Logo of jester cap with thought bubble.

Image source: The Motley Fool.

Mercury General Corp  (NYSE:MCY)
Q3 2018 Earnings Conference Call
Oct. 29, 2018, 1:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, my name is Jemaria and I will be your conference operator for today. At this time, I would like to welcome everyone to the Mercury General Third Quarter Conference Call. (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 -- Chief Executive Officer

Thank you very much. I would like to welcome everyone to Mercury's third quarter conference call. I'm Gab 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 am pleased to report our third quarter operating earnings were $1.11 per share compared to $0.60 per share in the third 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 95.6% in the third quarter of 2018 compared to 99.3% in the third quarter of 2017. The combined ratio in the quarter was aided by premium rate increases, lower catastrophe losses and a lower 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 for 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. California personal auto and homeowners'premiums represent about 77% of our direct companywide premiums earned.

Net catastrophe losses were $13 million in the quarter, primarily the result of the car firing read (ph) in California. This compares to $19 million of net catastrophe losses in the third quarter of 2017, primarily from Hurricane Harvey in Texas and Hurricane Irma in Florida and Georgia. During the quarter, we recorded $6 million of unfavorable prior-year reserve development, down from both the first and second quarter of 2018. The development in the quarter came primarily from our auto line of business. The expense ratio was 24% in the third quarter compared to 25% in the third quarter of 2017.

The lower expense ratio was primarily due to lower average commissions and a slight reduction in other operating expenses, coupled with a large increase in earned premiums. Advertising expense was $12 million in both the current and third quarter of 2017. Excluding the impact of catastrophe losses, unfavorable reserve development and ceded reinstatement premiums earned, the combined ratio was 94.5% for the nine-month period ending September 30, 2018 compared to 96.8% for the nine-month period ending September 30, 2017. After-tax investment income increased 24% to $33.5 million. The increase in the after-tax investment income was primarily due to higher short-term interest rates and 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 8% in the quarter and companywide homeowners applications increased 16% in the quarter. Earlier this month, Hurricane Michael caused significant damage in Florida as well as in Georgia and Virginia. At this time, based on the information currently available, we believe our ultimate losses from Hurricane Michael will be in a range between $4 million and $8 million, which will be recorded as losses in the fourth quarter.

Our catastrophe reinsurance treaty provides for $205 million of coverage in excess of our $10 million redemption. Lastly, we generally expect your combined ratio in the fourth quarter excluding catastrophes to be higher than the rest of the year due to increased loss frequency and higher severities caused by seasonal driving and weather. That said, it is hard to predict with certainty whether the underlying combined ratio will be higher, as there are many factors currently unknown or beyond our control.

With that brief background, we'll now take questions.

Questions and Answers:

Operator

(Operator Instructions) And your first question will come from Greg Peters with Raymond James. Please go ahead with your question.

Greg Peters -- Raymond James -- Analyst

Good morning. Based on what I see here, it looks like this third quarter results is the lowest combined ratio that you guys have produced in something like the last 10 years. Is that right read?

Gabriel Tirador -- Chief Executive Officer

Yeah, I believe that's right, Greg.

Greg Peters -- Raymond James -- Analyst

Congratulations.

Gabriel Tirador -- Chief Executive Officer

Thank you.

Greg Peters -- Raymond James -- Analyst

I know it's been a hard-fought battle. So I know you mentioned in your opening comments about some pending rate increases that are -- two are in the auto and one's in the homeowners line, I believe. Given that the underlying and reported results are trending favorably. Do you believe there's less possible is those rate -- those rates are going to be approved?

Gabriel Tirador -- Chief Executive Officer

No, we still think that they will be approved. I think the indications show that we need the rates. In Cal Auto, I think in the mass quarter we talked about the fact that we were expecting approval. Additional questions came in from the Department not necessarily really based on whether or not we needed the rate, but just some additional questions and I believe we've answered those questions in Cal Auto and we do expect to have approval sometime in the near future in Cal Auto. In MIC, again the rate templates from the Department of Insurance suggests that we do need the rate based on the trend.

