Progressive Corporation — Q1 2011 Form 10-Q Summary
Business context and reporting period
The Progressive Corporation is an insurance holding company focused primarily on personal auto, recreational vehicle and commercial auto insurance, with additional run-off indemnity and insurance-related service businesses. The filing covers the three months ended March 31, 2011, compared primarily with the three months ended March 31, 2010. Financial statements are unaudited.
Key financial metrics
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Net premiums earned | $3,665.3 million | $3,501.1 million | 5% |
| Total revenues | $3,893.5 million | $3,665.9 million | 6% |
| Income before taxes | $545.4 million | $438.9 million | 24% |
| Net income | $362.9 million | $295.6 million | 23% |
| Diluted earnings per share | $0.55 | $0.44 | 25% |
| Operating cash flow | $673.5 million | $670.0 million | Flat |
| Underwriting profit | $355.8 million | $318.1 million | 12% |
| Underwriting margin | 9.7% | 9.1% | Up 0.6 points |
| Combined ratio | 90.3% | 90.9% | Improved 0.6 points |
| Investment income | $123.3 million | $129.8 million | Down 5% |
| Net realized securities gains | $99.7 million | $30.8 million | Up 224% |
Net premiums written increased 3% to $3,900.0 million. Personal Lines net premiums written increased 4%, while Commercial Auto declined 3%. Policies in force increased 6% overall, including 6% growth in Personal Lines and a 1% decline in Commercial Auto.
Personal Lines produced a $315.3 million underwriting profit and a 90.5% combined ratio, compared with $266.8 million and 91.5% in the prior-year quarter. Commercial Auto underwriting profit declined to $41.1 million from $44.3 million, and its combined ratio increased to 88.4% from 88.0%.
Total assets were $21.5 billion at March 31, 2011, compared with $21.2 billion at December 31, 2010. Shareholders’ equity was $6.3 billion, compared with $6.0 billion at year-end. The investment portfolio was $15.8 billion at fair value, with 75.3% in fixed maturities, 10.5% in common equities and 7.2% in short-term investments.
Debt carried at approximately $2.0 billion consisted of senior notes and junior subordinated debentures. The company had no borrowings under its $125 million secured liquidity facility. The next scheduled debt maturity is $350 million in January 2012.
Material changes versus the prior comparable period
- Net income increased 23%, supported by stronger underwriting results and significantly higher realized investment gains.
- Underwriting profitability improved as the loss and loss adjustment expense ratio declined 0.8 points, reflecting lower personal auto frequency and severity. Favorable prior accident-year development was $99.0 million, compared with $103.5 million in Q1 2010.
- Personal Lines growth accelerated through the Direct channel: Direct auto policies in force increased 10%, while Agency auto policies in force increased 4%.
- Commercial Auto remained under pressure from economic conditions and competition; premiums earned declined 4%, policies in force declined 1% and new applications declined 6%.
- Investment income declined because of lower yields, while net realized securities gains increased to $99.7 million, including gains on preferred stocks and derivatives.
- Cash used in financing increased to $397.2 million from $146.6 million, primarily because of a $263.6 million annual variable dividend and $138.0 million of share repurchases.
- The investment portfolio shifted toward common equities, which represented 10.5% of portfolio fair value versus 7.7% one year earlier. Common equity holdings increased to $1,658.9 million.
Guidance, outlook, commentary and risks
- Management stated that the 9.7% underwriting margin exceeded its long-term target of a 4% margin. Capital planning is based on an underwriting discipline targeting a 96% combined ratio.
- For 2011, the board set the annual variable dividend target at 33⅓% of annual after-tax underwriting income. The year-to-date Gainshare factor was 1.26, but the final factor and dividend remain dependent on full-year results and board action.
- Management plans continued rollout of new product models, Snapshot usage-based insurance, mobile capabilities and multi-product offerings. Snapshot was available to Direct customers in 33 states at March 31, 2011, with further expansion subject to regulatory approval and business results.
- Management expects continued pressure in Commercial Auto from the economic downturn, especially in housing and construction, and from competition. Consumer shopping activity and new applications were lower year over year.
- Key investment risks include interest-rate movements, credit deterioration, mortgage-backed and preferred-stock exposures, valuation uncertainty and liquidity conditions. The portfolio had $82.7 million of gross unrealized losses at March 31, 2011; management concluded these securities were not other-than-temporarily impaired.
- Interest-rate swaps had $613 million of notional exposure and an aggregate realized loss of $27.9 million on the open position. Corporate credit default swaps included a $10 million sold-protection notional exposure.
- Litigation includes claims-practice, rating, policy-document, labor-rate and marketing-related matters. The company has not accrued for cases where loss is not probable or cannot be reasonably estimated; an adverse outcome materially exceeding accrued amounts could affect results.
- Management cautioned that results are not necessarily indicative of the full year and may be volatile because of reserve revisions, litigation accruals, weather events, investment markets, inflation, regulatory changes and changes in driving and claims trends.
Most important facts for investors to verify
- Whether favorable prior-year reserve development and unusually strong realized investment gains remain repeatable.
- Personal Lines retention, new-business trends, rate adequacy and the sustainability of Direct-channel growth.
- Commercial Auto premium, application and policy trends, including the effect of economic conditions and competition.
- Investment portfolio credit quality, unrealized losses, preferred-stock exposure, mortgage-backed securities and interest-rate sensitivity.
- Debt refinancing capacity ahead of the January 2012 $350 million maturity and continued availability of the secured liquidity facility.
- The final 2011 Gainshare factor and annual variable dividend, which are not determined by the first-quarter results alone.
- Potential changes from the new insurance acquisition-cost accounting standard effective January 2012; management expects to defer fewer acquisition costs but had not quantified the impact.