Mercury General Corporation (MCY) Q4 2014 Earnings Report, Transcript and Summary

Good morning. My name is Shirley and I will be your conference operator today. At this time, I would like to welcome everyone to the Mercury General Corporation, Fourth 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 go ahead, sir.

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; 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. Our fourth quarter operating loss was $0.13 per share, compared to operating income of $0.33 per share in the fourth quarter of 2013. Premiums written grew 4.4% in the quarter, primarily due to higher average premiums per policy, as a result of rate increases. Our fourth quarter operating results were negatively impacted by $27.6 million fine imposed by the California Insurance Commissioner related to a 2004 Notice of Non-compliance matter, $7 million of adverse loss reserve development and $4 million of catastrophe losses. Excluding the impact of the fine, operating earnings were $0.37 per share in the quarter, compared to $0.33 per share in 2013 and the combined ratio was 101.7% compared to 102.5% in 2013. We are very disappointed and strongly disagree with Insurance Commissioner's determination that Mercury violated California's rate loss and with his decision to impose a penalty. This notice of non-compliance matter is related to the Krumme versus Mercury lawsuit that was decided in 2003. In the Krumme decision, the judge ruled that based on the amount of evidence reviewed by the court that no financial execution as warranted in light of the Department of Insurance loose practices, including the amount of guidance provided as to what constitutes a broker or an agent. It is our strong belief that this decision is contrary to California's rate loss, new process and basic notions of fairness. We intend to rigorously litigate this matter of law and we expect to ultimately prevail on the merits in the court of law. As we mentioned on our third quarter conference call, our fourth quarter has historically been our highest frequency and severity quarter, due to weather and increase driving. In California, our combined ratio excluding the fine was 100.2% in the quarter, compared to 100.9% in the fourth quarter of 2013. Personal auto loss frequency and severity increased in the low to mid single digit range as compared to prior year. The year-over-year increase in frequency and severity is attributable to more bad weather in 2014 as compared to 2013 and possibly to increased driving as a result of lower gasoline prices. In 2013, we had unusually good weather during the fourth quarter. Our results were good in our two largest states outside of California. In both Florida and Texas we post a combined ratios 100% and we're growing the topline. Our results in other states outside of California were mixed and overall possibility outside of California has been negatively impacted by our New York and New Jersey operations. In New York and New Jersey, we instituted claims practices and procedures that sped up the set up of bodily injury case reserves and the payment of claims. These new practices have made it more difficult to estimate ultimate losses as historical incurred and paid loss patterns may no longer apply. As case reserves and payments were sped up, our expectation was to have less loss development as the claims matured. However, we expect that lower development has not yet materialized in the data. So consequently we use historical patterns to estimate our ultimate losses in these states. As a result we recorded $6 million of adverse development in New York and New Jersey in the quarter, which also have the effect of increasing our 2014 accident year loss estimates. California continued to experience positive premium growth in the quarter as rate increases more than offset lower policy sales. Outside of California and excluding our mechanical breakdown product, our growth was flat in the quarter. This compares to negative growth of 3.9% and 7.6% for 2014 and 2013 respectively. The improvement in growth outside of California is attributable to increased policy sales as a result of rate reductions taken in many states early in 2014 and increased distribution. For 2015, we expect to continue to improve our growth prospects outside of California from our improved competitive position, coupled with increased advertising spend and distribution. In California, a 6.9% personal auto rate increase went into effect in October 2014 for California automobile insurance company, representing 15% of our total company-wide premiums. In addition, we have a 6.9% rate increase pending department of insurance approval in Mercury Insurance Company, representing about half of our company-wide premiums written and an additional 6.9% rate increase was recently filed in California automobile insurance company. In January, we launched our first ever national advertising campaign. We currently operate in 13 states representing approximately 56% of the U.S. population. The economics made it more cost effective to advertise on a national basis rather than on a local basis. The national advertising campaign should bring more awareness to Mercury's brand outside of California. Lastly, we closed on the Workmens Auto Insurance Company acquisition in early January. This acquisition filled a strategic niche for Mercury as Workmens non-standard auto product will complement Mercury's more preferred product offerings. We believe Workmens Auto product will allow Mercury to better penetrate the non-standard market in California. With that brief background, we will now take questions.

[Operator Instructions] The first question comes from the line of Vincent DeAugustino from KBW. Your line is open.

Hi, good morning, gentlemen. How are you?

Good morning, Vince.

Just a couple of quick ones here. So we're starting to see some directional improvement in the first lines' PIF erosion. It seems like the growth outside of California is gaining traction, and so you guys had some comments this morning in the prepared remarks. Just wanted to double check and see from the growth outside of California, both in terms of the actual premium production and then margins, all of that so far to date has been coming in line with expectations?

I would say with the exception of the two states that I mentioned early in my prepared remarks, New York and New Jersey certainly not coming in from a margin perspectives in line with our expectations. It's mixed with the other states but our biggest states Florida and Texas certainly in line with our expectations and we’re going to top line as well. And keep in mind as we have mentioned in prior calls, that we are pricing our product outside of California and many of the states to combine ratio that we don't expect from a cost standpoint - pricing our expenses, or expense ratio that we not vary yet. So, we anticipate to have higher combined ratios in some of the states outside of California because of that probably closer to the 100% range as compared to 95% target in some of these states. Now in Florida and Texas year-to-date, we are well below on a year-to-date basis - we are well below 100% combined ratio and those two states are two biggest states.

Okay, perfect. New Jersey and New York, maybe I just kind of was assuming here, but I guess with the reserve movements, I would have figured that would've been on some of the older accident years, maybe two, three years older and not so much when you guys would have started growing that business. So is it more recent accident years where that growth has come in and the expectations haven't played out, or is it the older stuff where I would assume that might be the case?

Hi Vincent it's Ted. It’s really been on the last couple accident years and as we bring up estimates on the most recent accident years it also causes us to revaluate what we’re doing most current 2014 period.

Okay, thank you. Then I guess two quick ones, if I could squeeze them in. On ad spends, do you guys have anything strategically budgeted for the 2015 ad spend?

We are planning on spending about double the amount that we spent last year and I think last year we spent in the neighborhood of about 23 million - in the neighborhood of $26 million, $27 million.

Perfect, and then just one last one. Thanks for all the comments on the end mix I see August with the fine. I guess looking forward, the way I understood it is that California had previously bifurcated that issue into two. And so we have just gotten the state's ruling of that and understand that you guys are going to continue to defend that, but does that open the road forward on the second part of that, which I think was more around cause, not so much the rate side of it? Am I understanding that correctly?

There is two side one of them was on the rate side and the second one was the advertising - false advertising claim. Our Board basically claimed that customers paid broker fees at the end of the day. And the rate side was just adjudicated by the Administrative Law Judge which the commissioner got accepted his proposed decision. That went on Thursday we just filed a rate of mandate challenging in core. As far as the other case, the other part of the bifurcated case, that’s technically still out there. I haven't heard anything from the department on that with respect to that case. From my perspective I will say that, at the end of the day both cases led to the fact that, if someone paid at least from the department standpoint alleging unapproved broker fees. So they end up by the same result but technically that case is still out there, that is correct Vincent.

Okay. All right. Thank you for that. Best on luck in 2015.

[Operator Instructions] Once again Vincent DeAugustino from KBW. Your line is open.

I didn't expect to get back in so quick. Just one quick one. You had mentioned just with the gas prices. I know you said this was -- I think the word was possibly factor in. So you guys with the new company will be getting into nonstandard. So probably a little bit early to ask this question on the nonstandard side, but between, I guess, the preferred and standard books, we tend to think that frequency might react differently based off of the affluence of the drivers. I am wondering if between the two existing California subsidiaries if you are seeing any difference in frequency that might help explain the elasticity to gas prices, if you will.

I think rather from a frequency standpoint between, if I understood your question correctly that’s between our Mercury Insurance Company and our Cali auto company, the difference between the frequency in those two companies obviously Cali auto has a higher frequency rate and have higher absolute frequency rate and I think the rate of change in Cali auto was slightly higher than it was in Mercury Insurance Company. So call it the standard/non-standard at a higher frequency rates, not only absolute, but also as far as an increase on the margins year-over-year than it dated in our preferred book.

Okay. That would seem to support the premise that lower fluent drivers would be reacting a little bit -- the reaction is a little bit larger on response that you guess?

Yeah, I think it’s early to tell, it’s one quarter. We have more employment. Also there are more people on the roads with employment being better than it has been. But at this point, we know that our fourth quarter frequency is always higher. Now it was higher than typical this quarter, but we’re not ready to say that that’s a trend at this point, I mean that’s one quarter. It’s something that we’ll continue to monitor closely, but until we have more data I think it’s early for us to call that.

Okay, we’ll stay tuned. Thanks again guys take care.

Okay. Thanks.

Our next question comes from the line of Ken Billingsley with Compass Point Research

Hi. Good morning. I wanted to just follow up on one of the questions that was asked about the expense ratio, and your answer said that you're booking it below where you -- I believe you said you were booking at currently below where it will actually run. Maybe I misinterpreted that. Does that mean that essentially you're booking the expense ratio lower than what you're actually seeing right now or do I have that reversed?

No, no we’re pricing our product, so that we can be more competitive at expense ratio that we have not yet achieved it’s a pricing, which basically means that let’s say we’re targeting a 95%, if we hit our target expense ratio, but we’re not there yet, that means that we’re going to run it little harder than that. We’re going to run at about 100 or so until we hit those expense NRE ratios. So it’s a pricing.

You're pricing it below where the combined ratio would imply where the expense ratio needs to be based on…

Exactly.

Ultimate volume. I may have missed if you gave this answer about how much more growth do you need outside of California to get those expense ratios where they need to be. And I understand you are in multiple states now, so that may be harder to answer. But are we talking that we need to grow 20%, 30% from current levels, or…

It varies by state it really does. In some states like Florida where we have a lot of volume our expense ratios really already there. Although LAE ratio isn’t there in that state. So it’s going to vary pretty much by volume and by state I should say outside a California, Texas and other state that were pretty much at. But yes some other states where the volumes are low that we have a long way to go.

Okay. The underwriting leverage just been picking up. Where is your comfort level? How high do you feel you can take that, especially with the addition of the nonstandard business? And I know it may be a smaller piece right now, but where do you -- where are you comfortable taking statutory underwriting leverage to?

Well we’ve been 2.5 or something that we would be maybe comfortable with 2.5 times. And I think we’re at what 1.9 two times right now.

Wherever yes.

I mean in our history we’ve been -- I can recall years in our history where we came way about three, right but anyway 2.5 times is probably a decent target.

One of the best that we have is we have some additional capital up in the holding company. So if the margin, the underwriting leverage gets too high we always have the stability to contribute to capital down in the insurance subs.

And if you needed to do that, which it looks like you still have some room, does that impact maybe the future dividend payout ratio assumptions going forward? Is that holding company cash allowing you to maintain that high dividend currently?

Not really. Obviously that’s some additional cash that you can use to sale dividends, but most of the dividends are upstream out of current income from the insurance. So to the extent that your insurance subs are writing profitably, higher underwriting leverage actually gives you a higher capacity to pay off upstream dividends to the holding company, which then can be paid after the shareholders.

I want to say from a dividend standpoint our strong capital position does allow us to pay dividend in years, where maybe a dividend payout ratio is above 100 in years maybe like this year, where we had a tough fourth quarter. So, we obviously recognize that we cannot on a long-term basis have a payout ratio above a 100, but I think our very strong capital position that we have today allows us to continue to pay the dividends in years such as this one so.

And in talking about the tough fourth quarter, can you talk about any of these the cat exposure in the Northeast so far? I realize you said that it wasn't all East Coast storms, that some of it was rainstorms in California. Can you maybe separate that and tell us how the storms that we are seeing in the Northeast may be impacting results going forward?

Are you talking about the storms in January or the storms from the fourth quarter?

More about how may the January storms maybe shaping up versus what you saw in the fourth quarter. Are they going to be just as big?

I don’t think we really have a read on that yet.

Okay. Last question is the old case -- the adverse review that comes from California for the $27 million, if I read correctly, I believe you had said that at least there was no -- or maybe it was from California -- that there were no penalties or interest added to that $27 million. If you take this to court and you lose, do you run the risk of the penalties and interest being added back in?

Well, first of all this is fine, this is a penalty, so really the question has to do with interest, if interest do, we’re going to fine for stay with the court as well and stay the decision. And so the underlying question is interest is still this is not in our opinion, in our opinion this is not like a regular judgment where in a regular judgment interest would be due. So, that’s our view or I suppose that the other side may take it an opposing view. But our reading of the code, of the law suggests that a penalty is different than a judgment.

Thank you for taking my questions.

Thanks.

[Operator Instructions] Our next question comes from a line of Corey Wrenn from Pecaut and Company. Your line is open.

Yes. Good morning. My question is concerning more of the future. I guess I was wondering, we have had losses in New Jersey and New York and I was wondering what the aggregate results have been there, and at what point would you say enough is enough from an operating standpoint if it's just not working for you.

I don’t have the aggregate numbers but if we felt that we could not get an adequate return in those states at that point if we thought that we just could not make it work and get an adequate return that’s the point that we would do it. I will say that New York for the whole year actually posted combined ratio obviously around a 100% for the whole year. So the quarter was bad. So it’s a good question, obviously it’s a very good here. At some point we didn’t feel that we could get an adequate return and make the operations an offer that return, make the changes necessary that from a pricing operational standpoint then at that point we would have to take a look at that.

Okay. My next question, I see enormous amount of advertising from the direct writers, and basically I saw an advertisement for Mercury Insurance in Iowa on TBS or something like that. I thought it was a nice commercial. I was wondering what kind of impact can you make, given the huge budgets that these guys have. It's almost like you are Daniel in the lion's den or something. They have got these huge ad budgets and you are running your ads. Have you had any sort of feedback yet around the effectiveness of these?

It's early. It just started in January, leads in the 13 states that were in are up significantly I would say and we made this investment which $46 million odd investment, we made certain assessments on how many leads we were going to get based on the advertising that we’re going to be doing and the lifetime value of the business we sell, made assumptions over closed ratios. So we put together an investment analysis for this $46 million that we’re investing, I will say that’s new to us. Also we had to make assumptions based on our advertising in some of these states. California, the assumptions we made we’ve been here long time. We understand what the ads do here. So we did go in with the advertising with a plan and expected return and we’re going to have to see if that pans out or not. It is as you point out, we've competitors that spend a lot more money than we do and that is an accurate statement.

Where do you -- my last question is where do you see the business in five years? Obviously, there has been this big swing. I think back in the early 1990s I once asked George about Progressive doing both the direct model and the agency model, and he said, well, we will see how that works out. I'm just wondering where you do see personal lines insurance? I see your policies in force have declined on the personal line side, and when does that rate of decline start to bother you? That will be my last one. Thank you.

It's bothering me now but there is no question that this business has changed and has become more commoditized and it has in the past there is a more quoting, a lot more aggregators out there. Agents use comparative raters. It just become a lot more transparent and commoditized than it has in the past. There is a lot more quoting, a lot more aggregators out there, agencies, comparative raters it's just become a lot more transparent and commoditized. So our goal is to try to adapt to that environment. We're doing that now online sales. We have the buy button and it’s a small percentage of our overall sales, but it’s still strategy of ours is to be able to offer that to consumers. We have national aggregators that we partner with, national accounts, recent release with respect to Google that were going to be coming out with, Google is coming out with. So we’re trying to do everything we can to try to reach the customer and to try to get quoted, but there is no question in my mind that the last ten years have bought a lot of change and there is going to be more change in the future and we just have to be able to adapt, get autonomous cars that may be in the road ten years from now. One of our strategy is to continue to grow out homeowners market. We want to try to write more commercial business. So to diversify in that area as we'll, but the business has changed the past five-ten years.

Yeah, I'll get back to you. Thank you very much for answering my questions.

Thank you.

Our next question comes from the line of Vincent DeAugustino from KBW. Your line is open. Excuse me, Vincent DeAugustino from KBW. Your line is open.

Sorry about that. So thanks for your patience with me guys today with all the questions. I think this is a record for me, but Ted you had mentioned the Google aspect and sorry just wanted to make sure, I understand how that is all going to play out with any involvement of Mercury and kind of the Google platform if you could?

Well Google is -- they’re launching a new insurance marketplace called Google Compare and consumers will -- answer any questions and be able to view rates for a number of carriers, very similar to comparative rater. If the consumer likes the particular rate, the consumers can then link that carrier and complete the purchase. So we believe that's going to provide access to many customers that might not otherwise be exposed to the Mercury product. But I’m not sure when that’s launching as of the Ad, Google has not announced when that’s going out officially. There have been some articles out there and some blogs that talk about it, but we don’t have any kind of dates or anything like that.

Okay. And so just to make sure I understand that, there will be -- the end consumer will be able to go and you've come in kind of in tune with the Google side of it, but from a Mercury standpoint, the customer will be able to buy a Mercury policy through that Google platform.

Yes, that's correct.

Okay, excellent. Thanks guys, take care.

There are no further questions in queue at this time; I’ll turn the call back over to our presenters.

Okay. I would like to thank everyone for joining us this quarter and we look forward to talking to you in the first quarter of ‘15.