Aug 3, 2015
Executives
Gabriel Tirador - President and CEO Chris Graves - VP and Chief Investment Officer
Analysts
Ken Billingsley - Compass Point Research
Operator
Good morning. My name is Karen 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 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 positions. Such statements involve risks and uncertainties which can 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.
Sir, please go ahead.
Gabriel Tirador
Thank you very much. I would like to welcome everyone to Mercury's second quarter conference call.
I'm 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 question we will make a few comments regarding the quarter.
Our second quarter operating were $0.64 per share compared to $0.83 per share in the second quarter of 2014. The deterioration in operating earnings was primarily due to higher catastrophe losses, increased advertising expenses, the results of the recently acquired Workmen's Auto and net favorable reserve development as compared to prior year.
Excluding the impact of catastrophe and favorable reserve development, the combined ratio was 97.9% in the second quarter compared to 96.3% in the second quarter of 2014. Workmen's Auto added 0.2 points for the second quarter combined ratio.
Premium's rate grew 5% in the quarter primarily due to higher average premiums for policy, the acquisition of Workmen's Auto and an increase in new business policy sales. Workmen's Auto premiums written of $5.3 million added 0.8 points to the quarter's premium growth.
In the second quarter of 2015 California private passenger auto frequency and severity increased in the low single-digits. On the sequential basis, frequency and severity was relatively flat from the first quarter.
Higher average premiums for rate increases taken in 2014 partially offset the year-over-year increase in the frequency and severity in the quarter. To further address the increase in loss cost, a 6.4% rate increase was implemented in late May for Mercury Insurance Company representing about half of our company-wide premiums written.
In addition, a 6.9% rate increase for California Automobile Insurance Company representing about 15% of our company-wide premiums was implemented on August 2nd. Results outside of California were negatively impacted by $7 million of catastrophe losses primarily in Texas and Oklahoma and our private passenger auto business in New York.
Excluding catastrophe losses, the combined ratio was about 100% outside of California. In New York, we continue to value reserves as the impact of changes in claims procedures which includes the speeding up of claim settlement and case reserving have added an element of uncertainty to the estimates.
In New York, we implemented a 3% rate increase in January of 2015 and a 9% rate increase in July of 2015. Our expense ratio in the quarter increased to 27.3% from 26.8% in the second quarter of 2014.
The increase in expense ratio which primarily due to higher advertising expenses partially offset by lower average commissions. Net advertising expense in the quarter was $12.1 million compared to $5.5 million in the second quarter of 2014.
Our 2015 advertising budget is heavily weighted toward a first half spend. The advertising spend will be lower for the remaining two quarters of 2015.
Company-wide private passenger auto new business applications submitted to the company increased 11% in the second quarter of 2015 and homeowners new business submissions were up 32%. In California, we posted premiums written growth of 5.6%.
Outside of California and excluding our mechanical breakdown product, premiums written increased 5.5% in the quarter. This compares to negative growth of 3.9% and 7.6% for the years 2014 and 2013 respectively.
With that brief background, we will now take questions. Hello, are there any questions?
Operator
[Operator Instructions].
Gabriel Tirador
Are there any questions?
Operator
[Operator Instructions] And your first question comes from the line of Ken Billingsley from Compass Point.
Ken Billingsley
Hi. Can you hear me?
Gabriel Tirador
Yes Ken.
Ken Billingsley
Very good. Thank you for taking these questions.
Just a few questions, one on tax expense was the operating expense, was there a benefit during the quarter or is it just naturally lower in general, was there anything unique in the quarter?
Gabriel Tirador
No, there is nothing unique we get cash benefit on our realized losses on our investment portfolio which is primarily due to mark-to-market adjustments as we flow all our investments changes through the P&L and as you can know for the P&L we had an investment loss for the quarter so that would have positively impacted the fixed tax accruals.
Ken Billingsley
But after adjusting for backing out the realized loss portion, there was no other movement.
Gabriel Tirador
No.
Ken Billingsley
Okay. On the underwriting leverage side it looks like it’s just moving up slightly and I think I’ve asked this question before but just to clarify given your movement in mix of business where do you feel comfortable taking underwriting leverage to?
Gabriel Tirador
I would say about 2.5 times.
Ken Billingsley
And that's with the addition of commercial business in the Workmen's Group as well?
Gabriel Tirador
Yes.
Ken Billingsley
Okay. And essentially if you close in on that level depending on profitability at what point on the dividend payout ratio do you guys have to maybe slowdown on the dividend?
Gabriel Tirador
Well, the dividend payout ratio probably this quarter was what closed about a 100% a little under, just a little bit under 100%. There is a lot of factors that go in, in the dividend payout ratio.
We take a look at our earnings, our prospects it’s something that the board decides every quarter and we feel that today we have a pretty good capital position where near that we haven’t really earned the dividend, we’ve been able to payout the dividend. So it’s something for the board to evaluate every quarter but at this point with the amount of capital position that we have we feel pretty comfortable where we’re at.
Now to your question if we get up to 2.5 times leverage and we’re using more of our capital to guide more business I think your question is what happens to your dividend at that point? We obviously don’t expect though to have earnings at this level for a long period of time, in our combined ratio with 98.5% in this quarter we don’t expect that many in half percent to continue for a long period of time, so we do anticipate that our margins are going to improve.
Ken Billingsley
Okay. And then on the realized loss side and now you're talking about the payout ratio on the operating side in the first half of 2014 so first you had more realized gains than the last four quarter losses but you have had four quarters of realized losses, is there something that you’re invested in or is there some change that you’re making that there’s been these linked losses on the realized investment portfolio?
Gabriel Tirador
We -- I'll let Chris talk, but as we mark our securities to market, they are sensitive to changes in market interest rate because as you know most of our portfolio is primarily fixed income and we flow those changes through the P&L so we did the negatives when interest rates go up and the positive when interest rates go down as far as our P&L adjustment.
Ken Billingsley
I apologize, I didn't know the bulk of your portfolio held for trading, the entire?
Gabriel Tirador
The entire portfolio is trading.
Ken Billingsley
And strategically, I'm assuming obviously put some thought in there, what is the reason for doing that versus available sale?
Gabriel Tirador
When the new pronouncement came out, I think it had 159 a few years ago, we evaluated the accounting and we felt good, the true measure of earnings is really our core operating earnings but we had found that when you were having to write-down securities due to temporary market gyration, we weren’t able to get the benefit of when the market bounce back so we just felt like it was a better for the company to flow all the changes through the P&L and market, we're seeing the market, the trading portfolio.
Ken Billingsley
Okay.
Chris Graves
And then we’ve always discussed with the auditors every quarter with respect to what was permanently impaired what was other than temporary. The fact of the matter is whether you run it through your balance sheet or your income statement the numbers are there.
So to add it’s simpler and if you back out the realized gains or losses you get to your operating earnings.
Ken Billingsley
Okay. And then the last question I have just on policy in-force connected to the advertising it looks like you did have another uptick in personal auto policy in-force but flat year-over-year so I would imagine that maybe year-over-year comparison probably the most reflective given the fact that you've implemented a bunch of rate increases.
So how are you viewing that flat year-over-year but up on a sequential quarter?
Gabriel Tirador
In California we have in the very large block. So the new business probably represents about 10% of our premiums written and you have 90% coming in from renewals.
So new business somewhat has an impact. It's obviously not as big an impact as renewal business and our California private passenger auto new business sales were up something like 9% and they were up 11% company-wide.
So we are seeing some nice new business sales growth which should help our renewals in future years. Now in '14 my recollection is in '14 our new business sales were down quite a bit over '13 which had an impact this year on renewals.
So we feel relatively comfortable in our Mercury Insurance Company where we just implemented the 6.4% rate increase. Our retention did go down slightly, but it actually went down less than we anticipated.
So that was good news so far it's only been one month into that rate increase but the -- we were anticipating a larger reduction and retention than we have seen so far.
Ken Billingsley
Okay. And then on the advertising side, I believe you -- most of your advertising done more of an national plan as opposed to focused to how has that turned around -- turned out in the state outside of California?
Gabriel Tirador
Most of the advertising honestly is coming in California. Now, the TV advertising -- it's a national cable ad and it's national.
In addition to that we get leads from lead aggregators. We buy leads, we do online advertising, it's well so -- it encompasses a whole lot of avenues for us to try to get new business and outside of California I think our PPA count new business was up something like 15%.
So it's having a positive impact and when we take a look at how effective our advertising AA's, overall we take a look at the lifetime value of the premium that we expect from all these new business sales from the advertising. And we deduct cost of the advertising.
Obviously we deduct the cost of the commissions which are lower, much lower than our stated commissions because we paid much less commissions on this type of business that we get to our advertising. We deduct lead fees that we get from our agents.
So we take a look at the lifetime value of that premium deducting all the expenses including the advertising and right now we're not recovering quite all the dollars. We're recovering pretty much most of the dollars.
But I will say when you add back the anticipated underwriting income from the sales, the generator of the premium sales reduction in the back. So overall we need to improve, but overall I would say it's been a decent investment in the advertising.
Ken Billingsley
Great. Thank you for taking my questions.
Gabriel Tirador
Sure.
Operator
There are no further questions at this time.
Gabriel Tirador
Okay. Well, I'd like to thank everyone for joining us this quarter.
And we'll talk again next quarter.
Operator
This concludes today's conference call. All participants may now disconnect.