Nov 3, 2014
Executives
Gabriel Tirador - President, Chief Executive Officer, Director Robert Houlihan - Senior Vice President, CFO Allan Lubitz - Chief Information Officer, Senior Vice President
Analysts
Vincent DeAugustino - KBW Gary Ransom - Dowling & Partners Alison Jacobowitz - Bank of America Ron Bobman - Capital Returns
Operator
Good morning or afternoon. My name is Michelle and I will be your conference operator today.
At this time, I would like to welcome everyone to the Mercury General Quarterly 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. (Operator 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 operations to differ materially from those discussed here today.
I would now like to turn the call over to Mr. Gabriel Tirador.
Please go ahead.
Gabriel Tirador
Thank you very much. I would like to welcome everyone to Mercury's third quarter conference call.
I am Gabe Tirador, President and CEO. In the room with me is Mr.
George Joseph, Chairman; Ted Stalick, Senior Vice President and CFO; Robert Houlihan, Vice President and Chief Product Officer and Chris Graves, Vice President and Chief Investment Officer. Before we take questions, we will make a few comments regarding the quarter.
The company posted operating earnings of $0.81 per share, compared to $0.53 in the third quarter of 2013. The combined ratio was 96.7%, compared to 99.2% in the third quarter of 2013.
Higher average premiums per policy were a major contributor to the improved results. Also adding to the positive results was 5.5% improvement in investment income due to higher invested asset balances, favorable reserve development or $2 million and a low level of catastrophe losses totaling just 1 million for the quarter.
Written premiums continue to grow, although the 2.2% growth rate posted this quarter is the lowest quarterly growth rate this year. Rate increases have had a positive effect on premiums written or policies written and policy-in-force accounts have decline.
During 2014, the company took the following rate actions. A 6% rate increase was implemented in January for our Mercury Insurance Company, California personal auto book of business which represents about half of our company wide premiums written.
An 8.25% rate increase was implemented in January for a California homeowner’s book of business, which represents about 10% of our company wide premiums written. A 6.9% rate increase was approved and went into effect in October 2014 for our Cal -- auto California personal auto book which represents about 15% of our total [rent] premiums.
We have taken rate increases in several states outside of California during the first half of 2014 which has met to significant increases in new business volumes in those states. And we have a 6.9% rate increase pending DOI approval in our Mercury Insurance Company personal auto book of business.
California continues to experience positive premium growth, but outside California have experienced negative growth. The company continually balances growth and profitability objectives and addresses these by many means including rates underwriting, expense initiatives, advertising and distribution.
For 2015, we expect to improve our growth prospects outside of California to the rate changes taken this year coupled with increased advertising spend and distribution. As we have previously reported we have adjusted or combined ratio target outside of California to be above a 95% combined ratio as we have priced our products to expense target we have not yet achieved, but expect to achieve over the next several years.
Lost cost for California personal auto are in line with our expectations both, frequency and severity trends are in the low single digit range. However they are slightly elevated compared to the first half of the year.
In other states, loss trends vary a lot by state, but are generally moderate with the exception of New York where trends have been running high. For California home owners we are experiencing increased loss severity trends, because 8.25% rate increase in January was preceded by a 5.5% rate decrease.
The results for California homeowners have not improved yet this year. We are taking additional steps to improve our California homeowners business including the roll out of a new aligned homeowner’s product in the third quarter.
The new product has led to an increase in policy applications. We recently announced the planned acquisition of Workmen’s Auto Insurance Company for $8 million which is expected to close in the first quarter of 2015 pending regulatory approval.
Workmen’s is a Los Angeles based non-standard auto rider that is expected to produce about 30 million in premiums in 2014. This acquisition fills a strategic niche for Mercury as Workmen’s non-standard auto product will compensate -- complement Mercury’s more preferred product offerings.
Mercury’s product offerings including its policy provisions are more preferred in mid-market and are not tailored to the true non-standard market. We believe Workmen’s auto product will allow Mercury to better penetrate the non-standard market in California.
Year-to-date the company posted a combined ratio of 96.4%. Looking forward our fourth quarter results tend to be the worse of the year.
We generally expect our fourth quarter combined ratio to be higher than the rest of the year by several points due to increased loss frequency and higher severities caused by seasonal driving in weather. That said, it is hard to predict with certainly whether the combined ratio will be higher as there are many factors currently unknown or beyond our control.
With that brief background we will now take questions.
