A few thoughts on Progressive
Geoff and Andrew did a podcast last week where they discussed all of Geoff’s picks when he wrote the Singular Diligence newsletter. One of those stocks was Progressive (ticker PGR). Progressive is primarily a personal auto insurer. The best thing you can do to familiarise yourself with the company is, obviously, to read Geoff’s report.
Progressive’s stock is a lot more expensive than it was when Geoff wrote his report, and it’s a lot more expensive than his appraisal of the company as well. But I really think that of all the stocks Geoff recommended, Progressive is one of the most interesting right now and one that would be of most benefit for members to look at.
There’s a few reasons for this. First, it seems clear to me (and it sounds like Geoff agrees) that the risk he identified relating to autonomous vehicles was overblown. I don’t mean this as a criticism. It was quite right to worry about that when Geoff was writing the report. But this post really isn’t about that. It’s about the second reason – customer retention.
Geoff pointed out that one of the key constraints Progressive faced was its customer retention, which is lower than peers such as GEICO, USAA and Allstate. So, even if Progressive acquires customers at a fast rate (and it does), its snowball is melting faster than those of its competitors. It can still grow, but obviously the higher rate of attrition is a serious limiting factor in its growth and its economics. The reasons for Progressive’s lower retention rate are complex but really boil down to (i) having more single, renting, young people in their customer base, (ii) not offering bundled insurance (i.e., offering only auto insurance, not home and other insurance) and (iii) attracting more high risk drivers as a percentage of their customer base. The impact of bundling is particularly significant. I’ve seen a report that industry wide retention rates are 83% where the policyholder only buys auto insurance, but 95% where auto and home insurance are bundled. This is clearly a huge difference from the insurer’s perspective.
Progressive has recently been posting very strong (20%+) rates of growth in premiums. Obviously a big part of that is strong rates of new customer acquisition (and we could probably talk a lot about how Progressive has restored growth in its agency business). But, it’s also in very large part due to increased customer retention. Progressive has made huge strides in increasing customer retention towards the levels of their peers. There are a few components to this, but one of the really big differences from when Geoff wrote about the company is that Progressive now offers home insurance and so can bundle home and auto. They are attracting more and more customers who buy both home and auto insurance from them – a customer group they refer to as “Robinsons” – and who have by far the highest retention rates. Progressive segment customers into four categories (which they call Sams, Dianes, Wrights and Robinsons, in ascending order of customer value). Policy growth is much stronger in the Robinsons segment, where Progressive was traditionally very underrepresented. And this is doing wonderful things for Progressive’s customer retention.
Annual retention rate is not a statistic that Progressive disclose. I’ve seen reports that indicate their retention rate historically was around 80%. Peers such as GEICO are at around 90% and Allstate and State Farm are even higher. Progressive do disclose the change in something they call “policy life expectancy”, which is an actuarial estimate of (as you might guess) how long they expect an average policy to remain in force. The last few years have seen consistent growth in policy life expectancy. It’s not clear to me exactly how that translates to annual retention rate. I’ve tried to estimate what a 10-20% increase in policy life expectancy means for the annual retention rate, and I come up with something like an increase of 2-3%. This estimate may be out by a bit. But clearly, the annual retention rate is increasing as Progressive’s customer base shifts to longer retaining customer segments. There’s a lot of room for it to continue to increase towards the retention rates of peers like GEICO and Allstate.
A really big part of this was an acquisition Progressive made in 2014. They bought a majority share in a company called ASI – a home insurance company based in Florida. This was, to my knowledge, the first (and still the only) acquisition Progressive has made. It definitely brings risks. First, home insurance is a much riskier product to sell than auto insurance. Progressive is already a company that has a lot of underwriting leverage so it cannot afford to seriously misprice the home insurance it writes. And secondly, Progressive has a really unique culture which is at risk if the company starts to make acquisitions.
I’m comfortable with these two risks. The underwriting risk is small at the moment because home insurance (while fast growing) is still small compared to the auto business. Obviously this could change over time if home insurance gets really big. The cultural risk is significantly mitigated by the cultural fit between ASI and Progressive and by the way Progressive made the acquisition (basically, in stages, and they were already a minority shareholder as well as a distributor of ASI’s insurance, so knew the target well). And there’s absolutely no doubt that this acquisition was a really key part of Progressive significantly upping its customer retention. It’s making a big difference to the company’s economics.
Progressive is really well placed for very strong growth over the medium term. On top of this, it will earn a lot more on its investment portfolio if we are heading into a higher interest rate environment. So, there are a number of factors all converging to make Progressive’s prospects look really, really good.
Progressive stock has performed very well over the last few years but to me it still seems cheap. It’s a company that is higher quality than average, as safe or safer than average, faster growing than average and cheaper than average. It really isn’t often you can say that