Exhibit 13
The Progressive Corporation 2001 Annual Report
above
*
and beyond
2001 Financial Highlights 3
Vision, Customer Value Proposition, Core Values and Objectives 4
Letter to Shareholders 16
Financial Review 29
About Progressive
Since the Progressive insurance organization began business in 1937, we have
been innovators--growing into new markets and pioneering new ways to meet
consumers' needs. In 1956, Progressive Casualty Insurance Company was founded to
be among the first specialty underwriters of nonstandard auto insurance. Today,
The Progressive Corporation provides all drivers throughout the United States
with competitive rates and 24-hour, in-person and online services, through its
73 subsidiaries and two affiliates.
Our commitment to creating a Virtually Perfect customer experience led us to
choose service as the theme for this year's annual report. Progressive combines
online access to policy information with 24/7 personalized assistance for
buying, policyholder service and claims. For examples of Progressive's
commitment to service, please visit personal.progressive.com.
Artist Robert ParkeHarrison was commissioned to respond visually to service.
ParkeHarrison is the inventor, painter, set designer, producer and model of his
photographic situations. ParkeHarrison's work will become part of Progressive's
growing collection of contemporary art. For a brief history of Progressive's art
collection, stop by art.progressive.com.
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2001 Financial Highlights
(MILLIONS - EXCEPT PER SHARE AMOUNTS) 2001 2000 % CHANGE
- --------------------------------------------------------------------------------
FOR THE YEAR
Direct premiums written $ 7,379.2 $ 6,402.1 15%
Net premiums written 7,260.1 6,196.1 17
Net premiums earned 7,161.8 6,348.4 13
Total revenues 7,488.2 6,771.0 11
Net income 411.4 46.1 792
Per share-diluted 5.48 .62 784
Operating income(1) 485.5 55.4 776
Per share-diluted 6.47 .75 763
Underwriting margin 4.8% (4.4)%
AT YEAR-END
Consolidated shareholders' equity $ 3,250.7 $ 2,869.8 13
Common Shares outstanding 73.4 73.5 -
Book value per share $ 44.29 $ 39.04 13
Market capitalization $ 10,958.6 $ 7,616.8 44
Return on average shareholders' equity 13.5% 1.7%
Market share(2) 5.2% 4.7%
1-YEAR
- --------------------------------------------------------------------------------
STOCK PRICE APPRECIATION (DEPRECIATION)(3)
Progressive 44.1%
S&P 500 (11.8)%
(1) Defined as net income excluding net realized gains/losses on security sales
and one-time items. This is a non-GAAP disclosure. See Management's
Discussion and Analysis for a description of the one-time items.
(2) Represents Progressive's Personal Lines business; based on U.S. personal
auto insurance market net premiums written of an estimated $125.1 billion
for 2001 and $119.6 billion for 2000.
(3) Assumes dividend reinvestment.
3
Vision, Customer Value Proposition, Core Values and Objectives
Communicating a clear picture of Progressive by stating what we try to achieve
(Vision), how we interact with customers (Customer Value Proposition), what
guides our behavior (Core Values), what our people expect to accomplish
(Objectives), and how we evaluate performance (Measurements), permits all people
associated with Progressive to understand their roles and to enjoy their
contributions.
We seek to be an excellent, innovative, growing and enduring
Vision business by cost-effectively and profitably reducing the
human trauma and economic costs of auto accidents and other
mishaps, and by building a recognized, trusted, admired,
business-generating brand. We seek to earn a superior return
on equity and to provide a positive environment which
attracts quality people who develop and achieve ambitious
growth plans.
Our Customer Value Proposition provides a litmus test for
Customer Value customer interactions, relationships and innovation.
Proposition
FAST, FAIR, BETTER That's what you can
expect from Progressive. Everything we do
recognizes the needs of busy consumers who
are cost-conscious, increasingly savvy about
insurance and ready for easy, new ways to
quote, buy and manage their policies,
including claims service that respects their
time and reduces the trauma and
inconvenience of loss.
4
Progressive's Core Values are pragmatic statements of what
Core Values works best for us in the real world. They govern our decisions
and behavior. We want them understood and embraced by all
Progressive people. Growth and change provide new perspective,
requiring regular refinement of Core Values.
INTEGRITY We revere honesty. We adhere to high ethical standards, report
promptly and completely, encourage disclosing bad news and welcome disagreement.
GOLDEN RULE We respect all people, value the differences among them and deal
with them in the way we want to be dealt with. This requires us to know
ourselves and to try to understand others.
OBJECTIVES We strive to communicate clearly Progressive's ambitious objectives
and our people's personal and team objectives. We evaluate performance against
all these objectives.
EXCELLENCE We strive constantly to improve in order to meet and exceed the
highest expectations of our customers, shareholders and people. We teach and
encourage our people to improve performance and to reduce the costs of what they
do for customers. We base their rewards on results and promotion on ability.
PROFIT The opportunity to earn a profit is how the competitive free-enterprise
system motivates investment to enhance human health and happiness. Expanding
profits reflect our customers' and claimants' increasingly positive view of
Progressive.
5
Consistent achievement of superior results requires
Financial Objectives that our people understand Progressive's objectives
and Measurements and their specific role, and that their personal
objectives dovetail with Progressive's. Our
objectives are ambitious yet realistic. We are
committed to achieving financial objectives over
rolling five-year periods. Experience always
clarifies objectives and illuminates better
strategies. We constantly evolve as we monitor the
execution of our strategies and progress toward
achieving our objectives.
PROFITABILITY Progressive's most important goal is to produce an aggregate
calendar year 4% underwriting profit. Our business is a composite of many
products defined in part by product type, distribution channel, geography,
tenure of the customer and underwriting grouping. Each of these products has
targeted operating parameters based on level of maturity, underlying cost
structures, customer mix and policy life expectancy. Our aggregate goal is the
balanced blend of these individual performance targets in any calendar year.
Overall, we had an underwriting profit of 4.8% in 2001, and an underwriting
profit of 3.0% for the past five years and 4.5% for the past ten years.
Estimated industry results for the personal auto insurance market for the same
periods were underwriting losses of 7.0%, 4.2% and 3.0%.
GROWTH Our goal is to grow as fast as possible constrained only by our
profitability objective and our ability to provide high-quality customer
service. Progressive is a growth-oriented company and management incentives are
tied to profitable growth. We report Personal Lines' results by channel, Agent
and Direct, to give shareholders a more accurate picture of the business
dynamics of each distribution method and their respective rates of growth.
Aggregate expense ratios and aggregate growth rates disguise the true nature and
performance of each business. Personal Lines net premiums written grew 15% in
2001. See Management's Discussion and Analysis for a further breakdown of the
Agent and Direct results.
RETURN ON SHAREHOLDERS' EQUITY Our goal is to achieve an after-tax return on
shareholders' equity over a five-year period that is at least 15 percentage
points greater than the rate of inflation (measured by the Consumer Price Index
which was 1.6% in 2001, and averaged 2.2% over the past five years and 2.5% over
the past ten years). If we believe we can earn such a profit, we will invest in
business operations. If we do not believe we can earn such a profit, we will
return underleveraged capital to our investors. We prefer share repurchases over
dividends as a means of returning capital. As appropriate, we will substitute
debt for equity in our capital structure to reduce our cost of capital. Our
return on equity was 13.5% in 2001, and averaged 12.6% over the past five years
and 16.0% over the past ten years.
6
ACHIEVEMENTS We are convinced that the best way to maximize shareholder value is
to achieve these financial objectives consistently. A shareholder who purchased
100 shares of Progressive for $1,800 in our first public stock offering on April
15, 1971, owned 7,689 shares on December 31, 2001, with a market value of
$1,148,000, for a 23.5% compounded annual return, compared to the 8.3% return
achieved by investors in the Standard & Poor's 500 during the same period. In
addition, the shareholder received dividends of $2,153 in 2001, bringing total
dividends received to $24,494 since the shares were purchased.
In the ten years since December 31, 1991, Progressive shareholders have realized
compounded annual returns of 24.1%, compared to 12.9% for the S&P 500. In the
five years since December 31, 1996, Progressive shareholders' returns were
17.5%, compared to 10.7% for the S&P 500. In 2001, the returns were 44.1% on
Progressive shares and a negative 11.8% for the S&P 500.
Over the years, when we have had adequate capital and believe it is appropriate,
we have repurchased our shares. Since 1971, we spent $752.4 million repurchasing
our shares, at an average cost of $10.96 per share. During 2001, we repurchased
932,234 Common Shares at an average cost of $128.99 per share, including 76,368
Common Shares repurchased to offset obligations under various employee benefit
plans.
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High Expectations
VIRTUALLY PERFECT. It's our top service
priority. We think every customer deserves
personal attention. That's why we give our
customers choice in how to buy, how to make
payments and whether to call us or go online
for policy information and changes. If it's
not virtually perfect, we're working to make
it that way. To see more ways in which
Progressive is striving to be virtually
perfect, go to progressive.com/perfect.
9
Day and Night
WHILE YOU ARE SLEEPING, Progressive's call
center representatives are awake and ready
to serve. We work around-the-clock,
including weekends and holidays, because we
know customers want answers when they
call--not a call back. If you don't feel
like talking, try progressive.com/answers.
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On the Bright Side
PICKING UP THE PIECES. No one is ever
prepared for an accident. It's always
inconvenient. So, our most important job is
to help customers get things back in order.
Just tell us when and where you want us.
We're at your convenience. You'll have the
information and help when you need it. To
learn more about Immediate Response(R)
claims service, visit
progressive.com/claims.
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Expanding Horizons
ABOVE ALL, WE LISTEN CAREFULLY. When
customers say it is confusing to compare
rates, we try to make it easier. Getting a
car repaired is an unfamiliar experience to
most, and we're working to make that
simpler. Our best ideas come from our
customers, and we want you to know that
making your experience a virtually perfect
experience is what makes Progressive
different. "Not what you'd expect from an
insurance company--well, maybe you should."
To read more about our customer-centric
business relationships, go to
progressive.com/relationships.
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Letter to Shareholders
What a difference a year makes--after reporting unacceptable results last year,
we are pleased to report record operating income of $485.5 million in 2001. More
importantly, we've made substantial progress on every front toward making
Progressive consumers' #1 choice for auto insurance. In last year's letter,
Chairman and long-time CEO Peter Lewis reflected on his experience with past
insurance cycles:
"Increasing rates before competitors do slows growth and causes our competitors
to grow faster. While not growing, we fix the processing problems that always
arise during previous periods of fast growth and change. Some competitors grow
faster while both their underwriting results and customer service deteriorate.
Then competitors finally raise rates and restrict acceptances to stem their
losses. When this has happened, because Progressive's rates had been adequate
and our operations were running smoothly, we grew, usually quite profitably. We
will soon learn whether this long-time dynamic still operates."
The first phase of this market dynamic appears to be playing out as expected.
During 2001, we closely monitored our rates and continued to demand rate
adequacy in every market and product. Our focus was on restoring operating
margin. While the growth in policies in force was less than we would have liked,
we ended 2001 with an underwriting margin of 4.8%, in line with our most
important goal of a 4% underwriting profit. By year end, we were reporting
stronger growth rates and if this trend continues, we look forward to, and feel
prepared for, the second phase of the cycle--profitable growth.
16
The merit of Progressive's focused business vision became
Focus increasingly clearer to me since becoming CEO two years ago.
You can expect Progressive to maintain an almost fanatical
focus on auto insurance. We systematically eliminated other
than core businesses and business arrangements that were
inconsistent with our focus and/or distracting management
attention. The U.S. personal auto insurance market is huge and
while our share is substantial enough to count, it is small
enough to offer us growth opportunities over the next decade
to allow us to be a multiple of our current size. We take
considerable pride in understanding our business and applying
the collective energy of our 20,000+ people to perform every
operation of auto insurance extraordinarily well. We have an
intense curiosity to probe for opportunities to improve
customer service and reduce cost because consumers deserve and
demand it.
This year, we added a fourth element to the existing
Customer foundation of Vision, Values and Objectives--the Customer
Value Value Proposition. The Customer Value Proposition provides a
Proposition litmus test for customer interactions, relationships and
innovation.
FAST, FAIR, BETTER That's what you can expect from Progressive. Everything we do
recognizes the needs of busy consumers who are cost-conscious, increasingly
savvy about insurance and ready for easy, new ways to quote, buy and manage
their policies, including claims service that respects their time and reduces
the trauma and inconvenience of loss.
I expect this proposition will give added meaning to our brand line of "Not what
you'd expect from an insurance company--well, maybe you should."
17
In May, we began public reporting of our monthly underwriting
Open results. We had some misgiving about becoming the first, and
Disclosure so far only, public company to report monthly. I'm happy with
the decision to go forward, and can report nothing but
positive outcomes with our owners and interested parties, who
now receive more information sooner about our results. We
separately reported Personal Lines results for our two
distribution channels, Agent and Direct, during all of 2001.
Our loss reserving practices continue to evolve and improve as
we seek ways to be as confident as possible about reserve
adequacy. In June, we published a very open report on how
Progressive establishes and evaluates claim reserves. These
are but two actions that exemplify Progressive's Values and
are consistent with our consumer brand to be open and candid.
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Long-term observers of Progressive's business model will note
Our Evolving a dramatic change over the past ten years from a company with
Business Model a single distribution channel (independent agencies),
primarily variable acquisition costs (agent commission),
narrowly-focused product (nonstandard auto), poor customer
retention, and low liability limits to a multi-channel company
(independent agencies and direct, via both the telephone and
Internet) with a mixed acquisition cost model, product
availability for all drivers, a focus on policyholder
retention, and liability limit mixes reflective of the general
market.
The inclusion of the direct acquisition channel, with its substantial up-front
costs, is the most dramatic change, but each change has significant and
important implications for achieving our goals. The diversity of channel and
product gives Progressive an unlimited ability to meet the needs of consumers
shopping for auto insurance. However, each business area must meet very specific
and different profitability targets, so that the balanced blend meets our 4%
underwriting profit goal. Attempts to change the goals to reflect the new
business opportunities in 1998 led us to suboptimal decisions. In 2000, we
decided the business model must fit our goals, and during 2001, we have become
even clearer in the determination of individual product targets.
20
Progressive's Personal Lines earned premium increased 11% to
Insurance $6.5 billion for 2001, with a 4% increase in auto policies in
Operations force and a GAAP combined ratio of 95.5. In 2000, we made
organizational changes that allow us to understand and advance
each of our two distribution systems--independent agents and
direct to the consumer; 2001 marks the first full year of
operating with these changes. I am very pleased to report that
this structure has produced the desired focus within channel,
and enhanced opportunities for leveraging technology and
increased brand opportunities for our agents and business
partners. We strive to provide the best product possible in
each channel, allowing consumers to choose how they do
business with us.
AGENT OPERATIONS The Agent business produced earned premium of $4.7 billion, up
1% over 2000, with a 1% decrease in auto policies in force. The discipline to
improve operating margin and get to rate adequacy came at the expected cost of
low unit growth. The 94.7 combined ratio for the business was remarkable and the
largest part of our profit turnaround. The decline in policies in force was more
pronounced in the early part of the year, with substantial recovery as
competitors began taking rates up, started becoming more restrictive or even
withdrawing. We achieved a profitable year in nine of our top ten states, while
experiencing significant challenges in New York, Florida, California, Georgia
and Louisiana.
Our strategy of technology leadership in the Agent business, much of it
leveraging the Internet, advanced nicely during the year. Notable achievements
include close to full implementation of our paper-free relationship strategy
with agents in several states, an increasing number of policy endorsements
performed online by the agent versus Progressive's Policy Services group, a
substantial number of policies completely underwritten at the point of sale with
all underwriting data validation checks performed and a growing number of
policyholders electing an installment plan choosing electronic funds transfer.
We work closely with agent advisors in defining our agent technology strategy,
and share with them a goal to have technology be a significant driver of lower
overall cost and increased flexibility for product changes. Our attention will
remain focused in this area.
DIRECT OPERATIONS The important objective in 2001 was for the Direct business to
record a combined ratio under 100. With a substantial book of renewal customers,
sufficient scale in call center operations and media buying, and a substantial
and growing brand awareness, the business has matured such that calendar year
profitability is now expected. The Direct business produced earned premium of
$1.8 billion, up 46% over 2000, and increased auto policies in force by 18%. The
97.7 combined ratio, which was 12.8 points better than last year, and the
continued improvement in expense ratio to 25.9 for 2001 are extremely
encouraging.
During the year, we introduced a new advertising campaign we call "High
Expectations," providing examples in noninsurance encounters of the high
expectations that Progressive customers have come to expect as a result of doing
business with us. The advertising successfully generated an increasing number of
calls and online quotes. We expense all advertising costs as incurred and do not
defer either the development costs of new creatives or the media placements. Our
net investment in establishing this business over the last eight years has been
fully accounted for in operating results. We look forward to significant
contributions to profitable growth.
