Good afternoon. My name is Jesse, 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 speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number 1 on your telephone keypad. If you would like to withdraw your question, press the pound key. 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 fourth quarter conference call. I'm Gabe Tirador, President and CEO. In the room with me is Ted Stalick, Senior Vice President and CFO, Chris Graves, Vice President and Chief Investment Officer, and Robert Houlihan, Vice President and Chief Product Officer. Before we take questions, we will make a few comments regarding the quarter. Our fourth quarter operating earnings were $0.58 per share compared to $0.52 per share in the fourth quarter of 2015. The improvement in operating earnings was primarily due to an improvement in the combined ratio from 100.2% in the fourth quarter of 2015 to 99.2% in the fourth quarter of 2016. In California, we recorded an increase in personal auto severity in the mid-single-digit range for the 2016 accident year and an increase in frequency in the low single digits.
To help offset the increase in loss trends, we have been increasing rates in California. Last year, in our personal auto business in California, we implemented a 5% rate increase in late March 2016 for Mercury Insurance Company and a 6.9% rate increase in June 2016 for California Automobile Insurance Company. In addition, a 6.9% rate increase is pending approval with the Department of Insurance for California Automobile Insurance Company. Personal auto premiums in Mercury Insurance Company represents about half of our company-wide premiums earned, and California Automobile Insurance Company represents about 15% of our company-wide premiums earned. We have observed a significant number of our competitors also file for rate increases in California. Outside of California, increasing loss cost trends have negatively impacted our results. To address profitability outside of California, we have been increasing rates and tightening our underwriting.
The expense ratio in the quarter declined to 24.9% from 25.9% in the fourth quarter of 2015. The decrease in the expense ratio was primarily due to lower profitability-related accruals. Net advertising expense in the quarter was $5.5 million compared to $5 million in the fourth quarter of 2015. Premiums written grew 2.9% in the quarter, primarily due to higher average premiums per policy. Company-wide private passenger auto new business applications submitted to the company decreased approximately 8% in the fourth quarter of 2016 as we focused on improving profitability in our private passenger auto line. Company-wide homeowners applications increased about 7% in the fourth quarter of 2016. In California, we posted premiums written growth of 5.4%. Outside of California, premiums written decreased by 8.1% in the quarter. With that brief background, we will now take questions.
At this time, I would like to remind everyone, in order to ask a question, please press star, then the number one on your telephone keypad. We will pause for just a moment to compile the Q&A roster. Again, if you'd like to ask a question, please press star, then the number one on your telephone keypad. Your first question comes from Greg Peters with Raymond James. Your line is open.
Good morning, everyone. Thank you for the call and taking our questions. I wanted to just ask a couple of questions around some previous comments you made. I think you said in the last quarter that you plan to file a class plan in Mercury Insurance. At that time, it was 90 days. Where are you with that? Do you anticipate that you'll be looking for some additional rate at Mercury Insurance?
I think that we're getting close to filing that. I would say within the next probably 30 to 60 days, we plan on making that filing. I anticipate that the class plan filing will come with about low single-digit rate increase, anywhere from up to 5%, let's say, is what we're expecting right now.
Perfect. Thanks. In Cal Auto, I know you said you're waiting for approval on another 6.9%. I think in the past you've provided us some color that you think that's more of your standard to non-standard book of business versus Mercury Insurance is just more of your preferred book. Can you give us what your perspective is in the non-standard market? We're hearing of a lot of challenge results from your peers, and I'm just curious where you think we might be in that pricing cycle, and is it reasonable to expect that profitability should improve in that component over the next year or two?
I think that's going to vary by company, depending on how early they are in the cycle with respect to getting their rate approvals. We started increasing rates both inside and outside of California quite some time ago. We feel that from a rate perspective, 2017 is going to be much better year for us, depending on what the loss trends continue to do. I think it's going to vary by company. There are some companies that maybe were behind a little bit, and may take a little longer for the rate to catch up to the loss cost trend. I do think it's going to be company specific, depending on where they're at in the cycle. There's no question that there's pressure.
Perfect.
Severity trends are definitely up, really in bodily injury severity. Material damage severity is up as well. There's no question that there's increased loss cost pressure. If that stabilizes, though, I think that the rate action that we've taken is really going to help profitability in 2017.
How did the severity trend and frequency trend in the fourth quarter? I know you've provided some color around that in the second and third quarters of last year. Where were we in the fourth quarter?
It's pretty comparable. Mid to high mid single digits on severity and low single digits on frequency. We just saw the latest Fast Track in California, pure premium running close to 10%, pure frequency about five, severity about five. I think we're a little under Fast Track industry, but it's still mid to upper single digits for us.
That's for the 12-month period, I think.
Yeah, annualized.
Ending in September because they're a quarter behind.
Okay. Thank you for the color. I'll just close out with one other question. I know there's sometimes other analysts that are on the call. I noticed that you took a realized loss in the quarter. I thought maybe, Chris, you could tell us what's going on there.
Yeah. I agree. We mark-to-market the entire portfolio. Most of that is just market changes in the quarter, particularly with fixed income having sold off. Of that, we took about $12 million in losses that we realized against capital gains from prior periods. There's that in there as well.
Yeah. That was part of tax planning, utilizing expiring capital gains.
Our portfolio is classified as trading. Everything flows through the income statement as a realized gain or loss. Changes in market value as well.
Yeah. Dating back to 2008.
Yeah.
Okay, perfect. Thanks for the color. I'll requeue.
Thank you.
Again, if you'd like to ask a question, please press star then the number 1 on your telephone keypad. The next question comes from Ken Billingsley with Compass Point. Your line is open.
