I. OVERVIEW
During the second quarter 2012, we continued to experience solid growth in both
premiums and policies, but profitability was down from last year. The
Progressive Corporation's insurance subsidiaries generated net premiums written
and policies in force growth of 8% and 6%, respectively, on a year-over-year
basis. Our underwriting profitability of 2.4%, or $95.1 million, was lower than
the second quarter last year, reflecting higher loss costs due to an increase in
severity and, to a lesser extent, frequency. During the second quarter, our
investment operations produced investment income of $112.5 million and we also
recognized $4.7 million of net realized losses on securities. Overall, we
reported net income of $118.6 million, or $.19 per share, for the second quarter
2012. Our total capital position (debt plus equity) increased $19.0 million
during the quarter, to $8.3 billion at June 30, 2012.
A. Operations
During the second quarter 2012, we realized a year-over-year increase in net
premiums written of 8% on a companywide basis. Our Agency and Direct Personal
Lines businesses grew 6% and 7%, respectively, and our Commercial Auto business
grew 15%. Premium growth reflects a combination of new business applications
(i.e., issued policies), premium per policy (i.e., rates), and customer
retention.
On a quarter-over-prior-year quarter basis, Personal Lines new applications
increased 2%, with 7% growth in our Agency auto business and 1% growth in the
Direct auto business, offset by a 4% decline in our special lines new
applications. Rate competitiveness in several of our key Agency auto states has
helped strengthen conversion in this channel. Despite slower new business growth
in our Direct channel, we continue to view our advertising and media placement
as a critical component of our new customer generation. We will continue to take
advantage of the brand assets we have developed in both the "Superstore" and the
"Messenger" campaigns, and intend to add fresh and appealing messages to present
the consumer with compelling reasons to select and retain Progressive.
Both our Agency and Direct businesses contributed to the 5% increase in our
Personal Lines renewal applications. The Personal Lines increase in part
reflects our retention efforts, which include further penetration into
multi-product households.
In our Commercial Auto business, new applications increased 6%, led by an
increase in our for-hire transportation business market target. Our Commercial
Auto renewal applications were flat, compared to the second quarter last year,
partially reflecting the reduction in policies in force last year.
In addition to our efforts to further penetrate customer households through
cross-selling products, we remain focused on several other programs/initiatives
we have that are designed to help stimulate growth and provide consumers with
distinctive insurance options. These programs include:
• Snapshot®, our usage-based insurance product - in addition to promoting
Snapshot to our current customers, in July, we launched a national rollout
of a program to offer all consumers the opportunity to test drive Snapshot
and see the discount they would receive relative to Progressive's
pre-Snapshot rate
• Name Your Price® - a tool that allows consumers to name or select the
price they would like to pay for auto insurance and match it to a range of
available coverage combinations
• New product models in both our Personal Lines and Commercial Auto
businesses - these models are designed to improve competitiveness with
advanced segmentation and product features, and
• Additional functionality in the mobile device space - our mobile
functionality includes:
• a feature that enables customers in certain states to purchase
insurance for up to three drivers and three vehicles directly from
their mobile devices after receiving a quote
• the nationwide rollout of a mobile quoting application for our
Commercial Auto business and special lines products
• an application available in certain states with the ability to use the
camera in a mobile device to send a photo of a driver'slicense and/or
insurance card, along with some additional information, to get an
instantaneous quote, and
• expansion of our agent offerings on tablet computers, including full
quote/buy capabilities.
After years of flat to slightly lower average personal auto premiums, we began
to see written premium per policy increase during the second quarter. In light
of the rising claims costs, we started increasing rates earlier this year and
expect to continue to raise rates during the third quarter. On a year-over-year
basis, for the second quarter 2012, written premium per policy increased 1% in
both our Agency and Direct auto businesses. Commercial Auto saw premiums per
policy increase about 10% for the second quarter 2012, primarily reflecting rate
increases taken during both 2011 and the first half of 2012 and shifts in our
mix of business to higher average premium policies. Written premium per policy
for our special lines products was down 1%, driven largely by older average
model years of motorcycles insured. Adjusting rates is an ongoing process, and
we will continue to evaluate future rate needs and react quickly as we recognize
changing trends.
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On a companywide basis, year-over-year, we grew policies in force 6%, with
Personal Lines growing 6% and Commercial Auto increasing 3%. Our Agency auto
business contributed to this increase with policies in force growth of 6%, or
276,000 additional policies. In our Direct auto business, policies in force grew
7%, or 265,200 policies, over last June. With a 5% increase in our special lines
policies over last year, we ended the second quarter with nearly 12.9 million
Personal Lines policyholders.
To further grow policies in force, it is critical that we retain our customers
for longer periods, which is why increasing retention continues to be one of our
most important priorities and why our efforts to increase the number of
multi-product households continues to be a key initiative. Policy life
expectancy, which is our actuarial estimate of the average length of time that a
policy will remain in force before cancellation or lapse in coverage, is one
measure of customer retention. Policy life expectancy for our Agency auto
business increased about 6% over the same time last year. Our policy life
expectancy for our Direct auto business, our Commercial Auto business, and our
special lines products was relatively flat compared to last year.
Our 2.4% companywide underwriting profit margin for the second quarter 2012 was
below our target of 4%. On a quarter-over-prior-year-quarter basis, our margin
decreased 4.2 percentage points, reflecting a higher loss ratio. During the
second quarter 2012, we experienced $22.8 million, or 0.6 points, of unfavorable
prior accident year reserve development, compared to $52.0 million, or
1.4 points, of favorable reserve development in the second quarter last year.
Slightly more than half of the unfavorable reserve development reflected in our
second quarter 2012 results was in our Personal Lines Agency business, with the
balance primarily in Commercial Auto. On a year-over-year basis, for the second
quarter 2012, our personal auto business experienced increases in incurred
severity and, to a lesser extent, frequency, particularly in liability
coverages. On a companywide basis, we have raised our auto rates an average of
nearly 3% through June and expect to raise rates further during the third
quarter to offset increasing claims costs as we focus on our 96 calendar year
combined ratio target.
B. Investments and Capital Management
The fair value of our investment portfolio was $16.6 billion at June 30, 2012.
Our asset allocation strategy is to maintain 0-25% of our portfolio in Group I
securities, with the balance (75%-100%) of our portfolio in Group II securities.
We define Group I securities to include:
• common equities
• nonredeemable preferred stocks
• redeemable preferred stocks, except for 50% of investment-grade redeemable
preferred stocks with cumulative dividends, and
• all other non-investment-grade fixed-maturity securities
Group II securities include:
• short-term securities, and
• all other fixed-maturity securities
At June 30, 2012, 21% of our portfolio was allocated to Group I securities and
79% to Group II securities. We use the credit ratings from models provided by
the National Association of Insurance Commissioners (NAIC) for classifying our
residential and commercial mortgage-backed securities, while all other debt
securities derive their credit ratings from external vendors in determining
whether securities should be classified as Group I or Group II.
At June 30, 2012, we held no foreign sovereign debt. We held $686.9 million of
U.S. dollar-denominated corporate bonds, preferred stocks (redeemable and
nonredeemable), and other asset-backed securities issued by companies that are
domiciled, or whose parent companies are domiciled, in European countries. Of
these securities, $558.5 million are corporate bonds from U.K. and other
European companies primarily in the consumer, industrial, energy, and
communications industries; $6.0 million are U.K.-domiciled other asset-backed
securities; $99.2 million are U.K.-domiciled financial institution preferred
stocks (redeemable and nonredeemable); and $23.2 million is a nonredeemable
preferred stock in BBVA, a Spanish-domiciled financial institution. We also held
$0.7 million ($25 million notional value) of credit protection on BBVA. Our
total direct exposure to Southern European-domiciled companies, including the
BBVA nonredeemable preferred stock, was $64.0 million at June 30, 2012. In
total, our European-domiciled securities represent approximately 4% of our
portfolio at June 30, 2012.
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Our investment portfolio produced a fully taxable equivalent (FTE) total return
of 0.3% for the second quarter 2012. In our fixed-income and common stock
portfolios, we experienced FTE total returns of 0.7% and (2.9)%, respectively.
At June 30, 2012, the fixed-income portfolio had a weighted average credit
quality of AA-. We continue to maintain our fixed-income portfolio strategy of
investing in high-quality securities. At June 30, 2012, our duration was 1.9
years to limit the potential loss of capital in the event of an increase in
interest rates from their present low levels.
At June 30, 2012, our total capital (debt plus equity) was $8.3 billion,
compared to $8.2 billion at December 31, 2011, and our debt-to-total capital
ratio decreased to 24.7% from 29.6% at year-end 2011. During the first six
months of 2012, we retired $350 million of our 6.375% Senior Notes at maturity
in January, repurchased $30.4 million in principal amount of our 6.70%
Fixed-to-Floating Rate Junior Subordinated Debentures due 2067 (the "6.70%
Debentures"), and repurchased 4.0 million of our common shares at a total cost
of $83.0 million (average cost of $20.74 per share). We continue to manage our
investing and financing activities in order to maintain sufficient capital to
support all of the insurance we can profitably underwrite and service.
II. FINANCIAL CONDITION
A. Liquidity and Capital Resources
Progressive's insurance operations create liquidity by collecting and investing
premiums from new and renewal business in advance of paying claims. For the six
months ended June 30, 2012 and 2011, operations generated positive cash flows of
$1.1 billion and $1.0 billion, respectively.
We held total capital (debt plus equity) of $8.3 billion, at book value, at both
June 30, 2012 and June 30, 2011, compared to $8.2 billion at December 31, 2011.
Based upon our capital planning and forecasting efforts, we believe that we have
sufficient capital resources, cash flows from operations, and borrowing capacity
to support our current and anticipated business, scheduled principal and
interest payments on our debt, and expected capital requirements. The covenants
on our existing debt securities do not include any rating or credit triggers
that would require an adjustment of the interest rate or an acceleration of
principal payments in the event our securities are downgraded by a rating
agency.
We seek to deploy capital in a prudent manner and use multiple data sources and
modeling tools to estimate the frequency, severity, and correlation of
identified exposures, including, but not limited to, catastrophic losses,
natural disasters, and other significant business interruptions to estimate our
potential capital needs.
Management views our capital position as consisting of three layers, each with a
specific size and purpose:
• The first layer of capital, which we refer to as "regulatory capital," is
the amount of capital we need to satisfy state insurance regulatory
requirements and support our objective of writing all the business we can
write and service, consistent with our underwriting discipline of
achieving a 96 combined ratio. This capital is held by our various
insurance entities.
• The second layer of capital we call "extreme contingency." While our regulatory capital is, by definition, a cushion for absorbing financial
consequences of adverse events, such as loss reserve development,
litigation, weather catastrophes, or investment market corrections, we
view that as a base and hold additional capital for even more extreme
conditions. The modeling used to quantify capital needs for these
conditions is quite extensive, including tens of thousands of simulations,
representing our best estimates of such contingencies based on historical
experience. This capital is held either at a non-insurance subsidiary of
the holding company or in our insurance entities, where it is potentially
eligible for a dividend up to the holding company. Regulatory restrictions
on subsidiary dividends are discussed in Note 8-Statutory Financial
Information in our Annual Report to Shareholders for the year ended
December 31, 2011.
• The third layer of capital is capital in excess of the sum of the first
two layers and provides maximum flexibility to repurchase stock or other
securities, consider acquisitions, and pay dividends to shareholders,
among other purposes. This capital is largely held at a non-insurance
subsidiary of the holding company.
During the first six months of 2012 and at all times during 2011, our total
capital exceeded the sum of our regulatory capital layer plus our
self-constructed extreme contingency load.
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The amount of capital in our third layer was at a level that allowed our Board
of Directors to take several actions to return underleveraged capital to our
investors, including:
• Repurchases of our outstanding debt securities. From time to time, we may
elect to repurchase our outstanding debt securities in the open market or
in privately negotiated transactions, when management believes that such
securities are attractively priced and capital is available for such a
purpose. During the second quarter and first six months of 2012, and second half of 2011, we repurchased, in the open market, $17.8 million,
$30.4 million, and $15.0 million, respectively, in principal amount of our
6.70% Debentures.
