Progressive Corp (PGR) — Q3 2019 Earnings Call Transcript

Thank you, Chris, and good afternoon. Today, we will begin with a presentation on our horizon three strategy by our Chief Strategy Officer, Andrew Quigg. Our presentation will be followed by Q&A with our CEO, Tricia Griffith; and our CFO, John Sauerland. Also joining us by phone for Q&A will be our Chief Investment Officer, Bill Cody, and the General Manager of Progressive's Home business, Dave Pratt. 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 on 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 is now my pleasure to introduce our CEO, Tricia Griffith.

Good afternoon, and welcome to Progressive's Third Quarter webcast. We are genuinely excited about our results. I mentioned in my letter that we have consistently written net premiums over 15 consecutive quarters, with growth in double digits, which is remarkable. It's not only about premium growth—though that is vital—but also about the growth in units. I reflected on our progress and noted that we have seen nine consecutive quarters of double-digit growth in auto policies, which is equally impressive. We are optimistic about our past performance and future prospects, and that will be a significant part of our discussion today. Andrew, our new Chief Strategy Officer, will address horizon 3 and our vision for the future. After that, John Sauerland and I will be available for a Q&A session. Thank you for joining us. As you're aware, we refer to the 3 Horizons framework based on McKinsey's model. I won't cover horizon 3 today since Andrew will lead that discussion, along with some insights into horizon 2. In our previous webcast, John Barbagallo and Karen Bailo provided detailed information on the exciting initiatives we are pursuing in horizon 2, such as small businesses, BOP coverage, TNC, and fleet. We have made significant investments over the past few years, and we are now witnessing their benefits, which is incredibly exciting. However, we will also keep exploring further opportunities in horizon 2. We will leverage our brand, analytical skills, and segmentation strategies to ensure successful execution by our 40,000 employees. Execution, which we call horizon 1, remains a priority. Over recent years, we have directed our efforts towards executing horizon 2 initiatives, focusing on auto and home, whether bundled or monoline, to enhance growth and increase market share. Although it's tempting to focus on horizons 2 and 3, we have considerable potential in horizon 1, and I believe our strategy has been highly effective. In the next few slides, I will present our net premium written growth over the past decade, excluding our property business, starting from 2015 when we acquired a controlling interest in ASI. We will also review our combined ratio, comparing our orange line to the industry's gray line. Over the last ten years, we have experienced remarkable growth, especially in the last four to five years, increasing our premiums by $15.4 billion—over a 130% rise. Notably, we have maintained an average of 8 combined ratio points lower than the industry, which is impressive given our rapid growth. On the commercial side, we have similarly seen significant growth, with over 150% and an additional $2.7 billion in premium. Even more noteworthy is the average difference of 18 points in combined ratio between us and the industry, which demonstrates our understanding of market segmentation and our commitment to investing in horizon 2. Our property and home segment has also seen substantial growth as we expand nationwide, aligning closely with industry standards. However, we are not satisfied with merely keeping pace; we aim to ensure every product is profitable. We are actively developing our next product model, raising rates, implementing underwriting restrictions, and adjusting coverage to position ourselves for next year's profit margin targets. Over time, we continue to be impressed with our ability to achieve growth that is both substantial and profitable, particularly in comparison to our peers. The combined success of our insurance offerings and investment income has led to a robust return on equity, as illustrated in these slides. The blue bar represents Progressive, the orange bar represents the S&P 500 P&C index, and the gray bar represents the S&P 500 overall. As shown, over both 10 and 20 years, we have significantly outperformed the indexes and the S&P, which is commendable. We are pleased with these outcomes. In the last five years, we have returned 55% of net income to our shareholders through dividends and share buybacks. Regarding capital management, we prioritize investments to expand the business while adhering to our financial policies. Any under-leveraged capital is returned to shareholders, and we aim to achieve a return on equity that exceeds its cost. We are always mindful of the importance of net income, EPS, and ROE, but we believe that their long-term performance is rooted in our unwavering focus on the core elements of our business model, which is to grow as quickly as possible. We have been committed to this approach since our public debut in 1971. The data confirms this strategy works, and we will maintain it. Now, I would like to introduce Andrew Quigg, our Chief Strategy Officer. Many of you may have seen him on this stage before. To provide some background, Andrew holds a bachelor's degree in Applied Mathematics and Economics from Yale and an MBA from Harvard. He joined Progressive in 2007 as a Product Manager within the Agency division and has managed various roles in both agency and direct channels. He led our direct media business and served as the General Manager of our customer experience organization, focusing on customer retention, where he excelled. Last year, we appointed him as our first Chief Strategy Officer. He is here today to discuss Horizon 3. Andrew?

