前進保險 (PGR) 2011 Q2 法說會逐字稿

Welcome to The Progressive Corporation's investor relations conference call. This conference call is also available via audio webcast. Webcast participants will be able to listen only throughout the duration of the call. In addition, this conference is being recorded at the request of Progressive. If you have any objections, you may disconnect at this time.

The Company will not make detailed comments in addition to those provided in its annual report on Form 10-Q and letter to shareholders, which have been posted to the Company's website, and will use this conference call to respond to questions.

Acting as moderator for the call will be Clark Khayat. At this time, I will turn the call over to Mr. Khayat.

Thank you and good morning. Welcome to Progressive's second-quarter conference call.

Participating on today's call are Glenn Renwick, our CEO; Brian Domeck, our CFO; and also on the line is Bill Cody, our Chief Investment Officer. This call is scheduled to last about an hour.

As always, our discussions on this call may include forward-looking statements. These forward-looking 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 this call.

Additional information concerning those risks and uncertainties is available on our 2010 annual report on Form 10-K and our quarterly reports on Forms 10-Q issued during 2011, where you will find discussions of the risk factors affecting our businesses, Safe Harbor statements relating to forward-looking statements, and other discussions of the risks, uncertainties, and other challenges we face.

Each of these documents can be found via the investors page on our website, Progressive.com.

We are now ready for our first question.

(Operator Instructions). Paul Newsome, Sandler O'Neill.

Maybe we could just start off about the most recent update with respect to some of the more troubled states, like Florida and the PIP states. What I'm actually thinking about is whether or not you folks want to stand behind the comments that were made about optimism for accelerated PIP growth in the -- [illuminated] the comments that were made in the most recent analyst day?

Sure, Paul. It's a good place to start. Let me try to detail sort of four states that I think will give us the flavor of this, Florida, New Jersey, New York, and Michigan. Then I'll ask Brian to comment on things that I might miss.

Absolutely stand behind the comment with regard to Florida and New Jersey. We are -- again, recognize that we took a significant dip. So when I talk about returns we're not talking about pulling way from all-time highs, we're getting back to it.

But we're seeing, and I'll use the word significant, return to growth in Florida and New Jersey. Very significant return to growth there, but it is a return, and I hope, of course, we'll go on past the point that we were once at. But happy with -- very happy with the results Florida and New Jersey.

New York, also happy, but I would not use the word sort of significant growth there. We're sort of growing. We certainly have respect for GEICO in New York. They have a great position there, and we just don't have the growth that we would love to enjoy there. That doesn't mean we're not going to work at it every day, but happy with New York, less growth.

And Michigan, growth really hasn't been the issue in Michigan. Michigan is getting sort of the control around profitability, and we're much happier than we were in Michigan and starting to get to a point where our growth and profitability is a lot better balance.

So the optimism that -- I don't want to use that word, per se, but I think I described some optimism for the second quarter, stands and is led by New Jersey and Florida, and comfort with both of the other states being able to not be a drag at all. Brian, do you want to sort of add anything to that?

Nothing significant to add. In Florida, we actually did lower our rates in early June. So after that, we have seen a pretty significant rebound in new application counts.

Obviously, policies in force sort of lag that, but the growth that Glenn was referring to is we've seen a significant increase in new application counts, both in the agency channel and also in the direct channel. New Jersey, we're also seeing positive growth in new business applications.

The Michigan story is a little bit different there. It is -- we had some concerns about the profitability, and over the past year, year and a half, we have raised rates fairly consistently and aggressively in the state of Michigan. So that wouldn't be a growth in new applications story right now, but we feel much better about our rate adequacy and overall rate level yet there. Growth there will be slower to come.

Terrific. My second question is a different topic. We are obviously having an interesting time recently in the financial markets. Progressive has one of the highest -- higher proportion of government -- U.S. equity -- government investments relative to their equity. I was thinking, do you have any views on that? Does the AAA downgrade affect how you think about your total portfolio?

Hi, Paul. This is Bill Cody. No, it doesn't affect how we think about our total portfolio or about treasuries particularly.

