Back to GetFilings.com
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, 2000 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, 2001, was approximately
$800,435,690 (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, 2001, the Registrant had issued and outstanding an aggregate of
54,198,623 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 9, 2001 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 2000, private passenger automobile insurance and commercial
automobile insurance accounted for 90.2% and 3.7%, respectively, of the total
Company's gross premiums written. The percentage of gross automobile insurance
premiums written during 2000 by state was 90.0% in California, 3.3% in Texas,
3.2% in Florida, 1.5% in Oklahoma, 1.0% in Illinois 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 6.1% of gross written premiums
in 2000, of which approximately 23% 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 2000, 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 ("AMI"), American Mercury Lloyds Insurance Company
("AML") and Mercury County Mutual Insurance Company ("MCM"). 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). AMI and AML, which accounted
for approximately 5% of the Company's 2000 net written premiums, were rated A-
(Excellent) in 2000 by A.M. Best. MCM, which produced no premium for the Company
in 2000, was unrated by A.M. Best in 2000.
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. During 2000, the Company opened branch offices in
Richmond, Virginia and Latham, New York. 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 2,600
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
2
Georgia and Mercury Insurance Company of Illinois, received authority in late
1989 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
an 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.
("AFIMC"), 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. Concord's results of
operations are included in the consolidated financial statements of the Company
effective October 31, 1999.
During 2000, the Company acquired the authority and right to manage and
control Elm County Mutual Insurance Company, a mutual insurance company
organized under Chapter 17 of the Texas Insurance Code. The acquisition was made
through the purchase of a management agreement from Employers Reinsurance
Corporation, a Missouri corporation with its principal place of business in
Overland Park, Kansas. Effective January 2, 2001, Elm's name was changed to
Mercury County Mutual Insurance Company. The effective date of the transaction
was September 30, 2000. MCM's results of operations, which are immaterial to the
Company, are included in the consolidated results of the Company effective
September 30, 2000.
Prior to January 1, 2001, Mercury General furnished management services
to its California, Georgia, Illinois and Oklahoma subsidiaries. Following
December 31, 2000, these management services are provided by a subsidiary of
Mercury Casualty Company. Mercury General, its subsidiaries, AML, Concord and
MCM, are referred to as the "Company" unless the context indicates otherwise.
Mercury General Corporation individually is referred to as "Mercury General."
All of the subsidiaries as a group, including AML and MCM, but excluding AFIMC
and Concord, are referred to as the "Insurance Companies." 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, 2000, "good drivers" (as defined by the California
Insurance Code) accounted for approximately 75% of all voluntary private
passenger automobile policies in force in California, while the higher risk
categories accounted for approximately 25%. The renewal rate in California (the
rate of acceptance of offers to renew) averages approximately 96%.
3
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 approximately 4% 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, written by AMI, was insignificant at December
31, 2000.
The Company also offers non-standard private passenger automobile
coverage in Texas through Concord. Non-standard policies in force, written
through Concord, are not a significant portion of the Company's total premiums
in force at December 31, 2000.
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, 2000 was not significant.
The Company's Illinois and Georgia private passenger automobile
business in force is primarily standard and preferred risks and is not a
significant portion of the Company's total premiums in force at December 31,
2000.
Production and Servicing of Business
The Company sells its policies through more than 2,000 independent
agents, of which approximately 900 are located in California, approximately 300
are located in Florida and approximately 550 others represent AMI in Oklahoma
and Texas. The remainder are located in Georgia and Illinois. 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 18%, 19% and 19% during 2000, 1999
and 1998, respectively, of the Company's total direct premiums written. This
agency was sold during 1998 to a large national broker. 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 2000, total commissions and bonuses incurred were 16.4%
of net 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. During 2000 the Company began television
advertising and discontinued advertising on the radio. The Company intends to
continue the current level of advertising during the year 2001. 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).
4
Claims
Claims operations are conducted by the Company. The claims staff in
California, Georgia, Illinois, Florida, Oklahoma and Texas 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 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,
------------------------
2000 1999 1998
---- ---- ----
(Amounts in thousands)
Net reserves for losses and loss adjustment
expenses, beginning of year..................... $418,800 $385,816 $386,270
Incurred losses and loss adjustment expenses:
Provision for insured events of the
current year............................ 878,144 781,316 693,877
Increase (decrease) in provision for
insured events of prior years........... 23,637 7,787 (9,409)
-------- -------- --------
Total incurred losses and loss adjustment
expenses.............................. 901,781 789,103 684,468
-------- -------- --------
Payments:
Losses and loss adjustment expenses attribu-
table to insured events of the current
year..................................... 562,163 492,314 437,612
Losses and loss adjustment expenses attribu-
table to insured events of prior years... 294,615 263,805 247,310
-------- -------- --------
Total payments.......................... 856,778 756,119 684,922
-------- -------- --------
Net reserves for losses and loss adjustment
expenses at the end of the period............... 463,803 418,800 385,816
Reinsurance recoverable ......................... 28,417 16,043 20,160
-------- -------- --------
Gross liability at end of year................... $492,220 $434,843 $405,976
======== ======== ========
5
The increase in the provision for insured events of prior years in 2000
and 1999 largely relates to an increase in the ultimate liability for bodily
injury and physical damage claims over what was originally estimated. The
increases in these claims relate to increased severity over what was originally
recorded and are the result of inflationary trends in health care costs, auto
parts and body shop labor costs.
The decrease in the provision for insured events of prior years in 1998
largely relates to 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 bodily injury loss severity for calendar year 1997. In addition, a
new law, effective January 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.
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 2000 include approximately $1 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 statutory accounting principles
("SAP") is shown in the following table:
December 31,
------------------------------
2000 1999 1998
---- ---- ----
(Amounts in thousands)
Reserves reported on a SAP basis..... $463,803 $418,800 $385,816
Reinsurance recoverable.............. 28,417 16,043 20,160
-------- -------- --------
Reserves reported on a GAAP basis.... $492,220 $434,843 $405,976
======== ======== ========
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 1990 through 2000. 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 middle portion of
the table shows the re- estimated 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
6
estimate changes as more information becomes known about the frequency and
severity of claims for individual years. The bottom line shows the redundancy
(deficiency) that exists when the original reserve estimates are greater (less)
than the re-estimated reserves at December 31, 2000.
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.
As of December 31,
-----------------------------------------------------------------------------------------------
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
(Amounts in thousands)
Net reserves for
losses and loss
adjustment expenses........ $301,354 $280,157 $239,203 $214,525 $223,392 $250,990 $311,754 $386,270 $385,816 $418,800 $463,803
Paid (cumulative)
as of:
One year later............ 181,781 151,866 135,188 143,272 145,664 167,226 206,390 247,310 263,805 294,615
Two years later........... 238,030 197,640 184,119 187,641 198,967 225,158 291,552 338,016 366,908
Three years later......... 254,884 213,824 197,371 204,606 214,403 248,894 316,505 369,173
Four years later.......... 261,058 218,067 201,365 207,704 219,596 253,708 324,337
Five years later.......... 263,011 220,057 202,383 209,930 220,852 255,688
Six years later........... 262,741 220,313 203,578 210,281 221,771
Seven years later......... 262,770 221,098 203,461 210,767
Eight years later......... 263,527 220,974 203,657
Nine years later.......... 263,422 220,975
Ten years later........... 263,461
Net reserves re-estimated
as of:
One year later............ 285,212 230,991 204,479 204,451 216,684 247,122 324,572 376,861 393,603 442,437
Two years later........... 265,618 218,404 204,999 207,089 222,861 254,920 329,210 378,057 407,047
Three years later......... 259,624 220,620 203,452 210,838 221,744 257,958 327,749 383,588
Four years later.......... 264,259 221,118 204,603 210,890 222,957 257,196 329,339
Five years later.......... 264,127 221,264 203,705 211,192 221,947 256,395
Six years later........... 263,336 220,721 204,161 210,739 221,942
Seven years later......... 263,045 220,974 203,775 210,719
Eight years later......... 263,341 220,895 203,928
Nine years later.......... 263,292 221,070
Ten years later........... 263,505
Net Cumulative Redundancy
(deficiency).............. 37,849 59,087 35,275 3,806 1,450 (5,405) (17,585) 2,682 (21,231) (23,637)
As of December 31,
---------------------------------------------------------------------------------------
1992 1993 1994 1995 1996 1997 1998 1999 2000
---- ---- ---- ---- ---- ---- ---- ---- ----
(Amounts in thousands)
Gross liability - end of year 240,183 215,301 227,499 253,546 336,685 409,061 405,976 434,843 492,220
Reinsurance recoverable (980) (776) (4,107) (2,556) (24,931) (22,791) (20,160) (16,043) (28,417)
------- ------- ------- ------- ------- ------- ------- ------- -------
Net liability - end of year 239,203 214,525 223,392 250,990 311,754 386,270 385,816 418,800 463,803
======= ======== ======== ======= ======== ======= ======= ======= =======
Gross re-estimated liability - latest 209,307 218,470 235,315 266,552 357,443 409,051 429,212 459,701
Re-estimated recoverable - latest (5,379) (7,751) (13,373) (10,157) (28,104) (25,463) (22,165) (17,264)
------- ------- ------- ------- ------- ------- ------- -------
Net re-estimated liability - latest 203,928 210,719 221,942 256,395 329,339 383,588 407,047 442,437
======= ======= ======= ======= ======= ======= ======= =======
Gross cumulative redundancy (deficiency) 30,876 (3,169) (7,816) (13,006) (20,758) 10 (23,236) (24,858)
======= ======= ======= ======= ======= ======= ======= =======
For the calendar years 1998 and 1999, the Company's previously
estimated loss reserves produced a deficiency which was reflected in the
following years incurred losses. The Company attributes a large portion of the
deficiency to an increase in the ultimate liability for bodily injury and
physical damage claims over what was originally estimated. The increases in
these claims relate to increased severity over what was originally recorded
and are the result of inflationary trends in health care costs, auto parts and
body shop labor costs.
