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Progressive: |
Market ConditionsIn summarizing 2003, I reported that the auto insurance industry produced a combined ratio under 100% for just the second time in 25 years. We estimate 2004 will not only produce back-to-back profitability, but perhaps the lowest industry-wide combined ratio in history. Current market conditions seem to be setting up a likely three-peat in 2005. With profitability well in hand for most competitors, and continuing declines in automobile accident frequency, there was little in the way of rate pressure for the average consumer. (On a personal note, my Progressive policy premium has remained level for the two most recent renewals.) The predictable outcome was significantly less consumer shopping. These conditions tested our traditional understanding about elasticity of demand under rate reduction scenarios. In fact, it was very clear that while some rate reductions were in order, other potential reductions would produce little change in new business volume and simply reduce margins. Many companies were chasing fewer interested consumers. These conditions, in concert with favorable operating margins, caused us to temporarily reassess our goal of growing as fast as possible constrained only by our 96 combined ratio and the ability to provide high-quality service. Instead, we pursued a strategy of maintaining relatively robust margins without significantly impairing growth. Our product managers chose to be selective in rate changes, favoring rate stability, while advancing product design, brand and technology initiatives. While these market conditions and profitability levels are unusual, and perhaps transitional, they offer opportunities for us to improve our understanding and calibration of market responses to varying rate stimuli. We remain governed by long-term economics, and reaffirm our stated profit and growth objectives over any reasonable time frame. We estimate net premiums written in the auto insurance segment of the industry grew 3.7%* in 2004, down from the prior three year average of 8.0%, reflecting low increases in average premium per policy. The top 15 private passenger auto insurers, accounting for about 72% market share, again outperformed the industry in both growth and profitability, further supporting our view that consolidation will continue. We continue to believe scale, execution in information technology, pricing segmentation, superior claims handling, and brand development are all leading factors contributing to consolidation, as well as the differentiating factors within the consolidating group. Compared to the other 14 private passenger auto insurers, Progressive's Direct Business was the fastest growing player at 16.5% and our Agency Business, at 9.5%, slotted in fifth.
*Based on our internal analysis, using actual results through the first nine months of 2004, we estimate the annual growth rate in the personal auto insurance market to be 3.7%; A. M. Best reported an estimated growth rate of 4.7% for 2004. |
2004 (estimated)
Note: The above disclosure excludes two reciprocal companies, Zurich and USAA, due to uncertainty regarding the comparability of the data. Results disclosed were estimated by Progressive based on actual results through the first nine months of 2004, as reported by the National Underwriter Insurance Data Services; actual results may vary. The size of the circles is proportionate to each company's estimated 2004 net premiums written. 2000-2004 (estimated)
Note: The above disclosure excludes two reciprocal companies, Zurich and USAA, due to uncertainty regarding the comparability of the data. Results disclosed were estimated by Progressive based on actual results through the first nine months of 2004, as reported by the National Underwriter Insurance Data Services; actual results may vary. The size of the circles is proportionate to each company's estimated 2004 net premiums written. |
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What were the important advances on the strategic agenda?Brand On September 21st, we announced "Drive Insurance from Progressive," a brand focused on and designed for our independent agents and insurance brokers. All indications suggest this launch was exceptionally well received by agents. Providing consumers the choice of both an agency-distributed product, now sold as Drive Insurance from ProgressiveSM, and a direct-to-consumer product, Progressive DirectSM, is strategically important positioning for Progressive, and this branding provides additional clarity. We have long recognized that the specifics of product design and competitive focus within each distribution channel are very different and each warrant, and will be advanced by, separate identities. With this brand introduction, we have completed our organization of the company around our primary offerings—Agency Personal Lines, Direct Personal Lines and Commercial Auto. With a separate and distinctive Agency brand, we expect to enhance our positioning with agents and provide them with a more effective marketing voice by promoting their service proposition to consumers through television, Yellow Page and other advertising. More than 80% of all auto insurance sold in the United States is written through captive and independent agents. We believe the ongoing development of a premier brand in this important marketplace will be a significant component of our future growth and our ability to compete with both independent— and captive-agent-based companies. Creating two top share brands in personal auto is a key initiative, and in 2004 we took a huge step forward. Building on this introduction with agents and brokers will be a focus of our Agency Business in 2005. |
