UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
FORM 1O-Q
(Mark One)
| þ | Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended March 31, 2005
| o | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the transition period from to
Commission File Number 1-9518
THE PROGRESSIVE CORPORATION
| Ohio | 34-0963169 | |
| (State or other jurisdiction of | (I.R.S. Employer | |
| incorporation or organization) | Identification No.) | |
| 6300 Wilson Mills Road, Mayfield Village, Ohio | 44143 | |
| (Address of principal executive offices) | (Zip Code) | |
(440) 461-5000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Common Shares, $1.00 par value: 198,794,022 outstanding at April 30, 2005
1
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements.
The Progressive Corporation and Subsidiaries
Consolidated Statements of Income
(unaudited)
| Three Months Ended March 31, | 2005 | 2004 | % Change | |||||||||
| (millions - except per share amounts) | ||||||||||||
Revenues |
||||||||||||
Net premiums earned |
$ | 3,350.0 | $ | 3,093.5 | 8 | |||||||
Investment income |
120.4 | 114.9 | 5 | |||||||||
Net realized gains (losses) on securities |
10.2 | 59.5 | (83 | ) | ||||||||
Service revenues |
11.2 | 12.6 | (11 | ) | ||||||||
Other income (expense) |
— | (.2 | ) | NM | ||||||||
Total revenues |
3,491.8 | 3,280.3 | 6 | |||||||||
Expenses |
||||||||||||
Losses and loss adjustment expenses |
2,168.6 | 1,962.1 | 11 | |||||||||
Policy acquisition costs |
356.1 | 334.0 | 7 | |||||||||
Other underwriting expenses |
323.4 | 276.2 | 17 | |||||||||
Investment expenses |
2.8 | 3.3 | (15 | ) | ||||||||
Service expenses |
5.4 | 5.5 | (2 | ) | ||||||||
Interest expense |
20.8 | 20.5 | 1 | |||||||||
Total expenses |
2,877.1 | 2,601.6 | 11 | |||||||||
Net Income |
||||||||||||
Income before income taxes |
614.7 | 678.7 | (9 | ) | ||||||||
Provision for income taxes |
202.0 | 218.7 | (8 | ) | ||||||||
Net income |
$ | 412.7 | $ | 460.0 | (10 | ) | ||||||
Computation of Earnings Per Share |
||||||||||||
Basic: |
||||||||||||
Average shares outstanding |
199.0 | 216.4 | (8 | ) | ||||||||
Per share |
$ | 2.07 | $ | 2.13 | (2 | ) | ||||||
Diluted: |
||||||||||||
Average shares outstanding |
199.0 | 216.4 | (8 | ) | ||||||||
Net effect of dilutive stock-based compensation |
2.9 | 3.6 | (19 | ) | ||||||||
Total equivalent shares |
201.9 | 220.0 | (8 | ) | ||||||||
Per share |
$ | 2.04 | $ | 2.09 | (2 | ) | ||||||
Dividends per Share |
$ | .030 | $ | .025 | 20 | |||||||
| - | ||||||||||||
See notes to consolidated financial statements.
