Progressive Corporation: 2012 Q2 Form 10-Q Summary
Reporting period: Three and six months ended June 30, 2012; filed August 2, 2012. The filing covers Progressive’s Personal Lines, Commercial Auto, other indemnity, service, and investment operations. Results are unaudited and interim results are not necessarily indicative of the full year.
Financial Results and Position
| Metric | Three months ended June 30, 2012 | Year-over-year change | Six months ended June 30, 2012 | Year-over-year change |
|---|---|---|---|---|
| Total revenues | $4,113.1 million | 6% | $8,174.3 million | 5% |
| Net premiums earned | $3,996.1 million | 7% | $7,857.6 million | 6% |
| Income before taxes | $167.7 million | (53%) | $551.8 million | (39%) |
| Net income | $118.6 million | (52%) | $376.2 million | (38%) |
| Diluted earnings per share | $0.19 | (49%) | $0.62 | (34%) |
| Operating cash flow | Not separately provided for the quarter | — | $1,135.1 million | 10% |
- Underwriting: Pretax underwriting profit was $95.1 million in the second quarter and $323.8 million year to date. The underwriting margin was 2.4% and 4.1%, respectively, versus 6.6% and 8.1% in the comparable periods. The combined ratio was 97.6% for the quarter and 95.9% year to date, compared with 93.4% and 91.9% in 2011.
- Investment results: Investment income was $112.5 million in the quarter and $227.2 million year to date, down 7% in both periods. Net realized gains on securities were $0.7 million in the quarter and $79.1 million year to date; after impairment and other items, total net realized gains were a $4.7 million loss and a $72.8 million gain, respectively.
- Margins and claims: The principal driver of weaker profitability was increased claims severity, especially in personal auto, together with unfavorable prior accident-year reserve development of $22.8 million in the quarter and $67.1 million year to date. The prior-year periods had favorable development of $52.0 million and $151.0 million.
- Balance sheet: Total assets were $22.7 billion and shareholders’ equity was $6.3 billion at June 30, 2012. The investment portfolio was $16.6 billion, including $12.1 billion of fixed maturities, $2.1 billion of common equities, $0.8 billion of nonredeemable preferred stocks, and $1.7 billion of short-term investments.
- Debt and capital: Carrying-value debt was $2.1 billion at June 30, compared with $2.4 billion at December 31, 2011. Debt-to-total capital declined to 24.7% from 29.6%. Progressive retired $350 million of senior notes at maturity in January and repurchased $30.4 million principal amount of its junior subordinated debentures.
- Liquidity: Cash was $165.5 million at June 30. The company had $125 million available under a secured liquidity facility, with no borrowings through the first six months. Management stated that operating cash flow, capital resources, and borrowing capacity were sufficient for anticipated needs and debt obligations.
Material Changes Versus the Prior Comparable Period
- Premium growth remained strong: net premiums written increased 8% in the quarter and 7% year to date. Personal Lines grew 7% and 6%, while Commercial Auto grew 15% and 14%.
- Policies in force increased 6% companywide at June 30, including 6% growth in Personal Lines and 3% in Commercial Auto.
- Underwriting performance deteriorated materially as the total combined ratio increased 4.2 percentage points in the quarter and 4.0 points year to date. Loss and loss adjustment expense ratios increased 4.7 and 3.9 points, respectively.
- Personal auto incurred severity increased approximately 6% year over year in both the quarter and first six months. Catastrophe losses were $107.4 million in the quarter and $123.4 million year to date, lower than the prior-year amounts.
- Investment income declined because of lower yields, while realized investment results were substantially weaker than in 2011, when the company recorded $26.0 million of total net realized gains in the quarter and $125.7 million year to date.
- Progressive repurchased 4.0 million common shares for $83.0 million during the first six months, compared with 20.1 million shares for $420.9 million in the prior-year period.
- The company adopted new guidance on deferred acquisition costs prospectively on January 1, 2012. Approximately $23 million of costs that no longer qualified for deferral were recognized as a reduction to income, primarily during the first six months.
Guidance, Outlook, Risks, and Unusual Items
- Management’s underwriting target remained a 96 calendar-year combined ratio. The second-quarter margin of 2.4% was below the company’s 4% target.
- Progressive had raised personal auto rates nearly 3% through June and implemented additional increases in approximately 20 states in July, with further increases expected during the third quarter. Commercial Auto pricing increased about 10% per policy, reflecting prior rate actions and business mix.
- Management continued to emphasize growth and retention initiatives, including Snapshot usage-based insurance, product-model rollouts, multi-product household penetration, mobile quoting, and advertising campaigns. Snapshot was nationally rolled out as a test-drive offering in July, subject to business and regulatory considerations.
- The 2012 annual variable dividend target was 33-1/3% of annual after-tax underwriting income, subject to a Gainshare factor and Board discretion. The year-to-date Gainshare factor was 1.29, but the final factor and any dividend were not determined at quarter end.
- Management signed a letter of intent to acquire an indirect, noncontrolling interest in American Strategic Insurance; completion remained subject to due diligence and a binding agreement.
- Investment risks include interest-rate, credit, liquidity, concentration, structured-securities, preferred-stock, and equity-market exposure. The portfolio’s duration was 1.9 years and weighted-average fixed-income quality was AA-. Gross unrealized losses were $79.4 million at June 30, including $48.5 million in fixed income and $30.9 million in common equities.
- Open interest-rate swaps had a notional value of $1.263 billion and an aggregate liability of $91.5 million. The company also held $25 million notional of corporate credit protection related to a financial-services issuer.
- The company was involved in ordinary-course insurance claims litigation and other class-action or individual lawsuits involving claims handling, medical and injury benefits, policy documents, repair-shop labor rates, marketing, and other business practices. The filing states that an adverse judgment or settlement could materially affect results, cash flows, or financial condition.
- Key forward-looking uncertainties include loss severity and frequency, weather and catastrophe activity, rate approvals, competition, customer retention, investment valuations, interest rates, regulatory and health-care changes, litigation, technology operations, and reserve adequacy.
Most Important Facts for Investors to Verify
- Whether rate increases and other underwriting actions restore the combined ratio to or below the 96% target.
- Subsequent development of the 2011 and 2012 accident-year reserves, particularly Personal Lines Agency and Commercial Auto.
- Trends in personal auto claim severity, bodily injury and PIP costs, frequency, and regulatory approval of further rate increases.
- The sustainability of premium and policy growth, including retention, new applications, and Commercial Auto mix.
- Future investment income under persistently low yields and potential impairment or valuation losses in equities, preferred stocks, mortgage-backed securities, and other structured assets.
- Debt maturities, future debt repurchases, share repurchases, and the ultimate amount and timing of any 2012 variable dividend.
- Outcome of the American Strategic Insurance investment proposal and any material litigation or regulatory developments.