Editor’s Note: This will be the last post for the year. I’ll be back in early January with something fun for everyone to debate.
Progressive recently announced a special dividend of $13.50/sh, equal to over $8B. To put in context how large that is, it amounted to nearly 25% of their total surplus!
Progressive has done large dividends in the past, but I can’t recall anything of this magnitude.
Why did they do such a big dividend? It’s largely because their capital had grown so much in recent years due to the high profitability post the correction in auto pricing three years ago. GAAP equity is up nearly 50% YTD (before the dividend) and has more than tripled since 2022.
Most people likely reacted to the news as an unqualified positive and a sign of strength. But is that the only way to look at it? C’mon, you already know how I’m going to answer that!
Signaling Theory
Signaling theory is the idea that a company’s actions may reveal more about its future prospects than what it might appear at face value.
For example, is a company issuing stock to signal they are optimistic about their future growth? Or is it a statement about their concern about their capital adequacy because the business is getting worse?
When you see a stock go down on good news, it is often because people perceived a negative signal below the surface, not because they disagree that the news, in and of itself, is good.
Progressive’s announcement sent out a lot of possible signals, most of which are potentially negative.
Investor Signals
Let’s start with the positive. Paying out so much of their capital as a dividend suggests a high degree of confidence in future earnings.
This is especially so since Progressive writes at such a high leverage ratio (premiums to surplus is > 3:1) which leaves little margin for error to fund normal growth if earnings disappoint.
On the other hand, paying out so much capital suggests Progressive doesn’t see much opportunity to grow premium. After all, when you’re writing at 3:1 leverage, it’s easy for growth to consume all the capital generated by earnings.
To do a simple example, assume I have $1B of capital and $3B of premium and my earnings are $150M (so 15% ROE). If I grow 10% to $3.3B, I need to grow capital to $1.1B to maintain my ratio so that consumes $100M of earnings. If my normal dividend payout ratio is 1/3 of earnings, that uses up the other $50M of earnings.
Thus, I don’t have capacity to grow more than 10% in this example without cutting back the dividend or raising new capital. There are some other variables that can affect the result and Progressive’s ratios are somewhat different, but, directionally, the high dividend is a signal they don’t expect strong growth in 2026.
There is another significant signal to investors from the large dividend. Progressive is suggesting it thinks its stock is expensive. Otherwise, why wouldn’t they have reduced the size of the dividend to buy a lot of stock?
After all, the stock is down more than 20% from earlier in the year. If the company is unwilling to allocate $1B or $2B to buyback now, why should you buy the stock? They seem to be indicating they think the stock will get cheaper in the future.
Political Signals
But corporate actions send signals to more than just investors. Other stakeholders might be receiving a message as well.
There has been increasing chatter about “insurance affordability“. A number of states, including large ones like Illinois, Florida, and New York, are pushing legislative action to reduce insurance rates in the name of “affordability”.
What do you think a grandstanding politician (OK, that’s redundant!) will do when they hear about Progressive sending $8B of dividend checks to shareholders? Will they acknowledge it is the shareholder’s capital and Progressive is acting as a responsible steward by returning the capital when they can’t deploy it at high returns?
Or will they, instead, demand Progressive cut its rates rather than reward “greedy billionaires”? I think we all know the answer to that.
Signaling that profitability is well above normal is bound to draw political heat for Progressive which could, ironically, lower future profitability.
Regulatory Signals
In a similar fashion, state insurance departments are likely to have their own negative reaction irrespective of any political pressure.
Why would the local regulator approve a price increase for a company who had $8B of “excess profits”? Won’t they be more likely to pay extra scrutiny to the assumptions in last year’s filing and suggest revising some of the factors based on updated data?
How about the fact that Ohio recently allowed Progressive to increase its underwriting leverage from 3X to 3.5X? Might they feel taken advantage of after seeing this news?
Rather than the increased leverage going to support more growth, it’s being used to lower the denominator and reward shareholders. That’s got to be pretty embarrassing for the Ohio Department. How might they feel about next year’s rate filing as a result?
The large dividend signals to regulators that Progressive (and other insurers) cried wolf about the magnitude of price increases they needed in recent years and should be viewed more skeptically in the future. This also could lead to lower future profits.
Is There A Better Way To Signal?
So what should Progressive have done? Not paid the dividend and accepted lower future returns? Done something foolish with the capital like an unappealing acquisition?
There aren’t easy answers to this dilemma. There is likely going to be political pressure to cut prices regardless of the size of the dividend. The announcement merely turns up the volume of criticism.
Perhaps Progressive has anticipated all these issues and is already planning to cut prices faster than peers? In that case, the wise move may be to pay the big dividend, wait for the complaints from the states, and then ask for forgiveness by pushing through rate cuts they were already willing to implement?
Progressive is a very smart company and I wouldn’t be surprised if they have considered scenarios like this and that they might as well be perceived as “giving up” something to put through a price cut rather than doing it unprompted.
As for the investor signals, those are more difficult to solve. There isn’t an easy way to explain why someone should buy the stock if the company thinks a giant dividend is better than a giant repurchase, or even a medium dividend plus a medium repurchase.
If they believe the stock is overvalued, then the right thing to do is pay the dividend and wait for the stock to decline before initiating buybacks. Few companies have the courage to do this, but it’s the correct decision.
The signal over slowing growth is almost a derivative of the regulatory hurdles. Growth probably won’t pick up until Progressive passes through price cuts. Of course, investors won’t love this either as it suggests higher combined ratios in the future, but, hey, the company has already told you the stock is overpriced by their lack of buyback.
And one reason it would be overpriced is that the market hasn’t caught on yet to higher future combined ratios and, thus, lower earnings.
Progressive’s view may very well be “we know earnings are facing headwinds from necessary price cuts and thus our stock is overvalued. Also, we don’t need as much capital for growth if prices are headed lower, thus we should pay a big dividend. Investors may view this negatively in the near term but we will be rewarded in the long term for making smart decisions with our capital.”
In other words, they may understand the signals they are sending and be OK with it. If so, I applaud their intellectual honesty and agree with the decision to pay the big dividend and prepare for any negative repercussions that accompany it. This is what good managements are supposed to do.