• Repurchases of our common shares. In accordance with our financial policies, we continued our practice of repurchasing our common shares. In
June 2011, the Board of Directors approved an authorization to repurchase
up to 75 million common shares; we have 46.7 million shares remaining
under this authorization. The following table shows our share repurchase
activity during the respective periods:
Three Months Ended June 30, Six Months Ended June 30,
(millions, except per share amounts) 2012 2011 2012 2011
Total number of shares purchased 2.1 13.3 4.0 20.1
Total cost $ 45.3 $ 282.9 $ 83.0 $ 420.9
Average price paid per share $ 21.21 $ 21.26 $ 20.74 $ 20.93
• Declaration of dividends. As part of our capital strategy, in December 2011, we declared a dividend of $.4072 per share under our annual variable
dividend policy, which was paid in February 2012.
In January 2012, we retired $350 million of our 6.375% Senior Notes at maturity.
Our next scheduled debt maturity is $150 million of our 7% Notes due October
2013.
During the third quarter 2011, we issued $500 million of 3.75% Senior Notes due
2021 (the "3.75% Senior Notes"). We received proceeds of $497 million, after
deducting underwriter's discounts and commissions, and incurred an additional
$1.0 million of expenses related to the issuance. In addition, upon issuance of
the 3.75% Senior Notes, we closed a forecasted debt issuance hedge, which was
entered into to hedge against a possible rise in interest rates, and recognized
a $5.1 million pretax loss as part of accumulated other comprehensive income
(loss); the loss will be recognized as an increase to interest expense and
amortized over the life of the 3.75% Senior Notes.
Short-Term Borrowings
During the six months ended June 30, 2012 and throughout 2011, we did not engage
in short-term borrowings to fund our operations. As discussed above, our
insurance operations create liquidity by collecting and investing insurance
premiums in advance of paying claims. Information concerning our insurance
operations can be found below under Results of Operations-Underwriting, and
details about our investment portfolio can be found below under Results of
Operations-Investments. In addition, we have $125 million available under a
secured line of credit that is described in further detail in Note 4-Debt. The
line of credit is intended to provide liquidity in the event of disruptions in
our cash management operations; we have never borrowed under this line of
credit.
During 17 days in the second quarter 2012, we engaged in repurchase agreements
under which we loaned U.S. Treasury securities to accredited brokerage firms in
exchange for cash equal to the fair value of the securities, as described in
more detail below under Results of Operations-Investments; Repurchase and
Reverse Repurchase Transactions. These investment transactions were entered into
to enhance the yield from our fixed-income portfolio and not as a source of
liquidity or funding for our operations. We had no open repurchase commitments
at June 30, 2012 or 2011, or December 31, 2011.
B. Commitments and Contingencies
Contractual Obligations
During the first six months of 2012, our contractual obligations have not
changed materially from those discussed in our Annual Report on Form 10-K for
the year ended December 31, 2011.
Off-Balance-Sheet Arrangements
Our off-balance-sheet leverage includes derivative positions, operating leases,
and purchase obligations. See the "Derivative Instruments" section of Note
2-Investments and of this Management's Discussion and Analysis for a summary of
our derivative activity since year-end 2011. There have been no material changes
in the other off-balance-sheet items since the discussion in the notes to the
financial statements in Progressive's Annual Report on Form 10-K for the year
ended December 31, 2011.
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III. RESULTS OF OPERATIONS - UNDERWRITING
A. Growth
Three Months Ended June 30, Six Months Ended June 30,
% %
($ in millions) 2012 2011 Change 2012 2011 Change
NET PREMIUMS WRITTEN
Personal Lines
Agency $ 2,097.4 $ 1,973.6 6 $ 4,173.9 $ 3,943.8 6
Direct 1,561.2 1,454.2 7 3,217.7 3,005.3 7
Total Personal Lines 3,658.6 3,427.8 7 7,391.6 6,949.1 6
Commercial Auto 470.5 409.2 15 900.0 787.9 14
Other indemnity 0 0 NM 0 0 NM
Total underwriting operations $ 4,129.1 $ 3,837.0 8 $ 8,291.6 $ 7,737.0 7
NET PREMIUMS EARNED
Personal Lines
Agency $ 2,024.0 $ 1,905.9 6 $ 3,984.6 $ 3,793.7 5
Direct 1,564.2 1,451.0 8 3,077.4 2,871.0 7
Total Personal Lines 3,588.2 3,356.9 7 7,062.0 6,664.7 6
Commercial Auto 407.6 361.6 13 794.9 717.3 11
Other indemnity .3 1.4 (79 ) .7 3.2 (78 )
Total underwriting operations $ 3,996.1 $ 3,719.9 7 $ 7,857.6 $ 7,385.2 6
NM = Not Meaningful
Net premiums written represent the premiums generated from policies written
during the period less any premiums ceded to reinsurers. Net premiums earned,
which are a function of the premiums written in the current and prior periods,
are earned as revenue over the life of the policy using a daily earnings
convention.
Policies in force, our preferred measure of growth, represents all policies
under which coverage was in effect as of the end of the period specified. As of
June 30, our policies in force were:
%
(thousands) 2012 2011 Change
POLICIES IN FORCE
Personal Lines:
Agency auto 4,884.2 4,608.2 6
Direct auto 4,036.5 3,771.3 7
Total auto 8,920.7 8,379.5 6
Special lines1 3,972.0 3,796.8 5
Total Personal Lines 12,892.7 12,176.3 6
Commercial Auto 525.0 512.0 3
1 Includes insurance for motorcycles, ATVs, RVs, mobile homes, watercraft,
snowmobiles, and similar items, as well as a personal umbrella product.
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To analyze growth, we review new policies, rate levels, and the retention
characteristics of our books of business. The following table shows our
year-over-year changes in new and renewal applications (i.e., issued policies):
Growth Over Prior Year
Quarter Year-to-date
2012 2011 2012 2011
APPLICATIONS
Personal Lines:
New 2 % (3 )% 4 % (2 )%
Renewal 5 % 7 % 5 % 7 %
Commercial Auto:
New 6 % (4 )% 7 % (5 )%
Renewal 0 % (1 )% (1 )% (1 )%
Our Personal Lines business had an increase in new applications for both the
second quarter and first six months of 2012, compared to last year, led by solid
increases in our Agency auto business. These increases were primarily due to
growth in several large states, reflecting previous actions to make our rates
more competitive. Our Direct auto business had increases in new applications,
but to a lesser extent than the Agency channel. Our Commercial Auto business
also experienced a solid increase in new applications for both the second
quarter and first six months of 2012, driven by an increase in new applications
in our for-hire transportation business market target, and a significant
increase in new applications in Florida, our second largest Commercial Auto
state, compared to the same periods last year. We remain committed to our
advertising campaigns, product enhancements, and brand-building efforts in order
to stimulate new business in all channels.
We have several initiatives underway aimed at providing consumers with
distinctive auto insurance options, including the rollout of personal auto
product models, which began in 2010, and further refines our segmentation and
incorporates the best design elements of the Agency and Direct auto products. As
of June 30, 2012, these products have been rolled out to 45 jurisdictions,
including two states added during the second quarter. We plan to extend the
rollout to two additional states, which will substantially complete the rollout
of these product models.
In the second quarter 2012, we continued the expansion of Snapshot ®, our
usage-based insurance product. Snapshot was made available in two additional
states in the second quarter, bringing the total number of Direct markets to 43.
Agency auto customers have access to Snapshot in 36 of those 43 jurisdictions.
We plan to expand Snapshot into additional states, depending on regulatory
approval and business results. During July, we launched our national rollout of
a program to offer all consumers the opportunity to test drive Snapshot to
encourage many more people to consider Progressive for their auto insurance
needs. We expect this option will encourage people to shop for auto insurance
when they might not have otherwise done so.
We are also continuing with our efforts to further penetrate customer households
through cross-selling auto policies with our special lines products and vice
versa, as well as through Progressive Home Advantage®. Progressive Home
Advantage, the program in which we "bundle" our auto product with property
insurance provided by one of six unaffiliated insurance carriers (including one
carrier added in the second quarter 2012), is becoming an integral part of our
consumer offerings. This program is currently available to Direct customers in
48 states, Agency customers in 36 states, and to both Direct and Agency
customers in the District of Columbia. Progressive Home Advantage is not
available to customers in Florida and Alaska. In the first quarter 2012, we
scaled back the number of states in which we offer Progressive Home Advantage to
new Agency customers until we determine which combination of these unaffiliated
carriers are best suited to offer this program through independent agents.
During the second quarter, we signed a letter of intent to acquire an indirect,
non-controlling interest in American Strategic Insurance, our primary
Progressive Home Advantage provider for Agency customers, subject to the
completion of appropriate due diligence and the negotiation and execution of a
binding purchase agreement. These multi-product customers are an important part
of our strategic agenda, since they tend to stay with us longer, have better
loss experience, and represent a sizable segment of the market.
Improving our offerings in the mobile space remains an important initiative.
Consumers have the ability to obtain a quote and buy an auto insurance policy on
our mobile website in 42 states and the District of Columbia. In April 2012, we
began to offer the ability to quote up to three drivers and three vehicles on
mobile devices in ten states. We plan to make this multi-driver, multi-vehicle
feature available in all states in the near future. In the first quarter 2012,
we also launched a feature in 28 states that allows consumers to use the camera
in their mobile device to photograph their driver license, and/or current
insurance card, to provide easy data fill for an instantaneous quote; we plan to
rollout this feature in 14 additional states during the remainder of the year.
In addition, policyholders are able to make payments and add certain
endorsements from their mobile device, as well as receive identification cards
and severe weather text alerts. Furthermore, much of our agency-dedicated
website is now accessible to agents from most tablet computers, including
quote/buy, servicing, and reporting capabilities. We expect to add new
functionality to our mobile site and mobile applications over the remainder of
the year.
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We also continued the national rollout of a product model in our Commercial Auto
business that began in 2011. This model, which expands our coverage offerings,
simplifies the quoting and claims experience, and provides incentives for
customers to stay with us longer, is available in 31 states, including 10 states
added in the second quarter 2012. We plan to continue the rollout to our
remaining 18 Commercial Auto business states over the rest of this year and into
early next year. We also offer our Commercial Auto customers general liability
coverage in 49 states and workers' compensation coverage in 14 states through
our Progressive Commercial AdvantageSM program; these products are underwritten
by four unaffiliated insurance companies.
We experienced the following changes in written premium per policy:
Growth Over Prior Year
Quarter Year-to-date
2012 2011 2012 2011
WRITTEN PREMIUM PER POLICY
Personal Lines - auto 1 % 0 % 1 % (1 )%
Commercial Auto 10 % 4 % 10 % 2 %
During both the second quarter and first six months of 2012, written premium per
policy for our personal auto business increased 1%, while Commercial Auto was up
significantly, compared to the same periods in 2011. As a result of rising
claims costs driven primarily by increased severity, we started increasing rates
earlier this year and expect to continue to raise rates during the third
quarter. For our Commercial Auto business, rate increases taken since the
beginning of 2011 and continuing throughout the first six months of 2012, as
well as shifts in our mix of business, contributed to the increase in written
premium per policy. Adjusting rates is a continuous process and we will continue
to evaluate future rate needs and react quickly as we recognize changing trends.
See below for additional discussion on written premium per policy for our Agency
and Direct auto channels and our Commercial Auto business.
Another important element affecting growth is customer retention. One measure of
retention is policy life expectancy, which is our actuarial estimate of the
average length of time that a policy (including any renewals) will remain in
force before cancellation or lapse in coverage. The following table shows our
year-over-year changes in policy life expectancy:
Growth Over Prior Year
2012 2011
POLICY LIFE EXPECTANCY
Personal Lines:
Auto 3 % 3 %
Special lines 1 % (1 )%
Commercial Auto 1 % 0 %
The lengthening policy life expectancies in our personal auto business in part
reflect our state and payment mix, as well as rate level competitiveness in our
Agency business. Policy life expectancy for our special lines products and our
Commercial Auto business remained relatively flat, compared to last year.
Realizing the importance that retention has on our ability to continue to grow
profitably, we continue to emphasize competitive pricing, quality service, and
other retention initiatives for our customers.
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B. Profitability
Profitability for our underwriting operations is defined by pretax underwriting
profit, which is calculated as net premiums earned less losses and loss
adjustment expenses, policy acquisition costs, and other underwriting expenses.
