Jul 30, 2012
Executives
Gabriel Tirador - President and Chief Executive Officer George Joseph - Chairman Ted Stalick - Vice President and Chief Financial Officer Chris Graves - Vice President and Chief Investment Officer Robert Houlihan - Vice President and Chief Product Officer John Sutton - Senior Vice President of Customer Service
Analysts
Meyer Shields - Stifel Nicolaus Alison Jacobowitz - Bank of America Ron Bobman - Capital Returns
Operator
Good morning, my name is Regina and I will be your conference operator today. At this time I would like to welcome everyone to the Mercury General Corporation Second Quarter Results Conference Call.
All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session.
(Operating Instructions) This conference call may contain comments and forward-looking statements based on current plans, expectations, events, and financial and industry trends which may affect Mercury General's future operating results and financial position. Such statements involve risks and uncertainties which cannot be predicted or quantified and which may cause future activities and results of operation to differ materially from those discussed here today.
I would now like to turn the call over to Mr. Gabriel Tirador.
Sir, please go ahead.
Gabriel Tirador
Thank you very much. I would like to welcome everyone to Mercury's second quarter conference call.
I am Gabe Tirador, President and CEO. In the room with me is Mr.
George Joseph, Chairman; Ted Stalick, Vice President and CFO; Chris Graves, Vice President and Chief Investment Officer; John Sutton, Senior Vice President of Customer Service; and Robert Houlihan, Vice President and Chief Product Officer. Before we take questions, we will make a few comments regarding the quarter.
Our second quarter results were negatively impacted by unfavorable reserve development, severe weather outside of California and a general increase in severity trends. Our combined ratio was 104.5% in the second quarter of 2012 compared to 98% in the second quarter of 2011.
We recorded $23 million of unfavorable reserve development on prior accident years in the quarter and $29 million for the first quarter of 2012. Most of the development came from California’s bodily injury coverage.
Losses for the most recent accident years for California bodily injury developed at a rate quite a bit higher than historical averages. Accordingly, we felt it was prudent to weigh the more recent trends more heavily and increase our estimate for future loss development.
This had the effect of increasing our severity takes for the most recent accident years. Outside of California, catastrophe losses were approximately $8 million in the quarter, primarily as a result or severe Midwestern storms.
Excluding the impact of reserve development and catastrophe losses, the combined ratio was 99.6% in the second quarter of 2012 and 98.2% for the first six months of 2012. In California we have a 6% private passenger auto rate increase pending with the California Department of Insurance.
We expect to have final resolution of the pending auto rate filing within the next month or so. Our hearing on our California homeowner rate filing has concluded, and we expect a decision from the administrative law judge in the next few months.
Our combined ratio was aided during the quarter by our continued focus in reducing expenses. Consequently, our expense ratio declined to 26.5% from 27.7% in the second quarter of 2011.
On a more positive note, premiums written increased for the sixth consecutive quarter. The growth was 2.7%, the highest it had been since we started growing in 2011.
Our revenue neutral California rating plan we implemented in December 2011 caused dislocation to some of our existing customers, but improved our competitive position for new business. Consequently, our California new business, private passenger auto sales increased year-over-year in the quarter by 17%.
In addition, the company began writing annual policies in the largest California personal auto company. The number of annual policies written was approximately 4% of the total California auto policies written.
A portion of the company written premium increase is attributable to the introduction of annual policies. However, we estimate that was mostly offset by the temporary decline and retention from the dislocation caused by the rating plan we implemented in December 2011.
The rate dislocation caused our renewal rates to decrease but at a rate lower than we had expected. After-tax investment income decline by 12% to $28 million in the quarter.
As we mentioned last quarter, going forward, it will become increasingly difficult to maintain the current after-tax yields as bonds with higher coupons mature or are called and the reinvestment of those proceeds will most likely be made at lower after-tax yields. The after-tax yield in the quarter was 3.7% compared to 4.3% in the second quarter of 2011.
With that brief background, we will now take questions.
Operator
(Operator Instructions) Our first question will come from the line of [Ray Ardello] with Macquarie.
Unidentified Analyst
Just a couple of quick questions and then I will get back in the queue. I guess first, I guess you talked about the new business trends in California from the rate plan in December.
I mean do you guys expect that to continue in the third quarter or have we kind of gone through a complete cycle of new business?
Gabriel Tirador
Well, our expectation right now, if you take a look at what's happened in July, it’s continued. The new business has continued to be strong in July.
It’s hard to say what's going to happen in August and going forward, but what I can tell you is that July was a relatively strong month for new business.
Unidentified Analyst
Okay. That’s fair enough.
And then I guess thinking about the pending rate change in California and I know you guys have mentioned in plus 6% and kind of expecting decision in the next month or so. How quickly can you guys implement that into your policyholders?
Gabriel Tirador
I will let Robert Houlihan answer that.
Robert Houlihan
Well, we can implement from an IT perspective fairly quickly. We do need to send renewal notices in advance to customers, so the process easily takes a couple of months primarily because of the requirement to notify renewal customers.
Unidentified Analyst
Okay.
