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Mercury General Corp
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Good morning. My name is Erica, and I will be your conference operator today. At this time, I would like to welcome everyone to the Mercury General Fourth Quarter 2018 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, you may begin.
Thank you very much. I would like to welcome everyone to Mercury's fourth 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 Chris Graves, Vice President and Chief Investment Officer.
Before we take questions, we will make a few comments regarding the quarter. Our fourth quarter operating loss was $0.26 per share compared to $0.15 per share operating income in the fourth quarter of 2017. Included in the fourth quarter of 2017 results was a $0.13 per share tax benefit from the Tax Cuts and Jobs Act of 2017. Included in the fourth quarter of 2018 results was a $0.07 per share tax benefit from the reversal of an IRS rule related to sequestration adjustments from the 2017 Tax Act.
In addition, operating earnings deteriorated due to an increase in the combined ratio from 104.5% in the fourth quarter of 2017 to a 106.7% in the fourth quarter of 2018 and a lower corporate tax rate applied to the company's underwriting loss in 2018, partially offsetting the year-over-year reduction to operating earnings with an increase in after-tax investment income from $26.9 million in the fourth quarter of 2017 to $28.6 million in the fourth quarter of 2018.
The combined ratio in the quarter was significantly impacted by catastrophe losses, primarily from wildfire losses in California. Catastrophe losses net of reinsurance were $43 million in the fourth quarter compared to $20 million in the fourth quarter of 2017.
In addition, we recorded $5 million of reinsurance reinstatement premiums earned in the quarter compared to $3 million in the fourth quarter of 2017. Unfavorable reserve development was $23 million in the quarter compared to $36 million in the fourth quarter of 2017.
Excluding the impact of catastrophe losses unfavorable reserve development and ceded reinstatement premiums earned the combined ratio was 98.6% in the quarter and 95.6% for the 12-month period ending December 31, 2018 compared to 97.2% and 96.9% for the quarter and 12 month period ending December 31, 2017, respectively.
To improve our combined ratio, we have been increasing rates in most states. In California, a 6.9% personal auto rate increase in California Automobile Insurance Company was recently approved by the California Department of Insurance. The rate increase is expected to be implemented in March 2019.
A 6.9% personal auto rate increase for Mercury Insurance Company is pending approval with the California Department of Insurance as was 6.9% rate increase in our California homeowner’s line. California Personal auto and Homeowners premiums represent about 77% of our direct companywide premiums earned.
After-tax investment income increased 6.5% to $28.6 million. The increase in the after-tax investment income in the quarter was primarily due to higher short-term interest rates and increase in invested assets and a lower corporate tax rate.
Investment income in the quarter was down from the third quarter of 2018, primarily due to adjustments in investment income accruals related to investments in private funds.
Companywide private passenger auto new business applications submitted to the company increased approximately 1% in the quarter and companywide homeowners applications increased 9% in the quarter.
With that brief background, we will now take questions.
[Operator Instructions] And your first question comes from Christopher Campbell with KBW.
Hi, good morning, gentlemen.
Good morning.
My first question is on the core loss ratio. That was up about 170 bps year-over-year, so is there anything one-time in that number like elevated non-cat weather and property or any like prior accident year auto true ups from the first three quarters?
No. I mean, I think we always mentioned that the fourth quarter from a seasonal standpoint is usually higher. We mentioned that in the last conference call that we expect the fourth quarter to be higher.
We also had, as you -- as I noted earlier in my prepared remarks, we had some adverse development in the quarter. And as a result of that adverse development, we increased the picks to -- for the more recent accident year.
Okay. Got it. So the core loss ratio, so the 75.9% also includes kind of higher picks for 2018 as well?
Yes.
Okay, got it. And with that stuff you were just seeing in 1Q or does the prior period development. I guess, what accident years is the prior period development coming from?
Hi, Chris, this is Ted. The vast majority is from '16 and '15.
Okay, got it. And was there any like 1Q '18 or 3Q '18 on that as well?
We really just look at our development on an accident year basis. The estimate for individual quarters within a year, have some relative volatility to them, so we think those quarters development is less meaningful than that of the annual period. So we just prefer to look at it annually rather than quarterly.
Got it. And I noticed in some of the 1Qs like the past few years like reserve development has kind of spiked in some of the first quarters. Is there anything special you're doing then in terms of review that just maybe taken a deeper dive there that we could maybe expect some adverse development in 1Q as well?
