Good morning. My name is Marley, and I will be your conference operator today. At this time, I would like to welcome everyone to the Mercury General Corporation third quarter results 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 third quarter conference call. I'm Gabe Tirador, President and CEO. In the room with me is Mr. George Joseph, Chairman, Ted Stalick, Vice President and CFO, Christopher Graves, Vice President and Chief Investment Officer, and John Sutton, Senior Vice President, Customer Service. On the phone, we have Robert Houlihan, Vice President and Chief Product Officer. Before we take questions, we will make a few comments regarding the quarter. For the seventh consecutive quarter, our premiums written increased over the prior year. In the third quarter, premiums written grew by 3.4%, the highest it has been since we started growing in 2011.
The growth is attributable to several factors, including our California revenue-neutral rating plan we implemented in December of 2011 that made us more competitive for new business, as well as an increase in the number of agents selling our products. California new business private passenger automobile sales increased year-over-year in the quarter by 20%. Our combined ratio was 99.1% in the third quarter of 2012, compared to 98.3% in the third quarter of 2011. We recorded $4 million of unfavorable reserve development on prior accident years in the quarter and $33 million for the first nine months of 2012. Most of the $4 million development in the quarter came from our discontinued Florida homeowners line of business and from a few large claims in commercial property that developed worse than we anticipated. The third quarter results were aided by a decline in the expense ratio.
The 26.6% expense ratio in the quarter was lower than the 27% expense ratio recorded in the third quarter of 2011, primarily due to a reduction in profitability-related accruals. Going forward, our current expectation is for the expense ratio to be in the 27%-27.5% range. In California, we obtained approval from the California Department of Insurance for an approximately 4% private passenger auto rate increase. The increase went into effect on October 26, 2012, for both new and renewal policies. Although the 4% rate increase is less than the 6% increase we requested, this rate increase will get us closer to our targeted combined ratio. We are evaluating the possibility of filing for further rate increases. As I mentioned last quarter, our hearing on our California homeowners rate filing has concluded. A recommended decision from the judge was due to the commissioner on September 24th.
We expect to receive a copy of that decision any day now, the commissioner has up to 100 days from the date he received the decision to take action. Outside of California, the rate actions and cost management initiatives we have taken are starting to take hold. The combined ratio outside of California was a little over 100% in the quarter. We expect the results outside of California to continue to improve. I am pleased to report that last week we launched our buy button platform in California. Our buy button platform allows for the sale of new business online and also includes our agency partners in the transaction. Our board of directors approved an increase in our quarterly dividend to $0.6125 per share, marking the 27th consecutive year that Mercury has increased our shareholder dividend. We know that Hurricane Sandy is on everyone's mind right now.
We are following the hurricane closely, our catastrophe team will be ready to respond to our affected policyholders in their time of need. In our Northeast region, which includes New York, New Jersey, Pennsylvania, and Virginia, we have 25,000 homeowner policies in force. At this point, it's difficult to estimate what our losses from Hurricane Sandy will be. With that brief background, we will now take questions.
At this time, I would like to remind everyone, if you would like to ask a question, please press star, then the number one on your telephone keypad. Again, to ask a question, that is star, then the number one on your telephone keypad. Your first question comes from the line of Meyer Shields with Stifel Nicolaus.
Thanks. Good morning, everyone. Two quick questions, if I can. One, are the policies that are going to reflect the rate increase in California, are those going to be 12 months or six-month policies?
They're a combination of both, but I would say the majority are six-month policies.
Okay.
I would say probably 90% of the policies are six months right now.
Simply the insured's decision about whether they're going six months or 12?
Well, in Mercury Insurance Company, we started writing annual policies earlier this year. In Mercury Insurance, which is by far our biggest company in California, there was no option. It was historically only six months that we wrote. Yeah, typically the agent talks to the insured about the various alternatives, and it's up to them to decide whether it's a six-month or 12-month policy. In our largest company, again, we just started writing annual policies recently.
Okay. I guess the pre-tax investment yield picked up fairly significantly from the second quarter. I was wondering whether you could talk to that a little bit.
On the pre-tax or the after-tax or both?
I look at it on the pre-tax basis, if there's something on the after-tax, please let me know.
Okay. Well, there's been a larger allocation to dividend-paying stocks in the portfolio. I don't know if, Chris, you want to talk about that.
Well, yeah, in terms of the pre-tax, we are trying to pick up more yield mainly off of dividend stocks. The municipal bond income levels, the reinvestment yields are so low right now, and going out on the curve doesn't make a lot of sense to me. We have allocated quite a bit more into common equities. That's most likely what's driving that change.
On the after-tax, that's also driving the effective tax rate up a little bit on investment income as the dividends are not as tax-sheltered as the municipal bond interest.
Okay, thanks. That's very helpful. Thank you very much.
Your next question comes from Alison Jacobowitz with Bank of America.
Thanks. I guess two questions. One is, did the shift to annual policies impact premium growth materially this quarter? The second is, did you make any changes to current year reserves in the quarter?
