Kanik Varma
Personal Lines General Manager at Progressive Insurance at Progressive
Thanks, John. The goal of the product management organization is to deliver profitable growth at our target margin through adapting Progressive's products to win in our local markets. This organization comprises of highly talented individuals. They're results-oriented and were attracted by profit and loss ownership. They want accountability and decision rights, and we empower them to make decisions at the local level. Think of them as Chief Operating Officers of their own businesses. There are several aspects to a product managers job at Progressive.
Each product, state, channel is different, and our product managers design strategies to meet our goals within the individual businesses. Compliance is mandatory. Profit is our second priority. Growth at target margins comes next. Managing legislative, regulatory developments and relationships are key levers in order to respond to economic conditions and the competitive environment within their states. Today, I'm going to focus on one aspect of their role: tactics to deliver our target margins. And this is especially relevant in the current environment.
The first step in consistently hitting our target margins is to give our product managers very clear operational goals. You know it as our grow as fast as you can at a 96 objective. Just a reminder, that's a composite calendar year target number. Product managers manage to their respective targets within their channel product or geography down to the line coverage level. Each business fulfills their role within the overall portfolio to meet this composite goal. Our product managers have multiple tools that help us operationalize this goal.
We call it the product manager toolkit. Product managers actively monitor results with daily reporting on volume measures and monthly data across all other KPIs. The toolkit affords both diagnostics and informs actions to ensure we deliver segment-level results that roll up to our aggregate objectives. At the macro aggregate level, operationalizing this objective is like riding a wave. It requires a very delicate balance. Go too fast with rate, and you will be ahead of the market in compromise growth.
However, if you move too slowly and fall behind on rate, it's incredibly hard to catch back up, and you will miss profitability targets. Product managers continuously adjust rate level to match changing conditions, and the capability to be nimble is a source of competitive advantage for Progressive. Our product managers are not just trying to hit a 96 at the macro level but are making sure they are pricing each individual segment the same target margins.
That's very important. We don't have a bias towards any specific customer segment. We want to drive growth across the spectrum, provided those risks are priced accurately. This approach enables us to deliver on our broad acceptance or what we call take nearly all comers philosophy. Our heritage starting out writing less preferred customers required us to align our entire business around matching rate to risk. And as we've expanded our aperture over the past decades, this approach remains foundational to our strategy.
We have to make sure we are continuously matching rate to risk. Our scale provides us credible data and to make data-driven decisions at the micro level, which is a competitive advantage versus many industry competitors. Product upgrades in each state allow us to add new rating variables to our algorithms that feeds the virtuous cycle of risk selection. We've talked about this at length in the past, so today I'll just focus on how product managers manage profitability at the macro level. The aggregate rate level is determined for each state and channel.
Each product manager decides how much rate to take and how often to take that rate for the state and channel they manage. This decision-making relies very heavily on the advanced analytics John talked about earlier. Product managers also incorporate multiple local inputs into their decisions. I'd like to group these local inputs into three broad categories: state-specific loss trends, regulatory framework within the state and the mix of business we ensure in each state as that drives the earnings cadence. Let's walk through each one of these one-by-one. The first category of inputs is state-specific loss trends.
Each state is unique, and states have different loss trends at any given point of time. There are many reasons for this in the auto product. Coverages and limits offered are based on unique state laws. State laws change often and have a direct effect on loss cost going forward. Examples of this would be injury limit increases, fee schedule changes and new case law. States have unique weather patterns that impact loss costs. For example, hill states differ from hurricane states, and we use different weather loads in these states.
Claims processes are different by state, and we keep improving them to make sure we are paying accurately. Process changes like labor rate changes, litigation and fraud mitigation strategies can have an impact on loss costs annually. These are all different by state. And during the COVID pandemic, states had different lockdown and reopening laws. Product managers work closely with our cross-functional partners in their states, these partners provide valuable local market input and we incorporate those into our decisions.
