Mercury General Corporation (MCY) Q4 2015 Earnings Report, Transcript and Summary

Good morning. Good afternoon. My name is Stephanie and I will be your conference operator today. At this time, I would like to welcome everyone to the Mercury General 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 may contain comments and forward-looking statements based on current plans, expectations, events and financial and industry trends, which may affect Mercury General's future operating results and financial position. Such statements involve risks and uncertainties, which cannot be predicted or quantified and which may cause future activities and results of operations to differ materially from those discussed here today. I would now like to turn the call over to Mr. Gabriel Tirador. Sir, you may begin.

Thank you very much. I would like to welcome everyone to Mercury's fourth quarter conference call. I am Gabe Tirador, President and CEO. In the room with me, is Ted Stalick, Senior Vice President and CEO; and Robert Houlihan, Vice President and Chief Product Officer. On the phone, we have Mr. George Joseph, Chairman; 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 2014 operating results and ratios were distorted by a $27.6 million fine, imposed by the California Insurance Commissioner. Accordingly, all company-wide and California personal auto comparisons to 2014 are exclusive of the fine. Our fourth quarter operating earnings were $0.52 per share, compared to $0.37 per share in the fourth quarter of 2014. The improvement in operating earnings, was primarily due to an improvement in the combined ratio for 101.7% in the fourth quarter of 2014, to 100.2% in the fourth quarter of 2015. Our California private passenger auto combined ratio improved in the fourth quarter of 2015, as compared to the fourth quarter of 2014. California private passenger auto frequency declined slightly, and severity increased in the mid-single digits, as compared to the fourth quarter of 2014. Higher average premiums from rate increases taken in the latter part of 2014, and in 2015, offset the year-over-year increase in severity in the quarter. New rate increases pending Department of Insurance approval, include a 5% rate increase filed in June 2015, from Mercury Insurance Company, which represents about half of our company-wide premiums written, and a 6.9% rate increase filed in July 2015, for California Automobile Insurance Company, which represents 15% of our company-wide premiums written. Our California Homeowners combined ratio was 104.5% in the quarter compared to 97.5% in the fourth quarter of 2014. Adverse [ph] development and an increase in severity, negatively impacted our results. Outside of California, our results were negatively impacted by adverse development, catastrophe losses, and higher than expected loss frequency and severity in several states. The combined ratio was about 113% in the quarter compared to 108.1% in the fourth quarter of 2014. Our expense ratio was 25.9% in the quarter compared to 26.5% in the fourth quarter of 2014. The reduction in the expense ratio, was primarily due to lower average commissions and advertising expenses. Net advertising expense in the quarter was $4.8 million, compared to $6 million in the fourth quarter of 2014. We expect our advertising spend in the first quarter of 2016 to be similar to our first quarter 2015 spend of approximately $15 million. Premiums written grew 7% 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 at $4.1 million, added six-tenth of a point to the quarter's premium growth. Company-wide private passenger auto new business application submitted to the company, increased 13% in the fourth quarter 2015, and homeowners new business submissions declined 2%. In California, we posted premiums written growth of 6.8%. Outside of California, and excluding our mechanical breakdown product, premiums written increased 12.3% in the quarter. With that brief background, we will now take questions.

[Operator Instructions]. We do have a question from the line of Ken Billingsley with Compass Point. Your line is open.

It is Ken Billingsley with Compass Point. I wanted to just follow-up on the expense ratio. You said that average commissions were down in advertising expenses. I just wanted to verify one number, you said $15 million to spend in the first quarter of 2016?

Yes. That's what we expect. About the same level as in 2014, Ken.

Okay. And I am on the East Coast, and I have seen a lot more advertising for Mercury. And I mean, you have done a global campaign on the advertising side. Have you scaled that back, and if so or not, what is the plan for that advertising spend?

Well we spent about $44 million in 2015, and we expect to spend about $42 million in 2016, and we think that the advertising is working. We are recovering the majority of our advertising costs that we did in 2015. So our cost for sale is really close to where it needs to be, in 2015, and we expect to get through where it needs to be in 2016.

And on the lower average commissions, can you talk about that? I know at that point it is -- at least I believe you were paying slightly higher commissions in some new territories, and that at some point, you were expecting that the expenses were going to catch-up with the premiums, that you claim to write in this date. So is that a case of the premiums catching up, or is this actual less commission percentage being paid out?

Its really a combination of both. We are growing in some states outside of California quite well, in some of the states outside of California. But our average commissions are down. We are actually paying less, as a percentage of premium, as we were before. We cut our commissions.

And is it in line with competitive rates, or are you below your competitors now?

