In October 1992 the Company purchased a 158,000 square foot office building in Brea, California. The Company occupies approximately 59% of the facility and leases the remaining office space to others.
The Company leases all of its other offices under short-term leases. Office location is not material to the Company's operations, and the Company anticipates no difficulty in extending these leases or obtaining comparable office space.
In California, as in various other states, all property and casualty rates must be approved by the Insurance Commissioner before they can be used.
In September 1996, the California Insurance Commissioner issued new permanent rating factor regulations designed to implement the requirements that automobile insurance rates be determined by (1) driving safety record, (2) years
The new permanent regulations replaced emergency regulations which had been in use since their issuance in 1989. The new regulations required all automobile insurers in California to submit new rating plans complying with the regulations in early 1997. The Company submitted its new proposed rating plan on March 11, 1997.
In February 1998, the Company filed new reduced rates with the California DOI. The overall rate reduction of approximately 7% will become effective on April 1, 1998.
Premiums earned in 1997 of $1,031.3 million (including $65.1 million contributed by AMI) increased 36.6%, primarily reflecting unit growth. Average premium per policy for the year declined slightly. Net premiums written in 1997 of $1,086.2 million (including $72.8 million contributed by AMI) increased 36.5% over a year earlier, continuing a growth trend which began in the second quarter of 1993. Growth in written premiums in California of 28.5% for all of 1997 was aided by a new California law that became effective January 1, 1997 which requires proof of insurance for the registration (new or renewal) of a motor vehicle. The greater part of the new business generated by the new law occurred in the first half of 1997, and provided for only the minimum liability coverage required by law. The average premium on this business was substantially less than that produced by full coverage policies, which constitute a majority of the Company's total premium volume.
The loss ratio in 1997 (loss and loss adjustment expenses related to premiums earned) was 63.5%, compared with 66.5% in 1996. The improvement in loss experience in 1997 is in large part related to the effectiveness of Proposition 213, an initiative passed by a large majority of California voters in November 1996 which prohibits recovery of non-economic losses by uninsured motorists or drunk drivers injured in automobile accidents. The 1997 loss ratio reflects deficiencies from unfavorable development on allocated loss adjustment expenses from prior periods. The initial estimates were based principally on the Company's actual experience and did not fully reflect the increases in the legal expenses of defending the Company's insureds arising from the Company's policy
of aggressively defending, including litigating, exaggerated bodily injury claims arising from minimal impact automobile accidents.
The expense ratio (policy acquisition costs and other operating expenses related to premiums earned) was 25.1% in 1997 and 24.5% 1996. The increase in the expense ratio in 1997 reflects increased provisions for profit-related bonuses to both agents and employees and the inclusion of the operating results of AMI for a full year.
The income tax provision of $53.5 million in 1997 represented an effective tax rate of 25.5%, compared with an effective rate of 22.6% in 1996. The increase in the rate is attributable to the increased proportion of realized gains and the increase in underwriting gains, both of which are taxed at the full corporate rate of 35%, in contrast to investment income which consists primarily of tax-exempt interest and tax sheltered dividend income.
Net income in 1997 was $156.3 million, or $2.84 per share, (basic), compared with $105.8 million, or $1.93 per share, (basic), in 1996. Basic share results are based on 55.0 million average shares in 1997 and 54.8 million average shares in 1996, adjusted for a two-for-one stock split effective September 16, 1997. Diluted per share results, calculated in accordance with new accounting standards, were $2.82 in 1997 and $1.92 in 1996.
Net income in 1996 was $105.8 million, or $1.93 per share (Basic), compared with $90.3 million, or $1.65 per share (Basic), in 1995. Basic per share results are based on 54.8 million average shares in 1996 and 54.6 million average shares in 1995 adjusted for a two-for-one stock split effective September 16, 1997. Diluted per share results, calculated in accordance with new accounting standards, were $1.92 in 1996 and $1.65 in 1995.
Net cash provided from operating activities in 1997, was $268.2 million, while funds derived from the sale, redemption or maturity of investments was $734.0 million, of which approximately 80% was represented by the sale of equity securities. The amortized cost of fixed-maturity investments increased by $222.8 million during the year. Equity investments, including perpetual preferred stocks, increased by $21.7 million at cost, while short-term cash investments decreased by $6.3 million. The amortized cost of fixed-maturities available for sale that were sold, called or matured during the year was $142.4 million.
The market value of all investments held at market as "Available for Sale" exceeded the amortized cost of $1,377.3 million at December 31, 1997 by $71.0 million. That unrealized gain, reflected in shareholders' equity net of applicable tax effects, was $46.1 million at December 31, 1997 compared with an unrealized gain of $19.0 million at December 31, 1996. The increase in market values since December 31, 1996 reflects principally the substantial decline in intermediate and long term interest rates during 1997.
Holdings in the taxable sector consist largely of senior public utility issues. Fixed-maturity investments of $1,147.6 million (amortized cost), include $76.2 million (amortized cost) of sinking fund preferreds, principally utility issues. The market value of all fixed maturities exceeded cost by $67.4 million at December 31, 1997. 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, 1997 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 AMI, 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 November 23, 1998, LIBOR plus .50, the net interest cost on the loan approximates 6.125%.
