The Progressive Corporation (PGR) is a growing American insurance holding company, predominantly selling automobile insurance, leveraging technology and industry leading segmentation to grow its market share. I take a deeper look into this interesting company…
Where did I get the Idea?
The initial idea is from a talk of Dr. Hendrik Leber (Acatis) mid of April, featured in one of my Food for Thought posts. Since I like Dr. Lebers focus on technologys role, I decided to take a deeper look at Progressive. Conveniently I wanted to analyse an insurance company anyway, in the near future…
Progressive is a $ 45 bn leading US auto insurance company with +20mn customers in the US. Progressives stock (PGR US) trades at about $ 76 (as of May 4), with a P/E ratio of 12.7x. Its history began in 1937 when J. Lewis and J. Green started offering auto insurance in an innovative way. Nowadays, Progressive offers auto insurance and wide range of other insurance products as well through its many subsidiaries.
Indicative dividend yield is low with o.5%. It is based on a regular quarterly cash dividend of 10 cents only. Annual special dividend payments can be expected in the future. Last special dividend payed in January 2020 was $ 2.25. A total annual dividend of $ 2.65 indicated a current dividend yield of 3.5%, as of May 4.
Progressive is growing strongly. During the last few years, PGR grew above market averages. Net Premiums Earned (NPE – don’t worry, you will find explanations a few lines below 😉 ) grew to $ 36,192m in 2019 from 25,729 in 2017. At the same time reported net income for 2019 was $ 3,980m, up from 1,598m in 2017. PGRs market capitalization grew accordingly.
Progressives vision points to even more growth to come:
Progressive seeks to become consumers’ and agents’ No. 1 choice and destination for auto, home, and other insuranceinvestors.progressive.com
Progressives strategy to achieve that future growth rests on three pillars:
- Meeting the broader needs of consumers throughout their lifetimes.
- Maintaining a brand recognized for innovative offerings and supported by experiences that instill confidence.
- Offering competitive prices driven by industry-leading segmentation, claims accuracy, and operational efficiency.
Welcome to Insurance Economics 101. Before we dive into Progressives financials, I want to shed some light on how insurance companies work. Afterwards, I will provide you (me) with some important insurance metrics and insurance basics to make better sense of Progressives reporting. –> If you are familiar with insurance economics you might skip this section?
Insurance Economics 101
Insurance works based on pooling the same quantifiable risks. In general, insurance economics are not that hard to understand. Let’s imagine in year one …
In a small city with 100 people owning a bike, each bike owner pays $5 p.a. into a (paypal) money pool (called insurance). Each year one bike gets stolen and this $ 500 (claim) go to this one poor lad enabling him to buy a comparable new bike, making him happy…
Forming groups sharing the same risk features is very important for insurance companies. Otherwise it might result in adverse selection. Imagine…
There are two districts (N and S) in the city and its residents seldom mix. The northern district is very poor with only a few street lights actually working. Unlike the northern district, the southern district is quite rich and its people are well educated. After a while, the southerners realize that all the bikes going missing are actually stolen in the north. Accordingly, all southerners cancel their insurance. Since the northerners know when to strike a bargain they keep their insurance. After that, there are only 50 northerners left, buying insurance, leaving the annual pool with $250 ($5 x 50) only, which is not sufficient for the insurance to pay out $500 once, annually.
As in the above story, adverse selection can appear if one party (insurance buyer) has an information advantage, resulting in a disadvantage (loss) for the other party (insurance company). Mitigating adverse selection, insurance companies engage in so called segmentation.
Segmentation is about pricing risks accurately. Insurance companies engage in data science and due diligence processes before offering insurance coverage at a certain price to a certain individual. Charging higher (lower) prices for riskier endeavours is important to be profitable (competitive).
Gross Premiums Written (GPW) are the revenues (premiums) expected to be received over the life of a P&C insurance contract. Growth rates can be calculated based on this metric.
Net Premiums Written (NPW) result from reinsurance bought from other insurances to protect against the risk of catastrophic losses, with the cost of reinsurance (reinsurance premiums) being deducted from gross premiums written.
Risk Retention (RR) describes the relation of NPW / GPW, or how much underwritten risk is kept (not reinsured).
Net Premiums Earned (NPE) refer to NPW recognized in the relevant accounting period (month, quarter, financial year).
Combined Ratio (CR) might be the most important metric. CR expresses the profitability from underwriting activities with CR = LR + ER.
Loss Ratio (LR) measures the insurers loss experience in relation to premiums earned. LR is a function of the nature of underwritten risks and the (in)adequacy of pricing these risks. The relation of Net Claims Incurred or NCI to NPE with LR = NCI / NPE.
