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MERCURY GENERAL CORP – 10-K – Management's Discussion and Analysis of Financial Condition and Results of Operations
Forward-looking Statements
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for certain forward-looking statements. Certain statements contained in this report are forward-looking statements based on the Company's current expectations and beliefs concerning future developments and their potential effects on the Company. There can be no assurance that future developments affecting the Company will be those anticipated by the Company. Actual results may differ from those projected in the forward-looking statements. These forward-looking statements involve significant risks and uncertainties (some of which are beyond the control of the Company) and are subject to change based upon various factors, including but not limited to the following risks and uncertainties: changes in the demand for the Company's insurance products, inflation and general economic conditions, including general market risks associated with the Company's investment portfolio; the accuracy and adequacy of the Company's pricing methodologies; catastrophes in the markets served by the Company; uncertainties related to estimates, assumptions and projections generally; the possibility that actual loss experience may vary adversely from the actuarial estimates made to determine the Company's loss reserves in general; the Company's ability to obtain and the timing of the approval of premium rate changes for insurance policies issued in states where the Company operates; legislation adverse to the automobile insurance industry or business generally that may be enacted in the states where the Company operates; the Company's success in managing its business in non-California states; the presence of competitors with greater financial resources and the impact of competitive pricing and marketing efforts; the Company's ability to successfully manage its claims organization outside ofCalifornia ; the Company's ability to successfully allocate the resources used in the states with reduced or exited operations to its operations in other states; changes in driving patterns and loss trends; acts of war and terrorist activities; pandemics, epidemics, widespread health emergencies, or outbreaks of infectious diseases; court decisions and trends in litigation and health care and auto repair costs; and legal, cyber security, regulatory and litigation risks. From time to time, forward-looking statements are also included in the Company's quarterly reports on Form 10-Q and current reports on Form 8-K, in press releases, in presentations, on its web site, and in other materials released to the public. Investors are cautioned not to place undue reliance on any forward-looking statements, which speak only as of the date of this Annual Report on Form 10-K or, in the case of any document the Company incorporates by reference, any other report filed with theSEC or any other public statement made by the Company, the date of the document, report or statement. The Company undertakes no obligation to publicly update any forward-looking statements, whether as a result of new information or future events or otherwise. OVERVIEW
A. General
The operating results of property and casualty insurance companies are subject to significant quarter-to-quarter and year-to-year fluctuations due to the effect of competition on pricing, the frequency and severity of losses, the effect of weather and natural disasters on losses, general economic conditions, the general regulatory environment in states in which an insurer operates, state regulation of insurance including premium rates, changes in fair value of investments, and other factors such as changes in tax laws. The property and casualty insurance 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. These cycles can have a significant impact on the Company's ability to grow and retain business. The Company is headquartered inLos Angeles, California and writes primarily personal automobile lines of business selling policies through a network of independent agents, 100% owned insurance agents and direct channels, in 11 states:Arizona ,California ,Florida ,Georgia ,Illinois ,Nevada ,New Jersey ,New York ,Oklahoma ,Texas , andVirginia . The Company also offers homeowners, commercial automobile, commercial property, mechanical protection, fire, and umbrella insurance. Private passenger automobile lines of insurance business accounted for approximately 64% of the$4.0 billion of the Company's direct premiums written in 2022, and approximately 82% of the private passenger automobile premiums were written inCalifornia . This section discusses some of the relevant factors that management considers in evaluating the Company's performance, prospects, and risks. It is not all-inclusive and is meant to be read in conjunction with the entirety of management's discussion and analysis, the Company's consolidated financial statements and notes thereto, and all other items contained within this Annual Report on Form 10-K.
2022 Financial Performance Summary
The Company's net (loss) income for the year ended
30 -------------------------------------------------------------------------------- share, compared to$247.9 million , or$4.48 per diluted share, for the same period in 2021. Included in net (loss) income was$168.4 million of pre-tax net investment income that was generated during 2022 on a portfolio of$4.9 billion , at fair value, atDecember 31, 2022 , compared to$129.7 million of pre-tax net investment income that was generated during 2021 on a portfolio of$5.1 billion , at fair value, atDecember 31, 2021 . Also included in net (loss) income were pre-tax net realized investment (losses) gains of$(488.1) million and$111.7 million in 2022 and 2021, respectively, and pre-tax catastrophe losses, net of reinsurance and reinstatement premiums earned, of approximately$101.3 million and$103.7 million in 2022 and 2021, respectively. Pre-tax net realized investment losses for 2022 resulted largely from the decrease in fair value of fixed maturity securities due to increases in market interest rates as well as the decrease in fair value of equity securities due to the decline in overall equity markets. The Company continued its marketing efforts to enhance name recognition and lead generation in 2022, although it reduced the spending for advertising and marketing as part of its cost saving initiative. The Company believes that its marketing efforts, combined with its ability to maintain relatively low prices and a strong reputation, make its insurance products competitive inCalifornia and in other states. The Company believes its thorough underwriting process gives it an advantage over its competitors. The Company's agent relationships and underwriting and claims processes are its most important competitive advantages.
The Company's operating results and growth have allowed it to consistently
generate positive cash flow from operations, which was approximately
million
operations has been used to pay shareholder dividends and help support growth.
Economic and Industry Wide Factors
•Regulatory Uncertainty-The insurance industry is subject to strict state regulation and oversight and is governed by the laws of each state in which each insurance company operates. State regulators generally have substantial power and authority over insurance companies including, in some states, approving rate changes and rating factors, restricting cancellation and non-renewal of insurance policies, and establishing minimum capital and surplus requirements. In many states, insurance commissioners may emphasize different agendas or interpret existing regulations differently than previous commissioners. There is no certainty that current or future regulations and the interpretation of those regulations by insurance commissioners and the courts will not have an adverse impact on the Company. •Cost Uncertainty-Because insurance companies pay claims after premiums are collected, the ultimate cost of an insurance policy is not known until well after the policy revenues are earned. Consequently, significant assumptions are made when establishing insurance rates and loss reserves. While insurance companies use sophisticated models and experienced actuaries to assist in setting rates and establishing loss reserves, there can be no assurance that current rates or current reserve estimates will be adequate. Furthermore, there can be no assurance that insurance regulators will approve rate increases when the Company's actuarial analyses indicate that they are needed. •Economic Conditions-The Company's financial condition, results of operations, and liquidity may be negatively impacted by global, national and local economic conditions, such as recessions, increased levels of unemployment, inflation, and large fluctuations in interest rates. Further, volatility in global capital markets could adversely affect the Company's investment portfolio. The Company is not able to predict the timing and effect of these factors, or their duration and severity. •Inflation-The largest cost component for automobile insurers is losses, which include medical, replacement automobile parts, and labor costs. There can be significant variation in the overall increases in medical cost inflation, and it is often years after the respective fiscal period ends before sufficient claims have closed for the inflation rate to be known with a reasonable degree of certainty. Therefore, it can be difficult to establish reserves and set premium rates, particularly when actual inflation rates may be higher or lower than anticipated. •Loss Frequency-Another component of overall loss costs is loss frequency, which is the number of claims per risk insured. Loss frequency trends are affected by many factors such as fuel prices, the economy, the prevalence of distracted driving, collision avoidance and other technology in vehicles, and stay-at-home orders issued by state and local governments due to the pandemic. •Underwriting Cycle and Competition-The property and casualty insurance industry is highly cyclical, with alternating hard and soft market conditions. The Company believes that the automobile insurance market in most states has hardened during 2022 as insurance carriers began to increase rates reflecting high loss severity and increasing loss frequency as the country emerged from the COVID-19 pandemic. InCalifornia , market conditions in 31 --------------------------------------------------------------------------------
2022 were hard as companies tightened their underwriting due to difficulty in
obtaining regulatory approval for rate increases.
Technology
The Company has continued its core insurance platform modernization initiatives in 2022, and intends to complete the migration of most of its products from legacy systems to a single platform and continue to invest in the modernization of its technology and data science platforms in 2023.
