01—Abstract
Summary
Summary of the 10-K filed February 27, 2008. Cited figures are marked; the original filing is the authoritative source.
Progressive (PGR) closed 2007 with net income of $1.18 billiona ($1.65 diluted EPS), down about 28% from $1.65 billion ($2.10) in 2006, as the company deliberately cut auto rates from mid-2006 to chase growth.
Net premiums written fell 3% to $13.77 billionb and net premiums earned fell 2% to $13.88 billion, while policies in force grew 4%. The combined ratio deteriorated to 92.6 from 86.7 in 2006, though the 7.4% underwriting margin still exceeded management's stated 4% target. Management's stated long-run goal is to grow as fast as possible at a 96 combined ratio, so investors should view 2007 as a deliberate trade of margin for unit growth rather than an operational breakdown.
The year was dominated by a capital restructuring. Progressive issued $1 billionc of 6.70% junior subordinated debentures due 2067, paid a $2.00 per share extraordinary dividend (about $1.4 billion), and repurchased 72.9 million shares for $1.5 billion at an average of $21.24. Debt-to-total capital rose to 30.6% from 14.8%, slightly above the company's own 30% policy ceiling.
Book value per share fell to $7.26d from $9.15, and shareholders' equity dropped to $4.94 billion from $6.85 billion. Going forward, the variable annual dividend (20% of after-tax underwriting income times a Gainshare factor) means the 2008 payout will be uncertain and could be zero. Reserve development turned unfavorable, with $80.3 million of adverse prior-year development in 2007 compared with favorable development of $246.9 million in 2006.
The company also faces multiple putative class actions over claims practices, credit-based underwriting, and aftermarket parts, though management believes most are not yet probable and estimable losses. The investment portfolio of $14.2 billion (83% fixed income, average AA credit quality, 3.5-year duration) is conservatively positioned, but $306 million of unrealized losses on preferred stocks, largely financial issuers, reflect sub-prime market stress.
02—Key points
Key Highlights
- Net income fell to $1,182.5 million ($1.65 diluted EPS) from $1,647.5 million ($2.10) in 2006, a decline of about 28%.
- Combined ratio rose to 92.6 from 86.7, with the underwriting margin falling to 7.4% from 13.3%, though still above the 4% target.
- Net premiums written declined 3% to $13.77 billion while policies in force grew 4%, reflecting deliberate rate cuts to drive unit growth.
- Capital restructuring: $1 billion debenture issuance, $1.4 billion extraordinary dividend ($2.00/share), and $1.5 billion of share buybacks (72.9 million shares at $21.24 average).
- Debt-to-total capital rose to 30.6% from 14.8%, slightly above the company's 30% financial policy threshold; shareholders' equity fell to $4.94 billion.
- Unfavorable prior-year reserve development of $80.3 million (0.6 points) reversed favorable development of $246.9 million in 2006.
- Investment portfolio of $14.2 billion is 83% fixed income (AA average, 3.5-year duration), but preferred stocks carry $306 million of unrealized losses tied largely to financial-sector issuers.
03—One dollar
04—Financials
Financial Highlights
Figures from 10-KFY2007filed February 27, 2008Financial Statements
| Revenue | $14.69B |
| Interest Expense | $108.60M |
| Net Income | $1.18B |
| EPS (Basic) | $1.66 |
| EPS (Diluted) | $1.65 |
| Shares Outstanding (Basic) | 710.40M |
| Shares Outstanding (Diluted) | 718.50M |
05—Questions
Frequently Asked Questions
Why did Progressive's profitability decline in 2007?
Progressive began cutting auto rates in mid-2006 to pursue growth, and average written premium per policy fell about 5% in 2007. Loss severity rose about 3.5%, and prior-year reserve development turned unfavorable, pushing the combined ratio to 92.6 from 86.7. Management described this as an intentional trade of margin for longer-term customer growth.
What is the variable dividend, and will shareholders receive one in 2008?
The annual dividend equals 20% of after-tax underwriting income multiplied by the Gainshare factor (ranging from 0 to 2). The 2007 dividend was $0.145 per share, paid January 31, 2008. The Board will not declare the 2008 dividend until December 2008 and may alter or skip the policy, so the amount is highly uncertain.
Is the higher debt level a risk for Progressive?
Debt rose to $2.17 billion, and debt-to-total capital reached 30.6%, slightly above the company's 30% policy. The company states that its debt covenants contain no rating or credit triggers and that interest on existing notes is unaffected by downgrades. However, the 6.70% debentures allow interest deferral for up to ten years, during which dividends and buybacks would be restricted.
How exposed is Progressive to the sub-prime mortgage market?
Direct exposure is modest: about $148.7 million of home equity bonds and $52.3 million of Alt-A securities, with $12.3 million of unrealized losses. Roughly two-thirds of the $2.6 billion preferred stock portfolio is financial-sector issuers, with $306 million of unrealized losses at year-end, but management concluded none were other-than-temporarily impaired.
What are the main litigation risks?
Progressive faces numerous putative and certified class actions covering bodily injury database use, Fair Credit Reporting Act credit usage, aftermarket parts, PIP reimbursements, and rating practices at renewal. Management reserves only for matters it considers both probable and estimable, and several large settlements have been reached or reserved. Adverse outcomes exceeding reserves could materially affect results.
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