Our Internet quoting, buying and servicing capabilities continue to lead the
industry and gain favor with consumers. We believe our success with the Internet
business model was a function of great technology, supported by established call
centers for those consumers who start their experience on the Web and wish to
finish with an in-person consultation. Predictably, more consumers are becoming
more comfortable with the Internet for a variety of products and we see
increasing usage for all insurance transactions. We are designing our newer
innovations with the next generation of buyer in mind and it is clear the next
generation is markedly different in their use and expectations of Web-delivered
products. We are very pleased and see tremendous potential in this arena.
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We aspire to be recognized as the preeminent consumer
Commitment franchise in auto insurance, and understand that this requires
to Service an extraordinary commitment to creating new levels of service
expectations. During 2001, we made significant strides in
defining and advancing the concept of making every consumer
interaction Virtually Perfect. In a business that must manage
accuracy of pricing, validity of information and collection of
funds before provision of coverage, while continuously
reducing costs, this standard of care is a true challenge.
From the consumer perspective, service is all about ease of
doing business. We adopted three new and important operating
strategies by which to advance our thinking toward this goal.
ELECTRONIC TRANSACTIONS FOR EVERYTHING Imagine you were in Houston after
Tropical Storm Allison hit in June 2001, and you got an e-mail from Progressive
saying, "We hope things are OK, but based on your location and flood patterns,
we expect you may have had a loss." The e-mail included claim reporting
information and some helpful tips for avoiding damage to your car in flood
conditions. Progressive sent almost 4,100 e-mails and paid over 6,000
weather-related claims last June in Texas, in our single greatest catastrophe
loss ever. Almost 50% of our claims were settled in three weeks and 90% were
settled in 50 days. Many people who were safe from harm e-mailed back to say,
"Thanks for asking about us!" Not what you'd expect from an insurance
company--well, we think you should.
END-TO-END DESIGN Suppose you report an accident at nine o'clock on Sunday
night. Your car is damaged, but drivable and nobody is hurt. Now what happens?
You are offered Immediate Response(R) claims service, the opportunity to choose
your own repair shop or, in several locations, a new alternative we are testing.
Imagine this...You're asked, "When would it be convenient for you to drop your
car off--perhaps 7 a.m. tomorrow on your way to work?" We will transfer your
personal items, including that often forgotten garage door opener, to your
courtesy car, which is there waiting for you. You carry on, business as usual,
while we arrange and oversee the repairs of your vehicle until the beeper we
provide you alerts you your car is ready for pick up. When you return, we will
go over the repairs made by the selected body shop with you and, when satisfied,
you pay your deductible and leave with a guarantee on the work for as long as
you own the vehicle. Total elapsed time--as fast as possible, because we select
a qualified shop that's ready to start work immediately. Total commitment of
your time -- less than 20 minutes, plus drive time, because we follow your car
until it's repaired to our satisfaction--and yours. Not only do we think it's a
great new way to handle vehicle damage claims, but so do over 10,000 consumers
who have been involved in our testing. We plan expansion when we have achieved
specific prototype acceptance criteria. Not what you'd expect from an insurance
company -- well, maybe you should.
CUSTOMER RETENTION I've challenged Progressive people to take the loss of a
Progressive customer personally. We've created a level of self criticism that
demands change to existing procedures and reorientation to customer-centric
training and measurement. Many things have changed and will continue to change
as a result. We can now measure the retention impact of alternative claims
handling solutions. If a customer requests policy cancellation, we are now
probing much more deeply into the reasons for their decision with the hope of
providing alternative solutions. We predict events that may result in policy
cancellations in order to anticipate customer needs. The list of opportunities
is long and detailed, reflecting a growing culture of customer preservation and
detailed analysis of reasons for customer loss.
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Progressive's
Financial Policies
[CHART HERE]
*UNDERWRITING Risk-Failure to grow earned premium and earn a 96 combined ratio
Policies-A. Pursue short-tailed, high-frequency, low-severity opportunities B.
Use multiple insurance companies to maintain flexibility C. Establish growth and
profitability targets by term and channel D. Set rates that reflect claim costs,
acquisition costs and retention E. Ensure loss reserves are adequate and develop
with minimal variance
*INVESTING Risk-Failure to maintain portfolio liquidity and build
wealth Policies-A. Diversify portfolio with liquid asset classes B. Use fixed
income to cover operating liabilities and contingencies C. Use risk assets to
build wealth D. Manage interest rate, default, prepayment and concentration
risk E. Recognize capital gains and losses to promote tax efficiency
*FINANCING Risk-Failure to pay obligations and earn our cost of equity capital
Policies-A. Keep premium-to-surplus below 3:1 for each insurance company B.
Maintain debt between 20% and 30% of total capital at book value C. Pay modest,
increasing cash dividends to shareholders D. Split stock to maintain target
$50 share price if price exceeds $100 E. Neutralize dilution from stock options
with periodic share repurchases
24
Progressive chooses to take risk in and expects commensurate
Capital returns from underwriting auto insurance. Thus, the primary
Management and objective of capital management is always to have sufficient
Investments capital to support all the insurance we can profitably
underwrite and service. During 2001, we undertook a
comprehensive review of all our capital and investing
policies, essentially asking whether they are all congruent
with our objectives and with one another. This extensive and
detailed process resulted in a deeper understanding of all
interrelated components of our business model. The summary
on the preceding page provides a high-level overview of
Progressive's Underwriting, Investing and Financing
policies. Continually challenging our every action for
relevance and congruence is an important and ongoing capital
management function.
We ended 2001 with an $8.2 billion investment portfolio, up from $7.0 billion
last December. Our portfolio size grew due to strong cash flows from operations
and proceeds from a $350 million debt issuance in December 2001. We constrain
our use of capital by requiring ourselves to produce an excellent return on it.
Our return on average shareholders' equity was 13.5% for the year and 12.6% over
the past five years. Similar to our review of the underwriting business, our
review of investing practices has led us to eliminate certain investment
practices and change others. Our asset allocation at year end was 84% fixed
income, managed largely by Progressive Capital Management, and 16% common stock,
largely managed to track the Russell 1000 index. We achieved a 5.9%
fully-taxable equivalent total return for the year.
We stated last year that we would repurchase shares when our capital position,
view of the future and the stock's price make it attractive to do so. During the
year, we repurchased 932,234 shares and ended the year with 73.4 million shares
outstanding versus 73.5 million last year.
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PROGRESSIVE IS SPECIAL because our objectives are demanding and hard to achieve,
particularly all of them every year, and we aspire to ever increasing levels of
performance.
To become consumers' #1 choice in auto insurance requires people who enjoy
working hard, growing constantly, performing well and being rewarded
competitively in an environment of ever-improving business skills and science
with superior technology implementation and a genuine desire to create a better
consumer proposition. As we start 2002, I am proud to report this is my
assessment of the 20,442 Progressive people who make our future brighter than
ever.
We deeply appreciate the customers we are privileged to serve. Thank you for
your business. Thanks to the agents and service representatives in the more than
30,000 Independent Insurance Agencies who did business with Progressive in 2001.
We are grateful for our shareholders' continued confidence. To the men and women
who make Progressive a great company, thanks for all you do each day and for all
we have accomplished together in 2001.
/s/Glenn M. Renwick
Glenn M. Renwick
President and Chief Executive Officer
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*
Financial Review 2001
Consolidated Financial Statements 30 Report of Independent Accountants 45
Management's Discussion and Analysis 46 Ten Year Summaries 52
Quantitative Market Risk Disclosures 56 Analysis of Loss and LAE Development 58
Direct Premiums Written by State 58 Quarterly Financial and Common Share Data 59
29
Consolidated Statements of Income
(millions-except per share amounts)
FOR THE YEARS ENDED DECEMBER 31, 2001 2000 1999
- -----------------------------------------------------------------------------------------------------------------------------------
REVENUES
Premiums earned $ 7,161.8 $ 6,348.4 $ 5,683.6
Investment income 413.6 385.2 340.7
Net realized gains (losses) on security sales (111.9) 16.9 47.2
Service revenues 24.7 20.5 47.5
Other income(1) - - 5.2
- -----------------------------------------------------------------------------------------------------------------------------------
Total revenues 7,488.2 6,771.0 6,124.2
- -----------------------------------------------------------------------------------------------------------------------------------
EXPENSES
Losses and loss adjustment expenses 5,264.1 5,279.4 4,256.4
Policy acquisition costs 864.9 788.0 745.0
Other underwriting expenses 686.9 559.3 583.8
Investment expenses 12.7 9.1 9.5
Service expenses 19.8 21.4 40.9
Interest expense 52.2 77.8 76.4
Non-recurring item(2) - 4.2 -
- -----------------------------------------------------------------------------------------------------------------------------------
Total expenses 6,900.6 6,739.2 5,712.0
- -----------------------------------------------------------------------------------------------------------------------------------
NET INCOME
Income before income taxes 587.6 31.8 412.2
Provision (benefit) for income taxes 176.2 (14.3) 117.0
- -----------------------------------------------------------------------------------------------------------------------------------
Net income $ 411.4 $ 46.1 $ 295.2
============================================
COMPUTATION OF EARNINGS PER SHARE
Basic:
Average shares outstanding 73.7 73.2 72.9
--------------------------------------------
Per share $ 5.58 $ .63 $ 4.05
============================================
Diluted:
Average shares outstanding 73.7 73.2 72.9
Net effect of dilutive stock options 1.4 1.1 1.7
- -----------------------------------------------------------------------------------------------------------------------------------
Total equivalent shares 75.1 74.3 74.6
============================================
Per share $ 5.48 $ .62 $ 3.96
============================================
(1) See Note 12 - Related Party Transaction for discussion.
(2) Represents the realization of the foreign currency translation loss
associated with the substantial liquidation of the Company's foreign
subsidiary.
See notes to consolidated financial statements.
30 The Progressive Corporation and Subsidiaries
Consolidated Balance Sheets
(millions)
DECEMBER 31, 2001 2000
- -----------------------------------------------------------------------------------------------------------------------------------
ASSETS
Investments:
Available-for-sale:
Fixed maturities, at market (amortized cost: $5,873.0 and $4,741.9) $ 5,949.0 $ 4,784.1
Equity securities, at market:
Preferred stocks (cost: $675.4 and $806.3) 713.9 813.7
Common equities (cost: $1,263.7 and $1,141.3) 1,336.0 1,198.7
Short-term investments, at amortized cost (market: $227.4 and $186.8) 227.4 186.8
------------ ------------
Total investments 8,226.3 6,983.3
Cash 11.2 8.9
Accrued investment income 75.2 64.2
Premiums receivable, net of allowance for doubtful accounts of $46.2 and $42.0 1,497.1 1,567.0
Reinsurance recoverables 201.5 237.7
Prepaid reinsurance premiums 77.6 95.7
Deferred acquisition costs 316.6 309.9
Income taxes 178.1 241.1
Property and equipment, net of accumulated depreciation of $384.8 and $315.5 498.0 504.5
Other assets 40.8 39.3
------------ ------------
Total assets $ 11,122.4 $ 10,051.6
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Unearned premiums $ 2,716.7 $ 2,636.5
Loss and loss adjustment expense reserves 3,238.0 2,986.4
Accounts payable, accrued expenses and other liabilities 821.3 810.1
Debt 1,095.7 748.8
------------ ------------
Total liabilities 7,871.7 7,181.8
------------ ------------
Shareholders' equity:
Common Shares, $1.00 par value (authorized 300.0, issued 83.1,
including treasury shares of 9.7 and 9.6) 73.4 73.5
Paid-in capital 554.0 511.2
Accumulated other comprehensive income:
Net unrealized appreciation on investment securities 121.5 69.5
Forecasted hedges 9.2 -
Foreign currency translation adjustment (4.8) (4.8)
Retained earnings 2,497.4 2,220.4
------------ ------------
Total shareholders' equity 3,250.7 2,869.8
------------ ------------
Total liabilities and shareholders' equity $ 11,122.4 $ 10,051.6
============ ============
See notes to consolidated financial statements
The Progressive Corporation and Subsidiaries 31
Consolidated Statements of Changes in Shareholders' Equity
(millions-except per share amounts)
FOR THE YEARS ENDED DECEMBER 31, 2001 2000 1999
- -----------------------------------------------------------------------------------------------------------------------------------
RETAINED EARNINGS
Balance, Beginning of year $ 2,220.4 $ 2,210.5 $ 1,932.6
Net income 411.4 $ 411.4 46.1 $ 46.1 295.2 $ 295.2
------- --------- ---------
Cash dividends on Common Shares ($.28, $.27
and $.26 per share) (20.6) (19.8) (19.0)
Treasury shares purchased (112.5) (15.5) (.6)
Other, net (1.3) (.9) 2.3
----------- ----------- -----------
Balance, End of year $ 2,497.4 $ 2,220.4 $ 2,210.5
----------- ----------- -----------
ACCUMULATED OTHER COMPREHENSIVE
INCOME (LOSS), NET OF TAX
Balance, Beginning of year $ 64.7 $ (12.4) $ 103.7
Change in unrealized appreciation (depreciation) 52.0 72.9 (116.7)
Forecasted hedges 9.2 - -
Foreign currency translation adjustment - 4.2 .6
------- --------- ---------
Other comprehensive income (loss) 61.2 61.2 77.1 77.1 (116.1) (116.1)
----------- ------- ----------- --------- ----------- ---------
Balance, End of year $ 125.9 $ 64.7 $ (12.4)
----------- ----------- -----------
COMPREHENSIVE INCOME $ 472.6 $ 123.2 $ 179.1
======= ========= =========
COMMON SHARES, $1.00 PAR VALUE
Balance, Beginning of year $ 73.5 $ 73.1 $ 72.5
Stock options exercised .8 .7 .6
Treasury shares purchased (.9) (.3) -
----------- ----------- -----------
Balance, End of year $ 73.4 $ 73.5 $ 73.1
----------- ----------- -----------
PAID-IN CAPITAL
Balance, Beginning of year $ 511.2 $ 481.6 $ 448.3
Stock options exercised 25.2 17.9 12.0
Tax benefits on stock options exercised 24.4 11.3 20.4
Treasury shares purchased (6.8) (2.0) -
Other - 2.4 .9
----------- ----------- -----------
Balance, End of year $ 554.0 $ 511.2 $ 481.6
----------- ----------- -----------
TOTAL SHAREHOLDERS' EQUITY $ 3,250.7 $ 2,869.8 $ 2,752.8
=========== =========== ===========
There are 20.0 million Serial Preferred Shares authorized; no such shares are
issued or outstanding.
There are 5.0 million Voting Preference Shares authorized; no such shares have
been issued.
See notes to consolidated financial statements.
32 The Progressive Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(millions)
FOR THE YEARS ENDED DECEMBER 31, 2001 2000 1999
- -----------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 411.4 $ 46.1 $ 295.2
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 81.0 77.6 71.8
Net realized (gains) losses on security sales 111.9 (16.9) (47.2)
Gain on sale of property and equipment - - (5.2)
Realized foreign currency translation loss - 4.2 -
Changes in:
Unearned premiums 80.2 (144.9) 451.7
Loss and loss adjustment expense reserves 251.6 570.2 231.2
Accounts payable, accrued expenses and other liabilities 103.4 40.1 106.7
Prepaid reinsurance premiums 18.1 (7.4) (10.6)
Reinsurance recoverables 36.2 17.0 26.3
Premiums receivable 69.9 193.8 (304.6)
Deferred acquisition costs (6.7) 33.5 (44.3)
Income taxes 30.2 (6.9) (17.8)
Tax benefits from exercise of stock options 24.4 11.3 20.4
Other, net 23.0 4.7 21.0
-------- ------ --------
Net cash provided by operating activities 1,234.6 822.4 794.6
-------- ------ --------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases:
Available-for-sale: fixed maturities (4,935.2) (5,259.2) (6,076.7)
equity securities (1,696.0) (1,227.2) (1,094.7)
Sales:
Available-for-sale: fixed maturities 3,335.5 4,728.3 5,182.5
equity securities 1,436.3 837.5 480.0
Maturities, paydowns, calls and other:
Available-for-sale: fixed maturities 451.9 406.7 361.4
equity securities 135.9 27.0 26.6
Net (purchases) sales of short-term investments (40.6) 42.2 221.0
(Receivable) payable on securities (95.3) 64.3 (19.1)
Purchases of property and equipment (74.9) (130.3) (147.5)
Sale of property and equipment - - 12.1
Purchase of subsidiaries, net of cash acquired - - (9.9)
-------- ------ --------
Net cash used in investing activities (1,482.4) (510.7) (1,064.3)
-------- ------ --------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from exercise of stock options 26.0 18.6 12.6
Proceeds from debt 365.4 - 301.4
Payments of debt (.5) (300.4) (30.0)
Dividends paid to shareholders (20.6) (19.8) (19.0)
Acquisition of treasury shares (120.2) (17.8) (.6)
Other, net - 2.4 .9
-------- ------ --------
Net cash provided by (used in) financing activities 250.1 (317.0) 265.3
-------- ------ --------
Increase (decrease) in cash 2.3 (5.3) (4.4)
Cash, Beginning of year 8.9 14.2 18.6
-------- ------ --------
Cash, End of year $ 11.2 $ 8.9 $ 14.2
======== ====== ========
See notes to consolidated financial statements.
