Progressive Corp (PGR) — Q1 2016 Earnings Call Transcript

Good morning. Welcome to Progressive's conference call. Participating on today's call are Glenn Renwick, our CEO; John Sauerland, our CFO; Tricia Griffith, our Personal Lines Chief Operating Officer; and Bill Cody, our Chief Investment Officer. The call is scheduled to last about an hour. As always, our discussions on this call may include forward-looking statements. These forward-looking statements are based on management's current expectations and are subject to many risks and uncertainties that could cause actual events and results to differ materially from those discussed during this call. Additional information concerning those risks and uncertainties is available in our 2015 annual report on Form 10-K, where you will find discussions of the risk factors affecting our businesses, safe Harbor statements relating to forward-looking statements and other discussions of the risks, uncertainties and other challenges we face. These documents can be found via the Investors page of our website, progressive.com. Nicole, we are now ready to take our first question.

So Glenn and team, I'd love to ask sort of a big picture question on growth. You guys have had a really strong, probably 6 months here with growth rates rising. I'm wondering if you can help us a bit to segregate it because there are a lot of moving pieces. And I think the big picture question I'm sort of struggling with is how much is the cyclical story because of the environment? And how much is structural and the impact of your various initiatives? And so when I think about it, it would be really helpful to get your color on how much you think it is a function of just the competitive environment changing, with other folks taking pricing maybe on the first point. But then you obviously have a lot of retention initiatives underway as the second point. And then you got new products, whether it's Snapshot or homeowners. I imagine these are having some impact, probably more Snapshot than homeowners at this point. But what I'd love to get from your perspective, as we think about looking forward, how much of this is kind of a cyclical upswing in the growth rates and how much of this is the impact of big powerful initiatives working their way through?

You provided a solid overview of our strategy. You're correct, and while I may not get too specific, I recommend considering our upcoming October Investor Relations meeting to delve into many of these topics. Some issues are challenging to link cause-and-effect directly to, but I'd welcome another first quarter like this one. Although we experienced some hail at the end, we also faced a shortage in winter, so I’m not overly concerned about the growth rates we've reported. It was a good quarter, and the fact is, it’s not merely coincidence that our competitors increased their rates. We aim to optimize our rate adjustments in a timely manner to ensure we are consistently well-positioned. I previously used the analogy of riding a wave, and that's the essence of our approach. While we have various initiatives, it's crucial to manage the base business effectively, maintaining a position to seize favorable market conditions. We always aim to grow, which is part of our main focus: to achieve a 96 and grow as quickly as possible. When opportunities arise that others might miss, we intend to take advantage of them. Additionally, we need to drive our own future growth. Many are familiar with Snapshot, which now features nearly 2 million rated policies. As highlighted in my letter, this constitutes a significant portion of our portfolio, particularly on the direct side compared to the agency side. We have strong initiatives underway with Snapshot, including the app we mentioned, which aims to connect with customers who may be hesitant about using a dongle in their vehicles. We also have a new collaboration with General Motors that will launch in about ten days to gather vehicle data. As I’ve mentioned, we're focusing more on the data and algorithms and less on data collection methods. Snapshot is poised for considerable growth, and our brand strength continues to improve, especially as others have dialed back on advertising. In the agency channel, while we've talked mostly about the 8.3 product updates, we are continuously working on future improvements like 8.4 and 8.5. Our bundling strategies in the direct sector are also gaining traction, and regarding agency growth, ASI might not play a major role currently, but I foresee it being more significant by this time next year. All growth initiatives are progressing, albeit at different stages, and Snapshot has shown promising acceptance among agents, nearly doubling in newer states. Platinum in the agency realm is also gaining momentum, and we’ll provide further insights in October. As long as we maintain strict pricing discipline, we anticipate providing updates on numbers soon. We’re approaching the conclusion of April and will share information within the next 8 to 10 business days, although we expect that month to be challenging. Overall, we anticipate annualized rate increases in the range of 4 to 5, which is a positive outlook. We've shared trend indications, so that core should continue to move forward, and initiatives are performing well. I did not receive specific inquiries about growth percentages, which is difficult to quantify at this moment, but we have some insights that I prefer not to broadly communicate yet.

That's really helpful, Glenn. I want to ask a bit more of a numbers question. The market has been concerned about frequency for some time, but it seems to have eased recently. Would you describe this mainly as a result of favorable weather, which seems implied in your comments, or do you think frequency trends have peaked, allowing the industry to start discussing the potential for rating severity? I would appreciate your thoughts on that as well.

