Progressive Corporation — Q3 2016 Form 10-Q Summary
Business context and reporting period
The Progressive Corporation reported unaudited consolidated results for the three and nine months ended September 30, 2016. The company primarily writes personal auto and recreational vehicle insurance, commercial auto insurance, and residential property insurance through its ARX subsidiary. Progressive owned 69.2% of ARX at September 30, 2016.
Property results for the nine months are not fully comparable with 2015 because Progressive acquired control of ARX on April 1, 2015. During the second quarter of 2016, ARX exchanged a commercial property insurer for a residential property insurer.
Key financial metrics
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Total revenues | $5,935.0 million | $5,273.8 million | $17,311.8 million | $15,452.4 million |
| Net premiums earned | $5,723.4 million | $5,070.6 million | $16,602.6 million | $14,732.7 million |
| Net income attributable to Progressive | $198.7 million | $278.3 million | $647.8 million | $937.2 million |
| Diluted EPS | $0.34 | $0.47 | $1.11 | $1.59 |
| Operating cash flow | Not separately provided | Not separately provided | $2,259.6 million | $2,160.4 million |
| Combined ratio | 96.6% | 92.8% | 96.0% | 92.7% |
Total revenues increased 13% in the quarter and 12% year to date, while net premiums earned increased 13% in both periods. Net income attributable to Progressive declined 29% in the quarter and 31% year to date.
Third-quarter underwriting profit was $197.0 million, down 46% from $364.9 million. The underwriting margin declined to 3.4% from 7.2%. For the nine months, underwriting profit was $659.4 million versus $1,080.3 million, and the margin was 4.0% versus 7.3%.
At September 30, 2016, total assets were $33.6 billion, shareholders’ equity was $8.1 billion, cash was $143.4 million, and the investment portfolio was $23.5 billion. Debt had a carrying value of $3.2 billion and a fair value of $3.5 billion. Book-value total capital, consisting of debt plus shareholders’ equity, was approximately $11.2 billion. The debt-to-total-capital ratio was 28.0%.
Material changes versus the prior comparable period
- Policies in force grew 7% companywide year over year: Personal Lines increased 6%, Commercial Lines 12%, and Property 11%.
- Third-quarter net premiums written increased 12%; Personal Lines increased 11%, Commercial Lines 21%, and Property 9%.
- Loss and loss adjustment expenses increased 20% in the quarter and 18% for the nine months, exceeding premium growth.
- Catastrophe losses increased to $158.7 million in Q3 from $37.7 million and to $477.6 million for the nine months from $201.7 million. Severe storms in Louisiana, Texas, and Colorado were significant contributors.
- Favorable prior-year reserve development declined to $52.5 million in Q3 from $92.3 million and to $22.9 million for the nine months from $279.0 million.
- Commercial Lines’ third-quarter combined ratio rose to 99.3% from 84.8%, principally because of unfavorable development and higher bodily-injury frequency.
- Personal Lines’ third-quarter combined ratio increased to 96.2% from 93.8%; Property increased to 95.4% from 91.6%.
- Comprehensive income attributable to Progressive increased 97% in Q3 to $287.0 million and 31% for the nine months to $893.5 million, largely due to higher unrealized investment gains.
Debt, liquidity, investments, and capital allocation
- Progressive issued $500 million of 2.45% senior notes due 2027 and received net proceeds of $495.6 million. The notes have no restrictive financial covenants or credit-rating triggers.
- Operations generated approximately $2.3 billion of cash in the first nine months. The company had no borrowings under its $100 million discretionary line of credit.
- The company paid $519.0 million of dividends and repurchased $163.6 million of common shares during the first nine months. Approximately 7.5 million shares remained authorized for repurchase at September 30, 2016.
- The investment portfolio was 87.8% fixed-income securities and 12.2% common equities, with a weighted-average credit quality of A+ and fixed-income duration of 1.8 years.
- Progressive held $5.9 billion of short-term investments, supporting near-term liquidity. Management stated that capital resources, operating cash flows, and borrowing capacity were sufficient for anticipated needs, debt service, declared dividends, and other requirements.
Outlook, management commentary, risks, and unusual items
Management continued to emphasize profitable growth, customer retention, multi-product households, expanded property offerings, mobile capabilities, and the Platinum bundled home-and-auto product. It also raised rates and tightened underwriting in Commercial Lines and moderated Direct-channel growth to support profitability. Management cautioned that these actions could negatively affect future growth.
No formal earnings or revenue guidance was provided. The year-to-date Gainshare factor was 1.54, but the final factor and any annual variable dividend remained subject to full-year performance and Board discretion. The 2016 target percentage was 33⅓% of after-tax underwriting income, subject to policy limitations.
- Q3 included $61.6 million of net impairment losses, including $25.4 million of write-downs on redeemable preferred stocks and a $34.8 million impairment of a renewable-energy investment. The investment also generated an expected 2016 tax benefit of $34.4 million, of which $25.8 million had been recognized through September 30.
- Hurricane Matthew losses were estimated at approximately $85 million as of October 31, 2016, primarily in Florida, Virginia, North Carolina, and South Carolina. This estimate was subsequent to the September 30 reporting date.
- Property catastrophe reinsurance generally applies after losses exceed specified thresholds; the filing states that a single event generally must exceed $50 million, and aggregate severe-thunderstorm losses must exceed $175 million before certain coverage applies.
- Progressive’s insurance businesses remain exposed to catastrophe severity, claims inflation, frequency and severity trends, reserve-estimate changes, reinsurance recoverability, interest-rate and investment-market volatility, regulatory changes, competition, litigation, technology disruptions, and counterparty credit risk.
- Minority ARX shareholders have put rights in 2018 and 2021 that could increase Progressive’s ownership to more than 80% and ultimately 100%; redeemable noncontrolling interest was $472.5 million at September 30, 2016.
- Pending litigation accruals unrelated to ordinary insurance claims were not material, but management stated that adverse outcomes or inadequate accruals could materially affect results, liquidity, or financial condition.
Important facts for investors to verify
- Whether elevated catastrophe losses and weaker reserve development persist and continue to pressure combined ratios.
- Whether Commercial Lines pricing and underwriting actions restore profitability without materially reducing premium and policy growth.
- The final 2016 Gainshare factor and annual variable dividend declared by the Board.
- The treatment and potential redemption of the 6.70% fixed-to-floating junior subordinated debentures, including the company’s decision regarding the June 2017 redemption opportunity.
- The ultimate losses from Hurricane Matthew and the extent of available reinsurance recovery.
- The performance and tax benefits of the renewable-energy investment after the $34.8 million impairment.
- The comparability of Property results given the ARX acquisition and the 2016 exchange transaction.