Note on General Business and Economic Conditions
The outbreak of COVID-19 has had a notable impact on general economic conditions, including, but not limited to, the temporary closures of many businesses and reduced consumer spending. The Company has taken and continues to take a number of precautionary steps to safeguard its customers, business and employees from COVID-19. Most of the Company's employees have been working remotely, with only certain operationally critical employees working on site at various locations. InNovember 2021 , the Company extended its "work-from-home" policy indefinitely under the new "Mercury's My Workplace" policy, allowing most of its employees to work from anywhere in theU.S. beginningJanuary 2022 . The Company's automobile line of insurance business experienced a rapid drop in loss frequency in the second quarter of 2020 due to reduced driving following the outbreak of the pandemic. Since then, loss frequency has increased and is now near pre-pandemic levels. In 2022, inflationary trends accelerated to their highest level since the 1980s. Excessive inflation led to significant increases in loss severities related to vehicle repairs and bodily injuries. The COVID-19 pandemic also created more uncertainty, and the total effect on losses occurring during the COVID-19 era will not be known for several years. The Company expects more late reported claims and a prolonged settlement period. The sustained high loss severity, combined with loss frequency at near pre-pandemic levels, negatively impacted the Company's results of operations, and the Company has submitted private passenger automobile rate filings in many states requesting rate increases. In addition, the Company is taking various non-rate actions to improve profitability. TheFederal Open Market Committee started raising the federal funds rate inMarch 2022 as a response to inflationary pressures. The ensuing increases in market interest rates, combined with the high inflation, the supply chain and labor issues, and theRussia -Ukraine war, have placed significant strain on financial markets leading to market volatility and turmoil. The fair values of the Company's equity securities have reflected such market volatility and the fair values of its fixed maturity securities have decreased significantly as a result of increases in market interest rates during 2022. The Company believes that it will continue to have sufficient liquidity to support its business operations without the forced sale of investments, based on its existing cash and short-term investments, future cash flows from operations, and$175 million of undrawn credit in its unsecured credit facility. The Company will continue to monitor the effects of COVID-19 and its variants, the high inflation and interest rates, the supply chain and labor issues, theRussia -Ukraine war, and the legislative relief programs, including the Inflation Reduction Act of 2022 signed into law inAugust 2022 . The extent of these effects on the Company's business and financial results will depend largely on future developments, including the duration of the high inflation and interest rates and the war, most of which are highly uncertain and cannot be predicted. InOctober 2022 , the Company reduced its workforce by approximately 40 employees, and a one-time cost of approximately$3 million associated with the workforce reduction was recorded as an expense for the fourth quarter of 2022. The Company anticipates this reduction will result in ongoing annual cost savings of approximately$6 million .
B. Regulatory and Legal Matters
The process for implementing rate changes varies by state. For more detailed
information related to insurance rate approval, see "Item 1.
Business-Regulation."
During 2022, the Company implemented rate changes in 11 states. InCalifornia , no rate increases were approved by the California DOI for lines of insurance business that exceeded 5% of the Company's total net premiums earned in 2022. InJanuary 2023 , the California DOI approved a 6.9% rate increase on each of MIC's and CAIC's private passenger automobile line of insurance business, which represented approximately 51% and 5%, respectively, of the Company's total net premiums earned in 2022. The Company plans to implement these rate increases inMarch 2023 . In addition, the Company plans to file for another 6.9% rate increase with the California DOI inMarch 2023 on each of MIC's and CAIC'sCalifornia private passenger automobile line of insurance business. 32 -------------------------------------------------------------------------------- The Company is, from time to time, named as a defendant in various lawsuits or regulatory actions incidental to its insurance business. The majority of lawsuits brought against the Company relate to insurance claims that arise in the normal course of business and are reserved for through the reserving process. For a discussion of the Company's reserving methods, see "Critical Accounting Estimates" below and Note 1. Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements in "Item 8. Financial Statements and Supplementary Data." The Company also establishes accruals for estimated liabilities for non-insurance claims related lawsuits, regulatory actions, and other contingencies when the Company believes a loss is probable and is able to estimate its potential exposure. For material loss contingencies believed to be reasonably possible, the Company also discloses the nature of the loss contingency and an estimate of the possible loss, range of loss, or a statement that such an estimate cannot be made. In addition, the Company accrues for anticipated legal defense costs associated with such lawsuits and regulatory actions. While actual losses may differ from the amounts recorded and the ultimate outcome of the Company's pending actions is generally not yet determinable, the Company does not believe that the ultimate resolution of currently pending legal or regulatory proceedings, either individually or in the aggregate, will have a material adverse effect on its financial condition or cash flows.
For a discussion of additional regulatory and legal matters, see Note 18.
Commitments and Contingencies of the Notes to Consolidated Financial Statements
in "Item 8. Financial Statements and Supplementary Data." In all cases, the
Company vigorously defends itself unless a reasonable settlement appears
appropriate.
C. Critical Accounting Estimates
Loss and Loss Adjustment Expense Reserves ("Loss Reserves")
Preparation of the Company's consolidated financial statements requires
management's judgment and estimates. The most significant is the estimate of
loss reserves. Estimating loss reserves is a difficult process as many factors
can ultimately affect the final settlement of a claim and, therefore, the loss
reserve that is required. A key assumption in estimating loss reserves is the
degree to which the historical data used to analyze reserves will be predictive
of ultimate claim costs on incurred claims. Changes in the regulatory and legal
environments, results of litigation, medical costs, the cost of repair
materials, and labor rates, among other factors, can impact this assumption. 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
a claim, the more variable the ultimate settlement amount could be. Accordingly,
short-tail liability claims, such as property damage claims, tend to be more
reasonably predictable than long-tail liability claims.
The Company calculates a loss reserve point estimate rather than a range. There
is inherent uncertainty with estimates and this is particularly true with loss
reserve estimates. This uncertainty comes from many factors which may include
changes in claims reporting and settlement patterns, changes in the regulatory
and legal environments, uncertainty over inflation rates, and uncertainty for
unknown items. The Company does not make specific provisions for these
uncertainties, rather it considers them in establishing its loss reserve by
looking at historical patterns and trends and projecting these out to current
loss reserves. The underlying factors and assumptions that serve as the basis
for preparing the loss reserve estimate include paid and incurred loss
development factors, expected average costs per claim, inflation trends,
expected loss ratios, industry data, and other relevant information.
The Company also engages independent actuarial consultants to review the
Company's loss reserves and to provide the annual actuarial opinions required
under state statutory accounting requirements. The Company analyzes loss
reserves quarterly primarily using the incurred loss, paid loss, average
severity coupled with the claim count development methods, and the generalized
linear model ("GLM") described below. When deciding among methods to use, the
Company evaluates the credibility of each method based on the maturity of the
data available and the claims settlement practices for each particular line of
insurance business or coverage within a line of insurance business. The Company
may also evaluate qualitative factors such as known changes in laws or legal
rulings that could affect claims handling or other external environmental
factors or internal factors that could affect the settlement of claims. When
establishing the loss reserve, the Company generally analyzes the results from
all of the methods used rather than relying on a single method. While these
methods are designed to determine the ultimate losses on claims under the
Company's policies, there is inherent uncertainty in all actuarial models since
they use historical data to project outcomes. The Company believes that the
techniques it uses provide a reasonable basis in estimating loss reserves.
•The incurred loss method analyzes historical incurred case loss (case reserves
plus paid losses) development to estimate ultimate losses. The Company applies
development factors against current case incurred losses by accident period to
calculate ultimate expected losses. The Company believes that the incurred loss
method provides a
33
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reasonable basis for evaluating ultimate losses, particularly in the Company's
larger, more established lines of insurance business which have a long operating
history.
•The paid loss method analyzes historical payment patterns to estimate the
amount of losses yet to be paid.
