Newswires
MERCURY GENERAL CORP – 10-Q – 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 the states where it 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, cybersecurity, regulatory and litigation risks. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as the result of new information, future events or otherwise. For a more detailed discussion of some of the foregoing risks and uncertainties, see the Company's Annual Report on Form 10-K filed with theSecurities and Exchange Commission onFebruary 14, 2023 . 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.
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
Quarterly Report on Form 10-Q.
B. Business
The Company is primarily engaged in writing personal automobile insurance
through 12 insurance subsidiaries ("Insurance Companies") in 11 states,
principally California . The Company also writes homeowners, commercial
automobile, commercial property, mechanical protection, and umbrella insurance.
The Company's insurance policies are mostly sold through independent agents who
receive a commission for selling policies. The Company believes that it has
thorough underwriting and claims handling processes that, together with its
agent relationships, provide the Company with competitive advantages.
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The following tables present direct premiums written, by state and line of
insurance business, for the three months ended
Three Months Ended
(Dollars in thousands)
Private Commercial
Passenger Automobile Homeowners Automobile Other Lines (2) Total
California $ 509,017 $ 173,130 $ 56,482 $ 59,265 $ 797,894 78.4 %
Texas 29,923 35,326 13,281 1,209 79,739 7.8 %
Other states (1) 95,366 33,120 10,227 2,215 140,928 13.8 %
Total $ 634,306 $ 241,576 $ 79,990 $ 62,689 $ 1,018,561 100.0 %
62.3 % 23.6 % 7.9 % 6.2 % 100.0 %
Three Months Ended
(Dollars in thousands)
Private Commercial
Passenger Automobile Homeowners Automobile Other Lines (2) Total
California $ 567,202 $ 160,704 $ 49,872 $ 51,328 $ 829,106 81.4 %
Texas 23,180 24,680 12,351 1,557 61,768 6.1 %
Other states (1) 90,906 24,871 9,350 2,232 127,359 12.5 %
Total $ 681,288 $ 210,255 $ 71,573 $ 55,117 $ 1,018,233 100.0 %
66.9 % 20.7 % 7.0 % 5.4 % 100.0 %
______________
(1) No individual state accounted for more than 5% of total direct premiums
written.
(2) No individual line of insurance business accounted for more than 5% of total
direct premiums written.
C. Regulatory and Legal Matters
The Department of Insurance ("DOI") in each state in which the Company operates is responsible for conducting periodic financial, market conduct, and rating and underwriting 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 and upcoming examinations:
State Exam Type Exam Period Covered Status
CA, FL, GA, Coordinated Multi-state
IL, OK, TX Financial 2018-2021 Received draft examination reports. During the course of and at the conclusion of the examinations, the examining DOI generally reports findings to the Company. No material findings were noted in the draft examination reports of the coordinated multi-state financial examination. InJanuary 2023 , the California DOI approved a 6.9% rate increase on the private passenger automobile line of insurance business forMercury Insurance Company ("MIC") andCalifornia Automobile Insurance Company ("CAIC"), consolidated subsidiaries of the Company. The private passenger automobile line of insurance business of MIC and CAIC represented approximately 50% and 4%, respectively, of the Company's total net premiums earned for the three months endedMarch 31, 2023 . These rate increases became effective inMarch 2023 . The Company filed an additional 6.99% rate increase with the California DOI on the private passenger automobile line of insurance business for MIC and CAIC inMarch 2023 . InMarch 2023 , California DOI approved a 12.6% rate increase on theCalifornia homeowners line of insurance business, which represented approximately 17% of the Company's total net premiums earned for the three months endedMarch 31, 2023 . This rate increase becomes effective inMay 2023 . 25
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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 the Company's Annual Report on Form 10-K for the year endedDecember 31, 2022 . The Company establishes reserves 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 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. In all cases, the Company vigorously defends itself unless a reasonable settlement appears appropriate. For a discussion of any additional regulatory or legal matters, see the Company's Annual Report on Form 10-K for the year endedDecember 31, 2022 , and Note 12. Contingencies of the Notes to Consolidated Financial Statements of this Quarterly Report.