Thank you, Tricia. Today, I have the pleasure of sharing some additional details around Progressive's growth strategy. For our agenda, I'll first walk through our four strategy pillars and provide more details on the growth strategy framework, which Tricia discussed earlier. In this area, I'll underscore the mission of the strategy group, which I lead. Second, we'll discuss the important balance we are striking between being aggressive with the opportunities available to the company and our long history of using capital prudently. Finally, I will present our high-level framework for evaluating the Horizon 3 areas of opportunity. So let's get going with Progressive's business strategy. Executives, investors, and analysts all discuss company strategy, but it can take on a variety of meanings and approaches depending on the context. Definitions for the word strategy generally fall into two realms. Broadly, strategy can be any plan. Narrowly, strategy can be known as a plan for military action. But neither of these really corresponds to strategy in the context we're discussing today. I feel the topic was well examined in a Harvard Business Review article from 1996 by Michael Porter, appropriately titled, 'What is strategy?' In this article, Professor Porter asserts that differences in performance between companies result from the many, many activities that companies undertake. A company can outperform its rivals if it executes similar activities better. This is operational effectiveness. An example of this is segmentation. Every auto insurer segments their pool of risks. A company can also outperform if they choose different activities than rivals. This is strategic positioning, a historical example for Progressive has been Snapshot. Progressive uniquely invested in telematics starting in 1998 and continues to differentiate ourselves in this space today. Professor Porter also argues that operational effectiveness is necessary but not sufficient over the long run for outstanding performance. This is due to the rapid diffusion of best practices through talent movement, consultants, and benchmarking. Instead, Porter and many academics believe that choosing different activities is the basis for prolonged differentiation in performance. In particular, Porter detailed a method of looking at the activities of the firm and how they reinforce the strategy, the activity map. Strategic positions are strongest for firms where the activity map demonstrates a high degree of fit and internal consistency. On the screen is the activity map for Southwest Airlines in 1996 from the Porter paper. Each circle represents a strategic position of Southwest that was different than at least some of their competition. As a low-cost carrier, activities like automatic ticketing machines and quick gate turnarounds were important to keeping costs in check. However, not all of the activities were low cost if viewed in isolation. Southwest pays their employees more than others, recognizing that high-quality employees would help keep asset utilization high. With that background, let's turn to Progressive's business strategy. We have four general strategy pillars at Progressive: people and culture, competitive prices, broad needs, and a leading brand. Our core values, purpose, and vision also sit at the middle of these strategy pillars as a unifying focal point. Progressive has provided webcasts over the years to our investors outlining additional aspects of our organization. The webcasts provide a good overview of the additional activities and the fit of Progressive's activities. For example, in the fourth quarter of 2017, marketing and acquisition leaders discussed our leading brand and the supporting marketing tactics and innovations. In the first quarter of 2018, our business unit controllers discussed operational efficiency from different lenses, including how technology and automation play a role in reducing our expense ratio. In the second quarter of 2018, CRM President, John Murphy; and CIO, Steve Broz, outlined investments in relationships with our customers as we continue to refine our customer-centric approach. In the third quarter of 2018, Personal Lines President, Pat Callahan, demonstrated how the speed of innovation and product development creates a competitive moat. In the fourth quarter of 2018, our CHRO, Lori Niederst, outlined how our people and culture create sustainable competitive advantages for the company. Finally, in the first quarter of 2019, our portfolio managers, Rich Madigan and Jonathan Bauer, discussed how our investment approach supports our strategy pillar of competitive prices. The choices we make in these interlocking activities represent our unique strategic position, which is not as simple as low cost or focused on one segment. In my role, I have the fortune of interacting with external advisers, consultants, and partners. Each of them views Progressive differently and believes that some aspect of this activity map is the most important. I know I speak for the entire executive team when I say that it is truly the internal consistency of all these activities that makes Progressive special. It is extremely hard to duplicate the success of Progressive by replicating one bubble without the full tapestry. Along the bottom of this page are parts of our strategy that have emerged over the past decade and a half. Broad needs, in particular, became more pronounced as we entered into the destination era. We want to solve the broad needs of our customers over their lifetimes. This requires us to investigate the needs of our customers and adjacent areas where we can serve them. Broad needs also provide Progressive with an avenue for diversification as we look to disrupt other products and monitor changes in the mobility environment. Tricia articulated this investigation of new products and services in Progressive's growth strategy utilizing 3 horizons. We think of horizon 1 as executing on our current core products within property and casualty insurance. On the right-hand side, you can see that the market share we currently have today is only 8% of Personal Lines and 2% of Commercial Lines. We are fortunate to have ample headroom to grow. Horizon 2 includes expanding to adjacencies within property and casualty insurance. And beyond horizon 2, horizon 3 represents an opportunity to explore closed-end opportunities to leverage our core competencies. We think of this area as generally being outside of property and casualty insurance. As an example of horizon 2, we have Commercial Lines. In August, John Barbagallo and Karen Bailo discussed how the Commercial Lines business is expanding its addressable market from $14 billion to more than $50 billion. On the right-hand side are the efforts underway in Commercial Lines. Some of these reflect improvements in our core Commercial Auto product, but a large part of the expansion is from new products, general liability, and BOP that are horizon 2 initiatives within Commercial Lines. For horizon 3, the executive team decided to invest in a small group, the Progressive strategy group, to focus on horizon 3 in order to keep the vast majority of Progressive employees and resources focused on horizons 1 and 2. The vision for the strategy group is building an enduring Progressive for future generations, always growing. Our mission is to create lasting value by leading and establishing businesses beyond the core and supporting the expansion of our property and casualty business. With that introduction to Progressive's strategy overall and the strategy group’s mission within this, I'd like to turn to the important balance we are attempting to achieve in horizon 3. We have enormous growth potential as a company as we increase scope. We saw this play out in our acquisition of ASI, now Progressive Home, where we generated revenue synergies and leveraged our data footprint. On the revenue synergy side, you have heard over the past few years how we've created additional opportunities to sell the Progressive Home product. This included expanding the state footprint from 27 to 44 states, adding thousands of agent groups, and establishing the Platinum program. Finally, we invested in direct