•The average severity method analyzes historical loss payments and/or incurred losses divided by closed claims and/or total claims to calculate an estimated average cost per claim. From this, the expected ultimate average cost per claim can be estimated. The average severity method coupled with the claim count development method provides meaningful information regarding inflation and frequency trends that the Company believes is useful in establishing loss reserves. The claim count development method analyzes historical claim count development to estimate future incurred claim count development for current claims. The Company applies these development factors against current claim counts by accident period to calculate ultimate expected claim counts. •The GLM determines an average severity for each percentile of claims that have been closed as a percentage of estimated ultimate claims. The average severities are applied to open claims to estimate the amount of losses yet to be paid. The GLM utilizes operational time, determined as a percentile of claims closed rather than a finite calendar period, which neutralizes the effect of changes in the timing of claims handling. The Company analyzes catastrophe losses separately from non-catastrophe losses. For catastrophe losses, the Company generally determines claim counts based on claims reported and development expectations from previous catastrophes and applies an average expected loss per claim based on loss reserves established by adjusters and average losses on previous similar catastrophes. For catastrophe losses on individual properties that are expected to be total losses, the Company typically establishes reserves at the policy limits. There are many factors that can cause variability between the ultimate expected loss and the actual developed loss. While there are certainly other factors, the Company believes that the following three items tend to create the most variability between expected losses and actual losses.
(1) Inflation
For the Company's
reserves are comprised of the following:
•BI reserves-approximately 70% of total reserves
•Material damage ("MD") reserves, including collision and comprehensive property
damage-approximately 10% of total reserves
•Loss adjustment expense reserves-approximately 20% of total reserves.
Loss development on MD reserves is generally insignificant because MD claims are generally settled in a shorter period than BI claims. However, in periods of high rates of change in inflation rates, such as what has been experienced in late 2021 through 2022, loss development on MD reserves can be elevated for a short period of time. The majority of the loss adjustment expense reserves are estimated costs to defend BI claims, which tend to require longer periods of time to settle as compared to MD claims. BI loss reserves are generally the most difficult to estimate because they take longer to close than other coverages. BI coverage in the Company's policies includes injuries sustained by any person other than the insured, except in the case of uninsured or underinsured motorist BI coverage, which covers damages to the insured for BI caused by uninsured or underinsured motorists. BI payments are primarily for medical costs and general damages.
The following table presents the typical closure patterns of BI claims in the
Company's
% of Total
Claims Closed Dollars Paid
BI claims closed in the accident year reported 36% 12%
BI claims closed one year after the accident year reported 78% 50%
BI claims closed two years after the accident year reported 94% 76%
BI claims closed three years after the accident year reported 97% 88%
34
-------------------------------------------------------------------------------- BI claims closed in the accident year reported are generally the smaller and less complex claims that settle for approximately$8,000 to$9,000 on average, whereas the total average settlement, once all claims are closed for a particular accident year, is approximately$17,000 to$27,000 . The Company creates incurred and paid loss triangles to estimate ultimate losses utilizing historical payment and reserving patterns and evaluates the results of this analysis against its frequency and severity analysis to establish BI loss reserves. The Company adjusts development factors to account for inflation trends it sees in loss severity. As a larger proportion of claims from an accident year are settled, there emerges a higher degree of certainty for the loss reserves established for that accident year. AtDecember 31, 2022 , the accident years that are most likely to develop are the 2020 through 2022 accident years; however, it is possible that older accident years could develop as well. In general, the Company expects that historical claims trends will continue with costs tending to increase, which is generally consistent with historical data, and therefore the Company believes that it is reasonable to expect inflation to continue. Many potential factors can affect the BI inflation rate, including changes in claims handling process, changes in statutes and regulations, the number of litigated files, increased use of medical procedures such as MRIs and epidural injections, general economic factors, timeliness of claims adjudication, vehicle safety, weather patterns, changes in the relative percentages of single- and multi-car accidents, social inflation, and gasoline prices, among other factors; however, the magnitude of the impact of such factors on the inflation rate is unknown. The Company's automobile line of insurance business experienced a rapid drop in loss frequency in the second quarter of 2020 due to reduced driving following the outbreak of the pandemic. Since then, loss frequency has increased and is now near pre-pandemic levels. In 2022, inflationary trends accelerated to their highest level since the 1980s. Excessive inflation led to significant increases in loss severities related to vehicle repairs and bodily injuries. In addition, the COVID-19 pandemic created greater uncertainty in the reserve estimates: A greater number of large claims may emerge from the 2020, 2021 and 2022 accident years compared to the prior accident years as claimants may be reluctant to go to a medical provider due to the pandemic but subsequently seek monetary compensation to ease the economic hardship attributable to the pandemic. Based on these factors and uncertainty attributable to the pandemic and inflation, the reserve estimates for the 2020, 2021 and 2022 accident years are subject to a greater degree of variability.
The Company believes that it is reasonably possible that the
automobile BI severity could vary from recorded amounts by as much as 12%, 8%
and 6% for 2022, 2021 and 2020 accident years, respectively; however, the
variation could be more or less than these amounts.
During the years 2018 through 2022, the changes in the loss severity amounts for
the three preceding accident years from the prior year amounts (BI severity
variance from prior year) have ranged as follows:
High Low
Immediate preceding accident year 7.9% (2.9)%
Second preceding accident year 7.5% 0.1%
Third preceding accident year 5.2% (1.0)%
The following table presents the effects on the California automobile BI loss
reserves for the 2022, 2021 and 2020 accident years based on possible variations
in the severity recorded; however, the actual variations could be more or less
than these amounts:
California Automobile Bodily Injury Inflation Reserve Sensitivity Analysis
(A) Pro-forma (B) Pro-forma
severity if actual severity if actual Favorable loss Unfavorable loss
Actual severity is lower by severity is higher by development if development if
Recorded Implied 12% for 2022, 12% for 2022, actual severity is actual severity is
Accident Number of Claims Severity at Inflation Rate 8% for 2021, and 8% for 2021, and less than recorded more than recorded
Year Expected 12/31/2022 Recorded (1) 6% for 2020 6% for 2020 (Column A) (Column B)
2022 20,532 $ 26,590 (2) 13.0 % (2) $ 23,399 $ 29,781 $ 65,518,000 $ (65,518,000)
2021 20,514 $ 23,526 11.0 % $ 21,644 $ 25,408 $ 38,607,000 $ (38,607,000)
2020 18,560 $ 21,186 21.1 % $ 19,915 $ 22,457 $ 23,590,000 $ (23,590,000)
2019 29,375 $ 17,496 - - - - -
Total Loss
Development-Favorable (Unfavorable)
(127,715,000)
___________
(1) Implied inflation rate is calculated by dividing the difference between the
current and prior year actual recorded severity by
35 -------------------------------------------------------------------------------- the prior year actual recorded severity. The Company believes that severity increases are caused by litigation, medical costs, inflation, and increased utilization of medical procedures. (2) In 2022, inflationary trends accelerated to their highest level since the 1980s, which had a significant impact on medical expenses for bodily injuries. Bodily injury costs were also under pressure from social inflation. These inflationary factors led to an increase in loss severity in 2022.
(2)
The Company generally estimates ultimate claim counts for an accident period based on development of claim counts in prior accident periods. Typically, almost every claim is reported within one year following the end of an accident year and at that point the Company has a high degree of certainty as to the ultimate claim count. There are many factors that can affect the number of claims reported after an accident period ends. These factors include changes in weather patterns, a change in the number of litigated files, the number of automobiles insured, and whether the last day of the accident period falls on a weekday or a weekend. However, the Company is unable to determine which, if any, of the factors actually impact the number of claims reported and, if so, by what magnitude. The COVID-19 pandemic created greater uncertainty in the claims count development for the 2020, 2021 and 2022 accident years. The Company believes that the reduced services for non-critical cases at medical facilities and fear of infection during the pandemic combined with the economic hardship caused by the pandemic are likely to increase the late reporting of claims seeking settlement for monetary compensation. AtDecember 31, 2022 , there were 19,589California automobile BI claims reported for the 2022 accident year and the Company estimates that these are expected to ultimately grow by approximately 4.8%. The Company believes that while actual development in recent years has ranged approximately from 3% to 7%, it is reasonable to expect that the range of the development could be as great as between 0% and 10%. However, actual development may be more or less than the expected range.
