Welcome to The Progressive Corporation's Investor Relations conference call. This conference call is also available via an 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. 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 in 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.
At this time, we are ready to begin the formal question and answer session. If you would like to ask a question, you may press star one on your touchtone phone. You may press star two to withdraw your question. After pressing star one to ask a question, you will be prompted to state your name and company to help with pronunciation. Please be advised that during this process, you will be momentarily blocked from hearing the live call. To allow the company to respond to as many callers as possible, you will be limited to one initial question and one follow-up question per request. If your telephone has a mute capability, we ask that you use this function during the time your question is being answered to minimize any background noise.
To the extent you have additional questions, you will need to place your name back in the queue by selecting star one on your telephone. One moment please for our first question. Our first question comes from Paul Newsome, Sandler O'Neill. Your line is open.
Good morning. I'm surprised I ever get the first question. 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 remainder of the year, the comments that were made in the most recent Analyst Day.
Sure, Paul. That'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. I'll ask Brian to comment 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. When I talk about returns, we're not talking about pulling away from all-time highs. We're getting back to it. We are seeing, and I'll use the word significant return to growth in Florida and New Jersey. Very significant return to growth there. It's a return, and I hope, of course, we'll go on past the point that we were once at, but very happy with the results, Florida and New Jersey.
New York, also happy, I would not use the word significant growth there. We're sort of growing. We certainly have respect for GEICO in New York. They've got a great position there, 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, happy with New York, less growth. Michigan, growth really hasn't been the issue of Michigan. Michigan's getting sort of the control around profitability, 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 balanced.
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, you want to add anything to that?
Nothing significant to add. In Florida, we actually did lower our rates, I think it was early June. After that, we have seen a pretty significant rebound in new application counts. Obviously, policies enforced 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 and a half, we have raised rates fairly consistently and aggressively in the state of Michigan. That wouldn't be a growth new application story right now, but we feel much better about our rate adequacy and overall rate level yet there.
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 higher proportion of 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 a 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-. You're right, if you add up our cash in our treasury portfolio, it's roughly 30% of our total fixed income portfolio, which is substantial. That honestly feels pretty good to us right about now as we're seeing a little bit more turmoil. That may give us some dry powder if there are 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. We're maintaining a pretty short duration portfolio and looking for high-quality spread product on the front end when we can find it.
Terrific. Thank you very much.
Next, we have Cliff Gallant, KBW. Your line is open.
Hi, good morning. Just wanted to ask about Snapshot, get another update on how that product rollout is going. I was curious as to 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 spur some shopping activity?
Yeah, let me pick up a little bit. It's what, 40, 50 days since we were together in New York. 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 since then, and a couple of new ads that have yet to air, are continuing to allow us to own that space, and that was very important to us to sort of get something where usage base is really highly associated with Progressive, and our measures tell us that we're 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. We recognize that that's 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. There appears to be no roadblocks there that we couldn't continually report improvement on all of those numbers. Important to us, clearly, when we start to go, we've done testing for a long time, but important when we really get to this new model is profitability, and our loss ratio and our targets seem to be in line with our expectations, and we're actually quite happy there. Thirdly, retention. At this stage, all we can really comment on is what I'll call early term retention of customers, since we don't have long-term customers on the product. The early term retention is actually very encouraging for us. 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. 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. We're starting to get a significant market or base on which to derive these conclusions around profitability, retention, and brand acceptance as a more general concept. Yes. Really just a continuing positive update to the June comment. Clearly, you know our overall growth numbers, 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. There are options available
We have Meyer Shields, Stifel, Nicolaus, your line is open.
Thanks. Good morning. Looking at the direct channel, obviously, PIP growth is still pretty impressive, but it's been slowing down a little bit. I'm wondering whether there is a difference in the breakdown of new direct channel customers by their previous channel of buying insurance.
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. 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 product carrier coming to us, and I don't know of that. Rather than 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 and make a note to make sure that we've got that covered.
Okay, thanks. A separate question, I guess. In the Q, you talk about less shopping and lower conversion rates. I know it's a simplistic analysis to say that if there's less shopping, it's probably more committed shoppers out there, which might imply a higher conversion rate. I was wondering if you could talk about why that's 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 taken rate, which will actually force lower conversion rates. 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. 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. I don't have a macro response to you that sort of suggests that they're 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.
