Progressive Improving Quality At The Expense Of Growth

By Stephen D. Simpson, CFA | April 11, 2013 AAA

Every insurance company has to maintain a delicate balance between earning on capital as much as possible, and not take excessive risks in the pursuit of those earnings. As a high-quality, well-run insurance company, Progressive (NYSE:PGR) has a long history of making good decisions. Those decisions are starting to compromise growth, however, and it's becoming more difficult to make a value case for Progressive in the insurance sector.

SEE: The Industry Handbook: The Insurance Industry

First Quarter Results Good On Quality, Weak On Growth
Progressive's first quarter results highlight a lot of these conflicting priorities. Growth and return on equity (ROE) certainly aren't what they used to be, but it's hard to criticize the company for shoring up the quality of its underwriting and reserves.

Net written premiums rose 7% this quarter, but a large percentage of that growth was from price hikes. Policies in force (essentially a metric of volume for insurance companies) rose just 1.5% this quarter, further highlighting the substantial slowdown in the business as this was the lowest PIF growth in more than four years.

On the cost side, though, there was better news. The company's combined ratio improved almost two points from the year-ago period on a quarter-by-quarter basis, driven in large part by a 115bp improvement in the expense ratio. Accident loss trends are still problematic, though, as frequency and severity are both trending higher and the company has strengthened its reserves once again. All of that said, the accident loss ratio was better than the year-ago level, and is the best it has been in four years.

Investment income continues to be a sore subject for insurance companies like Progressive, as seen in the 12% year on year decline in net investment income. Net income after taxes (NIAT) still improved 20% though, due to very strong income growth in underwriting.

Market Share Isn't Everything
With Progressive choosing to raise rates and cut back on advertising spending, it doesn't seem unreasonable to think that the company's market share is going to suffer. That may not be such a bad thing. To a certain extent, insurance companies get the clients they deserve and Progressive may be willing to see Allstate (NYSE:ALL) or Berkshire Hathaway (NYSE:BRK.A, BRK.B) get a little more business from aggressive price-shoppers.

At the same time, there's that balancing act to consider. In more normal times, you could argue that Progressive could afford to be choosier with its policies and make up at least some of the difference with investment income. With today's zero interest rate policy and “QE infinity”, though, that's not really a viable option for any insurance company. While Berkshire Hathaway certainly has no shortage of reinvestment options for its capital (and the largest auto insurer, State Farm, is a mutual company), companies like Allstate and Progressive either have to accept lower growth or risk greater future underwriting losses.

SEE: Is Growth Always A Good Thing?

The Bottom Line
There's plenty to like about Progressive. This is a well-run company with a history of innovation in the space (name your own price, direct sales, and so on), and those innovations should continue to help the company generate policy growth. That said, I think we're past the point where Progressive is really a growth story relative to its industry and I'm not sure the stock deserves the premium it carries.

I do believe that Progressive will maintain long-term returns on equity in the mid-teens, with some chance of regaining the high teens on a year-by-year basis. That's really only good enough to make this stock a “hold” today, so Progressive would not be my first choice in the insurance space right now.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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