Consistent achievement of superior results requires that our people understand Progressive’s objectives and their specific roles, and that their personal objectives dovetail with Progressive’s. Our objectives are ambitious, yet realistic.
We recognize that the dynamics of each distribution channel are very different and, therefore, have established a product management system responsible for achieving stated financial objectives over rolling five-year periods. Progressive monitors its financial policies continuously and strives to meet these targets annually. Experience always clarifies objectives and illuminates better policies. We constantly evolve as we monitor the execution of our policies and progress toward achieving our objectives.
Objectives
Profitability Progressive’s most important goal is for our insurance subsidiaries to produce an aggregate calendar-year underwriting profit of at least 4%. Our business is a composite of many product offerings defined in part by product type, distribution channel, geography, customer tenure and underwriting grouping. Each of these products has targeted operating parameters based on level of maturity, underlying cost structures, customer mix and policy life expectancy. Our aggregate goal is the balanced blend of these individual performance targets in any calendar year.
Growth Our goal is to grow as fast as possible, constrained only by our profitability objective and our ability to provide high-quality customer service. Progressive is a growth-oriented company and management incentives are tied to profitable growth.
We report Personal Lines and Commercial Auto results separately. We further break down our Personal Lines’ results by channel (Agency and Direct) to give shareholders a clearer picture of the business dynamics of each distribution method and their respective rates of growth. Aggregate expense ratios and aggregate growth rates disguise the true nature and performance of each business.
Financial Policies
Progressive balances operating risk with risk of investing and financing activities in order to have sufficient capital to support all the insurance we can profitably underwrite and service. Risks arise in all operational and functional areas, and therefore must be assessed holistically, accounting for the offsetting and compounding effects of the separate sources of risk within Progressive.
We use risk management tools to quantify the amount of capital needed, in addition to surplus, to absorb consequences of foreseeable events such as unfavorable loss reserve development, litigation, weather-related catastrophes and investment-market corrections. Our financial policies define our allocation of risk and we measure our performance against them. If, in our view, future opportunities meet our financial objectives and policies, we will invest capital in expanding business operations. Underleveraged capital will be returned to investors. We expect to earn a return on equity greater than its cost. Presented is an overview of Progressive’s Operating, Investing and Financing policies.
Objectives and Policies Scorecard
| Financial Results | Target | 2006 | 2005 | 2004 | 5 Years1 | 10 Years1 |
|---|---|---|---|---|---|---|
| Underwriting margin—Progressive | 4% | 13.3% | 11.9% | 14.9% | 12.4% | 9.4% |
| —Industry2 | na | 7.0% | 4.9% | 5.7% | 3.2% | (.1)% |
| Net premiums written growth | (a) | 1% | 5% | 12% | 14% | 15% |
| Policies in force growth—Personal Auto | (a) | 1% | 8% | 9% | 11% | 13% |
| —Special Lines | (a) | 8% | 14% | 18% | 16% | 15% |
| —Commercial Auto | (a) | 7% | 11% | 15% | 19% | 21% |
| Companywide premiums-to-surplus ratio | (b) | 2.8 | 3.0 | 2.9 | na | na |
| Investment allocation—fixed:equity | (c) | 84%:16% | 85%:15% | 86%:14% | na | na |
| Debt-to-total capital ratio | < 30% | 14.8% | 17.4% | 19.9% | na | na |
| Return on average shareholders’ equity (ROE)3 | (d) | 25.3% | 25.0% | 30.0% | 26.1% | 21.5% |
| Comprehensive ROE4 | (d) | 28.4% | 24.1% | 30.4% | 27.9% | 22.9% |
(a) Grow as fast as possible, constrained only by our profitability objective and our ability to provide high-quality customer service.
(b) Determined separately for each insurance subsidiary.
(c) Allocate 75% to 100% in fixed-income securities with the balance in common equities.
(d) Progressive does not have a predetermined target for ROE.
na = not applicable
1) Represents results over the respective time period; growth represents average annual compounded rate of increase.
2) Represents the U.S. personal auto insurance industry; 2006 is estimated.
3) Based on net income.
