Progressive Corp Adverse Development Drive Earnings Miss

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Progressive February results were a little uneven given severe non-catastrophe winter weather and adverse development on the 2013 accident year. Operating EPS of $0.07 were $0.05 below our estimate, driven mainly by a significant jump in losses, which is likely because of an active non-catastrophe weather month.

Accident-year loss ratios, excluding catastrophes, came in at 73% for the month versus our estimate of 72%. On the growth side, PIF grew 0.5% sequentially driven by strength in both direct and agency personal auto. Overall, the company continues to operate within the ranges it set for growth (currently expecting 5% to 6% per year) and underwriting profitability (currently expecting a combined ratio in the 94 to 95 range for 2014 and 2015). The balance management strikes between these two dimensions will be the key to anticipating the trajectory of earnings growth.

We are reducing our first quarter 2014 operating EPS estimate by one cent, to $0.37, and our 2014 operating EPS by $0.07, to $1.50, to account for higher expenses in the direct segment. We are lowering our 2015 operating EPS by a penny, to $1.65.

If we look past the elevated loss ratio during the last four months that we believe is attributable to the severe winter that many parts of the country are experiencing, underlying severity and frequency trends continue to be quite benign. Severity appears to be in the 2% to 3% range for most auto lines, while frequency is essentially flat. If this type of loss environment persists, Progressive should be able to improve underwriting over the remainder of 2014. Three things to watch out for are lower gas prices, a return of inflation, and more robust economic activity, all of which could cause loss levels to pick up from very benign levels, resulting in deteriorating underwriting results.

The expense ratio in the direct segment shot up to 24% during February, three points above our estimate. Management attributed this to additional spending on advertising as the company tries to shift back into growth mode in that segment. We expect the expense ratio to remain relatively elevated for a few more months, but likely not to the same extent it was this month.

PIF growth has recovered nicely from the trough in the middle of 2013, but is still struggling with seasonal issues in the special lines segment, the competitive environment in the agency channel, and a tough marketplace for commercial auto. As rates become more attractive relative to peers and the company continues to aggressively advertise, we expect PIF growth to pick up to the 4% to 5% range for 2014 and 2015. However, with rate increases rolling off over the next several months, written premium growth will likely not exceed the 5% to 7% range over the next two years.

 

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