Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)

Mercury General Corporation (NYSE:MCY)

Q3 2007 Earnings Call

November 5, 2007 1:00 pm ET

Executives

Gabriel Tirador - President, Chief Executive Officer,Director

George Joseph - Chairman

Christopher Graves - Vice President, Chief InvestmentOfficer

Theodore R. Stalick - Chief Financial Officer, VicePresident

Analysts

Charles Gates - Credit Suisse

Alison Jacobowitz - Merrill Lynch

Joshua Shanker - Citigroup

Richard Sbaschnig - Oppenheimer

Robert Rodriguez - First Pacific Advisors

Dan Sorel

Meyer Shields - Stifel Nicolaus

Al Corpesino - Meadow Investments

William Jones - Now Gate Investor

Operator

Good afternoon. My name is Regina and I will be yourconference operator today. At this time, I would like to welcome everyone tothe Mercury General third quarter results conference call. (OperatorInstructions)

This conference call may contain comments andforward-looking statements based on current plans, expectations, events andfinancial and industry trends which may affect Mercury General's futureoperating results and financial position. Such statements involve risks anduncertainties which cannot be predicted or quantified and which may causefuture activities and results of operations to differ materially from thosediscussed here today.

Mr. Gabriel Tirador, you may begin your conference.

Gabriel Tirador

Thank you very much. I would like to welcome everyone toMercury’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 Presidentand CFO; and Chris Graves, Chief Investment Officer. On the phone we have BruceNorman, Senior Vice President of Marketing, and Ron Deep, Vice President of theSouth East Region.

Before we open it up for questions, I would like to make afew comments regarding the quarter. In our California operations, our lossratio increased from 61.7% in the third quarter of 2006 to 64.1% in the thirdquarter of 2007. The primary reason for the increase in the loss ratio was dueto a small amount of adverse development recorded in the third quarter of 2007on prior accident periods compared to positive developments recorded in thethird quarter 2006.

Our loss ratio on Californiabusiness on a year-to-date accident year basis, was 63.6% compared to 64.2% in2006. On an accident year basis, we are recording severity increases in the lowsingle digits and frequency as relatively flat. Offsetting the increase inseverity is an increase in the average premium collected for policy.

In addition to the higher calendar year loss ratio in ourauto personal line, our homeowners loss ratio in the third quarter was up overthe 2006 third quarter due to an increase in recorded severity. Our Californiaexpense ratio increased from 26.5% in the third quarter of 2006 to 26.9% in thethird quarter of 2007. The increase in the expense ratio was primarilyattributed to an increase in advertising expenses and aging contingentcommission.

Our combined ratio of 105.5% in our non-Californiaoperations in the quarter is still above our target. We continue to seeimprovements in some of our non-California operations as a result of ourcontinued focus on operation improvements. However, New Jersey is the primarystate that continues to exert a large negative effect on our non-Californiaresults. Excluding the New Jersey results, our combined ratio in ournon-California operations was about 100% in the quarter.

As I previously reported, to improve our results in our NewJersey operations, we implemented a revenue neutral rate change in Aprildesigned to improve profitability. This rate change had a negative impact onour new business submissions. In addition, we recently implemented anothersimilar rate change that became effective in October, 2007. Although these ratechanges were revenue neutral, we believe the rate changes will more accuratelyprice our risks which, over time, should lead to improved profitability and amore competitive product.

In addition, the April rate change we implemented included acap on the amount of increase any one policy holder receives. As this cap islifted over the next six to 12 months, our average premium should increase.

The competitive environment remains intense. We continue tobelieve that growth will be very difficult to achieve over the next severalquarters and most likely our premiums written growth will be slightly negative.However, we do believe that the market is beginning to change.

As we previously predicted, as a result of rate reductionsand increasing loss cost, the margins of many of our competitors for thepersonal auto line are deteriorating. In some cases, the margin deteriorationhas been significant. Consequently, we believe that over the next 12 months, wewill begin to see an increased level of rate action taken by some of ourcompetitors.

We continue to focus on various strategic initiatives,including standardizing our claims and underwriting processes, improving ourpricing to improve segmentation, and improving our technology. The developmentof our Mercury First front-end sales system is scheduled to be rolled out toour first date in the first quarter of 2008.

Lastly, in late October, the Southern California region wassignificantly affected by sweeping firestorms. Our catastrophe claims team hasbeen working diligently to begin the process of helping our insurers in theirtime of need. Our current loss estimate related to the firestorms is between$20 million and $30 million. However, this amount is our current best estimatebased on claims reported to date and claims that we anticipate will be reportedin the future. Since the fires are very recent, many of the claims have yet tobe reported and it is possible that our estimate will change as we receive moreinformation in the future.

