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Mercury General Corp
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Good morning. My name is Kelly, 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. Please, sir, go ahead.
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, Senior Vice President and CFO; and Robert Houlihan, Vice President and Chief Product Officer. On the phone is 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 were $0.88 per share, compared to $0.68 per share in the second quarter of 2017. The improvement in operating earnings was primarily due to an improvement in the combined ratio, an increase in after-tax investment income, and a lower corporate tax rate.
The combined ratio was 96.9% in the second quarter of 2018, compared to 97.8% in the second quarter of 2017. The combined ratio in the quarter was aided by premium rate increases and lower catastrophe losses, and negatively impacted by an increase in unfavorable reserve development, $4.7 million of reinsurance reinstatement premiums earned, and a higher expense ratio.
To improve our combined ratio, we have been increasing rates in most states. In California, a 5% personal auto rate increase in Mercury Insurance Company went into effect in March. A 6.9% personal auto rate increase from Mercury Insurance Company and California Automobile Insurance Company are pending approval with the California Department of Insurance.
In addition, a 6.9% rate increase in our California Homeowners line was filed in May. Personal auto and homeowners' premiums in Mercury Insurance Company and California Automobile Insurance Company represents about 77% of our direct companywide premiums earned.
Catastrophe losses were $2 million in the quarter, compared to $10 million in the second quarter of 2017. $21 million of unfavorable reserve development in the quarter came primarily from our commercial lines of business and an evaluation of ultimate loss adjustment expenses on our California personal auto line of business in light of increasing defense costs in an increasingly litigious environment.
The expense ratio was 24.3% in the second quarter compared to 24% in the second quarter of 2017. The higher expense ratio was primarily due to an increase in advertising and possibly related accruals, partially offset by lower average commissions and cost efficiency savings. Advertising expense was $9 million in quarter, compared to $6 million in the second quarter of 2017.
Excluding the impact of catastrophe losses, unfavorable reserve development, and ceded reinstatement premiums earned, the combined ratio was 95.2% for the six-month period ended June 30, 2018, compared to 97% for the six-month period ending June 30, 2017. After-tax investment income increased 11% to $31 million. The increase in after-tax investment income was primarily due to higher short-term interest rates, an increase in invested assets, a lower corporate tax rate, and higher yields obtained on certain classes of investments.
Companywide private passenger auto new business applications submitted to the company increased approximately 20% in the quarter, and companywide homeowners' applications increased 14% in the quarter. Lastly, the Carr Wildfire in Northern California has been burning since last week. At last report, the fire has destroyed over 800 structures, and is approximately 20% contained. As of this morning, 11 total loss claims, one partial loss claim, 16 evacuation claims, and two renter claims have been reported to the company. Our catastrophe reinsurance treaty provides for $205 million of coverage in excess of our $10 million retention.
With that brief background, we will now take questions.
[Operator Instructions] Your first question comes from the line of Greg Peters from Raymond James. Your line is open.
Good morning everyone. I had just a couple of quick questions for you. First, around the pending 6.9% rate increases, is there -- have you outlined an expectation around timing on when the insurance commissioner might provide you the green light on that?
On the Cal Auto one I believe that was filed sometime last September or so -- mid September. So that one is closer, I would say, to getting approved. The Mercury Insurance Company one that was just filed in April, I believe, so that's a more recent one. So the Cal Auto, our expectation is to get approved within the next few months, would you say, Robert, historically at least?
Yes, certainly. We've received questions and we've corresponded with the department. There's no outstanding issues, but we're still working through additional questions are coming in from the department. So we think there'll be progress on that in the very near future.
Robert, is it true that these -- it seems like from the time you make the initial filing to the time there's resolution one way or the other takes about a year. Is that an accurate read on it or am I missing something?
That's accurate, although we kind of break it down as to whether there's an intervener in the process or not. And generally, if there's no intervener it's been a shorter time -- a little bit shorter timeframe than that.
But the intervener only gets involved if the rate increase is in excess of 6.9%, correct?
