The Progressive Corporation (PGR) Q3 2009 Earnings Report, Transcript and Summary

Welcome to the Progressive Corporation’s Investor Relations Conference Call. This conference call is also available via an audio webcast. Webcast participants will be able to listen only throughout the duration of the call. In addition, this conference is being recorded at the request of Progressive. If you have any objections you may disconnect at this time. The company will not make detailed comments in addition to those provided in its quarterly report on form 10Q shareholders report or letter to shareholders, which have been posted in the company’s website, and we’ll use this conference call to respond to questions. Active moderator for the call will be Patrick Brennan. At this time I will turn the call over to Mr. Brennan.

Thank you. Good morning everyone. Welcome to Progressive’s conference call. Participating on today’s call are Glenn Renwick our CEO; and Brian Domeck our CFO. The call will last about an hour. Statements in this conference call that are not historical facts are forward-looking statement that are subject to certain risks and uncertainties that could cause actual events and results to differ materially from those discussed herein. These risks and uncertainties include without limitation, uncertainties related to estimates, assumptions and projections generally, inflation and changes in interest rates and security prices, the financial condition of and other issues relating to the strength of and liquidity available to issuers of securities held in our investment portfolios and other companies with which we have ongoing business relationships, including counter parties to certain financial transactions. The accuracy and adequacy of our pricing and loss reserving methodologies, the competitiveness of our pricing and the effectiveness of our initiatives to retain more customers, initiatives by competitors and the effectiveness of our response, our ability to obtain regulatory approval for requested rate changes and the timing thereof, the effectiveness of our brand strategy and advertising campaigns relative to those of competitors. Legislative and regulatory developments, disputes related to intellectual property rights, the outcome of litigation pending or that may filed against us, weather conditions, changes in driving patterns and loss trends, acts of war and terrorist activities, our ability to maintain the uninterrupted operation of our facilities, systems and business functions, court decisions and trends and litigations in healthcare, and auto repair cost and other matters described from time to time by us and other releases and publications. In addition, investor should be aware that Generally Accepted Accounting Principles prescribe when a company may reserve for particular risks, including litigation exposures. Accordingly, results per given reporting period could be significantly affected if and when a reserve is established for one or more contingencies. Also, our regular reserve reviews may result in adjustments of varying magnitude as additional information regarding pending loss and loss adjustment expense reserves become known. Reported results therefore may be volatile in certain accounting periods. And we are now ready to take our first question.

(Operator Instructions) Your first question comes from Vinay Misquith - Credit Suisse.

Could you provide us some color on your growth in agency auto, was that due to the rollout of the new agency model with higher price segmentation and how is that impacting the price charge for your customers within that segment?

Sure, as you could tell as for me with the highlight of the third quarter, but something that we sort of saw coming at the end of the second, so it was nice to have that. Let me put some color on a couple of different dimensions, maybe the more consistent and sustainable dimensions. We have been rolling out our, what we call 7.0, we don’t tend to give them particular names, but product versions that we are always looking to increase and improve on our segmentation. That product is now out in about 32 states, and we have a new product on the heels of that as we pretty much always do, that will continue to rollout. So, that offering to agents is sort of sustainable but perhaps the increase in third quarter would most likely be a result of competitive positioning, not necessarily something that we did other than stay disciplined to our approach, we talk about that a great deal and we will continue to shoot and price for our margins that we think are appropriate, and at different times in the market places, others that forced to take rate increases, and when they do and we’re positioned very well we benefit from that, and that’s something of course we try to do a great deal. You will also remember, perhaps that in June, [John Phalen] talked to us a little bit about retailing of our agent rates. So, we have a situation where many of our agents are using a comparative rate. I think if you like, that being a Google search , the position on, as you returned on that search is important, and clearly as our competitive position improves, as it has, we are going to improve our positioning on that search. We will also take some actions initiated by us we’re very pleased about and that’s what we call retailing when John talked to us about it, making sure that we optimize our conversion and make sure our agents know all of the potential product offerings or price points that we can offer their customer. So, very comfortable with the retailing aspect, I think that contributed in the third quarter. Clearly, I would say price was the biggest single competitive positioning I should say with the biggest single factor driving the third quarter in my opinion. I wouldn’t discount, but very hard to quantify. I think it absolutely deserves mention and that is the brand strength, and our brand strength as perceived by agents. I have met with many agents over the third quarter and in fact some last week, and it is very reasonable for me to say that agents are appreciative of the progressive brand and while it’s perhaps directed to have consumers call us more on a direct basis, the umbrella effect of the brand is very strong for them, and the consumers that are entering their agency are well aware of it. So, we have got a lot of factors that are actually helping. So, in terms of color, I would think those are relevant issues and many of them are sustainable going forward. Competitive positioning is probably the reason for the more specific event change to positive application growth. I would point out that we’ll just report as we see things. I am not going to speculate on the strength of that growth going forward. We have some states where we have to act on rate, including one of our largest states in Florida. So, we will see some mitigation there as we take some rate there and competitive positioning of other companies as they take rate either before or after us will change the dynamic of app flows there. The best thing we can do is continue to report as we do every month. But, frankly that was a very nice contribution for the third quarter, something we’re very pleased with and I think we have worked hard at it.

