Progressive Corp (PGR) — Q2 2017 Earnings Call Transcript

Thank you, Leanne, and welcome all to our second quarter remote investor event. As we announced in May, our quarterly investor events will now begin with a 30-minute presentation and be broadcast via live webcast. Today’s presentation topic is vehicle technology and shared mobility’s influence on the auto insurance industry. The presentation will last approximately 30 minutes and be followed by Q&A with our CEO, Tricia Griffith; our CFO, John Sauerland; our guest speaker today, John Curtiss, our Personal Auto Product Development Leader; and Bill Cody, our Chief Investment Officer will also be joining us by phone. The event is scheduled to last 90 minutes. As always discussions in this event may include forward-looking statements. These 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 the event. Additional information concerning those risks and uncertainties is available in our 2016 annual report on Form 10-K, where you will find discussions of the risk factors affecting our businesses, Safe Harbor statements related to forward-looking statements and other discussions of the risks, uncertainties and other challenges we face. These documents can be found via the investor page of our website, progressive.com. It is now my pleasure to introduce to you all our CEO, Tricia Griffith.

Good morning and welcome back. We've made some changes to this quarterly webcast for a couple of reasons. First, we want to provide you with deeper insights into topics that we believe will interest you. Second, we aim to showcase talent within Progressive that you will see more frequently than just once a year, as we did in the past. We welcome your feedback and hope you enjoy the webcast. Let me provide some context. Four years ago, John Curtiss conducted a thorough examination of the industry regarding trends and vehicle technology, and we believe it’s time for another deep dive, particularly focusing on our opportunities as the environment continues to evolve. John will lead this deep dive today, primarily centering on auto insurance. At Progressive, we consistently ask ourselves if we can grow profitably within the industry. We're optimistic about the market and our opportunities, and we believe the answer is yes. The charts you'll see outline a 30-year trend for a long-term perspective, along with a short-term view based on the last four years. Starting with the top left chart, it reflects the revenue potential in the private passenger auto market. Both the long-term and short-term trends indicate ongoing opportunities. In fact, the short-term trend shows over a 4% increase in the private passenger auto market over the last four years, aiding our continued growth at Progressive. Various factors contribute to this market growth, as illustrated in the top right chart, which shows the number of vehicles in the United States rising in both the short and long term, despite some fluctuations due to economic conditions. We carefully monitor trends, particularly severity and frequency. The severity of claims has increased for both the long and short term, with the last four years showing a rise of about 0.5 points over the long-term trend. This reflects advancements in car technology and rising repair and medical costs outpacing inflation, allowing us to factor these severity trends into our pricing. Conversely, frequency has gradually declined over the past 30 years at about 0.7% yearly, although it has seen a slight uptick in the last four years, influenced by macroeconomic factors which we observe but usually do not incorporate into our pricing. This context highlights the substantial growth opportunities we believe exist for Progressive, especially as the market continues to expand. The following insights showcase our combined ratio against industry averages and our market share. The orange line represents our statutory combined ratio over the last two decades, with our goal of achieving at least $0.04 of underwriting profit for every dollar received. Over the past 20 years, we've only exceeded a combined ratio of 100 once, and often remain below a 96 combined ratio. The industry’s average, marked by the dotted line, has consistently trailed our performance, showcasing a widening gap in recent years. The blue line indicates our growing market share. We've successfully leveraged our market position in recent years, and our commitment to maintaining a disciplined approach allows us to grow while achieving a 96 combined ratio. This chart illustrates the overall property casualty industry. The white segments represent revenue opportunities across different areas, with the blue slice indicating Progressive's market share. Today, we will primarily focus on the personal passenger auto segment, particularly the significant $250 billion opportunity where we currently hold less than 10% market share. We believe there is substantial potential for growth. Our ability to bundle auto and home offerings enhances our auto product line, supported by a strong brand. We’re optimistic about capturing additional market share in these areas. Later, I’ll revisit this chart to discuss home and commercial insurance. During the last quarterly call, I briefly explained how my team and I approach investments in the short and long term, referring to these as Horizons, a model inspired by McKinsey. The first Horizon, Execute, focuses on efficiently implementing the plans we've developed in recent years, like bundling auto and home insurance, which aligns with our aim of becoming the top choice for consumers regarding auto and other insurance. Significant investments include the acquisition of ASI, which provided access to new agency customers, as well as enhancing our support for agents through a new commission structure called Paths to Partnership. Our focus on the in-house agency, the Progressive Advantage Agency, has also expanded from 25 to nearly 400 consultants, showing our commitment to growing our product offerings and servicing customers effectively. Last year, we launched HomeQuote Explorer, aligning with our goal of making it easier for customers to shop for home insurance, which we know is often done online or via mobile devices. By investing in technology that simplifies this process, we can further bundle products with auto insurance. We believe there is significant potential for growth in the Execute Horizon over the next five to ten years, but we must continue investing for the future. The second Horizon, Expand, focuses on our core competencies including segmentation, service, brand, and cost structure, as we explore investments in adjacent products, like business owner’s policies as discussed by John Barbagallo in October. The third Horizon, Explore, requires us to invest in future needs and technology, even if current products and services may not exist. This is critical for us as we aim for Progressive to remain viable for decades. We must balance investments across all three Horizons concurrently for continued business success. To illustrate this approach, I will discuss the evolution of our product, Snapshot. Our journey began in 1997 with Autograph, which was an early attempt at capturing driving behavior but was not commercially viable. Over time, we learned from different iterations, moving through TripSense, MyRate, and ultimately rebranding it as Snapshot by 2010. In December of last year, we introduced a mobile app option alongside the Snapshot dongle, expanding our reach with nearly 30 million miles of data accumulated from customer trips. We are learning a great deal about user behavior through this app, which informs our future efforts. Looking ahead, we are excited about the ongoing relationship with GM for direct customer acquisition via their OnStar program. This process reflects our long-term investment strategy and adaptability. To sum up, not every initiative in our third Horizon may succeed, but recognizing the potential for innovation is essential. Our objective is to ensure the long-term sustainability of Progressive as a business, and we are enthusiastic about that future. Now, I invite John Curtiss to provide deeper insights into the industry's current state since our last meeting.

