In October 1992, the Company purchased a 158,000 square foot office building in Brea, California. The Company occupies approximately 81% of the facility and leases the remaining office space to others.
The Company leases all of its other office space. Office location is not material to the Company's operations, and the Company anticipates no difficulty in extending these leases
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. Except for the April 1, 1998 rate change, the rate changes made over the last several years have been substantially revenue-neutral overall, with physical damage rates being increased and bodily injury liability rates decreased. The rate change made effective May 1, 1994 resulted in a substantial increase in new business being submitted to the Company. The subsequent rate modifications have allowed the Company to maintain growth in policy count. Since March 31, 1994, Private Passenger Automobile ("PPA") policies in force in California have increased from approximately 300,000 to 775,000 at December 31, 1999, an annual rate of increase of approximately 18%. Policy count growth for the year 1999 was at a 4% rate reflecting increased competition in the marketplace.
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.
Year Ended December 31, 1999 Compared to Year Ended December 31, 1998 ---------------------------------------------------------------------
Investment income in 1999 was $99.4 million, compared with $96.2 million in 1998. The after-tax yield on average investments of $1,595.5 million (cost basis) was 5.62%, compared with 5.92% on average investments of $1,474.0 in 1998.
The effective tax rate on investment income was 9.8% in 1999, compared to 9.3% 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. Due to a recent rising interest rate environment, the Company expects the impact of redemptions to be less significant in future periods. Bonds matured and called in 1999 totaled $49.2 million, compared to $65.3 million in 1998. Approximately $24.1 million of bonds are expected to mature or be called in 2000. Average yields being obtained during the first quarter of 2000 are 10 to 20 basis points higher than the average yield realized during 1999.
The income tax provision of $34.8 million in 1999 represented an effective tax rate of 20.7%, compared with an effective rate of 24.5% in 1998. The lower rate in 1999 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%.
Net income in 1999 was $133.7 million or $2.44 per share (diluted), compared with $177.5 million or $3.21 per share (diluted), in 1998. Diluted per share results are based on 54.8 million average shares in 1999 and 55.4 million shares in 1998. Basic per share results were $2.45 in 1999 and $3.23 in 1998.
The loss ratio in 1998 (loss and loss adjustment expenses related to premiums earned) was 61.0%, compared with 63.5% in 1997. The favorable loss experience was largely related to the effectiveness of Proposition 213, an initiative made effective January 1, 1997 which prohibits recovery of non- economic (pain and suffering) losses by uninsured motorists or drunk drivers injured in automobile accidents. The 7% rate reduction beginning on April 1, 1998 negatively affected the Company's loss ratio during a large portion of 1998. The full impact of the rate reduction on the Company's loss ratio will be felt in 1999 and succeeding periods.
Total losses and expenses in 1998, excluding interest expense of $4.8 million, were $982.0 million, resulting in an underwriting gain for the period of $139.6 million, compared with an underwriting gain of $118.1 million in 1997.
Realized gain from sale of subsidiaries of $2.6 million was derived from the sale for cash of Cimmaron Insurance Company, an inactive company acquired in the American Mercury Insurance Group purchase made in December 1996.
The amortized cost of all investments held at market as "Available for Sale" exceeded the market value of $1,575.5 million at December 31, 1999 by $60.7 million. That unrealized loss, reflected in shareholders' equity, as Accumulated Other Comprehensive Loss, net of applicable tax effects, was $39.5 million at December 31, 1999 compared with an unrealized gain of $51.2 million at December 31, 1998. The decrease in market values since December 31, 1998 reflects principally the substantial increase in intermediate and long term interest rates during 1999.
