Progressive Corporation (The)

Good morning and thank you for joining us today for Progressive's second quarter investor event. I am Doug Constantine, Director of Investor Relations, and I will be moderator for today's event. The company will not make detailed comments related to its results in addition to those provided in its annual report on Form 10-K, quarterly reports on Form 10-Q, and the letter to shareholders, which have been posted to the company's website. This quarter includes a presentation on a specific portion of our business, followed by a question and answer session with members of our leadership team. The introductory comments by our CEO and the presentation were previously recorded. Upon completion of the previously recorded remarks, we will use the balance of the 90 minutes scheduled for this event for live questions and answers with leaders featured in our recorded remarks, as well as other members of our management team. As always, discussions in this event may include forward-looking statements. These statements are based on management's current expectations and are subject to many risks and uncertainties that can cause actual events and results to differ materially from those discussed during today's event. Additional information concerning those risks and uncertainties is available in our annual report on Form 10-K for the year ended December 31, 2022, as supplemented by our 10-Q reports for the first and second quarters of 2023, where you will find discussions of the risk factors affecting our businesses, safe harbor statements related to forward-looking statements, and other discussions of the challenges we face. These documents can be found via the Investor Relations section of our website at investors.progressive.com. To begin today, I am pleased to introduce our CEO, Tricia Griffith, who will kick us off with some introductory comments. Tricia?

Good morning, and thank you for joining us today. I usually begin these calls by extolling the commitment of Progressive's people and expressing my pride in the results they deliver. And this quarter will be no different. In the face of extraordinary pressure on the industry, our people continue to take the actions necessary to succeed in this difficult environment. While our results through the first half of 2023 fell well short of our 96 combined ratio target, I continue to believe in our people and our strategy. I believe we have assembled a progressive team of nearly 59,000 employees that's best in class. I have no doubt that we're continuing to lay the groundwork to ensure that our best days are ahead of us. We continue to manage to this calendar year target, maintaining the discipline that has allowed us to grow in the past with better profitability than the industry. At the same time, we will be pragmatic in our approach to growth and remain cognizant of long-term value, which we continue to believe is served well by balancing growth and profitability. We spent much of the first quarter call talking about actions we would be taking to address our calendar year profitability pressure, and those actions continue. In quarter two, we took seven points in personal auto, which puts our year-to-date rate take at just over 11%, and assuming regulatory approval, we plan to take approximately six additional points during the remainder of the year as we adjust rates to match loss trend. During last quarter's call, we also said that we would reduce our media spend, resulting in our quarter two direct expense ratio being amongst the lowest in recent history. These actions have had the expected effect on growth, with new app growth slower in the second quarter as compared to the first, and PIF growth, while still robust, slowing from highs we saw in prior months. Calendar year profitability continues to be a challenge, so with the calendar year 96 goal in mind, we will continue to evaluate the rate and non-rate actions we may need to take. Catastrophe losses were a significant part of our profitability pressures. To date, 2023 has been a significant catastrophic year, with some estimates suggesting that U.S. insured losses have already surpassed $25 billion this year. The events this year have been broadly felt, with 44 states affected by 43 events. At the company level, these events have added 4.5 points to our combined ratio year-to-date, which is 1.7 points higher than the impact catastrophe events had on our combined ratio for the first half of 2022. Our property business has been most affected by catastrophes, adding almost 46 points to the property loss ratio so far this year, which is about 16 points more when compared to this time in 2022. Historically, we have been among the best in the industry in reserve accuracy, with reserve changes contributing little to our calendar year combined ratio. We've advanced the science of reserving and employ a team of highly experienced individuals to support our goal of being as accurate as possible with our reserves. Accurate reserves help us to price more accurately and give us confidence to grow as fast as we have over the last decade. Having said that, the difficult environment of 2023 has presented challenges for our reserving practices. Through the end of the second quarter, prior year adverse development has contributed four points to our combined ratio and current accident year actuarial adjustments have contributed another 1.5 points. The majority of personal lines adverse development can be placed into two categories, Florida and fixing vehicle coverages. Florida's prior year adverse development accounts for just over 40% of the four points of prior year development. While we continue to be optimistic that March's new legislation will result in lower loss costs over time, the short-term effect has been a significant increase in attorney representation, largely in medical coverages. Our data has