We still feel really confident that we'll receive all our timely interest and principal payments on the treasury portfolio. Our weighted average credit rating, post the downgrade, remained at AA-.

But you're right. If you add up our cash in our treasury portfolio, it is roughly 30% of our total fixed income portfolio, which is substantial. And that, honestly, feels pretty good to us right about now as we're seeing a little bit more turmoil. That may give some dry powder if there is some opportunities down the road.

We've kept our duration short, which hasn't worked out as rates have fallen, but as rates get lower and lower, the math gets really tough there in that it doesn't take much of a price move to wipe out a full year's worth of income. So we're maintaining a pretty short duration portfolio and looking for high-quality spread product on the front end when we can find it.

Cliff Gallant, KBW.

Good morning. Just wanted to ask about Snapshot, get another update on how that product rollout is going. I was curious as to whether or not -- or what your view will be in terms of when you might be able to give Snapshot to non-Progressive policyholders? At some point, do you think Snapshot could be a marketing tool, something that you might be able to mail out to non-Progressive policyholders to perhaps try to get them to -- to spur some shopping activity?

Yes, let me pick up a little bit. It's, what, 40, 50 days since we were together in New York, so I'll hit a couple of things on Snapshot, and then I will at least comment on your second question of non-customers.

In general, we remain as comfortable and optimistic as we were in June. We think the branding work we've done, some since then, and a couple of new ads that have yet to air, are continuing to allow us to own that space. That was very important to us, to get something where usage base is really highly associated with Progressive, and our measures tell us that we are achieving that.

I would tell you on a both personal and, as best we can determine, objective measure, we've yet to really describe Snapshot to the consuming public as well as we ultimately will need to do so. My suspicion is that it will require continuous exposure and different presentations, and we're actually pretty excited about a couple more that are in the hopper. But we recognize that that is not a quick one ad, everybody gets it and gets excited, and therefore takes it up.

The take rate in the direct channel, I mentioned this in my comments for the annual report letter, remains very strong. Our agency distribution is actually starting to accept the concept and get certified, and there is an online certification process for our agents before they can use that. About 50% of our agents are now certified to use it.

The take rate in agency is about half to maybe a little less than half of what it is in the direct channel. I don't read too much into that at this point in time. I think it's a new concept, just as it is for consumers, but there appears to be no roadblocks there that we couldn't continue to report improvement on all of those numbers.

Important to us, clearly, when we start to go -- we've done testing for a long, long time, but important when we really get to this new model is profitability, and our loss ratio and our target seem to be in line with our expectations, and we're actually quite happy there.

And thirdly, retention. And at this stage, all we can really comment on is what I will call early-term retention of customers since we don't have long-term customers on the product, but the early-term retention is actually very encouraging for us. So, good things on Snapshot.

We continue to actually produce a fair percentage of our business. I'll give you sort of rough numbers, although I said I'm not going to continue to comment on numbers that are really a discount in our regular product, but of the customers that will come to us on a monthly basis, think in terms of between 30,000 and 40,000 customers are taking this product. So we're starting to get a significant market -- or face on which to derive these conclusions around profitability, retention, and brand acceptance as a more general concept.

You're so -- I'll -- really just a continuing positive update to the June comment. Clearly, you know our overall growth numbers, so it's not something that has sort of pulled in significant numbers of customers that we weren't otherwise getting, and we continue to hope to see that those numbers can get greater over time.

With regard to non-Progressive policyholders using the product, I was trying to be fairly direct in New York. While we have clearly thoughts on that matter, we have not disclosed and are not in a position to disclose our ultimate game plan on that one. But there are options available to us that we will intend to capitalize on.

Meyer Shields, Stifel Nicolaus.

Looking at the direct channel, obviously PIF growth is still pretty impressive, but it has been slowing down a little bit. And I'm wondering whether there is a difference in the breakdown of new direct-channel customers by their previous channel of volume churns?

I honestly haven't looked at that in enough detail to comment in a way that would be meaningful to your question. I don't have any reason -- I mean, we do it all the time.

