Good morning. My name is Michael, 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 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, 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 Chief Executive Officer. In the room with me is Mr. George Joseph, Chairman, Theodore Staal, Vice President and Chief Financial Officer, Robert Houlihan, Vice President and Chief Product Officer, Chris Graves, Vice President and Chief Investment Officer, and John Sutton, Senior Vice President, Customer Service. Before we take questions, we will make a few comments regarding the quarter. Our third quarter 2010 operating results deteriorated slightly as compared to the third quarter of 2009. Our combined ratio was 98% in the third quarter of 2010, compared to 96% in the third quarter of 2009. The increase in the combined ratio was primarily due to less positive reserve development in 2010 as compared to 2009.
Year-to-date, we have recorded approximately $18 million of positive reserve development on prior accident years, compared to $40 million in 2009. In addition, increases in advertising and technology related costs increased the expense ratio in the third quarter of 2010 to 29.4%, from 28.1% in the third quarter of 2009. As we look forward to 2011, we expect a reduction in technology related expenditures as compared to 2010. As we have previously reported, we have had an auto rate filing pending in California for some time. We have now reached a verbal agreement with the California Department of Insurance. The agreement reached includes a 4.96% rate reduction in Mercury Insurance Company and a 4.44% rate reduction in Mercury Casualty and California Automobile Insurance Company. In addition, the rate filing improves our segmentation and introduces new discounts and roadside assistance coverage.
We anticipate the rate filing to become effective on December 15, 2010. We expect our new rates will make us more competitive for new business. Although the rate reduction will put pressure on our California margins, we will be very diligent in underwriting our risks to ensure we obtain the proper premium for the risks written. 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 seven rating changes in our auto line and introduced homeowners in Nevada. Currently, seven private passenger auto rating changes and one homeowners rating change are planned for the fourth quarter of 2010. We are making significant progress in improving our profitability outside of California. Our Florida homeowner line continues to present significant challenges as a result of sinkhole claims.
Our Florida homeowner line produced a $5 million underwriting loss during the quarter on $3 million of earned premium. There is significant advertising in the state from public adjusters soliciting sinkhole claims. The legal requirements imposed makes it very difficult and expensive to defend these claims. We are planning on filing to withdraw from our Florida homeowner line with the Florida Department of Insurance. We see no other solution to this problem as the current environment is untenable. The rate of decline in premiums written of 1.2% during the quarter was similar to the 1% rate of decline during the second quarter of 2010. An improvement over the 4.7% rate of decline during the third quarter of 2009. With that brief background, we will now take questions.
At this time, I would like to remind everyone, in order to ask a question, simply press star followed by 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 Carolyn Spears with Macquarie.
Hi. It seems like in the quarter alone, there was some adverse development. I was just wondering what the driver of that was.
Hi, Carolyn. This is Ted. It's about $4 million. It's just a re-analysis of our BI losses from 2008 accident year and 2009 accident year. We took our severity estimates for the 2008 accident year up slightly.
Okay. That's what's sort of been driving the more favorable development year-to-date. It's just sort of re-estimating that?
Correct.
Okay. Just a question on the investment portfolio. I was just wondering how much of the portfolio gets reinvested over the next one or two years. I was just looking at the duration, and it's down a decent amount from year-end, and I was wondering if you had a target on where you wanted that to go.
Yeah. Hi, Carolyn. It's Chris. I think the duration probably continues to trend lower maybe down to three years. I can't really give you an estimate as to exactly when we get there, but it should be over the next 6-12 months. Coming horizon, we've got next year, something in the neighborhood of about $250 million bonds maturing with about another $150 million that are callable. The remainder of this year is about $100 million. We've got quite a lot of work to do as far as the rollover goes. We've got cash on hand, but frankly, it doesn't bother me in this environment quite yet. I'm okay with the way we're proceeding.
Okay. Where are you putting that money right now?
Most of it continues to go into municipal bonds.
Okay. Finally, can you just touch on what loss costs look like right now in California? Frequency and severity.
We're looking at a slight tick up in frequency in the low single digits, and severity is still running a low single-digit inflation.
Okay. That's great. Thank you.
Your next question comes from the line of Meyer Shields with Stifel, Nicolaus.
Thanks. Hi, it's Meyer Shields. Quick couple of questions, if I can. Gabe, am I correct in inferring that advertising costs for next year are expected to basically stay where they are now?
