Good morning, afternoon. 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 third 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, please press star then the number one 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 third 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 third quarter operating earnings were $0.60 per share, compared to $0.67 per share in the third quarter of 2016. The deterioration in operating earnings was primarily due to an increase in the combined ratio from 98.1% in the third quarter of 2016 to 99.3% in the third quarter of 2017. Our results in the quarter were negatively impacted by $19 million of catastrophe losses, primarily caused by Hurricane Harvey and Irma.
In addition, we recorded $4 million of unfavorable reserve development. This compares to the third quarter of 2016, which had $4 million of catastrophe losses and $7 million of unfavorable reserve development. Excluding the impact of catastrophe losses and unfavorable reserve development, the combined ratio was 96.5% in the quarter, compared to 96.7% in the third quarter of 2016. The expense ratio was 25% in the third quarter, compared to 25.2% in the third quarter of 2016. The lower expense ratio was primarily due to a decrease in acquisition costs and cost efficiency savings, offset by higher advertising spend. Net advertising expense in the quarter was $12 million, compared to $10 million in the third quarter of 2016. To help offset increasing loss trends, we have been increasing rates in most states.
In California, we implemented a 6.9% personal auto rate increase in California Automobile Insurance Company effective in May, and a 6.9% rate increase in our homeowners line in August. In addition, a 5% rate increase for Mercury Insurance Company and a 6.9% rate increase for California Automobile Insurance Company are pending approval with the Department of Insurance. Personal auto premiums in Mercury Insurance Company represent about half of our company-wide premiums earned, and California Automobile Insurance Company represents about 14% of our company-wide premiums earned. California homeowner premiums represent about 12% of our company-wide premiums earned. Premiums written grew 2.4% in the quarter, primarily due to higher average premiums per policy. Company-wide, private passenger auto new business applications submitted to the company increased approximately 1% in the quarter. Company-wide homeowners applications increased 5.5% in the quarter.
Lastly, we generally expect our accident quarter combined ratio for the fourth quarter, excluding catastrophes, to be higher than the rest of the year due to increased loss frequency and higher severities caused by seasonal driving and weather. That said, it is hard to predict with certainty whether the underlying combined ratio will be higher as there are many factors currently unknown or beyond our control. With that brief background, we will now take questions.
At this point, I would like to remind everyone, in order to ask a question, please press star then the number one on your telephone keypad. Your first question comes in line with Greg Peters with Raymond James. Greg, your line is open.
Good morning. It's Greg Peters, not Peppers. Thank you for the call and for taking the questions. Gabe, I was wondering if you could just go back and provide more color around new business trends, both inside California and outside California. I think last quarter you talked about some headwinds outside of the state of California weighing down on the consolidated result. I'm curious if you could provide an update.
Yeah. I think when you take a look at outside of California, our new business private passenger auto apps are down quite a bit. They're down about 19% quarter-over-quarter, that's the result of us just taking action on rates, Greg, and trying to improve the profitability. If you take a look at our results outside of California, excluding cats and excluding some positive development, we actually had some positive development outside of California. The combined ratio was under 100. It was, I think in the high 90s, 97%, 98% or so outside of California. Obviously, we paid a little bit of a price. We're paying a little bit of price with respect to growth as the app counts are down 19%. In California, our private passenger auto apps were up about 7.5% in California for private passenger auto.
Combined, total apps were up 1%, which is what I said in my prepared remarks.
What was the California only combined ratio? You gave us what it was running for outside California. What was the California piece?
Do you have that, Ted?
It's running for personal auto or for everything?
Well, I think he gave the split 97/98 for outside California.
Yeah.
Is that auto only?
In California for private passenger auto, we booked about a 96.5% for private passenger auto.
Okay.
About a 98.5% for homeowners.
Okay. Thanks for the color. The 19% outside, I guess what I'm trying to get to is trying to sort of figure out when the drag from outside of California will dwindle down and possibly stabilize and respectively grow. Is there an inflection point? Is it mid next year? Is it end of next year? If you have any updated perspective, that would be helpful.
There's some states that we think have leveled out. Other states, I think, have a little bit more to go, assuming that the app counts stay at its current level. You have various assumptions with respect to what's happening in the market. Are other people taking rate as well? We've been pretty aggressive, there's a lot of rate activity going on right now as well with the competitors. There's a lot of factors, I would say that there's still a ways to go for some states, and other states, I believe is we should plateau.