sales through our Progressive Advantage Agency, adding an online quote-and-buy process and analytical triggers for our customers. The impact is impressive as you can see on the right-hand side of this page. As we abstract away from this example, our base of customers help us generate revenue synergies from new efforts. As a reminder, we have existing relationships with about 15% of U.S. households and hundreds of thousands of small businesses. Our proven ability to extend relationships is the first component of our growth value as a company. Possibly even more important is our data footprint. As an example, we have two auto policy attributes and their impact on homeowner's loss cost. We continue to find that auto behaviors are predictive of homeowner losses. In general, we see product upgrades at Progressive Home, including auto, methods and variables that are much more powerful than using isolated product information. To build on this further, we have historically seen our data footprint driving data. What we found with Progressive Home is that we have responsibility data. Our data seems to be predictive of a number of behaviors. Our data footprint is larger than just our current insurance. We believe we have data on about 30% of U.S. households when we combine our quote data, active customers, and recently expired policies. This is the second facet of our growth potential as a company. If we go back to our activity map, we can see that to execute on the Progressive Home synergies, we were able to leverage the entire network of activities and reinforce new activities with an ability to market additional protection to our customers and leverage responsibility data for broad needs. While growth potential is exciting to consider, we are very cognizant of the fact that we have a historic reputation for being prudent stewards of capital. Progressive has an excellent reputation for efficiently generating returns for our shareholders and returning capital. Our comprehensive ROE since 2010 has been consistently high, especially in the past few years, and we have returned these earnings to shareholders at a high rate. More than 50% of comprehensive income is returned to our shareholders. This reputation has provided the company with a solid valuation and low cost of capital. Continuing to add to these high returns is a daunting task that is ever-present in my mind. It is our goal that these additional business lines will add to these impressive results while growing the company. We also know that diversification is inherently risky. As an example, Bain has produced insightful research on growth diversification. Let me describe this chart. Along the left-hand side are different dimensions by which a new business can be judged. The dimensions are the 5 Cs: customers, costs, channels, capabilities, and competitors. As the new business shares less and less of these aspects, they are defined as being further steps away from the core. Bain finds that each step away reduces the probability of success by about 60%. This work, and others like it have caused us to isolate certain factors like customers, channels, and capabilities as we think about new products and services. To summarize, we see both immense opportunities for Progressive, and we'll continue to balance these with a sober perspective of the challenges. With that background, I'd now like to spend some time explaining how we will identify and execute on horizon 3 ideas. We think about high potential ideas in three ways. First is market attractiveness. We want to invest in horizon 3 businesses where the overall market makes it more likely that we'll have success growing. We look at a number of factors here. Trends: we track a number of trends and have a subset of macro trends, which we believe will impact our industry and adjacent industries. Market metrics: factors such as size, profitability, and market concentration can be observed and evaluated for industries. Market dynamics, like Porter’s five forces, provide greater insights into the power structure of value chains. Next, we look at Progressive's ability to win. For any possible area, we need to ensure there is a fit with Progressive. Here, we examine the fit with our strategic pillars and our activity map. We look at assets that we could leverage, like relationships and data. Finally, we consider the proximity to our core and the likelihood of success. In the intersection of these two areas, we also need to find an unmet consumer need. These horizon 3 potential opportunities appear at the top of our horizon 3 process. Our strategy process team, led by Navin Verma, generates and researches these opportunities. Once we have an area of interest and a consumer need, we have two approaches to execute that are not mutually exclusive. We have formed a corporate development team under Erwin Raeth to investigate external organizations that fulfill our ideas. We also have an internal growth incubator, led by Azadeh Hardiman, to build new businesses. We believe building has a longer timeline but with lower risk. We're doing a pause for a moment on corporate development, given that Progressive has not traditionally been an acquisitive company. We still believe that this will be a rare event. Beyond acquisitions, the corporate development team has two additional methods to engage with companies: strategic alliances and strategic investments. Progressive has a long history of alliances through Progressive Advantage. On the screen, you can see 15 Progressive Advantage relationships that stretch across many products. We continue to believe that our Progressive Advantage organization is a well-suited path to meet the needs of our customers and provide income without capital requirements. An example of a successful horizon 3 product is life insurance, specifically term life insurance. On the left-hand side, you can see our view of the market attractiveness. It has medium to low attractiveness from a market perspective. However, Progressive's ability to win is higher, given that it is close to our core and could leverage our pillars and assets. We also find, in our research, that many families go unprotected due to a complex research and purchase process. Additionally, based on our brand, customers have told us they can see us offering the product more than other leading brands. Finally, we've been able to work with a carrier to distribute life insurance products and have increased sales by about 10 times over the past eight years. In addition to protecting consumers, Progressive has generated millions in commissions and materially increased retention for bundled customers on our core auto product. In addition to strategic alliances, we leverage strategic investments in the corporate development group. As you may have noticed in our quarterly and annual reporting, we do own a small amount of non-redeemable preferred securities in private companies. Today, these preferred securities represent strategic investments from Progressive. On the screen, you can see two of our representative investments so far: Upstart, our personal loans partner, and KeepTruckin, our commercial EBI partner. Strategic investments allow Progressive to better understand industry dynamics where Progressive has interest and better strategically and economically align with key partners. My purpose today was to keep you apprised of our investments, approach, and progress in horizon 3. I hope the past 20 minutes have been helpful in providing this context. As we reach material milestones in this exploration, we'll certainly provide additional updates. To recap our conversation, we believe that we have a robust strategic position underscored by previous investor presentations. We have generated impressive revenue and data synergies with Progressive Home and believe this will continue as we consider additional products and businesses. We balance this with a recognition that growth beyond the core is challenging, and we will continue to be prudent with our capital. Finally, we have our framework to evaluate opportunities and make them actionable, both through external and internal approaches. I'll now turn it back over to Tricia and John Sauerland for Q&A.

