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Morningstar | Signs of Mean Reversion in Progressive’s Second Quarter

Progressive has been playing with a hot hand recently, as strong pricing increases buoyed underwriting profitability, and the ability to bundle homeowners insurance has spurred growth in the agent channel. As a result, profitability and growth have been above the company’s historical range, with trailing 12-month ROE at a very impressive 28%. We think the franchise has a narrow moat and is well managed, but we also believe that mean reversion is inevitable for Progressive and that the current stock price doesn’t fully reflect this eventuality. While results stayed strong in the second quarter, there were some signs that this mean reversion is coming, and we will maintain our $57 fair value estimate.

Growth in the quarter was impressive but has started to tick down. Total personal auto policies in force were up 12% year over year, and growth in the agent channel remains good at 11%. However, it is notable, in our view, that policies in force growth has slowed steadily over the past four quarters, suggesting the boost Progressive received from its entrance into homeowners insurance and the resulting ability to bundle has started to ebb. The agent channel overall is a low growth channel, and we think there is a limit to how much share Progressive can ultimately take.

On the profitability front, underwriting results remain quite strong in an absolute sense, with the combined ratio in personal auto coming in at 89.7% for the quarter, compared with 91.3% last year. However, the combined ratio ticked up a bit sequentially, and, on a month-to-month basis, the combined ratio deteriorated throughout the quarter, with the June result coming in at 92.0%. Further, while pricing increases have been fading over the past year, it looks like they fully flattened this quarter. We think it is just a matter of time until this results in the combined ratio moving back in line with the company’s historical range.