The stock market has been unkind to investors through the first two and a half months of 2022. Since the beginning of the year, the S&P 500 has lost 12% and is in correction territory.
Progressive ( PGR -1.09% ), the property and casualty insurer, is up 3.6% on the year despite the sell-off in the broader market. Progressive’s outperformance goes back much further. Since the beginning of 2000, Progressive has delivered an eye-popping 3,260% return compared to the S&P 500’s 327% in that same time. This performance is comparable with Amazon during that same time!
With its long-term outperformance, the stock tends to be overlooked by investors because it’s in the boring insurance industry. That’s a mistake, though. Progressive is a great company because it is one of the best at consistently writing profitable policies.
Why insurance can be a good inflation hedge
Insurance will always be in demand because people want to protect what they have, and laws require people to own insurance on their car or home. Because of this, insurance companies can do well in various market conditions.
Insurance companies can be cash-generating machines, which is why Warren Buffett loves the industry so much. During inflationary times like those we’re experiencing, insurers can be good investments because they have pricing power. When prices rise, insurers must naturally increase the premiums charged to customers, making the best insurers — like Progressive — good hedges against inflation.
How inflation caused higher claims costs for Progressive
Progressive had a stellar year in 2020, as the number of drivers on the road plummeted drastically, as did claims. Last year was another story, however, as drivers returned to the highways. The good news was Progressive increased its premiums by 13% from the year before, raking in $44 billion. The bad news — net income declined 41% from 2020.
Progressive faced more claims during the year, and those claims were more expensive to settle due to the inflationary pressures in the economy. Loss expenses rose 34% from 2020, and it was hurt badly by property insurance claims related to Hurricane Ida, which caused $420 million in losses.
The company also saw auto accident frequency increase 14%, while the severity, or the cost of resolving those claims, was up 9%. With inflation hitting its highest level in 40 years, used car prices jumped 27%, hurting Progressive and other auto insurers.
How Progressive has already adapted
Management was surprised to see how much repairs and replacement vehicles were costing it early last year, and it began raising its premiums charged in the second quarter. The company increased premiums by 8% during the year while also eliminating specific policies, causing outsized losses.
These moves paid off, and Progressive was able to come in under its target combined ratio of 96%. The combined ratio is a crucial metric insurance companies use to measure profitability. The ratio takes the total expenses and claims costs and divides them by the premiums collected. A ratio below 100% means the company is writing profitable policies, and the lower the ratio, the better.
Progressive’s combined ratio came in at 95.3% despite the larger losses during the year. Perhaps the most impressive accomplishment by Progressive is that its combined ratio hasn’t gone above 96% for 21 straight years now.
The insurer has shown a remarkable ability to underwrite profitable insurance policies, and it continues to do so even with inflation of almost 8%. Because many of its policies have terms of six months, it can quickly adjust rates and collect higher premiums. In its most recent January earnings release, Progressive reported a solid 92.9% combined ratio.
Progressive is one of the best at writing profitable insurance policies, which is why the stock has outperformed the broader market for decades now. The company has excelled in various economic conditions and should be a great stock in the current inflationary environment.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.