The Progressive Corporation and Subsidiaries 33
Notes to Consolidated Financial Statements
December 31, 2001, 2000 and 1999
1 REPORTING AND ACCOUNTING POLICIES
NATURE OF OPERATIONS The Progressive Corporation, an insurance holding company
formed in 1965, owns 73 subsidiaries and has 1 mutual insurance company
affiliate and 1 reciprocal company affiliate. The companies provide personal
automobile insurance and other specialty property-casualty insurance and related
services throughout the United States.
BASIS OF CONSOLIDATION AND REPORTING The accompanying consolidated financial
statements include the accounts of The Progressive Corporation, its subsidiaries
and affiliates (the Company). All of the subsidiaries and the affiliates are
wholly owned or controlled. All intercompany accounts and transactions are
eliminated in consolidation.
ESTIMATES The Company is required to make estimates and assumptions when
preparing its financial statements and accompanying notes in conformity with
accounting principles generally accepted in the United States of America (GAAP).
Actual results could differ from those estimates.
INVESTMENTS Available-for-sale: fixed maturity securities are debt securities,
which may have fixed or variable principal payment schedules, held for
indefinite periods of time, and may be used as a part of the Company's asset/
liability strategy or sold in response to changes in interest rates, anticipated
prepayments, risk/reward characteristics, liquidity needs or similar economic
factors. These securities are carried at market value with the corresponding
unrealized appreciation or depreciation, net of deferred income taxes, reported
in accumulated other comprehensive income. Market values are obtained from a
recognized pricing service or other quoted sources. The asset-backed portfolio
is accounted for under the retrospective method; prepayment assumptions are
based on market expectations.
Available-for-sale: equity securities include common equities and non-
redeemable preferred stocks and are reported at quoted market values. Changes in
the market values of these securities, net of deferred income taxes, are
reflected as unrealized appreciation or depreciation in accumulated other
comprehensive income. Changes in value of foreign equities due to foreign
currency exchange are limited by foreign currency hedges; unhedged amounts are
not material and changes in value are recognized in income in the current
period. There were no foreign currency hedges outstanding at December 31, 2001.
Trading securities are securities bought principally for the purpose of
sale in the near term and are reported at market value within the
available-for-sale portfolio. Changes in market value are recognized in income
in the current period. During the year, the net activity in trading securities
was not material to the Company's financial position or cash flows; the effect
on results of operations is separately disclosed in Note 2 - Investments.
Derivative instruments may include futures, options, forward positions,
foreign currency forwards and interest rate swap agreements and may be used in
the portfolio for risk management, fair value hedging or trading purposes.
Derivatives are recognized as either assets or liabilities and are measured at
fair value with changes in fair value recognized in income in the period of
change. Changes in the fair value of the hedged items are recognized in income
while the hedge is in effect.
Derivatives designated as hedges are evaluated on established criteria to
determine the effectiveness of their correlation to and ability to reduce risk
of specific securities or transactions; effectiveness is reassessed regularly.
If the effectiveness of a fair value hedge becomes non-compliant, the adjustment
in the change in value of the hedged item will no longer be recognized in income
during the current period. During the year, the net activity in fair value
hedges and derivative instruments held or issued for risk management or trading
purposes was not material to the Company's financial position, cash flows or
results of operations; gains or losses during the year were reported in the
available-for-sale portfolio. Gains and losses on foreign currency hedges offset
the foreign exchange gains and losses on the foreign equity portfolio. The
Company did not have any foreign currency equity during 2001.
Derivatives may also be used to hedge forecasted transactions. Changes in
fair value of forecasted hedges are reported as a component of accumulated other
comprehensive income and subsequently amortized into earnings over the life of
the hedged transaction. Gains and losses on forecasted hedges are amortized over
the life of the hedged transaction (see Note 13-Debt). Forecasted hedges that no
longer qualify for hedge accounting due to lack of correlation are considered
derivatives used for risk management purposes.
Short-term investments include eurodollar deposits, commercial paper and
other securities maturing within one year and are reported at amortized cost,
which approximates market.
Investment securities are exposed to various risks such as interest rate,
market and credit risk. Market values of securities fluctuate based on the
magnitude of changing market conditions; significant changes in market
conditions could materially affect portfolio value in the near term. When a
security has a decline in market value which is other than temporary, the
Company reduces the carrying value of such security to its current market value.
Realized gains and losses on sales of securities are computed based on the
first-in first-out method and include write downs on available-for-sale
securities considered to have other than temporary declines in market value.
PROPERTY AND EQUIPMENT Property and equipment are recorded at cost. Depreciation
is provided over the estimated useful lives of the assets using accelerated
methods for computers and the straight-line method for all other fixed assets.
The useful lives range from 3 to 4 years for computers, 10 to 40 years for
buildings and improvements, and 5 to 6 years for all other property and
equipment. Property and equipment includes software capitalized for internal
use. At December 31, 2001 and 2000, land and buildings comprised 73% and 71%,
respectively, of total property and equipment.
34 The Progressive Corporation and Subsidiaries
As of December 31, 2001, the Company had completed its contractual commitments
related to the Company's construction project in Mayfield Village, Ohio. Total
construction cost was $129.0 million. Total interest capitalized was $1.2
million, $3.3 million and $3.4 million in 2001, 2000 and 1999, respectively,
relating to both the Company's construction projects and capitalized computer
software costs.
INSURANCE PREMIUMS AND RECEIVABLES Insurance premiums written are earned
primarily on a pro rata basis over the period of risk. The Company provides
insurance and related services to individuals, lenders and small commercial
accounts throughout the United States, and offers a variety of payment plans to
meet individual customer needs. Generally, premiums are collected in advance of
providing risk coverage, minimizing the Company's exposure to credit risk.
LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES Loss reserves represent the estimated
liability on claims reported to the Company, plus reserves for losses incurred
but not yet reported (IBNR). These estimates are reported net of amounts
recoverable from salvage and subrogation. Loss adjustment expense reserves
represent the estimated expenses required to settle these claims and losses. The
methods of making estimates and establishing these reserves are reviewed
regularly, and resulting adjustments are reflected in income currently. Such
loss and loss adjustment expense reserves could be susceptible to significant
change in the near term.
REINSURANCE The Company's reinsurance transactions include premiums written
under state-mandated involuntary plans for commercial vehicles (Commercial Auto
Insurance Procedures-CAIP), for which the Company retains no indemnity risk (see
Note 14 - Reinsurance for further discussion). The remaining reinsurance
arises from the Company seeking to reduce its loss exposure in its auto and
non-auto programs. Prepaid reinsurance premiums are recognized on a pro rata
basis over the period of risk.
EARNINGS PER SHARE Basic earnings per share are computed using the weighted
average number of Common Shares outstanding. Diluted earnings per share include
common stock equivalents assumed outstanding during the period. The Company's
common stock equivalents include stock options.
DEFERRED ACQUISITION COSTS Deferred acquisition costs include commissions,
premium taxes and other variable underwriting and direct sales costs incurred in
connection with writing business. These costs are deferred and amortized over
the policy period in which the related premiums are earned. The Company
considers anticipated investment income in determining the recoverability of
these costs. Based on current indications, management believes that these costs
will be fully recoverable in the near term. The Company does not defer
advertising costs.
SERVICE REVENUES AND EXPENSES Service revenues consist primarily of fees
generated from processing business for involuntary plans and are earned on a pro
rata basis over the term of the related policies. Acquisition expenses are
deferred and amortized over the period in which the related revenues are earned.
SUPPLEMENTAL CASH FLOW INFORMATION Cash includes only bank demand deposits. The
Company paid income taxes of $127.3 million, $13.8 million and $116.5 million in
2001, 2000 and 1999, respectively. Total interest paid was $51.3 million during
2001, $81.6 million during 2000 and $72.4 million during 1999.
STOCK OPTIONS The Company follows the provisions of Accounting Principles Board
(APB) Opinion No. 25, "Accounting for Stock Issued to Employees," to account for
its stock option activity in the financial statements. The Company granted all
options currently outstanding at an exercise price equal to the market price at
the date of grant and, therefore, under APB 25, no compensation expense is
recorded. The Company follows the disclosure provisions of Statement of
Financial Accounting Standards (SFAS) 123, "Accounting for Stock-Based
Compensation."
NEW ACCOUNTING STANDARDS In June 2001, the Financial Accounting Standards Board
issued SFAS 142, "Goodwill and Other Intangible Assets," which requires that
goodwill and other intangibles be assessed for impairment, yet no longer be
amortized. The statement is effective for fiscal years beginning after December
15, 2001. The Company does not have any goodwill that it is currently
amortizing. Therefore, this new accounting standard would have no impact on the
Company's financial condition, cash flows or results of operations.
35
2 INVESTMENTS
-----------
- --------------------------------------------------------------------------------
The composition of the investment portfolio at December 31 was:
<Table>
<Caption>
Gross Gross
Unrealized Unrealized Market
(millions) Cost Gains Losses Value
- -----------------------------------------------------------------------------------------------------------------------------------
2001
Available-for-sale:
U.S. government obligations $ 667.9 $ 3.1 $ (3.3) $ 667.7
State and local government obligations 1,066.0 24.6 (6.0) 1,084.6
Foreign government obligations 38.2 .9 - 39.1
Corporate and U.S. agency debt securities 1,823.7 41.7 (13.2) 1,852.2
Asset-backed securities 2,277.2 62.2 (34.0) 2,305.4
- -----------------------------------------------------------------------------------------------------------------------------------
5,873.0 132.5 (56.5) 5,949.0
Preferred stocks 675.4 39.4 (.9) 713.9
Common equities 1,263.7 110.8 (38.5) 1,336.0
Short-term investments 227.4 - - 227.4
- -----------------------------------------------------------------------------------------------------------------------------------
$ 8,039.5 $ 282.7 $ (95.9) $ 8,226.3
===================================================================================================================================
2000
Available-for-sale:
U.S. government obligations $ 447.8 $ 4.0 $ (1.1) $ 450.7
State and local government obligations 1,006.8 22.9 (4.3) 1,025.4
Foreign government obligations 39.0 .1 (.3) 38.8
Corporate and U.S. agency debt securities 1,061.2 18.2 (14.7) 1,064.7
Asset-backed securities 2,187.1 40.0 (22.6) 2,204.5
- -----------------------------------------------------------------------------------------------------------------------------------
4,741.9 85.2 (43.0) 4,784.1
Preferred stocks 806.3 22.8 (15.4) 813.7
Common equities 1,141.3 192.0 (134.6) 1,198.7
Short-term investments 186.8 - - 186.8
- -----------------------------------------------------------------------------------------------------------------------------------
$ 6,876.3 $ 300.0 $ (193.0) $ 6,983.3
===================================================================================================================================
</Table>
At December 31, 2001, bonds in the principal amount of $79.8 million were on
deposit with various regulatory agencies to meet statutory requirements.
The components of pretax investment income and net realized gains (losses) on
security sales for the years ended December 31 were:
<Table>
<Caption>
(millions) 2001 2000 1999
- -----------------------------------------------------------------------------------------------------------------------------------
Available-for-sale: fixed maturities $ 335.0 $ 296.8 $ 275.6
equity securities 68.0 63.6 53.4
Short-term investments 10.6 24.8 11.7
- -----------------------------------------------------------------------------------------------------------------------------------
Investment income 413.6 385.2 340.7
- -----------------------------------------------------------------------------------------------------------------------------------
Gross realized gains:
Available-for-sale: fixed maturities 63.0 41.3 35.4
equity securities 123.9 159.4 135.8
Short-term investments .1 .7 .1
Gross realized losses:
Available-for-sale: fixed maturities (51.9) (43.8) (55.8)
equity securities (247.0) (140.7) (68.3)
- -----------------------------------------------------------------------------------------------------------------------------------
Net realized gains (losses) on security sales (111.9) 16.9 47.2
- -----------------------------------------------------------------------------------------------------------------------------------
$ 301.7 $ 402.1 $ 387.9
===================================================================================================================================
</Table>
For 2001, 2000 and 1999, net realized gains (losses) on security sales include
$36.0 million, $43.1 million and $16.3 million, respectively, of write downs in
securities determined to have an other than temporary decline in market value
for securities held at December 31.
36
Trading securities are accounted for separately in accordance with SFAS 115,
"Accounting for Certain Investments in Debt and Equity Securities." At December
31, 2001, the Company did not hold any trading securities, compared to $3.7
million held at December 31, 2000. Net realized losses on trading securities for
the years ended December 31, 2001, 2000 and 1999 were $6.5 million, $19.0
million and $.3 million, respectively. Trading securities are not material to
the Company's financial condition, cash flows or results of operations and are
reported within the available-for-sale portfolio.
The composition of fixed maturities by maturity at December 31, 2001 was:
Market
(millions) Cost Value
- -------------------------------------------------------------------------------
Less than one year $ 397.6 $ 406.1
One to five years 3,045.6 3,111.9
Five to ten years 2,213.9 2,228.7
Ten years or greater 215.9 202.3
- -------------------------------------------------------------------------------
$ 5,873.0 $ 5,949.0
===============================================================================
Asset-backed securities are reported based upon their projected cash flows. All
other securities which do not have a single maturity date are reported at
average maturity. Actual maturities may differ from expected maturities because
the issuers of the securities may have the right to call or prepay obligations.
The Company records derivative instruments at fair value on the balance sheet,
with changes in value reflected in income during the current period. This
accounting treatment did not change when SFAS 133, "Accounting for Derivative
Instruments and Hedging Activities," became effective January 1, 2001;
therefore, no transition adjustment was required.
Derivative instruments are generally used to manage the Company's risks and
enhance the yields of the available-for-sale portfolio. This is accomplished by
modifying the basis, duration, interest rate or foreign currency characteristics
of the portfolio, hedged securities or hedged cash flows. During 2001, the
Company entered into a cash flow hedge in anticipation of our $350 million debt
issuance, which is described further in Note 13-Debt. During 1998, the Company
entered into a short futures position as part of an anticipatory debt hedge
relating to the then outstanding $300 million shelf registration. Driven by
changing economic conditions, the futures position did not meet the established
criteria for hedging correlation and was discontinued as a hedge. The short
futures position recognized a net realized gain of $8.1 million in 1999.
At December 31, 2001, the Company did not hold any open risk management
derivative positions. At December 31, 2000, the Company held open derivative
positions held or issued for risk management purposes in puts, calls and a
foreign currency hedge with a net market value of $(3.3) million. During 2001,
the Company recognized net gains (losses) on risk management derivatives of
$(2.7) million, compared to $(2.3) million in 2000 and $4.6 million in 1999.
Derivative instruments may also be used for trading purposes. At December 31,
2001, the Company held a credit default protection instrument, with a net market
value of less than $.1 million. At December 31, 2000, the Company had trading
positions in call and put options with a net market value of $(1.4) million. Net
gains (losses) on derivative positions were $1.9 million in 2001, $2.6 million
in 2000 and $(3.5) million in 1999, and are included in the available-for-sale
portfolio.
For all derivative positions, net cash requirements are limited to changes in
market values, which may vary based upon changes in interest rates, currency
exchange rates and other factors. Exposure to credit risk is limited to the
carrying value; collateral may be required to limit credit risk.
As of December 31, 2001, the Company had open investment funding commitments
of $48.4 million. The Company had no uncollateralized lines or letters of credit
as of December 31, 2001 or 2000.
3 LITIGATION
----------
The Company is named as a defendant in various lawsuits generally relating to
its insurance operations. All legal actions relating to claims made under
insurance policies are considered by the Company in establishing its loss and
loss adjustment expense reserves, including an estimated reserve related to a
diminution of value suit in Georgia. In February 2002, the Company reached a
settlement of its diminution of value lawsuit in Georgia for between $19.4
million and $20.0 million.
The Company is also named as a defendant in a number of putative class action
lawsuits, such as those alleging damages as a result of the Company's total loss
evaluation methodology, use of after-market parts, use of credit in
underwriting, charging betterment in first party physical damage claims,
offering alternative commission programs or the alleged diminution of value to
vehicles which are involved in accidents, and cases challenging other aspects of
the Company's claims and marketing practices and business operations. Other
insurance companies face many of these same issues.
The Company plans to vigorously contest these suits. The Company has
established reserves for those lawsuits for which the Company is currently able
to estimate its potential exposure; the Company is currently unable to estimate
the potential exposure on the other lawsuits. The Company believes that the
ultimate disposition of the lawsuits for which reserves have been established in
amounts in excess of the current reserves will not materially impact the
Company's annual cash flows or results of operations or financial condition.
