Progressive Insurance

Joseph Farizo, Clark Gibert, Lien Nguyen, Andrew Walker, Jordyn Webre 11/15/2011

Table of Contents

Executive Summary.. 2 An Overview of the Industry 3 Industry Analysis.. 4 Intra-Industry Analysis. 6 Overview of the Firm and Strategy Analysis 8 The Future of the Industry 12 The Future of the Firm.. 13 Recommendations 14

Executive Summary

The Progressive Corporation provides property and casualty insurance to drivers across the United States as well as Australia. Since the company began in 1937, it has focused on providing competitive rates in personal and commercial automobile insurance. Using statistical data and effective risk analysis, Progressive has accurately calculated rates to charge non-standard, standard, and preferred clients for automobile, boat, motorcycle, RV and other recreational vehicles. We plan on focusing specifically on the automobile insurance industry, including Progressive and its major competitors. After analyzing the industry, its major players, and structure, we will shift our focus to the history, structure, and functions of Progressive, as well as provide insight to the future of the company, and recommendations for continued profitability and growth. The Progressive Corporation has been an innovator in the field of automobile insurance by initiating Pay-As-You-Go plans. These methods allow for drivers to receive discounts based on their personal driving habits that may be safer than other drivers in their class. In this way, Progressive can offer the best rates to a driver without assigning them to a class of drivers that they may not be similar too. Calculation of risk in the insurance industry is one of the most important tasks of a company. Through programs such as Autograph, TripSense, MyRate, and Snapshot, Progressive has strived to achieve the highest accuracy in order to charge premiums that are fair for the consumer, while also insuring that they will only assume as much risk as allowed to remain solvent in a large payout. Not to be overlooked in the auto insurance industry is effective marketing, as well as claims and customer service. Our recommendations for Progressive include initiating a rewards program, expanding the size and functionality of the IRV fleet, forward integrating into owning repair shops, and reevaluating their marketing campaign.