Before we begin taking questions from the conference call line, Tricia, I've received several inquiries regarding the changes in our dividend policy that we announced in December 2018. Please start by explaining that history and the reasons behind the change.

Absolutely, so the Board terminated the dividend policy that we had for many years in December of last year. Let me give you a little bit of background. So in 2007, we initiated a very formulaic variable dividend policy. The three items we looked at were: one, full year after-tax underwriting profit multiplied by our internal gain share factor, which is a factor we used; then we looked at growth and profitability across the board. This factor ranges from 0 to 2.0, and then the Board would decide a percentage based on that. So it would be the after-tax underwriting profit times the factor, times 20% divided by the number of shares, and that's how we came up with the very formulaic dividend policy. We made a tweak in 2008 and added that if comprehensive income was less than the after-tax underwriting profit, there would not be a dividend. Although that was just a nuance, it was very important because in 2009, after the financial crisis, we did not pay a dividend. So it was a prudent change to the dividend policy. In 2010, the only change we made was raising the percentage from 20% to 25%. Then in 2011, we raised it to 33.3%, and that stayed the same until the end. We have also issued a couple of extraordinary dividends in addition, in 2010, '12 and '13, giving $1 per share as extraordinary dividends on top of the variable dividend. So as we started really growing in earnest around 2016 and going to the debt market occasionally because we needed capital due to how fast we were growing, we started thinking about whether this still worked. The logic behind it was that our shareholders would be in lockstep with our employees. This worked on a calendar year basis, but when we think of shareholders, we want to think about how we're creating this enduring business. Does it always make sense to return a lot of capital or when we needed capital to return it? It just wasn’t aligned. So we took a look and said we really want something that provides a little bit more flexibility. We spoke with the Board about it. They terminated the dividend as we know it in December of 2018. For us, this allows us some flexibility, whether we need capital, or there's some opportunistic event that we might want in horizon 2 or horizon 3. This is the first year. As you know, on a quarterly basis, we are providing shareholders with $0.10 per common share. In the fourth quarter, the Board will discuss any variable dividend, which will be payable in the first quarter of 2020. We also did a Q&A in December, and I believe that’s available on our investor website under stock and the dividend policy. So we did a bunch of Q&As if you want a deeper dive into that. But that really is the history of our dividend policy. It's evolved, as we have evolved, but I think it will be nice to continue to have some flexibility given our current state of thinking about so many growth opportunities in the future.

Sure. The trigger around comprehensive income being greater than after-tax underwriting income was certainly instrumental in 2009. In 2018, however, it was potentially an issue for us in that investment income was very low. You may recall there was a material sell-off in December while underwriting income was robust. We had around a 90 combined ratio and were growing 20%; however, comprehensive income was very close to becoming less than after-tax underwriting income. We could have been in a situation where we potentially would not pay any variable dividend or potentially pay what we ultimately paid, approximately $1.5 billion. We think that sort of binary trigger isn't optimal for the company or management or shareholders. So I think that's another benefit of moving away from the previous approach to the variable dividend. Obviously, the dividend is part of a capital management plan. We've been fairly transparent in our capital management philosophy. We have capital requirements from a regulatory perspective of about 3:1 for auto and about half of that for property. On top of that, we can carry a contingent capital layer, and generally speaking, both of those grow as we grow. So we have additional needs for capital. That said, at this point, we are in a very good position from a capital perspective, and we will continue to follow the path we have, as Tricia noted earlier, regarding returning under-leveraged capital to shareholders in the form of dividends or deploying them in share buybacks. In aggregate, as Andrew noted, our financial stewardship has been good over the years. We have achieved fairly impressive returns on our equity, and it is our aspiration and intent to continue to do so.

Great. So Chris, can you please introduce the first caller from the conference call line?

I had a couple of questions. First, we did see a moderation in auto severity this quarter. At the same time, there was a little less favorable frequency. Could you maybe talk about both of these shifts and what you see as the underlying causes for those?

Are you referring to collision, in particular?

I'm referring to overall severity and overall frequency.

Yes, the overall frequency was slightly lower, around 2%. Severity has increased a bit, and we view it differently between collision and property damage. In terms of collision, the severity was lower than in previous quarters. There could be various reasons for this, but we think our business mix is changing in a preferable way. On the severity side, we understand that it is becoming more expensive to repair vehicles, and vehicle components are also rising in cost. We associate a lot of severity with total losses, but frequency remains in a stable range. It has decreased slightly, but frequency can fluctuate and is difficult to predict. We don’t see anything systemic affecting it.