By looking at this as many ways as we can, whether through agent production, internet, comparative rating, so on and so forth, we do believe that shopping is down. Conversion is much more a function of just our rate level in individual states. We are 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's been at about a 1.6, or our estimate is about 1.6, so a little faster than us. Again, another reason to believe that maybe conversion would be stronger for us, but it's 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 or New Jersey will help us with aggregate conversion.
Okay, thank you very much.
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 they're coming from matters. I think in New York, John Sauerland clearly described taking 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. In terms of our mix of prospects, we are trying to get more and more just to look at us. 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 sort of media channels.
Next, we have Vinay Misquith, Evercore Partners. Your line is open.
Hi, good morning. First question on New Jersey, was pricing taken down there? 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 a catalyst for new application decreasing there. Recently, we have become more comfortable in our rate level, and I believe we recently lowered rates a small amount. It is either recently or soon to be recently.
Soon to be, yeah, I know.
Okay, fair enough.
I can't tell you exactly about the exact date of it, but in the summer months, we were planning to decrease rates a little bit in New Jersey. I suspect that it's already happened.
Sure, fair enough. The second question is on the expense ratio. First half of this year, the expense ratio on the direct increased versus the first half of last year. Just curious why that's happening and how much of Gainshare is in that, and was this year's numbers negatively impacted by the higher growth or the Snapshot product introduction?
Well, a part of the expense ratio being higher is we have continued to increase advertising spend, although in aggregate, it's fairly close to earned premium growth rate. We have increased advertising spend for certain. That is a component piece. Gainshare actually would not be a component piece because our Gainshare 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 Gainshare. For policy and direct have gone down a little bit, not markedly, but a little bit. Net-net, our aggregate cost per sale or cost per acquisition is higher this year than versus a year ago.
Okay. Can we expect that to come down next year if growth slows a little bit?
In terms of the amount of advertising spend?
No.
Expense ratio in general?
The expense ratio in general.
The major component, I'd say there's two major components in an expense ratio, particularly on the direct side. The first being sort of 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. We will always reevaluate that spend relative to its yield. We've talked about that a fair amount before, relative to cost per sale, relative to our targeted acquisition cost. We continue to reevaluate how much we spend. We have meetings regularly even as to what the next quarter spend might be or the remainder of the year spend might be. We will continue to reevaluate 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 sort of labor costs. We are trying and continue to try to increase efficiency in everything we do. Our policies and floors per FTE continue to increase, granted, at a slower pace than a couple of years ago. We continue to gain some efficiencies, but it's at a little slower pace than it had been in the last couple of years.
Sure. 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? Thank you.
You want to take that one? All right. This is Brian. We don't typically think in terms of what's a normalized amount at the holding company. I think we give you very clear direction as to what our overall capital models are and what we expect to do with capital when we're in a position of more than we can effectively put to work. The holding company is going to vary based on time of year, based on dividending up from operating companies, based on significant tax payments and other things that we might want to do, Gainshare variable dividends. 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 cashes. 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. Yeah. In terms of here are things that are paid out of that non-insurance subsidiary, interest payments, dividend payments, share repurchases, and the like. How, keep in mind, throughout the course of the year, the insurance companies hopefully are generating capital, 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. There are state regulations as to how much and timing of when those dividends can be sent up to the holding company.
During the course of the year, if you try to say what the normalized amount is, actually it fluctuates based upon the time of year.
I would add one other just comment. I mentioned it a little bit in my letter with regards 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. A big issue, I think, for those that are followers of the industry is really the denominator. 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.
Just a reminder, if you would like to ask a question, you may press star one on your touch-tone phone. Next, we have Matthew Heineman, JPMorgan. Your line is open.
Hi. Good morning, everybody. Just with respect to the premium per policy, I'd be curious. You gave us a sense of what's 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? 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 are any other factors that are playing into that?
Yeah, that's a very fair question. We do what we call decomposition
We do that very much at a state level. I don't have a generic decomposition that could sort of say X% is the long-term frequency decline, X% is the vehicle aging effect, Y% is the mix of business in the book in general, because we really manage the business state by state, and the state product managers would have, and do have a much better handle on that on a state-by-state basis. There's not necessarily a strong generic statement other than the ones that I've said, that overall, we've been seeing a fairly significant long-term trend in frequency decline that's going to affect everything. Yes, Progressive is seeing, in some states more so than others, a more of a shift to a different mix of customer.
I want to reinforce every time I say that, we welcome every customer, but we're able to now have a product that attracts classic customers that previously we didn't attract, and that is a decline on a per unit basis in average written premium. In a lifetime premium basis, that's a very welcome situation. Those are sort of the three factors that I'd say are generic. Anything more than that really requires a detailed composition, a decomp.
