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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1999 Commission File No. 0-3681
MERCURY GENERAL CORPORATION
(Exact name of registrant as specified in its charter)
California 95-221-1612
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
4484 Wilshire Boulevard, Los Angeles, California 90010
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (323)937-1060
Securities registered pursuant to Section 12(b) of the Act
Title of Class Name of Exchange on Which Registered
- -------------- -----------------------------------------
Common Stock New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act
NONE
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No___
---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
The aggregate market value of the Registrant's voting stock held by
non-affiliates of the Registrant at March 15, 2000, was approximately
$586,059,802 (based upon the closing sales price on the New York Stock Exchange
for such date, as reported by the Wall Street Journal).
At March 15, 2000, the Registrant had issued and outstanding an aggregate of
54,116,423 shares of its Common Stock.
Documents Incorporated by Reference
Portions of the definitive proxy statement for the Annual Meeting of
Shareholders of Registrant to be held on May 10, 2000 are incorporated herein by
reference into Part III hereof.
Item 1. Business
--------
General
Mercury General Corporation ("Mercury General") and its subsidiaries
(collectively, "the Company") are engaged primarily in writing all risk
classifications of automobile insurance in a number of states, principally
California. During 1999, private passenger automobile insurance and commercial
automobile insurance accounted for 91.9% and 3.7%, respectively, of the total
Company's direct premiums written. The percentage of direct automobile insurance
premiums written during 1999 by state was 92.9% in California, 2.5% in Florida,
1.6% in Oklahoma, 1.0% in Illinois, 1.0% in Texas, and 1.0% in Georgia. The
Company also writes homeowners insurance, mechanical breakdown insurance,
commercial and dwelling fire insurance and commercial property insurance. The
non-automobile lines of insurance accounted for 4.4% of direct written premiums
in 1999, of which approximately 35% was in commercial lines.
The Company offers automobile policyholders the following types of
coverage: bodily injury liability, underinsured and uninsured motorist, property
damage liability, comprehensive, collision and other hazards specified in the
policy. The Company's published maximum limits of liability for bodily injury
are $250,000 per person, $500,000 per accident and, for property damage,
$250,000 per accident. Subject to special underwriting approval, the combined
policy limits may be as high as $1,000,000 for vehicles written under the
Company's commercial automobile plan. However, under the majority of the
Company's automobile policies, the limits of liability are equal to or less than
$100,000 per person, $300,000 per accident and $50,000 for property damage.
In 1999, A.M. Best & Co. ("A.M. Best") assigned a rating of A+
(Superior) to all of the Company's insurance subsidiaries except American
Mercury Insurance Company ("AMIC") and American Mercury Lloyds Insurance Company
("AML"). This is the second highest of the fifteen rating categories in the A.M.
Best rating system, which range from A++ (Superior) to F (In Liquidation). AMIC
and AML, which accounted for approximately 5% of the Company's 1999 net written
premiums, were rated A-(Excellent) in 1999 by A.M. Best.
The principal executive offices of Mercury General are located in Los
Angeles, California. The home office of its California insurance subsidiaries
and the Company's computer and operations center is located in Brea, California.
The Company maintains branch offices in a number of locations in California as
well as a branch office in Clearwater, Florida. The non-California insurance
subsidiaries maintain offices in Vernon Hills, Illinois, Atlanta, Georgia and
Oklahoma City, Oklahoma. The Company also maintains offices in Austin, Dallas,
Fort Worth, Houston and San Antonio Texas, for a Texas insurance agency that it
controls (See Organization). The Company has approximately 2,500 employees.
Organization
Mercury General, an insurance holding company, is the parent of Mercury
Casualty Company ("Mercury Casualty"), a California automobile insurer founded
in 1961 by George Joseph, its Chief Executive Officer. Its insurance operations
in California are conducted through three California insurance company
subsidiaries, Mercury Casualty, Mercury Insurance Company ("Mercury Insurance"),
and California Automobile Insurance Company. Two subsidiaries, Mercury Insurance
Company of Georgia and Mercury Insurance Company of Illinois, received authority
in late 1989
2
to write automobile insurance in those two states. In 1992, Mercury Indemnity
Company of Georgia and Mercury Indemnity Company of Illinois were formed to
write preferred risk automobile insurance in those two states. Through the
Company's first acquisition in December 1996, three additional subsidiaries were
added to the group: American Fidelity Insurance Company, domiciled in Oklahoma;
Cimarron Insurance Company, domiciled in Kansas; and AFI Management Company,
Inc., a Texas corporation which serves as the attorney-in-fact for American
Fidelity Lloyds Insurance Company, a Texas insurer. Accordingly, their
operations are included in the consolidated financial statements of the Company
effective December 1, 1996. During 1997, the names of American Fidelity
Insurance Company and American Fidelity Lloyds Insurance Company were changed to
American Mercury Insurance Company and American Mercury Lloyds Insurance
Company, respectively. In June 1998, Cimarron Insurance Company was sold for
cash. Cimarron's results, which are not material to the Company's operations,
are included in the Company's 1998 operating results up to the sale date.
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. Concord's results of operations,
which are not material to the Company, are included in the consolidated
financial statements of the Company effective October 31, 1999.
Mercury General furnishes management services to its California,
Georgia, Illinois and Oklahoma subsidiaries. Mercury General, its subsidiaries,
AML and Concord, are referred to as the "Company" unless the context indicates
otherwise. Mercury General Corporation individually is referred to as "Mercury
General." The term "California Companies" refers to Mercury Casualty, Mercury
Insurance and California Automobile Insurance Company.
Underwriting
The Company sets its own automobile insurance premium rates, subject to
rating regulations issued by the Insurance Commissioners of the applicable
states. Automobile insurance rates on voluntary business in California have been
subject to prior approval by the California Department of Insurance ("DOI")
since November 1989. The Company uses its own extensive data base to establish
rates and classifications. The California DOI has in effect rating factor
regulations that influence the weight the Company ascribes to various
classifications of data.
At December 31, 1999, "good drivers" (as defined by the California
Insurance Code) accounted for approximately 74% of all voluntary private
passenger automobile policies in force in California, while the higher risk
categories accounted for approximately 26%. The renewal rate in California (the
rate of acceptance of offers to renew) averages approximately 95%.
In October 1998, the Company began offering a monthly pay policy
through its California Automobile Insurance Company subsidiary targeted at
higher risk drivers who do not fall into existing risk classifications. This
business accounts for less than 2% of the total voluntary private passenger
automobile policies in-force in California.
The Company's Oklahoma and Texas private passenger automobile business
in force, underwritten through AMI, is primarily standard and preferred risks.
AMI began offering a non-standard policy during 1998 in Texas. The amount of
non-standard policies in force at December 31, 1999 was insignificant.
3
The Company's Florida private passenger automobile business in force,
underwritten by Mercury Casualty Company, is primarily standard and preferred
risks. In December 1999, the Company began offering homeowners insurance to
Florida residents. The amount of Florida homeowners policies in force at
December 31, 1999 was not significant.
Production and Servicing of Business
The Company sells its policies through more than 1,800 independent
agents, of which approximately 900 are located in California, approximately 300
are located in Florida and approximately 590 others represent AMI in Oklahoma
and Texas. Approximately half of the agents in California have represented the
Company for more than ten years. The agents, most of whom also represent one or
more competing insurance companies, are independent contractors selected and
appointed by the Company.
One agency produced approximately 19%, 19% and 18% during 1999, 1998
and 1997, respectively, of the Company's total direct premiums written. This
agency was sold during 1998 to a large national broker. The buyer has continued
producing business for the Company at levels consistent with premium levels for
recent prior years. No other agent accounted for more than 2% of direct premiums
written.
The Company believes that its agents' compensation is higher than the
industry average. During 1999 total commissions and bonuses incurred averaged
16.9% of direct premiums written.
The Company has had in place since the fourth quarter of 1995 a
newspaper and direct mail advertising program. In April 1998, the advertising
program was expanded to include radio and billboard advertising. While the
majority of the advertising costs are borne by the Company, a portion of these
costs are borne by the Company's agents based upon the number of account leads
generated by the advertising. The Company intends to continue or may even expand
the current level of advertising program during the year 2000. The Company
believes that its advertising program is important to create brand awareness and
to remain competitive in the current insurance climate (See Competitive
Conditions).
Claims
Claims operations are conducted by the Company. The claims staff in
California, Georgia, Illinois, Florida and Oklahoma administers all claims and
directs all legal and adjustment aspects of the claims process. The Company
adjusts most claims without the assistance of outside adjusters.
Loss and Loss Adjustment Expense Reserves
The Company maintains reserves for the payment of losses and loss
adjustment expenses for both reported and unreported claims. Loss reserves are
estimated based upon a case-by-case evaluation of the type of claim involved and
the expected development of such claim. The amount of loss reserves and loss
adjustment expense reserves for unreported claims are determined on the basis of
historical information by line of insurance. Inflation is reflected in the
reserving process through analysis of cost trends and reviews of historical
reserving results.
The ultimate liability may be greater or lower than stated loss
reserves. Reserves are closely monitored and are analyzed quarterly by the
Company's actuarial consultants using new
4
information on reported claims and a variety of statistical techniques. The
Company does not discount to a present value that portion of its loss reserves
expected to be paid in future periods. The Tax Reform Act of 1986 does, however,
require the Company to discount loss reserves for Federal income tax purposes.
The following table sets forth a reconciliation of beginning and ending
reserves for losses and loss adjustment expenses, net of reinsurance deductions,
as shown on the Company's consolidated financial statements for the periods
indicated.
Year ended December 31,
----------------------------------------
1999 1998 1997
---- ---- ----
(Amounts in thousands)
Net reserves for losses and loss adjustment
expenses, beginning of year..................... $385,816 $386,270 $311,754
Incurred losses and loss adjustment expenses:
Provision for insured events of the
current year............................ 781,316 693,877 641,911
Increase (decrease) in provision for
Insured events of prior years........... 7,787 (9,409) 12,818
------- ------- -------
Total incurred losses and loss adjustment
expenses.............................. 789,103 684,468 654,729
------- ------- -------
Payments:
Losses and loss adjustment expenses attribu-
table to insured events of the current
year..................................... 492,314 437,612 373,823
Losses and loss adjustment expenses attribu-
table to insured events of prior years... 263,805 247,310 206,390
------- ------- -------
Total payments........................... 756,119 684,922 580,213
------- ------- -------
Net reserves for losses and loss adjustment
expenses at the end of the period............... 418,800 385,816 386,270
Reinsurance recoverable ......................... 16,043 20,160 22,791
------- ------- -------
Gross liability at end of year................... $434,843 $405,976 $409,061
======= ======= =======
The AMI 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.
Losses incurred through 1999 include approximately $0.5 million of
adverse development related to acquisition date loss reserves of AMI. As per
guidance provided by Financial Accounting Standards Board (FASB) release EITF
D-54, the Company has recorded the effects of the reserve guarantee separately
rather than netting the effect directly against the loss reserve and loss
expense accounts.
The difference between the reserves reported in the Company's
consolidated financial statements prepared in accordance with generally accepted
accounting principles ("GAAP") and those reported in the statements filed with
the Department of Insurance in accordance with
5
statutory accounting principles ("SAP") is shown in the following table:
December 31,
1999 1998 1997
---- ---- ----
(Amounts in thousands)
Reserves reported on a SAP basis......... $418,800 $385,816 $386,270
Reinsurance recoverable.................. 16,043 20,160 22,791
-------- -------- --------
Reserves reported on a GAAP basis........ $434,843 $405,976 $409,061
======== ======== ========
Under SAP reserves are stated net of reinsurance recoverable in
contrast to GAAP where reserves are stated gross of reinsurance recoverable.
The following table represents the development of loss reserves for the
period 1989 through 1999. The top line of the table shows the reserves at the
balance sheet date net of reinsurance recoverable for each of the indicated
years. This represents the estimated amount of losses and loss adjustment
expenses for claims arising in all prior years that are unpaid at the balance
sheet date, including losses that had been incurred but not yet reported to the
Company. The upper portion of the table shows the cumulative amounts paid as of
successive years with respect to that reserve liability. The lower portion of
the table shows the reestimated amount of the previously recorded reserves based
on experience as of the end of each succeeding year, including cumulative
payments made since the end of the respective year. The estimate changes as more
information becomes known about the frequency and severity of claims for
individual years. A redundancy (deficiency) exists when the original reserve
estimate is greater (less) than the re-estimated reserves at December 31, 1999.
In evaluating the information in the table, it should be noted that
each amount includes the effects of all changes in amounts for prior periods.
This table does not present accident or policy year development data. Conditions
and trends that have affected development of the liability in the past may not
necessarily occur in the future. Accordingly, it may not be appropriate to
extrapolate future redundancies or deficiencies based on this table.
6
As of December 31,
_______________________________________________________________________________________________
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
(Amounts in thousands)
Net reserves for
losses and loss
adjustment expenses. $291,408 $301,354 $280,157 $239,203 $214,525 $223,392 $250,990 $311,754 $386,270 $385,816 $418,800
Paid (cumulative)
as of:
One year later..... 167,850 181,781 151,866 135,188 143,272 145,664 167,226 206,390 247,310 263,805
Two years later.... 227,503 238,030 197,640 184,119 187,641 198,967 225,158 283,914 338,016
Three years later.. 249,371 254,884 213,824 197,371 204,606 214,403 248,894 308,867
Four years later... 256,659 261,058 218,067 201,365 207,704 219,596 253,708
Five years later... 259,147 263,011 220,057 202,383 209,930 220,852
Six years later.... 259,781 262,741 220,313 203,578 210,281
Seven years later.. 259,769 262,770 221,098 203,461
Eight years later.. 259,769 263,527 220,974
Nine years later... 260,444 263,422
Ten years later.... 260,336
Net reserves re-estimated as of:
One year later..... 269,934 285,212 230,991 204,479 204,451 216,684 247,122 324,572 376,861 393,603
Two years later.... 269,652 265,618 218,404 204,999 207,089 222,861 254,920 329,210 378,057
Three years later.. 259,635 259,624 220,620 203,452 210,838 221,744 257,958 327,749
Four years later... 256,694 264,259 221,118 204,603 210,890 222,957 257,196
Five years later... 260,365 264,127 221,264 203,705 211,192 221,947
Six years later.... 260,402 263,336 220,721 204,161 210,739
Seven years later.. 260,098 263,045 220,974 203,775
Eight years later.. 260,031 263,341 220,895
Nine years later... 260,233 263,292
Ten years later.... 260,203
Net Cumulative Redundancy
(deficiency)....... 31,205 38,062 59,262 35,428 3,786 1,445 (6,206) (15,995) 8,213 (7,787)
As of December 31,
------------------------------------------------------------------------------------------------
1992 1993 1994 1995 1996 1997 1998 1999
---- ---- ---- ---- ---- ---- ---- ----
(Amounts in thousands)
Gross liability - end of year 240,183 215,301 227,499 253,546 336,685 409,061 405,976 434,843
Reinsurance recoverable (980) (776) (4,107) (2,556) (24,931) (22,791) (20,160) (16,043)
------- ------- ------- ------- ------- ------- ------- -------
Net liability - end of year 239,203 214,525 223,392 250,990 311,754 386,270 385,816 418,800
======= ======== ======== ======= ======== ======= ======= =======
Gross re-estimated liability - latest 209,951 218,028 234,858 266,865 355,302 402,926 415,055
Re-estimated recoverable - latest (6,176) (7,289) (12,911) (9,669) (27,553) (24,869) (21,452)
------- ------- ------- ------- ------- ------- -------
Net re-estimated liability - latest 203,775 210,739 221,947 257,196 327,749 378,057 393,603
======= ======= ======= ======= ======= ======= =======
Gross cumulative redundancy (deficiency) 30,232 (2,727) (7,359) (13,319) (18,617) 6,135 (9,079)
======= ======= ======= ======= ======= ======= =======
For the calendar year 1998, the Company's previously estimated loss
reserves produced a deficiency which was reflected in 1999 incurred losses. The
Company attributes a large portion of the deficiency to an increase in the
ultimate liability for bodily injury claims over what was established as a
reserve on accident year 1998 and 1997 claims at calendar year-end 1998. The
Company has experienced a general downward trend in the average bodily injury
cost per claim. The actual decreases in average costs for the bodily injury
claims for the 1998 and 1997 accident years proved to be less significant when
developed through year-end 1999 than was originally projected for at year-end
1998.