I think I would know or Brian would know if there was any marked change in that distribution of prior carrier coming to us, and I don't know of that. So rather than sort of wing an answer to that, which is not what we would do, I simply don't know if there has been a change. My suspicion is not. I'm happy to respond to that next time on a conference call. I'll make a note to make sure that we have that covered.

Thanks. And a separate question, I guess. In the Q, you talked about less shopping and the lower conversion rates. I know this is a simplistic analysis to say that if there's less shopping, there's probably more committed shoppers out there, which might imply a higher conversion rate. I was wondering if you could talk about why that is not translating in that way.

That would require a fair amount of generalization. I wouldn't disagree with your premise, but in some cases we've had to -- we're taking rate, which will actually force lower conversion rates.

So, over the first six months or so, even though our average -- or our aggregate rate take would be about 0.6%, you have individual states that have taken more, and Brian mentioned earlier that we took rate down in Florida, but prior to that we were taking rate up a fair amount. That clearly affects conversion, and the rate decrease will do the opposite to that.

So I don't have a macro response to you that sort of suggests that there are more committed shoppers. I'm not sure that that is necessarily true. I understand the logic, but we can only really report what we see. And by looking at this as many ways as we can, whether it through agent production, Internet, comparative rating, so on and so forth, we do believe that shopping is down, and conversion is much more a function of just our rate level in the individual states.

We're feeling good about our rate level, our margins. I think the margins in general for the industry are starting to approach a little bit more of the mid-90s as opposed to lower 90s.

Those rate changes, I think the industry has been at about a 1.6, or our estimate is about a 1.6, so a little bit faster than us. Again, another reason to believe that maybe conversion would be stronger for us, but it is really a state-by-state issue.

We'll just keep reporting what we see. I'd love to think that some of the comments I've made with Florida and New Jersey will help us with aggregate conversions.

This is Brian. The other thing I'd add to it in terms of conversion, some of it -- certainly state mix is part of it, but also how and where they're coming from -- the prospects are coming from matters.

And I think -- in New York, John Sauerland clearly described taking search, paid search on the Internet, as an example. People who shop for Progressive Insurance will have a much higher close rate than people who shop just generally for auto insurance.

And in terms of our mix of prospects, we are trying to get more and more just to look at us, but as we look at our prospect flow in terms of where some of the prospects are coming, particularly on the Internet, they would be coming from some of our more lower-converting, by very nature, media channels.

Vinay Misquith, Evercore Partners.

First question on New Jersey. Was pricing taken down there? And why are you starting to see sort of a pickup in growth in that state?

This is Brian. Last year, we actually raised our rates fairly significantly in New Jersey, which was partially [callous] for new application decreasing there. And recently, we have become more comfortable in our rate level, and I believe we've recently lowered rates a small amount. It was either recently or soon to be recently (multiple speakers)

Okay, fair enough.

(Multiple speakers) exactly about the exact date of it, but it is -- in the summer months, we were planning to decrease rates a little bit in New Jersey. I suspect that has already happened.

Sure, fair enough. The second question is on the expense ratio. First half of this year, the expense ratio in the direct increased versus the first half of last year. I'm just curious why that is happening and how much of gain share is in that. And was this year's numbers negatively impacted by the higher growth or the Snapshot product introduction?

Part of the expense ratio being higher is we have continued to increase advertising spend, although in aggregate it is fairly close to earned premium growth rate. But we have increased advertising spend, for certain, so that adds a component piece.

Gain share actually would not be a component piece because our gain share score this year is lower than it was last year, so there would be actually a little bit less of an accrual set up for gain share relative to that.

And a little bit -- keep in mind, average premiums per policy in direct have gone down a little bit, not markedly, but a little bit. So net net, our aggregate cost per sale -- or cost per acquisition is higher this year than versus a year ago.

Can we expect that to come down next year if growth slows a little bit?

In terms of the amount of advertising spend? We always (multiple speakers). Or expense ratio in general?

The expense ratio in general.

A major component -- I'd say there are two major components in expense ratio, particularly on the direct side, the first being the cost of acquisition.