4) Based on comprehensive income. Comprehensive ROE is consistent with Progressive’s policy to manage on a total return basis and better reflects growth in shareholder value. For a reconciliation of net income to comprehensive income and for the components of comprehensive income, see Progressive’s Consolidated Statements of Changes in Shareholders’ Equity and Note 10 – Other Comprehensive Income, respectively, which can be found in the complete Consolidated Financial Statements and Notes included in Progressive’s 2006 Annual Report to Shareholders, which is attached as an Appendix to Progressive’s 2007 Proxy Statement.
achievements
We are convinced that the best way to maximize shareholder value is to achieve these financial objectives and policies consistently. A shareholder who purchased 100 shares of Progressive for $1,800 in our first public stock offering on April 15, 1971, owned 92,264 shares on December 31, 2006, with a market value of $2,234,634, for a 22.1% compounded annual return, compared to the 7.7% return achieved by investors in the Standard & Poor’s 500 during the same period. In addition, the shareholder received dividends of $2,999 in 2006, bringing total dividends received to $37,334 since the shares were purchased.
In the ten years since December 31, 1996, Progressive shareholders have realized compounded annual returns, including dividend reinvestment, of 16.0%, compared to 8.4% for the S&P 500. In the five years since December 31, 2001, Progressive shareholders’ returns were 14.4%, compared to 6.2% for the S&P 500. In 2006, the returns were (17.0)% on Progressive shares and 15.8% for the S&P 500.
Over the years, when we have had adequate capital and believed it to be appropriate, we have repurchased our shares. In addition, as our Financial Policies state, we will repurchase shares to neutralize the dilution from equity-based compensation programs and return any underleveraged capital to investors. During 2006, we repurchased 39,069,743 Common Shares, with 3,182,497 repurchased prior to the stock split and 35,887,246 repurchased after the stock split. The total cost to repurchase these shares was $1.2 billion, with an average cost, on a split-adjusted basis, of $24.98 per share. We did not split our treasury shares. Since 1971, we have spent $4.6 billion repurchasing our shares, at an average cost of $4.60 per share, on a split-adjusted basis.
Operations Summary
Agency Business 2006 results for our Agency Business reflected increased competition and declining premium per policy. While performance did not meet our expectations for unit and revenue growth, we can report sustained profitability with a combined ratio of 88.1. Auto policies in force and net earned premium both declined 1% while the special lines business continued to build on its market-leading position, growing policies by 8%. The underwriting expense ratio increased only slightly to 20.3, a positive in an environment of declining average premium.
We used the slower-growth year to affirm our strategy, improve our easy-to-use position in agents’ offices, introduce new products and evaluate our brand architecture to ensure it is working for our agents and their customers.
We are committed to being a low-cost provider with superior service that is broadly available through independent insurance agents and other intermediaries. To that end, we began a systematic approach of pricing all product segments closer to their target combined ratios. While this move is driven by sustained lower loss trends, we remain flexible so that we can respond if loss costs increase. We also focused product development efforts on increased customer retention. Agents will see the benefits of these efforts in 2007 and beyond.
We deployed real-time rating for comparative raters and Web-based agencies, positioning us well for the future. On ForAgentsOnly.com (FAO), the primary interface between us and agents, we made quotes faster and more accurate by increasing our real-time use of external databases and, in early 2007, we will introduce electronic signature functionality for both new agent appointments and new business applications.
Two new products, designed to increase the number of personal auto policies written, were introduced. Personal Umbrella is now available in five states with more coming in 2007. And, we reached agreement with Homesite Insurance to provide a homeowners product to select agents in three states. The coordinated quoting platform and multi-policy discounts will make it easy for agents to quote and sell a virtual auto/home package using FAO.
During the year we undertook a comprehensive assessment of our Agency brand—Drive® Insurance from Progressive. This work led to repositioning the Progressive name in the names of all products we sell through agents, including naming the private passenger auto product written through agents Progressive Drive Insurance. Agents and their customers identify with the Progressive name and this move to a single brand reinforces the strong Progressive identity. This change also allows agents to better leverage our unique concierge level of claims service available through more than 50 Progressive service centers throughout the country to satisfy—and retain—their customers.
| 2006 | 2005 | Change | ||||
|---|---|---|---|---|---|---|
| Net premiums written (in billions) | $ | 7.9 | $ | 8.0 | (2)% | |
| Net premiums earned (in billions) | $ | 7.9 | $ | 8.0 | (1)% | |
| Loss and loss adjustment expense ratio | 67.8 | 69.1 | (1.3) pts. | |||
| Underwriting expense ratio | 20.3 | 20.2 | .1 pts. | |||
| Combined ratio | 88.1 | 89.3 | (1.2) pts. | |||
| Auto policies in force (in thousands) | 4,433.1 | 4,491.4 | (1)% |
Direct Business In 2006, the Direct Business continued to generate excellent profitability with a combined ratio of 86.9. Growth, however, did not meet our expectations as policies in force grew only 4% as a result of fewer new customers and some degradation in retention rates of existing customers. A reduction in quotes drove the new customer decline and more than offset an increase in the rate of conversion. On a relative basis, we saw a greater decline in phone quotes than Internet quotes in 2006. We are seeing the majority of our new customers not only beginning their shopping process on the Internet, but they are also fully initiating their policies online.
