Reactionaries Dump Progressive (News) August 30, 1999

Reactionaries Dump Progressive

By Brian Graney (TMF Panic)
August 30, 1999

Auto and specialty property-casualty insurer Progressive Corp. (NYSE: PGR) took it on the chin this morning after the company said late Friday that its third quarter earnings will fall short of the First Call mean estimate of $1.46 per share. The warning is uncharacteristic for the Cleveland-based insurer, which is usually tight-lipped about giving earnings guidance to anyone, including Wall Street analysts. In a sense then, the announcement was a way to tell the whole world that analysts were completely missing the boat in regards to how the business is performing in the current quarter.

"Our business is changing -- our emphasis on targeting standard and preferred auto insurance and selling to consumers directly comes at a higher initial cost," said chairman and CEO Peter Lewis in a statement. "These changes are happening faster than we expected and at a time when we are also encountering the effects of prior price reductions and adverse changes in severity trends."

The upshot is that the company may not report an operating profit under Generally Accepted Accounting Principles (GAAP) for the period, which equates to a GAAP combined ratio of 100% or more. This fits in with the recent trend, as the company's GAAP combined ratio had risen on a year-over-year basis in the first two quarters of this year. That rates are falling in Progressive's main business lines is not a major shock and echoes statements by Berkshire Hathaway (NYSE: BRK.A) unit GEICO last quarter that price reductions were causing losses and loss expenses to grow relative to premiums. So, it seems the major problem was that analysts were severely underestimating the firm's rising acquisition costs.

Both Progressive and GEICO are approaching the auto insurance business from essentially the same angle that Dell Computer (Nasdaq: DELL) attacked the PC market. Both companies have built their market shares based on a direct distribution model that emphasizes holding costs down. Many analysts had figured that the low-cost model would allow the companies to quickly steal market share away from other insurers, but that theory isn't panning out quite the way some had once hoped.

With pricing competition thrown into the mix, attempts to build market share go out the window. Instead, maintaining profitability becomes the larger issue. Progressive is taking steps to do just that, tweaking its business in order to maintain a minimum 4% underwriting profit over the entire life of a policy. Meanwhile, it's not like the company is just treading water. Even though Progressive and GEICO individually hold less than 5% market shares in the industry, both generate a significant amount of float that can be plowed into investments. So while profitability may be in the decline, the firms' main value drivers -- their float -- continue to hum right along.

Progressive intends to keep growing its business despite the profitability decline, which it believes is "the right thing to do for shareholders." The goal is to sell insurance to as many drivers as possible, through as many direct channels as possible, and at the most competitive prices possible. "We are investing in all of these efforts and are confident that consumers will continue to respond enthusiastically," said Lewis. Based on Progressive's leaner business model, investors should be equally enthusiastic about the company's future prospects as well.

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