Dividend Policy the Progressive Corporation:

¶ … Dividend Policy

The Progressive Corporation: A new dividend calculation policy

Analyze the three factors that Progressive Corporation will use to calculate dividends.

Progressive Corporation will use three basic factors to calculate its dividends for shareholders. The first is called the gainshare factor: a performance score that will be based upon a grade given to the performance of the company's core source of profitability, its insurance businesses. The first performance score measures the growth and financial progression of the insurance businesses on a scale from 0-2. 1 is the baseline measure of a satisfactory performance in terms of Progressive's profit targets, while a zero would mean it had undershot its critical benchmarks. A 2 would mean it had overshot them and performed better than expected (Carlson 2006, p.1).

A gainsharing system is typically employed within a company, although Progressive is making use of this technique regarding the allocation of shares. A gainsharing process involves managers and employees meeting to review performance objectives, planning on how to improve them, and comparing current results with previously-set benchmarks. When improvements ensue, employees receive payments based upon the value of percentage improvements, giving employees an incentive to do better (Bowery 2010).

The philosophy of gainsharing is also manifest in Progressive's second measure when calculating dividends, its shareholder gainshare target, whereby a percentage of after-tax underwriting income is selected and released to the public. This figure will vary from year to year. The 2007 gainshare target was 20%, but is always reviewed prior to release (Carlson 2006, p.1). This is a general benchmark for income in Progressive's underwriting businesses, as opposed to its growth and progression in its core insurance businesses. Finally and perhaps most importantly is the company's annual after-tax underwriting income, which includes underwriting income but not investment and other income sources (Carlson 2006, p.1).

Why is it called a variable dividend policy?

The so-called variable policy was given its name because all of the dividends will be paid strictly according to Progressive's three-tier variable calculation policy. While all dividends paid are variable in theory, depending on firm profitability, most firms pay a fairly stable dividend, to keep investors happy and to keep stock prices stable (Carlson 2006, p.1). However, Progressive resolves to stand true to its policy and to stick to its formula and to give truly variable dividends to its shareholders, based strictly upon company gains.

The philosophy of gainsharing is based upon the idea that it improves company performance and acts as a motivating factor for employees and managers. It also encourages employees to feel invested in corporate decision-making, as they can give input into the process of setting benchmarks and reviewing company performance (Bowery 2010). However, it seems curious applying this strategy to shareholders, given that shareholders, especially for a large corporation like Progressive, have little ability to give meaningful input into the day-to-day decision-making of an organization. Whether the majority of shareholders 'perform' poorly or well in their decisions, such as electing corporate board members, most individuals with small numbers of shares can do little to affect company policy.

Will the dividends paid by Progressive Corporation increase or decrease? Why?

Even for ordinary shareholders, profits are supposed to increase under the new Progressive policy. Of course, the amount of increase will vary, based upon company performance. Given the poor performance of the insurance industry in recent months, it is possible that Progressive shares may contract in value and value may diminish. However, theoretically, they could experience a dramatic increase in the future, if the company is run well. According to the article in Forbes magazine entitled "A Progressive dividend policy," the final outcome for Progressive shareholders is likely to be an increase in profits during most ordinary, reasonably profitable years, although now dividends will be paid annually rather than quarterly (Carlson 2006, p.1). (This may also be seen as a negative by investors, who might want to pocket the dividends as soon as possible to reinvest and therefore make more money and capitalize upon their income in other ways).

What would change if Progressive Corporation used another dividend policy?

According to longtime investment analyst Charles Carlson (2006), dividend payments can take a variety of forms -- from increasing to omitting payments altogether, to paying special dividends during historic changes, to radically varying the schedule of payment. But the Progressive Corporation's strategy is seen as highly unique. A company's usual mode of dividend payment is to do so regularly, and shareholders can count upon the dividend.

Before, Progressive employed such a strategy. But now, it is leaving the regularity of its payments in doubt with the hope of investors gaining more. Carlson predicts that investors will be less-than-enthusiastic about such a method of reimbursement, pointing out that above all else, most average investors like predictability. On one hand, such a dividend policy allows for great rewards, but it also creates the conditions for great uncertainty. And it might be observed that an investor in a fairly 'blue chip' company like Progressive might prefer a more certain dividend payment.

Traditional dividend payment methods include residual, stability, and hybrid models. Residual policies mean that companies use internal equity to finance operating expenses and new ventures, and the dividend payments come out of what is left over. A stable debt-equity ratio is maintained (How and why do companies pay dividends, 2010, Investopedia). Residual dividend payments still fluctuate, although not as much as Progressive's current, unique policy. More conservative investors are likely to favor companies that make use of a stability policy, where dividends are paid at a fixed fraction of quarterly earnings or paid in quarterly portions of yearly earnings (How and why do companies pay dividends, 2010, Investopedia).