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Exhibit 13
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About the Art
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Each year, Progressive commissions an artist or a group of artists to create a
body of work for our Annual Report which is inspired by a Progressive theme.
This year, our inspiration is the American passion for car travel and the
culture born from it. The artist is photographer Stephen Frailey. Stephen works
by collaging found images to create new meaning from their juxtaposition.
Frailey's work will become part of Progressive's growing collection of
contemporary art.
ENTER
05 1998 Financial Highlights 15 Letter to Shareholders
06 Vision, Core Values and Objectives 33 Financial Review
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About Progressive
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The Progressive insurance organization began business in 1937. Progressive
Casualty Insurance Company was founded in 1956 to be among the first specialty
underwriters of nonstandard auto insurance. The Progressive Corporation, an
insurance holding company formed in 1965, owns 82 subsidiaries and has one
mutual insurance company affiliate. The companies provide personal automobile
insurance and other specialty property-casualty insurance and related services
throughout the United States and Canada.
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1998 Financial Highlights
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(millions-except per share amounts) AVERAGE ANNUAL COMPOUNDED
RATE OF INCREASE (DECREASE)
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5-YEAR 10-YEAR
1998 1997 % CHANGE 1994-1998 1989-1998
FOR THE YEAR
Direct premiums written $ 5,451.3 $ 4,825.2 13% 23% 15%
Net premiums written 5,299.7 4,665.1 14 24 15
Net premiums earned 4,948.0 4,189.5 18 24 15
Total revenues 5,292.4 4,608.2 15 22 15
Operating income 449.3 336.0 34 18 17
Net income 456.7 400.0 14 11 16
Per share:(1)
Operating income 6.01 4.46 35 18 19
Net income 6.11 5.31 15 11 17
Underwriting margin(2) 8.4% 6.6% 8 7
AT YEAR-END
Consolidated shareholders' equity $ 2,557.1 $ 2,135.9 20 21 20
Common Shares outstanding 72.5 72.3 -- -- (1)
Book value per share $ 35.27 $ 29.54 19 23 21
Market capitalization $ 12,279.7 $ 8,667.0 42 33 35
Return on average shareholders' equity(2) 19.3% 20.9% 21 22
STOCK PRICE APPRECIATION(3) 1-YEAR 5-YEAR 10-YEAR
Progressive 41.6% 33.6% 37.2%
S&P 500 28.5% 24.0% 19.1%
(1)Presented on a diluted basis.
(2)The 5-and 10-year amounts represent averages for the period, not rates of
increase.
(3)Assumes dividend reinvestment.
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Vision, Core Values and Objectives
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Communicating a clear picture of Progressive by stating what we try to achieve
(Vision), 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 role and enjoy their
contributions.
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VISION
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We seek to be an excellent, innovative, growing and enduring 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.
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CORE VALUES
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Progressive's Core Values are pragmatic statements of what 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. We value all people's well-being and strive to give back to our
communities.
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FINANCIAL OBJECTIVES AND MEASUREMENTS
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Consistent achievement of superior results requires that our people understand
Progressive's objectives 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.
RETURN ON SHAREHOLDERS' EQUITY Our most important financial 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 1998, and averaged 2.4% over the past
five years and 3.1% over the past ten years). Return on equity was 19.3% in
1998, and averaged 20.9% over the past five years and 21.8% over the past ten
years.
PROFITABILITY Progressive is driven by the goal of producing a 4% underwriting
profit over the entire retention period of a policyholder. Overall, we had an
underwriting profit of 8.4% in 1998, 8.0% for the past five years and 6.5% for
the past ten years. Estimated industry results for the personal auto insurance
market were underwriting gains of .3% in 1998 and underwriting losses of .5% and
2.5%, for the past five and ten years, respectively.
GROWTH We seek increases in net premium volume that are at least 15 percentage
points greater than the rate of inflation. Company-wide net premiums written
increased 13.6% in 1998, 23.8% compounded annually over the past five years and
15.3% over the past ten years. Net premiums written in the personal auto
insurance market for the same periods grew 3.9%, 4.8% and 5.4%.
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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, 1998, with a market value of
$1,302,000, for a 26.8% compounded annual return, compared to the 9.5% return
achieved by investors in the Standard & Poor's 500 during the same period. In
addition, the shareholder received dividends of $1,922 in 1998, bringing total
dividends received to $18,266 since the shares were purchased.
In the ten years since December 31, 1988, Progressive shareholders have
realized compounded annual returns of 37.2%, compared to 19.1% for the S&P 500.
In the five years since December 31, 1993, Progressive shareholders' returns
were 33.6%, compared to 24.0% for the S&P 500. In 1998, the returns were 41.6%
on Progressive shares and 28.5% on the S&P 500.
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1998 OBJECTIVES AND ACCOMPLISHMENTS
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LAST LAST
1998 5 YEARS 10 YEARS
RETURN ON SHAREHOLDERS' EQUITY
Objective 16.6% 17.4% 18.1%
Accomplishment 19.3 20.9 21.8
UNDERWRITING PROFIT (LOSS)
Objective 4.0 4.0 4.0
Accomplishment 8.4 8.0 6.5
Industry-Personal Auto Insurance Market .3 (.5) (2.5)
GROWTH (ANNUALIZED)
Objective 16.6 17.4 18.1
Accomplishment 13.6 23.8 15.3
Industry-Personal Auto Insurance Market 3.9 4.8 5.4
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The repurchase of Progressive stock is another way the Company increases
shareholder value. Over the years, when we have had adequate capital and
Progressive's stock was attractively priced, we have repurchased our shares.
Since 1971, we spent $613.7 million repurchasing our shares, at an average cost
of $7.44 per share. During 1998, we repurchased 404,079 Common Shares, including
11,079 Common Shares repurchased to offset obligations under various employee
benefit plans.
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Letter to Shareholders
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For 34 years, writing annually to shareholders has been my way to describe
Progressive's achievements and aspirations, and to explain our current
performance and prospects. I try to do it in a way that lets anyone interested
in Progressive understand the value of and reasons for what Progressive does.
Since 1965, Progressive has grown faster and more profitably than other auto
insurers. By 1988, we were the largest, fastest-growing, most-profitable insurer
specializing in high-risk auto insurance sold by Independent Insurance Agents.
This was achieved by Progressive's smart and creative people working hard to
serve auto insurance consumers better than competitors. In 1988, California
consumer activists turned their constituents' rage against escalating auto
insurance costs into laws and regulations that threatened auto insurance as a
free-enterprise activity. Progressive's strategic response has been to create a
new value proposition with redefined service, distribution and product that
enhances consumers' auto insurance experience.
Today, we offer auto insurance to every licensed driver, selling many ways while
innovating in claims, technology, pricing and consumer brand building. We first
changed claim service so we could respond to most claims within a few hours of
their being reported, any time, any day. Next, we made all services available 24
hours a day, 7 days a week and developed rates for all licensed owners and
drivers. Then we distributed in the many different ways consumers wanted to
buy-in person from Independent Agents, by telephone through 1 800 AUTO PRO(R)
or online at progressive.com. Another innovation was offering competitor premium
comparisons. We use a combination of television, direct mail and other media to
urge consumers to consider Progressive's unique combination of price and
service. As important as Independent Agents continue to be to Progressive, we no
longer depend solely on them choosing us for their nonstandard risks.
Progressive seeks to be consumers' #1 choice for auto insurance.
Progressive's Personal Lines net premiums written of $4.9 billion (93% of
Progressive's total net premiums written) were 4.0% of the industry's U.S.
personal lines insurance premiums, making Progressive the 5th largest U.S. auto
insurer. We had another year of excellent financial performance in 1998,
notwithstanding the aggressive competition in auto insurance history.
Progressive's underwriting profit margin was 8.4% (industry was .3%), compared
to 6.6% in 1997.
Although proud of our achievements, all Progressive people understand that
our customers, agents, partners and shareholders care only about what we WILL do
for them-no matter what we have already done for them. Competitors are imitating
Progressive's consumer-focused innovations. Industry-wide auto insurance service
is generally better. Auto insurance premiums are stable or declining due to
continuing trends with respect to safer cars and roads, the impaired driving
crackdown, better law enforcement and insurers operating more efficiently.
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Because auto insurance rates are based on history, and because experience
steadily improves, we are in the midst of the most profitable period in 20
years. There is an explosion in consumer advertising for auto insurance. Many
insurers are increasing producer incentives and many more are reducing rates.
Soon operating margins may shrink and be negative for the industry as a whole.
These circumstances historically have energized Progressive's great people to
focus their knowledge, creativity and effort to serve our customers even better
and more efficiently, to achieve our profit and growth aspirations.
To become consumers' #1 choice for auto insurance, Progressive seeks to provide
a competitive price for all drivers AND to produce at least a 4% underwriting
profit over the total time a person is insured by Progressive. We seek customers
for life and are more focused on retaining customers longer. To do this, and to
attract new customers, we will promote our brand based on Progressive's unique
customer proposition. We "kicked off" 1999 brand building by sponsoring the
Super Bowl(TM) XXXIII Halftime Show and by introducing new commercials featuring
E.T. as spokesterrestrial for Progressive's commitment to reduce the trauma and
costs of accidents by reducing their frequency and severity.
Customer focus has driven Progressive's innovation over the past decade. We
will work hard in 1999 to expand and improve the ways in which consumers become
Progressive customers and will foreclose no distribution option. We know that
costs must continue to come down for us to accomplish our vision and achieve our
financial objectives. We continue to improve claim operations, trying to reduce
claim costs faster than competitors. We continue to work hard to eliminate work
and simplify processes, obtain economies of
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scale, and reduce cycle times and costs, thereby improving customer satisfaction
and lowering customer cost. We regularly measure more activities more precisely
to understand them better and to improve performance.
We refine the definition and delivery of Immediate Response(R) claims
service as we gain greater understanding of customer/claimant needs.
Progressive's Immediate Response Vehicles (painted white with PROGRESSIVE
emblazoned in blue on the side) travel America's streets providing the help and
counseling people need when they are unfortunate enough to have an auto mishap
and reinforcing the defining service standard only available from us.
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OUR ORGANIZATION
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More customers and changing business processes require the talent and energy of
people who are better trained, harder working and better paid. How we train,
motivate, evaluate and compensate our people and how we organize are critical to
Progressive's success. Auto insurance differs greatly by community because
regulations differ by state and because traffic, law enforcement, cultural
attitudes, insurance agents, medical services and auto repair facilities differ
by community. Our matrix organization enables Progressive to meet varied local
conditions under a cohesive set of policies that ensure consistency and control,
while sustaining experimentation and excitement.
Progressive's 44 State and Community Managers actually run the business in
their state(s). State Managers are measured and paid based on profit and growth
in their state(s) or region. They manage claims, distribution, advertising
budgets, price levels, agent development, regulation and community relations for
their state. State Managers decide their state(s) organization, including
appointing Community Managers with responsibilities similar to their own for a
large part of the state.
State Managers report to members of the "Policy Team" which in 1999 includes
two CEOs (Insurance Operations, Investments and Capital Management), four
Distribution Leaders (Independent Agent, 1 800 AUTO PRO(R), progressive.com,
Strategic Alliances), Chief Pricing/Product Officer, Chief Claim Officer, Chief
Financial Officer, Chief Information Officer, Chief Human Resources Officer and
Chief Communications Officer. The Distribution Leaders are challenged to develop
and manage product offerings and customer service processes tailored to the
unique requirements of customers who discover and select Progressive through
different distribution modes.
Progressive's organization is like a growing cell inhabited by nearly 16,000
people, many soaring from team to team and task to task. The sphere's skin is
kept taut by straight lines between people which define the relationship of the
people connected by them (e.g. boss, former boss, direct report, former direct
report, relative, etc.). These relationships change constantly, responding to
business and personal needs. We eliminate organization confusion by being clear
and current about performance objectives, standards, measurements and rewards
for each team and each person. We help our people understand how their good work
enhances our customers' well-being, our shareholders' value, our agents'
prosperity, our partners' profits and their personal opportunities.
Objectives are regularly reviewed and renegotiated. Performance against
objectives is regularly and completely reported on and monitored. The whole
process is validated and reinforced by Progressive's performance-based employee
incentive compensation program, which paid $85.8 million for 1997 and $107.5
million for 1998. Progressive stays flexible by having people expect the
organization, their objectives and the Gainsharing formula to change regularly.
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PERSONAL LINES BUSINESS
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Ninety-three percent of Progressive's net premiums written is insurance for
private passenger automobiles, motorcycles and recreational vehicles. Net
premiums written for the Personal Lines business was $4,922.3 million, 15% more
than the $4,288.8 million in 1997. The underwriting profit margin was 7.9%,
compared to 6.3% in 1997. In 1998, we celebrated a milestone in our motorcycle
product expansion by taking over market share leadership from State Farm.
PRODUCT STRATEGY-COMPETITIVE RATES FOR ALL RISK PROFILES In 1997, we reported
that introducing financial responsibility as an auto insurance rating factor
would result in more competitive rates for many consumers. In 1998, we used
financial responsibility in 43 states and began to refine and improve our
product design. We expect product design and pricing methods to evolve
constantly, based on our developing understanding of loss data, work flows,
market conditions and technology, as well as consumer acceptance of our brand as
an insurer for all drivers. We introduced the next generation of product design
in mid-1998 and expect to have it in markets representing 80% of premium by
April 1999. Early results suggest we are attracting more drivers from all risk
profiles and retaining them longer.
BRAND STRATEGY - BE PROGRESSIVE In 1998, we expanded Progressive's brand
promotion and the service and price proposition it stands for by introducing
our television advertising in 43 additional markets, bringing the total number
of markets in which we regularly advertise to 83. We expanded our national
fleet of distinctively marked Immediate Response Vehicles, increased our
visibility in the Independent Agency channel with prominent Progressive
Authorized Independent Agent signs and significantly increased advertising
related to our Internet site, all aimed at substantially increasing awareness
of Progressive, what we offer, and what it means to BE PROGRESSIVE.
Customers evaluate our brand by the experiences we provide them. We measure
customer satisfaction and our performance with a combination of surveys,
customer response requests, phone monitoring and mystery shopping. Delivering
superior service depends on hiring superb people and training them all very
well. During 1998, we successfully hired and trained over 3,800 people
companywide, including claim representatives, policy service representatives,
sales representatives, and technology and management staff, and provided ongoing
training to several thousand employees across each service experience. We employ
a variety of techniques including aptitude simulations before hiring, coaching/
mentoring programs, team quality and productivity objectives, and
performance-based promotion to develop and empower exceptional people and
deliver consistently good customer experiences.
