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PGR > SEC Filings for PGR > Form 10-Q on 2-May-2013All Recent SEC Filings

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Form 10-Q for PROGRESSIVE CORP/OH/


2-May-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

I. OVERVIEW

During the first quarter 2013, The Progressive Corporation's insurance subsidiaries generated net premiums written and policies in force growth of 7% and 2%, respectively, on a year-over-year basis. Underwriting profitability for the quarter was 7.6%, or $317.7 million, and our investment operations produced investment income of $100.5 million. Our investment income was down on a year-over-year basis, primarily reflecting lower yields. During the quarter, we also recognized $80.6 million of net realized gains on securities. Overall, our net income was up 20% to $308.6 million, or $.51 per share, for the first quarter 2013. Our total capital position (debt plus equity) increased $0.4 billion during the quarter, to $8.5 billion at March 31, 2013.

A. Operations

During the first quarter 2013, we realized a year-over-year increase in net premiums written of 7% on a companywide basis. Our Agency and Direct Personal Lines businesses grew 6% and 8%, respectively, and our Commercial Auto business grew 7%. To analyze growth, we review written premium per policy (i.e., rates), new business applications (i.e., issued policies), and customer retention. For the first quarter 2013, rate increases taken during 2012 have been a significant contributor to the written premium growth, while new business applications decreased from last year in all our products and customer retention was down in personal auto but relatively flat in Commercial Auto and for our special lines products.

Adjusting rates is an ongoing process. In light of rising claims costs, we raised rates primarily in the second and third quarters of 2012 across all of our products, but primarily in personal auto. As a result, we started experiencing increases in personal auto written premium per policy that continued into the first quarter 2013. For the first quarter 2013, on a year-over-year basis, written premium per policy increased 7% and 6% in our Agency and Direct auto businesses, respectively. Commercial Auto premiums per policy increased about 9% for the first quarter 2013, and our special lines products written premium per policy was up 3%. We will continue to evaluate future rate needs and react quickly as we recognize changing trends.

As a result of the rate increases taken, new business applications declined. On a year-over-year basis, Personal Lines new applications decreased 12%, reflecting declines of 15% and 4% in our Agency and Direct auto businesses, respectively, and a 22% decrease in our special lines new applications. The colder weather in the northern states during the first quarter 2013, compared to an early motorcycle riding season last year, also contributed to a decline in our special lines new applications. Our Commercial Auto new applications decreased 5%.

Our renewal applications increased 5% in Personal Lines and 2% in Commercial Auto, primarily reflecting the policies in force growth we generated during 2012. Both our Agency and Direct businesses contributed to the Personal Lines increase.

We continued with the many initiatives we have in place to help stimulate growth and provide consumers with distinctive insurance options. During the quarter, our three primary initiatives all made meaningful progress, including:

• Expansion of our mobile acquisition capabilities - our mobile technology is now able to provide the capability for almost all combinations of cars and drivers quoted on a mobile device.

• Cross-sell our products - our relationships with our non-affiliated homeowner insurance carriers continue to grow and, during the quarter, significant marketing communication plans were developed or implemented to promote the bundling of home and auto insurance to our jointly appointed agents. In addition, we continued to enhance our systems to enable our agents and customer service representatives, as well as our customers, the ability to view all their Progressive products concurrently.

• Snapshot®, our usage-based insurance product - we worked with our agents to "test drive" Snapshot to allow them to experience the product for themselves and to be able to communicate to their customers the ease of using Snapshot and the benefits of capturing the additional driver specific information provided by the device. Also during the quarter, we completed the development of a marketing campaign, which was launched early in the second quarter 2013, to communicate the benefits of Snapshot in a way we believe will help demonstrate the advantages to consumers. Specifically, the messaging focuses on how good drivers are paying more for insurance due to the poorer driving and insurance profile of other drivers.

On a companywide basis, year-over-year, policies in force grew 2%, with Personal Lines growing 2% and Commercial Auto increasing 1%. Our Direct auto business contributed to this increase with policies in force growth of 3%, or 107,200 additional policies; policies in force in our Agency auto business were up 22,800, compared to the first quarter last year. With a 2% increase in our special lines policies over last year, we ended the first quarter with nearly 12.9 million Personal Lines policyholders.

