Progressive Is Living Up to Its Name

Progressive chief executive Glenn Renwick says company shareholders should be treated more like owners. (Via Bloomberg News)

Progressive Corp. has brought a lot of excitement to a boring product: auto insurance, which is what economists call a commodity. After all, insurance is insurance is insurance.

But Progressive has shaken up its industry by pioneering in peddling policies online, offering shoppers price quotes from other firms, and creating a one-stop claims service to save policyholders time and the company money.

Now Progressive is jazzing up another boring business practice: paying cash dividends to shareholders. You know, every three months companies send you checks for a fixed amount, occasionally raising it a bit. Yawn city.

Progressive has sent out such quarterly checks for 30-plus years -- but won't do so much longer. Starting in 2007, it will pay a once-a-year dividend determined by the same Gainshare methodology it uses to calculate employee bonuses.

In good times, shareholders would get paid much more than the three cents per share that they currently get four times a year. In bad times, they'd get less -- or nothing at all.

For instance, in a great year like 2004, holders would have gotten about $2.50 a share -- some 20 times the current level. In a bad year like 2000, they'd have gotten nothing.

Why this departure from common practice? Because Progressive chief executive Glenn M. Renwick began challenging the company's dividend policy in the same way that Progressive challenges conventional wisdom in everything it does.

"If the business has a good year, the owners should share in the profit," Renwick told me, "and if the business has a bad year, why should the owners get anything?" An excellent observation -- and one that's so obvious, you wonder why everyone's not thinking that way.

So Progressive's board opted to pay a variable dividend based on the company's after-tax underwriting profit. That's the premiums Progressive takes in, less claims paid out and expenses of running the business. Shareholders will get up to 40 percent of those underwriting profits in a great year, 20 percent in an average year, nothing in a bad year.

Progressive is the first company I know of to make its entire cash dividend dependent on corporate performance. Real estate investment trusts pay variable dividends -- but that's for tax reasons, not strategic ones. Some companies pay extra dividends in addition to their basic dividend -- but in a bad year, they still pay out the basic dividend.

What I really like about Progressive's plan is that it treats shareholders as owners in the truest sense of the word. Instead of using the dividend to support the share price or placate shareholders, Progressive will use it to give owners a piece of its profits.

It helps, of course, that Progressive is solidly profitable, that it has bought back large amounts of its own stock with surplus cash and that it generates far more capital from its operations than it can profitably deploy in its business. But should things turn bad, which has happened to many once-fine companies, Progressive won't be stuck trying to defend an unaffordable cash dividend that shareholders have come to expect. In these volatile days, locking yourself into a significant fixed dividend can be a bad idea.

Consider, if you will, a company that's the very opposite of Progressive: General Motors. GM recently cut its dividend 50 percent under pressure from Kirk Kerkorian adviser Jerry York, now a member of GM's board.

But why is a company that's hemorrhaging cash and has huge capital needs sending $565 million a year to its shareholders? Making these payments may keep investors at bay for a while, but it's not in the company's long-term interest. GM's response? It says it pays dividends "based on the outlook and indicated capital needs of the business."

Michael Hammer, author of "Reengineering the Corporation," says Progressive's innovative approach to its cash dividend typifies the way it does business. "They're original thinkers and masters of operational innovation," Hammer says. "They question everything and then do what makes the most sense. They've revolutionized how auto insurance works."

Now, with luck, Progressive will revolutionize how cash dividends work, too. Companies would pay out what they can afford and no more. That would make shareholders' cash income much less predictable and make share prices more volatile because they wouldn't be propped up by dividends. But in the long run, this would produce stronger companies. And that would be a better deal for all of us.

Sloan is Newsweek's Wall Street editor. His e-mail issloan@panix.com.