The Progressive Corporation DEF 14A
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
SCHEDULE 14A
Proxy Statement Pursuant to Section 14(a) of the Securities
Exchange Act of 1934 (Amendment No.  )
Filed by the Registrant þ
Filed by a Party other than the Registrant o
Check the appropriate box:
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o   Confidential, for Use of the Commission Only (as permitted by Rule 14a-6(e)(2))
þ   Definitive Proxy Statement
o   Definitive Additional Materials
o   Soliciting Material Pursuant to §240.14a-12
 
The Progressive Corporation
 
(Name of Registrant as Specified In Its Charter)
 
 
(Name of Person(s) Filing Proxy Statement, if other than the Registrant)
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(PROGRESSIVE LOGO
 
NOTICE OF ANNUAL MEETING OF SHAREHOLDERS
 
The Progressive Corporation will hold its Annual Meeting of Shareholders on Friday, April 18, 2008, at 10:00 a.m., local time, at 6671 Beta Drive, Mayfield Village, Ohio, for the following purposes:
 
  1.   To elect four directors, each to serve for a term of three years;
 
  2.   To approve amendments to the Company’s Amended Articles of Incorporation and Code of Regulations to adopt a majority voting standard in uncontested elections of directors;
 
  3.   To approve an amendment to the Company’s Code of Regulations to modify the definition of a director’s “term of office”;
 
  4.   To approve an amendment to the Company’s Code of Regulations to increase the maximum number of director positions from 12 to 13 and to fix the number of directors at 13;
 
  5.   To ratify the appointment of PricewaterhouseCoopers LLP as the Company’s independent registered public accounting firm for 2008; and
 
6.  To transact such other business as may properly come before the meeting.
 
The foregoing items of business are more fully described in the Proxy Statement accompanying this Notice. Only shareholders of record of The Progressive Corporation (NYSE:PGR) at the close of business on February 19, 2008, will be entitled to receive notice of and to vote at the meeting or any adjournment thereof.
 
Your vote is important. Whether or not you plan to be present at the meeting, please vote by Internet or telephone (following the instructions on the enclosed proxy card), or by completing and returning the proxy card in the enclosed postage-paid envelope. If you later choose to revoke your proxy, you may do so at any time before voting occurs at the Annual Meeting by following the procedures described in the “Questions and Answers about the Annual Meeting and Voting” section in the attached Proxy Statement.
 
By Order of the Board of Directors.
 
Charles E. Jarrett, Secretary
 
March 7, 2008
 
 
The Proxy Statement and the 2007 Annual Report to Shareholders are also available at progressiveproxy.com.


 

 
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THE PROGRESSIVE CORPORATION
PROXY STATEMENT
 
GENERAL INFORMATION REGARDING PROXY MATERIALS AND THE ANNUAL MEETING OF SHAREHOLDERS TO BE HELD ON APRIL 18, 2008
 
The Board of Directors of The Progressive Corporation provides this Proxy Statement to you to solicit your proxy to act upon the matters outlined in the accompanying Notice of Annual Meeting of Shareholders. These include the election of four directors, amendments to our Amended Articles of Incorporation and Code of Regulations, and the ratification of the appointment of Progressive’s independent registered public accounting firm for 2008, each described in more detail below.
 
The Annual Meeting will take place on Friday, April 18, 2008 at 10:00 a.m., local time, at 6671 Beta Drive, Mayfield Village, Ohio 44143. The proxies also may be voted at any adjournment or postponement of the meeting.
 
The form of proxy (proxy card) and this Proxy Statement, which includes Progressive’s 2007 Annual Report to Shareholders as an Appendix, are being mailed to shareholders beginning on or about March 10, 2008.
 
All properly executed written proxies, and all proxies that are properly completed and submitted by Internet or telephone, will be voted at the meeting in accordance with the directions given by the shareholder, unless the shareholder revokes his or her proxy before voting occurs at the meeting.
 
Only shareholders of record of The Progressive Corporation (NYSE:PGR) at the close of business on February 19, 2008, the record date, will be entitled to receive notice of and to vote at the meeting or any adjournment thereof. Each shareholder on the record date is entitled to one vote for each of our Common Shares, $1.00 par value, held. On the record date, there were 677,988,816 shares of our common stock issued and outstanding.
 
QUESTIONS AND ANSWERS ABOUT THE ANNUAL MEETING AND VOTING
 
Why did I receive these materials?
 
