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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 1O-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 1999
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or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
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Commission File Number 1-9518
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THE PROGRESSIVE CORPORATION
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(Exact name of registrant as specified in its charter)
Ohio 34-0963169
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6300 Wilson Mills Road, Mayfield Village, Ohio 44143
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(Address of principal executive offices) (Zip Code)
(440) 461-5000
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Common Shares, $1.00 par value: 73,112,244 outstanding at October 29, 1999
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PART I - FINANCIAL INFORMATION
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ITEM 1. Financial Statements.
The Progressive Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
Three Months Nine Months
----------------------------------------- ------------------------------------
Periods Ended September 30, 1999 1998 % Change 1999 1998 % Change
- -------------------------------------------------------------------------------------------- ------------------------------------
(millions - except per share amounts)
NET PREMIUMS WRITTEN $1,581.0 $1,359.3 16 $4,743.1 $4,053.7 17
========================== ======================
REVENUES
Premiums earned $1,459.2 $1,281.7 14 $4,185.9 $3,655.1 15
Investment income 88.5 71.3 24 249.2 219.8 13
Net realized gains on security sales 22.2 1.1 NM 40.9 49.2 (17)
Service revenues 15.3 9.2 66 38.7 29.2 33
Other income(1) -- -- -- 5.2 -- --
-------------------------- ----------------------
Total revenues 1,585.2 1,363.3 16 4,519.9 3,953.3 14
-------------------------- ----------------------
EXPENSES
Losses and loss adjustment expenses 1,110.0 847.4 31 3,028.6 2,481.2 22
Policy acquisition costs 190.3 171.0 11 551.7 488.6 13
Other underwriting expenses 144.6 122.4 18 426.6 355.9 20
Investment expenses 2.5 2.0 25 7.1 6.4 11
Service expenses 13.9 8.2 70 33.9 23.2 46
Interest expense 19.7 14.7 34 56.6 46.0 23
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Total expenses 1,481.0 1,165.7 27 4,104.5 3,401.3 21
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NET INCOME
Income before income taxes 104.2 197.6 (47) 415.4 552.0 (25)
Provision for income taxes 30.2 62.5 (52) 124.0 173.8 (29)
-------------------------- ----------------------
Net income $74.0 $135.1 (45) $291.4 $378.2 (23)
========================== ======================
COMPUTATION OF EARNINGS PER SHARE
Basic:
Average shares outstanding 73.0 72.5 1 72.9 72.5 1
========================== ======================
Per share $1.01 $1.86 (46) $4.00 $5.22 (23)
========================== ======================
Diluted:
Average shares outstanding 73.0 72.5 1 72.9 72.5 1
Net effect of dilutive stock options 1.6 2.2 (27) 1.8 2.3 (22)
========================== ======================
Total equivalent shares 74.6 74.7 -- 74.7 74.8 --
========================== ======================
Per share $.99 $1.81 (45) $3.90 $5.06 (23)
========================== ======================
(1) See Note 7 - Related Party Transaction for discussion.
See notes to consolidated financial statements.
NM = Not Meaningful
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The Progressive Corporation and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(unaudited)
September 30, December 31,
----------------------------- ----------------
1999 1998 1998
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(millions)
ASSETS
Investments:
Available-for-sale:
Fixed maturities, at market (amortized cost:
$4,876.1, $4,165.3 and $4,171.6) $4,802.4 $4,252.1 $4,219.0
Equity securities, at market
Preferred stocks (cost: $351.6, $439.9 and $374.3) 353.4 432.3 376.5
Common stocks (cost: $987.3, $607.1 and $512.2) 1,070.6 605.9 636.9
Short-term investments, at amortized cost
(market: $125.0, $273.5 and $441.9) 125.0 273.5 441.9
----------------------------- ----------------
Total investments 6,351.4 5,563.8 5,674.3
Cash 8.6 32.1 18.6
Accrued investment income 50.1 49.7 53.1
Premiums receivable, net of allowance for doubtful accounts of
$39.7, $32.5 and $34.0 1,854.1 1,456.3 1,456.2
Reinsurance recoverables 264.0 287.3 281.0
Prepaid reinsurance premiums 86.6 78.4 77.7
Deferred acquisition costs 365.6 301.4 299.1
Income taxes 250.8 178.9 192.9
Property and equipment, net of accumulated depreciation of
$234.9, $180.9 and $194.1 439.7 355.3 376.2
Other assets 73.3 32.9 34.0
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Total assets $9,744.2 $8,336.1 $8,463.1
============================= ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Unearned premiums $2,895.7 $2,377.3 $2,329.7
Loss and loss adjustment expense reserves 2,323.6 2,173.8 2,188.6
Policy cancellation reserve 19.7 29.7 29.1
Accounts payable and accrued expenses 701.7 567.2 582.0
Debt 1,040.8 776.4 776.6
----------------------------- ----------------
Total liabilities 6,981.5 5,924.4 5,906.0
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Shareholders' equity:
Common Shares, $1.00 par value
(treasury shares of 10.0, 10.7 and 10.6) 73.1 72.4 72.5
Paid-in capital 480.0 437.0 448.3
Accumulated comprehensive income:
Net unrealized appreciation on investment securities 7.5 50.5 113.3
Other comprehensive income (9.0) (9.0) (9.6)
Retained earnings 2,211.1 1,860.8 1,932.6
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Total shareholders' equity 2,762.7 2,411.7 2,557.1
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Total liabilities and shareholders' equity $9,744.2 $8,336.1 $8,463.1
============================= ================
See notes to consolidated financial statements.