Interveners can be on any filing. The rule around the 6.9% is if the increase is above that amount and the intervener requests a hearing they must be granted a hearing. If it's less than that it's at the commissioner's discretion as to whether to grant a hearing. But there can still be interveners on filings below the 6.9% and below.
Okay.
Now, we don't have one in the Cal Auto one, the 6.9%, that we don't have one on that. And we don't have one on the Mercury Insurance Company one as well.
Okay. So the second question is just around the combined ratio. You obviously showed a nice improvement in the second quarter, congratulations. And with the 95.2%, I'm going to call it an underlying combined ratio. Is it your expectation that that 95.2% should hold through the balance of the year or should better? Again the 95.2%, as I understand it, excluded catastrophes, reserve development, and reinsurance reinstatement premium, to clarify.
I mean, I think it'll depend on trends really, on what happens with loss trends and whether or not the rate increases that we have, that are still earning in, by the way, because the Mercury Insurance one went into effect -- I think the 6.9% went to effect in March. So we're going to still benefit from that going forward. It'll depend on the trends, whether or not the trends have stabilized or will stabilize. The Fast Track numbers do indicated that the first quarter severity came down a little bit for -- Ted, you want to share that?
Yes. So the Fast Track BI for California came down to 5.6% in the quarter. And overall paid severities are -- trended down for other coverages in the quarter. So that may be an indication that the inflationary pressures are moderating somewhat in California.
So if they stabilize at these levels the 95.2% could hold or get even better, right, if the rate increases continue to roll through or earn premium?
Yes, I mean I guess it's possible either way.
Yes, right. I got it -- okay, I'm not -- I'm not trying to put you in a box, sorry about that.
No, I -- we don't like to forecast combined ratios or operating earnings. We never have…
But you do have a -- you have a combined ratio target for the company, correct?
We do, and that's 95%, that's correct.
Is that 95% including all-in, including catastrophes, higher period reserve development?
Yes.
So the actual underlying combined ratio would be lower, the 95.2% on a -- if you were to, apples-to-apples, should actually be below that because you're going to assume there was going to be some catastrophe losses in any given year. Is that --?
That's a reasonable assumption that that's our goal.
Okay. That something below 95% is your -- underlying is your goal?
As you're defining it, yes. I think it's correct, yes.
Okay, perfect. And I don't mean to parse words here, but…
Yes. No, that's accurate. Well, our goal is to have a 95% combined ratio companywide all-in. That's our goal.
Got it, thank you for the clarity on that.
Sure.
And then I guess, and I know there's other people that are going to ask questions, so I'll just -- I'd like to ask Chris a question whenever I get a chance. And so it looks like the yield is up in the quarter. You did a real nice job of improvement investment income. And I'm just curious if the current run rate is sustainable, or are there some puts and takes that might moderate as we work through the balance of the year?
Chris, you want to handle that?
Yes. Can you hear me okay?
Yes.
Yes, okay, good. I'm calling in on a cell phone. Yes, there's some give and take going on in the portfolio. For example, on the municipal bonds we've still got some pretty nice book yields in the portfolio at current rate, still on place, in most cases at levels that can be accretive as bonds roll off. But on the flipside, we've got short rates rising, which was with the fed. We've got the portfolio more sensitive to short rates through CLOs, bank loans, and then the cash balances themselves. So in fact with those three together it's about 10% of the portfolio. So that makes us pretty sensitive each time the Fed moves rates up. The benefit…
Chris, did you say…
Yes.
Chris, did you say CLOs is part of that 10%?
Yes.
Okay.
CLOs are, I think, about 3% of the portfolio right now, and that's an increasing exposure that we're going to continue to build. And so with the benefit also of the company's -- with this quarter's good results and everything, that also adds wind in my back. So I can't say, yes, this is a sustainable rate just yet. But I certainly feel good about the numbers that I'm turning in right now.
Okay, fair enough. Thank you everyone for your answers.
Thank you, Greg.
And your next question comes from the line of Rob Bobman from Capital Returns. Your line is open.