Thank you. Thank you for having me today. So I plan to share our point of view on the growth outlook for the private passenger auto insurance market over the next 10 to 15 years. As you may recall, we stated back in 2015 that we fully expect to see real modest growth over the longer term in what was then approaching a $200 billion marketplace. In 2016, the industry was up to $215 billion in terms of direct written premium, and we’re off to a good start in terms of growth this year. So the question is what do we think that the next 10 to 15 years has in store for our business? When we look at our models and when we have internal conversations, we continue to forecast modest levels of growth in real terms for the industry over this time period. So today I’m going to share a little bit more about the 3 growth factors that Tricia discussed earlier, the fleet size, frequency and severity, and also how we’re thinking about key trends such as vehicle technology and shared mobility. But before I talk about the future, I want to talk a little bit about the past and take a quick trip down memory lane. Because as Tricia pointed out, I presented on a similar topic back in 2013. At that point in time, I shared our framework for how we were thinking about the effect that vehicle technology could have on accident frequency. Headlines were full of pretty aggressive claims around the timing of self-driving cars. Google was predicting them within five years for ordinary consumers, and some auto manufacturers were making similar claims. While these predictions have not yet come to fruition, our goal was to take a really analytical approach to the problem and figure out how to best respond. As Tricia pointed out, when you look at frequency, there is a long history of negative trend, likely driven by factors such as having safer cars, the introduction of the seatbelt, antilock brakes, electronic stability control, safer roads, safer infrastructure, tighter enforcement of drunk driving, graduated licensing programs, and many others. Based on what we were seeing in history and our understanding of these new technologies, their effectiveness, and fleet penetration rates, we were actually forecasting a continued decline in frequency in the future. But reality has been really different, and our models at that point were too conservative. Whether it’s been from consumers driving more due to lower gas prices or an improved economy, or increases in distracted driving, frequency has actually increased over the last few years. Our models certainly aren’t perfect, and I guarantee you the next time we give the update, they’ll have changed again. But they are really helpful in that they guide our thinking. What’s really important is that we continue to take a very disciplined view of the key trends that will shape our industry going forward. The growth and increased investment in vehicle technology and shared mobility models could evolve personal transportation in a variety of directions. We are thinking about the opportunities and considerations these various segments will create for Progressive. So let’s discuss some of the segments that we’re sure will expand over time with future updates. We continue to focus pretty heavily on the lower left-hand quadrant, those are personally owned driver-driven vehicles. It’s the majority of the fleet and as Tricia pointed out, our personal auto business is growing quickly and with less than 10% market share we feel really good about our growth prospects. We’re also starting to make investments in the lower right-hand quadrant, referring to this as shared usage or shared ownership and driver-driven. The primary example here would be ride-sharing. While we estimate that this is still a small segment of the overall vehicle mix, we believe that it will continue to grow. On the commercial line side, we have a relationship with Uber and a pilot underway in the state of Texas. On the personal line side, we’re modifying our policy contract to include an endorsement to insure the drivers of those vehicles. The autonomous segments you see in the upper row are currently a Horizon three focus for us, and we will continue to think about how to best tackle these opportunities as we learn more. Next, let me talk about these key trends from a personal auto perspective in a little bit more detail and the impact that we think it will have on fleet size, our frequency, and our severity trends. Let’s talk about fleet size first. As Tricia pointed out, it’s been growing at about 1.3% per year over the long-term and actually a little bit more quickly in recent years. If we break that down, we do see a steady increase in the number of licensed drivers in the United States, and we believe that this will continue to grow as our population expands. We’re also seeing a gradual increase in the number of registered vehicles per driver. This is good news, not only in terms of growing the fleet size but also indicates that consumers are not giving up vehicle ownership. Looking at this from a generational perspective, there has been discussion about whether Millennials and future generations will have a different attitude toward car ownership. A recent report by J.D. Power indicated that Millennials are now one of the fastest-growing car buying segments in the United States, and a second report by Kelly Blue Book and Auto Trader indicated that within Generation Z, the future drivers of America, 92% indicated that they plan to own a vehicle. As a result, we generally feel good that the vehicle fleet will continue to grow at a similar rate to historical levels. However, we acknowledge that some suggest that people will forgo vehicle ownership and move more toward shared mobility models. We are tracking some indicators to see what changes are emerging. The first metric we’ve been looking at is the household vehicle ownership rate. This represents the percentage of households in the United States that indicate they own at least 1 vehicle. This data comes from the U.S. Census Bureau’s American Community Survey. When comparing 2009 to 2015, which is the most recent year that we have data, the ownership rate at the national level is unchanged at 91.1%. We also looked at the statistic for major metropolitan areas, believing shared mobility is most viable. We see that in some metro areas, the ownership rate is higher while in others, it’s slightly down. But at this point, we’re not seeing a consistent pattern and any dramatic decreases. If we do see an impact, we think it will be in the most urban areas of the United States, where the cost of vehicle ownership tends to be higher. But also keep in mind that in these areas, the aggregate vehicle ownership rate tends to be a little bit lower. So the overall impact should be relatively small. We’re also looking to see if there are changes in how consumers use their vehicles. The Census Bureau tracks how people commute. What the graph shows is that commuting patterns are largely unchanged during this time period. In fact, the percentage of commuters driving alone in their own vehicles has actually slightly increased across all age groups. Our general view on shared mobility at this time is that the majority of consumers will use ride-sharing and other types of services as a supplement to owning a vehicle but not necessarily as a substitute. However, we do think that ride-sharing and these new services will continue to grow and will continue to compete with taxis, car rentals, and other forms of public transportation. Many taxi medallion prices have decreased by as much as 50% in certain cities. In others, there are more Uber and Lyft drivers today than taxi drivers. Recent articles have also suggested that the growth in ride-sharing makes it harder for traditional car rental companies to grow. Who will ultimately win? We don’t know. But for now, these vehicles will need to be insured and therefore do create new opportunities for us, primarily in the commercial side but also in our private passenger auto business. As I mentioned earlier, we do have a relationship with Uber and a pilot underway in Texas, and we are making some changes to our product to insure these drivers. Next, let me give a quick update on vehicle technology and the potential impact on claims frequency and severity. Similar to all of you, I receive many alerts on this topic every day, and the headlines have a wide range of predictions on how the future could unfold. Some believe that with the continued advancement in technology, self-driving cars are right around the corner, while others believe it will be a long time to program a car to effectively drive in all the conditions and situations that are a reality on our roadways today. One thing we know for certain is that investment levels are significantly growing, and whether or not we get to full autonomy, we will see more vehicles equipped with these safety technologies and it is really important for us to understand the implications for our business. From a product design perspective, pricing perspective, and claims handling perspective. Let me give a quick update based on our observations regarding the evolution of these technologies, their effectiveness, and fleet penetration. I’ll start with the evolution. The chart represents the standard format for how we think about levels of automation. They range from Level 0, which is no automation, all the way up to Level 5, which