Investing isn't always easy, as 2022 has made crystal clear. One thing we can do during times like this is invest in resilient companies with clear competitive advantages. Insurance companies can present this opportunity, but they often fly under the radar. The property and casualty (P&C) industry isn't exciting -- but don't be mistaken, these companies can deliver market-crushing returns. Going back to 2000, one insurance company delivered returns that would've turned a $10,000 investment into $378,000.
If you guessed Progressive (PGR 3.72%), you'd be right. With a huge head start on a specific technology that its rivals are only now developing, let's see whether Progressive can keep winning.
Progressive's technological advantage
Insurers must price policies well to see long-term success. Progressive prices its policies with surgical precision thanks to its secret sauce: a technology known as telematics. The company tracks driving behavior through a device installed in your car or an app on your phone, collecting data like mileage driven, speed, and braking time to develop personalized rates, and giving drivers discounts for safe driving behavior.
Progressive has used telematics for decades to price its insurance policies. The insurer first rolled out this technology in 2004 on a limited basis, then made it widely available in 2011 through its Progressive Snapshot product. The company's first-mover advantage here gave it a distinct edge over its competition in pricing its policies, putting it head and shoulders above the competition.
Measuring its underwriting ability
Progressive's telematics advantage becomes clearer when you look at the company's performance. The combined ratio -- total losses from claims, plus expenses, divided by total earned premiums -- is one way to measure how skillfully an insurer is writing policies. A ratio below 100% means a company is writing policies at a profit; the lower the percentage, the better.
Progressive has been one of the best in the industry when it comes to the combined ratio, outperforming other property & casualty (P&C) insurers. Progressive's combined ratio averaged 91.4% from 2002 to 2021. Last year it saw higher claims costs due to Hurricane Ida and elevated repair costs and used car values -- but it quickly adapted and came in just under management's goal of 96%.
During this time, the P&C industry average has been 99.7%. Allstate and Travelers are two similar companies that have also done a good job of writing policies -- but not nearly as well as Progressive. During that same 20-year period, these Allstate and Travelers have posted average combined ratios of 94.7% and 95.7%, respectively.
Competition is heating up, but Progressive still has an edge
Progressive changed the game when it introduced telematics, but competitors are catching up. Some 81% of Americans carry cellphones that can collect GPS data, giving insurance companies an easy way to collect driving information on the go.
Auto insurance heavyweights like Geico and State Farm have introduced telematics in recent years. Young upstarts have also jumped into the game, with companies like Root and Metromile (purchased by Lemonade) making usage-based insurance powered by telematics central to their business.
The influx of competitors could eat away at Progressive's business. However, the company has a huge first-mover advantage. When it comes to building good pricing models through machine learning, having loads of data points is crucial -- and Progressive has over 10 years of driver data from its Snapshot product alone.
Berkshire Hathaway's (NYSE: BRK-A)(NYSE: BRK-B) Geico began its telematics program in 2019, and Ajit Jain, Berkshire's vice chair of Insurance Operations, says that "my hope is that in the next year or two, Geico will be positioned to catch up with Progressive." To compete, Geico and other rivals still need to build up a database of information and build a model that effectively uses this data to price policies.
A stellar company with a high price tag
Progressive is a well-run company that has put up stellar growth for years. It has steadily grown revenue at 9.7% compounded annually and net income 8.7% compounded annually over 20 years.
Its impressive growth and superior underwriting ability come at a high cost, with the stock trading at a 32 price-to-earnings ratio (P/E). Competitors Allstate and Travelers trade at P/E ratios of 11.7 and 11. This could make Progressive a riskier investment if it does see its competitive edge erode.
PGR PE Ratio data by YCharts
As a Progressive shareholder, I'll be keeping a close eye on its combined ratio and its returns on equity. If the competition is truly catching up, you will begin to see these numbers drift more toward the industry averages, at which point the company wouldn't deserve its premium price tag. However, I think that's a few years away -- if it happens at all.