Hi, thanks a lot. I had two topics I wanted to ask you about. When you mentioned, Gabe, the adverse development, I think I heard to say -- just wondered if you would repeat it and maybe expand on it a little bit. But you started out saying that there was an element that that was the commercial book, but then you also referenced the personal auto. Could you correct me if I heard it wrong, and maybe expand on it a little bit?
Yes, it was a combination of both commercial lines of business loss side, and also on the personal auto loss adjustment expenses. Basically our defense costs are going up as we're defending more of these claims with bodily injury.
Should we think of the $20 million being like half and half, commercial being half and the defense cost element on personal auto is that in the ballpark?
That's pretty close.
Okay. And then separate and apart from that, the app count growth was pretty significant on both auto and home. What's going on there, what's driving that?
I think it's a combination of factors. I think there's been rate increase activity going on in the market. And as a result of that our close ratio has improved. In addition to that, there's been more quoting. So a combination of increased quoting activity and close ratio improvement as a result of, I believe, rate increases. Although it appeared to me, and Robert, I don't know if you want to mention anything here, that the more recent month rate increases, it looks like it started to slow down the number of rate increases and the magnitude of rate increases.
Yes, I would say the rate increase is -- more shopping. We've also shifted our advertising spend more towards California. We generated more business in California because of the shift in ad spend. So I think it's a combination of more shoppers, from more rate increases in the marketplace, and a slightly bigger ad spend in California driving growth in our auto and homeowners in California.
Thanks.
And our rates being competitive, I think the close ratio improved the Dow.
Is the legal representation -- back to the sort of adverse development and the LAE burden, is that geographically weighted? I mean are you seeing it more in a certain part of the state or -- not clear?
Well, I think I mentioned last quarter. I've seen it either throughout the whole state, but Southern California I would say is worse.
Okay. History repeats itself I guess.
Yes.
Okay. Thanks gentlemen, and a good quarter. Hope it continues.
Thank you.
And your next question comes from the line of Christopher Campbell from KBW. Your line is open.
Yes. Hi, good morning.
Good morning.
I guess my first question is the reserve additions. If I'm just looking at the last few quarters you guys have had about $100 million in the last three quarters. So at what point do you decide that this California BI issue might be bigger, and that you need to take maybe a larger reserve charge to kind of put it behind you once and for all?
Well, we essentially evaluate the reserves every quarter. And we pick our best estimate based on the data that's available and our view of what's going to happen in the future. And so what you're talking about is putting a bias into our estimate, biasing it higher or low. And we don't bake bias into our reserve analysis. What we do is we have -- the company creates its own internal analysis, and we have external actuaries create their own analysis independently, and then we sort of compare those analyses. And typically they -- the differences are not significant, and we come up with our point estimate from that process. But as far as taking sort of a big bath or a big charge to put it behind us, that's just not something that we do.
I'd also like to point out that I think the last couple of years the environment has changed, there's no question about it, especially here in California from a BI perspective. And the historical loss development factors that were chosen they've been changing because of the environment changing, and I think once that stabilizes and those factors become more stable, the accuracy of reserves are going to be much more stable as well.
So, and I think we are getting closer to that. It's not an exact science as you know, reserving. So that's -- we basically try to make our best estimate of the numbers. We use outside actuaries. We have internal actuaries, and we try to get to that best estimate. But there is no question that the change in the environment here in California has caused us to be off of some historical trends.
Got it. And are you loss development factors, I mean are they materially different if you look at that versus California and non-California?
I think the way you would look at it is that they are changing for as you progress through the triangle, whereas you look at some of the other states and we have favorable development in more than half of our states outside of California, and those have very stable development pattern. California has progressively increasing development patterns as you go across the triangle, and that was what Gabe was describing earlier, we think this is much more challenging to get ahead of the reserve.
Got it. That's very helpful. And I was reading on the press release that you started introducing or reintroducing 12-month policies, so any difference, any changes you are doing in your piping reserve, to kind of factor in that you might not be able to re-price so quickly, if there -- I mean you get the estimate -- you get like the first-half, is that incorrect?
Certainly in the indication process, we consider how long the next rate level be in effect, and that certainly affects that calculation, the higher percentage for annual policy. So, in that respect, we take it into consideration.