I thought that property damage already actually came in during the quarter.

Yes.

I would characterize it this way: so a point or two, quarter versus year. We don't normally view that as a material trend. It's tough to project as it is. But if it's a 6% severity change for the quarter, 7.4% year-to-date. We consider that to be a similar severity trend, and from what we can see, our severity trends are fairly consistent with those of our competitors. We obviously don't have full transparency there, but we have pretty good insight, and we think severity is in the 6% to 7% range right now. Frequency is down 2% to 3%. And that's generally speaking what we are thinking going forward as well.

Okay, that's helpful. And then my second question is around the agency's new application conversion rates this quarter. There seems to be a significant decline there. Could you maybe talk about what drove that?

Well, we've discussed a bit about a soft market, and there's been less shopping as people's rates remain stable. Over the past few quarters, we've seen either rate decreases or smaller increases, which has contributed to the reduced shopping. We continue to advertise, impacting both our agency and direct channels to support our growth, although that growth has been slowing slightly. We still believe our conversion rates are strong because when people do shop, our rates are competitive. Yes, we have noticed a slowdown due to the rate changes. We will need to monitor if this situation changes based on industry insights, particularly regarding severity.

I just would have thought that the lower rates would have driven lower new applications but not necessarily decrease the conversion rate of these new applications.

Well, yes. Good conversion is usually based on the rates. When you do shop, is it the right rate for you? Some people, if it's not significant, may not convert.

On a year-over-year basis, actually in both the agency and the direct channel, conversion has been up. It has been a highlight of our product model introductions. I would also add that conversions have been improving in segments that we're targeting. We're targeting more and more preferred customers, especially in the agency channel. We've seen nice shifts in preferred characteristics of the business we're writing, and that's predominantly driven by the new product models and the conversion that they create. We're getting more competitive by introducing factors for the preferred end of the segment that are more competitive.

Yes, I think the only one we haven't seen growth in new applications in the agency channel is among the inconsistently insured, which we refer to as SAMs.

Tricia, you mentioned in your letter on Snapshot that your program encourages customers to improve their driving behavior. That's a little different from what I've heard over the last several quarters regarding measuring for pricing and using Snapshot to measure pricing rather than changing behavior. Is there something behind that message that you're doing differently, either in your newer distracted driving measurements or in something else?

No, not necessarily. I mean, we use that obviously as our most predictive variable, but we also do want to encourage people to understand from a distracted driving perspective, as an example, when they are using their phone, hands-free or not, etc., mostly for the safety of all other drivers. We've always cared about that, and we've tested different things, whether it be beeps or giving you the information right away. It's still mostly used as a variable. But obviously, we want to give the best drivers the biggest discounts. Both aspects are important: understanding our rate to risk as well as helping people to drive better.

Do you have any intention of changing your Snapshot concept from measuring for 6 months, then you're done to making it continuous?

We discuss this frequently, and it might be more suitable for mobile devices compared to the dongle we currently offer. I’m continually exploring various ways to utilize that data, whether it’s for claims or other purposes. There are ongoing discussions about this.

I wanted to go back to Yaron's question on loss cost trends and maybe build on that. If you look at the frequency and severity data by quarter, it has been stable. But in the queue, you talk about additional pricing actions. So all things being equal, why would that translate into additional margin pressure as we head into 2020?

Well, I think that depends on each one of our products. Obviously, I talked about property, and we're seeing high loss costs on property. So of course, that affects trends. Our focus right now is to ensure profitability, expand our products, and our segmentation skills while making some underwriting changes. What we'll look at is the continued severity trends, and we feel really good as we've avoided substantial historic losses, where we thought that small decreases would increase conversion. We've done that. However, we haven't decreased rates to the extent that some of our competitors have. So we believe that if things change, we would likely need to make more significant adjustments to our rates. We've always communicated that with our customers because we know our customers want to have stable rates. So when we think about increasing rates substantially or decreasing them significantly, we try to make them stable to avoid topsy-turvy situations. We'll follow the trends, and we will, as we've said in the past, take small bites of the apple. We've always said if we increase rates, we want to be ahead of it because it’s better to maintain a stable environment rather than create erratic swings, making our customers stay with us due to our retention strategy.

Got it. The only other question I have is on commercial auto. In the queue, you talk about the change in loss cost trend. You talked about the shift in the mix of business toward for-hire trucking as one piece. Intuitively, as the book pivots and other pieces versus a monoline book grows, would that translate into a higher initial loss pick as we get into 2020?

I wouldn't take one quarter or one month of commercial to be something alarming. In fact, if you look at our year-to-date metrics, we're in the high 80s. So we feel very comfortable with that. Furthermore, if you examine the accident year, it's even better by about 2 points. We meticulously monitor every BMT and every state for new and renewal business and we always keep our competition in focus. You saw the delta we achieved in the combined ratio on Commercial Auto in comparison to the industry. We're continuously monitoring that aggressively, as we anticipate changes can arise from macroeconomic factors affecting our data.

I would just clarify that our loss ratios are always bottom-up. You mentioned a loss ratio pick going into the next year; that's not how we reserve. We actually have average reserves for losses that adjusters set below a threshold. Above that, we use the adjuster's estimate for the loss. We also have inflation factors that apply to other losses in the average layer over time. So if we generally think severity trend is X, we bake that into our calculations over the course of the year. When we incur claims and add those to our IBNR, that’s how we derive our loss ratio. We are seeing more large losses. As I'm sure you noted and Tricia alluded to, we did take a reserve change on commercial lines in September to reflect those trends. But again, we don't enter the year with a loss pick; we take a bottom-up approach.

