Examining Progressive’s Competitive Position

The Progressive Corporation has offered insurance products to consumers since 1937 and is currently estimated to be the fourth largest private passenger automobile insurer in the United States.  Progressive trails State Farm, GEICO, and Allstate and has overall market share of approximately nine percent. The private passenger auto insurance market is highly concentrated with the top four competitors accounting for nearly half of premium volume.  Despite the concentrated market share, competition has become increasingly fierce and transparent due to readily available online pricing. This article takes a brief look at Progressive’s position within the overall auto insurance market.

Market Share Trends

Although Progressive has recently diversified into other types of property insurance with its acquisition of ARX, the vast majority of premium volume is still derived from auto insurance.  GEICO, a subsidiary of Berkshire Hathaway, has long been Progressive’s most aggressive competitor.  Both Progressive and GEICO have gained market share over the past five years with GEICO overtaking Allstate as the second largest auto insurer.  The exhibit below shows data for the top four auto insurers compiled by the National Association of Insurance Commissioners for 2010 and 2015.  We can see that State Farm and Allstate have grown roughly in line with the overall auto insurance market with GEICO and Progressive picking up market share at the expense of smaller players.

NAIC 2010 vs 2015 Market Share

Taking a longer view specific to Progressive, we can see from the exhibit below that the company has increased its market share dramatically over the past two decades rising from 1.5 percent in 1993 to 8.8 percent in 2015.  During this period, the overall market for auto insurance has grown at a relatively subdued pace so the bulk of Progressive’s success has come from taking market share from its competitors.  The data contained in the exhibit were reported in Progressive’s 10-K reports for each year.

Progressive's Market Share 1993-2015

The Direct Channel

Why has Progressive been able to gain market share over the years?  Auto insurance is a product that nearly all drivers in the United States are legally required to purchase.  However, it is a cost that hardly anyone feels good about incurring, at least until a claim is made.  As a result, consumers can be very price sensitive when shopping for insurance.  In the past, most consumers obtained insurance quotes through independent agents and gathering competitive pricing data was time consuming.  A true apples-to-apples comparison for auto insurance must keep all variables, such as the deductible amount, constant when looking at the offerings of various insurers.  The level of service provided in the event of claims is a factor that insurers use to try to differentiate their products, but most consumers still shop based on price.

Progressive’s premium growth in recent years has been driven by the direct channel.  In 2015, 47 percent of total personal lines premium volume was attributed to the direct channel with the remainder coming from agencies.  In 2005, only 34 percent of total personal lines premium volume came from the direct channel.  During this period, the agency channel had annualized compound premium growth of only 1.3 percent while the direct channel’s premium growth rate was 7.2 percent.  The exhibit below presents the revenue breakdown for Progressive from 2005 to 2015 and illustrates the importance of growth in the direct channel (figures in millions; click on the image for a larger view).

Progressive's Revenue 2005-15

Progressive has been able to grow direct volume with consistent profitability with the combined ratio for the channel achieving an average over this period of 92.4 compared to 92.8 for the agency channel, which is roughly equivalent.  The exhibit below shows Progressive’s combined ratio for each segment as well as the overall total.  We can see that Progressive has demonstrated a long record of consistent underwriting profitability over time (click on the image for a larger view).

Progressive Combined Ratio 2005-15

Competing With GEICO

A closer reading of the market share data above indicates that one must consider GEICO to be Progressive’s most important competitor.  GEICO has grown at a more rapid pace than Progressive in recent years and has surpassed Allstate to become the second largest auto insurer in the United States.  Berkshire Hathaway has been particularly aggressive when it comes to marketing and the direct channel approach has given GEICO a competitive cost advantage that has allowed for aggressive marketing.  The exhibit below compares important statistics for GEICO and Progressive over the past seventeen years.

GEICO vs Progressive 1999-2015

 

We can see that GEICO generally runs at a higher loss ratio and at a lower expense ratio compared to Progressive.  In most years, GEICO operates at a combined ratio that is somewhat higher than Progressive because the higher loss ratio is not usually fully offset by the expense ratio advantage.  From reading Berkshire Hathaway annual reports over a long period of time, one can conclude that GEICO has a philosophy of very aggressive marketing in order to build share over time.  This is reflected in the higher expense ratio.  The marketing exposure, coupled with GEICO’s apparent willingness to accept a higher overall combined ratio has resulted in rapid growth.

Conclusion

Warren Buffett observed in his 2015 letter to Berkshire Hathaway shareholders that State Farm is still far ahead of GEICO in auto insurance market share but that GEICO is gaining ground.  This has certainly been the case over the past five years, as shown in the market share data above.  Mr. Buffett went on to say that he hopes to announce that GEICO has taken the top spot by 2030, his 100th birthday.  This might have been meant as a bit of humor but the reality is that GEICO has proven to be a formidable competitor and could very well dominate the auto insurance market fifteen to twenty years from now.