And although we don't expect that rate to go into effect until 2019, probably Spring or mid of 2019 is our best guess right now. And same really with the homeowners rate decline (ph) that we filed earlier this year. When you take a look at the rate templates that we filed, it clearly shows that based on the trends that we need the rate, I don't know, Robert, you want to add anything.

Robert Houlihan -- Vice President and Chief Product Officer

I really would -- don't have much to add to that commentary.

Greg Peters -- Raymond James -- Analyst

Okay, well, that's good color. On the prior-year development, obviously it's been -- you talked in earlier conference calls about some of the trends that we're popping up that were causing this year's adverse development, at least through the nine months to be worsen last year's result through the nine months, but the trend is improving as less unfavorable development. Can you talk about where we are with that and I know the fourth quarter has some volatility around it. But should we look at this improving trend and think that maybe you got the reserve issues resolved?

Robert Houlihan -- Vice President and Chief Product Officer

Well, we definitely are baking the trend into our selections -- their ultimate selections. We've gone through a period of the last several quarters, maybe four to six quarters where the underlying development was more than expected and that did moderate in the third quarter, which gives us some hope that this will be the end of adverse development going forward. But it's hard to tell, because things change and we look at the fast track data and it looked like the industry in California was moderating a bit in the last quarter or two. So that's also a good sign.

Gabriel Tirador -- Chief Executive Officer

Yeah, definitely better this quarter. But I think we mentioned last quarter our historical trends when we were forecasting forward, they were coming in higher. There's some actions on the link factors that we were selecting were coming in higher, but it appears to me at least that that's starting to stabilize which is why you saw in the third quarter less development. Whether or not that continues in the future, we don't know.

Greg Peters -- Raymond James -- Analyst

Right. Well, I know Gabe, you've talked for several years about your stated objective of 95 combined ratio. And I assume as part of that stated objective, you assume that there is not going to be negative or adverse reserve development, you assume that reserves are going to be adequately set. Is that the right read?

Gabriel Tirador -- Chief Executive Officer

We do not not assume any development, one or the other.

Greg Peters -- Raymond James -- Analyst

So we're -- some, if you're catching up on the reported side, maybe you're catching up on the reserve side too or maybe that would be what I refer from your results. Can I -- can we spend a little bit talking about the operating expenses, they were down a little bit in the third quarter. Were there some discretionary items that you just withheld back on or just talk to us a little bit about what the ebb (ph) inflow of underwriting expenses in the quarter?

Robert Houlihan -- Vice President and Chief Product Officer

Our operating expenses were fairly, I think they were flat in last year's third quarter. One of the things, I think, is really helping the ratio is really our growth in earned premium. We are growing that at a lot faster rate than we are of the operating expenses. Our ad spend, I think, was the same in the third quarter this year compared to last year.

Gabriel Tirador -- Chief Executive Officer

And our effective commission rate is down, that's helped and that's variable. So the effective commission rate is down. That's going to help, and we've been monitoring our expenses making sure our from an expense standpoint that were tight with the budget. So I think it's a combination of all those factors that are helping the expense ratio.

Greg Peters -- Raymond James -- Analyst

Can you just expand for a second on the commission rates being down, I'm surprised by that comment, usually agents are reluctant to give up commission?

Robert Houlihan -- Vice President and Chief Product Officer

Well, we are talking about maybe I think in the, overall maybe two or three-tenths of a point down year-over-year is my recollection and our commissions in California are variable and they're based on the profitability (ph) of the book of business and it's a three-year trading number that we use, so that has been trending down a little bit. We've also made some changes to our commission structure we were paying through certain type of business more and other types of business less, so a combination of all those factors have driven down the expense ratio or the commission rate here in California a little bit. I'm not talking about a lot, I think it's two or three-tenths of a point here in California.

Gabriel Tirador -- Chief Executive Officer

And we take our annual commission rate adjustments that is effective with the July 1st for all our agents, so if the commission rates typically go down, you would expect to see that in the second half of the year.

Greg Peters -- Raymond James -- Analyst

Right. And one more underwriting question and then I have a question for Chris. On the non-California business, can you comment about is Florida still a shrinking auto market for you or is that stabilized in a position to start growing again and talk about the other states as well.

