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Mercury General Corp (NYSE:MCY)
Q2 2020 Earnings Call
Aug 3, 2020, 1:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, my name is Michelle, and I'll 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 upon 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 go ahead.

Gabriel Tirador -- President and Chief Executive Officer

Thank you very much. I would like to welcome everyone to Mercury's second quarter conference call. I'm Gabe Tirador, President and CEO. On the phone, we have Mr. George Joseph, Chairman; Ted Stalick, Senior Vice President and CFO; Jeff Schroeder, 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. Net income in the second quarter was $228.2 million or $4.12 per share, which includes a $125.2 million of after-tax gains on our investment portfolio. The rebound in the markets in the second quarter, helped to partially offset first quarter after-tax losses of $198.5 million on our investment portfolio. Year-to-date, net income was $89 million or $1.61 per share, which includes $73.4 million of after-tax losses on our investment portfolio.

Most of the year-to-date investment losses are mark-to-market adjustments on securities that continue to be held by the Company. Our second quarter operating earnings were $1.86 per share compared to $0.74 per share in the second quarter of 2019. The improvement in operating earnings was primarily due to a reduction in the combined ratio from 98.3% in the second quarter of 2019 to 88.2% in the second quarter of 2020.

Catastrophe losses in the quarter was $12 million compared to $9 million in the second quarter of 2019. The Company recorded $12 million in unfavorable reserve development in the quarter compared to $9 million in the second quarter of 2019. The improvement in the combined ratio in the quarter was primarily due to improved results in our private passenger auto line of business. Lower frequency in the quarter as a result of less driving from the COVID-19 pandemic was the primary reason for the improved results. The lower frequency in the quarter was partially offset by an increase in severity and the give back of $100.3 million of premiums to personal auto customers as a result of less driving from the COVID-19 pandemic.

Partially offsetting the improved results in our private passenger auto line of business were worst results in our commercial auto, homeowners and commercial multi-payer lines of business. Although our commercial auto line of business also saw a decline in frequency in the quarter, increases in severity, unfavorable reserve development of $7 million and the give back of $5.5 million of premiums to commercial auto customers negatively impacted our commercial auto results in the quarter. In our homeowners line, both frequency and severity increased in the quarter. In addition, $3 million of unfavorable reserve development negatively impacted our homeowners results this quarter.

To improve our homeowners results, a 6.99% rate increase in our California homeowners line went into effect in April. In addition, a 6.99% rate increase was recently approved by the California Department of Insurance. We expect to implement the recently approved rate increase in October. California homeowners premiums earned represent about 87% of companywide direct homeowners premiums earned and 15% of direct companywide premiums earned.

Our commercial multi-payer results in the quarter were negatively impacted by a large $5 million fire loss net of reinsurance. In the second quarter, we launched two new programs. In June, we introduced our new personal auto usage-based insurance product MercuryGO in Texas. Early adoption rates are encouraging and above our expectations. We also introduced Phase 1 of our new commercial multi payroll product and system in California in the second quarter. The new product and system have been well received by our agents.

We recently completed our catastrophe reinsurance treaty renewal effective July 1, 2020. The total reinsurance limit purchased increased from $600 million in the prior period to $717 million for the July 2020 through June 2021 period. In addition, the new reinsurance program has wildfire coverage in all layers. Our retention remains the same at $40 million. Total annual premiums on a new reinsurance program are approximately $50 million. For the prior reinsurance treaty, total premiums were $38 million. More details of the catastrophe reinsurance treaty renewal will be included in our second quarter 10-Q filing.

The expense ratio was 27.2% in the second quarter of 2020 compared to 24.4% in the second quarter of 2019. The higher expense ratio in the quarter was primarily due to the reduction of premiums earned of $106 million due to premium refunds and credits to eligible policyholders for reduced driving and business activities as a result of the COVID-19 pandemic. Excluding the premium refunds and credits, the expense ratio would have been 24.1%. Premiums written declined 12.5% in the quarter primarily due to the $106 million in premium refunds and credits. Excluding the $106 million in premium refunds and credits, premiums written declined by 1.2%.

In addition, we plan on returning $22 million of July 2020 monthly premiums to eligible policyholders in August. Accordingly, we expect third quarter premiums written and earned to be reduced by approximately $22 million. We will continue to monitor the extend and duration of the economic impact related to COVID-19 and make further adjustments as necessary. We expect our underwriting and loss adjustment expense ratios to remain elevated in the third quarter as premiums declined from give backs without a proportionate reduction in expenses.

With that brief background, we will now take questions.

Questions and Answers:

Operator

[Operator Instructions] Our first question comes from Greg Peters of Raymond James, your line is open.

Greg Peters -- Raymond James -- Analyst

Well, good morning to you. Good afternoon to those listening on the East Coast. I first wanted to just give everyone a heads up, I had some trouble getting accessing the call this morning or this afternoon, depending on your time zone, we're asking for a conference ID. I don't know if that's normal or not. But let's pivot back to the results and your announcement around the $22 million of [Technical Issues].

Can you talk about the mechanics around that number? And if you are having favorable frequency continue in July and maybe an extent in August to September, is it reasonable to assume that this give back or refund is going to continue for the near term?

Gabriel Tirador -- President and Chief Executive Officer

Let me go ahead and have Jeff talk about the give backs. Jeff?

Jeffrey M. Schroeder -- Vice President and Chief Product Officer

Yeah. We saw continued frequency obviously declines through the month of June and into the month of July. Hence the give back, that Gabe just talked about for July. As far as that continuing in the subsequent months, we are going to continuously evaluate that and depending on how frequency moves over the next couple of months, we will potentially make adjustments, and to give back and extend that for those particular months. But it's a little early for us to tell at this point.

Gabriel Tirador -- President and Chief Executive Officer

You know I'll add that we -- I'll add that we did see an increase in upward slope in frequency as compared to April and May and June and July. So as Jeff mentioned, we'll just continue to monitor every month and we'll adjust based on the information that's coming in and severity is rising as well. So, offsetting some of the frequency benefits, but no question that there was an upward slope in frequency in the month of June and July, as compared to April and May.

Greg Peters -- Raymond James -- Analyst

Right. Just continuing on with that being in that concept, how is the -- how has the interaction been with the California Department of Insurance? I know if I look at your second quarter combined ratio result that's well below their mandated target. So I'm just curious how the regulatory authorities are getting involved with your process at this point?

Gabriel Tirador -- President and Chief Executive Officer

Well, I'm not sure what you mean by, it's well below our mandated target. I don't think I agree with that.

Greg Peters -- Raymond James -- Analyst

I'm sorry, I thought there was a 96% combined ratio sort of threshold. Maybe, I mis --

Gabriel Tirador -- President and Chief Executive Officer

No, no, there was no threshold of 96% that I'm aware of. They have a template that you have to file and that template has the maximum that you can take, based on the template. And I'll remind you that before COVID, we had rate pending. We had in both companies, I think on one or five, and another one, four or something like that pending because of severity increases and I'll add that the template allowed for quite a bit more rate increase. So prior to COVID, there was no question that we needed rate and the template allowed for quite a bit more rate then we were asking for.

Greg Peters -- Raymond James -- Analyst

Thank you for the clarification. So can you just, you know just as the final piece of that, how is your interaction with the California Department been as you're announcing these programs. So are they just accepting it or are they getting involved or I think you characterized before is they were just asking you to do something and leaving it up to you.

Gabriel Tirador -- President and Chief Executive Officer

Yeah, that's basically how it's been. We -- they basically are allowing companies to do whatever give back that they see fit, and they are not ordering any kind of specific give back.

Greg Peters -- Raymond James -- Analyst

Got it. Thanks.

Gabriel Tirador -- President and Chief Executive Officer

And there is no filing required.

Greg Peters -- Raymond James -- Analyst

Okay. Thank you for the clarification, Gabe. I appreciate it.

Gabriel Tirador -- President and Chief Executive Officer

Sure. No problem.

Greg Peters -- Raymond James -- Analyst

Can we pivot to the reinsurance? So more limit, the retention is still $40 million. Is that $40 million per event or is it aggregate in the quarter? Or just help us and maybe you can give us look into your crystal ball and tell us what you think the fire season is going to look like in the third and fourth quarter?

Gabriel Tirador -- President and Chief Executive Officer

Well, that's always hard to predict. But Ted, do you want to talk about the reinsurance?

Theodore R. Stalick -- Senior Vice President and Chief Financial Officer

Yeah. Hi Greg. So it's $40 million per event. We did buy more limit. I would like to mention that PG&E came out of bankruptcy on July 1, and that put into place the utility industry's subrogation fund, which will cover 40% of future losses caused by their equipment. So we see that as a favorable toward cat losses in the third and fourth quarter. We've already started having some fires, here, there is a big one out in Riverside County, but so far, I don't know if any structures have been burned and it seems to be going up into the -- into the mountains. So we'll see what happens the rest of the year. Normally the wildfires are the worst when the Santa Ana winds come in, which is generally later in the fall.

Greg Peters -- Raymond James -- Analyst

Great. Can you -- can you just go back and walk us through that 40%? How does that work? Let's say if there is an event that costs you $100 million, is $40 million of that going to -- on a gross basis, $100 million on a gross basis, is the $40 million of that covered by subrogated to PG&E or walk us through how that works? Obviously, there's got to be some blame involved with them, but.

Theodore R. Stalick -- Senior Vice President and Chief Financial Officer

Well, it would be -- if the loss was caused by their equipment and that it's shown to be caused by their equipment. My understanding is, yes, then this fund has been set up where the insurers can submit their claims and get the 40% reimbursement back from the fund.

Greg Peters -- Raymond James -- Analyst

Is that done before or after reinsurance?

Theodore R. Stalick -- Senior Vice President and Chief Financial Officer

So in that example, the $100 million that would net down to $60 million and then you would see -- and you would cede off under our treaty where our retention is at 40%, you would cede off a amount above $40 million up to the $60 million --

Greg Peters -- Raymond James -- Analyst

The $20 million. Perfect, thank you for that color. How many events -- do you have a first event, second event? How many events are covered under your treaty?

Theodore R. Stalick -- Senior Vice President and Chief Financial Officer

Our limits are, we have one reinstatement.

Greg Peters -- Raymond James -- Analyst

Got it.

Theodore R. Stalick -- Senior Vice President and Chief Financial Officer

So, and then once you exhaust the second reinstatement, you don't have any coverage. So you could have theoretically a dozen events that fall within the layer, but haven't exhausted the layer.

Greg Peters -- Raymond James -- Analyst

Okay. Thank you. I guess one other question just around operations, you mentioned your concentration in California, but you also highlighted some initiatives that are going on outside of California. I think you mentioned the Texas initiative in particular. Do you expect when we get to the end of the year that your non-California premium will be higher or the same as it was last year or lower?

Gabriel Tirador -- President and Chief Executive Officer

We -- I'm not going to predict that. There's just too much uncertainty going on right now, Greg, I'd rather not predict that. All I can tell you is that we're working on improving our segmentation outside of California. We have a new product that we launched Mercury Advantage in quite a few states and the launching of that product has increased new business significantly in the states that we've launched it, and we plan to continue to launch it in most of the rest of the country later this year and into next year as well.

We've got the MercuryGO program as well, the usage based program that's going well. But there's just too much uncertainty for us to predict where premiums are going to land. I will say that for the most part we -- not for the most part, we are keeping our underwriting discipline. So we're taking a long-term view in all our states, I would say that we are keeping our underwriting discipline going forward. So I'm not going to predict, but there are a lot of things in motion that I think that from a product standpoint that are positive.

Greg Peters -- Raymond James -- Analyst

Great, thank you for the answers. The final question just would be to Chris regarding investments. Just looking at the year-over-year and six months, both on the quarter and the six month basis, the average yield is down. Can you give us some perspective on how the new money rates compare with the existing portfolio yield? And given what's going on in the interest environment, where the new level will normalize that?

Christopher Graves -- Vice President and Chief Investment Officer

Yeah, well, yeah, I think you probably know much of that answer. And that is the new rates compare quite unfavorably to my average rates and where we were just six months ago. So cash rates are getting -- they are approaching zero. New money rates, the 10-year treasury, 55 basis points, AAA municipal bonds about 65 basis points. So it's sort of a bit of a spread on that and you're looking at 1%,1.5% out on the curve with significant duration risk. So how long are we going to be in this environment?