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The Progressive Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Nine Months Ended September 30, 1999 1998
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(millions)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $291.4 $378.2
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 49.7 41.0
Net realized gains on security sales (40.9) (49.2)
Gain on sale of property and equipment (5.2) --
Changes in:
Unearned premiums 566.0 397.2
Loss and loss adjustment expense reserves 135.0 27.2
Accounts payable and accrued expenses 154.8 108.9
Policy cancellation reserve (9.4) (5.0)
Prepaid reinsurance premiums (8.9) 1.4
Reinsurance recoverables 17.0 30.2
Premiums receivable (397.9) (295.5)
Deferred acquisition costs (66.5) (41.8)
Income taxes (.3) (23.8)
Other, net 15.8 26.2
-----------------------------------------
Net cash provided by operating activities 700.6 595.0
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases:
Available-for-sale: fixed maturities (5,502.1) (3,383.9)
equity securities (698.1) (708.0)
Sales:
Available-for-sale: fixed maturities 4,468.3 2,713.5
equity securities 289.8 501.8
Maturities, paydowns, calls and other:
Available-for-sale: fixed maturities 291.6 332.6
equity securities 12.7 26.2
Net sales of short-term investments 325.0 135.9
Receivable on securities (68.6) (38.8)
Purchases of property and equipment (116.4) (136.2)
Sale of property and equipment 12.1 --
Purchase of subsidiary, net of cash acquired (5.7) --
-----------------------------------------
Net cash used in investing activities (991.4) (556.9)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from exercise of stock options 11.8 7.8
Tax benefits from exercise of stock options 19.8 17.9
Proceeds from debt 293.7 --
Payments on debt (30.0) --
Dividends paid to shareholders (14.2) (13.4)
Acquisition of treasury shares (.3) (41.6)
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Net cash provided by (used in) financing activities 280.8 (29.3)
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Increase (decrease) in cash (10.0) 8.8
Cash, January 1 18.6 23.3
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Cash, September 30 $8.6 $32.1
=========================================
See notes to consolidated financial statements.
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The Progressive Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1 Basis of Presentation -- These financial statements and the notes
thereto should be read in conjunction with the Company's audited financial
statements included in its Annual Report on Form 10-K for the year ended
December 31, 1998.
The consolidated financial statements reflect all normal recurring adjustments
which were, in the opinion of management, necessary to present a fair statement
of the results for the interim periods. The results of operations for the period
ended September 30, 1999, are not necessarily indicative of the results expected
for the full year.
NOTE 2 Supplemental Cash Flow Information -- The Company paid income taxes
of $105.7 million and $174.6 million for the nine months ended September 30,
1999 and 1998, respectively. Total interest paid was $48.4 million and $38.5
million for the nine months ended September 30, 1999 and 1998, respectively.