You received these materials because you are a shareholder of Progressive. We hold a meeting of our shareholders annually. This year’s meeting will be held on Friday, April 18, 2008. At the meeting, shareholders will be asked to vote on several items of business. Since it is not practical or convenient for all shareholders to attend the meeting in person, our Board of Directors is seeking your proxy to vote on these matters.
 
What is a proxy?
 
A proxy is your legal authority for another person to vote the stock you own at our Annual Meeting. The person you designate to vote your shares is referred to as your proxy. If you designate someone as your proxy in a written document, that document is also sometimes referred to as a proxy or proxy card. When you submit a proxy card, the person(s) named as your proxy(ies) on the card are required to vote your shares at the Annual Meeting in the manner you have instructed. By voting via proxy, each shareholder is able to ensure that his or her vote is counted without having to attend the Annual Meeting in person.
 
Who is soliciting my proxy?
 
This solicitation of proxies is made by and on behalf of our Board of Directors. The Board has approved the matters to be acted upon at the Annual Meeting (described in more detail below), subject to approval by shareholders, and recommends that you vote in favor of each director nominee named in this Proxy Statement and for each of the other proposals. However, you control your vote, and the voting instructions that you provide will be followed.
 
What is the purpose of the Annual Meeting?
 
At the Annual Meeting, shareholders will act upon the matters outlined in the Notice of Annual Meeting of Shareholders. These include:
 
  •   Election of four directors, each to serve for a term of 3 years;
 
  •   Approval of amendments to our Amended Articles of Incorporation and Code of Regulations to:
 
  —   Elect directors by majority vote in uncontested elections;


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  —   Modify the definition of a director’s “term of office”;
 
  —   Increase the number of director positions on our Board of Directors from 12 to 13 and fix the size of the Board
at 13;
 
  •   Ratification of the selection of PricewaterhouseCoopers LLP as our independent registered public accounting firm for 2008; and
 
  •   Any other business that properly comes before the meeting.
 
Also, once the business of the Annual Meeting is concluded, management will briefly comment on the company’s performance and will be available to respond to appropriate questions from shareholders. The Annual Meeting will not be accessible via teleconference or webcast.
 
What is a proxy statement?
 
This document (including the exhibits, but excluding the 2007 Annual Report to Shareholders attached as an appendix) is our Proxy Statement. The proxy statement is a document that Securities and Exchange Commission (SEC) regulations require us to give shareholders when we are soliciting shareholders’ proxies to vote their shares. This Proxy Statement and the Annual Report contain important information about The Progressive Corporation and its subsidiaries, and about the matters that will be voted on at the meeting. Please read these materials carefully so that you have the information you need to make informed decisions.
 
Who is entitled to vote at the Annual Meeting?
 
Anyone who holds our common stock at the close of business on February 19, 2008, the record date, is entitled to receive the Notice of Annual Meeting and this Proxy Statement and to vote his or her shares at the Annual Meeting. As of the record date, there were 677,988,816 shares of our common stock outstanding and entitled to vote. Each share of common stock is entitled to one vote on each matter properly brought before the meeting.
 
What is the difference between a “shareholder of record” and a shareholder who holds stock in “street name”?
 
If you hold Progressive shares directly in your name with our transfer agent, National City Bank, you are a “shareholder of record” (also known as a “registered shareholder”). The Notice of Annual Meeting, Proxy Statement, 2007 Annual Report to Shareholders and proxy card have been sent directly to you by Progressive or our representative.
 
If you own your shares indirectly through a broker, bank or other financial institution, your shares are said to be held in “street name.” Technically, the bank or broker is the shareholder of record with respect to those shares. In this case, the Notice of Annual Meeting, Proxy Statement, Annual Report to Shareholders and a voting instruction form have been forwarded to you by your broker, bank, other financial institution or their designated representative. Through this process, your bank or broker collects the voting instructions from all of their respective customers who hold Progressive shares and then submits those votes to us.
 
What shares are included on the proxy card?
 
If you are a shareholder of record, you will receive only one proxy card for all the shares of common stock you hold as of February 19, 2008:
 
  •   in certificate form (i.e., you hold paper share certificates as evidence of your ownership); and
 
  •   in book-entry form (i.e., physical certificates are not issued; includes shares held in a direct registration program or shares of restricted stock held by some of our employees and former employees).
 
Employees and former employees who hold shares in our Retirement Security Program (RSP), our 401(k) plan, will receive separate instructions on the number of shares that are eligible to be voted and how to cast their votes on those shares.
 
If you hold shares in street name, the voting instruction form that you receive from your bank or broker should include a statement of the number of shares that you are entitled to vote. Any questions concerning this information should be directed to your bank or broker.


