PROGRESSIVE CORP quarterly report, Q3 FY2009

Progressive Corporation Form 10-Q Summary

Business context and reporting period

The Progressive Corporation is primarily a personal and commercial automobile insurer, with additional specialty lines, indemnity, and insurance-related service businesses. This unaudited Form 10-Q covers the three and nine months ended September 30, 2009, compared with the corresponding 2008 periods. The filing was issued November 9, 2009.

Personal Lines policies in force increased 4% year over year, led by 13% growth in Direct auto.
Commercial Auto policies in force declined 5%, reflecting weakness in housing, construction, and other economically sensitive markets.
Common shares outstanding were 674.2 million at October 31, 2009.

Financial performance and key metrics

Metric	Q3 2009	Q3 2008	9M 2009	9M 2008
Net premiums earned	$3,445.4 million	$3,416.2 million	$10,293.4 million	$10,217.4 million
Total revenues	$3,611.3 million	$2,210.1 million	$10,663.0 million	$9,332.6 million
Income before taxes	$372.0 million	$(1,080.9) million	$1,102.6 million	$(441.2) million
Net income	$269.9 million	$(684.2) million	$752.5 million	$(229.3) million
Diluted earnings per share	$0.40	$(1.03)	$1.12	$(0.34)
Net cash from operating activities	Not provided for quarter	Not provided for quarter	$1,415.1 million	$1,438.5 million
Combined ratio	92.7%	95.1%	91.6%	94.4%

Underwriting profit was $249.8 million in the third quarter and $859.6 million for the first nine months, versus $167.4 million and $569.3 million, respectively, in 2008.
Personal Lines produced a 93.6% third-quarter combined ratio and a 92.4% nine-month combined ratio. Commercial Auto produced 87.3% and 86.5%, respectively.
Recurring investment income declined 25% in the quarter and 23% year to date, primarily because new investments were directed toward lower-yielding U.S. Treasury Notes and short-term instruments.
Net realized gains on securities were $38.8 million in the quarter, compared with a $1.373 billion loss in the prior-year quarter. Year-to-date net realized losses were $18.7 million versus a $1.386 billion loss in 2008.
Other-than-temporary impairment losses recognized in earnings were $7.8 million in the quarter and $37.8 million for the six months since adoption of the revised impairment guidance. The filing reports $235.2 million of total portfolio write-downs for the first nine months, compared with $1.366 billion in 2008.

Financial position, liquidity, and capital

Total assets were $20.047 billion at September 30, 2009, compared with $18.251 billion at December 31, 2008.
Investments totaled $14.669 billion, including $11.730 billion of fixed maturities, $1.245 billion of nonredeemable preferred stocks, $466.6 million of common equities, and $1.228 billion of short-term investments.
Cash was $172.5 million at September 30, 2009, versus $2.9 million at year-end 2008.
Shareholders’ equity increased to $5.496 billion from $4.215 billion at December 31, 2008, reflecting net income and substantial improvement in unrealized investment values.
Debt was $2.177 billion carrying value, with a reported fair value of $2.139 billion. The debt consisted of senior notes and junior subordinated debentures.
Progressive had access to a $125 million secured liquidity facility with National City Bank, supported by a $125 million FDIC-insured deposit. No borrowings were outstanding through the first nine months.
Operating cash flow remained strong at $1.415 billion for the first nine months. Investing activities used $1.166 billion, primarily for purchases of fixed maturities, and financing activities used $79.1 million.
The company repurchased 5.9 million shares year to date for $93.4 million, including 4.5 million shares during the third quarter for $73.4 million.
The investment portfolio had a 2.5-year duration, an overall AA weighted average credit quality, and approximately $6.6 billion in short-term investments and U.S. Treasury securities.

Material changes versus the prior comparable period

Profitability reversed from a significant 2008 loss to substantial earnings in 2009, primarily because 2008 included more than $1.4 billion of investment write-downs and 2009 benefited from stronger underwriting and investment-market recovery.
Net premiums earned increased 1% in both the quarter and year to date, while net premiums written increased 1% in both periods.
Underwriting margin improved to 7.3% from 4.9% in the quarter and to 8.4% from 5.6% year to date.
Catastrophe losses decreased to $37.5 million from $82.4 million in the quarter and to $90.2 million from $151.7 million year to date.
Prior accident-year development improved materially, contributing 2.5 points to the third-quarter combined ratio versus 0.2 points in the prior-year quarter.
The portfolio shifted substantially toward fixed-income and short-term assets: common equities represented 3.2% of the portfolio versus 10.4% a year earlier, while fixed maturities represented 80.0% versus 73.5%.
Accumulated net unrealized securities gains improved to $313.1 million at September 30, 2009 from a $76.8 million loss at December 31, 2008.
A $189.6 million after-tax cumulative accounting adjustment reclassified the non-credit portion of prior impairment losses from retained earnings to accumulated other comprehensive income.

Guidance, outlook, management commentary, risks, and unusual items

Management stated that the 7.3% third-quarter underwriting margin exceeded its 4% target. It continues to manage capital to support business that can be profitably underwritten, using a 96% combined ratio as an underwriting discipline objective.
Management expects to continue expanding Name Your Price, agency product segmentation, and MyRate usage-based insurance, subject to regulatory approvals and business results.
For 2009, the Board set the target for the annual variable dividend at 20% of after-tax underwriting income. The Gainshare factor was 0.69 through the third quarter; the final factor and dividend remained subject to full-year results and Board discretion. The Board was expected to consider a dividend in December 2009.
Commercial Auto remained under pressure, with written premiums declining because customers were selecting less coverage and insuring fewer vehicles. Management noted that the economic downturn and competition continued to affect this business.
Management cautioned that accident frequency, severity, loss reserve development, catastrophe activity, pricing, retention, and regulatory approvals could materially affect future results.
The investment portfolio remained exposed to preferred stocks, mortgage-backed securities, financial-sector issuers, credit spreads, interest rates, liquidity conditions, and potential dividend deferrals. Gross unrealized losses were $361.6 million at September 30, 2009, including $358.2 million in fixed-income securities.
The portfolio exceeded the company’s 1.25% concentration guideline for preferred stock and non-investment-grade debt, and management expected that it could remain outside the guideline while the portfolio was repositioned.
Pending litigation includes claims involving consumer reports, medical and injury benefits, renewal rating, uninsured and underinsured motorist coverage, repair practices, labor rates, and other claims or marketing practices. The filing states that adverse outcomes beyond recorded reserves could materially affect results.
The company began reinsuring 100% of its community bank professional liability risk effective August 1, 2009, while pursuing a sale of that business. Completion could take up to one year and requires regulatory approvals.
The filing states that there were no material changes to previously disclosed risk factors, contractual obligations, or off-balance-sheet items other than the matters discussed.

Most important facts for investors to verify

Whether underwriting margins and the 91.6% year-to-date combined ratio remain sustainable after favorable prior-year reserve development and unusually low catastrophe losses.
Future loss frequency and severity trends, particularly the reported increase in auto accident frequency.
The recoverability and future valuation of preferred stocks, residential mortgage-backed securities, commercial mortgage-backed securities, and other structured investments.
The effect of lower investment yields on recurring investment income and future earnings.
The final 2009 Gainshare factor and any annual variable dividend declared by the Board.
The performance and regulatory rollout of Name Your Price, MyRate, and new agency product models.
The progress and financial effect of the proposed community bank program sale and related reinsurance arrangement.
Potential exposure from litigation and loss-reserve development not currently reserved because the loss is not considered probable or cannot be reasonably estimated.