Operator
(Operator Instructions) Your first question comes from Vincent DeAugustino from KBW. Your line is open.
Vincent DeAugustino - KBW
Just so start to on Workmen’s so I can appreciate the comments you guys have made about filling the non-standard slot for you guys and so I was curious about is, as that closes and you kind of bring that in house, what type of changes if any that you’d be making to their filings and then how just because from looking at it -- it’s been kind of challenge from the profitability standpoint on their end, but I assume that you guys would be taking some of your expertise in leveraging that on a go forward. So I was kind of just curious what you guys have been looking to do with that going forward?
Gabriel Tirador
Well, with respect to the profitability, Workmen’s just recently implemented a 6.9% rate increase in California and so we’ll be taking a look at whether or not we need the additional rate increases in 2015. We also believe that since increasing the production is going to provide them with some needed efficiencies, their LAE and expenses ratios are just much too high.
But just to clarified something, in order for us to offer a third non-standard price point in California, the Department of Insurance and California of statutes require us to qualify for what’s called the Super Group Exemption, which means that certain operations including sales, marketing, pricing and underwriting have to be separated from our other operations. So the Workmen’s purchase is going to allow us to qualify for this Super Group Exemption as their operations will be managed separately from our other operations, but it’s a way for us to better compete in this non-standard market.
Now, there is certain back-office operation that we are allowed to combine and that includes for example claims, finance, human capital, but certain other operations do have to be maintained separately. So we’re going to take a look at -- Workmen’s I should say is going to take at their overall rate adequacy.
They’re going to take a look their segmentation, we’re going to take at their distribution and Workmen’s I am pretty sure are going to be making some changes to all those aspects of the business.
Vincent DeAugustino - KBW
Okay, good to know. I think the structure now makes a lot more sense to me.
So that's definitely good. As far as looking at the policy enforce changes, so it looks like we've started the inflexion point for -- in both homeowners and auto, and it also looks like the commercial auto growth has been pretty strong and so just as we think about these mix changes going into our model, I know you guys don’t give us the sort of byline in loss performance anymore.
But as far as just thinking conceptually about how each of those products rank growth outside of California commercial auto homeowner growth, how would each of those rank in profitability versus say just the core California auto product. So the question is really getting at, as you grow in each of those buckets should we anticipate margin expansion to the overall aggregate buck?
Gabriel Tirador
Well, I think in California, compare to California auto, as I think that’s what your question is Vincent and I think homeowner is running hotter -- right now California homeowner is running hotter. Although we have that rate increase as to our earning in and we have new product, but it is running hotter than our California tri-pads near auto.
Outside of California as I’ve mentioned before, we expect to run hotter outside of California than in California for the next several years as we’re pricing our products to expense targets we haven’t achieved yet. And we have a goal to achieve certain expense targets by 2017 and we’re putting plans in place to achieve that.
But that in the interim, we can expect that the profitability outside of California is not going to be where California is at. I don’t if that answers your questions or not.
Vincent DeAugustino - KBW
And then on the commercial auto, sorry, if I missed it. That would be a bit little bit better I would assume?
Gabriel Tirador
Yes, now commercial auto has been exception -- that would -- our targets in commercial auto are better.
Vincent DeAugustino - KBW
Okay got you and then just sort of just modeling question. As far as other expenses running a little bit higher, I just wanted to see relative over the last few quarters the tick up there and just to make sure again from a modeling standpoint, understanding the drivers?
Gabriel Tirador
On the expense run rate, we have some saving from last year’s restructuring, but a large portion of that was in claims and affected the LAE ratio. We did have some cost savings from our commission changes outside the California that didn’t go into effect until the second quarter and those have taken a few quarters to fully impact in the policy acquisition cost but in addition we’ve reduced some cost outside -- although we’ve reduced some cost outside of California.
Our premium volume is down. We have some fixed cost spread over declining premium volume outside California and then finally the expense ratio was higher this quarter due to some higher profitability rated accruals that we booked.
And with that we’re still kind of projecting a normal run rate at the expense ratio around 27% this year.
Vincent DeAugustino - KBW
John, so the 58.5 million this quarter and other operating expenses versus say the 53.8 last quarter, I mean that’s going to be roughly the -- mostly the cost outside of California spread over fixed or fixed cost spread over kind of shrinking premium base?
Robert Houlihan
Partially, it all took some of the profitability related accruals.
Gabriel Tirador
Our margins are better this year than they were last year, so the profitability related accruals are up.
