Business Context and Reporting Period
The Progressive Corporation filed an unaudited Form 10-Q for the quarter and six months ended June 30, 2015. Progressive writes personal auto and specialty insurance, commercial auto insurance, and, beginning April 1, 2015, personal and commercial property insurance through its acquisition of a controlling interest in ARX Holding Corp., the parent of American Strategic Insurance and related businesses.
Progressive owned 69.1% of ARX at June 30, 2015 and consolidated 100% of ARX’s results from April 1, 2015. The remaining ownership is reported as redeemable noncontrolling interest.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2015 | Year-over-Year Change | Six Months Ended June 30, 2015 | Year-over-Year Change |
|---|---|---|---|---|
| Total revenues | $5,283.3 million | 11% | $10,178.6 million | 8% |
| Net premiums earned | $4,995.8 million | 11% | $9,662.1 million | 8% |
| Income before taxes | $525.3 million | 20% | $968.5 million | 5% |
| Net income attributable to Progressive | $363.3 million | 24% | $658.9 million | 7% |
| Diluted earnings per share | $0.62 | 25% | $1.12 | 8% |
| Operating cash flow | Not separately provided | Not applicable | $1,430.0 million | 37% |
| Underwriting profit | $373.8 million | 12% | $715.4 million | 15% |
| Combined ratio | 92.5% | Improved 0.1 points | 92.6% | Improved 0.4 points |
Net income attributable to Progressive represented approximately 6.9% of quarterly revenue and 6.5% of year-to-date revenue. The effective tax rate declined to 29.9% for the quarter and 31.4% for the six months, from 32.9% and 33.1%, respectively, primarily because of an approximately $14 million deferred-tax reversal related to the ARX acquisition.
Underwriting and Growth
- Second-quarter net premiums written increased 13%; excluding the newly acquired Property business, growth was 7%. Policies in force increased 10% overall and 2% excluding Property.
- Personal Lines underwriting profit was $290.0 million for the quarter, with a 93.3% combined ratio versus 93.6% in the prior-year quarter.
- Commercial Lines underwriting profit was $83.2 million, with an 83.0% combined ratio versus 82.5% in the prior-year quarter.
- The Property business generated $272.7 million of net premiums written and $198.7 million of net premiums earned, with a 99.5% combined ratio. Excluding 7.5 points of acquisition-related amortization and depreciation, the Property combined ratio was 92.0%.
- Progressive reported favorable prior accident-year reserve development of $88.8 million in the quarter and $186.7 million for the first six months, compared with $7.5 million and unfavorable development of $55.4 million, respectively, in the comparable 2014 periods.
Investments and Comprehensive Income
- The investment portfolio fair value was $20.6 billion at June 30, 2015, compared with $19.0 billion at December 31, 2014 and $18.8 billion at June 30, 2014.
- Investment income increased 14% to $113.3 million in the quarter and 8% to $218.4 million for the six months. Net realized gains on securities were $76.0 million and $109.0 million, respectively.
- Comprehensive income attributable to Progressive declined 43% to $216.0 million for the quarter and 23% to $537.8 million for the six months, primarily because of after-tax unrealized investment losses of $149.8 million and $114.4 million, respectively.
- The investment portfolio’s fully taxable equivalent total return was negative 0.1% for the quarter and 1.0% year to date, versus 1.6% and 3.0% in the comparable 2014 periods. Management attributed the decline to lower equity-market returns and rising interest rates.
Liquidity, Capital, and Debt
- Cash increased to $263.8 million at June 30, 2015, from $108.4 million at December 31, 2014.
- Total capital, defined as debt plus shareholders’ equity, was approximately $10.1 billion at June 30, 2015, compared with $9.1 billion at year-end 2014.
- Debt was $2,739.0 million at carrying value, compared with $2,164.7 million at December 31, 2014. The debt-to-total-capital ratio was 27.1%, versus 23.8% at year-end 2014.