7
For the calendar year 1997, the Company's previously estimated loss
reserves produced a small 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 bodily injury loss severity for calendar year 1997. In
addition, a new law, effective January 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 1990 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,
--------------------------------------------
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
Loss Ratio...................... 72.2% 66.5% 61.1% 63.5% 66.6%
Expense Ratio................... 26.4 26.5 26.3 24.7 24.0
---- ---- ---- ---- ----
Combined Ratio.................. 98.6% 93.0% 87.4% 88.2% 90.6%
==== ==== ==== ==== ====
Industry combined ratio (all
writers) (1).................. 108.7%(2) 102.6% 100.1% 99.5% 101.0%
Industry combined ratio (excluding
direct writers) (1)........... N.A. 102.3% 99.1% 100.1% 102.6%
__________________
(1) Source: A.M. Best, Aggregates & Averages (1997 through 2000), for all
property and casualty insurance companies (private passenger
automobile line only, after policyholder dividends).
(2) Source: A.M. Best, "Best's Review, January 2001," "Review Preview."
(N.A.) Not available.
Under GAAP, the loss ratio is computed in the same manner as under
statutory accounting, but the expense ratio is determined by matching
underwriting expenses to the period that net premiums were earned, rather than
by when net premiums were 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,
------------------------------------------------
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
Loss Ratio 72.2% 66.4% 61.0% 63.5% 66.5%
Expense Ratio 26.3 26.8 26.6 25.1 24.4
---- ---- ---- ---- ----
Combined Ratio 98.5% 93.2% 87.6% 88.6% 90.9%
==== ==== ==== ==== ====
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,
---------------------------------------------------
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
(Amounts in thousands, except ratios)
Net premiums written..... $1,272,447 $1,206,171 $1,144,051 $1,086,241 $795,873
Policyholders' surplus... $ 954,753 $ 853,794 $ 767,223 $ 679,359 $594,799
Ratio.................... 1.3 to 1 1.4 to 1 1.5 to 1 1.6 to 1 1.3 to 1
Risk Based Capital
------------------
In December 1993, the NAIC adopted a risk-based capital formula for
casualty insurance
9
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. 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, 2000. Each
of the companies exceeded the highest level of minimum required capital.
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 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, 2000, 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 became effective January 1, 2001. Certain state laws may
differ from codification. The Company estimates that it would realize a surplus
increase of approximately $33 million at December 31, 2000 under codification.
This increase primarily relates to the establishment of a net deferred tax asset
and does not include any adjustment for the elimination of the reserve for the
excess of statutory reserves over statement reserves for the California
domiciled companies. For its California domiciled companies, the Company is not
able to recognize a surplus increase of $9 million for the elimination of the
excess of statutory reserves over statement reserves prescribed by codification
because California law requires the establishment of a statutory reserve.
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 ("AMT") was imposed on casualty
companies. Changes in loss experience, growth rates and profitability produce
significant changes in the Company's exposure to AMT 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. Due to AMT considerations, the Company has
recently begun to purchase a greater percentage of taxable securities. At
year-end, approximately 74% 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, 2000.
The nominal average maturity of the bond portfolio is 15.0 years at
December 31, 2000,
10
but the call-adjusted average maturity of the portfolio is shorter,
approximately 9.4 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 6.8 years at
December 31, 2000. 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.
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. As the result of a liquidating
dividend, the Company realized a gain of $347,000 on the same equity security in
2000. Equity holdings consist primarily of perpetual preferred stocks and
dividend bearing common stocks on which dividend income is partially
tax-sheltered by the 70% corporate dividend exclusion.
The California energy crisis has created credit problems for Southern
California Edison and Pacific Gas & Electric. The Company has no investment in
Pacific Gas & Electric. The Company's investment in Southern California Edison
or Southern California Edison subsidiaries is less than one half of one percent
of total investments and is carried on the financial statements at current
market value.
The following table summarizes the investment results of the Company
for the five years ended December 31, 2000:
Year ended December 31,
-----------------------------------------------------------------
2000(1) 1999(1) 1998(1) 1997(1) 1996(1)
---- ---- ---- ---- ----
(Amounts in thousands)
Averaged invested assets (includes
short-term cash investments (2))............ $1,710,176 $1,595,466 $1,473,843 $1,263,167 $970,677
Net investment income:
Before income taxes................... 106,466 99,374 96,169 86,812 70,180
After income taxes.................... 95,154 89,598 87,199 77,917 63,371
Average annual return on investments:
Before income taxes................... 6.2% 6.2% 6.5% 6.9% 7.2%
After income taxes.................... 5.6% 5.6% 5.9% 6.2% 6.5%
Net realized investment gains (losses) after
income taxes.............................. 2,564 (7,754) (2,552) 3,232 (2,062)
Net increase (decrease) in unrealized
gains/losses on all investments after
income taxes.............................. $ 70,342 $ (90,667) $ 5,065 $ 27,175 $ (6,271)
(1) Includes AMI for the month of December 1996 and the full years 1997
through 2000 and MCM for the last three months of 2000.
(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,
------------------------------------------------------------------
2000 1999 1998
------------------ ------------------- -------------------
Amortized Market Amortized Market Amortized Market
Cost Value Cost Value Cost Value
---- ----- ---- ----- ---- -----
(Amounts in thousands)
Taxable Bonds.......... $ 151,281 $ 152,704 $ 21,461 $ 20,779 $ 28,339 $ 29,163
Tax-Exempt State and
Municipal Bonds....... 1,292,711 1,336,555 1,300,896 1,269,604 1,174,630 1,251,475
Sinking Fund Preferred
Stocks................ 19,905 20,215 31,408 31,671 42,471 44,270
--------- --------- --------- --------- --------- --------
Total Fixed Maturity
Investments........ 1,463,897 1,509,474 1,353,765 1,322,054 1,245,440 1,324,908
Equity Investments incl.
Perpetual Preferred
Stocks................ 250,593 252,510 238,856 209,843 220,449 219,745
Short-term Cash Invest-
ments................. 32,977 32,977 43,568 43,568 45,992 45,992
--------- --------- --------- --------- --------- ---------
Total Investments...... $1,747,467 $1,794,961 $1,636,189 $1,575,465 $1,511,881 $1,590,645
========= ========= ========== ========== ========= =========
At December 31, 2000, the Company had a net unrealized gain on all investments
of $47,494,000 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 Company's competitors
having greater shares of the California market sell insurance either directly
and/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 1996 through 1998 time period created a favorable environment for
automobile insurance writers. Many major automobile insurers attempted to
capitalize on the favorable climate by increasing their marketing efforts and
reducing rates in attempts to capture more business. These industry wide rate
reductions and increased severity trends on collision and physical damage
coverages contributed to the deterioration of industry loss ratios in 1999 and
2000 (See Operating Ratios - Loss and Expense). Most competitors have recently
filed for and implemented rate increases. Consequently, the Company believes
that the industry is now entering a period of rising premium rates and reduced
underwriting capacity.
12
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, 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. According to a
recent study released by the California DOI, the combined results for the
Company's California subsidiaries included in the study, tied the Company for
best among the largest seven automobile insurers in California when measured by
consumer complaints. The Company's California subsidiaries included in the study
had 1.3 million earned cars, as defined by the California Department of
Insurance, in 1999 and only 24 justified complaints, a ratio of 1.8 for every
100,000 cars. The Company had no justified complaints on its homeowners
business.
All rates charged by private passenger automobile insurers are subject
to the prior approval of the California DOI. See Regulation - Automobile
Insurance Rating Factor Regulations.
The Company encounters similar competition in each state and other
lines of business 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, which is rated A++ by A.M. Best, 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 had in place a treaty reinsurance agreement 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 was $5
million per risk. This treaty was revised effective October 1, 2000. The revised
treaty provides $4 million coverage in excess of $1 million for each risk.
13
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. For California, the Company has
reduced 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. Although the
Company's catastrophe exposure to earthquakes has been reduced, the Company
continues to have catastrophe exposure for fire following an earthquake.
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.
MCM has reinsurance treaties with several different reinsurers. 100% of
all risks written by MCM are ceded to reinsurers. The Company also holds a
formal guarantee from ERC which reimburses MCM if any of the reinsurers fail to
satisfy their obligations under their respective reinsurance agreements.
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.
14
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
Oklahoma DOI conducted an examination of AMI as of December 31, 1998. The exam
resulted in no material findings or recommendations. The state of Texas will
also conduct periodic examinations of AMI and MCM.
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 2000 and 1999, those contributions amounted to
$579,800 and $528,000, 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, and investments, 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
15
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 of the Holding Company Act. Regulatory approval
was obtained from California, Oklahoma and Texas before the acquisition of AMI
was completed. Approval was granted by Texas for the Mercury County Mutual
transaction.
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 0.5% of the direct automobile insurance
premium written by the Company was for assigned risk business. In 2000, assigned
risks represented 0.2% of total automobile direct premiums written and 0.2% 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 decreased in 1999
and again in 2000. The Company attributes these decreases 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 which became effective 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.
16
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 are assigned to insurance companies in proportion
to each insurer's share of the California private passenger automobile insurance
market. The volume and profitability of the program, including the annual
assessment, are insignificant to the consolidated financial results of the
Company. 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 four 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, (3) the number of years of driving experience
of the insured and (4) whatever optional factors are determined by the Insurance
Commissioner to have a substantial relationship to risk of loss and adopted by
regulation. 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 on 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 affected the 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 similar to 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
17
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.
Third Party "Bad Faith" Legislation
-----------------------------------
Recent initiatives to reinstate third party "bad faith" lawsuits have
been unsuccessful. 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 the most
recent information provided by the CEA, the Company's maximum total exposure to
CEA assessments at April 30, 2000, is approximately $14.6 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 the entire facility.
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 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
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.
18
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, 2001:
Name Age Position
---- --- --------
George Joseph 79 Chairman of the Board, President and
Chief Executive Officer
Cooper Blanton, Jr. 74 Executive Vice President
Bruce E. Norman 52 Senior Vice President in charge of
Marketing
Joanna Y. Moore 45 Vice President and Chief Claims Officer
Kenneth G. Kitzmiller 54 Vice President in charge of Underwriting
Gabriel Tirador 36 Vice President and Chief Financial
Officer
Judy A. Walters 54 Vice President - Corporate Affairs and
Secretary
Peter R. Simon 41 Vice President - Information Systems
Mr. Joseph, President and Chief Executive Officer of the Company and
Chairman of its Board of Directors, has served as Chairman and Chief Executive
Officer since 1961. He was named President in October 2000. Mr. Joseph has more
than 45 years experience in the property and casualty insurance business.
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 Directors of
those companies. In January 1999 he was named Chairman of the Board of AMIC and
President in April 2000. 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
19
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 fourteen
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.