What does this mean for Progressive?  Obviously, GEICO is a formidable competitor and has achieved greater market share gains than Progressive in recent years, but this has come at the cost of lower aggregate underwriting profits over time as GEICO invests in heavy marketing to build brand awareness.  GEICO has the advantage of having its policyholder float invested more aggressively than Progressive.  Mr. Buffett and his top investment managers have skillfully managed policyholder float for decades.  Although Berkshire manages insurance underwriting and investing separately, the greater utilization of float could very well make the economics of accepting lower underwriting profits in exchange for higher growth more palatable.

Progressive has a more conservative investing philosophy with only a small equity portfolio that is mostly tied to an unmanaged index.  As a result, Progressive’s management may be more inclined to manage the company for greater underwriting profitability than GEICO.  This has certainly been the case in recent years.  Because Progressive is at a disadvantage compared to GEICO when it comes to expenses, maintaining higher underwriting profits is likely to come at the expense of slower growth.  Progressive could very well continue to grow at a rapid clip over time while GEICO grows even more quickly.  In fact, this seems like the most likely outcome over the next decade.

Disclosure:  Individuals associated with The Rational Walk LLC own shares of Berkshire Hathaway.  No position in Progressive.

What Does Buffett’s Valuation of GEICO Imply for Progressive?

Note to Readers:  On March 1, 2011, The Rational Walk published a comprehensive report, Berkshire Hathaway: In Search of the Buffett Premium, which examines the intrinsic value of Berkshire in great detail.  Order the report for immediate electronic delivery, or download our free 22 page sample (pdf) — there is no registration required for the sample.

Warren Buffett provided an unusual level of insight into his views regarding Berkshire Hathaway’s intrinsic value in his latest letter to shareholders which we discussed in more detail when it was released last week.  While Mr. Buffett gave us his views of Berkshire’s normalized earnings power along with several other guideposts to his thinking on Berkshire’s intrinsic value, he did not present a specific estimate.  However, he came extremely close to doing so in the case of GEICO.  In this article, we will take a look at Mr. Buffett’s comments on GEICO and potential implications for the intrinsic value of Progressive, GEICO’s most fierce competitor.

Examining GEICO’s Economic Goodwill

Mr. Buffett’s letter describes his personal experience with GEICO over the past sixty years as well as the terms of Berkshire’s investments in the company.  In 1996, Berkshire purchased the 50 percent of GEICO that it did not already own for $2.3 billion implying a value of $4.6 billion for 100 percent of GEICO.  At that time, GEICO had tangible net worth of $1.9 billion which means that Berkshire valued GEICO’s goodwill at $2.7 billion.  Berkshire effectively paid 2.4 times tangible book value which was considered a high valuation at the time.

In the letter, Mr. Buffett elaborates on how he thought about the $2.7 billion of goodwill at GEICO in 1996 and how he views GEICO’s goodwill today:

The excess over tangible net worth of the implied value – $2.7 billion – was what we estimated GEICO’s “goodwill” to be worth at that time. That goodwill represented the economic value of the policyholders who were then doing business with GEICO. In 1995, those customers had paid the company $2.8 billion in premiums. Consequently, we were valuing GEICO’s customers at about 97% (2.7/2.8) of what they were annually paying the company. By industry standards, that was a very high price. But GEICO was no ordinary insurer: Because of the company’s low costs, its policyholders were consistently profitable and unusually loyal.

Today, premium volume is $14.3 billion and growing. Yet we carry the goodwill of GEICO on our books at only $1.4 billion, an amount that will remain unchanged no matter how much the value of GEICO increases. (Under accounting rules, you write down the carrying value of goodwill if its economic value decreases, but leave it unchanged if economic value increases.) Using the 97%-of-premium-volume yardstick we applied to our 1996 purchase, the real value today of GEICO’s economic goodwill is about $14 billion. And this value is likely to be much higher ten and twenty years from now. GEICO – off to a strong start in 2011 – is the gift that keeps giving.

Although a careful parsing of the statement shows that Mr. Buffett does not explicitly state that GEICO’s economic goodwill is $14 billion, it is strongly implied that using the “97%-of-premium-volume yardstick” is just as appropriate today as it was in 1996 when Berkshire acquired full control of GEICO.  Some analysts may question whether this is the case given that GEICO today has a much higher market share than it had in 1996 and presumably growth prospects from today’s levels might be slower.

Implied Value of GEICO:  $20.5 Billion

We do not have individual balance sheets for all of Berkshire’s insurance subsidiaries but GEICO publishes selected financial information based on statutory accounting rules, which generally presents a more conservative picture of a company’s net worth when compared to GAAP accounting.  According to data on GEICO’s website, policyholders’ surplus was approximately $6.5 billion as of December 31, 2010.  The policyholders’ surplus figure should be free of intangibles at this point (see this report for some information on statutory accounting and goodwill).  Therefore, if GEICO’s goodwill is worth $14 billion, it follows that the company as a whole is worth approximately $20.5 billion based on Mr. Buffett’s valuation methodology.