For the calendar year 1997, the Company's previously estimated loss
reserves produced a redundancy. The Company attributes the favorable loss
development primarily to the effect of Proposition 213, a California initiative
passed in November 1996 that prevents uninsured motorists, drunk drivers and
fleeing felons from collecting awards for "pain and suffering." See
Regulations - California Financial Responsibility Law. This new law produced an
overall reduction in loss severity for calendar year 1997. In addition, a new
law, effective January
7
1, 1997 requiring proof of insurance before registration of a motor vehicle
resulted in a much smaller pool of uninsured motorists, thereby decreasing the
frequency of uninsured motorists claims. See Regulations-California Financial
Responsibility Law.
For the calendar years 1995 and 1996, the Company's previously
estimated loss reserves produced deficiencies. These deficiencies relate to
increases in the Company's ultimate estimates for loss adjustment expenses which
are based principally on the Company's actual experience. The adverse
development on such reserves reflects 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.
For the calendar years 1989 through 1994, the Company's previously
estimated loss reserves produced redundancies. The Company attributes this
favorable loss development to several factors. First, the Company had completed
its development of a full complement of claims personnel early in this period.
Second, during 1988, the California Supreme Court reversed what was known as the
"Royal Globe" doctrine, which, since 1978, had permitted third party plaintiffs
to sue insurers for alleged "bad faith" in resolving claims, even when the
plaintiff had voluntarily agreed to a settlement. This doctrine had placed undue
pressures on claims representatives to settle legitimate disputes at unfairly
high settlement amounts. After the reversal of Royal Globe, the Company believes
that it has been able to achieve fairer settlements, because both parties are in
a more equal bargaining position (See Third Party "Bad Faith" Legislation).
Third, during the years 1988 through 1990, the volume of business written in the
Assigned Risk Program expanded substantially as rates were suppressed at grossly
inadequate levels. Following the California Insurance Commissioner's approval of
an 85% temporary rate increase in September 1990, the volume of assigned risk
business had declined by nearly 80%. Many of the claims associated with the high
volume of assigned risk business in the 1988-1990 period were later found to be
fraudulent or grossly exaggerated and were settled in subsequent periods for
substantially less than had been initially reserved.
Operating Ratios
Loss and Expense Ratios
-----------------------
Loss and underwriting expense ratios are used to interpret the
underwriting experience of property and casualty insurance companies. Losses and
loss adjustment expenses, on a statutory basis, are stated as a percentage of
premiums earned because losses occur over the life of a policy. Underwriting
expenses on a statutory basis are stated as a percentage of premiums written
rather than premiums earned because most underwriting expenses are incurred when
policies are written and are not spread over the policy period. The statutory
underwriting profit margin is the extent to which the combined loss and
underwriting expense ratios are less than 100%. The Company's loss ratio,
expense ratio and combined ratio, and the private passenger automobile industry
combined ratio, on a statutory basis, are shown in the following table. The
Company's ratios include lines of insurance other than private passenger
automobile. Since these other lines represent only a small percentage of
premiums written, the Company believes its ratios can be compared to the
industry ratios included in the table.
8
Year ended December 31,
---------------------------------------------------------
1999 1998 1997 1996 1995
---------------------------------------------------------
Loss Ratio...................... 66.5% 61.1% 63.5% 66.6% 67.8%
Expense Ratio................... 26.5 26.3 24.7 24.0 24.0
---- ---- ---- ---- ----
Combined Ratio.................. 93.0% 87.4% 88.2% 90.6% 91.8%
==== ==== ==== ==== ====
Industry combined ratio (all
writers) (1).................. 102.8%(2) 100.1% 99.5% 101.0% 101.3%
Industry combined ratio (excluding
direct writers) (1)........... N.A. 99.1% 100.1% 102.6% 102.0%
- -------------------------------
(1) Source: A.M. Best, Aggregates & Averages (1996 through 1999), for all
property and casualty insurance companies (private passenger automobile
line only, after policyholder dividends).
(2) Source: A.M. Best, "Best's Review, January 2000," "Review Preview."
(N.A.) Not available.
Under generally accepted accounting principles ("GAAP"), the loss ratio
is computed in the same manner as under statutory accounting, but the expense
ratio is determined by dividing underwriting expenses by net premiums earned,
rather than by net premiums written. The following table sets forth the
Company's loss ratio, expense ratio and combined ratio under GAAP for the last
five years.
Year ended December 31,
-----------------------------------------------
1999 1998 1997 1996 1995
---- ----- ----- ---- ----
Loss Ratio 66.4% 61.0% 63.5% 66.5% 67.6%
Expense Ratio 26.8 26.6 25.1 24.4 24.4
---- ---- ---- ---- ----
Combined Ratio 93.2% 87.6% 88.6% 90.9% 92.0%
==== ==== ==== ==== ====
Premiums to Surplus Ratio
-------------------------
The following table shows, for the periods indicated, the insurance
companies' statutory ratios of net premiums written to policyholders' surplus.
While there is no statutory requirement applicable to the Company which
establishes a permissible net premium writings to surplus ratio, widely
recognized guidelines established by the National Association of Insurance
Commissioners ("NAIC") indicate that this ratio should be no greater than 3 to
1.
Year ended December 31,
-----------------------------------------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(Amounts in thousands, except ratios)
Net premiums written....................... $1,206,171 $1,144,051 $1,086,241 $795,873 $636,590
Policyholders' surplus..................... $ 853,794 $ 767,223 $ 679,359 $594,799 $479,114
Ratio...................................... 1.4 to 1 1.5 to 1 1.6 to 1 1.3 to 1 1.3 to 1
Risk-Based Capital Requirements
-------------------------------
In December 1993, the NAIC adopted a risk-based capital formula for
casualty insurance companies which establishes recommended minimum capital
requirements for casualty companies.
9
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. Based on the formula adopted by the
NAIC, the Company has estimated the Risk-Based Capital Requirements of each of
its insurance subsidiaries as of December 31, 1999. Each of the companies
exceeded the highest level of minimum required capital.
Codification of Statutory Accounting Principles
-----------------------------------------------
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. During 1998,
the NAIC approved the codification of statutory accounting practices.
Codification will become effective for the year ended December 31, 2001. The
Company has estimated that its total surplus, at December 31, 1999 would have
increased by approximately $84 million if codified accounting rules, as
currently stated, were effective. The primary items that would cause the
increase are the elimination of excess of statutory reserves over statement
reserves and the establishment of a net deferred tax asset.
Investments and Investment Results
The investments of the Company are made by the Company's Chief
Investment Officer under the supervision of the Company's Board of Directors.
The Company follows an investment policy which is regularly reviewed and
revised. The Company's policy emphasizes investment grade, fixed income
securities and maximization of after-tax yields. The Company does not invest
with a view to achieving realized gains. However, sales of securities are
undertaken, with resulting gains or losses, in order to enhance after-tax yield
and keep the portfolio in line with current market conditions. Tax
considerations are important in portfolio management, and have been made more so
since 1986 when the alternative minimum tax was imposed on casualty companies.
Changes in loss experience, growth rates and profitability produce significant
changes in the Company's exposure to alternative minimum tax liability,
requiring appropriate shifts in the investment asset mix between taxable bonds,
tax-exempt bonds and equities in order to maximize after-tax yield. The optimum
asset mix is subject to continuous review. At year-end, approximately 81% of the
Company's portfolio, at market values, was invested in medium to long term,
investment grade tax-exempt revenue and municipal bonds. The average Standard &
Poor's rating of the Company's bond holdings was AA at December 31, 1999.
The nominal average maturity of the bond portfolio is 16.3 years at
December 31, 1999, but the call-adjusted average maturity of the portfolio is
shorter, approximately 11.5 years, because holdings are heavily weighted with
high coupon issues which are expected to be called prior to maturity. The
modified duration of the bond portfolio reflecting anticipated early calls was
7.8 years at December 31, 1999. Duration is a measure of how long it takes, on
average, to receive all the cash flows produced by a bond, including
reinvestment of interest. Because of its sensitivity to interest rates, it is a
proxy for a bond's price volatility. The longer the duration, the greater the
price volatility in relation to changes in interest rates.
10
Holdings of lower than investment grade bonds constitute approximately 1% of
total investments. The Company continually evaluates the recoverability of its
investment holdings. When a decline in value of fixed maturities or equity
securities is considered other than temporary, a loss is recognized in the
Consolidated Statement of Income. During 1999, the Company realized a loss of
approximately $6.0 million on one equity security where the decline in market
value was considered other than temporary. Equity holdings consist primarily of
perpetual preferred stocks and relatively high yielding electric utility common
stocks on which dividend income is partially tax-sheltered by the 70% corporate
dividend exclusion.
The following table summarizes the investment results of the Company
for the five years ended December 31, 1999.
Year ended December 31,
------------------------------------------------------------------------
1999(1) 1998(1) 1997(1) 1996(1) 1995
---- ---- ---- ---- ----
(Amounts in thousands)
Averaged invested assets (includes
short-term cash investments 2).... $1,595,466 $1,473,843 $1,263,167 $970,677 $828,726
Net investment income:
Before income taxes......... 99,374 96,169 86,812 70,180 62,964
After income taxes.......... 89,598 87,199 77,917 63,371 57,035
Average annual return on investments:
Before income taxes......... 6.2% 6.5% 6.9% 7.2% 7.6%
After income taxes.......... 5.6% 5.9% 6.2% 6.5% 6.9%
Net realized investment gains
(losses) after income taxes....... (7,754) (2,552) 3,232 (2,062) 681
Net increase (decrease) in un-
realized gains/losses on all invest-
ments after income taxes.......... $ (90,667) $ 5,065 $ 27,175 $ (6,271) $ 37,960
(1) Includes AMI for the month of December 1996 and the full years 1997
through 1999.
(2) Fixed maturities and equities at cost.
11
The following table sets forth the composition of the investment
portfolio of the Company at the dates indicated:
December 31,
-------------------------------------------------------------------------
1999 1998 1997
------------------ ------------------- -------------------
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
---- ----- ---- ----- ---- -----
(Amounts in thousands)
Taxable Bonds................................ $ 21,461 $ 20,779 $ 28,339 $ 29,163 $ 50,096 $ 50,662
Tax-Exempt State and Municipal Bonds......... 1,300,896 1,269,604 1,174,630 1,251,475 1,021,259 1,085,613
Sinking Fund Preferred Stocks................ 31,408 31,671 42,471 44,270 76,239 78,711
---------- ---------- ---------- ---------- ---------- ----------
Total Fixed Maturity Investments.......... 1,353,765 1,322,054 1,245,440 1,324,908 1,147,594 1,214,986
Equity Investments incl.
Perpetual Preferred Stocks.................. 238,856 209,843 220,449 219,745 169,943 173,522
Short-term Cash Investments.................. 43,568 43,568 45,992 45,992 59,740 59,740
---------- ---------- ---------- ---------- ---------- ----------
Total Investments............................ $1,636,189 $1,575,465 $1,511,881 $1,590,645 $1,377,277 $1,448,248
========== ========== ========== ========== ========== ==========
At December 31, 1999, the Company had a net unrealized loss on all investments
of $60,724,000 before income taxes.
Competitive Conditions
The property and casualty insurance industry is highly competitive. The
insurance industry consists of a large number of companies, many of which
operate in more than one state, offering automobile, homeowners and commercial
property insurance, as well as insurance coverage in other lines. Many of the
Company's competitors have larger volumes of business and greater financial
resources than the Company. Based on regularly published statistical
compilations, the Company in 1999 was the sixth largest writer of private
passenger automobile insurance in California. All of the insurance companies
having greater shares of the California market sell insurance either directly or
through exclusive agents, rather than through independent agents.
The property and casualty insurance industry is highly cyclical,
characterized by periods of high premium rates and shortages of underwriting
capacity followed by periods of severe price competition and excess capacity. In
the Company's view, the overall profitability of the California marketplace
during the past several years has created a favorable environment for automobile
insurance writers. Many major automobile insurers have attempted to capitalize
on the favorable climate by increasing their marketing efforts and reducing
rates in attempts to capture more business. The Company believes that industry
wide rate reductions have contributed to the deterioration of loss ratios in
1999 (See Operating Ratios -Loss and Expense). Consequently, the Company
believes that competitors will be less likely to institute rate decreases in the
near future than they have been over the last few years.
Price and reputation for service are the principal means by which the
Company competes with other automobile insurers. The Company believes that it
has a good reputation for service,
12
and it has, historically, been among the lowest-priced insurers doing business
in California according to surveys conducted by the California DOI. In addition
to good service and competitive pricing, for those insurers dealing through
independent agents, as the Company does, the marketing efforts of agents is a
means of competition.
All rates charged by private passenger automobile insurers are subject to
the prior approval of the California Insurance Commissioner. See "Regulation -
Automobile Insurance Rating Factor Regulations."
The Company encounters similar competition in each state in which it
operates outside California.
Reinsurance
The Company no longer maintains reinsurance for its liability coverage in
California. Effective January 1, 1994, the Company terminated its liability
reinsurance coverage with Employers Reinsurance Corporation ("ERC") because of
rising premiums and under utilization of such coverage. The Company regularly
evaluates the need for liability reinsurance.
The Company maintained property reinsurance under a treaty which was
effective April 1, 1995 through December 31, 1998, with National Reinsurance
Corporation, which is rated A+ by A.M. Best. The treaty provided $900,000
coverage in excess of $100,000 for each risk subject to a maximum of $2,700,000
for any one occurrence. A second layer of coverage provided an additional
$1,000,000 in excess of the first $1,000,000 per risk subject to a maximum of
$2,000,000 for any one occurrence. This treaty was replaced with Swiss Re
effective January 1, 1999. The new treaty provides $750,000 coverage in excess
of $250,000 for each risk subject to a maximum of $2,250,000 for any one
occurrence. A second layer of coverage provides an additional $1,000,000 in
excess of the first $1,000,000 per risk.