This is actually Charlie on for Mike. First question, one of your competitors recently announced initiatives that cut its expense ratio. Do you feel your expense ratio or loss adjustment expense ratio can fall in the coming years based on any specific initiatives that you are undertaking?

We always look to have competitive prices. When you think about what Andrew described regarding our cornerstones and pillars, it's important for us to have competitive prices. So we're continuously searching for efficiencies. A few enhancements have been discussed in the past that address LAE, including leveraging more estimates through photos to improve efficiency and overall customer satisfaction. That works as long as there are no supplements, but we've continued to improve the percentage of losses settled this way. We are committed to using technology advancements to facilitate this. In terms of expense ratio, this is a central topic for my team as we approach our objectives for 2020. We discuss how we regard both expense ratio and LAE with a goal to reduce that over the years. I talked about this a few years ago when we aimed to get down to a certain percentage. We're continually focused on that. Of course, we want to maintain the right amount of people with talent because if we drastically cut LAE, it could lead to a rise in indemnity that negates those benefits. We focus on balancing talent with technology, utilizing advanced AI on CRM to ensure efficiency in customer interactions for simple needs. Ultimately, this is a significant component of ensuring competitive pricing. We are determined to optimize expenses across the board as a key initiative.

Got it. And then can you update us on the take-up rate for Snapshot? What percentage of users stay on the program after the initial period? Have there been any changes to that rate recently?

Yes. The take rate on the direct side is significantly higher, likely around 40%?

40%.

40%, and it's single digits on the agency side. We continue to work with our agency workforce to enhance that rate. We would say that at any given time right now, around 15% of our policies enforced would indicate that someone has been on the Snapshot program at some point. We are working to make people understand the discount and what we're looking for. Oftentimes, it's perceived as invasive. Many consumers are hesitant, partly because we offer a participation discount. However, when we have data, it allows us to provide either a 20% decrease, which is great, or a 20% surcharge. We believe it's a fantastic rating variable and beneficial for society as it hopefully encourages safer driving habits. The take rate has been relatively stable, significantly higher on the direct side.

In the commercial space, we developed an analogous offering, Smart Haul, and our commercial business is still mainly agency-based. The take rate for the commercial business for Smart Haul has been significantly more promising than in the Snapshot side for Personal Auto. There we connect with agents to target the higher transportation segment. So I think interstate trucking, where the premiums are quite significant; if you can offer customers a material discount, it is a substantial consideration for them as independent operators. As we saw from the last quarter, I had John Barbagallo share our commercialized precursors, along with Karen Bailo, who shared promising results from that program. Loss ratios from the information coming from electronic logging devices have proven to be highly predictive, and we're offering substantial discounts as well as surcharges. Despite that, our loss ratio remains fairly steep. We see continuing potential with our Smart Haul program in Commercial lines.

In your comments, you mentioned the capital requirements for your property business being about half that for auto. I'm curious if that changes your expectations about underlying combined ratios or combined ratio targets. You also referred to the ASL agreement, and I was wondering if you could provide color on that.

Yes. No, I think that capital requirements are established from a regulatory perspective, to ensure we have the right amount in case of losses. Then I think John referenced briefly when we talked about the dividend policy. We also have a self-imposed contingency layer for unforeseen circumstances, like a significant catastrophe or similar events. So our capital requirements won't change based on that. Our reinsurance does aid us in understanding ultimate loss costs. We entered into ASL a couple of years ago; we wanted to gain help. That doesn't prevent going over 100, clearly, but we aimed to mitigate the downside regarding not only name storms because that's now part of the ASL but also 63 LAE and non-storm or liability. It's another protection factor besides our name storms, where we anticipate an occurrence that might happen once every 100 years. We've had that in place for a few years now, addressing downside risk.

To elaborate on your combined ratio inquiry, we target, generally, a return on capital across our product lines in a similar neighborhood. You're correct that if we need to have more capital around for property, we aim for combined ratios for property to be lower than auto. You might quickly point out that that is not presently our performance situation, and we are quite aware of it. As Tricia mentioned in her opening comments, we're taking measures to improve profitability in the property sector.

My follow-up question, using your own words from the conference call about an environment where there's less shopping. I'm curious how you might adjust your advertising budget, considering we might be in this new environment as you described it?

Yes. Our media spend is influenced by our allowable cost per policy. As long as our cost per sale falls below that threshold, we will continue to advertise efficiently. We monitor what we call NP6, which refers to new prospects who haven't shopped us in the last six months while tracking conversion. Provided these metrics remain aligned with our parameters, we will continue our advertising efforts. We aim to promote various aspects to our customer base. We market a savings message, protection message for auto and home, monitoring their effectiveness closely to assess how successful each ad is. We apply deep analytics to our media spend and my team and I regularly troubleshoot these efforts to confirm we maximize value.

We think low levels of shopping over recent periods stem from many competitors decreasing their rates. We believe this environment has changed, and we are witnessing fewer rate decreases and an increase in rates. Customers receiving rate increases tend to shop more than those enjoying rate decreases. It's a dynamic environment. As Tricia mentioned, we are meticulous in how we monitor our spend, making adjustments dynamically and swiftly when market changes arise.