NOTE 3 Debt -- On March 1, 1999, the Company issued $300 million of 6 5/8%
Senior Notes due March 1, 2029. Debt at September 30 consisted of:
1999 1998
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Market Market
Cost Value Cost Value
------------- -------------- -------------- ---------------
6 5/8% Senior Notes $ 293.7 $ 264.8 $ -- $ --
7.30% Notes 99.7 100.1 99.7 110.1
6.60% Notes 199.2 196.9 199.0 208.2
7% Notes 148.5 144.8 148.4 162.8
8 3/4% Notes -- -- 29.9 30.6
10% Notes 149.9 156.5 149.7 165.1
10 1/8% Subordinated Notes 149.8 156.7 149.7 165.1
------------- -------------- -------------- ---------------
$1,040.8 $1,019.8 $776.4 $841.9
============= ============== ============== ===============
NOTE 4 Comprehensive Income -- Total comprehensive income (loss) was ($5.7)
million and $33.7 million for the quarters ended September 30, 1999 and 1998,
respectively, and $186.2 million and $303.7 million for the nine months ended
September 30, 1999 and 1998, respectively.
NOTE 5 Dividends -- On September 30, 1999, the Company paid a quarterly
dividend of $.065 per Common Share to shareholders of record as of the close of
business on September 10, 1999. The dividend was declared by the Board of
Directors on August 27, 1999.
On October 22, 1999, the Board of Directors declared a quarterly dividend of
$.065 per Common Share. The dividend is payable December 31, 1999, to
shareholders of record as of the close of business on December 10, 1999.
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NOTE 6 Segment Information -- The Company's Personal Lines business units
write insurance for private passenger automobiles and recreation vehicles. The
other lines of business include writing insurance for small fleets of commercial
vehicles, lenders' collateral protection and directors' and officers' liability,
and providing related services. All revenues are generated from external
customers.
Periods ended September 30,
(millions)
Three Months Nine Months
-------------------------------------------- ------------------------------------------------
1999 1998 1999 1998
--------------------- --------------------- ------------------------ ----------------------
Pretax Pretax Pretax Pretax
Profit Profit Profit Profit
Revenues (Loss) Revenues (Loss) Revenues (Loss) Revenues (Loss)
--------- ---------- --------- ---------- ----------- ----------- ---------- ----------
Personal Lines $1,361.0 $ (3.6) $1,187.1 $119.5 $3,898.8 $138.0 $3,381.0 $288.7
Other 113.5 19.3 103.8 22.4 331.0 51.0 303.3 46.7
Investments(1) 110.7 108.2 72.4 70.4 290.1 283.0 269.0 262.6
Interest Expense -- (19.7) -- (14.7) -- (56.6) -- (46.0)
--------- ---------- --------- ---------- ----------- ----------- ---------- ----------
$1,585.2 $104.2 $1,363.3 $197.6 $4,519.9 $415.4 $3,953.3 $552.0
========= ========== ========= ========== =========== =========== ========== ==========
(1) Revenues represent recurring investment income and net realized gains on
security sales; pretax profit is net of investment expenses.
NOTE 7 Related Party Transaction -- On April 23, 1999, the Company sold its
corporate aircraft to a company independently owned by Peter B. Lewis, the
Company's Chairman of the Board, President and Chief Executive Officer-Insurance
Operations. The airplane had a net book value of $6.9 million and was sold to
Mr. Lewis for $12.1 million, the fair market value of the airplane as determined
by an independent appraiser.
NOTE 8 Litigation --The Company is named as defendant in various lawsuits
generally relating to its insurance operations. All legal actions relating to
claims made under insurance policies or in connection with previous reinsurance
agreements are considered by the Company in establishing its loss and loss
adjustment expense reserves. Various other legal and regulatory actions are
currently pending that involve the Company and specific aspects of its conduct
of business. Except as discussed below, the Company believes that the ultimate
disposition of these lawsuits in excess of amounts currently reserved will not
materially impact the Company's financial position, cash flows or results of
operations.
One of the Company's subsidiaries was named as a defendant in a lawsuit claiming
fraud and bad faith action arising out of the issuance of a blanket vendor
single interest and a loan deficiency balance policy. The suit challenges our
ability to cancel the policies and limit losses, and is scheduled to go to a
jury trial in November 1999. No amount for damages was specified in the
complaint and the Company is unable to estimate the potential exposure. The
Company plans to vigorously contest this lawsuit.
The Company is also named as defendant in five class action lawsuits alleging
damages as a result of the Company's use of after-market parts and for breach of
contract relating to such use. Numerous other insurance companies face similar
suits. There is the potential that similar lawsuits could be filed against the
Company. The Company plans to vigorously contest these suits and is currently
unable to estimate the potential exposure.
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ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.
