Oct 31, 2016
Executives
Gabriel Tirador - President and Chief Executive Officer Ted Stalick - SVP and Chief Financial Officer Chris Graves - VP and Chief Investment Officer Robert Houlihan - VP and Chief Product Officer
Analysts
Greg Peters - Raymond James Ken Billingsley - Compass Point Research & Trading Jay Cohen - Bank of America Ron Bobman - Capital Returns Management
Operator
Goof morning or afternoon. My name is Michelle, and 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. Sir, please go ahead.
Gabriel Tirador
Thank you very much. I would like to welcome everyone to Mercury's third 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; Chris Graves, Vice President and Chief Investment Officer; and Robert Houlihan, Vice President and Chief Product Officer. Before we take questions, we will make a few comments regarding the quarter.
Our third quarter operating earnings were $0.67 per share, compared to $0.59 per share in the third quarter of 2015. The improvement in operating earnings was primarily due to an improvement in the combined ratio, from 99.2% in the third quarter of 2015 to 98.1% in the third quarter of 2016.
In California, we recorded an increase in personal auto severity in the mid-single-digit range for the 2016 accident year and an increase in frequency in the low single-digits. Industry trends reflect frequency in California increased about 3% and severity about 6% for the 12-month period ending June 2016.
To help offset the increase in loss trends, we have been increasing rates in California. This year for our personal auto business in California, we implemented a 5% rate increase in late March 2016 for Mercury Insurance Company and a 6.9% rate increase in June 2016 for California Automobile Insurance Company.
Personal auto premiums in Mercury Insurance Company represents about half of our companywide premiums earned and California Automobile Insurance Company represents about 15% of our companywide premiums earned. We have observed a significant number of our competitors also file for rate increases in California.
Outside of California, increasing loss cost trends and higher loss ratio that come with an increasing new business have negatively impacted our results. To address profitability outside of California, we have been increasing rates and tightening our underwriting.
The expense ratio in the quarter declined to 25.2% from 26% in the third quarter of 2015. The decrease in the expense ratio was primarily due to lower profitability related accruals.
Net advertising expense in the quarter was $10 million compared to $11 million in the third quarter of 2015. Premiums written grew 3.8% in the quarter, primarily due to higher average premiums per policy.
Companywide private passenger auto new business applications submitted to the company decreased approximately 15% in the third quarter of 2016, as we focused on improving profitability in our private passenger auto line. Companywide homeowners' applications increased about 1% in the third quarter of 2016.
In California, we posted premium written growth of 5.7%. Outside of California, premiums written decreased by 4.4% in the quarter.
We are pleased to report the Superior Court of California ruled in our favor vacating the Commissioner's 2015 order that had imposed a penalty of $27.6 million against the company. The principal findings of the Superior Court Order were that the broker fees at issue were not premium and a charging of such fees did not result in any violation of Insurance Code Rate Regulation Provisions.
The $27.6 million penalty imposed violated Mercury's right to fair notice and due process and there was unreasonable delay by the department in issuing the notice of non-compliance in 2004, which resulted in a manifest injustice to the company. The financial statement recognition of the reversal of the $27.6 million penalty plus any related interest is yet to be determined as the Superior Court's Order is subject to appeal.
Lastly, we generally expect our accident quarter combined ratio for the fourth quarter to be higher than the rest of the year due to increased loss frequency and higher severity caused by seasonal driving and weather. That said it is hard to predict with certainty 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 Greg Peters from Raymond James. Your line is open.
Greg Peters
Good morning and congratulations on your results this quarter.
Gabriel Tirador
Good morning Greg.
Greg Peters
Just a couple of questions for you. On the severity commentary, I think last quarter you said, it was high single-digit, so now we're reverting back to mid-single-digit.
Is there anything sequentially in the trend that looks a little bit better in the third quarter versus the second quarter or the first half of the year?
Gabriel Tirador
Really here we're talking about maybe a one point difference. It's all semantic.
Ted, do you want to elaborate?
Ted Stalick
Yes. I mean Greg the difference between mid and high maybe is the matter of instead of a 7 or 8, it’s a 6 or 7.
So, -- and that maybe just to have to do with [inaudible] more than anything. So--
Greg Peters
That's perfectly understandable. So, can you just step back for a second and I noted your commentary on the expense ratio and the profitability accruals, maybe you can sort of walk us through the logistics behind that, especially considering the possibility that going forward your results may begin to improve a little bit as all the rate increases continue to flow through your book of business?
Gabriel Tirador
It’s primarily related to bonus accruals and because of the four underwriting results this year we’re not really accruing for a bonus accrual this year. So, that amounts to maybe six tenths of a point, half of that or maybe a little bit more than half of that is loss adjustment expenses and the other half is underwriting expense.
Greg Peters
I see. And so if the underwriting results improve next year at this time, we could expect the reversal, where the bonus accrual trend might move against the company, is that correct?
Gabriel Tirador
That is correct. And I think a full bonus accrual maybe in the neighborhood of $20 million.
Greg Peters
And for the full year that is, right, or for the quarter?
Gabriel Tirador
For the full year Greg. For the full year.
Greg Peters
And where do you think it’s going to come out this year?
Gabriel Tirador
Zero.
Greg Peters
Zero, wow. Okay.
So, just reverting back to the severity commentary in the current quarter and frequency, I know I've asked you this on previous calls and it always is worth asking again, where do you think you are in the possibility of filing traditional rate increases as both severity and frequency trends continue to march forward in the context of your California book of business?
Gabriel Tirador
Well, in Cal Auto, we have a 6.9% rate pending with the Department of Insurance, so that's already in there and--
Greg Peters
Is that--
Gabriel Tirador
…that’s California Automobile Insurance Company. And Mercury Insurance Company, I believe there's a pretty good likelihood that within the next I would say 90 days that we will file a class plan that will include some sort of rate increase.
Greg Peters
For Cal Auto, the 6.9% that’s pending, that’s on top of the 6.9% that was effective in June?
Gabriel Tirador
That is correct.
Greg Peters
Yes, okay. Thanks for that color.
On the non-California business, is there any one state of the remaining states that our net business that are more problematic than others or perhaps you could just provide some additional color around what's going on in your business outside of California?
Gabriel Tirador
Well, our biggest two states outside of California are Florida and Texas and the results have been poor in those states as a result of what I mentioned earlier, we had a lot of new business growth. In addition to that, the trends were high in those two states, but we feel that with the rate changes that we made, some other procedural changes that we’re going to be much better-positioned going into 2017.
Some of the smaller states in the Northeast with respect to New York and New Jersey, we’ve made improvements in those two states and we continue to make improvements in those two states, but the two bigger states outside of California, Florida and Texas, we feel that we have made the changes and are continuing to make the changes to basically get us well-positioned for 2017.
Greg Peters
And by well-positioned do you mean positioned to start growing again or positioned for profitability to hit your hurdles or both?
Gabriel Tirador
Profitability.
Greg Peters
Right.
Gabriel Tirador
I think the next year the growth is going to be outside of California down as a result of the rate changes and other remedies that we’ve taken to improve profitability.
Greg Peters
Okay.
Gabriel Tirador
So, I think it's more of a profitability play outside of California right now.
Greg Peters
So, I just want to -- if -- just to clarify your last comment, is it policy count that's going to be down outside of Florida or premium -- total premium or both?
Gabriel Tirador
I anticipate that both will probably be down next year.
Greg Peters
Okay. Thanks for that color.
Probably one final cleanup area, perhaps Chris could comment on the investment portfolio. I was looking at both pretax and after-tax income is down year-over-year and the average invested assets is up.
Perhaps you could give us some commentary on how he thinks that's going to look going forward?
Chris Graves
Yes. Hey, Greg.
A lot of that I think as you'd understand is interest rate related. We have got on the books with much higher book yield than current market rate being reinvested perhaps a point or more, less than what they were on the book.
So, even with increased cash flows coming into the portfolio, current rates don’t allow for us to fully offset what we're losing. So, it’s a bit of the battle, but I think in the past two years, we’ve provided some reasonable growth; this year is a bigger challenge.
But I think that we should be able to at least maintain where we currently are, especially with rates at these levels. And then we'll just see what the company does with these rate increases and what they allow to reinvest.
Greg Peters
So, just to close the loop on that commentary, if the interest rate environment stabilizes at this point or is stable from this point going forward, when would the yield on your total portfolio sort of bottom out? Does that happen next year, or is it happening right now, or do we still have some more runway?
Chris Graves
No, it would still take a little bit more for rates to move higher before I think we could see what you can call a bottoming, but it could easily be eclipsed with reasonable cash flow that's coming into the portfolio.
Greg Peters
Right. Yes, that makes sense.
Perfect. Thank you, everyone, for your answers.
Gabriel Tirador
Thanks Greg.
Operator
Your next question comes from Ken Billingsley from Compass Point. Your line is open.
Ken Billingsley
Thank you. Good morning.
A question for you on just following-up on your commentary earlier. I think Greg, you answered some accrual questions for him, but -- and maybe I just wrote this down wrong -- you said the lower expense ratio, and I wrote down lower property related accruals.
Did I hear that wrong?
Gabriel Tirador
Our profitability.
Ken Billingsley
Profitability.
Gabriel Tirador
That’s basically, bonus.
Ken Billingsley
Okay. That makes a lot more sense.
Thank you. And then I got the commentary that you answered for Greg here so.
Let me just move on to this, just a couple of follow -- fill-in questions. The mix of the business for what I guess the market generally considers standard versus non-standard mix of business, could you give me what your percentage is today and maybe how that's changed over the last year?
Gabriel Tirador
Well, I think that’s hard to measure nowadays, those lines have blurred. But let’s talk about our biggest state in California where we consider Mercury Insurance our biggest state obviously and our biggest company here in California.
We consider that our preferred company and that represents about -- I said earlier about 50% of our companywide premiums. And then we have Cal Auto which is -- what we referred to as midmarket non-standard and that represents about 15%, it’s less about 65% of the business.
Outside of California, we are more towards the non-standard arena as far as risk classification go. Robert, would you have any other comments on that?
Robert Houlihan
Certainly, in terms of new business, in terms of our portfolio, I think it's starting to skew more -- renewal books skews more toward standard even outside of California.
Ken Billingsley
The renewal book in general is shifting more toward standard, you said?
Robert Houlihan
No, I am just saying the new business probably skews more non-standard, but because of our [lower] [ph] policy life expectancy when you look at the renewal book it actually skews more standard.
Gabriel Tirador
Renewals by definition, if they renew long enough, they are more standard generally, is the point. But as far as the new business goes, I would say we skew more non-standard outside of California.
Ken Billingsley
Okay. And then within California, obviously, I know it's a big state, but is there any specific geographic concentration?
So, of the 65% of your premium that's in the state, is it concentrated 50% in a certain county or two?
Gabriel Tirador
Southern California represents the majority. I would have to say off the top of my head, Robert maybe 70% of the business down here in Southern California versus Northern California.
That's off the top of my head. Yes, that's where all the people are at.
Ken Billingsley
Sure. Okay.
Pretty broad. And then the last question I have is can you update on ad spending, if you're looking expecting to write maybe less outside of California, can you talk about your ad budget and ad spending plans?
And how that may be affecting the expense ratio now and going forward?
Gabriel Tirador
Well, we haven't decided yet for 2017. Our best expectation right now is that it will probably remain flat, but that has not been finalized yet for 2017.
Ken Billingsley
Would you reconsider -- I understand your answer here, but would you be considering staying with the national campaign as opposed to being focused? And does that cover California for you, as well, or do you have a specific ad plan in California?
Gabriel Tirador
Well, we advertise locally in California as well besides the national, so we do that already. And that we still haven't evaluated whether or not we're going to still continue with the national.
That's something still under evaluation. But we have always advertised here locally as well even though we have some national ad spend.
Ken Billingsley
Okay. And can -- do you have off the top of your head what the national ad campaign was on an annual basis, what the cost was?
Gabriel Tirador
Ted, do you have -- how much advertising expense?
Ted Stalick
Our total was about $40 million, $42 million I think.
Gabriel Tirador
Neighborhood of $49 million.
Ted Stalick
Yes. But just like Gabe mentioned, the national is one component of that.
I think it's maybe even less than half of that, because a lot of digital advertising, sports advertising.
Gabriel Tirador
He's talking just about the national substantial.
Ted Stalick
Yes.
Gabriel Tirador
Robert, do you have any--?
Robert Houlihan
Yes, it’s a little less than half.
Gabriel Tirador
Yes.
Ken Billingsley
Okay. Great.
Well, thanks for taking my questions.
Gabriel Tirador
Thank you, Ken.
Operator
Your next question comes from Jay Cohen from Bank of America. Your line is open.
Jay Cohen
Yes. Thank you.
A couple questions. For the fourth quarter, do you have any sense yet what Hurricane Matthew will do to the results?
Gabriel Tirador
We think at this point it's not going to be material Jay, maybe $1 million to $2 million is our best estimate right now from the data that we have.
Jay Cohen
Great, that's helpful. And then, secondly, outside of California, as you shrink, obviously the goal is to improve the loss ratio.
But at some point would you have a scale issue, simply a lack of scale, whether it's with the agents, from a claims standpoint? How do you deal with that balance, guys?
Gabriel Tirador
Well, one of the things that we did I guess the last year sometime where we centralized hubs so that we can get more scale and now we have basically some central hubs in Florida and Texas and in California and we closed down a lot of the other hubs that we had so that we can get some more scale and efficiencies. So -- that we try to deal it with that so that we can basically centralize our operations and get more leverage.
With the topline declining, it does put added pressure, there's no question about that. It's something we'll have to take a look at to see how much added pressure it's going to be adding.
Jay Cohen
Got it. You tried to build in I guess some -- at least some flexibility to the system there.
Gabriel Tirador
Yes, we did that -- two years ago I guess we did that Jay where we centralized our operations outside of California. We have major hubs now.
Jay Cohen
Yes. Okay.
Gabriel Tirador
It basically service many states.
Jay Cohen
Yes, I do remember you guys doing that. That's helpful.
Thanks Gabe.
Gabriel Tirador
Good.
Operator
[Operator Instructions] Your next question comes from Ron Bobman from Capital Returns. Your line is open.
Ron Bobman
Hi, gentlemen. I had a question on rates.
Obviously it sure seems like everybody in the business is pushing rate. And I'm wondering if you could talk a little about retention, maybe regionally, but also are you seeing less shopping and, thus, better retention?
And maybe all companies are doing so by virtue of the common lift in rates that all carriers are pushing. I'd be curious to get your thoughts and your view.
Thanks.
Gabriel Tirador
I'll let -- Robert why don't you talk about retention, because this is better than we expected actually.
Robert Houlihan
Yes, certainly in California, as you say, it's sort of a rising tide. We're seeing rate increases and underwriting actions from all of our competitors.
And with the rate increases, our new business application counts have held steadier, perhaps moved up slightly. And our retention is only down a point or so despite all the rate that we've taken.
Gabriel Tirador
And to give you an idea of a similar rate action, we have a lot of rate activity that has already occurred. In addition to that, we have a lot of rate funds that are pending.
You've got Geico, Allstate, Farmers, Infinity, 21st Century, Safeco, [Indiscernible], Progressive, State Farm, the Northern Club all with pending 6.9 or thereabouts rate increases pending.
Ron Bobman
Thanks. And I'd be curious to know whether the state is taking any different approach time line-wise as far as approving the 6.9s.
And I think the 6.9 is the typical threshold without having a hearing, but correct me if I'm wrong. And then could you comment about other states and what's going on retention and rate-wise, sort of the same question, but as you look at your other states?
Thanks, guys.
Gabriel Tirador
Robert?
Robert Houlihan
Yes. So, a couple of questions.
So, time-wise, the reviews with the department have actually been quicker than historical timelines. So, that hasn’t been an issue outside of California.
It’s a little bit of mixed bag. There are some states where the rate increases are moving us into a less competitive position.
Thus you know some of Gabe's comments about the slowdown in growth are actually declined in premium because we're becoming less competitive in a few states than we have seen some decline in retention in few states as our rates have become a little bit uncompetitive.
Ron Bobman
I would have thought it would be more common. We hear from so many auto companies about pushing rate but I guess it varies by state so you're seeing the differential.
Thanks, guys and best of luck.
Gabriel Tirador
Thank you.
Operator
I have no further questions at this time. I turn the call back over to presenters for closing remarks.
Gabriel Tirador
Well thank you very much for joining us this quarter. We look forward to talking to you again next quarter.
Thank you.
Operator
Thank you everyone. This concludes today's conference call.
You may now disconnect.