To further grow policies in force, it is critical that we retain our customers for longer periods, which is why increasing retention continues to be one of our most important priorities and why our efforts to increase the number of multi-product households continues to be a key initiative. Policy life expectancy, which is our actuarial estimate of the average length of time that a policy will remain in force before cancellation or lapse in coverage, is one measure of customer retention. Policy life expectancy decreased 3% and 5% for our Agency and Direct auto businesses, respectively, compared to last year, primarily due to rate increases taken during 2012. Our


policy life expectancy for our Commercial Auto business and our special lines products was relatively flat compared to last year. These declines in retention were not unexpected following the rate increases we took in 2012. As policies begin to renew within the same rate plan, we believe that the decline in policy life expectancy will begin to reverse.

Our 7.6% companywide underwriting profit margin for the first quarter 2013 was 1.7 points better than our margin for the same period last year and exceeded our target of at least 4%. As previously discussed, the rate increases taken primarily in the second and third quarters of 2012 led to increased earned premium per policy in 2013, which was a significant contributor to the increased underwriting profitability. The favorable impact from this increase was partially offset by higher catastrophe losses as well as increased unfavorable development in the first quarter 2013, compared to the first quarter 2012. Hail storms in the southeast during the first quarter were higher than in recent years, adding about 0.7 loss ratio points on a year-over-year basis. In addition, unfavorable prior accident year development, primarily due to higher frequency and severity on late emerging claims in both our personal auto and Commercial Auto products, contributed about 1.6 points to our first quarter combined ratio.

B. Investments and Capital Management

The fair value of our investment portfolio was $17.3 billion at March 31, 2013. Our asset allocation strategy is to maintain 0-25% of our portfolio in Group I securities, with the balance (75%-100%) of our portfolio in Group II securities. We define Group I securities to include:

• common equities

• nonredeemable preferred stocks

• redeemable preferred stocks, except for 50% of investment-grade redeemable preferred stocks with cumulative dividends, and

• all other non-investment-grade fixed-maturity securities

Group II securities include:

• short-term securities, and

• all other fixed-maturity securities

We use the credit ratings from models provided by the National Association of Insurance Commissioners (NAIC) for classifying our residential and commercial mortgage-backed securities, excluding interest-only securities, while all other debt securities derive their credit ratings from nationally recognized securities rating organizations (NRSRO) in determining whether securities should be classified as Group I or Group II. At March 31, 2013, 22% of our portfolio was allocated to Group I securities and 78% to Group II securities, compared to 21% and 79%, respectively, at December 31, 2012.

Our investment portfolio produced a fully taxable equivalent (FTE) total return of 2.1% for the first quarter 2013. Our common stock and fixed-income portfolios contributed to this positive total return with FTE returns of 10.6% and 0.9%, respectively. At March 31, 2013, the fixed-income portfolio had a weighted average credit quality of AA-. We continue to maintain our fixed-income portfolio strategy of investing in high-quality securities.

Our recurring investment income generated a pretax book yield of 2.6% for the first quarter 2013. At March 31, 2013, our duration was 1.9 years to limit the potential loss of capital in the event of an increase in interest rates from their present low levels. We remain confident that our preference for shorter duration during times of extremely low interest rates is our best positioning.

At March 31, 2013, we held $13.3 million in Australian Treasury Bills to support our Australian operations; we held no other foreign sovereign debt. We held $621.1 million of U.S. dollar-denominated corporate bonds, preferred stocks (redeemable and nonredeemable), and other asset-backed securities issued by companies that are domiciled, or whose parent companies are domiciled, in European countries. Of these securities, $527.8 million are corporate bonds from U.K. and other European companies primarily in the consumer, industrial, energy, and communications industries; $6.0 million are U.K.-domiciled other asset-backed securities; and $87.3 million are U.K.-domiciled financial institution nonredeemable preferred stocks. We had no direct exposure to Southern European-domiciled companies at March 31, 2013. In total, our European-domiciled fixed-income securities represented approximately 4% of our portfolio at March 31, 2013.

At March 31, 2013, our total capital (debt plus equity) was $8.5 billion, compared to $8.1 billion at December 31, 2012, and our debt-to-total capital ratio decreased to 24.4% from 25.6% at year-end 2012. We continue to manage our investing and financing activities in order to maintain sufficient capital to support all of the insurance we can profitably write and service.



