PROGRESSIVE CORP quarterly report, Q2 FY2009

Progressive Corporation 10-Q Summary

Business Context and Reporting Period

The Progressive Corporation is an insurance holding company focused primarily on personal automobile, special lines, and commercial automobile insurance. This unaudited Form 10-Q covers the three and six months ended June 30, 2009, compared with the corresponding 2008 periods.

Financial Performance and Key Metrics

Metric	Q2 2009	Q2 2008	Six Months 2009	Six Months 2008
Net premiums earned	$3,441.4 million	$3,411.2 million	$6,848.0 million	$6,801.2 million
Total revenues	$3,583.5 million	$3,536.6 million	$7,051.7 million	$7,122.5 million
Income before taxes	$353.9 million	$302.5 million	$730.6 million	$639.7 million
Net income	$250.1 million	$215.5 million	$482.6 million	$454.9 million
Diluted earnings per share	$0.37	$0.32	$0.72	$0.67
Net cash from operating activities	Not separately provided	Not separately provided	$928.1 million	$939.7 million

Net income increased 16% in the quarter and 6% year to date. Approximate net income margins were 7.0% for the quarter and 6.8% year to date. The effective tax rate for the first six months was 34%, compared with 29% in 2008.

Underwriting profit was $253.8 million in the quarter and $609.8 million year to date, with underwriting margins of 7.4% and 8.9%, respectively.
Combined ratios were 92.6% for the quarter and 91.1% year to date, compared with 93.6% and 94.1% in the comparable 2008 periods.
Personal Lines produced a $213.0 million quarterly underwriting profit and a $494.5 million year-to-date profit. Commercial Auto produced $38.7 million and $112.5 million, respectively.
Investment income declined 26% in the quarter and 22% year to date, primarily because cash flows and investment proceeds were shifted into lower-yielding U.S. Treasury and short-term securities.
Net realized gains on securities were $15.9 million in the quarter, versus a $44.6 million loss in 2008; year-to-date net realized losses were $57.5 million, versus a $12.4 million loss in 2008.
Other-than-temporary impairment losses recognized in earnings were $30.0 million in the quarter and $227.4 million year to date, including $206.3 million of preferred-stock write-downs recorded in the first quarter.

Balance Sheet, Debt, and Liquidity

Total assets were $19.1 billion at June 30, 2009, compared with $18.3 billion at December 31, 2008.
Total investments were $13.6 billion, including $10.9 billion of fixed maturities, $1.1 billion of nonredeemable preferred stocks, $408.7 million of common equities, and $1.1 billion of short-term investments.
Shareholders’ equity was $4.9 billion, compared with $4.2 billion at year-end 2008. Total capital, consisting of debt plus equity, was approximately $7.1 billion.
Long-term debt was $2.176 billion at June 30, 2009. The filing reports no borrowings under the $125 million secured liquidity facility with National City Bank.
Cash increased to $160.7 million from $2.9 million at December 31, 2008. The company also maintained $125 million on deposit with National City Bank under its liquidity arrangement.
Operating activities generated $928.1 million of cash in the first six months, while investing activities used $757.9 million and financing activities used $12.4 million.
Progressive repurchased 1.3 million shares year to date for $20.0 million and received authorization to repurchase up to 50 million additional shares beginning July 1, 2009.

Material Changes Versus the Prior Comparable Period

Policies in force increased 3% companywide. Direct auto policies increased 12%, while Agency auto declined 1% and Commercial Auto declined 5%.
Net premiums written increased 1% overall. Personal Lines increased 3%, led by 9% growth in Direct, while Commercial Auto declined 13% in the quarter and 12% year to date.
Underwriting profitability improved primarily because of modest severity trends, favorable frequency levels, and lower catastrophe losses. Catastrophe losses were $39.0 million in the quarter versus $56.3 million in 2008.
Prior accident-year development was unfavorable by $35.0 million in the quarter and $13.1 million year to date, primarily in Personal Lines, although the effect on the combined ratio was partly offset by other underwriting improvements.
The investment portfolio was repositioned toward U.S. Treasury and short-term securities. Fixed-income securities represented 97.0% of the portfolio at June 30, 2009, versus 85.4% a year earlier; common equities declined to 3.0% from 14.6%.
The company adopted new accounting guidance for other-than-temporary impairments, reclassifying $189.6 million after tax from retained earnings to accumulated other comprehensive income. The reclassification did not affect total shareholders’ equity.

Guidance, Outlook, Commentary, Risks, and Unusual Items

Management stated that the 7.4% quarterly underwriting margin exceeded its 4% target. The company’s capital planning objective is to maintain sufficient capital to support business written consistent with a 96 combined ratio.
Management expects continued expansion of Name Your Price, usage-based MyRate, product segmentation, cross-selling, and Direct distribution, subject to regulatory approvals and business results.
The 2009 annual variable dividend target is 20% of annual after-tax underwriting income, subject to the Gainshare factor, comprehensive-income limitations, and Board approval. The interim Gainshare factor was 0.71 and is not indicative of the final full-year factor.
Management expects to sell its bank liability insurance program to an American Bankers Association affiliate, subject to regulatory approvals. Beginning August 1, 2009, the risk was temporarily reinsured 100% with another carrier.
Key investment risks include credit deterioration, structured-security losses, preferred-stock dividend deferrals, interest-rate changes, valuation volatility, limited market liquidity, and concentration in financial-sector preferred stocks and mortgage-related securities. Gross unrealized losses were $633.6 million at June 30, 2009.
Management reported $30.4 million of second-quarter credit-related impairment losses on fixed maturities, primarily residential mortgage-backed securities, while retaining the affected securities because it did not intend or expect to be required to sell them before recovery.
Litigation includes disputes involving consumer reports, claims handling, medical and injury benefits, rating practices, uninsured and underinsured motorist coverage, repair costs, and marketing practices. The filing states that some potential exposures are not reserved because they are not probable or cannot currently be estimated.
Management believes liquidity and capital resources are sufficient for current operations, debt service, and anticipated capital requirements, but notes that actual results may be affected by reserve development, catastrophes, economic conditions, litigation, regulation, pricing, retention, and investment-market movements.

Most Important Facts for Investors to Verify

Whether underwriting margins remain above the company’s target as catastrophe losses, claim frequency, severity, and unfavorable reserve development evolve.
The performance and impairment risk of the $1.6 billion preferred-stock portfolio, mortgage-backed securities, and other structured investments.
Whether lower investment yields and continued allocation to Treasuries and short-term securities pressure recurring investment income.
The realization of the $704.9 million net deferred tax asset and the adequacy of the $18.0 million valuation allowance.
The final 2009 Gainshare factor and whether a variable annual dividend is declared and paid.
Progress on the proposed bank liability insurance program sale and the financial impact, if any, of related regulatory approvals or contingencies.
Potential adverse outcomes from pending litigation and future loss-reserve adjustments not currently recognized in the financial statements.