D. 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 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
reviewing 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 under
statutory accounting principles as required by state regulation. 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 will generally analyze 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 reasonable basis for evaluating ultimate losses, particularly
in the Company's larger, more established lines of
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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 provide 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. AtMarch 31, 2023 andDecember 31, 2022 , the Company recorded its point estimate of approximately$2.68 billion and$2.58 billion ($2.65 billion and$2.56 billion , net of reinsurance), respectively, in loss reserves, which included approximately$1.52 billion and$1.45 billion ($1.51 billion and$1.45 billion , net of reinsurance), respectively, of incurred but not reported loss reserves ("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 toMarch 31, 2023 andDecember 31, 2022 , and estimated future payments for reopened claims. Management believes that the liability for loss reserves 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 a further discussion of the Company's reserving methods, see the Company's
Annual Report on Form 10-K for the year ended
RESULTS OF OPERATIONS
Three Months Ended
Revenues
Net premiums earned increased 4.4% and net premiums written decreased 0.1% for the three months endedMarch 31, 2023 , from the corresponding period in 2022. The increase in net premiums earned was primarily due to increases in the number of policies written outside ofCalifornia 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 contributed to the decrease in net premiums written for the three months endedMarch 31, 2023 compared to the same period in 2022. Net premiums earned included ceded premiums earned of$23.2 million and$17.5 million for the three months endedMarch 31, 2023 and 2022, respectively. Net premiums written included ceded premiums written of$23.4 million and$17.6 million for the three months endedMarch 31, 2023 and 2022, respectively. The increases in ceded premiums earned and ceded premiums written resulted mostly from higher reinsurance coverage and rates and growth in the covered book of business. 27 -------------------------------------------------------------------------------- Table of Contents Net premiums earned, a GAAP measure, represents the portion of net premiums written that is recognized as revenue in the financial statements for the periods presented and earned on a pro-rata basis over the term of the policies. Net premiums written is a non-GAAP financial measure which represents the premiums charged on policies issued during a fiscal period, net of any applicable reinsurance. Net premiums written is a statutory measure designed to determine production levels. The following is a reconciliation of net premiums earned to net premiums written: Three Months Ended March 31, 2023 2022 (Amounts in thousands) Net premiums earned$ 1,004,704 $ 962,550
Change in net unearned premiums 5,498
48,248
Net premiums written $ 1,010,202 $ 1,010,798
Expenses
Loss and expense ratios are used to interpret the underwriting experience of
property and casualty insurance companies. The following table presents the
Insurance Companies' loss, expense, and combined ratios determined in accordance
with GAAP:
Three Months Ended March 31,
2023 2022
Loss ratio 92.5 % 85.4 %
Expense ratio 23.3 % 24.1 %
Combined ratio 115.8 % 109.5 %
Loss ratio is calculated by dividing losses and loss adjustment expenses by net
premiums earned. The loss ratio for the first quarter of 2023 and 2022 was
affected by favorable development of approximately $15 million and unfavorable
development of approximately $53 million , respectively, on prior accident years'
loss and loss adjustment expense reserves. The favorable development for the
first quarter of 2023 was primarily attributable to lower than estimated losses
and loss adjustment expenses in the homeowners line of insurance business. The
unfavorable development for the first quarter of 2022 was primarily attributable
to higher than estimated losses and loss adjustment expenses in the automobile
and commercial property lines of insurance business.
The 2023 loss ratio was negatively impacted by approximately $98 million of
catastrophe losses, primarily due to winter storms and rainstorms in California ,
Texas and Oklahoma . There was no development on prior years' catastrophe losses
for the three months ended March 31, 2023 . The 2022 loss ratio was negatively
impacted by approximately $21 million of catastrophe losses, excluding
unfavorable development of approximately $1 million on prior years' catastrophe
losses, primarily due to winter storms in Texas and California .
