Progressive’s dividend: The way it ought to be

December 7, 2010, 1:00 PM UTC

Instead of a fixed amount every quarter, the insurance company pays once-a-year based on performance.  The payout may not be consistent, but it’s the right thing to do.

Progressive Corp. is best known for Flo, the irritating star of the ubiquitous TV and radio commercials the company uses to flog car insurance. But despite having a pitchwoman almost as over the top as the Geico gecko, Progressive itself is low-key when it comes to promoting its most interesting policy: the way it pays dividends to shareholders.

The Progressive Way is something that our big banks and their regulators ought to pay serious attention to, but almost certainly won’t. Even though Progressive’s dividend model was implemented four years ago, I can’t find a single other company that’s adopted it.

I suspect the major reason is that a totally rational dividend is also an unpredictable dividend. In good years owners get a lot of money. In bad years they get nothing. That’s anathema to income-seeking investors who value a predictable dividend over a sustainable one. Predictable dividends can prop a stock’s price in a way that variable dividends can’t.

Now, let me show you how Progressive (PGR), in which I have a small stake, determines its dividend. And why I like its policy so much. Rather than paying a fixed amount every quarter, Progressive pays a once-a-year variable dividend based on the same formula that it uses to determine employee bonuses. That gives employees and owners a common interest, which is lacking in so many companies. In addition, Progressive pays an occasional extra dividend to give its shareholders the capital it feels it no longer needs for its business.

Until four years ago Progressive was a typical, autopilot dividend payer — it sent shareholders a token few cents every quarter. But then the company, which tries to challenge all assumptions, especially its own, had a revelation. “The idea of offering a fixed amount seemed totally nuts to me,” says Glenn Renwick, Progressive’s chief executive. “It seemed to us that if you make some money, you say, ‘There’s this much available.’ You pay some to the workers, you put some in the business, you give some to the owners.”

As a result, Progressive’s dividend has varied wildly since 2007, the first year the new policy went into effect. For that year Progressive paid $2.145 a share. For 2008 it paid nothing, because although it had an operating profit, its investment portfolio declined in the market meltdown, and it won’t pay a dividend if the portfolio’s value drops. “This wasn’t a time to be returning capital,” Renwick says.

For last year it paid 16.13¢. For this year, it’s paying a $1 extra dividend and will pay another 35¢ to 40¢, by my estimate. The company will reveal the exact number later this month.

Next year there’s no way to tell how much, if anything, shareholders will get. But that’s the point. Rather than committing to dividends that it might not be able to afford, Progressive pays based on how its business and securities portfolio do in a given year.

It’s not clear what effect, if any, this policy has had on Progressive stock. But it’s clearly the right way to handle dividends.

Contrast Progressive to the nation’s big banks, most of which continued paying serious dividends even after they ran into trouble when financial markets began melting down in mid-2007. Ultimately, some of those banks failed, and the rest had to replace capital they had paid out in dividends by selling new shares at low prices. “If you truly believe in ownership, your owners don’t want you to give back capital to them when you’re going to have to dilute them by raising more capital,” Renwick says.

Federal regulators, who rightly clamped down on bank dividends as part of the bailout that gave these institutions access to tons of ultra-cheap money, seem almost certain to let them start raising dividends again.

In an ideal world regulators would force banks to follow Progressive-like policies to produce less predictable but more sustainable dividends. That would be the rational way to let banks pay shareholders without putting taxpayers at excessive risk again. The odds of that happening? They are, alas, about the same as Progressive’s dividend policy becoming the new corporate norm anytime soon. Or Flo and the Geico gecko never appearing on TV again.