Now, with that brief background, I will now open it up forquestions.

Question-and-AnswerSession

Operator

(Operator Instructions) Our first question comes from Charlie Gates ofCredit Suisse.

Charles Gates -Credit Suisse

I have a couple of questions. One, the $20 million to $30million, that’s a pretax number?

Gabriel Tirador

Yes.

Charles Gates -Credit Suisse

Okay. There was the first one. The second question; Gabe, Ithink you indicated that you saw some seeds of change with regard to personalauto insurance pricing. Could you elaborate on that please, sir?

Gabriel Tirador

Well, we are seeing more margin deterioration from our topcompetitors. In some instances, we are seeing in the neighborhood of five, sixpoint changes year over year. We are seeing more increased rate action than wehave in the past and we believe we’ll continue to see that because we believethat frequency is relatively flat, severity is going up and with many of ourcompetitors taking rate reductions, all that’s done is squeeze the margins evenfurther. So we are seeing some evidence of margin deterioration, some signsthat competitors are actually starting to file for rate increases as well.

Charles Gates -Credit Suisse

What do you trace the increased severity to?

Gabriel Tirador

I would have to say primarily in the bodily injury line, itwould have to be medical costs. In the physical damage line, which we’ve seenincreased severity for some time, we also -- you know, labor rates and the costof materials to repair the cars has gone up as well.

Charles Gates -Credit Suisse

My last question -- would you foresee that the businessoutside the state of California will continue to contract?

Gabriel Tirador

At least for the next several quarters, I would continue toexpect that, Charlie.

Charles Gates -Credit Suisse

Thank you.

Operator

Your next question comes from the line of Alison Jacobowitzwith Merrill Lynch.

Alison Jacobowitz -Merrill Lynch

Thanks. We have been hearing a couple of people loweringrates by big amounts in California -- Geico and Infinity -- because of all theregulation changes in compliance with that, and I’m just wondering if you’restill seeing some of that, or what effect you expect that to have on themarket?

And then also, if you could just update us on your ownrating actions in California, any changes planned or going on?

Gabriel Tirador

I think here in California it’s a little differentsituation, Alison, with respect to some of the rate actions taken by some ofour competitors going down. I think Geico was one of the last companies thatwe’ve seen with a rather large reduction. And companies here in California havebeen, as you know, had to file for this new territorial regulations and they’vetaken I think the opportunity not to have a lot of dislocation in their books.And as a result of that, have taken some reductions.

But I don’t think California is immune from any of the losscost increases that we are generally seeing. Here in Californiafor Mercury’s standpoint, we have filed -- I think I mentioned it back in ourprevious conference call, we filed back in ’06. We’ve had recent discussionswith the department over the past several weeks. We believe that over the nextmonth or two, they will get back to us one way or another with respect to whattheir recommendation is going to be on our rate filing. So the situation inCalifornia is a little different than the rest of the country.

Alison Jacobowitz -Merrill Lynch

But when you’re then talking about the seeds of change thatCharlie so nicely phrased it, are you referring then more to markets outside ofCalifornia?

Gabriel Tirador

It’s hard to exactly predict, Alison, the timing of this, asyou know. We are seeing it -- obviously we are seeing the signs outside ofCalifornia with respect to actual rate increases already occurring. We are notseeing too much of that yet in California.

Alison Jacobowitz -Merrill Lynch

Okay, great. Thank you.

Operator

Your next question comes from the line of Joshua Shanker ofCitigroup.

Joshua Shanker -Citigroup

Following up on the same things that Charlie and Alison wereinterested in, I’m interested in finding out how your conversations withCalifornia regulators or even other states goes. Looking at the profitabilityof the industry, it is still quite high, even though I do here that there issome trend change in frequency and severity. When you go to ask for a rateincrease to a regulator, how does the relationship between your profitabilityrelate to your ability to get a rate increase approved?

Gabriel Tirador

I guess it would depend on each individual state, Joshua. Itjust depends on each individual state. A state like Illinois,obviously very easy to get a rate change. Here in California, with the new rateregulation, they are not really looking at how competitive you are.

I will state though that there are a lot of variances herein California that you can apply for with respect to a rate change, and in factthere is still a lot of uncertainty with respect to those variances. TheDepartment of Insurance just issued a bulletin last week that they wantadditional information from both consumer groups and the companies with respectto how they are going to treat these variances, how are you going to file forthese variances. So there is still a little bit of uncertainty with respect tothe variances here in California.

But it just varies by state, Joshua. It’s depending on thestate.

