PROGRESSIVE CORP quarterly report, Q1 FY2020

Business Context and Reporting Period

The Progressive Corporation filed an unaudited Form 10-Q for the three months ended March 31, 2020. Progressive is a property-casualty insurer with Personal Lines, Commercial Lines, Property, investment, and service businesses. Results were materially affected by the COVID-19 pandemic and related social-distancing and shelter-in-place restrictions, particularly during the final three weeks of March.

Key Financial Metrics

Metric	Q1 2020	Q1 2019	Change
Net premiums earned	$9,430.7 million	$8,459.8 million	+11%
Total revenues	$9,323.4 million	$9,300.0 million	Approximately flat
Income before taxes	$874.7 million	$1,567.5 million	-44%
Net income attributable to Progressive	$692.7 million	$1,078.4 million	-36%
Diluted earnings per share	$1.17	$1.83	-36%
Operating cash flow	$1,625.8 million	$1,868.5 million	-13%
Underwriting profit	$1,236.3 million	$949.2 million	+30%
Underwriting margin	13.1%	11.2%	+1.9 points
Combined ratio	86.9%	88.8%	Improved 1.9 points

Investment results offset stronger underwriting performance. Net realized losses on securities were $553.6 million, compared with net realized gains of $414.5 million in the prior-year quarter. The 2020 amount included $868.8 million of net holding-period losses, primarily from equity securities, partly offset by $315.2 million of gains on security sales. Recurring investment income declined approximately 5% to $241.2 million as interest rates fell.

The effective tax rate was 20.1%, compared with 30.9% in Q1 2019. The prior-year rate was elevated primarily by the reversal of tax credits and other benefits related to certain renewable-energy investments.

Net premiums written increased 7% to $9,871.3 million.
Policies in force increased 9% year over year to 22.9 million.
Personal Lines underwriting profit was $1,074.6 million, with a 13.7% margin.
Commercial Lines underwriting profit was $112.5 million, with a 9.5% margin.
Property underwriting profit was $49.2 million, with an 11.7% margin.
Total loss and loss-adjustment expenses increased to $6,155.2 million from $5,759.0 million.
Prior-year reserves developed unfavorably by $144.1 million, including approximately $104 million in Personal Auto and $54 million in Commercial Lines.

Balance Sheet, Debt, Liquidity, and Capital

Total assets were $56.3 billion at March 31, 2020, compared with $54.9 billion at December 31, 2019.
Total investments were $40.3 billion, including $36.8 billion of available-for-sale securities and $3.5 billion of equity securities.
Cash, cash equivalents, and restricted cash were $370.4 million, up from $227.4 million at year-end.
Shareholders’ equity was $14.4 billion, compared with $13.7 billion at December 31, 2019.
Debt carrying value was $5.4 billion, compared with $4.4 billion at March 31, 2019 and $4.4 billion at year-end 2019.
Progressive issued $500 million of 3.20% senior notes due 2030 and $500 million of 3.95% senior notes due 2050, generating approximately $986.3 million of net proceeds.
Total capital was $19.7 billion, and debt-to-total-capital was 27.3% at quarter-end.
Operating cash flow was positive at $1.6 billion. Investing activities used $1.1 billion, while financing activities used $429.0 million, including $1.4 billion of common dividends paid.
Management stated that liquidity and capital resources were sufficient for near-term operating needs, scheduled debt service, dividends, contractual obligations, and expected capital requirements.
The company had no borrowings under its $250 million discretionary bank line of credit. The facility was renewed in April 2020 through April 2021 at a variable rate based on the higher of PNC’s Prime Rate or the Federal Funds Open Rate plus 175 basis points.

Material Changes Versus the Prior Comparable Period

Underwriting improved materially as lower auto accident frequency more than offset higher claim severity and unfavorable prior-year reserve development.
Personal auto accident frequency declined approximately 18% for the quarter and 47% in March, while severity increased approximately 11% for the quarter and 21% in March.
COVID-19 caused significant declines in new business activity late in the quarter. Post-restriction personal auto applications declined approximately 23%, and Commercial Lines applications declined approximately 29%, year over year.
March companywide net premiums written declined 3% year over year after increasing 14% in January and 10% in February.
Equity-market declines produced a 20.5% negative first-quarter return for the common-stock portfolio and drove substantial holding-period losses.
The investment portfolio increased from $39.3 billion at year-end to $40.3 billion, reflecting debt issuance proceeds, comprehensive income, and unsettled security transactions, partly offset by shareholder dividends.
The allowance for doubtful accounts on premiums receivable was $344.7 million at March 31, 2020. Progressive recorded a $71.0 million increase related to COVID-19 billing leniency and had $170.3 million of total increases during the quarter, partly offset by $108.8 million of write-offs.
Progressive temporarily suspended open-market common-share repurchases while evaluating capital needs; first-quarter repurchases were primarily related to equity-compensation tax obligations.

Guidance, Outlook, Commentary, Risks, and Unusual Items

Management did not provide formal full-year earnings guidance. It stated that operations and financial results would continue to be affected while COVID-19 restrictions remained in place, with substantial uncertainty regarding the duration of restrictions, economic recovery, driving patterns, insurance shopping, regulatory actions, claims severity, and investment markets.

Progressive announced approximately $1.0 billion of credits or payments to personal auto customers with policies in force at the end of April and/or May 2020. The payments were expected to reduce second-quarter underwriting profitability and be funded from operating cash flow.
Billing leniencies and moratoriums suspended cancellations and non-renewals for nonpayment and paused collection activity. The company expected additional increases to its allowance for doubtful accounts but stated that the ultimate exposure could not yet be reasonably estimated.
On April 1, 2020, Progressive acquired the remaining ARX Holding Corp. shares, making ARX wholly owned, for an aggregate cost of $243.0 million including exercised employee options.
Management cited risks involving inaccurate pricing or reserving, increased claim severity, catastrophes, reinsurance recoverability, investment-market volatility, liquidity, regulation, litigation, cybersecurity, vendors, and the ability to maintain operations in a work-from-home environment.
The company recorded no allowance for credit losses on fixed-maturity securities and concluded that unrealized losses were primarily market-related rather than credit-related. Eight securities were downgraded during the quarter because of COVID-19-related market movement.
Net catastrophe losses were $80.4 million, compared with $71.9 million in Q1 2019.
Progressive reported that its disclosure controls and procedures remained effective and that COVID-19 had not materially affected internal control over financial reporting as of March 31, 2020.

Investor Verification Items

Verify the actual amount, timing, and accounting treatment of the approximately $1.0 billion customer credits or payments and their effect on second-quarter underwriting results.
Monitor premium receivable collections, allowance increases, policy cancellations, and the financial effect of extended billing leniencies.
Assess whether reduced driving frequency persists and whether higher claim severity, claim reopening, repair costs, medical costs, or reserve development offset frequency benefits.
Track new-business applications, policy retention, transportation-network-company mileage adjustments, and the recovery of Commercial Lines demand.
Review equity and fixed-income market performance, credit-spread changes, unrealized losses, and any future investment impairments or credit-loss allowances.
Confirm the impact of the ARX acquisition on ownership, earnings attributable to Progressive, capital, and future amortization expense.
Evaluate debt service, the 27.3% debt-to-total-capital ratio, dividend policy, suspended share repurchases, and liquidity under prolonged market or operating stress.
Review COVID-19-related regulatory actions, litigation, policyholder relief requirements, and other contingencies that could create additional payment obligations.