PROGRESSIVE CORP quarterly report, Q3 FY2011

Progressive Corporation 2011 Q3 Form 10-Q Summary

Business Context and Reporting Period

The Progressive Corporation is an insurance holding company whose principal businesses are Personal Lines auto and recreational-vehicle insurance, Commercial Auto insurance, service businesses, and run-off indemnity operations. This unaudited Form 10-Q covers the three and nine months ended September 30, 2011, compared primarily with the corresponding 2010 periods.

Financial Performance and Key Metrics

Metric	Q3 2011	Q3 2010	9M 2011	9M 2010
Net premiums earned	$3,740.7 million	$3,599.9 million	$11,125.9 million	$10,691.2 million
Total revenues	$3,811.0 million	$3,769.5 million	$11,577.2 million	$11,121.7 million
Income before taxes	$208.5 million	$387.2 million	$1,111.6 million	$1,139.0 million
Net income	$150.7 million	$261.6 million	$758.8 million	$769.1 million
Diluted earnings per share	$0.24	$0.40	$1.18	$1.16
Operating cash flow	Not separately provided	Not separately provided	$1,495.3 million	$1,677.9 million

Approximate net income margin was 4.0% in Q3 2011 versus 6.9% in Q3 2010; for the first nine months it was approximately 6.6% versus 6.9%.
Underwriting profit was $180.7 million in Q3 and $781.2 million for the first nine months. The companywide underwriting margin was 4.8% and 7.0%, respectively, versus 7.1% and 7.8% in the comparable periods.
The consolidated combined ratio was 95.2% in Q3 and 93.0% for the first nine months, compared with 92.9% and 92.2% in 2010. Management’s long-term profitability target is a 96 combined ratio.
Q3 investment income declined 11% to $117.4 million; nine-month investment income declined 8% to $361.5 million.
Net realized gains and losses on securities were a $52.6 million loss in Q3, compared with a $26.9 million gain in Q3 2010. For the first nine months, net realized gains were $73.1 million versus $18.2 million.
Catastrophe losses were $63.3 million in Q3 and $198.3 million year to date, compared with $22.8 million and $77.4 million, respectively, in 2010. Approximately $20 million of Q3 catastrophe losses related to Hurricane Irene.
Favorable prior accident-year reserve development was $72.5 million in Q3 and $223.5 million year to date, below the comparable 2010 amounts of $109.3 million and $271.2 million.
At September 30, total assets were $22.14 billion, investments were $15.99 billion, cash was $170.3 million, shareholders’ equity was $5.82 billion, and debt was $2.44 billion.
Operating cash flow was positive but declined 11% year over year to $1.50 billion, primarily reflecting higher tax payments, advertising expenditures, and employee-related costs.
Financing cash outflows included $832.1 million of treasury-share repurchases and $263.6 million of dividends paid. The company repurchased 22.2 million shares in Q3 for $411.2 million, or $18.53 per share.

Material Changes Versus the Prior Comparable Period

Net premiums earned increased 4% in both Q3 and the first nine months. Policies in force increased 5% year over year to 12.25 million Personal Lines policies, while Commercial Auto policies in force decreased 1%.
Personal Lines underwriting margin decreased to 4.9% in Q3 from 6.2%; the nine-month margin decreased to 6.9% from 7.2%.
Commercial Auto underwriting margin fell sharply to 5.0% in Q3 from 15.1% and to 8.6% year to date from 12.5%, driven by less favorable reserve development and increased frequency and severity in the truck business.
Investment results weakened materially. Q3 fully taxable-equivalent total return was negative 2.2%, compared with positive 3.3% in 2010, including a negative 14.4% return on common stocks.
Net unrealized gains on securities declined to $870.6 million pretax at September 30, 2011, from $1.18 billion at December 31, 2010 and $1.20 billion at September 30, 2010.
Progressive issued $500 million of 3.75% Senior Notes due 2021, receiving $497 million of proceeds after underwriting discounts and commissions. Debt increased from $1.96 billion at December 31, 2010 to $2.44 billion at September 30, 2011.
The company repurchased $12.7 million principal amount of its 6.70% junior subordinated debentures and modified their terms, surrendering the right to defer interest payments and eliminating the related obligation to reserve up to 250 million unissued common shares.
The company expects to adopt new insurance-acquisition-cost guidance prospectively in January 2012. Management estimates that approximately $20 million to $25 million of deferred acquisition costs will no longer qualify for deferral and will be recognized in income primarily during the first six months of 2012.

Guidance, Outlook, Commentary, Risks and Unusual Items

Management stated that Q3 underwriting profitability of 4.8% exceeded its 4% target. The company continues to emphasize retention, rate adjustments, product segmentation, Snapshot usage-based insurance, mobile capabilities, advertising, and multi-product households.
Progressive plans continued rollout of new Personal Lines and Commercial Auto product models, Snapshot, mobile purchasing, and other digital capabilities, subject to regulatory approvals and business results.
The 2011 variable annual dividend target is 33⅓% of annual after-tax underwriting income, subject to the Gainshare factor, comprehensive-income limitations, and Board discretion. The year-to-date Gainshare factor was 1.07 at September 30, but the final factor may change.
Management believes it has sufficient capital, operating cash flow, and borrowing capacity to meet business needs and debt obligations. The next scheduled debt maturity was $350 million in January 2012. A secured $125 million liquidity facility was available and had never been drawn.
Investment risks include interest-rate movements, credit deterioration, equity-market volatility, mortgage-backed and preferred-stock exposure, valuation uncertainty, derivatives, and unrealized losses. Gross unrealized losses at September 30 were $164.6 million, including $84.2 million in fixed-income securities and $80.4 million in common equities.
Litigation includes claims-related lawsuits and class or individual actions concerning medical and injury claims, policy documents, auto-body repair rates, claims practices, marketing, and other operations. Accruals have not been recorded where loss is not probable or cannot reasonably be estimated; an adverse outcome could materially affect results.
Results remain sensitive to catastrophe frequency and severity, loss-reserve development, claims inflation, driving patterns, competitive pricing, customer retention, regulatory approvals, economic conditions, financial-market movements, counterparty strength, tax and healthcare changes, and litigation outcomes.
The filing states that there were no material changes to previously disclosed risk factors, contractual obligations, other off-balance-sheet items, or internal controls over financial reporting.

Important Facts for Investors to Verify

Whether the deterioration in Q3 combined ratios, particularly Commercial Auto, persists after catastrophe effects and favorable prior-year reserve development.
The sustainability and quality of premium and policy growth, including declining Personal Lines new applications and the 1% decline in Commercial Auto policies in force.
Future catastrophe losses, bodily-injury and medical-cost trends, claim frequency and severity, and the adequacy of loss reserves.
Investment portfolio performance, unrealized losses, preferred-stock and mortgage-backed-security credit exposure, and the effect of interest-rate and equity-market changes.
Liquidity and capital coverage for the January 2012 $350 million debt maturity, ongoing share repurchases, dividends, and future catastrophe or reserve needs.
The final 2011 Gainshare factor and annual variable dividend decision, expected to be considered in December 2011.
The financial and earnings impact of the January 2012 accounting change affecting approximately $20 million to $25 million of deferred acquisition costs.
Pending litigation exposures and any subsequent reserve additions or settlements not reflected in the filing.