The second input that impacts decision-making at the state level is rate regulations. At a very basic level, there are two types of rate regulation mechanisms, filing used and prior approval. In filing new states, we can elevate rate changes literally the day after we file, though approval for the revision in these states can come months and, in some cases, years after the rates are effective. Prior approval means that state DUI needs to approve the revision before it's effective. This framework requires more time to get rates to the Street.
But even before approval and prior approval states, we typically go through a back and forth with regulators as they ask questions and we explain our data and answer their questions about what's changing with the specific revision. We call this the objection process. But don't be confused, these are questions raised to clarify and understand and not fix barriers to implementing our product changes.
Over decades, we've built incredibly strong relationships with our regulators as both credible and transparent operators, and we continue to work closely with regulators to ensure they're comfortable with what we're doing, why we're doing it and how what we're doing ensures we deliver rates that are adequate, are not excessive and are not unfairly discriminatory. When trends change, usually, we're the first carrier to share the latest credible data with state regulators.
So it's fairly normal for them to react to new information and ask questions and ask for support to confirm understanding. In practice, though, there are 51 different enforcement mechanisms, no two or alike. Each has to be managed independently. We have built institutional knowledge and dedicated resources to put together filings and additional support, to ensure we get the right price into every local market as quickly as possible. Each product manager has in-depth understanding of the state's regulatory mechanism.
They are on top of the unique deviations, which means we have to know how to calculate rate need on the state's template, how much rate can be approved under a certain mechanism, the flex bands, and how often we can file in a year. They also manage the approval time lines, which can vary based on the type of filing within each state. While we price our policies to run consistently at or below a 96 accident year combined ratio prospectively, we also manage our results to a calendar year 96 combined ratio target.
In order to do that, product managers need to plan for the time it takes for rate changes to earn into our financials. It's important to note that because we have a large book of in-force business, rate changes don't affect all policies at the same time. All new policies going forward are written on the new rates, but existing policies don't see a rating until they come up for renewal. Our combined ratio is a function of losses and expenses divided by earned premium. To put things into perspective, this is a chart of how much time it takes for that earned premium to reflect the new rates on our Personal Auto policies.
With a predominantly six-month book of business, if we increase rates by 5% today, five months from now, our earned premium, which is the denominator for the combined ratio, would have increased approximately 3.5%. And by month seven, we will be close to that 5%. So the rate we took in the second half of 2021, around 6%, will have largely earned into the financials by midyear. Any rate we will take now will partially offset the first half and, more materially, the second half's combined ratio.
For comparison, if a carrier had 75% of their policies as annuals, it will take even longer as only 65% of the premium would be at the right rate level seven months after the change. This is a big reason we've limited distribution of 12-month policies to primarily our Platinum agencies, while over 90% of our Personal Auto policies are six-month policies. And at times like these, we benefit from a shorter lag period to realize rate changes in our book. Let's use one example to show you how one auto product manager made high-level decisions over the last couple of years. This is a real example from one medium-sized state.
The gray line on the chart is monthly pure premium in that state, while the blue line is a trailing 12-month average pure premium. This takes out the weather-related seasonality in the state. In 2019, the state was running under a 96 combined ratio, and our loss cost trends were fairly stable in the state. With stable trends, the product manager was focused on growth strategies, which typically include lowering rates to convert more shoppers or increasing demand generation spend to generate more shoppers.
As early COVID-related frequency drop came through our data, the product manager responded, first, by participating in our April relief efforts. That included $1 billion of premium credits during the immediate post-COVID period. That was followed by an aggregate rate level decrease a couple of months later. In early 2021, as this product manager was evaluating their aggregate rate level, based on the data available at the time, they expected trends to start returning to pre-COVID level at a fairly slow pace.
The state's pure premium expectations at the time are shown in the orange line. At this point of time, our tools indicated no immediate rate action, nor did local conditions in the state weren't anything different. Our ability to review trends and rate level every month allow this product manager to very quickly spot a change in trend shortly after making their rate decision. This change in loss cost trend was supported by UBI data in the state, which showed driving returning at a faster pace than previously expected.