would be your fully self-driving car. Today, we estimate that the vast majority, more than 95% of cars on our roads, are still at level 0. What we are beginning to see is a gradual shift to Levels 1 and 2. Level 1 represents Driver Assist technologies, examples include auto-braking or lane-keeping technologies. These were first introduced back in 2006, and we estimate currently represent less than 5% of the fleet, probably closer to 1% to 2%. We expect the mix of these vehicles to increase as auto manufacturers have agreed to make technologies like auto-braking standard on new vehicles by 2022. In terms of Level 2, this is Partial Automation and is also beginning to emerge. This was first introduced back in 2014, with Tesla and their Autopilot. Currently, it represents just a small mix of the fleet, but we’re paying close attention. We do know that General Motors is planning to introduce Super Cruise, which is a similar technology expected later this fall on the Prestige package of their Cadillac CT6. What’s common at these levels is the driver is always responsible for operating the vehicle and monitoring the environment, so the key requirements for success are having really good technology and consumer demand or consumer willingness to pay. Research shows that consumers are getting more comfortable with these technologies, but they will turn them off if they find them distracting. We want to learn more about how consumers interact with these technologies. Moving on to Level 3, Level 4, and Level 5, the equation gets much more complex as the driving system itself starts to take over. The deployment or availability of these vehicles will not only be dependent on technology or consumer demand but also require changes to our regulations, legal code, and how we approach insurance. As algorithms become more responsible for the operation of the vehicle, we need to ensure that mechanisms are in place to guarantee data privacy and security. We’re primarily seeing testing of these vehicles. We’ll continue to see more testing but they are not yet available for commercial sale. On Level 3, Audi has recently announced plans on their A8 model to introduce a product called Traffic Jam Assist. This technology would operate autonomously under 60 kilometers per hour on a divided highway, but outside of that mode, the driver has to be ready to take over and ensure the safe operation of the vehicle. The challenge at this level is how do we keep the driver engaged and how do auto manufacturers guarantee an effective handoff between driver and vehicle? Some auto manufacturers will pursue this level, while others might go directly to Level 4 because of the risks inherent with that driver vehicle handoff. Level 4 is an example where the vehicle could drive autonomously in highway mode. Auto manufacturers like Honda, Toyota, and Volvo are working to introduce this type of technology by the early 2020s, and perhaps even earlier according to Tesla. Finally, Level 5 refers to the Fully Autonomous vehicle, and I don’t have specific dates on this level. Given the cost and complexity of the technology, our current view is that the first applications of these types of vehicles will be in commercial settings, in ride-sharing, or self-driving taxis confined to specific geofenced locations. Now let’s discuss effectiveness. Certain technologies such as auto-braking and blind spot warning show strong evidence for reducing frequency. The impact varies by coverage. For instance, the decrease in frequency is more significant in property damage than in a coverage like collision. This is because one type of coverage — property damage — largely involves accidents that this technology was designed to prevent. The other type of coverage tends to involve a mix of accident scenarios, so the impact might be lower. These technologies are often sold in packages, making it challenging to understand the effectiveness of each individual technology. We’re working hard to understand the specific technologies present on vehicles showing the most promise in reducing frequency so we can incorporate that into our pricing. Moving on to severity; some data is not credible, marked with an asterisk. However, where the data is credible, we see severity slightly higher on damage coverages. We expect above-average inflation rates for replacement cameras, sensors, and headlights. We believe more OEMs may require scans to certify that these replacement parts are working properly, which can add $200 to $300 onto a claim. Another question out there is whether accidents will be less severe for vehicles equipped with those technologies. Honestly, we don’t have a good answer yet, and it’s something we’ll need to understand better as we gain experience with these claims. Today, we’re making pricing adjustments for certain technologies, like auto-braking, where we can confirm the tech is on the vehicle. We plan to implement new product features in future model releases allowing us to expand our ability to segment for more technologies over time as we acquire data and grow more comfortable with it. Lastly, on vehicle technology penetration, we continue to see slower penetration for technologies such as Ford Collision Avoidance when compared to prior technologies like electronic stability control or antilock brakes. These new technologies are more complex as you’re designing something that will steer a vehicle or potentially stop or accelerate it. They tend to start as optional features on luxury models or higher-end trims. It has taken well over a decade for manufacturers to agree on making technology like auto-braking standard on new vehicles, so penetration curves will start slow before increasing rapidly. Though we still have a considerable time until fleet penetration rates reach 50%. If these technologies continue to penetrate at historic rates, the impact on our annual frequency trend will be gradually incremental. Let’s take a hypothetical example; suppose a technology can ultimately reduce frequency by 15% when fully deployed. Based on our experience, it may be less than 5% penetration during the first decade, ramping up to 50% within 20 years, and approaching 100% over 35, 40, or 45 years. If we make these assumptions, the annual impact on our trends will be small, perhaps 0.5% per year. Therefore, we understand the need to evaluate not only the effectiveness of the technology but also penetration rates. A significant question is whether future technologies will penetrate faster than traditional ones. We must consider the fleet turnover rate — the average vehicle age on our roads is currently 11.6 years, two years higher than the average in 2002. The pace of technological advancement, the vehicle manufacturers' speed in getting new technologies onto cars, or using existing technologies play critical roles. If autonomous highway mode starts at a $10,000 enhancement, it could make sense in luxury markets. However, tracking how quickly technologies migrate from optional to standard across models will be significant. Finally, as we discussed before, with the shift to Level 3 and higher automation levels, legal considerations and data security will also need careful attention. As we compile all this together, numerous possible scenarios emerge, and the level of certainty around our forecast decreases as we look further into the future. I want to acknowledge that there have been periods, such as after 2006 during the recession, where the industry did not see real growth, and that could happen again. Our models don’t necessarily capture hard markets, soft markets, and macroeconomic changes. However, based on our discussions today, we foresee modest growth potential in real terms for the industry over the next 10 to 15 years. Regarding the fleet, we expect slow growth with minimal shared mobility impact except in the most urban areas of the United States. Frequency, while my prior predictions were off, I believe these technologies will gradually penetrate the fleet and exert downward pressure over time. With respect to severity, our current outlook is that trends will continue to outpace inflation. The range of outcomes reflects greater confidence in the dark shaded area than the light shaded area on that graph. As I wrap up, I’d like to reiterate some actions we’re taking in our personal auto business to address these trends. We are continuing to roll out our product and underwriting models with positive results. We’ve begun implementing pricing actions for particular safety technologies. Our plans to introduce new features enabling further segmentation over time are also underway. We continue to collaborate with external data partners to gather detailed vehicle information. Leading in the usage-based insurance domain is a priority for us. As Tricia mentioned, we are expanding our mobile product to additional states. We are performing research on distracted driving to see how new variables may fit into our scoring algorithm. We are testing ways to provide better consumer feedback to improve driving safety. We are evaluating methods to identify third-party data opportunities, helping us to broaden our Snapshot product, so we can better segment our offerings. And perhaps most critically, we seek to remain flexible and agile, so we can respond to opportunities as they arise. That’s all I have for today. Thank you very much for your time. And now I will hand it back over to Tricia.