Excluding the effects of estimated prior periods' loss development and
catastrophe losses, the loss ratio was 84.3% and 77.7% for the first quarter of
2023 and 2022, respectively. The increase in the loss ratio was primarily due to
an increase in loss severity in the automobile line of insurance business. The
U.S. inflation rate accelerated to its highest level in decades in 2022, and had
a significant impact on the cost of auto parts and labor as well as medical
expenses for bodily injuries. Bodily injury costs were also under pressure from
social inflation. The inflationary pressures continued to negatively impact loss
severity in the automobile line of insurance business and increased losses and
loss adjustment expenses for the insured events of the current accident year for
the three months ended March 31, 2023 compared to the corresponding period in
2022. The Company has increased rates and filed for additional 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 expense ratio for the three
months ended March 31, 2023 decreased compared to the corresponding period in
2022, 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, and a combined ratio over 100% generally reflects
unprofitable underwriting results.
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Income tax benefit was$16.8 million and$56.2 million for the three months endedMarch 31, 2023 and 2022, respectively. The decrease in income tax benefit was primarily due to a$191.1 million decrease in total pre-tax loss. The Company's effective income tax rate can be affected by several factors. These generally relate to large changes in the composition of fully taxable income, including net realized investment gains or losses, tax-exempt investment income, non-deductible expenses, and periodically, non-routine tax items such as adjustments to unrecognized tax benefits related to tax uncertainties. Income tax benefit of$16.8 million on pre-tax loss of$62.1 million , including tax-exempt investment income of$22.0 million , resulted in an effective tax rate of 27.0%, above the statutory tax rate of 21%, for the three months endedMarch 31, 2023 , and income tax benefit of$56.2 million on pre-tax loss of$253.1 million , including tax-exempt investment income of$17.2 million , resulted in an effective tax rate of 22.2% for the corresponding period in 2022.
Investments
The following table presents the investment results of the Company:
Three Months Ended March 31,
2023 2022
(Dollars in thousands)
Average invested assets at cost (1)
Net investment income (2)
Before income taxes$ 51,973 $
35,351
After income taxes$ 44,795 $
30,921
Average annual yield on investments (2)
Before income taxes 4.1 % 2.9 %
After income taxes 3.6 % 2.5 %
Net realized investment gains (losses)
__________
(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) Higher net investment income before and after income taxes for the three months endedMarch 31, 2023 compared to the corresponding period in 2022 resulted largely from higher average yield combined with higher average invested assets. Average annual yield on investments before and after income taxes for the three months endedMarch 31, 2023 increased compared to the corresponding period in 2022, 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 or losses included in net loss: Three Months EndedMarch 31, 2023 Gains
(Losses) Recognized in Net Income
Changes in
Sales fair value Total
(Amounts in thousands)
Net realized investment gains (losses)
Fixed maturity securities (1)(2) $ (891) $ 39,776 $ 38,885
Equity securities (1)(3) 5,621 3,240 8,861
Short-term investments (1) - 34 34
Options sold 1,457 (229) 1,228
Total $ 6,187 $ 42,821 $ 49,008
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Three Months Ended
Gains
(Losses) Recognized in Net Income
Changes in fair
Sales value Total
(Amounts in thousands)
Net realized investment gains (losses)
Fixed maturity securities (1)(2) $ (2,800) $ (157,929) $ (160,729)
Equity securities (1)(3) 5,562 (40,321) (34,759)
Short-term investments (1) (825) 2 (823)
Options sold 1,307 (82) 1,225
Total $ 3,244 $ (198,330) $ (195,086)
__________
(1)The changes in fair value of the investment portfolio resulted from
application of the fair value option.
(2)The increases in fair value of fixed maturity securities for the first
quarter of 2023 primarily resulted from decreases in market interest rates. The
decreases in fair value of fixed maturity securities for the first quarter of
2022 primarily resulted from increases in market interest rates.
(3)The primary cause for the increases in fair value of equity securities for
the first quarter of 2023 was the overall improvement in equity markets. The
primary cause for the decreases in fair value of equity securities for the first
quarter of 2022 was the overall decline in equity markets.
Net Income (Loss)
Three Months Ended March 31,
2023 2022
(Amounts in thousands, except per share
data)
Net loss $ (45,288) $ (196,917)
Basic average shares outstanding 55,371 55,371
Diluted average shares outstanding 55,371 55,371
Basic Per Share Data:
Net loss $ (0.82) $ (3.56)
Net realized investment gains (losses), net of tax $ 0.70 $ (2.78)
Diluted Per Share Data:
Net loss $ (0.82) $ (3.56)
Net realized investment gains (losses), net of tax $ 0.70 $ (2.78)
LIQUIDITY AND CAPITAL RESOURCES
A. Cash Flows
The Company has generated positive cash flow from operations since the public
offering of its common stock in November 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 $417.2 million as well as $125 million of undrawn credit under
its unsecured credit facility at March 31, 2023 , 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.
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Net cash provided by operating activities for the three months endedMarch 31, 2023 was$18.2 million , a decrease of$88.4 million compared to the corresponding period in 2022. The decrease was primarily due to increases in payments for losses and loss adjustment expenses, partially offset by an increase in premium collections and an increase in investment income received. The Company utilized the cash provided by operating activities during the three months endedMarch 31, 2023 primarily for the net purchases of investment securities and payment of dividends to its shareholders. The following table presents the estimated fair value of fixed maturity securities atMarch 31, 2023 by contractual maturity in the next five years:Fixed Maturity Securities (Amounts in thousands) Due in one year or less $
131,354
Due after one year through two years
296,345
Due after two years through three years
156,907
Due after three years through four years
262,532
Due after four years through five years
287,637
Total due within five years $ 1,134,775
B. Reinsurance
For
exposure from earthquakes by placing earthquake risks directly with the
catastrophe exposure to fires following an earthquake.
The Company is the assuming reinsurer under a Catastrophe Participation Reinsurance Contract (the "Contract") effective throughDecember 31, 2025 . The Company reimburses a group of affiliates of a ceding company for a proportional share of a portfolio of catastrophe losses based on the premiums ceded to the Company under the Contract, to the extent the actual loss ratio exceeds the threshold loss ratio of 73.5%. The total assumed premium under the Contract is$15.0 million for each of the 12 month periods endingDecember 31, 2023 through 2025 and$10.0 million for the 12 months endedDecember 31, 2022 . The total possible amount of losses for the Company under the Contract is$30.0 million for each of the 12 month periods endingDecember 31, 2023 through 2025 and$25.0 million for the 12 months endedDecember 31, 2022 . The Company recognized$3.8 million and$2.5 million in earned premiums and$2.7 million and$2.4 million in incurred losses under the Contract for the three months endedMarch 31, 2023 and 2022, respectively. The Company is the ceding party to a Catastrophe Reinsurance Treaty (the "Treaty") covering a wide range of perils that is effective throughJune 30, 2023 . For the 12 months endingJune 30, 2023 and 2022, the Treaty provides approximately$936 million and$792 million of coverage, respectively, on a per occurrence basis after covered catastrophe losses exceed the Company retention limit of$60 million and$40 million , respectively. The Treaty specifically excludes coverage for anyFlorida business and forCalifornia earthquake losses on fixed property policies such as homeowners, but does cover losses from fires following an earthquake. The Treaty includes additional restrictions as noted in the tables below.
Coverage on individual catastrophes provided for the 12 months ending
2023
Catastrophe Losses and LAE
Percentage of
In Excess of Up to Coverage
(Amounts in millions)
Retained $ - $ 60 - %
Layer of Coverage 60 100 19.5
Layer of Coverage 100 200 98.8
Layer of Coverage (1) 200 530 98.6
Layer of Coverage (2) (3) (4) 530 930 100.0
Layer of Coverage 930 1,035 98.9
__________
(1) 5% of this layer covers
31 -------------------------------------------------------------------------------- Table of Contents (2) 33% of this layer coversCalifornia ,Arizona andNevada only. (3) Layer of Coverage represents multiple actual treaty layers that are grouped for presentation purposes. (4) 6.3% of this layer covers onlyCalifornia wildfires and fires following an earthquake inCalifornia , and is not subject to reinstatement.
Coverage on individual catastrophes provided for the 12 months ended
2022
Catastrophe Losses and LAE
Percentage of
In Excess of Up to Coverage
(Amounts in millions)
Retained $ - $ 40 - %
Layer of Coverage 40 100 70
Layer of Coverage (1) (2) 100 450 100
Layer of Coverage (1) (3) (4) (5) 450 850 100
__________
(1) Layer of Coverage represents multiple actual treaty layers that are grouped for presentation purposes. (2) 4.1% of this layer excludesTexas . (3) 11.9% of this layer excludesTexas . (4) 15.0% of this layer coversCalifornia ,Arizona andNevada only. (5) 12.7% of this layer covers onlyCalifornia wildfires and fires following an earthquake inCalifornia , and is not subject to reinstatement.
The table below presents the combined total reinsurance premiums under the
Treaty (annual premiums and reinstatement premiums) for the 12 months ending
Annual Premium Reinstatement Premium Total Combined
Treaty (1) (2) Premium (2)
(Amounts in millions)
For the 12 months ending June 30, 2023 $ 74 $ - $ 74
For the 12 months ended June 30, 2022 $ 55 $ - $ 55
__________
(1) The increase in the annual premium is primarily due to an increase in reinsurance coverage and rates and growth in the covered book of business. (2) The reinstatement premium and the total combined premium for the treaty period endingJune 30, 2023 are projected amounts to be paid based on the assumption that there will be no reinstatements occurring during this treaty period. The reinstatement premium for the treaty period endedJune 30, 2022 is zero, as there were no actual reinstatement premiums paid. The Treaty endingJune 30, 2023 and 2022 each provides for one full reinstatement of coverage limits. Reinstatement premiums are based on the amount of reinsurance benefits used by the Company at 100% of the annual premium rate, with the exception of the reinstatement restrictions noted in the tables above, up to the maximum reinstatement premium of approximately$72 million and$51 million if the full amount of benefit is used for the 12 months endingJune 30, 2023 and 2022, respectively. The total amount of reinstatement premiums is recorded as ceded reinstatement premiums written at the time of the catastrophe event based on the total amount of reinsurance benefits expected to be used for the event, and such reinstatement premiums are recognized ratably over the remaining term of the Treaty as ceded reinstatement premiums earned. The catastrophe events that occurred in 2023 caused approximately$98 million in losses to the Company, resulting primarily from winter storms and rainstorms inCalifornia ,Texas andOklahoma . No reinsurance benefits were available under the Treaty for these losses as none of the 2023 catastrophe events individually resulted in losses in excess of the Company's per-occurrence retention limit of$60 million under the Treaty for the 12 months endingJune 30, 2023 . The catastrophe events that occurred in 2022 caused approximately$105 million in losses to the Company as ofMarch 31, 2023 , resulting primarily 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 . No reinsurance benefits were 32 -------------------------------------------------------------------------------- Table of Contents available under the Treaty for these losses as none of the 2022 catastrophe events individually resulted in losses in excess of the Company's per-occurrence retention limit of$60 million and$40 million under the Treaty for the 12 months endingJune 30, 2023 and 2022, respectively. The Company carries a commercial umbrella reinsurance treaty and a per-risk property reinsurance treaty, and seeks facultative arrangements for large property risks. In addition, the Company has other reinsurance in force that is not material to the consolidated financial statements. If any reinsurers are unable to perform their obligations under a reinsurance treaty, the Company will be required, as primary insurer, to discharge all obligations to its policyholders in their entirety.
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.
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 and agencies $ 166,375 $ 166,118
Municipal securities 2,772,972 2,746,066
Mortgage-backed securities 181,210 163,591
Corporate securities 636,607 602,895
Collateralized loan obligations 367,262 355,905
Other asset-backed securities 116,364 107,512
4,240,790 4,142,087
Equity securities:
Common stock 445,201
542,377
Non-redeemable preferred stock 64,860
49,834
Private equity funds measured at net asset value (2) 142,096
93,894
652,157 686,105
Short-term investments 147,797 146,840
Total investments $ 5,040,744 $ 4,975,032
______________
(1) Fixed maturities and short-term bonds at amortized cost; equities and other
short-term investments at cost.
(2) The fair value is measured using the NAV practical expedient. See Note 5.
Fair Value Measurements of the Notes to Consolidated Financial Statements for
additional information.
At March 31, 2023 , 49.1% of the Company's total investment portfolio at fair
value and 59.0% of its total fixed maturity securities at fair value were
invested in tax-exempt state and municipal bonds. Equity holdings consist of
non-redeemable 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 March 31, 2023 , 71.8% of
short-term investments consisted of highly rated short-duration securities
redeemable on a daily or weekly basis.
33
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Fixed Maturity Securities and Short-Term Investments
Fixed maturity securities include debt securities, which are mostly long-term
bonds and other debt with maturities of at least one year from purchase, and
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 instruments
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.
The following table presents the maturities and durations of the Company's fixed
maturity securities and short-term investments:
March 31, 2023 December 31, 2022
(in years)
Fixed Maturity Securities
Nominal average maturity:
excluding short-term investments 12.2 12.4
including short-term investments 11.8 12.0
Call-adjusted average maturity:
excluding short-term investments 4.2 4.9
including short-term investments 4.0 4.8
Modified duration reflecting anticipated early calls:
excluding short-term investments
3.5 3.6 including short-term investments 3.3 3.5 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, atMarch 31, 2023 , consistent with the average rating atDecember 31, 2022 . The Company's municipal bond holdings, of which 89.0% were tax exempt, represented 59.0% of its fixed maturity securities portfolio atMarch 31, 2023 , at fair value, and are broadly diversified geographically. See Part I-Item 3. Quantitative and Qualitative Disclosures About Market Risks for a breakdown of municipal bond holdings by state. To calculate the weighted-average credit quality ratings disclosed throughout this Quarterly Report on Form 10-Q, individual securities were weighted based on fair value and credit quality ratings assigned by nationally recognized securities rating organizations. Taxable holdings consist principally of investment grade issues. AtMarch 31, 2023 , fixed maturity securities holdings rated below investment grade and non-rated bonds totaled$10.5 million and$32.1 million , respectively, at fair value, and represented 0.3% and 0.8%, 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, 2022 , fixed maturity securities 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 overall credit ratings for the Company's fixed maturity securities portfolio were relatively stable during the three months endedMarch 31, 2023 , with 86.6% of fixed maturity securities at fair value experiencing no change in their overall 34
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rating. 11.0% and 2.4% of fixed maturity securities at fair value experienced upgrades and downgrades, respectively, during the three months endedMarch 31, 2023 .