We also use underwriting profit margin, which is underwriting profit expressed
as a percentage of net premiums earned, to analyze our results. For the
respective periods, our underwriting profitability results were as follows:
Three Months Ended June 30, Six Months Ended June 30,
2012 2011 2012 2011
Underwriting Underwriting Underwriting Underwriting
Profit (Loss) Profit (Loss) Profit (Loss) Profit (Loss)($ in millions) $ Margin $ Margin $ Margin $ Margin
Personal Lines
Agency $46.4 2.3 % $ 119.4 6.3 % $ 185.6 4.7 % $ 329.5 8.7 %
Direct 26.0 1.7 91.2 6.3 87.3 2.8 196.4 6.8
Total Personal Lines 72.4 2.0 210.6 6.3 272.9 3.9 525.9 7.9
Commercial Auto 24.1 5.9 34.1 9.4 53.5 6.7 75.2 10.5
Other indemnity1 (1.4 ) NM 0 NM (2.6 ) NM (.6 ) NM
Total underwriting operations $95.1 2.4 % $ 244.7
6.6 % $ 323.8 4.1 % $ 600.5 8.1 %
1 Underwriting margins for our other indemnity businesses are not meaningful
(NM) due to the low level of premiums earned by, and the variability of loss
costs in, such businesses.
On a year-over-year basis, our underwriting margin decreased 4.2 and 4.0
percentage points for the second quarter and first six months of 2012,
respectively. Unfavorable loss reserve development this year, compared to
favorable development in 2011, contributed to almost half of the decrease in
underwriting profitability for the second quarter and nearly 75% of the
year-to-date variance. We also experienced a year-over-year increase in auto
claims severity, which contributed to our lower underwriting margins in both
periods.
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Further underwriting results for our Personal Lines business, including its
channel components, the Commercial Auto business, and our underwriting
operations in total, were as follows:
Three Months Ended June 30, Six Months Ended June 30,
Underwriting Performance1 2012 2011 Change 2012 2011 Change
Personal Lines-Agency
Loss & loss adjustment expense ratio 77.0 72.5 4.5 pts. 74.5 70.2 4.3 pts.
Underwriting expense ratio 20.7 21.2 (.5) pts. 20.8 21.1 (.3) pts.
Combined ratio 97.7 93.7 4.0 pts. 95.3 91.3 4.0 pts.
Personal Lines-Direct
Loss & loss adjustment expense ratio 76.1 71.0 5.1 pts. 73.9 70.4 3.5 pts.
Underwriting expense ratio 22.2 22.7 (.5) pts. 23.3 22.8 .5 pts.
Combined ratio 98.3 93.7 4.6 pts. 97.2 93.2 4.0 pts.
Total Personal Lines
Loss & loss adjustment expense ratio 76.6 71.8 4.8 pts. 74.2 70.3 3.9 pts.
Underwriting expense ratio 21.4 21.9 (.5) pts. 21.9 21.8 .1 pts.
Combined ratio 98.0 93.7 4.3 pts. 96.1 92.1 4.0 pts.
Commercial Auto
Loss & loss adjustment expense ratio 71.8 68.6 3.2 pts. 70.5 67.1 3.4 pts.
Underwriting expense ratio 22.3 22.0 .3 pts. 22.8 22.4 .4 pts.
Combined ratio 94.1 90.6 3.5 pts. 93.3 89.5 3.8 pts.
Total Underwriting Operations2
Loss & loss adjustment expense ratio 76.2 71.5 4.7 pts. 73.9 70.0 3.9 pts.
Underwriting expense ratio 21.4 21.9 (.5) pts. 22.0 21.9 .1 pts.
Combined ratio 97.6 93.4 4.2 pts. 95.9 91.9 4.0 pts.
Accident year loss & loss adjustment
expense ratio3 75.6 72.9 2.7 pts. 73.0 72.0 1.0 pts.
1 Ratios are expressed as a percentage of net premiums earned.
2 Combined ratios for the other indemnity businesses are not presented separately due to the low level of premiums earned by, and the variability of
loss costs in, such businesses. These businesses generated an underwriting
loss of $1.4 million and $0 for the three months ended June 30, 2012 and
2011, respectively, and $2.6 million and $0.6 million for the six months
ended June 30, 2012 and 2011, respectively; see the "Other Indemnity" section
of this Management's Discussion and Analysis for further discussion.
3 The accident year ratio includes only the losses that occurred during the
period noted. As a result, accident period results will change over time as
our estimates of loss costs improve or deteriorate when payments are made or
reserves for that accident period are reviewed.
Losses and Loss Adjustment Expenses (LAE)
Three Months Ended June 30, Six Months Ended June 30,
(millions) 2012 2011 2012 2011
Change in net loss and LAE reserves $ 198.4 $ 60.0
$ 298.8 $ 34.3
Paid losses and LAE 2,845.3 2,600.9
5,507.3 5,134.7
Total incurred losses and LAE $ 3,043.7 $ 2,660.9
$ 5,806.1$ 5,169.0
Claims costs, our most significant expense, represent payments made, and
estimated future payments to be made, to or on behalf of our policyholders,
including expenses needed to adjust or settle claims. Claims costs are a
function of loss severity and frequency and are influenced by inflation and
driving patterns, among other factors. Accordingly, anticipated changes in these
factors are taken into account when we establish premium rates and loss
reserves. Our estimated needed reserves are adjusted as these underlying
assumptions change.
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Our total loss and loss adjustment expense ratio increased 4.7 points and 3.9
points, respectively, for the three and six month periods ended June 30, 2012,
compared to the same periods in 2011. Unfavorable reserve development in 2012,
compared to favorable development in 2011, contributed to this increase. On an
accident year basis, our companywide loss and loss adjustment expense ratio
increased 2.7 points for the second quarter and 1.0 point year-to-date, compared
to last year, primarily reflecting year-over-year increases in the severity of
personal auto claims for all coverages except comprehensive.
The following discussion of our severity and frequency trends excludes
comprehensive coverage because of its inherent volatility, as it is typically
linked to catastrophic losses generally resulting from adverse weather.
Comprehensive coverage insures against damage to a customer's vehicle due to
various causes other than collision, such as windstorm, hail, theft, falling
objects, and glass breakage.
Total personal auto incurred severity (i.e., average cost per claim, including
both paid losses and the change in reserves) increased about 6% for both the
three months and six months ended June 30, 2012, compared to the prior year
periods. Increases in severity in most of our auto coverages were in the 5%-7%
range, including bodily injury, personal injury protection ("PIP"), property
damage, and collision. In response to the rising severity trends we experienced
in the first half of 2012, we have raised aggregate rates in our personal auto
business nearly 3% year-to-date through June 2012, and implemented rate
increases in about 20 states in July, with more planned throughout the remainder
of the third quarter. It is a challenge to estimate future severity, especially
for bodily injury and PIP claims, but we continue to monitor changes in the
underlying costs, such as medical costs, health care reform, and jury verdicts,
along with regulatory changes, and other factors that may affect severity.
Our incurred frequency of auto accidents, on a calendar year basis, increased
for the second quarter 2012, but remained relatively flat for the first half of
2012, compared to the same periods last year. On a year-over-year basis,
frequency for our collision coverage was up about 1% in the second quarter 2012,
but was down about 5% for the first six months, which is related to the mild
winter weather experienced in the northern states in first quarter 2012.
Frequency in our property damage and PIP coverages increased in the 2%-3% range
for the second quarter and about 0.5% year-to-date 2012. Frequency for our
bodily injury coverage was up about 5%-6% for both periods, compared to 2011.
Despite the year-over-year increases in frequency, our frequency levels are
equivalent to, or lower than, those experienced in the first half of 2010. We
continue to closely monitor the increases in frequency in the second quarter
2012, compared to 2011, but the degree or direction of frequency change is not
something that we are able to predict with any certainty. We will analyze trends
to distinguish changes in our experience from external factors, such as changes
in the number of vehicles per household, miles driven, gasoline prices, greater
vehicle safety, and unemployment rates, versus those resulting from shifts in
the mix of our business, to allow us to reserve more accurately for our loss
exposure.
We experienced severe weather conditions in several areas of the country during
both the second quarter 2012 and 2011. Despite the number of storms being
consistent between the years, the amount of losses incurred was lower this year.
The following table shows catastrophe losses incurred during the periods:
Three Months Ended Six Months Ended
June 30, June 30,
(millions) 2012 2011 2012 2011
Catastrophe losses incurred $ 107.4 $ 124.9 $ 123.4 $ 135.0
Increase to combined ratio 2.7 pts. 3.4 pts. 1.6 pts. 1.8 pts.
We continue to respond promptly to catastrophic storms when they occur in order
to provide exemplary claims service to our customers.
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The table below presents the actuarial adjustments implemented and the loss
reserve development experienced in the following periods:
Three Months Ended Six Months Ended
June 30, June 30,
(millions) 2012 2011 2012 2011
ACTUARIAL ADJUSTMENTS
Reserve decrease/(increase)
Prior accident years $ 7.8 $ 46.4 $ 34.8 $ 92.5
Current accident year (10.3 ) 22.0 (3.2 ) 24.8
Calendar year actuarial adjustment $ (2.5 ) $ 68.4 $ 31.6 $ 117.3
PRIOR ACCIDENT YEARS DEVELOPMENT
Favorable/(Unfavorable)
Actuarial adjustment $ 7.8 $ 46.4 $ 34.8 $ 92.5
All other development (30.6 ) 5.6 (101.9 ) 58.5
Total development $ (22.8 ) $ 52.0 $ (67.1 ) $ 151.0
(Increase)/decrease to calendar year
combined ratio (.6 )pts. 1.4pts. (.9 )pts. 2.0pts.
Total development consists of both actuarial adjustments and "all other
development." The actuarial adjustments represent the net changes made by our
actuarial department to both current and prior accident year reserves based on
regularly scheduled reviews. Through these reviews, our actuaries identify and
measure variances in the projected frequency and severity trends, which allows
them to adjust the reserves to reflect the current costs. We report these
actuarial adjustments separately for the current and prior accident years to
reflect these adjustments as part of the total prior accident years'
development.
"All other development" represents claims settling for more or less than
reserved, emergence of unrecorded claims at rates different than anticipated in
our incurred but not recorded (IBNR) reserves, and changes in reserve estimates
on specific claims. Although we believe that the development from both the
actuarial adjustments and "all other development" generally results from the
same factors, as discussed below, we are unable to quantify the portion of the
reserve development that might be applicable to any one or more of those
underlying factors.
Our objective is to establish case and IBNR reserves that are adequate to cover
all loss costs, while incurring minimal variation from the date that the
reserves are initially established until losses are fully developed. As
reflected in the table above, we experienced unfavorable development in the
first six months of 2012, compared to favorable development for the same period
in 2011.
Year-to-date 2012
• The majority of the unfavorable reserve development was attributable to
accident year 2011; the aggregate reserve development for accident years
2009 and prior was favorable.
• Nearly 80% of our unfavorable reserve development was in our Personal
Lines Agency business, with the remainder primarily in our Commercial Auto
business.
• The Personal Lines development reflected unfavorable reserve development
in our personal auto business, including IBNR reserves in the bodily
injury and property damage coverages, reflecting more late emerging claims
than expected, as well as higher severity on those late emerging claims in
the property damage coverage. We also had unfavorable reserve development
in Florida in our PIP coverage. In addition, our estimates of bodily
injury severity for accident years 2011 and 2010 increased over 2% and
about 0.5%, respectively, contributing to the total unfavorable
development for 2012.
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Year-to-date 2011
• Nearly half of the favorable prior year reserve development was
attributable to accident year 2010, while the remainder was primarily
related to accident years 2008 and prior.
• Approximately 70% of our favorable reserve development was in our Personal
Lines business, with our Agency and Direct channels contributing about 25%
and 75%, respectively.
• The reserve development reflected favorable settlement of claims with high limits (e.g., claims settling for less than reserved) and favorable
development of our defense and cost containment expense reserves,
primarily reflecting a greater percentage of litigated claims being
handled in a more cost-effective manner by our in-house counsel. We also
experienced favorable development in our collision reserves, due to an increase in the amount of salvage recovered, and in our PIP reserves,
reflecting a reduction in severity costs, due to changes in our mix of
business by policy limits and coverages. In contrast, our IBNR reserves
developed unfavorably due to an increase in the number of late emerging
claims.