2
The Progressive Corporation and Subsidiaries
Consolidated Balance Sheets
(unaudited)
| March 31, | December 31, | |||||||||||
| 2005 | 2004 | 2004 | ||||||||||
| (millions) | (audited) | |||||||||||
Assets |
||||||||||||
Investments — Available-for-sale, at market: |
||||||||||||
Fixed maturities (amortized cost: $9,548.0, $9,008.6 and $8,972.6) |
$ | 9,505.5 | $ | 9,297.3 | $ | 9,084.3 | ||||||
Equity securities: |
||||||||||||
Preferred stocks (cost: $952.0, $804.7 and $749.4) |
957.7 | 832.8 | 768.9 | |||||||||
Common equities (cost: $1,400.2, $1,600.1 and $1,314.0) |
1,898.9 | 2,004.0 | 1,851.9 | |||||||||
Short-term investments (amortized cost: $1,042.3, $1,113.6 and $1,376.6) |
1,042.8 | 1,113.6 | 1,376.9 | |||||||||
Total investments |
13,404.9 | 13,247.7 | 13,082.0 | |||||||||
Cash |
16.8 | 23.1 | 20.0 | |||||||||
Accrued investment income |
100.4 | 96.8 | 103.5 | |||||||||
Premiums receivable, net of allowance for doubtful accounts of $76.8, $62.9
and $83.8 |
2,469.2 | 2,248.2 | 2,287.2 | |||||||||
Reinsurance recoverables, including $53.7, $52.3 and $44.5 on paid losses |
391.7 | 294.5 | 381.6 | |||||||||
Prepaid reinsurance premiums |
121.3 | 120.1 | 119.8 | |||||||||
Deferred acquisition costs |
450.6 | 434.5 | 432.2 | |||||||||
Property and equipment, net of accumulated depreciation of $584.0, $498.3
and $562.1 |
660.9 | 616.0 | 666.5 | |||||||||
Other assets |
107.4 | 81.0 | 91.5 | |||||||||
Total assets |
$ | 17,723.2 | $ | 17,161.9 | $ | 17,184.3 | ||||||
Liabilities and Shareholders’ Equity |
||||||||||||
Unearned premiums |
$ | 4,364.3 | $ | 4,083.9 | $ | 4,108.0 | ||||||
Loss and loss adjustment expense reserves |
5,348.3 | 4,703.9 | 5,285.6 | |||||||||
Accounts payable, accrued expenses and other liabilities |
1,385.9 | 1,386.0 | 1,325.0 | |||||||||
Income taxes |
45.4 | 156.4 | 26.0 | |||||||||
Debt |
1,284.5 | 1,289.9 | 1,284.3 | |||||||||
Total liabilities |
12,428.4 | 11,620.1 | 12,028.9 | |||||||||
Shareholders’ equity: |
||||||||||||
Common Shares, $1.00 par value (authorized 600.0;
issued 213.2, 230.1 and 213.2, including treasury shares of 13.6, 12.6 and
12.8) |
199.6 | 217.5 | 200.4 | |||||||||
Paid-in capital |
805.8 | 755.3 | 743.3 | |||||||||
Unamortized restricted stock |
(82.0 | ) | (65.5 | ) | (46.0 | ) | ||||||
Accumulated other comprehensive income (loss): |
||||||||||||
Net unrealized gains on investment securities |
300.6 | 468.5 | 435.1 | |||||||||
Net unrealized gains on forecasted transactions |
9.4 | 10.5 | 9.7 | |||||||||
Foreign currency translation adjustment |
— | (3.9 | ) | — | ||||||||
Retained earnings |
4,061.4 | 4,159.4 | 3,812.9 | |||||||||
Total shareholders’ equity |
5,294.8 | 5,541.8 | 5,155.4 | |||||||||
Total liabilities and shareholders’ equity |
$ | 17,723.2 | $ | 17,161.9 | $ | 17,184.3 | ||||||
See notes to consolidated financial statements.