Effective January 1, 2000, the Company maintains property and liability
excess per risk coverage, through Swiss Re for its Florida homeowners line of
business. The treaty provides $200,000 coverage in excess of $100,000 for each
risk subject to a maximum of $600,000 for any one occurrence. A second layer of
coverage provides an additional $1,200,000 in excess of the first $300,000 per
risk subject to a maximum of $1,200,000 for any one occurrence.
The Company maintains treaty reinsurance with Swiss Re, effective October
1, 1998, where risks written under personal umbrella policies are ceded to Swiss
Re on a 100% quota share basis. The maximum coverage is $5 million per risk.
Prior to 1998, the Company maintained catastrophe reinsurance for property
and automobile physical damage business. Effective October 1, 1998, the Company
did not renew this catastrophe reinsurance. The reinsurance program was not
renewed because the Company believes it has adequate capitalization to absorb
catastrophe losses in these lines. The Company periodically reviews its
requirements for catastrophic reinsurance particularly in areas that are prone
to catastrophes such as Florida and California. In addition, the Company expects
a significant reduction in its catastrophe exposure from earthquakes due to the
placement, beginning in the second quarter of 1998, of earthquake risks written
in conjunction with California homeowners policies, with the California
Earthquake Authority (CEA). See Regulation -California Earthquake Authority.
13
ERC reinsures AMI through working layer treaties for property and casualty
losses in excess of $200,000. For the years 1990 through 1996 the mechanical
breakdown line of business was reinsured with Constitution Reinsurance
Corporation through a quota-share treaty covering 50% to 85% of the business
written depending on the year the policy incepted. For policies effective on or
after January 1, 1997, AMI is retaining the full exposure. AMI has other
reinsurance treaties and facultative arrangements in place for various smaller
lines of business.
If the reinsurers were unable to perform their obligations under the
reinsurance treaty, the Company would be required, as primary insurer, to
discharge all obligations to its insureds in their entirety.
Regulation
The Company's business in California is subject to regulation and
supervision by the California DOI, which has broad regulatory, supervisory and
administrative powers.
The powers of the California DOI primarily include the prior approval of
insurance rates and rating factors and the establishment of standards of
solvency which must be met and maintained. The regulation and supervision by the
California DOI are designed principally for the benefit of policyholders and not
for insurance company shareholders. The California DOI conducts periodic
examinations of the Company's insurance subsidiaries. The last examination
conducted of the California Companies was as of December 31, 1997. The reports
on the results of that examination recommended no adjustments to the statutory
financial statements as filed by the Company.
The insurance subsidiaries outside California, including AMI, are subject
to the regulatory powers of the insurance departments of those states. Those
powers are similar to the regulatory powers in California enumerated above.
Generally, the regulations relate primarily to standards of solvency and are
designed for the benefit of policyholders and not for insurance company
shareholders.
In California, insurance rates have required prior approval since November
1989. Georgia is also a prior approval state, while Illinois only requires that
rates be filed with the Department of Insurance prior to their use. Texas,
Oklahoma and Florida have a modified version of prior approval laws. In all
states, the insurance code provides that rates must not be "excessive,
inadequate or unfairly discriminatory."
The Georgia DOI conducted an examination of Mercury Insurance Company of
Georgia and Mercury Indemnity Company of Georgia as of December 31, 1997. The
reports on the results of that examination recommended no adjustments to the
statutory financial statements as filed by the Company. The Illinois DOI
conducted an examination of Mercury Insurance Company of Illinois and Mercury
Indemnity Company of Illinois as of December 31, 1995. The reports on that audit
have recommended no changes to the statutory financial statements as filed. The
states of Oklahoma and Texas will also conduct periodic examinations of AMI.
The operations of the Company are dependent on the laws of the state in
which it does business and changes in those laws can materially affect the
revenue and expenses of the Company. The Company retains its own legislative
advocates in California. The Company also makes financial contributions to
officeholders and candidates. In 1999 and 1998, those
14
contributions amounted to $528,000 and $1,137,000, respectively. The Company
believes in supporting the political process and intends to continue to make
such contributions in amounts which it determines to be appropriate.
Insurance Guarantee Association
-------------------------------
In 1969, the California Insurance Guarantee Association (the "Association")
was created pursuant to California law to provide for payment of claims for
which insolvent insurers of most casualty lines are liable but which cannot be
paid out of such insurers' assets. The Company is subject to assessment by the
Association for its pro-rata share of such claims based on premiums written in
the particular line in the year preceding the assessment by insurers writing
that line of insurance in California. Such assessments are based upon estimates
of losses to be incurred in liquidating an insolvent insurer. In a particular
year, the Company cannot be assessed an amount greater than 1% of its premiums
written in the preceding year. There have been no assessments imposed during the
past five years. Assessments are recouped through a mandated surcharge to
policyholders the year after the assessment. Insurance subsidiaries in the other
states are subject to the provisions of similar insurance guaranty associations.
No material assessments were imposed in the last five years in those states
either.
Holding Company Act
-------------------
The California Companies are subject to regulation by the California DOI
pursuant to the provisions of the California Insurance Holding Company System
Regulatory Act (the "Holding Company Act"). Pursuant to the Holding Company Act,
the California DOI may examine the affairs of each company at any time. The
Holding Company Act requires disclosure of any material transactions among the
companies. Certain transactions and dividends defined to be of an
"extraordinary" type may not be effected if the California DOI disapproves the
transaction within 30 days after notice. Such transactions include, but are not
limited to, certain reinsurance transactions and sales, purchases, exchanges,
loans and extensions of credit, andinvestments, in the net aggregate, involving
more than the lesser of 3% of the Company's admitted assets or 25% of surplus as
to policyholders, as of the preceding December 31. An extraordinary dividend is
a dividend which, together with other dividends or distributions made within the
preceding 12 months, exceeds the greater of 10% of the insurance company's
policyholders' surplus as of the preceding December 31 or the insurance
company's net income for the preceding calendar year. An insurance company is
also required to notify the California DOI of any dividend after declaration,
but prior to payment.
The Holding Company Act also provides that the acquisition or change of
"control" of a California domiciled insurance company or of any person who
controls such an insurance company cannot be consummated without the prior
approval of the Insurance Commissioner. In general, a presumption of "control"
arises from the ownership of voting securities and securities that are
convertible into voting securities, which in the aggregate constitute 10% or
more of the voting securities of a California insurance company or of a person
that controls a California insurance company, such as Mercury General. A person
seeking to acquire "control," directly or indirectly, of the Company must
generally file with the Insurance Commissioner an application for change of
control containing certain information required by statute and published
regulations and provide a copy of the application to the Company. The Holding
Company Act also effectively restricts the Company from consummating certain
reorganizations or mergers without prior regulatory approval.
The insurance subsidiaries in Georgia, Illinois, Oklahoma and Texas are
subject to holding company acts in those states, the provisions of which are
substantially similar to those
15
of the Holding Company Act. Regulatory approval was obtained from California,
Oklahoma and Texas before the acquisition of AMI was completed.
Assigned Risks
--------------
Automobile liability insurers in California are required to sell bodily
injury liability, property damage liability, medical expense and uninsured
motorist coverage to a proportionate number (based on the insurer's share of the
California automobile casualty insurance market) of those drivers applying for
placement as "assigned risks." Drivers seek placement as assigned risks because
their driving records or other relevant characteristics, as defined by
Proposition 103, make them difficult to insure in the voluntary market. During
the last five years, approximately 0.6% of the direct automobile insurance
premium written by the Company was for assigned risk business. In 1999, assigned
risks represented 0.2% of total automobile direct premiums written and 0.3% of
total automobile direct premium earned. Premium rates for assigned risk business
are set by the California DOI. In October 1990, more stringent rules for gaining
entry into the plan were approved, resulting in a substantial reduction in the
number of assigned risks insured by the Company since 1991. Effective January 1,
1994, the California Insurance Code requires that rates established for the plan
be adequate to support the plan's losses and expenses. The last rate increase
approved by the Commissioner approximated 4.8% and became effective June 1,
1995. The Commissioner approved a rate decrease of 28.3% effective February 1,
1999. Even with the rate decrease, the number of assignments was less in 1999
than in 1998. The Company attributes this decrease to the competitive voluntary
market.
California Automobile Insurance Low Cost Program
------------------------------------------------
In 1999, California enacted a pilot low cost automobile program ("LCP") for
low income good drivers in San Francisco City and County and Los Angeles County
to be implemented by July 1, 2000. The program provides a low limit policy
(bodily injury liability coverage of $10,000 per person and $20,000 per
occurrence and property damage liability coverage of $3,000) that satisfies
financial responsibility requirements, to those good drivers with income that
does not exceed 150% of the federal poverty level.
The LCP is administered by the California Automobile Assigned Risk Plan
("CAARP") which is the same entity that administers the assigned risk program
for California. LCP policies will be assigned to insurance companies in
proportion to each insurer's share of the California private passenger
automobile insurance market. In addition, the Company will be assessed an annual
fee to cover the costs of administering the program. The Company is not
currently able to accurately assess the volume and profitability of this
business or the amount of the assessments. The LCP will expire on January 1,
2004, unless reenacted by the California legislature.
Automobile Insurance Rating Factor Regulations
----------------------------------------------
Since 1989, California Proposition 103 has required that property and
casualty insurance rates be approved by the Insurance Commissioner prior to
their use, and that no rate be approved which is excessive, inadequate, unfairly
discriminatory or otherwise in violation of the provisions of the initiative.
The proposition specified three statutory factors required to be applied in
"decreasing order of importance" in determining rates for private passenger
automobile insurance: (1) the insured's driving safety record, (2) the number of
miles the insured drives annually, and (3) the number of years of driving
experience of the
16
insured. The law also gave the Insurance Commissioner discretion to adopt other
factors by regulation that have a substantial relationship to risk of loss. The
statute further provided that insurers are required to give at least a 20%
discount to "good drivers," as defined, from rates that would otherwise be
charged to such drivers and that no insurer may refuse to insure a "good
driver."
The Company, and most other insurers, historically charged different rates
for residents of different geographical areas within California. The rates for
urban areas, particularly in Los Angeles, have been generally substantially
higher than for suburban and rural areas. The Company's geographical rate
differentials have been derived by actuarial analysis of the claims costs in a
given area.
In September 1996, the California Insurance Commissioner issued new
permanent rating factor regulations which replaced emergency regulations which
have been in use since their issuance in 1989. They 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 in March 11,
1997.
The Company's plan, and the new plans of most other California automobile
insurers, were approved by the Department in October 1997. The Company's plan
became effective October 1, 1997. The rate changes resulting from implementation
of that plan have not materially affectedthe Company's competitive position or
its profitability.
California Financial Responsibility Law
---------------------------------------
Effective January 1, 1997 California enacted a new law which requires proof
of insurance for the registration (new or renewal) of a motor vehicle. It also
provides for substantial penalties for failure to supply proof of insurance if a
driver is stopped for a traffic violation. Media attention to the new law
resulted in a surge of new business applications during the first half of 1997.
The renewal experience of this new business has been similarto that of the
Company's existing business.
In November 1996 an initiative sponsored by the California Insurance
Commissioner was overwhelmingly approved by the California voters. It provides
that uninsured drivers who are injured in an automobile accident are able to
recover only actual, out-of-pocket medical expenses and lost wages and are not
entitled to receive awards for general damages, i.e., "pain and suffering." This
restriction also applies to drunk drivers and fleeing felons. The law has helped
in controlling loss costs.
17
Third Party "Bad Faith" Legislation
-----------------------------------
In October 1999, California enacted legislation to restore the right of an
injured party to sue the responsible party's insurance company for alleged "bad
faith" in resolving a claim. Under this legislation, such a lawsuit would be
permitted only if the insurance company rejected a settlement offer, and the
injured party obtained a larger judgement or arbitration award against the
insured party. Unlike the "Royal Glove" doctrine that had been overturned by the
California Supreme Court in 1988 (see "Loss and Loss Adjustment Expense
Reserves" at pg. 4), the new legislation would not permit a third party
plaintiff to sue an insurer for bad faith if the plaintiff had voluntarily
agreed to a settlement. In addition, there could be no "bad faith" suits for
claims under $50,000, if the parties agreed to an arbitration procedure.
The new law was scheduled to take effect on January 1, 2000. In December
1999, however, referenda on this legislation qualified for the March 2000
ballot, thereby placing the laws "on hold" until after a vote on the
legislation. At the election held on March 7, 2000, the California voters
rejected this legislation.
New legislation or voter proposed initiatives could be enacted to reinstate
third party "bad faith" lawsuits. If such legislation is enacted, it could have
a significant detrimental effect on the Company's operating results. This would
particularly be the case if the Company had difficulty in implementing rate
increases to compensate for increased loss costs.
California Earthquake Authority
-------------------------------
The California Earthquake Authority (CEA) is a Quasi-Governmental
organization that was established to provide a market for earthquake coverage to
California homeowners. During the second quarter of 1998, the Company began
placing all new and renewal earthquake coverage offered with its homeowners
policy through the California Earthquake Authority. The Company receives a small
fee for placing business with the CEA.
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
information provided by the CEA, the Company's maximum total exposure to CEA
assessments at October 28, 1999, is approximately $11.5 million.
Item 2. Properties
----------
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.
Since December 1986, Mercury General's executive offices are located in a
36,000 square foot office building in Los Angeles, California, owned by Mercury
Casualty. 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 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
18
or obtaining comparable office space.
Item 3. Legal Proceedings
-----------------
The Company is, from time to time, named as a defendant in various lawsuits
incidental to its insurance business. In most of these actions, plaintiffs
assert claims for punitive damages which are not insurable under California
judicial decisions. The Company vigorously defends these actions, unless a
reasonable settlement appears appropriate. The Company believes that adverse
results, if any, in the actions currently pending should not have a material
effect on the Company's operations or financial position.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
No matters were submitted to a vote of security holders by the Company
during the fourth quarter of the fiscal year covered by this report.
EXECUTIVE OFFICERS OF THE COMPANY
The following table sets forth certain information concerning the executive
officers of the Company as of March 16, 2000:
Name Age Position
---- --- --------
George Joseph 78 Chairman of the Board and Chief
Executive Officer
Michael D. Curtius 49 President and Chief Operating Officer
Cooper Blanton, Jr. 73 Executive Vice President
Bruce E. Norman 51 Senior Vice President in charge of
Marketing
Joanna Y. Moore 44 Vice President and Chief Claims Officer
Kenneth G. Kitzmiller 53 Vice President in charge of Underwriting
Gabriel Tirador 35 Vice President and Chief Financial Officer
Judy A. Walters 53 Vice President - Corporate Affairs and Secretary
Peter R. Simon 40 Vice President - Information Systems
Mr. Joseph, Chief Executive Officer of the Company and Chairman of its
Board of Directors, has served in those capacities since 1961. Mr. Joseph has
more than 45 years experience in the property and casualty insurance business.