The following table presents the credit quality ratings of the Company's fixed
maturity securities by security type at fair value:
March 31, 2023
(Dollars in thousands)
Total Fair
Security Type AAA(1) AA(1) A(1) BBB(1) Non-Rated/Other(1) Value(1)
U.S. government bonds and agencies:
Agencies $ 48,103 $ - $ - $ - $ - $ 48,103
Treasuries 118,015 - - - - 118,015
Total 166,118 - - - - 166,118
100.0 % - % - % - % - % 100.0 %
Municipal securities:
Insured 25,793 256,035 70,997 28,116 8,936 389,877
Uninsured 81,885 720,177 1,368,976 155,749 29,402 2,356,189
Total 107,678 976,212 1,439,973 183,865 38,338 2,746,066
3.9 % 35.5 % 52.5 % 6.7 % 1.4 % 100.0 %
Mortgage-backed securities:
Commercial 16,874 5,276 4,749 - - 26,899
Agencies 5,317 - - - - 5,317
Non-agencies:
Prime 21,120 90,137 18,450 - 391 130,098
Alt-A - 459 - 139 679 1,277
Total 43,311 95,872 23,199 139 1,070 163,591
26.5 % 58.5 % 14.2 % 0.1 % 0.7 % 100.0 %
Corporate securities:
Communications - 168 - 6,446 - 6,614
Consumer, cyclical - 1,853 - 40,195 - 42,048
Consumer, non-cyclical - - 18,203 8,518 - 26,721
Energy - 6,890 3,456 32,528 - 42,874
Financial - 20,524 192,917 55,629 3,200 272,270
Industrial - 62,100 83,318 47,241 - 192,659
Technology - - - 718 - 718
Utilities - - 9,084 9,907 - 18,991
Total - 91,535 306,978 201,182 3,200 602,895
- % 15.2 % 50.9 % 33.4 % 0.5 % 100.0 %
Collateralized loan obligations:
Corporate 52,359 73,957 229,589 - - 355,905
Total 52,359 73,957 229,589 - - 355,905
14.7 % 20.8 % 64.5 % - % - % 100.0 %
Other asset-backed securities 7,793 - 65,391 34,328 - 107,512
7.2 % - % 60.9 % 31.9 % - % 100.0 %
Total $ 377,259 $ 1,237,576 $ 2,065,130 $ 419,514 $ 42,608
$ 4,142,087 9.1 % 29.9 % 49.9 % 10.1 % 1.0 % 100.0 % _____________
(1)Intermediate ratings are included at each level (e.g., AA includes AA+, AA
and AA-).
35
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U.S. Government Bonds and Agencies
The Company had $166.1 million and $158.6 million , or 4.0% and 3.9% of its fixed
maturity securities portfolio, at fair value, in U.S. government bonds and
agencies at March 31, 2023 and December 31, 2022 , respectively. At March 31,
2023 , Moody's and Fitch ratings for U.S. government-issued debt were Aaa and
AAA , 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 on U.S. government debt as a risk-free rate and
have continued to invest in U.S. Treasury securities. The modified duration of
the U.S. government bonds and agencies portfolio reflecting anticipated early
calls was 1.3 years and 1.4 years at March 31, 2023 and December 31, 2022 ,
respectively.
The Company had$2.75 billion and$2.74 billion , or 66.3% and 67.0% of its fixed maturity securities portfolio, at fair value, in municipal securities,$389.9 million and$395.2 million of which were insured, atMarch 31, 2023 andDecember 31, 2022 , respectively. 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 securities ratings and the underlying credit ratings as ofMarch 31, 2023 andDecember 31, 2022 . AtMarch 31, 2023 andDecember 31, 2022 , 68.2% and 65.5%, respectively, of the insured municipal securities, at fair value, most of which were investment grade, were insured by bond insurers that provide credit enhancement and ratings reflecting the credit of the underlying issuers. AtMarch 31, 2023 andDecember 31, 2022 , 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 31.8% and 34.5% of insured municipal securities atMarch 31, 2023 andDecember 31, 2022 , respectively, were non-rated or below investment grade, and were insured by bond insurers that the Company believes did not provide credit enhancement. The modified duration of the municipal securities portfolio reflecting anticipated early calls was 3.3 years and 3.6 years atMarch 31, 2023 andDecember 31, 2022 , 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 future downgrades to below investment grade ratings by the rating agencies in the future, and such downgrades could impact the estimated fair value of municipal bonds.
AtMarch 31, 2023 andDecember 31, 2022 , substantially all of the mortgage-backed securities portfolio of$163.6 million and$166.3 million , or 3.9% and 4.1%, respectively, 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$26.9 million and$27.3 million at fair value ($27.9 million and$28.4 million at amortized cost) in commercial mortgage-backed securities atMarch 31, 2023 andDecember 31, 2022 , respectively. The weighted-average rating of the entire mortgage-backed securities portfolio was AA at each ofMarch 31, 2023 andDecember 31, 2022 . The modified duration of the mortgage-backed securities portfolio reflecting anticipated early calls was 10.7 years and 7.3 years atMarch 31, 2023 andDecember 31, 2022 , respectively.
