This year has been a challenge for the stock market, as inflation has reached its highest level in four decades. The Federal Reserve intends to lower it by raising interest rates, and recently raised its target interest rate the most since 1994.
Interest rates affect every aspect of the economy. One company that feels the effect is the insurance giant Progressive (PGR -0.50%). The company recently announced its profits in May, and investors learned that it had lost nearly $ 1 billion from its investment portfolio. Here’s what you need to know about Progressive investments and what they mean for business.
Net profit for the year decreased by 90%
Progressive provides insurance for individuals and businesses, focusing on cars. Insurance companies raise money from customer premiums, which they then use to pay damages later. Good insurance companies weigh the risks well, accruing more premiums than they pay on claims, and can accumulate that money in investments they keep in their books.
Investors had mixed reactions after Progressive reported its monthly profit for May. Net profit for the month fell by 73%, and during the year so far it has decreased by 90% – leading the investment losses. Progressive’s investment has lost more than $ 1 billion this year, after making $ 923 million in the first five months of last year.
Debt instruments make up the bulk of Progressive’s $ 51 billion investment portfolio, including US Treasuries (37% of its portfolio), corporate debt (21%) and mortgage-backed securities (15%). These debt instruments have interest rate risk, which means that they lose value as interest rates rise. This year, global interest rates rose at the fastest pace in 30 years, and five-year US bond yields rose from 1.26% earlier this year to 3.14% on Friday.
The core business continues to operate
Although investment valuations have declined, investors have reason to be optimistic, as Progressive’s premiums earned have risen by 11% and the insurer continues to take out winning policies.
The combined ratio gives a picture of the insurer’s profitability and measures the benefits plus the costs divided into premiums; insurers want this ratio to be below 100%, and the lower the better. Progressive has an impressive history of managing its combined ratio; this year it is 95.1%, has not exceeded the target management ratio of 96% since 2000 and is consistently below the industry average.
Progressive continues to write good policies and increase premiums collected. For investors, a 90% drop in net income is not a welcome sight, but it is good to put it in perspective and find out which part of the business is causing the decline. Investing is not Progressive’s core business, it’s just a way to generate extra money for long periods of time.
Investors should be aware that interest rates are likely to continue to rise as the Fed struggles to fight inflation, which will weigh on the value of Progressive’s investment portfolio. On the other hand, Progressive can trigger its inflow of cash by adding more government bonds and other debt instruments at higher interest rates, which will generate more interest income for the insurer in the long run.
Progressive remains a solid holding stock and as an investor I wouldn’t worry unless it starts struggling to maintain its combined ratio under the management’s goal for a few quarters.