Progressive Corporation 2013 Q2 Form 10-Q Summary
Business context and reporting period
The Progressive Corporation is a property and casualty insurer focused primarily on personal automobile, recreational vehicle, and commercial automobile insurance, with additional service and run-off indemnity businesses. This unaudited Form 10-Q covers the three and six months ended June 30, 2013, compared primarily with the corresponding 2012 periods.
Key financial metrics
| Metric | Three months ended June 30, 2013 | Year-over-year change | Six months ended June 30, 2013 | Year-over-year change |
|---|---|---|---|---|
| Total revenues | $4,593.6 million | 10% | $9,030.8 million | 9% |
| Net premiums earned | $4,277.0 million | 7% | $8,456.3 million | 8% |
| Net income | $324.6 million | 174% | $633.2 million | 68% |
| Diluted earnings per share | $0.54 | 176% | $1.05 | 70% |
| Underwriting profit | $285.8 million | 201% approximately | $603.5 million | 86% approximately |
| Underwriting margin | 6.7% | Up 4.3 points | 7.1% | Up 3.0 points |
| Combined ratio | 93.3% | Improved from 97.6% | 92.9% | Improved from 95.9% |
| Net cash from operating activities | Not provided for the quarter | Not provided | $1,137.2 million | Approximately flat |
Net realized gains on securities were $132.9 million in the second quarter and $213.5 million for the first six months, compared with a $4.7 million loss and a $72.8 million gain, respectively, in the prior-year periods. Investment income declined 9% in the quarter and 11% year to date, primarily because of lower yields.
At June 30, 2013, total assets were $23.84 billion, total shareholders’ equity was $6.52 billion, investments were $17.49 billion, and cash was $96.9 million. Debt was $2.06 billion, representing 24.0% of total capital, compared with 25.6% at December 31, 2012. The fixed-income portfolio had a weighted average credit quality of AA- and a duration of 1.9 years.
Material changes versus the prior comparable period
- Personal Lines net premiums earned increased 7% in both the quarter and year to date; Commercial Auto net premiums earned increased 8% and 10%, respectively.
- Policies in force increased 1% year over year to 13.0 million in Personal Lines, while Commercial Auto policies were essentially flat.
- Underwriting results improved substantially, driven by prior rate increases, lower catastrophe losses in the quarter, lower underwriting expense ratios, and less unfavorable reserve development in the quarter.
- Second-quarter catastrophe losses decreased to $83.4 million from $107.4 million; year-to-date catastrophe losses increased modestly to $129.6 million from $123.4 million.
- Investment portfolio fair value increased from $16.61 billion at June 30, 2012 and $16.48 billion at year-end 2012 to $17.49 billion at June 30, 2013. Net unrealized gains declined to $1.24 billion pretax from $1.28 billion at June 30, 2012 and $1.33 billion at year-end 2012, primarily because of higher interest rates.
- Progressive repurchased 5.3 million common shares for $126.7 million during the first six months, compared with 4.0 million shares for $83.0 million in the prior-year period. No debt securities were repurchased in the first half of 2013.
- The company revised the presentation of 2012 fees and other revenues, moving $69.9 million for the quarter and $135.1 million year to date into total revenues. The revision did not affect net income, comprehensive income, equity, or cash flows.
Guidance, outlook, management commentary, risks, and unusual items
- Management targets at least a 4% underwriting margin; the reported 6.7% quarterly and 7.1% year-to-date margins exceeded that target.
- Management expects to fund the $150 million maturity of its 7% Notes due October 2013 from operating cash flows and believes available capital, operating cash flow, and borrowing capacity are sufficient for current operations, debt service, dividends, and expected capital requirements.
- The 2013 annual variable dividend target remains 33⅓% of after-tax underwriting income, subject to a Gainshare factor and Board discretion. The year-to-date Gainshare factor was 1.19, but the final factor and any dividend had not been determined.
- Management continued rate reviews and indicated that prior rate increases supported premium growth and profitability but reduced new applications and policy retention, particularly in Agency and Direct auto. Personal auto policy life expectancy declined 6% for Agency and 7% for Direct.
- Claims severity increased approximately 2% to 3% in personal auto, while frequency was broadly stable for the quarter and increased approximately 1% year to date. Commercial Auto experienced unfavorable prior-year reserve development, particularly in bodily injury claims.
- The company plans to construct 10 to 20 additional service centers over the next four years, with estimated costs of $4 million to $6 million per center excluding land, funded through operating cash flows.
- Key exposures include catastrophe frequency and severity, claims inflation, reserve adequacy, litigation, rate approval and competitive pricing, customer retention, interest rates, credit and equity markets, investment valuation, counterparty risk, regulatory changes, technology and data security, and the financial condition of investment issuers.
- Outstanding litigation includes claims-related class actions and individual lawsuits involving medical and injury claims, policy documents, repair-shop labor rates, marketing, and other insurance practices. Accruals are recorded when losses are probable and estimable; material judgments or settlements could affect results.
- The company held $17.5 billion of investments, including $4.06 billion of asset-backed securities. Approximately 15% of asset-backed securities had exposure to non-prime mortgage loans. Gross unrealized losses totaled $146.7 million, and management concluded the securities were not other-than-temporarily impaired.
- A private equity investment with a $38.0 million fair value was subject to an expected sale that management estimated would generate a realized gain of approximately $35.6 million, subject to completion.
Most important facts for investors to verify
- Whether underwriting margins remain above the 4% target as rate increases mature and customer retention and new-business trends evolve.
- Future claims severity, catastrophe losses, and reserve development, particularly in Personal Lines bodily injury and Commercial Auto bodily injury.
- The sustainability of earnings excluding the substantial second-quarter realized investment gains and the expected private-equity sale gain.
- Investment portfolio sensitivity to higher interest rates, credit deterioration, equity-market declines, and valuation changes in structured securities and preferred stocks.
- Completion and funding of the October 2013 debt maturity and any subsequent changes in leverage or capital deployment.
- The final 2013 Gainshare factor and annual variable dividend decision.
- Material developments in pending litigation, regulatory approvals for rate changes, and regulatory or legislative changes affecting insurance claims and pricing.