Progressive Corp (PGR) — Q3 2016 Earnings Call Transcript

Good afternoon, everyone. Thank you to those who traveled here, and welcome to Progressive's 2016 Investor Relations Day. We're pleased to have you with us. I believe you're familiar with the Safe Harbor statements, and if not, there's a copy in your materials for reference. This investor relations meeting marks a significant change. For many years, Glenn Renwick led these meetings. Last week, he celebrated his 30th anniversary with Progressive, with more than half of that time as our CEO and President. During his tenure, he tripled the company's size, which is impressive by any standard. But what's remarkable is not just what he accomplished, but how he did it: instilling in us the desire to succeed while adhering to our core values. Each year, he set higher goals for us and actively supported us in achieving them. That is truly his legacy. So, Glenn, on behalf of the 30,000 Progressive employees, our shareholders, and the customers we serve, thank you for embodying Progressive. Now, moving on, I'd like to remind you of our segments. We outlined these several years ago when we began discussing our Destination Era strategy. Today, our focus will be on the Robinsons, and we’re excited to share updates since our last meeting in May 2015. Let’s start with Sam. He's our inconsistently insured customer who helped establish Progressive, and we refer to him as nonstandard. Sam cares about rates, may not stay long, but could return. We appreciate Sam and aim to write as many of his policies as possible while reaching our profitability goals. Diane is another crucial part of the Destination Era. We've previously mentioned her as a prospective Robinson. Diane is an auto customer who rents, possibly with renters insurance from us. We hope to grow with her as her needs change, such as when she purchases a home or gets married. The idea is that Diane will evolve into a Robinson. She represents our largest customer base, presenting significant opportunities. Then we have the Wrights, who maintain separate auto and home insurance. They have Progressive home insurance and auto insurance elsewhere. We see them as future Robinsons, hoping they will choose us for their home insurance and join our Robinson family. The Robinsons are central to today's discussion and our Destination Era strategy, focusing on the auto-home bundle. They constitute 40% of the market, and we’re excited about the progress we've made in acquiring more Robinsons over the last 18 months. Before diving deeper, I want to take a moment to address some objectives and core principles that will remain unchanged during my leadership. I've been part of the team that shaped the Destination Era strategy under Glenn's guidance, so adopting a different approach doesn’t make sense. I believe in this model, and the execution has been solid, inspiring confidence about our future. However, evolution is natural as we gain more experience. Let’s start with our top priority: profitability. We strive to achieve at least $0.04 of underwriting profit for every $1 of premium. This goal, referred to as 96, is ingrained in our culture. You are currently in Studio 96, a testament to how essential it is to our operations. This objective will remain unchanged, though we are also optimizing margins within the auto-home bundle. While the 96 target won't alter, the means to achieve it will evolve. On growth, we aim to expand as rapidly as possible, but there are two constraints: our profit objective and our capability to service our customers, which we take very seriously. About 18 months ago, we launched our 8.3 model and identified an opportunity to increase advertising, especially digitally, when competitors stepped back. We decided to hire in anticipation of future needs, which has proved beneficial as we've seen growth in preferred customers and been able to respond to unexpected events like catastrophes. Progressive adheres to a guideline where, on both the claims and product sides, if you believe we’re growing too quickly, you must voice your concerns. In the past, we’ve had to slow down growth, but I’m pleased to report that this year we didn’t have to, thanks to our proactive hiring strategy. As of August, we recorded a 96.2% net written premium growth. Should the year end today, it would be a remarkable performance given the business we’ve accumulated. I’m very satisfied with this growth and consider it a perfect storm of favorable conditions. This year, we’ve faced challenges like natural disasters, which added about 3 points to our combined ratio compared to 1.5% last year. In fact, due to the storms in Louisiana, we saw our combined ratio rise by over 4 points. While we can't predict these events, we can prepare for how we respond. I’m exceptionally proud of our team’s response during the Louisiana storms. Just a few weeks ago, we visited Lafayette and Baton Rouge to ensure our employees and customers were alright. I was impressed with how our CAT team quickly organized to assist customers. Even employees affected by flooding came to work to help others. As of yesterday, we have managed to close 96% of those flood claims, which is remarkable given their complexity. As for Hurricane Matthew, we have our plans in place and are ready to adapt. To summarize, I’m extremely satisfied with our profit and growth, especially as we expand our preferred business with the Robinsons, a key focus for today’s meeting. I also want to briefly touch on our financial fundamentals, which will remain stable with our business plan. We aim to balance operational risks with investment financing risks to ensure we have enough capital for growth. Operating principles include maintaining pricing and reserving discipline. We analyze pricing targets in detail, so we’re excited when new business aligns with our goals. We want our premium-to-surplus ratios to stay at or below state minimums, and we’re doing well in loss reserving—year-to-date, we’re in a favorable position. For investments, our goal is to maintain a liquid and diverse portfolio, focusing on total return, and managing associated risks. We also aim to keep our debt below 30% of total capital, and we're currently just above 28%, following a recent $500 million debt issuance. We are committed to offsetting dilution from equity compensation by repurchasing shares. Lastly, we will invest in opportunities that align with our objectives, such as our acquisition of ARX, which provides access to the $300 billion market for auto and home insurance. We’re pleased with our capital allocation in this acquisition, and we will utilize underleveraged capital for share buybacks or dividends as appropriate.