MARKETING STRATEGY-MANY WAYS TO BUY To accommodate consumer preferences, we
offer our products through more than 30,000 Independent Insurance Agents, by
calling 1 800 AUTO PRO(R) or by visiting our Web site, progressive.com. We are
the market leader in selling auto insurance through Independent Agents and seek
ever stronger ties between us and Independent Agents and their customers. In
1998, there was considerable development in agent systems to greatly improve
Agents' ability to quote accurately, to retrieve policyholder information, to
receive rate and software updates electronically, to eliminate paper and to use
the Internet to communicate with us.
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Our fastest growing distribution channel is 1 800 AUTO PRO(R), making
Progressive a leading direct writer of auto insurance. To support growth, we
expanded to five call center locations in 1998 and focused on sales
effectiveness training, measurement and call center management. Progressive is
the market leader in selling auto insurance on the Internet. Consumers can
comparison shop online for auto insurance in 47 states and can actually buy
online in 23 states plus the District of Columbia. In 1998, we introduced
"Personal Progressive," an online Internet-based system providing consumers
access to their own policy information and allowing them to process certain
changes and premium payments.
In 1998, our Strategic Alliances channel surpassed 200 active alliances with
companies that influence their constituents to buy Progressive's products. Our
expanded and improved product and offering rates for all drivers greatly expand
the opportunities for direct and affinity marketing programs aimed at all risks
to be sold through these long-term, exclusive alliances.
Midland Financial Group, acquired in 1997, underwrites and markets
nonstandard private passenger auto insurance, under the Midland name, through
Independent Agents in 11 southeastern and western states.
In 1999, because different distribution channels and the customer sets they
attract present different business opportunities and challenges, each channel
will be led by a Policy Team member. We seek to maximize the opportunities
within each distribution channel, while maintaining both the integrity of brand
experience for all customers and the ability to leverage our service and
technology infrastructures. However our customers decide to buy, we want them to
understand and benefit from the following Progressive service offerings.
SERVICE STRATEGY-WHEN AND WHERE YOU WANT IT Assistance after an accident or
other loss is Progressive's most important service. We implore our customers to
call 1-800-274-4499 immediately after any incident. Twenty-four hours a day, 7
days a week, Progressive people take claim report telephone calls, obtain the
relevant information, authorize emergency measures and dispatch Progressive
claim representatives to meet customers as quickly as possible, usually within
hours.
AROUND-THE-CLOCK SERVICE. Consumers want to do business when it's convenient for
them, so we operate 24 hours a day, 7 days a week, providing insurance sales and
policy change assistance, as well as the critically important Immediate
Response(R) claims service. Our customers come to depend on this level of
service, which we support by continuous real-time monitoring of internal systems
performance, threatening weather and other natural disasters. This approach
allows us immediately to reconfigure voice and data networks and to activate
disaster response teams when required.
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OTHER BUSINESSES
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The Company's other lines of business include writing insurance for small fleets
of commercial vehicles, 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 claims, underwriting and system services.
Revenues in these businesses were $405 million in 1998, compared to $402 million
last year. Pretax operating profit was $62 million, compared to $37 million last
year, up 68%, and return on revenue was 15.3%, compared to 9.2% in 1997. Most of
these businesses are in markets that are declining in size.
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INVESTMENTS AND CAPITAL MANAGEMENT
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Progressive employs a conservative approach to investments and capital
management, intended to ensure that there is sufficient capital to support all
the insurance premium that we can profitably write. Our objectives are to
finance growth internally, to sustain an A or better senior debt rating, to have
lower debt cost than peer companies and to repurchase stock cost-effectively.
Progressive's senior debt was rated A+ and A2 by S&P and Moody's, respectively,
at year-end 1998 and our debt to debt plus capital ratio was 23.3%. During 1998,
we repurchased 393,000 shares at an average cost per share of $104. We filed a
shelf registration to issue $300 million of senior debt intended to replace $300
million of debt expiring at year-end 2000.
Asset allocation considers the capital we have in excess of that required to
support premiums planned over the next three years, anticipated liquidity needs
and our analysis of the expected risks and returns on various assets. At
year-end 1998, $4,532.9 million, 79.9% of our total invested assets, was
investment-grade, fixed-maturity securities, compared to $4,168.3 million in
1997, 79.1%. Non-investment-grade fixed-maturity securities were $128.0 million,
2.3% of total invested assets, compared to $132.5 million in 1997, 2.5%. The
portfolio's duration was 2.8 years at year-end 1998, in the middle of our target
range.
Common stocks were $636.9 million, 11.2% of total invested assets, compared
to $620.8 million and 11.8% at year-end 1997. Our 3.7% total return
underperformed the S&P 500's 28.5% because we overweighted smaller
capitalization "value style" companies and foreign equities.
Included in our non-investment-grade fixed-maturity securities and our common
stock portfolio are $299.6 million, 5.3%, of other risk assets. Other risk
assets include such items as high yield and distressed debt, private equities
and warrants, and mezzanine investments. No individual security in the other
risk asset portfolio comprised more than one percent of Progressive's total
investment portfolio. Our total return on the average amount invested in this
asset class in 1998 was (4.4)%.
In 1998, Progressive earned $221.3 million of investment income after tax,
compared to $205.3 million in 1997. Realized gains were $11.4 million in 1998,
compared to $98.5 million in 1997. As of year-end 1998, there were $174.3
million in unrealized gains, compared to $188.4 million at year-end 1997. The
weighted average fully taxable equivalent book yield of the portfolio was 6.3%
in 1998, compared to 6.6% in 1997.
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RISKS
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LEGISLATIVE AND REGULATORY Highly complex regulation becomes more ambiguous in a
technology-driven economy and compliance with the variety of state regulatory
systems becomes more difficult. As Progressive innovates and grows, our
"cutting-edge" programs increase the risk of regulatory scrutiny. The constant
attention of the plaintiff bar to the insurance industry increases the risk of
added liabilities not contemplated when premiums were set.
ADVERTISED BRAND Heightened consumer awareness of the Progressive brand requires
ever higher performance standards. We regularly monitor consumer reaction to our
advertising and assess their service delivery expectations. We continually seek
ways to exceed consumer expectations in innovative and low-cost ways.
UNPREDICTABLE UNDERWRITING MARGIN AND GROWTH RATE Our goal is to achieve a 4%
underwriting profit over the entire retention period of a policyholder and we
monitor closely to ensure rates are adjusted promptly and adequately. However,
we cannot predict with precision the timing and pace of changes in underwriting
margins, retention or the rate of growth.
HOMEOWNERS INSURANCE Because many consumers buy auto and homeowners insurance
together, we plan to test offer a homeowners product in 1999, expanding
thereafter based on what we learn from the tests. Inexperience exposes us to
underwriting losses. Broad implementation could create underserved market issues
and aggregate exposures requiring precise measurement and conservative
management.
COMPETITOR RESPONSE Competitors notice Progressive's profitability and growth
and then attempt to copy our approach to improving auto insurance consumers'
experience. We cannot predict whether or when competitive tactics will influence
our profitability and growth, and/or if their attempts to attract our excellent
people will succeed. We constantly monitor competitors and improve our products
and services to keep them among the industry's best.
Y2K Between 1995 and 1998, nearly 100% of our system applications were
remediated. Critical applications are being tested in our Year 2000 Time Warp
Lab, an autonomous production environment simulating year 2000 operating time
frames. We are well under way in ensuring that mainframe computers, servers,
personal computers, operating systems, desktop applications and
telecommunications hardware and software are compliant. We have completed
contingency plans for all of our business processes and are assessing and
testing key business partners' readiness. During 1999, we will continue to test,
refine and challenge all our preparations. Nonetheless, Progressive, like other
well-prepared institutions, is subject to Y2K risks we cannot anticipate,
eliminate or quantify.
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THE FUTURE
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In 1998, I turned 65 and recovered from an illness. It became clear that
managing a smooth CEO succession that left people confident about Progressive's
future would be the best thing I could do for the organization I am so proud of
and care so much about. On January 1, 1999, Progressive's CEO responsibility was
divided so that we now have a CEO-Insurance Operations and a CEO-Investments and
Capital Management. Chuck Chokel, formerly CFO, became CEO-Investments and
Capital Management and I remain CEO-Insurance Operations. In 1998, we also
codified the Board structure, composition and protocols that resulted in
clarifying the role of Chairman of the Board, as distinct from the CEO. I remain
Chairman of the Board. There are no plans now to appoint a new CEO-Insurance
Operations. However, I am delighted to have a structure in place that allows it
and will permit me to contribute.
Progressive leads a wave of change in the United States' system for dealing
with auto accident injuries and property damage. We reduce auto accident
victims' trauma and cost. We are being rewarded for leadership and commitment.
Our success so far encourages us to expand at a pace that tests our ability to
provide the service we aspire to deliver.
We begin 1999 as we have begun all other years-excited, respectful of the
challenges implicit in our objectives and strategy, humbled by our failures,
proud of having responded to them and comfortable that our excellent people will
continue to achieve superior results. Much will be required to realize our
vision. At Progressive, it is always as if we are just beginning our business.
We see a future that is brighter than ever.
We deeply appreciate the customers we are privileged to serve. Thank you for
your business. Thanks to the more than 30,000 Independent Insurance Agents who
did business with Progressive in 1998. We are grateful for our shareholders'
continued confidence. To the 15,735 men and women who make Progressive a great
company, thanks for all your contributions in 1998 and for the promise you bring
to our future.
Joy, Love and Peace
/s/ Peter Lewis
Peter B. Lewis
Chairman, President and Chief Executive Officer-
Insurance Operations
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1998 Financial Review
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34 Consolidated Financial Statements
48 Management's Discussion and Analysis
52 Ten Year Summaries
56 Quantitative Market Risk Disclosures
58 Analysis of Loss and LAE Development
58 Direct Premiums Written by State
59 Quarterly Financial and Common Share Data
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Consolidated Statements of Income
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(millions-except per share amounts)
For the years ended December 31, 1998 1997 1996
NET PREMIUMS WRITTEN $ 5,299.7 $ 4,665.1 $ 3,441.7
=====================================
REVENUES
Premiums earned $ 4,948.0 $ 4,189.5 $ 3,199.3
Investment income 294.8 274.9 225.8
Net realized gains on security sales 11.4 98.5 7.1
Service revenues 38.2 45.3 46.2
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Total revenues 5,292.4 4,608.2 3,478.4
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EXPENSES
Losses and loss adjustment expenses 3,376.3 2,967.5 2,236.1
Policy acquisition costs 659.9 607.8 482.6
Other underwriting expenses 495.8 336.0 208.5
Investment expenses 7.4 9.9 6.1
Service expenses 30.8 43.9 41.9
Interest expense 61.1 64.6 61.5
- ---------------------------------------------------------------------------------------------------------
Total expenses 4,631.3 4,029.7 3,036.7
- ---------------------------------------------------------------------------------------------------------
NET INCOME
Income before income taxes 661.1 578.5 441.7
Provision for income taxes 204.4 178.5 128.0
- ---------------------------------------------------------------------------------------------------------
Net income $ 456.7 $ 400.0 $ 313.7
=====================================
COMPUTATION OF EARNINGS PER SHARE
Net income $ 456.7 $ 400.0 $ 313.7
Less: Preferred Share dividends -- -- (3.5)
Excess Preferred Share liquidation price over cost basis -- -- (2.9)
- ---------------------------------------------------------------------------------------------------------
Income available to common shareholders $ 456.7 $ 400.0 $ 307.3
=====================================
Basic:
Average shares outstanding 72.5 72.0 71.6
=====================================
Per share $ 6.30 $ 5.56 $ 4.29
=====================================
Diluted:
Average shares outstanding 72.5 72.0 71.6
Net effect of dilutive stock options 2.2 3.3 2.6
- ---------------------------------------------------------------------------------------------------------
Total equivalent shares 74.7 75.3 74.2
=====================================
Per share $ 6.11 $ 5.31 $ 4.14
=====================================
See notes to consolidated financial statements.
3
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35
--------------------------------------
Consolidated Balance Sheets
--------------------------------------
(millions)
December 31, 1998 1997
ASSETS
Investments:
Available-for-sale:
Fixed maturities, at market (amortized cost: $4,171.6 and $3,836.8) $ 4,219.0 $ 3,891.4
Equity securities, at market:
Preferred stocks (cost: $374.3 and $333.9) 376.5 348.8
Common stocks (cost: $512.2 and $501.9) 636.9 620.8
Short-term investments, at amortized cost (market: $441.9 and $409.4) 441.9 409.4
- -----------------------------------------------------------------------------------------------------------
Total investments 5,674.3 5,270.4
Cash 18.6 23.3
Accrued investment income 53.1 44.3
Premiums receivable, net of allowance for doubtful accounts of $34.0 and $32.4 1,456.2 1,160.8
Reinsurance recoverables 281.0 317.5
Prepaid reinsurance premiums 77.7 79.8
Deferred acquisition costs 299.1 259.6
Income taxes 192.9 116.5
Property and equipment, net of accumulated depreciation of $194.1 and $158.3 376.2 260.4
Other assets 34.0 27.0
- -----------------------------------------------------------------------------------------------------------
Total assets $ 8,463.1 $ 7,559.6
=========================
LIABILITIES AND SHAREHOLDERS' EQUITY
Unearned premiums $ 2,329.7 $ 1,980.1
Loss and loss adjustment expense reserves 2,188.6 2,146.6
Policy cancellation reserve 29.1 34.7
Accounts payable and accrued expenses 582.0 486.4
Debt 776.6 775.9
- -----------------------------------------------------------------------------------------------------------
Total liabilities 5,906.0 5,423.7
- -----------------------------------------------------------------------------------------------------------
Shareholders' equity:
Common Shares, $1.00 par value (authorized 300.0, issued 83.1,
including treasury shares of 10.6 and 10.8) 72.5 72.3
Paid-in capital 448.3 412.8
Accumulated other comprehensive income:
Net unrealized appreciation on investment securities 113.3 122.3
Other (9.6) (6.3)
Retained earnings 1,932.6 1,534.8
- -----------------------------------------------------------------------------------------------------------
Total shareholders' equity 2,557.1 2,135.9
- -----------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 8,463.1 $ 7,559.6
=========================
See notes to consolidated financial statements.