The following table presents the effects on loss development of different claim
counts within the broader possible range at
California Automobile Bodily Injury Claim Count Reserve Sensitivity Analysis
Amount Recorded Total Expected Total Expected
at 12/31/2022 at Approximately 4.8% Amount If Claim Amount If Claim
Claim Count Count Development is Count Development is
2022 Accident Year Claims Reported Development 0% 10%
Claim count 19,589 20,532 19,589 21,548
Approximate average cost per claim Not meaningful $ 26,590 $ 26,590 $ 26,590
Total dollars Not meaningful $ 545,946,000 $ 520,872,000 $
572,961,000
Total Loss
Development-Favorable (Unfavorable) $ 25,074,000 $
(27,015,000)
(3) Unexpected Losses From Older Accident Periods
Unexpected losses are generally not provided for in the current loss reserve because they are not known or expected and tend to be unquantifiable. Once known, the Company establishes a provision for the losses, but it is not possible to provide any meaningful sensitivity analysis as to the potential size of any unexpected losses. These losses can be caused by many factors, including unexpected legal interpretations of coverage, ineffective claims handling, regulations extending claims reporting periods, assumption of unexpected or unknown risks, adverse court decisions as well as many unknown factors. During 2022, the Company did not incur any material unexpected losses related to claims from accident periods prior to 2019. Unexpected losses are fairly infrequent but can have a large impact on the Company's losses. To mitigate this risk, the Company has established claims handling and review procedures. However, it is still possible that these procedures will not prove entirely effective, and the Company may have material unexpected losses in future periods. It is also possible that the Company has not identified and established a sufficient loss reserve for all material unexpected losses occurring in the older accident years, even though a comprehensive claims file review was undertaken. The Company may experience additional development on these loss reserves.
Discussion of Losses and Loss Reserves and Prior
At
approximately
36 -------------------------------------------------------------------------------- billion ($2.56 billion and$2.19 billion , net of reinsurance), respectively, in loss and loss adjustment expense reserves, which included approximately$1.28 billion and$1.03 billion ($1.28 billion and$1.02 billion , net of reinsurance), respectively, of incurred-but-not-reported liabilities ("IBNR"). IBNR includes estimates, based upon past experience, of ultimate developed costs, which may differ from case estimates, unreported claims that occurred on or prior toDecember 31, 2022 and 2021, and estimated future payments for reopened 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; however, since the provisions are necessarily based upon estimates, the ultimate liability may be more or less than such provisions. The Company evaluates its loss reserves quarterly. When management determines that the estimated ultimate claim cost requires a decrease for previously reported accident years, favorable development occurs and a reduction in losses and loss adjustment expenses is reported in the current period. If the estimated ultimate claim cost requires an increase for previously reported accident years, unfavorable development occurs and an increase in losses and loss adjustment expenses is reported in the current period. For 2022, the Company reported unfavorable development of approximately$47 million on the 2021 and prior accident years' loss and loss adjustment expense reserves. The unfavorable development in 2022 was primarily attributable to higher than estimated losses and loss adjustment expenses in the automobile line of insurance business. In 2022, inflationary trends accelerated to their highest level in decades, which had a significant impact on the cost of automobile parts and labor as well as medical expenses for bodily injuries, and supply chain and labor shortage issues lengthened the time to repair vehicles. Bodily injury costs were also under pressure from social inflation. These factors were major contributors to the adverse reserve development in the automobile line of insurance business. The Company recorded catastrophe losses net of reinsurance of approximately$102 million in 2022. Catastrophe losses due to the events that occurred during 2022 totaled approximately$101 million , with no reinsurance benefits used for these losses. The majority of the 2022 catastrophe losses resulted from the deep freeze of Winter Storm Elliott and other extreme weather events inTexas ,Oklahoma andGeorgia , winter storms inCalifornia , and the impact of Hurricane Ian inFlorida . In addition, the Company experienced unfavorable development of approximately$1 million on prior years' catastrophe losses in 2022. RESULTS OF OPERATIONS
Year Ended
Revenues
Net premiums earned and net premiums written in 2022 increased 5.6% and 3.2%, respectively, from 2021. The increase in net premiums earned and written was primarily due to increases in the number of policies written outside ofCalifornia , higher average premiums in theCalifornia homeowners line of insurance business, and rate increases in certain lines of insurance business in some states outside ofCalifornia , partially offset by a decrease in the number of private passenger automobile policies written inCalifornia . During 2022, the Company discontinued offering twelve-month private passenger automobile policies on new and renewal businesses in most states where it operates, includingCalifornia , which further offset the increase in net premiums written for the year endedDecember 31, 2022 compared to the same period in 2021. AtDecember 31, 2022 , the Company's twelve-month private passenger automobile policies represented approximately 21% of its total private passenger automobile policies in force. Net premiums earned included ceded premiums earned of$81.0 million and$65.0 million in 2022 and 2021, respectively. Net premiums written included ceded premiums written of$81.3 million and$65.5 million in 2022 and 2021, respectively. The increase in ceded premiums earned and written resulted mostly from higher reinsurance coverage and rates and growth in the covered book of business. Net premiums earned, a GAAP measure, represents the portion of net premiums written that is recognized as revenue in the financial statements for the periods presented and earned on a pro-rata basis over the term of the policies. Net premiums written is a non-GAAP financial measure which represents the premiums charged on policies issued during a fiscal period less any applicable reinsurance. Net premiums written is a statutory measure designed to determine production levels. 37
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The following is a reconciliation of total net premiums earned to net premiums
written:
Year Ended December 31,
2022 2021
(Amounts in thousands)
Net premiums earned $ 3,952,482 $ 3,741,948
Change in net unearned premiums 25,535 113,421
Net premiums written $ 3,978,017 $ 3,855,369
Expenses
Loss and expense ratios are used to interpret the underwriting experience of
property and casualty insurance companies. The following table presents the
Company's consolidated loss, expense, and combined ratios determined in
accordance with GAAP:
Year Ended December 31,
2022 2021
Loss ratio 85.1 % 73.8 %
Expense ratio 23.6 % 24.5 %
Combined ratio 108.7 % 98.3 %
Loss ratio is calculated by dividing losses and loss adjustment expenses by net
premiums earned. The Company's loss ratio was affected by unfavorable
development of approximately $47 million and favorable development of
approximately $26 million on prior accident years' loss and loss adjustment
expense reserves for the years ended December 31, 2022 and 2021, respectively.
The unfavorable development in 2022 was primarily attributable to higher than
estimated losses and loss adjustment expenses in the automobile line of
insurance business. Inflationary trends accelerated to their highest level in
decades in 2022, which had a significant impact on the cost of automobile parts
and labor as well as medical expenses for bodily injuries, and supply chain and
labor shortage issues lengthened the time to repair vehicles. Bodily injury
costs were also under pressure from social inflation. These factors were major
contributors to the adverse reserve development in the automobile line of
insurance business. The favorable development in 2021 was primarily attributable
to lower than estimated losses and loss adjustment expenses in the homeowners
and private passenger automobile lines of insurance business.
The 2022 loss ratio was negatively impacted by a total of approximately $101
million of catastrophe losses, excluding unfavorable development of
approximately $1 million on prior years' catastrophe losses, primarily due to
the deep freeze of Winter Storm Elliott and other extreme weather events in
Texas , Oklahoma and Georgia , winter storms in California , and the impact of
Hurricane Ian in Florida . The 2021 loss ratio was negatively impacted by a total
of approximately $109 million of catastrophe losses, excluding favorable
development of approximately $5 million on prior years' catastrophe losses,
primarily due to the deep freeze of Winter Storm Uri and other extreme weather
events in Texas and Oklahoma , rainstorms, wildfires and winter storms in
California , and the impact of Hurricane Ida in New Jersey and New York .
Excluding the effect of estimated prior periods' loss development and
catastrophe losses, the loss ratio was 81.3% and 71.5% for the years ended
December 31, 2022 and 2021, respectively. The increase in the loss ratio was
primarily due to increases in loss severity and frequency in the automobile line
of insurance business. The inflationary pressures and the supply chain and labor
shortage issues discussed above, coupled with a lag in obtaining timely rate
increases to offset the effects of inflationary trends, led to a significant
increase in automobile loss severity and increased losses and loss adjustment
expenses for the insured events of the current accident year for 2022 compared
to 2021. After bottoming out in the second quarter of 2020, automobile loss
frequency has mostly been increasing and is near pre-pandemic levels. The
Company has filed for rate increases in many states and is taking various
non-rate actions to improve profitability.
