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Morningstar | Progressive Is Firing on All Cylinders, but We Expect Some Mean Reversion

Progressive is one of the strongest franchises in the insurance industry, and it is currently firing on all cylinders. The auto industry had seen an uptick in costs in previous years, as a multitude of factors ranging from low gas prices to distracted driving pushed up claims. This compressed industry underwriting margins, but Progressive and the industry have executed a more than sufficient pricing response. Progressive has fully moved past the issue, and underwriting margins are now at the low end of its historical range. However, we view this as a cyclical phenomenon and expect mean reversion over time.Progressive is also currently benefiting from an aggressive move to expand its reach, having acquired homeowners insurance operator ARX in 2015. We're skeptical that the homeowners business will match the returns on Progressive's legacy business and believe that it potentially introduces greater volatility. But the ability to bundle homeowners and auto has allowed Progressive to broaden its demographic reach and increase its penetration among relatively affluent customers. This has reignited growth in its historically dormant agent channel and makes this expansion value-creative overall, in our view.Progressive also has a factor working in its favor in the longer term. It has continually pioneered ways to reach customers and segment their individual risks. Its most recent innovation is the Snapshot Discount, which monitors an insured person's driving behavior through a wireless device and exponentially increases the data available to Progressive to evaluate its customers' driving habits. Snapshot creates the possibility of usage-based auto insurance via telematics, which has the potential to meaningfully change the industry. Progressive will be able to better identify its safest customers and make them more sticky by offering discounts, while higher-risk customers are charged an appropriate premium. While a number of competitors have followed its lead, we think Progressive's early entry could allow it to lock up a disproportionate number of safe drivers.