During the first half of 2006, average premium per policy was fairly stable to slightly increasing. We began lowering rates in the latter half of the year to move closer to our pricing targets. For the year, average premium dropped 2% for new customers and 1% for renewal customers. Total premium earned for the year grew 6% relative to 2005.
Our expense ratio increased slightly due to higher levels of advertising that delivered diminished returns relative to 2005. The dramatic increase in competitors’ advertising spend that we first noted in 2005 continued through 2006 and will likely continue in 2007. Our media mix continued to shift toward the Internet and away from more traditional means such as direct mail. And, in October, we retained a new primary advertising agency and have subsequently migrated to a new overall Progressive brand positioning characterized by our new tagline, "It’s about you. And it’s about time.SM"
In addition, we rolled out our patented usage-based discount program, TripSense®, in two more states, bringing the total to three states, and remain committed to a usage-based approach because it helps to give drivers control over what they pay. During the year, we were also awarded a patent on functionality available at our online customer service site, available at progressive.com.
| 2006 | 2005 | Change | ||||
|---|---|---|---|---|---|---|
| Net premiums written (in billions) | $ | 4.4 | $ | 4.2 | 4% | |
| Net premiums earned (in billions) | $ | 4.3 | $ | 4.1 | 6% | |
| Loss and loss adjustment expense ratio | 66.8 | 68.4 | (1.6) pts. | |||
| Underwriting expense ratio | 20.1 | 19.9 | .2 pts. | |||
| Combined ratio | 86.9 | 88.3 | (1.4) pts. | |||
| Auto policies in force (in thousands) | 2,428.5 | 2,327.7 | 4% |
Commercial Auto Competitors were very aggressive in 2006 as once again the industry enjoyed strong profits. Reductions in rate continued in 2006 and will likely extend into the early part of 2007. As a result of overall declining premium per policy, we expect no growth in the $30 billion commercial auto market in 2006, following the market decline experienced in 2005. However, supported by our entry into New Jersey and a strong position in the specialty trucking market, Commercial Auto’s net premiums written grew 5% to $1.9 billion with policies in force rising 7%. With our growth, we believe it is likely we ended 2006 in a virtual dead heat with St. Paul Travelers and Zurich for market leadership.
Our profits were very strong as decreased accident frequency and a cautious approach to the trade off of rate for volume led to a combined ratio of 80.2. However, we experienced a decline in the rate of new business growth and, more notably, a reduction in the proportion of customers who choose to renew their policies. We are moving quickly to address these issues. For the first four months of 2007, we have an aggressive schedule that will provide the large majority of our current customers with a more competitive rate as well as position us more favorably with potential new customers. At the same time, we are enhancing distribution by adding new agents and doubling the commercial account managers serving independent agents throughout the country. We also entered Massachusetts in January.
We do not expect to reach our long-term goals by rate alone. Our growth over these past few years has given us the additional data needed to segment our customers more finely. This enables us to deliver services, products and rates that align more closely to the needs of specific business groups. Later this year we will be offering select customer groups best-in-class coverages and services. In addition, we continue to invest in training more claims representatives in specific commercial auto estimating and repair processes. We expect that these efforts will deepen our relationships with customers and agents as well as extend average policy life as we deliver a more compelling business value proposition.
| 2006 | 2005 | Change | ||||
|---|---|---|---|---|---|---|
| Net premiums written (in billions) | $ | 1.9 | $ | 1.8 | 5% | |
| Net premiums earned (in billions) | $ | 1.9 | $ | 1.7 | 11% | |
| Loss and loss adjustment expense ratio | 61.0 | 62.4 | (1.4) pts. | |||
| Underwriting expense ratio | 19.2 | 19.7 | (.5) pts. | |||
| Combined ratio | 80.2 | 82.1 | (1.9) pts. | |||
| Policies in force (in thousands) | 503.2 | 468.2 | 7% |
