2009 Annual Report Objectives, Policies, and Operations Summary
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Consistent achievement of superior results requires that our people understand Progressive’s objectives and their specific roles, and that their personal objectives dovetail with Progressive’s. Our objectives are ambitious, yet realistic. Progressive monitors its financial policies continuously and strives to meet these targets annually. Experience always clarifies objectives and illuminates better policies. We constantly evolve as we monitor the execution of our policies and progress toward achieving our objectives.
Objectives
Profitability Progressive’s most important goal is for our insurance subsidiaries to produce an aggregate calendar-year underwriting profit of at least 4%. Our business is a composite of many product offerings defined in part by product type, distribution channel, geography, customer tenure, and underwriting grouping. Each of these products has targeted operating parameters based on level of maturity, underlying cost structures, customer mix, and policy life expectancy. Our aggregate goal is the balanced blend of these individual performance targets in any calendar year.
Growth Our goal is to grow as fast as possible, constrained only by our profitability objective and our ability to provide high-quality customer service. Progressive is a growth-oriented company and management incentives are tied to profitable growth.
We report Personal Lines and Commercial Auto results separately. We further break down our Personal Lines’ results by channel (Agency and Direct) to give shareholders a clearer picture of the business dynamics of each distribution method and their respective rates of growth. Aggregate expense ratios and aggregate growth rates disguise the true nature and performance of each business.
Financial Policies
Progressive balances operating risk with risk of investing and financing activities in order to have sufficient capital to support all the insurance we can profitably underwrite and service. Risks arise in all operational and functional areas, and therefore must be assessed holistically, accounting for the offsetting and compounding effects of the separate sources of risk within Progressive.
We use risk management tools to quantify the amount of capital needed, in addition to surplus, to absorb consequences of foreseeable events such as unfavorable loss reserve development, litigation, weather-related catastrophes, and investment-market corrections. Our financial policies define our allocation of risk and we measure our performance against them. If, in our view, future opportunities meet our financial objectives and policies, we will invest capital in expanding business operations. Underleveraged capital will be returned to investors. We expect to earn a return on equity greater than its cost. Presented is an overview of Progressive’s Operating, Investing, and Financing policies.
Operating Monitor pricing and reserving discipline
Manage profitability targets and operational performance at our lowest level of product definition
Sustain premiums-to-surplus ratios at efficient levels, and at or below applicable state regulations, for each insurance subsidiary
Ensure loss reserves are adequate and develop with minimal variance
Investing Maintain a liquid, diversified, high-quality investment portfolio
Manage on a total return basis
Manage interest rate, credit, prepayment, extension, and concentration risk
Allocate portfolio between two groups:
Group I – target 0% to 25% (common equities, redeemable and nonredeemable preferred stocks, and below investment-grade fixed-maturity securities)
Group II – target 75% to 100% (other fixed-maturity and short-term securities)
Financing Maintain sufficient capital to support insurance operations
Maintain debt below 30% of total capital at book value
Neutralize dilution from equity-based compensation in the year of issuance through share repurchases
Return underleveraged capital through share repurchases and a variable dividend program based on annual underwriting results
Objectives and Policies Scorecard
Financial Results |
Target |  2009 |
2008 | 2007 | 5 Years1 | 10 Years1 |
|---|---|---|---|---|---|---|
| Underwriting margin: | ||||||
| Progressive | 4% | 8.4% | 5.4% | 7.4% | 9.3% | 9.1% |
| Industry2 | na | .7% | (.2)% | 1.7% | 2.3% | .2% |
| Net premiums written growth: | ||||||
| Progressive | (a) | 3% | (1)% | (3)% | 1% | 9% |
| Industry2 | na | .5% | (1)% | (1)% | —% | 3% |
| Policies in force growth: | ||||||
| Personal Auto | (a) | 5% | 2% | 2% | 3% | 7% |
| Special Lines | (a) | 3% | 7% | 8% | 8% | 13% |
| Commercial Auto | (a) | (5)% | —% | 7% | 4% | 15% |
| Companywide premiums-to-surplus ratio | (b) | 2.8 | 3.0 | 3.0 | na | na |
| Investment allocation: | ||||||
| Group I | (c) | 20% | 18% | na | na | |
| Group II | (c) | 80% | 82% | na | na | |
| Debt-to-total capital ratio | < 30% | 27.5% | 34.0% | 30.6% | na | na |
| Return on average shareholders’ equity (ROE)3 | (d) | 21.4% | (1.5)% | 19.5% | 18.8% | 19.7% |
| Comprehensive ROE4 | (d) | 35.5% | (13.3)% | 17.7% | 19.5% | 21.1% |
(a) Grow as fast as possible, constrained only by our profitability objective and our ability to provide high-quality customer service.
(b) Determined separately for each insurance subsidiary.
(c) Allocate portfolio between two groups:
Group I – Target 0% to 25% (common equities, redeemable and nonredeemable preferred stocks, and below investment-grade fixed-maturity securities)
Group II – Target 75% to 100% (other fixed-maturity and short-term securities)
(Policy implemented in April 2009; 2008 results are shown for comparative purposes).
