Progressive Corporation — Q1 2019 Form 10-Q Summary
Business context and reporting period
The Progressive Corporation is an insurance holding company whose principal businesses are Personal Lines, Commercial Lines, Property, investment management, and related services. This unaudited Form 10-Q covers the three months ended March 31, 2019, compared with the three months ended March 31, 2018. Progressive owned 86.8% of ARX Holding Corp. at March 31, 2019.
Financial performance and key metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Net premiums earned | $8,459.8 million | $7,174.0 million | 18% |
| Total revenues | $9,300.0 million | $7,430.1 million | 25% |
| Income before taxes | $1,567.5 million | $910.8 million | 72% |
| Net income attributable to Progressive | $1,078.4 million | $718.0 million | 50% |
| Diluted earnings per share | $1.83 | $1.22 | 50% |
| Net cash from operating activities | $1,868.5 million | $1,747.1 million | 7% |
| Net realized gains on securities | $414.5 million | $(48.2) million | Material improvement |
| Total underwriting profit | $949.2 million | $830.6 million | 14% |
| Combined ratio | 88.8% | 88.4% | 0.4 points higher |
Net income benefited substantially from investment results: net holding-period gains were $392.7 million, primarily on equity securities, compared with $155.2 million of losses in the prior-year quarter. The effective tax rate increased to 30.9% from 19.9%.
- Personal Lines underwriting profit was $774.9 million, with a 10.9% margin and 89.1% combined ratio.
- Commercial Lines underwriting profit was $166.6 million, with a 16.4% margin and 83.6% combined ratio.
- Property underwriting profit was $7.7 million, with a 2.1% margin and 97.9% combined ratio.
- Net premiums written increased 16% to $9.24 billion. Policies in force increased 11% year over year to approximately 21.1 million.
- Personal auto frequency declined approximately 3%, while severity increased approximately 8%; commercial auto severity increased 11% and frequency declined 4%.
Balance sheet, debt, liquidity, and capital
- Total assets were $48.85 billion at March 31, 2019, versus $46.58 billion at December 31, 2018.
- The investment portfolio had a fair value of $34.51 billion, including $27.82 billion of fixed maturities, $2.58 billion of short-term investments, and $3.01 billion of common equities.
- Cash, cash equivalents, and restricted cash were $158.7 million, compared with $75.0 million at December 31, 2018.
- Debt was $4.41 billion carrying value, with a fair value of $4.73 billion. Debt-to-total capital was 26.7%, compared with 28.9% at year-end 2018.
- Shareholders’ equity was $12.11 billion, compared with $10.82 billion at December 31, 2018.
- Operating cash flow was positive; investing activities used $277.4 million and financing activities used $1.51 billion, primarily reflecting the $1.47 billion payment of the prior-year variable common dividend.
- Progressive stated that it had sufficient capital and operating cash flows to support its business, debt service, dividends, contractual obligations, and other expected requirements. A $250 million discretionary line of credit was renewed in April 2019 through April 30, 2020; no borrowings were outstanding.
Material changes versus the prior comparable period
- Growth accelerated across the insurance platform: Personal Lines net premiums written increased 14%, Commercial Lines 26%, and Property 19%.
- Underwriting profit increased, but the overall margin narrowed to 11.2% from 11.6%, and the combined ratio worsened modestly to 88.8% from 88.4%.
- Commercial Lines profitability improved materially, while Property profitability declined because of higher loss costs and catastrophe activity.
- Unfavorable prior-year reserve development increased to $142.6 million from $55.6 million. Personal auto accounted for approximately $111 million, primarily from late-reported 2018 losses, reopened Florida PIP claims, and higher medical-cost-related injury severity.
- Net catastrophe losses increased to $71.9 million from $49.3 million, including significant wind and hail losses in Texas.
- Investment results reversed from prior-year losses to substantial gains, materially increasing reported earnings and comprehensive income.
- Progressive changed its common dividend policy from an annual variable dividend to regular quarterly dividends, while retaining the ability to consider additional dividends annually.
- Adoption of the new lease standard resulted in recognition of operating lease assets of $201.6 million and liabilities of $211.4 million at March 31, 2019, without affecting earnings or cash flows.
Guidance, outlook, management commentary, risks, and unusual items
- Management expects continued growth but noted signs of a softening personal auto market, including competitors lowering rates. Advertising spending increased 30% year over year and will continue where management believes customer acquisition costs are attractive.
- Retention weakened: total auto policy life expectancy declined 1% on a trailing-12-month basis and 2% on a trailing-three-month basis. Management expects the adverse effects of targeted underwriting changes introduced in 2018 to continue through the second quarter or first half of 2019.
- Management expects rate increases taken in the Property business during 2018 to continue earning in and plans further rate actions where needed to meet profitability targets.
- Progressive reversed $156.1 million of previously recognized tax credits and other benefits related to three federal renewable-energy tax-credit funds after concluding that the sponsor committed fraud and that the benefits were invalid. The company also wrote down its remaining investment in the funds by $24.3 million. Future recoveries are uncertain.
- The filing identifies exposure to reserve-estimation uncertainty, medical and repair-cost inflation, catastrophe losses, competitive pricing, retention, interest-rate and equity-market volatility, credit and reinsurance risk, litigation, regulatory changes, cyber and technology risks, and potential impairment of goodwill or intangible assets.
- Pending litigation is described as typical for the insurance industry. Accruals for non-claims-related lawsuits were not material, but the company stated that adverse outcomes or inadequate accruals could materially affect financial condition, cash flows, or results of operations.
- The filing states that results for the quarter are not necessarily indicative of full-year results and provides no formal full-year earnings or revenue guidance.
Important facts for investors to verify
- Determine how much of earnings growth is recurring underwriting and investment income versus volatile equity holding-period gains.
- Monitor personal auto severity, reopened PIP claims, late-reported losses, and subsequent reserve development.
- Assess whether the modest deterioration in the combined ratio persists as advertising costs, medical costs, repair costs, and catastrophe losses evolve.
- Track policy retention, competitive rate activity, and the effect of 2018 underwriting-model changes on policy growth.
- Follow developments related to the renewable-energy tax-credit fund fraud, including potential recoveries, investigations, and additional tax consequences.
- Review catastrophe exposure and the adequacy and recoverability of Property reinsurance, including aggregate stop-loss and catastrophe programs.
- Reconcile future capital deployment, quarterly dividends, potential share repurchases, debt maturities, and the 2021 ARX minority-share put or call rights.