Traditionally, it has been the Company's policy not to invest in high yield or "junk" bonds. In 1995, the Company adopted a policy to place a small proportion of its investments in the taxable sector in bonds rated lower than investment grade, but not lower than Ba by Moody's or BB by Standard & Poor's. At December 31, 1999 bond holdings rated below investment grade totaled $16.3 million at market (cost $16.6 million), or 1% of total investments. The average rating of the $1,322.4 million bond portfolio (at amortized cost) was AA, while the average effective maturity, giving effect to anticipated early call, approximates 11.5 years. The modified duration of the bond portfolio at year-end was 7.8 years, reflecting the heavy weighting of high coupon issues, including housing issues subject to sinking funds, and other issues which are pre-refunded or are expected to be called prior to their maturity. Duration measures the length of time it takes to receive all the cash flows produced by a bond, including reinvestment of interest. 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, within the tax-exempt sector, consist largely of high coupon revenue issues, many of which have been pre-refunded and escrowed with U.S. Treasuries. General obligation bonds of the large eastern cities have generally been avoided. Holdings in the taxable sector consist largely of senior public utility issues. Fixed-maturity investments of $1,353.8 million (amortized cost), include $31.4 million (amortized cost) of sinking fund preferreds, principally utility issues. The cost of all fixed maturities exceeded market value by $31.7 million at December 31, 1999. The only securities held which may be considered derivatives are a small amount of adjustable rate preferred stocks.
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, 1999. Each of the companies' policyholders' surplus exceeded the highest level of minimum required capital.
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 is currently evaluating the impact that it will have on the Consolidated Financial Statements. The Company will adopt this new standard on January 1, 2001.
The Year 2000 issue was the result of many computer programs being written using two digits rather than four digits to define the applicable year. Computer programs that had date-sensitive software might recognize a date using "00" as the year 1900 rather than the year 2000, or as no date. This could have resulted on and after January 1, 2000 in a system failure or miscalculations causing disruptions of operation.
We have audited the accompanying consolidated balance sheets of Mercury General Corporation and subsidiaries as of December 31, 1999 and 1998, 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, 1999. 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, 1999 and 1998, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1999, in conformity with generally accepted accounting principles.
The Company is primarily engaged in the underwriting of private passenger automobile insurance in the state of California. In 1999 and 1998 over 90% of the net written premiums were from California.
Net premiums written during 1999, 1998 and 1997 were $1,206,171,000, $1,144,051,000, and $1,086,241,000, respectively.
One agent produced direct premiums written of approximately 19%, 19% and 18% of the Company's total direct premiums written during 1999, 1998 and 1997, respectively. This agency was sold during 1998 to a large national broker. The buyer has continued producing business for the Company at levels consistent with recent prior years' premium levels. No other agent accounted for more than 2% of direct premiums written.
Statement of Financial Accounting Standards No. 130 (SFAS No. 130), "Reporting Comprehensive Income," effective for fiscal years beginning after December 15, 1997 was adopted by the Company during 1998. The Company is reporting comprehensive income for the same periods presented on the Consolidated Statements of Income. The implementation of SFAS No. 130 had no effect on the financial position or results of operations of the Company.
At December 31, 1999, the cash balance includes $3,000,000 of restricted cash related to the Concord transaction (See Note 8).
Interest paid during 1999, 1998, and 1997 was $4,758,000, $4,494,000 and $5,077,000, respectively. Income taxes paid were $33,102,000 in 1999, $65,984,000 in 1998 and $52,611,000 in 1997.
The Company accounts for stock-based compensation under the accounting methods prescribed
by Accounting Principles Board (APB) Opinion No. 25, as allowed by Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation"(SFAS No. 123). Disclosure of stock-based compensation determined in accordance with SFAS No. 123 is presented in Note 14.
