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. 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, please 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 positions.
Such statements involve risks and uncertainties which cannot be predicted or quantified and which may cause certain 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. You may begin.
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, 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 from 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 for 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 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 of $4.1 million added six tenths of a point to the quarter's premiums growth. Company-wide private passenger auto new business applications submitted to the company increased 13% in the fourth quarter of 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 Protection, premiums written increased 12.3% in the quarter. With that brief background, we will now take questions.
At this time, if you would like to ask a question, please press star followed by the number one on your telephone keypad. We will pause for just a moment to compile the Q&A roster. Again, if you would like to ask a question, please press star one on your telephone keypad. Yeah, do you have a question from the line? Ken Billingsley with Compass Point, your line is open.
This is Ken Billingsley with Compass Point. I wanted to just follow up on the expense ratio. You said that average commissions were down and advertising expenses. I just want to verify one number. You said, is it $15 million to spend in the first quarter of 2016?
Yes. That's what we expect. About the same level in 2014, Ken.
Okay. I'm on the East Coast, I've seen a lot more advertising for Mercury, I know you had done a global campaign on that advertising side. Have you scaled that back? That's the first one. Have you scaled it back? If so or not, what is the plan for that advertising spend?
Well, we spent about $44 million in 2015, we expect to spend about $42 million in 2016. We think that the advertising is working. We're recovering the majority of our advertising costs that we did in 2015. Our cost per sale is really close to where it needs to be in 2015, we expect to get to where it needs to be in 2016.
On the lower average commissions, can you talk about that? I know at one point, at least I believe you were paying slightly higher commissions in some new territories. At some point, you were expecting that the expenses were going to catch up with the premiums that you planned to write in the state. Is it a case of the premiums catching up, or is this actual less commission percentage being paid out?
It's 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've cut our commissions.
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're quite a bit above our competitors. I think in California, we average about 17% or so commission rate, 16%-17%, and the competition's probably around 13%. Outside of California, we're probably hovering around 13% and change, which is where the competition's at.
Okay. 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 two and a half times your surplus level. It looks like you still have 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. If we were in even at a 98.5, 98, you're talking about more than paying the dividend. Our target is a 95. 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're going to be pretty much where we need to be for the time being in MIC. In Cal Auto, we have a 6.9 that's pending approval that hopefully we'll get that approved well, pretty soon, I should say. Those two rate increases are going to go a long way to improve our profitability. Outside of California, this quarter was a disappointment.
When you take a 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 did not keep pace with that. We anticipate increasing rates outside of California. We're also going to be driving down our LAE and expense ratios outside of California. They're not where they need to be. The 101 and 100 that I quoted earlier, that's with the higher expense and LAE ratios that we have. We're going to be very focused going forward in driving that down, our LAE and expense ratios, especially outside of California.
We're going to be increasing rates where we need to offset some of this frequency and severity that we saw outside of California. In California, as I said, in MIC and Cal Auto, we have some pending. To answer your question, we don't expect our combined ratio to be at this level. If we drive that combined ratio down closer to our target our dividend-paying capacity will be fine.
Your California expense ratio or your commission ratio, you said it was 17, almost 400 basis points higher than the comp. Is there a reason? Does it need to be that elevated? Is that just historical, and it's driving better business, at least in your opinion?
Well, it's historical. I also do think it can drive better business, that's actually come down as well. We've actually reduced some commissions here in California. We do think that in California, it's a different market, and we've been here a long time, and we have very strong agent relationships. Even though we've driven that down a little bit, it's not going to be driven down as much as you're seeing outside of California.
Well, thank you for taking my questions.
You're welcome, Ken.
Your next question comes from the line of Gregory Peters with 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 went through and identified a couple 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 to flow through immediately, or is there a waiting for approval process that you're following?
It's much easier to get a rate outside of California, but I'm going to go ahead and Robert talk about that.
Yeah, I think in our larger states, we actually already have had recent rate increases that are starting to earn in most of our big states outside of California. Texas, Florida, 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've seen in those states.
You went through and identified those states. I imagine those are the states where you're running a combined ratio temperature. What's been the magnitude on average of the rate increase that you've filed for or are implementing?
In general, high single digits.
Okay.
New York, the pending increase a little bit higher, but on average, high single digits.
Okay. I think you cited what your ultimate target of a combined ratio is in the mid-90s. I think you also, in answer to the previous question, used a 98%-98.5% sort of benchmark. Should we view that as an intermediate term sort of objective for management? Do you have a timestamp on when you think you might get there?