Okay. Just on the California piece for the auto business. Would you characterize the, I'm trying to sort of read into your fourth quarter commentary about a deterioration in the underlying, I guess with all the rate activities that you've applied in California, I would've expected that the trend would be positive or a little bit positive, gradually growing, I'm not sure we have it yet, or maybe some color on that would be helpful.
Well, the only thing we want to comment on is that generally speaking, the fourth quarter has higher frequency and severity here in California. You go back many years, our fourth quarter here in California primarily has been higher than the rest of the quarters from a frequency and severity standpoint. That's really the only thing that we're trying to say, that generally speaking, there's some seasonality. We feel that the fourth quarter here in California, and California being such a large market for us, we just thought it was prudent to let folks know that generally speaking, right after Thanksgiving, you got the holidays, and typically you have some weather that contribute to the higher fourth quarter frequency and severity. Sometimes it may not occur. We don't know. There's things that we just can't foresee, but that's why I made that comment.
Okay. That's fair. Two other questions, then I'll re-queue. First, appreciate your color around wildfire potential losses. I'm just curious if you have a perspective on what kind of changes might happen to your reinsurance costs next year, considering that it looks like there's a pretty big gross loss for the company this year.
Well, the reinsurers, this is Ted. The reinsurers in general are assuming a lot of losses from the storms, the sort of hurricanes in the Southeast, then this fire. Pricing in general may go up depending on the capacity of the reinsurers. We're not sure yet. We think we may take a long-term view, we may see some increases next renewal, at this point, we're not really sure.
It's really too early to tell right now, Greg.
When's the renewal period again? I'm sorry, I forgot that one.
The July 1 to June 30 treaty.
Okay, perfect. Thank you. Last question, Chris, I'd be remiss if I didn't ask you a question. I noticed that the after-tax yield's down year-over-year and down in the third quarter relative to the year-to-date results. Is there something going on there that's driving a lower yield or on an after-tax basis, or is it just, well, I'll let you answer.
Yeah. Hi, Greg. Rates are where they are. They've come down a lot from year-end. Actually have allowed our cash to build up some much less activity on fixed income investing through the third quarter. There's some dilution there. This recent reversal in the 10-year Treasury and rates in general is making me a little more optimistic. We're putting money back to use. Spreads have also been very tight. That's been the primary problem, really, at least the way I look at it.
With this recent reversal in rates, I'm optimistic that I'll get a lot more money to use at better levels through the fourth quarter and should hopefully then see a lift in those yields.
Thanks for the answers. Thank you for the call.
Thank you, Greg.
If you'd like to ask a question, please press star then the number 1 on your telephone keypad. Your next question comes from the line of Alison Jacob with Bank of America. Alison, your line is open.
Hi. Thanks. Two numbered questions, actually. Other revenue looked like it was up a lot year-over-year. I was just wondering what was in there, and then also the acquisition expense ratio was the lowest we've seen in a while. I just was wondering if you could give more color on what's driving that number down and if it's sustainable going forward.
Hi, Alison, it's Ted. On the other revenue, other income, the company realized a $3.3 million gain on the sale of land. We had some land in Brea that we had been holding for about 10 years that we sold. That's sort of a one-time impact to that line item. On the question on the acquisition expenses, I think we said on calls before, but we kind of had a long-term decrease in our acquisition expenses, primarily due to lower commissions. Our commissions have gone down gradually. July 1st is when we do our annual agent commission adjustment, there were some decreases in the third quarter, and those flow through to the whole acquisition expense ratio.
Thanks.
You're welcome.
Your next question comes from the line of Greg Peters with Raymond James. Greg, your line is open.
Thanks. Just one other follow-up to sort of building on Alison's question. Ad spend, I think you said, is up to $12 million in the third quarter from $10 million a year ago. I know your big expenses are in the first and third quarter. As we think about 2018, do you have any perspective on whether the budget's going to be flat, up, or down for our models?
I think right now we believe it'll be slightly up in 2018.
Okay, perfect. Thanks for the answers.
There are no further questions at this time. I'll turn the call back over to the presenters.
Well, thank you for joining us today, and we look forward to speaking with you next quarter. Thank you very much.
This concludes today's conference call. You may now disconnect.