Year ended December 31, (Amounts in thousands) ------------------------------ 1999 1998 1997 ---- ---- ---- Balance, beginning of year................. $ 61,947 $ 57,264 $ 46,783 Costs deferred during the year............. 269,427 257,275 235,364 Amortization charged to expense............ (267,399) (252,592) (224,883) ------- ------- --------- Balance, end of year....................... $ 63,975 $ 61,947 $ 57,264 ======== ======== =========
(5) Notes Payable Notes payable at December 31, 1999 consist of two revolving credit facilities with a consortium of banks. A November 21, 1996 credit facility provides for an aggregate commitment of $75 million, of which $75 million has been drawn and is outstanding. The $75 million notes are due November 21, 2002. This due date may be extended annually for additional periods of one year to maintain the three-year maturity date. The other outstanding debt consists of a 364 day $100 million line of credit dated October 28, 1999. The outstanding draw at December 31, 1999 on this line of credit is $17 million and is due on October 26, 2000.
The $75 million and $100 million credit facilities are subject to a commitment fee on the undrawn balances of 0.15% and 0.125%, respectively. In addition, the $100 million credit facility imposes a utilization fee of 0.05% on the outstanding debt of both lines of credit if the aggregate principal outstanding balance of both lines of credit exceeds 66 2/3% of the sum of the aggregate commitments. For both debts, the interest rate is variable and is optionally related to the Federal Funds rate, Bank of New York prime rate or the Eurodollar London
Year ended December 31, (Amounts in thousands) ----------------------- 1999 1998 1997 ---- ---- ---- Federal Current................................ $36,535 $57,237 $54,447 Deferred............................... (2,123) 190 (1,265) ------ ------ ------ $34,412 $57,427 $53,182 ====== ====== ====== State
December 31, (Amounts in thousands) ------------------------ 1999 1998 ---- ---- Deferred tax assets 20% of net unearned premium $ 24,264 $ 22,951 Tax asset on net unrealized loss on securities carried at market value........ 21,253 -- Discounting of loss reserves and salvage and subrogation recoverable for tax purposes.................................... 8,383 6,732 Write-down of other than temporarily impaired investments...................... 2,116 -- Other deferred tax assets.................. 1,172 1,101 -------- -------- Total gross deferred tax assets.......... 57,188 30,784 Less valuation allowance................ -- -- -------- -------- Net deferred tax assets................. 57,188 30,784 -------- --------
Net reserves for losses and loss adjustment expenses at end of year................... 418,800 385,816 386,270 Reinsurance recoverable.................... 16,043 20,160 22,791 ------- ------- ------- Gross reserves, end of year................ $434,843 $405,976 $409,061 ======= ======= =======
Decreases in prior years incurred losses in 1998 reflects the favorable loss experience during these years attributed to a number of combined factors which have produced favorable frequency and severity trends.
The increase in prior years incurred losses in 1997 reflects increases in the Company's estimate of loss adjustment expenses.
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 2000, the direct insurance subsidiaries of the Company are permitted to pay approximately $101 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.
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, 1999, there were no material permitted statutory accounting practices utilized by the Insurance Companies.
The Company has estimated the Risk-Based Capital Requirements of each of its insurance subsidiaries as of December 31, 1999 according to the formula issued by the NAIC. Each of the companies' policyholders' surplus exceeded the highest level of minimum required capital.
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, 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 $1,100,000 for each plan year ended December 31, 1999 and 1998 and $1,000,000 for the plan year ended December 31, 1997.
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 $1,878,000, $1,648,000, and $1,349,000 for the plan years ended December 31, 1999, 1998 and 1997.
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 $4,000,000, $5,000,000, and $2,000,000 at December 31, 1999, 1998 and 1997, 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 $746,000, $970,000, and $5,368,000 in 1999, 1998 and 1997, respectively. The ESOP shares as of December 31 were as follows:
(13) Profit Sharing Plan (Continued) 1999 1998 ---- ---- Allocated shares 23,000 -- Shares committed-to-be released 23,000 23,000 Unreleased shares 69,000 92,000 --------- --------- Total ESOP shares 115,000 115,000 ========== ========= Market value of unreleased shares at December 31, $1,535,000 $4,031,000 ========= =========
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 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, 1999 no awards other than options have been granted.
A summary of the status of the Company's plans as of December 31, 1999, 1998 and 1997 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, 1999: