Mercury General Corporation (MCY) Q1 2015 Earnings Report, Transcript and Summary

Good afternoon. My name is Laurel, and I will be your conference operator today. At this time, I would like to welcome everyone to the Mercury General First 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 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.

Thank you very much. I would like to welcome everyone to Mercury's first quarter conference call. I am Gabe Tirador, President and CEO. In the room with me is Mr. George Joseph, Chairman; Robert Houlihan, Vice President and Chief Product Officer; and Chris Graves, Vice President and Chief Investment Officer. On the phone, we have Ted Stalick, Senior Vice President and CFO. Before we take questions, we will make a few comments regarding the quarter. Our first quarter operating earnings were $0.59 per share, compared to $0.77 per share in the first quarter of 2014. Excluding the impact of catastrophes and favorable reserve development, the combined ratio was 99.2% in the quarter, compared to 96.6% in the first quarter of 2014. The deterioration in the combined ratio was primarily due to an increase in frequency and severity in our Private Passenger Auto business and higher advertising expenses. In addition, the recently acquired Workmen's Auto added 0.4 points to the combined ratio. Premiums written grew 2.2% in the quarter, primarily due to higher average premiums per policy, the acquisition of Workmen’s Auto and an increase in new business policy sales. Workmen’s Auto premiums written of $6.9 million added 1 point to the quarter’s premium growth. In the first quarter of 2015, California private passenger auto frequency increased by about 8% and severity increased in the mid-single digits. We believe there are a few factors contributing to the elevated frequency level this quarter. Although California remained in a severe drought, the winter of 2015 had more precipitation than in 2014. In addition, total vehicle miles driven have increased due to lower gasoline prices and an improving economy. Higher average premiums from rate increases taken in 2014 partially offset the increase in frequency and severity in the quarter. To further address the increase in loss costs, a 6.4% rate increase was recently approved by the California Department of Insurance from Mercury Insurance Company, representing about half of our company-wide premiums written. A 6.9% rate increase in California Automobile Insurance Company, representing about 15% of our company-wide premiums is pending approval. We expect to implement the 6.4% rate increase from Mercury Insurance Company in late May. Results outside of California were mixed. For Florida and Texas, our two largest states other than California, private passenger auto results were good with combined ratios below 100%. Both of these states also had positive premium growth. However, our results in our Northeastern states were not good with combined ratios well above 100%. Winter storms had an impact on the results. Also for New York and New Jersey, we continue to evaluate reserves as the impact of changes in claims procedures which include the speeding up of claim settlement and case reserving have added an element of uncertainty to the estimates. For New York and New Jersey combined, the company reported $1 million of adverse loss reserve development. We implemented rate increases of 3% in New York in January of 2015 and 2% in New Jersey in February 2015. Our expense ratio in the quarter increased to 27.7% from 26.9% in the first quarter of 2014. The increase in the expense ratio was primarily due to higher advertising expenses from our national advertising campaign launched in January, partially offset by lower profitability related accruals. Net advertising expense in the quarter was $16 million compared to $6.4 million in the first quarter of 2014. Our 2015 annual advertising budget of $48 million is heavily weighted toward the first quarter spend. The advertising spend will be lower for the remaining three quarters of 2015. We value the effectiveness of our advertising by comparing the lifetime acquisition cost built into our pricing to actual acquisition cost while also giving some consideration to the long-term value of increasing brand awareness. However, for accounting purposes, the cost of advertising is expensed when incurred and is not amortized over the life of the policy. Based on our first quarter results, we expect to recover the vast majority of our advertising expenses over the lives of the policy sold. We are currently evaluating changes to improve the results going forward with the objective of recovering these higher advertising spend over the lives of the policies. Companywide private passenger auto and new business application submitted to the company, increased 11% in the first quarter of 2015 and homeowners new business submissions were up 29%. In California, we posted premiums written growth of 4.4%. Outside of California and excluding our mechanical breakdown product, premiums written were down 1.2% in the quarter. This compares to negative growth of 3.9% and 7.6% for 2014 and ‘13, respectively. With that brief background, we will now take questions.

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

Good morning gentlemen. Thanks for taking the questions. Just looking at the first one here, so some of the industry [ISO] [ph] data that just came out last week, it looks like California property damage and then collision severity, both maybe ticking up decently. And so you ran through some of the frequency drivers here and then mentioned severity as well. So I just wanted to see on those particular coverages for severity what you might be seeing in the state as well?

Yeah. We’re seeing about anywhere from 3% to 5% in the physical damage lines and with respect to severity here in California. We had in the first quarter -- we had an increase in total losses in the first quarter year-over-year and that contributed to the increase in severity. We’re also seeing some small increases obviously in parts and labor.

Okay. On the parts and labors, is there anything for some of the old -- now old, reform stuff on the OEM parts. Is there any driver there?

I don’t think so. We are not attributing any of that. I think that new regulation was in March of 2013 is my recollection, Vincent. We are not attributing the cost increase to that regulation at this point.

Okay. Great. And then on the total losses, is that pretty much an anomaly or do you think there is -- anything there that – now you had mentioned some and just a little bit more rainfall and that kind of stuff, maybe that would slow down some of these breaking ability and that type of thing. But is it just that type of activity, or is there anything else that would be kind of underlying there?

I don’t know of anything else. We are going to have to wait to see the next several quarters to see what occurs. But I can’t attribute it to anything else.

Okay. Thanks for the color there. And on Google Compare, I know it’s something we’ve talked about the last few quarters. What I’m trying to understand is on the commission and expense structure side, how do you think that that’s going to play out versus the traditional business? And then on the loss ratio side, one of the things we talked about is the benefit of frontline agent underwriting. What I’m trying to get to -- are there gives and takes perhaps maybe between the loss and the expense ratio we may have some shifting on some of that business that comes through on the Google side?

Well, first, I’d say that there is -- the Google Compare is relatively new, so it hasn’t being live very long. The sales from the program at this point are not significant. I think we’ve been doing it maybe a couple months now, a month and a half, something like that. So they are not very significant. From an acquisition standpoint -- cost of acquisitions, it’s favorable to us. I will just say that, that the cost of acquiring a Google customer is favorable. We are paying on a per sale basis and we believe that the cost is very reasonable. On the loss ratio side, we actually compare the loss ratio that we have on our Buy Button compared to our agent business and the loss ratios are not that significantly different.

Okay. Very good. And then -- sorry, I was trying to write this down. I think I missed it. It was around new business submission activity and then just linking that to the national advertising campaign and so could we just revisit how, I guess how that’s performing relative to your expectations on it?

Well, our initial hope was to recover the entire advertising spend of the $48 million that we are budgeting. And we are recovering the vast majority of that spend but we are learning from it. We are making some adjustments with respect to the advertising. The advertising campaign is composed of TV. You have digital. You have lead aggregators that we have in that $48 million. So it’s comprised of various avenues for us to trying to get some growth. And what we are doing is we are learning some - this first quarter and we are going to probably be making some adjustments. There are certain states for example that aren’t closing as well as other states. So we will probably be moving some money that we are spending in some states and moving them to other states, things of that nature. But I would say that over 90% of the advertising spend, we are recovering at this point or we plan on recovering over the life of the policies. The new business submissions that I mentioned at the beginning of the call, 11% increase in private passenger auto and about 29% in homeowners.

Okay. Thank you for that. And last question would be is on the preferred rate approval. Could you see that come through, I guess in the course of historical precedent here? Should we expect you to kind of increase short order and come back with another rate increase there in light of some of California loss cost trends?

That’s something we are going to evaluate. That’s something we are evaluating. We will do our indication after this first quarter and it’s something we will definitely evaluate.

Okay. All right. Thanks for all the answers, guys. Best of luck.

Thank you.

