MILEW - Baron Fintech Fund - Progressive Corp.: Rising Interest Rates A Financial Tailwind

• We initiated a position in The Progressive Corporation, the third-largest auto insurer in the U.S. and a top-15 homeowners insurance carrier.
• The personal auto insurance market is approximately $250 billion in size and is recession-resistant given that auto insurance is legally required for drivers in almost every state.
• Rising interest rates provide PGR a financial tailwind from higher interest income on the company’s nearly $50 billion fixed income portfolio, with each 1% rise in interest rates adding an estimated 11% to earnings.

The following segment was excerpted from this fund letter .

The Progressive Corporation ( PGR )

We initiated a position in The Progressive Corporation , the third-largest auto insurer in the U.S. and a top-15 homeowners insurance carrier. After having followed the company for years, we believe Progressive is a best-in-class insurer that should continue gaining market share in a fragmented industry.

Progressive has 14% share of the U.S. personal auto insurance market, up from 8% ten years ago, while achieving industry leading profitability. The company has a long track record of superior underwriting, which was honed by its early focus on the non-standard market for risky drivers that most carriers avoid. In contrast to its less profitable competitors, Progressive has a long-standing commitment to earn a combined ratio of 96% or better, with this margin target forming a key part of incentive compensation for most employees.

This underwriting know-how and discipline have helped Progressive consistently gain market share through industry pricing cycles when peers sacrifice growth to mitigate losses. In addition, Progressive’s strategy of selling direct to consumers has helped it reduce costs and gain share as consumers increasingly choose to purchase insurance by themselves rather than through brokers. Progressive is run by an experienced management team, most of whom have spent decades at the company (e.g., CEO Tricia Griffith joined Progressive in 1988 as a claim rep).

Throughout its history, Progressive has relied heavily on technology, data, and analytics to operate more efficiently and price risk more accurately. For example, the company was the first to use credit scores in its underwriting algorithms and has developed a substantial amount of know-how from over 20 years of experience with usage-based insurance and analyzing the data from 43 billion driving miles derived from telematics devices. Progressive continues to use data and technology to test new variables, better segment its customers, and update its rates more frequently than competitors.

Selling policies direct to customers online instead of through the traditional agent model is another way in which Progressive has used technology to its advantage. Back in 2020 when we were researching insure-tech start-ups Root ( ROOT ) and Metromile ( MILEW ), the management teams of those companies touted their superior underwriting models based on proprietary telematics data. However, we subsequently learned from their regulatory rate filings that most of their original product designs and rates were copied directly from Progressive.

While we didn’t invest in Root or Metromile, our research into those companies gave us a greater appreciation for Progressive’s market leadership and competitive advantages. The personal auto insurance market is approximately $250 billion in size and is recession-resistant given that auto insurance is legally required for drivers in almost every state. The industry is currently experiencing a hard market wherein carriers are raising prices and cutting back on marketing to offset higher losses from more frequent and costly accidents.

Progressive has historically performed well during times like this because it’s usually among the first to recognize mounting loss pressures and take corrective underwriting actions, resulting in faster margin improvement and an earlier return to customer acquisition while competitors are still retrenching and raising prices. Rising interest rates provide a financial tailwind from higher interest income on the company’s nearly $50 billion fixed income portfolio, with each 1% rise in interest rates adding an estimated 11% to earnings.

We believe that Progressive will continue gaining market share and growing earnings at a double-digit rate for many years to come.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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