Implications for Progressive

We have periodically followed Progressive on The Rational Walk mainly because of the fierce competition between GEICO and Progressive but also because the companies are so similar in terms of performance over the years.  If Mr. Buffett loves GEICO, it is quite likely that he also admires Progressive’s performance.  In The Rational Walk’s recent report on Berkshire, In Search of the Buffett Premium, we include an appendix comparing GEICO and Progressive.  The following exhibit is taken from the report:

The similarities between the companies are striking particularly when viewed from the perspective of very consistent underwriting profits over the past decade.  Over the 1999 to 2010 period, GEICO grew premiums earned at a 10.5 percent rate while Progressive grew premiums at a 8.8 percent rate.  The average combined ratio was 93.6 for GEICO and 92.3 for Progressive.  In general, GEICO posted lower expense ratios while Progressive posted lower loss ratios in most years.  In 2010, earned premiums were very similar for GEICO and Progressive and underwriting results were almost identical.

We have not performed a thorough valuation of Progressive, but it does not seem too far of a stretch to consider the implications of Mr. Buffett’s views on GEICO’s intrinsic value on Progressive given the similarities between the two companies.

As of December 31, 2010, Progressive had tangible equity (based on GAAP) of $6,049 million.  If we use the “97%-of-premium-volume yardstick” to estimate Progressive’s economic goodwill, this results in a goodwill estimate of $13,886 million.  The total intrinsic value estimate would be $19.9 billion, or slightly over $30 per share.  Progressive’s market capitalization as of Friday, March 4 was $13.78 billion, or $20.88 per share.

Jumping to Conclusions?

Are we safe in assuming that Mr. Buffett would value Progressive in the same manner as he values GEICO?  Possibly not since he could believe that GEICO has important advantages over Progressive that will result in a higher level of growth going forward.  Past history would suggest that GEICO appears to be able to grow at a somewhat higher rate than Progressive while also maintaining excellent combined ratios.  Perhaps this is due to important competitive advantages emanating from a higher level of goodwill at GEICO compared to Progressive.

However, we can also look at Progressive’s valuation from another perspective.  Using the market value of $13.78 billion, implied economic goodwill assigned by the market is currently $7.73 billion.  As a percentage of last year’s earned premiums, economic goodwill is currently at a “54%-of-premium-volume yardstick” as compared to the “97%-of-premium-volume yardstick” that Mr. Buffett used in 1996 to value GEICO and appeared  to endorse as being equally relevant today.  It would appear that Progressive’s  track record is strong enough to justify a higher valuation if we use Mr. Buffett’s methodology even if Progressive’s position is not quite as strong as GEICO’s.

We should stress that a $19.9 billion valuation for Progressive would be quite aggressive at nearly 3.3 times tangible book value.  In addition, we are not stating that Progressive is worth $19.9 billion at this time, having not performed sufficient due diligence on the company to make such an assertion.  Instead, we are simply making the observation that Warren Buffett’s valuation of GEICO seems to imply that he would regard Progressive as undervalued if he views Progressive and GEICO as having similar economic characteristics.  Of course, he never made any such statement.  But the inference is, at the very least, interesting and warrants further study of Progressive.

Disclosure:  Long Berkshire, No Position in Progressive.

J.D. Power Releases Auto Insurance Customer Satisfaction Survey

The criteria for selecting an auto insurer involves some of the same factors one must consider when selecting a dentist.  It may be very tempting to go with the low bid when selecting a dentist to clean your teeth, but that may not be the best decision when facing a root canal.  Similarly, buying auto insurance is normally a decision based entirely on the premium cost until an accident makes it necessary to file a claim.  Only then will a policyholder know if a discounted insurance policy was a wise decision.

J.D. Power released its 2010 U.S. National Auto Insurance Study (pdf) today and found that overall consumer satisfaction with insurance companies declined in 2010 after peaking in 2009.  Overall satisfaction averages 777 on a 1,000 point scale which represents a decrease of ten points from 2009.  The study measures consumer satisfaction across five factors:  interaction, policy offerings, billing and payment, price, and claims.  The main factor that led to the 2010 decline in satisfaction was due to price increases, which were reported by 22 percent of customers.

According to the survey, Berkshire Hathaway’s GEICO subsidiary ranked #6 with a score of 793.  Progressive, GEICO’s most aggressive rival, ranked #13 at 775, just slightly below the average ranking.  J.D. Power provides a sortable table that shows which insurers rank the highest for each of the five factors considered in the survey.  The highest ranked insurer was Amica Mutual with a score of 849.

Auto insurance is a non-discretionary purchase that all drivers are legally required to make and price is always going to be a key factor.  However, the survey also revealed that service and the ability to talk to an agent can be important considerations for baby boomers.  Older drivers may prefer the traditional agent relationship offered by insurers such as State Farm while younger drivers tend to be more comfortable with insurers emphasizing a heavy internet presence and a direct sales model such as GEICO and Progressive. Of course, the key test for policyholders who end up in an accident is the quality of the claims process – the equivalent of a botched root canal for drivers who select the wrong insurer.

Disclosure:  The author of this article owns shares of Berkshire Hathaway.