3
The Progressive Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(unaudited)
| Three Months Ended March 31, | 2005 | 2004 | ||||||
| (millions) | ||||||||
Cash Flows From Operating Activities |
||||||||
Net income |
$ | 412.7 | $ | 460.0 | ||||
Adjustments to reconcile net income to net cash provided by
operating activities: |
||||||||
Depreciation |
22.2 | 22.8 | ||||||
Amortization of fixed maturities |
42.0 | 38.4 | ||||||
Amortization of restricted stock |
6.7 | 4.7 | ||||||
Net realized (gains) losses on securities |
(10.2 | ) | (59.5 | ) | ||||
Changes in: |
||||||||
Unearned premiums |
256.3 | 189.2 | ||||||
Loss and loss adjustment expense reserves |
62.7 | 127.6 | ||||||
Accounts payable, accrued expenses and other liabilities |
(13.3 | ) | 95.9 | |||||
Prepaid reinsurance premiums |
(1.5 | ) | (5.4 | ) | ||||
Reinsurance recoverables |
(10.1 | ) | (23.2 | ) | ||||
Premiums receivable |
(182.0 | ) | (168.6 | ) | ||||
Deferred acquisition costs |
(18.4 | ) | (22.2 | ) | ||||
Income taxes |
91.9 | 210.9 | ||||||
Tax benefit from exercise/vesting of stock-based
compensation |
13.2 | 15.3 | ||||||
Other, net |
(13.7 | ) | 14.6 | |||||
Net cash provided by operating activities |
658.5 | 900.5 | ||||||
Cash Flows From Investing Activities |
||||||||
Purchases: |
||||||||
Fixed maturities |
(1,757.6 | ) | (1,931.2 | ) | ||||
Equity securities |
(409.4 | ) | (229.1 | ) | ||||
Sales: |
||||||||
Fixed maturities |
1,094.1 | 1,659.0 | ||||||
Equity securities |
53.6 | 129.4 | ||||||
Maturities, paydowns, calls and other: |
||||||||
Fixed maturities |
123.3 | 170.6 | ||||||
Equity securities |
— | 50.0 | ||||||
Net (purchases) sales of short-term investments |
334.3 | (465.6 | ) | |||||
Net unsettled security transactions |
73.3 | (13.1 | ) | |||||
Purchases of property and equipment |
(16.6 | ) | (54.2 | ) | ||||
Net cash used in investing activities |
(505.0 | ) | (684.2 | ) | ||||
Cash Flows From Financing Activities |
||||||||
Proceeds from exercise of stock options |
15.7 | 25.9 | ||||||
Payment of debt |
— | (200.0 | ) | |||||
Dividends paid to shareholders |
(6.0 | ) | (5.4 | ) | ||||
Acquisition of treasury shares |
(166.4 | ) | (25.8 | ) | ||||
Net cash used in financing activities |
(156.7 | ) | (205.3 | ) | ||||
Increase (decrease) in cash |
(3.2 | ) | 11.0 | |||||
Cash, January 1 |
20.0 | 12.1 | ||||||
Cash, March 31 |
$ | 16.8 | $ | 23.1 | ||||
See notes to consolidated financial statements.
4
The Progressive Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(unaudited)
Note 1 Basis of Presentation — These financial statements and the notes thereto should be read in conjunction with the Company’s audited financial statements and accompanying notes included in its Annual Report on Form 10-K for the year ended December 31, 2004.
The consolidated financial statements reflect all normal recurring adjustments which, in the opinion of management, were necessary for a fair statement of the results for the interim periods presented. The results of operations for the period ended March 31, 2005, are not necessarily indicative of the results expected for the full year.
Note 2 Stock-Based Compensation —The Company follows the provisions of Statement of Financial Accounting Standards (SFAS) 123, “Accounting for Stock-Based Compensation,” to account for its stock compensation activity in the financial statements. Prior to January 1, 2003, the Company followed the provisions of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” to account for its stock option activity.
The change to the fair value method of accounting under SFAS 123 was applied prospectively to all non-qualified stock option awards granted, modified, or settled after January 1, 2003. No stock options were granted after December 31, 2002. As a result, there is no compensation cost for stock options included in net income for 2003 and forward; however, compensation expense would have been recognized if the fair value method had been used for all awards since the original effective date of SFAS 123 (January 1, 1995). Prior to 2003, the Company granted all options currently outstanding at an exercise price equal to the market price of the Company’s Common Shares at the date of grant and therefore, under APB 25, no compensation expense was recorded.
