Mercury General Corporation (MCY) Q1 2018 Earnings Report, Transcript and Summary

Good morning. My name is Amy 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 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.

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; 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 first quarter operating earnings were $0.07 per share compared to $0.20 per share in the first quarter of 2017. The deterioration in operating earnings was primarily due to an increase in unfavorable reserve development partially offset by a reduction in catastrophe losses, lower policy acquisition costs and flat other operating expenses as compared to a 2.3% increase in earned premiums. The combined ratio was 103.8% in the first quarter of 2018 compared to 103.1% in the first quarter of 2017. The combined ratio was negatively impacted by $43 million of unfavorable prior accident year reserve development, $9 million of catastrophe losses and $4.6 million of reinsurance reinstatement premiums earned. The unfavorable reserve development in the quarter came primarily from the bodily injury line of coverage on our California auto lines of business. As we discussed on our fourth quarter conference call, the Company uses historical loss development patterns for estimating ultimate losses. Over the past few years, actual case reserve and paid loss development have tended to exceed the Company’s historical loss development patterns. Accordingly, at year-end 2017, the Company factored this tendency into the Company’s ultimate loss selection. During the first quarter of 2018, prior accident year losses developed beyond what was expected despite the fact that year-end 2017 we weighted more heavily to more recent year’s development factors into our loss selections. Increased utilization of medical services including epidural injection and surgical procedures, along with an increase in alleged traumatic brain injuries and an aggressive plaintiffs’ bar are contributing to the increase in California bodily injury severity. As reported by Fast Track, in the fourth quarter of 2017, California private passenger automobile bodily injury severity increased by 10% for the industry and the liability loss ratio has increased from 76.7% in 2014 to 91% in 2017. Catastrophe losses of $9 million in the quarter were primarily due to winter storms and mudslides in California. This compares to $30 million of catastrophe losses in the first quarter of 2017, primarily due to severe rainstorms in California. Excluding the impact of catastrophe losses, unfavorable reserve development and ceded reinstatement premiums earned, the combined ratio was 96.8% in the first quarter of 2018 compared to 98.8% in the first quarter of 2017. The expense ratio was 25.5% in the first quarter compared to 26.3% in the first quarter of 2017. The lower expense ratio was primarily due to a decrease in acquisition costs, primarily from lower average commissions and cost efficiency savings. To help offset increasing loss trends, we’ve been increasing rates in most states. In California, a 5% personal auto rate increase in Mercury Insurance Company went into effect in March. In addition, a 6.9% rate increase for Mercury Insurance Company and California Automobile Insurance Company are pending approval with the Department of Insurance. Personal auto premiums in Mercury Insurance Company represents about half of our direct companywide premiums earned, and California Automobile Insurance Company represents about 14% of our direct companywide premiums earned. Premiums written grew 6.1% in the quarter, primarily due to an increase in policies written, and higher average premiums for policy. Companywide private passenger auto new business applications submitted to the Company increased approximately 9.5% in the quarter as competitors continue to increase rates and tighten their underwriting. Companywide homeowners’ applications increased 10% in the quarter. With that brief background, we’ll now take questions.

[Operator Instructions] Your first question today comes from the line of Carl Doirin of Raymond James. Your line is open.

Just a couple of clarification here. Gabe, you’ve mentioned a 6-point -- rate increases pending for both Mercury and California auto. For California auto, is it that same 6.9% pending that you mentioned in the fourth quarter?

Yes. That’s the same one. I think that we filed that sometime in September of last year.

Mid-September.

Mid-September.

And then of course, there was a 5% that went to effect in March for Mercury. What was -- what’s the -- can you tell us what the rate increase was, that was filed recently that’s pending?

6.9.

Okay, same thing. All right. And of course, just I guess given the adverse user development in the quarter, I guess my next question is -- I guess, how many rounds of rate increases you think you need going forward, just sort of catch up with the loss trends?

Robert, do you want to handle that question?

Yes. Based accident year basis, results are better. I think, the pending rate increases we project will be enough to maintain an underwriting profit prospectively.