matured each month since the bill passed, which has allowed us to continue to fine-tune reserving in the face of changes to Florida's ultimate loss costs. In fixing vehicle coverages, unforeseen severity trend steepening on previously closed claims continues to be the major driver of prior year adverse development countrywide. The contributors to the steeper trends come from a variety of sources, including longer vehicle repair times, longer rental times, higher parts prices and labor rates, and changes in subrogation trends. Fixing vehicle coverages are short-tailed, which explains why over 80% of the total year-to-date prior year development is from the 2022 accident year. In fact, excluding Florida, accident years prior to 2022 have developed favorably. Our current year actuarial adjustments are primarily due to fixing vehicle coverages. Since fixing vehicle coverages are short-tailed, most of the claims that are affected by emerging trends have happened in the recent past. As we have moved deeper into the year, the new, steeper trends in fixing vehicle coverages have increasingly affected claims that occurred in the current accident year. Florida litigation has been a relatively small part of current year actuarial adjustments since the increase in attorney representation rates largely affected claims that occurred before March of 2023. We continue to monitor loss trends across all states and coverages and will adjust if necessary to ensure we're always adequately reserved. While both reserving and pricing have been a challenge this year, I have great confidence in the teams and our strategies, which have delivered results better than the industry for a very long time. To showcase these skill sets, this morning we have two senior leaders to speak to these two topics for our presentation. First, Gary Trakoff, our corporate actuary business leader and head of our reserving group, will discuss reserving practices at Progressive and how we endeavor to accurately set and adjust reserves. Gary is a 28-year Progressive veteran and has led our reserving group for almost 11 of those years. After Gary, Jim Curtis, our personal lines controller, will discuss cohort pricing. Cohort pricing is our term for managing to both our calendar year and lifetime 96 target, when new business and renewal business have different expense and loss characteristics. Jim has been with Progressive for 28 years and in his current role for four. Again, thank you for joining us this morning. I will now pass you to Gary.

Gary? Thank you, Tricia, and good morning, everyone. I'm excited to talk to you today about loss reserving at Progressive. I will first cover some key definitions and metrics in our general process, then walk through an example on how our overall reserve levels are determined, and finally, walk through an example of the reserving life cycle of an individual claim and how it would flow through the actuarial categories of the earnings release. Let's start off with the size of our Loss and Loss Adjustment Expense, or LAE, reserves. The columns represent our carried reserve balance at the end of each calendar year from 2013 through 2022 and at June 30, 2023 for the rightmost column. On the left side of the graph, we can see that in 2013, Progressive had about $8.5 billion in reserves on a gross of reinsurance basis at year-end 2013. This would be the sum of the orange and blue sections within the bar. With our growth as a company, reserves before reinsurance as of June 30, 2023, is now almost $33 billion, and almost four times greater than what it was in 2013, while our premium growth was a little less than $1. three times greater over this same time period. Much of this difference in reserves outpacing premium growth relates to our growth in longer-tailed products and commercial lines over this period. This means that we believe for all accidents that have occurred through June 30th of 2023, our ultimate future liabilities will be almost $33 billion. The orange section of the bars represent how much of our reserves are seeded for reinsurance. Some examples of this include state-regulated plans such as Michigan Catastrophic Claims Association and the Florida Hurricane Cat Fund and private reinsurers. Our seeded reserves now make up about 16% of our gross reserves versus just over 12% in 2013. Much of this increase in the higher proportion of seeded reserves relates to newer products that have been added over time, including property and protective, which have more reinsurance needs than our historical products. The blue section of the columns represent how much of our reserves are retained after reinsurance, almost $28 billion as of June 30th of 2023. Next, let's look at some metrics and how our reserves are distributed. The chart on the left shows that 67% of our net reserves are in loss case, 17% loss IBNR, and the remainder under LAE. Any open claim will be assigned a case reserve that may be set by a claims adjuster or an actuarially derived estimate set by the actuarial team. We will discuss this in more detail in a future slide. IBNR, which stands for incurred but not reported, makes up about 17% of our net reserves. IBNR may have different meanings across companies. For most of Progressive's products, one can think of IBNR as the future liabilities to cover claims that have already happened and are currently not recorded as open case reserves. This would include late reports, reopens, and salvage and subrogation recoveries. Anticipated salvage and subrogation recoveries can be thought of as a contra-reserve and as a reduction to future liabilities. For most of our products, IB&R does not cover any anticipated development in case reserves. This is because, since our case reserves are a combination of adjuster estimates and actuarially set case reserves, for the majority of our products, our IBNR reserve does not cover expected