I don't think so. We essentially use the same process every quarter. We don't weighted one way or another by quarter. What happened in '18 in Q1 is we did see some development trends spike up and we reacted to that fairly meaningfully in the first quarter and that's why we probably thought additional development earlier this year and than in the middle of the year.
Got it. Mostly just California, are you seeing that in your other states as well?
California.
Got it.
The historical trends have definitely increased. Our development factors are higher now than historical trends. And we think that there has been a change in the environment over the last several years here in California. There has been increased medical procedures, aggressive attorneys, we've had more policy limit demands than before. And they tend to impact the older accident years, because they're the bigger claims.
And as a result of that, we've been taking a look at and saying, look, we got to increase the development factors for the more recent accident years. So it's had an impact on the more recent years as a result of that.
So we hope it stabilizing. We hope we're getting closer to stabilization. We've introduced various procedures here in the claims department as well to try to mitigate the impact of this new environment, and we're hoping that in 2019 we will have a more stable environment.
Got it. Very helpful. And then just kind of a question on, obviously, with the -- you guys had a big gross losses on the wildfires. How does that impact your reinsurance renewals? And I guess just what happened with your rate online, you're purchasing all of that kind of stuff?
Well, our treaty is July 1 renewal date, so we haven't begun process of renegotiating or redoing the treaties for this year. We expect there will be some increase in the rates modest probably based on the early indications and discussions we've had, that's kind of how we see it right now.
Got it. And then how would that -- obviously, it's been two years in a row that you've been hit with the loss, I guess just, how are you thinking about your retentions going into that renewals? Like is there an opportunity to lower those, or I guess just...
It's pretty low right now.
Yes. Our retention right now is only $10 million. We may be looking at increasing the limit on the top end. So right now, our limit goes up to $200 million and we may increase a limit on the top end a bit.
Okay, got it. Because you're just probably to the tower [ph] Okay, great. That's all the questions I had. Thanks for all the answers. Best of luck in 2019.
Thank you, Chris.
[Operator Instructions] Your next question comes from Samir Khare from Capital Markets.
Hi. Good morning. I was wondering if you can talk about how the company calculated their gross cat losses for the wildfire some of the assumptions, the average severity et cetera?
Yes, we gone through a fairly detailed process. We segregate out all of the total losses and assume policy limit. We evaluate the policy limit and assume that for several of the coverages they're going to hit the policy limit and on some of the smaller coverages, there will be some percentage of the policy limit.
Total losses make up something like 90% of the dollars of the cat loss. So if you get that right, you're going to be pretty close to your estimate and your booking policy limits, the chances for development on those is significantly reduced. But partial we look at -- partial losses we look at claims from previous events that are similar in nature.
And so for example, for the 2018 fire, we have pretty good history from the 2017 fires. And we apply average severity is, I guess, expected claim counts to come up with the ultimate losses on partials.
Okay. And what are you guys assuming, what average spread you guys assuming for the partials?
I don't think we're in a liberty to disclose that right now. Just that it was comparable to last year to '17.
Okay. And then you mentioned that the - I think 90% of the dollars loss is coming from total claims -- claims that are totaled. What percentage of claims is attributable to total losses?
The actual count -- claim count?
Yes, exactly.
On the Camp Fire, it's actually more than half. On the Woolsey, it's significantly less than half.
In the camp everything burned down.
Yes, camp just gone.
Yes.
Okay. And specifically on the Camp Fire, do you have the gross paid in IBNR for that matter you just bring up.
Yes, I don't think we're disclosing that. Our ultimate -- our gross ultimate is $206 million on Camp and a large percentage of that has already been paid out as of year-end.
Okay.
In the nutshell, we feel good about where -- what we've done from a procedural standpoint to estimate our gross losses.
Okay. And just in general for all the wildfires, any sign a risk of demand surge that could increase loss estimates from here?
Well, if you're booking most of it at policy limits, our obligation -- our policy limits on the total losses as Ted mentioned.
Okay. And then as the company bought any backup coverage for reinsurance from now until the renewal date, or do they intend to do so?
We have existing limit on our most of the layers of our treaty that -- if another significant event happen between now and June 30, we'd be on the hook for the first $40 million. And then beyond that, I think $3 million then we're -- we have reinsurance for something like $160 million.