We don't want to retract our efforts. We believe it's crucial to maintain a presence because as the market fluctuates, we want to sustain our visibility. If people remain aware, they will consider us in their shopping patterns. We notice emerging trends indicating there could be turning points with some increases. Future predictions remain uncertain, but John and I often discuss and analyze the data to evaluate the shifting conditions in the market.

I'm actually going to take a question from the webcast now because it builds on a question that Greg just had. The question is, what specific actions is the company taking to achieve underwriting profitability in the property segment? Should investors be confident that Progressive will achieve underwriting profitability when that has been a challenge over the last several years?

Let me start with the last question. If you know the history of Progressive, when we aim to do something, we will execute it. I referred to 2016 when our trends escalated, and we were slightly over 96. We convened, made adjustments to our expense ratio and implemented rate changes, and we rectified that within a short timeline. Regarding the previous couple of years, if you exclude catastrophes, we are profitable. The severe weather events, especially wind and hail, have been considerable. We’re adjusting our underwriting guidelines, coverages, and deductibles in specific states where we are experiencing significant hail and wind. We're also rolling out our 4.0 product. We have it currently in three states, and we aim to have three more by the end of the year, with plans for a thorough rollout in 2020. If we need to scale back growth, we will. We also leverage reinsurance. The beauty of having ASI under the Progressive umbrella is that we can utilize the auto R&D and pricing for home; we are able to share insights to truly understand loss experiences across various customer segments. We are all hands on deck with this. I'll leave from here today to go down to St. Pete to Progressive Home. We're encouraged about the progress, but it takes time due to the annual nature of policy renewals. I feel very confident that we will achieve target profit margins. Remember, we always aim for both growth and profitability; however, if a choice must be made, profitability is paramount. We will take every measure to ensure we fulfill target profit margins.

Tricia, I could add just a little detail regarding the wind and hail comment if that's okay.

Yes, please.

If you analyze our losses, the weather losses in the last few years have surpassed our pricing estimations. The non-weather claims in water, fire, theft, liability, etc., have aligned closely with our pricing objectives. So when we project losses due to weather, owing to its volatility, we can't solely rely on our own experience over the last few years to predict next year's losses. Instead, we heavily depend on models. The hurricane models have proven to be fairly effective. However, our examination revealed that many tools for severe convective storms, such as thunderstorms that yield wind and hail, haven’t performed well at all. Consequently, we've initiated significant work, adopting a new tool from Karen Clark and Company, which we feel, alongside our proprietary adjustments, offers a much better predictor of future losses. We're employing that tool to assist in pricing strategies in states with significant wind and hail risk, so I'm much more confident moving ahead that we’ll be accurately priced for those risks. Additionally, we will be managing concentrations in regions prone to hail to mitigate risk.

Yes! Dave is down in St. Pete right now. I have to tell you, he has an extensive career at Progressive, managing many facets of this. If there's anyone who can right this ship, it will be him. We have all hands on deck with this, which further boosts my confidence level.

Great. I actually have a follow-up question related to the prior comments about weather and weather data. The question is: what do you think the long-term impact to the company will be from the risks of climate change?

I mean, that's really hard to say. And we'll continue to use reinsurance to protect against the downside. I think what Dave stated is spot on regarding our efforts on understanding models and how it affects our book of business. We have been undertaking extensive analysis on severe convective storms recently and feel confident about it. We will keep adapting and improving our underwriting guidelines as needed while maintaining our focus on pricing for risks responsibly.

This is Crystal Lu in for Ryan Tunis. For our first question, can you please talk about what is driving the increased severity trends in the parts of your commercial auto book that are seeing higher losses? Why are those drivers or characteristics not impacting the healthier portions of your commercial auto book?

I think the main driver of many of the severities is medical costs. They are affecting the book overall; whether it’s auto or commercial auto becomes more pronounced in the for-hire trucking.

Could you talk about which sections of the commercial auto reserves you reviewed in September and which portions of the book are going to be reviewed in the fourth quarter? Did you pull forward any reserve reviews when you observed trends of increasing severity in certain segments?

Yes, I’ll have Gary Traicoff summarize this because he’ll know exactly what he’s reviewing and what we will look into going forward. However, we review a substantial portion of our entire organization frequently to ensure our reserves are accurate. When we spot any trends, we strive to strengthen reserves. That's why I mentioned in my letter this quarter about strengthening reserves due to the trends we're seeing.

Sure, everyone. I'm Gary Traicoff, Chief Actuary. Regarding commercial auto, we review approximately 90% of the reserves each quarter. For example, with bodily injury, where we took the $25 million increase, we look at that each quarter. Are we changing how we approach our reviews in terms of timing? No, we assess most of the reserve each quarter, with only about 10% comprising smaller coverages like collision, property damage, etc., that we might review a couple of times a year. Just to clarify, across all of our products, we’ll review about 80% to 85% of reserves every quarter.

Thanks, Gary.