RESULTS OF OPERATIONS
For the third quarter 1999, operating income, which excludes net realized gains
on security sales, was $59.5 million, or $.80 per share, compared to $134.4
million, or $1.80 per share, last year. The combined ratio was 99.0, compared to
89.0 for the third quarter 1998. For the nine months ended September 30, 1999,
operating income was $262.0 million, or $3.51 per share, compared to $346.2
million, or $4.63 per share, in 1998. The year-to-date combined ratio was 95.7,
compared to 91.0 last year.
Net premiums written increased 16% over the third quarter 1998 and 17% over the
first nine months of 1998, primarily reflecting an increase in unit sales driven
by the Company's competitive rates and its effort to increase brand awareness
through its advertising campaign. Premiums earned, which are a function of the
amount of premiums written in the current and prior periods, increased 14% for
the quarter and 15% for the first nine months of 1999.
The Personal Lines business units write insurance for private passenger
automobiles and recreation vehicles and generate 93% of the Company's net
premiums written. The Personal Lines business is generated either by an agent or
written directly by the Company. The Agent channel includes business written by
our network of 30,000 Independent Insurance Agents and through Strategic
Alliance business relationships (other insurance companies, financial
institutions, employers and national brokerage agencies). Total net premiums
written through the Agent channel increased 9% to $1,199.5 million for the third
quarter 1999, compared to $1,102.6 million for the same period last year, and
increased 10% to $3,720.8 million for the nine months ended September 30, 1999,
compared to $3,386.0 million for the same period last year. Direct business
includes business written through 1 800 AUTO PRO(R), the Internet and the
Strategic Alliances business unit on behalf of affinity groups. Net premiums
written on a Direct basis increased 74% to $277.2 million for the third quarter
1999, compared to $159.4 million for the same period last year, and increased
85% to $703.8 million for the nine months ended September 30, 1999, compared to
$379.5 million for the same period last year. The sales generated via the
Internet represented approximately 8% and 7% of the Direct business net premiums
written in the third quarter and first nine months of 1999, respectively.
Four factors contributed to the Company's inability to meet its traditional
goals in 1999. The first factor was during the first nine months of 1999, the
company reduced loss reserves relating to prior accident years $41 million,
compared to $122 million and $36 million for the first nine months of 1998 and
1997, respectively. The second was continued strong growth in the Direct
business in 1999. In periods of rapid growth in the direct business, the
Company's earnings may be lower as a result of higher up-front costs and higher
loss costs traditionally associated with new business. In response, the Company
decided to return to profit targets based on a calendar year measure rather
than over the entire retention period of a policyholder, with the intent to
bring the combined ratio back to the historic goal of 96. The Company's profit
and growth opportunities change from year to year; however, over every
consecutive 5-year period, the Company strives to produce a four percent
underwriting profit and to grow at 15 percentage points greater than the rate
of inflation. The third factor was that the Company lowered rates during the
last 12 months in an attempt to raise its combined ratio to 96 while achieving
its growth target. Lastly, during the last two quarters, loss trend accelerated
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at a pace not anticipated; consequently, loss costs rose faster than expected.
As a result of a combination of reduced rates, higher loss trends and the
success of writing direct business, the Company believes that meeting both
historic growth and profit margin targets will be particularly difficult over
the next several quarters. Furthermore, if trend continues to accelerate given
that a significant percentage of the Company's policies are annual, the Company
may not make an underwriting profit over the next quarter or two.
The Company also continues to pursue multichannel distribution, allowing
customers to purchase its products from Independent Agents, via the Internet or
by calling the Company directly at 1 800 AUTO PRO(R). The Company plans to
balance its efforts among these different channels in order to produce the best
outcome for profit and growth on a companywide basis.
The Company is winding down its Canadian operations and reducing the volume of
nonstandard auto premiums written by the Midland Financial Group, which was
acquired in 1997. Each of these groups contribute less than 1% of the Company's
consolidated net premiums written.
Claim costs, which represent actual and estimated future payments to or for our
policyholders, as well as loss estimates for future assignments and assessments
under state-mandated assigned risk programs, were 76% of premiums earned for the
quarter, compared to 66% the same period last year. Year-to-date claim costs
were 72%, compared to 68% last year. The increase in claim costs was primarily
driven by increases in loss cost trends and the effects of the Company taking
rate decreases over the last year. The Company expects adverse changes in
severity trends to continue and has begun raising prices.
Policy acquisition costs and other underwriting expenses were 23% of premiums
earned for both the third quarter 1999 and 1998, and 23% for both the first nine
months of 1999 and 1998.