Gabriel Tirador -- Chief Executive Officer

Florida was down in the quarter, was still down in the quarter, posted a very good combined ratio in Florida in the quarter, but the top line was down. Overall, outside of California, our premiums were up about 2% for prior passenger auto and about 5% up in the homeowners outside of California on the top line and I think as I mentioned earlier from an application count standpoint, in the third quarter we were up 7.9% in applications for private passenger auto for the entire quarter, about 8% up in California and about 7.2% up outside of California in the quarter. So some of the states that are growing, but Texas is growing on the top line in the half (ph) count, New York, Oklahoma.

The states that are down are -- the two primary states that are down are Florida and Virginia.

Greg Peters -- Raymond James -- Analyst

Great, thanks for that color. And I know you, in your prepared remarks, talked a little bit about investment income, but it really was a whopper of a quarter for you, maybe you could give us more details about that, is the 38 million a new run rate to expect going forward, et cetera. Chris, this would be a good opportunity for you to chime in as well.

Christopher Graves -- Chief Investment Officer and Vice President

Yeah. Hi, Greg. Going back to several years, we were sort of positioning the portfolio to be more sensitive to LIBOR rates. We're definitely seeing the benefits of both positioned, particularly through our CLO investments, we've been putting more capital toward investment grade CLOs and so that helps and then obviously just higher rates in general. We've seen quite a big move this year which is allowing us to see more and more opportunities to buy fixed income that's accretive to our book yield, which has not been the case for some time. We've been challenged to maintain where we were and that's no longer been the case. We can actually add some pretty good balance now and see a pickup in yield. And we're not having to stretch for anything either. We can get pretty good credits and not have to take a lot of risk.

And then dividends, we're seeing more dividend bumps come through. The equity investments have helped. So all of that combined has put some good winds to our back this year. I really can't speak toward the run rate. It's hard to say, but I'm certainly feeling pretty good about where we are right now.

Gabriel Tirador -- Chief Executive Officer

The only thing I would add to that is our investment balances have also -- has been one which is up as well.

Robert Houlihan -- Vice President and Chief Product Officer

Yeah. And that's something else -- that's a good point, Gabe. Mercury's business, when it does well, doesn't put any strain on me, and as you can see, our investment balances have really picked up and has translated into investment income pickup. And if you go back over the history, we are approaching investment -- annualized investment income numbers that we haven't seen in 10 years but on a much higher balance, so I think you can -- as rates normalize, I think you can start to speculate that investment income is going continue to do better.

Greg Peters -- Raymond James -- Analyst

So -- certainly the last two quarters have been particularly noteworthy so and the third quarter was a blockbuster, no doubt. Well, listen, I'm sure there's other analysts that want to ask questions. Congratulations on your quarter.

Gabriel Tirador -- Chief Executive Officer

Thank you, Greg.

Operator

(Operator Instructions) Your next question is from Christopher Campbell with KBW. Please go ahead with your question.

Christopher Campbell -- KBW -- Analyst

Yeah, hi, good morning, gentlemen.

Robert Houlihan -- Vice President and Chief Product Officer

Good morning.

Gabriel Tirador -- Chief Executive Officer

Hi, Chris.

Christopher Campbell -- KBW -- Analyst

I guess my first question is on the premium growth, so looks like it maybe like 250 bps was from the -- of the growth this quarter, year-over-year was from the 12-month policy reintroduction, but if you back that out, you're still seeing 7% growth. So I guess like if you're decomposing that, how much of that would be exposure versus rate, because I noticed the auto and the home were picking up this quarter.

Gabriel Tirador -- Chief Executive Officer

Yeah, it's probably about 2% on the policy growth, the rest on rate.

Christopher Campbell -- KBW -- Analyst

Okay, so 2% would be exposure and then the other 5% excluding the policy introduction would be rate.

Gabriel Tirador -- Chief Executive Officer

Yeah. In that ballpark.

Christopher Campbell -- KBW -- Analyst

Okay, -- that's really helpful. And I guess just you know kind of another question on the reserves, I think Greg asked a few. So just looking at the reserves in last few years, it looks like the adverse reserved government seems to be the lowest in the third quarter and kind of heavier in the other three quarters of the year. Is there anything seasonal in terms of your review process that wouldn't -- that would kind of bias the third quarter to be lower than the other -- the other quarters of the year.

