Progressive Corporation 2012 Q3 Form 10-Q Summary
Business context and reporting period
The Progressive Corporation, primarily a personal auto and commercial auto insurer, reported unaudited results for the three and nine months ended September 30, 2012. Personal Lines represented approximately 90% of third-quarter net premiums written, while Commercial Auto represented approximately 10%. The company had 604.7 million common shares outstanding at September 30, 2012.
Key financial metrics
| Metric | Three months ended Sept. 30, 2012 | Year-over-year change | Nine months ended Sept. 30, 2012 | Year-over-year change |
|---|---|---|---|---|
| Net premiums earned | $4,054.8 million | 8% | $11,912.4 million | 7% |
| Total revenues | $4,345.5 million | 14% | $12,519.8 million | 8% |
| Net income | $277.0 million | 84% | $653.2 million | (14%) |
| Diluted earnings per share | $0.46 | 91% | $1.07 | (9%) |
| Underwriting profit | $165.2 million | Not separately stated | $489.0 million | Not separately stated |
| Underwriting margin | 4.1% | Down 0.7 points | 4.1% | Down 2.9 points |
| Combined ratio | 95.9% | Up 0.7 points | 95.9% | Up 2.9 points |
| Net cash from operating activities | Not separately stated | Not separately stated | $1,665.3 million | Up from $1,495.3 million |
Third-quarter net realized gains on securities were $171.9 million, compared with a $52.6 million loss in the prior-year quarter. The gains primarily reflected the liquidation of approximately $580 million, or about 25%, of the common stock portfolio. Investment income declined 7% to $109.0 million in the quarter and to $336.2 million for the nine-month period.
At September 30, 2012, total assets were $23.4 billion, total shareholders’ equity was $6.6 billion, cash was $192.2 million, and the investment portfolio had a fair value of $17.2 billion. Debt was $2.1 billion, down from $2.4 billion at December 31, 2011. The debt-to-total-capital ratio declined to 23.9% from 29.6% at year-end 2011.
Material changes versus comparable periods
- Net premiums written increased 10% in the third quarter and 8% for the first nine months. Personal Lines grew 9% and 7%, respectively; Commercial Auto grew 15% in both periods.
- Policies in force increased 5% year over year to 12.9 million in Personal Lines and increased 2% to 526,500 in Commercial Auto.
- Third-quarter underwriting profit declined to $165.2 million from $180.7 million, and the underwriting margin decreased to 4.1% from 4.8%. The nine-month margin declined to 4.1% from 7.0%.
- Higher personal auto claims severity, unfavorable year-to-date prior-year reserve development, and lower favorable reserve development pressured underwriting results. Personal auto incurred severity increased approximately 4% to 6% in both the quarter and year-to-date period.
- Prior accident-year reserve development was favorable by $29.2 million in the third quarter, versus $72.5 million in the prior-year quarter, but unfavorable by $37.9 million for the first nine months, versus favorable development of $223.5 million in 2011.
- The company raised auto rates nearly 6% on average through September 2012 and implemented approximately 65 rate increases in 39 states. New applications declined as a result of rate increases, while renewal applications increased.
- Net cash from operations increased to $1.7 billion from $1.5 billion. Financing cash outflows included $350.0 million of debt repayment, $170.1 million of share repurchases, and $252.4 million of dividends paid.
- The company retired $350 million of 6.375% Senior Notes at maturity in January 2012 and repurchased $30.9 million principal amount of its 6.70% junior subordinated debentures.
Guidance, outlook, commentary, risks, and unusual items
- Management reiterated a long-term underwriting profitability target of at least a 4% margin, consistent with a 96% calendar-year combined ratio target. Future results remain dependent on claims severity, frequency, pricing, retention, and rate approvals.
- Management expects to continue evaluating rate needs and expanding product and distribution initiatives, including Snapshot, mobile quoting, product segmentation, cross-selling, and the Commercial Auto product rollout.
- The company declared a $1.00 per share special cash dividend on October 12, 2012, expected to total approximately $605 million and payable November 29, 2012. The annual variable dividend program remains separate; for 2012, the target percentage is 33⅓% of annual after-tax underwriting income, with a year-to-date Gainshare factor of 1.24 subject to change.
- In late October, Hurricane Sandy caused losses, but the company stated that it could not yet quantify the financial impact. An estimate was expected in a subsequent Form 8-K.
- Progressive adopted new insurance-contract acquisition-cost guidance prospectively on January 1, 2012. Approximately $23 million of deferred acquisition costs that no longer qualified for deferral were recognized as a reduction to income, primarily during the first six months.
- Investment risks include interest-rate movements, credit deterioration, mortgage-backed and preferred securities exposure, market liquidity, derivative positions, and unrealized losses. Gross unrealized losses at September 30, 2012 were $29.2 million on fixed-income securities and $6.1 million on common equities; management concluded these were not other-than-temporary impairments.
- Pending litigation includes claims-related, medical and injury benefits, policy-document, labor-rate, marketing, and other operational matters. The filing states that a substantial judgment or settlement could materially affect financial condition, cash flows, or results of operations.
- The company had a $125 million secured liquidity facility, expandable to $150 million at the lender’s discretion, with no borrowings through the first nine months of 2012. Management stated that available capital, operating cash flow, and borrowing capacity were sufficient for anticipated needs.
Important facts for investors to verify
- Assess whether rate increases are sufficient to offset continuing claims-severity inflation without materially impairing new-business growth and retention.
- Monitor subsequent reserve development, particularly for 2011 and 2012 accident years and personal auto bodily injury, property damage, and Florida PIP claims.
- Verify the ultimate Hurricane Sandy losses and their effect on fourth-quarter underwriting results and capital.
- Separate recurring operating performance from the $171.9 million of third-quarter realized investment gains, including gains from the common-stock liquidation.
- Evaluate the cash and capital impact of the approximately $605 million special dividend, ongoing share repurchases, and future annual variable dividend.
- Review the investment portfolio’s preferred-stock, mortgage-backed, European issuer, derivative, and interest-rate exposures, including the $101.6 million liability position on interest-rate swaps.
- Confirm the outcome and financial exposure of disclosed litigation and any changes in regulatory rate approvals or insurance-market conditions.