Description

Progressive, the US auto insurer, was founded in 1937 in Ohio, initially focussing on nonstandard auto insurance.  It listed in 1971 at which point it stated an objective of growing as fast as possible whilst achieving a maximum combined ratio of 96 i.e. a minimum profit margin from underwriting (before investment returns) of 4%.  This remains a tenet today and is generally achieved or exceeded.  In 2020, Progressive generated $39.3bn of total Premiums Earned, split $32.6bn in Personal Lines (mostly personal auto but some lines in RVs, boats and motorcycles), $4.9bn in Commercial Lines (mostly small business trucks and cars) and $1.6bn in Property (Homeowners Insurance).

Progressive sells insurance directly and via agents.  Alongside Berkshire Hathaway’s GEICO, it is the only other auto insurer that has a significant direct auto insurance business.  Progressive’s fictional character Flo vies with GEICO’s Gecko for consumer attention.  It has a 13% market share in personal auto insurance which is a joint #2 position with GEICO behind State Farm, and has been increasing share steadily.  It is the market leader in Commercial Auto insurance.

Risk Pricing

Progressive has several sources of moat but primary among these is its ability to more accurately appraise individual risk and so better “match rate to risk”. Progressive has achieved an average underwriting margin in the last two decades of 7.5%.  This is in the context of an industry that generally loses money on underwriting and relies on investment returns for profitability. 

The 4 main buckets of cost, with approximate relative weighting expressed as % of premium earned are: Loss Costs (61%), Loss Adjustment Expenses (11%), Customer Acquisition Costs (12%) and Non-Acquisition Expenses (9%).  GEICO is often referenced as the low-cost operator in the industry.  It is true that its Non-Acquisition Expenses and Customer Acquisition Costs are moderately lower than Progressive’s, albeit Progressive’s costs are low relative to most of the industry.  However, Progressive is clearly advantaged in the largest cost bracket, Loss Costs, the payments for settling claims.  Progressive consistently achieves this through being early and skilful at capturing and analysing data that is suggestive of risk. 

Progressive was the first auto insurer to recognise the significance of credit ratings and incorporate this to its risk pricing.  It was early to embrace telematics.  Risk pricing is a constantly evolving game of finding small data and analytical edges and incorporating these as tools with marginal gains into the system.  Progressive’s heritage in doing this may stem from its early focus on non-standard (riskier) insurance.  Its book still skews to non-standard today.  Progressive’s edge here has allowed it to grow market share steadily, whilst maintaining profitability. 

There is a positive feedback loop whereby an insurer with a risk pricing edge is able to sell insurance at an attractive price to customers that competitors over-charge (thereby gaining a profitable customer) while avoiding selling insurance to customers at too low a price (thereby pushing loss making customers over to competitors who price the risk too low). 

At the 2019 Berkshire Hathaway Shareholder’s Meeting, Ajit Jain, Vice Chairman of Insurance Operations commented:

“GEICO has a significant advantage over Progressive when it comes to the expense ratio to the extent of about 7 points or so. On the loss ratio side, Progressive does a much better job than GEICO does. They have, I think, about a 12 point advantage over GEICO. So net-net, Progressive is ahead by about 5 points”

It is nice to see high praise from a major competitor. 

Complementing its risk pricing capability, Progressive has a robust loss adjustment operation that is efficient in ensuring they pay out only for genuine loss claims. They have hundreds of claims offices around the country and they often benefit from having local knowledge of how to manage claims.  It is impressive how operations were maintained by virtual video inspections throughout the pandemic as on-site inspections were sometimes restricted.  It is clear that under-investing in loss adjusting is ‘penny-wise and pound-foolish’. It is reassuring that the current CEO started her career at Progressive in claims management and not in sales.

Industry Structure / Direct Selling

The other key source of moat is that Progressive is one of only two scaled direct auto insurance sellers in a market in which there is limited online price comparison via aggregators.

It is interesting that the US market is very different to many others in that price comparison websites have never taken off in the US despite repeated attempts.  This is partly from the resistance of the larger insurers and also from complexities in the regulatory landscape which are particular to each State.

Direct selling comprises c.25% of the market, with the rest made up of Captive and Independent Agents.  Direct selling is growing and slowly gaining share (it was 10% in 2000) but unless one has a strong brand and a very large marketing budget, such that customers come directly to your website, it is difficult to do this profitably.  Barriers are lower in markets such as the UK where anyone can reach customers via price comparison websites. 

The #4 player Allstate tried to develop a direct business by acquiring Esurance, a relatively small direct business, in 2011, but largely gave up after incurring significant losses from investment in customer acquisition, in an attempt to build the brand.  GEICO’s and Progressive’s marketing budgets are huge, both spending c.$2bn annually on advertising.  It seems likely that the direct channel will be a long-term source of growth, as it captures further share and that it will only be enjoyed by these two players.