That’s great, just a follow up. Who do you see you are taking market share from? Whether it would be from the top five competitors or would it be from the smaller competitors, and what are the rate increases you’ve taken so far year-to-date?

Let me start with the second one, the first one is probably not something I’m going to get into a great detail even though we tracked the prior carrier, so we do actually know about that a fair amount. Rate increases so far, and I know we have made some comments in the Q about average premium. So I’ll try to relate those if that’s important to you later. On an agency basis, year-to-date rate is probably a plus 3, maybe a 2 to 3, and again, that’s going to vary. To talk in macro it’s sort of always interesting because it really relates to an individual state, but two to three, and on a direct base we’re looking at may be just a smidge over one. With regard to market share, as it’s coming from the agency players, we are generally reluctant to talk about other companies, but I would say it’s moderately broad based, but you can put some greater emphasis on those carriers that have taken rate significantly in key stakes and a couple of those that probably comes to mind for all of us.

(Operator Instructions) Your next question comes from Meyer Shields - Stifel Nicolaus. Meyer Shields – Stifel Nicolaus: Can you talk a little bit about whether rising unemployment is impacting severity at all?

Let me talk about severity, but whether I can link that to rising unemployment is a tough one. I’m sure we can say some things about broad and the like, but I suspect that those become opinion and fact, and I would like it for the generally stated fact. So let me take that caution if I can and just talk about general severity, I’ll stay with severity and then come back on frequency if that’s valuable to the audience. BI Severity is the one that we worried most about because of the fact sort of reserving and in general and we sort of gave this indication in the Q. Not a lot happening on BI Severity. On a year-to-date basis we may be just down a touch which is good but one that we actually have concerns and may be it’s just a experience that tells us that’s what we need to watch and we certainly have some states where that is starting to tick up. BI Severity in general has not been a big issue at this point in time. BI Frequency is different story but I will stay with severity. PIP Severity you have seen both in my letter and the Q that that’s the one we are worried about. If there was any sort of good news on the horizon it seem to moderate just a little bit in the last quarter, but we are still looking at PIP Severity being up, I said 5% on the last call, maybe 3 to 5, frankly I am just in a mode where we need to watch that one, we see some spikes from time to time, it is still going up and has been going up consistently for many years, but the increase in frequency there is a great driver of our concerns right now. But severity in PIP, when we talked about that on the last call can come from lots of different sources, one that can creep in there is fraud, and that’s something that maybe, maybe you could relate to unemployment to, but I think that is a little bit too speculative to get into. Just finishing on severity, PD Severity for us is actually down slightly and that’s great, I always sort of attribute that to having our claims organization and nice control, we also are very well aware that the average age of vehicles on the road is getting slightly older, also another reason to affect average premiums. So, perhaps not unexpected but PD severity is well within control and you could say essentially the same thing for collision. So that covers most of the issues on severity. If I could pickup on your unemployment reference, the thing that I might be a little bit more likely to comment on is what appears to be much softer market in, what we would call traditionally non-standard market place, not that unemployment is only affecting non-standard market place, but we are seeing a cool off in non-standard relative to our other tiers and certainly we would love to see a return for that, feel good that we are positioned well for it. We certainly don’t speculate on timing of it, but the economic conditions probably have affected a little bit more than non-standard market place in terms of people maintaining their insurance. I suspect it has crept into claims in some way shape or form and drives severity, but I wouldn’t put it as an overwriting issue that we can pinpoint. We are very-very alert to those types of things and it’s sort of silly to say we are trying to catch the fraud, the bad frauds we catch, the good fraud because we probably don’t catch, but we are very well aware of it and there are certain locations in the country where these things emerge considerably faster and stronger than other places and we are alert to that. Meyer Shields – Stifel Nicolaus: That’s very helpful, I appreciate that. In terms of follow up it has no objection, we haven’t heard any update on the plans in a while, is there anything going on?