An Overview of the Industry The first automobile insurance policy written in the United States was issued in 1898 by the Travelers Insurance Company. It provided liability coverage in the event of an accident and paid out an average of $7,500 per year. However, auto insurance was not prevalent in the U.S. until 1927, when Massachusetts and Connecticut passed laws requiring vehicle owners to have liability insurance. Other states followed suit after World War II, when high consumer demand spurred rapid growth in the automobile industry. More vehicles on the road meant more accidents, and a need for financial responsibility was evident. Regulation at the state level was established in the early 1960s and varied with each states independent insurance board. Much of the new legislation gave the industry flexibility in terms of pricing and competition. Some states regulated with prior approval action, or strict action, while others regulated with competitive rating action, or lenient action. For instance, a state with strict regulation, or prior approval, will most likely tighten price controls during times when industry costs are increasing. Many exogenous factors have affected the environment of the industry. One such factor is politics. Because insurance commissioners are elected officials and exert a high degree of influence, the industry can suffer from political interest. Another factor to consider is the behavior of financial markets. Because insurance companies place much of their premium revenues into investment opportunities, the state of financial markets can have a large impact on the strategies and pricing of the competitors. Overall, government regulation has a very profound place in the insurance industry. Many studies have shown that government regulatory action suppresses insurance premiums by several percentage points. Regulation also depresses incentives for firms to invest in distribution systems, and it also depresses the incentive for new firms to enter the market. In other words, government
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regulation can be considered a major barrier to entry for new firms. Regulation, both current and potential, also can encourage firms to leave the industry. Unintended consequences of government regulation include greater price volatility, diminished availability of coverage in the voluntary market (creates market inefficiencies), and reduces incentives for driver safety which in turn leads to higher claims costs for the industry. Despite being a regulated market, the auto insurance industry has performed well in recent years. Top insurance firms experienced high profitability in the late 80s and 90s, and despite the economic issues of late, the industry remains financially strong. The key performance drivers for the industry have now become superior underwriting and development of advanced, innovative analytic tools. For instance, Progressive Insurance has developed a Pay-As-You-Go insurance plan option, where drivers are able to pay a rate that correlates with how much they drive. The industry has amassed the largest amount of policyholder of surplus that they have ever obtained, which has provided a cushion during the recent economic downturn. The industry also has maintained adequate loss reserves, and firms continue to have access to inexpensive capital. Therefore, the profitability outlook for the industry is positive, and the key performance drivers will continue to be superior underwriting and risk assessment. Industry Analysis It is important to note that insurance is a service, not a good or product. While this may seem obvious, it is an important factor to keep in mind when analyzing the industry through Porters FiveForces Framework. First, we will consider the bargaining power of suppliers. We will assume that the suppliers in the insurance industry are suppliers of financial and human capital. Sources of financial capital, which include but are not limited to banks, creditors, and investment firms, tend to have low bargaining power. While financial capital as sourced by suppliers may be important during an
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insurers start up, it tends to be less important after an insurer has enough clients and income from premiums and investments to no longer require injected capital from suppliers. Human capital is also required by insurers. Underwriters, actuaries, salesmen, and claims adjusters are all vital to the insurance industry. Underwriters are professionals who evaluate the risks of insuring an individual and determine the premium to charge based on several calculated risk factors. Actuaries are statisticians that work to develop models which simulate the probabilities and likelihood of an insured individual experiencing a loss. Actuarial data is used by underwriters to determine the price of a policy. Salesmen or producers actually sell the insurance policy to a client. These producers can either be independent or captive, depending on the structure of their employer. Claims adjusters calculate the amount that an insurance company will pay out after a client has experienced a loss by evaluating the damage to property and determining the monetary amount that the person is eligible to receive. Premiums are normally set based on the assessed risk of an area, not through supply and demand determinants. Insurance, especially in the auto or home industry, is often required either by law or by lien-holder. This means that buyers will generally purchase insurance regardless of overall market prices. For this reason, bargaining power of buyers for the industry tends to be low. Threat of new entrants is also low. Insurance requires large numbers of clients or pools in order to spread the risk of a loss across members of that pool. This requires the establishment of a large customer base. New entrants will struggle to obtain needed capital to overcome large sunk costs, large client bases, advertising exposure, and name recognition in this mature insurance industry. Government regulation by the states insurance commissioner is also a significant barrier to entry as insurance companies must adhere to several state rules and laws. The threat of substitutes is low if not nonexistent. There is a matrix that can be used to determine whether insurance should be purchased or not, and the factors are severity and frequency.
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High frequency and high severity of loss suggest avoidance, high frequency and low severity allows for the option to purchase insurance, and low severity generally means retention. Thus, retention and avoidance are the two substitutes to insurance, but they may be difficult for consumers to manage. Retention may also be very expensive and avoidance impossible, so insurance is often an only option. Additionally, hedging and contracts may be a means of transferring risks without using insurance, and are thus viable substitute options. Industry rivalry is essentially a battle for market share, but not by price wars. Rather, through a mix of advertising, calculating effective rates, and concentrating on customer service, insurance companies attempt to attract clients from other insurance providers. From what we observe, industry rivalry is at moderate levels. While differentiation is difficult in the auto insurance industry, companies can advertise differently to appeal to different client bases. The strength of each of the five forces is directly related to the structure as well as the stage of development of the industry. The structure of the insurance industry, an often required financial service, can explain why both the power of suppliers and buyers are low. While the five forces may indicate strong profitability, the profit margin is in the 2%-4% range. This is because the industry incurs high expenses in the form of claims, often varying from year to year as natural disasters occur. Natural disasters are unpredictable, and represent a major source of volatility for the earnings of an insurance industry. If it were not for the investment revenue that insurance companies receive, premiums would not be enough to cover loss payouts as well as sales and administrative expenses. Intra-Industry Analysis The top ten U.S. auto insurers are (by market share): State Farm, Allstate, Progressive, GEICO, Farmers, Nationwide, USAA, AIG, Liberty Mutual, and American Family. The two largest, State Farm and Allstate, capture nearly one fifth of the market. All these firms have different strategic

goals, marketing and sales methods, and technology employed in their organizations in attempt to create a competitive advantage. The technological boom in the 1990s permanently changed the nature of the insurance industry. Specifically, advances in wireless technology allowed claims adjusters to be notified of customer incidents more quickly. By using complex software to track correlations amongst variables, underwriters can now more precisely segment customers to find the most appropriate premium. These technological advances gave firms a variety of ways to achieve a competitive advantage through innovation. Auto insurance is sold through an assortment of mediums, such as independent agents, dedicated agents, and directly through the internet and phone. Dedicated agents work for a specific insurance company sell only their policies. Independent agents, on the other hand, can sell multiple policies under different insurance companies. State Farm does not use independent agents, and Progressive does not operate with dedicated agents. Allstate uses a mix of the two. All companies employ direct sales methods, but only GEICO operates exclusively through direct sales, using no agents. A strategic decision all firms have to make is what type of insurance to sell. State Farm and Allstate sell a wide range of financial products from auto and home insurance to investments. GEICO and Progressive sell only auto insurance. Progressive tried its hand at home insurance, but did not find the venture to be profitable and discontinued the program. Another important strategic decision that must be made is whether the company wants to insure standard, preferred, non-standard drivers, or a combination of all based on risk of loss. State Farm and Allstate traditionally sold only to standard or preferred drivers, but Allstate began writing non-standard insurance in the early 1990s. In response, Progressive moved away from its solely non-