(d) Progressive does not have a predetermined target for ROE.
na = not applicable
1) Represents results over the respective time period; growth represents average annual compounded rate of increase (decrease).
2) Represents private passenger auto insurance market data as reported by A.M. Best Company, Inc.; 2009 is estimated.
3) Based on net income (loss).
4) Based on comprehensive income (loss). Comprehensive ROE is consistent with Progressive’s policy to manage on a total return basis and better reflects growth in shareholder value. For a reconciliation of net income (loss) to comprehensive income (loss) and for the components of comprehensive income (loss), see Progressive’s Consolidated Statements of Changes in Shareholders’ Equity and Note 11 – Other Comprehensive Income (Loss), respectively.
Achievements
We are convinced that the best way to maximize shareholder value is to achieve these financial objectives and policies consistently. A shareholder who purchased 100 shares of Progressive for $1,800 in our first public stock offering on April 15, 1971, owned 92,264 shares on December 31, 2009, with a market value of $1,659,829, for a 19.7% compounded annual return, compared to the 6.4% return achieved by investors in the Standard & Poor’s 500 during the same period. In addition, the shareholder did not receive any dividends during 2009, keeping their total dividends received to $235,224 since the shares were purchased.
In the ten years since December 31, 1999, Progressive shareholders have realized compounded annual returns, including dividend reinvestment, of 12.8%, compared to (0.9)% for the S&P 500. In the five years since December 31, 2004, Progressive shareholders’ returns were (1.1)%, compared to 0.4% for the S&P 500. In 2009, the returns were 21.5% on Progressive shares and 26.4% for the S&P 500.
Over the years, when we have had adequate capital and believed it to be appropriate, we have repurchased our shares. In addition, as our Financial Policies state, we will repurchase shares to neutralize the dilution from equity-based compensation programs and return any underleveraged capital to investors. During 2009, we repurchased 11,053,953 common shares. The total cost to repurchase these shares was $181 million, with an average cost of $16.34 per share. Since 1971, we have spent $6.5 billion repurchasing our shares, at an average cost of $5.94 per share.
Operations Summary – 2009
Personal Lines Our Personal Lines operations improved profit margins relative to 2008 and added close to a half million policies.
The combined ratio for the year was 92.4. This was 2.2 points better than 2008 and better than our targeted profit margins. Auto claims frequency, specifically property damage and collision, continued to run lower than expected and even lower than we were experiencing during the gas price hikes in the latter half of 2008. Trends in auto claims severity were negative for physical damage coverages, fairly flat for bodily injury, and positive for personal injury protection. For the year, we implemented rate level changes totaling +2.9% in our auto programs.
Profitability in our Special Lines programs was especially good. The absence of significant coastal storm activity helped margins in our watercraft programs and frequency in our motorcycle programs dropped versus the prior year when higher gas prices appear to have increased usage.
Across all products, we reduced our expense ratio slightly and our loss adjustment ratio significantly in 2009. While we enjoy one of the more competitive cost structures in the industry today, we remain highly cognizant of the need to continue to get our cost structure even lower to drive greater competitiveness. At the same time, we will continue investing heavily in our brand and consumers’ awareness of our brand.
New customer growth in Personal Lines was solid, led by our Direct auto programs at 20% and our Agency auto programs at 3%. This marks the first time since 2003 that we enjoyed new customer growth in Agency auto. This growth came as a result of our agents considering us more frequently for more “preferred” business and finding our “7.0” program design to be more competitive for those customers. We also continued to improve our approaches to ensuring that our agents see our most competitive price through whatever means they use to quote Progressive.
Direct auto new business growth was driven by an increase in the number of consumers shopping with Progressive, and by an increase in the conversion of those shoppers to customers. We believe that some of the increased shopping was environmental and some was driven by increased advertising with our very effective campaign headlined by Flo. Conversion gains were driven by improvements in our online quoting experience, including continuing to roll out Name Your Price ®. Our boat and motor home businesses also grew new customers. New motorcycle business was considerably off the pace of 2008, when the spike in gas prices caused an increase in motorcycle and scooter new unit sales.
Retention of auto customers improved, driven by a continuing shift in our customer characteristics towards more stable preferred customers. Retention of Special Lines customers was down slightly versus 2008, which we believe is likely a function of economic pressures that reduced consumers’ propensity to use and insure their recreational vehicles. Customers’ perception of our service, as measured by our Net Promoter® Score did not improve in 2009. However, our commitment to making gains in the customer experience remains as strong as ever.
In total, we grew our policy base in Personal Lines by nearly 476 thousand, or 5%, to almost 11 million policies. Average written premium per policy was down about 2% in our auto programs and flat in our Special Lines programs. In total, net premiums written were up 5%.
We made further progress during the year in meeting the broader Personal Lines needs of more preferred customers. We added two more providers to our Progressive Home Advantage® program, through which we package auto and home insurance for consumers. We’ve also continued to roll out an umbrella product, which we now offer in 30 states. In 2009, our new preferred auto customers, including those combining their auto and homeowners policy with Progressive Home Advantage, grew approximately 20% within our Agency business and about 30% in our Direct business. We’ve learned much about cross-selling and are gaining insights around household loss and acquisition economics in contrast to the policy level view we have historically taken. In short, we are excited by the opportunity to broaden the spectrum of customers we serve to include those with whom we expect to have a much longer relationship.