3
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36
-----------------------------------------------------------------------
Consolidated Statements of Changes in Shareholders' Equity
-----------------------------------------------------------------------
(millions-except per share amounts)
For the years ended December 31, 1998 1997 1996
--------------------- --------------------- ---------------------
RETAINED EARNINGS
Balance, Beginning of year $ 1,534.8 $ 1,155.2 $ 899.8
Net income 456.7 $ 456.7 400.0 $ 400.0 313.7 $ 313.7
------- ------- -------
Cash dividends on Preferred Shares
(9 3/8% annually) -- -- (3.2)
Cash dividends on Common Shares ($.25, $.24
and $.23 per share) (18.1) (17.3) (16.4)
Treasury shares purchased: Common Shares (39.8) (2.7) (35.5)
Preferred Shares -- -- (.3)
Preferred Shares redeemed -- -- (2.9)
Other, net (1.0) (.4) --
- ------------------------------------------------------------------------------- --------------------- ---------------------
Balance, End of year $ 1,932.6 $ 1,534.8 $ 1,155.2
- ------------------------------------------------------------------------------- --------------------- ---------------------
ACCUMULATED OTHER COMPREHENSIVE
INCOME, NET OF TAX
Balance, Beginning of year $ 116.0 $ 68.4 $ 45.5
Change in unrealized appreciation (depreciation) (9.0) 48.3 22.9
Other (3.3) (.7) --
------- ------- -------
Other comprehensive income (loss) (12.3) (12.3) 47.6 47.6 22.9 22.9
- ------------------------------------------------------------------------------- --------------------- ---------------------
Balance, End of year $ 103.7 $ 116.0 $ 68.4
- ------------------------------------------------------------------------------- --------------------- ---------------------
COMPREHENSIVE INCOME $ 444.4 $ 447.6 $ 336.6
======= ======= =======
PREFERRED SHARES, NO PAR VALUE
Balance, Beginning of year $ -- $ -- $ 83.6
Redemption of shares -- -- (77.9)
Treasury shares purchased-cost basis -- -- (5.7)
- ------------------------------------------------------------------------------- --------------------- ---------------------
Balance, End of year $ -- $ -- $ --
- ------------------------------------------------------------------------------- --------------------- ---------------------
COMMON SHARES, $1.00 PAR VALUE
Balance, Beginning of year $ 72.3 $ 71.5 $ 72.1
Stock options exercised .6 .8 .4
Treasury shares purchased (.4) -- (1.0)
- ------------------------------------------------------------------------------- --------------------- ---------------------
Balance, End of year $ 72.5 $ 72.3 $ 71.5
- ------------------------------------------------------------------------------- --------------------- ---------------------
PAID-IN CAPITAL
Balance, Beginning of year $ 412.8 $ 381.8 $ 374.8
Stock options exercised 10.9 13.3 6.5
Tax benefits on stock options exercised 25.6 17.6 5.9
Treasury shares purchased (2.4) (.2) (5.4)
Other 1.4 .3 --
- ------------------------------------------------------------------------------- --------------------- ---------------------
Balance, End of year $ 448.3 $ 412.8 $ 381.8
- ------------------------------------------------------------------------------- --------------------- ---------------------
TOTAL SHAREHOLDERS' EQUITY $ 2,557.1 $ 2,135.9 $ 1,676.9
========== ========== ==========
There are 20.0 million Serial Preferred Shares authorized. In May 1991, the
Company sold 4.0 million 9 3/8% Serial Preferred Shares, Series A; all remaining
Preferred Shares were redeemed, at the Company's option, on May 31, 1996, at a
cost of $25 per share, plus accrued and unpaid dividends through the redemption
date.
There are 5.0 million Voting Preference Shares authorized; no such shares
have been issued.
See notes to consolidated financial statements.
3
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37
---------------------------------------------
Consolidated Statements of Cash Flows
---------------------------------------------
(millions)
For the years ended December 31, 1998 1997 1996
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 456.7 $ 400.0 $ 313.7
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 56.1 36.6 23.8
Net realized gains on security sales (11.4) (98.5) (7.1)
Changes in:
Unearned premiums 349.6 442.3 257.7
Loss and loss adjustment expense reserves 42.0 204.6 190.1
Accounts payable and accrued expenses 76.7 49.9 50.1
Policy cancellation reserve (5.6) (8.6) 2.5
Prepaid reinsurance premiums 2.1 33.3 (15.3)
Reinsurance recoverables 36.5 62.7 28.1
Premiums receivable (295.4) (310.9) (170.9)
Deferred acquisition costs (39.5) (52.7) (18.2)
Income taxes (71.3) (67.8) (16.3)
Other, net 21.5 43.8 14.0
- --------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 618.0 734.7 652.2
- --------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases:
Available-for-sale: fixed maturities (3,998.8) (6,764.3) (4,447.2)
equity securities (942.9) (658.2) (725.3)
Sales:
Available-for-sale: fixed maturities 3,210.2 5,840.0 3,306.3
equity securities 774.3 581.7 537.7
Maturities, paydowns, calls and other:
Available-for-sale: fixed maturities 419.9 578.0 465.7
equity securities 126.0 125.4 62.5
Net (purchases) sales of short-term investments (32.5) (248.6) 143.1
(Receivable) payable on securities 18.9 (2.0) 76.3
Purchases of property and equipment (174.2) (121.9) (35.8)
Purchase of subsidiary, net of cash acquired -- (48.0) --
- --------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (599.1) (717.9) (616.7)
- --------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from exercise of stock options 11.5 14.1 6.9
Tax benefits from exercise of stock options 25.6 17.6 5.9
Redemption of Preferred Shares -- -- (80.8)
Proceeds from debt -- -- 99.6
Payments of debt -- (20.4) (.4)
Dividends paid to shareholders (18.1) (17.3) (19.6)
Acquisition of treasury shares (42.6) (2.9) (47.9)
- --------------------------------------------------------------------------------------------------------------
Net cash used in financing activities (23.6) (8.9) (36.3)
- --------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash (4.7) 7.9 (.8)
Cash, Beginning of year 23.3 15.4 16.2
- --------------------------------------------------------------------------------------------------------------
Cash, End of year $ 18.6 $ 23.3 $ 15.4
=================================================
See notes to consolidated financial statements.
3
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38
----------------------------------------------
Notes to Consolidated Financial Statements
----------------------------------------------
December 31, 1998, 1997 and 1996
01 REPORTING AND ACCOUNTING POLICIES
NATURE OF OPERATIONS The Progressive Corporation, an insurance holding company
formed in 1965, owns 82 subsidiaries and has one mutual insurance company
affiliate. The companies provide personal automobile insurance and other
specialty property-casualty insurance and related services throughout the United
States and Canada.
BASIS OF CONSOLIDATION AND REPORTING The accompanying consolidated financial
statements include the accounts of The Progressive Corporation, its subsidiaries
and affiliate (the Company). All of the subsidiaries and the affiliate are
wholly owned or controlled. All intercompany accounts and transactions are
eliminated in consolidation. The parent company's investments in subsidiaries
exceeded their underlying book value at dates of acquisition by $17.9 million,
of which $6.3 million remains. In the opinion of management, there is no present
indication of diminished value in this amount.
INVESTMENTS Available-for-sale: fixed maturity securities are securities 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. 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 stocks and nonredeemable
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 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.
Trading securities are securities bought principally for the purpose of
selling them in the near term and are reported at market value. 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, cash flows or results of operations. The Company had no
trading securities at December 31, 1998 and 1997.
Derivative instruments, as defined by Statement of Financial Accounting
Standards (SFAS) 119, "Disclosures about Derivative Financial Instruments and
Fair Value of Financial Instruments," include futures, options, short positions,
forward positions, foreign currency forwards and interest rate swap agreements.
Derivative instruments held or issued for purposes other than trading include
derivative positions used for risk management purposes and hedge positions.
Derivative positions used for risk management are evaluated as to their
effectiveness to modify the Company's risk characteristics and enhance the
yields of the available-for-sale portfolios. Hedges are evaluated on established
criteria to determine the effectiveness of their correlation and ability to
reduce risk of specific securities or transactions. Those instruments held or
issued for risk management purposes are carried at market value in the
appropriate available-for-sale portfolio based on the nature of the derivative
instrument; changes in value of futures, options, foreign currency forwards and
short positions are recorded to income in the current period, and changes in the
value of forward positions and interest rate swaps are reflected in other
comprehensive income as unrealized appreciation or depreciation, net of deferred
income taxes. At disposition, changes in value of forward positions and interest
rate swap agreements are recognized in income as "net realized gains or losses
on security sales." Those instruments entered into for the purpose of hedging
are carried at market value; changes in value follow the recognition of the
asset being hedged. Gains or losses on closed hedge positions are recorded as
basis adjustments to the cost of the assets hedged and amortized over their
expected life. Unamortized amounts are recognized in income at the disposition
of the assets hedged. Gains and losses on instruments entered into for the
purpose of hedging anticipated transactions are deferred and amortized over the
life of the hedged transaction, beginning at the inception of the transaction.
Gains and losses on foreign currency hedges offset the foreign exchange gains
and losses on the foreign equity portfolio. The net hedged gain or loss is not
material and is recognized into income in the current period. Hedges that no
longer qualify for hedge accounting due to lack of correlation are reclassified
to derivative instruments held or issued for purposes other than trading and
used for risk management purposes. Those instruments held or issued for trading
purposes are carried at market value and include derivatives held or issued for
the specific purpose of generating profits and all other derivatives not meeting
the criteria for derivatives held or issued for other than trading purposes;
changes in value are recorded to income in the current period. During the year,
the net activity in derivative instruments held or issued for trading purposes
was not material to the Company's financial position, cash flows or results of
operations; gains or losses during the year were recognized in the
available-for-sale portfolio. See Note 4-Investments for further discussion.
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. 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.
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 straight line for all other fixed assets. The Company
early adopted the accounting treatment required by Statement of Position (SOP)
98-1, "Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use," and, as a result, capitalized $19.4 million, or $.17 per share,
of computer software costs incurred during the year ended December 31, 1998.
3
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39
As of December 31, 1998, the Company had contractual commitments related to the
Company's construction projects in Tampa, Florida and Mayfield Village, Ohio
totalling $99.0 million, of which $55.5 million had been paid through 1998.
Total interest capitalized related to the Company's construction projects and
capitalized computer software costs was $3.5 million in 1998.
INSURANCE PREMIUMS AND RECEIVABLES Insurance premiums written are earned
primarily on a pro rata basis over the period of risk. For products where more
than 50% cancellations are anticipated, premiums written and earned are reduced,
though cancellations have not yet occurred.
The Company provides insurance and related services to individuals, lenders and
motor carriers throughout the United States and Canada, 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. 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 7-Reinsurance for further discussion). The remaining reinsurance arises
from the Company seeking to reduce its loss exposure in its auto and non-auto
businesses and to build its strategic alliance relationships. 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 and diluted earnings per share
include common stock equivalents, including stock options, assumed outstanding
during the period.
DEFERRED ACQUISITION COSTS Deferred acquisition costs include commissions,
premium taxes and other costs incurred in connection with writing business.
These costs are deferred and amortized over the period in which the related
premiums are earned. The Company considers anticipated investment income in
determining the recoverability of these costs. There is no indication that these
costs will not be fully recoverable in the near term. The Company does not defer
advertising costs.
SERVICE REVENUES AND EXPENSES Service revenues 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 $235.9 million, $166.9 million and $121.5 million
in 1998, 1997 and 1996, respectively. Total interest paid was $63.8 million for
both 1998 and 1997 and $60.3 million for 1996.
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 SFAS 123, "Accounting
for Stock-Based Compensation."
NEW ACCOUNTING STANDARDS In June 1998, the Financial Accounting Standards Board
issued SFAS 133, "Accounting for Derivative Instruments and Hedging Activities,"
which standardizes the accounting for derivative instruments and requires that
all derivatives be recognized at fair value on the balance sheet. Changes in
fair value are recorded in current period earnings or in other comprehensive
income if the derivative transaction is a qualified cash flow hedge. The
statement is effective for fiscal years beginning after June 15, 1999. At
December 31, 1998, the Company estimates that the net effect of all derivative
transactions would not be significant. The Company held an anticipatory debt
issuance hedge at December 31, 1998, that, under SFAS 133, would have been
recorded as a $7.2 million loss, net of tax, to other comprehensive income.
ESTIMATES The Company is required to make estimates and assumptions when
preparing its financial statements and accompanying notes in conformity with
generally accepted accounting principles (GAAP). Actual results could differ
from those estimates.
RECLASSIFICATIONS Certain amounts in the financial statements for prior periods
were classified to conform with the 1998 presentation.
02 LITIGATION
The Company is named as defendant in various lawsuits generally relating to its
insurance operations. Numerous legal actions arise from claims made under
insurance policies issued by the subsidiaries or in connection with previous
reinsurance agreements. These actions were considered by the Company in
establishing its loss and loss adjustment expense reserves. The Company believes
that the ultimate disposition of these and other pending lawsuits will not
materially impact the Company's financial position, cash flows or results of
operations.
03 CONTRACTUAL COMMITMENTS
The Company has operating lease commitments, licensing 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, 1998 are as follows (in millions): 1999-$61.6; 2000-$51.6;
2001-$34.4; 2002-$10.3; 2003-$6.0; and thereafter-$.9. Total expense incurred by
the Company for such purposes for 1998, 1997 and 1996 was $93.1 million, $83.3
million and $57.5 million, respectively.
3
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40
04 INVESTMENTS
The components of pretax investment income and net realized gains on security
sales for the periods ended December 31 were:
(millions)
1998 1997 1996
Available-for-sale: fixed maturities $ 233.9 $ 219.1 $ 183.9
equity securities 34.1 24.6 27.7
Short-term investments 26.8 31.2 14.2
- --------------------------------------------------------------------------------------
Investment income 294.8 274.9 225.8
- --------------------------------------------------------------------------------------
Gross realized gains:
Available-for-sale: fixed maturities 34.6 56.9 23.9
equity securities 159.1 121.4 39.7
Short-term investments .2 -- --
Gross realized losses:
Available-for-sale: fixed maturities (37.1) (36.9) (29.6)
equity securities (145.4) (42.9) (26.9)
- --------------------------------------------------------------------------------------
Net realized gains on security sales 11.4 98.5 7.1
- --------------------------------------------------------------------------------------
$ 306.2 $ 373.4 $ 232.9
======================================
During 1998, the Company realized losses of $32.2 million related to write downs
on investment securities considered to have other than temporary declines in
market value and a $9.2 million net realized loss on an anticipatory hedge.