1999 High Low
---- ---
1st Quarter.............................. $45.500 $31.875
2nd Quarter.............................. $40.000 $31.938
3rd Quarter.............................. $36.375 $26.375
4th Quarter.............................. $28.875 $20.938
2000 High Low
---- ---
1st Quarter.............................. $29.688 $21.063
2nd Quarter.............................. $30.250 $23.563
3rd Quarter.............................. $28.375 $23.375
4th Quarter.............................. $44.875 $26.125
2001 High Low
---- ---
1st Quarter (January 1 - March 15)....... $43.813 $32.625
Dividends
Following the public offering of its common stock in November 1985, the
Company has paid regular quarterly dividends on its common stock. During 2000
and 1999, the Company paid dividends on its common stock of $0.96 per share and
$0.84 per share, respectively. On January 26, 2001, the Board of Directors
declared a $0.265 quarterly dividend payable on March 29, 2001 to stockholders
of record on March 15, 2001.
20
The common stock dividend rate has been increased seventeen 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 2001 of up to
approximately $94 million. See Note 11 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, 2001 was 262. The approximate number of beneficial holders
as of March 15, 2001 was 7,500 according to the Bank of New York, the Company's
transfer agent.
21
Item 6. Selected Consolidated Financial Data
------------------------------------
Year ended December 31,
------------------------------------------------------------------
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
(Amounts in thousands, except per share data)
Income Data:
Premiums earned.................. $1,249,259 $1,188,307 $1,121,584 $1,031,280 $754,724
Net investment income............ 106,466 99,374 96,169 86,812 70,180
Realized investment gains(losses) 3,944 (11,929) (3,926) 4,973 (3,173)
Realized gain from sale of
subsidiary..................... -- -- 2,586 -- --
Other............................ 6,349 4,924 5,710 4,881 3,233
--------- --------- --------- --------- -------
Total Revenues.......... 1,366,018 1,280,676 1,222,123 1,127,946 824,964
--------- --------- --------- --------- -------
Losses and loss adjustment
expenses....................... 901,781 789,103 684,468 654,729 501,858
Policy acquisition costs......... 268,657 267,399 252,592 224,883 160,019
Other operating expenses......... 59,733 50,675 44,941 33,579 24,493
Interest......................... 7,292 4,960 4,842 4,976 2,004
--------- --------- --------- --------- -------
Total Expenses.......... 1,237,463 1,112,137 986,843 918,167 688,374
--------- --------- --------- --------- -------
Income before income taxes....... 128,555 168,539 235,280 209,779 136,590
Income taxes..................... 19,189 34,830 57,754 53,473 30,826
--------- --------- --------- --------- -------
Net Income....................... $ 109,366 $ 133,709 $ 177,526 $ 156,306 $105,764
========= ========= ========= ========= =======
Per Share Data:
Basic earnings per share *....... $ 2.02 $ 2.45 $ 3.23 $ 2.84 $ 1.93
========= ========= ========= ========= =======
Diluted earnings per share *..... $ 2.02 $ 2.44 $ 3.21 $ 2.82 $ 1.92
========= ========= ========= ========= =======
Dividends paid *................. $ .96 $ .84 $ .70 $ .58 $ .48
========= ========= ========= ========= =======
December 31,
--------------------------------------------------------------------
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
(Amounts in thousands, except per share data)
Balance Sheet Data:
Total investments................ $1,794,961 $1,575,465 $1,590,645 $1,448,248 $1,168,287
Premiums receivable.............. 123,070 115,654 107,950 104,216 83,748
Total assets..................... 2,142,263 1,906,367 1,877,025 1,725,532 1,419,927
Unpaid losses and loss
adjustment expenses............. 492,220 434,843 405,976 409,061 336,685
Unearned premiums................ 365,579 340,846 327,129 309,376 260,878
Notes payable.................... 107,889 92,000 78,000 75,000 75,000
Deferred income tax
liability (asset)............... 8,336 (28,541) 22,639 19,722 6,349
Shareholders' equity............. 1,032,905 909,591 917,375 799,592 641,222
Book value per share*............ 19.08 16.73 16.80 14.51 11.69
*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.
Further expansion into Texas occurred with the Concord Insurance Services, Inc.
transaction in December 1999 and the Mercury County Mutual Insurance Company
("MCM") transaction in September 2000.
During 2000, approximately 91% of the Company's direct premiums
written 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. The rate change made effective May 1, 1994
resulted in a substantial increase in new business being submitted to the
Company. Since March 31, 1994, Private Passenger Automobile ("PPA") policies in
force in California have increased from approximately 300,000 to 771,000 at
December 31, 2000, an annual rate of increase of approximately 15%. Policy count
growth for the year 2000 was down negligibly from 1999 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) miles
driven per year, (3) years of driving experience 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
23
1997. The Company's plan was approved by the California DOI and became effective
October 1, 1997. Although the rate changes produced some minor dislocations,
implementation of the new plan has not materially changed the Company's overall
competitive position or its profitability.
Results of Operations
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999
---------------------------------------------------------------------
Premiums earned in 2000 of $1,249.3 million increased 5.1% and net
premiums written in 2000 of $1,272.4 million increased 5.5% over amounts
recorded in 1999. Contributing to the overall premium written growth were
initial automobile premiums in Texas from the recent Concord agency transaction,
and increases in California homeowner premiums, California non-standard
automobile premiums and Florida automobile premiums. The Company's core
California private passenger automobile premiums were relatively flat and AMI
experienced a decline in premium volume.
The Company believes that downward pressure on premium rates due to
highly competitive conditions in the California private passenger auto market
has resulted in higher loss ratios. To improve loss ratios many California auto
insurers have either filed for rate increases recently or will do so in the
immediate future. The Company has filed for a 6.9% rate increase in both its
non-standard automobile line and its private passenger automobile line written
by Mercury Casualty Company in California. The combined premium volume for these
two lines was $297.6 million in 2000 representing approximately 29% of the
California private passenger business written in 2000. Despite the proposed
increase, the Company believes that its rates will remain among the lowest in
the market. During 2000, the Company continued its marketing efforts for name
recognition and lead generation. The Company feels that its marketing effort
combined with price and reputation for service make the Company very competitive
in California.
The GAAP loss ratio (loss and loss adjustment expenses related to
premiums earned) was 72.2% in 2000 and 66.4% in 1999. The major reason for the
less favorable result is an increase in severity for California automobile
claims which is the result of inflationary trends in health care costs, auto
parts and body shop labor costs.
The GAAP expense ratio in 2000 (policy acquisition costs and other
operating expenses related to premiums earned) was 26.3% compared with 26.8% in
1999. The decrease was due mainly to a reduction in base and contingent
commissions, which are tied to loss performance, partially offset by an increase
in advertising spending.
Total losses and expenses in 2000, excluding interest expense of $7.3
million, were $1,230.2 million, resulting in an underwriting gain (premiums
earned less losses, policy acquisition costs and other operating expenses) for
the period of $19.1 million compared with an underwriting gain of $81.1 million
in 1999.
Investment income in 2000 was $106.5 million compared with $99.4
million in 1999. The after-tax yield on average investments of $1,710.2 million
(cost basis) was 5.56%, compared with 5.62% on average investments of $1,595.5
million in 1999. The effective tax rate on investment income in 2000 was 10.6%,
compared with 9.8% in 1999. The higher tax rate in 2000 reflects a modest shift
in the Company's portfolio mix from non-taxable to taxable issues. Bonds matured
and called in 2000 totaled $45.6 million compared with $49.2 million in 1999.
Approximately $22.9 million of bonds are expected to mature or be called in
2001.
Realized investment gains in 2000 were $3.9 million compared with
realized losses of $11.9 million in 1999. The gains realized in 2000 were
designed to utilize capital loss tax benefits.
24
Included in 1999 losses was a $6.0 million write-down of a preferred stock
investment that became other than temporarily impaired during the third quarter.
The income tax provision of $19.2 million in 2000 represented an
effective rate of 14.9%, compared with an effective rate of 20.7% in 1999. The
lower rate in 2000 is primarily attributable to the increased proportion of
investment income which consists primarily of tax-exempt interest and tax
sheltered dividend income in contrast to underwriting income which is taxed at
the full corporate rate of 35%.
Net income in 2000 was $109.4 million or $2.02 per share (diluted),
compared with $133.7 or $2.44 per share (diluted), in 1999. Diluted per share
results are based on 54.3 million average shares in 2000 and 54.8 million shares
in 1999. Basic per share results were $2.02 in 2000 and $2.45 in 1999.
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
continued to be extremely competitive which has placed downward pressure on
rates. In April 1998, the Company reduced its average premium rate by 7%. Since
1999 was the first full year with the rate decrease in effect, average 1999
rates were lower than average 1998 rates. The Company has continued to increase
its marketing efforts for both name recognition and lead generation purposes.
Total amounts spent on advertising efforts during 1999 exceeded 1998
expenditures by approximately 70%.
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.
25
The higher tax rate in 1999 reflects a modest shift in the mix of the Company's
equity investments from non-taxable to taxable issues. The redemption of bonds
acquired during higher interest periods has been a negative influence on
realized yields in each of the last several years. Bonds matured and called in
1999 totaled $49.2 million, compared to $65.3 million in 1998.
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.
Liquidity and Capital Resources
Net cash provided from operating activities in 2000, was $153.1
million, while funds derived from the sale, redemption or maturity of
investments was $273.7 million, of which approximately 50% was represented by
the sale of fixed maturities. The amortized cost of fixed-maturity investments
increased by $110.1 million during the year. Equity investments, including
perpetual preferred stocks, increased by $11.7 million at cost, while short-term
cash investments decreased by $10.6 million. The amortized cost of fixed-
maturities available for sale that were sold, called or matured during the year
was $191.8 million.
The market value of all investments held at market as "Available for
Sale" exceeded the amortized cost of $1,747.5 million at December 31, 2000 by
$47.5 million. That unrealized gain, reflected in shareholders' equity, as
Accumulated Other Comprehensive Income, net of applicable tax effects, was $30.9
million at December 31, 2000 compared with an unrealized loss of $39.5 million
at December 31, 1999. The increase in market values since December 31, 1999
reflects principally the substantial decrease in intermediate and long term
interest rates during 2000.
The Company's unrestricted cash and short term investments totaled
$35.9 million at December 31, 2000. Together with funds generated internally,
such liquid assets are more than adequate to pay claims without the sale of long
term investments.