II. FINANCIAL CONDITION

A. Liquidity and Capital Resources

Progressive's insurance operations create liquidity by collecting and investing premiums from new and renewal business in advance of paying claims. For the three months ended March 31, 2013 and 2012, operations generated positive cash flows of $722.1 million and $708.4 million, respectively.

We held total capital (debt plus equity) of $8.5 billion, at book value, at March 31, 2013, compared to $8.3 billion and $8.1 billion at March 31, 2012 and December 31, 2012, respectively.

Based upon our capital planning and forecasting efforts, we believe that we have sufficient capital resources, cash flows from operations, and borrowing capacity to support our current and anticipated business, scheduled principal and interest payments on our debt, any announced dividends, and other expected capital requirements. The covenants on our existing debt securities do not include any rating or credit triggers that would require an adjustment of the interest rate or an acceleration of principal payments in the event our securities are downgraded by a rating agency. Our next scheduled debt maturity will be in October 2013 of the entire $150 million of our 7% Notes.

We seek to deploy capital in a prudent manner and use multiple data sources and modeling tools to estimate the frequency, severity, and correlation of identified exposures, including, but not limited to, catastrophic losses, natural disasters, and other significant business interruptions to estimate our potential capital needs.

Management views our capital position as consisting of three layers, each with a specific size and purpose:

• The first layer of capital, which we refer to as "regulatory capital," is the amount of capital we need to satisfy state insurance regulatory requirements and support our objective of writing all the business we can write and service, consistent with our underwriting discipline of achieving a 96 combined ratio. This capital is held by our various insurance entities.

• The second layer of capital we call "extreme contingency." While our regulatory capital is, by definition, a cushion for absorbing financial consequences of adverse events, such as loss reserve development, litigation, weather catastrophes, or investment market corrections, we view that as a base and hold additional capital for even more extreme conditions. The modeling used to quantify capital needs for these conditions is quite extensive, including tens of thousands of simulations, representing our best estimates of such contingencies based on historical experience. This capital is held either at a non-insurance subsidiary of the holding company or in our insurance entities, where it is potentially eligible for a dividend up to the holding company. Regulatory restrictions on subsidiary dividends are discussed in Note 8-Statutory Financial Information in our Annual Report to Shareholders for the year ended December 31, 2012.

• The third layer of capital is capital in excess of the sum of the first two layers and provides maximum flexibility to repurchase stock or other securities, consider acquisitions, and pay dividends to shareholders, among other purposes. This capital is largely held at a non-insurance subsidiary of the holding company.

During the first three months of 2013 and at all times during 2012, our total capital exceeded the sum of our regulatory capital layer plus our self-constructed extreme contingency load.

The amount of capital in our third layer was at a level that allowed our Board of Directors to take several actions to return underleveraged capital to our investors, including:

• Repurchases of our outstanding debt securities. From time to time, we may elect to repurchase our outstanding debt securities in the open market or in privately negotiated transactions, when management believes that such securities are attractively priced and capital is available for such a purpose. Although we did not repurchase any debt securities in the first quarter of 2013, during the first quarter of 2012, we repurchased, in the open market, $12.6 million in principal amount of our 6.70% Debentures.



• Repurchases of our common shares. In accordance with our financial policies, we continued our practice of repurchasing our common shares. As of March 31, 2013, we had 39.8 million shares remaining under our 2011 Board repurchase authorization. The following table shows our share repurchase activity during the respective periods:

                                                Three Months Ended March 31,
       (millions, except per share amounts)       2013                2012
       Total number of shares purchased                 2.3                 1.9
       Total cost                             $        51.3       $        37.7
       Average price paid per share           $       22.59       $       20.19

• Dividends. As part of our capital management activities, in February 2013 and 2012, we paid our annual variable dividend of $.2845 and $.4072 per share, respectively, which were each declared in December of the prior year.

Short-Term Borrowings

During the three months ended March 31, 2013 and throughout 2012, we did not engage in short-term borrowings to fund our operations. As discussed above, our insurance operations create liquidity by collecting and investing insurance premiums in advance of paying claims. Information concerning our insurance operations can be found below under Results of Operations-Underwriting, and details about our investment portfolio can be found below under Results of Operations-Investments.