There was enough credibility in the data for the product manager to react and the adjusted rate level upwards to reflect the change in frequency trend. As time went on, severity continued to rise at a faster pace than expected back in May, especially in collision comprehensive property damage coverages. Frequency also continued to see modest positive trend as driving behavior reverted back to normal. At this point, the product manager took another rate adjustment to ensure they would hit the accident year 96 and calendar year 96 combined ratio objectives.
Since we're in the business of trying to predict the future, there is near certainty that we'll be wrong. However, our business model is to minimize this error by shortening our future pricing time horizon to provide more frequent opportunities to adjust our future prices to market conditions. Our product managers have the advantage of getting updated indications and other diagnostics often and have the resources to act when needed. This allows us to react very quickly when conditions are changing and when the regulatory framework allows it.
As Tricia shared, this approach of taking more frequent smaller bites of the apple continues to serve us well as our rates are more closely aligned with true underlying costs, which enable us to deliver more consistent underwriting profitability and more competitive rates that drive long-term growth. If a carrier either does not have the ability to review data often and/or does not have the flexibility to react quickly, you can fall behind on rate need.
The margin of error grows the longer you have to wait to react. This is why we have invested heavily in the tools to evaluate trend quickly, and the systems to react as fast as possible. This chart also illustrates the challenge in states with longer approval times. Our product managers deploy different strategies to manage rate revision length risk in states where we aren't afforded the flexibility to change rates as often as necessary to accurately match rate to risk.
Our product managers typically act earlier and more conservatively to ensure we have adequate rates while making sure they are not excessive. They also have a full toolkit of levers available to deploy to protect the book and meet their target margins. We just talked about the science and the product manager toolkit. Now let's talk about how we deploy changes to the market. Having data and analytics to inform pricing decision-making is necessary but not sufficient to effectively manage a book of business.
You must also have decision makers and the deployment resources to file in a timely manner, get regulators comfortable with our actions and the IT infrastructure to get the updated pricing to market. In the example I shared, this particular product manager implemented 10 rate revisions in the state in the last two years alone, five each for direct and five for agency. These actions resulted in the state meeting its profit targets, both years in a very dynamic market and achieving 7.4% earned premium growth last year or over 25% earned premium growth over the two-year period while continuing to keep us ahead of the industry on segmentation.
The backbone of our deployment capabilities is our rate revision factory. We have the ability to act multiple times in a year in every state. Our resources dedicated for product upgrades are incremental to those for rate increases. Just to give you an idea. Last year, we deployed over four rate revisions per state in auto, and approximately 60% of our premium picked up the latest product model. It's also important to note, each tool in the product manager toolkit is supported with dedicated IT infrastructure. These are separate systems and resources that are incremental to our rate revision factory.
That gives us added flexibility to deploy other tools as needed in individual states. We have long seen revision deployment and cadence as a potential source of competitive advantage, which is why several years ago, we invested in the factory to increase its throughput and improve its quality to ensure we can continue to lead in both pricing and segmentation. We believe this investment has provided us with best-in-class capabilities. And this is just a view of our auto product. Each business, commercial, recreational lines and property, have, incremental dedicated capabilities.
Our ability to react early to changes in market conditions creates opportunities for us. The last time the market hardened, we followed our playbook and reacted fast and decisively. We believe faster response times help us compress the industry cyclicality during both hard and soft markets. That continues to drive our growth during times of change.
This market cycle may be different in magnitude but requires a similar playbook. We reacted as soon as we saw trends turned in 2020 in addition to the $1 billion April relief effort. Trends changed direction in 2021, and we reacted immediately. We've had a head start, and we'll continue to react quickly as we see changes in the results in either direction. While we can't know if this cycle will play out exactly like cycles of the past, we do continue to have trust in our process and believe it will help us deliver the best possible results. Thank you.
