Business Context and Reporting Period
The Progressive Corporation filed an unaudited Form 10-Q for the quarter and nine months ended September 30, 2017. Progressive is primarily a personal auto, commercial auto, and property insurer, with insurance-related service and investment operations. The company owned 69.0% of ARX Holding Corp. at quarter-end.
Financial Performance and Position
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Total revenues | $6,791.8 million | $5,935.0 million | $19,719.2 million | $17,311.8 million |
| Net premiums earned | $6,544.0 million | $5,723.4 million | $18,884.0 million | $16,602.6 million |
| Income before taxes | $251.4 million | $258.5 million | $1,447.5 million | $933.2 million |
| Net income attributable to Progressive | $224.0 million | $198.7 million | $1,015.9 million | $647.8 million |
| Diluted EPS | $0.38 | $0.34 | $1.73 | $1.11 |
| Operating cash flow | Not separately provided | Not separately provided | $3,206.6 million | $2,275.8 million |
- Q3 total revenue and premiums earned increased 14% year over year. Pretax income declined 3%, while net income attributable to Progressive increased 13%, principally because of a $23.1 million year-to-date excess tax benefit from employee share-based compensation accounting.
- Nine-month net income attributable to Progressive increased 57%, and diluted EPS increased 56%. The effective tax rate was 14.6% in Q3 and 29.7% for the nine months, compared with 20.5% and 29.4%, respectively, in the prior-year periods.
- Q3 underwriting profit was $172.0 million, with a 2.6% underwriting margin and a 97.4 combined ratio, compared with $197.0 million, a 3.4% margin, and a 96.6 combined ratio in Q3 2016.
- Nine-month underwriting profit was $1,100.0 million, with a 5.8% margin and a 94.2 combined ratio, versus $659.4 million, a 4.0% margin, and a 96.0 combined ratio in 2016.
- Q3 segment combined ratios were 96.4% for Personal Lines, 94.0% for Commercial Lines, and 127.0% for Property. Nine-month combined ratios were 93.9%, 91.8%, and 108.0%, respectively.
- Net catastrophe losses were $431.1 million in Q3, or 6.6 combined-ratio points, compared with $158.7 million, or 2.8 points, in Q3 2016. Hurricanes Harvey and Irma were the primary drivers.
- At September 30, 2017, total assets were $38.9 billion, investments were $27.0 billion, cash was $224.9 million, and reinsurance recoverables were $2.7 billion. Shareholders’ equity was $9.3 billion.
- Debt carrying value was $3.3 billion and total capital was approximately $12.6 billion. Debt-to-total-capital was 26.3%, compared with 28.0% at September 30, 2016. The company reported no borrowings under its $250 million line of credit.
Material Changes Versus the Prior Comparable Period
- Policies in force grew 9% companywide. Auto policies in force increased 11% to approximately 11.4 million, while Property policies increased 16% to approximately 1.4 million.
- Q3 net premiums written increased 18%; nine-month net premiums written increased 14%. Personal Lines, Commercial Lines, and Property all contributed to growth.
- Q3 underwriting results weakened because catastrophe losses more than offset lower auto accident frequency and investment-income growth. Property shifted from a 95.4% combined ratio in Q3 2016 to 127.0% in Q3 2017.
- Q3 investment income increased 20% to $142.9 million. The investment portfolio’s Q3 fully taxable equivalent total return was 1.1%, compared with 1.3% in the prior year.
- Progressive issued $850 million of 4.125% senior notes due 2047 and redeemed $563.7 million of 6.70% junior subordinated debentures. Interest expense increased 6% in Q3.
- The company adopted new share-based compensation tax accounting, moving excess tax benefits into the income tax provision and increasing potential quarterly tax-rate volatility.
- Nine-month prior-year reserve development changed from $22.9 million of favorable development in 2016 to $42.5 million of unfavorable development in 2017. Personal auto had $76 million of unfavorable development, partly offset by $24 million of favorable Property development.
- The estimated useful life of the Property trade-name intangible asset was revised to a remaining two years as Progressive transitions from the ASI name to “Progressive Home.”
Guidance, Outlook, Risks, and Unusual Items
- Management stated that nine-month aggregate underwriting profit met its 4% or better profitability goal despite a Property underwriting loss.
- The year-to-date Gainshare factor was 1.67. The 2017 annual variable dividend target was set at 33⅓% of annual after-tax underwriting income, but the final dividend remains subject to full-year results, the final Gainshare factor, and Board approval.
- Management said liquidity was sufficient to pay claims, including catastrophe claims, without disrupting portfolio strategy. The investment portfolio had an A+ weighted average credit quality and 2.2-year duration.
- The Property aggregate stop-loss reinsurance recoverable was $95.5 million at September 30, 2017 and may fluctuate through year-end depending on the applicable full-year loss ratio. Property also had $280.0 million of catastrophe-reinsurance recoverables and $344.2 million due from the National Flood Insurance Program.
- Key risks include catastrophe severity, reserve adequacy, claims inflation and frequency, reinsurance recoverability, interest-rate and investment-market movements, competition, regulatory approval of rates and products, litigation, information-technology disruptions, and potential impairment of goodwill or intangible assets.
- Pending litigation is generally related to insurance claims, claims practices, policy documents, repair-shop rates, labor matters, and marketing or operating practices. The filing states that material losses were not generally considered both probable and estimable, but adverse outcomes could materially affect results.
- Minority ARX shareholders may put shares to Progressive in installments beginning in early 2018 and again in early 2021. The redeemable noncontrolling interest was $498.2 million, excluding an estimated $32.2 million obligation related to unexercised employee options.
Important Facts for Investors to Verify
- Whether catastrophe losses, especially from Harvey and Irma, produce additional reserve or reinsurance adjustments in subsequent quarters.
- Progressive’s ability to sustain premium and policy growth while preserving target underwriting margins, particularly in Personal Lines and Property.
- Reserve development trends, including the unfavorable nine-month 2017 development in personal auto and the effect of claims severity.
- The ultimate 2017 Gainshare factor and variable dividend declared after year-end.
- The collectability and timing of the $2.7 billion reinsurance-recoverable balance, including Property catastrophe, stop-loss, and NFIP recoverables.
- The effect of the new share-based compensation tax accounting and other tax changes on quarterly effective tax rates.
- Funding requirements and valuation changes associated with the scheduled ARX minority-shareholder put and call rights.