I’m going to bring you back to this slide that we started with, which really highlights the opportunities in the overall P&C market. If you go to the pie underneath the $215 billion auto opportunity, we have about a $91 billion home opportunity, which we’ve made a lot of our investments in. That auto-home bundle is vital to our customers and the retention of those customers. We’re excited about the homeowners opportunity; it's at $91 billion, as I said. From the captive agency, independent agency, and direct channels, if you look just primarily at the areas with the most access, the independent agent and direct channel, that’s a $63 billion opportunity. So a lot of opportunity exists; we currently have only 1% of the property market. Together with that over $300 billion opportunity in personal lines, we believe that we are positioned to continue to grow. During the November session, the deep dive will cover all things property, so we look forward to that. Under personal lines, there’s another $300 billion opportunity on the commercial side. We are already the number 1 writer of commercial auto while holding less than 8% market share. Hence, we still have room for growth in that area. The other opportunities on the commercial side will be investing in and discussing in greater detail at a future date. Overall, when you step back, the entire P&C industry represents over a $0.5 trillion opportunity, and we believe that we can significantly increase our share in every single one of those segments. What we know from today and from what John talked about is that our industry is dynamic and will continue to evolve. That excites us. We embrace change, and we believe that companies that succeed are those that remain agile and continually adjust their models to adapt to change. We’re excited about the contribution we can make to both growth and long-term sustainability of Progressive. Thank you for joining us today. We’re going to set up for Q&A, so just give us a few minutes.