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The Progressive Corporation and Subsidiaries
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Claims Our Claims organization deserves considerable credit for continued progress on their quality agenda. By our most objective measures, we achieved our best claim file quality in 2004 and the overwhelming trend continues to be steady and consistent improvement. The relationship between great claim file quality, customer satisfaction and accurate payments is undeniable, although sometimes difficult to measure except in overall results. Our focus on claims quality is no longer a response to a problem, in fact far from it. Rather, we are now challenging ourselves against a standard we call "Virtually Perfect." This standard requires a level of performance such that we would be delighted if every claim file were handled in exactly the same way were it to be handled again. This is a demanding standard that is central to our long-term success. We work harder at, and care more about, claims management than most—I think it shows. Our strategic initiative to change physical damage handling from a we-will-pay-for-your-loss mindset to a we-will-handle-all-aspects-of-the-repair mindset (aka concierge-level service), had an important and largely successful year. With 20 concierge centers open and a sufficient number of eligible vehicles passing through them, we are now at an evaluation scale where execution against design specifications is crucial. We demand of ourselves not only the execution standards, but the process flows, physical designs and geographic optimization necessary for thoughtful expansion. While disappointed we did not open more centers in 2004, our discipline and planning has positioned us well for expansion throughout 2005 and 2006. I look forward to an appreciable and growing percentage of our customers and claimants experiencing concierge-level claims service. The newest component of this level of service is finding and offering to our customers the choice of a replacement vehicle rather than just payment when we declare their car un-repairable. We are testing this in limited locations and we now know enough to believe that, while difficult to do, it can be an effective economic tool as well as a way for our claims representatives to create extraordinary customer experiences. We expect significant expansion in 2005.
Commitment to improve our customer experiences was evident throughout our Claims organization in 2004 as we added emphasis to listening to the customer by seeking more feedback. Much of the feedback is, as hoped for, excellent, but frankly we learn more when we identify and recognize opportunities for improvement. We are very conscious that our aspiration to be recognized as the preeminent consumer franchise in auto insurance is not yet a market reality and understand the intensity of commitment required. We're signed up for the long haul on this one.
Our real technology strength remains the close business integration and the numerous opportunities seized to continuously improve everything we do in cost-effective ways. We remain committed to a level of technology investment that ensures we never constrain our business opportunities. In 2005, we will make meaningful progress on improved customer management systems and an infrastructure plan that will ensure yet another performance increment to our level of system availability and disaster preparedness.
We respect the efforts of many in the New Jersey state government to effect thoughtful and meaningful change. We are currently active in New Jersey, handling claims for our customers traveling through the state, as well as participating as a servicing carrier for the Commercial Auto Insurance Plan (CAIP). We are at our best when challenged. Improving retention is a challenge we have accepted. By our current best measures, 2004 did not produce the degree or speed of retention improvement we had hoped for and is reason for some disappointment. However, I have more than cautious optimism as we continue to attack this opportunity and list it among the key initiatives of the Company. We have always recognized that good customer service, efficient operations and fair pricing were necessary conditions for success in our business. The challenge we currently face is one of degree. As a culture, we now recognize and accept that the only standard for which we will be rewarded with the loyalty we seek is one that combines extraordinary customer experience and total competency in everything we do, all at an attractive price. Investments and Capital ManagementThe financial market results were "not what you'd expect" when the Federal Reserve Board raised rates five times. Although short-term interest rates moved higher, from historically low levels at the start of the year, longer-term rates initially increased then reversed course to finish lower on the year. Equity markets rallied on solid corporate earnings and wide margins. Our portfolio managers executed well on our investment strategy, maintaining about an 85% portfolio allocation to high-quality, intermediate-duration, fixed-income securities and 15% to indexed equities, while reducing exposure to interest-rate risk. The portfolio ended the year