The following table shows the effects on net income and earnings per share had the fair value method been applied to all outstanding and unvested stock option awards for the periods presented. The Company used the modified Black-Scholes pricing model to calculate the fair value of the options awarded as of the date of grant.
| Three months ended March 31, | ||||||||
| (millions, except per share amounts) | 2005 | 2004 | ||||||
Net income, as reported |
$ | 412.7 | $ | 460.0 | ||||
Deduct: Total stock-based employee
compensation expense determined under
the fair value based method for all
stock option awards, net of related tax
effects |
(.6 | ) | (1.4 | ) | ||||
Net income, pro forma |
$ | 412.1 | $ | 458.6 | ||||
Earnings per share |
||||||||
Basic — as reported |
$ | 2.07 | $ | 2.13 | ||||
Basic — pro forma |
2.07 | 2.12 | ||||||
Diluted — as reported |
$ | 2.04 | $ | 2.09 | ||||
Diluted — pro forma |
2.04 | 2.09 | ||||||
In 2003, the Company began issuing restricted stock awards. Compensation expense for restricted stock awards is recognized over the respective vesting periods. The current year expense is not representative of the effect on net income for future years since each subsequent year will reflect expense for additional awards.
See “Item 5-Other Information” in Part II of this Form 10-Q for details regarding the restricted stock awards granted by the Company during the first quarter 2005.
5
Note 3 Supplemental Cash Flow Information — The Company paid income taxes of $99.0 million and $54.0 million during the three months ended March 31, 2005 and 2004, respectively. Total interest paid was $21.1 million and $27.7 million for the three months ended March 31, 2005 and 2004, respectively. Non-cash activity includes the liability for deferred restricted stock compensation and the changes in net unrealized gains (losses) on investment securities.
Note 4 Debt — Debt at March 31 consisted of:
| 2005 | 2004 | |||||||||||||||
| Market | Market | |||||||||||||||
| (millions) | Cost | Value | Cost | Value | ||||||||||||
7.30% Notes due 2006 |
$ | 99.9 | $ | 103.6 | $ | 99.9 | $ | 110.9 | ||||||||
6.375% Senior Notes due 2012 |
347.8 | 376.7 | 347.5 | 395.2 | ||||||||||||
7% Notes due 2013 |
148.9 | 168.3 | 148.8 | 177.0 | ||||||||||||
6 5/8% Senior Notes due 2029 |
294.2 | 328.0 | 294.1 | 323.6 | ||||||||||||
6.25% Senior Notes due 2032 |
393.7 | 423.5 | 393.6 | 420.6 | ||||||||||||
Other debt |
— | — | 6.0 | 6.0 | ||||||||||||
| $ | 1,284.5 | $ | 1,400.1 | $ | 1,289.9 | $ | 1,433.3 | |||||||||
Note 5 Comprehensive Income — Total comprehensive income was $277.9 million and $510.1 million for the quarters ended March 31, 2005 and 2004, respectively.
Note 6 Dividends — On March 31, 2005, the Company paid a quarterly dividend of $.03 per Common Share to shareholders of record as of the close of business on March 11, 2005. The Board of Directors declared the dividend on January 31, 2005.
On April 15, 2005, the Board of Directors declared a quarterly dividend of $.03 per Common Share. The dividend is payable June 30, 2005, to shareholders of record as of the close of business on June 10, 2005.
Note 7 Segment Information — The Company’s Personal Lines business units write insurance for private passenger automobiles and recreation vehicles. The Commercial Auto business unit writes primary liability and physical damage insurance for automobiles and trucks owned by small businesses. The Company’s other-indemnity businesses primarily include writing professional liability insurance for community banks and managing the Company’s run-off businesses. The Company’s other-service businesses include providing insurance-related services, primarily processing business for Commercial Auto Insurance Procedures/Plans (CAIP), which are state-supervised plans serving the involuntary market. All revenues are generated from external customers.