Well, our target is a 95. The reason I stated a 98.5, it was related to the dividend question and the fact that our earnings are below.
Right
the dividend of $263 or so. Reaching a 98 and change in combined ratio gets us to about that level. Our objective is still to get to a 95. I think in California, absent any trend, I think we're going to be starting to get close to that number. Outside of California, it's going to take time for these rate increases to earn in. It'll take us a little time to reduce our expense and LAE outside of California. I would say that in 2016, outside of California, no, we don't expect to be near that combined ratio target. In California, I think we're going to be much closer to it. If you want to call it an interim step of 98, an interim step, I wouldn't argue too much about that.
Okay. That's fair. Of course, this is going to be a gradual improvement. It's not going to come all up in the first quarter. It's going to bleed in through the course of the year. Frankly, the next couple of years.
Yes.
I imagine.
Yes. It doesn't happen overnight. Yes.
Perfect. Thank you. Thank you for that clarification .
Sure.
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. 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, where your exposures are on the property side? The second question is going to segue into the investment portfolio. I know you've had periods where you've been very successful. I'm 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.
On the property side, we write homeowners in a variety of states or in many states. California being the biggest state that we write homeowners in. Probably over $300 million in homeowners in California. 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. I think our next biggest state is probably about $14 million, $15 million, and that would be Texas. We also write some commercial property business primarily in California. That's about $75 million or so of business in the property side. We do have catastrophe coverage. We have a retention of about $100 million. You can read about that in the 10-K for more specifics.
That's on the property side as far as our exposure. Most of our exposure, as you can see, is in California.
Right.
On the investment side, Chris, are you on the line?
I'm right here. Greg, thanks for the question. It's interesting. I've really been getting more and more bearish as time has been moving along here. Last year, we took down our equity investments by 25%-30% and pushed a lot more capital towards municipal bonds, which turned out to be a pretty decent move for the 2015 cycle. In terms of high yield, we don't have as much of an axe there. We do have investments in senior secured bank loans through two special investment vehicles in that area. On a $2 billion or, excuse me, a $3 billion portfolio, 70% of it is in municipal bonds, AA rating. The overall portfolio rating is pretty much AA as well.
You don't have any meaningful energy components in that either, correct?
In the equities, no. We've taken down, I think we've got a couple of MLPs maybe still in there that we may be kicking ourselves over. For the most part, the energy exposures are significantly down from where they were many years ago. In fact, the portfolio is much more broadly diversified at this point. There is still a fairly good concentration in utility stocks, as you can understand, for the income. Thankfully, those have had a nice, well, they've firmed in here anyway, for this year so far. We're definitely watching the risks, but the concentration in risk is much lower than where it was just from a few years ago. I actually went through this whole walk-through last week with the investment committee and the board that I continue to really watch our risk exposures and have a de-risk bias in the portfolio.
Great. Thank you very much for that color.
Sure.
Thank you for the other answers as well.
Sure.
Again, if you would like to ask a question, please press star followed by the number 1 from your telephone keypad. 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, what's the balance between six-month and annual policies? Are they all six months? I don't remember.
Robert?
There's a couple states where we write annual policies, the vast majority are six-month policies.
Thanks. Also, I didn't hear it, forgive me if you said it already, on the frequency and severity in California, or particularly the 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. We had a fairly favorable fourth quarter where it dropped down to a favorable trend, slightly. We're not sure why. Sometimes frequency, for example, in the first quarter of 2015, we had a big spike up in frequency. Sometimes there's just some variability from quarter to quarter.
Great. Thank you.
Again, if you would like to ask a question, please press star one on your telephone keypad. Your next question comes from the line of Wesley Guiley with Wesley Guiley Capital. Your line is open.
Hi. Good morning there. What is the combined ratio running in California Auto?
We don't disclose that, but it's not at our target right now, Wesley. It's above our 95% target. It's between 95% and 100%.
You think these rate increases that are coming, I think you said shortly, will get you down to your target?
I think it gets us to our target in our largest company-
Right
On a go-forward basis. Depending on what the trends are. Yes, we think that in MIC, our largest company in California gets us to target. Cal Auto, I think that there may still be more rate need, which is a non-standard company, or the standard mid-market company. In MIC, our largest company, I think it gets us where we need to be absent any kind of adverse loss trends that we're not anticipating.
That'd be very good. There's a lot of leverage just in getting that towards your target.
Yeah. I agree.
Okay, thanks very much.
Thanks, Wes.
I currently show that 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.