Progressive Slides to Underperform

We are downgrading Progressive Corp. (PGR - Analyst Report) to Underperform from Neutral as the company continues to deliver lower net investment income and incur higher expenses.

Progressive’s first quarter earnings surpassed the Zacks Consensus Estimate by three cents but fell below the year-ago quarter. Lower net investment gains and higher expenses resulted in lower numbers during the quarter.

Despite lowering its combined ratios in the past few years, Progressive has started reporting a higher combined ratio. It deteriorated 380 basis points over the prior-year quarter to 94.1% in the reported quarter. The combined ratio represents the percentage of premiums paid out as claims and expenses and is a primary measure of underwriting profitability. A higher combined ratio thus concerns the company’s profitability.

We expect underwriting margins to remain volatile, considering the loss cost trends and the stressed macro environment. It further dipped to 5.9% in the first quarter of 2012, largely due to unfavorable loss reserve development. However, it exceeded the company’s long-term target of 4%.

Also, growth remains a challenge at Progressive’s Commercial Auto businesses (growing a meager 1% in the first quarter). A stressed economy and elevated levels of unemployment are expected to persist for a while, thus pressurizing growth.

Counting on the positives, Progressive scores strongly with the credit rating agencies. Fitch Ratings reiterated the Issuer Default Rating of 'A+', Senior debt ratings of 'A' and Junior subordinated debt of 'BBB+' for the company. The credit rating agency also reaffirmed the Insurer Financial Strength (“IFS”) rating of 'AA' on Progressive’s subsidiaries. The outlook is stable. We believe, the company’s strong ratings scores will help retain investor confidence and augment its business going forward.

Management continues to focus on customer retention. The policy life expectancy, a customer retention measure, for its Agency auto business increased by 6%. The company has several initiatives underway aimed at providing consumers with distinctive new auto insurance options.

Progressive’s net premiums written in the first quarter grew 7% with policies in force reporting growth of 6%. New businesses, higher premium per policy and customer retention aided the company to report better results. Business at Agency improved 1% while at Direct Personal Lines it increased slightly with Commercial Auto business delivering a growth of 10%.

The quantitative Zacks #5 Rank (short term Strong Sell rating) for the company indicates downward pressure on the stock over the near term. The company competes with The Allstate Corporation (ALL - Analyst Report).