We also made advancements during the year with our usage-based insurance program, MyRate®, which is now in 19 states. Our experience with multiple variations of our MyRate model deployed in 2009 has led to the development of a “MyRate 2.0” model, which we’ll be rolling out in 2010. We think this version presents a more appealing consumer proposition and is aimed at a segment that we know displays markedly better loss experience. Today, well over 100,000 Progressive customers enjoy the benefit of controlling their premium through MyRate.
Our 2010 plans include ensuring that we remain a leader in our core segments, continuing to grow capabilities and customers in preferred and multi-product households, further improving our cost structure, and continuing to provide distinctive products and services valued by consumers.
Personal Lines
| 2009 |
2008 | Change | ||||
|---|---|---|---|---|---|---|
| Net premiums written (in billions) | $ | 12.5 | $ | 11.9 | 5% | |
| Net premiums earned (in billions) | $ | 12.4 | $ | 11.8 | 4% | |
| Loss and loss adjustment expense ratio | 71.5 | 73.5 | (2.0) pts. | |||
| Underwriting expense ratio | 20.9 | 21.1 | (.2) pts. | |||
| Combined ratio | 92.4 | 94.6 | (2.2) pts. | |||
| Policies in force (in thousands) | 10,940.6 | 10,464.9 | 5% |
Commercial Auto Progressive’s Commercial Auto business produced a combined ratio of 85.8, an improvement of 8.9 points versus the prior year. The combined ratio benefitted from an increased focus on high exposure claims handling, lower claims frequency, gains in operating efficiency, and reflects prior rate increases. The combined ratio includes several points of favorable development on prior accident years. Rate increases taken in the first half of 2009, combined with favorable loss trends, allowed us, by May, to make all product options available in California, one of our largest markets.
While the general economy began to show signs of recovery, the commercial auto insurance sector continued to contract in 2009. Depressed levels of employment, construction spending, and new business creation, combined with constraints on commercial credit, led to a reduction in insurable risks, particularly for small businesses, our primary customers. For the year, Commercial Auto net premiums written declined 10%, which was in step with industry results but still disappointing.
The written premium decline was driven by both a reduction in policies written and business mix changes toward lower average premium business auto policies and more preferred risk profiles. Policies in force declined 5% as new business applications fell 9% and we experienced no change in our policy life expectancy. The negative production trends were more conspicuous in the specialty truck category, since these policies have higher average premiums, than with business auto.
Faced with soft demand and the prospects of a slow economic recovery, we sought and found opportunities to improve our operating efficiency. Improvements in workforce management and key business processes yielded a reduction in operations cost per policy in force and a significant gain in our core efficiency measure, policies in force per FTE (full time equivalent). As a result, the Commercial Auto expense ratio declined 0.4 points to 21.1, a gratifying result against a background of declining premium. We believe that our low relative cost structure provides us with an ongoing pricing advantage.
Commercial Auto policies have higher average policy limits than our Personal Lines policies. In 2009, we intensified our focus on high exposure claims through the consolidation of their handling by a smaller number of more seasoned adjusters and increased training. We have seen measurable improvement in investigation, diagnosis, and exposure recognition for large losses. These improvements increase the accuracy of our loss cost estimates and pricing and allow us to be more responsive to changes in the environment. As our large loss claims handling improves and cycle time comes down, we reduce both indemnity and handling costs associated with these claims. Inclusive of the improvements in large loss handling, Commercial Auto’s loss adjustment expenses declined significantly for the year.
In response to an increasingly competitive, yet contracting, market sector, we invested heavily in product development. In December, we rolled out our new Commercial Auto product in Arizona. This new design improves pricing segmentation and more accurately allocates costs associated with high limit policies by business type. The program will roll out nationally in 2010. We also developed a series of program enhancements that broaden risk acceptance and increase appeal for the specialty truck and transportation categories. These will also hit the market in the first quarter 2010.
We enter 2010 confident in our pricing and with the flexibility to respond quickly to changes in the environment. Continued discipline on expense management and process improvement gives us a relative cost advantage and the ability to continue investing in the business during a down economy. With new products that improve segmentation and expand market reach, we are well positioned to take advantage of current opportunities and the anticipated economic recovery.
Commercial Auto
| 2009 |
2008 | Change | ||||
|---|---|---|---|---|---|---|
| Net premiums written (in billions) | $ | 1.5 | $ | 1.7 | (10)% | |
| Net premiums earned (in billions) | $ | 1.6 | $ | 1.8 | (8)% | |
| Loss and loss adjustment expense ratio | 64.7 | 73.2 | (8.5) pts. | |||
| Underwriting expense ratio | 21.1 | 21.5 | (.4) pts. | |||
| Combined ratio | 85.8 | 94.7 | (8.9) pts. | |||
| Policies in force (in thousands) | 512.8 | 539.4 | (5)% |