Yes, it's always tricky with the variation, but I'm happy to share my thoughts. In fact, some of my comments this time will differ from those I made previously. Frequency remains stable, and when we examine the bodily injury frequency, which I tend to monitor closely, we are in a good position. There’s nothing alarming happening at this moment. I would advise waiting for an additional conference call or two before worrying too much about commentary on PIP. We have some issues in New Jersey that may be influencing that number differently than what the long-term perspective would suggest. Severity is really the main area of focus, and for the most part, I have little concern regarding bodily injury. An interesting point about severity relates to collisions. It's still early to state definitively that winter weather in the Midwest and Northern states has moderated frequency this year, but it certainly has. We also noted previously that our Snapshot measurements indicated that the last quarter of 2015 did not align with the last quarter of 2014 in terms of vehicle miles driven. That trend has changed in the first quarter of 2016, where we see an increase in miles driven compared to the first quarter of 2015. This aligns well with public gasoline demand trends. While we can speculate on the impact of increased mileage, and I have consistently cautioned about understanding the nature of those miles, the longer trip miles appear to be the key factor driving this change. We might see a slight uptick in frequency, which we will need to monitor for short- to mid-term pricing. However, there’s a possibility of a more structural long-term shift towards lower frequency, considering that cars are becoming safer. This is complex to quantify on a monthly or quarterly basis, but it wouldn't surprise me if we experience a long-term decline in frequency, accompanied by a similar change in severity. Those are my main concerns. Overall, given the historical fluctuations in frequency and severity, this appears to be a relatively predictable time for miles driven. The only exception at this moment may be some heightened severity in PIP and collision, which we are examining. However, from a pricing standpoint, these issues are being balanced out by frequency.

So Glenn, I'm just curious. You've owned ASI for about a year. Obviously, some high CAT loss activity in March. It sounds like in April there is also. Is it higher than you would have expected? And as a result, any thoughts about maybe changing the reinsurance program or something you can do to maybe mitigate some of that volatility?

I'll answer the first question now. No thoughts. That doesn't mean we won't ever have thoughts. We're always going to consider that, but I think about the percentage of the overall book of business that we have, we currently have a small quarter share percentage. We have a single attachment point of about $45 million for any single event, and we have an aggregate attachment of $175 million. Those feel very much in proportion to things that we're willing to handle. Do I like volatility? Of course not. No one does. You don't and I don't. But if this was sort of in the realm of understanding of what likely could happen when we did something like this, absolutely, it certainly also plays to the fact that we're writing an awful lot of homeowners, not necessarily with some of these results that we have to report in-house. So the partners that we have, they're all obviously having those problems. So it's a different dynamic when we have it in the place that we absolutely need it, and as I said in my letter, it hasn't even been a momentary thought to be of any concern whatsoever. And there's no pressure from my perspective to take any less reinsurance, but equally no more reinsurance.

Great. And then just quickly, on the Commercial Auto business, the strong growth that you guys have been seeing, some of that, I know, comes from some new products that you have out there, but I imagine there's also some of this going on from the dislocations that we're seeing out in the marketplace, especially with some large Commercial Auto riders. How long do you think that continues for?

You're right in your summary. John, do you have any insight? I don't have a strong opinion since I'm not aware of what our competitors are doing.

Sure. Yes, we have seen a lot of dislocation, and we think we were well ahead of the marketplace even as much as 2 to 3 years ago in seeing some trends that we took some material rates to address, and also added some significant underwriting efforts to a lot of the lines we write there to ensure we were writing business that was going to be profitable. So we're really well positioned now. And yes, we are seeing a big increase in corporate volumes. So if you think about new business incoming, it's either a function of an increase in conversion or quotes, and in Commercial Lines, it's predominantly in quotes, which generally means competitors are raising rates or just not choosing to quote the business. As far as where that goes, we can't know with certainty for sure. We are confident on our rate level. In some of the areas, we might take rates up a bit, but obviously, you see combined ratios there that are very good. And we expect they'll continue to be very good, so we're pretty bullish on growth moving forward for commercial.

I noticed you gave some attention to your new relationship with Uber in Texas, and it seems like there's a big increase in the potential for the data that you can collect and your understanding of driving behavior. It's not just individual drivers like you're doing with Snapshot, but it's tracking a network. Every one of these drivers has a GPS, and you'll have your own app that you can combine with it. I'm just wondering if you could give us a little more color on how much of this might change your view? Or how you can look at driving patterns, driving behavior out there.

