Will Progressive's Growth Strategy Pay Off?
The auto insurer continues to add customers but posted disappointing results in the second quarter due to catastrophe losses and inadequate pricing.
Progressive reported June results last week and the market was not pleased. The insurer’s stock price declined by 13.1% on Thursday before recovering 1.8% on Friday. The stock is down 22.1% from its all-time high on April 11. The decline on Thursday was attributed to quarterly earnings coming in at 57 cents, well short of the consensus estimate of 85 cents. Progressive was the worst performer in the S&P 500 on Thursday and its decline on that day was the largest more than fifteen years.
Markets are always ravenous for data and Progressive certainly delivers a higher than normal stream of information for analysts to review. The company releases financial data on a monthly basis, three times as often as nearly all publicly traded companies. Although I am not sure that this level of granularity is particularly useful for valuation purposes, it is certainly interesting to monitor for those of us who follow insurance.
Progressive is an important company to follow for Berkshire Hathaway shareholders. Berkshire’s second quarter results should be released in three weeks and will include an update on GEICO. Progressive and GEICO have been fierce competitors for many years and this rivalry has been the subject of several articles on The Rational Walk. The most recent article was on May 5, the day before the Berkshire annual meeting.
In addition, I wrote a detailed profile of Progressive in December 2022 as well as a survey of the competitive landscape of the auto insurance industry in April 2022.
This article presents a brief update on Progressive’s recent results that builds on the discussion contained in Progressive vs. GEICO: The Battle Continues, so readers who haven’t seen that article yet might want to review it before proceeding.
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The brief discussion that follows is based on Progressive’s monthly financial reports for April, May, and June. Progressive’s 10-Q will be filed on Tuesday, August 1 and the company will hold its quarterly earnings call on August 2. During the first half of the call, management will make a presentation on loss reserving and pricing. This will be particularly interesting given the company’s unsatisfactory results in recent months.
The most interesting data to track on a monthly basis is policies in force. This figure represents the number of outstanding insurance contracts that are in effect as of the end of each month. Unlike other metrics that involve estimation, policies in force should be known with precision at each reporting date.
On one hand, growth in policies in force is positive because it is a sign that the company is gaining market share. On the other hand, growth is only good if it generates underwriting profits. Progressive reports underwriting profits on a monthly basis, but these figures are heavily dependent on loss estimates which could prove to be incorrect. However, it’s still an interesting data point to track.
The exhibit below shows Progressive’s policies in force segmented by product line over the past twelve months along with sequential and annual percentage changes:
At the end of June, Progressive had a total of 29.6 million policies in force, up 11.6% over the past year. While the year-over-year change is high, we can see that the companywide total figure has been decelerating on a month-to-month basis during the second quarter compared to the pace of the first quarter.
As I noted in my article on May 5, during the first quarter earnings call, Progressive’s CEO indicated that the company would take “aggressive” actions to increase rates throughout the rest of 2023, but she also said that management remained focused on growing policies in force consistent with meeting target underwriting profitability margins. Progressive has long targeted a 96% combined ratio.
Based on the comments made during the first quarter call, the decelerating trend in growth of policies in force seems to make sense. However, Progressive posted an underwriting loss for the second quarter with a combined ratio of 100.4%, materially higher than the 96% target. The exhibit below shows net premiums earned and the combined ratio on a monthly basis over the past year:
There are limitations to examining the data on a monthly basis. As Progressive notes in its guide to interpreting the monthly reporting release, the first month of each quarter is five weeks followed by two four week months. As a result, the first month of each quarter has higher premium volume and lower expense ratios. This accounts for the higher earned premiums in July, September, January, and April in the exhibit.
As I discussed in the May article, Progressive has been suffering from inflationary conditions in recent quarters, a situation that has impacted all auto insurers including GEICO. As inflationary conditions have caused the price of used cars to increase along with auto repairs, the reserves set aside by management have been insufficient.
Certain inflationary pressures may be starting to abate. For example, used car prices declined in four of the past six months according to the latest CPI report. However, the cost of motor vehicle repair continues to increase. When customers have accidents, insurers are on the hook for repairing vehicles or, in the case of a total loss, providing the customer with cash compensation for the cost of replacing the vehicle.
During the first quarter, Progressive reported $621.2 million of adverse development for prior years, meaning that loss estimates were inadequate. During the second quarter, Progressive reported an additional $489.3 million in adverse development bringing the total for the first half of the year to $1,110.5 million.
Implications for GEICO
I wrote up a brief update on GEICO as part of an article on Berkshire’s first quarter results. In that article, I noted that GEICO experienced a significant drop in policies in force over the past year. GEICO made the strategic decision to reduce advertising spending and increase premiums. It seems very likely that many of the customers that left GEICO signed up with Progressive. We will learn more about GEICO’s second quarter in three weeks when Berkshire releases its results.
As I wrote in my article on Berkshire’s 2023 annual meeting, Ajit Jain seems determined to improve results at GEICO. He announced a target of a 96% combined ratio but thought that GEICO’s combined ratio for the full year would be just under 100%. Since GEICO posted a 93% combined ratio for the first quarter, Mr. Jain’s projection for the year implies that GEICO might post a higher combined ratio for the second quarter. That would not be surprising in light of Progressive’s results.
I should also note that GEICO posted favorable reserve development of $338 million in the first quarter, indicating that management was conservative when reserving for losses in 2022. Given Progressive’s continued adverse development into the second quarter, it will be interesting to see if GEICO’s reserve development remains positive.
The Competition Continues …
Warren Buffett has always been bullish on GEICO’s growth prospects while acknowledging that Progressive also has a formidable track record. The market share gains of both GEICO and Progressive have been remarkable over the past two decades and the companies have long been fierce competitors.
But as much as Berkshire wants to see growth at GEICO, the culture of the company has never favored growth at any price. Only profitable growth adds value in the long run. Grabbing market share through aggressive pricing that leads to underwriting losses is what gets insurance companies into trouble. Berkshire’s underwriters are told to reject inadequate pricing even when market share declines as a result.
Over the past year, Progressive has been winning the market share game but at what cost? At least in retrospect, it looks like GEICO has played the hand they were dealt more skillfully. Unlike Progressive, GEICO is unconstrained by the expectations of the stock market and can formulate policies meant to maximize value over multiple years and decades. In contrast, Progressive is a public company with a “growth” story. I suspect that management’s attitude toward pricing over the past year has, in part, been driven by a need to show growth in policies in force.
Berkshire Hathaway’s second quarter earnings are expected to be filed with the SEC on Saturday, August 5 and I plan to write up some thoughts on the results.
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Long Berkshire Hathaway. No position in Progressive.