No. It's in line with our competition. In California, we are quite a bit above our competitors. I think in California, we average about 17% or so commission rate, 16% and 17%, and the competition is probably around 13%. Outside of California, we are probably covering around 13% in change, which is where the competition is at.

Okay. And the last question I just wanted to ask was, again, on the dividend and the payout ratio; it looks like you still have a lot of capital capacity? I believe you said in the past, you could write up to 2.5 times your surplus level. So it looks like you have sales room to maintain this dividend. Is there anything you guys are looking to see change in 2016, to create a footing to maintain the high dividend payout ratio?

Yeah. Improve our combined ratio. Really, if we ran even at a 98.5%, 98%, we are talking about more than paying the dividend. And our target is a 95%. Now in California, we have some rate increases in MIC that are pending approval, that we feel that, once we get that rate increase in MIC, we are going to be pretty much what we need to be for the time being in MIC. In Cal Auto, we have a 6.9 that's pending approval. Hope we will get that approved as well, pretty soon I should say. So those two rate increases are going to go a long way to improve our profitability. Outside of California, we were -- this quarter was a disappointment. But when you look at our accident year results for private passenger auto, I think in 2013, we ran a combined of about 101% outside of California for PPA, private passenger auto, and in 2014, we ran at about 100%. This year, we got surprised by the increase in frequency and severity, and our rates really were not -- did not keep pace with that. So we anticipate increasing rates outside of California. We are also going to be driving down our LOE and expense ratios, outside of California. They are not where they need to be. And the 101 and the 100 that I quoted earlier, that's with the higher expense and LOE ratios that we have. So we are going to be very focused going forward in driving that down, our LOE and expense ratio, especially outside of California. We are going to be increasing rates, where we need to; to offset some of this frequency and severity that we saw outside of California. And in California, as I said in MIC and Cal Auto, we have some pending. So to answer your question, we don't expect our combined ratio to be at this level, and if we drive that combined ratio down to -- closer to our target, our dividend paying capacity will be fine.

And your California expense ratio or your commission ratio, you said it was 17, and is 400 basis points higher than the comp. Is there a reason -- does it need to be that elevated, and is it just historical, and its driving better business, at least in your opinion?

Well, its historical; and I also do think it can drive better business. But it is -- that has actually come down as well. We have actually reduced some commissions here in California. But we do think that in California, it’s a different market, and we have been here a long time, and we have very strong agent relationships. So even though we are trimming that down a little bit, its not going to be driven down as much as you are seeing outside of California.

Thank you for taking my questions.

You're welcome Ken.

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

Good morning and thank you for hosting this call. I just wanted to circle back on the pending rate increases. I think you entered and identified a couple of pieces in California that were pending for approval. What's going on outside of California? Are there rate increases that are on the board, that will begin the flow-through immediately? Or is there a waiting for approval process that you are following?

Its lucky if you get rate outside of California. But I am going to go ahead and let Robert talk about that.

I think in our larger stage, we actually already have had recent rate increases that are starting to earn in most of our big states, outside of California. Texas lowered it, Georgia. We do have one pending for New York. By and large, we have already taken rate increases to react to the trend that we are seeing in those states.

And I mean, you went through and identified those states. I imagine, those are the states where you are running combined ratio temperature [ph]. What has been the magnitude on average of the rate increase that you have filed for or are implementing?

In general, high single digits, New York, the pending increase a little bit higher, but on average, high single digits.

Okay. And I think you know, you cited what your ultimate target of a combined ratio is the mid-90s, that I think you also, in answer to the previous question, used in 98% to 98.5% sort of benchmark is -- should we view that as an intermediate term sort of objective for management, and do you have timestamp on when you think you might get there?

Well, I mean, our target is 95%. And the reason I stated 98%, 98.5%, it was related to a dividend question and the fact that our earnings are below our -- the dividend, $2.63 or so. So we think the 98% in change, in combined ratio, gets us to about that level. But our objective is still to get to 95%. I think in California, absent any trend, I think we are going to begin -- starting to get close to that number. Outside of California, its going to take time for these rate increases to earn in, and it will take us a little time to reduce our expense and LOE outside of California. So I would say that in 2016, outside of California; no, we don't expect to be near that combined ratio target. But in California, I think you are going to be much closer to it. So if you want to call it an interim step towards -- 98%, an interim step, you know; that's -- I don't want to argue too much about that.

Okay. That's fair. And of course, this is going to be a gradual improvement, its not going to come all up in the first quarter, its going to bleed into the course of the year, I think the next couple of years, I imagine?

Yeah. Its not an overnight -- it doesn't happen overnight.