We continue to focus on our loss reserve analysis, attempting to enhance
accuracy and to further our understanding of our loss costs. A detailed
discussion of our loss reserving practices can be found in our Report on Loss
Reserving Practices, which was filed in a Form 8-K on June 30, 2011.
Underwriting Expenses
Progressive's other underwriting expenses and policy acquisition costs as a
percentage of premiums earned decreased 0.5 points for the second quarter 2012
and remained relatively unchanged for the first six months of 2012, compared to
the same periods last year.
C. Personal Lines
Growth over prior year
Quarter Year-to-date
Net premiums written 7 % 6 %
Net premiums earned 7 % 6 %
Policies in force (at June 30) 6 %
Progressive's Personal Lines business writes insurance for personal autos and
recreational vehicles and represented 89% of our total net premiums written in
both the second quarter and first six months of 2012 and in the second quarter
2011, compared to 90% for the first six months of 2011. We currently write our
Personal Lines products in all 50 states. We also offer our personal auto
product (not special lines products) in the District of Columbia and on an
Internet-only basis in Australia.
Personal auto represented 86% and 90% of our total Personal Lines net premiums
written in the second quarter and first six months of 2012, respectively,
compared to 86% and 89%, respectively, for the corresponding periods in 2011.
These auto policies are primarily written for 6-month terms. The remaining
Personal Lines business is comprised of special lines products (e.g.,
motorcycles, watercraft, and RVs), which are written for 12-month terms.
Compared to June 30, 2011, policies in force grew 6% for auto and 5% for special
lines products. In addition, on a year-over-year basis, for the second quarter
and first six months of 2012, net premiums written increased 8% and 7%,
respectively, for auto, and net premiums written for our special lines products
increased 2% in both periods.
Our total Personal Lines business generated combined ratios of 98.0 and 96.1 for
the second quarter and first six months of 2012, respectively, compared to 93.7
and 92.1, respectively, last year. In the second quarter 2012, 37 states and the
District of Columbia were profitable, including 8 of our 10 largest states; 45
states and the District of Columbia were profitable year-to-date 2012, including
9 of 10 of our largest states. The special lines products had an unfavorable
impact on the total Personal Lines combined ratio for the second quarter 2012
and 2011 of 0.3 points and 0.5 points, respectively, compared to a favorable
effect of 1.2 points and 1.3 points for the first six months of 2012 and 2011,
respectively. The special lines products are typically used more during the
warmer weather months and, therefore, historically our Personal Lines combined
ratio is higher during the second and third quarters.
The Personal Lines business is comprised of the Agency business and the Direct
business.
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The Agency Business
Growth over prior year
Quarter Year-to-date
Net premiums written 6 % 6 %
Net premiums earned 6 % 5 % Auto: policies in force (at June 30)
6 %
new applications 7 % 8 %
renewal applications 5 % 4 % written premium per policy 1 %
1 %
policy life expectancy (at June 30)
6 %
The Agency business includes business written by more than 35,000 independent
insurance agencies that represent Progressive, as well as brokerages in New York
and California. On a year-over-year basis, for both the three- and six-month
periods ended June 30, 2012, we generated new Agency auto application growth in
26 states and the District of Columbia; 5 of our top 10 Agency auto states
experienced an increase for the quarter and 4 of our top 10 experienced an
increase year to date. For both the second quarter and first six months of 2012,
as compared to the same periods last year, written premium per policy for Agency
auto increased 1%-2% for both new and renewal business. The increase in
retention in our Agency auto business (measured by policy life expectancy) in
part reflects changes in our state mix, payment mix, and rate level
competitiveness.
On a year-over-year basis, we saw an increase in Agency auto quotes in both the
second quarter and first six months of 2012, reflecting solid increases in
quoting on third-party comparative rating systems. We strive to continually
improve our presentation on these systems and identify opportunities to ensure
our prices are available for our agents, including efforts to make agent quoting
and servicing available on tablet computers. Our Agency auto rate of conversion
(i.e., converting a quote to a sale) increased modestly for both the second
quarter and first six months of 2012 over the same periods last year.
The Direct Business
Growth over prior year
Quarter Year-to-date
Net premiums written 7 % 7 %
Net premiums earned 8 % 7 %
Auto: policies in force (at June 30)
7 %
new applications 1 % 2 %
renewal applications 7 % 7 % written premium per policy 1 %
1 %
policy life expectancy (at June 30)
0 %
The Direct business includes business written directly by Progressive online and
over the phone. For the second quarter 2012, we experienced a year-over-year
increase in new Direct auto applications in 24 states; 4 of our top 10 Direct
auto states experienced an increase. On a year-to-date basis, the Direct auto
business had new application growth in 25 states, including 6 of our top 10
states.
Written premium per policy for total Direct auto increased about 1% for both the
three- and six-month periods ended June 30, 2012, compared to the same periods
last year, driven by an increase of about 4% for new business in both periods;
written premium per policy was relatively flat for renewal business.
Direct business quotes decreased 3% and 4% for the second quarter and first six
months of 2012, respectively, driven by decreases in Internet quotes. Quotes
generated via the phone slightly increased for both the second quarter and first
six months of 2012. Quotes that initially begin on a mobile device may be
completed on the phone, which partially explains the decrease in Internet quotes
and the increase in phone quotes. The overall Direct business conversion rate
increased modestly for the second quarter 2012 and had a solid increase for the
first six months of 2012, compared to the same periods last year, reflecting
increases in conversion rates for both Internet-initiated business and business
initiated over the phone.
We remain focused on establishing a well-respected brand and added to our
inventory of television commercials and Internet advertising. We continue to use
"Flo" and the "Superstore" to provide fresh and engaging messages, and have used
a complementary campaign with the "Messenger" to supplement our advertising
initiatives. In addition, during 2012, we have continued to invest in the
infrastructure of both our mobile capabilities and our usage-based insurance
products.
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D. Commercial Auto
Growth over prior year
Quarter Year-to-date
Net premiums written 15 % 14 %
Net premiums earned 13 % 11 %
Policies in force (at June 30) 3 %
New applications 6 % 7 %
Renewal applications 0 % (1 )%
Written premium per policy 10 % 10 %
Policy life expectancy (at June 30) 1 %
Progressive's Commercial Auto business writes primary liability, physical
damage, and other auto-related insurance for automobiles and trucks owned by
small businesses, with the majority of our customers insuring three or fewer
vehicles. For both the second quarter and first six months of 2012, our
Commercial Auto business represented 11% of our total net premiums, compared to
11% and 10%, respectively, for the same periods last year. This business is
primarily distributed through independent agents and operates in the following
business market targets:
• Business auto - autos, vans, and pick-up trucks used by small businesses,
such as retailing, farming, services, and private trucking
• For-hire transportation - tractors, trailers, and straight trucks primarily used by regional general freight and expeditor-type businesses
and non-fleet long-haul operators
• Contractor - vans, pick-up trucks, and dump trucks used by small
businesses, such as artisan contractors, heavy construction, and
landscapers/snowplowers
• For-hire specialty - dump trucks, log trucks, and garbage trucks used by
dirt, sand and gravel, logging, and coal-type businesses, and
• Tow - tow trucks and wreckers used in towing services and gas/service
station businesses.
Business auto and for-hire transportation are the two largest Commercial Auto
business market targets measured by premium volume, and together account for
approximately 60% of our total Commercial Auto premiums and approximately 55% of
the vehicles we insure in this business. We currently write our Commercial Auto
business in 49 states; we do not write Commercial Auto in Hawaii or the District
of Columbia. The majority of our policies in this business are written for
12-month terms.
Our Commercial Auto business generated double digit growth in net premiums
written for both the second quarter and first six months of 2012, compared to
last year, continuing the growth we began to see in the second half of 2011 and
showing encouraging signs of possible recovery from the economic downturn that
has significantly impacted this business over the last several years. The growth
in net premiums written for the second quarter and year-to-date 2012 was driven
by 6%-7% increases in new applications and 10% increases in written premium per
policy. We have been increasing rates in our Commercial Auto business since the
beginning of 2011 and into 2012 and continued to see shifts in our mix of
business toward business market targets with higher average premium.
E. Other Indemnity
Our other indemnity businesses consist of managing our run-off businesses, which
include the run-off of our professional liability businesses. As of April 30,
2012, we are no longer writing any new professional liability business; the
business written for these products during 2012 and 2011 was 100% reinsured.
F. Service Businesses
Our service businesses, which represent less than 1% of our total revenues and
do not have a material effect on our overall operations, primarily include:
• Commercial Auto Insurance Procedures/Plans (CAIP)-We are the only
servicing carrier on a nationwide basis for CAIP, which are
state-supervised plans servicing the involuntary market. As a service
provider, we provide policy issuance and claims adjusting services and
collect fee revenue that is earned on a pro rata basis over the terms of
the related policies.
• Progressive Home Advantage®-Through Progressive Home Advantage, we offer, either directly or through our network of independent agents, new and
existing Agency and Direct customers home, condominium, and renters insurance underwritten by unaffiliated homeowner's insurance companies.
Progressive Home Advantage is not available to customers in Florida and
Alaska. For the policies written under this program in our Direct
business, we receive commissions, all of which are used to offset the
expenses associated with maintaining this program.
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• Progressive Commercial AdvantageSM-We currently offer our Commercial Auto
customers the ability to package their auto coverage with other commercial
coverages that are underwritten by four unaffiliated insurance companies
or placed with other companies through an unaffiliated agency. This
program offers general liability coverage in 49 states and workers'
compensation coverage in 14 states as of June 30, 2012. We receive
commissions for the policies written under this program, all of which are
used to offset the expenses associated with maintaining the program.
Our service businesses generated an operating profit of $0.3 million for both
the second quarter and first six months of 2012, compared to an operating profit
of $1.2 million and $2.4 million for the same periods last year.
G. Income Taxes
As reported in the balance sheets, income taxes are comprised of net current
income taxes payable/recoverable and net deferred tax assets and liabilities. A
deferred tax asset/liability is a tax benefit/expense that is expected to be
realized in a future tax return. At June 30, 2012 and 2011, and at December 31,
2011, our income taxes were in a net asset position.
Our net deferred tax asset was $127.0 million at June 30, 2012, compared to
$98.9 million at June 30, 2011, and $196.0 million at December 31, 2011. The
increase in our net deferred tax asset since June 30, 2011, is primarily due to
the increase in our unearned premium reserve, a portion of which is not
currently deductible for tax purposes, while the decrease since December 31,
2011 is mostly attributable to the increase in unrealized gains that occurred in
our investment portfolio. At June 30, 2012 and 2011, and at December 31, 2011,
we determined that we did not need a valuation allowance on our deferred tax
asset. Although realization of the deferred tax asset is not assured, management
believes it is more likely than not that the gross deferred tax asset will be
realized based on our expectation that we will be able to fully utilize the
deductions that are ultimately recognized for tax purposes.
There were no material changes in our uncertain tax positions during the quarter
ended June 30, 2012.
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IV. RESULTS OF OPERATIONS-INVESTMENTS
A. Portfolio Allocation
The composition of the investment portfolio was:
% of
Total Duration
($ in millions) Fair Value Portfolio (years) Rating1
June 30, 2012
Fixed maturities $ 12,075.9 72.7 % 2.2 AA-
Nonredeemable preferred stocks 799.3 4.8 1.0 BBB-
Short-term investments-other 1,679.2 10.1 <1 AA+
Total fixed-income securities 14,554.4 87.6 1.9 AA-
Common equities 2,055.1 12.4 na na
Total portfolio2,3 $ 16,609.5 100.0 % 1.9 AA-
June 30, 2011
Fixed maturities $ 11,788.5 73.5 % 2.2 AA
Nonredeemable preferred stocks 1,029.7 6.4 1.0 BBB-
Short-term investments-other 1,343.5 8.4 <1 AAA-
Total fixed-income securities 14,161.7 88.3 2.0 AA-
Common equities 1,867.9 11.7 na na
Total portfolio2,3 $ 16,029.6 100.0 % 2.0 AA-
December 31, 2011
Fixed maturities $ 11,759.3 73.6 % 2.1 AA-
Nonredeemable preferred stocks 806.3 5.1 1.1 BBB-
Short-term investments-other 1,551.8 9.7 <1 AA+
Total fixed-income securities 14,117.4 88.4 1.9 AA-
Common equities 1,845.6 11.6 na na
Total portfolio2,3 $ 15,963.0 100.0 % 1.9 AA-
na = not applicable
1 Represents ratings at period end. Credit quality ratings are assigned by
nationally recognized securities rating organizations. To calculate the
weighted average credit quality ratings, we weight individual securities
based on fair value and assign a numeric score of 0-5, with
non-investment-grade and non-rated securities assigned a score of 0-1. To the
extent the weighted average of the ratings falls between AAA and AA+, we
assign an internal rating of AAA-.