6
Following are the operating results for the three months ended March 31:
| 2005 | 2004 | |||||||||||||||
| Pretax | Pretax | |||||||||||||||
| Profit | Profit | |||||||||||||||
| (millions) | Revenues | (Loss) | Revenues | (Loss) | ||||||||||||
Personal Lines — Agency |
$ | 1,975.4 | $ | 279.8 | $ | 1,871.4 | $ | 294.5 | ||||||||
Personal Lines — Direct |
972.6 | 132.2 | 865.9 | 138.7 | ||||||||||||
Total
Personal Lines
1 |
2,948.0 | 412.0 | 2,737.3 | 433.2 | ||||||||||||
Commercial Auto |
395.2 | 84.5 | 346.8 | 87.8 | ||||||||||||
Other-indemnity |
6.8 | 5.4 | 9.4 | .2 | ||||||||||||
Total underwriting operations |
3,350.0 | 501.9 | 3,093.5 | 521.2 | ||||||||||||
Other-service |
11.2 | 5.8 | 12.6 | 7.1 | ||||||||||||
Investments
2 |
130.6 | 127.8 | 174.4 | 171.1 | ||||||||||||
Interest expense |
— | (20.8 | ) | — | (20.5 | ) | ||||||||||
Other income (expense)3 |
— | — | (.2 | ) | (.2 | ) | ||||||||||
| $ | 3,491.8 | $ | 614.7 | $ | 3,280.3 | $ | 678.7 | |||||||||
The Company’s management uses underwriting margin and combined ratio as primary measures of underwriting profitability. The underwriting margin is the pretax profit (loss) [calculated as net premiums earned less losses and loss adjustment expenses, policy acquisition costs and other underwriting expenses] expressed as a percent of net premiums earned (i.e., revenues). Combined ratio is the complement of the underwriting margin. Following are the underwriting margins/combined ratios for the Company’s underwriting operations for the three months ended March 31:
| 2005 | 2004 | ||||||||
| Underwriting | Combined | Underwriting | Combined | ||||||
| Margin | Ratio | Margin | Ratio | ||||||
Personal Lines — Agency |
14.2% | 85.8 | 15.7% | 84.3 | |||||
Personal Lines — Direct |
13.6 | 86.4 | 16.0 | 84.0 | |||||
Total Personal Lines |
14.0 | 86.0 | 15.8 | 84.2 | |||||
Commercial Auto |
21.4 | 78.6 | 25.3 | 74.7 | |||||
Other — indemnity1 |
NM | NM | NM | NM | |||||
Total underwriting operations |
15.0 | 85.0 | 16.8 | 83.2 | |||||
Note 8 Litigation — The Company is named as defendant in various lawsuits arising out of its insurance operations. All legal actions relating to claims made under insurance policies are considered by the Company in establishing its loss and loss adjustment expense reserves.
In addition, the Company is named as defendant in a number of class action or individual lawsuits, the outcomes of which are uncertain at this time. These cases include those alleging damages as a result of the Company’s total loss evaluation methodology, use of after-market parts, use of consumer reports (such as credit reports) in underwriting and related notice requirements under the federal Fair Credit Reporting Act, charging betterment in first party physical damage claims, the adjusting of personal injury protection and medical
7
payment claims, the use of preferred provider rates for payment of personal injury protection claims, the use of automated database vendors to assist in evaluating certain first party bodily injury claims, and cases challenging other aspects of the Company’s claims and marketing practices and business operations.
The Company plans to contest the outstanding suits vigorously, but may pursue settlement negotiations in appropriate cases. In accordance with accounting principles generally accepted in the United States (GAAP), the Company has established accruals for lawsuits as to which the Company has determined that it is probable that a loss has been incurred and the Company can reasonably estimate its potential exposure. Pursuant to GAAP, the Company has not established reserves for those lawsuits where the loss is not probable and/or the Company is currently unable to estimate the potential exposure. If any one or more of these lawsuits results in a judgment against or settlement by the Company in an amount that is significantly in excess of the reserve established for such lawsuit (if any), the resulting liability could have a material effect on the Company’s financial condition, cash flows and results of operations.
For a further discussion on the Company’s pending litigation, see Item 3-Legal Proceedings in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.
