Progressive Corporation 10-Q Summary
Reporting period: Three and six months ended June 30, 2016. The filing is unaudited and covers Progressive and its subsidiaries, including ARX Holding Corp., in which Progressive owned 69.2%. Common shares outstanding at June 30, 2016 were approximately 581.9 million.
Financial Performance and Condition
| Metric | Three months ended June 30, 2016 | Change vs. 2015 | Six months ended June 30, 2016 | Change vs. 2015 |
|---|---|---|---|---|
| Net premiums earned | $5,561.8 million | 11% | $10,879.2 million | 13% |
| Total revenues | $5,819.3 million | 10% | $11,376.8 million | 12% |
| Net income attributable to Progressive | $190.9 million | (47%) | $449.1 million | (32%) |
| Diluted earnings per share | $0.33 | (47%) | $0.77 | (31%) |
| Pretax underwriting profit | $175.6 million | (53%) | $462.4 million | (35%) |
| Combined ratio | 96.8% | Up 4.3 points | 95.7% | Up 3.1 points |
| Operating cash flow | Not separately provided | — | $1,554.8 million | Up from $1,430.0 million |
Investment income was $114.6 million in the second quarter and $233.4 million year to date, up 1% and 7%, respectively. Net realized gains on securities declined 58% in both periods, to $32.3 million and $49.7 million, largely due to losses on derivative positions. Comprehensive income attributable to Progressive increased 30% for the quarter to $280.7 million and 13% year to date to $606.5 million, supported by higher unrealized investment gains.
At June 30, 2016, total assets were $32.0 billion, total investments were $22.4 billion, cash was $134.7 million, shareholders’ equity was $7.8 billion, and debt was $2.7 billion on a carrying-value basis. Debt represented 25.4% of total capital, down from 27.1% at both June 30, 2015 and December 31, 2015. Debt fair value was $3.0 billion. Progressive reported a $100 million unsecured discretionary line of credit, with no borrowings outstanding.
Cash used in investing activities was $989.1 million and cash used in financing activities was $655.6 million during the first six months. Financing uses included $519.0 million of dividends and $112.1 million for share repurchases. Ending cash declined $89.7 million from year-end 2015 to $134.7 million.
Material Changes Versus Prior Comparable Period
- Growth remained strong: second-quarter net premiums written increased 13%, policies in force increased 7%, and year-to-date net premiums earned increased 13%.
- Profitability deteriorated despite growth. Second-quarter underwriting profit fell 53%, primarily because of higher catastrophe losses, less favorable prior accident-year development, and increased claim frequency and severity.
- Catastrophe losses increased to $216.5 million in the quarter and $318.9 million year to date, compared with $154.6 million and $164.0 million, respectively, in 2015. Flood, wind, and hail storms in Texas were significant contributors.
- Personal Lines combined ratio increased to 96.7% from 93.3% in the quarter and to 95.6% from 93.5% year to date. Commercial Lines increased to 94.7% from 83.0% in the quarter and to 91.9% from 83.1% year to date.
- Property reported a $13.6 million second-quarter underwriting loss and a $38.1 million year-to-date loss, compared with a $1.0 million profit in the comparable periods. The six-month comparison is not fully comparable because Progressive acquired control of ARX in April 2015.
- ARX completed an exchange transaction in the second quarter, acquiring a personal-property insurer and disposing of a commercial-property insurer. The transaction added approximately 96,000 policies and increased goodwill by $1.8 million.
- Progressive repurchased $19.8 million principal amount of its 6.70% junior subordinated debentures for $18.2 million, recognizing a $1.6 million extinguishment gain. It had approximately $594.6 million principal amount outstanding and is evaluating whether to redeem the debt beginning June 15, 2017.
- The investment portfolio increased from $20.9 billion at December 31, 2015 to $22.4 billion, with short-term investments increasing to $5.2 billion and fixed maturities declining to $13.6 billion.
Guidance, Outlook, Commentary, Risks, and Unusual Items
The filing does not provide formal full-year earnings or revenue guidance. Management intends to continue investing in marketing, product development, digital and mobile capabilities, customer retention, bundled auto and property offerings, and newer auto pricing models. Management expects to expand the latest auto product model into additional states during the remainder of 2016 and into 2017. Commercial Lines planned to begin writing business in Hawaii in late 2016.
Progressive’s year-to-date Gainshare factor was 1.50. The 2016 annual variable dividend target remained 33⅓% of after-tax underwriting income, but the final factor and dividend remain subject to full-year performance and Board discretion. No quarterly dividend was declared; the company paid the prior year’s $519.0 million annual variable dividend in February 2016.
Management stated that it believes available capital, operating cash flow, and borrowing capacity are sufficient for anticipated business needs, debt service, dividends, and other capital requirements. Key forward-looking risks include catastrophe events, claim frequency and severity, reserve adequacy, pricing and retention, competition, regulatory approvals and rate changes, reinsurance recoverability, interest rates and investment-market performance, counterparty credit, litigation, technology and cybersecurity, and potential goodwill or intangible-asset impairment.
Pending litigation includes matters involving claims handling, medical and injury benefits, policy documents, repair-shop labor rates, wage and hour issues, marketing, and other business practices. Accruals for non-claim litigation were not material at June 30, 2016, but the company stated that an adverse judgment or settlement could materially affect results, cash flows, or financial condition.
Other unusual items included $31.1 million of year-to-date intangible amortization primarily associated with the ARX acquisition, a loss related to the ARX exchange transaction, the termination of a 10% Property quota-share reinsurance contract, and a change in recognition of ceded catastrophe reinsurance premiums. The quota-share termination increased second-quarter Property net premiums written by $70.3 million but did not affect results of operations.
Investor Verification Items
- Assess whether premium and policy growth can continue without further deterioration in claim frequency, severity, catastrophe exposure, or combined ratios.
- Review the sustainability of the 2016 underwriting margin, particularly in Personal Lines, Commercial Lines, and Property.
- Verify the effect of catastrophe losses, prior-year reserve development, and Texas exposure on future earnings and reserve adequacy.
- Monitor the performance and comparability of the ARX Property business following the exchange transaction and the planned exercise of minority-shareholder put rights.
- Evaluate the redemption or repricing decision for the 6.70% junior subordinated debentures beginning in 2017.
- Reconcile cash generation with large annual dividends, share repurchases, investment purchases, and potential ARX ownership funding requirements.
- Review investment-market sensitivity, including $22.4 billion of investments, preferred-stock and structured-securities exposure, interest-rate swaps, and unrealized gains.
- Track pending litigation, reinsurance recoverables, regulatory developments, and the potential impact of the new accounting standards described in the filing.