Gary, right now, I'm not dodging that question. I'm genuinely not, but the fact is your thesis is so on point. Just understand, that's sort of what we're all about. And when you get a situation like Uber where you can truly collect the data, there's a wealth of data, whether you incorporate Snapshot or whether we use the data that's otherwise available to us, this is truly an exciting situation because it just plays entirely into everything that we feel we're good at. And, hopefully, we're playing into one of Josh's comments earlier, just one more thing to have another arrow in the quiver of places to see growth coming later. But there's not a lot to report right now, and I'm simply not dodging your question. But the idea that this is just an insurance program, it's much more than that. And that's why I used the analogy of a square peg in a round hole. And I think we've really developed a program that makes a lot of sense. And hopefully, the way this is really successful is that we know what that vehicle is doing, where it's going, sort of route intensity, braking intensity. All sorts of things that we can know, not only at the fleet level, but we can know at the driver level as well. So frankly, this is one that, if I was in person, you'd see me smiling because I think this is sort of one of those opportunities that comes along relatively frequently, and this just seems like we had our name written all over.

My imagination may not be enough to see other opportunities of a similar nature, but are there other opportunities out there where you can gather more informative data like that?

Yes, I think, you've got to accept strategically that, that is the mindset you've got to have. You can take it all the way from the private passenger automobile, which we're doing slowly with Snapshot, but you'll see taxicabs being sort of more involved in this type of thing. There's a release today in The Wall Street Journal about GM working with Lyft. We have a relationship with Lyft. There's a lot more vehicle sharing. It's a minute part of the economy right now, but certainly one that if you are a betting person, you'd probably bet on seeing that being a lot bigger later. We want to make sure that we're designing contemporary style insurance programs for those kinds of options. And frankly, I think we're extremely well-suited for it. We know others will have some interest, but we're doing an awful lot of groundwork right now, and we're very happy with that. So I think this is going to be something we're going to be talking about a lot more in the years to come.

Glenn, you mentioned, I think in response to Josh, that you expect increases in severity to offset the frequency decreases that you can anticipate from improving cars. And that kind of surprised me because I guess I wouldn't have necessarily seen the historical connection persist, and I was hoping if you could talk a little bit more about that.

Well, we've actually shown in at least one Investor Relations meeting, I'm not quite sure whether it was 2 or 3 years ago, sort of what I would call, if not a perfect monotonic function over some reasonable period of time, a declining frequency. The fact is we made our cars safer in this country for the last 30 years. And there's nothing on the immediate horizon that suggests that we're not going to make them continuously safer. Some of the things, even the federal mandate for emergency braking. Those sorts of things, it's impossible for me to think there isn't a real macro driver to yet make cars safer. So that's my premise for declining frequency. What's interesting is that over that time period, the market for private passenger auto has grown, and that is largely a severity offset to, actually, it's even more than an offset, it's a gain over the frequency decline. And those are interesting and accurate and observable facts. When you start to decompose it to try to sort of say exactly coverage by coverage what's driving it, that gets a little trickier. But I'm working, at least my mindset, is that a long-term strategic view is that we will see fewer accidents and more expensive accidents.

Okay. That's fair enough. And a second sort of a detailed question. The jump in the Commercial Auto sales ratio in March, is it fair to tie that to the new Uber relationship?

No, I wouldn't directly link that. It might be a small amount, around $0.01 or $0.02, but there are likely two larger factors at play. We are implementing a new system for our commercial sector, which incurs some related expenses. However, the main driver is the increase in advertising costs as we enhance our market presence and appeal for direct operations. This applies particularly to small businesses that have needs similar to those of private passenger auto and prefer to engage with us directly. We are expanding this area, and the demand appears to be strong, prompting us to increase our advertising efforts. This will be the primary factor behind the expense variation.

Glenn, I just want to talk real quick on the frequency comments in the Q sounding a little bit better and then your comments earlier about miles driven being up, which we can all see. Usually, though, those two seem to correlate a little bit more. It seems like they went in opposite directions this quarter? Any thoughts on that?

Yes, I'd be careful to make a quarter-to-quarter comparison there. Let's take a look together sort of to the next quarter, even the next six months to see how frequency is ultimately being reflected through. It should be a pretty close comparison, but I'm not always convinced that it gets one for one, so I'd wait just a quarter and see.

