Progressive and the Rising Cost of Auto Insurance

Progressive (NYSE: PGR) is struggling with a dramatically changing auto insurance market that threatens to undermine its long streak of revenue growth.

Some of the insurer’s recent actions raise questions about its potential for long-term profitability. Progressive wants to start charging drivers over 65 in Maine, a higher rate, National Public Radio (NPR) and The Portland Press Herald reported. The company has applied to the Maine Bureau of Insurance for such an action which may violate the state’s laws.

Such an action was rejected last year, but it’s apparently back on the table. This sounds suspiciously like a test case; because Loretta Worters of the Insurance Information told Maine NPR that she had not heard of such a request in any other states.  

Why would Progressive Raise Rates for seniors?

The rationale behind Progressive’s proposal is not as clear cut as you might think. Some seniors – those over 75 – do have a higher accident rate. Persons over 85 are considered high risk, Katherine Freund of ITN America told NPR.

My guess is that two factors are driving Progressive’s logic here. The first is medical costs; which are the most expensive part of an accident for an insurance company. The average bodily injury claim; the payout to a person hurt in a car crash reached $16,600 in 2016, according to the Insurance Research Council.

Since older people are more likely to be in poor physical shape and require more treatment after an accident the cost of treating them might be higher. Age also plays a role here, older people are more likely to suffer more serious injuries such as broken bones because their bones are more brittle for example.

A problem with this thesis is Medicare; which covers most seniors’ medical bills, even though older drivers’ medical costs are potentially higher. The actual bill is lower because Uncle Sam picks up the tab.

Another likely rationale is the number of fatal accidents which are increasing. The number of fatal accidents in the United States rose by 7.7%, according to the Insurance Information Institute. Since older drivers are more likely to be in poor health they are more likely to die in an accident.

Yet the number of fatalities is still fairly low, which brings us to another and even more intriguing possibility.

Age and Driving

The other statistic that Progressive might be looking at is the changing pattern of driving in America. Researchers Michael Sivak and Brandon Schoettle; of the University of Michigan’s Transportation Research Institute, discovered data that indicates younger people are less likely to drive and older people are more apt to get behind the wheel.

The percentage of 16 to 44-year olds with drivers’ licenses is dropping; while the percentage of persons with driver’s licenses between 45 and 69 is holding steady, their analysis of Federal High Administration Data Indicates. They noted that 76.7% of people between 16 and 44 lacked a driver’s license in 2014, while 92.1% of people between 45 and 69 had one.

The real thinking here might be that companies like Progressive will make less off of up and coming generations, so they will charge those actually on the road. Progressive’s may also think that those around 65 are more at risk for an accident; simply because they are more likely to be on the road.

A reason for that line of thinking is that traffic fatalities are increasing which is a sure sign that more serious traffic accidents are becoming common place. State police data indicates that traffic fatalities in Michigan increased by 10% between 2014 and 2015, The Detroit News reported. Traffic fatalities nationwide increased by 7.7% in 2015, the National High Transportation Safety Administration or NHTSA reported.

The risk to all drivers is increasing; so Progressive is trying to raise rates for those are more likely to drive. That would include Baby Boomers (persons between age ages 50 and 69) who came of age in the auto-obsessed 1960s and 70s. Those less likely to drive such as video game loving Millennials (those aged 20 to 35) will be given a lower rate.

Something we must remember here is that the biggest risk factor for auto accidents is simply being in a vehicle on the road. Another risk is that older drivers are more likely to die in an accident.  From an insurance standpoint those less likely to drive are taking less of a risk. Traditional insurance logic is that those who take the risks pay more.

Another motivating factor is that younger drivers might be more likely to change providers in the face of a rate increase. Older drivers might be more likely to stick with an insurer that charges more.

My guess is that this will lead to a nasty political backlash because seniors are more likely to vote. Progressive is testing the waters in Maine to see if such a plan is possible.

Progressive is Making Less Money

Anybody who looks at Progressive’s financial numbers can understand why the insurer is considering such a bold policy change. It is making less money from its insurance business.

Progressive’s net income fell by $127 million during the second quarter of 2016. The insurer reported a net income of $1.23 billion March 2016; that fell to $1.058 billion in June 2016. That net income has been falling for the past year, Progressive reported a net income of $1.325 billion in June 2015 that fell to $1.058 billion a year later. That adds up to a yearly income decline of $267 million.

If the income drop continues, Progressive’s business might no longer be profitable or sustainable. A strong possibility is that the company’s net income will drop below $1 billion in third or fourth quarter 2016.

This calls Progressive’s whole business model of direct sales of discount insurance into question because its revenues have been growing steadily for years. Progressive added $530 million in revenue in second quarter 2016, even as it lost $127 in income. Progressive’s revenues reached $21.52 billion in March 2016 and $22.05 billion in June 2016.

Despite that Progressive is still a pretty good value investment because its cash and short-term investments reached $5.166 billion in June 2016. Progressive is generating a lot of flat from its premiums which means that auto insurance is still a cash cow. That float is growing dramatically too, the amount Progressive has in the bank grew by $3.233 billion between June 2015 and June 2016; rising from $1.933 billion in 2015 to $5.166 billion a year later.

What does it mean for Investors?

What all this means for investors is simple, auto insurers like Progressive are still a value investment but the value may not last because the business they operate in is very unstable. Increasing risk factors are slowly eating up their profits.

That means Progressive investors should enjoy the 2.7% dividend yield; and 14.1% return on equity they received on July 20, 2016, while they can. If the income drop continues those income streams are not going to last.