Mr. Curtius, President and Chief Operating Officer, has been employed by
the Company since 1977. In October 1987, Mr. Curtius was named Vice President
and Chief Claims Officer, and in August 1991 he was appointed Executive Vice
President. He was elected President and Chief Operating Officer of Mercury
General and the California Companies in May 1995 and elected to the Board of
Directors of Mercury General and the California Companies in 1996. In December
of 1996 he was appointed Vice Chairman of AMIC. Mr. Curtius has over 20 years of
experience in the insurance industry.
Mr. Blanton, Executive Vice President, joined the Company in 1966 and
supervised its underwriting activities from 1967 until September 1995. He was
appointed Executive Vice President of Mercury Casualty and Mercury Insurance in
1983 and was named Executive Vice President of Mercury General in 1985. In May
1995 he was named President of the Georgia and Illinois insurance company
subsidiaries and in February 1996 he was elected to the Board of
19
Directors of those companies. In January 1999 he was named Chairman of the Board
of AMIC. Mr. Blanton has over 40 years of experience in underwriting and other
aspects of the property and casualty insurance business.
Mr. Norman, Senior Vice President in charge of Marketing, has been employed
by the Company since 1971. Mr. Norman was named to this position in February
1999, and has been a Vice President since October 1985 and a Vice President of
Mercury Casualty since 1983. Mr. Norman has supervised the selection and
training of agents and managed relations between agents and the Company since
1977. In February 1996 he was elected to the Board of Directors of the
California Companies.
Ms. Moore, Vice President & Chief Claims Officer, joined the Company in the
claims department in March 1981. She was named Vice President of Claims of
Mercury General in August 1991 and has held her present position since July
1995.
Mr. Kitzmiller, Vice President in charge of Underwriting, has been employed
by the Company in the underwriting department since 1972. In August 1991 he was
appointed Vice President of Underwriting of Mercury General and has supervised
the underwriting activities of the Company since early 1996.
Mr. Tirador, Vice President and Chief Financial Officer, served as the
Company's assistant controller from March 1994 to December 1996. During January
1997 to February 1998 he served as the Vice President and Controller of the
Automobile Club of Southern California. He rejoined the Company in February 1998
as Vice President and Chief Financial Officer. Mr. Tirador has over thirteen
years experience in the property and casualty insurance industry and is a
Certified Public Accountant.
Ms. Walters has been employed by the Company since 1967, and has served as
its Secretary since 1982. Ms. Walters was named Vice President - Corporate
Affairs in June 1998.
Mr. Simon has been employed by the Company since 1980. He was named Vice
President of Information Systems in December 1999.
PART II
Item 5. Market for the Registrant's Common Equity and Related Security Holder
---------------------------------------------------------------------
Matters
- -------
Price Range of Common Stock
The common stock is traded on the New York Stock Exchange (symbol: MCY).
The following table shows the high and low sales prices per share in each
quarter during the past two years as reported in the consolidated transaction
reporting system.
1998 High Low
---- ---
1st Quarter.............................. $63.625 $46.000
2nd Quarter.............................. $66.313 $58.250
3rd Quarter.............................. $69.438 $36.563
4th Quarter.............................. $45.625 $33.250
20
1999 High Low
---- ---
1st Quarter.............................. $45.500 $32.938
2nd Quarter.............................. $39.625 $31.938
3rd Quarter.............................. $35.938 $26.750
4th Quarter.............................. $28.188 $21.063
2000
1st Quarter (January 1 - March 15)....... $24.938 $21.063
Dividends
Following the public offering of its common stock in November 1985, the
Company has paid regular quarterly dividends on its common stock. During 1999
and 1998, the Company paid dividends on its common stock of $0.84 per share and
$0.70 per share, respectively. On January 28, 2000, the Board of Directors
declared a $.24 quarterly dividend payable on March 30, 2000 to stockholders of
record on March 15, 2000.
The common stock dividend rate has been increased sixteen times since
dividends were initiated in January, 1986, at an annual rate of $0.05, adjusted
for the two-for-one stock splits in September 1992 and September 1997. For
financial statement purposes, the Company records dividends on the declaration
date. The Company expects to continue the payment of quarterly dividends. The
continued payment and amount of cash dividends will depend upon, among other
factors, the Company's operating results, overall financial condition, capital
requirements and general business conditions.
As a holding company, Mercury General is largely dependent upon
dividends from its subsidiaries to pay dividends to its shareholders. These
subsidiaries are subject to state laws that restrict their ability to distribute
dividends. The state laws permit a casualty insurance company to pay dividends
and advances within any 12-month period, without any prior regulatory approval,
in an amount up to the greater of 10% of statutory earned surplus at the
preceding December 31, or net income for the calendar year preceding the date
the dividend is paid. Under this test, the direct insurance subsidiaries of the
Company are entitled to pay dividends to Mercury General during 2000 of up to
approximately $101 million. See Note 10 of Notes to Consolidated Financial
Statements and "Business -- Regulation -- Holding Company Act."
Shareholders of Record
The approximate number of holders of record of the Company's common
stock as of March 15, 2000 was 287. The approximate number of beneficial holders
as of March 15, 2000 was 9,224 according to the Bank of New York, the Company's
transfer agent.
21
Item 6. Selected Consolidated Financial Data
------------------------------------
Year ended December 31,
---------------------------------------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(Amounts in thousands, except per share data)
Income Data:
Premiums earned........................ $1,188,307 $1,121,584 $1,031,280 $754,724 $616,326
Net investment income.................. 99,374 96,169 86,812 70,180 62,964
Realized investment gains(losses)...... (11,929) (3,926) 4,973 (3,173) 1,048
Realized gain from sale of
subsidiary........................... -- 2,586 -- -- --
Other.................................. 4,924 5,710 4,881 3,233 3,341
---------- ---------- ---------- -------- --------
Total Revenues................ 1,280,676 1,222,123 1,127,946 824,964 683,679
---------- ---------- ---------- -------- --------
Losses and loss adjustment
expenses............................. 789,103 684,468 654,729 501,858 416,556
Policy acquisition costs............... 267,399 252,592 224,883 160,019 128,743
Other operating expenses............... 50,675 44,941 33,579 24,493 22,017
Interest............................... 4,960 4,842 4,976 2,004 2,040
---------- ---------- ---------- -------- --------
Total Expenses................ 1,112,137 986,843 918,167 688,374 569,356
---------- ---------- ---------- -------- --------
Income before income taxes............. 168,539 235,280 209,779 136,590 114,323
Income taxes........................... 34,830 57,754 53,473 30,826 24,022
---------- ---------- ---------- -------- --------
Net Income............................. $ 133,709 $ 177,526 $ 156,306 $105,764 $ 90,301
========== ========== ========== ======== ========
Per Share Data:
Basic earnings per share *............. $ 2.45 $ 3.23 $ 2.84 $ 1.93 $ 1.65
========== ========== ========== ======== ========
Diluted earnings per share *........... $ 2.44 $ 3.21 $ 2.82 $ 1.92 $ 1.65
========== ========== ========== ======== ========
Dividends paid *....................... $ .84 $ .70 $ .58 $ .48 $ .40
========== ========== ========== ======== ========
December 31,
----------------------------------------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(Amounts in thousands, except per share data)
Balance Sheet Data:
Total investments.................. $1,575,465 $1,590,645 $1,448,248 $1,168,287 $ 923,194
Premiums receivable................ 115,654 107,950 104,216 83,748 58,902
Total assets....................... 1,906,367 1,877,025 1,725,532 1,419,927 1,081,656
Unpaid losses and loss adjustment
expenses.......................... 434,843 405,976 409,061 336,685 253,546
Unearned premiums.................. 340,846 327,129 309,376 260,878 168,404
Notes payable...................... 92,000 78,000 75,000 75,000 25,000
Deferred income tax liability
(asset)........................... (28,541) 22,639 19,722 6,349 10,158
Shareholders' equity............... 909,591 917,375 799,592 641,222 565,188
Book value per share*.............. 16.73 16.80 14.51 11.69 10.34
*Adjusted for a two-for-one stock split effective September 1997.
___________________
22
Item 7. Management's Discussion and Analysis of Financial Condition and Results
-----------------------------------------------------------------------
of Operations
-------------
Overview
- --------
The operating results of property and casualty insurance companies are
subject to significant fluctuations from quarter-to-quarter and from year-to-
year due to the effect of competition on pricing, the frequency and severity of
losses, including the effect of natural disasters on losses, general economic
conditions, the general regulatory environment in those states in which an
insurer operates, state regulation of premium rates and other factors such as
changes in tax laws. The property and casualty industry has been highly
cyclical, with periods of high premium rates and shortages of underwriting
capacity followed by periods of severe price competition and excess capacity.
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.
During 1999, approximately 92% of the Company's direct premiums written,
including AMI, were derived from California.
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 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.
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
of driving experience, (3) miles driven per year and (4) whatever optional
factors are determined by the Insurance Commissioner to have a substantial
relationship to the risk of loss and adopted by regulation. The law further
requires that each of the four factors be applied in decreasing order of
importance.
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,
23
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.
Results of Operations
Year Ended December 31, 1999 Compared to Year Ended December 31, 1998
---------------------------------------------------------------------
Premiums earned in 1999 of $1,188.3 million increased 5.9% and net
premiums written in 1999 of $1,206.2 million increased 5.4% over amounts
recorded in 1998. These premium increases were principally attributable to
larger Florida private passenger automobile insurance volume, premiums from the
California non-standard automobile policy introduced in late 1998 and sales of
California homeowners insurance. The Company's core California private passenger
automobile insurance lines achieved only modest premium growth, entirely
attributable to a larger policy count, and AMI experienced a decline in its
premium volume.
The California private passenger automobile insurance marketplace
continues 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%. The Company believes that its advertising
program is important to create brand awareness and to remain competitive in the
current insurance climate.
The GAAP loss ratio in 1999 (loss and loss adjustment expenses related to
premiums earned) was 66.4% compared with 61.0% in 1998. The less favorable loss
ratio is primarily related to the rate decrease taken in April 1998 which had
its full impact on the Company's results in 1999.
The GAAP expense ratio (policy acquisition costs and other operating
expenses related to premiums earned) was 26.8% in 1999 and 26.6% in 1998. The
increase in the expense ratio was primarily attributable to increased expenses
associated with the advertising program that were partially offset by decreased
profit-related bonuses to agents.
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.
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.
24
Realized investment losses in 1999 were $11.9 million, compared with
realized losses of $3.9 million in 1998. Included in realized losses for 1999 is
a $6.0 million write-down of a preferred stock investment that became other than
temporarily impaired during the third quarter of 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.
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
---------------------------------------------------------------------
Premiums earned in 1998 of $1,121.6 million increased 8.8%, reflecting
unit growth which was somewhat offset by reduced average premiums per policy.
The reduction in average premium per policy was primarily the result of the 7%
rate decrease taken for California business in April 1998. In addition, a large
portion of the new California business written during 1997, which grew at a rate
of 28.5% due to a new law requiring proof of insurance to register a car,
qualified for a discount on renewal in 1998. Consequently, the average premium
per policy declined in 1998 as compared to 1997.
Net premiums written in 1998 of $1,144.1 million increased 5.3% over a
year earlier, continuing a growth trend which began in the second quarter of
1994. The Company increased its marketing efforts in April 1998, launching a
fully integrated radio and billboard advertising program. Although the campaign
has not met expectations, the Company believes continuing the advertising
program is necessary in the current competitive climate. The California
automobile insurance marketplace remains intensely competitive. Most of the
major direct writers, who represent the Company's chief competition, have
instituted one or more rate reductions over the last twenty-four months and many
have significantly increased their marketing efforts.
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.
The expense ratio (policy acquisition costs and other operating expenses
related to premiums earned) was 26.6% in 1998 and 25.1% in 1997. The increase in
the expense ratio was largely attributable to increased base commissions and
profit-related bonuses to agents, expenses associated with the advertising
program implemented in April 1998, and start up costs from the Company's entry
into the Florida market.
25
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.
Investment income in 1998 was $96.2 million, compared with $86.8 million
in 1997. The after-tax yield on average investments of $1,474.0 million (cost
basis) was 5.92%, compared with 6.17% on average investments of a $1,263.2
million in 1997. The effective tax rate on investment income was 9.3% in 1998,
compared to 10.3% in 1997. The lower tax rate in 1998 reflects the benefits
derived from replacing taxable issues held in the AMI investment portfolio, when
purchased in December 1996, to non-taxable issues throughout the 1997 and 1998
fiscal years. 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 is expected to continue in 1999. Bonds matured and called in 1998
totaled $65.3 million, compared with $54.0 million in 1997.
Realized investment losses in 1998 were $3.9 million, compared with
realized gains of $5.0 million in 1997. The gains and losses in both years were
principally incurred to enhance investment income on both fixed maturities and
equity securities, including perpetual preferred stocks. The losses realized in
1998 were designed to utilize expiring capital gains tax benefits.
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 income tax provision of $57.8 million in 1998 represented an
effective tax rate of 24.5%, compared with an effective rate of 25.5% in 1997.
The 1997 rate is higher primarily because the Company had a large non tax-
deductible charge for ESOP compensation expense in 1997 that did not occur in
1998. ESOP compensation expense is calculated based on the current market value
for the Company's stock multiplied by shares allocated to employees, however,
only the Company's cost basis is deductible for tax purposes. The increase in
the Company's share price on the shares allocated in 1997, which had been
purchased in 1994, caused the large non-deductible charge that resulted in
increasing the Company's effective tax rate in 1997. This situation did not
occur in 1998 as the shares allocated to employees during 1998 had a similar
cost and market value.
Net income in 1998 was $177.5 million or $3.23 per share, (basic),
compared with $156.3 million, or $2.84 per share, (basic), in 1997. Basic per
share results are based on 55.0 million average shares in 1998 and 55.0 million
average shares in 1997. Diluted per share results were $3.21 in 1998 and $2.82
in 1997.
Liquidity and Capital Resources
Net cash provided from operating activities in 1999, was $188.9 million,
while funds derived from the sale, redemption or maturity of investments was
$558.3 million, of which approximately 80% was represented by the sale of equity
securities. The amortized cost of fixed-maturity investments increased by $108.3
million during the year. Equity investments, including perpetual preferred
stocks, increased by $18.4 million at cost, while short-term cash investments
decreased by $2.4 million. The amortized cost of fixed-maturities available for
sale that were sold, called or matured during the year was $112.9 million.
26
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.
The Company's unrestricted cash and short term investments totaled $48.6
million at December 31, 1999. Together with funds generated internally, such
liquid assets are more than adequate to pay claims without the sale of long term
investments.
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.
Except for Company-occupied buildings, the Company has no direct
investments in real estate and no holdings of mortgages secured by commercial
real estate.
Equity holdings of $209.8 million at market (cost $238.9 million),
including perpetual preferred issues, are largely confined to the public utility
and banking sectors and represent about 23.1% of total shareholders' equity.
The Company had outstanding debt at December 31, 1999 of $92 million. Of
this amount, $75 million has been borrowed under a three year 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 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, the Company did not extend
the maturity for an
27
additional one year period. The Company will reevaluate extending the current
2002 maturity date of this loan during 2000. 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 current
effective rates, the net interest cost on the loan approximates 6.53%.