[Operator Instructions] Your next question comes from the line of Alison Jacobowitz with Bank of America Merrill Lynch. Your line is open.

Thanks. First, a favor please, it just went by me too fast. I believe you gave the frequency and severity numbers for private passenger auto in California, if you could repeat those. And then if you could talk some about the frequency outside of California?

Sure. In California, the frequency increased about 8% and severity in the mid-single digit area.

Okay. And then frequency outside of California?

Outside of California in the Northeast region, we certainly saw an increase in as a group of the companies that we write in the Northeast region we saw an increase in frequency up there primarily probably related to the winter that the Northeast had. And it varies by state somewhat, but generally speaking I would say that as a whole we are seeing an increase in the frequency.

Thanks. And then another question, I was wondering if you could talk some about just your ongoing reviews of your loss reserves if there is anything in particular you are watching more than others or how are you feeling about that going forward?

Well, I mean, we feel good about our loss reserves. Obviously, there is two states that I mentioned in my prepared remarks, New York and New Jersey, which we continue to evaluate in light of the claims procedure changes that we made there which have basically sped up claims settlement and case reserving, and that’s added an element of uncertainty to the estimates for those two states. So those are the two states that I would say that we are watching, but overall we feel good with our reserve position. And in fact, I think that we recorded $3 million this quarter of positive or favorable reserve development on a consolidated basis.

Great. Thank you very much.

Thank you.

Your next question comes from the line of Greg Peters with Raymond James. Your line is open.

Thank you for hosting the call. I had just a couple of questions. You talked briefly about your participation in the Google venture. And I was wondering if you could comment on whether you’re participating in the comparative raters with independent agencies, and if so, what states?

We are participating with independent agents through comparative raters and pretty much every state that we are in.

I see. And is there -- I guess in the context of your advertising budget where you laid out what some $48 million that you expect to spend this year, how are you skewing that advertising expense in the context, because most of your business obviously is California oriented? Should we assume that the advertising expense is modeled after your market share or is it pushed in a different direction?

Well, on the TV spend, which is a significant portion, maybe half, maybe not quite half of the spend, it’s national cable primarily. So we are spending on a national basis, and we are doing some local buys in California in addition to that. And then the rest of the spend is in digital, as well as in lead aggregators and we’re spending more money in California as you would assume as compared to outside of California.

Right.

But I will say that outside of California the growth was quite a bit more from account standpoint. I think outside of California our new business submissions in the quarter were up like 26%. I mean, in California they were up in the mid-single digits. So that’s how the spend is allocated.

Okay. Is -- in the context of the $48 million, is it assumed that you’re going to spread that out pretty evenly throughout the year or is it going to be front-end loaded or any color there?

No, no. As I mentioned in my prepared remarks, it’s front-end loaded. The first quarter historically has been our biggest sales quarter and we front loaded it in the first quarter. So it was $16 million in the first quarter. I think you’ll see for the next several quarters, $2 million or $3 million reduction there for the next several quarters and in our fourth quarter we drop quit a bit.

Yeah.

So it -- the first quarter is going to be the highest spend.

Okay. Just circle back on the 26% increase in submissions? Is that bound business, new business or I’m trying to understand how you’re defining submissions?

Well, we define submission as how many applications were submitted to us either through the agent or through our [buy one] [ph] process for us to issue. We may not have issued these, but these are one that had been submitted to us for issuance. That’s how I’m defining it. By and large we’ve pretty much issue what’s submitted to us. But the vast majority of what’s submitted we issue.

Okay. Perfect. One last question, just as we think about any unusual litigation of regulatory expense. I know you highlighted the recent rate increase you got approved for California? Is there any additional expense either with litigation regulatory that you might anticipate in the balance of the year that is unusual?

Not that I’m anticipating.

Okay. Perfect. Thanks for your answers.

Thank you.

[Operator Instructions] Your next question comes from the line of Ken Billingsley with Compass Point. Your line is open.

Good morning. Thanks for taking the question. Just two follow-up questions. On the reserve release it was -- on the net basis. Did -- are these -- did you mention what years are they coming from?

I didn’t mention the years. But there most recent accident years, maybe two or three back.

And from looking at the reserve tables and again, this is coming from more of the year end table, if you reported. Seems that you intend to release early on and then add slowly after that? Do you see a change in that or is that likely to continue? Are you seeing net additions to later years still?

I’m not significant to later years. I mean, most of the additions are in the most recent two to three years. We try to book the most accurate reserve number possible. We have over a $1 billion of reserves up, so you’re going to be off a little bit, $3 million one way or the other is not in the whole schema thing is not significant when you are taking a look at that big of a reserve balance, our intention is not to release positive development in the first quarter and then slowly over the next several quarters reduce that, that’s not the intention. So in a perfect world, we would have no development from here on out but that's not going to occur. We are going to have some development, one way or the other typically.

All right. And then on policies in force -- personal auto, the decline is slowing. Obviously, I’m assuming some of that is from the increased advertising spending. Can you just break down -- I believe you said it was 26% increase in submissions outside, but can you talk about the policies in force? Are they continuing to shrink in California and growing a lot faster outside or can you talk about the mix?

Well as far as California, I think from year end, California from 12/31/14, California is up slightly from year-end. You have states like Texas, Florida, Georgia, Virginia where they are up. And then we have some states -- a lot of the states are stabilizing now. We have states like New Jersey where that have been declining significantly for some time and now since year end I would say that the PIF is stabilized now, so it varies. But in California, up slightly, outside of California and some of these states I mentioned. Texas, Florida, Georgia, Virginia up and some of the states where we had large declines, they are starting to stabilize.

And then on the homeowner side, does the growth still looks -- I mean, comparatively is much stronger there in policies in force, where is that coming from, is that mostly California?

That is mostly from California. We introduced a new product back in October of ’14. That new product has been well received here in California and coupled with the advertising that we are doing, I think most of that is in California.

Thank you for taking my questions.

Thank you.

Your next question comes from the line of Ron Bobman with Capital Returns. Please go ahead.

Hi, gentlemen. I had a question about the Google initiative and I recognized it is early days. I was just curious. Are your rate plans the same whether alike risk makes it to your sort of underwriting desk by way of an independent agent or comes in via Google's website?

Yes. Those are same.

Okay. And what -- I assume you’ve received the conclusion that sort of channel conflict in your -- and what I am really getting at is sort of your agent’s relationships that you can sort of temper any concerns that they have, sort of alienation, challenge going forward. Would you sort of talk about that as this sort of plays itself out in the years to come?

Yeah. I think we’ve been selling online now for sometime in California. And our agents are involved in that process. We basically assign those sales to an agent for a cost. On the Google compare, it’s a very new program. And currently our agents are now participating and we’ve informed this to our agents, the way the program is clearly structured, it make it difficult to involve them at this point. But it’s a -- as the program evolves, it’s something that we’re taking a look at.

And for consumers that use the Google compare website. Is it sort of straight through binding or do you -- do your systems and/or people sort of play catcher and sort of make underwriting decisions and pricing decision or is it sort of, it’s an automated binding element to it?

Well, there is an automated binding element, in addition to -- and someone who needs to talk to someone for it to finalize the sales. We have Auto Insurance Specialist, AIS, who we own to finalize the sales.

Good. That’s an if, I think it you said -- did you use the word, if?

Yeah. There are some sales that are coming in directly. They bind online and they are done.

Okay.

There are some sales that come through Google that they don’t want to bind online. They want to talk to somebody and that’s when we pick up their piece.

Understood.

So it’s nominated.

Okay. Thanks for your thoughts. Best of luck.

Thank you.

There are no further questions. I’ll turn the call back to the presenters.

Well, I’d like to thank everyone for participating this quarter. And we hope to bring you better results in the second quarter. Thank you very much.

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