37
4 LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
-----------------------------------------
- --------------------------------------------------------------------------------
Activity in the loss and loss adjustment expense reserves, prepared in
accordance with GAAP, is summarized as follows:
<Table>
<Caption>
(millions) 2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at January 1 $ 2,986.4 $ 2,416.2 $ 2,188.6
Less reinsurance recoverables on unpaid losses 201.1 216.0 242.8
- ------------------------------------------------------------------------------------------------------------------------------------
Net balance at January 1 2,785.3 2,200.2 1,945.8
- ------------------------------------------------------------------------------------------------------------------------------------
Incurred related to:
Current year 5,363.1 5,203.6 4,286.2
Prior years (99.0) 75.8 (29.8)
- ------------------------------------------------------------------------------------------------------------------------------------
Total incurred 5,264.1 5,279.4 4,256.4
- ------------------------------------------------------------------------------------------------------------------------------------
Paid related to:
Current year 3,570.4 3,447.7 2,919.2
Prior years 1,409.3 1,246.6 1,082.8
- -----------------------------------------------------------------------------------------------------------------------------------
Total paid 4,979.7 4,694.3 4,002.0
- ------------------------------------------------------------------------------------------------------------------------------------
Net balance at December 31 3,069.7 2,785.3 2,200.2
Plus reinsurance recoverables on unpaid losses 168.3 201.1 216.0
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31 $ 3,238.0 $ 2,986.4 $ 2,416.2
===================================================================================================================================
</Table>
The Company's objective is to establish case and IBNR reserves that are adequate
to cover all loss costs, while sustaining minimal variation from the date that
the reserves are initially established until losses are fully
developed. The Company's reserves developed conservatively in 2001 and prior to
2000. Beginning in 1999 and continuing throughout 2000, the Company experienced
an increase in severity trends which led to adverse development on prior
accident years in 2000.
Because the Company is primarily an insurer of motor vehicles, it has limited
exposure for environmental, product and general liability claims. The Company
has established reserves for these exposures, in amounts which it believes to be
adequate based on information currently known. The Company does not believe that
these claims will have a material impact on the Company's liquidity, financial
condition, cash flows or results of operations.
The Company writes auto insurance in the coastal states, which could be
exposed to natural catastrophes, such as hurricanes. Although the occurrence of
a major catastrophe could have a significant impact on the Company's quarterly
results, the Company believes such an event would not be so material as to
disrupt the overall normal operations of the Company. The Company is unable to
predict if any such events will occur in the near term.
5 STATUTORY FINANCIAL INFORMATION
--------------------------------
At December 31, 2001, $333.8 million of consolidated statutory policyholders'
surplus represents net admitted assets of the Company's insurance subsidiaries
and affiliates that are required to meet minimum statutory surplus requirements
in such entities' states of domicile. The companies may be licensed in states
other than their states of domicile, which may have higher minimum statutory
surplus requirements. Generally, the net admitted assets of insurance companies
that, subject to other applicable insurance laws and regulations, are available
for transfer to the parent company cannot include the net admitted assets
required to meet the minimum statutory surplus requirements of the states where
the companies are licensed.
During 2001, the insurance subsidiaries paid aggregate cash dividends of
$461.2 million to the parent company. Based on the dividend laws
currently in effect, the insurance subsidiaries may pay aggregate dividends of
$436.0 million in 2002 without prior approval from regulatory authorities.
Statutory policyholders' surplus was $2,647.7 million and $2,177.0
million at December 31, 2001 and 2000, respectively. Statutory net income was
$469.5 million, $33.8 million and $199.3 million for the years ended December
31, 2001, 2000 and 1999, respectively.
The Company files statutory-basis financial statements with state insurance
departments in all states in which the Company is licensed.
On January 1, 2001, significant changes to the statutory basis of accounting
became effective. The cumulative effect of these changes was recorded as a
direct adjustment to statutory surplus. The effect of adoption increased
statutory surplus by $340.5 million.
38
6 INCOME TAXES
------------
- -------------------------------------------------------------------------------
The components of the Company's income tax provision (benefit) were as follows:
<Table>
<Caption>
(millions) 2001 2000 1999
- -----------------------------------------------------------------------------------------------------------------------------------
Current tax provision $ 176.6 $ 25.0 $ 136.2
Deferred tax benefit (.4) (39.3) (19.2)
- ------------------------------------------------------------------------------------------------------------------------------------
Total income tax provision (benefit) $ 176.2 $ (14.3) $ 117.0
=============================================
</Table>
The provision (benefit) for income taxes in the accompanying consolidated
statements of income differed from the statutory rate as follows:
<Table>
<Caption>
(millions) 2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------------------------
Income before income taxes $ 587.6 $ 31.8 $ 412.2
--------------------------------------------------------------------------
Tax at statutory rate $ 205.7 35% $ 11.1 35% $ 144.3 35%
Tax effect of:
Exempt interest income (14.7) (3) (17.6) (55) (22.1) (5)
Dividends received deduction (12.6) (2) (10.3) (32) (6.1) (2)
Goodwill amortization -- -- 1.4 4 1.6 --
Foreign currency translation loss -- -- 1.4 4 -- --
Other items, net (2.2) -- (.3) (1) (.7) --
- -----------------------------------------------------------------------------------------------------------------------------------
$ 176.2 30% $ (14.3) (45)% $ 117.0 28%
=========================================================================
</Table>
Deferred income taxes reflect the impact for financial statement reporting
purposes of temporary differences between the financial statement carrying
amounts and the tax bases of assets and liabilities. At December 31, 2001 and
2000, the components of the net deferred tax assets were as follows:
<Table>
<Caption>
(millions) 2001 2000
- -----------------------------------------------------------------------------------------------------------------------------------
Deferred tax assets:
Unearned premiums reserve $ 191.4 $ 183.8
Non-deductible accruals 54.6 59.6
Loss reserves 135.5 134.2
Capital loss carryforward 14.1 --
Other 13.0 28.3
Deferred tax liabilities:
Deferred acquisition costs (110.8) (108.5)
Unrealized gains (65.3) (37.5)
Forecasted hedges (5.0) --
- ------------------------------------------------------------------------------------------------------------------------------------
Net deferred tax assets $ 227.5 $ 259.9
=============================
</Table>
The Company is able to demonstrate that the benefit of its deferred tax assets
is fully realizable.
39
7 EMPLOYEE BENEFIT PLANS
----------------------
RETIREMENT PLANS The Company has a two-tiered Retirement Security Program. The
first tier is a defined contribution pension plan covering all employees who
meet requirements as to age and length of service. Contributions vary from 1% to
5% of annual eligible compensation up to the Social Security wage base, based on
years of eligible service. Company contributions were $10.7 million in 2001,
$9.3 million in 2000 and $8.0 million in 1999.
The second tier is a long-term savings plan under which the Company matches
amounts contributed to the plan by an employee up to a maximum of 3% of the
employee's eligible compensation. Effective April 1, 2002, Company matching
contributions may be invested by a participant in any of the investment funds
available under the plan. Previously, such contributions were required to be
invested in the Company stock fund until fully vested. Company matching
contributions were $14.4 million in 2001, $12.9 million in 2000 and $11.3
million in 1999.
During 2000, the Company terminated its defined benefit pension plan and
recognized $3.2 million in settlement expenses. In addition, the Company
recognized pension expense of $2.8 million in 2000 and $2.3 million in 1999.
POSTEMPLOYMENT BENEFITS The Company provides various postemployment benefits to
former or inactive employees who meet eligibility requirements, their
beneficiaries and covered dependents. Postemployment benefits include salary
continuation and disability-related benefits, including workers' compensation,
and, if elected, continuation of health-care benefits. The Company's liability
was $8.3 million at December 31, 2001, compared to $6.6 million in 2000.
POSTRETIREMENT BENEFITS The Company provides postretirement health and life
insurance benefits to all employees who met requirements as to age and length of
service at December 31, 1988. The Company recognized income of $.3 million in
2001, and $.4 million in both 2000 and 1999. The Company's funding policy is to
contribute annually the maximum amount that can be deducted for Federal income
tax purposes. Contributions are intended to provide not only for benefits
attributed to services to date, but also for those expected to be earned in the
future.
DEFERRED COMPENSATION The Company maintains The Progressive Corporation
Executive Deferred Compensation Plan (Deferral Plan), which permits eligible
executives to defer receipt of some or all of their annual bonuses or other
incentive awards. These deferred amounts are deemed invested in one or more
investment funds, including Common Shares of the Company, offered under the
Deferral Plan. All distributions from the Deferral Plan will be made in cash,
except that distributions representing amounts deemed invested in Common Shares
will be made in Common Shares. The Company reserved 300,000 Common Shares for
issuance under the Deferral Plan. The Company established an irrevocable grantor
trust to provide a source of funds to assist the Company in meeting its
liabilities under the Deferral Plan. At December 31, 2001 and 2000, the trust
held assets of $19.2 million and $17.6 million, respectively, of which $5.0
million and $3.4 million were held in Common Shares, to cover its liabilities.
INCENTIVE COMPENSATION Plans The Company's 1995 Incentive Plan, which provides
for the granting of stock options and other stock-based awards to key employees
of the Company, has 5,000,000 shares authorized. The 1989 Incentive Plan has
expired. In addition to the Incentive Plans, the Company registered 650,000
Common Shares relating to stock options granted to directors of the Company. The
nonqualified stock options granted are for periods up to ten years, become
exercisable at various dates not earlier than six months after the date of
grant, and remain exercisable for specified periods thereafter. All options
granted have an exercise price equal to the market value of the Common Shares on
the date of grant.
A summary of all employee stock option activity during the years ended December
31 follows:
<Table>
<Caption>
2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Number of Average Number of Average Number of Average
Options Outstanding Shares Exercise Price Shares Exercise Price Shares Exercise Price
- ------------------------------------------------------------------------------------------------------------------------------------
Beginning of year 4,525,392 $ 61.60 4,458,463 $ 58.20 4,705,811 $ 46.07
Add (deduct):
Granted 670,694 92.67 1,085,789 59.01 476,850 139.18
Exercised (812,585) 31.41 (678,924) 25.59 (552,473) 22.54
Cancelled (156,041) 85.75 (339,936) 80.80 (171,725) 65.50
- ------------------------------------------------------------------------------------------------------------------------------------
End of year 4,227,460 $ 71.43 4,525,392 $ 61.60 4,458,463 $ 58.20
====================================================================================================================================
Exercisable, end of year 1,402,203 $ 39.57 1,544,614 $ 30.91 1,571,538 $ 25.15
==================================================================================
Available, end of year 2,579,894 3,625,569 4,371,422
========= ========= =========
</Table>
40
The following employee options were outstanding or exercisable as of December
31, 2001:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------------------------- ----------------------------
WEIGHTED AVERAGE WEIGHTED WEIGHTED
RANGE OF NUMBER OF REMAINING AVERAGE NUMBER OF AVERAGE
EXERCISE PRICES SHARES CONTRACTUAL LIFE EXERCISE PRICE SHARES EXERCISE PRICE
- ----------------------------------------------------------------------------------------------- ----------------------------
$ 29 - 40 886,460 2.21 years $ 33.51 886,460 $ 33.51
41 - 60 1,368,921 6.57 years 53.96 487,142 47.20
61 - 80 546,597 5.24 years 68.68 14,277 68.82
81 - 125 1,042,858 7.95 years 102.22 8,164 113.44
126 - 161 382,624 7.02 years 141.81 6,160 143.02
- ----------------------------------------------------------------------------------------------- ----------------------------
$ 29 - 161 4,227,460 1,402,203
========= =========
Under SFAS 123, the Company uses the Black-Scholes pricing model to calculate
the fair value of the options awarded as of the date of grant, including 48,411
options awarded to directors during the last three years, using the following
assumptions:
2001 2000 1999
- -------------------------------------------------------------------------------------------
Option Term 6 years 6 years 7 years
Annualized Volatility Rate .377 .314 .284
Risk-free Rate of Return 5.24% 6.40% 6.18%
Dividend Yield .30% .50% .18%
Black-Scholes Value 44.5% 41.6% 44.3%
The Company elected to account for terminations when they occur rather than
include an attrition factor into its model.
In 2001, the Company granted to certain senior managers options which, in
addition to having a fixed vesting date, contain a provision for accelerated
vesting based on achieving predetermined objectives. To calculate the fair value
of these options awarded, the Company used the assumptions above, except for an
eight-year option term, based on the exercise pattern of this group of
employees. These assumptions produced a Black-Scholes value of 51.1%.
If compensation cost had been measured based on the fair-value based accounting
method under SFAS 123, the following would have been disclosed for December 31:
(millions-except per share amounts) 2001 2000 1999
- --------------------------------------------------------------------------------------
PRO FORMA
Net income $ 396.0 $ 34.0 $ 283.9
=================================
Earnings per share
Basic $ 5.37 $ .46 $ 3.90
Diluted 5.29 .46 3.81
ACTUAL
Earnings per share - diluted $ 5.48 $ .62 $ 3.96
The amounts charged to income for incentive compensation plans, including
executive cash bonus programs for key members of management and a gain sharing
program for all other employees, were $128.3 million in 2001, $8.3 million in
2000 and $55.6 million in 1999.
41
8 SEGMENT INFORMATION
The Company writes personal automobile and other specialty property-casualty
insurance and provides related services throughout the United States. The
Company's Personal Lines business consists predominantly of auto insurance and
is either generated by an agent or written directly by the Company. The Personal
Lines-Agent channel includes business primarily written by the Company's network
of more than 30,000 Independent Insurance Agencies, while the Personal
Lines-Direct channel business is generated primarily through the telephone or
Internet. The Personal Lines business units, which include both Agent and Direct
channels, are managed at a local level and structured into six regions. Each
business area has a business leader and a product team, with local product man-
agers at the state or regional level.
The Company's other lines of business include insurance for small fleets of
commercial vehicles, lenders' collateral protection, directors' and officers'
liability and related services, including processing business for involuntary
plans. The other lines of business accounted for 9% of the Company's
2001 consolidated revenues.
All revenues are generated from external customers and the Company does not
have a reliance on any major customer.
The Company evaluates segment profitability based on pretax underwriting
and service profit (loss). Expense allocations are based on certain assumptions
and estimates; stated segment operating results would change if different
methods were applied. The Company does not allocate assets, investment income,
interest expense or income taxes to operating segments. In addition, the Company
does not separately identify depreciation and amortization expense by segment
and such disclosure would be impracticable. Companywide depreciation and
amortization expense was $81.0 million in 2001, $77.6 million in 2000 and
$71.8 million in 1999. The accounting policies of the operating segments are the
same as those described in Note 1-Reporting and Accounting Policies.
For the years ended December 31,
2001 2000 1999
------------------------- ------------------------ --------------------------
PRETAX PRETAX PRETAX
(millions) REVENUES PROFIT (LOSS) REVENUES PROFIT (LOSS) REVENUES PROFIT (LOSS)
------------------------- ------------------------ --------------------------
Personal Lines-Agent $4,706.8 $ 251.2 $4,643.4 $ (176.0) $4,548.7 $ 161.2
Personal Lines-Direct 1,787.0 40.9 1,220.6 (128.7) 745.4 (98.0)
- ------------------------------------------------------------------------------------------------------------------
Total Personal Lines(1) 6,493.8 292.1 5,864.0 (304.7) 5,294.1 63.2
Other(2) 692.7 58.7 504.9 21.3 442.2 47.0
Investments(3) 301.7 289.0 402.1 393.0 387.9 378.4
Interest expense -- (52.2) -- (77.8) -- (76.4)
- ------------------------------------------------------------------------------------------------------------------
$7,488.2 $ 587.6 $6,771.0 $ 31.8 $6,124.2 $ 412.2
===================================================================================
(1) Personal automobile insurance accounted for 93% of the total Personal Lines
segment net premiums written in 2001 and 2000, compared to 94% in 1999.
(2) For 2000, pretax profit includes the realization of a $4.2 million foreign
currency translation loss associated with the substantial liquidation of
the Company's foreign subsidiary. 1999 revenues and pretax profit include
a $5.2 million gain on the sale of the corporate aircraft; see Note
12-Related Party Transaction for discussion.
(3) Revenues represent recurring investment income and net realized
gains/losses on security sales; pretax profit is net of investment
expenses.
9 COMMITMENTS AND CONTINGENCIES
The Company has operating lease commitments and service agreements with terms
greater than one year, some with options to renew at the end of the contract
periods. The minimum commitments under such noncancelable contracts at
December 31, 2001 are as follows (in millions): 2002-$89.9; 2003-$60.8;
2004-$29.7; 2005-$16.4; 2006-$3.1; and thereafter-$2.9. Total expense incurred
by the Company for such purposes for 2001, 2000 and 1999 was
$119.8 million, $100.0 million and $96.3 million, respectively.
During 2000, the Company accrued $20.0 million related to the termination of a
Strategic Alliance relationship. As a result of this dissolution, a related
reinsurance agreement terminated and the Company was entitled to the run-off of
all of the premium written under this agreement. The amount accrued represents
the Company's best estimate of the share of the net present value of the future
profit on that business that the other party was entitled to receive upon this
termination.