Thanks, Tricia. So last year, when we talked, I laid out 3 key strategic priorities for our Personal Lines business. And those are: Restoring growth in agency, increasing our bundled penetration and ultimately, advancing our product development cycle. I want to give you updates on all 3. And what we'll do is start with an overview of the market from an overall channel and market size perspective. As Tricia mentioned, U.S. personal auto and home is rapidly approaching a $300 billion market. And when you look at the independent agency share of that, it's a little more than 1/3, or about $100 billion of home and auto premium. And despite the fact that technology adoption has been rapidly increasing the growth rate for direct distribution of personal lines products, the independent agency channel continues to grow premium. And that's due in part to broad distribution of their footprint, but also a great value proposition from a breadth of products offered and depth of carrier choice available. When you look more specifically at the homeowners market in the U.S., it's about a $90 billion market, and that's about 90% sold through agents, more than 40% through independent agents. And as the #1 writer of auto insurance through the independent agency channel, we believe we're incredibly well-positioned to leverage our strength in the channel, combined with ASI's property offerings, to become the #1 writer of auto and home insurance through the agency channel. Last year, I told you that restoring growth in agency was a top priority for myself and lots of other folks within our Personal Lines organization. So today, I'm thrilled to show you some information that after our business shrunk slightly into 2014 and barely recovered into 2015, we've turned that agency business around from a size perspective. And at this point, our agency auto business, as well as ASI's homeowner business through independent agents, have both never been larger. And if we zoom in on what's driving that auto improvement, we look primarily to start with at new business apps. New business growth is the lifeblood of a growing organization like Progressive. And as you see on the screen, midway through 2015, we turned new business positive on a year-over-year basis within the agency channel. Our new business growth continues to be up in the double digits on a year-over-year basis ever since. New business growth originates from 2 primary metrics. The first is demand, so quoting. The second is conversion. And our improvements in the agency channel are driven by just about equal parts of both, which indicate to us: number one, we have a more competitive product in market; but number two, that more competitive product is inducing agents to come to us more frequently to meet the needs of their clients. An absolutely fantastic combination within the channel.