2 At June 30, 2012, we had $15.5 million of net unsettled security transactions
included in other liabilities, compared to $7.1 million and $46.9 million
included in other assets at June 30, 2011 and December 31, 2011,
respectively.
3 The total fair value of the portfolio at June 30, 2012 and 2011, and December 31, 2011 included $1.4 billion, $1.6 billion, and $2.0 billion,
respectively, of securities held in a consolidated, non-insurance subsidiary
of the holding company, net of any unsettled security transactions.
Our asset allocation strategy is to maintain 0-25% of our portfolio in Group I
securities, with the balance (75%-100%) of our portfolio in Group II securities,
as defined in the Overview - Investments and Capital Management section and as
reflected in the following tables. We believe this asset allocation strategy
allows us to accurately assess the risks associated with these securities for
capital purposes and is in line with the treatment by our regulators.
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The following tables show the composition of our Group I and Group II securities
at June 30, 2012 and 2011, and December 31, 2011:
% of
Total
($ in millions) Fair Value Portfolio
June 30, 2012
Group I securities:
Non-investment-grade fixed maturities $ 391.0 2.3 %
Redeemable preferred stocks1 290.8 1.8
Nonredeemable preferred stocks 799.3 4.8
Common equities 2,055.1 12.4
Total Group I securities 3,536.2 21.3
Group II securities:
Other fixed maturities2 11,394.1 68.6
Short-term investments - other 1,679.2 10.1
Total Group II securities 13,073.3 78.7
Total portfolio $ 16,609.5 100.0 %
June 30, 2011
Group I securities:
Non-investment-grade fixed maturities $ 454.6 2.8 %
Redeemable preferred stocks1 335.6 2.1
Nonredeemable preferred stocks 1,029.7 6.4
Common equities 1,867.9 11.7
Total Group I securities 3,687.8 23.0
Group II securities:
Other fixed maturities2 10,998.3 68.6
Short-term investments - other 1,343.5 8.4
Total Group II securities 12,341.8 77.0
Total portfolio $ 16,029.6 100.0 %
December 31, 2011
Group I securities:
Non-investment-grade fixed maturities $ 384.4 2.4 %
Redeemable preferred stocks1 287.8 1.8
Nonredeemable preferred stocks 806.3 5.1
Common equities 1,845.6 11.6
Total Group I securities 3,324.1 20.9
Group II securities:
Other fixed maturities2 11,087.1 69.4
Short-term investments - other 1,551.8 9.7
Total Group II securities 12,638.9 79.1
Total portfolio $ 15,963.0 100.0 %
1 Includes non-investment-grade redeemable preferred stocks of $208.2 million,
$216.1 million, and $201.7 million at June 30, 2012 and 2011, and
December 31, 2011, respectively.
2 Includes investment-grade redeemable preferred stocks, with cumulative
dividends of $82.6 million, $119.5 million, and $86.1 million at June 30,
2012 and 2011, and December 31, 2011, respectively.
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Unrealized Gains and Losses
As of June 30, 2012, our portfolio had pretax net unrealized gains, recorded as
part of accumulated other comprehensive income, of $1,283.5 million, compared to
$1,304.9 million and $1,050.5 million at June 30, 2011 and December 31, 2011,
respectively.
Since December 31, 2011, the net unrealized gains in our fixed-income and common
stock portfolios increased $87.4 million and $145.6 million, respectively,
primarily due to spread tightening (i.e., a decrease in the risk premium paid
above the comparable Treasury rate) in some fixed-income sectors and positive
returns in the equity market. Since June 30, 2011, our fixed-income portfolio's
net unrealized gains decreased $93.5 million, reflecting sales of our
fixed-income securities over the last 12 months, primarily in our nonredeemable
preferred stocks. The net unrealized gains in our common stock portfolio
increased $72.1 million over the same time period, reflecting positive returns
in the broad equity market.
See Note 2-Investments for a further break-out of our gross unrealized gains and
losses.
Fixed-Income Securities
The fixed-income portfolio is managed internally and includes fixed-maturity
securities, short-term investments, and nonredeemable preferred stocks.
The fixed-maturity securities (including redeemable preferred stocks) and
short-term securities, as reported on the balance sheets, were comprised of the
following:
June 30, 2012 June 30, 2011 December 31, 2011
% of % of % of
($ in millions) Fair Value Total Fair Value Total Fair Value Total
Investment-grade fixed maturities:1
Short/intermediate term
$ 12,957.7 94.2 % $
12,238.6 93.2 % $ 12,539.3 94.2 %
Long term
47.2 .3 54.7 .4 55.7 .4
Non-investment-grade fixed maturities2 750.2 5.5
838.7 6.4 716.1 5.4
Total $ 13,755.1 100.0 % $ 13,132.0 100.0 % $ 13,311.1 100.0 %
1 Long term includes securities with expected liquidation dates of 10 years or
greater. Asset-backed securities are reported at their weighted average
maturity based upon their projected cash flows. All other securities that do
not have a single expected maturity date are reported at average maturity.
2 Non-investment-grade fixed-maturity securities are non-rated or have a
quality rating of an equivalent BB+ or lower, classified by the lowest rating
from a nationally recognized rating agency.
A primary exposure for the fixed-income portfolio is interest rate risk, which
is managed by maintaining the portfolio's duration between 1.5 and 5 years.
Interest rate risk includes the change in value resulting from movements in the
underlying market rates of debt securities held. The duration of the
fixed-income portfolio was 1.9 years at June 30, 2012, compared to 2.0 years at
June 30, 2011 and 1.9 years at December 31, 2011. The distribution of duration
and convexity (i.e., a measure of the speed at which the duration of a security
is expected to change based on a rise or fall in interest rates) is monitored on
a regular basis.
The duration distribution of our fixed-income portfolio, represented by the
interest rate sensitivity of the comparable benchmark U.S. Treasury Notes, was:
Duration Distribution June 30, 2012 June 30, 2011 December 31, 2011
1 year 27.4 % 20.4 % 22.6 %
2 years 21.2 19.5 22.3
3 years 27.9 31.7 31.5
5 years 19.1 26.7 20.8
10 years 4.4 1.7 2.8
Total fixed-income portfolio 100.0 % 100.0 % 100.0 %
Another primary exposure related to the fixed-income portfolio is credit risk.
This risk is managed by maintaining an A+ minimum average portfolio credit
quality rating, as defined by nationally recognized rating agencies.
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The credit quality distribution of the fixed-income portfolio was:
Rating June 30, 2012 June 30, 2011 December 31, 2011
AAA 53.0 % 54.8 % 53.6 %
AA 14.4 10.8 13.4
A 5.6 8.1 5.1
BBB 19.8 18.0 21.3
Non-rated/other 7.2 8.3 6.6
Total fixed-income portfolio 100.0 % 100.0 % 100.0 %
Our portfolio is also exposed to concentration risk. Our investment constraints
limit investment in a single issuer, other than U.S. Treasury Notes or a state's
general obligation bonds, to 2.5% of shareholders' equity, while the single
issuer guideline on preferred stocks and/or non-investment-grade debt is 1.25%
of shareholders' equity. Additionally, the guideline applicable to any state's
general obligation bonds is 6% of shareholders' equity. As of June 30, 2012, the
investment portfolio slightly exceeded the 1.25% limitation on a preferred stock
position due to an increase in fair value. We determined that no corrective
action was required at this time, but that we should continue to monitor closely
the performance of this preferred stock position. Our credit risk guidelines
limit single issuer exposure; however, we also consider sector concentration a
risk, and we frequently evaluate the portfolio's sector allocation with regard
to internal requirements and external market factors. We consider concentration
risk in the context of asset classes, including but not limited to common
equities, residential and commercial mortgage-backed securities, municipal
bonds, and high-yield bonds.
We monitor prepayment and extension risk, especially in our structured product
and preferred stock portfolios. Prepayment risk includes the risk of early
redemption of security principal that may need to be reinvested at less
attractive rates. Extension risk includes the risk that a security will not be
redeemed when anticipated, and that the security that is extended has a lower
yield than a security we might be able to obtain by reinvesting the expected
redemption principal. Our holdings of different types of structured debt and
preferred securities, which are discussed in more detail below, help minimize
this risk. During the first six months of 2012, we did not experience
significant prepayment or extension of principal relative to our cash flow
expectations in the portfolio.
The pricing on the majority of our preferred stocks continues to reflect
expectations that many issuers will not call such securities on the first call
date, and hence reflects an assumption that the securities will remain
outstanding for a period of time beyond such initial call date (extension risk).
Post the call date, the coupons on these securities convert from a fixed-rate
coupon to a variable-rate coupon. The variable-rate coupon is determined by
adding a benchmark interest rate, which is reset quarterly to a credit spread
premium that was fixed when the security was first issued. Extension risk on
holding this security is limited to the credit risk premium being below that of
a new similar security since the benchmark variable rate portion of the
security's coupon adjusts for movements in interest rates. Reinvestment risk is
similarly limited to receiving a below market level coupon for the credit risk
premium portion of a similar security as the benchmark variable interest rate
adjusts for changes in short-term interest rate levels. One nonredeemable
preferred stock had its first call date during the second quarter of 2012; this
security was not called.
We also face the risk that our preferred stock dividend payments could be
deferred for one or more periods. As of June 30, 2012, all of our preferred
securities continued to pay their dividends in full and on time.
Liquidity risk is another risk factor we monitor. Our overall portfolio remains
very liquid and is sufficient to meet expected liquidity requirements. As of
June 30, 2012 and 2011 and December 31, 2011, we held $4.6 billion, $4.3
billion, and $4.5 billion, respectively, of U.S. Treasury and short-term
securities. The short-to-intermediate duration of our portfolio provides an
additional source of liquidity, as we expect approximately $0.9 billion, or 9%,
of our fixed-income portfolio, excluding U.S. Treasury Notes and short-term
investments, to repay principal during the remainder of 2012. Cash from interest
and dividend payments provides an additional source of recurring liquidity.
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Included in the fixed-income portfolio are U.S. government obligations, which
include U.S. Treasury Notes and interest rate swaps. Although the interest rate
swaps are not obligations of the U.S. government, they are recorded in this
portfolio as the change in fair value is correlated to movements in the U.S.
Treasury market. The duration of these securities was comprised of the following
at June 30, 2012:
Fair Duration
($ in millions) Value (years)
U.S. Treasury Notes
Less than two years $ 861.5 1.7
Two to five years 2,077.1 3.5
Total U.S. Treasury Notes 2,938.6
3.0
Interest Rate Swaps
Two to five years ($900 notional value) 0
(4.2 )
Five to nine years ($363 notional value) 0
(6.8 )
Total interest rate swaps ($1,263 notional value) 0
(5.0 )
Total U.S. government obligations $ 2,938.6 .9
The interest rate swap positions show a fair value of zero as they are in an
overall liability position of $91.5 million, which is fully funded through
collateral payments to the counterparty; the liability is reported in the "other
liabilities" section of the Consolidated Balance Sheets. The negative duration
of the interest rate swaps is due to the positions being short interest-rate
exposure (i.e., receiving a variable-rate coupon). In determining duration, we
add the interest rate sensitivity of our interest rate swap positions to that of
our Treasury holdings, but do not add the notional value of the swaps to our
Treasury holdings in order to calculate an unlevered duration for the portfolio.