Good morning out there. Question is on. I apologize if you mentioned this, I got in just a little bit late. For the 2.7 points on the reserves increase, can you talk about where that's coming from specifically, maybe the fourth quarter number? I estimate that's around $14 million-$15 million of unfavorable development. What years is that coming from?
For the year, it's generally California and Florida personal auto and commercial auto. About half of it is from the 2015 accident year, and the rest is kind of spread across the preceding couple two, three years.
The question I have then. I hope I'm not looking at this wrong. I look at the accident year loss pick for 2015, this is excluding CATs, my calculation's about 71.5%. I'm showing that you're pretty much in the same position for 2016. If you're taking reserves up for, you said half of it's for 2015. Does that mean that maybe your accident year loss picks even need to be a little higher for 2016? Is the rate approvals that you've already received going to offset most of that uptick?
Go ahead.
Yeah. We've taken substantial rate beginning in 2015 and into 2016. Our belief is that the rates that we're earning in in 2016 have outpaced or at least equaled the loss trend.
I will say the accident year combined ratio is at a 98%, and we are for 2016, it varies by state, but overall, we are anticipating and have recorded higher severity in 2016 on an accident year basis versus 2015. There's no question about that.
Were there any current year adjustments made true ups at the end of the year? Current year adjustments for 2016?
We really evaluate it on a year-to-date basis. We prefer to comment on the year-to-date numbers more than the intra-quarter numbers as far as development goes.
Okay. maybe year-to-date, on a cumulative basis, was there?
Correct. No, there was not.
The last question to turn it back into the queue is just looking from a statutory surplus underwriting leverage. All the statutory surpluses remain relatively flat year-over-year. From a premium standpoint, how much can you take the leverage up given that your top line still is growing, but the surplus is remaining flat? Where's the comfort level on that underwriting leverage?
We think that the premiums to surplus in 2017 will be relatively flat to what it was, depending on what happens with our dividends.
We expect our operating earnings in 2017 be quite a bit better than 2016. We don't really anticipate 2017 to have a lot of top-line growth. If those two things are achieved, I don't think you're going to see much movement in the premiums to surplus ratio in 2017.
Okay. The expectation, obviously, that the payout ratio would be under 100%, so you wouldn't have a decline in surplus.
That is certainly the objective.
Understood.
Yeah.
I understand. Thank you for taking my question.
Your next question comes from Alison Jacobowitz with Bank of America Merrill Lynch. Your line is open.
Hi, thanks. I'm just wondering if you could talk a little bit maybe about the weather in California, the rain levels in the first quarter, if you can, and if there was anything seasonally in the fourth quarter that was of note from a weather standpoint.
Well, I think El Niño has come a year late, in my opinion. The forecasters have said that El Niño was coming last year, and in my opinion, they got it a year late because we've had a significant amount of rain. It took me two and a half hours to get into the office this morning because of the rain. There's definitely a lot of rain. It's going to impact our homeowners' results in the first quarter, as an example. We received a lot of rain-related claims in the first quarter. As far as the fourth quarter goes, Ted, do you have any comments on that?
It was a typical fourth quarter. A little bit elevated frequency, but pretty typical.
Thank you.
Okay.
Your next question comes from Greg Peters with Raymond James. Your line is open.
Great. I just wanted to follow up with just a couple other questions. First of all, Gabe, I think your objective from a combined ratio perspective, I think you previously said you want to get the combined ratio down to around 96 or better. One, can you confirm that that's your target? Then two, what's the time horizon where you think you might be able to get to that objective, if there is that objective?
Well, one, yes, it is. I think 2017, I don't think that we're going to get there probably all the way down there in 2017. I certainly would expect our objective to be there in 2018.
Okay. As a couple of housekeeping items, I know your bonus accruals were down in 2016. Is there an expectation that you're going to be paying out these bonus accruals in 2017? Have you set your objective for your advertising budget for 2017, and how does that compare with 2016?
As far as the bonus accrual for 2017, we expect to pay a bonus. What that net will be is hard to say at this point, but it was zero. Bonus accrual was zero for 2016. In 2017, the anticipation is that there will be some bonus accrual in 2017. What was the second part of the question? Advertising is going to be similar, about $40 million or so, 2016 and 2017. We anticipate the advertising spend to be similar.
Okay. The final question I have for you. You talked about the rain and affecting your drive and weather-related losses. One of the most difficult things I've had in following your company is trying to understand exactly how your catastrophe exposures lay out. Could you provide us some color around where your book of business, where the exposures are, and where the catastrophe risk is when we think about quarter-to-quarter volatility?
I think it varies, obviously, by state. In California, we have rain-related events. We follow ISO. When they name a cat, we follow that definition of a cat. Historically, we've averaged about, I think over the last five years, something in the neighborhood of about $24 million, $23 million, something in that neighborhood in cat losses. This last year in 2017 was a little higher. I think it was $27 million in 2016. We obviously price in for that amount of cat when we make our estimates. In California, you're looking at primarily rain-related events. Outside of California, you have wind events in homeowners that are probably your biggest exposure. In Texas and the Northeast states, you have hurricane exposure. You have fire following earthquake as an exposure here in California.
Wildfire.
You have wildfires as an exposure here in California. It does vary a little bit by state. I don't know if that answered your question.
That was very helpful. Thank you very much.
Okay.
There are no more questions at this time. I turn the call back to the presenters.
Well, I'd like to thank everyone for joining us this quarter, and we look forward to talking to you next quarter. Thank you very much.
This concludes today's conference call. You may now disconnect.