So in terms of advertising spend, we have mentioned so far this year it was up close to double digits through the first six months of the year, and we will always re-evaluate that spend relative to a deal. I know we've talked about that a fair amount before, relative to cost of sale, relative to our targeted acquisition cost.

So we continue to re-evaluate how much we spend. And we have meetings regularly even as to what the next quarter's spend might be or the remainder of the year's spend might be. So, we will continue to re-evaluate that based upon where we feel our yield is relative to targets.

The second component piece in all of our expense ratios, a large amount of it, is labor costs. And we are trying and continue to try to increase efficiency in everything we do. Our policies in force per FTE continue to increase, but, granted, at a slower pace than a couple of years ago. So we continue to gain some efficiencies, but it is at a little slower pace than it had been in the last couple of years.

Sure, fair enough. One last question, if I may just sneak it in. On the capital front, you had about $1.6 billion at the holding company, cash. How much do you think is a normalized amount that you would like to keep?

We don't typically think in terms of what is a normalized amount at the holding company. I think we gave you very clear direction as to what our overall capital models are and what we expect to do with capital when we are in a position of more than we can effectively put to work.

But the holding company is going to vary based on time of year, based on dividend [being] up from operating companies, based on significant tax payments and other things that we might want to do, gain share, variable dividend, so that will vary throughout the course of the year very much in anticipation of the cash flows that we expect, either from the operating companies or outflow of cash. But we don't have a particular amount. We try to be much more normalized for the operating companies and let the holding company be the excess.

In terms of -- here are things that are paid out of that non-insurance subsidiary, interest payments, dividend payments, share repurchases, and the like.

And how -- keep in mind, throughout the course of the year the insurance companies hopefully are generating capital, and so far based upon underwriting margins and returns to date we have generated capital in the insurance companies, and we go through a process generally towards the latter half of the year where those profits are dividended up to the holding company.

Now that -- there are state regulations as to how much and timing of when those dividends can be sent up to the holding company. So during the course of the year, if you try to say what is a normalized amount, it actually fluctuates based upon the time of year.

I would add one other just comment. I mentioned it a little bit in my letter with regard to the expense.

Brian went through the numerator very well, and certainly that's the one that ultimately we are accountable for controlling, and I don't think there's any lack of attention inside the Company on that. But a big issue, I think, for those that are followers of the industry is really the denominator. And for some time, at least for Progressive as our mix is changing, as our acceptance of our direct channel specifically is changing, we've been on a fairly long-term decline in average written premium.

There are some factors that are general to all lines of business, and there are some factors that are more specific to Progressive's direct business and our entry and quite successful entry into bundled products.

It does appear, and I will continue to give the numbers rather than opinions, but it does appear that that decline in average written premium has slowed somewhat, and I think that we're probably at a point where the denominator is not working against us on the ratio, the expense ratio itself. That will clearly bear out as you see the numbers coming forward in the next several quarters, but I think we're probably at a level that we can expect that the denominator will not be working against us.

(Operator Instructions). Matthew Heimermann, JPMC.

Just with respect to the premium per policy. I'd be curious -- you gave us the sense of what is happening with rates, but I'd just be curious. As we look at that and we look at the declines, how much of that is a function of just the customer mix shift and moving to higher average lifetime value customers, which have longer retention periods and, I would assume, have lower average premium?

And then, how much of that is kind of vehicle mix in terms of age of vehicle, new versus used, et cetera, and whether or not there any other factors that are playing into that?

Yes, that's a very fair question. We do what we call decompositions, but we do that very much as a state level.

So I don't have a generic decomposition that could say X percent is the long-term frequency decline, X percent is the vehicle aging affect, Y percent is the mix of business in the book in general. Because we really manage the business state by state, and state product managers would have and do have a much better handle on that on a state-by-state basis, but that is not necessarily a strong generic statement, other than the ones that I have said that overall we've been seeing a fairly significant long-term trend in frequency decline. That is going to affect everything.

