Progressive Corporation 2010 First-Quarter Form 10-Q Summary
Business context and reporting period
The Progressive Corporation is an insurance holding company focused primarily on personal auto and recreational-vehicle insurance, with additional commercial auto, other indemnity, and insurance-related service businesses. This unaudited report covers the three months ended March 31, 2010, compared with the three months ended March 31, 2009. The company adopted new consolidation guidance effective January 1, 2010, resulting in continued consolidation of its mutual company affiliate.
Financial performance and key metrics
| Metric | Q1 2010 | Q1 2009 | Change |
|---|---|---|---|
| Net premiums earned | $3,501.1 million | $3,406.6 million | 3% |
| Total revenues | $3,665.9 million | $3,468.2 million | 6% |
| Income before taxes | $438.9 million | $376.7 million | 17% |
| Net income | $295.6 million | $232.5 million | 27% |
| Diluted earnings per share | $0.44 | $0.35 | 28% |
| Net cash from operating activities | $670.0 million | $541.4 million | 24% |
| Underwriting profit | $318.1 million | $356.0 million | (11%) |
| Underwriting margin | 9.1% | 10.5% | (1.4 points) |
| Combined ratio | 90.9% | 89.5% | 1.4 points worse |
- Net premiums written increased 7%, led by Personal Lines growth of 9%, including 15% growth in Direct business. Commercial Auto net premiums written declined 4%.
- Policies in force increased 5% companywide: Personal Lines increased 6%, including 15% growth in Direct auto, while Commercial Auto declined 4%.
- Investment income declined 1% to $129.8 million, but net realized gains on securities improved to $30.8 million from a $73.4 million loss in the prior-year quarter.
- Investment results included $3.1 million of credit-related other-than-temporary impairment losses, compared with $223.4 million of total portfolio write-downs in Q1 2009.
- Total assets were $21.05 billion at March 31, 2010, and shareholders’ equity was $6.21 billion, compared with $20.05 billion and $5.75 billion, respectively, at December 31, 2009.
- The investment portfolio was $15.56 billion at fair value, with 92.3% in fixed-income securities and short-term investments and 7.7% in common equities. Portfolio duration was 2.2 years and weighted average credit quality was AA.
- Total debt was $2.18 billion at carrying value. The company had no borrowings under its $125 million secured liquidity facility, which could be increased to $150 million at the company’s request subject to lender discretion. No scheduled debt maturities occur before January 2012.
- Cash was $155.1 million at March 31, 2010, compared with $160.7 million at December 31, 2009. Management stated that operating cash flow, capital resources, and borrowing capacity were sufficient for anticipated needs.
Material changes versus the prior comparable period
- Profitability improved substantially because of stronger investment results and the absence of the large preferred-stock and common-equity impairments recorded in Q1 2009.
- Underwriting remained profitable but weakened. The total combined ratio increased to 90.9% from 89.5%, primarily because of higher advertising expenditures, slightly higher personal auto frequency and severity, and increased expenses.
- Personal Lines underwriting margin declined to 8.5% from 9.4%; Direct’s combined ratio worsened to 94.6% from 91.6%. Commercial Auto’s combined ratio worsened to 88.0% from 82.1%, despite remaining profitable.
- Favorable prior accident-year reserve development increased to $103.5 million from $21.9 million and reduced the current-quarter combined ratio by approximately 3.0 points.
- Net unrealized securities gains improved to $963.6 million from net unrealized losses of $338.2 million at March 31, 2009. Total comprehensive income increased to $491.0 million from $80.7 million.
- The company added approximately $300 million of common equities during the quarter, increasing common equities to $1.19 billion from $350.4 million at March 31, 2009.
- Progressive repurchased 2.43 million shares for $42.6 million and paid $108.2 million under its annual variable dividend program. The 2010 annual dividend target was set at 25% of after-tax underwriting income, subject to board discretion and other limitations.
Guidance, outlook, management commentary, risks and unusual items
- Management reported a 9.1% underwriting margin, above its stated 4% target, but indicated that the result was below the prior-year level. Its capital planning objective references a 96 combined ratio.
- Management expects continued rollout of Name Your Price, new auto product models, and MyRate usage-based insurance, subject to regulatory approvals and business results. It planned expansion of the new product models to approximately 20 additional states during the remainder of 2010.
- Commercial Auto remained pressured by the economic downturn, particularly in housing and construction, lower premium-per-policy levels, and competition. Management expected the market to remain challenging while the economy recovered.
- The company held $5.9 billion in U.S. Treasury and short-term securities and expected approximately $1.0 billion of its non-Treasury, non-short-term fixed-income portfolio to repay principal during 2010, supporting liquidity.
- Investment risks include interest-rate changes, credit deterioration, mortgage-backed and asset-backed securities, preferred-stock concentration, non-investment-grade holdings, valuation uncertainty, and potential extension or prepayment risk. Gross unrealized losses at March 31, 2010 were $228.2 million.
- Several preferred-stock and non-investment-grade positions exceeded internal single-issuer concentration guidelines; management expected compliance to be influenced by market prices and liquidity.
- Potential liabilities include litigation involving consumer reports, claims handling, medical and injury benefits, rating practices, repair-shop labor rates, and other insurance practices. The filing states that unaccrued litigation exposure could materially affect results if adverse outcomes exceed recorded amounts.
- Other risks include catastrophe losses, changes in driving patterns and claims severity, inflation, healthcare and auto-repair costs, regulatory changes, pricing competition, advertising effectiveness, information-technology disruptions, and financial-market volatility.
- The company recorded no significant catastrophe losses during the quarter, and management stated that there were no material changes in risk factors from the 2009 Form 10-K.
Most important facts for investors to verify
- Whether premium and policy growth, particularly in Direct auto, can continue without further deterioration in premium per policy or underwriting margins.
- Whether favorable reserve development of $103.5 million is repeatable or masks emerging accident-year frequency and severity pressures.
- The sustainability of investment gains and the potential for additional impairments in preferred stocks, mortgage-backed securities, corporate debt, and other structured assets.
- The effect of higher advertising and infrastructure spending on future expense ratios and combined ratios.
- The status and ultimate exposure of pending litigation and the adequacy of loss, litigation, and reinsurance reserves.
- The company’s ability to maintain liquidity and capital above regulatory and extreme-contingency requirements while funding dividends and share repurchases.
- The assumptions supporting the realization of the deferred tax asset and the possibility that future market declines could require a valuation allowance.