On March 25, 2013, we entered into an unsecured, discretionary line of credit with PNC Bank, National Association ("PNC") in the maximum principal amount of $100 million. All advances under this agreement are subject to PNC's discretion, would bear interest at a variable, daily rate, and must be repaid on the earlier of the 30th day after the advance or the expiration date of the facility, March 25, 2014. We did not have any borrowings under this agreement during March 2013.

We did not enter into any repurchase agreements in the first quarter 2013. During eight days in the first quarter 2012, we engaged in repurchase agreements under which we loaned U.S. Treasury securities to internally approved brokerage firms in exchange for cash equal to the fair value of the securities, as described in more detail below under Results of Operations-Investments; Repurchase and Reverse Repurchase Transactions. These investment transactions were entered into to enhance the yield from our fixed-income portfolio and not as a source of liquidity or funding for our operations. We had no open repurchase commitments at March 31, 2013 or 2012, or December 31, 2012.

B. Commitments and Contingencies

Contractual Obligations

During the first three months of 2013, our contractual obligations have not changed materially from those discussed in our Annual Report on Form 10-K for the year ended December 31, 2012.

Off-Balance-Sheet Arrangements

Our off-balance-sheet leverage includes derivative positions, operating leases, and purchase obligations. See the "Derivative Instruments" section of Note 2-Investments and of this Management's Discussion and Analysis for a summary of our derivative activity since year-end 2012. There have been no material changes in the other off-balance-sheet items since the discussion in the notes to the financial statements in Progressive's Annual Report on Form 10-K for the year ended December 31, 2012.

Other

As of March 31, 2013, we have in operation 56 service centers, 2 of which were added in the first quarter 2013, in 41 metropolitan areas across the country, that provide our concierge level of claims service and are designed to provide end-to-end resolution for auto physical damage losses. In 17 of these centers, we have combined a claims office with a service center to improve our efficiency. In an effort to provide the service center experience to more of our expanding customer population, over the next four years we expect to complete construction of 10-20 new service centers, each co-located with a full service claims office. The cost of these facilities, excluding land, is estimated to average $4 to $6 million per center, depending on a number of variables, including the size and location of the center.


III. RESULTS OF OPERATIONS - UNDERWRITING

A. Growth



                                              Three Months Ended March 31,
                                                                           %
        ($ in millions)                     2013            2012         Change
        NET PREMIUMS WRITTEN
        Personal Lines
        Agency                          $    2,202.2      $ 2,076.5            6
        Direct                               1,786.3        1,656.5            8

        Total Personal Lines                 3,988.5        3,733.0            7
        Commercial Auto                        460.9          429.5            7
        Other indemnity                            0              0           NM

        Total underwriting operations   $    4,449.4      $ 4,162.5            7

        NET PREMIUMS EARNED
        Personal Lines
        Agency                          $    2,107.2      $ 1,960.6            7
        Direct                               1,641.6        1,513.2            8

        Total Personal Lines                 3,748.8        3,473.8            8
        Commercial Auto                        430.4          387.3           11
        Other indemnity                           .1             .4          (75 )

        Total underwriting operations   $    4,179.3      $ 3,861.5            8

NM = Not Meaningful

Net premiums written represent the premiums generated from policies written during the period less any premiums ceded to reinsurers. Net premiums earned, which are a function of the premiums written in the current and prior periods, are earned as revenue over the life of the policy using a daily earnings convention.

Policies in force, our preferred measure of growth, represents all policies under which coverage was in effect as of the end of the period specified. As of March 31, our policies in force were:

                                                                       %
               (thousands)               2013           2012        Change
               POLICIES IN FORCE
               Personal Lines:
               Agency auto               4,839.4        4,816.6           0
               Direct auto               4,094.7        3,987.5           3

               Total auto                8,934.1        8,804.1           1
               Special lines1            3,935.8        3,852.3           2

               Total Personal Lines     12,869.9       12,656.4           2

               Commercial Auto             519.6          513.8           1

1 Includes insurance for motorcycles, ATVs, RVs, mobile homes, watercraft, snowmobiles, and similar items, as well as a personal umbrella product.