As of December 31, 2000, the average rating of the $1,444.0 million
bond portfolio (at amortized cost) was AA-, while the average effective
maturity, giving effect to anticipated early call provisions, approximates 9.4
years. The modified duration of the bond portfolio at year-end was 6.8 years.
Duration measures the length of time it takes to receive all cash flows produced
by a bond, including reinvestment of interest income. Because it measures four
factors (maturity, coupon rate, yield and call terms) which determine
sensitivity to changes in interest rates, modified duration is considered a much
better indicator of price volatility than simple
26
maturity alone. Bond holdings are broadly diversified geographically and by
obligor. Traditionally, it has been the Company's policy not to invest in high
yield or "junk" bonds. At December 31, 2000 bond holdings rated below investment
grade totaled $19.1 million at market (cost $20.6 million), or less than 1% of
total assets.
Fixed maturity investments of $1,463.9 million (amortized cost),
include $19.9 million (amortized cost) of sinking fund preferred stocks,
principally utility issues. The market value of all fixed maturities exceeded
cost by $45.6 million at December 31, 2000.
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 $252.5 million at market (cost $250.6 million),
including perpetual preferred issues, are largely confined to the public utility
and banking sectors and represent about 24.4% of total shareholders' equity.
The Company had outstanding debt at December 31, 2000 of $108 million.
Of this amount, $75 million has been borrowed under a three year revolving
credit bank loan and is due November 21, 2001. The loan agreement requires the
Company to meet numerous affirmative and negative covenants. The proceeds of the
loan were used to repay a prior loan and to acquire AMI, with the balance
contributed as capital to AMI. The loan agreement may be extended annually for
additional periods of one year each to maintain the three year maturity date.
Due to an increase in interest rate spreads in the loan syndication market
during 1999 and 2000, the Company did not extend the maturity for an additional
one year period. The Company will reevaluate refinancing or extending the
current 2001 maturity date of this loan during 2001. The interest rate is
variable and is optionally related to the Federal Funds rate, Bank of New York
rate (prime rate) or the Eurodollar London Interbank rate (LIBOR). Based on
rates effective at December 31, 2000, the net interest cost on the loan
approximates 6.96%.
The Company also maintains a $30 million line of credit, of which $27
million was drawn at December 31, 2000 and is due October 26, 2001. The line of
credit may be used to fund the Company's stock repurchase program authorized by
the Board of Directors in August 1998 as well as for general corporate purposes.
The interest rate is variable and is optionally related to the Federal Funds
rate or the Eurodollar London Interbank rate (LIBOR). Based on rates effective
at December 31, 2000, the net interest cost on the loan approximates 7.51%. The
loan covenants are similar to the Company's $75 million loan discussed above.
The Company regularly evaluates repayment and refinancing for its
outstanding debt, including the amounts outstanding under its $75 million loan
and the $30 million line of credit that become due and payable in 2001.
As part of the Elm County Mutual transaction the Company agreed to make
annual $1 million payments to Employers Reinsurance Corporation over 7 years
beginning September 30, 2001. At December 31, 2000, the Company is carrying a
note payable for $5.4 million, which represents the discounted value of the
seven annual payments using a 7% rate. An additional $500,000 note payable to
Employers Reinsurance Corporation is due during the first quarter of 2001 and
represents the remainder of the initial purchase price.
Under the stock repurchase program, the Company may purchase over a
one-year period up to $200 million of Mercury General's common stock. The
purchases may be made from time to time in the open market at the discretion of
management. The program will be funded by the sale of
27
lower yielding tax-exempt bonds, the proceeds of the $30 million credit facility
and internal cash generation. During 2000, the Company purchased 314,900 shares
of the common stock in the open market at an average price of $22.16. Since the
inception of the program in 1998 through December 31, 2000, the Company has
purchased 1,266,100 shares of common stock at an average price of $31.36. 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 2000, was 6.72%.
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, 2000. Each of the Companies'
policyholders' surplus exceeded the highest level of minimum required capital.
As of December 31, 2000, 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 the most
current information provided by the CEA, the Company's maximum total exposure to
CEA assessments at April 30,2000, is approximately $14.6 million.
Industry and regulatory guidelines suggest that the ratio of a property
and casualty
28
insurer's annual net premiums written to statutory policyholders' surplus should
not exceed 3.0 to 1. Based on the combined surplus of all of the Insurance
Companies of $954.8 million at December 31, 2000, and net written premiums for
the twelve months ended on that date of $1,272.4 million, the ratio of writings
to surplus was approximately 1.3 to 1.
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. This standard, adopted by the Company on January
1, 2001 will have no impact on the Consolidated Financial Statements.
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, 2000 comprised 84% of total investments at market value.
Tax-exempt bonds represent 89% 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 14% of
total investments at market. The remaining 2% of the investment portfolio
consists 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. During 2000, interest rates declined, which
increased the value of the Company's fixed income investments, resulting in a
total pretax unrealized gain of $45.6 million on the fixed maturity holdings.
During 2000, lower market interest reduced the duration of the
Company's bond portfolio. Bond investments made by the Company typically have
call options attached, which reduce the duration of the asset as interest rates
decline. Consequently, the average modified duration of the portfolio declined
from 7.8 years at December 31, 1999 to 6.8 years at December 31, 2000. Given a
hypothetical parallel increase of 100 basis points in interest rates, the fair
value of the bond portfolio would decrease by approximately $101.3 million.
At December 31, 2000, 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 $94.6 million in common stocks and $157.9 million in non-sinking
fund preferred stocks. The common stock equity assets are
29
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 most of the year 2000, non-sinking fund preferred stocks were
not actively traded by the market, though lower interest rates intrinsically
benefit their market values. At December 31, 2000, the duration on the Company's
non-sinking fund preferred stock portfolio was 10.3 years. This implies that an
upward parallel shift in the yield curve by 100 basis points would reduce the
asset value at December 31, 2000 by approximately $16.3 million, everything else
remaining the same.
The remainder of the equity portfolio, representing 5% 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 0.46. 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 $8.7
million.
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.
30
Quarterly Data
Summarized quarterly financial data for 2000 and 1999 is as follows (in
thousands except per share data):
Quarter Ended
----------------------------------------
March 31 June 30 Sept. 30 Dec. 31
-------- ------- -------- -------
2000
- ----
Earned premiums..................... $304,655 $312,187 $315,108 $317,309
Income before income taxes ......... $ 36,038 $ 30,232 $ 32,045 $ 30,240
Net income.......................... $ 29,938 $ 26,002 $ 27,421 $ 26,005
Basic earnings per share............ $ .55 $ .48 $ .51 $ .48
Diluted earnings per share.......... $ .55 $ .48 $ .51 $ .48
Dividends declared per share........ $ .24 $ .24 $ .24 $ .24
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
31
Item 8. Financial Statements
--------------------
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Independent Auditors' Report............................................ 33
Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 2000 and 1999..... 34
Consolidated Statements of Income for Each of the Years in the
Three-Year Period Ended December 31, 2000....................... 35
Consolidated Statements of Comprehensive Income for each of the
Years in the Three-Year Period Ended December 31, 2000....... 36
Consolidated Statements of Shareholders' Equity for Each of the
Years in the Three-Year Period Ended December 31, 2000....... 37
Consolidated Statements of Cash Flows for Each of the Years in
the Three-Year Period Ended December 31, 2000................... 38
Notes to Consolidated Financial Statements....................... 40
32
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, 2000 and 1999, and the
related consolidated statements of income, comprehensive income, shareholders'
equity and cash flows for each of the years in the three-year period ended
December 31, 2000. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. 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, 2000 and 1999, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2000, in conformity with accounting
principles generally accepted in the United States of America.
KPMG LLP
Los Angeles, California
February 2, 2001
33
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2000 AND 1999
AMOUNTS EXPRESSED IN THOUSANDS, except share amounts
ASSETS
2000 1999
---- ----
Investments:
Fixed maturities available for sale (amortized cost
$1,463,897 in 2000 and $1,353,765 in 1999)........... $1,509,474 $1,322,054
Equity securities available for sale (cost $250,593
in 2000 and $238,856 in 1999)........................ 252,510 209,843
Short-term cash investments, at cost, which
approximates market.................................. 32,977 43,568
--------- ---------
Total investments.......................... 1,794,961 1,575,465
Cash..................................................... 5,935 8,052
Receivables:
Premiums receivable................................... 123,070 115,654
Premium notes......................................... 14,205 13,375
Accrued investment income ............................ 25,707 23,815
Other................................................. 36,410 19,235
---------- ---------
199,392 172,079
Deferred policy acquisition costs ....................... 71,126 63,975
Fixed assets, net ....................................... 35,208 34,221
Current income taxes .................................... -- 1,796
Deferred income taxes.................................... -- 28,541
Other assets............................................. 35,641 22,238
--------- ---------
$2,142,263 $1,906,367
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Losses and loss adjustment expenses...................... $ 492,220 $ 434,843
Unearned premiums........................................ 365,579 340,846
Notes payable............................................ 107,889 92,000
Loss drafts payable...................................... 49,954 40,063
Accounts payable and accrued expenses.................... 39,715 53,121
Current income tax....................................... 3,471 --
Deferred income taxes.................................... 8,336 --
Other liabilities........................................ 42,194 35,903
--------- ---------
Total liabilities.......................... 1,109,358 996,776
--------- ---------
Shareholders' equity:
Common stock without par value or stated value.
Authorized 70,000,000 shares; issued and outstanding
54,193,423 shares in 2000 and 54,425,323 in 1999..... 52,162 50,963
Accumulated other comprehensive income (loss)......... 30,871 (39,471)
Unearned ESOP compensation............................ (2,000) (3,000)
Retained earnings..................................... 951,872 901,099
--------- ---------
Total shareholders' equity................. 1,032,905 909,591
--------- ---------
Commitments and contingencies ........................
$2,142,263 $1,906,367
========= =========
See accompanying notes to consolidated financial statements.