42
10 FAIR VALUE OF FINANCIAL INSTRUMENTS
Information about specific valuation techniques and related fair value detail is
provided in Note 1-Reporting and Accounting Policies, Note 2-Investments and
Note 13-Debt. The cost and market value of the financial instruments as of
December 31 are summarized as follows:
2001 2000
--------------------------------------------------------
MARKET MARKET
(millions) COST VALUE COST VALUE
- -------------------------------------------------------------------------------------------------
Investments:
Available-for-sale: fixed maturities $ 5,873.0 $ 5,949.0 $ 4,741.9 $ 4,784.1
preferred stocks 675.4 713.9 806.3 813.7
common equities 1,263.7 1,336.0 1,141.3 1,198.7
Short-term investments 227.4 227.4 186.8 186.8
Debt (1,095.7) (1,092.5) (748.8) (712.0)
11 OTHER COMPREHENSIVE INCOME
The components of other comprehensive income (loss) for the years ended December
31 were as follows:
2001 2000
- ------------------------------------------------------------------------------------------------------
TAX TAX
(PROVISION) AFTER (PROVISION) AFTER
(millions) PRETAX BENEFIT TAX PRETAX BENEFIT TAX
- ------------------------------------------------------------------------------------------------------
Unrealized gains (losses)
arising during period:
Available-for-sale:
fixed maturities $ 17.0 $ (5.9) $ 11.1 $ 191.3 $ (67.0) $ 124.3
equity securities 40.9 (14.3) 26.6 (69.8) 24.4 (45.4)
Reclassification adjustment:(1)
Available-for-sale:
fixed maturities 16.7 (5.8) 10.9 (30.9) 10.7 (20.2)
equity securities 5.2 (1.8) 3.4 21.8 (7.6) 14.2
------ ------ ------ ------- ------- -------
Net unrealized gains (losses) 79.8 (27.8) 52.0 112.4 (39.5) 72.9
Forecasted hedges(2) 14.2 (5.0) 9.2 -- -- --
Foreign currency
translation adjustment(3) -- -- -- 4.2 -- 4.2
------ ------ ------ ------- ------- -------
Other comprehensive
income (loss) $ 94.0 $ (32.8) $ 61.2 $ 116.6 $ (39.5) $ 77.1
====== ======= ====== ======= ======= =======
1999
- -------------------------------------------------------------------
TAX
(PROVISION) AFTER
(millions) PRETAX BENEFIT TAX
- -------------------------------------------------------------------
Unrealized gains (losses)
arising during period:
Available-for-sale:
fixed maturities $ (150.7) $ 52.8 $ (97.9)
equity securities 25.7 (9.0) 16.7
Reclassification adjustment:(1)
Available-for-sale:
fixed maturities (14.9) 5.2 (9.7)
equity securities (39.8) 14.0 (25.8)
-------- ------ -------
Net unrealized gains (losses) (179.7) 63.0 (116.7)
Forecasted hedges(2) -- -- --
Foreign currency
translation adjustment(3) .6 -- .6
-------- ------ -------
Other comprehensive
income (loss) $ (179.1) $ 63.0 $(116.1)
======== ====== =======
(1) Represents adjustments for gains (losses) realized in net income.
(2) Entered into for the purpose of managing interest rate risk associated with
debt issuances. See Note 13-Debt. The Company expects to reclassify $1.4
million into income within the next 12 months.
(3) Foreign currency translation adjustments have no tax effect.
12 RELATED PARTY TRANSACTION
On April 23, 1999, the Company sold its corporate aircraft to a company
independently owned by Peter B. Lewis, the Company's Chairman of the Board, and
then President and Chief Executive Officer. The airplane had a net book value of
$6.9 million and was sold to Mr. Lewis for $12.1 million, the fair market value
of the airplane as determined by an independent appraiser.
43
13 DEBT
Debt at December 31 consisted of:
2001 2000
- -----------------------------------------------------------------------------------------------------------------------------------
MARKET MARKET
(millions) COST VALUE COST VALUE
- -----------------------------------------------------------------------------------------------------------------------------------
6.375% Senior Notes due 2012 (issued: $350.0, December 2001)(1) $ 347.0 $ 348.4 $ -- $ --
65/8% Senior Notes due 2029 (issued: $300.0, March 1999)(1) 293.9 271.1 293.8 257.4
7.30% Notes due 2006 (issued: $100.0, May 1996) 99.8 106.1 99.7 102.4
6.60% Notes due 2004 (issued: $200.0, January 1994) 199.6 209.5 199.4 200.3
7% Notes due 2013 (issued: $150.0, October 1993) 148.6 150.6 148.6 144.6
Other debt 6.8 6.8 7.3 7.3
---------- --------- ---------- --------
$ 1,095.7 $ 1,092.5 $ 748.8 $ 712.0
========== ========= ========== ========
(1) Prior to issuance of the 6.375% Senior Notes and the 6 5/8% Senior Notes,
the Company entered into forecasted debt issuance hedges to hedge against
possible rises in interest rates. Upon issuance of the applicable debt
securities, the hedges were closed. Pursuant to SFAS 133, the Company
recognized an $18.4 million gain associated with the 6.375% Senior Notes as
a part of accumulated other comprehensive income and, in 2001, reclassified
the remaining $4.2 million loss associated with the 6 5/8% Senior Notes
from a deferred asset account, in accordance with SFAS 80, "Accounting for
Futures Contracts," to accumulated other comprehensive income. The
gain/loss on these hedges is recognized as an adjustment to interest
expense over the life of the related debt issuances.
Debt includes amounts the Company has borrowed and contributed to the capital of
its insurance subsidiaries or borrowed for other long-term purposes. Market
values are obtained from publicly quoted sources.
The Company's debt is noncallable, except for the 6.375% Senior Notes and
the 6 5/8% Senior Notes which may be redeemed in whole or in part at any time,
subject to a "make whole" provision. Interest is payable semiannually.
In May 1990, the Company entered into a revolving credit arrangement with
National City Bank, which is reviewed by the bank annually. Under this
agreement, the Company has the right to borrow up to $10.0 million. By selecting
from available credit options, the Company may elect to pay interest at rates
related to the London interbank offered rate, the bank's base rate or at a money
market rate. A commitment fee is payable on any unused portion of the committed
amount at the rate of .125 percent per annum. The Company had no borrowings
under this arrangement at December 31, 2001 or 2000.
Aggregate principal payments on debt outstanding at December 31, 2001, are
$0 for 2002, $.8 million for 2003, $206.0 million for 2004, $0 for 2005, $100.0
million for 2006 and $800.0 million thereafter.
14 REINSURANCE
Reinsurance contracts do not relieve the Company from its obligations to
policyholders. Failure of reinsurers to honor their obligations could result in
losses to the Company. The Company evaluates the financial condition of its
reinsurers and monitors concentrations of credit risk to minimize its exposure
to significant losses from re-insurer insolvencies.
As of December 31, 2001 and 2000, approximately 50% and 60%, respectively, of
the "prepaid reinsurance premiums" and "reinsurance recoverables" are comprised
of CAIP, for which the Company retains no indemnity risk, and the Company's
Strategic Alliance relationships. See Note 9-Commitments and Contingencies
regarding a Strategic Alliance relationship termination.
The effect of reinsurance on premiums written and earned for the years ended
December 31 was as follows:
2001 2000 1999
- --------------------------------------------------------------------------------------------------------------
(millions) WRITTEN EARNED WRITTEN EARNED WRITTEN EARNED
- --------------------------------------------------------------------------------------------------------------
Direct premiums $ 7,379.2 $ 7,299.0 $ 6,402.1 $ 6,547.0 $ 6,305.3 $ 5,853.5
Ceded (119.2) (137.3) (206.0) (198.6) (180.6) (169.9)
Assumed .1 .1 -- -- -- --
---------- ---------- ---------- ---------- ---------- ----------
Net premiums $ 7,260.1 $ 7,161.8 $ 6,196.1 $ 6,348.4 $ 6,124.7 $ 5,683.6
========== ========== ========== ========== ========== ==========
Losses and loss adjustment expenses are net of reinsurance ceded of $102.4
million in 2001, $161.0 million in 2000 and $132.8 million in 1999.
44
Report of PricewaterhouseCoopers LLP, Independent Accountants
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS, THE PROGRESSIVE CORPORATION:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, changes in shareholders' equity and cash
flows present fairly, in all material respects, the financial position of The
Progressive Corporation and its subsidiaries at December 31, 2001 and 2000, and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 2001, in conformity with accounting principles
generally accepted in the United States of America. These financial statements
are the responsibility of the Company's management; our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States of America which require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
Cleveland, Ohio
January 23, 2002
The Progressive Corporation and Subsidiaries 45
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION
The consolidated financial statements and the related notes on pages 30 through
44, together with the supplemental information on pages 52 through 59, should be
read in conjunction with the following discussion of the consolidated financial
condition and results of operations.
The Company views the estimates and assumptions used in determining
impairment on its investment portfolio, deferral of acquisition costs,
establishment of its loss reserves and reserves for pending litigation as its
critical accounting policies. Discussions relating to the Company's treatment of
these critical accounting policies are discussed in further detail herewith.
FINANCIAL CONDITION The Progressive Corporation is a holding company and does
not have any revenue producing operations of its own. It receives cash through
borrowings, equity sales, subsidiary dividends and other transactions, and may
use the proceeds to contribute to the capital of its insurance subsidiaries in
order to support premium growth, to repurchase its Common Shares, to retire its
outstanding indebtedness, to pay dividends and for other business purposes.
During 2001, the Company repurchased 932,234 of its Common Shares at a
total cost of $120.3 million (average $128.99 per share), including 76,368
Common Shares (average $114.37 per share) repurchased to satisfy obligations
under the Company's benefit plans. During the three-year period ended December
31, 2001, the Company repurchased 1,239,332 of its Common Shares at a total cost
of $138.7 million (average $111.89 per share), including 110,966 Common Shares
(average $102.05 per share) repurchased to satisfy obligations under the
Company's benefit plans. During the same period, The Progressive Corporation
received $578.1 million of dividends from its subsidiaries, net of capital
contributions made to these subsidiaries. The regulatory restrictions on
subsidiary dividends are described in Note 5 to the financial statements.
The Company has substantial capital resources and is unaware of any trends,
events or circumstances not disclosed herein that are reasonably likely to
affect its capital resources in a material way. In November 2001, the Company
filed a shelf registration statement with the Securities and Exchange Commission
for the issuance of up to $500 million of debt securities. The registration
statement was declared effective on November 29, 2001, and, in December 2001,
the Company issued $350.0 million of 6.375% Senior Notes due 2012 under the
shelf. The net proceeds of $365.4 million, which include $18.4 million received
under a forecasted hedge that the Company entered into in anticipation of the
debt issuance, are intended to be used for general corporate purposes. Thus,
$150 million remains available for the issuance of additional securities under
the shelf. In March 1999, the Company issued $300.0 million of 6 5/8% Senior
Notes due 2029. The net proceeds of $293.7 million were used to repay
outstanding debt upon maturity. During the last three years, the Company repaid
$330.9 million of debt. See Note 13-Debt for further discussion on the Company's
current outstanding debt. The Company also has available a $10.0 million
revolving credit agreement. The Company's debt to total capital ratio is 25%.
Management believes that the Company has substantial capital resources and
sufficient borrowing capacity to support current and anticipated growth.
The Company's insurance operations create liquidity by collecting and
investing premiums from new and renewal business in advance of paying claims.
For the three years ended December 31, 2001, operations generated positive cash
flows of $2,851.6 million, and cash flows are expected to be positive in both
the short-term and reasonably foreseeable future. The Company's investment
portfolio is highly liquid and consists substantially of readily marketable,
investment-grade securities.
Total capital expenditures for the three years ended December 31, 2001,
aggregated $352.7 million. The Company constructed a five building, 732,300
square foot, corporate office complex in Mayfield Village, Ohio. The total cost
was $129.0 million. Four buildings and the parking garage were completed prior
to 2001. The fifth building was completed in the first quarter of 2001. In 1999,
the Company completed the third and final building of a 307,000 square foot
regional call center in Tampa, Florida. The cost of this project was $45.5
million. These construction projects were funded through operating cash flows.
The Company does not currently have any plans to construct substantial
additional facilities in the near term.
Other than the items disclosed in Note 2-Investments and Note 9-Commitments
and Contingencies regarding open derivatives and investment funding commitments
and operating leases and service agreements, respectively, the Company does not
have any off-balance-sheet leverage.
INVESTMENTS The Company invests in fixed-maturity, equity and short-term
securities. The market value of the portfolio was as follows:
(millions) DECEMBER 31, 2001 DECEMBER 31, 2000
- -------------------------------------------------------------------------------------------------------------------
Investment-Grade Fixed Maturities:
Short/Intermediate-Term $ 5,827.3 70.8% $ 4,639.9 66.4%
Long-Term(1) 202.3 2.5 236.4 3.4
Non-Investment-Grade Fixed Maturities(2) 146.8 1.8 94.6 1.4
---------- ----- ---------- -----
6,176.4 75.1 4,970.9 71.2
---------- ----- ---------- -----
Common Equities:
Common Stocks(3) 1,201.0 14.6 860.1 12.3
Term Trust Certificates(4) 50.1 .6 220.4 3.2
Other Risk Investments(5) 84.9 1.0 118.2 1.7
---------- ----- ---------- -----
1,336.0 16.2 1,198.7 17.2
Preferred Stocks(6) 713.9 8.7 813.7 11.6
---------- ----- ---------- -----
Total Portfolio $ 8,226.3 100.0% $ 6,983.3 100.0%
========== ===== ========== =====
(1) Includes securities with maturities of 10 years or greater. Asset-backed
securities are reported based upon their projected cash flows. All other
securities which do not have a single maturity date are reported at average
maturity. See Note 2-Investments.
(2) Non-investment-grade fixed-maturity securities offer the Company higher
returns and added diversification but may involve greater risks often
related to creditworthiness, solvency and relative liquidity of the
secondary trading market.
(3) Common stocks are traded on nationally recognized securities exchanges.
(4) Term trust certificates, the common shares of closed-end bond funds, have
the risk and reward characteristics of the underlying bonds.
(5) Includes private equity investments and limited partnership interests in
private equity and mezzanine investment funds which have no
off-balance-sheet exposure or contingent obligations. See Note
2-Investments for open funding commitments.
(6) Comprised of over 95% of fixed-rate preferred stocks with mechanisms that
are expected to provide an opportunity to liquidate at par.
46 The Progressive Corporation and Subsidiaries
As of December 31, 2001, the Company's portfolio had $186.8 million in
unrealized gains, compared to $107.0 million in unrealized gains in 2000. The
increase was the result of declining interest rates and the recognition of
$111.9 million of net realized losses in 2001, offset by the decline in the
equity markets. The realized losses during 2001 were primarily driven by
rebalancing the common stocks to the Russell 1000 during the year and write
downs in securities determined to have an other than temporary decline in market
value. The weighted average fully taxable equivalent book yield of the portfolio
was 6.2% for the year ended December 31, 2001, 6.4% for 2000 and 6.3% for 1999.
The pretax recurring book yield of the portfolio was 5.6%, 5.7% and 5.6% for the
years ended December 31, 2001, 2000 and 1999, respectively.
The quality distribution of the fixed-income portfolio, which includes
fixed-maturity securities and preferred stocks, was as follows:
RATING DECEMBER 31, 2001 DECEMBER 31, 2000
- -------------------------------------------------------------------------------
AAA 58.0% 50.6%
AA 10.6 11.7
A 15.3 25.3
BBB 14.0 8.1
Non Rated/Other 2.1 4.3
- -------------------------------------------------------------------------------
100.0% 100.0%
===== =====
The duration of the fixed-income portfolio was 3.7 years at December 31, 2001,
compared to 3.5 years at December 31, 2000.
Included in the fixed-income portfolio, the Company held asset-backed securities
at December 31, 2001 which were comprised of the following:
MARKET DURATION UNREALIZED
(millions) VALUE (YEARS) RATING(1) GAINS (LOSSES)(2)
- ------------------------------------------------------------------------------------------------------------------------------------
Collateralized Mortgage Obligations (CMO):
Sequential Bonds $ 200.1 2.50 AAA $ 4.2
Planned Amortization Class Bonds 321.5 3.80 AAA- 6.6
------------ ----------
521.6 3.35 AAA- 10.8
------------ ----------
Commercial Mortgage-Backed Obligations (CMB)(3) 868.8 4.33 AA- 1.8
CMB-Interest-Only Certificates 223.3 3.32 AAA (6.1)
------------ ----------
1,092.1 4.12 AA (4.3)
------------ ----------
Other asset-backed securities(4) 691.7 2.54 AA+ 21.7
------------ ----------
Total asset-backed securities(5) $ 2,305.4 3.47 AA+ $ 28.2
============ ==========
(1) Weighted average Moody's or Standard & Poor's rating.
(2) The single largest unrealized loss in any individual CMO security was $1.0
million and in any CMB security was $5.5 million at December 31, 2001.
(3) These securities sensitivity to prepayment risk is reduced by prepayment
lock out provisions and yield maintenance payments.
(4) Home equity loans represent $395.4 million, or 57% of the other
asset-backed securities; the remainder of the portfolio is comprised of
equipment leases, auto loans, credit card receivables, manufactured housing
loans and other structured loans.