Yes, Progressive is seeing, in some states more so than others, more of a shift to a different mix of customer. And I want to reinforce every time I say that. We welcome every customer, but we're able to now have a product that attracts us to a class of customers that previously we didn't attract, and that is a decline on a per-unit basis in average written premium, but in a lifetime premium basis, that is a very welcome situation.

So, those are the three factors that I'd say are generic. Anything more than that really requires a detailed composition, or decomp.

One of the reasons it is important to decomp, particularly at a state level, because state mix matters.

Think of the high average premium states, Florida, New York, New Jersey, and certainly last year those are states for us where, due to profit concerns, et cetera, we were slowing our growth. And then, hopefully as they have started to return and come back, that will actually also influence aggregate average premiums.

So, when we talk about aggregate average premiums, also know that state mix factors into it. The average premium in New York and New Jersey is very different than what it is in Iowa.

And mathematically, we could have average premiums going up in two states, but a radical change in mix between the states, and in aggregate looking as if the average premium is coming down.

No, that is helpful. Just wanted to make sure I had a handle on all that.

The other question is just if we look back at -- who knows what is going to happen with markets? Your guess is as good as mine, but if I look back at what the balance sheet looked like four years ago, you had some pretty significant kind of single-shot returns of capital. The portfolio at that time, the leverage was higher asset to equity, certainly the duration was longer. I think there was less cash short term, issues on the book, and there was a much bigger preferred exposure on the balance sheet.

Given where things sit today, what would it take -- I'd just be curious whether or not your -- how you're thinking about risk vis-a-vis capital flexibility. And I'm not approaching this from the standpoint that I think there is a dramatic change to your capital flexibility coming. I guess it has more to do with how you would think about deploying that flexibility against the backdrop where perhaps things are getting a little bit more challenging.

I will get Brian and Bill to comment on this one, see if we can surround the question.

But I would tell you -- I would start with repeating something I wrote significantly during the somewhat awkward days of 2008 and 2009 from a risk perspective. Our focus is always on preserving the ability to write as much insurance as we can possibly write. We think that's our value proposition to shareholders, that we do the operational part of this business exceptionally well.

So post-2008, where we don't think we were necessarily way out of bounds, we have taken changes. We've addressed those changes and we've communicated them. For example, one of them would be have a lower position in preferreds.

We still have a lot of preferreds that we had at that time. They recovered, in many cases, very nicely. But they're not at a point where they're causing us distress and they're not necessarily so liquid that we can change the position overnight, nor do we want to.

But in general, you'll see that the balance sheet is strong, and this time to the extent that -- I'll say this time that we've got a significant market disruption, we've got a very strong balance sheet. We're not in any way concerned about the operating company or overall capital.

We want the flexibility. There was some discussion about money at the holding company. That gives us the most flexibility. We've described our capital in three levels, three tiers. It's at the holding company that we have the most flexibility, and frankly we feel right now with our position, Bill commented, maybe being short with interest rates going lower was a strange combination, but we're still feeling very good about our overall position.

We don't feel particularly threatened in any one area or vulnerability, and a lot of flexibility at the holding company that, frankly, we are very happy to have at this time. If we see opportunities that are in our best interest and shareholders' best interest, obviously, we're in a position to take advantage of them.

Anything you would like to add, Brian or Bill, that tries to get at that question with more specificity?

Not a whole lot to add from my perspective. Just in terms of capital, we've tried to articulate how we think about it, and that which is required for, say, regulatory purposes, plus we always maintain some for contingent purposes.

Oftentimes, we think about contingent purposes being things like hurricanes and tornadoes and the like, and certainly investment marketplace disruptions is also another thing that we maintain for contingent purposes.

But as Glenn said, we feel comfortable with our balance sheet and our capital position, but we always re-evaluate where we are and what future uses may be. We regularly discuss what capital opportunities there are, both in terms of return to shareholders, as well as what the total capital structure is and makeup is.

This is Bill. I don't have a whole lot to add, either, other than I think, as you noted correctly, our portfolio is less exposed to some of the more volatile elements that are driving the market right now. And we have a fair amount of dry powder, and we feel like we're trying to avoid some of the risks that are front and center right now, then living us with more flexibility and an opportunity should some meaningful opportunities occur.