34
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Three years ended December 31, 2000
Amounts expressed in thousands, except per share data
2000 1999 1998
---- ---- ----
Revenues:
Earned premiums............................... $1,249,259 $1,188,307 $1,121,584
Net investment income ........................ 106,466 99,374 96,169
Net realized investment gains (losses)........ 3,944 (11,929) (3,926)
Net realized gain from sale of subsidiary..... -- -- 2,586
Other......................................... 6,349 4,924 5,710
--------- --------- ---------
Total revenues........................... 1,366,018 1,280,676 1,222,123
--------- --------- ---------
Expenses:
Losses and loss adjustment expenses........... 901,781 789,103 684,468
Policy acquisition costs ..................... 268,657 267,399 252,592
Other operating expenses...................... 59,733 50,675 44,941
Interest ..................................... 7,292 4,960 4,842
--------- --------- ---------
Total expenses........................... 1,237,463 1,112,137 986,843
--------- --------- ---------
Income before income taxes.................... 128,555 168,539 235,280
Income taxes ................................... 19,189 34,830 57,754
--------- --------- ---------
Net income.................................... $ 109,366 133,709 $ 177,526
========= ========= =========
Basic earnings per share........................ $ 2.02 2.45 $ 3.23
========= ========= =========
Diluted earnings per share...................... $ 2.02 2.44 $ 3.21
========= ========= =========
See accompanying notes to consolidated financial statements.
35
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Three Years ended December 31, 2000
Amounts expressed in thousands
2000 1999 1998
---- ---- ----
Net income.............................................. $109,366 $133,709 $177,526
Other comprehensive income (loss), before tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising
during period ................................... 109,432 (146,637) 12,397
Less: reclassification adjustment for net
losses (gains) included in net income............ (1,214) 7,149 (4,605)
------- ------- -------
Other comprehensive income (loss),
before tax ...................................... 108,218 (139,488) 7,792
Income tax expense (benefit) related to unrealized
holding gains (losses) arising during period........... 38,301 (51,323) 4,339
Income tax expense (benefit) related to
reclassification adjustment for (gains) losses
included in net income ................................ (425) 2,502 (1,612)
------- ------- -------
Comprehensive income, net of tax........................ $179,708 $ 43,042 $182,591
======= ======= =======
See accompanying notes to consolidated financial statements
36
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Three years ended December 31, 2000
Amounts expressed in thousands
2000 1999 1998
---- ---- ----
Common stock, beginning of year................ $ 50,963 $ 48,830 $ 47,412
Proceeds of stock options exercised............ 1,304 565 1,216
Tax benefit on sales of incentive stock
options....................................... 549 152 748
Release of common stock by the ESOP............ (358) (254) (30)
Purchase and retirement of common stock........ (296) (330) (516)
Issuance of restricted common stock............ -- 2,000 --
--------- ------- -------
Common stock, end of year...................... 52,162 50,963 48,830
--------- ------- -------
Accumulated other comprehensive income,
beginning of year.............................. (39,471) 51,196 46,131
Net increase (decrease) in other comprehensive
income........................................ 70,342 (90,667) 5,065
--------- ------- -------
Accumulated other comprehensive income (loss),
end of year................................... 30,871 (39,471) 51,196
--------- ------- -------
Unearned ESOP compensation, beginning of year.. (3,000) (4,000) --
Unearned ESOP compensation relating to common
stock purchases by ESOP....................... -- -- (5,000)
Amortization of unearned ESOP compensation..... 1,000 1,000 1,000
--------- ------- -------
Unearned ESOP compensation, end of year........ (2,000) (3,000) (4,000)
--------- -------- -------
Retained earnings, beginning of year........... 901,099 821,349 706,049
Purchase and retirement of common stock........ (6,683) (8,105) (23,775)
Net income..................................... 109,366 133,709 177,526
Dividends paid to shareholders................. (51,910) (45,854) (38,451)
--------- ------- -------
Retained earnings, end of year................. 951,872 901,099 821,349
--------- ------- -------
Total shareholders' equity.............. $1,032,905 $909,591 $917,375
========= ======= =======
See accompanying notes to consolidated financial statements.
37
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Years Ended December 31, 2000
Amounts expressed in thousands
2000 1999 1998
---- ---- ----
Cash flows from operating activities:
Net income .......................................... $ 109,366 $ 133,709 $ 177,526
Adjustments to reconcile net income to net cash
provided from operating activities:
Increase (decrease) in unpaid losses and loss
adjustment expenses ................................ 41,719 28,867 (3,085)
Increase in unearned premiums......................... 15,389 13,717 17,753
(Increase) decrease in premium notes receivable......... (831) 364 (177)
Increase in premiums receivable......................... (7,417) (7,704) (3,734)
Increase in deferred policy acquisition costs........... (7,151) (2,028) (4,683)
Increase in loss drafts payable......................... 9,891 1,630 6,375
Decrease (increase) in accrued income taxes,
excluding deferred tax on change in unrealized gain 2,153 1,577 (8,957)
(Decrease) increase in accounts payable and accrued
expenses........................................... (13,407) (1,223) 2,801
Depreciation......................................... 6,926 6,896 5,444
Net realized investment (gains) losses............... (3,944) 11,929 3,926
Net realized gain from sale of subsidiary............ -- -- (2,586)
Bond accretion, net.................................. (7,337) (5,450) (4,146)
Other, net........................................... 7,713 6,793 6,778
--------- ------- -------
Net cash provided from operating activities.. 153,070 189,077 193,235
Cash flows from investing activities:
Fixed maturities available for sale:
Purchases........................................... (294,827) (215,960) (295,723)
Sales............................................... 137,448 54,537 111,779
Calls or maturities................................. 54,914 58,411 84,445
Equity securities available for sale:
Purchases........................................... (83,372) (475,525) (800,620)
Sales............................................... 81,294 445,330 745,275
Elm County Mutual Insurance Company (ELM)
transaction less cash acquired (See Note 9)......... (5,138) -- --
Proceeds from sale of subsidiary less cash
transferred......................................... -- -- 11,018
Concord transaction (See note 8)..................... -- (3,665) --
(Increase) decrease in receivable from securities.... (200) 613 (347)
Decrease in short-term cash investments, net......... 10,591 2,424 12,059
Purchase of fixed assets............................. (8,342) (9,268) (7,164)
Sale of fixed assets................................. 1,031 916 444
-------- ------- --------
Net cash used in investing activities........ $ (106,601) $(142,187) $(138,834)
(Continued)
38
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Years Ended December 31, 2000
Amounts expressed in thousands
(Continued)
2000 1999 1998
---- ---- ----
Cash flows from financing activities:
Additions to notes payable........................ $ 37,000 17,000 $ 3,000
Principal payments on notes payable............... (27,000) (3,000) --
Dividends paid to shareholders.................... (51,910) (45,854) (38,451)
Proceeds from stock options exercised............. 1,303 565 1,217
Purchase and retirement of common stock........... (6,979) (8,436) (24,291)
Net increase (decrease) of ESOP loan.............. (1,000) (1,000) 3,000
------- ------- -------
Net cash used in financing activities.... (48,586) (40,725) (55,525)
------- ------- -------
Net (decrease) increase in cash................... (2,117) 6,165 (1,124)
Cash:
Beginning of the year........................... 8,052 1,887 3,011
------- ------- -------
End of the year................................. $ 5,935 $ 8,052 $ 1,887
======= ======= =======
See accompanying notes to consolidated financial statements.
39
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000 and 1999
(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 2000 and 1999 over 90% of
the net written premiums were from California.
The consolidated financial statements include the accounts of Mercury
General Corporation (the Company or MGC) and its wholly-owned subsidiaries,
Mercury Casualty Company, Mercury Insurance Company, California Automobile
Insurance Company, California General Underwriters Insurance Company, Inc.,
Mercury Insurance Company of Georgia, Mercury Insurance Company of Illinois,
Mercury Indemnity Company of Georgia, Mercury Indemnity Company of Illinois,
American Mercury Insurance Company (AMIC), Cimarron Insurance Company, Inc., AFI
Management Company, Inc. (AFIMC), American Mercury Lloyds Insurance Company
(AML) and Mercury County Mutual Insurance Company (MCM). AML is not owned by
MGC, but is controlled by MGC through its attorney-in-fact, AFIMC. MCM is not
owned by the Company but is controlled through a management contract. American
Mercury MGA, Inc. (AMMGA),is a wholly owned subsidiary of AMIC. The 1998
financial statements include the results of Cimarron Insurance Company through
June 5, 1998, the date it was sold to an unrelated party. This sale is discussed
further in Note 10. Effective October 31, 1999 the financial statements also
include Concord Insurance Services, Inc., (Concord) a Texas insurance agency
controlled by MGC. Concord is discussed further in Note 8. The results of MCM
are included in the financial statements effective September 30, 2000. MCM is
discussed further in Note 9. All of the subsidiaries as a group, including AML
and MCM, but excluding AFIMC, AMMGA, and Concord, are referred to as the
Insurance Companies. The consolidated financial statements have been prepared in
conformity with generally accepted accounting principles (GAAP) which differ in
some respects from those filed in reports to insurance regulatory authorities.
All significant intercompany balances and transactions have been eliminated.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. The most significant assumptions in the preparation of these
consolidated financial statements relate to loss and loss adjustment expenses.
Actual results could differ from those estimates.
40
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2000 and 1999
(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 non- sinking fund preferred stocks, are, with minor
exceptions, actively traded on national exchanges, and were valued at the last
transaction price on the balance sheet date.
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 million write-down of a preferred stock investment that became
other than temporarily impaired during the third quarter of 1999. As the result
of a liquidating dividend, the Company realized a gain of $347,000 on the same
equity security in 2000.
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.
41
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2000 and 1999
(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 2000, 1999 and 1998 were $1,272,447,000,
$1,206,171,000 and $1,144,051,000, respectively.
One agent produced direct premiums written of approximately 18%, 19% and
19% of the Company's total direct premiums written during 2000, 1999 and 1998,
respectively. The owner of this agency sold it during 1998 to a large national
broker. 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.
42
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2000 and 1999
(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 16
contains the required disclosures which make up the calculation of basic and
diluted earnings per share.
43
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2000 and 1999
(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. Implemented
in 1999, SOP 98-1 provided less than a $.01 contribution to diluted earnings per
share in both 2000 and 1999.
Statement of Financial Accounting Standards No. 133 (SFAS No. 133)
"Accounting for Derivative Instruments and Hedging Activities" became effective
for fiscal years beginning after June 15, 1999. Statement of Financial
Accounting Standards No. 137 (SFAS No. 137) "Accounting for Derivative
Instruments and Hedging Activities-Deferral of the Effective Date of FASB
Statement No. 133" defers the effective date of SFAS 133 to fiscal years
beginning after June 15, 2000. The Company adopted this new Standard on January
1, 2001 and it will have no impact on the
44
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2000 and 1999
(1) Significant Accounting Policies (Continued)
Consolidated Financial Statements.