The Company also maintains a $100 million line of credit, of which $17
million was drawn on at December 31, 1999 and is due October 26, 2000. 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. Based on the current effective rates the net interest cost on the loan
approximates 6.76%. The loan covenants are the same as the Company's $75 million
loan discussed above. The Company plans to extend the maturity date of this loan
during 2000.
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 lower yielding tax-exempt
bonds, the proceeds of the $100 million credit facility and internal cash
generation. During 1999, the Company purchased 371,200 shares of the common
stock in the open market at an average price of $22.73. Since the inception of
the program in 1998 through December 31, 1999, the Company has purchased 951,200
shares of common stock at an average price of $34.41. The shares purchased were
retired.
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 was 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. In August 1998, the
Plan purchased 115,000 shares of Mercury General's common stock in the open
market at a price of $43.05 per share. The purchases were funded by a five year
term bank loan of $5 million to the Plan which is guaranteed by the Company. The
shares are being allocated to the employees over a five-year period, with the
initial allocation made 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
effective rate of interest on the loan, which, in 1999 was 6.47%.
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.
28
As of December 31, 1999, the Company had no material commitments for
capital expenditures.
The California Earthquake Authority (CEA) is a Quasi-Governmental
organization that was established in 1996 to provide a market for earthquake
coverage to California homeowners. During the second quarter of 1998, the
Company began placing all new and renewal earthquake coverage offered with its
homeowners policy through the California Earthquake Authority. The Company
receives a small fee for placing business with the CEA.
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
information provided by the CEA, the Company's maximum total exposure to CEA
assessments at October 28, 1999, is approximately $11.5 million.
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 $853.8 million at December 31, 1999, and net
written premiums for the twelve months ended on that date of $1,206.2 million,
the ratio of writings to surplus was approximately 1.4 to 1.
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.
Year 2000
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.
The Company incurred total costs of approximately $600,000 to modify its
systems for Year 2000 compliance. The Company did not experience material Year
2000 problems and does not expect to incur any additional costs related to Year
2000 matters.
Item 7A. Quantitative and Qualitative Disclosures about Market Risks
-----------------------------------------------------------
The Company is subject to various market risk exposures including
interest rate risk and equity price risk. The following disclosure reflects
estimates of future performance and economic conditions. Actual results may
differ.
The Company invests its assets primarily in fixed maturity investments,
which at December 31, 1999 comprised 84% of total investments at market value.
Tax-exempt bonds represent 97% of the fixed maturity investments with the
remaining amount consisting of sinking fund preferred stocks and taxable bonds.
Equity securities, consisting primarily of preferred stocks, account for 13% of
total investments at market. The remaining 3% of the investment portfolio
consists
29
of highly liquid short-term investments which are primarily U.S. Treasury backed
overnight repurchase agreements and short-term money market funds.
The value of the fixed maturity portfolio is subject to interest rate
risk. As market interest rates decrease, the value of the portfolio goes up with
the opposite holding true in rising interest rate environments. A common measure
of the interest sensitivity of fixed maturity assets is modified duration, a
calculation that takes maturity, coupon rate, yield and call terms to calculate
an average age of the expected cash flows. The longer the duration, the more
sensitive the asset is to market interest rate fluctuations.
The Company has historically invested in fixed maturity investments with
a goal towards maximizing after-tax yields and holding assets to the maturity or
call date. Since assets with longer maturity dates tend to produce higher
current yields, the Company's investment philosophy has resulted in a portfolio
with a moderate duration. This has exposed the portfolio to interest rate risk,
which, in periods of rising interest rates, as was experienced during 1999,
resulted in total pre-tax realized and unrealized losses of $111.1 million on
the fixed maturity holdings.
During 1999, higher market interest rates also increased the duration of
the Company's fixed income portfolio. Bond investments made by the Company
typically have call options attached, which increase the duration of the asset
as rates increase. Consequently, the average modified duration of the portfolio
increased from 5.8 years at December 31, 1998 to 7.8 years at December 31, 1999.
Given a hypothetical parallel increase of 100 basis points in interest rates,
the fair value of the fixed maturity portfolio would decrease by approximately
$103.1million.
At December 31, 1999, the Company's strategy for equity investments is a
buy and hold strategy which focuses primarily on current income with a secondary
focus on capital appreciation. The value of the equity investments consists of
$49.4 million in common stocks and $160.4 million in non-sinking fund preferred
stocks. The common stock equity assets are typically valued for future economic
prospects as perceived by the market. The non-sinking fund preferred stocks are
typically valued using credit spreads to U. S. Treasury benchmarks. This causes
them to be comparable to fixed income securities in terms of interest rate risk.
During 1999, higher interest rates, widening credit spreads and year-end
tax loss selling adversely affected non-sinking fund preferred stock values. At
December 31, 1999, the duration of the Company's non-sinking fund preferred
stock portfolio was 11.5 years. This implies that an upward parallel shift in
the yield curve by 100 basis points would reduce the asset value at December 31,
1999 by approximately $18.4 million, everything else remaining the same.
The remainder of the equity portfolio, representing 3% of total
investments at market value, consists primarily of public utility common stocks.
These assets are defensive in nature and therefore have low volatility to
changes in market price as measured by their Beta. Beta is a measure of a
security's systematic (non-diversifiable) risk, which is the percentage change
in an individual security's return for a 1% change in the return of the market.
The average Beta for the Company's common stock holdings was 0.51. Based on a
hypothetical 20% reduction in the overall value of the stock market, the fair
value of the common stock portfolio would decrease by approximately $5.0
million.
30
Forward-looking statements
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 intense
competition currently existing in the California automobile insurance markets,
the success of the Company in integrating and profitably operating the business
of AMI, and in expanding generally in Florida and other states outside of
California, the impact of potential third party "bad-faith" legislation, the
ability of the Company to obtain the approval of the California Insurance
Commissioner for premium rate changes for private passenger automobile policies
issued in California and to obtain similar rate approvals in other states and
the level of investment yields obtainable in the Company's investment portfolio
in comparison to recent yields, as well as the cyclical and general competitive
nature of the property and casualty insurance industry and general uncertainties
regarding loss reserve estimates and legislative and regulatory changes,
particularly in California.
31
Quarterly Data
Summarized quarterly financial data for 1999 and 1998 is as follows (in
thousands except per share data):
Quarter Ended
----------------------------------------
March 31 June 30 Sept. 30 Dec. 31
-------- ------- -------- -------
1999
- ----
Earned premiums................... $290,518 $295,934 $300,070 $301,785
Income before income taxes........ $ 52,484 $ 41,086 $ 33,456 $ 41,513
Net income........................ $ 40,044 $ 32,961 $ 27,696 $ 33,008
Basic earnings per share.......... $ .73 $ .60 $ .51 $ .61
Diluted earnings per share........ $ .73 $ .60 $ .51 $ .60
Dividends declared per share...... $ .21 $ .21 $ .21 $ .21
1998
- ----
Earned premiums................... $274,454 $278,768 $282,198 $286,164
Income before income taxes ....... $ 70,107 $ 67,966 $ 54,596 $ 42,611
Net income........................ $ 51,414 $ 50,255 $ 41,442 $ 34,415
Basic earnings per share.......... $ .93 $ .91 $ .75 $ .63
Diluted earnings per share........ $ .93 $ .90 $ .75 $ .63
Dividends declared per share...... $ .175 $ .175 $ .175 $ .175
32
Item 8. Financial Statements
--------------------
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Independent Auditors' Report.................................................. 34
Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 1999 and 1998........... 35
Consolidated Statements of Income for Each of the Years in the
Three-Year Period Ended December 31, 1999............................. 36
Consolidated Statements of Comprehensive Income for each of the
Years in the Three-Year Period Ended December 31, 1999............... 37
Consolidated Statements of Shareholders' Equity for Each of the
Years in the Three-Year Period Ended December 31, 1999............... 38
Consolidated Statements of Cash Flows for Each of the Years in
the Three-Year Period Ended December 31, 1999......................... 39
Notes to Consolidated Financial Statements............................. 41
33
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Mercury General Corporation:
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.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
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.
KPMG LLP
Los Angeles, California
February 4, 2000
34
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1999 AND 1998
AMOUNTS EXPRESSED IN THOUSANDS, except share amounts
ASSETS
1999 1998
---- ----
Investments:
Fixed maturities available for sale (amortized cost
$1,353,765 in 1999 and $1,245,440 in 1998)........... $1,322,054 $1,324,908
Equity securities available for sale (cost $238,856
in 1999 and $220,449 in 1998)........................ 209,843 219,745
Short-term cash investments, at cost, which approxi-
mates market......................................... 43,568 45,992
---------- ----------
Total investments.......................... 1,575,465 1,590,645
Cash..................................................... 8,052 1,887
Receivables:
Premiums receivable................................... 115,654 107,950
Premium notes......................................... 13,375 13,739
Accrued investment income ............................ 23,815 22,356
Other................................................. 19,235 24,884
---------- ----------
172,079 168,929
Deferred policy acquisition costs ....................... 63,975 61,947
Fixed assets, net ....................................... 34,221 31,901
Current income taxes recoverable......................... 1,796 5,895
Deferred income taxes.................................... 28,541 --
Other assets............................................. 22,238 15,821
---------- ----------
$1,906,367 $1,877,025
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Losses and loss adjustment expenses...................... $ 434,843 $ 405,976
Unearned premiums........................................ 340,846 327,129
Notes payable............................................ 92,000 78,000
Loss drafts payable...................................... 40,063 38,433
Accounts payable and accrued expenses.................... 53,121 53,196
Deferred income taxes.................................... -- 22,639
Other liabilities........................................ 35,903 34,277
---------- ----------
Total liabilities.......................... 996,776 959,650
---------- ----------
Shareholders' equity:
Common stock without par value or stated value.
Authorized 70,000,000 shares; issued and outstanding
54,425,323 shares in 1999 and 54,684,438 in 1998..... 50,963 48,830
Accumulated other comprehensive income (loss)......... (39,471) 51,196
Unearned ESOP compensation............................ (3,000) (4,000)
Retained earnings..................................... 901,099 821,349
---------- ----------
Total shareholders' equity................. 909,591 917,375
---------- ----------
Commitments and contingencies ........................
$1,906,367 $1,877,025
========== ==========
See accompanying notes to consolidated financial statements.
35
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Three years ended December 31, 1999
Amounts expressed in thousands, except per share data
1999 1998 1997
---- ---- ----
Revenues:
Earned premiums............................... $1,188,307 $1,121,584 $1,031,280
Net investment income ........................ 99,374 96,169 86,812
Net realized investment gains (losses)........ (11,929) (3,926) 4,973
Net realized gain from sale of subsidiary..... -- 2,586 --
Other......................................... 4,924 5,710 4,881
---------- ---------- ----------
Total revenues........................... 1,280,676 1,222,123 1,127,946
---------- ---------- ----------
Expenses:
Losses and loss adjustment expenses........... 789,103 684,468 654,729
Policy acquisition costs ..................... 267,399 252,592 224,883
Other operating expenses...................... 50,675 44,941 33,579
Interest ..................................... 4,960 4,842 4,976
---------- ---------- ----------
Total expenses........................... 1,112,137 986,843 918,167
---------- ---------- ----------
Income before income taxes.................... 168,539 235,280 209,779
Income taxes ................................... 34,830 57,754 53,473
---------- ---------- ----------
Net income.................................... $ 133,709 $ 177,526 $ 156,306
========== ========== ==========
Basic earnings per share........................ $ 2.45 $ 3.23 $ 2.84
========== ========== ==========
Diluted earnings per share...................... $ 2.44 $ 3.21 $ 2.82
========== ========== ==========
See accompanying notes to consolidated financial statements.
36
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Three Years ended December 31, 1999
Amounts expressed in thousands
1999 1998 1997
---- ---- ----
Net income............................................. $133,709 $177,526 $156,306
Other comprehensive income (loss), before tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising
during period................................... (146,637) 12,397 44,185
Less: reclassification adjustment for net
losses (gains) included in net income........... 7,149 (4,605) (2,377)
-------- -------- --------
Other comprehensive income (loss),
before tax...................................... (139,488) 7,792 41,808
Income tax expense (benefit) related to unrealized
holding gains (losses) arising during period.......... (51,323) 4,339 15,465
Income tax expense (benefit) related to
reclassification adjustment for (gains) losses
included in net income................................ 2,502 (1,612) (832)
-------- -------- --------
Comprehensive income, net of tax....................... $ 43,042 $182,591 $183,481
======== ======== ========
See accompanying notes to consolidated financial statements
37
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Three years ended December 31, 1999
Amounts expressed in thousands
1999 1998 1997
---- ---- ----
Common stock, beginning of year....................... $ 48,830 $ 47,412 $ 42,644
Proceeds of stock options exercised................... 565 1,216 999
Tax benefit on sales of incentive stock
options.............................................. 152 748 401
Release of common stock by the ESOP................... (254) (30) 3,368
Purchase and retirement of common stock............... (330) (516) --
Issuance of restricted common stock................... 2,000 -- --
-------- -------- --------
Common stock, end of year............................. 50,963 48,830 47,412
-------- -------- --------
Accumulated other comprehensive income, beginning
of year.............................................. 51,196 46,131 18,956
Net increase (decrease) in other comprehensive
income............................................... (90,667) 5,065 27,175
-------- -------- --------
Accumulated other comprehensive income (loss),
end of year.......................................... (39,471) 51,196 46,131
-------- -------- --------
Unearned ESOP compensation, beginning of year......... (4,000) -- (2,000)
Unearned ESOP compensation relating to common
stock purchases by ESOP.............................. -- (5,000) --
Amortization of unearned ESOP compensation............ 1,000 1,000 2,000
-------- -------- --------
Unearned ESOP compensation, end of year............... (3,000) (4,000) --
-------- -------- --------
Retained earnings, beginning of year.................. 821,349 706,049 581,622
Purchase and retirement of common stock............... (8,105) (23,775) --
Net income............................................ 133,709 177,526 156,306
Dividends paid to shareholders........................ (45,854) (38,451) (31,879)
-------- -------- --------
Retained earnings, end of year........................ 901,099 821,349 706,049
-------- -------- --------
Total shareholders' equity..................... $909,591 $917,375 $799,592
======== ======== ========
See accompanying notes to consolidated financial statements.