Perfect. Thank you for that clarification. And I'd like to spend just a minute talking or asking you about two other components of your business, that you don't spend a lot of time talking about. And I thought it'd be a good opportunity for you to remind us, first and foremost on the property side. Can you tell us a little bit about your business mix, what your exposures are, on the property side? And then the second question is going to segue into the investment portfolio? And I know you have had periods where you have been very successful? And I am just curious, what your portfolio exposure looks like to limited partnerships or high yield or energy investments? It certainly seems to be topical these days to be asking about that?

Okay. On the property side, we write homeowners in a variety of states or many states. California, being a bigger state that we write homeowners in, over $300 million in homeowners in California. But we also write in Arizona, a little bit in Georgia, Illinois, New Jersey, Nevada, New York, Oklahoma, Pennsylvania, Texas and Virginia. Many of those states are very-very small though. To give you an example, we wrote $329 million in homeowners in California, and I think our next biggest state is probably about $14 million, $15 million, and that would be like Texas. We also write some commercial property business, primarily in California, and that's about $75 million or so of business in the property side. We do have cat cover, we have a retention of about $100 million, and you can read about that in the 10-K for more specifics. So that's on the property side, as far as our exposure. Most of our exposure, as you can see, is in California. And on the investment side, Chris, are you on the line?

Yeah. Yeah, I am right here. Greg, thanks for the question. It's interesting, I am actually -- I forget. I have really been getting some more and more bearish as the plan has been moving along here. Last year, we took down on equity investments by 25% to 30% and pushed a lot more capital towards municipal bonds, which turned out to be a pretty decent move for 2015 cycle. In terms of high yield, we don't have a much of an axe there. We do have investments in senior secured bank loans, to special [indiscernible] vehicles in that area. But on a $2 trillion portfolio, 70% of it is in municipal bonds, AA rating. The overall portfolio rating is pretty much AA as well.

And you don't have any energy? Meaningful energy components of that either, correct?

And the equities; no. We have taken down -- actually we have a couple of MLPs, maybe still in there that we may be kicking ourselves over. But for the most part, the energy exposures are significantly down from where they were, many-many years ago, and in fact, the portfolio was much more broadly diversified at this point. There is still a fairly big concentration on utility stocks, as you can understand, for the income and thankfully those have had a nice -- there's [indiscernible] here anyway for this year so far. So we are definitely watching the risks, but the concentration in risk is much-much lower than where it was, just from a few years ago, and actually went through this whole cycle walk through last week, investor committee on the board, that I continue to really watch our risk exposures, and kind of derisk bias of the portfolio.

Great. Thank you very much for that color, and thank you for the other answers as well.

Welcome.

[Operator Instructions]. Your next question comes from the line of Jay Cohen with Bank of America. Your line is open.

Hey, it's Alison Jacobowitz. Just wondering the policies outside of California, are they -- what's the balance between six months and annual policies, or they are all six months? I don't remember.

This is Robert. There is a couple of stakes for an annual policy. But the best, which already has six month policies.

Thanks. And also, I didn't hear it, so forgive me if you said it already, but on the frequency and severity in California, or particularly a frequency, it seems like it’s a little bit different than some of your competitors. Can you add a little bit more color, if you didn't already on frequency trends?

Well, hi Alison. In California, in general, we had frequency for the year, up slightly in the low single digits. But we had a fairly favorable fourth quarter, where it dropped down to favorable trends slightly. And we are not sure, why sometimes frequency for the first quarter of 2015, we had a big spike-up in frequencies, because sometimes there is just some variability from quarter-to-quarter.

Great. Thank you.

[Operator Instructions]. Your next question comes from the line of Leslie Riley with [indiscernible] Capital. Your line is open.

Hi. Good morning there. What is the combined ratio running in California new order?

Hey, we don't disclose that, but its not at our target right now, Leslie, above our 95% target. Its between 95% and 100%.

So you take these rate increases that are coming -- I think you said shortly, what will get you down to your targets?

I think it gets us to our target in our largest company, on a go forward basis. Depending on where the trends are. But yes, we think that in MIC, our largest company in California gets us to target. How longer I think, that there may still be a market need [ph], which is the non-standard company, you know, a standard mid market company. But in MIC, our largest company, I think it gets us where we need to be, absent any kind of adverse lost trends that we are not anticipating.

That'd be very good. There is a lot of leverage just to getting that towards your target.

Yeah. I agree.

Thanks very much.

Thanks Les.

Thank you. There are no further questions at this time. I turn the call back over to the presenters.

Well thank you for joining us this quarter, and we look forward to speaking with you first quarter of 2016. Thank you very much.

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