(5) The majority of asset-backed securities are liquid with available market
quotes and contain no residual interests.
47
The Company's investment strategy recognizes its need to maintain capital
adequate to support its insurance operations. The Company evaluates the
risk/reward tradeoffs of investment opportunities, measuring their effects on
stability, diversity, overall quality and liquidity of the investment portfolio.
Investments in the Company's portfolio have varying degrees of risk. The primary
market risk exposure to the fixed-income portfolio is interest rate risk, which
is limited by managing duration to a defined range of 1.8 to 5 years. The
distribution of maturities and convexity are monitored on a regular basis.
Interest rate risk includes the risk from movements in the underlying market
rate and in credit spreads of the respective sectors of debt securities held.
Common equities, excluding term trust certificates, which generally have greater
risk and volatility of market value, may range from 0 to 25% of the portfolio;
at December 2001, these securities comprised 15.6% of the total portfolio.
Common stocks, which represent 90% of the common equity portfolio, are managed
externally by State Street Global Advisors Inc. to track the Russell 1000 index
within +/- 50 basis points. The Company monitors the composition and performance
of the common stock portfolio to ensure compliance with the objectives. Exposure
to foreign currency exchange risk is limited by Company restrictions and is
monitored quarterly for compliance. Exposures are evaluated individually and as
a whole, considering the effects of cross correlation. The Company monitors the
value at risk of the fixed-income and equity portfolios as well as the total
portfolio. For the quantitative market risk disclosures, see page 56.
An additional exposure to the fixed-income portfolio is credit quality
risk, which is limited by managing to a defined minimum credit quality rating of
A+, as defined by nationally recognized rating agencies, and limiting
non-investment-grade securities to a maximum of 5% of the fixed-income
portfolio. Except for U.S. treasury and agency bonds, concentration in single
issuers is limited to no more than 5% of the portfolio.
On a quarterly basis, the Company examines its investment portfolio for
evidence of impairment. In such cases, changes in market value are evaluated to
determine the extent to which such changes are attributable to: (i) interest
rates, (ii) market-related factors other than interest rates and (iii) financial
conditions, business prospects and other fundamental factors specific to the
issuer. Declines attributable to issuer fundamentals are reviewed in further
detail. Available evidence is considered to estimate the realizable value of the
investment. When a security in the Company's investment portfolio has a decline
in market value which is other than temporary, the Company is required by GAAP
to reduce the carrying value of such security to its current market value. The
write-down activity for the years ended December 31, follows:
(millions) 2001 2000 1999
- ------------------------------------------------------------------------------------------
Total write-downs during the year $ 60.0 $ 46.5 $ 16.3
Write-downs on securities sold (24.0) (3.4) --
------- -------- -------
Write-downs on securities held at year end $ 36.0 $ 43.1 $ 16.3
======= ======== =======
Trading securities are entered into for the purpose of near-term profit
generation. At December 31, 2001, the Company did not have any trading
securities, compared to $3.7 million at December 31, 2000. Net realized losses
on trading securities for the years ended December 31, 2001, 2000 and 1999 were
$6.5 million, $19.0 million and $.3 million, respectively, and are included in
the available-for-sale portfolio.
Derivative instruments are primarily used to manage the risks and enhance
the returns of the available-for-sale portfolio. This is accomplished by
modifying the basis, duration, interest rate or foreign currency characteristics
of the portfolio, hedged securities or hedged cash flows. During 2001, the
Company recognized net gains (losses) on derivatives used to manage risk in the
available-for-sale portfolio of $(2.7) million, compared to $(2.3) million in
2000 and $4.6 million in 1999. Derivative instruments may also be used for
trading purposes. Derivatives used for trading purposes generated net gains
(losses) of $1.9 million in 2001, $2.6 million in 2000 and $(3.5) million in
1999, and are included in the available-for-sale portfolio. For all derivative
positions, net cash requirements are limited to changes in market values which
may vary based upon changes in interest rates and other factors. Exposure to
credit risk is limited to the carrying value; collateral may be required to
limit credit risk.
RESULTS OF OPERATIONS Net income was $411.4 million, or $5.48 per share, in
2001, compared to $46.1 million, or $.62 per share, in 2000, and $295.2 million,
or $3.96 per share, in 1999. The GAAP combined ratio (CR) was 95.2 in 2001,
104.4 in 2000 and 98.3 in 1999. Operating income, which the Company defines as
net income excluding the after-tax effect of net realized gains/losses on
security sales and one-time items, was $485.5 million, or $6.47 per share, in
2001, $55.4 million, or $.75 per share, in 2000 and $266.7 million, or $3.58 per
share, in 1999. The increase in operating income from 2000 is primarily driven
by improved underwriting results as discussed below. By excluding items which
are not of a recurring nature, the Company believes that operating income
provides a useful measure of the Company's operating results. However, since
operating income is not a term defined by generally accepted accounting
principles, the Company's operating results may not be comparable to similarly
titled measures reported by other companies.
48
Following is a reconciliation of the Company's net income to operating income:
2001 2000
-------------------------------------------------------------
(millions, except per share amounts) $ PER SHARE $ PER SHARE
- ------------------------------------------------------------------------------------------------------------------------
Net Income $ 411.4 $ 5.48 $ 46.1 $ .62
Reconciling items (after-tax):
Net realized (gains) losses on security sales 72.7 .97 (11.0) (.15)
One-time items:
Termination of strategic alliance relationship -- -- 13.0 .17
Foreign currency translation loss -- -- 4.2 .06
Termination of defined benefit pension plan -- -- 2.0 .03
Gain on sale of corporate aircraft -- -- -- --
Nonrealization of advertising commitments -- -- -- --
Severance and other costs(1) 1.4 .02 1.1 .02
---------------------------- ----------------------------
Operating Income $ 485.5 $ 6.47 $ 55.4 $ .75
============================ ============================
1999
---------------------------------
(millions, except per share amounts) $ PER SHARE
- --------------------------------------------------------------------------------------------
Net Income $ 295.2 $ 3.96
Reconciling items (after-tax):
Net realized (gains) losses on security sales (30.7) (.41)
One-time items:
Termination of strategic alliance relationship -- --
Foreign currency translation loss -- --
Termination of defined benefit pension plan -- --
Gain on sale of corporate aircraft (3.4) (.05)
Nonrealization of advertising commitments 4.9 .07
Severance and other costs(1) .7 .01
---------------------------
Operating Income $ 266.7 $ 3.58
===========================
(1) 2001 related to the Company's reduction in force in New York; 2000 is
associated with the Company's reorganization at the general manager level;
and 1999 was for the wind-down of the Company's Canadian operations.
Direct premiums written increased 15% to $7,379.2 million in 2001, compared to
$6,402.1 million in 2000 and $6,305.3 million in 1999. For 2001, 2000 and 1999,
net premiums written increased 17%, 1% and 16%, respectively, to $7,260.1
million, $6,196.1 million and $6,124.7 million. The difference between direct
and net premiums written is attributable to premiums written under
state-mandated involuntary Commercial Auto Insurance Procedures, for which the
Company retains no indemnity risk, of $80.5 million in 2001, $50.9 million in
2000 and $49.7 million in 1999, and reinsurance the Company maintains in its
auto and non-auto programs. Net premiums written continued to be impacted by the
shift from 12-month to 6-month policies. The shift in policy term resulted in a
higher number of policies renewing in 2001, compared to 2000, primarily in the
second half of the year. At December 31, 2001, substantially all of the
Company's new auto policies were written for six-month terms, compared to 80% at
December 31, 2000 and 35% at December 31, 1999. As of December 31, 2001, 73% of
total auto policies in force were for 6-month terms. The Company expects the
shift in policy terms to continue to affect the net premiums written growth
rates through the first quarter 2002.
Premiums earned, which are a function of the premiums written in the
current and prior periods and are recognized into income over the policy term,
are not affected by the shift in policy term. Therefore, the Company believes
that net premiums earned may be a more meaningful measure of growth during the
period of transition from 12-month to 6-month policy terms. For 2001, 2000 and
1999, premiums earned increased 13%, 12%, and 15%, respectively. The majority of
the growth was due to increased rate levels. During 2001, the Company
implemented 81 auto rate revisions in various states, and plans to implement
additional rate revisions as any rate need or product opportunity emerges.
The Company's Personal Lines business units write insurance for private
passenger automobiles and recreation vehicles and currently represent 89% of the
Company's total net premiums written. Personal Lines net premiums written grew
15% in 2001, declined 1% in 2000 and grew 16%in 1999; net premiums earned grew
11% in both 2001 and 2000 and 16% in 1999. The Personal Lines business is
generated either by an Agent or written directly by the Company. The Agent
channel includes business written by the Company's network of 30,000 Independent
Insurance Agencies and through strategic alliance business relationships (other
insurance companies, financial institutions, employers and national brokerage
agencies). Direct business includes business written through
1-800-PROGRESSIVE(SM), the Internet (progressive.com) and on behalf of affinity
groups.
In addition to its Personal Lines business, the Company's other lines of
business include writing insurance for small fleets of commercial vehicles,
lenders' collateral protection and loan tracking for auto lenders and financial
institutions, directors' and officers' liability and fidelity coverage for
American Bankers Association member community banks and independent credit
unions, and providing related claim, underwriting and system services.
49
Underwriting results for the Company's Personal Lines, including its channel
components, and the other lines of business were as follows:
(millions) 2001 2000 1999
- ----------------------------------------------------------------------------------------------------------------
NET PREMIUMS WRITTEN
Personal Lines-Agent $ 4,614.7 $ 4,358.4 $ 4,746.5
Personal Lines-Direct 1,861.7 1,293.1 955.9
------------ ------------ ------------
Total Personal Lines 6,476.4 5,651.5 5,702.4
Other Lines 783.7 544.6 422.3
------------ ------------ ------------
Companywide $ 7,260.1 $ 6,196.1 $ 6,124.7
============ ============ ============
NET PREMIUMS EARNED
Personal Lines-Agent $ 4,706.8 $ 4,643.4 $ 4,548.7
Personal Lines-Direct 1,787.0 1,220.6 745.4
------------ ------------ ------------
Total Personal Lines 6,493.8 5,864.0 5,294.1
Other Lines 668.0 484.4 389.5
------------ ------------ ------------
Companywide $ 7,161.8 $ 6,348.4 $ 5,683.6
============ ============ ============
PERSONAL LINES-AGENT CR
Loss & loss adjustment expense ratio 74.8 85.0 75.8
Underwriting expense ratio 19.9 18.8 20.7
------------ ------------ ------------
94.7 103.8 96.5
============ ============ ============
PERSONAL LINES-DIRECT CR
Loss & loss adjustment expense ratio 71.8 80.9 74.6
Underwriting expense ratio 25.9 29.6 38.5
------------ ------------ ------------
97.7 110.5 113.1
============ ============ ============
PERSONAL LINES-TOTAL CR
Loss & loss adjustment expense ratio 74.0 84.1 75.6
Underwriting expense ratio 21.5 21.1 23.2
------------ ------------ ------------
95.5 105.2 98.8
============ ============ ============
OTHER LINES-CR
Loss & loss adjustment expense ratio 68.9 71.3 65.1
Underwriting expense ratio 23.1 23.2 25.8
------------ ------------ ------------
92.0 94.5 90.9
============ ============ ============
COMPANYWIDE GAAP CR
Loss & loss adjustment expense ratio 73.5 83.2 74.9
Underwriting expense ratio 21.7 21.2 23.4
------------ ------------ ------------
95.2 104.4 98.3
============ ============ ============
COMPANYWIDE ACCIDENT YEAR
Loss & loss adjustment expense ratio 74.9 82.0 75.4
============ ============ ============
AUTO POLICIES IN FORCE (AT DECEMBER 31)
(thousands)
Agent 2,779 2,821 3,046
Direct 1,209 1,026 710
------------ ------------ ------------
3,988 3,847 3,756
============ ============ ============
The Agent channel net premiums written increased 6% in 2001, compared to an 8%
decrease in 2000 and an 8% increase in 1999. As discussed previously, the
increase in net premiums written for 2001 was influenced by the Company's shift
to six-month policies. Net premiums earned, which again may reflect a more
meaningful picture of the Agent business growth during this transition period,
increased 1%, 2% and 9% in 2001, 2000 and 1999, respectively. The rate increases
the Company has taken were partially offset by decreases in Agent auto policies
in force. Growth in the Agent business can be impacted by competitor rate
activity and local market conditions. The Company was generally ahead of
competitors in recognizing the increases in loss trends and filing necessary
rate increases. Therefore, as competitors raise rates, the Company could
experience an increase in its share of business generated in the Agent channel.
In addition, a number of national companies have recently begun
50
reunderwriting their books of business to improve results and some competitors
have become more reluctant to accept nonstandard or even some standard risks or
even withdrawing. The Company believes that these signals may indicate the
beginning of a market change and welcomes the opportunity to write this business
in most states.
The Company's Direct channel net premiums written increased 44% in 2001,
35% in 2000 and 80% in 1999. For 2001, net premiums written increased 41%,
excluding the $37.7 million of previously ceded written premiums that were
assumed by the Company upon the commutation of a reinsurance agreement that was
part of a Strategic Alliance relationship that was terminated in the first
quarter 2001. This Strategic Alliance relationship was terminated by mutual
agreement of the Company and the other party because the business interests of
the parties were no longer aligned. In addition, the Company did not envision
that this relationship would help the Company in meeting its long-term
profitability objectives. The commutation of the reinsurance agreement was a
natural and required result of terminating the relationship (see Note 9).
The Direct channel net premiums earned grew 46%, 64% and 85% in 2001, 2000
and 1999, respectively. The Company believes that continued growth in the Direct
business is heavily dependent on the success of the Company's advertising and
other marketing efforts, realizing that price sensitivity is always a factor.
The Company is advertising on a national basis and supplements its coverage by
local market media campaigns in over 100 designated marketing areas.
Claim costs, the Company's most significant expense, represent actual
payments made and changes in estimated future payments to be made to or on
behalf of its policyholders, including expenses required to settle claims and
losses. These costs include a loss estimate for future assignments and
assessments, based on current business, under state-mandated involuntary
automobile insurance programs. Claim costs are influenced by inflation and loss
severity and frequency, the impact of which is mitigated by adequate pricing.
Increases in the rate of inflation increase loss payments, which are made after
premiums are established. Accordingly, anticipated rates of inflation are taken
into account when the Company establishes premium rates and loss reserves. Claim
costs, expressed as a percentage of premiums earned, were 74% in 2001, compared
to 83% in 2000 and 75% in 1999.
During 2001, the Company's loss ratios improved across the country,
reflecting both the Company's pricing actions and favorable loss reserve
development. For both 2001 and 1999, approximately 75% of the Company's personal
lines markets earned an underwriting profit, compared to approximately 40% in
2000. Florida and New York, which have been difficult operating environments
over the last couple of years, reported slightly better than break-even
underwriting results for 2001. The Company will continue to monitor and adjust
rates as needed to meet its financial goals.
The Company is encouraged by signs of moderation in the severity trend, but
is cautious about predicting claims frequency in future months. Personal injury
protection coverage severity trend, which has been a significant contributor to
rate escalation, turned negative during the second half of 2001. Physical damage
severity trends have been moderate all year. In 2001, the Company saw increases
of over 10% in bodily injury severity trend, while frequency trend was negative
for the last half of the year. The Company plans to continue to be diligent in
its efforts to recognize trend when setting rates and establishing loss
reserves.
During 2001, the Company experienced $99.0 million, or 1.4 points, of
favorable loss reserve development, compared to $75.8 million, or 1.2 points, of
adverse development in 2000 and $29.8 million, or .5 points, of favorable
development in 1999. The favorable development in 2001 is primarily attributable
to the settlement of claims at less than amounts reserved, while the prior
year's adverse development reflected the Company's effort to fully recognize the
loss trends that were emerging. The development in 2001 primarily relates to the
2000 accident year, while the majority of the 2000 adverse development related
to the 1999 accident year. The Company conducts extensive reviews each month on
portions of its business to help ensure that the Company is meeting its
objective of always having reserves that are adequate, with minimal variation.
Results would differ if different assumptions were made. In June 2001, the
Company released a Report on Loss Reserving Practices, via Form 8-K, which
provides a discussion of the Company's loss reserving practices.
Because the Company is primarily an insurer of motor vehicles, it has
limited exposure for environmental, product and general liability claims. The
Company has established reserves for these exposures, in amounts which it
believes to be adequate based on information currently known by it. Management
does not believe that these claims will have a material impact on the Company's
liquidity, financial condition, cash flows or results of operations.
Policy acquisition costs and other underwriting expenses as a percentage of
premiums earned were 22% in 2001, 21% in 2000 and 23% in 1999. Policy
acquisition costs are amortized over the policy period in which the related
premiums are earned (see Note 1). The increase in other underwriting expenses in
2001 was primarily driven by an increase in costs incurred relating to the
Company's incentive compensation programs. The Agent channel expense ratio is in
line with the Company's expectations. The Company continues to see improvement
in the Direct business expense ratio. New business growth will place upward
pressure on the expense ratios due to slightly higher new business commission,
new business transaction processing costs and media spending.