During 1997, the Company sold $178.4 million (proceeds of $200.8 million) of
non-investment-grade commercial mortgage-backed securities, recognizing a net
realized gain of $22.4 million and accounted for the transaction in accordance
with SFAS 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities."
The composition of the investment portfolio at December 31 was:
(millions) GROSS GROSS
UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
1998
Available-for-sale:
U.S. government obligations $ 610.8 $ 4.1 $ (.4) $ 614.5
State and local government obligations 1,649.0 44.9 (.3) 1,693.6
Foreign government obligations 52.9 .4 -- 53.3
Corporate debt securities 315.5 4.5 (1.8) 318.2
Asset-backed securities 1,491.4 19.8 (24.3) 1,486.9
Other debt securities 52.0 .7 (.2) 52.5
- ------------------------------------------------------------------------------------------------------------
4,171.6 74.4 (27.0) 4,219.0
Preferred stocks 374.3 14.0 (11.8) 376.5
Common stocks 512.2 144.3 (19.6) 636.9
Short-term investments 441.9 -- -- 441.9
- ------------------------------------------------------------------------------------------------------------
$ 5,500.0 $ 232.7 $ (58.4) $ 5,674.3
===========================================================
1997
Available-for-sale:
U.S. government obligations $ 918.1 $ 2.1 $ (.6) $ 919.6
State and local government obligations 1,231.8 32.6 (.2) 1,264.2
Foreign government obligations 57.6 1.0 (.1) 58.5
Corporate debt securities 89.2 .8 -- 90.0
Asset-backed securities 1,501.4 23.9 (5.3) 1,520.0
Other debt securities 38.7 .7 (.3) 39.1
- ------------------------------------------------------------------------------------------------------------
3,836.8 61.1 (6.5) 3,891.4
Preferred stocks 333.9 15.1 (.2) 348.8
Common stocks 501.9 139.0 (20.1) 620.8
Short-term investments 409.4 -- -- 409.4
- ------------------------------------------------------------------------------------------------------------
$ 5,082.0 $ 215.2 $ (26.8) $ 5,270.4
===========================================================
4
0
41
The composition of fixed maturities by maturity at December 31, 1998 was:
(millions) MARKET
COST VALUE
Less than one year $ 368.2 $ 371.7
One to five years 2,602.9 2,639.3
Five to ten years 1,049.5 1,068.9
Ten years or greater 151.0 139.1
- ------------------------------------------------------------------------------
$ 4,171.6 $ 4,219.0
================================
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.
At December 31, 1998, bonds in the principal amount of $67.9 million were on
deposit with various regulatory agencies to meet statutory requirements.
Securities with a market value of $2.4 million were held at December 31, 1998,
by a bankruptcy remote subsidiary and are not available to the general creditors
of the Company.
The components of derivative financial instruments held or issued for purposes
other than trading at December 31 were:
(millions)
MARKET VALUE/ CONTRACT/
CARRYING VALUE AT NOTIONAL VALUE AT
DECEMBER 31, DECEMBER 31,
1998 1997 1998 1997
----------------- ----------------
Forward and future positions:
Assets $ 2.8 $ .8 $ 30.9 $ 13.7
Liabilities -- (.1) -- 13.4
Anticipatory debt issuance hedge:
Short futures position 4.4 -- 203.7 --
Interest rate swap hedge (11.0) -- 150.0 --
Foreign currency forward and future positions:
Assets -- (.7) -- 50.9
Liabilities (.5) 1.7 31.8 67.2
- -------------------------------------------------------------------------------------
$ (4.3) $1.7 $416.4 $145.2
================= ================
Derivative instruments classified as held or issued for purposes other than
trading are 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. The anticipatory debt issuance hedges
were entered into to hedge against possible rises in interest rates prior to the
issuance of debt under the Company's outstanding $300 million shelf
registration, which is intended to replace debt expiring December 2000. The
interest rate swap hedge performed as expected and is recorded as a deferred
asset under SFAS 80, "Accounting for Futures Contracts," as a qualified hedge.
Gains or losses on the hedge are deferred and will be recognized into income as
adjustments to interest expense upon the issuance of the debt. The short futures
position, driven by changing economic conditions, did not meet the established
criteria for hedging correlation and was discontinued as a hedge, recognizing a
net realized loss of $9.2 million in 1998. The Company continues to hold the
short futures position for risk management of the anticipated debt offering.
Derivative instruments may also be used for trading purposes. The Company had
net losses of $1.2 million (gross gains of $9.9 million; gross losses of $11.1
million) during 1998 and net losses of $.7 million (gross gains of $9.9 million;
gross losses of $10.6 million) during 1997 in the trading portfolio; these
losses were not material to the Company's results of operations and are included
in the results of the available-for-sale portfolio. At December 31, 1998, the
Company had short trading positions in foreign currency and treasury forwards
with net market values of $(.4) million and notional values of $31.5 million;
the average market values for long and short positions in 1998 were $(.2)
million and $.5 million, respectively. At December 31, 1997, the Company had
short trading positions in foreign currency and commodity futures with net
market values of $1.1 million and notional values of $64.4 million; the average
market values for long and short positions in 1997 were $.5 million and $.4
million, respectively.
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; unless otherwise noted, collateral is not required to support
the credit risk.
As of December 31, 1998, the Company had open investment funding commitments
of $56.0 million. The Company had no uncollateralized lines or letters of credit
as of December 31, 1998 or 1997.
4
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42
05 STATUTORY FINANCIAL INFORMATION
At December 31, 1998, $245.7 million of consolidated statutory policyholders'
surplus represents net admitted assets of the Company's insurance subsidiaries
that are required to meet minimum statutory surplus requirements in the
subsidiaries' states of domicile. The subsidiaries 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
subsidiaries 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 subsidiaries are licensed.
During 1998, the insurance and other subsidiaries paid aggregate cash
dividends of $151.0 million to the parent company. Based on the dividend laws
currently in effect, the insurance subsidiaries may pay aggregate dividends of
$274.2 million in 1999 without prior approval from regulatory authorities.
Statutory policyholders' surplus was $2,029.9 million and $1,722.9 million at
December 31, 1998 and 1997, respectively. Statutory net income was $331.5
million, $274.7 million and $277.9 million for the years ended December 31,
1998, 1997 and 1996, respectively.
The Company's insurance subsidiaries, as part of their statutory filings, are
required to disclose their risk-based capital (RBC) requirements. The National
Association of Insurance Commissioners (NAIC) developed the RBC program to
enable regulators to take appropriate and timely regulatory actions with respect
to insurers that show signs of weak or deteriorating financial condition. RBC is
a series of dynamic surplus-related formulas which contain a variety of factors
that are applied to financial balances based on a degree of certain risks, such
as asset, credit and underwriting risks.
In 1998, the NAIC adopted the Codification of Statutory Accounting Principles
guidance which will replace the current NAIC Annual Statement Instructions and
Accounting Practices and Procedures manual as the NAIC's primary guidance on
statutory accounting. The Codification provides guidance for areas where
statutory accounting has been silent and changes current statutory accounting in
some areas. The implementation date established by the NAIC is January 1, 2001;
however, the effective date will be specified by each insurance company's state
of domicile. The Company is currently evaluating the potential effect of the
Codification guidance, but does not expect it to have a material impact on the
Company's statutory surplus.
06 LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
Activity in the loss and loss adjustment expense reserves, prepared in
accordance with GAAP, is summarized as follows:
(millions)
1998 1997 1996
Balance at January 1 $ 2,146.6 $ 1,800.6 $ 1,610.5
Less reinsurance recoverables on unpaid losses 279.1 267.7 296.1
- -------------------------------------------------------------------------------------------
Net balance at January 1 1,867.5 1,532.9 1,314.4
- -------------------------------------------------------------------------------------------
Net reserves of subsidiary purchased -- 82.2 --
- -------------------------------------------------------------------------------------------
Incurred related to:
Current year 3,560.5 3,070.8 2,341.9
Prior years (184.2) (103.3) (105.8)
- -------------------------------------------------------------------------------------------
Total incurred 3,376.3 2,967.5 2,236.1
- -------------------------------------------------------------------------------------------
Paid related to:
Current year 2,376.0 1,971.5 1,424.7
Prior years 922.0 743.6 592.9
- -------------------------------------------------------------------------------------------
Total paid 3,298.0 2,715.1 2,017.6
- -------------------------------------------------------------------------------------------
Net balance at December 31 1,945.8 1,867.5 1,532.9
Plus reinsurance recoverables on unpaid losses 242.8 279.1 267.7
- -------------------------------------------------------------------------------------------
Balance at December 31 $ 2,188.6 $ 2,146.6 $ 1,800.6
======================================
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. 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.
07 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 reinsurer insolvencies.
As of December 31, 1998 and 1997, 36% and 44%, respectively, of the "prepaid
reinsurance premiums" and 56% and 60%, respectively, of the "reinsurance
recoverables" relate to CAIP, for which the Company retains no indemnity risk.
4
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43
The effect of reinsurance on premiums written and earned as of December 31 was
as follows:
(millions)
1998 1997 1996
------------------------ ------------------------ ------------------------
Written Earned Written Earned Written Earned
Direct premiums $ 5,451.3 $ 5,100.5 $ 4,825.2 $ 4,382.9 $ 3,638.4 $ 3,380.7
Assumed -- -- -- -- 3.8 3.8
Ceded (151.6) (152.5) (160.1) (193.4) (200.5) (185.2)
- ----------------------------------------------------------------------------------------------------
Net premiums $ 5,299.7 $ 4,948.0 $ 4,665.1 $ 4,189.5 $ 3,441.7 $ 3,199.3
======================== ======================== ========================
Losses and loss adjustment expenses are net of reinsurance ceded of $131.9
million in 1998, $150.8 million in 1997 and $117.3 million in 1996.
08 INCOME TAXES
Significant components of the Company's income tax provision were as follows:
(millions)
1998 1997 1996
Current tax provision $ 237.1 $ 241.6 $ 163.9
Deferred tax benefit (32.7) (63.1) (35.9)
- -------------------------------------------------------------------------
Total income tax provision $ 204.4 $ 178.5 $ 128.0
=================================
The provision for income taxes in the accompanying consolidated statements of
income differed from the statutory rate as follows:
(millions)
1998 1997 1996
---------------- ---------------- ----------------
Income before income taxes $ 661.1 $ 578.5 $ 441.7
======== ======== ========
Tax at statutory rate $ 231.4 35% $ 202.5 35% $ 154.6 35%
Tax effect of:
Exempt interest income (23.1) (3) (19.6) (3) (21.1) (5)
Dividends received deduction (6.6) (1) (7.0) (1) (7.7) (2)
Other items, net 2.7 -- 2.6 -- 2.2 1
- --------------------------------------------------------------------------------------------------------
$ 204.4 31% $ 178.5 31% $ 128.0 29%
================ ================ ================
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, 1998 and
1997, the components of the net deferred tax assets were as follows:
(millions)
1998 1997
Deferred tax assets:
Unearned premiums reserve $ 161.2 $ 132.1
Non-deductible accruals 43.1 37.0
Derivative financial instruments 4.4 6.9
Capitalized expenditures 10.9 12.7
Loss reserves 109.5 93.8
Other 14.3 12.3
Deferred tax liabilities:
Deferred acquisition costs (104.7) (88.7)
Unrealized gains (61.0) (66.1)
- -----------------------------------------------------------
Net deferred tax assets $ 177.7 $ 140.0
====================
The Company is able to demonstrate that the benefit of its deferred tax assets
is fully realizable.
4
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44
09 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 $6.5 million in 1998, $5.1
million in 1997 and $4.2 million in 1996.
The second tier is a long-term savings plan under which the Company matches,
into a Company stock account, amounts contributed to the plan by an employee up
to a maximum of 3% of the employee's eligible compensation. Company
contributions were $9.9 million in 1998, $7.3 million in 1997 and $5.8 million
in 1996.
The Company has a defined benefit pension plan which covered employees hired
before January 1, 1989, who met requirements as to age and length of service.
This plan and future benefit accruals were frozen on December 31, 1993; the
benefits accruals through the date the plan was frozen were based on years of
service and career average compensation up to the Social Security tax base. As
of December 31, 1998, the Company had a pension asset of $3.5 million, compared
to $2.0 million in 1997 and a pension liability of $1.2 million in 1996. The
Company recognized income of $.1 million in both 1998 and 1997, and $0 in 1996.
The Company's funding policy is to contribute annually the minimum amount
required by the Employee Retirement Income Security Act of 1974, as amended.
There is no past service liability requiring funding by the Company.
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 $1.8 million at December 31, 1998, compared to $1.5 million in 1997.
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 expenses of $.7 million in
1998, $.2 million in 1997 and $.4 million in 1996. 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, 1998 and 1997, the trust
held assets of $14.6 million and $6.4 million, respectively, of which $3.9
million and $1.4 million were held in Common Shares, to cover its liabilities.
INCENTIVE COMPENSATION PLANS The Company's 1989 Incentive Plan and 1995
Incentive Plan provide for the granting of stock options and other stock-based
awards to key employees of the Company. The 1989 Incentive Plan has 6,500,000
shares authorized and the 1995 Incentive Plan has 5,000,000 shares authorized.
In addition to the Incentive Plans, the Company registered 1,425,000 and 650,000
Common Shares relating to stock options granted to key employees and directors
of the Company, respectively. 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 three years ended
December 31 follows:
1998 1997 1996
-------------------------- --------------------------- ---------------------------
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 4,968,964 $ 35.52 5,109,390 $ 28.09 4,943,324 $ 23.76
Add (deduct):
Granted 441,210 124.61 726,889 69.82 852,989 47.52
Exercised (641,013) 16.99 (758,580) 17.44 (454,348) 14.89
Cancelled (63,350) 61.03 (108,735) 41.07 (232,575) 32.95
- ------------------------------------------------------------- --------------------------- ---------------------------
End of year 4,705,811 $ 46.07 4,968,964 $ 35.52 5,109,390 $ 28.09
========================== =========================== ===========================
Exercisable, end of year 1,342,801 $ 20.26 1,497,050 $ 15.53 1,561,428 $ 15.75
========================== =========================== ===========================
Available, end of year 4,676,547 5,054,407 5,672,561
========= ========= =========
4
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45
The following employee options were outstanding or exercisable as of December
31, 1998:
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
$ 9 - 20 923,070 2.41 years $ 15.31 923,070 $ 15.31
21 - 40 1,817,028 5.17 years 33.32 393,928 29.83
41 - 60 818,637 6.98 years 47.17 19,687 44.97
61 - 80 694,752 7.99 years 68.64 5,527 67.14
81 - 120 29,239 8.25 years 104.08 589 114.19
121 - 161 423,085 9.01 years 124.83 - -
- -----------------------------------------------------------------------------------------------
$ 9 - 161 4,705,811 1,342,801
========= =========
Under SFAS 123, the Company uses the Black-Scholes pricing model to calculate
the fair value of the options awarded, including 138,696 options awarded to
directors. This model produced a value of 40.6% for 1998 awards, 43.2% for 1997
awards and 41.4% for 1996 awards. The following assumptions were used to derive
the ratio: a 7-year option term; an annualized volatility rate of .259 for 1998,
.255 for 1997 and .246 for 1996; a risk-free rate of return of 5.49% for 1998,
6.63% for 1997 and 6.69% for 1996; and a dividend yield of .20% for 1998, .25%
for 1997 and .5% for 1996. The Company elected to account for terminations when
they occur rather than include an attrition factor into its model.
