Progressive Corporation 2011 Q2 Form 10-Q Summary
Business context and reporting period
The Progressive Corporation is an insurance holding company focused primarily on personal automobile, recreational vehicle and commercial automobile insurance. The filing covers the unaudited three and six months ended June 30, 2011, compared with the respective 2010 periods. Personal Lines generated approximately 90% of six-month net premiums written.
Key financial metrics
| Metric | Three months ended June 30, 2011 | Year-over-year change | Six months ended June 30, 2011 | Year-over-year change |
|---|---|---|---|---|
| Net premiums earned | $3,719.9 million | 4% | $7,385.2 million | 4% |
| Total revenues | $3,872.7 million | 5% | $7,766.2 million | 6% |
| Net income | $245.2 million | 16% | $608.1 million | 20% |
| Diluted earnings per share | $0.38 | 19% | $0.93 | 22% |
| Underwriting profit | $244.7 million | Down from $262.0 million | $600.5 million | Up from $580.1 million |
| Underwriting margin | 6.6% | Down 0.7 points | 8.1% | Down 0.1 points |
| Combined ratio | 93.4% | Up 0.7 points | 91.9% | Up 0.1 points |
| Operating cash flow | Not separately provided | — | $1,031.1 million | Down from $1,204.5 million |
Investment income declined 8% in the quarter and 6% year to date, to $120.8 million and $244.1 million, respectively, primarily because of lower investment yields following the reduction in portfolio duration. Net realized gains on securities were $26.0 million in the quarter and $125.7 million year to date, compared with losses of $39.5 million and $8.7 million in the 2010 periods.
At June 30, 2011, total assets were $21.8 billion, shareholders’ equity was $6.35 billion and total investments were $16.0 billion. Cash was $149.7 million. Debt had a carrying value of $1.96 billion and a fair value of $2.13 billion. Total capital was approximately $8.3 billion, and debt-to-total-capital was 23.6%.
Operating trends and material changes
- Net premiums written increased 3% in both the quarter and first six months. Personal Lines net premiums written increased 4%, while Commercial Auto was up 3% in the quarter and flat year to date.
- Policies in force increased 5% year over year to 12.2 million in Personal Lines, driven by 8% growth in Direct auto and 3% growth in Agency auto. Commercial Auto policies declined 2%.
- Personal Lines underwriting profit was $210.6 million for the quarter and $525.9 million year to date. Commercial Auto underwriting profit was $34.1 million and $75.2 million, respectively.
- Higher catastrophe losses were the principal quarterly underwriting pressure: $124.9 million, or 3.4 combined-ratio points, versus $46.9 million, or 1.3 points, in the prior-year quarter.
- Favorable prior accident-year development contributed $52.0 million in the quarter and $151.0 million year to date, but was below the comparable 2010 amounts.
- Net unrealized gains on securities increased to $1.30 billion pretax at June 30, 2011, from $852.3 million at June 30, 2010. The investment portfolio included 11.7% common equities, versus 7.3% a year earlier.
- The company repurchased 13.3 million common shares for $282.9 million during the quarter and 20.1 million shares for $420.9 million year to date. The board authorized an additional 75 million share repurchase program.
Liquidity, debt and capital management
Progressive generated $1.03 billion of operating cash flow during the first six months and had $4.3 billion of U.S. Treasury and short-term securities at June 30, 2011. The company had a secured liquidity facility of up to $125 million, expandable to $150 million at PNC’s discretion, with no borrowings through June 30, 2011. Management stated that available capital, operating cash flow and borrowing capacity were sufficient for anticipated needs.
The next scheduled debt maturity was $350 million in January 2012. Interest expense declined to $63.0 million year to date from $70.3 million, primarily because of the 2010 repurchase of $222.9 million of junior subordinated debentures. Progressive maintained an annual variable dividend program; the 2011 target percentage was 33⅓% of annual after-tax underwriting income, and the year-to-date Gainshare factor was 1.17, subject to final full-year results and board approval.
Guidance, outlook, risks and unusual items
- Management’s long-term underwriting target is a 96 combined ratio, equivalent to a 4% underwriting margin. The reported 6.6% quarterly margin exceeded that target despite elevated catastrophe losses.
- Management planned continued expansion of Snapshot usage-based insurance, new product models, mobile quoting and purchasing, multi-product offerings and advertising initiatives. Further state rollouts were subject to regulatory approvals and business results.
- Management expected a new Commercial Auto product model to reach approximately 15 to 20 additional states by year-end 2011.
- Key risks include catastrophe severity and frequency, loss-cost inflation, medical and auto repair costs, reserve development, pricing and retention competition, regulatory approval of rate changes, investment credit and interest-rate risk, litigation, technology and business interruption risk, and economic conditions affecting Commercial Auto demand.
- The investment portfolio had $56.5 million of gross unrealized losses at June 30, 2011, including $49.9 million in fixed maturities. Management concluded these securities were not other-than-temporarily impaired and did not expect to be required to sell them before recovery.
- Litigation consisted of ordinary insurance claims litigation and other class and individual actions. The filing states that an adverse judgment or settlement materially exceeding recorded accruals could affect financial condition, cash flows and results of operations.
- The filing states that no material changes occurred in previously reported risk factors, contractual obligations or other off-balance-sheet arrangements. A new accounting standard effective in January 2012 is expected to result in less deferred acquisition costs, but the impact was still under analysis.
Important facts for investors to verify
- Whether catastrophe losses and favorable prior-year reserve development normalize, and how they affect future combined ratios.
- The sustainability of premium and policy growth given declines in new applications and continued weakness in Commercial Auto.
- The effect of lower investment yields, increased common-equity exposure and investment credit or interest-rate movements on earnings and capital.
- Progress on the January 2012 $350 million debt maturity and the continued availability of the secured liquidity facility.
- The final 2011 Gainshare factor and annual variable dividend declaration.
- Potential reserve, litigation, regulatory and accounting effects not yet quantifiable from the filing.