Vincent DeAugustino – KBW
It’s only a good thing. So, I guess one or two last one, so on the litigation issues with the news in non-compliances.
So, I’m always just eager to get an update there, if there first one?
Gabriel Tirador
There was actually a call on the 2004 non-compliance, there was a call with a judge last Friday to get an update on where the judge was at and basically the judge says that, they expect you issue a ruling in mid-November, is what the judge told the parties. And that ruling then goes to the commissioner and it may or may not become public for another 30 days, so it goes directly to the commissioner.
So, we’re probably looking if the judge does send out his ruling in mid-November and if the commissioner waits for full 30 days, we’re probably looking mid-December, late December before we found out the ruling, Vincent. You get that Vincent?
Operator
Your next question comes from Gary Ransom from Dowling & Partners. Your line is open.
Gary Ransom - Dowling & Partners
Yes in Workmen’s, is there an overlap with the agency force that they operate through or is there any new agents that you are bringing in that acquisition?
Gabriel Tirador
I am sure there is going to be some overlap, but as an example in the early Orange County area they don’t have their many agents right now, very, very few agents relative to the size of the market. They probably have, I don’t know something like 30, 50 agents in LA Orange County area.
So, there is a lot of opportunity from our standpoint to increase this distribution.
Gary Ransom - Dowling & Partners
Okay. And on the homeowner’s product, can you tell us a little bit more about what the features of the new product are that make it attractive?
Gabriel Tirador
Sure, I’ll let Lubitz move in and handle that one.
Allan Lubitz
New product, there is three areas where we’ve improved significantly, we’ve moved to our guide wire platform, so that provides much better technology then we had for our previous product. We’ve also added a lot of new feature to the program, before some of our coverage fell short of what the competition offered, now we’ve sort of match those coverage and expand and have some coverage features above and beyond what’s offered by many of our competitors.
And then lastly we move to by-payroll reading, which we think gives us much more accurate reading going forward. And we’ve seen, we’ve off balanced to zero, relative to the pricing on our old product and we see about 25% increase in new business applications with the new program.
Above 5% or so those are rewrite. So, the net 20% we see in sort of incremental new business.
Gary Ransom - Dowling & Partners
Can you give an example of what the new coverage features were?
Allan Lubitz
Yes, so some of the new features we have now water back up coverage, service line coverage, we have a home system protection program, so that coverage breakdown in any mechanical features in the household, we have ID [forward] expense in resolution convergence with the new product.
Gary Ransom - Dowling & Partners
And just one broader question on a capital adequacy. Could you talk a little bit about where you stand and what your view is of your capital base at this time?
Being mindful that you are adding on with 30 million of premium next year and your payout ratio was relatively high Where do you stand right now?
Gabriel Tirador
Well, we believe we stand -- we’re in a good position with respect to our capital position, we’re riding at about 1.9 to 1. Obviously the acquisition of Workmen’s is not really going to move the needle at least in the short run.
We have always maintained a dividend policy back-dating at lead-back till 1985 when the company went public, that’s been our -- the Board of Director has continually maintained that dividend policy for all these years, that’s how we distribute back our capital. The capital position that we do have today the strong capital position allows us to maintain this dividend in times where maybe we are not -- the earnings aren’t as we would like.
So overall I think that we’re comfortable with the capital position that we have today.
Gary Ransom - Dowling & Partners
Okay, thank you. That’s it from me.
Operator
Your next question comes from Alison Jacobowitz from the Bank of America. Your line is open.
Alison Jacobowitz - Bank of America
I’m going to assume that’s me, I’m Alison Jacobowitz. So most of my questions have been answered, but I was just wondering if looking at the policies enforced and the pressure in the auto business, can you just give us any more color?
Details you can provide as to the environment inside and outside of California.
Gabriel Tirador
Inside California the environment is competitive and we have taken rate increases in California that have impacted our new business sales and that has had a negative impact on our policies enforcing on California. Outside of California we reduced rates, Alison.
As I mentioned earlier in the year and that’s had a very significant impact on new business sales outside of California. Now albeit average premiums are down when you take a rate reduction, but we believe that in ’15 a new competitive rates coupled with some increased advertising spend that we plan on doing will allow us to grow outside of California in ‘15.
In California it’s going to remain a challenging environment to build significantly in California excluding our acquisition of Workmen’s and what we may be able to do with the Workmen’s acquisition in the non-standard area.
Alison Jacobowitz - Bank of America
Great. Thank you.