Expense ratio is calculated by dividing the sum of policy acquisition costs and
other operating expenses by net premiums earned. The decrease in the expense
ratio is primarily due to lower expenses for advertising and
profitability-related accruals combined with higher net premiums earned.
Combined ratio is equal to loss ratio plus expense ratio and is the key measure
of underwriting performance traditionally used in the property and casualty
insurance industry. A combined ratio under 100% generally reflects profitable
underwriting results; a combined ratio over 100% generally reflects unprofitable
underwriting results.
Income tax (benefit) expense was
years ended
38 --------------------------------------------------------------------------------
respectively. The
to a significant decrease in pre-tax income of
The Company's effective income tax rate can be affected by several factors. These generally include large changes in fully-taxable income including net realized investment gains or losses, tax-exempt investment income, nondeductible expenses, and periodically, non-routine tax items such as adjustments to unrecognized tax benefits related to tax uncertainties. The effective income tax rate was 23.6% and 17.2% for 2022 and 2021, respectively. The effective income tax rate for 2022 was higher than the statutory tax rate of 21% because tax-exempt investment income of approximately$75 million was included in pre-tax loss of approximately$671 million , while the effective income tax rate for 2021 was lower than the statutory tax rate because tax-exempt investment income of approximately$74 million was included in pre-tax income of approximately$299 million .
Investments
The following table presents the investment results of the Company:
Year Ended December 31,
2022 2021
(Amounts in thousands)
Average invested assets at cost (1)
Net investment income (2)
Before income taxes$ 168,356 $
129,727
After income taxes$ 146,204 $
115,216
Average annual yield on investments (2)
Before income taxes 3.4 % 2.8 %
After income taxes 3.0 % 2.5 %
Net realized investment (losses) gains
__________
(1)Fixed maturities and short-term bonds at amortized cost; equities and other short-term investments at cost. Average invested assets at cost are based on the monthly amortized cost of the invested assets for each period. (2)Net investment income before and after income taxes increased primarily due to higher average yield combined with higher average invested assets. Average annual yield on investments before and after income taxes increased primarily due to the maturity and replacement of lower yielding investments purchased when market interest rates were lower with higher yielding investments, as a result of increasing market interest rates, as well as higher yields on investments based on floating interest rates.
The following tables present the components of net realized investment gains
(losses) included in net income:
Year Ended
Gains
(Losses) Recognized in Income
Changes in fair
Sales value Total
(Amounts in thousands)
Net realized investment gains (losses):
Fixed maturity securities (1)(2) $ (70,562) $ (260,223) $ (330,785)
Equity securities (1)(3) 24,916 (185,694) (160,778)
Short-term investments (1) (2,492) 88 (2,404)
Options sold 5,786 101 5,887
Total $ (42,352) $ (445,728) $ (488,080)
39
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Year Ended December 31, 2021
Gains (Losses) Recognized in Income
Changes in
Sales fair value Total
(Amounts in thousands)
Net realized investment gains (losses):
Fixed maturity securities (1)(2) $ (4,384) $ (39,649) $ (44,033)
Equity securities (1)(3) 45,235 107,701 152,936
Short-term investments (1) (145) (141) (286)
Note receivable (1) - (4) (4)
Options sold 2,964 81 3,045
Total $ 43,670 $ 67,988 $ 111,658
__________
(1)The changes in fair value of the investment portfolio and note receivable
resulted from the application of the fair value option.
(2)The decreases in fair value of fixed maturity securities in 2022 and 2021
were primarily due to increases in market interest rates.
(3)The decrease in fair value of equity securities in 2022 was primarily due to
the overall decline in equity markets, and the increase in fair value of equity
securities in 2021 was primarily due to the overall improvement in equity
markets.
Net (Loss) Income
Year Ended December 31,
2022 2021
(Amounts in thousands, except per share
data)
Net (loss) income $ (512,672) $ 247,937
Basic average shares outstanding 55,371 55,368
Diluted average shares outstanding 55,371 55,374
Basic Per Share Data:
Net (loss) income $ (9.26) $ 4.48
Net realized investment (losses) gains, net of tax $ (6.96) $ 1.59
Diluted Per Share Data:
Net (loss) income $ (9.26) $ 4.48
Net realized investment (losses) gains, net of tax $ (6.96) $ 1.59
Year Ended
See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" of the Company's Form 10-K for the year endedDecember 31, 2021 for a discussion of changes in its results of operations from the year endedDecember 31, 2020 to the year endedDecember 31, 2021 . LIQUIDITY AND CAPITAL RESOURCES A. General The Company is largely dependent upon dividends received from its insurance subsidiaries in the current and prior years to pay debt service costs and to make distributions to its shareholders. Under current insurance law, the Insurance Companies are entitled to pay ordinary dividends of approximately$151 million in 2023 toMercury General . As ofDecember 31, 2022 ,Mercury General had approximately$96 million in investments and cash that could be utilized to satisfy its direct holding company obligations. 40 -------------------------------------------------------------------------------- The principal sources of funds for the Insurance Companies are premiums, sales and maturity of invested assets, and dividend and interest income from invested assets. The principal uses of funds for the Insurance Companies are the payment of claims and related expenses, operating expenses, dividends toMercury General , and the purchase of investments.
B. Cash Flows
The Company has generated positive cash flow from operations since the public offering of its common stock inNovember 1985 . The Company does not attempt to match the duration and timing of asset maturities with those of liabilities; rather, it manages its portfolio with a view towards maximizing total return with an emphasis on after-tax income. With combined cash and short-term investments of$412.7 million atDecember 31, 2022 as well as$175 million of undrawn credit in its unsecured credit facility, the Company believes its cash flow from operations is adequate to satisfy its liquidity requirements without the forced sale of investments. Investment maturities are also available to meet the Company's liquidity needs. However, the Company operates in a rapidly evolving and often unpredictable business environment that may change the timing or amount of expected future cash receipts and expenditures. Accordingly, there can be no assurance that the Company's sources of funds will be sufficient to meet its liquidity needs or that the Company will not be required to raise additional funds to meet those needs or for future business expansion, through the sale of equity or debt securities or from credit facilities with lending institutions. Net cash provided by operating activities for the year endedDecember 31, 2022 was$352.6 million , a decrease of$149.0 million compared to the year endedDecember 31, 2021 . The decrease was primarily due to increases in payments for losses and loss adjustment expenses and policy acquisition costs, partially offset by an increase in premium collections, a decrease in payments for income taxes, and an increase in investment income received. The Company utilized the cash provided by operating activities during the year endedDecember 31, 2022 primarily for the net purchases of investment securities and payment of dividends to its shareholders. The average annual net cash provided by operating activities for the past 10 years was approximately$364 million , and cash generated from operations was sufficient to meet the liquidity requirements over this period. The following table presents the estimated fair value of fixed maturity securities atDecember 31, 2022 by contractual maturity in the next five years.Fixed Maturity Securities (Amounts in thousands) Due in one year or less $
144,357
Due after one year through two years
282,736
Due after two years through three years
160,817
Due after three years through four years
245,663
Due after four years through five years 293,680
$ 1,127,253
See "D. Debt" below for cash flow related to outstanding debt.
C. Invested Assets
Portfolio Composition
An important component of the Company's financial results is the return on its
investment portfolio. The Company's investment strategy emphasizes safety of
principal and consistent income generation, within a total return framework. The
investment strategy has historically focused on maximizing after-tax yield with
a primary emphasis on maintaining a well-diversified, investment grade, fixed
income portfolio to support the underlying liabilities and achieve return on
capital and profitable growth. The Company believes that investment yield is
maximized by selecting assets that perform favorably on a long-term basis and by
disposing of certain assets to enhance after-tax yield and minimize the
potential effect of downgrades and defaults. The Company believes that this
strategy enables the optimal investment performance necessary to sustain
investment income over time. The Company's portfolio management approach
utilizes a market risk and consistent asset allocation strategy as the primary
basis for the allocation of interest sensitive, liquid and credit assets as well
as for determining overall below investment grade exposure and diversification
requirements. Within the ranges set by the asset allocation strategy, tactical
investment decisions are made in consideration of prevailing market conditions.
