Progressive Takes One Step Forward, One-Half Back

By Stephen D. Simpson, CFA | April 05, 2012 AAA


As property and casualty insurance companies go, Progressive (NYSE:PGR) is an exceptionally well-run one. Memorable advertising gets the company noticed, but it's the innovation in underwriting that has allowed the company to generally match industry pricing while realizing superior returns. Given the recent rebound in the price, though, investors may want to wait for a better entry point on these shares.

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First Quarter Results
Progressive reported that net
written premiums rose almost 7% in the first quarter, showing a little more momentum later in the quarter. Direct premiums rose about 7%, while agent premiums rose about 5%. With many auto insurers boosting rates in response to above-trend losses, it looks as though Progressive is gaining some share.

Where Progressive took a step back was with its underwriting margin. The combined ratio came in higher than expected, as reported combined ratio rose almost four points from last year. On an adjusted basis (stripping out cats and prior year developments), the comparison was more favorable with a half-point improvement. What stands out here, though, is the first adverse loss reserve development in several years.

All in all, then, pre-tax operating income plunged about 30%. It's also worth noting that, like almost every insurance company, Progressive is suffering from lower interest rates in its investment portfolio (with investment income down 7% this quarter).

SEE:

How An Insurance Company Determines Your Premiums

How Are Competitors Going to Respond to Losses?
Due to both premium price pressure and weather-related loses, many of Progressive's competitors have seen higher than normal underwriting losses. That seems to be pushing rivals like Berkshire Hathaway's (NYSE:BRK.A) GEICO and Traveler's (NYSE:TRV) to get more aggressive on rate increases, while Allstate (NYSE:ALL) is getting more active in its marketing efforts.

All in all, this is not a bad development for Progressive.
More aggressive advertising from Allstate (the second-largest auto insurance company) is a threat, but Progressive's historically better underwriting margins should allow them benefit from this stronger rate environment. However, Progressive's historically better underwriting margins should allow them benefit from this stronger rate environment - through either gaining market share on price or boosting profits.

That said, mutual companies (many of which are prominent in terms of market share) don't have quite the same profit pressures as Allstate, Progressive or Berkshire, so they can be something of a wildcard.

A Legacy of Innovation
One of the notable features of Progressive is that it's not just like every other insurance company. They were the first with online quotes, the first with 24-hour claim service and the first to use "advanced" factors like credit scores in underwriting. Many competitors have since matched these, but Progressive continues to explore new ways of assessing risk while also offering new products like Snapshot Discount (a wireless device that monitors driver behavior) and "Name Your Price."

The Bottom Line
Progressive shares have been strong lately, as have shares for many insurers. That has mopped up most of the undervaluation in these shares. Assuming that Progressive can regain and hold a high teens ROE, these shares are worth somewhere around $24 per share. With the stock close to this level, this is a respectable hold, but not a compelling buy.

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

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