Business Context and Reporting Period
The Progressive Corporation is a property-and-casualty insurer focused primarily on personal auto, recreational vehicle, and commercial auto insurance, with related service and run-off businesses. This unaudited Form 10-Q covers the three and nine months ended September 30, 2010, compared with the corresponding 2009 periods.
Financial Performance and Position
| Metric | Q3 2010 | Q3 2009 | 9M 2010 | 9M 2009 |
|---|---|---|---|---|
| Net premiums earned | $3,599.9 million | $3,445.4 million | $10,691.2 million | $10,293.4 million |
| Total revenues | $3,769.5 million | $3,611.3 million | $11,121.7 million | $10,663.0 million |
| Income before taxes | $387.2 million | $372.0 million | $1,139.0 million | $1,102.6 million |
| Net income | $261.6 million | $269.9 million | $769.1 million | $752.5 million |
| Diluted EPS | $0.40 | $0.40 | $1.16 | $1.12 |
| Underwriting profit | $255.0 million | $249.8 million | $835.1 million | $859.6 million |
| Combined ratio | 92.9% | 92.7% | 92.2% | 91.6% |
- Net premiums written increased 5% in the quarter and 6% year to date. Personal Lines grew 6% and 7%, respectively, while Commercial Auto declined 4% in both periods.
- Personal Lines policies in force increased 7% year over year; Direct auto policies increased 14%, Agency auto 3%, and special lines 5%. Commercial Auto policies declined 1%.
- Q3 underwriting margin was 7.1%, above management’s 4% target but down 0.2 percentage points from 2009. Year-to-date margin was 7.8%, down from 8.4%.
- Operating cash flow for the first nine months was $1,677.9 million, compared with $1,415.1 million in 2009. Cash at September 30 was $155.0 million.
- Total investments were $16.4 billion, including $15.1 billion of fixed-income securities and $1.3 billion of common equities. The portfolio had a weighted-average credit quality of AA and duration of 2.0 years.
- Total assets were $22.0 billion and shareholders’ equity was $6.7 billion at September 30, 2010. Total capital, defined by management as debt plus equity, was $8.7 billion.
- Debt carrying value was $1,957.8 million, down from $2,176.8 million at September 30, 2009. The company repurchased $222.9 million of junior subordinated debentures and recognized a $6.4 million gain on extinguishment.
- Progressive had no borrowings under its $125 million secured liquidity facility and no short-term borrowings used to fund operations. No debt maturities were scheduled until January 2012.
Material Changes Versus the Prior Comparable Period
- Revenue increased 4% in both the quarter and first nine months, but Q3 net income declined 3% because higher underwriting and tax expenses more than offset revenue growth.
- Other underwriting expenses increased 14% in Q3 and year to date, primarily due to higher advertising expenditures and increased Gainsharing accruals. Policy acquisition costs increased 3% in Q3 and 1% year to date.
- Losses and loss adjustment expenses increased 3% in both comparison periods, while the loss ratio improved in Q3 due primarily to more favorable prior-year reserve development.
- Progressive recorded $109.3 million of favorable prior accident-year development in Q3 and $271.2 million for the first nine months, reducing the Q3 combined ratio by 3.0 points.
- Investment portfolio fair value increased from $14.7 billion at September 30, 2009 to $16.4 billion at September 30, 2010. Pretax net unrealized gains increased to $1,204.2 million from $481.7 million.
- Common equities increased to $1,285.3 million, or 7.8% of the portfolio, from $466.6 million, or 3.2%, one year earlier. The company continued shifting some assets toward equities while maintaining Group I investments within its 0% to 25% policy range.
- Other-than-temporary impairment losses declined substantially to $13.8 million for the first nine months from $37.8 million in 2009. Gross unrealized losses were $71.7 million at September 30, 2010, compared with $361.6 million a year earlier.
Outlook, Management Commentary, Risks, and Unusual Items
- Management stated that growth initiatives include Name Your Price, new auto product models, expansion of Snapshot usage-based insurance, increased bundling of auto and homeowners coverage, and retention efforts.
- Name Your Price was available in 49 jurisdictions, with the final two states expected by year-end 2010. Snapshot was available to Direct customers in 24 states, subject to regulatory approval and business results for further expansion.
- Management expects the economic downturn, particularly in housing and construction, to continue affecting Commercial Auto demand. Commercial Auto premiums per policy declined because customers selected fewer or lower-value coverages and business mix shifted.
- The 2010 annual variable dividend program targets 25% of annual after-tax underwriting income multiplied by a Gainshare factor. The year-to-date Gainshare factor was 1.65, but the final factor remained subject to full-year results and Board discretion.
- On October 21, 2010, the Board declared an extraordinary cash dividend of $1.00 per share, approximately $663 million in aggregate, payable December 29, 2010 to shareholders of record December 20, 2010.
- Management identified risks involving loss reserve estimates, catastrophe frequency and severity, inflation, medical and auto repair costs, pricing and retention, competition, regulatory approvals, financial markets, investment credit quality, interest rates, information systems, and litigation.
- The company is involved in lawsuits arising from insurance claims, consumer reports, claims handling, rating, coverage forms, diminished value, repair-shop labor rates, and other business practices. Accruals are recorded only when a loss is probable and reasonably estimable; material adverse outcomes could affect results.
- At September 30, 2010, the portfolio included $1.3 billion of preferred stocks and $1.9 billion of debt securities rated BBB or lower or non-rated. The company also disclosed concentration, liquidity, credit, extension, prepayment, and valuation risks in investment holdings.
- The filing states that there were no material changes in previously reported risk factors, contractual obligations, off-balance-sheet arrangements, market risk, or internal control over financial reporting.
Investor Verification Checklist
- Verify whether favorable prior-year reserve development remains sustainable and how accident-year loss trends evolve without reserve releases.
- Monitor the Personal Lines growth and retention strategy against declining premium per policy, higher advertising costs, and the Direct channel’s higher expense ratio.
- Assess Commercial Auto exposure to economic conditions, declining policies in force, lower premiums per policy, and changing frequency trends.
- Review investment portfolio performance, equity allocation, preferred-stock and structured-securities exposure, unrealized gains, and future impairment sensitivity.
- Confirm the cash impact and capital effects of the $222.9 million debt repurchase, share repurchases, and approximately $663 million extraordinary dividend.
- Evaluate the effect of catastrophe losses, litigation, regulatory developments, interest-rate movements, credit deterioration, and potential changes in loss reserves on future earnings and liquidity.