In March 1994, the Company's Employee Stock Ownership Plan (the "Plan") purchased 322,000 shares of Mercury General's common stock in the open market at a price of $14.875 per share, adjusted for the two-for-one stock split effective September 16, 1997. The purchases were funded by a five year term bank loan of $5.0 million to the Plan which is guaranteed by the Company. The shares have been allocated to employees over the amortization period of the loan, with the initial allocation made in December 1994. The remaining balance of the loan of $2.0 million is being retired in March 1998 with the proceeds of contributions to the Plan by the Company for the year 1997, and the remaining unallocated shares were credited to employees' ESOP balances at December 31, 1997. A new $5.0 million ESOP loan is currently being arranged with an amortization period of not more than five years. The proceeds of that loan will be used to purchase the Company's shares in the open market, with the shares to be allocated to employees over the amortization period beginning in December 1998. Since dividends on unallocated shares held by the Plan are tax deductible if they are used for debt service, as are Company contributions to the Plan, the net, after- tax interest cost to the Company for the borrowed funds used for the Plan stock purchase is less than the nominal fixed rate of interest on the loan, which, in 1997, was 6.98%.
In December 1993, the NAIC adopted a risk-based capital formula for casualty insurance companies which establishes recommended minimum capital requirements for casualty companies. The formula has been designed to capture the widely varying elements of risks undertaken by writers of different lines of
insurance having differing risk characteristics, as well as writers of similar lines where differences in risk may be related to corporate structure, investment policies, reinsurance arrangements and a number of other factors. The Company has estimated the Risk-Based Capital Requirements of each of its insurance subsidiaries as of December 31, 1997. Each of the companies' policyholders' surplus exceeded the highest level of recommended capital requirements.
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 of the licensed insurance subsidiaries of $679.4 million at December 31, 1997, and net written premiums for the twelve months ended on that date of $1,086.2 million, the ratio of writings to surplus was approximately 1.6 to 1.
The Year 2000 Issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any computer programs that have date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000, or as no date. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business activities.
While the Year 2000 considerations are not expected to materially impact the Company's internal operations, they may have an effect on some of the Company's agents, suppliers and financial institutions with whom the Company conducts business, and thus indirectly affect the Company. It is not possible to quantify the aggregate cost to the Company with respect to external Year 2000 problems, although the Company does not anticipate it will have a material adverse impact on its business.
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 AMI, and
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, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997, in conformity with generally accepted accounting principles.
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
During 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings per Share", which requires presentation of basic and diluted earnings per share for all publicly traded companies effective for fiscal years ending after December 15, 1997. Note 14 contains the required disclosures which make up the calculation of basic and diluted earnings per share.
Deferred income taxes result from temporary differences in the recognition of income and expense for tax and financial reporting purposes.
The amortized costs and estimated market values of investments in fixed maturities available for sale as of December 31, 1997 are as follows:
The amortized costs and estimated market values of investments in fixed maturities available for sale as of December 31, 1996 are as follows:
The Company utilizes repurchase agreements for investing funds overnight. All repurchase agreements utilized require U.S. Treasury securities or obligations of U.S. government corporations or agencies as collateral.
The terms of the loan agreement include certain affirmative and negative covenants, all of which are met by the Company at December 31, 1997.
Decreases in incurred losses relating to 1996 and 1995 reflects the favorable loss experience during these years attributable to a number of combined factors which have produced favorable frequency and severity trends.
Effective November 30, 1996 the Company acquired all of the issued and outstanding common stock of American Mercury 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 AMI. The acquisition was accounted for using the purchase method and resulted in a minimal amount of goodwill. The purchase agreement includes an indemnification by the seller on the loss and loss adjustment expense reserves of AMI 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.
AMI 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 1996 and all of 1997 are included in the consolidated financial statements of the Company.
The following unaudited proforma consolidated results of operations for 1996 give effect to the acquisition as though it had occurred at the beginning of each year presented:
The Insurance Companies prepare their statutory financial statements in accordance with accounting practices prescribed or permitted by the various state insurance departments. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners (NAIC), as well as state laws, regulations, and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. As of December 31, 1997, there were no material permitted statutory accounting practices utilized by the Insurance Companies. The NAIC is working on a project to codify statutory accounting practices, the result of which is expected to constitute the only source of "prescribed" statutory accounting practices. When complete, that project will most likely change the definition of prescribed versus permitted statutory accounting practices and may result in changes to the accounting policies that insurance enterprises use to prepare their statutory financial statements.
The Insurance Companies' statutory net income, as reported to regulatory authorities, was $147,255,000, $97,979,000, and $86,210,000 for the years ended December 31, 1997, 1996 and 1995, respectively. The statutory policyholders' surplus of the Insurance Companies, as reported to regulatory authorities, as of December 31, 1997 and 1996 was $679,359,000 and $594,799,000, respectively.
The Company is obligated under various noncancellable lease agreements providing for office space and equipment rental that expire at various dates through the year 2002. Total rent expense under these lease agreements, all of which are operating leases, was $1,885,000, $1,583,000 and $1,461,000 for the years ended December 31, 1997, 1996 and 1995, respectively.
The Company, at the option of the Board of Directors, may make annual con- tributions 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 $1,000,000 for each of the plan years ended December 31, 1997, 1996 and 1995.
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 $1,349,000, $955,000, and $773,000 for the plan years ended December 31, 1997, 1996 and 1995.
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, 1997, 1996 and 1995, 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 current 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 $5,368,000, $1,509,000 and $1,145,000 in 1997, 1996 and 1995, respectively. The ESOP shares as of December 31 were as follows:
The Company adopted a stock option plan in October 1985 (the "1985 Plan") under which 5,400,000 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,
5,400,000 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 1997, 1996 and 1995 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.
A summary of the status of the Company's plans as of December 31, 1997, 1996 and 1995 and changes during the years ending on those dates is presented below:
The following table summarizes information regarding the stock options outstanding at December 31, 1997: