Jul 31, 2017
Executives
Gabriel Tirador - President & Chief Executive Officer George Joseph - Chairman Ted Stalick - Senior Vice President and Chief Financial Officer Robert Houlihan - Vice President & Chief Product Officer
Analysts
Greg Peters - Raymond James Alison Jacobowitz - Bank of America Merrill Lynch Wesley Guiley - Wesley Guiley Capital
Operator
Good afternoon. My name is Krista and I will be your conference operator today.
At this time, I would like to welcome everyone to the Mercury General Second Quarter 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 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 questions, we will make a few comments regarding the quarter.
I’m pleased to report our second quarter operating earnings of $0.68 per share improved significantly as compared to our second quarter 2016 operating earnings of $0.35 per share. The improvement in operating earnings was primarily due to an improvement in a combined ratio from 101.7% in the second quarter of 2016 to 97.8% in the second quarter of 2017.
Our results in the quarter were negatively impacted by $10 million of catastrophe losses, primarily caused by severe Midwestern weather, including tornadoes in Oklahoma. In addition, we recorded $10 million of unfavorable reserve development, which came primarily from our commercial lines of business.
This compares to the second quarter of 2016, which had $11 million of catastrophe losses and $22 million of unfavorable reserve development. Excluding the impact of catastrophe losses and the unfavorable reserve development, the combined ratio was 95.3% in the quarter.
The improvement in the combined ratio was primarily due to an improvement in our personal and commercial auto combined ratio. Our second quarter auto combined ratio was 97.2% compared to 104.6% in the second quarter of 2016.
Partially offsetting the improvement in our auto combined ratio was a deterioration in our homeowners and California commercial property combined ratio. Our homeowners combine ratio was 98.9% in the second quarter of 2017 compared to 91.4% in the second quarter of 2016.
In our California commercial property line of business, several large losses negatively impacted the results in that line. We posted a combined ratio of 129.9% in the quarter compared to 84.9% in the second quarter of 2016.
Historically, our California commercial property line has produced favorable underwriting results. The expense ratio was 24% in the second quarter compared to 25.4% in the second quarter of 2016.
The lower expense ratio was primarily due to a decrease in acquisition costs, a lower advertising spend and cost efficiency savings. To help offset increasing loss trends, we have been increasing rates in most states.
In California, we implemented a 6.9% personal auto rate increase in California Automobile Insurance Company effective in May and a 6.9% rate crease in our homeowners’ line is going into effect in August. In addition, a 5% rate increase is pending approval with the Department of Insurance for Mercury Insurance Company.
Personal auto premiums in Mercury Insurance Company represents about half of our companywide premiums earned and California Automobile Insurance Company represents about 14% of our companywide premiums earned. California homeowners premiums represent about a 11% of our companywide premiums earned.
Premiums rent grew 2% in the quarter, primarily due to higher average premiums per policy. Companywide private passenger auto new business applications submitted to the company decreased approximately 9% in the quarter as we continue to focus on improving profitability in our private passenger auto line.
The 9% decline in new business application is an improvement over the 16% decline we experienced in the first quarter of 2017. Companywide, homeowners applications were relatively flat in the quarter.
With that brief background, we will now take questions.
Operator
[Operator Instructions] Your first question comes from the line of Greg Peters with Raymond James. Your line is now open.
Greg Peters
Good morning. Thank you for the call, Mr.
Joseph and team, great. A couple of questions for you.
First of all, just if I step back and look at big picture with the net premium written only up about 2%, both in the second quarter pretty much approximately on a year-to-date basis, I’m curious why the top line seems to be stalling when you’re getting these rate increases approved and implemented?
George Joseph
Well, it’s primarily a result of lower application. It has an impact on our new business applications and it also has an impact on retention as well.
I will say that most of that is coming from outside of California. I think in the quarter, our California new business applications for private passenger auto were relatively flat, but they were down quite a bit over 30% to be outside of California.
So when you combine it, the apps were down about 9% or so, but it’s really just a function of less new business applications and renewal applications being written in total.
Greg Peters
Okay. And is there a period in time later this year, will anniversary the difficult trends in new business apps, or is that something that is likely to occur in 2018?
George Joseph
I think that the new business apps are going to continue to have an impact on the renewal business, for instance, in the next few quarters. So I think, we mentioned at the end of last year that, we were expecting relatively minor growth in 2017.
As far as 2018, we don’t have any guidance for you on that yet.
Greg Peters
Okay. So switching gears to the margin improvement of the combined ratio, when I look at the second quarter result, it appears that a part of the reason for the improvement was both a lower policy acquisition cost and other operating expense ratio.
And I’m curious what the drivers were behind the improvement in those two components in the second quarter?
Gabriel Tirador
Ted, you want to…
Ted Stalick
Hey, Greg, it’s Ted here. So the expense ratio was favorably impacted, as Gabe mentioned earlier.
Q1 and Q3 are typically are higher advertising spend and Q2 and Q4 are lower quarters for advertising spend. So that low advertising spend is going to definitely help the expense ratio.
And then we have a slightly lower acquisition costs and some operating efficiencies, they’re also reflected in the 24%. We do expect that the third quarter expense ratio will take back up to be closer to the 25% range, that’s been earlier.
Greg Peters
I see. And was - has the advertising budget for the full-year 2017 is that down compared with the full-year 2016, or is it flat?
Ted Stalick
Well, it’s down maybe a few million dollars.
Greg Peters
Okay.
Ted Stalick
Year-over-year.
Greg Peters
Okay. Another question for you is just regarding reserve development.
If I look at the results for the first-half of the year, last year in 2016, it seem like the at least what you’re reporting was it most of the adverse reserve development related to auto liability, and the first-half of this year, it seems to have migrated over to the property book. Should we take some sauce from the result this year to infer that the auto liability reserve position has stabilized or, am I reading too much into it?
Ted Stalick
Well, we expect the auto reserve liability has stabilized, there’s minimal development. And if you remember, the numbers last year were quite large, I think, $80 million or something like that for the whole year, and there’s quite a bit of that to happen in the first-half of the year.
And this year, it’s pretty much isolated to some very large losses at the commercial property lines.
Greg Peters
Okay.
Gabriel Tirador
The development factors are much more stable when we take a look at historical factors, that’s the year they had jumped up quite a bit. But now over the last several quarters, we’ve seen those development factors triangles to be much more stable.
Greg Peters
Okay, Gabe. And I’ll - one last question then I’ll requeue.
You said the underlying combined ratio ex-reserves and caps was 95.3. Is - I think that - is that your target, or is your target for underlying lower than that?
Gabriel Tirador
Our target historically has been a 95% combined ratio.
Greg Peters
Is that including caps and development, or excluding?
Gabriel Tirador
That’s everything.
Greg Peters
Okay. Thank you, all.
Thank you for your answers and I’ll requeue.
Gabriel Tirador
Okay.
Operator
[Operator Instructions] Your next question comes from the line of Alison Jacobowitz with Bank of America Merrill Lynch. Your line is now open.
Alison Jacobowitz
Hi, thanks. I was wondering if we could - if you could talk about expenses a little bit more and maybe what you’re doing with commissions?
And then if it’s possible, if you could just quantify a little bit how much of the lower expense rate is few specifically to ad expensing, or commissions, et cetera?
Ted Stalick
Well, the commissions are adjusted periodically. And Alison, we’ve had a gradual downward trend in our average commission rates probably for the last several years.
And so that just continuously get reflected in the results. The second part of your question was around the ad spend.
Could you clarify the second part of your question?
Alison Jacobowitz
Yeah, I don’t know if you could quantify, maybe just give us a little bit more mathematically the effect, I know you talked about the seasonality, but I didn’t know, if there’s a way you can quantify how much - what the effect is by quarter of these items on the expense ratio?
Ted Stalick
Yes, let me see it right.
Alison Jacobowitz
You may not have, I get it, but…
Gabriel Tirador
While he’s looking for that information, Alison, I will note that, our commissions have been coming down over the last several years. But in California, our average commission rate, ballpark, was around 16%, which is still above probably several points above industry average.
Outside of California, I would say, it’s closer to 13%, which is still a very competitive commission rate. So, although, the commission rate has been helping us, it’s been trending downward.
And in California, it’s been trending downward as a result of the fact that the profitability hasn’t been there as well. So that our base rate commission has been trending downward.
It’s still several points, as I mentioned earlier above the competition and again outside of California, we’re at about 13, and that’s pretty close to where the competition is at.
Ted Stalick
And on the ad - the ad expense - the second quarter is more than a full point lower than the first quarter was on the expense ratio.
Alison Jacobowitz
Thank you.
Operator
[Operator Instructions] Your next question comes from the line of Greg Peters of Raymond James. Your line is now open.
Greg Peters
Thank you for allowing me to ask a follow-up or two. There seems to be a lot of emerging technology around smartphones and apps that have the potential to help reduce and/or affect distracted driving.
And I’m just curious if you have a perspective on some of these products if you’ve looked at them and if you’re beginning to think about them, as it relates to your book of business?
Gabriel Tirador
It is something that we have looked at, and in fact, I’ve tested. I’ve actually tested it myself, put it - the app on my phone and they say, I’m not as good as a driver as I think I’m.
But anyway, Robert, you want to mention some of the stuff we’re doing there?
Robert Houlihan
Yes, we’ve certainly been monitoring this space. We’re looking at doing a test in commercial auto using a smartphone app for user space insurance.
On the personal line side, it’s an intriguing development and helps lower the cost of UBI program relative to the older approaches downward and upward diagnostic port. We still have some concerns in the independent agent channel how this can be sold without just sort of cannibalizing business we would have otherwise sold at a higher rate?
And I’d say, we’re intrigued by the technology and we’re doing some testing in commercial auto. But on the personal lines, we’re just continue to monitor at this point.
Greg Peters
Perfect.
Robert Houlihan
And I will say, Greg, in our biggest market in California, you’re not allowed to use these devices for how you drive. The only way you can use these device is for your annual miles then you drive in the other means to get the annual mileage.
So in California, which is our biggest market, and we do have a program to verify mileage in California.
Gabriel Tirador
Yes, we have a verified mileage program in California. So this would be really right now, I think something everybody want outside of California.
Greg Peters
Great, that an excellent color. I guess, one final question.
I realize Mr. Joseph has probably got at least another 20 years left in the tank, and frankly, I’m jealous.
But one of the most frequently asked questions I get from other smaller shareholders is about the state plans for Mr. Joseph stock.
So I said with the sincerest respect for Mr. Joseph and everyone, I was wondering if there’s some sort of relevant update or answer you could provide me would be helpful?
George Joseph
Yes. Well, I own about 17% of the stock and my ex-wife owns - well, I’m sorry, I own 35% and she owns 17%.
So we have an agreement with her, which probably won’t be applied until it’s through her state. Mercury and/or me have an option to buy her stock, she has to present it to us first.
My wife is quite a bit younger than I’m, and we don’t need to sell stock for state purposes. We have provided other liquid investments to take care of whatever estate tax would be assessed among wife’s or my wife - ex-wife, no either my death or my wife’s death, whichever occurs later, was upon my death, as you know, there was really be no estate tax today.
And my wife is about 30 years younger than I’m.
]
Greg Peters
Thank you for that color, Mr. Joseph.
Does this sort of your 30%-plus stock then just transferred to your wife in 20 years from now when you meet or make her?
George Joseph
This in her trust, and she is the beneficiary of the trust. And there’s provisions in the trusts that restricts her right to sell a stock.
Greg Peters
Excellent.
George Joseph
Because the intent is that the stocks stays even after her death stays in the family.
Greg Peters
Excellent. And I have no other questions on that subject.
I really appreciate your answer. Congratulations on the quarter, everyone.
Gabriel Tirador
Thank you, Greg.
Operator
Your next question comes from the line of Wesley Guiley with Wesley Guiley Capital. Your line is now open.
Wesley Guiley
Good morning. I’d like to ask Gabe and Mr.
Joseph, if in view of these higher rates that are coming in and the more stable development in the prior results, as well as a lower expense ratio. Does the company expect to go back and meet its goal of a 95% combined ratio looking ahead into the near future?
Gabriel Tirador
Wesley, we don’t forecast or we don’t give any guidance, but that is definitely our goal. Our goal is to hit a 95% combined ratio.
Although, we don’t provide guidance as to when we’re going to think - when we think we’re going to hit that, but that is our goal.
Wesley Guiley
All right. Yes, I don’t mean putting a date on this thing.
But I’m wondering if the top management is comfortable enough with that goal, looking at the sharply improved results of this quarter?
Gabriel Tirador
Yes, that’s - we - a lot of it depends on loss trends, and what happens with loss trends and we’re trying to stay above on track with the loss trends, but which is why we keep making clients for trend, right?
Wesley Guiley
Right.
Gabriel Tirador
To we keep making clients for trend. And if we’re successful there and we keep, there’s a lot of things going on in the company right now.
I won’t say this. We’ll have to try and improve every aspect of the business, whether it’s on the expense side or on the indemnity side on the plains, underwriting, market segmentation, agent relationships.
Every facet of the business right now is focused on trying to improve the probability of this company. So…
Wesley Guiley
So you’re - it’s pretty clear that you’re focused on trying to get this profitability up to where it should be, which in my mind would reflect the company’s long-term combined ratio goals?
Gabriel Tirador
That is correct, that that’s our objective. That’s our objectives.
Wesley Guiley
All right. I’m wondering if Mr.
Joseph is comfortable with that as well?
George Joseph
I don’t, nobody is comfortable with the 95 provided there’s some growth unless.
Wesley Guiley
Yes, I Agree. Okay, it looks like the - there’s a deceleration of this cutback in new business applications and that should help in the future as well?
Gabriel Tirador
Yes.
Wesley Guiley
Thank you very much.
Gabriel Tirador
Thank you, Wes.
Operator
[Operator Instructions] And we have no further questions at this time, sir.
Gabriel Tirador
Okay. Thank you for joining us this quarter.
We look forward to talking again next quarter. Thank you very much, everyone.
Operator
And this concludes today’s conference call. You may now disconnect.