Note 9 New Accounting Standards — On April 15, 2005, the Securities and Exchange Commission issued an amendment to Rule 4-01(a) of Regulation S-X, which became effective April 21, 2005, regarding the compliance date for SFAS 123 (revised 2004), “Share-Based Payment.” Pursuant to the amendment, companies are not required to prepare financial statements in accordance with SFAS 123R until the first quarter of the first fiscal year beginning after June 15, 2005, although earlier compliance is permitted. The Company plans to adopt SFAS 123R on January 1, 2006, and, as a result, estimates that net income will be reduced by approximately $.9 million in 2006. The Company will not incur any additional expense relating to currently outstanding stock options in years subsequent to 2006, since the latest vesting date of stock options previously granted is January 1, 2007. The Company does not currently intend to issue additional stock options.
8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
OVERVIEW
For the first quarter 2005, The Progressive Corporation and subsidiaries (the “Company”) generated strong profitability in each business segment and experienced modest growth as expected. On a companywide basis, net premiums written increased 10% and the Company generated a combined ratio of 85.0 for the quarter. For the first quarter 2005, net income was $412.7 million, or $2.04 per share.
During the first quarter 2005, companywide policies in force growth remained strong at 12%. Policy life expectancy, which is one measure of retention, increased in each of the Company’s auto tiers, as compared to the prior quarter. In addition, the Company is experiencing a decrease in its premium per application on both new and renewal business, consistent with market pricing refinements in several states. The Company will continue to evaluate prudent tradeoffs of profit for growth and seek growth where it deems appropriate. The Company continues to take actions it believes will enhance its competitiveness and allow the Company to be ready for future growth if and when market conditions change.
The favorable underwriting margins in the first quarter benefited from 3.4 points of favorable reserve development. This favorable development reflects both actuarial adjustments, as well as other favorable development (e.g., claims settling for less than reserved). The Company is continuing to experience low accident frequency. In addition, the quality of the Company’s claims processes continues to rise.
The Company made no substantial changes in the allocation of its investment portfolio during the quarter. The Company’s investment portfolio produced a fully taxable equivalent total return of (.4)%, with negative total returns for the quarter in both fixed-income securities and common stocks. The Company continued to keep its credit quality high and exposure to interest rate risk low. At March 31, 2005, the fixed-income portfolio duration was 2.9 years with a weighted average credit quality of AA+.
FINANCIAL CONDITION
Capital Resources and
Liquidity
The Company has substantial capital resources and believes it has sufficient borrowing capacity and
other capital resources to support current and anticipated growth and satisfy scheduled debt and
interest payments. The Company’s existing debt covenants do not include any rating or credit
triggers.
Progressive’s insurance operations create liquidity by collecting and investing premiums from new and renewal business in advance of paying claims. For the three months ended March 31, 2005, operations generated a positive cash flow of $658.5 million. Operating cash flows decreased 27% from the first quarter last year, primarily reflecting a one-time IRS refund in the first quarter 2004 and timing differences associated with accrued expenses. During the first quarter 2005, the Company repurchased 1.9 million Common Shares at a total cost of $166.4 million (average cost of $87.47 per share).
Commitments and
Contingencies
The Company is currently constructing a data center in Colorado Springs, Colorado at an estimated
total cost of $67 million. Construction on this data center is expected to be completed in 2006.
In addition, the Company is converting a building purchased in Austin, Texas to a call center. The
project is scheduled to be completed in June 2005, at an estimated total cost of $40 million. The
Company is also currently pursuing the acquisition of additional land for future development to
support corporate operations near its current corporate headquarters with the intent to begin
construction in 2006. All such projects, including the additional service centers discussed below,
are or will be funded through operating cash flows.
The Company currently has in operation a total of 21 centers that provide concierge-level claims service, including one facility opened in May 2005, the first since the first quarter 2004. The Company has announced a significant
9
expansion of this service and is currently looking for additional sites. The Company expects to more than double the number of sites in the next two years, with a total of approximately 50 additional facilities opened over the next several years.
Off-Balance-Sheet Arrangements
Except for the open investment funding commitment and operating leases and service agreements
discussed in the notes to the financial statements in the Company’s Annual Report on Form 10-K for
the year ended December 31, 2004, the Company does not have any off-balance-sheet leverage.