Recurring investment income (interest and dividends) increased 24% for the
quarter and 13% for the first nine months, reflecting an increase in the
average investment portfolio and a shift in the portfolio from tax free to
taxable securities during the third quarter. The weighted average annualized
fully taxable equivalent book yield of the portfolio was 6.3% for both the
quarter and first nine months ended September 30, 1999, compared to 6.1% and
6.4% for the third quarter and first nine months of 1998, respectively. The
Company had net realized gains on security sales of $22.2 million and $40.9
million for the third quarter and first nine months of 1999, respectively,
compared to $1.1 million and $49.2 million in 1998. On September 30, 1999, the
Company's portfolio had $11.4 million in total unrealized gains, compared to
$174.3 million at December 31, 1998; the decrease was driven by rising interest
rates and the overall decline in the equity market. During the nine months
ended September 30, 1999, the yield on the 5-year Treasuries rose 121 basis
points over which time the total return was (1.59)%. During the same period,
the Company's fixed-income portfolio had a total return of 2.31%.
The Company continues to invest in fixed maturity, equity and short-term
securities. The majority of the portfolio was in short-term and
intermediate-term, investment-grade fixed-maturity securities ($4,485.8 million,
or 70.6%, at September 30, 1999, and $3,987.6 million, or 71.7%, at September
30, 1998). Long-term investment-grade fixed-maturity securities represented
$229.3 million, or 3.6%, and $411.9 million, or 7.4%, of the total investment
portfolio at September 30, 1999 and 1998, respectively. Non-investment-grade
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fixed-maturity securities were $212.3 million, or 3.3%, in 1999, and $126.1
million, or 2.2%, in 1998, 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.
A portion of the investment portfolio is invested in marketable equity
securities. Common stocks represented $1,070.6 million, or 16.9%, in 1999,
compared to $605.9 million, or 10.9%, in 1998. The majority of the common stock
portfolio is invested in domestic equities traded on nationally recognized
securities exchanges. The Company also invests in foreign equities (1.3% in
1999, compared to 2.0% in 1998), partnership investments (1.4% in 1999, compared
to 1.0% in 1998) and equity investments in closed-end unit investment trusts
(3.6% in 1999, compared to .4% in 1998). Preferred stocks represented $353.4
million, or 5.6% of the portfolio in 1999, compared to $432.3 million, or 7.8%,
in 1998.
Derivative instruments are primarily used to manage the risks and enhance the
returns of the available-for-sale portfolio and may be used for trading
purposes. Derivative instruments classified as held or issued for other than
trading had a net market value of $(2.3) million at September 30, 1999, compared
to $(2.7) million at September 30, 1998. Trading positions had a net market
value of $.2 million at September 30, 1999, compared to $(.1) million at
September 30, 1998. As of September 30, 1999, the Company had open investment
funding commitments of $36.0 million.
FINANCIAL CONDITION
Progressive's insurance operations create liquidity by collecting and investing
premiums written from new and renewal business in advance of paying claims. For
the nine months ended September 30, 1999, operations generated a positive cash
flow of $700.6 million.
In October 1999, the Company entered into a Contribution Agreement with Netrex
LLC (Netrex) pursuant to which the Company contributed United Financial
Adjusting Company (UFAC), a wholly-owned subsidiary of the Company, and UFAC's
subsidiaries along with the Company's 50.1% interest in Progressive Vehicle
Inspection Services, Inc. (PVIS) to Netrex Holdings L.L.C. (Holdings), a newly
formed limited liability company. In return for this contribution, the Company
received a 51% interest in Holdings. The Company's interest will decrease to
19% when Netrex makes an additional capital contribution to Holdings, which is
scheduled to occur no later than October 31, 2000. In addition, the Company has
two put agreements, under which the Company has the option to cause Netrex to
purchase all of its interest in Holdings. The first put is exercisable in
December 2004 or January 2005, or earlier upon the occurrence of certain
events, and is for $50 million, plus an amount equal to any additional capital
contributions made by Progressive to Netrex up to $7.6 million, to be paid in
full on December 31, 2011. The second put is exercisable any time on or prior
to December 31, 2001, and is for $15 million, plus the additional capital
contributions discussed above; if exercised, this put would be paid on January
2, 2002. UFAC and its subsidiaries and PVIS provide claims services to fleet
owners and other insurance companies, vehicle inspection services, as well as
software development, and represented less than .5% of the Company's
year-to-date consolidated revenues. The transaction closed on November 5, 1999.