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)
1998 1997 1996
PRO FORMA
Net income $447.3 $393.5 $310.3
=================================
Earnings per share
Basic $ 6.17 $ 5.46 $ 4.24
Diluted 6.00 5.22 4.09
The effect of applying SFAS 123 in the current year is not representative of the
effect on income for future years since each subsequent year will reflect
expense for additional years' vesting.
The amounts charged to income for incentive compensation plans, including
executive cash bonus programs for key members of management and a gainsharing
program for all other employees, were $107.5 million in 1998, $85.8 million in
1997 and $45.3 million in 1996.
10 DEBT
During 1998, there were no bank borrowings outstanding. Debt includes amounts
the Company has borrowed and contributed to the capital of its insurance
subsidiaries or borrowed for other long-term purposes.
Debt at December 31 consisted of:
(millions)
1998 1997
------------------- -------------------
MARKET MARKET
COST VALUE COST VALUE
7.30% Notes, due 2006 (issued: $100.0, May 1996) $ 99.7 $ 109.5 $ 99.7 $ 105.3
6.60% Notes, due 2004 (issued: $200.0, January 1994) 199.1 199.4 198.9 200.7
7% Notes, due 2013 (issued: $150.0, October 1993) 148.4 157.2 148.4 154.4
8 3/4% Notes, due 1999 (issued: $30.0, May 1989) 29.9 30.4 29.7 30.9
10% Notes, due 2000 (issued: $150.0, December 1988) 149.8 162.7 149.6 164.6
10 1/8% Subordinated Notes, due 2000 (issued: $150.0, December 1988) 149.7 162.4 149.6 164.6
- ------------------------------------------------------------------------------------------------------------------
$ 776.6 $ 821.6 $ 775.9 $ 820.5
=================== ===================
All debt is noncallable with interest payable semiannually.
4
5
46
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, 1998 or 1997.
In addition, the Company may issue from time to time, in one or more
transactions, up to $300 million of its debt securities under an outstanding
shelf registration, which became effective in 1998.
Aggregate principal payments on debt outstanding at December 31, 1998, are
$30.0 million for 1999, $300.0 million for 2000, $0 for 2001, 2002 and 2003, and
$450.0 million thereafter.
11 SEGMENT INFORMATION
During 1998, the Company adopted SFAS 131, "Disclosures about Segments of an
Enterprise and Related Information," which requires companies to report
financial and descriptive information about their reportable operating segments.
The Company writes personal automobile and other specialty property-casualty
insurance and related services throughout the United States and Canada. The
Company's Personal Lines business is predominantly auto insurance and is
organized by states. The Company's 44 state/community managers are located in or
near the market served. These managers are measured and paid based on profit and
growth in their state(s)/community and manage claims, distribution, advertising,
budgets, price levels, agent development, regulation and community relations for
their area. The Canadian business unit's revenues are less than 1% of the
Company's consolidated revenues.
The Company's other lines of business include insurance for commercial
vehicles, lenders' collateral protection, directors' and officers' liability and
related services, including processing business for involuntary plans and claim
services to fleet owners and other insurance companies. The other businesses
accounted for less than 8% of the Company's 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 operating profit.
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
$56.1 million in 1998, $36.6 million in 1997 and $23.8 million in 1996. 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, 1998 1997 1996
(millions) --------------------- --------------------- ----------------------
PRETAX PRETAX PRETAX
REVENUES PROFIT (LOSS) REVENUES PROFIT (LOSS) REVENUES PROFIT (LOSS)
Personal Lines(1) $ 4,580.7 $ 361.3 $ 3,832.7 $ 243.0 $ 2,916.0 $ 230.8
Other 405.5 62.1 402.1 36.6 329.5 45.6
Investments(2) 306.2 298.8 373.4 363.5 232.9 226.8
Interest Expense -- (61.1) -- (64.6) -- (61.5)
- ----------------------------------------------------- ----------------------- ---------------------
$ 5,292.4 $ 661.1 $ 4,608.2 $ 578.5 $ 3,478.4 $ 441.7
======================= ======================= =====================
(1)94% of the Personal Lines segment is personal automobile insurance.
(2)Revenues represent recurring investment income and net realized gains/losses
on security sales; pretax profit is net of investment expenses.
12 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 4-Investments and
Note 10-Debt. Pursuant to SFAS 119, the cost and market value of the financial
instruments as of December 31 are summarized as follows:
(millions) 1998 1997
--------------------- -----------------------
MARKET MARKET
COST VALUE COST VALUE
Investments:
Available-for-sale: fixed maturities $4,171.6 $4,219.0 $3,836.8 $3,891.4
preferred stocks 374.3 376.5 333.9 348.8
common stocks 512.2 636.9 501.9 620.8
Short-term investments 441.9 441.9 409.4 409.4
Debt (776.6) (821.6) (775.9) (820.5)
4
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47
13 OTHER COMPREHENSIVE INCOME
During 1998, the Company adopted SFAS 130, "Reporting Comprehensive Income,"
which requires disclosure of comprehensive income and its components in the
financial statements. The components of other comprehensive income (loss) for
the years ended December 31 were as follows:
(millions)
1998 1997 1996
----------------------------- ---------------------------- ---------------------------
TAX TAX TAX
(PROVISION) AFTER (PROVISION) AFTER (PROVISION) AFTER
PRETAX BENEFIT TAX PRETAX BENEFIT TAX PRETAX BENEFIT TAX
Unrealized gains (losses)
arising during period:(1)
Available-for-sale:
fixed maturities $ 2.8 $ (1.0) $ 1.8 $ 29.5 $ (10.3) $ 19.2 $ (18.3) $ 6.4 (11.9)
equity securities 64.3 (22.5) 41.8 44.8 (15.7) 29.1 53.7 (18.9) 34.8
Reclassification adjustment:(2)
Available-for-sale:
fixed maturities (10.0) 3.5 (6.5)
equity securities (71.2) 25.1 (46.1)
- ---------------------------------------------------------------------------------------------------------------------------------
Net unrealized gains (losses) (14.1) 5.1 (9.0) 74.3 (26.0) 48.3 35.4 (12.5) 22.9
Other(3) (3.3) -- (3.3) -- (.7) (.7) -- -- --
- ---------------------------------------------------------------------------------------------------------------------------------
Other comprehensive
income (loss) $ (17.4) $ 5.1 $ (12.3) $ 74.3 $ (26.7) $ 47.6 $ 35.4 $ (12.5) $ 22.9
============================= ============================ ===========================
(1)Amounts for 1997 and 1996 reflect changes in net unrealized gains (losses).
(2)Represents adjustments for gains (losses) realized in net income;
reclassification adjustments for prior years are not available.
(3)Other includes foreign currency translation adjustments, which have no tax
effect, and minimum pension liability, which is taxed at the statutory rate.
14 SUBSEQUENT EVENT
On March 1, 1999, the Company issued $300 million of 6 5/8% Senior Notes due
March 1, 2029, under a shelf registration statement filed with the Securities
and Exchange Commission in 1998. The Company may redeem all or part of the Notes
at any time, subject to a "make whole" provision. There are no sinking fund
requirements. The Notes were priced at 98.768% to yield 6.721% to maturity.
Interest is payable semiannually on March 1 and September 1, beginning September
1, 1999. Net proceeds to the Company of $293.7 million are intended to be used,
together with other available funds, to retire certain of the Company's current
outstanding debt upon its maturity.
------------------------------------------
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 subsidiaries at December 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1998, in conformity with generally accepted
accounting principles. 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 generally accepted auditing standards 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 the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
Cleveland, Ohio
January 25, 1999 (March 1, 1999 as to Note 14)
4
7
48
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The consolidated financial statements and the related notes on pages 34 through
47, 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.
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 and other
outstanding securities, to retire its outstanding indebtedness, to pay dividends
and for other business purposes.
During 1998, the Company repurchased 404,079 of its Common Shares at a
total cost of $42.6 million (average $105.28 per share), including 11,079 Common
Shares repurchased to satisfy obligations under the Company's benefit plans.
During the three-year period ended December 31, 1998, the Company repurchased
1.4 million of its Common Shares at a total cost of $87.4 million (average
$60.75 per share), .2 million of its 9 3/8% Serial Preferred Shares, Series A,
at a total cost of $6.0 million (average $25.60 per share) and redeemed its
remaining Preferred Shares at a total cost of $82.1 million ($25.00 per share).
The Company also sold $100.0 million of Notes. During the same period, The
Progressive Corporation made $1.1 million of capital contributions to its
subsidiaries, net of dividends received from 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 that are reasonably likely to affect its capital
resources in a material way. In March 1999, the Company issued $300 million of
6 5/8% Senior Notes due 2029 under an outstanding shelf registration, which
became effective in 1998. The net proceeds of $293.7 million are intended to
replace current outstanding debt upon its maturity. The Company also has
available a $10.0 million revolving credit agreement. With its current 29% debt
to capital ratio, management believes the Company has sufficient borrowing
capacity and other capital resources 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, 1998, operations generated positive cash
flows of $2,004.9 million, and cash flows are expected to be positive in both
the short-term and reasonably foreseeable future. The Company's substantial
investment portfolio is highly liquid, consisting almost entirely of readily
marketable securities.
In March 1997, the Company acquired Midland Financial Group, Inc. for about
$50 million in cash. Midland underwrites and markets nonstandard private
passenger automobile insurance through Independent Agents across 11 states,
primarily in the southeastern and western United States.
Total capital expenditures for the three years ended December 31, 1998,
aggregated $331.9 million. In December 1997, the Company purchased approximately
72 acres in Tampa, Florida to construct a three-building, 307,000 square foot,
regional call center. The cost of the project is currently estimated at $45.2
million; $41.3 million has been paid as of December 31, 1998. The first two
buildings were completed during 1998. The third building was completed in
February 1999. In addition, in November 1997, the Company purchased 91 acres in
Mayfield Village, Ohio to construct an office complex, near the site of its
current corporate headquarters. This office complex is part of a five-year
cooperative effort with Mayfield Village to develop over 300 acres. Progressive
will serve as the anchor corporate user with additional business users and
recreational facilities on the site. The Company is constructing three buildings
containing a total of approximately 443,000 square feet on the site and could
build up to two additional buildings, containing about 500,000 square feet in
total, in the future. The first three buildings are expected to be completed
during 1999 and are estimated to cost $68.3 million. As of December 31, 1998,
$28.7 million has been paid. The construction projects are being funded through
operating cash flows.
INVESTMENTS The Company invests in fixed-maturity, equity and short-term
securities. 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.
The majority of the portfolio is invested in high-grade, fixed-maturity
securities, of which short-and intermediate-term securities represented $4,439.4
million, or 78.3%, at the end of 1998, compared to $4,024.9 million, or 76.4%,
at the end of 1997. Long-term investment-grade securities, including those
principal paydowns from asset-backed securities that are greater than 10 years,
were $93.5 million, or 1.6%, at the end of 1998, compared to $143.4 million, or
2.7%, at the end of 1997. Non-investment-grade fixed-maturity securities were
$128.0 million, or 2.3%, at the end of 1998, compared to $132.5 million, or
2.5%, at the end of 1997, and offer the Company higher returns and added
diversification without a significant adverse effect on the stability and
quality of the investment portfolio as a whole. Non-investment-grade securities
may involve greater risks often related to creditworthiness, solvency and
relative liquidity of the secondary trading market. The duration of the
fixed-income portfolio was 2.8 years at December 31, 1998, compared to 3.3 years
at December 31, 1997.
A portion of the investment portfolio is invested in marketable equity
securities. Common stocks represented $636.9 million, or 11.2%, of the
portfolio, at the end of 1998, compared to $620.8 million, or 11.8%, a year
earlier. The majority of the common stock portfolio is invested in domestic
equities traded on nationally recognized securities exchanges. In addition, the
Company invests in foreign equities, which may include stock index futures and
foreign currency forwards, which comprised $130.7 million of the common stock
portfolio at the end of 1998, compared to $106.0 million last year, and
partnership investments, which comprised $63.7 million of the common stock
portfolio at the end of 1998, compared to $31.8 million last year. Preferred
stocks represented $376.5 million, or 6.6%, of the portfolio at the end of 1998,
compared to $348.8 million, or 6.6%, a year earlier, and was comprised of over
72% of fixed-rate preferred stocks with mechanisms that are expected to provide
an opportunity to liquidate at par.
As of December 31, 1998, the Company's portfolio had $174.3 million in
unrealized gains, compared to $188.4 million in 1997. This decrease in value was
the result of widening credit spreads on all non-treasury related products and
the Company's underperformance relative to the S&P 500, due to overweighting in
smaller capitalization value stocks.
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49
The weighted average fully taxable equivalent book yield of the portfolio was
6.3%, 6.6% and 6.7% for the years ended December 31, 1998, 1997 and 1996,
respectively.