case development. LAE reserves make up the remaining 16% and typically cover the anticipated expenses needed to settle claims that have already happened, such as defense counsel costs and claims adjuster salaries. The middle chart shows the distribution of our reserves by product. As expected, reserves will index more to longer-tailed products with higher limits relative to premium size. Thus, our commercial lines business makes up almost one-third of our total reserves, but a smaller proportion of premium. The graph on the right shows that in personal auto, 83% of our reserves are set to cover injury and medical costs and 17% to cover the cost to fix vehicles. Again, this is due to the longer tail nature and higher severity costs to injury and medical coverages versus fixing vehicle coverages. And reserves are over indexed to injury and medical relative to premium. In addition, fixing vehicle coverages have a higher proportion of contra-reserves from salvage and subrogation compared to injury and medical. One additional point, this data is as of year-end 2022 and is on a net of reinsurance basis. While the previous slide gave a high-level overview of the distribution of our reserve mix by various parts, we review the reserves at a much more granular level. We typically review reserves by some combination of product, geographic area such as group of states, individual states, and even down to a region or subset within a state. Further breakouts typically include individual line coverages such as bodily injury, uninsured motorist bodily injury, and property damage, and even by limit. To determine these breakouts, we weigh the credibility of the data, homogeneity in the data, and additional value of segmenting the data at a finer level. For example, in personal auto bodily injury, almost all states are reviewed separately, with the majority of states reviewed quarterly. State-level data is credible and many states have different development patterns which warrant the data to be reviewed separately. In personal auto collision, while state-level data is credible, many states exhibit similar data patterns and several clusters of states are reviewed together. About 25% to 30% of our reserves are reviewed at this in-depth level monthly, and about 85% of our reserves quarterly. About 700 reviews, which is some combination of product, state, line, et cetera, are reviewed over the course of the year. By reviewing reserves at this detailed level, we are able to adjust reserves more accurately at a granular level, which helps our pricing teams better match price to risk. We also have a robust roll-forward process that we will discuss later on, which allows up to 100% of the reserves to be adjusted monthly. The roll-forward process allows us the time to do a deep analysis on a portion of the reserves monthly, while still feeling comfortable that all of our reserves are being updated monthly. Here is an example of how an in-depth review schedule would look over three months. In the first month of the quarter, 57 reserve reviews were completed. Each reserve review is either a loss or LAE review, which is further broken down between defense cost containment, or DCC, and adjusting and other expenses, or ANO. Some combination of product, such as personal auto, CL, or one of our core commercial auto products, or T&C, which represents transportation network companies, line coverages such as bodily injury and some combination of state is reviewed. These 57 reviews would make up about 25 to 30 percent of our total reserves. In the following month, 60 reviews were completed. Again, there is some combination of type, product, coverage, and state, but all 60 reviews are independent of reviews completed during the first month and represent another 25 to 30 percent of our total reserves. Finally, the third month of the quarter had 68 reviews completed, which are all different from any reviews completed during the previous two months and represent an additional 25 to 30 percent of the total reserves. Over the course of the quarter, about 85 percent of the reserves were reviewed. Typically, between 50 to 70 reviews are completed per month. Now let's talk about how the overall reserve level is determined. We use several different methods. One of the methods that we use is called the accident period chain ladder method in a standard industry practice. In the example above, each row represents a six-month period when the accident occurred, and each column represents how much in paid losses had been paid out for those accidents at certain time periods after the accident. For example, the top row represents all accidents that occurred from July 1st of 2021 through December 31st, 2021. The $100 in column 1 means that the $100 was paid out as of December 31st, 2021 for those accidents. Moving to the right of the same row, column two of $120 means that for accidents that occurred during the last six months of 2021, as of June 2022, cumulatively that $120 had been paid out. Thus, an additional $20 was paid out during the first half of 2022. The increase of $20 could be due to payments on known claims, late reports, or reopen activity. The increase of 20% from $100 to $120 is shown in the Lost Development Factor section in the December 2021 row and column 1. Similarly, the loss development factor of 1.08 in column 2 of the December 2021 row is calculated by taking the paid loss of $130 in column 3 divided by the paid loss of $120 in column 2 for the December 2021 row. Next, the Actual Analyst selected a 1.27 in the first column as the predicted column 1 loss development factor for the accidents happening in the six-month period ending June of 2023. We can see that in the June 2023 row, $120 had been paid out by the end of June 2023. The analyst is predicting that paid losses will increase by 27% or $33 during the second half of 2023 and cumulatively