PROGRESSIVE CORP quarterly report, Q2 FY2019

Progressive Corporation: Q2 2019 Form 10-Q Summary

Business context and reporting period

The Progressive Corporation, an insurance holding company, filed its unaudited Form 10-Q for the quarter and six months ended June 30, 2019. Its principal businesses are Personal Lines, Commercial Lines, Property, service operations, and investment management. Progressive owned 87.1% of ARX Holding Corp. at quarter-end. The filing states that interim results are not necessarily indicative of full-year results.

Key financial metrics

Metric	Q2 2019	Q2 2018	Six months 2019	Six months 2018
Total revenues	$9,450.7 million	$8,018.0 million	$18,750.7 million	$15,448.1 million
Net premiums earned	$8,824.7 million	$7,634.2 million	$17,284.5 million	$14,808.2 million
Income before taxes	$1,243.6 million	$880.1 million	$2,811.1 million	$1,790.9 million
Net income attributable to Progressive	$979.4 million	$704.2 million	$2,057.8 million	$1,422.2 million
Diluted earnings per share	$1.66	$1.19	$3.48	$2.42
Operating cash flow	Not separately provided	Not separately provided	$3,374.7 million	$3,483.3 million
Underwriting margin	9.6%	9.1%	10.4%	10.3%
Combined ratio	90.4%	90.9%	89.6%	89.7%

Revenue increased approximately 18% year over year in both the quarter and six-month period. Net income attributable to Progressive increased approximately 39% in Q2 and 45% year to date. The results benefited from premium and policy growth, improved underwriting margins, higher investment income, and substantially higher investment gains.

Q2 net premiums written were $9.1 billion, up 13%; six-month net premiums written were $18.4 billion, up 14%.
Policies in force totaled 21.6 million at June 30, 2019, up 10% from a year earlier.
Q2 underwriting profit was $851.3 million, compared with $697.2 million; six-month underwriting profit was $1,800.5 million, compared with $1,527.8 million.
Q2 investment income was $261.3 million, compared with $192.1 million; six-month investment income was $514.2 million, compared with $358.4 million.
Net realized gains on securities were $179.9 million in Q2 and $594.4 million for six months, compared with $32.8 million and a $15.4 million loss, respectively, in the prior-year periods.
The investment portfolio had a fair value of $36.8 billion at June 30, 2019, with a 2.7-year fixed-income duration and AA- weighted-average credit quality.

Liquidity, capital, and balance sheet

Total assets were $51.3 billion at June 30, 2019, compared with $46.6 billion at December 31, 2018.
Shareholders’ equity was $13.3 billion, compared with $10.8 billion at year-end 2018, largely reflecting comprehensive income and higher unrealized fixed-maturity gains.
Debt carrying value was $4.4 billion and debt fair value was $5.0 billion. Debt-to-total capital was 24.8%, versus 28.9% at December 31, 2018.
Cash, cash equivalents, and restricted cash totaled $92.9 million at June 30, 2019. Liquidity is also supported by premiums collected before claims payments, investment maturities, and the company’s investment portfolio.
Progressive renewed its $250 million unsecured, uncommitted line of credit through April 30, 2020; no borrowings were outstanding under the line.
Cash used in financing activities was $1,566.5 million for the first six months, primarily reflecting $1,526.3 million of common dividends and $13.4 million of preferred dividends.

Material changes versus the prior comparable periods

Growth accelerated across the insurance portfolio: six-month net premiums earned increased 17%, while policies in force increased 10%.
Personal Lines six-month underwriting profit rose to $1,536.2 million from $1,355.9 million, although its combined ratio modestly worsened to 89.4% from 89.2%.
Commercial Lines six-month underwriting profit increased to $291.0 million from $195.1 million, and its combined ratio improved to 86.0% from 88.5%.
Property remained unprofitable on an underwriting basis, with a six-month loss of $26.7 million and a 103.6% combined ratio. Q2 Property losses were $34.4 million, despite improvement from the prior-year quarter.
Unfavorable prior-year reserve development increased to $210.0 million for the first six months from $81.5 million. Personal auto accounted for approximately $116 million, Commercial Lines for $57 million, Property for $20 million, and special lines for $17 million.
Personal auto severity increased approximately 8% in both Q2 and the six-month period, while frequency declined approximately 4% and 3%, respectively.
Advertising expense increased 29% in Q2 and 30% year to date as Progressive continued investing in customer acquisition.
The effective tax rate increased to 26.7% for six months from 20.1%, principally because the company reversed tax credits and other benefits associated with certain renewable-energy tax-credit investments.
Fixed-maturity securities generated a $598.1 million pretax net unrealized gain at June 30, 2019, compared with a $267.3 million net unrealized loss at June 30, 2018.

Guidance, outlook, management commentary, and risks

The filing does not provide formal earnings or premium guidance. Management expects sufficient capital and operating cash flow to support current operations, scheduled debt payments, dividends, contractual obligations, and expected capital needs for the foreseeable future.

Management described the marketplace as softening, with competitors lowering rates. Progressive expects to use selective rate actions and continue marketing where customer-acquisition costs are acceptable.
Retention remains a key priority. Trailing 12-month personal auto policy life expectancy declined 2%, while the trailing three-month measure improved 1%; management said the effects of prior underwriting changes are beginning to diminish.
Property growth is being moderated through targeted underwriting changes in Texas and Colorado, with additional rate increases planned where needed to meet profitability targets.
Q2 catastrophe losses were $211.7 million, primarily from tornadoes, wind, hail, and thunderstorms. Property reinsurance and aggregate stop-loss agreements mitigated a portion of the losses.
The company identified risks involving pricing and reserve adequacy, claims severity, medical and repair costs, catastrophe events, reinsurance recoveries, interest rates and investment valuations, competition, regulation, litigation, tax-credit investments, cybersecurity, and access to capital.
Progressive reported that alleged fraud involving the sponsor of three renewable-energy tax-credit funds invalidated associated tax credits and benefits, resulting in a $156.1 million first-quarter tax provision increase and related impairment activity.
Pending litigation is generally similar to that described in the 2018 Form 10-K. Non-claims litigation accruals were not material, but the company stated that an adverse judgment or settlement could materially affect results.
The company adopted operating-lease accounting on January 1, 2019, recording lease assets of $213.0 million and liabilities of $217.6 million at transition; the adoption did not affect earnings or cash flows.

Most important facts for investors to verify

Whether unfavorable reserve development, particularly in personal auto bodily injury and reopened Florida PIP claims, persists or reverses.
Whether premium and policy growth can continue as competitors reduce rates and the insurance market softens.
Whether Property underwriting reaches profitability after catastrophe losses, rate actions, and targeted underwriting changes.
The sustainability of reported earnings given the substantial contribution from equity holding-period gains, security-sale gains, and fixed-maturity valuation changes.
The ultimate tax, recovery, and legal consequences of the alleged renewable-energy tax-credit fund fraud.
Changes in catastrophe frequency and severity, reinsurance recoverables, and the adequacy of loss reserves.
Investment portfolio credit quality, interest-rate sensitivity, liquidity, and the company’s ability to maintain its target debt-to-total-capital level.