There is probably a reason you haven’t heard it, and that would be the strategy or plan and that is because we are working very constructively by the way with the regulatory authorities in Australia. We had hoped quite frankly to have our regulatory approval by now, we’ll give them a great deal of credit and it seems like they are doing a very nice job, making sure that the players they have in their financial services business in Australia are very solid. We are very comfortable that that approval will be given to us. We just do not know the exact timing. But if I had to speculate I would say this year, that’s later than we expected, and as soon as we get that you will see more of a communication from us other than that we are well prepared to do our business.

(Operator Instructions) Your next question comes from Brian Meredith - UBS. Brian Meredith – UBS: A couple of quick questions here; first, I think you talked a little bit more about the homeowner’s initiatives. Looks like you’ve got a couple more carriers and then on that topic also where do we see the economics of the homeowners business coming through in your results, is that a reduction of the policy acquisition costs?

Brian, I will take the last piece. Yes, the homeowners just the repeat of the reason we are in the first place obviously we will not be able to track different class of customers that we may have and that’s sort of price of entry. The good news is many of our applications now in both channels are starting to shift more to either rented or homeowners, so when we talk about home owners just also sort of make sure that our mental models include rentals we are selling a good amount of rentals as well. The additional carrier is very consistent with that plan, the multiple carriers, and for us the economics of this, Brian will talk to exactly how the commissions are accounted for but that’s certainly not the economic win from our perspective, the economic win is; (a) attracting a different part of the market segment that’s working. Two, is retaining the customers that we actually bundle something with whether they are rentals or homeowners, and that’s actually working very well from our perspective. So we are very happy, with regard to the economics and the commission, Brian you want to…

Yes. The commission that we receive would be reflected as a reduction to our underwriting expenses sort of contra expense segment. Brian Meredith – UBS: And then just a follow up to that homeowners question; the reduction in direct distribution, average premium per policy, does any of that have to do with the homeowner’s product in selling the package policies given the discount there?

That would be a contributing factor but to be perfectly honest with you, by the time you wait that out, it’s actually a small factor. When we put in the queue we talk about mix, if I was going to give you a breakdown of the reason that we see reduction on average premium even in a situation of increasing absolute rate level, setting state mix aside which quite frankly is a big issue, the percentage of customers that come to us with prior insurance, i.e. they are more in the category of what might have traditionally been called a standard towards preferred, it just increased significantly for us. So the stand of customers with proof of prior has gone up, and in some sense that’s also reflected for the comment I said in terms of softening of the non-standard market place. Well, that is one reason and probably the biggest single driver. I touched on the what I would call the second biggest driver and that is the average age of vehicle is getting older, and we are seeing a reduction in average age of vehicle. I know there has been some commentary industry wide which may very well affect others more than us about changes in deductible levels, that would not really be a major driver from our perspective. Same thing with regards to limits; in fact we are seeing our more recent production be at a slightly higher level than the minimum limit, so the minimum limit is actually smaller part of our new part of the book, and we are going up a level up or two in limits, not necessarily all the way to the top. So we are seeing that partially reflects our recommended packages and name your price offerings in direct as well. So, it would not be really be driven by coverage and deductible selection, a little bit more by mix of business, proof of prior, age of vehicle, even age of driver. Those would be the primary drivers aside from the statements. Brian Meredith – UBS: Just one quick question for Brian; Brian, is December going to be a five week month?

Yes. Every five, six years based on our calendar convention we have a five week month and 2009 December will be a five week month.

(Operator Instructions)

Okay, if there are no more questions that will be the final question for the call. We have one more. Okay.