Okay, great. And then, I saw like the strong premium growth, part of that was reintroduction of the 12-month policies, but are you seeing any benefit from the Axis bankruptcy?
Yes, we did. And our non-standard auto company showed significant growth there.
Okay. And then, like, so are you doing -- so, is it coming in…
Yes.
So, what are the rates on that versus like what that look like people are -- yes, the Axis bankruptcy, like, how are they up or are they down, and then kind of -- is there indication that how much higher your prices are than Axis' were?
Based on some samples that we took, you know, looking at their previous policy, substantially higher.
Okay. Got it, that's very helpful.
That would the reason that they're no longer in business.
Right, yes, yes. There has been some other non-standard carriers that have been picking up business from that as well.
Yes.
And there is one follow-up, numbers, tax rate was a little lower, is that just the more investment income versus underwriting income, that kind of mixing this quarter or adding special?
Well, if you look at our effective tax rate in 2018, now we are under the benefit of the lower Federal tax rate. Our investment income effective tax rate is around 10%, and underwriting income and capital engagement losses are around 21%. So that's sort of how the math works out, and it depends on the relative weight of those components of income.
Okay. Gabe, thanks for all the answers. Best of luck in the third quarter.
Thank you.
Thanks.
[Operator Instructions] Your next question comes from the line of Greg Peters of Raymond James. Your line is open.
Thank you. Thanks for letting me ask a follow-up. Actually two follow-ups; first of all, on the unfavorable development in the auto, not the commercial auto, the auto side, you said most of it is skewing -- or a portion of it is skewing from Southern California, I know you are pretty thoughtful in how you segment your customers, and I'm curious if there has been any predisposition to one segment being more at risk for these reserve adjustments than another segment?
When we take a look at our reserves in total, we don't segment our total reserves based on segments. Pricing is a different matter. We know obviously we do consider territory from a pricing standpoint, and that -- we take that into account, but when we take a look at our reserves and calculate our total reserves, we are not taking Southern California and calculating a reserve for Southern California and one for Northern California. We take a look at our whole book of business. First of all, we have more credibility. And second of all, from a pricing standpoint, there is no question that we take territory into account.
Got it. And then I think you mentioned that there is favorable development outside of California, and I know that's been a business that hasn't been growing for you, and I'm curious now that you seemingly turned the corner around development, these favorable development, I'm wondering if your growth profile is going to change for states outside of California?
Actually in this quarter outside of California, we actually saw a slight increase in our new business applications, and private passenger auto, they grew about 2% -- 2.3% outside of California. We've got a lot of initiatives going on trying to make it easier for our agents, we have new software that we are implementing in the next couple of weeks, we have improvements in segmentation that we've been working on, on the underwriting as well. So we are hopeful that all the things that we are working on are going to improve not only the top line but also our bottom line.
And are there -- would you like to call any other states that are working, you are seeing some sense of optimism or you are just -- like to leave it with that?
I would just say that most of the states right now are well below 100 Fed. And some of our bigger states, Florida -- I mean, Texas actually I think grew a little bit.
Okay.
And Florida was down a little bit, is my recollection of the two biggest states. But overall like I said, from an application count standpoint, which is something that we monitor…
Yes.
- our application count this quarter was up slightly.
And that's the first time in a while, correct?
Yes, yes. I mean because if you take a look at the year-to-date, application counts are down like 10%.
Right. But I mean going back over for an extended period of time, that's been shrinking market for you, so…
Yes, yes.
Do you feel like…
We are hopeful that -- we are hoping that we can continue that trend.
Yes. It sounds like you may have turned the corner there. Last question around advertising, you talked about moving around some of the pieces within the company, I'm wondering if the overall budget has changed for the full-year, and how it compares with the previous year?
It's up slightly. I think our budget this year is up $2 million or $3 million, and we expect to spend around $40 million tax.
Yes. Great, thank you again for your answers.
Thank you.
And there are no further questions at this time.
Well, great. Thank you for joining us this quarter, and we look forward to talking with you in the third quarter. Thank you very much.
And this does conclude today's conference call. You may now disconnect.