If you want a little alone time at a cocktail party, broach the subject of insurance with your fellow revelers. Unless they are insurance agents or brokers, I guarantee you'll find yourself relegated to a dark corner in short order.



Insurance, though tedious in a social setting, can be potentially profitable in an investment setting, even in its most pedestrian incarnation -- automobile insurance. The key is execution, and few automobile insurers execute better than Mercury General (NYSE: MCY).

Mercury General peddles its automobile insurance through a network of 4,900 independent agents and brokers. During 2005, private, passenger automobile insurance accounted for 85.5% of the company's total gross-premiums, with commercial automobile insurance accounting for another 4.5%.

The percentage of gross automobile-insurance-premiums written, by state, is 72.0% in California, 9.0% in Florida, 8.0% in New Jersey, 4.0% in Texas and 7.0 % in all others. (Wondering about your own coverage? Check out Fifteen Insurance Policies You Don't Need.)

Growing Pains
Until recently, California represented an even higher percentage of Mercury General's revenue stream. The company is embarking on an aggressive countrywide expansion plan, which unfortunately, is still a work in progress, as witnessed by the degradation of its combined ratio. In 2006, non-California operations posted a 108.3% combined ratio -- 18 points worse than the California segment's 90.3% combined ratio.

Management has identified Florida and New Jersey as particularly tough markets, which forced the company to increase reserves for larger potential individual, bodily and personal injury losses. Exacerbating matters in these states is increased competition from Berkshire Hathaway's (NYSE: BRK.A) GEICO and Progressive (NYSE: PGR).

Dull Can Be Profitable
Despite recent stumbles, many of Mercury General's financial numbers continue to improve. For 2006, net written premium increased 3.2% to $3.04 billion, led by a 5.8% increase in automobile premiums in California. Revenue growth was further enhanced by a 23.2% increase in net investment income to $151.09 million. For the year, Mercury General's operations generated a 12.46% return-on-equity (ROE), which is higher than most of its insurance-industry peers.

Earnings, though, were the exception, dropping to $214.8 million, or $3.92 a share, in 2006, compared to $253.3 million, or $4.63 a share, in 2005.

Expect EPS to improve for 2007 and beyond as Mercury General regains its footing. Management believes its underwriting process trumps its competitors'. Indeed, its underwriting process and agent relationship are proven competitive advantages, allowing Mercury General to charge lower prices yet realize better margins.




New Markets, New Opportunities
To further strengthen this competitive advantage, Mercury General is implementing a new-generation computer system to replace its existing underwriting claims legacy system. The new technology will enable the company to enter new states more rapidly, as well as respond to legislative and regulatory changes more easily. The investment is expected to boost revenue growth later this year.

If the past is indeed prologue, Mercury General should prove to be a formidable competitor in its new territories, gradually improving results as it gains more experience and scale (its long-term target is a 95% combined ratio), though management admits it will take time. While you're waiting, you're compensated with a well-funded $2.08 annual dividend which has grown at an average annual rate of 12% over the past decade.

Insurance can be a less-than-engaging topic for general discussion, to be sure, but for investors interested in the sector, Mercury General is a very alluring subject.

Looking to cook up a market-stomping stock portfolio? Check out our FREE report "7 Ingredients to Market Beating Stocks" and get started right now!



Filed Under:
Tickers in this Article: MCY, BRK.A, BRK.B, PGR

comments powered by Disqus

Trading Center