Good afternoon. My name is Nicole, and I will be your conference operator today. At this time, I would like to welcome everyone to the Mercury General first quarter 2011 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 that time, simply 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. Thank you. I would now like to turn the conference over to Mr. Gabe Tirador, President and CEO. Sir, you may begin your conference.
Thank you, Nicole. I would like to welcome everyone to Mercury's first quarter conference call. In the room with me is Mr. George Joseph, Chairman, Ted Stalick, Vice President and CFO, Chris Graves, Vice President and Chief Investment Officer, John Sutton, Senior Vice President of Customer Service, and Robert Houlihan, Vice President and Chief Product Officer. Before we take questions, we will make a few comments regarding the quarter. I am pleased to report that our first quarter results improved on many fronts. Although premiums written increased by a modest nine-tenths of 1% in the quarter, it marked the first quarter of positive premium growth since the first quarter of 2007. Our operating results also improved on a sequential and accident year basis.
Although the combined ratio of 98.2% in the current quarter was worse than the 96.3% combined ratio in the first quarter of 2010, it was significantly better than the 109.9% combined ratio posted in the fourth quarter of 2010. In the first quarter of 2011, we recorded $1 million of unfavorable reserve development compared to $20 million of favorable development in the first quarter of 2010. Excluding the impact of the reserve development in both years, the combined ratio was 98% in the first quarter of 2011, compared to 99.4% in the first quarter of 2010. The combined ratio was aided during the quarter by our continued focus in reducing expenses. Consequently, our expense ratio declined to 28.3% from 29.1% in the first quarter of 2010. Our loss adjustment expenses included approximately $4 million of severance-related costs from a reduction in force taken during the quarter.
We estimate that the reduction will lower expenses by approximately $11 million on an annual go-forward basis. We recently filed a class plan filing in our largest California company to improve our segmentation. We plan on making a similar filing for our two other California companies this week. Based on our analysis, we believe there are significant opportunities to improve our segmentation. In other words, our current rating plan is overpricing and underpricing many risks. Since these class plans are revenue neutral, we expect the approval process to be relatively smooth, with an implementation date probably sometime in the fall. In states outside of California, we continue to aggressively make changes to our rating plans to improve our segmentation and overall pricing adequacy. During the quarter, we implemented 10 rating changes in our auto line and four in our homeowners line.
For our private passenger auto business outside of California, six out of the 12 states had combined ratios under 100%. Although we are not where we want to be, we continue to improve our results outside of California, and my expectation is that most of our states outside of California will have a combined ratio below 100% by year-end. 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. We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Meyer Shields with Stifel Nicolaus.
Thanks. Good morning, or, yeah, good morning out there in any event. Gabe, did you comment on whether you're expecting a combined ratio below 100% in California auto for this year?
What was the question? Expecting 100% where?
In California itself.
Yeah, we are expecting below 100% in California.
Okay. Secondly, I guess where I found the most outperformance relative to my expectations was in the policy acquisition expense. Can you talk about a little bit, is that where the employees are, where you had the restructuring, or is there another initiative going on?
No, Meyer, this is Ted. The restructuring was primarily in the claims operations. I think when you look at the policy acquisition cost ratio, you kind of need to look at it in the context of the entire expense ratio. The policy acquisition cost ratio is 19.1% this quarter, 20.1% in Q1 2010, but 19.5% sequentially in the fourth quarter of 2010. There are some adjustments this quarter between policy acquisition expenses and general operating expenses, as well as some reductions in contingent commission accruals. These affected both the policy acquisition and general operating expenses during the quarter. Overall, the expense ratio was down compared to prior periods, which was generally helped by budgeted cost reduction efforts for 2011, primarily in the IT area. For the rest of this year, we do expect the expense ratio to be lower than it was last year.
Are you expecting any seasonality in the expense ratio?
Seasonality? No.
You're not going to have it vary over the year? No. Okay.
No.
Okay, that covers me. Thank you so much.
Your next question comes from the line of Dean Evans with KBW.
Yeah, thanks, good afternoon. I was first wondering if you could talk a bit about Florida. Was there any sinkhole losses in the quarter? Also, how is the planned withdrawal from Florida Homeowners going?
On the sinkhole losses, yes, we had some sinkhole losses in the quarter, although that has improved from previous quarters. Although we are running on an accident year basis, our Florida Homeowners line is running well above 100. It's much improved as compared to previous quarters. The withdrawal from our Florida Homeowners line is proceeding as planned. We started mailing out the non-renewal notices in, I believe, early March, and we expect to be out of that line 18 months from March, so sometime in the fall of next year.
Do you know offhand what the dollar value of the sinkhole losses was in the quarter?
Ted, do you know on an accident year basis?
I don't have that handy. I can tell you that the volume of sinkhole claims is running maybe less than half of what it was for the entire year last year. The amount of claims reported has slowed down quite a bit.
Okay. I guess thinking about so far what we've seen in the second quarter, how do you see your exposure to some of the events we've had, the tornadoes, et cetera? Do you have any sort of commentary?
Yeah. It's preliminary right now. We weren't affected. We don't write business in Alabama, but we certainly write business in Georgia and some other states that were affected. Right now, and again, it's very early, I would anticipate a reasonable range being somewhere in the $2 million, $3 million range. $1 million-$3 million, let's say. Not real significant, but again, it's very early on. We're still getting some claims in. I think that range is reasonable from the information that we know today.
Okay. That is very helpful. Thank you.
Okay.