Your next question comes from David Small - JP Morgan. David Small – JP Morgan: In terms of pricing, it looks like you have come in over the past few month below your target 96 combined ratio, I know there has been some noise there, but if I look back over the past six-seven months you have been fairly consistently below the 96. So is this the time where we would think that, I know you were talking about the pricing up plus 1 and direct plus 2 to 3 in agency. A few years ago when we started to slip below the target you started to lower price, is that something we should expect to see again?

I don’t think you will see it any mass way David. We have some states where we are probably more below the 96 than we would otherwise plan to be. We don’t ever try to plan to be significantly below that. And if we think the elasticity is there, we would take rates down. But those would be very selected states, and I don’t think you would sort of suggest that that’s an action that would be similar to what we talked about a few years ago, we took them down. In fact, I think, on average, you are going to see more of a rate positive environment probably for the industry, and that is driven at least by the types of things we are seeing in frequency which didn’t come back in touch on. But our BI frequency this year is up fairly significantly, and as we said in the Q, it is now back at 2007 levels, but it dipped quite significantly and it gave the whole industry some quite significant relief and some pretty good results. But that’s now back to 2007 levels. When we price even in state where we are below our 96, we are always pricing in the future trend. We will consider on a state-by-state basis whether or not that glide path of the trend takes us back to the 96 rather than reduced rates. And in some states, we are actually above our 96 and we are having to take rat e action. So, in general, you get the personal lines result as we publish them. Although, it was just a smidge higher than the personal lines in general, our special lines business will now actually have a nice contribution to the reported combined ratio. So, I am not at all unhappy with where we are in auto, if I could sort of have a perfect board and pick the points maybe we would be a slight higher on our combined ratio, if we thought that would generate more business. Based on the trends that we’ve got, I think we are more likely to glide into that 96 and approach it from below, which is far more preferable to me than sort of taking a shot and bouncing above it and having to correct in the market. It’s absolutely our belief that consistency of pricing in the marketplace reasonably stable both on our new business for our agents and our renewal book is absolutely the preferred strategy versus almost any ability to change up or down when we are perhaps not at our target and are not driven by trend. David Small – JP Morgan: Just a second question, have you spend any time thinking about your 96 target combined ratio, given that you have de-risked the investment portfolio and given where interest rates are?

We think about our 96 a great deal and almost all the time; and I am not being flippant on that. Tying it to other issues, no, I think 96 is sort of a long term strategy. I think next time we get together we’ll talk about 96 is how we view it segment-by-segment business, by business new renewal we’ve done that before; but I think it’s a good time to refresh that especially as we start to see the mix of our business from direct and agency become different than it was a few years ago. So that’s a great topic and I think we’ll explore that probably in next investor relations meeting. But with regard to the investment strategy, we have done, I think we have communicated so I am not going to repeat that, we have done what we felt was very prudent to protect the operating business that we value so much as we have started to see, it’s only been 9 months, the environment change you have started to see us change. And I get Bill just say a couple of words about a few actions he is taking in the investment portfolio but we are starting to become a little bit more aggressive where we think that makes sense. We are not going to do a major knee-jerk. Our capital management was talked about in some length, and over the last few months you have started to see us execute on our capital management philosophy that we haven’t changed. I think we brought about a million shares back in June and for about three months about a million and a half, a little stronger in the last month. We are a couple of months away, so there’s no definitive here at all, but if the year ended today, we would looking at paying out a dividend and we recognize we are talking sort of all told in that ball of wax, $250 million may be. But ultimately, we will execute on our capital management, return capital where we think that’s the right thing to do. And we will start to assume, where we think it’s appropriate, a little bit more opportunity for return in our investment portfolio. We are going to try to do this in a way that I recognize that from the outside it would be great if we could sort of shift every time the market shifts, we are going to try to do it in a very nice controlled way. No one wants to increase their net income more than I do. I want to do it in a way that’s sustainable, I want to do it in a way that’s respectful to the entire business; and it wasn’t that many months ago that we were talking very differently, and I just want to sort of recognize that there’s still a fair amount of volatility in the marketplace and we will try to do the best we can to get a good balance of operating and investment results. Bill, I know you are on the line; do you want to just say a couple of words of some things you have done recently?

