Good morning. My name is Amy. 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 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 one 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 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'm 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 selections.
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 the more recent years' development factors into our loss selections. Increased utilization of medical services, including epidural injections 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 FastTrack, in the fourth quarter of 2017, California prior 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 have 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 represent about half of our direct company-wide premiums earned, and California Automobile Insurance Company represents about 14% of our direct company-wide premiums earned. Premiums written grew 6.1% in the quarter, primarily due to an increase in policies written and higher average premiums per policy. Company-wide, prior passenger auto new business applications submitted to the company increased approximately 9.5% in the quarter as competitors continued to increase rates and tighten their underwriting. Company-wide homeowners applications increased 10% in the quarter. With that brief background, we will now take questions.
As a reminder, ladies and gentlemen, if you would like to ask a question, please go ahead and press star, then the number one on your telephone keypad. Again, that's star, then the number one in order to ask a question. We'll pause for just a moment to compile the Q&A roster. Your first question today comes from the line of Carl Doirin of Raymond James. Your line is open. Mr. Doirin, you could be unmuted.
Yep. I was on mute, sorry. Good morning on the West Coast. Just a couple of clarification here. Gabe, you've mentioned 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.
Yep, mid-September.
Mid-September.
Of course, there is a 5% that went into effect in March for Mercury. Can you tell us what the rate increase was that was filed recently that's also pending?
6.9.
Okay. Same thing. All right. Of course, I guess, given the adverse reserve development in the quarter, I guess my next question is how many rounds of rate increases do you think you need going forward to sort of catch up with the loss trends?
Robert, do you want to handle that question?
Yeah. Smith, on an accident year basis, the results are better. I think the pending rate increases we project will be enough to maintain an underwriting profit prospectively.
Yeah. We're running at about company-wide, if you take away the development at about a 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. A lot of it depends on the future, what happens with not only development but also just with overall trends in the market. 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 the rate increases that we have pending are going to be sufficient.
Okay. Fair. I guess you also mentioned plaintiff bar being more aggressive. Has it gotten progressively worse, meaning are you seeing it getting worse in 2017 as the months go by versus 2016?
I would say that it's probably started in 2016. Yes, we saw an increase in 2017. That is somewhat anecdotal, but we feel that 2017 was worse. In 2018, that trend continued. As I mentioned earlier, the Fast Track showed a pretty big spike in PPA liability loss ratio. You have 2013 ended at a 77, 2014 ended at a 77 about, then you saw a big spike in 2015, then a really big spike in 2016. Then it seems to be leveled off a little bit in 2017. Really from 2014 to 2017, there's been a big increase in trends in the industry.
Okay. Last question from me. Can you talk about sort of your, I guess, growth in outside of California?
Outside of California, we've had negative growth. We've been shoring up there the profitability. We posted a combined ratio in the high 90s, 98 and a half, something like that outside of California in the quarter. 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 rider, Workmen's Auto was up almost 20%. It was up 19% in California private passenger auto applications.
All right. Well, thank you very much. That's all for me.
Thank you.
Your next question comes from the line of Gary Ransom of 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. I'm not sure I understood the significance of what you were saying about those severe injuries. Could you clarify why are those new and why are those different?
Well, epidural injections are really one of the things that we're seeing a lot more often now. Which is basically just an injection in the back between the epidural space in the back. It used to be we didn't really see as many of these. Now many claims are being built up by the plaintiff's attorney. They're attorney driven really medical procedures in our view in many cases. In many cases, people have had back injuries before the accident. We're 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 specials so they can drive up the cost of the claim. Now we're doing a lot of things internally to try to combat that. Some of these we're taking to trial.
Nevertheless, when you have an increase in medical costs and increase in medical procedures, it's going to impact severity. We're also seeing more surgical procedures in the back. People more willing to actually go ahead and have the back surgery. Another 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. Those three things, I think, in sum, is what we're seeing more of as compared to the past. 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.