Your next question comes from the line of Corey Wrenn with Pecaut & Company.
Yes. Good morning. I had a question in regard to growth. I am looking at the written premium line, and we are writing about the same level of premiums we wrote back in 2004 on an annual basis. I have noticed over the past few years, we have seen a huge ramp-up in advertising spending by the direct writers in the auto line business. Where do you see growth going forward in the next four to five years without spending the kind of money that we are seeing that these larger companies are spending right now? Thank you.
Well, as you mentioned, this is the first time in, I think it was 16 quarters that we have had any kind of positive premium growth, and we were glad to see that positive premium growth for the first time in 16 quarters. As you mentioned, it does continue to be a very competitive environment. The increased advertising spend in the insurance space today as compared to maybe five to 10 years ago is dramatic. Our goal is to increase the number of quotes being presented to potential customers. We believe we have competitive rates but need more looks. We also believe that our closing ratio can be improved upon with better segmentation. We have plans to do both. We are looking at various means to increase both the number of quotes, and as I mentioned before, just improving our segmentation, which should improve our closing ratio.
We also plan on adding to our distribution. We have some work that's being done that we refer to internally as the buy button, where we are experimenting with selling online in conjunction with the agent. That's going to roll out sometime, probably in the next month or two in Georgia. We'll see how that goes and see if we're going to expand that to other states.
Would that be-
We're trying to get more looks, and we're trying to improve our closing ratio both at the same time.
That would be online. Would that be through an agent still? Or would that be direct?
No. We would actually close the business online.
Okay.
Have arrangements with the agent on the back end for servicing.
Okay. Have you looked at trying to implement a direct line, direct business and with the agency business also?
Are you still committed 100% to the agency?
We're still committed. The way the buy button is currently modeled that we're going to task is, again, that we're going to be able to sell online, but we're going to partner with the agent.
Okay. Thank you.
Thank you.
Your next question comes from the line of Allison Jakubik with BofA Merrill Lynch.
Hi. Thanks. I think I'm sort of following up on the previous two questions but maybe asking it in a slightly different way. When I look at the expense ratio, if I take out $4 million for the severance, I get about 27.6% for the quarter, which is notably lower than the run rate in the past several quarters. Is that the kind of base expense ratio we should be looking at for the remainder of the year? Also, is ad spending a function of that? Have you slowed your ad spending? What are the cost saves that go into that, if you could elaborate?
Hi, Allison. First of all, the $4 million was primarily in claims, so that would be through the LAE and ULAE.
All right. Thank you.
That probably is worth noting. Ad spend I think is comparable, maybe slightly lower than last year, but it's fairly comparable.
It's down.
Yeah. As I mentioned before, we are expecting this year's expense ratio to be lower than it was in 2010.
All right, great. Thank you for the clarification.
Okay.
Your next question comes from the line of Ron Bobman with Capital Returns.
Hi. Thanks a lot. I had a question about Florida and the legislative session that I think is winding down. I'm not sure if it's one week left or two weeks left, but measured in weeks at most. Is there much hope of PIP reform in any meaningful degree this session? Are you optimistic? I appreciate your thoughts. Presumably, you follow quite closely.
Based on the most recent information that I've received, I don't think that we're going to probably see PIP reform this year. That's again based on the most recent information that I have. We may see some legislation on the sinkhole issues. As far as the PIP legislation that had been out there, it's my understanding that is probably not going to move forward.
Thank you.
Once again, if you would like to ask a question, please press star, then the number one on your telephone keypad. You do have a follow-up question from the line of Meyer Shields with Stifel Nicolaus.
Thanks. I just wanted to dig into the class plan issues because Gabriel talked about increasing sophistication there. Is this another step forward from the December 15th filing or the filing that was implemented December 15th last year? Or were there some, I guess, miscalculations in that one that you want to undo?
I'll have Robert Houlihan, our Vice President, Chief Product Officer, answer that.
Hi. No, we just made some minor changes last year, these aren't intended as corrections to the changes we made last year. For example, we updated our symbol relativities last year, which we believe are appropriate. In the new filing, we're going out with a whole new proprietary symbol set. It's that sort of order of magnitude of difference. This is a full GLM, full symbol set filing. It's an entirely new class plan. I would characterize last year's changes as just minor modifications to improve the existing class plan.
Okay. Is there a risk of the department deciding that you need another rate decrease even if that's not part of the original filing?
Well, not with this filing. They are separate filings. In California, there are two separate filings. There are class plan filings, and there are rate filings, and this is a class plan filing. So when we make a rate filing, that is when the rates get discussed.
Okay. You are not concerned about that at all this time?
Not with the filing that we just mentioned as far as the class plan, no.
Okay. If I can shift gears a little bit, are you at the point now where you can start looking at additional states for growth?
I don't think we're ready for that right now. There are no plans right now. 2012 is about six months out, but currently no plans for geographic expansion in 2012. That may change as the year goes on. We're trying to get all of our class plans, all of our segmentation in order, our technology. We're working on the existing states that we have. We have added products to existing states we're in. We've added homeowner products in various states. At this point in time, there are no plans for geographic expansion right now.
Okay, thanks. Ted, is there any way I could get a ballpark estimate of the contingent commission adjustments?
I think it's about $2 million, $2.5, something like that.
Okay. Great. Thanks so much, everyone.
There are no further questions at this time.
Okay. Well, I'd like to thank everyone for joining us today, and we look forward to talking to you next quarter. Thank you very much.
Sure.
Thank you for participating in today's conference call.