Joshua Shanker -Citigroup

And here in New York, I’ve seen television commercials forGeico where they are announcing New Jersey rate decreases. Are you seeing inCalifornia local advertising announcing the rate decreases for Geico startingto hit the airwaves?

Gabriel Tirador

I have not seen any. I have not seen any announcing the ratereductions.

Joshua Shanker -Citigroup

Thank you.

Operator

Your next question comes from the line of Richard Sbaschnigof Oppenheimer.

Richard Sbaschnig -Oppenheimer

Just a quick follow-up on your rate regulation inCalifornia, it’s been quite a while for that to get approved. I’m just curiouswhat -- is the price level the main sticking point? What kind of rate reductionare regulators thinking about?

Gabriel Tirador

Well, we really don’t have any sticking point at this pointbecause they haven’t really gotten back to us, so we have to wait and see whatthey come back and tell us.

George Joseph

I had a recent conversation with the rates regulatorsbecause our filings had been trending so long. And the problem was when thecommissioner issued a regulation to change the territorial rate, the departmentwas hit with roughly a thousand filings all within a short time, so that is oneof the principal reasons they have been backed up, but understand they arebeginning to get current.

Richard Sbaschnig -Oppenheimer

The other question I had is in the non-California business,you’ve been able to keep the loss ratio fairly steady, despite a substantialdecline in the premium. I’m just curious I guess how have you been able to dothat? What might be behind that steady expense ratio?

Gabriel Tirador

We’ve been reducing expenses as well, at the same time.

Richard Sbaschnig -Oppenheimer

I mean, where is it coming from? Is it coming from agentcommissions or --

Gabriel Tirador

No, no, primarily salary related and advertising.

Richard Sbaschnig -Oppenheimer

Okay, thanks a lot.

Operator

Your next question comes from the line of Robert Rodriguezof First Pacific Advisors.

Robert Rodriguez -First Pacific Advisors

Yes, just a quick question on the, since it’s so topicaltoday, on the asset quality of the investment portfolio as it relates to thevarious levels there. Can you disclose or have you disclosed what proportion ofyour investment portfolios would be in level one, two, or three presently?

Secondly would be your exposure to any of the CDO/sub-primeissues that are going on today.

Christopher Graves

The overall portfolio, the portfolio, the average rating isDouble A by both services. We don’t have any sub-prime exposure. We have about$20 million in Alt-A, which are Triple A rated and have maintained theirrating. We don’t have any CDOs.

Speaking of topical subjects on the area of municipal bondinsurance, we have, as you know, about $2.4 billion in municipal bonds andthere’s various ways to slice and dice this kind of data, but just looking atwhat’s insured and giving credit towards other enhancements, such as FHA orJenny Mae, PSF, permanent school fund, other enhancements that are along withthe insurance, the underlying rating on the municipal bond portfolio -- thetotal rating currently on just municipal bonds is Double A1, Double A-plus. Ifyou take off just the insurance, it drops down to Double A3, Double A-minus,and there’s a lot of other ways to cut through this data.

About 48% of the municipal bond portfolio is insured.

Robert Rodriguez -First Pacific Advisors

Okay, that was going to be my next question, given the factthat when you have bond insurers selling that between 20% and 35% a book, itdoes raise a question as to the integrity and, shall we say, value of theinsurance that they are providing. Thank you very much.

Operator

Your next question comes from the line of Dan [Sorel] of[inaudible].

Dan Sorel

Good afternoon. Just a couple of quick questions; the NewJersey book, how large is that right now?

Gabriel Tirador

We’ve written close to about $90 million year-to-date sofar.

Dan Sorel

Okay, and then just in terms of the decline in premiumoutside of California, is it across the board in a lot of states, or is itparticular states like New Jersey that are driving the decline now?

Gabriel Tirador

We are seeing declines across the board but by far thebiggest decline is New Jersey.

Dan Sorel

Okay, and then just last question, development in thequarter, it looks like it was about $2 million adverse, which isn’t that big anumber, but within that, any significant movements in any particular states, orany other color you can add to it?

Theodore R. Stalick

Most of the development is in California. Outside of California,there’s some pluses and minuses that kind of netted out close to zero, butnothing significant.

Dan Sorel

Okay. Thanks, guys.

Operator

Your next question comes from the line of Meyer Shields ofStifel Nicolaus.

Meyer Shields -Stifel Nicolaus

Looking at the California policy count, it was actually downfor the first time in a long time. I was hoping you could talk a little bitabout what’s --

George Joseph

It’s hard to hear you. Can you speak up?

Meyer Shields -Stifel Nicolaus

Sorry. Is this better?

Gabriel Tirador

Yeah, that’s much better.