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 Statement of Financial Accounting
Standards No. 109 (SFAS No. 109),"Accounting for Income Taxes".
Reinsurance
In accordance with Statement of Financial Accounting Standards No. 113
(SFAS No. 113), "Accounting and Reporting for Reinsurance of Short-Duration and
Long-Duration Contracts," the liabilities for unearned premiums and unpaid
losses are stated in the accompanying consolidated financial statements before
deductions for ceded reinsurance. The ceded amounts are immaterial and are
carried in other assets and other receivables. Earned premiums are stated net of
deductions for ceded reinsurance.
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, 2000, the cash balance includes $3,000,000 of restricted
cash related to the Concord transaction (See Note 8).
Interest paid during 2000, 1999, and 1998 was $7,357,000, $4,758,000 and
$4,494,000, respectively. Income taxes paid were $14,609,000 in 2000,
$33,102,000 in 1999 and $65,984,000 in 1998.
The tax benefit realized on stock options exercised and included in cash
provided from operations in 2000, 1999 and 1998 was $550,000, $152,000 and
$748,000, respectively.
In 2000, notes payable with a discounted value of $5,889,000 were issued as
part of the consideration for the right to manage and control Elm County Mutual
Insurance Company (ELM) (See Note 9).
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.
45
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 3000 and 1999
(1) Significant Accounting Policies (Continued)
Stock-Based Compensation
The Company accounts for stock-based compensation under the accounting
methods prescribed by Accounting Principles Board (APB) Opinion No. 25, as
allowed by Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation"(SFAS No. 123). Disclosure of stock-based compensation
determined in accordance with SFAS No. 123 is presented in Note 15.
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)
-----------------------------
2000 1999 1998
---- ---- ----
Interest and dividends on fixed maturities........ $ 86,644 $ 78,559 $75,602
Dividends on equity securities.................... 17,136 18,885 18,027
Interest on short-term cash investments........... 3,380 2,840 3,460
------- ------- ------
Total investment income.................... 107,160 100,284 97,089
Investment expense................................ 694 910 920
------- -------- ------
Net investment income...................... $106,466 $ 99,374 $96,169
======= ======== ======
A summary of net realized investment gains (losses) is as follows:
Year ended December 31,
(Amounts in thousands)
------------------------------
2000 1999 1998
---- ---- ----
Net realized investment gains (losses):
Fixed maturities.......................... $ 549 $ 67 $ 914
Equity securities......................... 3,395 (11,996) (4,840)
------- ------- ------
$ 3,944 $(11,929) $(3,926)
======= ======= ======
46
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2000 and 1999
(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)
------------------------------
2000 1999 1998
---- ---- ----
Fixed maturities available for sale:
Gross realized gains...................... $ 1,740 $ 865 $ 394
Gross realized losses..................... (908) (259) (370)
------- -------- -------
Net................................. $ 832 $ 606 $ 24
======= ======== =======
Equity securities available for sale:
Gross realized gains...................... $ 5,259 $ 5,506 $ 9,452
Gross realized losses..................... (1,621) (11,536) (14,166)
------ ------- ------
Net................................. $ 3,638 $ (6,030) $(4,714)
====== ======= ======
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)
-----------------------------
2000 1999 1998
---- ---- ----
Net increase (decrease) in net unrealized
investment gains and losses:
Fixed maturities available for sale........ $77,288 $(111,179) $12,076
Income tax expense (benefit)............... 27,051 (38,912) 4,227
------ ------- ------
$50,237 $ (72,267) $ 7,849
====== ======= ======
Equity securities.......................... $30,930 $ (28,309) $(4,283)
Income tax expense (benefit)............... 10,825 (9,909) (1,499)
------ ------- -------
$20,105 $ (18,400) $(2,784)
====== ======= ======
47
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2000 and 1999
(2) Investments and Investment Income (Continued)
Accumulated unrealized gains and losses on securities available for sale is as
follows:
December 31,
(Amounts in thousands)
----------------------
2000 1999
---- ----
Fixed maturities available for sale:
Unrealized gains............................... $ 60,318 $ 21,193
Unrealized losses.............................. (14,741) (52,904)
Tax effect..................................... (15,952) 11,099
-------- ---------
$ 29,625 $ (20,612)
======== ========
Equity securities available for sale:
Unrealized gains............................... $ 16,799 $ 1,817
Unrealized losses.............................. (14,882) (30,830)
Tax effect..................................... (671) 10,154
-------- ---------
$ 1,246 $ (18,859)
======== =========
Net unrealized investment gains (losses)
(classified as accumulated other comprehensive
income/(loss) on the balance sheet)........ $ 30,871 $ (39,471)
======== =========
The amortized costs and estimated market values of investments in fixed
maturities available for sale as of December 31, 2000 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.............. $ 7,897 $ 187 $ 16 $ 8,068
Obligations of states and political
subdivisions........................... 1,315,024 57,686 13,318 1,359,392
Corporate securities..................... 121,071 1,838 1,110 121,799
Redeemable preferred stock............... 19,905 607 297 20,215
---------- -------- ------- ----------
Totals............................... $1,463,897 $ 60,318 $14,741 $1,509,474
========== ======== ======= ==========
48
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2000 and 1999
(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, 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
=========== ========= ======== ===========
At December 31, 2000, bond holdings rated below investment grade totaled
approximately 1% of total investments. The average Standard and Poor's rating of
the bond portfolio is AA-. The amortized cost and estimated market value of
fixed maturities available for sale at December 31, 2000 by contractual
maturity, are shown below. Expected maturities will differ from contractual
maturities because borrowers may have the right to call or prepay obligations
with or without call or prepayment penalties.
Estimated
Amortized Market
Cost Value
--------- -------
(Amounts in thousands)
---------------------
Fixed maturities available for sale:
Due in one year or less ........................ $ 6,478 $ 6,530
Due after one year through five years........... 90,899 92,324
Due after five years through ten years.......... 157,491 160,819
Due after ten years............................. 1,209,029 1,249,801
----------- -----------
$ 1,463,897 $ 1,509,474
=========== ===========
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.
49
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2000 and 1999
(3) Fixed Assets
A summary of fixed assets follows:
December 31,
(Amounts in thousands)
----------------------
2000 1999
---- ----
Land............................. $ 6,084 $ 6,084
Buildings........................ 23,291 22,932
Furniture and equipment.......... 46,666 40,413
Leasehold improvements........... 598 565
-------- --------
76,639 69,994
Less accumulated depreciation.... (41,431) (35,773)
-------- --------
Net fixed assets................. $ 35,208 $ 34,221
======== ========
(4) Deferred Policy Acquisition Costs
Policy acquisition costs incurred and amortized are as follows:
Year ended December 31,
(Amounts in thousands)
--------------------------------
2000 1999 1998
---- ---- ----
Balance, beginning of year................. $ 63,975 $ 61,947 $ 57,264
Costs deferred during the year............. 275,808 269,427 257,275
Amortization charged to expense............ (268,657) (267,399) (252,592)
--------- --------- ---------
Balance, end of year....................... $ 71,126 $ 63,975 $ 61,947
========= ========= =========
(5) Notes Payable
Notes payable at December 31, 2000 consist of two revolving credit
facilities and a note payable associated with the Elm County Mutual transaction
(Note 9). A November 21, 1996 credit facility from a consortium of banks,
provides for an aggregate commitment of $75 million, of which $75 million has
been drawn and is outstanding at December 31, 2000 and 1999. The $75 million
notes are due November 21, 2001. This due date may be extended annually for
additional periods of one year. The other outstanding debt on credit facilities
consists of a 364 day $30 million line of credit with Bank of America dated
October 27, 2000. The outstanding draw at December 31, 2000 on this line of
credit is $27 million and is due on October 26, 2001.
The $75 million and $30 million credit facilities are subject to a
commitment fee on the undrawn balances of 0.15% and 0.125%, respectively. The
interest rate is variable and is optionally related to the Federal Funds rate,
Bank of New York prime rate or the Eurodollar London Interbank rate (LIBOR) for
the $75 million facility and to the Federal Funds rate or LIBOR for the $30
million facility. Based on current effective rates, net interest cost on the $75
million loan and the $27 million draw at December 31, 2000 is approximately
6.96% and 7.51%, respectively.
50
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2000 and 1999
(5) Notes Payable (Continued)
The terms of the loan agreements include certain affirmative and negative
covenants, all of which are met by the Company at December 31, 2000.
As part of the Elm County Mutual transaction, the Company agreed to make
annual $1 million payments to Employers Reinsurance Corporation over 7 years
beginning September 30, 2001. At December 31, 2000, the Company is carrying a
note payable for $5.4 million, which represents the discounted value of the
seven annual payments using a 7% rate. An additional $500,000 note payable to
Employers Reinsurance Corporation is due during the first quarter of 2001 and
represents the remainder of the initial purchase price.