Yes. We’re running at about, companywide, if you take away the development at about 98.5% combined ratio excluding the development, severity is going up here in California for BI as I mentioned earlier. Frequency is down a little bit. So, a lot of it depends on the future, what happens with not only development but also with -- just with overall trends in the market. So, we think that from an accident year basis, as Robert alluded to that if we don’t have any further development and if trends stabilize, that rate increases that we have pending are going to be sufficient.

Okay, fair. And I guess, you also mentioned plaintiffs bar being more aggressive. Have you seen -- has it gotten progressively worst, meaning are you seeing again worse than 2017 as the months go by versus 2016?

Yes. I would say that it’s probably started in ‘16 but yes, we saw an increase in ‘17. That is somewhat anecdotal, but we feel that ‘17 was worse. And in ‘18 that trend continued. As I mentioned earlier, the Fast Track sort of pretty big spike in PPA liability loss ratio. You have ‘13 ended at a 77, ‘14 ended at a 77 about, and then you saw big spike in ‘15 and then a really big spike in ‘16, and then seems to beveled off a little bit in ‘17. So, really, from ‘14 to ‘17, there’s been a big increase in trend in the industry.

Okay. And then, last question for me. Can you talk about sort of I guess growth outside of California?

Well, outside of California, we’ve had a negative growth. We’ve been shoring up there the profitability. We posted a combined ratio in the high 90s, 98.5, something like that, outside of California in the quarter. So as a result of that, the top-line has suffered a little bit. The application count outside of California for private passenger auto was down about 20% or so. In California though, our app count including our non-standard writer Workmen’s Auto was up almost 20%, it was 19% in California private passenger auto applications.

Your next question comes from the line of Gary Ransom with Dowling & Partners. Your line is open.

Yes. Thank you. I wanted to go more into the bodily injury trends. You mentioned certain types of injuries, and I am not sure I understood the significance of what you were saying about those severe injuries. Could you clarify what -- why are those new and why are those different?

Epidural injections are really one of the things that we are seeing a lot more often now and which is basically just an injection in the back, between the epidural space in the back and it used be -- we didn’t really see as many of these. And now many claims are built up by the plaintiffs’ attorney. They are attorney driven really medical procedures in our view in many cases. In many cases, people have had back injuries before the accident. So, we are seeing more and more of these epidural injections in our claims that are coming in being driven by attorneys and trying to drive up the medical special, so they can drive up the cost of the claim. Now, we are doing a lot of things internally to try to combat that. Some of these we are taking to trial. But nevertheless, when you have an increase in medical costs and increase in medical procedures, it’s going to impact severity. We are also seeing more surgical procedures in the back, people more willing to actually go ahead and have the back surgery. And the other thing is traumatic brain injuries. We’re seeing more of that where there’s an accident and now they’re alleging a concussion. They’re not the same anymore, cognitive abilities have declined and things of that nature. So, those three things I think in sum is what we’re seeing more off as compared to the past. And I think it’s not only us, it’s the industry, which is why I think that you’re seeing or have seen the increase in severity going on in the industry here in California.

So, you think that’s been filtering into what you are talking about in the severity for Fast Track as well?

Absolutely. And we’ve spoken to a lot of our counsel outside that handle our claims and handle claims for other carriers as well. And there’s no question that this is impacting or has impacted the industry.

I may not remember exactly right but I kind of recall that collision was also up a lot in California, in the last Fast Track data. I may not have the right, but it’s -- have you seen any unusual trends on the auto repair side, call it?

I mean, it’s up a little bit, not a lot. I am looking at Fast Track here for PPA collision loss ratio. According to Fast Track, at the end of ‘13, it was 70%; at the end of ‘14, it’s 71.6%; at the ‘15, 73%; at the end of ‘16, 75.8%; and in ‘17 dipped down a little bit, 72.1%. Now, that’s loss ratio. That includes rate increases. But, we’re seeing in a mid single digits, Ted, severity increases with frequency down a little bit.

What do you think is the solution for the -- I mean, as plaintiffs’ bar is pushing for all of this, is the answer just 6.9% every chance you get, or is -- are there more things you could do on the claims management side, even maybe the underwriting side?