During 2001, the Company incurred $14.6 million of guaranty fund
assessments, primarily related to the Reliance Insurance Company insolvency,
compared to $2.0 million in 2000 and $1.2 million in 1999. The Company believes
that any assessment in excess of its current reserves will not materially impact
the Company's financial condition, cash flows or results of operations.
The Company is named as a defendant in a number of putative class action
lawsuits, such as those alleging damages as a result of the Company's use of
after-market parts, total loss evaluation methodology, use of credit in
underwriting, charging betterment in first party physical damage claims,
offering alternative commission programs or the alleged diminution of value to
vehicles which are involved in accidents, and cases challenging other aspects of
the Company's claims and marketing practices and business operations. Other
insurance companies face many of these same issues. The Company plans to
vigorously contest these suits. The Company has established reserves for those
lawsuits in which the Company is currently able to estimate its potential
exposure; the Company is currently unable to estimate the potential exposure on
the other lawsuits. The Company believes that the ultimate disposition of the
lawsuits in which reserves have been established in amounts in excess of the
current reserves will not materially impact the Company's annual cash flows or
results of operations or financial condition. In February 2002, the Company
reached a settlement of its diminution of value lawsuit in Georgia for between
$19.4 million and $20.0 million.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995: STATEMENTS IN THIS ANNUAL REPORT THAT ARE NOT HISTORICAL FACT ARE
FORWARD-LOOKING STATEMENTS THAT ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES
THAT COULD CAUSE ACTUAL EVENTS AND RESULTS TO DIFFER MATERIALLY FROM THOSE
DISCUSSED HEREIN. THESE RISKS AND UNCERTAINTIES INCLUDE, WITHOUT LIMITATION,
UNCERTAINTIES RELATED TO ESTIMATES, ASSUMPTIONS AND PROJECTIONS GENERALLY;
CHANGES IN ECONOMIC CONDITIONS (INCLUDING CHANGES IN INTEREST RATES AND
FINANCIAL MARKETS); PRICING COMPETITION AND OTHER INITIATIVES BY COMPETITORS;
ABILITY TO OBTAIN REGULATORY APPROVAL FOR REQUESTED RATE CHANGES AND THE TIMING
THEREOF; LEGISLATIVE AND REGULATORY DEVELOPMENTS; THE OUTCOME OF LITIGATION
PENDING AGAINST THE COMPANY; WEATHER CONDITIONS (INCLUDING THE SEVERITY AND
FREQUENCY OF STORMS, HURRICANES, SNOWFALLS, HAIL AND WINTER CONDITIONS); CHANGES
IN DRIVING PATTERNS AND LOSS TRENDS; ACTS OF WAR AND TERRORIST ACTIVITIES; COURT
DECISIONS AND TRENDS IN LITIGATION AND HEALTH CARE COSTS; AND OTHER MATTERS
DESCRIBED FROM TIME TO TIME BY THE COMPANY IN OTHER PUBLICATIONS AND IN ITS
PERIODIC REPORTS AND OTHER DOCUMENTS FILED WITH THE UNITED STATES SECURITIES AND
EXCHANGE COMMISSION.
51
TEN YEAR SUMMARY--FINANCIAL HIGHLIGHTS
(not covered by report of independent accountants)
(millions-except ratios, per share amounts and number of people employed) 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
INSURANCE COMPANIES SELECTED FINANCIAL INFORMATION AND OPERATING STATISTICS--STATUTORY BASIS
Policyholders' surplus(1) $ 2,647.7 $ 2,177.0
Ratios:
Net premiums written to policyholders' surplus 2.7 2.8
Loss and loss adjustment expense reserves to policyholders' surplus 1.2 1.3
Loss and loss adjustment expense 73.6 83.2
Underwriting expense 21.1 21.0
------------ ------------
Statutory combined ratio 94.7 104.2
SELECTED CONSOLIDATED FINANCIAL INFORMATION--GAAP BASIS
Total revenues $ 7,488.2 $ 6,771.0
Total assets 11,122.4 10,051.6
Total shareholders' equity(2) 3,250.7 2,869.8
Common Shares outstanding 73.4 73.5
Common Share price
High $ 151.80 $ 111.00
Low 82.13 45.00
Close(3) 149.30 103.63
Market capitalization $ 10,958.6 $ 7,616.8
Book value per Common Share(2) $ 44.29 $ 39.04
Return on average common shareholders' equity(4) 13.5% 1.7%
Debt outstanding $ 1,095.7 $ 748.8
Ratios:
Debt to total capital 25% 21%
Earnings to fixed charges(5) 10.7x 1.3x
Price to earnings(6) 23 138
Price to book 3.4 2.7
Net premiums written growth 17% 1%
GAAP underwriting margin(2) 4.8% (4.4)%
Number of people employed 20,442 19,490
(1) During 1994, the Company began accruing salvage and subrogation
recoverables.
(2) In 1994, the $71.0 million "supplemental reserve" was eliminated,
increasing book value per share $.65, underwriting profit margin 3.2% and
shareholders' equity $46.2 million.
(3) Represents the closing price at December 31.
(4) Net income minus preferred share dividends (divided by) average common
shareholders' equity.
(5) 1995 and prior represents the ratio of earnings to combined fixed charges
and preferred share dividends.
(6) Represents the closing stock price (divided by) operating earnings
per share.
52 The Progressive Corporation and Subsidiaries
1999 1998 1997 1996 1995 1994 1993 1992
- ----------------------------------------------------------------------------------------------------------------------------------
$ 2,258.9 $ 2,029.9 $ 1,722.9 $ 1,292.4 $ 1,055.1 $ 945.1 $ 701.9 $ 658.3
2.7 2.6 2.7 2.7 2.8 2.6 2.6 2.2
1.0 1.0 1.1 1.2 1.2 1.2 1.5 1.5
75.0 68.5 71.1 70.2 71.6 64.2 62.6 68.3
22.1 22.4 20.7 19.8 21.4 22.4 25.4 29.8
-------- --------- --------- --------- --------- --------- --------- ---------
97.1 90.9 91.8 90.0 93.0 86.6 88.0 98.1
$ 6,124.2 $ 5,292.4 $ 4,608.2 $ 3,478.4 $ 3,011.9 $ 2,415.3 $ 1,954.8 $ 1,738.9
9,704.7 8,463.1 7,559.6 6,183.9 5,352.5 4,675.1 4,011.3 3,440.9
2,752.8 2,557.1 2,135.9 1,676.9 1,475.8 1,151.9 997.9 629.0
73.1 72.5 72.3 71.5 72.1 71.2 72.1 67.1
$ 174.25 $ 172.00 $ 120.88 $ 72.25 $ 49.50 $ 40.50 $ 46.13 $ 29.38
68.50 94.00 61.50 40.38 34.75 27.75 26.63 14.75
73.13 169.38 119.88 67.38 48.88 35.00 40.50 29.13
$ 5,345.4 $12,279.7 $ 8,667.0 $ 4,817.3 $ 3,523.9 $ 2,492.0 $ 2,920.1 $ 1,954.3
$ 37.66 $ 35.27 $ 29.54 $ 23.45 $ 19.31 $ 14.97 $ 12.62 $ 7.94
10.9% 19.3% 20.9% 20.5% 19.6% 27.4% 36.0% 34.7%
$ 1,048.6 $ 776.6 $ 775.9 $ 775.7 $ 675.9 $ 675.6 $ 477.1 $ 568.5
28% 23% 27% 32% 31% 37% 32% 47%
5.7% 10.2% 9.2% 7.7% 5.6x 6.1x 7.1x 3.7x
20 28 27 16 17 13 15 17
1.9 4.8 4.1 2.9 2.5 2.3 3.2 3.7
16% 14% 36% 18% 19% 35% 25% 10%
1.7% 8.4% 6.6% 8.5% 5.7% 11.5% 10.7% 3.5%
18,753 15,735 14,126 9,557 8,025 7,544 6,101 5,591
53
TEN YEAR SUMMARY--GAAP CONSOLIDATED OPERATING RESULTS
(not covered by report of independent accountants)
(millions-except per share amounts) 2001 2000
- ---------------------------------------------------------------------------------------
Direct premiums written:
Personal lines $ 6,485.1 $ 5,773.2
All other lines 894.1 628.9
--------- ---------
Total direct premiums written 7,379.2 6,402.1
Reinsurance assumed .1 --
Reinsurance ceded (119.2) (206.0)
--------- ---------
Net premiums written 7,260.1 6,196.1
Net change in unearned premiums reserve(1) 98.3 152.3
--------- ---------
Premiums earned 7,161.8 6,348.4
--------- ---------
Expenses:
Losses and loss adjustment expenses(2) 5,264.1 5,279.4
Policy acquisition costs 864.9 788.0
Other underwriting expenses 686.9 559.3
--------- ---------
Total underwriting expenses 6,815.9 6,626.7
--------- ---------
Underwriting profit (loss) before taxes 345.9 (278.3)
Provision (benefit) for income taxes 121.1 (97.4)
--------- ---------
Underwriting profit (loss) after taxes 224.8 (180.9)
Service operations profit (loss) after taxes 3.2 (.6)
--------- ---------
228.0 (181.5)
Investment income after taxes 296.1 278.3
Net realized gains (losses) on security sales after taxes (72.7) 11.0
Interest expense after taxes (33.9) (50.6)
Non-recurring items after taxes(3) -- (4.2)
Other income after taxes(4) -- --
Net expenses after taxes(5) (6.1) (6.9)
--------- ---------
Income before cumulative effect of accounting change 411.4 46.1
Cumulative effect of accounting change(6) -- --
--------- ---------
Net income $ 411.4 $ 46.1
--------- ---------
Items to reconcile net income to operating income:
Net realized (gains) losses on security sales after taxes 72.7 (11.0)
One-time items after taxes:
Non-recurring items(3) -- 4.2
Other income(4) -- --
Cumulative effect of accounting change(6) -- --
Other(2), (9) 1.4 16.1
--------- ---------
Operating income(7) $ 485.5 $ 55.4
--------- ---------
Per share(8)
Net income $ 5.48 $ .62
Operating income(7) 6.47 .75
Dividends .280 .270
Average equivalent shares
Basic 73.7 73.2
Diluted 75.1 74.3
(1) Amount represents change in unearned premiums reserve less change in
prepaid reinsurance premiums.
(2) In 1994, the "supplemental reserve" was eliminated, resulting in a one-time
decrease to losses and loss adjustment expenses of $71.0 million, or $.62
per share.
(3) 2000 reflects a foreign currency translation loss; 1993 reflects a charge
on debt extinguishment; 1992 reflects the termination of an investment
management agreement and the end of an employment agreement with the then
Chairman of the Company's Board of Directors.
(4) 1999 reflects a gain on the sale of the corporate aircraft; 1992 reflects
the Proposition 103 reserve reduction.
(5) Reflects investment expenses after taxes and other tax adjustments.
(6) Reflects adoption of SFAS 109, "Accounting for Income Taxes."
(7) Defined as net income excluding net realized gains/losses on security sales
and one-time items. This is a non-GAAP disclosure.
(8) Presented on a diluted basis. In 1997, the Company adopted SFAS 128,
"Earnings Per Share," and, as a result, restated prior periods per share
amounts, if applicable.
54 The Progressive Corporation and Subsidiaries
1999 1998 1997 1996 1995 1994 1993 1992
- --------------------------------------------------------------------------------------------------------------------
$ 5,799.4 $ 4,987.1 $ 4,355.9 $ 3,165.4 $ 2,644.6 $ 2,181.7 $ 1,548.9 $ 1,214.6
505.9 464.2 469.3 473.0 424.3 463.4 417.5 422.2
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
6,305.3 5,451.3 4,825.2 3,638.4 3,068.9 2,645.1 1,966.4 1,636.8
-- -- -- 3.8 .1 2.9 9.2 4.3
(180.6) (151.6) (160.1) (200.5) (156.2) (190.8) (156.4) (189.9)
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
6,124.7 5,299.7 4,665.1 3,441.7 2,912.8 2,457.2 1,819.2 1,451.2
(441.1) (351.7) (475.6) (242.4) (185.6) (266.1) (150.5) (25.1)
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
5,683.6 4,948.0 4,189.5 3,199.3 2,727.2 2,191.1 1,668.7 1,426.1
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
4,256.4 3,376.3 2,967.5 2,236.1 1,943.8 1,397.3 1,028.0 930.9
745.0 659.9 607.8 482.6 459.6 391.5 311.6 304.1
583.8 495.8 336.0 208.5 167.2 150.8 151.3 141.5
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
5,585.2 4,532.0 3,911.3 2,927.2 2,570.6 1,939.6 1,490.9 1,376.5
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
98.4 416.0 278.2 272.1 156.6 251.5 177.8 49.6
34.4 145.6 97.4 95.2 54.8 88.0 62.2 16.9
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
64.0 270.4 180.8 176.9 101.8 163.5 115.6 32.7
4.3 4.8 .9 2.8 5.6 6.5 4.4 (2.8)
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
68.3 275.2 181.7 179.7 107.4 170.0 120.0 29.9
249.6 221.3 205.3 175.6 156.2 131.2 107.1 110.4
30.7 7.4 64.0 4.6 30.4 15.5 70.1 9.6
(49.7) (39.7) (42.0) (40.0) (37.1) (35.9) (25.8) (29.4)
-- -- -- -- -- -- (2.6) (42.6)
3.4 -- -- -- -- -- -- 69.9
(7.1) (7.5) (9.0) (6.2) (6.4) (6.5) (1.5) (8.2)
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
295.2 456.7 400.0 313.7 250.5 274.3 267.3 139.6
-- -- -- -- -- -- -- 14.2
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
$ 295.2 $ 456.7 $ 400.0 $ 313.7 $ 250.5 $ 274.3 $ 267.3 $ 153.8
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
(30.7) (7.4) (64.0) (4.6) (30.4) (15.5) (70.1) (9.6)
-- -- -- -- -- -- 2.6 42.6
(3.4) -- -- -- -- -- -- (69.9)
-- -- -- -- -- -- -- (14.2)
5.6 -- -- -- -- (46.1) (2.5) 27.1
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
$ 266.7 $ 449.3 $ 336.0 $ 309.1 $ 220.1 $ 212.7 $ 197.3 $ 129.8
- ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
$ 3.96 $ 6.11 $ 5.31 $ 4.14 $ 3.26 $ 3.59 $ 3.59 $ 2.08
3.58 6.01 4.46 4.12(10) 2.85 2.76 2.62 1.74
.260 .250 .240 .230 .220 .210 .200 .191
72.9 72.5 72.0 71.6 71.8 71.6 69.3 60.7
74.6 74.7 75.3 74.2 74.2 74.0 71.8 70.9
(9) Other one-time items consist of the following pretax items:
2001: $2.1 million of severance and other costs related to the Company's
reduction in force in New York.
2000: $20.0 million accrual related to the estimated cost of terminating a
Strategic Alliance relationship; $3.2 million additional expense associated
with the termination of the Company's defined benefit pension plan; and
$1.7 million of severance costs associated with the Company's
reorganization at the general manager level.
1999: $7.5 million additional expenses associated with previous advertising
commitments that will no longer be realized due to changes in marketing
strategy; and $1.2 million reserve for the wind-down of the Company's
Canadian operations.
1993: $.9 million charge from the early adoption of SFAS 112, "Employer's
Accounting for Postemployment Benefits;" a $1.5 million benefit from the
curtailment of the defined benefit pension plan; and $2.1 million benefit
from the retroactive tax impact of the Omnibus Budget Reconciliation Act of
1993.
1992: $41.0 million increase to reserves for the discontinued
Transportation division.
(10) Excludes $.04 per share associated with the excess preferred stock
liquidation price over the carrying value at the date of redemption.
55
QUANTITATIVE MARKET RISK DISCLOSURES
(not covered by report of independent accountants)
Quantitative market risk disclosures are only presented for market risk
categories when risk is considered material. Materiality is determined based on
the fair value of the financial instruments at December 31, 2001, and the
potential for near term losses from reasonably possible near term changes in
market rates or prices.
OTHER THAN TRADING FINANCIAL INSTRUMENTS
Financial instruments subject to interest rate risk were:
MARKET VALUE
------------------------------------------------------------------------
-200 BPS -100 BPS +100 BPS +200 BPS
(millions) CHANGE CHANGE ACTUAL CHANGE CHANGE
- ---------------------------------------------------------------------------------------------------------------------------
U.S. Government obligations $ 748.0 $ 706.9 $ 667.7 $ 631.9 $ 598.8
State and local government obligations 1,166.3 1,124.4 1,084.6 1,046.8 1,011.1
Asset-backed securities 2,458.3 2,385.1 2,305.4 2,221.2 2,134.7
Corporate and other debt securities 2,045.0 1,966.1 1,891.3 1,820.4 1,753.3
Preferred stocks 785.2 748.4 713.9 681.8 652.1
Term trust certificates 50.5 50.3 50.1 49.9 49.8
Short-term investments 227.4 227.4 227.4 227.4 227.4
- ---------------------------------------------------------------------------------------------------------------------------
Balance as of December 31, 2001 $ 7,480.7 $ 7,208.6 $ 6,940.4 $ 6,679.4 $ 6,427.2
------------------------------------------------------------------------
Balance as of December 31, 2000 $ 6,364.6 $ 6,202.6 $ 6,005.0 $ 5,809.1 $ 5,611.5
------------------------------------------------------------------------
Exposure to risk is represented in terms of changes in fair value due to
selected hypothetical movements in market rates. Bonds and preferred stocks are
individually priced to yield to the worst case scenario. State and local
government obligations, including lease deals and super sinkers, are assumed to
hold their prepayment patterns. Asset-backed securities are priced assuming deal
specific prepayment scenarios, considering the deal structure, prepayment
penalties, yield maintenance agreements and the underlying collateral. Over 95%
of the preferred stocks have mechanisms that are expected to provide an
opportunity to liquidate at par.