Sure, the most notable one was an add of about 2% of our assets to the equity portfolio. When we reduced that we did that for all the reasons Glenn just outlined, now that our capital position has improved and evaluations are still reasonable in the equity market, especially relative to some of those in the fixed income market. We took advantage of small pull back that we are getting on November to add a bit to equities and bring a little bit of more balance of sort of group one assets and that is now to just about 20% of the portfolio. Within the fixed-income portfolio, we have continued to reduce our duration as rates have been low as you noted. Although it has had an effect on our book yield, as you know we don’t manage the book yield, we think about our total return basis and with rates where they are, at some point that doesn’t give us a whole lot of cushion against a large increase in rates as well as no immediate catalyst for that. But we are thinking more about our total return after a year or two years and trying to mitigate any large capital that we might have from a sharp rise in rates by reducing our portfolio duration. We have also added some non-treasury products we have added to our ABS portfolio, well not huge yield they are roughly; they’ll double the short treasury yield that they are replacing. We have added to the corporate portfolio as well, particularly the non-financial part that’s pretty nicely spread And then to CMBS where it’s another favorite sector and that’s been consistent with our current portfolio holdings other than the absolute bonds and we have bought sort of 2001-2003 vintage off of the capital structure type bonds as well as some of the sell powered bonds we talked about in June. And also added to the credit affected IL portfolio with some very nice yields and I think it produced some very positive total returns for us.

Your next question comes from [Mark Sorenson] - Citadel. Mark Sorenson – Citadel: Jim, I think you just mentioned that common stock purchases were funded from short term investments. Could you just confirm that and you had mentioned the difference in yield, what would be the approximate difference in yield in the common stocks versus what you are getting in the short-term bucket?

Well, if you think about it as cash, the cash is yielding a handful of basis points at the moment; short treasuries inside two years are under 1%. The yield on the index, the dividend yield is about 2.2%. Mark Sorenson – Citadel: Then Glenn just a question we talked a lot about mix shift and can you talk a little bit about what your expected margins would be in that business versus the rest of the portfolio?

Mark, margins in which part of business. Mark Sorenson – Citadel: You talked a little bit about the mix shift to the more preferred customer and how that’s been driving your average written premiums down especially in the direct channel. So, what I am trying to get a sense for is how that drives margins going forward?

Yes, and even as I take the opportunity in your question I want to reinforce that, while we are happy to see the mix shift, because it means we are now competing in the bigger part of the market, we absolutely love all the parts of the marketplace that we have served before, and I hope to see that to be a driver growth in the future going forward. The expectation on margin is really the same. The key, while average premiums may go down, I don’t worry about that from a marginal perspective as long as it’s proportionate to the lost cost that we incur on that book of business. So, I think we actually understand the lost cost quite well and so far and you would see that very quickly in our results if that wasn’t the case, so no change in margin expectation. We price all parts of our business to a 96. Clearly, the more preferred end of the business has as longer retention, and that allows us to acquire new business at a slightly higher rate, a combined ratio I should say rather than rate than it might be true in shorter retaining business, but all of that’s factored into our target, and that’s why I said maybe it’s a good conversation to have at our next investor relations meet.

Your next question comes from Ian Gutterman - Adage Capital. Ian Gutterman – Adage Capital: Can I get you to clarify, when you were talking earlier about rates being up in 2003 in agency and one interact, is that filed rate, is that achieved rate adjusted for mix change, what exactly is that number?

That’s the file rate Ian Gutterman – Adage Capital: So can you tell us what your achieved rate is? Because I am guessing in between mix shift, and just you may file everybody up but if people go towards sales that are the ones where rate went down and not the ones where rate went up, you could even achieve a negative rate with file positive rates, right?

Yes absolutely correct. Do we have that Brian?

