Progressive Corporation: 2012 First-Quarter Form 10-Q Summary
Business context and reporting period
The Progressive Corporation reported unaudited consolidated results for the three months ended March 31, 2012, compared with the same period in 2011. The company primarily writes personal auto and recreational vehicle insurance through Agency and Direct channels, as well as Commercial Auto insurance. Progressive filed the report on May 7, 2012.
Key financial metrics
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Total revenues | $4,061.2 million | $3,893.5 million | 4% |
| Net premiums earned | $3,861.5 million | $3,665.3 million | 5% |
| Net income | $257.6 million | $362.9 million | (29%) |
| Diluted earnings per share | $0.42 | $0.55 | (24%) |
| Comprehensive income | $459.9 million | $391.9 million | 17% |
| Operating cash flow | $708.4 million | $673.5 million | 5% |
| Underwriting profit | $228.7 million | $355.8 million | (36%) |
| Underwriting margin | 5.9% | 9.7% | Down 3.8 points |
| Combined ratio | 94.1% | 90.3% | Up 3.8 points |
| Investment income | $114.7 million | $123.3 million | (7%) |
| Net realized gains on securities | $77.5 million | $99.7 million | (22%) |
At March 31, 2012, total assets were $22.27 billion, shareholders’ equity was $6.25 billion, debt was $2.08 billion, and cash was $156.0 million. The investment portfolio had a fair value of $16.40 billion, including $11.95 billion of fixed maturities, $2.10 billion of common equities, $0.83 billion of nonredeemable preferred stocks, and $1.52 billion of short-term investments.
Total capital, defined as debt plus equity, was approximately $8.3 billion, and debt represented 25.0% of total capital. Management stated that operating cash flows, capital resources, and borrowing capacity were sufficient for current and anticipated needs. A secured $125 million liquidity facility was available, with no borrowings through the quarter-end.
Material changes versus the prior comparable period
- Net premiums written increased 7%, while policies in force increased 6%. Personal Lines premiums written increased 6%, and Commercial Auto premiums written increased 13%.
- Personal Lines underwriting profit declined to $200.5 million from $315.3 million, and its combined ratio deteriorated to 94.2% from 90.5%.
- Commercial Auto underwriting profit declined to $29.4 million from $41.1 million, while its combined ratio increased to 92.4% from 88.4%.
- Prior accident-year reserve development was unfavorable by $44.3 million, compared with favorable development of $99.0 million in Q1 2011. Nearly 95% of the unfavorable development was in Personal Lines, primarily the Agency channel.
- Loss and loss adjustment expenses increased 10% to $2.76 billion, exceeding the 5% increase in premiums earned. Management cited higher personal auto severity, including bodily injury and personal injury protection claims, despite lower accident frequency.
- Net income was reduced by a $16.8 million pretax recognition of deferred acquisition costs that no longer qualified for deferral under newly adopted accounting guidance. The company expects the remaining $6.2 million of the $23 million adjustment to be recognized primarily during the first half of 2012.
- Recurring investment income declined because of lower investment yields, although average invested assets increased. The portfolio’s fully taxable equivalent total return improved to 3.3% from 1.8%, driven partly by stronger equity returns.
- Cash flow from operations increased to $708.4 million. Investing cash usage improved to $61.1 million from $279.9 million, while financing cash usage increased to $647.4 million, primarily reflecting debt repayment, dividends, and share repurchases.
- Progressive retired $350 million of 6.375% Senior Notes at maturity in January 2012 and repurchased $12.6 million principal amount of its 6.70% junior subordinated debentures, recognizing a $0.7 million extinguishment loss.
- The company repurchased 1.9 million common shares for $37.7 million, or an average of $20.19 per share. Approximately 48.8 million shares remained available under the repurchase authorization at March 31, 2012.
Guidance, outlook, management commentary, risks, and unusual items
- Management’s long-term underwriting profitability target is a 4% margin, and the reported 5.9% margin exceeded that target despite the year-over-year deterioration.
- Management identified continued growth initiatives including advertising, improved customer retention, cross-selling, Snapshot usage-based insurance, mobile quoting and purchasing, new product models, and expansion of Commercial Auto offerings.
- Personal Lines product models had been rolled out to 43 jurisdictions, with approximately four additional states planned. Snapshot was available in 41 Direct markets and to Agency customers in 34 of those jurisdictions.
- Commercial Auto growth was supported by higher new applications, rate increases implemented since early 2011, and a shift toward higher-premium business. Management described the business as showing signs of recovery from the economic downturn.
- Management expects the annual variable dividend program to remain subject to Board discretion. For 2012, the target percentage was 33⅓% of annual after-tax underwriting income, and the year-to-date Gainshare factor was 1.26 as of March 31, 2012. The final dividend and Gainshare factor could differ based on full-year results.
- The company recognized $0.9 million of other-than-temporary impairment losses on securities, compared with $1.4 million in Q1 2011. Gross unrealized losses were $58.7 million, while pretax net unrealized gains were $1.36 billion.
- Investment risks include interest-rate movements, credit deterioration, mortgage-backed and asset-backed securities exposure, preferred-stock concentration, liquidity, valuation uncertainty, and derivative counterparty exposure. The portfolio had a 1.9-year duration and an AA- weighted average credit quality.
- Progressive reported $72.8 million of liabilities related to interest-rate swaps and had delivered $79.7 million of collateral to counterparties at March 31, 2012.
- Litigation includes ordinary-course insurance claims litigation and class or individual actions involving claims handling, medical and injury benefits, policy documents, repair-shop labor rates, marketing, and other operations. The filing states that material adverse outcomes could affect financial condition, cash flows, or results of operations.
- The filing states that there were no material changes to previously disclosed risk factors, contractual obligations, or most off-balance-sheet arrangements.
Most important facts for investors to verify
- Whether unfavorable reserve development, particularly in Personal Lines Agency business, persists or reverses in subsequent quarters.
- Whether loss severity, medical costs, regulatory changes, and litigation trends pressure the combined ratio and underwriting margin.
- Whether premium growth and policy growth remain profitable as pricing, retention, advertising, and product initiatives develop.
- The timing and magnitude of the remaining deferred acquisition cost recognition under the 2012 accounting change.
- The composition, valuation, and credit performance of the $16.4 billion investment portfolio, especially mortgage-backed securities, preferred stocks, and unrealized-loss positions.
- The company’s ability to maintain liquidity and capital while funding claims, dividends, debt maturities, and share repurchases.
- The final 2012 Gainshare factor and annual variable dividend, which remain dependent on full-year performance and Board approval.
- Developments in pending litigation, catastrophe losses, regulatory approvals, interest rates, credit markets, and weather-related claims frequency.