Thank you, Pat. Good afternoon. It's been some time since we provided an in-depth update on Snapshot, our usage-based rating program. We have a new model available in the market, which I'll discuss, as well as explain why Snapshot is such a significant asset for Progressive. This year, we will introduce a new mobile delivery mechanism for Snapshot, and I'm eager to share our rollout plans and the expected advantages of this development. Additionally, there's a valuable benefit that comes from Snapshot, which is our enhanced big data management and analysis capabilities. These developments are yielding benefits across our organization and could serve as a competitive advantage moving forward. As you know, Progressive has a strong history of innovation, and Snapshot is a product of that legacy. We began by installing devices in some cars in Texas, which helped us validate the concept. Thanks to advancements in technology, we've been able to create devices that connect directly to car systems, albeit with early connectivity challenges. We previously relied on our customers to connect these devices via their desktops, which proved to be cumbersome. The breakthrough came when we managed to reduce the size of the technology and lower transmission costs, allowing for nearly real-time data transmission, a precursor to what we now recognize as the Internet of Things. We're preparing to move into the mobile space shortly, which I will elaborate on later. Ultimately, the ideal model for Snapshot targets direct data collection from vehicles rather than requiring a separate device or phone. I'm pleased to report that we are currently in partnership with General Motors, the only manufacturer with this capability at present. While it may take time for this model to become widespread, we are excited about this collaboration, and I will provide further details soon. As technology continues to advance, the volume of data generated from it doubles more frequently. Currently, we have 2.2 trillion records in our Snapshot database. To put that into perspective, those records can be visualized as rows in a spreadsheet, with data fields expanding thanks to GPS data that we’re collecting for research, even though we don't currently use it for rating. When mobile functionality is introduced, the amount of data we collect will increase dramatically. This data surge presents both challenges and tremendous opportunities, which I will discuss shortly. Before diving deeper, let’s ensure everyone is up to speed on Snapshot. We currently operate two models: the 2.0 and the 3.0 models. The 3.0 model has rolled out alongside version 8.3. In the 2.0 model, we did not provide an upfront discount when customers opted into Snapshot; they would agree to the program and receive a discount based on their driving behavior after 30 days. If they drive well for another five months, they would lock in that discount for their time with Progressive. In the 3.0 model, we now offer an upfront participation discount that varies by customer segment, which I will explain shortly, and then customers drive for six months to lock in their discount or potential surcharge. This marks a significant change with the 3.0 model. In the 2.0 model, we focused on establishing consumer acceptance of the concept, and we saw positive results, as consumers are now more willing to opt into the program, even with the possibility of a surcharge. In the 2.0 model, approximately 60% of customers who participated received a discount, while in 3.0, around 75% benefited from a discount, with over half receiving discounts greater than 10%, which is substantial in the auto insurance market. I wanted to give you some context on the various models as we discuss the results. Overall, we're seeing encouraging results. New app numbers are increasing, though I can't solely attribute this to Snapshot since the 3.0 model launched simultaneously with 8.3, where many changes were implemented. However, we are seeing a rise in new Snapshot apps, and agency apps have increased even more significantly. Adoption of Snapshot by agencies has been a challenge for years, but offering an upfront participation discount has significantly helped in this area. As Pat noted, adoption heavily depends on comparative raters in a somewhat competitive environment; the more competitive our rates are for new business, the higher the chances of attracting customers to Snapshot. Participation discounts vary by customer segment, ranging from about 2% for some segments up to approximately 6% for others. This discount is not solely reliant on marketing targets but represents the average discount across segments. Unsurprisingly, conversion rates are better on the preferred end of the spectrum. Even with the 2.0 model, Snapshot customers had a higher conversion rate than those not in the program. The trend continues with 3.0, showing a greater gap in conversion rates on the preferred end, where the participation discounts are more substantial. When analyzing new apps by customer segment, there is some bias toward preferred segments, but the growth slope in agency business is steeper, indicating greater engagement from preferred customers. Pat and Tricia mentioned that the Robinson segment is the largest available in Personal Lines, yet we have the lowest market share in that segment. Therefore, attracting more customers in this category is crucial for us. It’s worth mentioning that usage-based rating is becoming broadly accepted. For instance, the percentage of 18 to 22-year-olds opting into Snapshot is comparable to those aged 55 and above. While there’s still room for growth in acceptance, the current levels are promising. If I haven’t convinced you yet, let me reinforce that Snapshot is significantly impacting our preferred customer acquisition and overall growth. I often get asked for numerical evidence of this impact. Here are some key points: it’s the most influential rating variable we’ve encountered, and with the 3.0 model, it’s even more predictive of losses than the 2.0 model, which was already superior to any other rating variable we’ve analyzed. Since we launched Snapshot, we’ve provided more than $0.5 billion in discounts to customers, which raises the question: how does this benefit Progressive? To clarify, I’ll refer back to a chart we shared in 2012 that illustrates the loss ratio and retention rates across different discount levels for Snapshot customers. The chart shows how the loss ratio improves as discounts increase, with non-Snapshot customers representing a robust base for comparison. Customers receiving a 0% discount, which included some surcharges, had the highest loss ratios. Additionally, customer retention was significantly lower for those expecting a discount but not receiving one. Not surprisingly, the most profitable customers tend to remain with us, while less profitable customers, often those who leave, gravitate to competitors. This is beneficial for us, as many competitors are not adequately priced to accommodate these customers. Regarding 3.0, customers with lower performance who are not being surcharged see improved loss ratios, while better drivers continue to enjoy higher discounts. Overall, Snapshot is aiding in attracting more preferred customers and enhancing our rating segmentation and management of risk selection. I hope these points were clear.

Thank you, John. I have the pleasure of speaking to you today on 2 topics. The first half of the section will be on retention, and I'm going to tell you about the improving momentum we see with our retention. And then in the second half of the section, I'll provide an overview of our customer marketing initiative and I'll describe the advanced analytics we're applying to this problem, as John Sauerland alluded to. So first off, I want to just reiterate our preferred retention measure, which is Policy Life Expectancy or PLE. PLE is the average length of time we expect a new policy to stay with Progressive. We calculate PLE by first calculating our retention decay curve, and then we take the area under this curve to get our PLE statistic. That retention decay curve can be calculated multiple ways depending on the trade-off in responsiveness versus stability that we see. Our standard measure is to use 12 months for each point along that curve. That is our trailing 12 PLE that we've always reported out. We also calculate a trailing 3 PLE starting in 2014. That trailing 3 PLE uses the most recent 3 months along that retention decay curve. So it's more responsive to more recent observations. Just some notes on the PLE calculation. The first 60 months represent actual data that we've recently observed and between months 60 and 300, we use an extrapolation. And we've seen all policies end after 300 months, which is a conservative assumption. We think the PLE statistic is accurate for a number of reasons and I'll highlight one of those today. We think it removes any tenure bias. So if we use simple retention rates, as our book of business ages, all else being equal, we think we'd see higher retention rates and that would be although that retention curve didn't shift. So using the PLE calculation removes any tenure bias from our statistics. So with that background, I wanted to give you an update on the current progress with trailing 12 PLE. I'm happy to report that we've seen very positive PLE growth in 2016. We are up 6% year-over-year. 6% year-over-year, there we go. This is the largest increase since 2009 and as Tricia said on our last quarterly conference call, for every one month of PLE, we see $1.5 billion in additional lifetime earned premium for the company. We're also pleased that we're seeing similar percentage increases within our agency channel and in our direct channel; and direct is at an all-time high. While we're really pleased with the overall momentum we see, we're even more pleased with what we see with our Robinsons in the Destination Era. For our Robinsons, PLE is up 17% over the past 3 years. And in the past 12 months, we're up 9%. So just great momentum that we're seeing with the Robinsons. As Tricia alluded to earlier, the Robinsons are now 3x greater and yearly 3.5x greater than our Sams for PLE. We'll also be adjusting the PLE calculation in the coming months. We haven't updated that extrapolation for a while, and we're seeing better retention in that tail of the PLE curve than we've seen historically. And so when we update the PLE calculation, overall PLEs will go up by more than 2%, and for our Robinsons, it will be even higher. Our Robinsons are disproportionately represented in the tail of the PLE curve. This means that we'll have even more opportunity with our Robinsons. We'll be able to acquire them more aggressively, and we'll be able to bundle our current customers more aggressively.

We hope it's evident how bullish we feel about the future. Clearly, last year, Pat stood up here and said his primary goal, our primary goal, is to restore business in the agency channel. We didn't just restore it; it's at the highest level ever. We continue with our segmentation of more and more product models and having deeper segmentation at the quickest amount of time ever. So we really think that's a competitive advantage. And our bundled PIFs have grown 20% to 30% across channels. John Sauerland talked about our most important variable, our UBI or usage-based insurance, so Snapshot, and how we're continuing on that evolution and how with that work we've actually had even more data capabilities across the enterprise that we believe will be a winning strategy for Progressive. Andrew Quigg talked about PLE. We finally made that breakthrough in PLE, especially in the Robinsons segment. Andrew talked about the massive amount of customer data that we have and how we're going to use that data to understand the moves of our customers and be out in front of that, give them a reason to stay. John Barbagallo talked about the fact that we're outperforming our peers relative to profit and growth, so that's extraordinary. Bottom line is though, we have to respond quickly to our frequency trend, and we're doing that with rate. John has his own era coming up in terms of the direct business with small business owners as well as technology and data-driven technology in the commercial space. I hope you're thrilled as our team is about what we've executed upon and what we're going to be doing in the future. And I want to thank you for your interest in Progressive. So with that, I will ask John Sauerland to join me for some Q&A.

So my first question is in terms of the 96% margin target. The way you spoke about it today, seems like a company-wide goal. From the last conference call, you kind of spoke as the homeowners focus not necessarily included in that 96% target for now. So if you could just clarify that. When you look at the 96% goal versus the 96.2% year-to-date, is that company-wide goal? Or I thought for the time being, you were excluding the homeowners portion of the business.

Yes, Ian asked that question during the conference call. I corrected myself. I was thinking from a gain share perspective. It is a 96% across all products, including homeowners.