As of December 31, 1998, the Company held $1,486.9 million of asset-backed
securities, which represented 26.2% of the total investment portfolio. The
asset-backed portfolio included collateralized mortgage obligations (CMO) and
commercial mortgage-backed obligations (CMB) totaling $325.3 million and $728.9
million, respectively. The remainder of the asset-backed portfolio was invested
primarily in auto loan and other asset-backed securities. As of December 31,
1998, the CMO portfolio primarily included sequential bonds, representing 90.3%
of the CMO portfolio ($293.7 million) with an average life of 3.6 years. At
December 31, 1998, the CMO portfolio had a weighted average Moody's or Standard
& Poor's rating of AAA and the CMB portfolio had an average life of 6.1 years
and a weighted average Moody's or Standard & Poor's rating of AA. At December
31, 1998, the CMO and CMB portfolios had unrealized gains/(losses) of $.1
million and $(8.2) million, respectively. The single largest unrealized loss in
any individual CMO security was $.9 million and in any CMB security was $5.4
million, at December 31, 1998. The CMB portfolio includes $132.5 million of CMB
interest-only certificates, which had an average life of 6.6 years and a
weighted average Moody's or Standard & Poor's rating of AAA at December 31,
1998. Both the CMO and CMB portfolios are highly liquid with readily available
quotes and contain no residual interests. During 1997, the Company sold $178.4
million (proceeds of $200.8 million) of non-investment-grade CMB securities to
a third-party purchaser. The purchaser subsequently transferred the securities
to a trust as collateral in a resecuritized debt offering. The transaction was
accounted for as a sale under Statement of Financial Accounting Standards
(SFAS) 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," resulting in a net gain of $22.4 million. A
bankruptcy remote subsidiary of the Company acquired $22.8 million of the
resecuritized debt, which was subsequently sold in 1998 for a net gain of $3.5
million. This portion of the transaction was not accounted for as a sale in
1997 in accordance with SFAS 125.
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. Common stocks and similar investments, which generally have greater risk
and volatility of market value, are limited to a target of 15%, with a range of
0 to 25%. Market values, along with industry and sector concentrations of common
stocks and similar investments, are monitored daily. Exposure to foreign
currency exchange risk is limited by Company restrictions and is monitored
regularly. Exposures are evaluated individually and as a whole, considering the
effects of cross correlation. For the quantitative market risk disclosures, see
page 56. The Company regularly examines its 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
generally accepted accounting principles (GAAP) to reduce the carrying value of
such security to its net realizable value. In 1998, the Company wrote down $32.2
million, including $20.8 million in two securities in emerging markets driven by
changing economic conditions.
Included in our non-investment-grade fixed-maturity securities and our
common stock portfolios are $299.6 million of other risk assets. Other risk
assets include such items as high yield and distressed debt, private equities
and warrants, mezzanine investments, and securities in emerging markets. No
individual security in the other risk asset portfolio comprised more than one
percent of Progressive's total investment portfolio. The total return on the
average amount invested in this asset class in 1998 was (4.4)% with a total net
unrealized gain of $4.7 million at December 31, 1998. The single largest
unrealized loss in any individual other risk asset security was $5.4 million.
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 1998, the
Company entered into two transactions, an interest rate swap hedge and a short
futures position, to hedge against possible rises in interest rates prior to the
issuance of debt under the $300 million shelf registration. The interest rate
swap hedge performed as expected and is recorded as an $11.0 million deferred
asset under SFAS 80, "Accounting for Futures Contracts," as a qualified hedge.
The short futures position, driven by changing economic conditions, did not meet
the established criteria for hedging correlation and was discontinued as a
hedge, recognizing a net realized loss of $9.2 million in 1998. The Company
continues to hold the short futures position for risk management of the
anticipated debt offering. Derivative instruments may also be used for trading
purposes. During 1998, net activity in the trading portfolio was not material to
the Company's financial position, cash flows or results of operations. Net cash
requirements of derivative instruments 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 is not required to
support the credit risk. The Company has stringent restrictions on the amount of
open positions in the trading portfolios, limiting exposure to defined levels.
At December 31, 1998, trading positions had a net market value of $(.4) million;
at December 31, 1997, the net market value was $1.1 million.
RESULTS OF OPERATIONS Operating income, which excludes net realized gains and
losses from security sales and one-time items, was $449.3 million, or $6.01 per
share, in 1998, $336.0 million, or $4.46 per share, in 1997 and $309.1 million,
or $4.12 per share, in 1996. The GAAP combined ratio was 91.6 in 1998, 93.4 in
1997 and 91.5 in 1996.
Direct premiums written increased 13% to $5,451.3 million in 1998, compared
to $4,825.2 million in 1997 and $3,638.4 million in 1996. Net premiums written
increased 14% to $5,299.7 million in 1998, compared to $4,665.1 million in 1997
and $3,441.7 million in 1996. The difference between direct and net premiums
written is partially attributable to premiums written under state-mandated
involuntary Commercial Auto Insurance Procedures (CAIP), for which the Company
retains no indemnity risk, of $60.7 million in 1998, $78.4 million in 1997 and
$99.5 million in 1996. The Company provided policy and claim processing services
to 27 state CAIPs in all three years. Premiums earned, which are a
49
50
function of the amount of premiums written in the current and prior periods,
increased 18% in 1998, compared to 31% in 1997 and 17% in 1996.
Net premiums written in the Company's Personal Lines, which write insurance
for private passenger automobiles and recreational vehicles, grew 15%, 36% and
20% in 1998, 1997 and 1996, respectively, primarily reflecting an increase in
unit sales. The slower growth in 1998 is a result of intensified competition in
the auto insurance market. Many of the Company's competitors reduced rates,
increased advertising, entered new states, expanded their distribution channels,
entered the nonstandard auto insurance market and increased agents'
compensation. The Company expects continued growth in 1999 despite increased
competition. The Company decreased rates an average of 5.3% in 1998, compared to
rate decreases of .9% in 1997 and rate increases of 2.5% in 1996. The Company
continues to write through multiple distribution methods, including Independent
Agents, Direct (via 1 800 AUTO PRO(R) and progressive.com) and through
Strategic Alliances. In 1998, the Direct distribution channel represented
between 10% and 15% of the Personal Lines volume, compared to between 5% and 10%
in 1997 and less than 5% in 1996. The sales generated via the Internet
represented approximately 2% of the Direct business net premiums written in
1998. The Company also writes through its Strategic Alliances channel, which
includes alliances with other insurance companies, employers, affinity groups
and national brokerage agencies. The Strategic Alliances channel represented
between 5% and 10% of the Personal Lines premiums in all three years. The
remainder of the Personal Lines premiums are written through a network of over
30,000 Independent Insurance Agents. Through these multiple distribution
channels, the Company continues to write standard and preferred risks, which
represented between 30% and 35% of total 1998 Personal Lines volume, compared to
between 20% and 25% in 1997 and between 10% and 15% in 1996, as well as its
traditional nonstandard auto products.
In 1997, the Company began using rating criteria based partially on
consumer financial responsibility. This approach is in use in 43 states that
represent 91% of the Personal Lines volume. The Company expects product design
and pricing methods to evolve constantly, based on the developing understanding
of loss data, work flows, market conditions and technology, as well as consumer
acceptance of the Progressive brand as an insurer for all drivers. The Company
introduced the next generation of product design in mid-1998 and expects to have
it in markets representing 80% of premium by April 1999. Early results suggest
that the Company is attracting drivers from all risk profiles and retaining them
longer. The Company believes that growing the numbers of policyholders,
particularly standard and preferred risks with their higher retention rates,
builds intrinsic value because renewals are more profitable than first year
business. The drive to add customers faster resulted in more spending to promote
the Progressive brand and to hire and develop more claim adjusters and customer
service representatives, and the Company expects this to continue at least in
the near term. These costs, along with lower margins on first year business, are
expected to bring profit margins more in line with the Company's objective of
achieving a 4% underwriting profit margin over the entire retention period of a
policyholder. In 1998, Personal Lines generated an underwriting profit margin of
8%, compared to 6% in 1997 and 8% in 1996.
The Company's other lines of business include writing insurance for small
fleets of commercial vehicles, 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. Revenues in these businesses were $405 million in 1998, compared to
$402 million in 1997 and $330 million in 1996. Pretax operating profit was $62
million in 1998, compared to $37 million in 1997 and $46 million in 1996. Most
of these businesses are in markets that are declining in size.
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 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 68% in 1998, compared
to 71% in 1997 and 70% in 1996. In recent years, the industry has had favorable
loss experience driven by continuing trends with respect to safer cars and
roads, the impaired driving crackdown, better law enforcement and insurers
operating more efficiently.
The Company writes directors and officers and other professional liability
coverage for community banks and credit unions and, therefore, could potentially
be exposed to liability for errors made by these institutions relating to the
year 2000 conversion. To minimize its risk, from October 1997 through May 1998,
the Company included year 2000 exclusions in all new and renewal policies for
commercial banks which have multi-year terms that extend beyond December 31,
1999. This placed the Company at a competitive disadvantage since few of its
competitors included similar exclusions. The Company has obtained additional
reinsurance to limit its potential exposure to about 7% of the average policy
limits in the event any of the insured directors or officers are held liable for
year 2000 noncompliance by their financial institutions. In light of this
additional reinsurance contract, which reduced the Company's net exposure by 68%
and covers all of the Company's inforce directors and officers insurance
business, in June 1998, the Company stopped including year 2000 exclusions in
its multi-year policies. Additionally, the Company has begun to selectively
remove previously issued year 2000 exclusions. As a regulated industry,
financial institutions are under pressure from government regulatory agencies
and other interested parties to ensure they achieve readiness for the year 2000.
The Company is monitoring its customers' compliance efforts and believes that
substantially all such customers are pursuing plans to achieve year 2000
compliance. It is currently unknown whether these financial institutions will be
able to completely avoid errors relating to year 2000 compliance and the Company
is unable to predict to what extent such financial institutions will incur
losses as a result of noncompliance and whether their directors and officers
will be subject to individual liability for such noncompliance. In the event of
a claim, applicable factual and coverage issues would have to be resolved. Based
on information currently available and management's best estimate, the Company
does not believe that any losses resulting from this exposure will have a
material impact on the Company's liquidity, financial condition, cash flows or
results of operations.
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 and other underwriting expenses as a percentage of
premiums earned were 23% in 1998 and 1997 and 22% in 1996. During 1998, the
Company expanded its television advertising
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51
campaign on a national level. The Company also introduced its local advertising
campaign to 14 more states during 1998, bringing the total number of states in
which the Company advertises to 32 plus Washington D.C. (83 markets).
Recurring investment income (interest and dividends) increased 7% to $294.8
million in 1998, compared to $274.9 million in 1997 and $225.8 million in 1996,
primarily due to an increase in the size of the investment portfolio. Net
realized gains on security sales were $11.4 million in 1998, $98.5 million in
1997 and $7.1 million in 1996. Investment expenses were $7.4 million in 1998,
compared to $9.9 million in 1997 and $6.1 million in 1996; in 1997, the Company
purchased a new portfolio management system and incurred expenses related to the
sale of the commercial mortgage-backed securities.
YEAR 2000 COMPLIANCE The year 2000 problem exists because many computer programs
only use the last two digits to refer to a year and could recognize "00" as 1900
instead of 2000. If not corrected, many computer and other microchip supported
applications could fail or create erroneous results. The extent of the potential
impact is still unknown but could affect the global economy. In response to this
issue, the Company has evaluated its applications and operating software
(including its claims reporting, financial reporting, policy issuance, policy
maintenance and other internal production systems), hardware and software
products, and third-party data exchanges and business relationships, and is in
the process of evaluating its end user computing activities and facilities
implications (including public utility services), and has established a
dedicated, tenured project team responsible for overseeing progress on the
Company's compliance program and periodically reporting to management.
The Company began converting its applications software to be year 2000
compliant in July 1995 and, as a result, has been able to avoid redeploying
significant resources or deferring other important projects to specifically
address the year 2000 issues. During the first quarter 1998, the Company
retained independent consultants to determine its state of readiness. Although
some additional areas of focus were identified, the consultants noted that the
Company was adequately addressing its critical internal systems and issues. As
of December 31, 1998, the Company has completed approximately 94% of its efforts
to bring its applications software in compliance. Testing of critical
applications is being accomplished through the use of a special systems
environment known as a "Time Warp Lab," which mimics the Company's production
environment. As a final test of year 2000 readiness, after conversion and year
2000 certification, critical applications are run in the Time Warp Lab while
systems clocks turn over from 1999 to 2000 and beyond. The total cost to modify
these existing production systems, which includes both internal and external
costs of programming, coding and testing, is estimated to be $8.0 million, of
which $7.1 million had been expensed through December 31, 1998. The Company also
replaced some of its systems during 1998. In addition to being year 2000
compliant, these new systems added increased functionality to the Company. The
total cost of these systems, which include both internal and external costs, is
estimated to be $4.8 million, and the majority of the projects were completed in
1998, with remaining parallel testing scheduled during the first quarter 1999.
As of December 31, 1998, $4.7 million had been paid for these systems. All costs
are being funded through operating cash flows. In addition, the Company has
identified approximately 330 third parties with which data is exchanged. All
critical data exchanges are being tested for compliance. Although dependent on
business partners' testing schedules, testing of critical data exchanges is
expected to be completed by the end of the second quarter 1999.
The Company continually evaluates computer hardware and software upgrades
for enhancements and, therefore, many of the costs to replace these items to be
year 2000 compliant are not likely to be incremental costs to the Company. The
Company's remediation of its mainframe hardware and operating software is 94%
complete and the remediation of its servers and client server operating software
is 30% complete. The Company estimates that all mainframe and client server
hardware and operating software will be year 2000 compliant by the first half of
1999. In addition, during 1998, the Company secured software which will assist
in the discovery of noncompliant desktop hardware and software. It is estimated
that the assessment and remediation process will be completed by the first half
of 1999.
The Company is currently unable to determine the impact that year 2000
noncompliance may have on its financial condition, cash flows and results of
operations. The Company believes that it is taking the necessary measures to
address issues that may arise relating to the year 2000 and that its production
systems will be compliant. The Company realizes, however, that noncompliance by
third parties could impact its business. The possibility exists that a portion
of the Company's distribution channel may not be compliant, that communication
with agents could be disrupted, that underwriting data, such as motor vehicle
reports, could be unobtainable, that the claim settling process could be
delayed or that frequency and severity of losses may increase due to external
factors. The Company is contacting its key independent insurance agents,
vendors and suppliers (e.g. banks, credit bureaus, motor vehicle departments,
rating agencies, etc.) to determine their status of compliance and to assess
the impact of noncompliance to the Company. The Company is working closely with
all critical business relationships to minimize its exposure to year 2000
issues, including on-site visits to identify their state of readiness.