I'll add that while we're on that topic, as a reference back to our last quarterly webcast, John Barbagallo and/or Karen Bailo, if I recall correctly, shared a chart around last year's reserve development from 2012 through 2018 and showed how Progressive had performed versus the rest of the industry. Kudos to Gary Traicoff and team, as the Progressive dots lay fairly close to the 0 line for accuracy. Not always right at 0, we won't be perfect, but our numbers look good. This year, we are just above 2 points year-to-date, and the industry average has historically been significantly higher, hitting 9 points in some years of prior development. This level of reserve accuracy aids our commercial auto pricing accuracy. Additionally, we reserve down to a finer level than many competitors in that space, driving our prices to be more accurate, competitive and profitable. We have experienced some development, which is slightly higher than our historical norms. The product managers for commercial lines are diligently focusing on taking necessary actions as Tricia has mentioned; it is their responsibility.

Could you provide us with an update on your efforts to move into the small business market? This is a sizeable opportunity, but any details you can share on your growth outlook there?

Yes. Clearly, we view this opportunity as extraordinary, but it's too early to really delve into specifics. Our emphasis is on the 30 million small businesses with 20 or fewer employees. We've just rolled out the initiative in the agency channel. We'll continue to learn and gather insights, and once we have more to share, we will, but we firmly believe that this aligns with our growth opportunities, so we're excited about it.

Got it. Okay. Then just a question on catastrophe losses. They've been left out of the last three or four monthly reports. In the queue, I think they were close to $160 million in the third quarter. While it's useful to observe those underlying loss trends with those excluded. Should we anticipate those to return to the monthly results, or will they be omitted moving forward?

We've maintained a longstanding policy to include cat information in monthly reports if it impacts 2 points or more on the combined ratio. That’s been our standard for decades. Therefore, we are unlikely to alter this. We strive for transparency through our monthly reporting and share a wealth of data during this webcast. The chances of changing our practice remains low, but we will always consider it.

That swept away my question, but I want to at least cast a vote for including the information. That way, we can better assess the ongoing situation. I understand you're not expecting to change it, but I did want to urge reconsideration. I wanted to get your comments on the softening of the softening in personal auto. Can you break down how much of Progressive's anticipated response might involve retracting modest rate decreases or expecting improved top-line policy growth?

Yes. We always seek to improve top-line growth. We’ve taken modest decreases across the board strategically to achieve a balance of growth and profitability while optimizing our conversion rates. As we monitor the competition, you’ll see that the industry has remained relatively stable. In fact, we’ve observed some competitors implementing small increases. John and I often assess these industry trends closely, pondering how we fit in. I feel we have positioned ourselves well since we haven’t succumbed to taking substantial rate drops in exchange for growth nor have we dramatically reduced our rates so far. We're deliberate in understanding the impact of any adjustments to recommendations. If we recognize the need to modify rates, we would absolutely do it, but we’re keenly aware that trend fluctuations might vary across different states, channels, and products.

On my end, it is. I had a quick follow-up question if I can. I was just curious, when we look at the relationships between auto data and homeowner data, I wonder if claims that don't necessarily reflect responsibility have any relationship?

We're investigating that relationship between the data shared in auto versus homeowners policies. There is overlap, and our current exploration is to comprehend how we can adequately leverage that data to enhance our target fine segments more accurately. So yes, there's interplay we are discovering, but it isn't something we can publicly disclose comprehensively at this moment.

Could you give us an idea of how digital acquisition is expanding? Over the past three to five years, how much of your auto personal business is being acquired through the digital channel, whether it directs or goes through agencies? What was it like three years ago compared to today? Where are you in terms of homeowners and bundled in the realm of digital rollout?

The acquisition via the digital side has seen substantial increases when compared to mass media in years past. However, it is challenging to quantify exact percentages, particularly in relation to what customers observe before making decisions through other channels like agents. Digital avenues likely attract different customer profiles who seek to finalize purchases online rather than engage in one-on-one consultations. I can say it's seen substantial growth, although I don't have precise metrics right now. We are also evolving the home bundle program, progressively adjusting our messaging. Historically, our focus was solely on auto. We have found that actively discussing home can significantly impact the bundle response. Therefore, we anticipate that as we continue to invest in our digital capabilities, our home offerings will trend efficiency at the same pace as auto.

By far, the majority of our auto sales now are digital, and this trend continues to climb. It's remarkable that so many people are willing to purchase insurance via mobile devices, and that trend doesn’t seem to be abating. This transition has yet to materialize as much in home insurance. We're beginning to build capabilities for clients to efficiently quote and buy property insurance online, and we are observing some interest in mobile for property insurance as well as our auto business.

And I was mentioning the acquisition side; John added his take with the advertising angle. I interpreted your inquiry more towards the overall efficiency of advertising spend, for which we are conscious. Nonetheless, we’re expediting our spending on home in that aspect. For years, digital channels haven't served as the primary avenues for insurance purchasing; with HQX, our HomeQuote Explorer, we are currently integrating Progressive Home and the buy button in multiple states. We expect to increase to 14 states by year-end, confirming that ease of access and reducing complexity is key since we expect this to mirror our auto growth.

Could you give an update on process improvements in the five states where you're addressing some of the BI severity on the auto side? How are those progressing? When should we expect to see improvements?

Early metrics indicate that it is performing positively. Again, this is preliminary, but we are encouraged by the results.

That concludes the Progressive Corporation's third quarter investor event. Information about a replay of the event will be available on the Investor Relations section of Progressive's website for the next year. You may now disconnect.