41
--------------------------------------------------------------------------------
The following table presents the composition of the total investment portfolio
of the Company at
Cost(1)
Fair Value
(Amounts in
thousands)
Fixed maturity securities:
U.S. government bonds$ 159,256
Municipal securities 2,794,476
2,737,183
Mortgage-backed securities 184,936 166,260
Corporate securities 607,945 569,553
Collateralized loan obligations 332,859 320,252
Other asset-backed securities 147,318 136,456
4,226,790 4,088,311
Equity securities:
Common stock 463,940 558,169
Preferred stock 64,686
51,236
Private equity funds measured at net asset value (2) 140,217
90,147
668,843 699,552
Short-term investments 123,928 122,937
Total investments $ 5,019,561 $ 4,910,800
__________
(1)Fixed maturities and short-term bonds at amortized cost and equities and
other short-term investments at cost.
(2)The fair value is measured using the net asset value practical expedient. See
Note 4. Fair Value Measurements, of the Notes to Consolidated Financial
Statements in "Item 8. Financial Statements and Supplementary Data" for
additional information.
At December 31, 2022 , 49.7% of the Company's total investment portfolio at fair
value and 59.7% of its total fixed maturity investments at fair value were
invested in tax-exempt state and municipal bonds. Equity holdings consist of
preferred stocks, dividend-bearing common stocks on which dividend income is
partially tax-sheltered by the 50% corporate dividend received deduction, and
private equity funds. At December 31, 2022 , 51.3% of short-term investments
consisted of highly rated short-duration securities redeemable on a daily or
weekly basis.
Fixed maturity securities include debt securities, which may have fixed or
variable principal payment schedules, may be held for indefinite periods of
time, and may be used as a part of the Company's asset/liability strategy or
sold in response to changes in interest rates, anticipated prepayments,
risk/reward characteristics, liquidity needs, tax planning considerations, or
other economic factors. Short-term investments include money market accounts,
options, and short-term bonds that are highly rated short duration securities
and redeemable within one year.
A primary exposure for the fixed maturity securities is interest rate risk. The
longer the duration, the more sensitive the asset is to market interest rate
fluctuations. As assets with longer maturity dates tend to produce higher
current yields, the Company's historical investment philosophy has resulted in a
portfolio with a moderate duration. The Company's portfolio is heavily weighted
in investment grade tax-exempt municipal bonds. Fixed maturity securities
purchased by the Company typically have call options attached, which further
reduce the duration of the asset as interest rates decline. The holdings, that
are heavily weighted with high coupon issues, are expected to be called prior to
maturity. Modified duration measures the length of time it takes, on average, to
receive the present value of all the cash flows produced by a bond, including
reinvestment of interest. As it measures four factors (maturity, coupon rate,
yield and call terms) which determine sensitivity to changes in interest rates,
modified duration is considered a better indicator of price volatility than
simple maturity alone.
42
--------------------------------------------------------------------------------
The following table presents the maturities and durations of the Company's fixed
maturity securities and short-term investments:
December 31, 2022 December 31, 2021
(in years)
Fixed Maturity Securities
Nominal average maturity:
excluding short-term investments 12.4 10.8
including short-term investments 12.0 10.4
Call-adjusted average maturities:
excluding short-term investments 4.9 4.6
including short-term investments 4.8 4.5
Modified duration reflecting anticipated early calls:
excluding short-term investments
3.6 3.5 including short-term investments 3.5 3.4 Short-Term Investments - - Another exposure related to the fixed maturity securities is credit risk, which is managed by maintaining a weighted-average portfolio credit quality rating of A+, at fair value atDecember 31, 2022 , consistent with the average rating atDecember 31, 2021 . The Company's municipal bond holdings, of which 89.1% were tax exempt, represented 67.0% of its fixed maturity portfolio atDecember 31, 2022 , at fair value, and were broadly diversified geographically. To calculate the weighted-average credit quality ratings as disclosed throughout this Annual Report on Form 10-K, individual securities were weighted based on fair value and a credit quality numeric score that was assigned to each security's average of ratings assigned by nationally recognized securities rating organizations. Taxable holdings consist principally of investment grade issues. AtDecember 31, 2022 , fixed maturity holdings rated below investment grade and non-rated bonds totaled$6.6 million and$26.5 million , respectively, at fair value, and represented 0.2% and 0.6%, respectively, of total fixed maturity securities. The majority of non-rated issues are a result of municipalities pre-funding and collateralizing those issues withU.S. government securities with an implicitAAA equivalent credit risk. AtDecember 31, 2021 , fixed maturity holdings rated below investment grade and non-rated bonds totaled$7.1 million and$17.3 million , respectively, at fair value, and represented 0.2% and 0.4%, respectively, of total fixed maturity securities. Credit ratings for the Company's fixed maturity portfolio were stable in 2022, with 95.0% of fixed maturity securities at fair value experiencing no change in their overall rating. 4.2% and 0.8% of fixed maturity securities at fair value experienced upgrades and downgrades, respectively, in 2022. 43 --------------------------------------------------------------------------------
The following table presents the credit quality ratings of the Company's fixed
maturity securities by security type at fair value:
December 31, 2022
Total Fair
Security Type AAA(1) AA(1) A(1) BBB(1) Non-Rated/Other (1) Value(1)
(Dollars in thousands)
U.S. government bonds and agencies:
Agencies $ 55,088 $ - $ - $ - $ - $ 55,088
Treasuries 103,519 - - - - 103,519
Total 158,607 - - - - 158,607
100.0 % - % - % - % - % 100.0 %
Municipal securities:
Insured 33,647 253,317 72,421 33,335 2,456 395,176
Uninsured 71,152 624,946 1,424,816 209,605 11,488 2,342,007
Total 104,799 878,263 1,497,237 242,940 13,944 2,737,183
3.8 % 32.1 % 54.7 % 8.9 % 0.5 % 100.0 %
Mortgage-backed securities:
Commercial 16,722 5,820 4,709 - - 27,251
Agencies 5,499 - - - - 5,499
Non-agencies:
Prime 18,312 94,505 19,013 - 396 132,226
Alt-A - 454 - 141 689 1,284
Total 40,533 100,779 23,722 141 1,085 166,260
24.4 % 60.5 % 14.3 % 0.1 % 0.7 % 100.0 %
Corporate securities:
Communications - 167 - 6,379 - 6,546
Consumer, cyclical - 1,854 - 39,815 - 41,669
Consumer, non-cyclical - - 17,924 8,246 - 26,170
Energy - 6,871 3,430 36,109 - 46,410
Financial - 20,060 184,073 56,204 6,421 266,758
Industrial - 62,100 53,391 46,772 - 162,263
Technology - - - 708 - 708
Utilities - - 9,097 9,932 - 19,029
Total - 91,052 267,915 204,165 6,421 569,553
- % 16.0 % 47.1 % 35.8 % 1.1 % 100.0 %
Collateralized loan obligations:
Corporate 19,825 63,911 224,916 - 11,600 320,252
Total 19,825 63,911 224,916 - 11,600 320,252
6.2 % 20.0 % 70.2 % - % 3.6 % 100.0 %
Other asset-backed securities 7,552 29,899 65,172 33,833 - 136,456
5.5 % 21.9 % 47.8 % 24.8 % - % 100.0 %
Total $ 331,316 $ 1,163,904 $ 2,078,962 $ 481,079 $ 33,050 $ 4,088,311
8.1 % 28.5 % 50.8 % 11.8 % 0.8 % 100.0 %
__________
(1)Intermediate ratings are included at each level (e.g., AA includes AA+, AA
and AA-).
U.S. Government Bonds The Company had$158.6 million and$13.1 million , or 3.9% and 0.3% of its fixed maturity portfolio, at fair value, inU.S. government bonds atDecember 31, 2022 and 2021, respectively. AtDecember 31, 2022 , Moody's and Fitch ratings for 44 --------------------------------------------------------------------------------U.S. government issued debt were Aaa andAAA , respectively, although a significant increase in government deficits and debt could lead to a downgrade. The Company understands that market participants continue to use rates of return onU.S. government debt as a risk-free rate and have continued to invest inU.S. Treasury securities. The modified duration of theU.S. government bonds portfolio reflecting anticipated early calls was 1.4 years and 0.9 years atDecember 31, 2022 and 2021, respectively.