One of the reasons it's important to decomp, particularly at a state level, is because state mix matters. Think of the high average premium states, Florida, New York, New Jersey. Certainly last year, those were states for us where due to profit concerns, et cetera, we were slowing our growth. Hopefully, as they have started to return and come back, that will actually also influence aggregate average premiums. 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.
Mathematically, we could have average premiums going up in two states, but a radical change in mix between the states and an aggregate looking as if the average premium is coming down.
No, that's helpful. Just wanted to make sure I had a handle on all of that. I guess the other question is just if we look back at, who knows what's going to happen with markets, your guess is as good as mine. If I look back at kind of 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 kind of preferred exposure on the balance sheet. Given kind of where things sit today, what would it take? I'd just be curious whether or not kind of how you're thinking about risk and vis-à-vis capital flexibility.
I'm not kind of approaching this from the standpoint that I think there's 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 a backdrop where perhaps things are getting a little bit more challenging.
Well, I'll get Brian and Bill to comment on this one, see if we can surround the question. I would tell you, I would start with repeating something I wrote significantly during the somewhat awkward days of 2008, 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. Post-2008, where we don't think we were necessarily way out of bounds, we've 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 the preferreds that we have at that time, and they've recovered, in many cases, very nicely.
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. In general, you'll see that the balance sheet is strong. 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 3 levels, 3 tiers. It's at the holding company that we have the most flexibility.
Frankly, we feel right now with our position, Bill commented, maybe being short with interest rates going lower was a strange combination, we're still feeling very good about our overall position. We don't feel particularly threatened in any one area or vulnerability, 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, the shareholders' best interest, obviously, we're in a position to take advantage of them. Anything you'd 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. As Glenn said, we feel comfortable with our balance sheet and our capital position, but we always reevaluate
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 Phil. 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. We have a fair amount of dry powder. We feel like we're trying to avoid some of the risks that are front and center right now and leaving us with more flexibility and opportunities should some meaningful opportunities occur.
Much appreciated. Thanks.
Just a reminder, if you would like to ask a question, you may press star one on your touch-tone phone. Next, we have Ian Gutterman, Adage Capital. Your line is open.
Hi, Brian. I just want to also 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, Bill?
Yeah.
Where you're putting the new money?
Yeah. 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. What we did in June, let's say, is going to be very different from what's available to us right now as rates move sharply.
Right.
I can tell you that what we've done has been consistent of staying relatively in the front end of the curve, and some spread products will 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 what 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%. I don't think I would use that as guidance going forward.
Okay. What I was trying to get to, I could just maybe use some rough numbers, but Glenn, it goes 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's 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. I don't know. I'm trying to do some very quick math, but if we've lost 200 basis points of pre-tax investment yield, that's equivalent to over a point on the combined ratio, maybe a point and a half. Does that 96 need to become a 95 at some point?
Well, I guess if I was the only one in the marketplace, I would probably consider changing the target. As you also know, there's very competitive environment out there for our product and probably an all-time high in advertising, quality players advertising. I am going to tell you just point-blank, we're going to stay with that 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 consumer's number one choice for auto insurance. To do that requires getting more customers. Our focus is getting more customers, clearly not at any cost. Therefore, we define what we mean by acceptable margin. 96 not only serves us well financially, and I understand the trade-offs there.
Not only serves us well financially, but culturally it's a very strong goal. I would say, clearly I'm biased on this one, but Progressive is the company it is partly because it has constancy of purpose. That constancy of purpose, while it's okay to challenge it from time to time, it has to be an extraordinary challenge to change it. I just tell you, I have not reached that conclusion.
Very fair. Just wanted to check. Thank you.
Next, we have Josh Shanker, Deutsche Bank. Your line is open.
Yes. Thank you. There's been a lot of attention given to New York and New Jersey, 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.
Yeah, I could. I actually probably should have thrown Massachusetts in there, although sort of don't think of it as one of our classical PIP states. Massachusetts, I think I've said this before, as a quick recap, we went in at the wrong rate level. You 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 good job of being able to get us back to a rate level and try 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.
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 with starting to turn the direction on Massachusetts and increasing our customer count there at the same kind of disciplines that you would expect us to do in most other states.
Thank you very much.
A longer entry than I had expected, I think we're back on course.
Great. Thank you.
That was our final call. 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 twenty-sixth by calling 1-800-272-5957, or can be accessed via the Investor Relations section of Progressive's website for the next year