Contractual Obligations
During the first quarter 2005, the Company’s contractual obligations have not changed materially
from those discussed in the Company’s Annual Report on Form 10-K for the year ended December 31,
2004.
RESULTS OF OPERATIONS
| Growth over prior year | ||
Net premiums written |
10% | |
Net premiums earned |
8% | |
Policies in force |
12% |
Companywide net premiums written represent the premiums generated from policies written during the period less any premiums ceded to reinsurers. Net premiums earned, which are a function of the premiums written in the current and prior periods, are being earned into income using a daily earnings convention.
The Company analyzes its growth by reviewing rate levels, new policies and customers, and the retention characteristics of its books of business. During the first quarter 2005, the Company filed 42 auto rate revisions in various states. The overall effect of these revisions was a slight decrease in rates for the year. The Company will continue to assess market conditions on a state-by-state basis, will consider rate reductions in states where it will be able to maintain an attractive combination of profit and growth while still maintaining service quality, and will seek selective rate increases where it is necessary to maintain rate adequacy. New business applications increased slightly in both the Company’s Personal Lines and Commercial Auto businesses for the quarter.
Customer retention is another factor that affects growth. One measure of improvement in customer retention is policy life expectancy (PLE), which is the estimate of the average length of time that a policy will remain in force before cancellation or non-renewal. The Company has seen slight increases in PLE for its auto business in both the Agency and Direct channels, as compared to the prior quarter. Another way to analyze retention is through customer relationship life expectancy (i.e., focusing on the customer rather than the policy in force). The Company is beginning to develop customer relationship life expectancy estimates for both new and renewal business at a detailed segment level under varying market conditions. With an increasing percentage of the Company’s premium coming from renewal business, increasing retention remains an area where the Company is continuing to focus its efforts.
10
Profitability
Profitability for the Company’s underwriting operations is defined by pretax underwriting profit, which is calculated as net premiums earned less losses and loss adjustment expenses, policy acquisition costs and other underwriting expenses. The Company also uses underwriting profit margin, which is underwriting profit expressed as a percent of net premiums earned, to analyze the Company’s results. For the three months ended March 31, the Company’s underwriting profitability measures were as follows:
| 2005 | 2004 | |||||||||||||||
| Underwriting Profit | Underwriting Profit | |||||||||||||||
| (millions) | $ | Margin | $ | Margin | ||||||||||||
Personal Lines — Agency |
$ | 279.8 | 14.2 | % | $ | 294.5 | 15.7 | % | ||||||||
Personal Lines — Direct |
132.2 | 13.6 | 138.7 | 16.0 | ||||||||||||
Total Personal Lines |
412.0 | 14.0 | 433.2 | 15.8 | ||||||||||||
Commercial Auto |
84.5 | 21.4 | 87.8 | 25.3 | ||||||||||||
Other-indemnity |
5.4 | NM | .2 | NM | ||||||||||||
Total underwriting operations |
$ | 501.9 | 15.0 | % | $ | 521.2 | 16.8 | % | ||||||||
Further underwriting results for the Company’s Personal Lines businesses, including its channel components, the Commercial Auto business and other-indemnity businesses, were as follows (details discussed below):
11
| THREE MONTHS ENDED MARCH 31, | ||||||||||||
| (dollars in millions) | 2005 | 2004 | Change | |||||||||
NET PREMIUMS WRITTEN |
||||||||||||
Personal Lines – Agency |
$ | 2,081.8 | $ | 1,957.1 | 6 | % | ||||||
Personal Lines – Direct |
1,081.0 | 937.9 | 15 | % | ||||||||
Total Personal Lines |
3,162.8 | 2,895.0 | 9 | % | ||||||||
Commercial Auto |
436.3 | 376.2 | 16 | % | ||||||||
Other-indemnity |
5.7 | 6.1 | (7 | )% | ||||||||
Total underwriting operations |
$ | 3,604.8 | $ | 3,277.3 | 10 | % | ||||||
NET PREMIUMS EARNED |
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