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In April 1999, UFAC purchased a 58.7% interest in Frontier Adjusters of America,
Inc. for $6.8 million. Frontier licenses and franchises independent claims
adjusters throughout the United States and Canada, with 650 advertised
locations. Frontier also owns and operates independent insurance adjusting
businesses in 2 states.
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 (after discount
and underwriting fees) are intended to be used, together with other available
funds, to retire certain of the Company's current outstanding debt upon its
maturity, including $30 million of 8 3/4% Notes, which were due and paid on
June 1, 1999, and $150 million each of 10% Notes and 10 1/8% Subordinated Notes,
both of which are due December 15, 2000.
The Company is currently constructing a corporate office complex in Mayfield
Village, Ohio at an estimated cost of $105.5 million, of which $56.3 million has
been paid through September 30, 1999, including $14.1 million paid in the third
quarter 1999. The first of four buildings was completed in May 1999, with the
second building to be completed by the end of 1999. The third building, parking
garage and fourth building are scheduled to be completed in February 2000,
October 2000 and February 2001, respectively.
The Company has substantial capital resources and believes it has sufficient
borrowing capacity and other capital resources to support current and
anticipated growth.
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 continues to evaluate
its end user computing activities and facilities implications (including public
utility services). The Company 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
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addressing its critical internal systems and issues. As of September 30, 1999,
the Company has substantially completed 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 $9.0 million, of which $8.9 million had been expensed through
September 30, 1999. 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 majority of the projects were completed in
1998, with remaining parallel testing completed during the first half of 1999.
As of September 30, 1999, $5.5 million, which include both internal and external
costs, had been paid for these systems. All costs are being funded through
operating cash flows. In addition, the Company has identified approximately 380
third parties with which data is exchanged. The majority of scheduled critical
data exchanges with our business partners were successfully tested for
compliance.
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 were not incremental costs to the Company. The Company's
remediation of its mainframe hardware and operating software is over 99%
complete and the remediation of its servers and client server operating software
is 98% complete. The Company estimates that all mainframe and client server
hardware and operating software will be year 2000 compliant before the end of
the year. In addition, during 1998, the Company secured software which will
assist in the discovery of noncompliant desktop hardware and software. The
evaluation of software compliance is complete, with all standard software
certified as compliant at the current versions. The Company also completed the
inventory and remediation of SAS code user libraries; all user SAS code was
either remediated by the customers or archived to prevent its usage.
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 continues to contact 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
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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 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 contingency plans were substantially
completed for all material relationships during the first quarter 1999, and were
reviewed in detail in the third quarter 1999. The Company will continue to
review these plans throughout 1999.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995: EXCEPT FOR HISTORICAL INFORMATION, THE MATTERS DISCUSSED IN THIS QUARTERLY
REPORT ON FORM 10-Q 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 AND HEALTH CARE COSTS,
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 QUARTERLY REPORT.
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk.
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. The
duration of the fixed-income portfolio was 3.0 years at September 30, 1999,
compared to 2.9 years at September 30, 1998. Based on a hypothetical 100 basis
point rise in market rates, exposure to risk in terms of a change in market
value is $155 million, or 3.2% of the fixed-income portfolio, at September 30,
1999, compared to $136 million, or 3.2% of the fixed-income portfolio, at
December 31, 1998.
Derivative financial instruments held or issued for purposes of managing
interest rate exposure on the anticipated debt issuance were closed on March 1,
1999, upon the issuance of the $300 million 6 5/8% Senior Notes. The net market
value of these instruments at closing was $3.3 million.
No other material changes have occurred in market risk since reported in the
Annual Report on Form 10-K for the year ended December 31, 1998.
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PART II - OTHER INFORMATION
---------------------------
ITEM 6. Exhibits and Reports on Form 8-K.
(a) Exhibits:
See exhibit index on page 15.
(b) Reports on Form 8-K during the quarter ended September 30, 1999:
None
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE PROGRESSIVE CORPORATION
---------------------------
(Registrant)
Date: November 15, 1999 BY: /s/ W. Thomas Forrester
-------------------------------------
W. Thomas Forrester
Treasurer and Chief Financial Officer
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EXHIBIT INDEX
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Exhibit No. Form 10-Q
Under Reg. Exhibit
S-K Item 601 No. Description of Exhibit
- ------------ --------- ----------------------
(27) 27 Financial Data Schedule for the
nine months ended September 30, 1999
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