ASSET-BACKED SECURITIES
Included in the fixed-income portfolio are asset-backed securities, which were
comprised of the following at the balance sheet dates listed:
% of
Fair Net Unrealized Asset-Backed Duration Rating
($ in millions) Value Gains (Losses) Securities (years) (at period end)
June 30, 2012
Prime collateralized mortgage
obligations $ 199.1 $ .5 5.3 % 2.1 A-
Alt-A collateralized mortgage
obligations 42.2 2.3 1.1 1.7 A-
Subtotal collateralized
mortgage obligations 241.3 2.8 6.4 2.0 A-
Commercial mortgage-backed
securities 1,855.3 63.7 49.1 2.4 AA+
Commercial mortgage-backed
securities: interest-only 238.2 9.6 6.3 1.9 AAA-
Subtotal commercial
mortgage-backed securities 2,093.5 73.3 55.4 2.3 AA+
Other asset-backed securities:
Automobile 653.1 6.3 17.3 1.2 AAA
Credit card 157.2 4.2 4.1 1.0 AAA
Home equity (sub-prime bonds) 180.3 (10.4 ) 4.8 <.1 BBB+
Other1 453.7 3.0 12.0 1.0 AAA-
Subtotal other asset-backed
securities 1,444.3 3.1 38.2 .9 AA+
Total asset-backed securities $ 3,779.1 $ 79.2 100.0 % 1.8 AA+
42
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% of
Fair Net Unrealized Asset-Backed Duration Rating
($ in millions) Value Gains (Losses) Securities (years) (at period end)
June 30, 2011
Prime collateralized mortgage
obligations $ 300.7 $ (7.4 ) 8.2 % 1.5 A-
Alt-A collateralized mortgage
obligations 46.5 1.7 1.3 1.7 A-
Subtotal collateralized
mortgage obligations 347.2 (5.7 ) 9.5 1.5 A-
Commercial mortgage-backed
securities 1,505.4 45.3 41.1 2.4 AA+
Commercial mortgage-backed
securities: interest-only 307.0 11.5 8.4 1.1 AAA-
Subtotal commercial
mortgage-backed securities 1,812.4 56.8 49.5 2.2 AA+
Other asset-backed securities:
Automobile 787.0 8.3 21.5 1.3 AAA
Credit card 157.2 3.8 4.3 1.7 AAA
Home equity (sub-prime bonds) 172.7 (11.4 ) 4.7 .3 BBB+
Other1 383.5 2.1 10.5 1.3 AAA-
Subtotal other asset-backed
securities 1,500.4 2.8 41.0 1.2 AAA-
Total asset-backed securities $ 3,660.0 $ 53.9 100.0 % 1.7 AA+
% of
Fair Net Unrealized Asset-Backed Duration Rating
($ in millions) Value Gains (Losses) Securities (years) (at period end)
December 31, 2011
Prime collateralized mortgage
obligations $ 228.6 $ (9.6 ) 6.5 % 1.2 A
Alt-A collateralized mortgage
obligations 43.2 .9 1.2 2.1 A-
Subtotal collateralized
mortgage obligations 271.8 (8.7 ) 7.7 1.3 A-
Commercial mortgage-backed
securities 1,595.7 39.8 45.3 2.4 AA+
Commercial mortgage-backed
securities: interest-only 280.9 7.0 8.0 1.6 AAA-
Subtotal commercial
mortgage-backed securities 1,876.6 46.8 53.3 2.2 AA+
Other asset-backed securities:
Automobile 682.6 5.1 19.4 1.3 AAA
Credit card 157.2 4.0 4.4 1.4 AAA
Home equity (sub-prime bonds) 155.1 (17.3 ) 4.4 <.1 A-
Other1 380.8 .9 10.8 1.1 AAA-
Subtotal other asset-backed
securities 1,375.7 (7.3 ) 39.0 1.1 AAA-
Total asset-backed securities $ 3,524.1 $ 30.8 100.0 % 1.7 AA+
1 Includes equipment leases, manufactured housing, and other types of
structured debt.
Substantially all of the asset-backed securities have widely available market
quotes. As of June 30, 2012, approximately 6% of our asset-backed securities are
exposed to non-prime mortgage loans (home equity and Alt-A). Consistent with our
plan to add high-quality, short-maturity, fixed-income securities, we continue
to purchase investment-grade structured securities, primarily in the commercial
mortgage-backed and consumer asset-backed markets. These investments typically
have a maturity profile of five years or less, and have substantial structural
credit support (i.e., the amount of underlying principal balance that is
available to absorb losses before our position begins to recognize losses due to
further defaults). We reviewed all of our asset-backed securities for
other-than-temporary impairment (OTTI) and yield or asset valuation adjustments
under current accounting guidance, and we realized $0.5 million and $1.1 million
of OTTI losses during the second quarter and first six months of 2012,
respectively, compared to $2.2 million and $3.2 million during the second
quarter and first six months of 2011, respectively.
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Collateralized Mortgage Obligations At June 30, 2012, 6.4% of our asset-backed
securities were collateralized mortgage obligations (CMO), which are a component
of our residential mortgage-backed securities. During the second quarter and
first six months of 2012, we recorded $0.4 million and $0.8 million,
respectively, of credit loss write-downs on our CMO portfolio due to estimated
principal losses in our most recent cash flow projections, including $0.1
million of Alt-A securities during the second quarter of 2012. During the second
quarter and first six months of 2011, we recorded $2.0 million and $2.6 million,
respectively, of write-downs. We did not have any write-downs on Alt-A
securities during 2011. The following table details the credit quality rating
and fair value of our collateralized mortgage obligations, along with the loan
classification and comparison of the fair value at June 30, 2012 to our original
investment value (adjusted for returns of principal, amortization, and
write-downs):
Collateralized MortgageObligations (at June 30, 2012)
% of
Collateralized
($ in millions) Non-Investment Mortgage
Category AAA AA A BBB Grade Total Obligations
Non-agency prime $ 68.5 $ 7.9 $ 16.2 $ 11.7 $ 80.6 $ 184.9 76.6 %
Alt-A .7 24.1 0 0 17.4 42.2 17.5
Government/GSE1 9.3 2.1 0 0 2.8 14.2 5.9
Total fair value $ 78.5 $ 34.1 $ 16.2 $ 11.7 $ 100.8 $ 241.3 100.0 %
Increase (decrease) in value 1.0 % 1.6 % (3.2 )% (2.2 )% 2.2 % 1.2 %
1 The securities in this category are insured by a Government Sponsored Entity
(GSE) and/or collateralized by mortgage loans insured by the Federal Housing
Administration (FHA) or the U.S. Department of Veteran Affairs (VA).
Commercial Mortgage-Backed Securities At June 30, 2012, 49.1% of our
asset-backed securities were commercial mortgage-backed securities (CMBS) and
6.3% were CMBS interest-only securities (IO). During the six months ended
June 30, 2012, we recorded $0.1 million in write-downs on our IO portfolio,
compared to $0.2 million and $0.6 million during the three and six months ended
June 30, 2011, respectively. No write-downs were recorded on our CMBS portfolio
during the same periods. The following table details the credit quality rating
and fair value of our CMBS and IO portfolios:
Commercial Mortgage-Backed Securities (at June 30,2012)
% of
($ in millions) Non-Investment Total
Category AAA AA A BBB Grade Total Exposure
CMBS $ 1,373.2 $ 190.0 $ 117.2 $ 144.8 $ 30.1 $ 1,855.3 88.6 %
IO 221.6 8.9 0 .7 7.0 238.2 11.4
Total fair value $ 1,594.8 $ 198.9 $ 117.2 $ 145.5 $ 37.1 $ 2,093.5 100.0 %
% of Total fair value 76.2 % 9.5 % 5.6 % 6.9 % 1.8 % 100.0 %
44
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The CMBS portfolio contained 9.4% of securities that are rated BBB or lower,
with a net unrealized gain of $10.6 million at June 30, 2012, and an average
duration of 1.2 years, compared to 2.4 years for the entire CMBS portfolio. The
BBB and non-investment-grade exposure includes $81.6 million of cell tower
securitizations; all of these bonds have a single borrower, are backed by a
cross-collateralized pool of cell towers throughout the U.S., and have
significant net cash flow relative to their interest payments. Approximately
22.2% of our CMBS portfolio was originated from 2005 to 2007, a period in which
the CMBS market saw more aggressive underwriting as reflected in the table
below:
CMBS Portfolio (at June 30, 2012)
($ in millions)
Vintage Agency Cell Tower Multi-Borrower Single-Borrower Total
1997 $ 0 $ 0 $ 23.5 $ 0 $ 23.5
2001 0 0 5.3 0 5.3
2002 0 0 89.7 0 89.7
2003 0 0 309.2 0 309.2
2004 0 0 277.0 0 277.0
2005 0 0 247.4 10.3 257.7
2006 0 0 10.6 11.7 22.3
2007 0 81.6 0 49.4 131.0
2009 0 0 0 29.0 29.0
2010 12.6 0 32.3 44.1 89.0
2011 0 0 350.9 87.1 438.0
2012 0 0 79.1 104.5 183.6
Total $ 12.6 $ 81.6 $ 1,425.0 $ 336.1 $ 1,855.3
Planned amortization class IOs comprised 48.0% of our $238.2 million IO
portfolio. This is a class that is structured to provide bondholders with
greater protection against loan prepayment, default, or extension risk. The
bonds are at the top of the payment order for interest distributions and benefit
from increased structural support over time as they repay. With the exception of
$104.8 million in Freddie Mac senior multi-family IOs, we have no multi-borrower
deal IOs originated after 2006.
Home-Equity Securities At June 30, 2012, 4.8% of our asset-backed securities
were home-equity securities, which are a component of our residential
mortgage-backed securities. For the three and six months ended June 30, 2012, we
recorded $0.1 million and $0.2 million, respectively, in write-downs; no
write-downs were recorded during the same periods last year. The following table
shows the credit quality rating of our home-equity securities, by deal
origination year, along with a comparison of the fair value at June 30, 2012, to
our original investment value (adjusted for returns of principal, amortization,
and write-downs):
Home-Equity Securities (at June 30, 2012)
% of
Deal Origination Year Home-
($ in millions) Equity
Rating (date acquired) 2007 2006
2005 2004 Total Securities
AAA (January 2008-February 2011)
$ 0 $ 0 $ 33.4 $ 0 $ 33.4 18.5 %
AA (February 2008-April 2010) 0 0 8.7 3.2 11.9 6.6
A (March 2008- December 2011) 0 8.2 18.9 0 27.1 15.0
BBB (January 2012-May 2012) 0 12.7 0 11.4 24.1 13.4
Non-investment grade (March 2007-March 2012) .2 33.8 39.9 9.9 83.8 46.5
Total $ .2 $ 54.7 $ 100.9 $ 24.5 $ 180.3 100.0 %
Increase (decrease) in value (14.9 )% 3.4 % (10.9 )% 1.0 % (5.4 )%
45
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MUNICIPAL SECURITIES
Included in the fixed-income portfolio at June 30, 2012 and 2011 and
December 31, 2011, were $1,977.6 million, $1,857.4 million, and $2,002.1
million, respectively, of state and local government obligations. These
securities had a duration of 2.9 years and an overall credit quality rating of
AA+ (excluding the benefit of credit support from bond insurance) at June 30,
2012, compared to 2.3 years and AA+ at June 30, 2011, and 2.6 years and AA+ at
December 31, 2011. These securities had a net unrealized gain of $50.7 million
at June 30, 2012, compared to $44.7 million and $63.5 million at June 30, 2011
and December 31, 2011, respectively. During the three and six months ended
June 30, 2012 and 2011, we did not record any write-downs on our municipal
portfolio. The following table details the credit quality rating of our
municipal securities at June 30, 2012, without the benefit of credit or bond
insurance:
Municipal Securities (at June 30, 2012)
(millions) General Revenue
Rating Obligations Bonds Total
AAA $ 240.6 $ 634.7 $ 875.3
AA 475.5 541.6 1,017.1
A 33.5 11.1 44.6
BBB 1.5 33.8 35.3
Other1 0 5.3 5.3
Total $ 751.1 $ 1,226.5 $ 1,977.6
1 Includes non-investment-grade and non-rated securities.
Included in revenue bonds were $905.3 million of single family housing revenue
bonds issued by state housing finance agencies, of which $425.1 million were
supported by individual mortgages held by the state housing finance agencies and
$480.2 million were supported by mortgage-backed securities. Of the programs
supported by mortgage-backed securities, approximately 30% were collateralized
by Fannie Mae and Freddie Mac mortgages; the remaining 70% were collateralized
by Ginnie Mae loans, which are fully guaranteed by the U.S. Government. Of the
programs supported by individual mortgages held by the state housing finance
agencies, the overall credit quality rating was AA+. Most of these mortgages
were supported by FHA, VA, or private mortgage insurance providers.