Expense Ratio (ER) indicates the efficiency of the insurance operations as it expresses incurred expenses for acquiring and managing policies (premiums) in relation to premiums earned with ER = Expenses / NPE. Expenses can be further segemented into the following categories:
- Acquisition Expenses
- Loss Adjustment Expenses or LAE refer to costs in relation to settling claims.
Investment Yield depicts the average yield of the insurers investment portfolio as investment income over the average value of the investment portfolio. Income from investments is another profit besides the underwriting profit (loss).
Operations in more Detail
Personal lines forms the main segment when considering the number of policies in force. Commercial lines and Property represent two additional segements. Auto insurance represents the bulk of PGRs personal policies.
Progressives opearing results for 2019 look very good as do Q1 results.
Progressive personal lines grows strongly. PGR grew its policies in force by 9.0% p.a. sine 2015, constantly winning market share (in 2019 likely +1%p). Progressive can offer competitive prices through its ‘industry leading segmentation’ and an ‘efficient organisation’. As the chart below illustrates, PGR was able to lower its personal non-acquisition expense ratio by 3%p since 2009. Progressives LAE (loss adjustment expense) dropped 1%p since 2009. Since its claims organization employes the moist employees, so there is probably some more potential for future automation and tools.
The personal segment is very profitable, showing NPW growth of 15% in 2019 and achieving a low CR of 90.5%, generating an underwriting profit of 9.5% (supported by industry wide rate increases).
Consumer Satisfaction high enough?
Consumer satisfaction, reviews are important for selling a service online, especially if price competition is fierce.
Progressives Auto Insurance overall ConsumerAffairs satisfactory rating is a mere 3/5, indicating consumer dissatisfaction. All J.D. Power studies rank Progressives Auto Insurance below average (but in California). Both, Geico and State Farm are mostly ranked compared to PGR. Creasurance paints another picuter of Progressive as well: about 80% of customers would renew their policy, would recommend PGR to a friend and had a positive claims experience. User ratings were about equal to Geico, but average rates seem to be higher compared to Geico.
I wonder if these ratings are representative. According to nerdwallet, Progressive is the 3rd biggest auto insurance in the US with an 11% market share, but an average rate for a ‘good driver’ seems to be higher than at State Farm (1st) or Geico (2nd). Based on Progressives growth, if not for customer satisfaction PGR had to do something right in the (recent) past …
Here, some user comments shed some more light on different experiences. Additionally, another nerdwallet article paints a more differentiated picture (different states, different coverage options, UBI product and discounts, …)
I am inclined to give Progressive the benfit of the doubt. The growth in policies might be based on the fact, that overall customers are more happy with Progressive than some of the reviews indicate. Some of Progressives internal metrics support that notion, but I might be wrong here.
Snapshot: Progressives UBI Product
Progressive offers ‘Snapshot‘, an usage based insurance or UBI product to its auto insurance customers. UBI prodcuts enable insurers to gather detailed user specific data, i.e. how much they drive, driving style. Spnapshot enables Progressive to improve its pricing capabilities (better segmentation). Thus, Progressive can better match customer needs.
2019 NPW were $ 4.8 bn, up 20% yoy, generating underwriting profits with a combined ratio or CR of 89.6% (+2.9%p) for the commercial lines (p29f).
Progressives wins new commercial customers. Providing transportation network company (TNC) businesses with insurance services, namely Uber and Lyft. Other initiatives aim at truck policies (Smart Haul) and small businesses.
Progressives property business grew NPW by 16% to $1.7 bn in 2019, resulting from 2.2 mn PIF (+14%). The CR was slightly above 100%, but adjusting for 4.3%p of amortization expenses related to the ARX acquisition, CR was 97.4%. Progressive increased property rates in 2019 (c. +5%) and buys significant reinsurance mitigating catastrophe risk. Additionally a new risk model was introduced.
Progressive agreed on buying the remaining shares of ARX, in Jan 2020. Going forward, the property line will report into the Personal Line, which could lead to better collaboration. According to reuters, Progressive initially acquired a controlling stake in ARX Holding in Dec 2014 for $ 875m. Strengthening the progressive brand, property business lines will appear as Progressive Home.
The synergies, shared data on segmentation variables, and ongoing R&D expertise, we believe, will be instrumental as we continue to grow our bundled customers, the Robinsons.
Progressive targets the Robinsons described as customers looking for bundled insurance (auto+property) that are not that price sensitive (Sam) often looking for some ease provided by an agency. Progressive aims for high potential in the segment.
This transaction is a nice fit stratigically and could benefit Progressive in two ways. It should (i) further fuel PGRs growth in the property insurance segment driving investment income and (ii) enable PGR to sell more insurance bundles. I imagine, bundled customers do not switch insurance all that easily, since the other provider has to offer attractive rates for both products (auto, property).