The Company's process teams and business groups are identifying potential
year 2000 scenarios. For those scenarios deemed to be both probable and with a
potentially significant business impact, the Company is developing contingency
plans. The majority of the contingency plans are drafted and were reviewed by
the Company's chief financial and technology officers during 1998. Contingency
plans may include such items as hardening facilities with back-up generators,
prioritizing resources, securing alternative vendors, developing alternative
processes, pre-ordering policyholder information, and other measures. The
Company anticipates that contingency plans will be completed for all material
relationships during the first quarter 1999.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995: Except for historical information, the matters discussed in this annual
report are forward-looking statements that are subject to certain risks and
uncertainties that could cause the actual results to differ materially from
those projected. These risks and uncertainties include, without limitation,
pricing competition and other initiatives by competitors, legislative and
regulatory developments, weather conditions (including the severity and
frequency of storms, hurricanes, snowfalls, hail and winter conditions), driving
patterns, court decisions and trends in litigation, interest rate levels and
other conditions in the financial and securities markets, unforeseen
technological issues associated with the year 2000 compliance efforts and the
extent to which vendors, public utilities, governmental entities and other third
parties that interface with the Company may fail to achieve year 2000
compliance, and other risks detailed from time to time in the Company's SEC
reports. The Company assumes no obligation to update the information in this
annual report.
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Ten Year Summary - Financial Highlights
(not covered by report of independent accountants)
(millions-except per share amounts and number of people employed)
1998 1997
INSURANCE COMPANIES SELECTED FINANCIAL INFORMATION
AND OPERATING STATISTICS-STATUTORY BASIS
Reserves:
Loss and loss adjustment expense(1) $ 1,945.8 $ 1,867.5
Unearned premiums 2,253.3 1,901.9
Policyholders' surplus(1) 2,029.9 1,722.9
Ratios:
Net premiums written to policyholders' surplus 2.6 2.7
Loss and loss adjustment expense reserves to policyholders' surplus 1.0 1.1
Loss and loss adjustment expense 68.5 71.1
Underwriting expense 22.4 20.7
- ----------------------------------------------------------------------------------------------------------------------
Statutory combined ratio 90.9 91.8
SELECTED CONSOLIDATED FINANCIAL INFORMATION-GAAP BASIS
Total revenues $ 5,292.4 $ 4,608.2
Total assets 8,463.1 7,559.6
Total shareholders' equity(2) 2,557.1 2,135.9
Common Shares outstanding 72.5 72.3
Common Share price
High $ 172 $ 120 7/8
Low 94 61 1/2
Close(3) 169 3/8 119 7/8
Market capitalization $ 12,279.7 $ 8,667.0
Book value per Common Share(2) $ 35.27 $ 29.54
Return on average common shareholders' equity(4) 19.3% 20.9%
Debt outstanding $ 776.6 $ 775.9
Ratios:
Debt to total capital 23% 27%
Price to earnings(5) 28 27
Price to book 4.8 4.1
GAAP underwriting margin(2) 8.4 6.6
Number of people employed 15,735 14,126
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 / average common shareholders'
equity.
5 Represents the closing stock price / operating earnings per share.
All share and per share amounts were adjusted for the December 1992, 3 for 1
stock split.
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1996 1995 1994 1993
INSURANCE COMPANIES SELECTED FINANCIAL INFORMATION
AND OPERATING STATISTICS-STATUTORY BASIS
Reserves:
Loss and loss adjustment expense(1) $ 1,532.9 $ 1,314.4 $ 1,100.2 $ 1,053.7
Unearned premiums 1,382.9 1,140.4 954.8 688.9
Policyholders' surplus(1) 1,292.4 1,055.1 945.1 701.9
Ratios:
Net premiums written to policyholders' surplus 2.7 2.8 2.6 2.6
Loss and loss adjustment expense reserves to policyholders' surplus 1.2 1.2 1.2 1.5
Loss and loss adjustment expense 70.2 71.6 64.2 62.6
Underwriting expense 19.8 21.4 22.4 25.4
- --------------------------------------------------------------------------------------------------------------------------------
Statutory combined ratio 90.0 93.0 86.6 88.0
SELECTED CONSOLIDATED FINANCIAL INFORMATION-GAAP BASIS
Total revenues $ 3,478.4 $ 3,011.9 $ 2,415.3 $ 1,954.8
Total assets 6,183.9 5,352.5 4,675.1 4,011.3
Total shareholders' equity(2) 1,676.9 1,475.8 1,151.9 997.9
Common Shares outstanding 71.5 72.1 71.2 72.1
Common Share price
High $ 72 1/4 $ 49 1/2 $ 40 1/2 $ 46 1/8
Low 40 3/8 34 3/4 27 3/4 26 5/8
Close(3) 67 3/8 48 7/8 35 40 1/2
Market capitalization $ 4,817.3 $ 3,523.9 $ 2,492.0 $ 2,920.1
Book value per Common Share(2) $ 23.45 $ 19.31 $ 14.97 $ 12.62
Return on average common shareholders' equity(4) 20.5% 19.6% 27.4% 36.0%
Debt outstanding $ 775.7 $ 675.9 $ 675.6 $ 477.1
Ratios:
Debt to total capital 32% 31% 37% 32%
Price to earnings(5) 16 17 13 15
Price to book 2.9 2.5 2.3 3.2
GAAP underwriting margin(2) 8.5 5.7 11.5 10.7
Number of people employed 9,557 8,025 7,544 6,101
1992 1991 1990 1989
INSURANCE COMPANIES SELECTED FINANCIAL INFORMATION
AND OPERATING STATISTICS-STATUTORY BASIS
Reserves:
Loss and loss adjustment expense(1) $ 994.7 $ 901.7 $ 827.4 $ 787.7
Unearned premiums 538.5 513.6 474.1 467.6
Policyholders' surplus(1) 658.3 676.7 636.7 578.1
Ratios:
Net premiums written to policyholders' surplus 2.2 2.0 1.9 2.0
Loss and loss adjustment expense reserves to policyholders' surplus 1.5 1.3 1.3 1.4
Loss and loss adjustment expense 68.3 65.7 62.1 65.9
Underwriting expense 29.8 33.5 31.1 31.4
- -----------------------------------------------------------------------------------------------------------------------------------
Statutory combined ratio 98.1 99.2 93.2 97.3
SELECTED CONSOLIDATED FINANCIAL INFORMATION-GAAP BASIS
Total revenues $ 1,738.9 $ 1,493.1 $ 1,376.2 $ 1,392.7
Total assets 3,440.9 3,317.2 2,912.4 2,643.7
Total shareholders' equity(2) 629.0 465.7 408.5 435.2
Common Shares outstanding 67.1 63.3 69.3 76.2
Common Share price
High $ 29 3/8 $ 20 5/8 $ 18 3/4 $ 14 1/2
Low 14 3/4 15 11 7 1/2
Close(3) 29 1/8 18 17 1/8 12 7/8
Market capitalization $ 1,954.3 $ 1,139.4 $ 1,186.8 $ 981.1
Book value per Common Share(2) $ 7.94 $ 5.83 $ 5.89 $ 5.71
Return on average common shareholders' equity(4) 34.7% 6.7% 21.5% 17.4%
Debt outstanding $ 568.5 $ 644.0 $ 644.4 $ 645.9
Ratios:
Debt to total capital 47% 58% 61% 60%
Price to earnings(5) 17 14 13 14
Price to book 3.7 3.1 2.9 2.3
GAAP underwriting margin(2) 3.5 (3.7) 1.0 (1.2)
Number of people employed 5,591 6,918 6,370 6,049
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TEN YEAR SUMMARY - GAAP CONSOLIDATED OPERATING RESULTS
(not covered by report of independent accountants)
(millions-except per share amounts)
1998 1997
Direct premiums written:
Personal lines $ 4,987.1 $ 4,355.9
All other lines 464.2 469.3
- -----------------------------------------------------------------------------------------
Total direct premiums written 5,451.3 4,825.2
Reinsurance assumed - -
Reinsurance ceded (151.6) (160.1)
- -----------------------------------------------------------------------------------------
Net premiums written 5,299.7 4,665.1
Net change in unearned premiums reserve(1) (351.7) (475.6)
- -----------------------------------------------------------------------------------------
Premiums earned 4,948.0 4,189.5
- -----------------------------------------------------------------------------------------
Expenses:
Losses and loss adjustment expenses(2) 3,376.3 2,967.5
Policy acquisition costs 659.9 607.8
Other underwriting expenses 495.8 336.0
- -----------------------------------------------------------------------------------------
Total underwriting expenses 4,532.0 3,911.3
- -----------------------------------------------------------------------------------------
Underwriting profit (loss) before taxes 416.0 278.2
Provision (benefit) for income taxes 145.6 97.4
- -----------------------------------------------------------------------------------------
Underwriting profit (loss) after taxes 270.4 180.8
Service operations profit (loss) after taxes 4.8 .9
- -----------------------------------------------------------------------------------------
275.2 181.7
Investment income after taxes 221.3 205.3
Net realized gains (losses) on security sales after taxes 7.4 64.0
Interest expense after taxes (39.7) (42.0)
Proposition 103 reserve reduction after taxes - -
Non-recurring items after taxes - -
Other expenses after taxes(3) (7.5) (9.0)
- -----------------------------------------------------------------------------------------
Income before tax adjustments and cumulative
effect of accounting change 456.7 400.0
Tax adjustments(4) - -
Cumulative effect of accounting change5 - -
- -----------------------------------------------------------------------------------------
Net income $ 456.7 $ 400.0
=================================
Per share(6)
Net income(2) $ 6.11 $ 5.31
Dividends .250 .240
Average equivalent shares
Basic 72.5 72.0
Diluted 74.7 75.3
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 Reflects investment expenses after taxes and other tax adjustments.
4 1991 reflects a deferred tax asset write-down and 1990 reflects a fresh start
tax benefit.
5 Reflects adoption of SFAS 109, "Accounting for Income Taxes."
6 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.
All share and per share amounts were adjusted for the December 1992, 3 for 1
stock split.
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1996 1995 1994 1993
Direct premiums written:
Personal lines $ 3,165.4 $ 2,644.6 $ 2,181.7 $ 1,548.9
All other lines 473.0 424.3 463.4 417.5
- -------------------------------------------------------------------------------------------------------------------
Total direct premiums written 3,638.4 3,068.9 2,645.1 1,966.4
Reinsurance assumed 3.8 .1 2.9 9.2
Reinsurance ceded (200.5) (156.2) (190.8) (156.4)
- -------------------------------------------------------------------------------------------------------------------
Net premiums written 3,441.7 2,912.8 2,457.2 1,819.2
Net change in unearned premiums reserve(1) (242.4) (185.6) (266.1) (150.5)
- -------------------------------------------------------------------------------------------------------------------
Premiums earned 3,199.3 2,727.2 2,191.1 1,668.7
- -------------------------------------------------------------------------------------------------------------------
Expenses:
Losses and loss adjustment expenses(2) 2,236.1 1,943.8 1,397.3 1,028.0
Policy acquisition costs 482.6 459.6 391.5 311.6
Other underwriting expenses 208.5 167.2 150.8 151.3
- -------------------------------------------------------------------------------------------------------------------
Total underwriting expenses 2,927.2 2,570.6 1,939.6 1,490.9
- -------------------------------------------------------------------------------------------------------------------
Underwriting profit (loss) before taxes 272.1 156.6 251.5 177.8
Provision (benefit) for income taxes 95.2 54.8 88.0 62.2
- -------------------------------------------------------------------------------------------------------------------
Underwriting profit (loss) after taxes 176.9 101.8 163.5 115.6
Service operations profit (loss) after taxes 2.8 5.6 6.5 4.4
- -------------------------------------------------------------------------------------------------------------------
179.7 107.4 170.0 120.0
Investment income after taxes 175.6 156.2 131.2 107.1
Net realized gains (losses) on security sales after taxes 4.6 30.4 15.5 70.1
Interest expense after taxes (40.0) (37.1) (35.9) (25.8)
Proposition 103 reserve reduction after taxes -- -- -- --
Non-recurring items after taxes -- -- -- (2.6)
Other expenses after taxes(3) (6.2) (6.4) (6.5) (1.5)
- -------------------------------------------------------------------------------------------------------------------
Income before tax adjustments and cumulative
effect of accounting change 313.7 250.5 274.3 267.3
Tax adjustments(4) -- -- -- --
Cumulative effect of accounting change(5) -- -- -- --
- -------------------------------------------------------------------------------------------------------------------
Net income $ 313.7 $ 250.5 $ 274.3 $ 267.3
=========================================================
Per share(6) $ 4.14 $ 3.26 $ 3.59 $ 3.59
Net income(2) .230 .220 .210 .200
Dividends
Average equivalent shares 71.6 71.8 71.6 69.3
Basic 74.2 74.2 74.0 71.8
Diluted
1992 1991 1990 1989
Direct premiums written:
Personal lines $ 1,214.6 $ 1,047.4 $ 876.0 $ 800.1
All other lines 422.2 489.4 482.8 487.0
- -------------------------------------------------------------------------------------------------------------------
Total direct premiums written 1,636.8 1,536.8 1,358.8 1,287.1
Reinsurance assumed 4.3 .1 .1 7.2
Reinsurance ceded (189.9) (212.3) (162.6) (134.0)
- -------------------------------------------------------------------------------------------------------------------
Net premiums written 1,451.2 1,324.6 1,196.3 1,160.3
Net change in unearned premiums reserve(1) (25.1) (37.7) (5.1) 36.2
- -------------------------------------------------------------------------------------------------------------------
Premiums earned 1,426.1 1,286.9 1,191.2 1,196.5
- -------------------------------------------------------------------------------------------------------------------
Expenses:
Losses and loss adjustment expenses(2) 930.9 858.0 762.9 799.3
Policy acquisition costs 304.1 313.7 292.7 296.7
Other underwriting expenses 141.5 162.1 123.7 114.9
- -------------------------------------------------------------------------------------------------------------------
Total underwriting expenses 1,376.5 1,333.8 1,179.3 1,210.9
- -------------------------------------------------------------------------------------------------------------------
Underwriting profit (loss) before taxes 49.6 (46.9) 11.9 (14.4)
Provision (benefit) for income taxes 16.9 (15.9) 4.0 (2.9)
- -------------------------------------------------------------------------------------------------------------------
Underwriting profit (loss) after taxes 32.7 (31.0) 7.9 (11.5)
Service operations profit (loss) after taxes (2.8) (1.4) 2.8 2.5
- -------------------------------------------------------------------------------------------------------------------
29.9 (32.4) 10.7 (9.0)
Investment income after taxes 110.4 121.1 126.4 135.3
Net realized gains (losses) on security sales after taxes 9.6 4.9 (8.4) (.4)
Interest expense after taxes (29.4) (31.6) (32.0) (32.5)
Proposition 103 reserve reduction after taxes 70.0 -- -- --
Non-recurring items after taxes (42.6) -- -- --
Other expenses after taxes(3) (8.3) (14.9) (13.2) (15.4)
- -------------------------------------------------------------------------------------------------------------------
Income before tax adjustments and cumulative
effect of accounting change 139.6 47.1 83.5 78.0
Tax adjustments(4) -- (14.2) 9.9 --
Cumulative effect of accounting change(5) 14.2 -- -- --
- -------------------------------------------------------------------------------------------------------------------
Net income $ 153.8 $ 32.9 $ 93.4 $ 78.0
=========================================================
Per share(6) $ 2.08 $ .41 $ 1.20 $ .94
Net income(2) .191 .172 .160 .147
Dividends
Average equivalent shares 60.7 65.4 72.3 79.5
Basic 70.9 66.6 81.9 88.8
Diluted
55
56
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, 1998, 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 as of December 31, 1998
were:
(millions)
MARKET VALUE
--------------------------------------------------------
-200 BPS -100 BPS +100 BPS +200 BPS
CHANGE CHANGE ACTUAL CHANGE CHANGE
U.S. Government obligations $ 639.4 $ 627.0 $ 614.5 $ 603.2 $ 592.0
State and local government obligations 1,814.1 1,752.5 1,693.6 1,638.2 1,579.8
Asset-backed securities 1,567.5 1,527.1 1,486.9 1,443.6 1,398.3
Other debt securities 455.0 439.3 424.0 409.9 396.1
Preferred stocks 399.3 388.4 376.5 365.3 355.0
Short-term investments 444.1 443.0 441.9 440.8 439.7
- -------------------------------------------------------------------------------------------------
$ 5,319.4 $ 5,177.3 $ 5,037.4 $ 4,901.0 $ 4,760.9
========================================================
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 72%
of the preferred stocks have mechanisms that are expected to provide an
opportunity to liquidate at par.