You think that's been filtering into what you were talking about on the severity for Fast Track as well?
Yeah. Absolutely. We've spoken-
Yeah
to a lot of our counsel outside that handle our claims and handle claims for other carriers as well, there's no question that this is impacting or has impacted the industry.
Huh. I may not remember exactly right, I kind of recall that collision was also up a lot in California in the last Fast Track data. I may not have that right, have you seen any unusual trends on the auto repair side, call it?
It's up a little bit. Not a lot. I'm looking at Fast Track here for PPA collision loss ratio according to Fast Track. At the end of 2013, it was 70%. At the end of 2014, it was 71.6%. At the end of 2015, 73%. At the end of 2016, 75.8%. Then at 2017, dipped down a little bit at 72.1%. Now that's-
Okay
that's loss ratio. That includes-
Right
rate increases. We're seeing in the mid-single digits, 10 severity increases with frequency down a little bit.
Okay. What do you think is the solution for the, as plaintiffs' bar is pushing for all of this, is the answer just 6.9% every chance you get, or are there more things you can do on the claims management side, even maybe the underwriting side?
I think it's all 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 that we've been focused on the last couple of years. On the underwriting side, working with our agents, and also taking rate. We're really attacking this problem, all three facets of the business. We're attacking it by trying to do things on the claims side, taking some of these cases to trial, and on the underwriting side, and then with some rate. 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 know about using the word sympathy.
Is it just business as usual? Yeah, maybe that's the wrong word.
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 on surplus formula, and with more losses in the system, higher trend. That works its way through the formulas, which makes it easier to justify a rate increase.
For example, there's one major competitor here in California that recently was approved something like a 6.5%. Actually, has not yet been approved for a 6.5%, and they've already filed for another 6.9%.
Yeah.
This is a big competitor.
Yeah. Does anyone brave the possibility of doing seven or 10 or 12?
Well-
Is that just too problematic?
I don't think, unless you're way behind, I think that's probably too problematic. Robert, do you want to?
Of course, if you file for more than seven, an intervener requests a rate hearing.
Yeah.
It's no longer at the discretion of the commissioner. It must go to rate hearing. That process is so lengthy and could potentially delay the rate increase so much that I think it's, and as Dave said, unless you're really far behind on rate.
Right
It doesn't make sense to step beyond the 7%.
Right. Okay. Well, I hope it all gets better. Thanks for all your answers.
Thank you.
As a reminder, in order to ask a question, please go ahead and press star, then the number one on your telephone keypad. Your next question comes from the line of Ron Bobman of 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?
Yeah. About half of it is from 2016, a little over half. About a third of it is from 2015, and the rest is spread across the other accident years.
Okay. Did this charge come from a full reserve review done in Q1 or an actual versus expected type exercise?
Well, we do an 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've spoken before, is that widespread in California or more confined to a specific region within California?
I would say it's throughout the whole state. I've seen cases up north and down south, although I would say more so down in Southern California.
Okay. 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 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. There was one carrier that was put under conservatorship by the California Department of Insurance here in California. That led to some increase in apps, I think, for the industry as well. Yes, I would characterize it as such right now.
Great. Thank you.
There are no further questions in queue at this time. I turn the call back to the presenter for any closing remarks. Sorry, we do have one more question in queue.
Okay.
From the line of Sam Hoffma n of Lincoln Square, your line is open.
Yes, thanks for taking my question. 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?
Most of the trend is kind of more on the severity side than the frequency side right at this point in time. I'm sure there are some cases, but we haven't really seen a broad trend yet.
Yeah.
Are you expecting that to take place? Have you looked at Colorado as an example, or do you feel confident 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.
We'll have to monitor it.
Terrific. Thanks for taking my question.
Okay.
There are no further questions in queue. I turn the call back to the presenters for their closing remarks.
Okay. I'd like to thank everyone for joining us this quarter and hope to bring you better results in the second quarter. Thank you.
This concludes today's conference call. You may now disconnect.