The Company had$2.74 billion and$2.84 billion , or 67.0% and 70.5% of its fixed maturity securities portfolio, at fair value, in municipal securities atDecember 31, 2022 and 2021, respectively, of which$395.2 million and$424.1 million , respectively, were insured by bond insurers. The underlying ratings for insured municipal bonds have been factored into the average rating of the securities by the rating agencies with no significant disparity between the absolute bond ratings and the underlying credit ratings as ofDecember 31, 2022 and 2021. AtDecember 31, 2022 and 2021, respectively, 65.5% and 56.8% of the insured municipal securities, at fair value, most of which were investment grade, were insured by bond insurers that provide credit enhancement in addition to the ratings reflected by the financial strength of the underlying issuers. AtDecember 31, 2022 and 2021, the average rating of the Company's insured municipal securities was A+, which corresponded to the average rating of the investment grade bond insurers. The remaining 34.5% and 43.2% of insured municipal securities atDecember 31, 2022 and 2021, respectively, were insured by non-rated or below investment grade bond insurers that the Company believes did not provide credit enhancement. The modified duration of the municipal securities portfolio reflecting anticipated early calls was 3.6 years and 3.1 years atDecember 31, 2022 and 2021, respectively. The Company considers the strength of the underlying credit as a buffer against potential market value declines which may result from future rating downgrades of the bond insurers. In addition, the Company has a long-term time horizon for its municipal bond holdings, which generally allows it to recover the full principal amounts upon maturity and avoid forced sales prior to maturity of bonds that have declined in market value due to the bond insurers' rating downgrades. Based on the uncertainty surrounding the financial condition of these insurers, it is possible that there will be additional downgrades to below investment grade ratings by the rating agencies in the future, and such downgrades could impact the estimated fair value of those municipal bonds.
AtDecember 31, 2022 and 2021, respectively, the mortgage-backed securities portfolio of$166.3 million and$137.0 million , or 4.1% and 3.4% of the Company's fixed maturity securities portfolio, at fair value, was categorized as loans to "prime" residential and commercial real estate borrowers. The Company had holdings of$27.3 million and$25.2 million , at fair value, in commercial mortgage-backed securities atDecember 31, 2022 and 2021, respectively. The weighted-average rating of the entire mortgage backed securities portfolio was AA atDecember 31, 2022 and 2021. The modified duration of the mortgage-backed securities portfolio reflecting anticipated early calls was 7.3 years and 7.9 years atDecember 31, 2022 and 2021, respectively.
AtDecember 31, 2022 and 2021, respectively, the company had corporate securities of$569.6 million and$523.9 million , or 13.9% and 13.0% of its fixed maturity securities portfolio, at fair value. The weighted-average rating was A- and BBB+ atDecember 31, 2022 and 2021, respectively. The modified duration reflecting anticipated early calls was 3.1 years and 3.8 years atDecember 31, 2022 and 2021, respectively.
Collateralized Loan Obligations
AtDecember 31, 2022 and 2021, the Company had collateralized loan obligations of$320.3 million and$314.2 million , respectively, which represented 7.8% of its fixed maturity securities portfolio, at fair value, at each of those dates. The weighted-average rating was A+ and AA- atDecember 31, 2022 and 2021, respectively. The modified duration reflecting anticipated early calls was 4.6 years and 6.3 years atDecember 31, 2022 and 2021, respectively.
Other Asset-Backed Securities
The Company had other asset-backed securities of
million
portfolio, at fair value, at
weighted-average
45 --------------------------------------------------------------------------------
rating was A+ and AA- at
duration reflecting anticipated early calls was 3.1 years and 2.6 years at
Equity holdings of$699.6 million and$970.9 million , at fair value, as ofDecember 31, 2022 and 2021, respectively, consisted of preferred stocks, common stocks on which dividend income is partially tax-sheltered by the 50% corporate dividend received deduction, and private equity funds. The net (losses) gains due to changes in fair value of the Company's equity portfolio were$(185.7) million and$107.7 million in 2022 and 2021, respectively. The primary cause for the decrease in fair value of the Company's equity securities in 2022 was the overall decline in equity markets, and the primary cause for the increase in fair value of the Company's equity securities in 2021 was the overall improvement in equity markets. The Company's common stock allocation is intended to enhance the return of and provide diversification for the total portfolio. AtDecember 31, 2022 , 14.2% of the total investment portfolio, at fair value, was held in equity securities, compared to 18.9% atDecember 31, 2021 . The following table presents the equity security portfolio by industry sector atDecember 31, 2022 and 2021: December 31, 2022 2021 Cost Fair Value Cost Fair Value (Amounts in thousands) Equity securities: Basic materials$ 5,091 $ 5,597 $ 6,017 $ 7,766 Communications 23,035 22,824 29,906 35,458 Consumer, cyclical 39,289 53,261 63,596 100,364 Consumer, non-cyclical 48,869 62,534 61,366 78,911 Energy 87,205 103,949 67,816 68,065 Financial 105,568 105,964 116,921 160,002 Funds 172,897 125,428 173,634 168,947 Industrial 53,677 70,645 61,003 88,276 Technology 56,406 67,264 95,342 175,291 Utilities 76,806 82,086 78,935 87,859$ 668,843 $ 699,552 $ 754,536 $ 970,939 D. Debt
The Company's debt consists of the following:
December 31,
Lender Interest Rate Expiration 2022 2021
(Amounts in thousands)
Senior unsecured notes(1) Publicly traded 4.40% March 15, 2027 $ 375,000 $ 375,000
Bank of America,
Wells Fargo Term SOFR plus
Unsecured credit Bank, and U.S. 112.5-150.0 basis
facility(2) Bank points November 16, 2026 25,000 -
Total principal amount 400,000 375,000
Less unamortized discount
and debt issuance costs(3) 1,670 2,069
Total $ 398,330 $ 372,931
__________
(1) On March 8, 2017 , the Company completed a public debt offering issuing $375
million of senior notes. The notes are unsecured senior obligations of the
Company, with a 4.4% annual coupon payable on March 15 and September 15 of each
year commencing September 15, 2017 . These notes mature on March 15, 2027 . The
Company used the proceeds from the notes to pay off the total outstanding
balance of $320 million under the existing loan and credit facility agreements
and terminated the agreements on March 8, 2017 . The remainder of the proceeds
from the notes was used for general corporate
46
--------------------------------------------------------------------------------
purposes. The Company incurred debt issuance costs of approximately $3.4
million , inclusive of underwriters' fees. The notes were issued at a slight
discount of 99.847% of par, resulting in the effective annualized interest rate,
including debt issuance costs, of approximately 4.45%.
(2) On March 29, 2017 , the Company entered into an unsecured credit agreement
(the "2017 Credit Agreement") that provided for revolving loans of up to $50
million and was set to mature on March 29, 2022 . On March 31, 2021 , the Company
entered into an amended and restated credit agreement (the "Amended and Restated
Credit Agreement") that amended and restated the 2017 Credit Agreement. The
Amended and Restated Credit Agreement increased the aggregate commitments by all
the lenders to $75 million from $50 million under the 2017 Credit Agreement and
extended the maturity date of the loan that was the subject of the 2017 Credit
Agreement to March 31, 2026 . On November 18, 2022 , the Company entered into the
First Amendment to Amended and Restated Credit Agreement (the "First
Amendment"). The First Amendment extended the maturity date of the loan to
November 16, 2026 from March 31, 2026 with possible further extension if certain
conditions are met, increased the aggregate commitments by all the lenders to
$200 million from $75 million , and replaced the LIBOR with the term SOFR. The
interest rates on borrowings under the credit facility are based on the
Company's debt to total capital ratio and range from Term SOFR plus 112.5 basis
points when the ratio is under 20% to Term SOFR plus 150.0 basis points when the
ratio is greater than or equal to 30%. Commitment fees for the undrawn portions
of the credit facility range from 12.5 basis points when the ratio is under 20%
to 22.5 basis points when the ratio is greater than or equal to 30%. The debt to
total capital ratio is expressed as a percentage of (a) consolidated debt to (b)
consolidated shareholders' equity plus consolidated debt. The Company's debt to
total capital ratio was 20.8% at December 31, 2022 , resulting in a 15.0 basis
point commitment fee on the $175 million undrawn portion of the credit facility.