be at $153 by December 2023. Multiplying the $153 by an additional 8% predicts that an additional $12 will get paid out by the third column for a cumulative of $165. Thus, the shaded numbers in blue are predictions of what will be paid out in the future. The indicated reserve is then calculated by taking the ultimate estimated paid losses minus what has already been paid as of June 2023, since reserves are to cover future liabilities. The indicated reserve is $45 for accidents happening in the six-month period ending June 2023 and $13 for accidents happening during the second half of 2022. In total, the indicated reserve is the sum of all accident periods or row and adds up to $58. This example illustrates an accident period chain ladder approach using paid data. Triangles similar to this by product and grouped by line coverage can be found in our annual report. Other approaches that we typically employ include using case-incurred data, developing severity and frequency separately, and stratifying the data by size of loss layer. In addition, data is also segmented by late report and reopen lag time from the date of loss to the date of late report and reopen, and hindsight testing to prior reserve amounts are considered as well. Additional ad hoc analysis is typically completed to understand changes in the underlying data and lost development factors. Based off the indications from the multiple reviews completed during the month, the actuarial team will then decide how much of an overall reserve change is needed and adjust reserve factors accordingly. Those changes will show up in the earnings release under the actuarial adjustment section and be reported showing the breakout for the current accident year and all prior accident years. For example, in June of 2023, based off the scheduled reserve reviews which represented between 25 to 30 percent of reserves, the actuarial team increased reserves $130.9 million for accident years 2000 and 2000. 2022 and prior and increased reserves $160.3 million for the 2023 accident year for a total change of $291.2 million. The $130.9 million increase to prior accident years directly impacted the prior accident year development. In addition, due to other changes not related to actuarial reviews, prior accident years developed an additional $6.9 million unfavorably for a total amount of unfavorable development of $137.8 million. Next, we will discuss what are some of the other items that are in the all-other development. Now, let's go through an example of the pathway of a case reserve over time and the impact on our monthly earnings release. Remember, case reserves make up about 67% of our total reserves. In this example, a claim happens on December 15th and is reported and opened in our claims system on December 19th. Since the claim was reported in the same month as the occurrence of the accident, this would not be considered an IBNR claim. The adjuster does not have much information about the claim at this point and sets a case reserve of $5,000, noted by the orange dot. In parallel, a tabular case reserve is determined for this claim from an algorithm used by the actuarial team. The actuarial team uses predictive modeling techniques based off of certain characteristics of the claim and policy to predict what the expected costs would be for all claims that meet the criteria. In personal auto, there are over 200,000 unique combinations of tabular case reserves. It is important to note that the actuarial algorithm does not expect this one claim to pay exactly the tabular case reserve. but on average, all claims that meet the similar criteria should pay close to the tabular case reserve. This is similar to a pricing rate order of calculation formula. In this example, the tabular case reserve is $12,125. Finally, the adjuster case reserve is compared to a reserve threshold set at $25,000 in this example. If the adjuster estimate is below the reserve threshold, the tabular case reserve is booked to the general ledger as the financial case reserve for that claim and is reflected on the balance sheet. If the adjuster case reserve is greater than or equal to the threshold, the adjuster case reserve becomes the financial case reserve booked to the general ledger. The logic here is that the predictive modeling approach is fairly accurate for lower dollar claims. For more severe claims, the adjuster has received more specific information pertinent to the claim and will predict better than the model for higher dollar claims. This combination of adjuster and tabular reserves provides more consistency and accuracy on a monthly basis. the threshold varies by several variables, including product, line coverage, and limit, just to name a few. Since the adjuster case reserve is $5,000 and below the threshold, the tabular case reserve of $12,125 is used in the general ledger. In addition, $1,000 of IBNR is set to cover claims that happened in December and at some point after December would either be late reported or reopened. The IBNR reserve is not attached to any one claim and instead set as a factor related to earned premium to cover all potential late reported or reopened claims. The total reserve liability on the balance sheet is $12,125 for Case plus $1,000 for IBNR, equaling a total of $13,125, denoted as the dark blue dot, and will be the reserve booked at the end of December. In January, the adjuster has kept their initial estimate of $5,000. Since this is below the $25,000 threshold, the tabular case reserve will again be booked to the general ledger. As part of our roll-forward process, all tabular case reserves can be adjusted monthly by an aging factor and inflation factor. As the claim is one month older, the actuarial algorithm predicted that all claims remaining open would have a higher ultimate cost. In addition, all tabular case reserves that are not part of an in-depth