Operator
Your next question comes from Ron Bobman from Capital Returns. Your line is open.
Ron Bobman - Capital Returns
Good afternoon here, I guess good morning there. I had a question you made a comment Gab I think regarding the Workmen’s and the non-standard concentration.
In essence that Workmen’s complemented your non-standard book. I guess it was sort of -- maybe it’s weak in certain areas.
Could you elaborate on sort of the elements of your existing non-standard book and where it strong and where Workmen’s sort of feels the void? Thanks.
Gabriel Tirador
Sure. Let me just first start by saying that, our preferred company in California, that’s where our statutory good drivers going in to, in Mercury Insurance Company and the non-statutory good drives goal in Cal Auto.
But that doesn’t necessarily mean it’s a true non-standard company I mean that’s just by statute that -- we have [rights] that are by statute good drivers going to our preferred company and by statute that are non-good drivers going Cal Auto. We don’t have, for example the income policy provisions of typical, non-standard riders are much more restrictive than what we have as an example.
Workmens’ has those steps of restrictions. We are not in -- we don’t have agents that are pointed in many areas that are appointed by really true non-standard carriers.
So it’s a different market we think it’s of sizable market here in California, it’s probably $1 billion size market here in California for enabling two non-standard versus our historical non-standard here in California for Cal Auto which is our non-standard carrier here. So there are differences between the two.
Ron Bobman - Capital Returns
Great Gab, thanks. Could you just elaborate what do you mean by, on that restriction with my --?
Gabriel Tirador
No, policy retraction what’s afforded in the policy what kind of coverages are afforded in the policy, there are more restrictions non-standard type of policies where, as an example there maybe not be any coverage for a permissive used driver in a non-standard policy, wherein our policy we provide the coverage for that.
Ron Bobman - Capital Returns
Okay, that helps.
Operator
(Operator Instructions) Your next question comes from the Ken Billingsley from Compass Point. Your line is open.
Ken Billingsley - Compass Point
Thank you, just a couple of questions on the non-standard business and I understand you’re talking about Cal Auto’s, that’s a little different that non-standard, kind of Workmen’s as you just bought. But what percentage of your business would consider not prime and I guess maybe unhistorical, you have would considered you non-standard business prior to Workmen’s acquisition?
Gabriel Tirador
I think Cal Auto represents about 15% of our auto book -- maybe the total book now. I would say it’s closer to 25% probably of our auto book -- of California auto book something in that neighborhood.
Ken Billingsley - Compass Point
And was there anything that prevented you from prevented from putting in some of those restrictions and building out the call auto book or did you specifically need or desire to create that third bucket to essentially target customers depending on their risk profit?
Gabriel Tirador
Well we needed that bucket as I mentioned earlier, we needed that third non-standard price point and to get that done, I mentioned earlier we need that Super Group Exemption, which I described earlier in the call.
Ken Billingsley - Compass Point
So we knew the super group exemption that’s stimulated the Workmen’s acquisition?
Gabriel Tirador
I am sorry.
Ken Billingsley - Compass Point
That it was easier -- I guess my question is, is it something that you could not have developed in-house or was Workmen’s just attractive to maybe accelerate the pace of creating that group?
Gabriel Tirador
Much more difficult to doing in-house form approval and regulatory standpoint.
Ken Billingsley - Compass Point
Okay and last question I have is this is regarding comments for outside of California and I apologize if I misinterpreted earlier statements on calls. Did I understand your current expense ratio outside of California -- the agent commission that you pay, are a little higher than what’s you pay in California?
So first of, is that true? And if so, can you talk about how much more it is and many how that has helped develop business?
Gabriel Tirador
It’s not accurate in it’s actually -- last in it is in California by quite a few points.
Ken Billingsley - Compass Point
Outside of California is -- you’re paying smaller agent commission as will, will that change as you’re looking to grow to be competitive as you mix your advertising or will you expect that to stay the same?
Gabriel Tirador
We expect that to stay the same. As we’ve made some changes earlier in the year with respect to compensation commissions, but we expect that to stay the same going forward.
Ken Billingsley - Compass Point
Great, thank you for taking my questions.
Operator
At this time, I have no further questions. I’ll turn the call back over to speakers for closing remarks.
Gabriel Tirador
We would like to thank everyone for joining us this quarter and we look forward to speaking with you in the fourth quarter. Thank you very much.
Operator
Thank you everyone. This concludes today's conference call.
You may now disconnect.