(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)
--------------------------
2000 1999 1998
---- ---- ----
Federal
Current........................... $ 20,270 $ 36,535 $ 57,237
Deferred.......................... (1,236) (2,123) 190
-------- -------- --------
$ 19,034 $ 34,412 $ 57,427
======== ======== ========
State
Current........................... $ 155 $ 418 $ 327
Deferred.......................... -- -- --
-------- -------- --------
$ 155 $ 418 $ 327
======== ======== ========
Total
Current........................... $ 20,425 $ 36,953 $ 57,564
Deferred.......................... (1,236) (2,123) 190
-------- -------- --------
Total........................ $ 19,189 $ 34,830 $ 57,754
======== ======== ========
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)
------------------------
2000 1999 1998
---- ---- ----
Computed tax expense at 35% ..................... $ 44,994 $ 58,989 $82,348
Tax-exempt interest income....................... (27,295) (25,398) (23,496)
Dividends received deduction..................... (3,152) (3,953) (5,437)
Reduction of losses incurred deduction for 15% of
income on securities purchased after
August 7, 1986 4,496 4,348 4,245
Other, net....................................... 146 844 94
-------- -------- -------
Income tax expense ......................... $ 19,189 $ 34,830 $57,754
======== ======== =======
51
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2000 and 1999
(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)
----------------------
2000 1999
---- ----
Deferred tax assets
20% of net unearned premium.................. $ 25,920 24,264
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.................................... 9,445 8,383
Other deferred tax assets.................... 5,966 3,288
-------- --------
Total gross deferred tax assets............ 41,331 57,188
Less valuation allowance.................. -- --
-------- --------
Net deferred tax assets................... 41,331 57,188
-------- --------
Deferred tax liabilities
Deferred acquisition costs................... (27,623) (22,391)
Tax liability on net unrealized gain on
securities carried at market value.......... (16,623) --
Tax depreciation in excess of book
depreciation................................ (1,167) (1,351)
Accretion on bonds........................... (2,962) (2,008)
Other deferred tax liabilities............... (1,292) (2,897)
-------- --------
Total gross deferred tax liabilities....... (49,667) (28,647)
-------- --------
Net deferred tax assets (liabilities)...... $ (8,336) $ 28,541
======== ========
52
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2000 and 1999
(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)
-------------------------
2000 1999 1998
---- ---- ----
Gross reserves for losses and loss
adjustment expenses at beginning of year.. $434,843 $405,976 $409,061
Less reinsurance recoverable............... (16,043) (20,160) (22,791)
-------- -------- --------
Net reserves, beginning of year............ 418,800 385,816 386,270
Incurred losses and loss adjustment expenses
related to:
Current year........................... 878,144 781,316 693,877
Prior years............................ 23,637 7,787 (9,409)
-------- -------- --------
Total incurred losses and loss adjustment
expenses.................................. 901,781 789,103 684,468
-------- -------- --------
Loss and loss adjustment expense payments
related to:
Current year........................... 562,163 492,314 437,612
Prior years............................ 294,615 263,805 247,310
-------- -------- --------
Total payments............................. 856,778 756,119 684,922
-------- -------- --------
Net reserves for losses and loss adjustment
expenses at end of year.................. 463,803 418,800 385,816
Reinsurance recoverable.................... 28,417 16,043 20,160
-------- -------- --------
Gross reserves, end of year................ $492,220 $434,843 $405,976
======== ======== ========
Increases in prior years incurred losses in 2000 a nd 1999 relate to
increases in the severity estimates on bodily injury and p hysical damage
coverages over what was originally recorded in the prior year. The increases in
these claims relate to increased severity over what was recorded and are the
result of inflationary trends in health care costs, auto parts and body shop
labor costs.
Decreases in prior years incurred losses in 1998 reflects the favorable
loss experience during these years attributed to a number of combined factors
which produced favorable frequency and severity trends.
53
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2000 and 1999
(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, written directly by a Texas County Mutual Insurance Company,
was assumed 100% by an unaffiliated reinsurer. Effective January 1, 2000, the
Company replaced Concord's existing reinsurer (for new and renewal business) and
assumed 100% of the risks produced by Concord. The Company has expanded
Concord's product line to include standard and preferred risks.
The transaction was accounted for using the purchase method of
accounting, and resulted in an immaterial amount of goodwill that is being
amortized using the straight-line method over a ten-year period.
(9) Elm County Mutual Insurance Company Transaction
Effective September 30, 2000, the Company completed a transaction with
Employers Reinsurance Corporation purchasing the authority and right to manage
and control Elm County Mutual Insurance Company. Effective January 2, 2001, the
name was changed to Mercury County Mutual Insurance Company ("MCM"). The results
of operations of MCM, which are not material to the Company, are included in the
consolidated financial statements of the Company effective September 30, 2000.
In 2001, the Company began writing Texas automobile risks that were
previously placed through third-party Texas county mutual insurers and 100%
reinsured by the Company, directly with MCM. Risks produced by the Company that
are written directly through MCM will be 100% ceded to affiliated Mercury
Companies.
The MCM 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.
(10) 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.
54
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2000 and 1999
(10) Sale of Subsidiary (Continued)
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.
(11) 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 2001, the direct insurance subsidiaries of the Company are permitted to
pay approximately $94 million in dividends to the Company without the prior
approval of the Commissioner of Insurance of the state of domicile. The above
statutory regulations may have the effect of indirectly limiting the ability of
the Company to pay dividends. During 2000 and 1999, the Insurance Companies paid
dividends to Mercury General Corporation of $62.5 million and $61 million,
respectively.
(12) 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, 2000, 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 $103,937,000, $135,667,000 and $173,473,000 for the years ended
December 31, 2000, 1999 and 1998, respectively. The statutory policyholders'
surplus of the Insurance Companies, as reported to regulatory authorities, as of
December 31, 2000 and 1999 was $954,753,000 and $853,794,000, respectively.
The Company has estimated the Risk-Based Capital Requirements of each of
its insurance subsidiaries as of December 31, 2000 according to the formula
issued by the NAIC. Each of the Companies' policyholders' surplus exceeded the
highest level of minimum required capital.
Codification
Codification became effective January 1, 2001. The Company estimates that it
would realize a surplus increase of approximately $33 million at December 31,
2000 under Codification. This increase primarily relates to the establishment of
a net deferred tax asset and does not include any adjustment for the elimination
of the reserve for the excess of statutory reserves over
55
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2000 and 1999
(12) Statutory Balances and Accounting Practices (Continued)
statement reserves for the California domiciled Companies. For its California
domiciled Companies, the Company is not able to recognize a surplus increase of
$9 million for the elimination of the excess of statutory reserves over
statement reserves prescribed by Codification because California law still
requires a statutory reserve.
(13) 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 $4,138,000, $3,320,000 and $2,074,000 for the
years ended December 31, 2000, 1999 and 1998, respectively.
The annual rental commitments, expressed in thousands, are shown as
follows:
Rent
Year Expense
---- -------
2001.................... $3,814
2002.................... $2,837
2003.................... $1,889
2004.................... $1,675
2005.................... $1,311
Thereafter.............. $2,950
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
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.
(14) 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, 2000, 1999 and 1998.
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
$1,805,000, $1,878,000, and $1,648,000 for the plan years ended December 31,
2000, 1999 and 1998.
56
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2000 and 1999
(14) Profit Sharing Plan (Continued)
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 $3,000,000, $4,000,000, and
$5,000,000 at December 31, 2000, 1999 and 1998, 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 $642,000, $746,000, and $970,000 in 2000, 1999 and
1998, respectively.
The ESOP shares as of December 31 were as follows:
2000 1999
---- ----
Allocated shares 46,000 23,000
Shares committed-to-be released 23,000 23,000
Unreleased shares 46,000 69,000
---------- ----------
Total ESOP shares 115,000 115,000
========== ==========
Market value of unreleased shares at
December 31, $2,018,000 $1,535,000
========== ==========
(15) Common Stock
Dividends paid per-share in 2000, 1999 and 1998 were $0.96, $0.84 and
$0.70, respectively and dividends paid in total in 2000, 1999 and 1998 were
$51,910,000, $45,854,000 and $38,451,000, respectively.
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 1985 Plan. Under the 1995 Plan, 5,400,000 shares
of Common Stock are
57
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2000 and 1999
(15) Common Stock (Continued)
authorized for issuance upon exercise of options, stock appreciation rights and
other awards, or upon vesting of restricted or deferred stock awards. During
1995, the Company granted incentive stock options under both the 1995 Plan and
the 1985 Plan. The options granted become exercisable 20% per year beginning one
year from the date granted and were granted at the market price on the date of
the grant. The options expire in 10 years. At December 31, 2000 no awards other
than options have been granted.
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 $395,000, $542,000 and $454,000 in 2000, 1999 and 1998,
respectively, and earnings per share (basic and diluted) would have been reduced
by $.01 in 2000, 1999 and 1998. 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 2000,
1999 and 1998: dividend yield of 2.2 percent for 2000, 3.8 percent for 1999 and
2.0 percent for 1998, expected volatility of 33.4 percent in 2000, 31.6 percent
in 1999 and 32.7 percent for 1998 and expected lives of 7 years for all years.
The risk-free interest rates used were 6.4 percent for the options granted
during 2000, 5.6 percent for the options granted during 1999 and 5.4 percent for
the options granted during 1998.
A summary of the status of the Company's plans as of December 31, 2000,
1999 and 1998 and changes during the years ending on those dates is presented
below:
2000 1999 1998
------------------- ----------------- ---------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------- -------- -------- -------- -------- --------
Outstanding at beginning of year 597,875 $ 22.370 539,146 $ 20.575 629,621 $ 16.269
Granted during the year 77,000 26.386 102,100 28.800 73,000 45.385
Exercised during the year (83,000) 15.706 (37,371) 15.129 (144,475) 10.329
Canceled or expired (53,200) 31.144 (6,000) 15.625 (19,000) 51.484
-------- -------- --------
Outstanding at end of year 538,675 23.104 597,875 22.370 539,146 20.575
======== ======== ========
Options exercisable at year-end 346,855 329,575 265,146
Weighted-average fair value of
options granted during the year $ 9.95 $ 8.12 $ 16.37
58
MERCURY GENERAL CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2000 and 1999
(15) Common Stock (Continued)
The following table summarizes information regarding the stock options
outstanding at December 31, 2000:
Number Weighted Avg. Weighted Avg. Number Weighted Avg.
Range of Outstanding Remaining Exercise Exercisable Exercise
Exercise Prices at 12/31/00 Contractual Life Price at 12/31/00 Price
- ---------------- ------------- ---------------- ------------- ----------- -------------
$15.00 to 15.9375 220,475 3.61 $15.405 220,475 $15.405
$21.75 to 29.77 232,200 7.22 23.545 100,880 23.921
$31.22 to 44.8209 86,000 8.01 38,884 25,500 40.147
------- -------
$15.00 to 44.8209 538,675 5.87 22.662 346,855 19.701
======= =======
(16) Earnings Per Share
A reconciliation of the numerator and denominator used in the basic and
diluted earnings per share calculation is presented below:
2000 1999 1998
----------------------------- ----------------------------- ----------------------------
(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 $ 109,366 54,100 $2.02 $133,709 54,596 $2.45 $177,526 55,003 $3.23
Effect of dilutive
securities
Options -- 158 -- 219 -- 351
Diluted EPS
- -----------
Income available to
common stockholders
after assumed
conversions $ 109,366 54,258 $2.02 $133,709 54,815 $2.44 $177,526 55,354 $3.21
========= ====== ===== ======== ====== ===== ======== ====== =====
The diluted weighted shares excludes incremental shares of 51,000, 28,000
and 0 for 2000, 1999 and 1998, respectively. These shares are excluded due to
their antidilutive effect.