actuarial review during the month gets inflated as well. The new tabular case reserve is $12,376, which is an increase of $251. A portion of this $251 increase is aging, and a portion is inflation. This will show up in the earnings release as unfavorable prior accident year all other reserve development in January. It is important to note that other claims that settled in January may have settled for more or less than the December tabular case reserve, which would also show up in the all other development category of the earnings release. In February, the adjuster has received new information and increased their estimate to $15,000. This amount is still below the threshold, and thus the tabular case reserve is still used to set the case reserve liability. In February, this claim was part of the 25% to 30% of reserves reviewed at an in-depth level by the actuarial team. The actuarial team increased the tabular case reserve for all claims that have a similar criteria as this claim to $13,500, which is an increase of $1,124 from January. This increase will show up as unfavorable prior accident year actuarial adjustments in the earnings release. In March, the adjuster increased their estimate again, this time to $20,000. Since $20,000 is still below the threshold of $25,000, the tabular case reserve is still used as the case reserve booked to the general ledger. The claim becomes plaintiff-attorney-repped in March. Thus, while the tabular case reserve will be inflated and aged again, it will also change due to becoming plaintiff attorney-repped, as this is one of the variables used in the actuarial algorithm. The tabular case reserve is now $20,050, which is $6,550 greater than the prior month. A portion of this $6,550 increase is due to inflation, a portion due to aging, and a portion due to the claim becoming plaintiff-attorney-repped. The $6,550 will show up as unfavorable prior accident year, all other development in the monthly earnings release. In April, the adjuster has increased the reserve again to $25,000. Since the adjuster case reserve is now at least equal to the reserve threshold, the adjuster's estimate is booked to the general ledger as the case reserve for this claim. This is an increase of $4,950 in the case reserve on the balance sheet, moving from the tabular reserve at the end of March to the adjuster reserve at the end of April. the $4,950 will show up as unfavorable prior accident year all other development in the monthly earnings release. The adjuster made no change to their estimate in May. Case reserves set equal to or over the threshold can only be changed by the adjuster revising their estimates. Thus, there are no additional changes for inflation, aging, or any other factors used in the actuarial algorithm. In June, the claim closed out and settled for $20,000. This will show as $5,000 favorable in the prior accident year, all other development section of the monthly earnings release. Finally, in July, the claim was reopened and an additional payment occurred for $1,500. A claim could be reopened for several reasons. For example, a claimant may have initially been undecided about a vehicle repair and received a cash settlement based upon the initial estimate. Several months later, they may have ultimately decided to repair the vehicle and additional damage may have been found. Another example is when a claimant may initially feel that they are not injured in an accident. The claim is closed and subsequently reopened when the person realizes that they were injured in the accident. While the case reserve had closed out in June, we were still carrying $1,000 of IBNR reserves for the potential of a December claim being late reported or reopening. For this example, the IBNR reserve was released in July, which means that there is an expectation that there will be no future costs from late reports or reopens from any accident that occurred in 2022 and is currently not an open case reserve as of the end of July. The development is unfavorable $500. This would show up in the prior accident year all other category of the earnings release. In practice, the IBNR reserve for prior accident years tends to get released monthly as part of another actuarial algorithm as the probability of late reports and reopens decreases with time. An in-depth review of IBNR reserves are completed in tandem with case reserves. Remember, any changes made to factors by the actuarial team as a result of those reviews will show up under the prior accident year actuarial category. For the year, the starting reserve was $13,125 and the claim was eventually paid for $21,500. The year-to-date development is unfavorable by this difference, which is $8,375. I, as the chief actuary, have complete decision-making authority on our reserves. And while the actuarial team has complete independence in determining the reserves to be booked, there are many checks and balances in place. Internally, we have a close partnership with our claims, pricing, and product management business partners. Meetings are held throughout the month at both the localized and national level, discussing trends, changes in the mix of business, claims process changes, rate activity, and methodologies. Quarterly, I meet with the audit committee members of the board of directors to discuss results and trends for the quarter. Furthermore, our external auditors perform an annual audit of the company as required by the SEC. My actuarial team meets with the audit firm to discuss our actuarial process, current trends, and results for the respective quarters and year. I hope that you have found this presentation helpful. For more information on Progressive's loss-reserving practices, we post a report under the investor site of Progressive.com. This report is updated every two years. Thank you for your time today, and I will next turn it over to Jim to discuss cohort pricing.