38
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE YEARS ENDED DECEMBER 31, 1999
Amounts expressed in thousands
1999 1998 1997
---- ---- ----
Cash flows from operating activities:
Net income.................................................. $ 133,709 $ 177,526 $ 156,306
Adjustments to reconcile net income to net cash
provided from operating activities:
Increase (decrease) in unpaid losses and loss
adjustment expenses........................................ 28,867 (3,085) 72,376
Increase in unearned premiums............................... 13,717 17,753 48,498
Decrease (increase) in premium notes receivable............. 364 (177) (1,167)
Increase in premiums receivable............................. (7,704) (3,734) (20,468)
Increase in deferred policy acquisition costs............... (2,028) (4,683) (10,481)
Increase in loss drafts payable............................. 1,630 6,375 3,026
(Decrease) increase in accrued income taxes, excluding
deferred tax on change in unrealized gain................. 1,577 (8,957) 469
Increase (decrease) in accounts payable and accrued
expenses................................................... (1,223) 2,801 17,553
Depreciation................................................ 6,896 5,444 5,157
Net realized investment (gains) losses...................... 11,929 3,926 (4,973)
Net realized gain from sale of subsidiary................... -- (2,586) --
Bond accretion, net......................................... (5,450) (4,146) (2,295)
Other, net.................................................. 6,641 6,030 8,479
--------- --------- ---------
Net cash provided from operating activities......... 188,925 192,487 272,480
Cash flows from investing activities:
Fixed maturities available for sale:
Purchases................................................. (215,960) (295,723) (362,932)
Sales..................................................... 54,537 111,779 71,313
Calls or maturities....................................... 58,411 84,445 72,515
Equity securities available for sale:
Purchases................................................. (475,525) (800,620) (608,260)
Sales..................................................... 445,330 745,275 590,155
Proceeds from sale of subsidiary less cash
transferred............................................... -- 11,018 --
Concord transaction (See note 8)........................... (3,665) -- --
Decrease (increase) in receivable from securities.......... 613 (347) (3,274)
Decrease in short-term cash investments,
net....................................................... 2,424 12,059 6,327
Purchase of fixed assets................................... (9,268) (7,164) (6,854)
Sale of fixed assets....................................... 916 444 1,165
--------- --------- ---------
Net cash used in investing activities............... $(142,187) $(138,834) $(239,845)
(Continued)
39
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
1999 1998 1997
---- ---- ----
Cash flows from financing activities:
Additions to notes payable........................ $ 17,000 $ 3,000 $ --
Principal payments on notes payable............... (3,000) -- --
Payment of American Mercury Insurance Company
indemnification holdback......................... -- -- (1,750)
Dividends paid to shareholders.................... (45,854) (38,451) (31,879)
Proceeds from stock options exercised............. 717 1,965 1,400
Purchase and retirement of common stock........... (8,436) (24,291) --
Net increase (decrease) of ESOP loan.............. (1,000) 3,000 (1,000)
-------- -------- --------
Net cash used in financing activities.... (40,573) (54,777) (33,229)
-------- -------- --------
Net increase (decrease) in cash................... 6,165 (1,124) (594)
Cash:
Beginning of the year........................... 1,887 3,011 3,605
-------- -------- --------
End of the year................................. $ 8,052 $ 1,887 $ 3,011
======== ======== ========
See accompanying notes to consolidated financial statements.
40
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999 and 1998
(1) Significant Accounting Policies
Principles of Consolidation and Presentation
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.
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), and American Mercury Lloyds Insurance Company
(AML). AML is not owned by MGC, but is controlled by MGC through its attorney-in
- -fact, AFIMC. 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 9. 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. All
of the subsidiaries as a group, including AML, 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.
41
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1999 and 1998
(1) Significant Accounting Policies (Continued)
Investments
Fixed maturities available for sale include those securities that
management intends to hold for indefinite periods, but which may be sold in
response to changes in interest rates, tax planning considerations or other
aspects of asset/liability management. Fixed maturities available for sale,
which include bonds and sinking fund preferred stocks, are carried at market.
Short-term investments are carried at cost, which approximates market.
Investments in equity securities, which include common stocks and non-redeemable
preferred stocks, are carried at market.
In most cases, the market valuations were drawn from standard trade data
sources. In no case were any valuations made by the Company's management. Equity
holdings, including nonsinking 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.
Temporary unrealized investment gains and losses on securities available
for sale are credited or charged directly to shareholders' equity as accumulated
other comprehensive income, net of applicable tax effects. When a decline in
value of fixed maturities or equity securities is considered other than
temporary, a loss is recognized in the consolidated statements of income.
Realized gains and losses are included in the consolidated statements of income
based upon the specific identification method. Included in realized losses for
1999 is a $6.0 millionwrite-down of a preferred stock investment that became
other than temporarily impaired during the third quarter of 1999.
Fair Value of Financial Instruments
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 Statement of Financial Accounting Standards No. 115 (SFAS No.
115), "Accounting for Certain Investments in Debt and Equity Securities", 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 carrying value of receivables, accounts payable and other
liabilities is equivalent to the estimated fair value of those items. 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.
42
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1999 and 1998
(1) Significant Accounting Policies (Continued)
Premium Income Recognition
Insurance premiums are recognized as income ratably over the term of the
policies. Unearned premiums are computed on the monthly pro rata basis. Unearned
premiums are stated gross of reinsurance deductions, with the reinsurance
deduction recorded in other assets.
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.
Premium Notes
Premium notes receivable represent the balance due to the Company from
policyholders who elect to finance their premiums over the policy term. The
Company requires both a downpayment and monthly payments as part of its
financing program. Premium finance fees are charged to policyholders who elect
to finance premiums. The fees are charged at rates that vary with the amount of
premium financed. Premium finance fees are recognized over the term of the
premium note based upon the effective yield.
Deferred Policy Acquisition Costs
Acquisition costs related to unearned premiums, which consist of
commissions, premium taxes and certain other underwriting costs, which vary
directly with and are directly related to the production of business, are
deferred and amortized to income ratably over the terms of the policies.
Deferred acquisition costs are limited to the amount which will remain after
deducting from unearned premiums and anticipated investment income, the
estimated losses and loss adjustment expenses and the servicing costs that will
be incurred as the premiums are earned. The Company does not defer advertising
expenses.
43
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1999 and 1998
(1) Significant Accounting Policies (Continued)
Losses and Loss Adjustment Expenses
The liability for losses and loss adjustment expenses is based upon the
accumulation of individual case estimates for losses reported prior to the close
of the accounting period, plus estimates, based upon past experience, of
ultimate developed costs which may differ from case estimates and of unreported
claims. The liability is stated net of anticipated salvage and subrogation
recoveries. The amount of reinsurance recoverable is included in other
receivables.
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 regulatory and legal environment, 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 the liability for losses and loss adjustment
expenses is adequate to cover the ultimate net cost of losses and loss
adjustment expenses incurred to date. Since the provisions are necessarily based
upon estimates, the ultimate liability may be more or less than such provisions.
Depreciation
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.
Earnings per Share
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 15
contains the required disclosures which make up the calculation of basic and
diluted earnings per share.
44
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1999 and 1998
(1) Significant Accounting Policies (Continued)
Comprehensive Income
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.
Segment Reporting
Statement of Financial Accounting Standards No. 131 (SFAS No. 131),
"Disclosures about Segments of an Enterprise and Related Information," became
effective for fiscal years beginning after December 15, 1997. SFAS 131
establishes standards for the way information about operating segments is
reported in financial statements. The Company does not have any operations that
require separate disclosure as operating segments.
Recently Issued Accounting Standards
Statement of Position 97-3 (SOP 97-3), "Accounting by Insurance and Other
Enterprises for Insurance Related Assessments", provides guidance on the timing
of recognition and measurement of liabilities for insurance related assessments.
SOP 97-3 prescribes liability recognition when three conditions are met: (1) an
assessment has been imposed or information available prior to the issuance of
the financial statements indicates that it is probable that an assessment will
be imposed, (2) the event obligating an entity to pay an imposed or probable
assessment has occurred on or before the date of the financial statements and
(3) the amount of the assessment can be reasonably estimated. It is effective
for financial statements with fiscal years beginning after December 15, 1998.
The Company initially adopted SOP 97-3 in 1999 with no impact to the Financial
Statements.
Statement of Position 98-1 (SOP 98-1), "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use" is effective for
financial statements beginning after December 15, 1998. SOP 98-1 requires that
the cost of internally developed computer software be capitalized. The
implementation of SOP 98-1 in 1999 provided less than a $.01 contribution to
1999 earnings per share (diluted).
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.
45
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1999 and 1998
(1) Significant Accounting Policies (Continued)
Income Taxes
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 SFAS 109, "Accounting for
Income Taxes".
Reinsurance
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.
The Insurance Companies, as primary insurers, would be required to pay
losses in their entirety in the event that the reinsurers were unable to
discharge their obligations under the reinsurance agreements.
Statements of Cash Flows
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 subsidiary sold in 1998 consisted primarily of invested assets
totaling $8,408,000 at the sale date.
In 1998, non-cash financing activities included receipt of $276,000 of
common stock tendered at market value to exercise stock options.
On December 30, 1997, the Company paid $1,750,000 of principal plus
$87,500 of interest to the seller of AMI. This amount represented repayment of a
one year note which secured the seller's guaranty of the collectibility of
certain assets of AMI.
Stock-Based Compensation
The Company accounts for stock-based compensation under the accounting
methods prescribed
46
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1999 and 1998
(1) Significant Accounting Policies (Continued)
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.
Reclassifications
Certain reclassifications have been made to the prior year balances to
conform to the current year presentation.
(2) Investments and Investment Income
A summary of net investment income is shown in the following table:
Year ended December 31,
(Amounts in thousands)
-----------------------------
1999 1998 1997
---- ---- ----
Interest and dividends on fixed maturities........ $ 78,559 $75,602 $67,948
Dividends on equity securities.................... 18,885 18,027 16,317
Interest on short-term cash investments........... 2,840 3,460 3,321
------- ------- -------
Total investment income.................... 100,284 97,089 87,586
Investment expense................................ 910 920 774
-------- ------- -------
Net investment income...................... $ 99,374 $96,169 $86,812
======== ======= =======
A summary of net realized investment gains (losses) is as follows:
Year ended December 31,
(Amounts in thousands)
-----------------------------
1999 1998 1997
---- ---- ----
Net realized investment gains (losses):
Fixed maturities.......................... $ 67 $ 914 $ 1,400
Equity securities......................... (11,996) (4,840) 3,573
-------- ------- -------
$(11,929) $(3,926) $ 4,973
======== ======= =======
47
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1999 and 1998
(2) Investments and Investment Income (Continued)
Gross gains and losses realized on the sales of investments (excluding
calls and other than temporarily impaired securities) are shown below:
Year ended December 31,
(Amounts in thousands)
------------------------------
1999 1998 1997
---- ---- ----
Fixed maturities available for sale:
Gross realized gains...................... $ 865 $ 394 $ 849
Gross realized losses..................... (259) (370) (389)
-------- ------- -------
Net................................. $ 606 $ 24 $ 460
======== ======= =======
Equity securities available for sale:
Gross realized gains...................... $ 5,506 $ 9,452 $ 7,257
Gross realized losses..................... (11,536) (14,166) (3,565)
-------- ------- -------
Net................................. $ (6,030) $(4,714) $ 3,692
======== ======= =======
A summary of the net increase (decrease) in unrealized investment gains
and losses less applicable income tax expense (benefit), is as follows:
Year ended December 31,
(Amounts in thousands)
-----------------------------
1999 1998 1997
---- ---- ----
Net increase (decrease) in net unrealized
investment gains and losses:
Fixed maturities available for sale........ $(111,179) $12,076 $38,077
Income tax expense (benefit)............... (38,912) 4,227 13,327
--------- ------- -------
$ (72,267) $ 7,849 $24,750
========= ======= =======
Equity securities.......................... $ (28,309) $(4,283) $ 3,731
Income tax expense (benefit)............... (9,909) (1,499) 1,306
--------- ------- -------
$ (18,400) $(2,784) $ 2,425
========= ======= =======
48
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1999 and 1998
(2) Investments and Investment Income (Continued)
Accumulated unrealized gains and losses on securities available for sale is as
follows:
December 31,
(Amounts in thousands)
----------------------
1999 1998
---- ----
Fixed maturities available for sale:
Unrealized gains....................................... $ 21,193 $ 80,651
Unrealized losses...................................... (52,904) (1,183)
Tax effect............................................. 11,099 (27,814)
-------- --------
$(20,612) $(51,654)
-------- --------
Equity securities available for sale:
Unrealized gains....................................... $ 1,817 $ 5,934
Unrealized losses...................................... (30,830) (6,638)
Tax effect............................................. 10,154 246
-------- --------
$(18,859) $ (458)
======== ========
Net unrealized investment gains (losses)
(classified as accumulated other comprehensive
income/(loss) on the balance sheet)................. $(39,471) $ 51,196
======== ========
The amortized costs and estimated market values of investments in fixed
maturities available for sale as of December 31, 1999 are as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
(Amounts in thousands)
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies.............. $ 8,354 $ 20 $ 179 $ 8,195
Obligations of states and political
subdivisions........................... 1,307,893 20,548 52,209 1,276,232
Corporate securities..................... 6,110 1 154 5,957
Redeemable preferred stock............... 31,408 624 362 31,670
---------- -------- ------- ----------
Totals.............................. $1,353,765 $ 21,193 $52,904 $1,322,054
========== ======== ======= ==========
49
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1999 and 1998
(2) Investments and Investment Income (Continued)
The amortized costs and estimated market values of investments in fixed
maturities available for sale as of December 31, 1998 are as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
(Amounts in thousands)
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies.............. $ 10,206 $ 223 $ 1 $ 10,428
Obligations of states and political
subdivisions........................... 1,179,043 78,003 933 1,256,113
Public utilities......................... 881 55 -- 936
Corporate securities..................... 12,839 336 14 13,161
Redeemable preferred stock............... 42,471 2,034 235 44,270
---------- ------- ------- ----------
Totals............................... $1,245,440 $ 80,651 $ 1,183 $1,324,908
========== ======== ======= ==========
Traditionally, it has been the Company's policy not to invest in high yield or
non-investment grade bonds. In 1995, the Company adopted a policy allowing a
small percentage of its investments to be placed 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
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, 1999, 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 ........................ $ 17,480 $ 17,657
Due after one year through five years........... 21,756 22,074
Due after five years through ten years.......... 89,126 89,847
Due after ten years............................. 1,225,403 1,192,476
---------- ----------
$1,353,765 $1,322,054
========== ==========
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.
50
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1999 and 1998
(3) Fixed Assets
A summary of fixed assets follows:
December 31,
(Amounts in thousands)
----------------------
1999 1998
---- ----
Land............................. $ 6,084 $ 6,084
Buildings........................ 22,932 22,461
Furniture and equipment.......... 40,413 33,120
Leasehold improvements........... 565 410
------- -------
69,994 62,075
Less accumulated depreciation.... (35,773) (30,174)
------- -------
Net fixed assets................. $34,221 $31,901
======= =======
(4) Deferred Policy Acquisition Costs
Policy acquisition costs incurred and amortized are as follows:
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
51
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1999 and 1998
(5) Notes Payable (Continued)
Interbank rate (LIBOR). Based on current effective rates, net interest cost on
the $75 million loan and the $17 million draw at December 31, 1999 is
approximately 6.53% and 6.76%, respectively.
The terms of the loan agreements include certain affirmative and negative
covenants, all of which are met by the Company at December 31, 1999.