Approximately 9%, or $178.4 million, of our total municipal securities were
insured general obligation ($138.5 million) or revenue bonds ($39.9 million),
with an overall credit quality rating of AA- at June 30, 2012, excluding the
benefit of credit insurance provided by municipal bond insurers. These
securities had a net unrealized gain of $7.5 million at June 30, 2012, compared
to $10.4 million and $9.2 million at June 30, 2011 and December 31, 2011,
respectively. We buy and hold these securities based on our evaluation of the
underlying credit without reliance on the municipal bond insurance. Our
investment policy does not require us to liquidate securities should the
insurance provided by the municipal bond insurers cease to exist.
CORPORATE SECURITIES
Included in our fixed-income securities at June 30, 2012 and 2011 and
December 31, 2011, were $3,007.2 million, $2,855.4 million, and $2,896.2
million, respectively, of fixed-rate corporate securities. These securities had
a duration of 3.4 years at June 30, 2012, compared to 3.3 years at June 30, 2011
and 3.2 years at December 31, 2011; the overall credit quality rating was BBB
for all three periods. At June 30, 2012 and 2011, and December 31, 2011, these
securities had net unrealized gains of $108.8 million, $84.4 million, and $87.8
million, respectively. During the three and six months ended June 30, 2012 and
2011, we did not record any write-downs on our corporate debt portfolio. The
table below shows the exposure break-down by rating and sector:
Corporate Securities (at June 30, 2012)
Non- % of
Investment Corporate
Sector AAA AA A BBB Grade Securities
Consumer 0 % 0 % 3.0 % 23.1 % 3.6 % 29.7 %
Industrial 0 0 3.4 14.3 4.9 22.6
Communications 0 0 1.9 13.6 .6 16.1
Financial Services 0 3.8 6.5 6.6 .8 17.7
Technology 0 0 2.3 .3 0 2.6
Basic Materials 0 0 0 3.8 .8 4.6
Energy 1.3 0 1.7 3.7 0 6.7
Total 1.3 % 3.8 % 18.8 % 65.4 % 10.7 % 100.0 %
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PREFERRED STOCKS - REDEEMABLE AND NONREDEEMABLE
We hold both redeemable (i.e., mandatory redemption dates) and nonredeemable
(i.e., perpetual with call dates) preferred stocks. At June 30, 2012, we held
$373.4 million in redeemable preferred stocks and $799.3 million in
nonredeemable preferred stocks, compared to $455.1 million and $1,029.7 million,
respectively, at June 30, 2011 and $373.9 million and $806.3 million,
respectively, at December 31, 2011.
At June 30, 2012 and 2011, and December 31, 2011, our preferred stock portfolio
had net unrealized gains of $379.0 million, $554.3 million, and $333.5 million,
respectively. We did not have any write-downs during the six months ended
June 30, 2012 or 2011.
Our preferred stock portfolio had a duration of 1.5 years, which reflects the
portfolio's exposure to changes in interest rates, at June 30, 2012 and 2011,
compared to 1.6 years at December 31, 2011. The overall credit quality rating
was BB+ at June 30, 2012, compared to BBB- at both June 30, 2011 and
December 31, 2011. Approximately 40% of our preferred stock securities are
fixed-rate securities and 60% are floating-rate securities. All of our preferred
securities have call or mandatory redemption features. Most of the securities
are structured to provide some protection against extension risk in the event
the issuer elects not to call such securities at their initial call date, by
either paying a higher dividend amount or by paying floating-rate coupons. Of
our fixed-rate securities, approximately 90% will convert to floating-rate
dividend payments if not called at their initial call date. The interest rate
duration of our preferred securities is calculated to reflect both the call and
floating rate features. Although a preferred security may remain outstanding if
not called, its interest rate duration will reflect the floating rate dividend
structure of the security. The table below shows the exposure break-down by
sector and rating, reflecting any changes in ratings since acquisition:
Preferred Stocks (at June 30, 2012)
Non-Investment % of Preferred
Sector BBB Grade Stock Portfolio
Financial Services
U.S. banks 37.6 % 16.7 % 54.3 %
Foreign banks 0 3.6 3.6
Insurance holdings 8.0 7.6 15.6
Other financial institutions 0 2.3 2.3
Total financial services 45.6 30.2 75.8
Industrials 3.0 12.2 15.2
Utilities 9.0 0 9.0
Total 57.6 % 42.4 % 100.0 %
Approximately 60% of our preferred stock securities pay dividends that have tax
preferential characteristics, while the balance pay dividends that are fully
taxable. In addition, the issuers of all our non-investment-grade preferred
stock holdings maintain investment-grade senior debt ratings.
Common Equities
Common equities were comprised of the following:
($ in millions) June 30, 2012 June 30, 2011 December 31, 2011
Common stocks $ 2,042.9 99.4 % $
1,856.0 99.4 % $ 1,834.1 99.4 %
Other equity-like investments
12.2 .6 11.9 .6 11.5 .6
Total common equities $ 2,055.1 100.0 % $ 1,867.9 100.0 % $ 1,845.6 100.0 %
At June 30, 2012, 12.4% of the total investment portfolio was in common
equities, compared to 11.7% at June 30, 2011 and 11.6% at December 31, 2011. Our
indexed common stock portfolio, which makes up 94% of our June 30, 2012 common
stock holdings, is managed externally to track the Russell 1000 Index with an
anticipated annual tracking error of +/- 50 basis points. Our individual
holdings are selected based on their contribution to the correlation with the
index. For all three periods reported in the table above, the GAAP basis total
return was within the desired tracking error when compared to the Russell 1000
Index. We held 745 out of 991, or 75%, of the common stocks comprising the
Russell 1000 Index at June 30, 2012, which made up 93% of the total market
capitalization of the index.
The remaining 6% reflects our decision to invest in common stocks outside of the
index. During the fourth quarter 2011, we selected an external investment
manager to invest up to $150 million in such common stocks; at June 30, 2012,
$116.4 million of the $150 million was invested in such securities with a fair
value of $122.9 million.
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We recorded $5.2 million in write-downs on our common equities for the six
months ended June 30, 2012, compared to $0.4 million for the same period in
2011; we had $4.9 million in write-downs during the second quarter 2012,
compared to no write-downs for the second quarter 2011.
Other equity-like investments include private equity investments and limited
partnership interests in private equity and mezzanine investment funds, which
have no off-balance-sheet exposure or contingent obligations.
Derivative Instruments
We have invested in the following derivative exposures at various times:
interest rate swaps, asset-backed credit default swaps, U.S. corporate debt
credit default swaps, cash flow hedges, and equity options. See Note
2-Investments for further discussion of our derivative positions.
INTEREST RATE SWAPS
We invest in interest rate swaps primarily to manage the fixed-income portfolio
duration. The following table summarizes our interest rate swap activity:
Net Realized
Gains (Losses)
Notional Value Three Months Ended Six Months Ended
(millions) Date June 30, June 30, June 30,
Term Effective Maturity Coupon 2012 2011 2012 2011 2012 2011
Open:
5-year 05/2011 05/2016 Receive variable $ 400 $ 400 $ (5.2 ) $ (1.8 ) $ (6.6 ) $ (1.8 )
5-year 08/2011 08/2016 Receive variable 500 0 (7.0 ) 0 (8.6 ) 0
9-year 12/2009 01/2019 Receive variable 363 613 (12.3 ) (22.2 ) (11.6 ) (19.6 )
Total open positions $ (24.5 ) $ (24.0 ) $ (26.8 ) $ (21.4 )
Closed:
9-year NA NA Receive variable $ 0 $ 100 $ 0 $ 0 $ 0 $ .5
Total interest rate swaps $ (24.5 ) $ (24.0 ) $ (26.8 ) $ (20.9 )
NA = Not Applicable
CORPORATE CREDIT DEFAULT SWAPS
We invest in corporate credit default swaps primarily to manage the fixed-income
portfolio credit risk. The following table summarizes our corporate credit
default swap activity:
Net Realized Gains
(Losses)
Notional Value
Three Months Ended Six Months Ended
(millions) Date Bought June 30, June 30, June 30,
or Sold
Term Effective Maturity Protection 2012 2011 2012 2011 2012 2011
Open:
5-year1 09/2008 09/2013 Bought $ 25 $ 25 $ .1 $ 0 $ (.3 ) $ (.6 )
Corporate swap NA NA Sold 0 10 0 .3 0 .3
Treasury Note2 NA NA 0 10 0 .2 0 .1
Total corporate swaps $ .1 $ .5 $ (.3 ) $ (.2 )
NA = Not Applicable
1 Financial services sector, see Note 2-Investments for details.
2 Used to replicate a long corporate bond position.
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CASH FLOW HEDGES
During the second quarter and first six months of 2012, and the second half of
2011, we repurchased, in the open market, $17.8 million, $30.4 million, and
$15.0 million, respectively, in aggregate principal amount of our 6.70%
Fixed-to-Floating Rate Junior Subordinated Debentures due 2067 (the "6.70%
Debentures"). For the portion of the 6.70% Debentures we repurchased, we
reclassified $0.3 million, $0.6 million, and $0.3 million, in the respective
periods, on a pretax basis, of the unrealized gain on forecasted transactions
from accumulated other comprehensive income on the balance sheet to net realized
gains on securities on the comprehensive income statement.
B. Investment Results
We reported the following investment results for the periods ended June 30:
Three Months Six Months
2012 2011 2012 2011
Pretax recurring investment book yield 3.0 % 3.3 % 3.1 % 3.4 %
Weighted average FTE book yield 3.3 % 3.7 % 3.4 % 3.7 %
FTE total return:
Fixed-income securities .7 % 1.6 % 2.8 % 3.0 %
Common stocks (2.9 )% .3 % 9.1 % 6.8 %
Total portfolio .3 % 1.5 % 3.6 % 3.3 %
Recurring investment income (interest and dividends, before investment and
interest expenses) decreased 7% for both the second quarter and the first six
months of 2012, compared to the same periods last year. The reduction is
primarily the result of a decrease in investment yields, partially offset by an
increase in average assets.
We report total return to reflect more accurately the management philosophy
governing the portfolio and our evaluation of investment results. The fully
taxable equivalent (FTE) total return includes recurring investment income, net
realized gains (losses) on securities, and changes in unrealized gains (losses)
on investments.
A further break-down of our FTE total returns for our fixed-income securities,
excluding short-term investments but including the net gains (losses) on our
derivative positions, for the periods ended June 30, follows:
Three Months Six Months
2012 2011 2012 2011
U.S. Treasury Notes 0 % 2.0 % (.3 )% 2.5 %
Municipal bonds 1.4 % 2.3 % 2.3 % 3.4 %
Corporate bonds 1.3 % 2.1 % 3.7 % 3.2 %
Commercial mortgage-backed securities 1.4 % 1.4 % 3.7 % 2.0 %
Collateralized mortgage obligations 1.2 % (.6 )% 6.3 % 0 %
Asset-backed securities .6 % .6 % 1.7 % .9 %
Preferred stocks 0 % 2.1 % 11.2 % 8.9 %
Investment expenses were $8.0 million for the first six months of 2012, compared
to $6.6 million for the same period last year. The increase partially reflects
fees associated with our external investment manager who was selected during the
fourth quarter 2011.
Interest expense for the first six months of 2012 was $62.6 million, compared to
$63.0 million for the same period last year.