- Progressive issued $400 million of 3.70% senior notes due 2045 in January 2015. It had no borrowings under its $100 million discretionary line of credit.
- Shareholders’ equity was $7,359.8 million at June 30, 2015, compared with $6,928.6 million at December 31, 2014.
Material Changes Versus Prior Comparable Period
- ARX was acquired for approximately $890 million in cash, adding Property operations, approximately $470 million of goodwill, approximately $520 million of intangible assets, $178.5 million of debt, and redeemable noncontrolling interest of $433.4 million.
- ARX contributed $208.2 million of revenue and $16.8 million of net income to second-quarter consolidated results.
- Operating cash flow rose from $1,041.2 million to $1,430.0 million, while investing cash outflows increased to $1,146.4 million, primarily because of the ARX acquisition.
- Net premiums written growth accelerated in Direct Personal Lines and Commercial Lines, while Agency auto policies in force declined 2% year over year.
- Auto claim severity increased approximately 3% and incurred accident frequency increased approximately 2% in the quarter. Catastrophe losses increased to $154.6 million from $129.8 million, including $54.3 million of Property catastrophe losses, primarily from Texas hail storms.
- Progressive repurchased 4.0 million common shares for $108.1 million during the first six months and had approximately 16 million shares remaining under its repurchase authorization at June 30, 2015.
Guidance, Outlook, Commentary, and Risks
- Management stated that underwriting margins exceeded its long-term target of at least 4% in both the quarter and year-to-date period.
- Progressive expects to continue evaluating rates in response to state-level loss-cost trends. Management identified customer retention, bundled auto and property products, mobile distribution, Snapshot usage-based pricing, and competitiveness in the Agency channel as key strategic priorities.
- The 2015 annual variable dividend target was 33⅓% of after-tax underwriting income, subject to a Gainshare factor, comprehensive-income limitations, and Board discretion. The year-to-date Gainshare factor was 1.33 at June 30, 2015, but the final factor may differ.
- Management said it believes available capital, operating cash flows, and borrowing capacity are sufficient for current and anticipated operations, debt service, declared dividends, acquisition commitments, and other capital needs.
- Key risks include catastrophe losses, reinsurance availability and collectability, interest-rate and investment-market volatility, credit deterioration, claims frequency and severity, pricing and retention execution, regulatory approval of rates and products, litigation, information-technology disruptions, and reserve-estimation uncertainty.
- Pending litigation includes matters involving claims practices, medical and injury benefits, policy documents, labor rates, wage-and-hour issues, marketing, and other operations. Accruals for non-claims litigation were not material at June 30, 2015, but the filing states that material adverse outcomes remain possible.
- ASI had a noncancelable minimum obligation of $81.0 million under newly entered property catastrophe excess-of-loss reinsurance contracts. ARX term loans were subject to leverage, coverage, capital, and rating covenants, and ARX was reported to be in compliance.
Important Facts for Investors to Verify
- Assess the sustainability of reported earnings after separating recurring underwriting results from favorable reserve development, realized investment gains, acquisition-related tax benefits, and other unusual items.
- Evaluate ARX integration, Property-business catastrophe exposure, amortization of acquired intangibles, minority-interest economics, and the put/call arrangements that could lead to Progressive acquiring the remaining ARX shares by 2021.
- Monitor Agency auto retention and policy-life-expectancy declines, as well as the effects of rate actions on future growth and customer retention.
- Review investment sensitivity to higher interest rates, credit spreads, equity-market declines, unrealized losses, and the change in fixed-income credit quality from AA- to A+.
- Verify reserve adequacy and the extent to which favorable prior-year development reverses as claims mature, particularly amid higher auto severity and frequency.
- Consider debt growth, variable-rate ARX obligations, the $100 million undrawn credit facility, reinsurance commitments, catastrophe exposure, and pending litigation when assessing liquidity and capital adequacy.