In the agency, our effective rate change and what we are realizing is relatively flat. It’s actually on a year-to-date basis. Slightly positive for new business and slightly negative on our per renewal basis, but in aggregate relatively flat, and then as we’ve said relative to the average premiums under the direct side, we are seeing decreases on particularly more so on the new average premium in direct but we are also seeing a slight decrease on the average premium even on the renewal book as the previous business that we previously renews in. So in agency, even though file rate changes 2% to 3%, I think average premium is relatively flat. Direct even though rate change file is plus 1 absolutely due to the mix shifts, the new average premium is down mid single digits and renewal is a little bit less than that. Ian Gutterman – Adage Capital: Okay. And what about, part of that, I guess what I am trying to think through is, the difference between those two numbers can come in two ways, right, one could be such that people trading down to lower profitable sales for you and the other way is just exposure went down, right? They are going to buy a new car they are keeping the older cars, there is less liability. So it seems it can come from one or two ways. Can you talk about how much of that decline in earned premium I guess, earned rate, is exposure change versus sort of a mix in your profitability?

Similar to the way Glenn mentioned previously. In terms of the profit target that we set for each of the segments that we write, it would be the same, the 96 profit on that segment of business. I think what we know is that the mix of business is changing. Glenn referred to more with prior insurance or the change in age or change in vehicle age, change in points is driving average premium, and the biggest thing to match it up against is the change in lost cost, and in particular, change in frequency. So in terms of more of the standard and preferred end of the business, the frequency of losses is lower as well. And so, what’s very important for us to match, monitor and ensure we have right, is the matching of the average premium with the changes in lost cost and in particular frequency. So we have to, and we watch that. We say, hey on the mix of business that we got in what will be the frequency and we monitor that over time and as long as those two are in sync, we feel very-very comfortable that we’ll meet our profit objectives, and in particular, one of the things that we’ve talked about in the past is we look and have profit targets for new business somewhat separate from renewal business. So if this is a new mix we are getting in, we look at the profitability of that new business, not just how the whole aggregate is and we’ll see whether each of those sales both at new business and also even at sub segments of new business that are relative to the profit targets. So we continue to monitor those segments. Ian Gutterman – Adage Capital: Okay. Because I guess where that’s leading towards is if I looked, if I said achieve rate is down a little bit and loss trend given the increase in frequency is up, if I just do simple math, I would actually get to over 96, and I wonder if may be the simplistic reported loss trend is maybe overstated, because exposures come down underneath, and just due to mixed changes in the fleet and things like that. Do you see what I am saying, if I just loss trends are backs and prices down why I would get a several point increase in your combines going forward?

Yes. That’s exactly what you do and recognize it, as we price we include in our pricing future trends to get there. I think the real issue without getting us tied up here a little bit is that if we have mixed shifts and you have philosophically a view that you’ve got subsidized segments, you can get into real trouble. We try to price every part of our offering as best we can, doing 96. So, if we incur mix shifts, we’re really not in a position of saying, gee we’ve got now a change in the macro reported number. And, other than, from time to time, where we leave a hole which you sort of referenced by saying, gee you could put the rates up, perhaps misses out or no one buys in that sell off which you may actually ultimately or unintentionally create a sell that is very attractive to people and the lost cost aren’t matched to it. That’s really what we do; I mean that’s what we spend all of our time trying to make sure it doesn’t happen. So, I think philosophically you should take it as, we don’t try to subsidize any one sector with a different sector or one channel with a different channel, and we try to price for consistency across all parts of our business to a 96 taking into account the differences in retention by different segments. Hopefully that helps and you are right, but with regard to some of trends and I think you should think about that more on a going forward basis because trends as in the past have already been price into our indications. So, as we start to talk about frequency increases and the biggest one that I have referenced here is BI then you could imagine that as we think about our pricing going forward we will have a frequency driver in there even though the severity seems to be reasonably moderate.

(Operator Instructions) Your next question comes from Meyer Shields - Stifel Nicolaus.

Is the 96% goal before or after the contra expense of homeowners mission?

I didn’t catch the last; you broke up a little bit at the very end there. 96 goal before or after?

The homeowners mission.

Oh, I think you are talking about a number that would be so small that it would hardly matter at this point in time. But it would be, we would consider that, as Brian said, the counter or a contra expense. So it would be included.

Okay, if there are no questions in the queue, so that will be our last question. Thank you everyone.

Thank you. That concludes the Progressive Corporation’s investor relations conference call. An instant replay of the call will be available through November 27, by calling 1-800-294-0991 or can be accessed via the investor relations section of Progressive’s website for the next year. Thank you, for joining you may disconnect at this time.