Got it. Okay. Great. And then a couple of things on the homeowners. One is just can you tell us a little bit about how your reinsurance is structured? And I guess what I'm getting at is I'm guessing because a lot of others have done this. You probably have some aggregate coverage. And just given the March events and the April events, sort of how do you stand with the aggregate cover? What's the risk of essentially going through that if we have more events later in the year, especially a hurricane? Do you need to sort of buy live cover for the rest of the year? And then just big picture on your home, just the one I could see in the market share, obviously, your two biggest states are Florida and Texas, which are heavy CAT states. As you roll out the Platinum, is it a specific goal to grow away from CAT areas? Or is this just sort of take it where you can get it if it's a good customer, and you'll sort out the CAT mix later?

We focus on planning ahead rather than waiting until later. However, Florida and Texas are key markets where many people reside, so we will be actively involved there and feel confident about it. The reinsurance that ASI established from the start is designed to accommodate their coastal risks. John, could you go over the three layers? We are not overly concerned about Ian's impact, but let's discuss the $45 million single event and the $175 million bond. Trevor is here as well, so we can reach out for additional support if needed.

We provided insights into the ASI reinsurance program during the Q. The first layer is $45 million for the first event, and while we won't divulge specific PMLs, I can assure you it's significantly higher than what the average industry expects. Going to the top is highly unlikely. Additionally, we have a pretest, pre-bond facility totaling $175 million, which is stable throughout the calendar period. The second event has a slightly lower tower, but we've prepurchased reinstatement on many layers, so we’re fully covered. Unlike many players, if reinstatement is needed, those premiums are prepaid for much of the reinsurance. ASI has a solid reinsurance program, with nearly all participants rated A or better, giving us great confidence. The $45 million retention was targeted to ensure that any single event risks less than 10% of their surplus. This is a relatively small percentage of the combined entities, indicating a strong reinsurance program. Trevor, do you have anything to add?

No, I think you nailed it pretty well.

That's great, very helpful. If I could just clarify, Glenn, about the Platinum part again. Are there any restrictions? For instance, do you prefer not to grow in Houston if you're focusing on Texas, or not to grow in Miami if you're growing in Florida? Would you consider marketing more aggressively in the Midwest or Northeast or other areas where there is less CAT risk?

ASI has managed its risk effectively in Florida by only taking on the amount of business it feels comfortable with. We're aware of the concentration risks involved. As we expand nationally, our dependence on any single state will decrease. So, the answer is both yes and no. Yes, given our current position, but ultimately, our goal is to provide a significant bundled option for consumers, with Florida being a major market. We will ensure we have the appropriate reinsurance in place and will not overextend ourselves. Our focus is on acquiring customers and retaining them long-term. We are comfortable allowing others to take on additional layers of risk, hoping they will be profitable over time while we fulfill our objectives as well. However, we don't plan to limit our marketing efforts to interior states; we will pursue opportunities in all states, being mindful of the right level of risk sharing. It's worth noting that while we have achieved our results, we are currently facing challenges in managing them. The key question is how we feel about the resulting volatility. We're becoming more aware of its implications. While our reporting is monthly, making fluctuations appear more pronounced than over longer periods, we're not reconsidering our strategy or changing our approach at this time. We are simply reaffirming our current positions.

ASI did enter California in January, I believe you said where we started writing business, in February. And we expect to be in New York midyear May. So sort of naturally as they expand across the country, you'll see less concentration in those coastal states. But to date, yes, they've been pretty highly concentrated in the Southeast. But I think naturally, as they enter more states where there’s a large populace as well, you'll see that concentration decrease.

I just wanted to get a little bit more information on the CAT losses that you've already reported for the second quarter. Were those primarily concentrated in the Texas market? Or was it a little bit more geographically dispersed than that?

Jump in guys. I think Texas is a big driver. You probably, even if you watch television, you'll see that Oklahoma has got something. There's a little in Kansas, but the real driver is Texas.

Is that more skewed towards the flood losses in Houston or the hail losses in San Antonio?

Let's break down the two areas. For vehicles, we face the same real issue. Hail and adverse driving conditions have significantly impacted both auto and home insurance. The home segment isn't largely affected by the flooding in Houston, although some of our vehicle losses are related to it, which totals around 450 losses due to the floods. That's not a major factor in our results this month. The figure of 135, with an 85-50 split, should remind you of the serious peril posed by hail. When hail reaches large sizes, it causes severe damage to roofs and sheet metal. Hail is one of the most destructive risks we encounter, which will greatly affect our comparing results. As mentioned, we'll take a few opportunities to address this, even though the numbers will remain as they are. First, these are first-party claims, meaning we will pay the losses, which transforms into a marketing expense. This is our chance to improve our customers' experiences following an incident, whether it’s damage to their roofs, windshields, or anything else. The important attitude we're adopting is to treat this as a marketing expense. Customer retention is crucial, and we understand the correlation between excellent claims service and future retention, which is our priority. Secondly, we will reassess our pricing to ensure we're aligned with our goals. A single month of spikes is something we've witnessed multiple times, and we have no concern about deviating from our commitments to shareholders, which remain stable at 96 or higher. We will also reevaluate our catastrophe losses. Observing the overall market, there seems to be an increase in rates, driven by larger competitors. The last data we have from February shows a rate increase of around 4.5%, about 110 basis points stronger than earlier this year. Based on filings, we expect to see more clarity from competitors in April and May, as many rate changes are reported, possibly pushing the rates a bit higher. In our last discussion, I would have suggested expecting around 4% increases quarterly. Now, I would say we should anticipate an additional 25 to 40 basis points per quarter as we progress through the year, potentially slightly higher when considering catastrophe losses. Overall, I believe we can manage these changes effectively.

That's really helpful. One last question. When events like these occur, do they contribute to frequency and severity statistics? Or is that calculated differently for catastrophic events or claimants?

Well, they are mostly comp, at least on the vehicle side. Typically, when we provide numbers for frequency and severity, we don't include comp because that would result in a random walk in terms of your graph. Most of the frequency and severity numbers we share are for the more sustainable coverages like BIU and BIPD. However, as we evaluate it, yes, it is factored in.

Glenn, I'm going to push back a little bit on your sort of slight warning about miles driven potentially having an impact on frequency. I mean, gas prices are up 30% from roughly the average level of where they were in the quarter. And we're going to soon be sort of lapping year-over-year impact of gas prices. If lower gas prices haven't really driven a big impact on frequency to your book to date, why in the future should we be incrementally more nervous about it?

I want to clarify a few points. In the last quarter, our 2015 fourth quarter was quite similar to the fourth quarter of 2014. As we head into the first quarter of 2016, we are beginning to see a significant increase in miles driven, which aligns with gasoline demand. However, the key question is how much higher this will go. People won't drive endlessly just because gas is cheaper; their driving will largely remain for recreational and discretionary trips. There are many theories on this subject, but I can confirm that there’s a noticeable change in the first quarter. Our significant data shows that miles driven have increased, contrasting with the fourth quarter's stagnant figures. Now, as we enter a period where vehicle miles traveled typically peak, it will be interesting to see if recreational driving continues to rise. In this regard, I can only share what we're observing. There is significant interest in this data, as it matters greatly, but I can't definitively state that we're witnessing a substantial change in driving frequency solely due to these factors. The rise in longer discretionary trips suggests that the impact on frequency is not as straightforward as one might expect.

Totally with you. I guess I was asking more a futuristic question. The data that you're looking at is when gas prices were down a whole lot year-over-year, and we've had a 30% spike in gas prices. And I'm just saying if you're looking at real-time data the last few weeks, I would think that you're not going to see the same year-over-year mileage increases that we saw in the first quarter where gas prices were down a whole lot versus a year ago.

I wouldn't bet against you on that one. I don't have the April numbers actually. As soon as I get off this call, I'm actually probably going to get more of the April numbers because that will be very interesting.

While we can't model it perfectly, we believe there are factors influencing gas prices. When prices reached $4, it acted as a barrier that caused people to change their behavior significantly. However, we think the way driving is affected by changes in gas prices is not purely linear within a reasonable range.

Certainly, the economy plays a role. The competition between trucks and trains can have a significant impact.

Airline travel, too. Discretionary travel. Yes. Unfortunately, we reported news more here, but we have our own theories, but I don't dismiss or suggest that yours is not an interesting one as well. April will tell a story because we're really going into April in May and June, which are the high travel vehicle miles travel months.

Sure. Yes. Actually, we shortened the duration of the portfolio a little bit in the first quarter as rates sell. The short-term change or the big increase in short-term in the first quarter is really not so much a portfolio strategy change as it is a definitional change. What I tried to get through in this Q is that we had about $1.1 billion of short coupon treasuries that accounted in our Treasury portfolio that matured in the first quarter. And we rolled those into treasury bills, which were accounted in the short-term portfolio. So no real big change there other than a tenth of a year decline in the duration of the portfolio. The other changes that we had was we increased our corporates a little bit in the first quarter as we saw some more compelling opportunities when spreads were wider. And then we've made some repositioning around the ARX portfolio where we took control of the management of that portfolio on January 1. So there has been some turnover in regards to that. But other than that, no material changes in the portfolio and certainly no changes in our overall strategy there.

It would appear that that was our last question. So that concludes our call today.