standard strategy and began to sell standard policies. Overview of the Firm and Strategy Analysis Progressive Casualty Insurance Company was founded in 1937 in Cleveland, Ohio by two lawyers who were inspired to start their own firm after representing the state in a court battle over insurance fraud. Joe Lewis and Jack Green proved to be innovators in the industry from the beginning, even at a time when car insurance was emerging as a new segment of the market. Progressive aimed to provide low-cost automobile insurance to working-class customers with payment methods and service benefits unequaled by competitors. Policy features such as the availability of drive-in claims centers and payment by monthly installments offered profitable advantages for the budding company. For 50 years between 1956 and 2006, Progressive held a large and unique competitive advantage over its rivals by dominating the non-standard segment of the market. The non-standard segment consists of high-risk customers with above average claims rates and comprises roughly 20% of the insurance market as a whole. This group of clients normally includes young male drivers, drivers over 65, people with no prior insurance, and people driving high-performance cars. Progressives major competitors saw this segment as a risk without adequate return, and for the most part chose to insure only low-risk, standard premium customers. The key to Progressives strategy and its ability to stay afloat while insuring these high-risk drivers was in its extensive use of sophisticated data mining techniques and price segmenting. Progressives underwriting software was able to analyze and integrate consumer data and behavior at a highly detailed level. Where a competitors framework would simply reject an applicant with a bad driving record and a history of accidents, Progressives innovative pricing system was able to establish a rate for a wider range of otherwise uninsurable customers based on correlative data analysis. Characteristics of the customer, such as gender, age, and credit score, along with
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characteristics of the vehicle and geographical location were some of the factors utilized in Progressives data mining model. Throughout the years, Progressive has been able to maintain a competitive position against its three biggest competitors: State Farm, Allstate, and GEICO. State Farm has upheld its status as an industry forerunner with leading sales in auto and home policies. In addition to providing insurance, both State Farm and Allstate have aspired to be a one-stop-shop for financial services, offering retirement and investment products to new and existing clients. GEICO, founded solely as a provider to military families, established profitability by passing on savings from direct policy writing to its customers. Progressive had carved its own niche in the insurance market by using the price segmenting techniques discussed above, but encroachment on this strategy by competing firms as well as litigation stemming from Proposition 103 presented Progressive with challenges in the 1980s. In an effort to halt escalating rates, in 1989 California legislature passed Proposition 103, requiring a 20% cut back on all insurance rates and in some cases a reimbursement to customers for exorbitant premiums. In total, the Proposition cost Progressive $60 million in refunded business and forced them to fire 1,300 employees after experiencing gross underwriting losses. This mandate, along with Allstates decision to begin writing in the non-standard segment and subsequently surpassing Progressive in sales caused CEO Peter Lewis to rethink the companys operations. It was obvious that targeting the non-standard market alone would not be a sustainable competitive advantage for Progressive. In Lewiss own words, I decided that from then on, anything we did had to be good for the consumer or we werent going to do it. The Immediate Response initiative arose from Progressives desire to implement fast service at a more personalized level than ever before. It began with a change in availability for claims representatives. The teams now handled claims 24 hours per day instead of simply from 8-5. They were challenged to respond to accident reports within hours, not days, and with the boom of
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communications technology in the early nineties, Immediate Response became a force to be reckoned with. What started out as a representative-to-dispatcher calling network turned into a fullyfunctioning onsite mobile claims office with the introduction of the Immediate Response Vehicle, a van equipped with a laptop connected to the companys mainframe, a file cabinet, generator, printer, chairs, fax machine, and small refrigerator. The idea was for the representatives to handle as much business as possible on the scene and provide a degree of reassurance to the customer. For instance, the representative could offer the customer a cup of coffee, a cell phone to call a relative, or even write a check on the spot to help cover damages to the vehicle. In 1990 when the program was first launched, Progressive was only inspecting 15% of vehicles within nine hours of a report being filed. By 1997, this figure rose to 57% and the percentage of claims settled within one week had risen to 50%. The Immediate Response initiative embodied Progressives commitment to reliable service and customer satisfaction. Recently, Progressive has tried to go beyond service innovations and actually change the fundamentals of policy underwriting to create value for its customers. The Autograph program was the first of such endeavors, tested in Houston in 1998. The concept was for customers to be charged not solely by a set rate, but also by how much they drove, where they drove, and under what conditions they drove, all tracked by a Global Positioning System. Users of the system saved an average of 25% on their insurance payments. But many customers had concerns with fairness and privacy, and ultimately the program was scrapped in 2002. Two years later, however, Progressive reconsidered the venture and tested a new program, TripSense, in 2004. This time, the computer chip programmed into customers cars recorded the time they drove, how far they drove, and how fast they drove, but was not able to record vehicle location as it was not equipped with a GPS. This program never came to fruition.
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Throughout the years, Progressive seems to have remained committed to the idea of pay-as-you-go insurance. In 2008, the company introduced MyRate, a program similar to Autograph and TripSense that let customers control how much they paid for car insurance based on how much they actually drove. The most recent and currently advertised version of pay-as-you-go insurance is Progressives Snapshot program. The Future of the Industry Because the auto insurance industry is mature, we do not think that there will be any radical developments in the way business is conducted; however, increased technological integration may prove to be instrumental in establishing further competitive advantages. For example, writing direct policies over the internet may allow companies to achieve a cost advantage over rivals. Claims services may also be expedited through the use of standardized forms and policy documents that can be housed in online databases. Investment of premiums is a large source of additional revenue for insurers that can sometimes be the determinant of profits or losses for the year. Therefore, several years of poor economic conditions or poor investment choices could strongly impact the financial outlook of the company. We believe that the industry as a whole will continue to be profitable, so long as financial markets remain strong and provide a reasonably stable means of investing premiums to generate profits. The Future of the Firm Progressives emphasis on continual innovation has made them successful in the past, and will continue to do so in the future. They have committed to the idea of usage based premiums, and have learned from their experiences with the Autograph system, and the research experiment TripSense. Their new product Snapshot combines the knowledge of these past products, and has been well-received by consumers on a national level. Progressives Name-Your-Own-Price program is
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unique to the company, and will set it apart from the competition in the future. We feel Progressive will be moving more into customized service, finding the most accurate premiums for customers based on their individualized risk. We also feel that technology will become more highly integrated into the business in an effort to cut costs. New opportunities for Progressive are limited, but do exist. They could venture into other lines of insurance such as homeowners like they have in the past (although unsuccessfully). They could also sell securities and provide retirement planning services, as Allstate and State Farm have. Progressive is not without problems. Their goal is to be customers number one choice for auto insurance, but in 2006 JD Power & Associates ranked them #14 in customer satisfaction in the auto insurance industry. Obviously there is lots of room for improvement here considering customer satisfaction is a strategic goal of the company. Progressive was also ranked #14 in collision repair satisfaction, which is another negative indicator of company performance. Progressive faces some strategic issues going forward, the main being how to innovate and maintain a competitive advantage. Progressive has employed complex software to finely segment its customers to gain an edge in the past. But, by 2006 all companies were usin sophisticated data mining to segment their customers. Progressive must come up with a new product or process to differentiate themselves.