59
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 9, 2001, which will be filed with the
Securities and Exchange Commission within 120 days after December 31, 2000, 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, 2000 are contained herein as listed in the Index to
Consolidated Financial Statements on page 32.
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.
60
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 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.
61
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.
10.34 Credit agreement dated as of October 27, 2000 between Mercury
General Corporation and Bank of America, N.A.
10.35 Management Agreement effective January 1, 2001 between
Mercury Insurance Services LLC and Mercury Casualty Company,
Mercury Insurance Company, California Automobile Insurance
Company and California General Underwriters Insurance
Company.
10.36 Management Agreement effective January 1, 2001 between
Mercury Insurance Services LLC and American Mercury Insurance
Company.
10.37 Management Agreement effective January 1, 2001 between
Mercury Insurance Services LLC and Mercury Insurance Company
of Georgia.
10.38 Management Agreement effective January 1, 2001 between
Mercury Insurance Services LLC and Mercury Indemnity Company
of Georgia.
10.39 Management Agreement effective January 1, 2001 between
Mercury Insurance Services LLC and Mercury Insurance Company
of Illinois.
10.40 Management Agreement effective January 1, 2001 between
Mercury Insurance Services LLC and Mercury Indemnity Company
of Illinois.
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, 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, 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
62
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
Chairman of the Board, President and
Chief Executive Officer
March 16, 2001
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
--------- ----- ----
Chairman of the Board,
President and Chief
Executive Officer
/s/ GEORGE JOSEPH (Principal Executive Officer) March 27, 2001
- ------------------------
George Joseph
Vice President and
Chief Financial Officer
/s/ GABRIEL TIRADOR (Principal Financial Officer) March 27, 2001
- ------------------------
Gabriel Tirador
/s/ NATHAN BESSIN Director March 27, 2001
- -----------------------
Nathan Bessin
/s/ BRUCE A. BUNNER Director March 27, 2001
- -----------------------
Bruce A. Bunner
/s/ MICHAEL D. CURTIUS Director March 27, 2001
- -----------------------
Michael D. Curtius
63
Signature Title Date
--------- ----- -----
/s/ RICHARD E. GRAYSON Director March 27, 2001
- -------------------------
Richard E. Grayson
/s/ GLORIA JOSEPH Director March 27, 2001
- -------------------------
Gloria Joseph
/s/ CHARLES MCCLUNG Director March 27, 2001
- -------------------------
Charles McClung
/s/ DONALD P. NEWELL Director March 27, 2001
- -------------------------
Donald P. Newell
/s/ DONALD R. SPUEHLER Director March 27, 2001
- -------------------------
Donald R. Spuehler
64
INDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULES
The Board of Directors
Mercury General Corporation:
Under date of February 2, 2001, we reported on the consolidated balance
sheets of Mercury General Corporation and subsidiaries as of December 31, 2000
and 1999, and the related consolidated statements of income, comprehensive
income, shareholders' equity and cash flows for each of the years in the
three-year period ended December 31, 2000, as contained in the annual report on
Form 10-K for the year 2000. 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 2, 2001
S-1
SCHEDULE I
MERCURY GENERAL CORPORATION
SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTS IN RELATED PARTIES
December 31, 2000
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....................... $ 7,897 $ 8,068 $ 8,068
States, municipalities................ 1,315,024 1,359,392 1,359,392
All other corporate bonds............. 121,071 121,799 121,799
Redeemable preferred stock.............. 19,905 20,215 20,215
--------- --------- ---------
Total fixed maturities available for
sale................................ 1,463,897 1,509,474 1,509,474
--------- --------- ---------
Equity securities:
Common stocks:
Public utilities...................... 59,445 69,880 69,880
Banks, trust and insurance companies.. 5,974 8,153 8,153
Industrial, miscellaneous and
all other............................ 15,792 16,576 16,576
Nonredeemable preferred stocks.......... 169,382 157,901 157,901
--------- --------- ---------
Total equity securities available for
sale................................ 250,593 252,510 252,510
--------- --------- ---------
Short-term investments...................... 32,977 32,977
--------- ---------
Total investments..................... $1,747,467 $1,794,961
========= =========
S-2
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-3
SCHEDULE II
MERCURY GENERAL CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS
December 31, 2000 and 1999
Amounts in thousands
ASSETS
2000 1999
---- ----
Investments:
Fixed maturities available for sale (amortized
cost $2,150 in 2000 and $2,130 in 1999)......... $ 2,080 $ 2,126
Equity securities, available for sale (cost
$26,702 in 2000 and $25,831 in 1999)............ 25,566 22,985
Short-term cash investments......................... 3,486 5,956
Investment in subsidiaries.......................... 1,111,382 975,488
--------- ---------
Total investments......................... 1,142,514 1,006,555
Amounts due from affiliates............................. 8,806 8,320
Income taxes............................................ 8,373 9,288
Other assets............................................ 2,912 2,371
--------- ---------
$1,162,605 $1,026,534
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Notes payable........................................... $ 107,889 $ 92,000
Accounts payable and accrued expenses................... 12,695 18,459
Other liabilities....................................... 9,116 6,484
--------- ---------
Total liabilities................................ 129,700 116,943
--------- ---------
Shareholders' equity:
Common stock........................................ 52,162 50,963
Accumulated other comprehensive income (loss)....... 30,871 (39,471)
Unearned ESOP compensation.......................... (2,000) (3,000)
Retained earnings................................... 951,872 901,099
--------- ---------
Total shareholders' equity................ 1,032,905 909,591
--------- ---------
$1,162,605 $1,026,534
========= =========
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, 2000
Amounts in thousands
2000 1999 1998
---- ---- ----
Revenues:
Net investment income......................... $ 2,230 $ 1,867 $ 1,956
Management fee income from subsidiaries....... 216,413 208,245 186,387
Other......................................... 12 11 94
------- ------- -------
Total revenues............................ 218,655 210,123 188,437
------- ------- -------
Expenses:
Loss adjustment expenses...................... 136,835 128,474 115,242
Policy acquisition costs...................... 34,567 35,527 33,550
Other operating expenses...................... 46,274 45,302 38,815
Interest...................................... 7,292 4,958 4,839
------- ------- -------
Total expenses............................ 224,968 214,261 192,446
------- ------- -------
Loss before income taxes and equity in net
income of subsidiaries....................... (6,313) (4,138) (4,009)
Income tax benefit.............................. (2,446) (1,380) (2,010)
------- ------- -------
Loss before equity in net income
of subsidiaries.............................. (3,867) (2,758) (1,999)
Equity in net income of subsidiaries............ 113,233 136,467 179,525
------- ------- -------
Net income................................ $109,366 $133,709 $ 177,526
======= ======= =======
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, 2000
Amounts in thousands
2000 1999 1998
---- ---- ----
Cash flows from operating activities:
Net cash used by operating activities............ $ (9,120) $(10,705) $ (5,295)
Cash flows from investing activities:
Capital contribution to controlled entity........ (3,000) (7,550) --
Dividends from subsidiaries...................... 62,500 61,000 55,000
Elm County Mutual Insurance Company (ELM)
transaction .................................... (7,000) -- --
Fixed maturities, at market:
Purchases...................................... (2,042) (2,008) (2,700)
Sales.......................................... -- -- 3,849
Calls or maturities............................ 2,028 854 731
Equity securities:
Purchases...................................... (4,067) (41,004) (75,180)
Sales.......................................... 3,359 36,759 79,852
Calls.......................................... -- 1,119 222
Increase in payable for securities............... -- -- 203
(Increase) decrease in short term cash
investments, net ................................ 2,470 3,233 (2,484)
------- ------- -------
Net cash provided by investing
activities.................................. 54,248 52,403 59,493
Cash flows from financing activities:
Additions to notes payable....................... 37,000 17,000 3,000
Principal payments on notes payable.............. (27,000) (3,000) --
Dividends paid to shareholders................... (51,910) (45,854) (38,452)
Purchase and retirement of common stock.......... (6,979) (8,435) (24,291)
Stock options exercised.......................... 1,853 717 1,964
Net decrease of ESOP loan........................ (1,000) (1,000) 3,000
------- ------- -------
Net cash used in financing activities......... (48,036) (40,572) (54,779)
Net increase (decrease) in cash.................... (2,908) 1,126 (581)
Cash:
Beginning of the year............................ (2,484) (3,610) (3,029)
------- ------- -------
End of the year ................................. $ (5,392) $ (2,484) $ (3,610)
======= ======= =======
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, 2000 and 1999
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. Effective January 1, 2001 these management services are provided by a
subsidiary of Mercury Casualty Company.
Dividends Received From Subsidiaries
Dividends of $62,500,000, $61,000,000, and $55,000,000 were received by
the Company from its wholly-owned subsidiaries in 2000, 1999 and 1998,
respectively, and are recorded as a reduction to Investment in Subsidiaries.
Cash Overdraft
At December 31, 2000 and 1999, the Company had cash overdrafts of
$5,392,000 and $2,484,000 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, 2000
Amounts in thousands
Ceded to
Gross other Net
amount companies Assumed amount
------ --------- ------- ------
Property and Liability insurance earned premiums
2000....................... $1,233,263 $ 8,659 $24,655 $1,249,259
1999....................... $1,186,385 $ 8,844 $10,766 $1,188,307
1998....................... $1,130,597 $14,352 $ 5,339 $1,121,584
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.
10.34 Credit agreement dated as of October 27, 2000 between
Mercury General Corporation and Bank of America, N.A.
10.35 Management agreement effective January 1, 2001 between
Mercury Insurance Services LLC and Mercury Casualty Company,
Mercury Insurance Company, California Automobile Insurance
Company and California General Underwriters Insurance
Company.
10.36 Management Agreement effective January 1, 2001 between
Mercury Insurance Services LLC and American Mercury
Insurance Company.
10.37 Management Agreement effective January 1, 2001 between
Mercury Insurance Services LLC and Mercury Insurance Company
of Georgia.
10.38 Management Agreement effective January 1, 2001 between
Mercury Insurance Services LLC and Mercury Indemnity Company
of Georgia.
10.39 Management Agreement effective January 1, 2001 between
Mercury Insurance Services LLC and Mercury Insurance Company
of Illinois.
10.40 Management Agreement effective January 1, 2001 between
Mercury Insurance Services LLC and Mercury Indemnity Company
of Illinois.
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, 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, 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