Meyer Shields -Stifel Nicolaus

Okay, sorry, my microphone was messed up. Can you talk alittle bit about what led to the declining policy count in California personalauto in the quarter? Because we haven’t seen this in quite a while.

Theodore R. Stalick

One thing that I would like to point out is we typically seethe growth in the sequential change in policy growth from the June 30th quarterto the September 30th quarter is less than any other quarter during the year.And if you go back, we went back and looked at the last 15 years and it’s thatsame pattern. So it’s not unusual to see less of a rate of growth in the thirdquarter than you have previously in the year.

On top of that, we did have a slight decrease in the renewalratio in the third quarter. So you kind of couple that with a seasonalphenomena and you see the decline in PIP count.

Gabriel Tirador

Our third quarter -- actually, our first quarter we had thehighest amount of new business historically, and the first and third quartershave the largest amount of renewals. And as the year progresses, typically forus, the new business goes down quarter by quarter, the first quarter being thehighest new business and the third quarter, the new business wasn’t quiteenough to offset the decline in the renewal ratio.

Meyer Shields -Stifel Nicolaus

Gabe, in your comments at the beginning of the call, youmentioned that you are getting higher average premium per policy in California.What’s driving that?

Gabriel Tirador

I think there’s quite a few things driving that. There’s thecombination of symbol and model year drift. We no longer are using portable persistencyand that had the impact of lowering average premiums in previous years, and asthe book matured and those discounts increased, it had the impact of loweringthe average premium. I think also a distribution shift to higher averagepremiums, as an example, we’re a lot more competitive with the young drives andfamily risks today, which tend to have higher average premiums.

Meyer Shields -Stifel Nicolaus

Okay, that’s very thorough. Also, with regard to theCalifornia fires, was there any material impediment to business production?

Gabriel Tirador

Well, obviously the homeowners production slowed a littlebit during that period. Whenever we have fires like that, we have setmoratoriums in place in certain areas, and you always see a little bit of adip. People are not really worried about either homeowners or auto insuranceduring that week, so -- in certain segments, so you do see a little bit of aslowdown during that time.

Meyer Shields -Stifel Nicolaus

Fantastic. Thanks so much.

Operator

(Operator Instructions) Your next question comes from theline of Al [Corpesino] of [Meadow Investments].

Al Corpesino - MeadowInvestments

Thanks very much. Actually, Josh asked my main question. Ijust wanted maybe just one follow-up though, which was to verify that theimpact of catastrophes, both in California and the non-California operations,was de minimis this quarter?

Gabriel Tirador

In Q3?

Al Corpesino - MeadowInvestments

Yeah.

Gabriel Tirador

Yes, that’s correct.

Al Corpesino - MeadowInvestments

Okay. Thanks very much.

Operator

Your next question comes from the line of Richard Sbaschnigof Oppenheimer and Company.

Richard Sbaschnig -Oppenheimer

One thing I kind of noticed is the paid to incurred seems tobe running a little bit high year-to-date, relative to last year, despite someof these reserve adjustments. I’m just wondering if you could maybe talk aboutthe dynamics there.

Theodore R. Stalick

Typically what happens as your growth slows down, your paidto incurred starts to get close to being the same number. As you are growing,you are setting up more reserves but you haven’t paid them yet, so it’s more ofa timing thing. Does that make sense?

Richard Sbaschnig -Oppenheimer

No, absolutely. Also, I wonder, George, if you could shareus what your thoughts on kind of the recent up-tick in M&A activity andwhat your outlook for maybe Mercury or the industry in general in terms ofwhere merger activity is headed.

George Joseph

Well, I think over the next three or four years, you aregoing to see some more mergers in the insurance business because, at least fromMercury’s viewpoint, we are entering a new era. We need to develop prioritiesthat we had to pay a lot of attention to in the past, such as significantlyimproved segmentation and a much better point of sales system, even continuedimprovements in the back-end programs. These issues are [costs] and Mercury ispositioned to handle it. We have the wherewithal to do it and we are going todo it. And over the next couple of years, you’ll see we’ll develop a muchdifferent Mercury from what you see today.

But for a number of companies, I don’t think that’s going tohappen, and if it doesn’t happen, I think you are going to see like you saw inMassachusetts. When the environment changes, it is going to result in the kindof merger that you saw with commerce, where they may feel that while they’vebeen quite successful with the old environment, maybe it’s much morequestionable with the new environment. The new environment, they are differentfrom the new environment we’re talking about but it is a different environment.

So in summary, yes, I would expect to see more mergers andacquisitions over the next three or four years.

Operator

Your next question comes from the line of William Jones of[Now Gate] Investor.