Progressive is about 50:50 direct vs via agents, whereas GEICO is purely direct.  Selling through agents represents the dominant channel (75%) in US auto insurance and is declining slowly as many customers like dealing with agents who handle the annual renewals for them and do not charge them an obvious fee.  Progressive have invested to improve their position in the agency market.  In 2016 they acquired a Homeowners insurer.  The main reason was so that they could offer bundled Auto + Home Insurance via agents to customers.  Progressive estimates that these bundled customers comprise half the market.  The acquisition catalysed an acceleration in their agency channel as Progressive could tap into a significant area of the market which hitherto it had not been able to properly address.  These customers are naturally much stickier with higher lifetime values.

Culture & Management

Progressive has a very distinctive culture.  The company was founded in 1937.  Peter Lewis, the son of the founder, joined the business after university and was CEO from 1965 to 2000, remaining as Chairman until he died in 2013.  When he started Progressive had 40 employees, by the time he died its revenue was over $18bn.  The first non-family CEO was Glenn Renwick from 2000-2016 and he was succeeded by the current CEO Tricia Griffith in July 2016 who joined the business as a claims representative in 1988.  We treat Progressive as having an outstanding “owner occupied” culture where the employees and management team are very well aligned with outside shareholders.

Progressive is the only company we are aware of that reports an abbreviated Profit & Loss Account including Net Income, alongside operational metrics, on a monthly basis.  This suggests a transparent and confident organisation.  Progressive incentivises employees through a unique and long-standing incentive plan called ‘Gainshare’.  Bonuses are algorithmically determined by the Gainshare Factor, which can range from 0 to a maximum of 2.0.  Performance is measured against targets for growth and profitability.  This creates a performance-driven environment with collective skin-in-the-game. Our final observation on culture is that Progressive is located in Mayfield Village, outside of Cleveland, Ohio, in the Midwest, but the resolute focus on data and analytics makes us wonder whether its spiritual home would be closer to Silicon Valley.

Bear Case

With much to like it is important to understand the bear case and test whether our positive perception is valid. There are two main bear cases against Progressive for us to consider.

Firstly, some investors are naturally nervous about Progressive’s terminal value as autonomous cars will in due course impinge on the need for insurance.  In time, autonomous cars will reduce the number of car accidents, and to the extent insurance is provided, it may be included in ‘uber-style’ autonomous taxi services, or possibly supplied directly by manufacturers like Tesla (which will effectively be taking responsibility for driving the cars).

The question is about timing and what this means for value.  Many of the forecasts in recent years, even aside from those of the Panglossian Elon Musk, have proved to be overly ambitious.  The barrier to adoption is as much regulatory and psychological as it is technological.  For regulatory approval and widespread adoption, autonomous cars need to be significantly safer than human-driven cars because higher standards are demanded from machines.

We take account of the transition to autonomous driving by modelling a period during which existing drivers gradually give up driving and new cohorts of young drivers never learn to drive as they begin to rely on autonomous cars.  We model Progressive continuing to grow and capture market share of its addressable human-driving market, but the ultimate inevitability of an autonomous car transition means it is likely that Progressive’s revenues will peak sometime in the 2030s and decline thereafter. 

In terms of valuation, by the mid-2030s, $1 of cashflow is worth 40 cents today based on our discount rate.  By 2050, when autonomous cars may well have materially impaired the auto insurance industry, $1 dollar of cashflow is worth 15c in today’s money.  Progressive’s intrinsic value today is more a function of the next 10-15 years when the autonomous threat is not that material, than the period beyond, when it may start to really bite.

The second main bear case is that Progressive’s combined ratio is unsustainably low.  This concern is salient at the time of writing.  Profitability has dropped in recent months with an increased frequency of accidents plus higher costs, not least from a spike in used car prices.  This has pressured underwriting margins which are currently below the long-term average, with losses reported in some recent months.  There is evidence Progressive is adjusting pricing with agility, and its peers will do the same as the insurance cycle hardens to reflect a change in underlying economics.  This should support a reversion to under-writing profitability just as has been seen many times in past cycles.

This concern is best judged with a long historical perspective.  Below we present Progressive’s personal auto underwriting margin for last 20 years from 2001 to 2020 versus the total personal auto market.  For the reasons discussed earlier, it is clear that there are structural factors that support Progressive’s superior underwriting performance.  In this period Progressive has generated an average combined ratio of 72.4 whereas this has averaged 100.2 for the broader industry.  The gap does not appear to be narrowing.

Source: S&P Capital IQ

If we apply the long-term average underwriting margin to 2021 expected Earned Premium, we estimate a ‘normalised’ Net Income of $3.1bn.  At a market capitalisation of $60bn, Progressive is trading on a ‘normalised’ p/e of 19x. This is not especially cheap, but we sleep well being invested in a competitively advantaged business growing at c.10% p.a. trading at close to the long-term average multiple of the S&P500, and at a sharp discount to where the broader market is today.

Catalyst

The pitch is not predicated on a catalyst but a view that the business is under-valued by the market. However, if pushed, it is possible that if recent weaker monthly underwriting results ease as pricing adjusts in a hardening of the cycle, then some market concerns will abate.