Strong Balance Sheet
Insurance business is done based on trust (that the insurance can pay claims), consequently insurers financial strength is of highest importance. Progressives debt has credit default ratings of high quality (A2, A, A+) with stable outlooks. Progressive did end 2019 with long-term debt of $4,407m, representing 32% of total shareholder equity of $13,673m.
Progressive is earning high underwriting profits, well above industry and its own (minimum) target margin.
Investment income should provide a long-term uplift to the underwriting profit generated, with considerable annual variations. Progressive aims to maintain ‘a liquid, diversified, high-quality investment portfolio’, probabaly earning lower yields going forward.
I wonder if there could be a flywheel effect for Progressive …
Scale gives you an edge in a game of data and statistics. As data pools get broader and deeper, insurances can improve their segmentation and price their policies more competitive, resulting in higher market shares. Additionally, fixed costs — such as overhead, marketing, IT investments, R&D — can be shared with a larger base.
Technology investments drive efficiency everywhere. Technology is important not just from an operational efficiency perspective, but in attracting and retaining more customers. Progressive companies give (potential) customers the freedom to shop for, buy, and manage their insurance policies via agencies or directly from the company (online, by phone, on mobile devices). Its usage based insurance or UBI-product attracts customers and enables better segmentation/competitive pricing as should research and development (R&D) expenses resulting in improved modeling capabilities.
Customer satisfaction is a strong lever. Happy customers stay with Progressive, saving the company acquisition costs to replace this customer with a new one (with fewer insights). Satisfaction can be partially driven by technology (i.e. a good mobile app). Handling claims is of course an important driver of (expensive?) customers* satisfaction.
*) Many negative reviews of Progressive auto insurance indeed claim, that their claims were handled unfairly. I believe that such unhappy customers are much more likely to write a (negative) review than happy ones.
Growth in both, net premium earned (NPE) and policies in force (PIF) as well as market share gains are important metrics to watch. But in the near term, market rate increases could slow down significantly an thus NPE growth.
Profitability, predominantly a high or growing overall combined ratio (CR) and a growing income (net/comprehensive) over time.
Usually, I perform an absolute valuation approach (DCF) using explicit assumptions for key drivers to guesstimate annual free cashflows for a firm (FCFF). Sometimes modeling several scenarios. Exceptions so far using a sum-of-the-parts valuation or SOTP approach involve companies such as Porsche SE and Softbank Group.
This time I choose another approach for valuing Progressive. Valuing financial companies using a DCF is an unsuitable approach. Progressive trades at a low double digit P/E (comparable to peers) which I believe is not (too) expensive for a growing company these days. Taking into account current and past business fundamentals only, I believe it might be slightly undervalued to fairly valued. Either way, I think downside is rather limited (in let’s call it negative and base cases). But I can imagine a very positive case for Progressive…
The Positive Case
What if the flywheel effect is taking place and Progressive continues to grow strongly for several years with high profitability. Technology investments increase operational effeciency, segementation and pricing capabilitites, market share and customer satisfaction as well as loyalty. I believe a positive flywheel effect for PGR looks like the following
As one of the biggest (auto) insurance companies in the US, Progressives scale enables it to gather a lot of data. Leveraging technology as its UBI product snapshot, PGR can even gather more detailed data. All that data helps its segmentation efforts and to offer competitive pricing. Competitive prices, userfriendly channels (online, telephone, mobile) and smart bundles combined with various discounts leads to higher customer satisfactions, resulting in higher loyalty driving down customer acquisition expenses. Loosing fewer existing customers and winning more new customers and selling more policies per customer increases Progressives scale further.
Why not trading higher?
Do I see something that the market does not see? Currently, the indicative low dividend yield could be a reason. Possibly, the market does not fully incorporate the special dividend. Increasing regular dividend payments could representing a catalyst. Long-term investments in efficient processes, technology resulting in higher future earnings are not appreciated, yet. Focus on technology should result in higher market shares.
Or, are there negative issues that I am not aware of? A young and growing property business could result in catastrophe losses if not properly modeled and reinsured accordingly (so far there reinsurance program seems prudent). Rates for auto insurance will not experience the same increases going forward, squeezing margins. This argument is of general nature and could affect all insurance companies (but PGR should be well prepared through its bundling and agency strategy, maybe generating lower underwriting margins in the short term).
Summary and Decision
I want to buy Progressive, based on the above. For me, PGR is one of the rare cases without performing a DCF valuation, but I feel good about the overall investment case and my notion of Progressives attractive long-term risk/reward profile.
Update: I bought into PGR on May 21st, 2020 and will likely buy more.
I will monitor growth metrics for NPW and PIF and profitability, specifically overall CR as well as segment CRs.
I hope you enjoyed this blog post. Please feel very encouraged to discuss my assumptions and methods below or to give me general feedback. Best, s4v
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