Well, the shift to annual policies really started in late December last year, and we're seeing that under 7% of the total California personal auto policies written are now annual policies. It's hard to tell because it's somewhat distorted when you look at it on a year-over-year basis, and there was somewhat of an offset from the temporary decline in retention from the dislocation that was caused by our rate plan we implemented last December. We do know that California personal auto policies in force counts are up a little over 2% when you compare them from September of 2012 to September of 2011. To the extent that you can measure it based on policies in force, they're growing at a comparable rate to the rate of premium growth.
On your question on the loss development within the year, we really, Alison, analyze it on a year-to-date basis now, it's hard for us to make any comments on what was happening within the current accident year.
Okay, great. Thanks.
Your next question comes from Ray Arrieta with Macquarie.
Thanks for taking the call. Just a few questions from me. Would you mind repeating the policyholder number you gave in terms of the Northeast?
It's 25,000 homeowner policies in the Northeast region for us. Homeowners.
That's perfect. How does that compare to, I guess, last year around this time? Has that materially increased? Has it been pretty consistent, or has it been declining?
The growth in our homeowners business, it's up. I don't have that specific number for you, but it's definitely up year-over-year. Our homeowners line has grown. To give you some context, last year we had Hurricane Irene, it's hard to estimate what the impact of Sandy is going to be compared to Irene. Irene cost us $4 million last year, to try to put it into context. It's just way too early for us to estimate what we think the impact is going to be.
No, I can appreciate that. Just trying to get directionally how we should be thinking about that relative to Irene. The other question, I know in the past you guys talked a lot about BI severity in California. Just curious, what are the current loss trends in California, given, I guess, the roughly 4% rate increase you guys are putting into place in late October?
Ray, we're seeing severity in the lower middle single digits, if that makes sense. 3%-4% range in frequency in the low single digits, 1%-2% in California.
Okay. No, that's certainly helpful as well. Just last one for me. In terms of Proposition 33, can you guys kind of comment on your thoughts on that initiative and kind of how that would position Mercury going forward if it were to pass and if it weren't to pass?
Well, if it were to pass, we think it's going to make it easier to attract new business for us, since companies today are not allowed to offer a continuous insurance discount to new customers, but only to existing clients. I think it's going to improve our competitiveness on new business by allowing us to offer this discount to customers that are getting it from their existing carrier. It'll improve our competitive position. If it doesn't pass, well, we still feel that we have a competitive product. We're growing in California, as we mentioned earlier. Our app count in the quarter year-over-year was up a little bit over 20%. We still feel good about Mercury's position here in California, despite what happens with the initiative.
Obviously, if the initiative were to pass, we feel that long term, that would be a nice plus for Mercury because it would allow us to attract new business. We also feel it's good for consumers as well, because consumers are going to be able to shop for better rates. It's a net-net win for both, we believe for us and consumers. Again, I just want to reiterate, we are growing. We grew 20% this quarter. If it doesn't pass, we still feel pretty good about our position here in California.
Okay. Thanks. That's certainly helpful. One last one, if I could sneak it in and just update the Florida homeowners business, assuming that you guys are completely out of that. I think the previous guidance was the end of September.
Yes, we are completely out of the homeowner business in Florida. We do have some runoff claims that we're going to have for some time. Basically have no policies in force as at the end of September in Florida for homeowners.
Okay. Thanks again.
Thank you.
Again, to ask a question, press star, then the 1 on your telephone keypad. Your next question comes from Ron Bobman with Capital Returns.
Hi, a question about Florida auto. I was curious, in the wake of the PIP legislative changes, what's your rate plan and your thoughts about recognizing or not yet recognizing any impact from the legislative change there? Thanks.
Okay. Thank you. Robert, do you want to take that question?
Sure. In Florida, I'm just checking our filing for our aligned product.
Well, we made the required filing. I guess it was due on 10/1, Robert.
Yeah.
The filing indicated that our PIP indication was higher than 10% for PIP.
Oh.
Basically, we filed for no change in rates because even though the new statute required you to reduce rates by 10%, our indication was that for PIP that it would be higher than 10%. We did not take the rate increase that was indicated because of that. That's what I believe we did, Robert.
Yes, that's correct. We are assuming that the improvement in PIP from the regulatory changes will offset our indicated rate need, but we didn't actually decrease our PIP rates.
Right.
Some people, I think, have assumed adverse losses in BI or other liability lines in the auto product. If I'm close to right, are you making any assumptions about that?
Robert, did we make any assumptions on BI? I think we just used, in our latest filing, we just used our historical trends, which BI was going up in Florida. I don't believe that in our latest filing, we made any kind of estimated forecast as to what we thought BI would be after the PIP legislation, at least not in this latest filing.
That's correct. Yes. We used our historical trends. We didn't project for any changes in BI relative to the PIP reform.
Right.
All right. Thanks for the help. Appreciate it, and best of luck.
Thank you.
There are no further questions at this time.
Okay. Well, thank you everyone for joining us, and those of you in the East Coast, please stay safe. Thank you very much, and we'll talk to you next quarter.
Thank you for your participation. This does conclude today's conference.