Thank you, Leanne. We will begin with the questions submitted by webcast participants to give folks on the phone the opportunity to dial in and talk to the operator. The first question from the webcast is can you help us understand what’s driving growth in the agency channel? Is it Platinum and The Robinsons, or something else? Platinum is definitely a part of it. We continue to increase our mix of preferred business. Platinum, although still a small part of it, is growing. As I outlined in my letter, it’s becoming a bigger part of it, and we believe will continue to grow. That’s the short answer. The longer answer is that during 2016, when rates were increasing, we had to increase rates. We didn’t have to as much as our competition. There was a lot of shopping in the agency channel, and we witnessed stronger quoting and conversion from our agents. We have a preferred product that we launched several years ago, called 8.3, and we’re now into our 8.4 model, which has yielded better results. So we finally understood that preferred customer, ensuring we have the right rates for them. Also, agents appreciate our ability to service our customers, both on the policy side and the claims side. The local presence is critical to our agents, and they often refer to that when discussing our combined efforts.

Yes, we’re feeling really good about our model results in both 8.3 and 8.4. Our loss ratios are looking really good. We’re satisfied with the business mix we’re writing, and we are finding ways to develop our models quickly and deploy them effectively. Getting new segmentation to market has been a major initiative for us, and we believe we are executing well.

My first question was about your recent margins. In June, you saw sequential improvement for the first time in over 10 years, comparing June to May, along with a year-over-year improvement in your underlying loss ratio. What was the year-over-year improvement?

We’ve definitely changed our mix. That’s something we’ve noticed as we write more and more preferred business. We also have some underwriting to ensure we get the right rate for each customer. I discussed frequency during my presentation, which has risen recently. We've actually seen a slight decrease in frequency in the last quarter, which we believe is contributing to our expanded margins.

I have a couple of questions on the homeowner side. You provided a slide showing that you have low market share. Do you have a market share goal for expanding on the homeowner side? Also, could you update us on your property catastrophe reinsurance coverage and any significant changes made this year versus last year?

Yes, I’ll ask Trevor to elaborate on the reinsurance aspect. We aspire to operate similarly in home as we do in auto — to grow as swiftly as we can while achieving target margins. Our first step was aligning our sales force from ASI and Progressive to adequately service agents with both home and auto or monoline auto. That has been resolved, and we’re excited about the momentum. We are also expanding into many states; we’re in 41 states now with ASI or Progressive Home, and we’ll be bringing more offerings to many states and agents. Our goal is to continue growing rapidly on the home side, as long as we achieve target margins. We want to have bundle customers, as we know that they last longer. That’s really important to us. We work seamlessly with the ASI product team to ensure we’re putting the right products in the market with the right rates for individual risks we see. Regarding reinsurance, we made changes this year, adding to our reinsurance plan with our aggregate stop-loss agreement, which provides $200 million worth of coverage whenever our loss plus a loss equalization goes over 63, excluding liability or named storms. That’s working as planned this year with our catastrophes. Trevor, would you like to speak more about the reinsurance plan?

The catastrophe program we have outside of the aggregate stop-loss is very similar to previous years. We’ve always preferred a program that can protect us for at least two one-in-a-hundred-year events in any given year, and this year follows the same pattern. We have a multi-event structure that provides coverage beyond the first couple of events.

Thank you, Trevor. Leanne, I’ll take a question now from the webcast. Given the continued growth from homeowners, which presumably operates at a lower target combined ratio, will the company gradually move toward accepting a higher level of target combined ratio within the residual personal auto book?

We’ve been clear about our calendar year combined ratio goals and our lifetime combined ratio objectives of 96. We evaluate all our products holistically. We will attempt to write as much business as we can, but we won't do that if it means compromising our target margins. Clearly, we monitor pricing across states and DMAs, and if we can lower prices while still bringing in business, we will.

A couple of questions here. First, regarding commercial auto. What is the loss trend looking like there? You mentioned that you still have about 9% rate to come through. Is that well in excess of where trend is going right now?

The loss rate has been favorable. It’s a much more volatile coverage. Last year was particularly volatile during the summer months, so we think we’ve got the correct rate margin to earn in, and we’re feeling good about these margins. Again, we remain cautious because of the volatility in that business.

Does that mean that there could be more margin expansion to come?

I can’t predict the future, especially given the volatility involved. We believe we have the right rates being earned in, of course, that earn in slightly slower than our auto book because it’s on a yearly basis. But again, we feel good. We’re always cautious given the volatility of that business.

Can you explain a bit about the severity you’re seeing on auto property damage? I know you mentioned claims costs growing and a specific influence on severity. What’s happening there that causes that increased severity? Does it also impact your loss ratios, or is it strictly a paid number?

Yes, we’re observing increased severity in property damage, likely due to escalated technology costs in vehicles. We’re closely monitoring it. The fleet is noticeably different than our average fleet historically. So Gary, do you want to share further insights?

This is Gary Traicoff. In the first half of the year, property damage severity rose around 6% to 6.5%, while for a trailing 12-month basis, it aligns closer to 5%. We see severity increasing due to technology costs and have observed delayed claim closures causing settlements at higher amounts. We believe the long-term rate is likely to settle around 4% to 5%.

Leanne, can we take another call from the conference line, please?

I have one big question and one small one. Tricia, when we look at the market share numbers — focusing mostly on non-auto lines — is the aim for Progressive to be the underwriter of all your market share or would you be comfortable serving that through Progressive’s Agency, I'm sorry, the Progressive Advantage Agency?

It really depends, is the answer. There’s a significant opportunity in commercial lines, as I have frequently discussed with John Barbagallo about the right strategy for Progressive and our customers. We’re likely to do a mix of both. When it benefits and enhances retention for our commercial auto customers, we won’t necessarily need to underwrite; we may do it differently, similar to how we have approached auto. Regarding auto, we have ASI and a brand for home where we underwrite, compared to the direct side where 9 or 10 brands are used, the majority being unaffiliated while we have under ASI as one of them. We likely will do the same in commercial, taking into account what strategically makes the most sense.

Okay, that's helpful. One question for John if I can. I’m curious whether the early adopters of more capable cars have different accident propensities from the larger driving population?

That’s a really good question, but as of now, we don’t have ample data to discern what’s being driven by technology versus who is choosing to drive those cars. As we gather more data and control for variables in our products, we may arrive at some insights. It’s something we need to keep considering.

All right. We’re taking another question from the webcast. The year-to-date results have been favorable relative to the 96 target, and growth has been impressive. Do you have any desire to lower pricing and/or dramatically increase marketing spend to reach 96?

Yes, we have been increasing our marketing spending cautiously. We want to ensure it’s incremental. When increasing marketing, the intention is not just to increase but to drive incremental sales. We assess when we boost marketing spend carefully. We have raised our marketing spend in the first and second quarters and will continue so long as we believe it will lead to incremental sales. Observation of acquisition costs for each customer is integral; if that cost remains lower than the acquisition cost, we can proceed with increasing marketing, as long as we’re below a 96. We monitor pricing carefully across states, DMAs, etc., and will lower prices when we’re confident it will positively impact business while following the trend.

Leanne, can you take the next caller, please?

When discussing trends, do you see a difference between the two main channels: independent agency versus your direct channel?

Yes, Kai, we identify differences at the aggregate level regarding state mix, channel mix, and customer mix. That’s how we determine targets for both new and renewal policies. So yes, we tracks differences.

I do not know if there are notable differences in technology trends by channel, as we haven’t focused on that yet.

Remember, the number of vehicles equipped with this technology is a very small percentage. We monitor this closely, but it’s about data; we want enough to understand it fully. As soon as we can correlate that with loss costs, we can quantify it in both channels and every segment, but it’s still a minor portion of the fleet.

Great. As a follow-up, could you please elaborate on your relationships with technology and shared mobility companies? Are they viewed as long-term partners or competitors?

I’ll let John expand on that, but I’ll start with we view these as partnerships. Some may be long-term, while others could be shorter. We're collaborating well with many OEMs and the shared mobility space to understand loss behaviors, which differ significantly between an Uber driver and data shared through OnStar. We're committed to investing in these sectors. Our expertise in insurance, segmentation, and pricing is something we bring to the partnership table, as they do to us. We anticipate continuing to foster more partnerships as technology evolves.

I think that’s a comprehensive answer, Tricia.

We will now take the next caller from the conference line, please.

Regarding the long-standing 96 goal you’ve upheld, given past adjustments during industry shifts, what leads us to still adhere to this goal? Why the 96, especially with record growth this year resulting in favorable stock reactions? Would it not provide more value in maintaining a lower combined ratio during growth phases?

If you had a crystal ball, you might have a different formula. This goal is a part of Progressive’s culture. There’s no specific magic number; 96 has been part of our mission for as long as I can remember. This discipline ensures we uphold our commitment to our stakeholders’ interests. It’s about balancing growth while making at least $0.04 of underwriting profit. We are okay with achieving more, but we do not want to limit our growth; that’s the anchoring principle we keep in mind. While frequency is declining along with a changing mix, we remained capable of delivering profits.

The discipline surrounding that target keeps you honest. Moreover, it’s resulted in impressive ROEs over time. Interest rate environments may alter but maintaining this underwriting margin has worked effectively.

Reflecting on the combined ratio gap that continues to widen between you and industry peers, is this attributed to your pricing expectations versus management actions correlated to underwriting and points?

That’s a great question. It stems from everything we've seen. We’ve consistently attempted to stay ahead of trend by capturing small portions of increases, which keeps us in a favorable position. Last year was indicative of this; while we increased rates, we didn’t need to do it as aggressively as our competition allowed for strong shopping behavior. Having our discipline in the number one objective of growing profitably at 96 helps immensely.

Can you remind me of the target margin for homeowners, if you don't mind?

We typically do not disclose product-specific target margins. Our overarching objective of 96 integrates every product, state, and channel dynamics, especially with varying acquisition costs.

We adjust those targets by product, considering market opportunities, while entering each year with a projection of growth for renewal business.

I’ll take another question from the webcast. Can we dissect the long-term severity claims trends? How do they compare across injury, medical, and auto repair? Can we get further clarification on the contributors to severity?

That’s a multifaceted inquiry. Gary, could you delve into the prevalent trends in severity?

For the short term, property and injury severity trends are similar, about a 4% to 5% range. The state varies; some trends are above that, while some below. Over the longer term, property remains stable but injury severity exhibits more variability. As medical expenses rise, there are gradual influences, but our trends may not perfectly align with all medical inflation metrics.

This year, one influence on our severity has also stemmed from Michigan’s PIP issues, which add substantial complexity.

Leanne, let’s take another caller from the conference line.

I would like to address capital. The debt to capital ratio rests at 27.3%. Following the bond issue, it rebounded with the retirement. What are the targets here, and what should we consider in terms of premiums to surplus? What’s your excess capital position at present?

We aim for less than 30% debt to capital. We knew the ratio would rise with the issuance of the $850 million bond, but that allows us to retire the existing 6.7% hybrid bond. The timing was deliberate, keeping it under 30%. For premium to surplus, we maintain a 3:1 ratio on Auto and about half that for Home. Regarding our capital status, over the past few years, we’ve shifted focus to leveraging capital for growth. As stated, under-leveraged capital can be used for buybacks or special dividends, but currently we ascertain that our capital is well-utilized in fostering growth.

So would a special dividend be unlikely for the next two years following the homeowners acquisition? Is the hesitance driven by the current growth opportunities?

We’re focused on business growth utilizing our capital effectively. We possess a robust variable dividend, aligned with our year-to-date performance, and the shareholder gains are promising. Applying our capital toward sustainable growth remains our priority.

We’ll take another question from the webcast. Does Progressive have insights into the cost/ability to retrofit vehicles for safety-enhancing technologies like auto braking or lane departure warning? How might the growth in retrofitting affect penetration and claims trends? Would insurers encourage retrofitting through premium discounts as potential acceleration?

That question is more for consumers. We haven’t observed a robust adoption of retrofitting options. We’re cost-driven. We haven't seen a rapid penetration from most consumers. John touched on the challenges — having a luxury vehicle modification versus typically financed cars that consumers may not wish to invest in. Examples are limited.

We haven’t observed much progress in the retrofitting market, mainly viable when providing driver alerts rather than controlling the vehicle's operation. These solutions will be held to strict safety requirements just like new models. Therefore, at the present moment, it's not on our agenda to promote retrofitting to consumers.

Not at this time.

We have another question about the Paths to Partnership commission program. How much more do agents earn, and how is the annual bonus structured?

I don’t have specific details, but we regard it as a zero-sum scenario regarding the total commission package. We’re offering higher commissions to those agents committed to delivering longer-retained preferred businesses. Agents can opt for growth segments to transition into the Paths to Partnership, and more specifics will be shared in up-and-coming meetings; it's structured similar to our Platinum Program.

Overall, the cost structure will see an internal balance. The enhanced commissions should contribute to better results, but mainly minimal impact on our expense ratio. At the same time, we’ve been focused on decreasing our non-acquisition expense ratio, excluding commission and advertising costs. Therefore, we expect our expense ratio to remain highly competitive even with this commission enhancement.

And we’ve just rolled out this program, which will take until the end of the year to fully implement across all agents.

Let’s take another question from the webcast. Can you comment on competition with mutual insurers? They have lower profit targets, thus often writing at an underwriting loss. With increasing net investment income, do you expect them to become more competitive? And finally —

Each entity operates under its own guidelines. We focus on our growth plan, targeting our objective at 96 and enhancing service to our customers. Some competitors may have different metrics; we remain cautious in investment matters for our customers on the underwriting side. That’s been successful for us overall.

How significant of an expense ratio or pricing advantage should Progressive maintain versus mutual insurers to ensure competitive positioning?

It’s essential to remain efficient and we analyze our expense ratios meticulously. Loss adjustment expenses are pertinent too. We observe customer calls and try to communicate effectively, aiming to resolve inquiries swiftly. The claims side's loss adjustment makes a substantial difference, where we have continuously reduced expenses over the past decade, increasingly improving our claims organization’s efficiency.

The experiential brand matters too; the inflection point includes the channels through which we are engaged with customers and how we understand business expectations and price competitively.

I described earlier that making investments in the future is integral to our strategy; these elements are not mutually exclusive. We want to be competitive while embracing growth opportunities and strategic investments.

Lastly, we have a question from the webcast regarding the market position of preferred agents for homeowners. Can you share current numbers while also discussing opportunities over the next three years? They may inquire regarding Platinum agent appointments versus potential preferrable agents in the market.

Currently, we have about 2,000 Platinum agents. In our independent agent channel, we approximately have 35,000 agents overall. We continue to grow our access across the country, emphasizing that having Platinum agents means being a top-choice for preferred customers. Not all independent agents have homeowners to insure; it can be limiting. We’ve deployed the Platinum badge to create a scarcity model to have it with fewer agents since it’s complex and special. The Platinum model, along with the increase of additional agencies, leads to a promising opportunity. We are excited and engaged in the Destination Era and feel like we are at the beginning of gaining market share in homeowners. The investments we made in commissions, acquiring ASI, the in-house agency, and the HomeQuote Explorer will ultimately enhance our offerings. We have only just begun, and we anticipate appointing many additional agents as we press on.

Along those same lines, we have a question about the Robinsons. Many Robinsons operate within insurers in the captive agency channel, like State Farm or Allstate. Do we have a specific strategy to target that subset versus the independent agency channel?

I indicated the $91 billion opportunity within homeowners and the $63 billion from areas where we possess access. Most of our clients come from the captive agency channel. While we don’t focus efforts solely on that demographic, our brand reputation and agility in catering to clients will lead us to many customers coming from captive agencies as well. Although it’s not a direct strategy, we aim for every potential customer we can access, and we expect to be competitive given our accessibility.

In this environment, as rates have historically fluctuated with different lines, we see an influx of preferred shoppers entering the marketplace across various channels, including captive agents, IAs, and direct.

That appears to be the final question. We look forward to seeing you in November.