I think, it’s off three. I think, there’s things that we are doing and are going to continue to do on the claims side, better segmentation of our losses, which is something we’ve been focused on the last couple years. On the underwriting side working with our agents and also taking the rate. We’re really attacking this problem, all three facets of the business. We’re attacking it by trying to do things on the claim side, taking some of these cases to trial, and on the underwriting side and then with some rates. So, it’s a combination of all three factors.

When you try to get rate, is there any, call it, sympathy from the commissioner that these rate increases are becoming more necessary?

I don’t…

Or is it just business as usual? Yes, maybe that’s the wrong word.

But I -- we’ve been able to get our rate. And Robert, do you want to comment on that?

No. I think, the department looks at the return of surplus formula and with more losses in the system higher trend that works its way through the formulas, which makes it easier to justify rate increase.

For example, there’s one major competitor here in California that recently was approved something like at 6.5, actually has not yet been approved for 6.5, and they’ve already filed for another 6.9. And this a big competitor.

Has anyone -- does anyone brave the possibility of doing 7 or 10 or 12 or is that just too problematic?

I don’t think. Unless, you are way, way behind, I think that’s probably too problematic. Robert, do you want to…

No. Of course, if you file for more than 7 and intervene a request of rate hearing, it’s no longer at the discretion of the commissioner, once you go to rate hearing. And that process is so lengthy and it can potentially delay the rate increases so much that I think it’s -- as Gabe said, unless you are really far behind on rate increase, it doesn’t make sense to step beyond the 7%.

[Operator Instructions] Your next question comes from the line of Samir Khare with Capital Returns Management. Your line is open.

Hi. Good morning. A few questions centered around the prior year development. What accident years does this come from?

Yes. About half of it is from 2016, a little over half; about a third of it is from ‘15; and the rest is spread across the other accident years.

Okay. And does this charge come from a full reserve review done in Q1 or an actual versus expected type exercise?

Both, we do actual versus expected; we also have our external actuaries and our internal actuaries do a full review quarterly.

Okay. The increase in plaintiffs bar activity that you spoke of before, is that widespread in California or more compliant to a specific region within California?

I would say, it’s throughout the whole state. I’ve seen cases of north and down south. But, I would say, more so down in Southern California.

Okay. And then, with the ability to get the rate increases that you’ve submitted for, it sounds like a hard market exists in California auto. Would you characterize the current market as such?

I mean, I would say so. I think there’s a lot of rate activity going on. Results have deteriorated. Our app counts in California are up 19%, and we’ve taken a 5% rate increase recently in our biggest company. So, we had -- there was one carrier that was put under I guess conservatorship by the Department of Insurance here in California. So, that’s just some increase in apps I think for the industry as well. So, yes, I would characterize it as such right now.

And there are no further questions in queue at this time. I turn the call back to the presenters for any closing remarks. Sorry, we do have one more question in queue.

Okay.

From the line of Sam Hoffman with Lincoln Square. Your line is open.

Yes. Thanks for taking my question. And I missed the beginning of the call. So, it may have been covered. But, I wanted to know, have you guys seen any impact from the legalization of marijuana in California or do you anticipate any impact from that on frequencies?

I can’t say that we’ve seen any impact to-date regarding the legalization of marijuana. Robert do you have?

No. I mean, most of the trends are more on the severity side than frequency side, right, at this point in time. So, I am sure there’re some cases, but we haven’t really seen a broad trend yet.

Yes.

Are you expecting that to take place? And have you looked at like Colorado as an example or do you feel confident that they’ve fund the first quarter that based on the first quarter that at least in your state -- and in California, it’s less of an issue?

As Robert mentioned, it doesn’t appear after the first quarter that it had an impact. We’ll have to monitor it. Whether or not the people that are buying it, were just smoking it before legally, I don’t know. But, we’ll have to monitor it.

And there’re no further questions in queue. I turn the call back to the presenters for their closing remarks.

Hey, I’d like to thank everyone for joining us this quarter and hope to bring you better results in the second quarter. Thank you.

And this concludes today’s conference call. You may now disconnect.