Recommendations So where should the company go from here? What can they do in order to improve their competitive position? Currently, Progressive only maintains about a 7.3% market share in the auto insurance industry, as State Farm and Allstate lead at 18.0% and 11.1%, respectively, and GEICO trails nearby at 6.7%. Progressive should consider four major options. First, the company should establish a rewards program whereby they can offer points to safe drivers that can be redeemed at the
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end of their policy term for gifts or a credit to the next policy period. Pay-As-You-Go data acquired through programs such as Snapshot can supplement this data, and be another source of points in the reward program. Secondly, Progressive should consider purchasing or establishing exclusive Progressive-only repair shops for its clients that have experienced an accident. This could help to push a quality customer service image, and provide much needed face time with clients. Also, routine maintenance such as oil changes and tire pressure checks can be conducted for a fee to anyone. Next, Progressive must reevaluate the way in which it handles claims. This can best be done by expanding the size and function of the IRV fleet. The IRVs could offer policy quoting and act as traveling salespersons when not responding to claims. Additionally, Progressive must make a conscience effort to educate clients about reporting claims as soon as possible following an accident. Immediate response isnt effective if claims arent reported to Progressive until too much time has passed after a wreck. The recent low rating in customer service by J.D. Power and Associates also presents the need for a more effective agency management system. A subscription or even purchasing of such a system can be very costly, but also may increase customer satisfaction. Finally, Progressive must market effectively through advertising. The insurance industry heavily competes by advertising and marketing, and it is important that Progressive not fall behind. Embracing social media and experimenting with new mascots is important. Sites such as Facebook and Twitter allow for a company to connect with its followers in a way a company could never do before. Originally Progressive maintained a competitive advantage by using advanced data and statistical methods to calculate the best rates. Recently, the competition has caught on to these data mining techniques to chip away at Progressives competitive advantage. Progressive must continue to provide a cost advantage by hiring top-rate actuaries and statisticians that can effectively calculate risks based on histories and risk profiles of clients. This would not be initiating a price war with competitors; it would be providing accuracy that is necessary in the insurance industry.
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Appendix Exhibit 1: Auto Industry Timeline

Exhibit 2: 5 Forces Framework

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Exhibit 3: Market Share of the Auto Insurance Industry

Exhibit 4: Income Structure of the Auto Insurance Industry

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