Corporate securities included in fixed maturity securities were as follows:
March
31, 2023
(Dollars in thousands)
Corporate securities at fair value $ 602,895 $ 569,553
Percentage of total fixed maturity securities portfolio 14.6 % 13.9 %
Modified duration 3.0 years 3.1 years
Weighted-average rating A- A-
36
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Collateralized Loan Obligations
Collateralized loan obligations included in fixed maturity securities were as
follows:
March 31, 2023 December 31, 2022
(Dollars in thousands)
Collateralized loan obligations at fair value $ 355,905 $ 320,252
Percentage of total fixed maturity securities portfolio 8.6 % 7.8 %
Modified duration 4.1 years 4.6 years
Weighted-average rating A+ A+
Other Asset-Backed Securities
Other asset-backed securities included in fixed maturity securities were as
follows:
March 31, 2023 December 31, 2022
(Dollars in thousands)
Other asset-backed securities at fair value $ 107,512 $ 136,456
Percentage of total fixed maturity securities portfolio 2.6 % 3.3 %
Modified duration 2.9 years 3.1 years
Weighted-average rating A A+
Equity Securities
Equity holdings of $686.1 million and $699.6 million at fair value, as of
March 31, 2023 and December 31, 2022 , respectively, consisted of non-redeemable
preferred stocks, common stocks on which dividend income is partially
tax-sheltered by the 50% corporate dividend received deduction, and private
equity funds. The Company had a net gain (loss) of $3.2 million and $(40.3)
million due to changes in fair value of the Company's equity securities
portfolio for the three months ended March 31, 2023 and 2022, respectively. The
primary cause for the increase in fair value of the Company's equity securities
portfolio for the three months ended March 31, 2023 was the overall improvement
in equity markets. The primary cause for the decrease in fair value of the
Company's equity securities portfolio for the three months ended March 31, 2022
was the overall decline in equity markets.
The Company's common stock allocation is intended to enhance the return of and
provide diversification for the total portfolio. At March 31, 2023 , 13.8% of the
total investment portfolio at fair value was held in equity securities, compared
to 14.2% at December 31, 2022 .
D. Debt
OnMarch 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 onMarch 15 andSeptember 15 of each year commencingSeptember 15, 2017 . The notes mature onMarch 15, 2027 . The Company used the proceeds from the notes to pay off amounts outstanding under the existing loan and credit facilities and for general corporate 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%. OnMarch 31, 2021 , the Company entered into an unsecured$75 million five-year revolving credit facility. OnNovember 18, 2022 , the Company entered into the First Amendment to this credit facility. The First Amendment extended the maturity date of the loan toNovember 16, 2026 fromMarch 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 23.6% atMarch 31, 2023 , resulting in a 15.0 basis point commitment fee on the$125 million undrawn portion of the credit facility. As ofApril 27, 2023 , a total of$75 million was drawn under this facility on a 37 -------------------------------------------------------------------------------- Table of Contents three-month revolving basis at an annual interest rate of approximately 6.28%. The Company contributed$50 million of the total amount drawn to the surplus of one of its consolidated insurance subsidiaries in the first quarter of 2023, and used the remainder for general corporate purposes. The Company was in compliance with all of the financial covenants pertaining to minimum statutory surplus, debt to total capital ratio, and risk based capital ratio under the unsecured credit facility atMarch 31, 2023 .
For additional information on debt, see Note 11. Notes Payable of the Notes to
Consolidated Financial Statements.
E. Regulatory Capital Requirements
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$1.47 billion atMarch 31, 2023 , and net premiums written of$3.98 billion for the twelve months ended on that date, the ratio of net premiums written to surplus was 2.70 to 1 atMarch 31, 2023 .
LINCOLN NATIONAL CORP FILES (8-K) Disclosing Results of Operations and Financial Condition, Regulation FD Disclosure, Other Events, Financial Statements and Exhibits
Greenlight Capital Re, Ltd. Schedules First Quarter 2023 Financial Results and Conference Call
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