Financial instruments subject to equity market risk were:
HYPOTHETICAL MARKET CHANGES
---------------------------
MARKET
(millions) VALUE +10% -10%
- -----------------------------------------------------------------------------------------------------------
Common equities as of December 31, 2001 $ 1,285.9 $ 1,414.5 $ 1,157.3
Common equities as of December 31, 2000 $ 978.3 $ 1,071.6 $ 885.0
The model represents the estimated value of the Company's common
equity portfolio given a + (-) 10% change in the market, based on the common
stock portfolio's weighted average beta of 1.0. The beta is derived from recent
historical experience, using the S&P 500 as the market surrogate. The historical
relationship of the common stock portfolio's beta to the S&P 500 is not
necessarily indicative of future correlation, as individual company or industry
factors may affect price movement. Betas are not available for all securities.
In such cases, the change in market value reflects a direct + (-) 10% change;
the number of securities without betas is less than 7% and the remaining 93% of
the equity portfolio is indexed to the Russell 1000. The model does not include
term trust certificates, which comprised $50.1 million of the common equity
portfolio at the end of 2001, as these securities are more sensitive to interest
rate risk than to equity market risk.
56 The Progressive Corporation and Subsidiaries
As an additional supplement to the sensitivity analysis, the Company is
presenting summarized Value-at-Risk (VaR) of the fixed-income and equity
portfolios for the following periods:
DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31, DECEMBER 31,
(millions) 2001 2001 2001 2001 2000
- -------------------------------------------------------------------------------------------------------------------------------
Fixed-income portfolio $ (182.8) $ (120.1) $ (128.8) $ (113.1) $ (93.7)
(2.6)% (1.8)% (2.0)% (1.8)% (1.6)%
Equity portfolio $ (101.3) $ (97.5) $ (80.3) $ (70.7) $ (88.9)
(7.9)% (8.4)% (8.8)% (8.1)% (9.1)%
Total portfolio $ (218.3) $ (151.1) $ (149.8) $ (102.8) $ (117.0)
(2.7)% (1.9)% (2.0)% (1.4)% (1.7)%
The model results represent the maximum expected loss in a one month period at a
95% confidence level. The results are based on 10,000 paths generated using
Monte Carlo methodology. Fixed-income securities are priced off simulated term
structures, capturing the path-dependency of instruments with embedded options.
Equities are priced off a 10 factor model; risk factors include both
macroeconomic and industry segment exposures. The variance/covariance matrix is
estimated using the last two years (rolling) and is exponentially-weighted,
making the model especially sensitive to recent volatility. The VaR of the total
investment portfolio is less than the sum of the two components (fixed income
and equity) due to the benefit of diversification.
The VaR of the total investment portfolio increased 100 basis points from
December 31, 2000 to December 31, 2001, driven by increased volatility in the
fixed-income markets.
Financial instruments subject to foreign currency risk were:
MARKET HYPOTHETICAL
(millions) VALUE GAIN (LOSS)
- ---------------------------------------------------------------------------------------------
Canadian fixed income investments $ 39.0 $ (3.9)
Other foreign fixed income investments .5 (.1)
- ---------------------------------------------------------------------------------------------
Balance as of December 31, 2001 $ 39.5 $ (4.0)
------------------------------------
Balance as of December 31, 2000 $ 41.6 $ (3.7)
------------------------------------
The model calculates a gain or loss in market value if the U.S. dollar
depreciates by 10% to the respective currency. The model does not attempt to
reflect the correlation of multiple currencies to changes in the U.S. dollar. At
December 31, 2001, the Company did not have any cross currency exposures.
TRADING FINANCIAL INSTRUMENTS
At December 31, 2001, the Company did not have any trading securities, compared
to $3.7 million held at December 31, 2000. During 2001 and 2000, net activity of
trading securities was not material to the Company's financial position or cash
flows. For 2001 and 2000, the Company realized $6.5 million and $19.0 million,
respectively, of net losses on trading securities.
57
Analysis of Loss and Loss Adjustment Expenses (LAE) Development
(not covered by report of independent accountants)
(millions)
For the years ended
December 31, 1991 1992 1993 1994(3) 1995 1996 1997 1998 1999 2000 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Loss and LAE
reserves(1) $ 861.5 $ 956.4 $1,012.4 $1,098.7 $1,314.4 $1,532.9 $1,867.5 $1,945.8 $2,200.2 $2,785.3 $3,069.7
Re-estimated
reserves as of:
One year later 810.0 857.9 869.9 1,042.1 1,208.6 1,429.6 1,683.3 1,916.0 2,276.0 2,686.3
Two years later 771.9 765.5 837.8 991.7 1,149.5 1,364.5 1,668.5 1,910.6 2,285.4
Three years later 718.7 737.4 811.3 961.2 1,118.6 1,432.3 1,673.1 1,917.3
Four years later 700.1 725.2 794.6 940.6 1,137.7 1,451.0 1,669.2
Five years later 695.1 717.3 782.9 945.5 1,153.3 1,445.1
Six years later 692.6 711.1 780.1 952.7 1,150.1
Seven years later 688.2 709.2 788.6 952.6
Eight years later 687.9 714.6 787.5
Nine years later 690.3 713.3
Ten years later 691.1
Cumulative development:
conservative/(deficient) $ 170.4 $ 243.1 $ 224.9 $ 146.1 $ 164.3 $ 87.8 $ 198.3 $ 28.5 $ (85.2) $ 99.0
Percentage(2) 19.8 25.4 22.2 13.3 12.5 5.7 10.6 1.5 (3.9) 3.6
The chart represents the development of the property-casualty loss and LAE
reserves for 1991 through 2000. The reserves are re-estimated based on
experience as of the end of each succeeding year and are increased or decreased
as more information becomes known about the frequency and severity of claims for
individual years. The cumulative development represents the aggregate change in
the estimates over all prior years.
(1) Represents loss and LAE reserves net of reinsurance recoverables on unpaid
losses at the balance sheet date.
(2) Cumulative development divided by loss and LAE reserves.
(3) In 1994, based on a review of its total loss reserves, the Company
eliminated its $71.0 million "supplemental reserve."
DIRECT PREMIUMS WRITTEN BY STATE
(not covered by report of independent accountants)
(millions) 2001 2000 1999 1998 1997
- ---------------------------------------------------------------------------------------------------------------------------
Florida $ 799.6 10.8% $ 773.2 12.1% $ 895.6 14.2% $ 784.4 14.4% $ 663.0 13.7%
Texas 572.5 7.8 532.6 8.3 557.6 8.8 518.6 9.5 509.4 10.6
Ohio 567.2 7.7 563.2 8.8 528.1 8.4 447.7 8.2 404.3 8.4
New York 560.6 7.6 425.6 6.6 600.4 9.5 522.2 9.6 446.3 9.2
California 416.5 5.6 376.6 5.9 416.0 6.6 343.2 6.3 291.7 6.0
Georgia 405.3 5.5 368.6 5.8 301.9 4.8 277.8 5.1 261.9 5.4
Pennsylvania 368.4 5.0 312.3 4.9 322.3 5.1 292.3 5.4 248.3 5.1
All other 3,689.1 50.0 3,050.0 47.6 2,683.4 42.6 2,265.1 41.5 2,000.3 41.6
- ---------------------------------------------------------------------------------------------------------------------------
Total $ 7,379.2 100.0% $ 6,402.1 100.0% $ 6,305.3 100.0% $ 5,451.3 100.0% $ 4,825.2 100.0%
=========================================================================================================
58 The Progressive Corporation and Subsidiaries
Quarterly Financial and Common Share Data
(not covered by report of independent accountants)
(millions-except per share amounts)
NET INCOME OPERATING
(LOSS) INCOME (LOSS)(1) STOCK PRICE(2)
------------------ ----------------- ----------------------------------------
OPERATING PER PER RATE OF DIVIDENDS
QUARTER REVENUES(3) TOTAL SHARE(4) TOTAL SHARE(4) HIGH LOW CLOSE RETURN(5) PER SHARE
- -------------------------------------------------------------------------------------------------------------------------
2001
1 $ 1,678.8 $ 86.6 $ 1.16 $ 88.3 $ 1.18 $ 103.48 $ 82.13 $ 97.05 $ .070
2 1,761.7 103.7 1.38 107.0 1.42 136.78 93.60 135.19 .070
3 1,839.7 96.4 1.29 150.5 2.01 135.95 114.60 133.90 .070
4 1,906.3 124.7 1.67 139.7 1.87 151.80 130.85 149.30 .070
- -------------------------------------------------------------------------------------------------------------------------
$ 7,186.5 $ 411.4 $ 5.48 $ 485.5 $ 6.47 $ 151.80 $ 82.13 $ 149.30 44.1% $ .280
- -------------------------------------------------------------------------------------------------------------------------
2000
1 $ 1,526.2 $ (46.6) $ (.64) $ (36.6) $ (.50) $ 85.75 $ 45.00 $ 76.06 $ .065
2 1,584.9 (14.1) (.19) 4.0 .06 100.00 60.00 74.00 .065
3 1,620.5 58.8 .79 37.9 .51 85.38 62.25 81.88 .070
4 1,637.3 48.0 .64 50.1 .67 111.00 69.63 103.63 .070
- -------------------------------------------------------------------------------------------------------------------------
$ 6,368.9 $ 46.1 $ .62 $ 55.4 $ .75 $ 111.00 $ 45.00 $ 103.63 42.3% $ .270
- -------------------------------------------------------------------------------------------------------------------------
1999
1 $ 1,333.3 $ 105.3 $ 1.41 $ 104.0 $ 1.39 $ 174.25 $ 115.44 $ 143.50 $ .065
2 1,416.8 112.1 1.50 98.5 1.32 152.13 127.38 145.00 .065
3 1,474.5 74.0 .99 59.5 .80 144.94 81.50 81.69 .065
4 1,506.5 3.8(6) .05(6) 4.7(6) .06(6) 97.63 68.50 73.13 .065
- -------------------------------------------------------------------------------------------------------------------------
$ 5,731.1 $ 295.2 $ 3.96 $ 266.7 $ 3.58 $ 174.25 $ 68.50 $ 73.13 (56.7)% $ .260
- -------------------------------------------------------------------------------------------------------------------------
(1) Defined as net income excluding net realized gains/losses on security sales
and one-time items. This is a non-GAAP disclosure. See Management's
Discussion and Analysis for a description of the one-time items.
(2) Prices as reported on the consolidated transaction reporting system. The
Company's Common Shares are listed on the New York Stock Exchange.
(3) Represents premiums earned plus service revenues.
(4) Presented on a diluted basis. The sum may not equal the total because the
average equivalent shares differ in the periods.
(5) Represents annual rate of return, including quarterly dividend
reinvestment.
(6) During the fourth quarter 1999, the Company increased loss reserves $33
million, $.29 per share, primarily relating to the 1999 accident year and
recognized $7 million, $.06 per share, of losses related to Hurricane
Irene. The remainder of the decline was primarily attributable to increased
loss severity.
The Progressive Corporation and Subsidiaries 59
DIRECTORS
Milton N. Allen (1),(2),(5)
Consultant, Director and Trustee,
Profit and Not-for-profit
Organizations
B. Charles Ames(1)
Partner,
Clayton, Dubilier & Rice, Inc.
(investment banking)
James E. Bennett III(3)
President and
Chief Executive Officer,
EmployOn.com LLC
(online recruiting)
Charles A. Davis(4)
President and
Chief Executive Officer,
MMC, Inc.
(private equity investing)
Stephen R. Hardis(2),(4),(5)
Chairman of the Board,
Axcelis Technologies, Inc.
(manufacturing)
Janet Hill(1)
Vice President,
Alexander & Associates, Inc.
(management consulting)
Jeffrey D. Kelly(4)
Executive Vice President and
Chief Financial Officer,
National City Corporation
(commercial banking)
Philip A. Laskawy
Retired,
formerly Chairman and
Chief Executive Officer,
Ernst & Young LLP
(professional services)
Peter B. Lewis(2),(4),(5)
Chairman of the Board
Norman S. Matthews(3)
Consultant,
formerly President,
Federated Department Stores, Inc.
(retailing)
Glenn M. Renwick(2),(5)
President and
Chief Executive Officer
Donald B. Shackelford(3)
Chairman,
Fifth Third Bank, Central Ohio
(commercial banking)
(1) Audit Committee member
(2) Executive Committee member
(3) Executive Compensation Committee member
(4) Investment and Capital Committee member
(5) Nominating Committee member
CORPORATE OFFICERS
Peter B. Lewis
Chairman
Glenn M. Renwick
President and
Chief Executive Officer
W. Thomas Forrester
Vice President and Chief
Financial Officer
Charles E. Jarrett
Vice President, Secretary
and Chief Legal Officer
Jeffrey W. Basch
Vice President and Chief
Accounting Officer
Thomas A. King
Vice President
Stephen D. Peterson
Treasurer
ANNUAL MEETING
The Annual Meeting of Shareholders will be held at the offices of The
Progressive Corporation, 6671 Beta Drive, Mayfield Village, Ohio 44143 on April
19, 2002, at 10:00 a.m. eastern time. There were 3,592 shareholders of record on
December 31, 2001.
PRINCIPAL OFFICE
The principal office of The Progressive Corporation is at 6300 Wilson Mills
Road, Mayfield Village, Ohio 44143.
Web site: progressive.com
TOLL-FREE TELEPHONE NUMBERS
For assistance after an accident or to report a claim, 24 hours a day, 7 days a
week, call: 1-800-274-4499.
To check rates available to you from Progressive and up to three other leading
auto insurance companies, call: 1-800-PROGRESSIVE(SM) (1-800-776-4737) or visit:
progressive.com.
For 24 Hour Policy Service, call: 1-800-888-7764.
COUNSEL
Baker & Hostetler LLP, Cleveland, Ohio
COMMON SHARES
The Progressive Corporation's Common Shares (symbol PGR) are traded on the New
York Stock Exchange. Dividends are customarily paid on the last day of each
quarter. The 2002 quarterly dividend record dates, subject to Board approval,
are as follows: March 8, June 14, September 13 and December 13.
TRANSFER AGENT AND REGISTRAR
If you have questions about a specific stock ownership account, write or call:
Corporate Trust Customer Service, National City Bank, 1900 East Ninth Street,
Cleveland, Ohio 44114. Phone: 1-800-622-6757.
SHAREHOLDER/INVESTOR RELATIONS
The Progressive Corporation does not maintain a mailing list for distribution of
shareholders' reports. To view Progressive's publicly filed documents as well as
its earnings and other releases, shareholders can access the Company's Web site:
progressive.com/investors.
To request copies of public financial information on the Company, write to: The
Progressive Corporation, Investor Relations, 6300 Wilson Mills Road, Box W33,
Mayfield Village, Ohio 44143, e-mail: investor_relations@ progressive.com or
call: 1-440-446-7165.
For specific questions on financial information, call: 1-440-446-2851 or e-mail:
investor_relations@progressive.com.
For stock ownership account information, call National City Bank at:
1-800-622-6757.
For all other Company information, call: 1-440-461-5000 or e-mail:
webmaster@progressive.com.
CHARITABLE CONTRIBUTIONS
Progressive supports qualified not-for-profit organizations working to reduce
the human trauma and economic cost of auto accidents. In addition, The
Progressive Foundation, established in December 2001, will contribute to
qualified tax-exempt organizations that are financially supported by Progressive
employees.
60
For more information and a fully interactive version of this annual report,
please visit
progressive.com/annualreport
(C)2002 The Progressive Corporation DESIGN Nesnadny + Schwartz, Cleveland + New
York + Toronto PRINTING Fortran Printing ARTWORK All pieces (C)2002 Robert
ParkeHarrison, Courtesy Bonni Benrubi Gallery COVER Cloud Cleaner P2
Pollination P8 Kingdom P11 Forestbed P12 The Clearing P15
The Sower P18 Tree Sonata P22 Turning to Spring P26 Passage P28
The Navigator Back Cover The Navigator (detail)
The Progressive Corporation 6300 Wilson Mills Road Mayfield Village, Ohio 44143
440.461.5000 progressive.com
[PROGRESSIVE logo]