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

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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.

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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 state’s

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 Porter’s Five-

Forces 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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insurer’s 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 state’s 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, Farmer’s, 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

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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-

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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.

Progressive’s 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 Progressive’s 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.

Progressive’s underwriting software was able to analyze and integrate consumer data and

behavior at a highly detailed level. Where a competitor’s framework would simply reject an applicant

with a bad driving record and a history of accidents, Progressive’s 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

Progressive’s 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 Allstate’s decision to begin writing in the non-standard segment and subsequently

surpassing Progressive in sales caused CEO Peter Lewis to rethink the company’s operations. It was

obvious that targeting the non-standard market alone would not be a sustainable competitive

advantage for Progressive. In Lewis’s own words, “I decided that from then on, anything we did had

to be good for the consumer or we weren’t going to do it.”

The Immediate Response initiative arose from Progressive’s 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 fully-

functioning onsite “mobile claims office” with the introduction of the Immediate Response Vehicle, a

van equipped with a laptop connected to the company’s 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 Progressive’s 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 customer’s 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 Progressive’s

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

Progressive’s 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. Progressive’s “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 homeowner’s 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 isn’t effective if claims aren’t 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 Progressive’s 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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