Derivative financial instruments held or issued for purposes of managing
interest rate exposure on the anticipated debt issuance as of
December 31, 1998 were:
(millions)
MARKET VALUE
------------------------------------------------------------------
-200 BPS -100 BPS +100 BPS +200 BPS
CHANGE CHANGE ACTUAL CHANGE CHANGE
Short futures position $ (32.0) $ (10.0) $ 4.4 $ 26.5 $ 42.3
Interest rate swap hedge (55.1) (33.1) (11.0) 11.0 33.1
Exposure to risk is represented in terms of changes in fair value due to
selected hypothetical movements in market rates. During 1998, the Company
entered into two transactions to hedge against possible rises in interest rates
prior to the issuance of debt under the $300 million shelf registration. The
interest rate swap hedge performed as expected and is recorded as a deferred
asset under SFAS 80, "Accounting for Futures Contracts," as a qualified hedge.
The short futures position, driven by changing economic conditions, did not meet
the established criteria for hedging correlation and was discontinued as a
hedge, recognizing a net realized loss of $9.2 million in 1998. The Company
continues to hold the short futures position for risk management of the
anticipated debt offering. Changes in market rates will have a reciprocal effect
on the cost of borrowing of the debt upon issuance.
56
57
Financial instruments subject to equity market risk as of December 31, 1998
were:
(millions)
HYPOTHETICAL
MARKET CHANGES
--------------------------------
MARKET
VALUE +10% -10%
Common stocks $ 636.9 $ 697.4 $ 576.4
The model represents the estimated value of the Company's common stock portfolio
given a + (-) 10% change in the market, based on the common stock portfolio's
weighted average beta of .94. 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 effect 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 25%. The common stock
portfolio includes stock index futures with a market value of $1.9 million.
Financial instruments subject to foreign currency risk as of December 31, 1998
were:
(millions)
MARKET NOTIONAL HYPOTHETICAL
VALUE VALUE GAIN (LOSS)
Canadian fixed income investments $ 73.0 N/A $ 7.3
Other foreign fixed income investments 11.1 N/A 1.1
Foreign equity investments 111.4 N/A 11.1
Foreign currency forwards-assets .5 25.8 3.9
Foreign currency forwards-liabilities (.5) 31.8 (1.8)
- --------------------------------------------------------------------------------
$ 195.5 N/A $ 21.6
=======================================
N/A = not applicable; notional value pertains only to derivative instruments
The foreign equity portfolio, which may include stock index futures, foreign
currency forwards and foreign preferred stocks, is comprised of numerous
currencies, none of which are individually material. Therefore, sensitivity
results are presented by class of financial instrument. 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, 1998, the
Company did not have any cross currency exposures.
TRADING FINANCIAL INSTRUMENTS
At December 31, 1998, the Company had short trading positions with a market
value of $(.4) million. Exposure to loss from open trading positions is not
material individually or in the aggregate. The Company did not have any trading
securities as of December 31, 1998.
57
58
ANALYSIS OF LOSS AND LOSS ADJUSTMENT EXPENSES (LAE) DEVELOPMENT
(not covered by report of independent accountants)
(millions)
For the years ended
December 31, 1988 1989 1990 1991 1992 1993 1994(3) 1995 1996 1997 1998
Loss and LAE
reserves(1) $ 651.0 $ 748.6 $ 791.6 $ 861.5 $ 956.4 $1,012.4 $1,098.7 $1,314.4 $1,532.9 $1,867.5 $1,945.8
Re-estimated
reserves as of:
One year later 610.3 685.4 748.8 810.0 857.9 869.9 1,042.1 1,208.6 1,429.6 1,683.3
Two years later 573.4 677.9 726.5 771.9 765.5 837.8 991.7 1,149.5 1,364.5
Three years later 581.3 668.6 712.7 718.7 737.4 811.3 961.2 1,118.6
Four years later 575.1 667.1 683.7 700.1 725.2 794.6 940.6
Five years later 578.4 654.7 666.3 695.1 717.3 782.9
Six years later 582.2 647.1 664.8 692.6 711.1
Seven years later 574.3 645.7 664.5 688.2
Eight years later 574.4 645.4 661.4
Nine years later 575.0 641.9
Ten years later 572.4
Cumulative redundancy $ 78.6 $ 106.7 $ 130.2 $ 173.3 $ 245.3 $ 229.5 $ 158.1 $ 195.8 $ 168.4 $ 184.2
Percentage(2) 12.1 14.3 16.4 20.1 25.6 22.7 14.4 14.9 11.0 9.9
The chart represents the development of the property-casualty loss and LAE
reserves for 1988 through 1997. 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 redundancy 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 redundancy / 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) 1998 1997 1996 1995 1994
------------------ ------------------ ------------------ ------------------ ------------------
Florida $ 784.4 14.4% $ 663.0 13.7% $ 467.4 12.9% $ 421.9 13.7% $ 369.9 14.0%
New York 522.2 9.6 446.3 9.2 358.0 9.8 225.6 7.4 195.2 7.4
Texas 518.6 9.5 509.4 10.6 349.9 9.6 313.2 10.2 246.4 9.3
Ohio 447.7 8.2 404.3 8.4 340.8 9.4 284.1 9.3 232.0 8.8
California 343.2 6.3 291.7 6.0 171.6 4.7 126.6 4.1 126.8 4.8
Pennsylvania 292.3 5.4 248.3 5.1 201.3 5.5 184.9 6.0 161.2 6.1
Georgia 277.8 5.1 261.9 5.4 212.1 5.8 155.1 5.1 129.7 4.9
All other 2,265.1 41.5 2,000.3 41.6 1,537.3 42.3 1,357.5 44.2 1,183.9 44.7
- -----------------------------------------------------------------------------------------------------------------
Total $ 5,451.3 100.0% $ 4,825.2 100.0% $ 3,638.4 100.0% $ 3,068.9 100.0% $ 2,645.1 100.0%
========== ======== ======= ====== ========== ====== ========== ====== ========== ======
58
59
QUARTERLY FINANCIAL AND COMMON SHARE DATA
(not covered by report of independent accountants)
(millions-except per share amounts)
Net Income Operating Income(1)
----------------------------- ----------------------------
Operating Per Per
Quarter Revenues(7) Total(2) Share(3) Total(2) Share(3)
1998
1 $ 1,156.2 $ 120.1 $ 1.58 $ 102.8 $ 1.35
2 1,237.2 123.0 1.61 109.1 1.43
3 1,290.9 135.1 1.81 134.4 1.80
4 1,301.9 78.5(6) 1.05(6) 103.1 1.38
- --------------------- --------------------------------- --------------------------------
$ 4,986.2 $ 456.7 $ 6.11 $ 449.3 $ 6.01
======== ===== ==== ===== ====
1997
1 $ 905.7 $ 76.5 $ 1.02 $ 78.6 $ 1.05
2 1,020.9 102.1 1.36 82.8 1.10
3 1,090.1 116.2 1.54 89.3 1.18
4 1,218.1 105.3 1.39 85.3 1.13
- --------------------- --------------------------------- --------------------------------
$ 4,234.8 $ 400.0 $ 5.31 $ 336.0 $ 4.46
======= ===== ==== ===== ====
1996
1 $ 741.4 $ 63.3 $ .82 $ 60.2 $ .78
2 794.9 78.4 1.01 78.5 1.05
3 840.3 80.3 1.08 82.5 1.11
4 868.9 91.7 1.23 87.9 1.18
- --------------------- --------------------------------- --------------------------------
$ 3,245.5 $ 313.7 $ 4.14 $ 309.1 $ 4.12
======= ===== ==== ===== ====
Stock Price(4)
-------------------------------------------
Rate of Dividends
Quarter High-Low Close Return(5) Per Share
1998
1 $ 135 1/2 - 106 11/16 $ 134 11/16 $ .060
2 150 - 126 1/2 141 .060
3 156 3/4 - 95 112 3/4 .065
4 172 - 94 169 3/8 .065
- ------------------------------- ------------------ ------------
$ 172 - 94 $ 169 3/8 41.6% $ .250
======================= ================== ============
1997
1 $ 73 5/8 - 63 7/8 $ 63 7/8 $ .060
2 87 3/8 - 61 1/2 87 .060
3 111 7/8 - 86 1/2 107 1/8 .060
4 120 7/8 - 99 119 7/8 .060
- ------------------------------- ------------------ ------------
$ 120 7/8 - 61 1/2 $ 119 7/8 78.4% $ .240
======================= ================== ============
1996
1 $ 51 1/4 - 43 1/2 $ 44 5/8 $ .055
2 48 7/8 - 40 3/8 46 1/4 .055
3 58 1/2 - 43 1/8 57 1/4 .060
4 72 1/4 - 55 3/8 67 3/8 .060
- ------------------------------- ------------------ ------------
$ 72 1/4 - 40 3/8 $ 67 3/8 38.5% $ .230
======================= ================== ============
1 Represents net income less realized gains and losses on security sales and
one-time items.
2 The sum may not equal the total due to rounding in the individual periods.
Each period is properly stated.
3 Presented on a diluted basis. The sum may not equal the total because the
average equivalent shares differ in the periods. In 1997, the Company adopted
SFAS 128, "Earnings Per Share," and, as a result, restated prior periods per
share amounts, if applicable.
4 Prices as reported on the consolidated transaction reporting system. The
Company's Common Shares are listed on the New York Stock Exchange.
5 Represents annual rate of return, including quarterly dividend reinvestment.
6 During the fourth quarter 1998, the Company wrote down $24.5 million, $.21 per
share, on investment securities considered to have other than temporary
declines in market value and realized a $9.2 million, $.08 per share, net loss
on an anticipatory hedge.
7 Represents premiums earned plus service revenues.
59
60
DIRECTORS
Milton N. Allen(1,2)
Director,
various companies
B. Charles Ames(1)
Partner,
Clayton, Dubilier & Rice, Inc.
(investment banking)
James E. Bennett III(1)
Senior Executive Vice President
KeyCorp
(banking)
Charles A. Davis(1)
President and
Chief Executive Officer
Marsh & McLennan
Capital, Inc.
(investment banking)
Stephen R. Hardis(1,2)
Chairman of the Board
and Chief Executive Officer
Eaton Corporation
(manufacturing)
Janet Hill(3)
Vice President
Alexander & Associates, Inc.
(management consulting)
and President,
Staubach Alexander Hill, LLC
(commercial real estate
consulting)
Peter B. Lewis(2)
Chairman of the Board,
President and
Chief Executive Officer-
Insurance Operations
Norman S. Matthews(3)
Consultant,
formerly President,
Federated Department Stores, Inc.
(retailing)
Donald B. Shackelford(3)
Chairman,
Fifth Third Bank of
Central Ohio
(commercial bank)
Dr. Paul B. Sigler(3)
Henry Ford II Professor,
Yale University
and Investigator,
Howard Hughes Medical
Institute
(education and medical
research)
(1) Audit Committee member
(2) Executive Committee member
(3) Executive Compensation Committee member
CORPORATE OFFICERS
Peter B. Lewis
Chairman, President and
Chief Executive Officer -
Insurance Operations
Charles B. Chokel
Chief Executive Officer -
Investments and
Capital Management
David M. Schneider
Secretary
W. Thomas Forrester
Treasurer
POLICY TEAM
Alan R. Bauer
Charles B. Chokel
W. Thomas Forrester
Moira G. Lardakis
Daniel R. Lewis
Peter B. Lewis
Robert J. McMillan
Brian J. Passell
Glenn M. Renwick
David L. Roush
Tiona M. Thompson
Robert T. Williams
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
23, 1999, at 10:00 a.m. There were 3,974 shareholders of record on December 31,
1998.
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 loss, 24 hours a day, 7 days a
week, call: 1-800-274-4499.
For Progressive's smart new way to shop for auto insurance, available 24 hours a
day, 7 days a week, call: 1 800 AUTO PRO(R) (1-800-288-6776)
For 24 Hour Policy Service, call: 1-800-888-7764
COUNSEL
Baker & Hostetler, Cleveland, Ohio
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
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.
SHAREHOLDER/INVESTOR RELATIONS
The Progressive Corporation does not maintain a mailing list for distribution of
shareholders' reports. To hear the text of the latest earnings release, receive
key financial information for the past several quarters, receive dividend and
other information, shareholders can call 1-800-879-PROG. This toll-free
shareholder services line is available 24 hours a day, 7 days a week. Such
information is also available from the Company's web site: progressive.com.
To request copies of public financial information on the Company, shareholders
and potential investors may call the Company's shareholders services line at
1-800-879-PROG or write to: The Progressive Corporation, Investor Relations,
6300 Wilson Mills Road, Box W33, Mayfield Village, Ohio 44143.
For specific questions on financial or other Company information call:
440-446-2851.