(6) Income Taxes
The Company and its subsidiaries file a consolidated Federal income tax
return. The provision for income tax expense (benefit) consists of the
following components:
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
Current................................ $ 418 $ 327 $ 291
Deferred............................... -- -- --
------ ------ ------
$ 418 $ 327 $ 291
====== ====== ======
Total
Current................................ $36,953 $57,564 $54,738
Deferred............................... (2,123) 190 (1,265)
------ ------ ------
Total............................. $34,830 $57,754 $53,473
====== ====== ======
The income tax provision reflected in the consolidated statements of
income is less than the expected federal income tax on income before income
taxes as shown in the table below:
Year ended December 31,
(Amounts in thousands)
------------------------
1999 1998 1997
---- ---- ----
Computed tax expense at 35% ..................... $ 58,989 $ 82,348 $ 73,423
Tax-exempt interest income....................... (25,398) (23,496) (19,188)
Dividends received deduction..................... (3,953) (5,437) (5,389)
Reduction of losses incurred deduction for 15% of
income on securities purchased after
August 7, 1986 4,348 4,245 3,640
Other, net....................................... 844 94 987
------ ------ ------
Income tax expense ......................... $ 34,830 $ 57,754 $ 53,473
====== ====== ======
52
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1999 and 1998
(6) Income Taxes (Continued)
The "temporary differences" that give rise to a significant portion of the
deferred tax asset (liability) relate to the following:
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
-------- --------
Deferred tax liabilities
Deferred acquisition costs (22,391) (21,681)
Tax liability on net unrealized gain on
securities carried at market value........ -- (27,567)
Tax depreciation in excess of book
depreciation.............................. (1,351) (1,545)
Accretion on bonds......................... (2,008) (1,467)
Other deferred tax liabilities............. (2,897) (1,163)
-------- --------
Total gross deferred tax liabilities..... (28,647) (53,423)
-------- --------
Net deferred tax assets (liabilities).... $ 28,541 $(22,639)
======== ========
53
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1999 and 1998
(7) Reserves for Losses and Loss Adjustment Expenses
Activity in the reserves for losses and loss adjustment expenses is
summarized as follows:
Year ended December 31,
(Amounts in thousands)
----------------------
1999 1998 1997
---- ---- ----
Gross reserves for losses and loss
adjustment expenses at beginning of year.. $405,976 $409,061 $336,685
Less reinsurance recoverable............... (20,160) (22,791) (24,931)
------- ------- -------
Net reserves, beginning of year............ 385,816 386,270 311,754
Incurred losses and loss adjustment
expenses related to:
Current year........................... 781,316 693,877 641,911
Prior years............................ 7,787 (9,409) 12,818
------- ------- -------
Total incurred losses and loss adjustment
expenses.................................. 789,103 684,468 654,729
------- ------- -------
Loss and loss adjustment expense
payments related to:
Current year........................... 492,314 437,612 373,823
Prior years............................ 263,805 247,310 206,390
------- ------- -------
Total payments............................. 756,119 684,922 580,213
------- ------- -------
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
======= ======= =======
Increases in prior years incurred losses in 1999 relate to a reduction
in the Company's estimate of the decrease in average bodily injury cost per
claim. In prior years, the average bodily injury cost had trended downward and
the Company had factored this trend into its 1998 year-end reserve estimates.
The actual amount of reduction in average claim costs proved to be less when
developed through year-end 1999 than was originally anticipated at year-end
1998.
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.
54
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1999 and 1998
(8) Concord Transaction
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.
Concord produces annually approximately $20 million of non-standard auto
business in the state of Texas and performs all duties associated with an
insurance company, including underwriting and claims management. However,
Concord as an agent assumes no underwriting risk. Through December 31, 1999, the
Concord business was assumed 100% by an unaffiliated reinsurer. Effective
January 1, 2000, the Company replaced Concord's existing reinsurer (for new and
renewal business) and is assuming 100% of the risks produced by Concord. The
Company plans to expand Concord's product line.
The transaction was accounted for using the purchase method of accounting,
and resulted in an immaterial amount of goodwill that will be amortized using
the straight-line method over a ten-year period.
(9) Sale of Subsidiary
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.
Cimarron ceased writing new business in 1997 and all renewal business was
underwritten and retained by American Mercury Insurance Company. The
consolidated results for 1998 include $0.2 million of revenue and $0.1 million
of net income from the operations of Cimarron up to the sale date of June 5,
1998.
(10) Dividend Restrictions
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.
55
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES NOTES TO
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1999 and 1998
(11) Statutory Balances and Accounting Practices
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 Insurance Companies' statutory net income, as reported to regulatory
authorities, was $135,667,000, $173,473,000 and $147,255,000, for the years
ended December 31, 1999, 1998 and 1997, respectively. The statutory
policyholders' surplus of the Insurance Companies, as reported to regulatory
authorities, as of December 31, 1999 and 1998 was $853,794,000 and $767,223,000,
respectively.
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.
Codification (unaudited)
During 1998, the NAIC approved the codification of statutory accounting
practices. Codification will become effective for the year ended December 31,
2001. The Company has estimated that its total surplus, at December 31, 1999
would have increased by approximately$84 million if codified accounting rules,
as currently stated, were effective. The primary items that would cause the
increase are the elimination of excess of statutory reserves over statement
reserves and the establishment of a net deferred tax asset.
(12) Commitments and Contingencies
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 $3,320,000,$2,074,000 and $1,885,000 for the
years ended December 31, 1999, 1998 and 1997, respectively.
Mercury Casualty 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:
Rent Rent
Year Expense Income
---- ------- ------
2000.................... $3,577 $(186)
2001.................... $3,121 --
2002.................... $2,330 --
2003.................... $1,393 --
2004.................... $1,176 --
Thereafter.............. $3,784 --
56
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1999 and 1998
(12) Commitments and Contingencies (Continued)
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.
(13) Profit Sharing Plan
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:
57
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued) December 31, 1999 and 1998
(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
========= =========
(14) Common Stock
In September 1997, the common stock of the Company was split two-for-one.
All share information has been adjusted accordingly.
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
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.
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 $542,000, $454,000, and $363,000 in 1999, 1998 and 1997,
respectively, and earnings per share (basic and diluted) would have been reduced
by .01 in 1999 and 1998 and would have remained the same in 1997. 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 1999, 1998 and 1997: dividend yield of 3.8
percent for 1999 and 2.0 percent for prior years, expected volatility of 31.6
percent in 1999, 32.7 percent for 1998 and 30 percent for 1997 and expected
lives of 7 years for all years. The risk-free interest rates used were 5.6
percent for the options granted during 1999, 5.4 percent for the options granted
during 1998, and 6.4 percent for the options granted during 1997.
58
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1999 and 1998
(14) Common Stock(Continued)
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:
1999 1998 1997
------------------- ------------------- -------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------- --------- ------- ---------- ------- ----------
Outstanding at beginning of year 539,146 $20.575 629,621 $16.269 717,350 $14.452
Granted during the year 102,100 28.800 73,000 45.385 45,000 27.406
Exercised during the year (37,371) 15.129 (144,475) 10.329 (116,729) 8.553
Canceled or expired (6,000) 15.625 (19,000) 51.484 (16,000) 21.750
------- ------- -------
Outstanding at end of year 597,875 22.370 539,146 20.575 629,621 16.269
======= ======= =======
Options exercisable at year-end 329,575 265,146 277,021
Weighted-average fair value of
options granted during the year $8.12 $16.37 $9.91
The following table summarizes information regarding the stock options
outstanding at December 31, 1999:
Number Weighted Avg. Weighted Avg. Number Weighted Avg.
Range of Outstanding Remaining Exercise Exercisable Exercise
Exercise Prices at 12/31/99 Contractual Life Price at 12/31/99 Price
- ----------------- ----------- ---------------- ----------- ----------- ------------
$15.00 to 15.9375 303,475 4.80 $15.487 247,475 $15.476
$21.75 to 27.4006 189,900 7.47 23.894 71,300 24.198
$31.22 to 44.8209 104,500 8.99 39.588 10,800 43.239
------- -------
$15.00 to 44.8209 597,875 6.38 22.370 329,575 18.273
======= =======
59
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1999 and 1998
(15) Earnings Per Share
A reconciliation of the numerator and denominator, adjusted for a
two-for-one stock split effective September 1997, used in the basic and diluted
earnings per share calculation is presented below:
1999 1998 1997
-------------------------------- ----------------------------- ---------------------------
(000's) (000's) (000's) (000's) (000's) (000's)
Weighted Weighted Weighted
Income Shares Income Shares Income Shares
(Numera- (Denomi- Per-Share (Numera- (Denomi- Per-Share (Numera- (Denomi- Per-Share
tor) nator) Amount tor) nator) Amount tor) nator) Amount
-------- -------- --------- -------- --------- ---------- --------- -------- ----------
Basic EPS
- ---------
Income available to
common stockholders $133,709 54,596 $2.45 $177,526 55,003 $3.23 $156,306 54,997 $2.84
Effect of dilutive
securities
Options -- 219 -- 351 -- 386
Diluted EPS
- -----------
Income available to
common stockholders
after assumed
conversions $133,709 54,815 $2.44 $177,526 55,354 $3.21 $156,306 55,383 $2.82
======== ====== ===== ======== ====== ===== ======== ====== =====
60
Item 9. Changes in and Disagreements with Accountants on Accounting and
---------------------------------------------------------------
Financial Disclosure
--------------------
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
--------------------------------------------------
Item 11. Executive Compensation
----------------------
Item 12. Security ownership of Certain Beneficial Owners and Management
--------------------------------------------------------------
Item 13. Certain Relationships and Related Transactions
----------------------------------------------
Information regarding executive officers of the Company is included in
Part I. For this and other information called for by Items 10, 11, 12 and 13,
reference is made to the Company's definitive proxy statement for its Annual
Meeting of Shareholders, to be held on May 10, 2000, which will be filed with
the Securities and Exchange Commission within 120 days after December 31, 1999,
and which is incorporated herein by reference.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
---------------------------------------------------------------
(a) The following documents are filed as a part of this report:
1. Financial Statements: The Consolidated Financial Statements for the
year ended December 31, 1999 are contained herein as listed in the Index to
Consolidated Financial Statements on page 33.
2. Financial Statement Schedules:
Title
-----
Independent Auditors' Report on Financial Statement Schedules
Schedule I -- Summary of Investments -- Other than Investments in
Related Parties
Schedule II -- Condensed Financial Information of Registrant
Schedule IV -- Reinsurance
All other schedules are omitted as the required information is
inapplicable or the information is presented in the Consolidated Financial
Statements or Notes thereto.
61
3. Exhibits:
3.1&& Articles of Incorporation of the Company, as amended to
date.
3.2@@@ By-laws of the Company, as amended to date.
4.1* Shareholders' Agreement dated as of October 7, 1985
among the Company, George Joseph and Gloria Joseph.
10.1&& Form of Agency Contract.
10.2# Management Agreement, as amended, effective July 1,
1992, among the Company, Mercury Casualty Company,
Mercury Insurance Company and California Automobile
Insurance Company.
10.3## Profit Sharing Plan, as Amended and Restated as of
March 11, 1994.
10.7** Amendment 1994-I to the Mercury General Corporation
Profit Sharing Plan.
10.8** Amendment 1994-II to the Mercury General Corporation
Profit Sharing Plan.
10.9& Amendment 1996-I to the Mercury General Corporation
Profit Sharing Plan.
10.10& Amendment 1997-I to the Mercury General Corporation
Profit Sharing Plan.
10.11&& Amendment 1998-I to the Mercury General Corporation
Profit Sharing Plan.
10.12& Revolving Credit Agreement by and among Mercury General
Corporation, the Lenders Party Thereto and The Bank of
New York, as Agent dated as of November 21, 1996.
10.18@@ Management Agreement effective January 1, 1995 between
the Company and Mercury Insurance Company of Illinois.
10.19@@ Management Agreement effective January 1, 1995 between
the Company and Mercury Indemnity Company of Illinois.
10.20@@ Management Agreement effective January 1, 1995 between
the Company and Mercury Insurance Company of Georgia.
10.21@@ Management Agreement effective January 1, 1995 between
the Company and Mercury Indemnity Company of Georgia
10.22@ The 1995 Equity Participation Plan.
10.23& Stock Purchase Agreement between Mercury General
Corporation as Purchaser and AFC as Seller dated
November 15, 1996.
10.24&& Management Agreement effective January 1, 1997 between
the Company and American Mercury Insurance Company,
AFI Management Co., Inc. and Cimarron Insurance
Company.
10.25&&& Amendment to Revolving Credit Agreement by and
among Mercury General Corporation, the Lender
Party thereto and The Bank of New York, as Agent,
dated as of November 21, 1996.
10.26&&& Revolving Credit Agreement by and among Mercury
General Corporation, the Lender Party thereto and
The Bank of New York, as Agent, dated as of
October 30, 1998.
10.27 ESOP Master Trust Agreement between the Company and BNY
Western Trust Company, as Trustee, effective January 1,
1998.
10.28 ESOP Loan Agreement between Union Bank and BNY Western
Trust Company, as Trustee, of the Mercury General
Corporation ESOP Master Trust dated as of September 29,
1998.
10.29 Continuing Guaranty, dated as of August 29, 1998,
executed by Mercury General Corporation in favor of
Union Bank.
10.30 Amendment 1999-I and Amendment 1999-II to the Mercury
General Corporation Profit Sharing Profit sharing Plan.
10.31 Amendment and Restatement to and of Revolving Credit
Agreement by and among Mercury General Corporation, the
Lender's Party hereto and The Bank of New York, as
Agent, dated as of October 29, 1999.
10.32 Multiple Line Excess of Loss Reinsurance Agreement
between Swiss Reinsurance America Corporation and
Mercury Casualty Company, effective January 1, 1999.
10.33 Multiple Line Excess of Loss Reinsurance Agreement
between Swiss Reinsurance America Corporation and
American Mercury Insurance Company, effective January
1, 2000.
21.1 Subsidiaries of the Company.
23.1 Accountants' Consent.
27.1 Financial Data Schedule.
62
* This document was filed as an exhibit to Registrant's Registration
Statement on Form S-1, File No. 33-899, and is incorporated herein by
this reference.
# This document was filed as an exhibit to Registrant's Form 10-K for the
fiscal year ended December 31, 1992, and is incorporated herein by this
reference.
## This document was filed as an exhibit to Registrant's Form 10-K for the
fiscal year ended December 31, 1993, and is incorporated herein by this
reference.
** This document was filed as an exhibit to Registrant's Form 10-K for the
fiscal year ended December 31, 1994, and is incorporated herein by this
reference.
@ This document was filed as an exhibit to Registrant's Form S-8 filed on
March 8, 1996 and is incorporated herein by this reference.
@@ This document was filed as an exhibit to Registrant's Form 10-K for the
fiscal year ended December 31, 1995, and is incorporated herein by this
reference.
@@@ This document was filed as an exhibit to Registrant's Form 8-K filed on
September 14, 1999 and is incorporated herein by this reference.
& This document was filed as an exhibit to Registrant's Form 10-K for the
fiscal year ended December 31, 1996 and is incorporated herein by this
reference.
&& This document was filed as an exhibit to Registrant's Form 10-K for the
fiscal year ended December 31, 1997 and is incorporated herein by this
reference.
&&& This document was filed as an exhibit to Registrant's Form 10-K for the
fiscal year ended December 31, 1998 and is incorporated herein by this
reference.