Big election coming up. I think that's part of the answer, but I think we can expect to be at these low rates for some time to come. And so yeah the comparisons are going to be challenging. We're evaluating different options, certainly taking more risk say on equity is an option, but it's, we have a very conservative investment policy, and we're actually getting up against those types of restrictions. Dividend yields are attractive compared to fixed income, but again the risk there is certain tolerances that we don't want to have to consider breaching. So we're going to keep pushing the best we can. And I think you could, but I think you kind of already understand that it's probably the most challenging environment we've ever been in.

Greg Peters -- Raymond James -- Analyst

All right. It certainly looks like that. Listen, thank you everyone for your answers. I appreciate the time.

Gabriel Tirador -- President and Chief Executive Officer

Thank you, Greg.

Operator

[Operator Instructions] Our next question comes from Ron Bobman of Capital Returns. Your line is open.

Ronald Bobman -- Capital Returns Management -- Analyst

Hi, thanks a lot, and hope everyone's well. I had a question about agent compensation. My understanding is that the carriers in sort of a uniform fashion, even in light of sort of the give back on consumer premiums basically not adjusted agent commissions. And I assume that isn't changing. But I'm wondering if you could confirm that that would be great. But I was really wondering about sort of incentive compensation that some of the agents may have whether it's sort of be in particular sort of profitability based. Have there been any adjustments to the sort of profit based compensation programs to incorporate the impact of COVID and the give backs? Thanks.

Gabriel Tirador -- President and Chief Executive Officer

Well, to answer your first question on base commissions. You're correct, base commissions have not been adjusted and for the give backs. As far as contingent commissions, we haven't made a determination on that yet.

Ronald Bobman -- Capital Returns Management -- Analyst

Got you. Okay. And would you say that the -- your peer group is sort of largely in the same spot. It's sort of to be determined. Or have some declared positions to your knowledge?

Gabriel Tirador -- President and Chief Executive Officer

I don't know about all our competitors. I don't know. I'm not sure.

Ronald Bobman -- Capital Returns Management -- Analyst

Okay. Okay. And then if you don't mind, I remember, not too long after the fires. I remember you, I think you sold your subrogation rights to I guess a third party for some of the, I guess, fire losses. And I'm wondering if there -- if you have any other remaining sort of fire losses that are sort of either subject to subrogation from the utilities or potentially could -- I guess could be sold, is there or is everything sort of baked as far as prior year's fire losses? As far as baked as meaning your losses are sort of -- they are what they are going to be, and there's not -- there's not a lot of uncertainty or variability to subrogation opportunities. Thanks.

Gabriel Tirador -- President and Chief Executive Officer

Ted, you want to handle that?

Theodore R. Stalick -- Senior Vice President and Chief Financial Officer

Yeah, so the -- you're right, we did sell these subrogation rights to a third party, although we kept our subrogation rights to the 2017 fires, which was the generally known as the Tubbs Fire. And we received an initial payment from the PG&E trust I think just last week. Now that subrogation and any future subrogation came from fully reinsured losses. So all those monies will be returned to our reinsurance partners. So there is really no net reduction in losses for Mercury from that subrogation.

I will mention there was a small benefit to the company from a reduction in reinstatement premiums, previously paid on those losses. And that was a little under $2 million that we did record in the second quarter numbers. As far as subrogation, we do have wildfires from Q4 2019, the Saddleridge Fire, which was in Southern California and the Kincade Fire, which was in Northern California. Those -- both of those were under our reinsurance retention and it hasn't been determined yet whether those events were caused by the utilities equipment, although there is some evidence that both of them were. So there is the potential for some subrogation on those two events, but right now it's -- that's unclear.

Ronald Bobman -- Capital Returns Management -- Analyst

Great, thanks for the color. If there is deemed to be sort of culpability from the equipment, the earlier mention about the California reimbursement fund and the 40% that you mentioned. Would these Q4 2019 fires and your losses potentially be eligible for reimbursement from that fund that you mentioned earlier?

Theodore R. Stalick -- Senior Vice President and Chief Financial Officer

I'm not exactly sure, but I believe that's correct and I also think that the -- the 40% kind of sets the benchmark for where those claims would be paid out of anyway. So that's all I really know. I think our ultimate losses on those two claims were in the $25 million to $30 million range right now.

Ronald Bobman -- Capital Returns Management -- Analyst

Okay. What do you mean by the benchmark of 40%? Why you chose the word benchmark? What's that mean?

Theodore R. Stalick -- Senior Vice President and Chief Financial Officer

All I mean by that is that as these -- as all these fire claims have come in over the years, there has been different varying levels of subrogation as a percentage of incurred losses that have been paid out. And now you have this fund, it's essentially saying we're going to guarantee you a 40% payout. So what I meant by benchmark is, if there is prior claims that are not eligible under the fund, they'll probably look toward this 40% rate as kind of the standard of what you pay.

Ronald Bobman -- Capital Returns Management -- Analyst

Okay. I can follow up if I still have a question.

Theodore R. Stalick -- Senior Vice President and Chief Financial Officer

Yeah.

Ronald Bobman -- Capital Returns Management -- Analyst

Thanks and be well.

Gabriel Tirador -- President and Chief Executive Officer

Thank you.

Operator

Our next question comes from Corey Wrenn of Pecaut & Company. Your line is open.

Corey Wrenn -- Pecaut & Company -- Analyst

Good morning, good afternoon from here in the Midwest. I had a couple of questions. The first one was given the low interest rates that you're seeing, low returns on invested -- on investments that you're seeing, have you rethought your dividend or your stock repurchase policy at all? It seems like the dividend yield is much higher than the dividend -- or the return you can give on the investment?

And then my second question is that, obviously we've entered into a more technological world. You see the online sales numbers going from 18% to 28% things like that. And then you have an upstart like a company called Lemonade, which says they can capture, I don't know who knows what the numbers are 100,000 data points when you log into their site and things like that. Have you ever -- have you thought about how you can use technology more in the business? And given that, how does having an agency based model work in today's world? Thank you.

Gabriel Tirador -- President and Chief Executive Officer

Let me, first, I guess answer the first question as far as the dividend. This is something that the Board reviews on a quarterly basis and makes determination on a quarterly basis. And based on our prospects, our earnings, the coverage and a lot of factors. And so it's something that we just review every quarter. So I'm going to leave that at that. We just, as you know, announced a dividend this quarter as well, a $0.63 dividend.

As far as online, Lemonade, yeah, I mean I know of them, I mean 100 data -- 100,000 data points, which I think you're referring to is potentially the segmentation. We obviously have data warehouse and we resegment our business as well. We're continually trying to update our segmentation. I mentioned earlier that we launched our Mercury Advantage program outside of California, which significantly improves our segmentation and we've seen very positive results with respect to Mercury Advantage.

In the State of California, which is our biggest market you're limited to what you can use. So there is more limitations in California because of the regulatory constraints as far as what you can price on and what you can't price on including homeowners, which is what Lemonade sells. As far as technology goes, we continue to advance our technology. I mean I can't tell you how many box that we're using right now. We've improved our agency facing system, we're improving our online portal. We're using technology to settle claims, to underwrite our risks. So we continue to try to improve our technology to streamline our operations without sacrificing our underwriting or claims accuracy, and that's the key.

I mean I don't think it's very difficult in this business to write a lot of business and maybe Lemonade will write a lot of business. And we'll see how they end up on the profitability end of it. But writing business is not difficult.

Corey Wrenn -- Pecaut & Company -- Analyst

Do you think the -- you have an advantage with the agents upfront underwriting for you, selecting good business for you? Do you still think you have the advantage?

Gabriel Tirador -- President and Chief Executive Officer

We think that our operators, we think that our agency partnerships are extremely important -- extremely important.

Corey Wrenn -- Pecaut & Company -- Analyst

Okay. Okay. Well, thank you, and stay safe. Thank you.

Gabriel Tirador -- President and Chief Executive Officer

Okay, thank you.

Operator

There are no further questions at this time.

Gabriel Tirador -- President and Chief Executive Officer

Well, thank you for joining us today. Thank you very much.

Operator

[Operator Closing Remarks]

Duration: 31 minutes

Call participants:

Gabriel Tirador -- President and Chief Executive Officer

Jeffrey M. Schroeder -- Vice President and Chief Product Officer

Theodore R. Stalick -- Senior Vice President and Chief Financial Officer

Christopher Graves -- Vice President and Chief Investment Officer

Greg Peters -- Raymond James -- Analyst

Ronald Bobman -- Capital Returns Management -- Analyst

Corey Wrenn -- Pecaut & Company -- Analyst

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