Business Context and Reporting Period
The Progressive Corporation, an insurer focused primarily on personal auto, recreational vehicle, and commercial auto coverage, filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2010. Personal Lines generated approximately 89% of net premiums written; Commercial Auto represented approximately 11%.
Key Financial Metrics
| Metric | Three months ended June 30, 2010 | Year-over-year change | Six months ended June 30, 2010 | Year-over-year change |
|---|---|---|---|---|
| Net premiums earned | $3,590.2 million | 4% | $7,091.3 million | 4% |
| Total revenues | $3,686.3 million | 3% | $7,352.2 million | 4% |
| Income before taxes | $312.9 million | (12%) | $751.8 million | 3% |
| Net income | $211.9 million | (15%) | $507.5 million | 5% |
| Diluted earnings per share | $0.32 | (14%) | $0.76 | 6% |
| Underwriting profit | $262.0 million | 3% | $580.1 million | (5%) |
| Underwriting margin / combined ratio | 7.3% / 92.7% | Down 0.1 point | 8.2% / 91.8% | Down 0.7 point |
Recurring investment income increased 7% in the quarter and 3% year to date, while net realized losses on securities were $39.5 million in the quarter and $8.7 million year to date, compared with gains of $15.9 million and losses of $57.5 million, respectively, in the prior-year periods. The second-quarter net margin was approximately 5.7%, compared with approximately 7.0% in the prior-year quarter; the six-month net margin was approximately 6.9%, compared with approximately 6.8%.
Operating cash flow was $1,204.5 million for the first six months, compared with $928.1 million in 2009. Cash was $153.8 million at June 30, 2010. The investment portfolio totaled $15.83 billion, including $5.8 billion of U.S. Treasury and short-term securities. Shareholders’ equity was $6.30 billion, and total capital, including debt, was approximately $8.5 billion.
Debt had a carrying value of $2.18 billion and fair value of $2.24 billion. The company had no borrowings under its $125 million secured liquidity facility, which could be increased to $150 million at the company’s request, and no scheduled debt maturities until January 2012.
Material Changes Versus Prior Comparable Period
- Net premiums written increased 5% in the quarter and 6% year to date. Personal Lines written premiums increased 7% and 8%, respectively, while Commercial Auto declined 5% and 4%.
- Policies in force increased 6% companywide, led by 15% growth in Direct auto and 7% growth in total Personal Lines; Commercial Auto policies declined 2%.
- Underwriting remained profitable but weakened year to date. Personal Lines’ six-month combined ratio increased to 92.3% from 91.8%, while Commercial Auto’s increased to 88.8% from 86.2%.
- Higher advertising expenditures and Gainsharing accruals increased underwriting expense ratios by 0.8 percentage points in both the quarter and six-month period.
- Net unrealized investment gains improved substantially to $852.3 million pretax at June 30, 2010, from net unrealized losses of $71.4 million at June 30, 2009. However, common-equity exposure increased to 7.3% of the portfolio from 3.0%.
- Other-than-temporary impairment losses declined to $8.6 million in the quarter and $11.7 million year to date, compared with $30.0 million and $227.4 million in the prior-year periods.
- The company repurchased 5.7 million common shares for $107.3 million during the first six months, including 3.3 million shares for $64.7 million in the second quarter.
Guidance, Outlook, Commentary, Risks, and Unusual Items
- Management reiterated a long-term underwriting objective corresponding to a 96% combined ratio, or a 4% underwriting margin. No specific full-year earnings guidance is provided.
- Management cited continued growth opportunities from advertising, Name Your Price, new product models, usage-based insurance, and bundled auto and homeowners offerings. Name Your Price was available in 48 jurisdictions, with the final three expected by year-end 2010; further usage-based expansion was planned subject to regulatory approval and results.
- Management expects Commercial Auto to remain challenging because of economic weakness, particularly in housing and construction, lower premiums per policy, and competitive conditions.
- Second-quarter favorable prior accident-year development was $58.4 million, including $33.6 million of actuarial adjustments. Catastrophe losses were $46.9 million, adding 1.3 points to the quarterly combined ratio.
- On July 8, 2010, after the reporting date, the company repurchased $222.9 million principal amount of its junior subordinated debentures. The transaction produced a July net gain of $8.5 million and approximately $6.5 million of cumulative net gain, including June expenses. The Replacement Capital Covenant on the 2032 Notes was terminated after majority-holder consent.
- Key risks include loss-reserve estimation, catastrophe and weather losses, claims severity and frequency, litigation, regulatory and rate approvals, competition, interest rates, credit and liquidity conditions, investment valuation, counterparty exposure, and changes in health-care and auto-repair costs.
- Outstanding litigation includes matters involving consumer reports, claims handling, rating practices, uninsured and underinsured motorist coverage, diminished vehicle value, repair-shop labor rates, and marketing practices. The filing states that unaccrued matters could materially affect results if adverse outcomes exceed recorded reserves.
Important Facts for Investors to Verify
- Whether favorable reserve development continues or reverses, particularly given the higher accident-year loss ratio.
- The sustainability of Personal Lines and Direct-channel growth as premium per policy declines and advertising costs rise.
- Commercial Auto retention, policy counts, premium trends, and loss frequency amid economic weakness.
- The credit performance and valuation of mortgage-backed, preferred-stock, non-investment-grade, and other structured securities, including the $158.8 million of gross unrealized investment losses at June 30, 2010.
- The final effects of the July 2010 debt tender offer, including the reduced debt balance, cash usage, and accounting gain.
- The variable annual dividend: the 2010 target is 25% of after-tax underwriting income, but the final Gainshare factor and dividend remain subject to full-year performance and board discretion.
- Potential changes to deferred-tax-asset realizability, litigation accruals, and loss reserves that could materially affect future earnings, equity, or cash flow.