William Jones - NowGate Investor

Good morning. Could you give us an update on your next gensystems and how they are progressing?

Gabriel Tirador

Our next gen system has, which is our back-end systems forunderwriting claims, billing, commissions, has been deployed to four of ourstates. California being one of them, and that was deployed back in May of thisyear. Our next three states are scheduled to be deployed in ’08. I don’t have aspecific date for you right now.

And our Mercury First system, which is our front-end salessystem that we believe is going to be a huge benefit to our agents, that isscheduled to be released in the first quarter of ’08, with pretty rapid releasedates for each subsequent state. So there is going to be a pretty quick releaseof this system throughout ’08.

William Jones - NowGate Investor

Is there any impact on the income statement for thosedevelopment costs at the moment?

Theodore R. Stalick

On the development side, they are all capitalized as theyget rolled into production. You have maintenance and depreciation costs, whichare adding maybe 10 to 20 basis points to the expense ratio.

Gabriel Tirador

And we’ve been seeing that -- for example, next gen isalready being expensed at this point, so you are already seeing those costs inthe numbers.

William Jones - NowGate Investor

And then lastly, are you still holding off expansion intoother states, pending completion of the next gen system?

Gabriel Tirador

Well, we are holding off expansion for a couple of reasons-- technology, and we want to get our price segmentation structure in order,those couple of things, so I wouldn’t anticipate any expansion really in ’08 --geographic expansion.

William Jones - NowGate Investor

Thank you.

Operator

(Operator Instructions) Your next question comes from theline of Meyer Shields of StifelNicolaus.

Meyer Shields - StifelNicolaus

Thanks. Two quick follow-ups, if I can; we haven’t talkedabout [inaudible] in a while, which I guess is good, but I was wondering, isthere anything going on that we should know about or is it basically a closedissue?

Gabriel Tirador

What’s going on there is we plan on going back to the courtby the end of the year to vacate the injunction. We had an injunction earlier-- not an injunction, a hearing earlier this year to vacate the injunction andthe court allowed a little bit more discovery on the plaintiff’s side and weare in the process of that, and we are scheduled to go back. We don’t have afirm date but we plan on going back to the court by the end of the year. I willsay that the number of applications that we get from these brokers are minimalto our overall application. It’s very minor.

Meyer Shields - StifelNicolaus

Turning to New Jersey, if I can, we don’t have the numbersbut I’m trying to break out the New Jersey loss ratio or [inaudible] ratiotrends versus the remainder of the non-California book. Is it safe to say thatNew Jersey is getting worse or has it been constant?

Gabriel Tirador

It’s been pretty constantly bad. It hasn’t really gottenworse. It’s about a similar level that it has been. And really, as I mentionedbefore on previous conference calls, the big issue in New Jersey from ourperspective is making the estimates for PIP and BI. For example, what we’redoing is we are basing it on our 2004 year, which is our most developed year.But there is still quite a number of open claims in ’04, believe it or not,with respect to BI and PIP, a significant number, more than any other statethat I’ve ever seen that we’re in business in.

So we use the ’04 year to try to predict ’05 and ’06 andfurther years, and that’s what we have been doing. But as you know, there’smore uncertainty with respect to a state that has a longer tail like New Jerseydoes. I imagine that some of our other competitors are probably going to haveto deal with that as well.

Meyer Shields - StifelNicolaus

From your perspective though, it sound to me like you arepursing premium growth in New Jersey with the two revenue units you’re filing.Am I reading that correctly?

Gabriel Tirador

Well, what we are pursuing is more -- what we found intaking a look at our rate level in New Jersey is that we had groups of risksthat were very unprofitable, and we decided that we are going to raise thoserates significantly. And as we do that, what should occur is we should eitherwrite them at a profit or they are going to go away, which is one of thereasons that we’ve seen this decline in business in New Jersey.

In other words, we are trying to improve our results throughimproved segmentation at this point, not an overall rate increase.

Meyer Shields - StifelNicolaus

Right, but if it’s revenue neutral, that means that you aredropping rates elsewhere, which means I guess --

Gabriel Tirador

Yeah, and we should be dropping rates on those that deserveto be dropped.

Meyer Shields - StifelNicolaus

Okay, perfect. Thank you very much.

Operator

(Operator Instructions) There appear to be no furtherquestions at this time.

Gabriel Tirador

Okay. Well, thank you for joining us this quarter and we’lltalk to you next quarter. Thank you very much.

Operator

This concludes today’s conference. Thank you forparticipating. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Mercury General Q3 2007 Earnings Call Transcript

Check out Seeking Alpha’s new Earnings Center »

This Transcript
All Transcripts