To analyze growth, we review new policies, rate levels, and the retention characteristics of our books of business. The following table shows our year-over-year changes in new and renewal applications (i.e., issued policies):

                                    Growth Over Prior Year Quarter
                                       2013                 2012
                APPLICATIONS
                Personal Lines
                New                        (12) %                 7 %
                Renewal                       5 %                 4 %
                Commercial Auto
                New                         (5) %                 8 %
                Renewal                       2 %               (3) %

New applications in our Personal Lines business decreased for the first three months of 2013, compared to last year, with a significant decrease in our Agency auto business and a more modest decrease in our Direct auto business, primarily reflecting rate increases taken in the second and third quarters of 2012. In addition, new applications for our special lines products decreased significantly, primarily reflecting both rate increases taken during the second half of 2012 and cooler weather in the northern states during the first quarter 2013. Our Commercial Auto business also experienced a decrease in new applications, primarily reflecting rate increases taken throughout 2012 and during the first quarter 2013.

We remain focused on providing consumers with distinctive auto insurance options and, as such, we are always refining our core product design. Our newest personal auto product model, which further refines our segmentation and incorporates the best design elements of the Agency and Direct auto products, was available in 44 states plus the District of Columbia ("jurisdictions") as of March 31, 2013. We plan to extend the rollout to two additional states during the year, which will substantially complete the rollout of this product model.

Snapshot®, our usage-based insurance product, provides customers the opportunity to improve their auto insurance rates based on their personal driving behavior. Snapshot was made available in one additional state in the first quarter 2013. Snapshot is available to our Direct auto customers in 45 jurisdictions, while our Agency auto customers have access to Snapshot in 40 of those 45 jurisdictions. We plan to expand Snapshot into additional states, subject to regulatory approval.

In 2012, we launched a national rollout of our program to offer consumers the opportunity to "test drive" Snapshot without having to change their current insurance to encourage many more people to consider Progressive for their auto insurance needs. In an effort to increase participation in the program, during the first quarter 2013, we completed the development of a marketing campaign, which was launched early in the second quarter 2013, to communicate the benefits of Snapshot in a way we believe will help make the product offering relevant for consumers. Specifically, the messaging focuses on how good drivers are paying more for insurance due to the poorer driving and insurance profile of other drivers. In addition, several thousand of our independent insurance agents took the opportunity to "test drive" Snapshot to allow them to experience the product and enable them to communicate with their customers the ease of using the Snapshot device and the benefits of capturing the additional rating variable. We are hopeful that these messages will resonate with consumers.

We are also continuing with our efforts to further penetrate customer households through cross-selling auto policies with our special lines products and vice versa, as well as through Progressive Home Advantage® (PHA). Multi-product customers are an important part of our strategic agenda, since they stay with us longer, have better loss experience, and represent a sizable segment of the market. We have additional opportunity for growth in this area.

Progressive Home Advantage, the program in which we "bundle" our auto product with property insurance provided by one of several unaffiliated insurance carriers, is increasingly an integral part of our consumer offerings. As of March 31, 2013, this program was available to Direct customers in 48 states, Agency customers in 23 states, and to both Direct and Agency customers in the District of Columbia. PHA is not currently available to customers in Florida and Alaska.

During the first quarter 2013, we developed and implemented significant marketing communication plans with American Strategic Insurance (ASI), the primary PHA provider for our Agency customers. These plans were designed to promote the home and auto insurance bundle to our jointly appointed agents. We acquired a non-controlling interest in the corporate parent of ASI during 2012.

Expanding our offerings in the mobile space remains an important initiative. Consumers have the ability to obtain a quote and buy an auto insurance policy on our mobile website in all states and the District of Columbia. In the first quarter 2013, we expanded our mobile quoting feature to allow up to five drivers and four vehicles to obtain a quote. This multi-driver, multi-vehicle feature is available nationwide. We continue to see an increasing number of our Direct business quotes starting on a mobile device.


We continue to provide the comparison rate experience on a mobile device in most of the country. We also allow consumers to use the camera in their mobile device to photograph their driver license, and/or current insurance card, to provide easy data fill for an instantaneous quote. This feature is available in 36 . . .
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