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What methods can I use to vote?
 
By Mail.  All shareholders of record can vote by written proxy card. Please be sure to complete, sign and date the proxy card and return it in the enclosed, prepaid envelope. If you are a street name holder, you will receive a voting form and instructions from your bank or broker.
 
By Telephone or Internet.  All shareholders of record also can vote by touch-tone telephone from the U.S. and Canada, using the toll-free telephone number on the proxy card, or through the Internet using the procedures and instructions described on the proxy card.
 
The availability of telephone and Internet voting for street name holders will depend on the voting processes of your broker, bank or other financial institution. Voting instructions will be included in the materials you receive from them.
 
If you vote by telephone or on the Internet, you do not have to return your proxy card or voting instruction form.
 
In Person.  All shareholders of record may vote in person at the Annual Meeting. Street name holders may vote in person at the Annual Meeting only if they bring a legal proxy from their bank or broker. If you are a street name holder and you plan to vote in person, you must request the legal proxy from your bank or broker well in advance of the meeting date.
 
If you hold shares in our RSP, you will receive voting instructions from our plan administrator. If voting instructions are received by the plan administrator, they will be voted according to the instructions received. If you do not specify your voting instructions in the manner required by the plan administrator, the administrator will not vote your RSP shares. To allow sufficient time for voting by the RSP administrator, your voting instructions must be received by 11:59 p.m., eastern time, on Tuesday, April 15, 2008. You can change your vote at any time prior to this cut-off time; only your last vote will be counted.
 
Whether or not you plan to attend the Annual Meeting, the Board of Directors strongly encourages you to vote your shares by proxy prior to the meeting. Your vote is important. Please follow the voting instructions carefully to make sure that your shares are voted appropriately. You can save us the expense of a second mailing if you vote your shares promptly.
 
If I submit a proxy, may I later change or revoke it?
 
If you are a shareholder of record, you can revoke your proxy before votes are cast at the Annual Meeting by:
 
  •   written notice to the Secretary of the company;
 
  •   timely delivery of a valid, later-dated and signed proxy card or a later-dated vote by telephone or via the Internet; or
 
  •   voting in person at the Annual Meeting.
 
If you are a street name holder of shares, you may submit new voting instructions by contacting your bank, broker or other financial institution. You may also vote in person at the Annual Meeting if you obtain a legal proxy as described in the answer to the previous question.
 
All shares that have been properly voted and not revoked will be voted at the Annual Meeting as instructed.
 
Who counts the votes?
 
Votes will be tabulated by or under the direction of the Inspectors of Election, some of whom may be regular employees of Progressive. The Inspectors of Election will certify the results of the voting at the Annual Meeting.
 
What are my voting choices when voting for director nominees, and what vote is needed to elect directors?
 
When you vote on our nominees for the Board of Directors, you will have the following choices:
 
  •   vote for all nominees (by marking your proxy card “WITH” authority to vote for the election of the nominees);
 
  •   withhold votes as to all nominees (by marking your proxy card “WITHOUT” authority to vote for all nominees); or
 
  •   vote for certain nominees, but withhold votes as to specified nominees (by marking your proxy card “WITH” authority to vote for the nominees, in general, and identifying in the space provided individual nominees as to whom you withhold your authority to vote).
 
The director nominees who receive the greatest number of affirmative votes will be elected directors. Broker non-votes (discussed below) thus will not affect the results of the election. The Board recommends a vote for each of the nominees.


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What are my voting choices when voting on the proposals to amend our Amended Articles of Incorporation or Code of Regulations (Items 2 through 4), and what vote is needed to pass the proposals?
 
For each proposal, you may select from the following choices:
 
  •   vote FOR the proposal;
 
  •   vote AGAINST the proposal; or
 
  •   ABSTAIN from voting on the proposal.
 
The proposal to approve majority voting for directors in uncontested elections (Item 2 below) will be adopted if approved by the affirmative vote of a majority of the company’s common shares outstanding as of the record date. As such, abstentions and broker non-votes will have the same effect as votes against the proposal.
 
The proposals to amend the definition of a director’s “term of office” in our Code of Regulations (Item 3 below) and to increase the number of director positions from 12 to 13 and to fix the number of directors at 13 (Item 4 below) will be adopted if approved by the affirmative vote of seventy-five percent (75%) of the company’s common shares outstanding as of the record date. Abstentions and broker non-votes will have the same effect as votes against the proposal. In addition, shareholders’ approval of Item 3 will be deemed effective only if shareholders have also approved the proposal in Item 2 described in the immediately preceding paragraph.
 
