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Progressive earnings: Rate around the corner!

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Heading into Progressive's earnings, there was some anticipation that we could see a repeat of the trendline seen over the past few months of higher-than-expected combined ratios. This was also partly indicated in the recently concluded earnings season, when multiple management teams alluded to above-normal loss-cost trends.

Consequently, there wasn't any real surprise when its monthly results came in at 96.7%, higher than its long-term stated goal of 96% and lower than June's 100.5%.

The company pointed to the higher-than-anticipated severity trends driven by used-car pricing, in conjunction with the reversion of frequency trends as the economy re-opened, contributing to the uptick.

This trend has been seen across the personal auto industry, as companies have started raising rates in response to the higher loss-cost trends. The only potential offset could be if the Delta variant spreads widely, leading the general population to modify their driving behavior again. However, it's too early to see any benefit in loss trends from that yet.

The key takeaway is that margins could remain under pressure in the near future. As a result, personal lines carriers are increasingly talking about rate action, although we might just be at the start of a rising curve.

Historically, average filed rate increases have hovered around 1%-2%, until the worsening trends in 2016 led to companies taking higher rates.

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Progressive has historically been quick to react to changing loss-cost trends. Below, we see the company has been somewhat faster to react than Allstate. In 2018, Progressive appears to have lowered rates prior to Allstate. Both companies appear to have been raising rates over the past couple of months, but they are coming from different baselines, given cumulative rate changes.

The company has compared its current reaction to the 2016 environment, so we would not be surprised to see rates moving significantly higher. Moreover, given that most policies are six months, we expect to see this trend continuing for a while longer.

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Although underwriting results are still slightly above target, we don't think that the company was caught by surprise and see this as part of its long-term strategy. In the meantime, Progressive has been quick to address the loss-cost trends, and while margin expansion is not in the cards this year, the company is on track to mean revert.

On the other hand, rate increases lead customers to shop around. As a result, policies-in-force growth has decelerated to 9.9% YoY, after seeing double-digit increases in the past 12 months. We expect this deceleration to slow in the longer term, once other personal auto carriers take more aggressive rate actions.

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The company reported $0.27 in operating EPS, down significantly from $0.91 in July 2020 and $0.55 in July 2019, primarily driven by the higher underlying loss ratio of 75% for July (11pts higher YoY). Progressive also saw higher catastrophe losses and lower net investment income for the month.

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PERSONAL AUTO SEGMENT: ANTICIPATED CHALLENGES TO CONTINUE

The frequency benefits that personal auto carriers experienced during the peak of the pandemic have generally faded. In addition, personal auto carriers are facing higher-than-anticipated severity trends due partly to the rise in used car prices and replacement parts, along with higher attorney involvement and changing driver behavior.

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As shown in the chart below, July’s loss ratio of 79.1% is up 14.2pts YoY, given the unfavorable comparison with June 2020. The expense ratio is lower than in previous months.

Management noted during the Q2 call that as part of its reaction to the trends, the company would be reducing expenses and pulling back on marketing, similar to the 2016 response. This follows the company’s heavy advertising during the pandemic, with nearly $2bn spent on this.

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COMMERCIAL SEGMENT: FOCUSED ON GROWTH

Progressive's commercial lines segment continues to grow but at a slightly slower pace, with PIF increasing 18.4% YoY, a 0.4pt increase from June.

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The segment's combined ratio of 87.3% is well below the target of 96%, suggesting that last month's miss of 96.7% was an anomaly.

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During Progressive's Q2 earnings call two weeks ago, management stressed how the firm is better positioned than its competitors to take advantage of the current increase in both frequency and severity thanks to the company's segmentation of the commercial sector, conservative pricing, and cost-cutting measures.

Frequency and severity trends are both on the rise as the economy bounces back from Covid lows, indicating the loss-cost trends will follow. Progressive is also watching for changing habits affected by the pandemic, including speeding trends, which have an impact on frequency and severity.

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Management also touted the acquisition of Protective last month as opening opportunities for the firm in larger fleet coverage.

PROPERTY SEGMENT: CATASTROPHE LOSSES DRIVE COMBINED RATIO OVER 100%

The property segment is important to Progressive as it aims to further capture the benefits of bundling auto and homeowners. The company has consistently recorded PIF growth in the low teens throughout the pandemic and 2021. It has noted that this growth helps it obtain new auto customers in direct and agency segments.

Our Hippo note highlighted that the InsurTech cohort is already beginning to branch out through partnerships to build a diversified book. However, we view that development as too soon, as companies have too many balls up the air. In contrast, Progressive has built a successful moat around its personal auto business and has continued to expand into other products in recent years.

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July benefited from a lower underlying loss ratio of 59.7% (vs 48.8% in July 2020 and 53.5% in July 2019) but had higher catastrophe losses than June, adding up to a higher combined ratio at 112.8%.

On the Q2 earnings call, management stressed that they are working to diversify the property segment geographically to get the combined ratio to reach the 96% company target.

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Looking forward, we expect to see further rate pick-up in the coming months. However, margins are likely to remain pressured for the remainder of the year as companies balance growth against responding to loss-cost trends.

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