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Realized Gains/Losses
The components of net realized gains (losses) for the three and six months ended
June 30, were:
Three Months Six Months
(millions) 2012 2011 2012 2011
Gross realized gains on security sales
Fixed maturities:
U.S. government obligations $ 2.5 $ 3.6 $ 9.6 $ 34.9
State and local government obligations 0 .4 12.1 3.5
Corporate and other debt securities 3.9 8.5 26.1 17.4
Residential mortgage-backed securities 0 .4 0 .4
Commercial mortgage-backed securities 3.5 0 4.5 0
Other asset-backed securities 0 1.0 0 1.0
Redeemable preferred stocks .4 2.8 .4 3.4
Total fixed maturities 10.3 16.7 52.7 60.6
Equity securities:
Nonredeemable preferred stocks 6.3 37.7 36.9 94.9
Common equities 8.8 6.8 10.0 7.9
Subtotal gross realized gains on security
sales 25.4 61.2 99.6 163.4
Gross realized losses on security sales
Fixed maturities:
U.S. government obligations (.4 ) (6.0 ) (.9 ) (9.3 )
Corporate and other debt securities 0 (.6 ) 0 (3.4 )
Redeemable preferred stocks 0 0 0 (2.2 )
Total fixed maturities (.4 ) (6.6 ) (.9 ) (14.9 )
Equity securities:
Common equities 0 (5.8 ) 0 (6.1 )
Subtotal gross realized losses on security
sales (.4 ) (12.4 )
(.9 ) (21.0 )
Net realized gains (losses) on security sales
Fixed maturities:
U.S. government obligations 2.1 (2.4 ) 8.7 25.6
State and local government obligations 0 .4 12.1 3.5
Corporate and other debt securities 3.9 7.9 26.1 14.0
Residential mortgage-backed securities 0 .4 0 .4
Commercial mortgage-backed securities 3.5 0 4.5 0
Other asset-backed securities 0 1.0 0 1.0
Redeemable preferred stocks .4 2.8 .4 1.2
Total fixed maturities 9.9 10.1 51.8 45.7
Equity securities:
Nonredeemable preferred stocks 6.3 37.7 36.9 94.9
Common equities 8.8 1.0 10.0 1.8
Subtotal net realized gains (losses) on
security sales 25.0 48.8
98.7 142.4
Other-than-temporary impairment losses
Fixed maturities:
Residential mortgage-backed securities (.5 ) (2.0 ) (1.0 ) (2.6 )
Commercial mortgage-backed securities 0 (.2 ) (.1 ) (.6 )
Total fixed maturities (.5 ) (2.2 ) (1.1 ) (3.2 )
Equity securities:
Common equities (4.9 ) 0 (5.2 ) (.1 )
Subtotal other-than-temporary impairment
losses (5.4 ) (2.2 )
(6.3 ) (3.3 )
Net holding period gains (losses)
Hybrid securities (.2 ) 2.9 6.9 7.7
Derivative instruments (24.1 ) (23.5 ) (26.5 ) (21.1 )
Subtotal net holding period gains (losses) (24.3 ) (20.6 )
(19.6 ) (13.4 )
Total net realized gains (losses) on
securities $ (4.7 ) $ 26.0 $ 72.8 $ 125.7
Gross realized gains and losses were the result of customary investment sales
transactions in our fixed-income portfolio, affected by movements in credit
spreads and interest rates, sales of common stocks, and holding period valuation
changes on derivatives and hybrid securities. From time to time, gross realized
losses also include write-downs for securities in our fixed-income and/or equity
portfolios, which are determined to be other-than-temporarily impaired.
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Other-Than-Temporary Impairment (OTTI)
Realized losses may include write-downs of securities determined to have had
other-than-temporary declines in fair value. We routinely monitor our portfolio
for pricing changes that might indicate potential impairments and perform
detailed reviews of securities with unrealized losses. In such cases, changes in
fair value are evaluated to determine the extent to which such changes are
attributable to (i) fundamental factors specific to the issuer, such as
financial conditions, business prospects, or other factors, (ii) market-related
factors, such as interest rates or equity market declines (e.g., negative return
at either a sector index level or at the broader market level), or
(iii) credit-related losses where the present value of cash flows expected to be
collected is lower than the amortized cost basis of the security.
Fixed-income securities and common equities with declines attributable to
issuer-specific fundamentals are reviewed to identify all available evidence,
circumstances, and influences to estimate the potential for, and timing of,
recovery of the investment's impairment. An other-than-temporary impairment loss
is deemed to have occurred when the potential for recovery does not satisfy the
criteria set forth in the current accounting guidance.
For fixed-income investments with unrealized losses due to market- or
sector-related declines, the losses are not deemed to qualify as
other-than-temporary where we do not have the intent to sell the investments,
and it is more likely than not that we will not be required to sell the
investments, prior to the periods of time that we anticipate to be necessary for
the investments to recover their cost bases. In general, our policy for common
equity securities with market- or sector-related declines is to recognize
impairment losses on individual securities with losses we cannot reasonably
conclude will recover in the near term under historical conditions by the
earlier of (i) when we are able to objectively determine that the loss is
other-than-temporary, or (ii) when the security has been in such a loss position
for three consecutive quarters.
When a security in our fixed-maturity portfolio has an unrealized loss and we
intend to sell the security, or it is more likely than not that we will be
required to sell the security, we write-down the security to its current fair
value and recognize the entire unrealized loss through the comprehensive income
statement as a realized loss. If a fixed-maturity security has an unrealized
loss and it is more likely than not that we will hold the debt security until
recovery (which could be maturity), then we determine if any of the decline in
value is due to a credit loss (i.e., where the present value of cash flows
expected to be collected is lower than the amortized cost basis of the security)
and, if so, we recognize that portion of the impairment in the comprehensive
income statement as a realized loss; any remaining unrealized loss on the
security is considered to be due to other factors (e.g., interest rate and
credit spread movements) and is reflected in shareholders' equity, along with
unrealized gains or losses on securities that are not deemed to be
other-than-temporarily impaired. The write-down activity recorded in the
comprehensive income statement was as follows:
Three Months Ended June 30, Six Months Ended June 30,
Write-downs Write-downs
Write-downs on Securities Write-downs on Securities
Total on Securities Held at Total on Securities Held at
(millions) Write-downs Sold Period End Write-downs Sold Period End
2012
Residential mortgage-backed
securities $ .5 $ 0 $ .5 $ 1.0 $ 0 $ 1.0
Commercial mortgage-backed
securities 0 0 0 .1 0 .1
Total fixed income .5 0 .5 1.1 0 1.1
Common equities 4.9 0 4.9 5.2 0 5.2
Total portfolio $ 5.4 $ 0 $ 5.4 $ 6.3 $ 0 $ 6.3
2011
Residential mortgage-backed
securities $ 2.0 $ 0 $ 2.0 $ 2.6 $ 0 $ 2.6
Commercial mortgage-backed
securities .2 0 .2 .6 0 .6
Total fixed income 2.2 0 2.2 3.2 0 3.2
Common equities 0 0 0 .4 (.3 ) .1
Total portfolio $ 2.2 $ 0 $ 2.2 $ 3.6 $ (.3 ) $ 3.3
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The following table stratifies the gross unrealized losses in our fixed-income
and common equity portfolios at June 30, 2012, by duration in a loss position
and magnitude of the loss as a percentage of the cost of the security:
Total
Gross Decline of Investment Value
Fair Unrealized
(millions) Value Losses >15% >25% >35% >45%
Fixed Income:
Unrealized loss for less than 12 months $ 342.4 $ 3.4 $ .4 $ .4 $ .4 $ 0
Unrealized loss for 12 months or greater 517.4 45.1 20.8 13.2 9.1 4.2
Total $ 859.8 $ 48.5 $ 21.2 $ 13.6 $ 9.5 $ 4.2
Common Equity:
Unrealized loss for less than 12 months $ 173.4 $ 17.8 $ 4.1 $ 2.2 $ 1.3 $ 1.0
Unrealized loss for 12 months or greater 55.6 13.1 10.8 7.6 0 0
Total $ 229.0 $ 30.9 $ 14.9 $ 9.8 $ 1.3 $ 1.0
We completed a thorough review of the existing securities in these loss
categories and determined that, applying the procedures and criteria discussed
above, these securities were not other-than-temporarily impaired. We do not
intend to sell these securities. We also determined that it is more likely than
not that we will not be required to sell these securities for the periods of
time necessary to recover their respective cost bases, and that there are no
additional credit-related impairments on our debt securities.
Since total unrealized losses are already a component of other comprehensive
income and included in shareholders' equity, any recognition of these losses as
additional OTTI losses would have no effect on our comprehensive income, book
value, or reported investment total return.
C. Repurchase and Reverse Repurchase Transactions
From time to time we enter into reverse repurchase commitment transactions. In
these transactions, we loan cash to internally approved counterparties and
receive U.S. Treasury Notes pledged as collateral against the cash borrowed. We
choose to enter into these transactions as rates and credit quality are more
attractive than other short-term rates available in the market. Our exposure to
credit risk is limited due to the nature of the collateral (i.e., U.S. Treasury
Notes) received. The income generated on these transactions is calculated at the
then applicable general collateral rates on the value of U.S. Treasury
securities received. We have counterparty exposure on reverse repurchase
agreements in the event of a counterparty default to the extent the general
collateral security's value is below the amount of cash we delivered to acquire
the collateral. The short-term duration of the transactions (primarily overnight
investing) reduces that exposure.
We earned income of $0.2 million and $0.3 million on these reverse repurchase
transactions for the three and six months ended June 30, 2012, respectively,
compared to $0.1 million and $0.3 million for the same periods in 2011. We had
$400.6 million of open reverse repurchase commitments with two counterparties at
June 30, 2012, compared to $384.2 million with two counterparties at
December 31, 2011. We had no open reverse repurchase commitments at June 30,
2011. For the six months ended June 30, 2012, our largest outstanding balance of
reverse repurchase commitments was $968.1 million, which was open for one day;
the average daily balance of reverse repurchase commitments was $754.1 million.
Additionally, during the first six months of 2012 and 2011, we entered into
repurchase commitment transactions for periods of 25 days and 10 days,
respectively. In these transactions, we loan U.S. Treasury securities to
internally approved counterparties in exchange for cash equal to the fair value
of the securities. The cash proceeds were invested in unsecured commercial paper
with a maturity matching the repurchase transaction issued by large,
high-quality institutions. These transactions were entered into as overnight
arrangements, and we had no open repurchase commitments at June 30, 2012 and
2011 or December 31, 2011. During the first half of 2012, the largest
outstanding balance was $145.1 million, which was open for one day; the average
daily balance of these repurchase commitments was $144.2 million. We earned
income of less than $0.1 million on these transactions during the period they
were open in 2012 and 2011.
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Safe Harbor Statement Under the Private Securities Litigation Reform Act of
1995:Statements in this report that are not historical fact are forward-looking
statements that are subject to certain risks and uncertainties that could cause
actual events and results to differ materially from those discussed herein.
These risks and uncertainties include, without limitation, uncertainties related
to estimates, assumptions, and projections generally; inflation and changes in
economic conditions (including changes in interest rates and financial markets);
the possible failure of one or more governmental entities to make scheduled debt
payments or satisfy other obligations; the potential or actual downgrading of
governmental, corporate, or other securities by a rating agency; the financial
condition of, and other issues relating to the strength of and liquidity
available to, issuers of securities held in our investment portfolios and other
companies with which we have ongoing business relationships, including
counterparties to certain financial transactions; the accuracy and adequacy of
our pricing and loss reserving methodologies; the competitiveness of our pricing
and the effectiveness of our initiatives to retain more customers; initiatives
by competitors and the effectiveness of our response; our ability to obtain
regulatory approval for requested rate changes and the timing thereof; the
effectiveness of our brand strategy and advertising campaigns relative to those
of competitors; legislative and regulatory developments, including, but not
limited to, health care reform and tax law changes; disputes relating to
intellectual property rights; the outcome of litigation pending or that may be
filed against us; weather conditions (including the severity and frequency of
storms, hurricanes, snowfalls, hail, and winter conditions); changes in driving
patterns and loss trends; acts of war and terrorist activities; our ability to
maintain the uninterrupted operation of our facilities, systems (including
information technology systems), and business functions; court decisions and
trends in litigation and health care and auto repair costs; and other matters
described from time to time in our releases and publications, and in our
periodic reports and other documents filed with the United States Securities and
Exchange Commission. In addition, investors should be aware that generally
accepted accounting principles prescribe when a company may reserve for
particular risks, including litigation exposures. Accordingly, results for a
given reporting period could be significantly affected if and when a reserve is
established for one or more contingencies. Also, our regular reserve reviews may
result in adjustments of varying magnitude as additional information regarding
claims activity becomes known. Reported results, therefore, may be volatile in
certain accounting periods.
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