Gabriel Tirador
So following about 60 days once we get approval, something like that.
Unidentified Analyst
Okay. So it’s a fourth quarter event, just trying to put a timeframe around it, when you could actually pass these rate increases on to the policyholders.
Gabriel Tirador
That’s probably reasonable.
Unidentified Analyst
Okay. And then last quickly, an update on Florida homeowners business.
Are you guys still on track to get out in September.
Gabriel Tirador
Yes, we are on track.
Unidentified Analyst
Okay.
Gabriel Tirador
Yes.
Operator
Your next question comes from the line of Meyer Shields with Stifel Nicolaus.
Meyer Shields - Stifel Nicolaus
Gabe, you mentioned that you are going to be incorporating higher more recent severity trends in your results. Does that explain why the loss ratio excluding catastrophe from development went to 73 or so from just under 70 last quarter.
Is that a good run rate going forward?
Ted Stalick
Meyer, its Ted. We are seeing, you know severity from low single-digits and now we are estimating mid-single digits.
And that’s definitely increasing pressure on the loss ratio.
Meyer Shields - Stifel Nicolaus
Was there any impact to your contingent commission bookings in the quarter from the adverse development or maybe from the catastrophes as well?
Ted Stalick
We did adjust some profitability related accruals. So you will see our expense ratio was about 26.5.
We expect the run rate is going to be closer to 27%.
Meyer Shields - Stifel Nicolaus
Thanks. That’s helpful.
One last more if I can. Does the shift -- obviously, policies are growing fast around the homeowners side.
Does that have any implications for, I guess, your target premium to surplus ratio?
Ted Stalick
Could you repeat the question?
Meyer Shields - Stifel Nicolaus
Yeah, I am sorry. It appears based on the data in the press release that you are growing policies much rapidly on the homeowners side than on the auto side.
Because homeowners is a little bit more volatile, does that mean that there is going to be more of a capital demand which would limit the premium surplus ratio (inaudible)?
Ted Stalick
Generally speaking, you are correct that the homeowners line required more capital, but I think we are writing right now 1.8, something like that, to 1. So we feel that we have more than ample capital to continue to grow our business both in the homeowner and the auto line.
Operator
Your next question comes from the line of Alison Jacobowitz with Bank of America.
Alison Jacobowitz - Bank of America
I guess two questions. I don’t know if you can give more color on the severity trends and just maybe talk some about what you are seeing.
Is it an industry trend or how do feel about what's happening there and what's driving the change? And then if you could talk about the regions outside of California in total and how underwriting is going there, maybe give us an update.
Gabriel Tirador
Well, as far as the severity trends, I think the other carriers are showing that they are seeing severity trends going up as well. I think I saw progressors and travelers talk about severity trends going up fast track, indicates that severity trends are going up.
So this is, I think, an industry trend not just a Mercury specific trend. As far as the regions outside of California, we continue to make improvements with our pricing and our segmentation outside of California.
This quarter, Alison, we were hit very hard. We had some -- there were catastrophes in the Midwest.
We booked about $8 million of cat-losses there. That hurt us.
And in addition to that it was just a bad quarter outside of California with respect to losses. I think the weather, even outside cats was not that favorable this quarter.
But we continue to make aggressive changes outside of California in our rates. And in most of the states outside of California, we are able to get rates.
So we are feeling better about what we are doing out there, outside of California. And so that’s basically it.
Operator
(Operator Instructions) Your next question will come from the line of [Ray Ardello] with Macquarie.
Unidentified Analyst
Thanks for taking the follow-up. Just a question on the development.
Any favorable offsets in business outside of California? I am sorry if you guys mentioned that but I might have missed it.
Gabriel Tirador
Not really. There is some modest favorable development in a couple of states but nothing significant that would offset the unfavorable.
Unidentified Analyst
Okay.
Gabriel Tirador
The numbers we report gives a -- it clearly is a net number. Obviously.
Unidentified Analyst
Yeah. And just one other quick question.
As far as the accident year loss ratio, I think year-to-date about 71.5% roughly is kind of what I am calculating. Is that the right way to think about what you guys are selecting going forward for the business?
All else equal if nothing changes today.
Gabriel Tirador
Well, I think on a year-to-date basis, what did I say, I think that we had a combined at a 98.2, combined ratio. I tend to look at year-to-date results, you know a quarter can fluctuate, so that implies I guess 71.5, something like that.
Operator
(Operator Instructions) Our next question will come from the line of Ron Bobman with Capital Returns.
Ron Bobman - Capital Returns
Hi, good afternoon. I had a question about your cats, and I was wondering which particular cats the company suffered from this month, sort of what geographies?
Gabriel Tirador
It was primarily Midwestern storms Oklahoma, Texas, Georgia. Hail, some tornados.
There is multiple events.
Operator
And at this time there are not further questions, I will turn the conference back over to management.
Gabriel Tirador
Well, we would like to thank everyone for joining us this quarter and we hope to give you some better news next quarter. Thank you very much.
Operator
Ladies and gentlemen this does conclude today's conference, thank you all for joining and you may now disconnect.