This year has been challenging for the stock market, as inflation reached its highest level in four decades. The Federal Reserve intends to bring it down by raising interest rates, and it recently increased its target interest rate the most since 1994.
Interest rates impact every aspect of the economy. One company feeling the effects is the insurance giant Progressive (PGR 0.30%). The company recently announced its May earnings, and investors learned that it lost nearly $1 billion on its investment portfolio. Here's what you should know about Progressive's investments and what it means for the business.
Image source: Getty Images.
Net income for the year is down 90%
Progressive provides insurance for individuals and businesses, focusing on automobiles. Insurance companies bring in money from customer premiums, which they then use to pay out claims later. Good insurance companies weigh risks well, charging more in premiums than they pay out in claims, and can pile this cash into investments they hold on their books.
Investors had mixed reactions after Progressive reported its monthly earnings for May. Net income for the month fell 73%, and year to date, it is down 90% -- with investment losses leading the way. Progressive's investments have lost over $1 billion this year after making $923 million through the first five months of last year.
Debt instruments make up most of Progressive's $51 billion investment portfolio, including U.S. Treasuries (37% of its portfolio), corporate debt (21%), and mortgage-backed securities (15%). These debt instruments have interest rate risk, meaning they lose value as interest rates go up. This year, global interest rates have risen at the fastest pace in 30 years, and the five-year U.S. Treasury yield went from 1.26% at the beginning of this year to 3.14% as of Friday.
5 Year Treasury Rate data by YCharts.
The core business keeps performing
While investment valuations have declined, investors have reasons to be optimistic, as Progressive's premiums earned rose 11% and the insurer continues to underwrite profitable policies.
The combined ratio gives a picture of an insurer's profitability and it measures claims plus expenses divided by premiums; insurers want this ratio to be below 100%, and the lower it is the better. Progressive has an impressive history of managing its combined ratio; this year, it sits at 95.1%, hasn't exceeded management's target ratio of 96% since 2000, and is consistently below the industry average.
Data sources: Progressive SEC filings and NAIC for industry averages. Chart by author.
Investor takeaway
Progressive continues to write good policies and increase its premiums collected. For investors, net income falling 90% is not a welcome sight, but it's good to put it in perspective and understand which part of the business is causing the decline. Investing isn't Progressive's main business but merely a way to generate additional cash over long periods, which it has.
Investors should know that interest rates will likely continue to rise as the Fed attempts to fight inflation, which will weigh on the value of Progressive's investment portfolio. On the flip side, Progressive can put its incoming cash flow to work, adding more Treasuries and other debt instruments at higher interest rates, which will generate more interest income for the insurer over the longer term.
Progressive remains a solid stock to hold, and as an investor I wouldn't be concerned unless it begins to struggle to maintain its combined ratio below management's target for several quarters.