Got it. Okay, thank you. And just on the loss trends that you guys are experiencing in California. You guys noted that you guys are converted some of your MIC book to 12-month policies. How much of that book is now 12-month policies? And I'm just asking and I'm hoping to understand if that will -- it will take longer for any earn -- any rate to earn in?
The majority of the in-force book is still six month policies. I don't have the exact statistics, but it's well over 50% is still six month policies.
Okay. All right. I appreciate it. I'll re-queue. Thank you.
Okay, thanks.
And there are no further questions at this time. And sir, we do have one question from the line of Ron Bobman from Capital Returns.
Hi, thanks a lot. I had a question about the -- through the go-forward reinsurance tower purchase, with the Camp Fire generating in excess of $200 million of loss and with your such sort of modest participation of 5% looking backwards between the $200 million and $400 million sort of tranche of your tower.
I would think that you're going to be -- that you'd be wise to buy a good bit more and I know you touched on it, I think in Chris Campbell's question, but could -- it would seem to me that you'd be buying a good bit more, could you discuss that and what magnitude that might be?
Currently, we have that layer you're talking about is $300 million excess of $200 million and we placed 5% of that in the last couple of years. Really, one of the main reasons why we only place that the fraction of that was to get to set a price. So now we sort of have a baseline price, because we felt like sometime in the future, we may want to place more of that or possibly even all of that.
So now we kind of have an anchor of a price from the past or at least on a fraction of that, which will allow us to be at a better position when we go forward to buy more of that in the July 2019 renewal.
Yes. And I think there's a good chances, we are going to buy more. How much more we will have to wait and see, but I think there is a very good probability that will buy more. It would seem with the Camp Fire just sort of delivering such significant losses one wildfire taking you through the -- in effect through your tower that you bought nowhere near enough and that the magnitude of the incremental by necessary to protect the balance sheet is so much greater than what you bought historically. Am I thinking about it wrong or...
No. I mean, I think you're thinking about it right. I mean we bought just about the right amount is what it ended up having, but we do think that there's good likelihood that we're going to buy more coming in July.
Yes, I would just add that the Camp Fire was unprecedented. It was a lot of worst wildfire in California history. And so, when it kind of look at it that way, the level that we bought was really for an event of that nature. And in essence, we sort bought the appropriate reinsurance.
But that said, our view of risk changes over time. And as more of these fires are burning in California, we are looking at that higher limits on the reinsurance to protect our capital.
And not only that we're trying to learn from this event, trying to find other areas that we may be exposed similar to Camp, and noted from an underwriting standpoint, trying to learn from it as well. So it's a combination of both underwriting and buying more reinsurance is what we're looking at.
The 2017 wildfires were unprecedented until 2018, right?
That's true.
Yes.
And then, you mentioned policy limits, and do the policy actually -- they don't specify a dollar number. Could you discuss about sort of how an insured sort of determines the policy limits on a homeowners' policy when you have a total loss like, is it simple and straightforward or is there more to it?
No. There is a specified dollar limit on the policy. And it's different coverages. So there's policy limit for the dwelling. There's a policy limit for living expenses. There's another limit for personal property. And -- but it's all -- it's very quantifiable to have the exact dollar.
All right. Thank you very much, gentlemen.
Thank you.
And we have an additional question from Samir Khare with Capital Returns.
Hi, thanks for taking my second question. I just wanted to ask on the subject of the AM Best downgrade in December. Has anything changed in the production front either volume, quality of business or your acceptance rates of the business coming in?
No. There's been no -- absolutely nothing from that. I mean, we're still an A-rated company and there's been zero impact.
Okay. And then previously, you've said that you'd be comfortable with rating up to a net premium to equity ratio of up to 2.5%, which you're approaching? Given that you have the lower AM Best rating now, are you comfortable with the higher underwriting leverage ratio?
Well, a lot of our business is PPA auto. So with prior passenger auto, we're more than comfortable actually writing at even a higher level than that. So we're going have to watch it with respect to the mix of business as rewrite more homeowners. The ratios would -- that we target would change, but we feel comfortable where we're at right now.
Okay, great. Thank you.
Thank you.
And there are no further questions at this time.
Well, thank you for joining us this quarter and we hope to bring you better results in the first quarter of '19.
Thank you. This does conclude today's conference call. You may now disconnect.