,535 Deferred .............. (2,546) (1,236) (2,123) -------- -------- -------- $ 18,831 $ 19,034 $ 34,412 ======== ======== ======== State Current ............... $ 196 $ 155 $ 418 Deferred .............. 443 -- -- -------- -------- -------- $ 639 $ 155 $ 418 ======== ======== ======== Total Current ............... $ 21,573 $ 20,425 $ 36,953 Deferred .............. (2,103) (1,236) (2,123) -------- -------- -------- Total ............ $ 19,470 $ 19,189 $ 34,830 ======== ======== ========
December 31, (Amounts in thousands) ---------------------- 2001 2000 -------- -------- Deferred tax assets 20% of net unearned premium ................... $ 30,363 $ 25,920 Discounting of loss reserves and salvage and subrogation recoverable for tax purposes ..................................... 10,553 9,445 Other deferred tax assets ................... 8,850 5,966 -------- -------- Total gross deferred tax assets ........... 49,766 41,331 Less valuation allowance ................. -- -- -------- -------- Net deferred tax assets .................. 49,766 41,331 -------- --------
Deferred tax liabilities Deferred acquisition costs .................. (32,652) (27,623) Tax liability on net unrealized gain on securities carried at market value ......... (9,140) (16,623) Tax depreciation in excess of book depreciation ............................... (941) (1,167) Accretion on bonds .......................... (3,629) (2,962) Other deferred tax liabilities .............. (2,152) (1,292) -------- -------- Total gross deferred tax liabilities ...... (48,514) (49,667) -------- -------- Net deferred tax assets (liabilities) ..... $ 1,252 $ (8,336) ======== ========
Although the ultimate outcome of these audits is uncertain, management believes the Company will prevail for all years under audit. Accordingly, no provision for additional state income tax liabilities has been made in the consolidated financial statements.
Increases in prior years incurred losses in 2001, 2000 and 1999 largely relate to increases in the severity estimates on bodily injury and physical 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 2001, the Company began writing Texas automobile risks that were previously placed through third-party Texas county mutual insurers and 100% reinsured by the Company, directly with MCM. Risks produced by the Company that are written directly through MCM are 100% ceded to affiliated Mercury Companies.
The MCM transaction was accounted for using the purchase method of accounting and resulted in a small amount of an intangible asset. As required by SFAS No. 142, the Company has assessed the asset which at December 31, 2001 was $9.3 million and determined that it is not impaired. Also, per SFAS No. 142, the Company will no longer amortize this asset after 2001 as it has an indefinite life. Total amortization expense in 2001 related to this asset was $1.0 million.
The Insurance Companies are subject to the financial capacity guidelines established by the Office of the Commissioner of Insurance of their domiciliary states. The payment of dividends from statutory unassigned surplus of the Insurance Companies is restricted, subject to certain statutory limitations. For the year 2002, the direct insurance subsidiaries of the Company are permitted to pay approximately $102 million in dividends to the Company without the prior approval of the Commissioner of Insurance of the state of domicile. The above statutory regulations may have the effect of indirectly limiting the ability of the Company to pay dividends. During 2001 and 2000, the Insurance Companies paid dividends to Mercury General Corporation of $60.0 million and $62.5 million, respectively.
The Insurance Companies' statutory net income, as reported to regulatory authorities, was $93,720,000, $103,937,000 and $135,667,000 for the years ended December 31, 2001, 2000 and 1999, respectively. The statutory policyholders' surplus of the Insurance Companies, as reported to regulatory authorities, as of December 31, 2001 and 2000 was $1,045,104,000 and $954,753,000, respectively.
The Company has estimated the Risk-Based Capital Requirements of each of the Insurance Companies as of December 31, 2001 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 $4,428,000, $4,138,000 and $3,320,000 for the years ended December 31, 2001, 2000 and 1999, respectively.
The Company, at the option of the Board of Directors, may make annual contributions to an employee profit sharing plan. The contributions are not to exceed the greater of the Company's net income for the plan year or its retained earnings at that date. In addition, the annual contributions may not exceed an amount equal to 15% of the compensation paid or accrued during the year to all participants under the plan. The annual contribution was $1,300,000, $1,100,000 and $1,100,000 for plan years ended December 31, 2001, 2000 and 1999, respectively.
The Profit Sharing Plan also includes an option for employees to make salary deferrals under Section 401(k) of the Internal Revenue Code. Company matching contributions, at a rate set by the Board of Directors, totaled $1,787,000, $1,805,000, and $1,878,000 for the plan years ended December 31, 2001, 2000 and 1999.
Effective March 11, 1994 the Profit Sharing Plan also includes a leveraged employee stock ownership plan ("ESOP") that covers substantially all employees. The Company makes annual contributions to the ESOP equal to the ESOP's debt service less dividends received by the ESOP. Dividends received by the ESOP on unallocated shares are used to pay debt service and the ESOP shares serve as collateral for its debt. As the debt is repaid, shares are released from collateral and allocated to employees, based on the proportion of debt service paid in the year. The Company accounts for its ESOP in accordance with Statement of Position 93-6.
Accordingly, the debt of the ESOP, which was $2,000,000, $3,000,000, and $4,000,000 at December 31, 2001, 2000 and 1999, respectively, is recorded in the balance sheet as other liabilities. The shares pledged as collateral are reported as unearned ESOP compensation in the shareholders' equity section of the balance sheet. As shares are committed to be released from collateral, the Company reports compensation expense equal to the market price of the shares, and reduces unearned ESOP compensation by the original cost of the shares. The difference between the market price and cost of the shares is charged to common stock. As shares are committed to be released from collateral, the shares become outstanding for earnings-per-share computations. Dividends on allocated ESOP shares are recorded as a reduction of retained earnings; dividends on unallocated ESOP shares are recorded as a reduction of accrued interest. ESOP compensation expense was $862,000, $642,000, and $746,000 in 2001, 2000 and 1999, respectively. The ESOP shares as of December 31 were as follows:
Dividends paid per-share in 2001, 2000 and 1999 were $1.06, $0.96 and $0.84, respectively and dividends paid in total in 2001, 2000 and 1999 were $57,430,000, $51,910,000 and $45,854,000, respectively.
As explained in Note 1, the Company applies APB Opinion No. 25 in accounting for its stock option plan. Accordingly, no compensation cost has been recognized in the Consolidated Statements of Income. Had compensation cost for the Company's Plans been determined based on the fair value at the grant dates consistent with the method of SFAS No. 123, the Company's net income would have been reduced by $459,000, $395,000 and $542,000 in 2001, 2000 and 1999, respectively, and earnings per share (basic and diluted) would have been reduced by $.01 in 2001, 2000 and 1999. Calculations of the fair value under the method prescribed by SFAS No. 123 were made using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 2001, 2000 and 1999: dividend yield of 2.4 percent for 2001, 2.2 percent for 2000 and 3.8 percent for 1999, expected volatility of 34.2 percent in 2001, 33.4 percent in 2000 and 31.6 percent for 1999 and expected lives of 6 years in 2001 and 7 years in 2000 and 1999. The risk-free interest rates used were 4.9 percent for the options granted during 2001, 6.4 percent for the options granted during 2000 and 5.6 percent for the options granted during 1999.
A summary of the status of the Company's plans as of December 31, 2001, 2000 and 1999 and changes during the years ending on those dates is presented below: