Progressive Corp (PGR) — Q4 2018 Earnings Call Transcript

Thank you, Carmen, and good afternoon to all. Today we will begin with a brief presentation by our Chief Human Resources Officer, Lori Niederst, about our culture and people being a competitive advantage. This presentation will include two videos, so we recommend joining our live webcast through the Events page on investors.progressive.com. Our presentation will be followed by a Q&A session with our CEO, Tricia Griffith; and our CFO, John Sauerland. Our Chief Investment Officer, Bill Cody; and our General Manager of Progressive's Home business, Dave Pratt, will also join us by phone for Q&A. This 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 2018 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 challenges we face. These documents can be found via the Investors page of our website, progressive.com. It's now my pleasure to introduce our CEO, Tricia Griffith.

Good afternoon, and welcome to Progressive's fourth quarter webcast. We have a great session for you today. I'm going to quickly recap 2018. Hopefully, you've had a chance to read the Annual Report and my letter to shareholders. But in a nutshell, it was an incredible year. We saw 20% net written premium growth with a combined ratio of 90.6, so a lot of margin, far more than our actual goal of at least $0.04. We grew the topline by over $5.4 billion in net written premium. That was on top of a $3.8 billion growth in 2017 and a $2.8 billion growth in 2016. In summary, we had $2.8 billion, $3.8 billion, $5.4 billion in incredible growth. That momentum has really sustained us as we head into 2019. All of this compiled into a comprehensive return on equity with our investment returns just around 24%. So these are great results. We also had many celebrations and milestones that we accomplished this year. I wrote about them in my annual letter to shareholders; it's been a wonderful year for Progressive as we celebrated both internal and external goals. I would like to take a moment to thank all Progressive employees for all their hard work this year and how we've succeeded together, which is the theme of this year's Annual Report. Our four cornerstones remain consistent: who we are, why we're here, where we're headed, and how we're going to get there. Who we are: we have five core values that we talk about frequently. I won't go into detail about them today, but Lori Niederst will when she gives her presentation. Why we're here: we have a purpose statement that is true to our name, Progressive, about doing better today than yesterday. Progress on how we approach our people and culture, and progress for our shareholders and the customers we serve. We continually challenge ourselves to maintain this growth mindset. Where we are headed: our vision is to be consumers' number one choice and destination for auto and other insurance. We get closer to that goal every single day as we add more customers. And how we get there is through our strategy, which we discussed in several previous sessions. I’ll tell you about this graphic shortly, it’s from our Colorado Springs call center employees participating in the artwork for the Annual Report. The tactics in the blue sections have been focused on segmentation, brands, and cost-effectiveness—these are crucial, but they don't work without our people and culture. I’ve seen so much growth, especially with our employees in Colorado Springs over the past few months, as part of our Annual Report celebrations. It was truly a fantastic day to celebrate our achievements. Art is integral to our culture and environment at Progressive, a practice initiated by Peter Lewis many years ago. In 1988, he chose to incorporate art into the Annual Report, selecting themes and artists fitting to that year's focus. For example, my first year as CEO, my theme was transition, which represented my shift into leadership smoothly in July 2016. Last year's theme was acceleration, emphasizing our determination to speed up growth. This year’s theme is togetherness, which arose as we progressed through an amazing year as a unified team. To illustrate this theme, we engaged artist Nathaniel Parsons, who collaborated with Progressive employees nationwide to create an installation called Camp Waterfall—Wanderfall. This piece is being crafted to be displayed at our campus locations for all to enjoy. Instead of explaining the production of the 2018 Annual Report, we compiled a video for you to watch the creation process. I hope you enjoyed that presentation. All the artwork is available on our Investor Relations webpage for viewing. It’s interesting how much we’ve expanded. In that video just a few months ago, I mentioned that we had 36,000 employees, and we now exceed 38,000. Our culture and people strategies are crucial to management, so I’ve asked our Chief Human Resources Officer, Lori Niederst, to present today. Following her, John Sauerland will discuss our dividend policy change.

Thank you, Tricia. I assumed I would need to make a case for why culture is relevant for this audience today. However, about a month ago, State Street’s CEO supported this notably in his letter to board members, emphasizing corporate culture as a critical intangible that impacts a company’s ability to implement its long-term strategy. He cited an EY study indicating that intangible assets like culture drive over half of an organization’s market value. At Progressive, we believe our people and culture are our greatest sources of competitive advantage. My objective today is to describe why we believe this to be true. Our culture serves as the foundation for our people strategies, which collectively generate business outcomes. If there are any faults in this foundation, our results will suffer. Misalignment between our people strategies and business objectives will also lead to diminished outcomes. However, the strength of our culture and successful people strategies have refined our ability to achieve exceptional results and maintain a sustainable competitive advantage. As Tricia mentioned, our culture is grounded in our core values introduced over 30 years ago by Peter Lewis. These five values are not mere words on a piece of paper. We take them seriously. We introduce our core values in new hire training and reinforce them daily. These core values guide our business decisions and determine how we treat one another, our customers, and our investors. Although they have been in place for decades, our core values still closely align with our company strategy. As an insurance provider, our product is a promise—an assurance to be there for our customers when they most need us. We must instill a culture of integrity to fulfill that promise and earn trust. Our customers have options regarding insurance providers, so we must maintain a culture governed by the Golden Rule to motivate our customers to choose to remain with us. The competition in our evolving industry is fierce, requiring a culture of excellence that always aims to improve to adapt to the changing market. We strive to consistently deliver consumer and shareholder value, necessitating a team of 38,000 Progressive employees focused on achieving defined goals while striving for growth at or below a 96 combined ratio. Peter's core values are pragmatic; we recognize that profit is essential for successful business operation. It is chiefly the first four values that guide us toward earning this profit correctly. We are confident that our core values and culture continue to align with our company's strategy and the interests of our people, consumers, and shareholders. Beyond just a wording of core values, our culture can be challenging to define. To provide insight into our Progressive culture, I would like you to hear testimonials from our employees. We anticipate our culture indicates our competitive advantage based on reports from our employees. Recently, I received an email from Tim, an analyst in our IT control group, describing our core values as the anchor of our culture. He likened his Progressive experience to his time in the Coast Guard, stating that he felt a sense of teamwork upon joining. In addition to anecdotal evidence, we have data supporting this conclusion. We conduct an annual employee survey and have recently started using Gallup's Engagement Index. As expected, engagement at Progressive is significantly higher than the national average; 68% of Progressive employees are engaged compared to 33% of U.S. workers. Positively, only 4% of our employees are actively disengaged, whereas 16% of U.S. workers fall into that category. Our 2018 results place us at the 96th percentile among all companies utilizing the Gallup survey, with only 2% of our employees disagreeing with the statement that “Our core values guide our business decisions and define how we treat each other.” We have also conducted an annual compliance and ethics survey, which further demonstrates the strength of Progressive's culture. Last year's results were the best among 32 companies surveyed by Ethisphere, with 99% of Progressive employees familiar with our core values. Our work at Progressive is challenging. We maintain high expectations and are unapologetic about it, which means Progressive isn't the right fit for everyone. Nevertheless, our 8% voluntary turnover rate within this job market is evidence that a strong culture yields significant business advantages. Our firm foundation has allowed us to establish people strategies to harness our talent, ideas, and energy. These strategies are stable and tested, having proven successful in every insurance cycle phase. While we foresee these strategies continuing to serve us well, much like every aspect of our business, we continually analyze results, monitor outcomes, and adapt when necessary. Three key people strategies uniquely define Progressive. The first is transparency and openness. Our 2002 Annual Report expressed our belief that good decisions arise from straightforward information. There are many instances where we have maintained transparency with our investors and customers, the most prominent being our practice of monthly financial reporting and comparative rates for customers. We apply the same transparency standards to our workforce. If you missed everything I just said because you were distracted by the art in this particular Annual Report, then I will likely have to inform Glenn that 16 years later, it’s still generating the desired effects. So returning to transparency and openness—we begin with communication. Consistent with our monthly reporting to investors, we strive to communicate with our people what we know as soon as we know it. This practice often necessitates sharing information before we have complete answers, which can be uncomfortable at times, yet we believe it builds trust with our leadership and strengthens our culture. Another example of our commitment to transparency and openness in communication is our diversity and inclusion report, launched last year. This report summarizes our progress, highlights opportunities, and tells the stories of some exceptional individuals within our firm. In this report, we also disclose employee demographics and publicly commit to pay equity, proudly stating that we have achieved gender and racial pay equity at Progressive. Our commitment to transparency and openness extends beyond communication; it also applies to other areas like compensation. Similar to how we provide comparison rates for customer quotations, we disclose the salary range and bonus targets for all jobs in the firm. We also share market median data to help our employees understand potential earnings relative to similar roles at other companies. We believe that this degree of transparency fosters meaningful conversations and ensures equitable outcomes. This diligent approach requires our management to enforce fair compensation practices. Transparency and openness are key strategies that underpin the behaviors we expect in our interactions with customers, shareholders, and each other. The second strategy I’ll discuss is cohesive diversity. At Progressive, we harness each unique difference to enhance our collective strength. We are disciplined, focused, and competitive, but we compete as a unified group to become the consumers' number one choice for insurance. We reinforce cohesion or togetherness—as Tricia noted—in various ways. We align job objectives throughout the organization, providing each individual insight into how their work contributes to company goals. Our performance evaluation process focuses on coaching and development, and every Progressive employee benefits from our gain share bonus program. Gain share rewards our teamwork based on the company's growth and profitability. Last year, our gain share factor reached 1.91, meaning each employee earned nearly double their annual bonus target, while the factor was 0 in 2000, leading to no bonuses that year. On gain share day this past December, Tricia received a heartfelt message from Eric, a call center consultant who has been with us since 2002. Eric shared a story about his mother, who passed away shortly after he joined Progressive. He promised her he would send his son Noah to college, relying on his gain share bonuses to fulfill that promise. For Eric, last year’s bonus was the final funding he needed to make his mother's wish come true. This cohesion may appear small, but it holds significant implications for our culture; employees are motivated to support and educate one another. It’s not uncommon for colleagues vying for the same promotion to encourage one another and even share interview strategies. I've experienced this firsthand throughout my Progressive career, most recently when applying for the CHRO position. I was aware of several peers who were also pursuing the role, and a few even called ahead to request insights on my HR experience. Upon my appointment announcement, one of my peers rushed to congratulate me with enthusiasm, despite typically not being a hugger. Cohesion alone is part of our strategy, and it is strengthened by embracing our diversity. Diversity and inclusion are consistent strategies woven through every aspect of talent management—from our hiring practices ensuring diverse candidate pools to our development programs that promote cultural competence and raise awareness of unconscious bias. Our job objectives also hold leaders accountable for cohesive diversity. While many organizations leverage ERGs, or employee resource groups, to support their diversity goals, at Progressive, our results are exceptional. More than 13,000 Progressive staff belong to an ERG, and its members tend to be more engaged, likelier to seek promotions, and more likely to remain with Progressive. Unlike many companies studying ERGs merely as affinity groups, our groups unite us to address pressing societal issues. A prime example is our courageous conversations series, which brings small groups together to discuss real instances of bias in our workplace. Though often uncomfortable, these dialogues take place in a safe space, promoting mutual learning. For over 40 years, we have leveraged our art collection to ignite discourse and foster respect for our differences. One of Peter Lewis’s initial installations in the '70s was of Andy Warhol’s Maos, which elicited strong reactions during the Vietnam War. Peter was inspired by this response, further solidifying the art collection's mission of provocation. Presently, we still utilize art to facilitate conversations regarding our values and cohesive diversity. For instance, our three-day workshop for new leaders includes 'Uniquely Me, Together Progressive,' where we utilize artworks to recognize varied perspectives and embrace them as we lead our teams. Our ERGs and our art collection are two examples of how cohesive diversity is an essential part of our lives, emphasizing our differences to foster strength. The third strategy I will highlight is our talent pipeline approach. For decades, we have been cultivating claims representatives, call center personnel, analysts, and product managers into capable business leaders within our executive ranks. This 'grow our own' strategy truly differentiates us, so let me clarify how it operates. Over 90% of our employees in entry-level positions are externally hired, ensuring we attract a talented and diverse applicant pool. In our managerial ranks, over 90% were promoted internally. While many firms emphasize promotion from within, our internal promotion rates significantly exceed those of other organizations recognized by Fortune as among the best companies to work for. Feeding our pipeline relies on external hiring; our growth has necessitated more than 20,000 external hires in the last three years. We have achieved this during one of the lowest unemployment periods in 50 years, facing challenges in over 250 labor markets with distinct competitors. We are selling a career in insurance. Despite the competitive labor market, we consistently fill open positions with exceptional candidates. Our Progressive brand helps attract a significant candidate pool for every job posting. We hire fewer than 2% of applicants for positions at Progressive. To manage this substantial applicant volume, we apply sophisticated analytics, helping us understand the number of desired candidates per job and per market to ensure we’re selecting a qualified hire. We also adopt methodologies learned from marketing and media teams to optimize job advertising. We monitor our cost per hire relative to candidate demographics and job success, applying the insights to improve our spending. While our recruiting marketing budget pales in comparison to larger firms, we believe we are learning and applying best practices effectively, aiming to hire fitting talent, equipping them for success. All our HR practices support the talent pipeline strategy, including our compensation schemes. Employees looking to increase their earnings at Progressive must seek promotions, and transparent processes allow them to pinpoint advancement opportunities and the corresponding remuneration. Promotions at Progressive are not mere titles or designations. Open positions are posted, and any interested and qualified individual can apply—a transparent process requiring employees to take charge of their career paths, which consequently leads to innovative opportunities. Tricia detailed my journey from analyst to CHRO, and I’ll highlight John Barbagallo's path. John began as a claims representative, progressed to a supervisor, transitioned to a field sales manager, became a product manager, later a National Accounts Manager, and pursued other opportunities before he returned to hold positions in product design and agency management before becoming our Commercial Lines President. This is not singular to John and me; our talent pipeline strategy has produced our current class of executives. The average tenure among our executive team is 22 years, significantly higher than the average in our industry peers, indicating a management team with profound business and cultural understanding, capable of transmitting this legacy to future Progressive leaders. Jeff Charney is the only current executive hired externally. That’s not to say we will never hire externally again; when we do, it will result from changed business needs requiring skills or experiences that our existing talent doesn’t possess. This was the case for recent additions to our strategy organization and when Jeff came on board nearly nine years ago, which is amusing as we still regard him as the new guy. This strategy has served us well for decades. When our organic promotion process doesn’t yield enough opportunities for development, we generate those opportunities through job swaps. A recent example involves seven high-performing senior leaders selected for a leadership challenge in a different sector of our organization. Sanjay Vyas, who presented at our last webcast, was one of those leaders; he shifted from our product organization, where he had 15 years of experience, to serve as our claims controller. This transition allows Sanjay to gain granular insights into our claims operations. We prioritize talent development by conducting job swaps when deemed beneficial for our employees, even if it doesn't align perfectly with immediate business needs. We are committed to cultivating talent, assembling functional work groups to tackle intricate business challenges. Diverse teams are formed and assigned supplemental responsibilities alongside their everyday tasks, which cultivates both personal growth and yields business advantages. An important recent example is a team tasked with identifying horizon 2 and horizon 3 opportunities, ultimately leading to the establishment of our strategy organization, now directed by Andrew Quigg. For our newer leaders, we invest in numerous development programs that prepare them for advanced roles. Our flagship initiative, sponsored by our ERGs, is an 18-month development program imparting business acumen, analytical capabilities, and cultural competence. Because our talent pipeline is essential, we evaluate promotions and internal transitions as carefully as other companies assess turnover. Our development program participants are 50% more likely to attain promotions. We also observe that office-based employees apply for promotions at a higher frequency than their work-from-home counterparts, consequently allowing data-driven adjustments for career paths that best leverage our talent. While I’m sharing this competitive advantage with you, it is affirmed by external validation. We recently evaluated our organizational effectiveness through McKinsey's Organizational Health Index, ranking in the top decile among users. We align with their leadership factory classification, demonstrating strengths in cultivating emerging leaders while fostering an open and trusting culture. The third facet of our talent pipeline strategy involves managing staffing efficiently. Both over- and understaffing carry substantial risks to our company, and we account for this as we make staffing decisions. We principally measure staffing efficiency through PIPs per FTE, which has improved over recent years and remained consistent in 2018. We also gauge employee expenses as a percentage of premium, which illustrates how personnel costs are influencing our combined ratio. This metric improved by just over a point last year. Operational efficiencies stemmed from enhancements in mobile usage, automation, and outsourcing. In claims, we have made strides in photo estimating and outsourcing glass claims as two noteworthy advancements. In our CRM division, we are increasingly automating simpler customer service functions, removing traditionally manual policy servicing tasks. Our estimate of the remaining advantages of these adjustments signifies notable cost savings, with a manageable impact on staffing as we currently hire 1,000 individuals monthly and have successfully redeployed talent as our business evolves. A recent instance of this is the adjustment made to our service center model, which necessitated considerable changes to our systems, workflows, and staffing. Nevertheless, we managed to redeploy 95% of the 650 impacted individuals successfully. Due to our talent pipeline strategy and robust culture, we knew our employees had sufficient experience to excel in new roles and a keen desire to stay with Progressive. I understand I’m addressing a financial analyst audience, and I realize excitement may not stem from softer subjects, but it is our culture and people strategies that influence the results most crucial to you. Here’s the evidence: despite having a median tenure of 1.6 years, the quality and efficacy of our claims representatives’ work has improved. Our CRM representatives also exhibit even lower median tenure yet a rise of 2 points in sales conversion while maintaining stable service measures. In our product organization, we have improved speed-to-market by 50% while simultaneously decreasing quality defects at nearly that same rate. Collectively, these outstanding individual results contributed to our 2018 growth of $5.4 billion, with a combined ratio of 90.6, and a 2.7% enhancement in PLE. Our historical performance confirms our #3 market position in the auto insurance segment and leadership in the commercial auto, specialty RV, and motorcycle markets. Our Progressive culture and people strategies I shared represent the contributions of thousands over numerous years. It’s an honor to relay this narrative on behalf of all 38,000 of us at Progressive, as well as all of those who have come before us, shaping this truly sustainable competitive advantage. Now I’d like to pass the floor to the individual who transitioned from Progressive intern to our CFO, John Sauerland.

Thank you, Lori. Good afternoon, everyone. Culture is not a typical topic for an Investor Relations meeting, and I believe Lori emphasized its importance well. Our culture and people lie at the heart of our success. I am convinced that we have the finest team in the industry and that we retain remarkable talent while fostering both collaboration and motivation. I am enthusiastic about fostering this culture as we proceed forward and look forward to this journey. Now we would transition to a more conventional topic for this environment: our new dividend program. In December of last year, our board declared the 2018 variable dividend. We reiterated that the dividend would not be dispersed unless comprehensive income exceeds after-tax underwriting income. During our upcoming Q&A session, we anticipate and encourage your inquiries regarding our dividend program, so I think it would be beneficial to explain our rationale. As a reminder, Tricia mentioned some prepared Q&A in the November news release as well as the associated 8-K filed on December 12. On February 11, we paid the 2018 variable dividend of $2.51 a share, totaling around $1.5 billion. Our comprehensive income for the year reached $2.52 billion, while after-tax underwriting income amounted to approximately $2.303 billion. Thus, based on our criteria surrounding comprehensive income and after-tax underwriting income, we were $217 million away from potentially not issuing any variable dividend in 2018, pending board discretion. The intent behind this threshold is clear and undoubtedly well intended. However, we recognize that such a situation, where we might withhold a dividend or pay $1.5 billion as a dividend, lacks alignment with the interests of both our owners and management. This is part of our rationale for the change. Funding growth is another key rationale behind this adjustment. Our insurance company subsidiaries must carry statutory surplus equal to at least one-third of net premiums written. In 2018, we added $5.4 billion of incremental premium. Therefore, all else being equal, we were required to have $1.8 billion of additional surplus in our insurance companies. Furthermore, we maintain what we call an extreme contingency capital layer derived from several factors; in summary, it typically scales with our balance sheet. Consequently, for that $5.4 billion growth in 2018, we required an additional $2 billion in capital. We can generate necessary capital via maintaining comprehensive income or raising additional capital. We have a clear strategy regarding leverage—keeping our debt at or below 30% of total capital. Depending on the nature of our comprehensive earnings and growth projections, the formulaically determined dividend might hinder our capacity for rapid growth while meeting the 96 combined ratio benchmark. This, succinctly, acts as further rationale for the adjustments we have made. Our sustainable growth has been robust recently, and we seek to ensure we possess the necessary capital moving forward. While we have been heavily investing in numerous near-term opportunities for growth, we also wish to ensure that we are positioning Progressive for long-term success. While maintaining focus on our core offerings has served us well, we will continue doing so. Moreover, we aim to invest in Progressive's long-term growth across future decades. A substantial part of the rationale for our modification involves ensuring that we possess the flexibility to invest for that long-term vision. A prime example of our current investments in horizon 2 revolves around developing our commercial lines business, including the general liability and business owner policies program. We firmly believe that our strategy aligns well with these markets and significantly expands the addressable market for our commercial lines group by more than threefold. We seek to bring this to market soon, ideally within the first half of this year. We continue to explore additional avenues to spur our growth within horizons 2 and 3, and we will keep you updated as we unveil new opportunities. Finally, while we perceive the variable nature of dividends as aligned with our aim to grow as quickly as possible, we understand that the inconsistency in cash flow can misalign with shareholder expectations. On this slide, we display our trailing 12-month dividend yield—both with and without special dividends—relative to a peer group as well as the broader market represented by the S&P 500. Interestingly, when we broaden our examination of our dividend yield over an extensive timeframe—here's a trailing five-year perspective—we see that our dividend yield is comparatively robust. We are indeed positioned as a growth stock; however, we might not gain attention from a wider segment of potential investors due to our dependence on variable and special dividends. As a result, we are introducing a quarterly dividend commencing at $0.10 per share alongside our anticipated annual variable dividend. This brief overview covers our rationale behind the changes to our dividend structure. We have effectively managed capital at Progressive, and we anticipate continuing this practice. As a friendly reminder, for the previous two decades, we have consistently produced returns on common shareholder equity in the high teens. Additionally, during this time, we have returned 70% of net income through dividends and share repurchases while simultaneously growing the company’s top line by $27 billion or 9.5% per annum. Hence, though our common stock dividend mechanisms are evolving, our financial policies remain unchanged. We aspire to deliver results as good as, or even better than, those produced for our shareholders to date. We will prepare for the Q&A now and eagerly welcome your inquiries.

And with that, Carmen, could you please introduce our first participant from the conference call line?

My first question, going back to some of your closing comments, John. You spoke about your efforts to expand into general liability and business owners policies. I know you guys mentioned that briefly on your last quarter's call. I just wanted an update with numbers on how big you think that opportunity is. You also mentioned, seemingly looking at other lines as well. Do you envision Progressive’s continued expansion in Commercial Lines? Assuming all goes well, what do you see in terms of organic versus potential M&A to enhance this initiative?

Let me start, Elyse. We believe the addressable market is significant, and our approach mirrors that which we implemented for the Progressive Advantage Agency in Personal Lines. We initiate partnerships with third-party unaffiliated partners, and this year we will also write on our own paper with BOP. This year will evolve slowly; we've been investing in this for some time. However, we believe there's excellent synergy by combining our leadership in commercial auto with household management. I envision a business owner that operates from home or nearby, with their vehicles insured by us along with their home and recreational vehicles. So, there is considerable potential. We plan to utilize both direct writing and partnerships to ensure we cover as many small business owners as possible.

To extend that, we hold the number one position in commercial auto writing across the country, and we see excellent performance in that sector currently. In 2018, we achieved 28% growth with an impressive combined ratio. There is continuous potential for growth there, particularly as GL and BOP target markets are approximately three times larger than the commercial auto market. As Tricia mentioned, we are embarking on various products while maintaining the product offerings of both third-party and direct business segments. This acquisition of experience and opportunity is advantageous for our customers.

It’s great that we have a robust addressable market given the competitive landscape. This encourages us to be better and provides differentiation. We are well-positioned to take a measured approach; we’ve placed investments over the past 18 months to ensure we are ready to compete effectively.

Okay, thanks, Tricia. And regarding commercial auto, your results are indeed noteworthy compared to the industry, particularly given some competitors have been grappling with frequency and severity challenges. Can you discuss what you're currently observing in your book, including price trends and loss cost dynamics? How do you foresee the margin profile of your business shaping up in 2019?

In 2016, we faced significant profitability challenges; John Barbagallo reinspected our pricing strategy. We recognized that it takes time for rate changes to materialize because these policies cover 12-month periods. We took proactive measures and adequately set our necessary rates. In commercial, we adjusted rates by approximately 5.5% last year. Additionally, we are prepared to adapt and segment our pricing strategy on a state-by-state basis, as we had to navigate restrictions until we reached favorable positions. Our numbers affirm that we handle margins and growth exceptionally well in this area.

I want to reiterate our commendable positioning in commercial. Moreover, we are optimistic about electronic logging devices. We think we have a successful approach in employing usage-based insurance rating in the commercial sector, akin to methods utilized in personal lines. This is evidenced by the substantial discounts provided to interstate truckers mandated to have electronic logging devices installed, which yield critical insights into driving behavior, allowing us to refine our rating process effectively.

Carmen, can we take our next question?

I’d like to start focusing on the expense ratio. I’ve noted a considerable increase in the January expense ratio compared to 2018. What specific drivers led to this change? Additionally, in the past, you indicated targets for a non-acquisition expense ratio of roughly 9% by the end of 2019, primarily based on the successful results observed in Personal Lines. Are you on track to achieve that target, as well as a similar goal for LAE?

That's an internal target we evaluate, and many factors weigh into it, including gainshare flows. We estimate this at a 1.0 gain share, which, if achieved, would correspond to our identified expense targets. As for the expense ratio, we've increased our advertising spend as it contributes significantly to our overall expenditure. Indeed, advertising has substantially influenced our ratio, and we engage in such spending only when we deem efficient. It’s critical to note that January's numbers are simply early indicators.

Understood. My second question concerns PIP in Florida. Where do we currently stand there? How many reopened claims do you expect to persist into 2019 and beyond? Has that number reached a plateau?

Several factors contribute to this, including claims type—some being pre-suit demands, while others may still be managed in litigation. As we analyzed the litigation landscape, we felt secure that we were addressing the deductible accurately. The Fourth District of Appeals affirmed our approach, yet conflated circumstances led to the Florida Supreme Court ruling creating added complexity. We proactively recognized claims at risk and managed an inventory expressly, promptly addressing many and reserving for all significant cases appropriately.

Most importantly, I don’t see this as an overarching concern reaching other states. PIP legislation varies significantly across different states—only 15 states have PIP regulations in place, all with distinctly varying litigious environments. Florida tends to generate a wealth of litigation that isn't necessarily translatable elsewhere, so I do not foresee similar challenges emerging in alternative regions.

Carmen, could we take the next question from the conference call line, please?

I want to congratulate you on these presentations. They are notably helpful. I hope others in the industry follow suit. Regarding your commentary on the investment community, we have high expectations for this type of clarity. My initial question pertains to the comment made in the 10-K regarding PLE. You noted a decline due to targeted underwriting changes incorporated in the new model. Could you elaborate on that?

We instituted more stringent efficacy measures concerning renewals, particularly regarding lapse coverage. Previously, we assessed renewals at a specific frame of time; now, we have shortened this window because we found those customers could compromise our margin objectives. We modeled the anticipated effects, resulting in the observations you currently see reflected in the reports.

Understood. My additional question takes a broader perspective. In the 10-K, the report indicates a pricing increase of 1.2% and a premium-per-policy growth outpacing agency at 5% and direct at 4%. How do you anticipate these trends evolving throughout the remainder of 2019? Will we observe a continuation of these movements?

We are quite optimistic regarding 2019, especially in relation to the initiatives concerning the Robinsons. Notably, our network of platinum agents has expanded significantly. We continue to increase our footprint nationwide, contributing positively to both agency and direct sides of the business. We perceive ample opportunity to innovate as we are still operating with less than 2% market penetration in the Robinson domain. At one point, we remained below 1% for an extended duration, currently sitting at 0.7%. The infrastructure is now robust; the Progressive Advantage Agency has evolved from having 25 employees to hundreds now assisting direct callers to facilitate effective growth. This reliably influences our rise in renters' policies, representing a gateway to future home insurance transactions.

Indeed, there are remarkable growth trajectories in the preferred market, particularly given that our share sits at a low threshold. However, our opportunities to expand across other segments remain fundamentally resilient. We have demonstrated growth throughout varying segments and channels alike. As for loss cost trend premium dynamics, it is tough to forecast accurately. Our product managers endeavor to predict loss trajectories while formalizing pricing structures. Assurance cannot be guaranteed. Currently, claims frequency seems to be in decline, indicating stable trends, whereas severity manifests an increase; we anticipate this trend will likely persist due to several contributing factors.

I’ll now address a question posed by our webcast viewers. As we navigate the preservation of our company culture, particularly with a growing workforce which you mentioned exceeded 2,000 people in a few recent months, how do you ensure that these new hires maintain an alignment with our culture? Considering the company's size, we know the culture likely differs from what it was a decade ago. How do you confront this change?

That’s an excellent and fair question. I firmly believe no one can disagree; we prioritize discussions about culture. This year alone, we expect to hire 10,000 employees. I personally attend and speak at every new hire class alongside my senior leadership team. This commitment means that I engage with either in-person or via webcast nearly every new employee on a near-weekly basis, aside from isolated circumstances. I consistently focus on our culture, core values, and what I require from each team member. My team embraces similar practices. Additionally, it’s essential for company leadership to adopt an extensive presence; we frequently converse with teams informally and gather feedback regularly.

Carmen, can we take the next participant from the conference call line?

Following up on previous inquiries regarding small commercial: your foray into this market aligns with recent competitor announcements. Therefore, I’d like to understand the dynamics at play influencing the competitiveness in the small commercial space, especially in direct forms. You mentioned previously that GL and BOP are three times the size of the commercial auto market, could you clarify that distinction?

My reference to GL and BOP relates to an extensive overall market size, offering context for the enormous opportunity as we now open fill the market further. While we develop our presence, we realize immense potential. We don't compete in every niche market, but the vast breadth of growth signifies our opening into lasting partnerships with our clients. Further ingraining ourselves into existing clientele allows us to upsell products to retain satisfaction.

Moreover, competition cultivates improvement within our industry, prompting us to innovate and better serve customer needs. I am enthusiastic about our position given the investments made over the past year, ensuring we’re well-equipped to meet upcoming challenges.

Carmen, let’s connect with the next question from the conference call line, please?

I have a couple of inquiries. Firstly, the advertising expenses revealed in the 10-K exhibited an increase of approximately $0.5 billion year-over-year. How might these costs fluctuate in the coming years? For instance, could they increase or decrease dramatically in 2020?

We analyze advertising from an efficiency perspective. Considering multiple forms of advertisement, be it radio, mass media, or digital, we specifically assess the acquisition costs. This can vary for different customers, and we also started evaluating lifetime customer value alongside company growth. Available targeted acquisition costs influence when we engage in advertising, and we will adjust expenditure accordingly. Our recent strategies enabled substantial investments in advertising, producing incredible returns and heightened conversion rates.

Moreover, we maintain a data-driven approach to evaluate our advertising expenditures. We excel at monitoring our advertising effectiveness across various channels, purchasing the majority of our marketing in-house, providing considerable leverage to negotiate based on the data we've acquired, enhancing decision-making processes.

That makes sense. I also wanted to ask about the frequency statistic indicating a 3% drop in 2018. I observed it was reported as being attributed to mix; if you had controlled for mix, what would your frequency estimates appear to be?

It’s difficult to accurately respond to this question because we would need to backtrack and analyze multiple variables at play, including macroeconomic factors, driving patterns, climate impact on road conditions, etc.—many dynamics factor into determining frequency fluctuations. I would hesitate to assert a specific estimate.

I agree fully.

Finally, concerning adverse developments from December to January, there seems to be a trend that indicates a potential deficiency in IBNR at year-end. Could you share any insights on this aspect?

Certainly, January's challenges stem from various causes, including late reports from December spanning holidays. Some of the adverse development experienced this year relates to Florida PIP claims along with late reporting. Importantly, when we analyze claims over several years, we noticed that January often represents temporary fluctuations as circumstances normalize through the subsequent months, calculating better at the year’s close. We strive to maintain precision as we reserve for claims, and we have a robust record in that regard.

Thank you for your question, Ryan. Carmen, could we connect to the next caller?

I'd like to inquire about severity trends, particularly in bodily injury, which appeared to conclude the year at 4%. This indicates a potential value closer to 8% for the fourth quarter. Additionally, John—given your earlier comments—could you further elaborate on the severity trends you are witnessing and what justifications underpin your forecasts?

For the trailing 12 months, the situation seems mild; however, the fourth quarter overall reflected a 6.8% rise in severity driven largely by escalating medical costs for injuries and complex repairs stemming from advanced technology implemented in vehicles. Hence, we expect these trends to persist.

Susan accurately summarized that bodily injury has consistently fluctuated around a 4% increase, while collision experiences an 8% uptick; both severity aspects correlate to technological advancements within vehicles that inflate crash costs. Hence, we believe these trends will continue into 2019.

I’d like to follow-up regarding the recent improvements observed in January's personal auto underlying loss ratios. The notable increases in this regard are unusual and exceeding previous trends. Can you provide insight into what triggered this notable change? Are there anomalies impacting this data?

The fluctuations are predominantly based on our business mix. With our increasing share in preferred markets, we expect to see shifts in loss ratio metrics. We anticipate tremendous growth potential in the coming months as we traffic more clients, which should further enhance our ratios.

Could I take the liberty to squeeze one more question in? How does your advertising investment breakdown look between mass media and digital, especially regarding your spending strategy?

While we typically do not disclose exact percentages, I would emphasize that our investments reliant on consumer demand fluctuate on seasonality and buying trends, taking into account the ongoing balance of channels. However, our digital expenditures have become an increasingly significant part of our overall mix.

Carmen, could we take the next participant from the conference call line, please?

I have a couple of brief inquiries. Firstly, your renewal retention rates appear to have significantly improved relative to what we once saw in your personal auto sector. How substantial was this improvement in retaining existing customers for your growth figures? Further, could strong retention have contributed to your loss ratio outcomes?

The uptick we’ve witnessed in terms of renewal growth is considerable. Every time we can retain a customer, we’ve circumvented acquisition costs while continuing to meet their expectations. I don't have an exact percentage on hand but affirm that focusing on customer satisfaction significantly boosts retention, thereby improving our overall metrics.

Understood. Just one follow-up: as you pivot towards commercial, coupled with homeowners and the broader shift, should we expect your premium-to-surplus ratios to decline? Additionally, will your target combined ratio reflect any needed adjustment as a result?

To clarify, the combined ratio of 96 is an aggregate figure. We do have diverse targets across our various departments. Surplus requirements for particular lines, such as commercial, naturally will differ from others. Premium-to-surplus ratios can vary significantly, typically pricing below 3:1 for commercial lines as opposed to 1:3 for auto categories.

In adding on, commercial risks generally have lower ratios than personal lines due to unaffordability. Nonetheless, we aim for balance, ensuring we have sustainable returns with appropriate underwriting margins combined with investment returns across all business lines.

Carmen, let's connect with the next question from the conference call line.

You’ve shown encouraging early results regarding your digital efforts focused on homeowners and bundling. What specific measures will you implement to accelerate progress in these areas throughout 2019? Furthermore, will expanding this commercial mix include digital enhancements as part of your strategy?

Absolutely. We aim to enhance access on our HomeQuote Explorer—our digital platform—allowing potential clients to quote and ultimately bind online. We’ll strive for broader state coverage as shoppers desire seamless transactions. Our approach parallels commercial expansion. The BusinessQuote Explorer will see enhanced accessibility, executing a method similar to our achievements in personal lines, where we've had ampler success.

Currently, the buy button for Progressive Home is limited to specific states. Meanwhile, HomeQuote Explorer reflects widespread deployment across the majority of the country. The buy button option is key to enhancing conversion rates, and we intend to enroll it steadily in more states.

I noticed your letter details a new algorithm addressing distracted driving in your telematics product. Would you elaborate on its qualitative effectiveness and potential rollout to additional states?

The algorithm utilizes our handheld devices; we can distinguish when a user operates the phone hands-free as opposed to holding it. We’ve detected a strong correlation with accident frequencies. While detailed data remains internal, we have confirmed that prolonged phone usage correlates negatively with driving ability; hence, we will further analyze this mechanism.

We maintain confidence in its considerable potential and plan to extend its reach. Continuous assessments and evaluations will occur to adhere to deployment norms.

Additionally, I noted your mention of saving on loss-adjustment expenses. Can you highlight the main drivers helping this KPI to trend positively?

We leverage advanced technology to promote efficiencies, with a prime example being the photo method of inspection allowing customers to submit photos or videos. This process enhances efficiency without sidestepping safety, ensuring we maintain accurate valuations.

Regrettably, we have exceeded our scheduled time today. Carmen, I will turn this back over to you for closing remarks.