with a total return of 5.2%. At year end, our fixed-income securities had a weighted average credit quality of AA and duration of 2.9 years. Our overall investment and capital management objective remains the same: Ensure that our insurance operations have sufficient capital to support all the insurance we can profitably underwrite and service. We ended 2004 with $13.1 billion in invested assets, up from $12.5 billion in December 2003. But that is not the whole story. With the release of our August results, we announced a "Dutch auction" tender offer to purchase up to 17.1 million of our outstanding Common Shares. The tender period closed on October 15th and 16.9 million shares were tendered. Those shares were purchased at $88 per share for a total cost of $1.5 billion. In addition, we repurchased 1.7 million shares for $139.5 million in open market transactions. We ended 2004 with 200.4 million Common Shares outstanding, compared to 216.4 million shares at the beginning of the year. Our long-standing and continuing position on capital management is that we will repurchase shares when our capital position, view of the future, and the stock's price make it attractive to do so. The tender offer in 2004 was our attempt to execute on this position in the most transparent manner possible respecting, and we hope accommodating, the varied investment objectives of our owners. We continued to operate well within all of our stated financial policies post the transaction, specifically our targeted debt-to-total capital ratio which ended the year at 20%. Our transition from the use of stock options to restricted stock for equity-based compensation is now also effectively complete. The shares purchased in this tender offer have offset the remaining unexercised stock options. Our commitment to neutralizing dilution from equity-based compensation will be ongoing for restricted stock and matched in the year of issue. I reported last year that we would begin a process in 2004 to slowly increase operating leverage through higher premiums-to-surplus ratios in our insurance subsidiaries. We ended 2004 at a 2.9 ratio. Our ongoing policy will be to continue to increase operating leverage to efficient levels, while staying below applicable state regulations. Company CommunicationWe continuously look for ways to enhance the quality of our communications with owners and analysts. In 2004, we offered management commentary with our monthly results in anticipation of specific questions and produced a quarterly online update to the shareholders' letter. The update replaced the prepared commentary previously provided at the start of our investor relations conference calls. Our conference calls, now timed to follow the release of our SEC quarterly filings, are simply an opportunity to address further questions. We hope these changes have been effective and meaningful. The Progressive CultureIn large part, this report is a way to present an accounting of the Company and quantification of assets. There are, of course, crucial assets that simply do not get accounted for in any GAAP measure—the people and the culture of a company. Succinctly describing the culture of Progressive has always eluded me, but I would suggest it is dramatically undervalued and cannot be reflected on a formal balance sheet. Our vision, values and objectives help set the tone. Being rewarded competitively is an essential ingredient, but there remains a set of intangible factors that seem to define a culture where people enjoy working hard, growing constantly and performing well. I believe it is in these intangibles that the real Progressive lies. In some cases, our tools, techniques or methods, often valued by others, have been duplicated, but our culture is not transportable. We achieve little of note without a strong sense of mission and a culture to match. Whether or not we will ever accurately describe our culture, it is real, it is not perfect, but it is us. The theme of this report is our work environment, which through the use of art in the workplace, is just one more dimension of our culture that seeks to encourage and reward initiative, risk, innovation and constant improvement. Nowhere was our company culture more obvious in 2004 than in our response to the four hurricanes that pounded Florida and other Southeastern states. The economic effects of the hurricanes were well reported, but for us the real story was the extraordinary actions and initiatives taken by our people, many of whom were dealing with their own storm-related problems. During those challenging days, our people were doing what we do best: helping others get back to normal. With assistance from around the country and every area of the company, claims were managed relatively seamlessly and resolved quickly after each incident. Customers were generous with their praise at such a trying time. We are motivated by our aspiration of becoming Consumers' No. 1 Choice for Auto Insurance and enter 2005 with exciting momentum and energy for executing key business initiatives, as well as a continued commitment to enhance our culture and work environment. We deeply appreciate the customers we are privileged to serve, the more than 27,000 Progressive people who make it all possible, the agents and brokers who choose to represent us and shareholders who believe in our game plan.
Glenn M. Renwick | |
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continue to OPERATIONS SUMMARY |
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