Much appreciated. Thanks.

(Operator Instructions). Ian Gutterman, Adage Capital.

Hi. Brian, I just want to -- also a question on investments. Can you tell us where your new money yield is versus the portfolio yield?

Bill, do you want to take that one?

Yes.

(Multiple speakers) new money.

Yes, it's a little tough because we don't track that exactly as far as showing what our new money yield is, and we certainly don't have a target there. And what we did in June, let's say, is going to be very different from what's available to us right now as (multiple speakers) sharply.

I can tell you that what we've done is been consistent of staying relatively in the front of the curve. In some spread products, we go a little bit longer, but not changing the overall portfolio duration.

In the second quarter, we slowed down our purchase of spread product to a little bit less than half of it was in the first quarter as spreads compressed. Right now, what we're seeing is lower treasury benchmark yields, but wider spreads to a significant degree, which may give us some opportunity at the same levels.

I can tell you just as a fact, on an FTE basis what we bought in June had a yield of about 2.8%, but I don't think I would use that as guidance going forward.

What I was trying to get to, and I could just maybe use some rough numbers, but Glenn, it goes back sort of back to the, is 96 the right target if rates remain low?

I know maybe it was a year ago, I think you were at the point of, it is still the right target. But now that we're not just seeing rates lower since then, but two more years of rates being this low, if I -- I'm trying to do some very quick math, but if we lost 200 basis points of pretax investment yield, that is equivalent to over a point on the combined ratio, maybe 1.5 point. Does that 96 need to become a 95 at some point?

Well, if I -- I guess if I was the only one in the marketplace, I would probably consider changing the target.

But as you also know, there is a very, very competitive environment out there for our product and probably an all-time high in advertising. Quality players advertising, and I'm going to tell you just point blank, we're going to stay with our 96 target because it is not something we're going to change tactically for the moment in time.

Our long-term goal remains, even as lofty as it sounds. It is absolutely the long-term goal that drives us to be the consumers' number-one choice for auto insurance. To do that, that requires getting more customers. So our focus is getting more customers, clearly not at any cost, so therefore we defined what we mean by acceptable margin, and 96 not only serves us well financially -- and I understand the trade-offs there. It not only serves us well financially, but culturally it is a very, very strong goal.

I would say -- clearly, I am biased on this one -- that Progressive is the Company it is partly because it has constancy of purpose, and that constancy of purpose, while it is okay to challenge it from time to time, it has to be an extraordinary challenge to change it, and I will just tell you I have not reached that conclusion.

Very fair. Just wanted to check. Thank you.

Josh Shanker, Deutsche Bank.

There's been a lot of attention given to New York and New Jersey, but one of the four states is also Massachusetts you spoke about. I'm wondering if you can address some of the peculiarities of Massachusetts and talk about the opportunity there?

Yes, good. I probably should've thrown Massachusetts in there, although I don't sort of think of it as one of our classical PIP states. But Massachusetts -- I think I've said this before, it's a quick recap, we went in at the wrong rate level. I could probably make a longer story out of that, but that would be the same outcome whichever way you get to it.

We have very talented product management in that position now, and they have done a very, very good job of being able to get us back to a rate level and tried to manage the customer set that we've had. Clearly we've lost some of those customers that we took on at the wrong rate level as we adjust rate level.

But we're at a point now, I would tell you, that we have a rate level that we can attract new customers at. Some of our renewal customers arguably may be still a little bit off, but not by a lot and not something that is on my top 10 list of things to worry about.

I would look forward to next year, maybe even the latter part of this year, but we're starting to turn the direction on Massachusetts and increasing our customer account there at the same kind of disciplines that you would expect us to do in most other states. So (multiple speakers) a longer entry that I had expected, but I think we're back on course.

Great. Thank you.

That was our final call. So, operator, please close the call.

Thank you. That concludes The Progressive Corporation's investor relations conference call. An instant replay of the call will be available through Friday, August 26, by calling 1-800-272-5957 or can be accessed via the investor relations section of Progressive's website for the next year.