As I wrote in prior articles, the insurance industry is one of those boring, stable sectors where leaders seem unshakeable. In short, it is a sector that could appeal to retirees in search of increasing dividends or younger investors looking for additional income. Mercury General Corporation (NYSE:MCY) appears to check all boxes:
- Aristocrat Dividend
- A dividend rate which oscillates around 5%
- Favorable position in the California auto insurance market.
On November 2, 2021, the company announced a 0.4% increase of its quarterly dividend. Nonetheless, this anemic dividend growth is the revealing example of Mercury's major business issue: a weak operating performance reflected in a high combined ratio.
Even though the insurer is a significant player in California, a dividend aristocrat that has held its title for decades, Mercury is a poor investment choice compared to other, more successful insurers that have created more value for their shareholders. Consequently, Mercury remains on my watchlist in the "Always No, Forever No" category.
Back to Pre-Covid Levels
In 2020, the insurance company benefited from COVID-19's consequences, like stay-at-home restrictions, reducing the road traffic, and impacting mechanically auto insurers' claims experience. While other insurers such as Cincinnati Financial (CINF) or CNA Financial (CNA) have seen the loss experience of certain insurance lines increase, the opposite has been confirmed for insurers mainly active in the automobile insurance market.
As a result of the drop in motor claim activity, States' insurance regulators required insurers to redistribute a portion of premiums already earned to their policyholders.
Although the pandemic is not yet over, people have lived with it, and the restrictions were reduced over the months in 2021. Consequently, the claims activity rose, and MCY's combined ratio deteriorated significantly in 2021.
As a reminder, the combined ratio measures the underwriting profitability for a property and casualty (P&C) insurer to gauge how well it is performing in its daily operations. The combined ratio is calculated by taking the sum of incurred losses and expenses and dividing them by the earned premiums.
The combined ratio is typically expressed as a percentage. A ratio below 100 percent indicates that the company is making an underwriting profit. In comparison, a ratio above 100 percent means that it is paying out more money in claims that it is receiving from premiums.
Mercury General used not to be the best-in-class U.S. motor insurer in terms of underwriting profitability.
The average combined ratio between 2010 and 2020 was 99.7% (99.4% for 2015-2020), knowing that the combined ratio in 2020 was meager.
Source: Annual Reports
This drastic decrease in the combined ratio was mainly due to the positive effects of COVID-19.
In other words, the improvement in the combined ratio was not linked to an intrinsic change in the business model but to external events, which some might call luck.
Nonetheless, the 9M2021 claims activity remained low, reflected in a combined ratio below 96%, although it deteriorated compared to 9M2020.
Source: 9M2021 Report
Based on the combined ratio recorded for the first nine months of 2021, it can be assumed that the FY2021 combined ratio is expected to be worse than that of 2020 but better than those recorded in previous years.
However, it might be interesting to compare Mercury's profitability with its peers'.
Over the same period, other auto insurers have posted many better-combined ratios. For example, Progressive (PGR) reported a combined ratio of 95.1% for its personal lines segment and 88.7% for its commercial lines segment.
Source: 9M2021 Report
Travelers, Inc. (TRV) reported a combined ratio of 91.3% for its private auto insurance division.
Source: 9M2021 Presentation
Mercury General struggles to convince investors of the viability of its model, at least from an underwriting perspective. The diversification operated on other segments and other states than California has not yet borne fruit.
Other insurers, such as Progressive, have either cut into their business or have established themselves in segments that would have allowed Mercury General to improve its profitability over the long term. Unfortunately, Mercury remains a low-tier insurer and can only rely on investment income to offset underwriting losses or boost profits when the insurance portfolio is profitable.
The dividend, Crick, look at the dividend
Mercury's enthusiasts - if they exist - will tell me the following: Mercury is a good pick with a dividend that has been growing for several decades.
Admittedly, Mercury is a dividend aristocrat. But dividend growth has been anemic for several years, with a tremendous 0.4% annual increase since 2012. So the paid dividend has gone from $2.44 per share in 2012 to $2.53 per share in 2021, a less than 4% increase in a decade.
Over the same period, Cincinnati Financial increased its dividend by 55% and Travelers by 95%.
This dividend increase did not come at the expense of the company's book value, as the book value per share of Travelers and Cincinnati Financial also increased in the same period by almost 86% and 137%, while Mercury's book value per share increased by only 14% in the same period.
In other words, Travelers Inc. and Cincinnati Financial shareholders have earned more money than Mercury shareholders over the past decade.
Always No, Forever No
Mercury General has failed to generate increasing profits year after year despite its position in the California market. This failure is linked to its poor technical profitability, lack of presence in a niche market, and late and weak diversification.
Investing in Mercury General is betting on a transformation that may never happen or happen too late. An insurer could be interested in Mercury because of its position on the Californian market and offer to acquire it. But this is a gamble rather than a sound investment for someone who would like to invest in Mercury.
As I have written in many articles, Mercury General is not the best choice for U.S. (and non-US) investors interested in investing in P&C insurers. The lack of value creation generated by the insurer should scare off any long-term investor. I'm not saying that some investors won't make "good moves" by buying and selling Mercury stocks at the right time. Some will get rich easily if they are intelligent and bold enough.
Unfortunately, this is not my case. I may have been bold - I still am, sometimes even a little too bold - but I am not brighter than others without a doubt. For me, Mercury General, as an investment, can be summed up in one sentence "Always No, Forever No."
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