As of February 14, 2023 , a total of $25 million was drawn down under this
facility on a three-month revolving basis at an annual interest rate of
approximately 5.68%.
(3) The unamortized discount and debt issuance costs are associated with the
publicly traded $375 million senior unsecured notes. These are amortized to
interest expense over the life of the notes, and the unamortized balance is
presented in the Company's consolidated balance sheets as a direct deduction
from the carrying amount of the debt. The unamortized debt issuance cost of
approximately $0.9 million associated with the $200 million unsecured revolving
credit facility maturing on November 16, 2026 is included in other assets in the
Company's consolidated balance sheets and amortized to interest expense over the
term of the credit facility.
The Company was in compliance with all of its financial covenants pertaining to
minimum statutory surplus, debt to total capital ratio, and RBC ratio under the
unsecured credit facility at December 31, 2022 .
For a further discussion, see Note 8. Notes Payable, of the Notes to
Consolidated Financial Statements in "Item 8. Financial Statements and
Supplementary Data."
E. Uses of Capital Dividends Cash returned to shareholders through dividends in 2022, 2021 and 2020 totaled approximately$105.5 million ,$140.2 million and$139.6 million , respectively. OnFebruary 10, 2023 , the Board of Directors declared a$0.3175 quarterly dividend per share payable onMarch 29, 2023 to shareholders of record onMarch 15, 2023 , with an expected payout of approximately$18 million . The Company currently expects quarterly dividends to continue in future periods, although the declaration and amount of any future cash dividends are at the discretion and subject to the approval of its Board of Directors. The decisions of the Company's Board of Directors regarding the amount and payment of dividends will depend on many factors, such as its financial condition, results of operations, capital requirements, business conditions, debt service obligations, industry practice, legal requirements, regulatory constraints, and other factors that its Board of Directors may deem relevant. The Company expects to fund its future dividend payments primarily with a combination of cash expected to be generated from future operations and cash and short-term investments on hand.
For a further discussion, see Note 13. Dividends, of the Notes to Consolidated
Financial Statements in "Item 8. Financial Statements and Supplementary Data."
Capital Expenditures
The Company's capital expenditures were approximately$35.5 million ,$41.4 million and$40.0 million for 2022, 2021 and 2020, respectively, and they were primarily related to improving the Company's information technology infrastructure and corporate facilities. The Company expects the capital spending for 2023 to be at a level similar to that for 2022 and intends to use the capital to continue to invest in its technology assets and improve corporate facilities. The Company expects to fund its 47 --------------------------------------------------------------------------------
2023 capital expenditures primarily with a combination of cash expected to be
generated from future operations and cash and short-term investments on hand.
Contractual Obligations
The Company's material cash requirements include the following contractual
obligations at
Contractual Obligations
(4) Payments Due By Period
Total 2023 2024 2025 2026 2027 Thereafter
(Amounts in thousands)
Debt (including
interest)(1) $ 474,609 $ 41,859 $ 16,500 $ 16,500 $ 16,500 $ 383,250 $ -
Lease obligations(2) 30,223 12,227 7,952 5,316 3,443 1,146 139
Loss and loss adjustment
expense reserves(3) 2,584,910 1,551,264 474,087 237,340 144,328 74,478
103,413
Total contractual obligations$ 3,089,742 $ 1,605,350 $ 498,539 $ 259,156 $ 164,271 $ 458,874 $ 103,552 __________ (1)The Company's debt contains various terms, conditions and covenants which, if violated by the Company, would result in a default and could result in the acceleration of the Company's payment obligations. Amounts differ from the balances presented on the consolidated balance sheets as ofDecember 31, 2022 because the debt amounts above include interest, calculated at the stated 4.4% coupon rate, and exclude the discount and issuance costs of the debt. (2)The Company is obligated under various non-cancellable lease agreements providing for office space, automobiles, office equipment, and electronic data processing equipment that expire at various dates through the year 2028. Lease obligations include$3.6 million in lease commitments that have not yet commenced as ofDecember 31, 2022 . See Note 7. Leases, of the Notes to Consolidated Financial Statements in "Item 8. Financial Statements and Supplementary Data" for additional information on lease obligations. (3)Loss and loss adjustment expense reserves represents an estimate of amounts necessary to settle all outstanding claims, including IBNR as ofDecember 31, 2022 . The Company has estimated the timing of these payments based on its historical experience and expectation of future payment patterns. However, the timing of these payments may vary significantly from the amounts shown above. The ultimate cost of losses may vary materially from recorded amounts which are the Company's best estimates. For more detailed information on the Company's historical loss experience and payment patterns, see "Overview-C. Critical Accounting Estimates" in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations," as well as Note 12. Loss and Loss Adjustment Expense Reserves, of the Notes to Consolidated Financial Statements in "Item 8. Financial Statements and Supplementary Data." (4)The table excludes liabilities of$6.6 million related to uncertainty in tax settlements as the Company is unable to reasonably estimate the timing and amount of related future payments. The Company expects to meet these contractual obligations primarily with a combination of cash expected to be generated from future operations and cash and short-term investments on hand, except for the payment of the principal of the debt, which is expected to be made with a future borrowing.
F. Regulatory Capital Requirements
The Insurance Companies must comply with minimum capital requirements under applicable state laws and regulations. The RBC formula is used by insurance regulators to monitor capital and surplus levels. It was designed to capture the widely varying elements of risks undertaken by writers of different lines of insurance business 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 periodically monitors the RBC level of each of the Insurance Companies. As ofDecember 31, 2022 , 2021 and 2020, each of the Insurance Companies exceeded the minimum required RBC level, as determined by the NAIC and adopted by the state insurance regulators. None of the Insurance Companies' RBC ratios were less than 330% of the authorized control level RBC as ofDecember 31, 2022 , none less than 400% as ofDecember 31, 2021 , and none less than 350% as ofDecember 31, 2020 . Generally, an RBC ratio of 200% or less would require some form of regulatory or company action. Among other considerations, industry and regulatory guidelines suggest that the ratio of a property and casualty insurer's annual net premiums written to statutory policyholders' surplus should not exceed 3.0 to 1. Based on the combined surplus of all the Insurance Companies of$1.50 billion atDecember 31, 2022 and net premiums written in 2022 of$4.0 billion , the ratio of premiums written to surplus was 2.65 to 1. 48 -------------------------------------------------------------------------------- Insurance companies are required to file an Own Risk and Solvency Assessment ("ORSA") with the insurance regulators in their domiciliary states. The ORSA is required to cover, among many items, a company's risk management policies, the material risks to which the company is exposed, how the company measures, monitors, manages and mitigates material risks, and how much economic and regulatory capital is needed to continue to operate in a strong and healthy manner. The ORSA is intended to be used by state insurance regulators to evaluate the risk exposure and quality of the risk management processes within insurance companies to assist in conducting risk-focused financial examinations and for determining the overall financial condition of insurance companies. The Company filed its most recent ORSA Summary Report with the California DOI inNovember 2022 . Compliance with the ORSA requirements did not have a material impact on the Company's consolidated financial statements.
The DOI in each state in which the Company operates is responsible for
conducting periodic financial and market conduct examinations of the Insurance
Companies in their states. Market conduct examinations typically review
compliance with insurance statutes and regulations with respect to rating,
underwriting, claims handling, billing, and other practices.
The following table presents a summary of recent examinations:
State Exam Type Period Under Review Status
Coordinated
CA, FL, GA, Multi-state
IL, OK, TX Financial 2018-2021
Examination began in the second quarter of 2022.
Examination was completed in the third quarter of
CA Premium Tax 2018-2021 2022.
During the course of and at the conclusion of these examinations, the examining
DOI generally reports findings to the Company. The Company has not been notified
of any material findings related to the coordinated multi-state financial
examination that began in the second quarter of 2022, and no material findings
were reported at the completion of the California premium tax examination in the
third quarter of 2022.
49
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Greater Hartford has enough office space for lease to fill Westfarms mall five times. Here’s why that matters to average homeowners. [Hartford Courant]
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