Gabriel Tirador -- Chief Executive Officer

We follow the same process every quarter, so that's an interesting observation, but I don't think there is anything biasing one way or the other.

Christopher Campbell -- KBW -- Analyst

Okay. And there is no like different data that you use for a quarter depending or is it just you have the same inputs every quarter?

Gabriel Tirador -- Chief Executive Officer

The same input, same process.

Christopher Campbell -- KBW -- Analyst

Okay, got it. And then just kind of finally like a high level one on the regulatory environment in California. So I guess is merger (ph) we get more profitable, does this kind of create a heightened risk that regulators might order the rate go-backs that I think were like they were rumored a few months ago? And then just secondary one on that is like how could the November elections kind of sheet California's regulatory environment going forward?

Gabriel Tirador -- Chief Executive Officer

We'll let Robert talk about the prescribed formula that we have here in California with respect to rates, then I can shift -- chime in on the election.

Robert Houlihan -- Vice President and Chief Product Officer

Yeah, on the rate filings, it's subject to return on surplus formula. So only to the extent that that formula would yield a decrease turn the department force reduction in rates and right now as we discussed earlier, we have two pending increases which we think are supported. The department is company hasn't filed in a period of time. The department has right to come and request a filing, but other than that, there is no mechanisms for a rate rollback.

Christopher Campbell -- KBW -- Analyst

Okay, got it. I thought like the commissioner was like ordering like his staff to review all of the rates now, when would that be a risk I guess or does that vary by line. So I know you guys are catching up in homeowners, but if auto is becoming more profitable, does it become more of a risk for auto versus homeowners?

Robert Houlihan -- Vice President and Chief Product Officer

I was going to say the department can request a filing to be reviewed for a potential decrease, but we already have pending filings going through the process right now. So there is nothing above and beyond that. Everything I can think of is there was some kind of (inaudible) out, maybe what you're referring to is on when the taxes went down.

Christopher Campbell -- KBW -- Analyst

Yeah, that's it.

Robert Houlihan -- Vice President and Chief Product Officer

That's what I think you're referring to, but we've already incorporated the lower tax rate into our filings. So I think that's what you're referring to is that the Commissioner came out and said, hey, we're going to look at the rates, you know lower tax rate, but those lower tax rates are in the form of that we're -- that we have for our filings.

Christopher Campbell -- KBW -- Analyst

Okay, so that's already baked into the 609 (ph) you have going in Mercury and then in Cal Auto. So that's already got the lower tax rate. And you are still asking for 609 (ph), correct?

Robert Houlihan -- Vice President and Chief Product Officer

Yeah, those filings already reflect the lower tax rate.

Christopher Campbell -- KBW -- Analyst

Okay, got it.

Gabriel Tirador -- Chief Executive Officer

And as far as the election, I'll just make the comment that we don't think whoever gets elected will be any more adverse than what we have today, that's my feeling.

Christopher Campbell -- KBW -- Analyst

Okay, that's very helpful. Thanks for all of the answers, and best of lock in rest of the year in 2019.

Gabriel Tirador -- Chief Executive Officer

Thank you.

Operator

And at this time, there are no further questions. I would now like to turn it back over to the panel (ph) for any closing remarks at this time.

Gabriel Tirador -- Chief Executive Officer

We'd like to thank you for joining us for the third quarter and we hope to bring you some good news as well in the fourth quarter. Thank you very much.

Operator

This concludes today's conference call. You may now disconnect.

Duration: 24 minutes

Call participants:

Gabriel Tirador -- Chief Executive Officer

Greg Peters -- Raymond James -- Analyst

Robert Houlihan -- Vice President and Chief Product Officer

Christopher Graves -- Chief Investment Officer and Vice President

Christopher Campbell -- KBW -- Analyst

More MCY analysis

Transcript powered by AlphaStreet

This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see our Terms and Conditions for additional details, including our Obligatory Capitalized Disclaimers of Liability.

Motley Fool Transcribers has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.