Either that or lower. Our expectation is they're not going to be any higher.
If we were to break up the sequential change in written premium growth, is that more inside California or outside California, where you saw the quarterly deterioration?
Can you say that again? I didn't quite hear that, Meyer.
Yeah, sure. I'm sorry. When we looked, the net written premium growth rate was a little worse in the third quarter than in the second. Is that change inside California or outside?
Well, outside of California, they were up, I think in the low single digits, maybe 2.5% or so. They were down a little bit in California.
Last question, if I can. The tax rate on the investment income was lower than I thought. Is that a function of the focus on munis?
What were you expecting?
About 13% overall.
It's been running about 11, 10 or 11.
Okay. 10 or 11 would be basically flat.
Yeah.
Okay. That's perfect. Thanks so much, guys.
Okay.
Thank you.
Once again, if you would like to ask a question, simply press star followed by the number one on your telephone keypad. Your next question comes from the line of Dean Evans with KBW.
Yeah, thanks. I guess most of my questions have been answered at this point. One kind of numbers question. Was there any particular cat losses in the quarter at all? Anything of note?
Nothing of note, unless you call sinkholes cats.
How much did the sinkholes impact the overall loss ratio again?
Well, it was a $5 million underwriting loss.
On $3 million of earned premium.
When does the withdrawal begin? Is that effective fourth quarter, or will it take longer than that?
Well, no, we plan on filing to withdraw early this month in November. I think the process will probably take a good 18 months. These are annual policies.
You got to give appropriate notice. Once we get approval from the Florida Department, which we believe we will get approval. Others have been approved that are slightly larger than us. We're a small player in that market. That will happen within the next 18 months. In addition to that, I will note that we have a 25% rate increase that's going into effect. I believe that's going into effect in the first quarter, sometime in January or February. A 25% rate increase in that line.
Okay. I guess the other question is the modest rate declines you spoke of about in California. Can you touch on those again? I think I'm correct in saying that in August you did have a 1.5% increase go through. This is sort of a downward adjustment now?
No, we have not had a rate increase go through in August. Just to clarify that, we haven't had a rate change here in California for at least two years. This rate filing is over two years old. With this filing, we're now compliant with the auto rating factor regulations. Part of the reason for the delay in finalizing this filing was really the capacity of the California Department of Insurance. When the regulations were issued a couple of years ago, every company had to make a filing, and the department simply did not have the resources to review all the filings in a timely manner. We wanted to move forward with this not only because it would make us compliant with the new auto rating factors, but there's other changes in this filing that I mentioned in my prepared remarks that's going to improve our segmentation.
It's going to introduce new discounts and roadside assistance. There were other things in the filing that we wanted to get out there. We're probably going to follow up shortly with another class plan filing and another rate filing.
Okay. Do you have any idea what they'll be as far as percentage change as of yet, or is that still in the works?
Well, on the class plan filing, a class plan filing will be revenue neutral, which will just further improve our segmentation and our competitive position, we believe. On the rate filing, I can't give you an answer to that right now. Maybe by the time we meet in the next quarter, I'll have some more information that I can share with you.
Okay, perfect. Thank you.
Thanks.
Once again, if you would like to ask a question, simply press star followed by the number one on your telephone keypad. Your next question is a follow-up from Meyer Shields with Stifel Nicolaus.
Thanks. Did you say before that the Florida homeowners written premium is about $3 million? Did I get that right?
Yeah. For the quarter, earned premium, yeah.
Okay. Do you have any sense as to how many of your Florida homeowners policyholders are also auto policyholders?
Do you have that, Robert, offhand?
I don't have that at my fingertips, no.
Yeah, I don't have that offhand.
Last question, I guess. The agreed-to rate decrease from the 4.5%-5%, roughly. Is that an average rate for your entire California auto book?
Yeah. The average will probably be in the neighborhood of like 475, 480, something like that when you weight the three companies. In that neighborhood, Meyer.
Okay. Great. Thank you.
Thanks.
There are no further questions at this time. I'd now like to turn the call back to management.
Well, I'd like to thank everyone for joining us at this third quarter conference call. We look forward to speaking with you next quarter. Thank you very much.
Thank you, ladies and gentlemen. This does conclude today's