(b) Reports on Form 8-K:
None
63
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
MERCURY GENERAL CORPORATION
By /s/ GEORGE JOSEPH
--------------------------------
George Joseph
Chief Executive Officer and
Chairman of the Board
March 16, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
Chief Executive Officer
and
Chairman of the Board
/s/ GEORGE JOSEPH (Principal Executive Officer) March 16, 2000
- --------------------------
George Joseph
Vice President and
Chief Financial Officer
/s/ GABRIEL TIRADOR (Principal Financial Officer) March 16, 2000
- --------------------------
Gabriel Tirador
/s/ NATHAN BESSIN Director March 16, 2000
- --------------------------
Nathan Bessin
/s/ BRUCE A. BUNNER Director March 16, 2000
- --------------------------
Bruce A. Bunner
/s/ MICHAEL D. CURTIUS Director March 16, 2000
- -------------------------
Michael D. Curtius
64
Signature Title Date
--------- ----- ----
/s/ RICHARD E. GRAYSON Director March 16, 2000
- ---------------------------
Richard E. Grayson
/s/ GLORIA JOSEPH Director March 16, 2000
- ---------------------------
Gloria Joseph
/s/ CHARLES MCCLUNG Director March 16, 2000
- ---------------------------
Charles McClung
/s/ DONALD P. NEWELL Director March 16, 2000
- ---------------------------
Donald P. Newell
/s/ DONALD R. SPUEHLER Director March 16, 2000
- ---------------------------
Donald R. Spuehler
65
INDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULES
The Board of Directors
Mercury General Corporation:
Under date of February 4, 2000, we reported on the 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, as contained in the annual report on Form
10-K for the year 1999. In connection with our audits of the aforementioned
consolidated financial statements, we also have audited the related financial
statement schedules as listed under Item 14(a)2. These financial statement
schedules are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statement schedules based on our
audits.
In our opinion, the related financial statement schedules, when considered
in relation to the basic consolidated financial statements taken as a whole,
present fairly, in all material respects, the information set forth therein.
KPMG LLP
Los Angeles, California
February 4, 2000
S-1
SCHEDULE I
MERCURY GENERAL CORPORATION
SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTS IN RELATED PARTIES
December 31, 1999
Amounts in Thousands
Amount at
which shown
in the
Type of Investment Cost Value balance sheet
- ------------------ ---- ----- -------------
Fixed maturities available for sale
Bonds:
U.S. Government....................... $ 8,354 $ 8,195 $ 8,195
States, municipalities................ 1,307,893 1,276,231 1,276,231
All other corporate bonds............. 6,110 5,957 5,957
Redeemable preferred stock.............. 31,408 31,671 31,671
---------- ---------- ----------
Total fixed maturities available for
sale................................ 1,353,765 1,322,054 1,322,054
---------- ---------- ----------
Equity securities:
Common stocks:
Public utilities...................... 55,551 49,184 49,184
Banks, trust and insurance companies.. 9 9 9
Industrial, miscellaneous and
all other............................ 190 219 219
Nonredeemable preferred stocks.......... 183,106 160,431 160,431
---------- ---------- ----------
Total equity securities available for
sale................................ 238,856 209,843 209,843
---------- ---------- ----------
Short-term investments...................... 43,568 43,568
---------- ----------
Total investments..................... $1,636,189 $1,575,465
========== ==========
S-2
SCHEDULE I
MERCURY GENERAL CORPORATION
SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTS IN RELATED PARTIES
December 31, 1998
Amounts in Thousands
Amount at
which shown
in the
Type of Investment Cost Value balance sheet
- ------------------ ---- ----- -------------
Fixed maturities available for sale
Bonds:
U.S. Government....................... $ 10,206 $ 10,428 $ 10,428
States, municipalities................ 1,179,043 1,256,113 1,256,113
Public utilities...................... 881 936 936
All other corporate bonds............. 12,839 13,161 13,161
Redeemable preferred stock.............. 42,471 44,270 44,270
---------- --------- ----------
Total fixed maturities available for
sale................................ 1,245,440 1,324,908 1,324,908
---------- --------- ----------
Equity securities:
Common stocks:
Public utilities...................... 38,260 40,650 40,650
Banks, trust and insurance companies.. 1,666 1,813 1,813
Industrial, miscellaneous and
all other............................ 5,233 5,372 5,372
Nonredeemable preferred stocks.......... 175,290 171,910 171,190
---------- --------- ----------
Total equity securities available for
sale................................ 220,449 219,745 219,745
---------- --------- ----------
Short-term investments...................... 45,992 45,992
---------- ----------
Total investments..................... $1,511,881 $1,590,645
========== ==========
S-3
SCHEDULE II
MERCURY GENERAL CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS
December 31, 1999 and 1998
Amounts in thousands
ASSETS
1999 1998
---- ----
Investments:
Fixed maturities available for sale (amortized
cost $2,130 in 1999 and $1,002 in 1998)...... $ 2,126 $ 980
Equity securities, available for sale (cost
$25,831 in 1999 and $22,885 in 1998)......... 22,985 22,274
Short-term cash investments...................... 5,956 9,189
Investment in subsidiaries....................... 975,488 979,695
--------- ---------
Total investments...................... 1,006,555 1,012,138
Amounts due from affiliates.......................... 8,320 8,544
Income taxes......................................... 9,288 3,693
Other assets......................................... 2,371 1,963
---------- ----------
$1,026,534 $1,026,338
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Notes payable........................................ $ 92,000 $ 78,000
Accounts payable and accrued expenses................ 18,459 22,353
Other liabilities.................................... 6,484 8,610
---------- ----------
Total liabilities............................. 116,943 108,963
---------- ----------
Shareholders' equity:
Common stock..................................... 50,963 48,830
Accumulated other comprehensive income (loss).... (39,471) 51,196
Unearned ESOP compensation....................... (3,000) (4,000)
Retained earnings................................ 901,099 821,349
---------- ----------
Total shareholders' equity............ 909,591 917,375
---------- ----------
$1,026,534 $1,026,338
========== ==========
See notes to condensed financial information
S-4
SCHEDULE II, Continued
MERCURY GENERAL CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF INCOME
Three years ended December 31, 1999
Amounts in thousands
1999 1998 1997
---- ---- ----
Revenues:
Net investment income...................... $ 1,867 $ 1,956 $ 2,139
Management fee income from subsidiaries.... 208,245 186,387 162,352
Other...................................... 11 94 --
------- ------- --------
Total revenues......................... 210,123 188,437 164,491
------- ------- --------
Expenses:
Loss adjustment expenses................... 128,474 115,242 102,889
Policy acquisition costs................... 35,527 33,550 31,543
Other operating expenses................... 45,302 38,815 28,454
Interest................................... 4,958 4,839 4,972
------- ------- --------
Total expenses......................... 214,261 192,446 167,858
------- ------- --------
Loss before income taxes and equity in net
income of subsidiaries.................... (4,138) (4,009) (3,367)
Income tax benefit........................... (1,380) (2,010) (528)
------- ------- --------
Loss before equity in net income
of subsidiaries........................... (2,758) (1,999) (2,839)
Equity in net income of subsidiaries......... 136,467 179,525 159,145
------- ------- --------
Net income............................. $133,709 $177,526 $156,306
======= ======= ========
See notes to condensed financial information.
S-5
SCHEDULE II, Continued
MERCURY GENERAL CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF CASH FLOWS
Three Years ended December 31, 1999
Amounts in thousands
1999 1998 1997
---- ---- ----
Cash flows from operating activities:
Net cash provided from operating activities...... $ 50,295 $ 49,705 $ 42,590
Cash flows from investing activities:
Capital contribution to controlled entity........ (7,550) -- --
Fixed maturities, at market:
Purchases...................................... (2,008) (2,700) (3,556)
Sales.......................................... -- 3,849 2,398
Calls or maturities............................ 854 731 1,234
Equity securities:
Purchases...................................... (41,004) (75,180) (71,446)
Sales.......................................... 36,759 79,852 59,786
Calls.......................................... 1,119 222 358
Increase (decrease) in payable for securities.... -- 203 (1,493)
(Increase) decrease in short term cash
investments, net ................................ 3,233 (2,484) 1,385
-------- -------- --------
Net cash provided by (used) in investing
activities.................................. (8,597) 4,493 (11,334)
Cash flows from financing activities:
Additions to notes payable....................... 17,000 3,000 --
Principal payments on notes payable.............. (3,000) -- --
Payment of AMI indemnification holdback.......... -- -- (1,750)
Dividends paid to shareholders................... (45,854) (38,452) (31,879)
Purchase and retirement of common stock.......... (8,435) (24,291) --
Stock options exercised.......................... 717 1,964 1,400
Net increase (decrease) of ESOP loan............. (1,000) 3,000 (1,000)
-------- -------- --------
Net cash provided by (used) in financing
activities................................... (40,572) (54,779) (33,229)
Net increase (decrease) in cash.................... 1,126 (581) (1,973)
Cash:
Beginning of the year............................ (3,610) (3,029) (1,056)
-------- -------- --------
End of the year ................................. $ (2,484) $ (3,610) $ (3,029)
======== ======== ========
See notes to condensed financial information.
S-6
SCHEDULE II, Continued
MERCURY GENERAL CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
NOTES TO CONDENSED FINANCIAL INFORMATION
December 31, 1999 and 1998
The accompanying condensed financial information should be read in
conjunction with the consolidated financial statements and notes included in
this statement.
Management Fee Income
Under a management agreement, the Company performs management services
which include all underwriting and claims servicing functions for its
subsidiaries. The Company is compensated by monthly reimbursement of expenses
incurred.
Dividends Received From Subsidiaries
Dividends of $61,000,000, $55,000,000, and $33,500,000 were received by the
Company from its wholly-owned subsidiaries in 1999, 1998 and 1997, respectively,
and are recorded as a reduction to Investment in Subsidiaries.
Cash Overdraft
At December 31, 1999 and 1998, the Company had cash overdrafts of
$2,484,000 and $3,610,000 respectively which are classified in "other
liabilities" in the accompanying condensed balance sheet.
S-7
SCHEDULE IV
MERCURY GENERAL CORPORATION
REINSURANCE
Three years ended December 31, 1999
Amounts in thousands
Ceded to
Gross other Net
amount companies Assumed amount
------- --------- ------- -------
Property and Liability insurance
1999....................... $1,186,385 $ 8,844 $10,766 $1,188,307
1998....................... $1,130,597 $14,352 $ 5,339 $1,121,584
1997....................... $1,055,114 $24,241 $ 407 $1,031,280
S-8
EXHIBIT INDEX
3.1&& Articles of Incorporation of the Company, as amended to
date.
3.2@@@ By-laws of the Company, as amended to date.
4.1* Shareholders' Agreement dated as of October 7, 1985 among
the Company, George Joseph and Gloria Joseph.
10.1&& Form of Agency Contract.
10.2# Management Agreement, as amended, effective July 1, 1992,
among the Company, Mercury Casualty Company, Mercury
Insurance Company and California Automobile Insurance
Company.
10.3## Profit Sharing Plan, as Amended and Restated as of March 11,
1994.
10.7** Amendment 1994-I to the Mercury General Corporation Profit
Sharing Plan.
10.8** Amendment 1994-II to the Mercury General Corporation Profit
Sharing Plan.
10.9& Amendment 1996-I to the Mercury General Corporation Profit
Sharing Plan.
10.10& Amendment 1997-I to the Mercury General Corporation Profit
Sharing Plan.
10.11&& Amendment 1998-I to the Mercury General Corporation Profit
Sharing Plan.
10.12& Revolving Credit Agreement by and among Mercury General
Corporation, the Lenders Party Thereto and The Bank of New
York, as Agent dated as of November 21, 1996.
10.18@@ Management Agreement effective January 1, 1995 between the
Company and Mercury Insurance Company of Illinois.
10.19@@ Management Agreement effective January 1, 1995 between the
Company and Mercury Indemnity Company of Illinois.
10.20@@ Management Agreement effective January 1, 1995 between the
Company and Mercury Insurance Company of Georgia.
10.21@@ Management Agreement effective January 1, 1995 between the
Company and Mercury Indemnity Company of Georgia.
10.22@ The 1995 Equity Participation Plan.
10.23& Stock Purchase Agreement between Mercury General Corporation
as Purchaser and AFC as Seller dated November 15, 1996.
10.24&& Management Agreement effective January 1, 1997 between the
Company and American Mercury Insurance Company,
AFI Management Co., Inc. and Cimarron Insurance Company.
10.25&&& Amendment to Revolving Credit Agreement by and among Mercury
General Corporation, the Lender Party thereto and The Bank
of New York, as Agent, dated as of November 21, 1996.
10.26&&& Revolving Credit Agreement by and among Mercury General
Corporation, the Lender Party thereto and The Bank of New
York, as Agent, dated as of October 30, 1998.
10.27 ESOP Master Trust Agreement between the Company and BNY
Western Trust Company, as Trustee, effective January 1,
1998.
10.28 ESOP Loan Agreement between Union Bank and BNY Western Trust
Company, as Trustee, of the Mercury General Corporation ESOP
Master Trust dated as of September 29, 1998.
10.29 Continuing Guaranty, dated as of August 29, 1998, executed
by Mercury General Corporation in favor of Union Bank.
10.30 Amendment 1999-I and Amendment 1999-II to the Mercury
General Corporation Profit Sharing Plan.
10.31 Amendment and Restatement to and of Revolving Credit
Agreement by and among Mercury General Corporation, the
Lender's Party hereto and The Bank of New York, as Agent,
dated as of October 29, 1999.
10.32 Multiple Line Excess of Loss Reinsurance Agreement between
Swiss Reinsurance America Corporation and Mercury Casualty
Company, effective January 1, 1999.
10.33 Multiple Line Excess of Loss Reinsurance Agreement between
Swiss Reinsurance America Corporation and American Mercury
Insurance Company, effective January 1, 2000.
21.1 Subsidiaries of the Company.
23.1 Accountants' Consent.
27.1 Financial Data Schedule.
* This document was filed as an exhibit to Registrant's Registration
Statement on Form S-1, File No. 33-899, and is incorporated herein by
this reference.
# This document was filed as an exhibit to Registrant's Form 10-K for the
fiscal year ended December 31, 1992, and is incorporated herein by this
reference.
## This document was filed as an exhibit to Registrant's Form 10-K for the
fiscal year ended December 31, 1993, and is incorporated herein by this
reference.
** This document was filed as an exhibit to Registrant's Form 10-K for the
fiscal year ended December 31, 1994, and is incorporated herein by this
reference.
@ This document was filed as an exhibit to Registrant's Form S-8 filed on
March 8, 1996 and is incorporated herein by this reference.
@@ This document was filed as an exhibit to Registrant's Form 10-K for the
fiscal year ended December 31, 1995, and is incorporated herein by this
reference.
@@@ This document was filed as an exhibit to Registrant's Form 8-K filed on
September 14, 1999 and is incorporated herein by this reference.
& This document was filed as an exhibit to Registrant's Form 10-K for the
fiscal year ended December 31, 1996 and is incorporated herein by this
reference.
&& This document was filed as an exhibit to Registrant's Form 10-K for the
fiscal year ended December 31, 1997 and is incorporated herein by this
reference.
&&& This document was filed as an exhibit to Registrant's Form 10-K for the
fiscal year ended December 31, 1998 and is incorporated herein by this
reference.
(b) Reports on Form 8-K:
None