The Board recommends a vote FOR each of the proposals.
 
What are my voting choices when voting on the ratification of the appointment of PricewaterhouseCoopers LLP as our independent registered public accounting firm for 2008 (Item 5 below), and what vote is needed to ratify their appointment?
 
In the vote on the approval of the appointment of PricewaterhouseCoopers LLC as the company’s independent registered public accounting firm for 2008, shareholders may:
 
  •   vote FOR the ratification;
 
  •   vote AGAINST the ratification; or
 
  •   ABSTAIN from voting on the ratification.
 
This proposal will be adopted if approved by the affirmative vote of a majority of the votes cast on this proposal, provided the total number of votes cast represents a majority of the outstanding common shares. Broker non-votes will not be treated as votes cast. Abstentions will be treated as votes cast and, consequently, will have the same effect as votes against the proposal.
 
The Board recommends a vote FOR the ratification.
 
What is a broker non-vote?
 
A broker non-vote occurs when a broker’s or bank’s customer does not provide the broker or bank with voting instructions on “non-routine” matters for shares owned by the customer (sometimes referred to as the “beneficial owner”) but held in the name of the broker or bank. For such matters, the broker or bank cannot vote on behalf of the shareholder and reports the number of such shares as “non-votes.” By contrast, if a proposal is considered “routine,” the broker or bank, in its discretion, may vote any shares as to which it has not received specific instructions from its customer. Whether the proposal is non-routine or routine is governed by the rules of the New York Stock Exchange. Of the proposals included in this Proxy Statement, Item 4 is considered “non-routine” by the NYSE and, therefore, the broker or bank will not be allowed to vote shares with respect to that proposal without specific instructions from the beneficial owner.
 
What if I do not specify a choice for a matter when returning a proxy?
 
Shareholders should specify their choice for each matter on the enclosed proxy card. For shareholders of record, if no specific instructions are given, proxies that are signed and returned will be voted in accordance with the recommendations of the Board of Directors, as follows:
 
  •   FOR the election of all four director nominees, each for a term of 3 years;
 
  •   FOR the proposal to approve amendments to the company’s Amended Articles of Incorporation and Code of Regulations to adopt a majority voting standard in uncontested elections of directors;
 
  •   FOR the proposal to approve an amendment to the company’s Code of Regulations to modify the definition of a director’s “term of office”;


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  •   FOR the proposal to approve an amendment to the company’s Code of Regulations to increase the maximum number of director positions from 12 to 13 and to fix the number of directors at 13; and
 
  •   FOR the proposal to ratify the appointment of PricewaterhouseCoopers LLP as the company’s independent registered public accounting firm for 2008.
 
Can I access the Notice of Annual Meeting, Proxy Statement, Annual Report on Form 10-K and the Annual Report to Shareholders on the Internet?
 
The Notice of Annual Meeting, Proxy Statement and 2007 Annual Report to Shareholders are available on a dedicated Web site at progressiveproxy.com. The Annual Report on Form 10-K is available at the Investor Relations section of our Web Site at progressive.com/sec. We will also provide a copy of any of these documents to any shareholder free of charge, upon request by e-mail to investor_relations@progressive.com, by calling toll-free 1-800-542-1061 or by writing to: The Progressive Corporation, Investor Relations, 6300 Wilson Mills Road, Box W33, Mayfield Village, Ohio 44143.
 
Street Name Holders.  If you hold your shares in a bank or brokerage account, your bank or broker may also provide you copies of these documents electronically. Please check the information provided in the proxy materials mailed to you by your bank or broker regarding the availability of this service.


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ITEM 1: ELECTION OF DIRECTORS
 
Four of our directors have been nominated for re-election this year. Information about the structure of our Board of Directors and about our individual directors follows.
 
Progressive’s Code of Regulations provides that the number of directors shall be fixed at no fewer than five and no more than 12. The number of directors has been fixed by shareholders at 12, and there are currently 11 directors on the Board and one vacancy. The Code of Regulations also provides that the directors are to be divided into three classes as nearly equal in number as possible and that the classes are to be elected for staggered terms of three years each. Directors of one class are elected annually, except as provided below. At the Annual Meeting, the shares represented by the proxies obtained hereby, unless otherwise specified, will be voted for the election as directors of the four nominees named below, each to serve for a three-year term, and until their respective successors are duly elected and qualified. If, by reason of death or other unexpected occurrence, any one or more of the nominees named below is not available for election, the proxies will be voted for such substitute nominee(s), if any, as the Board of Directors may propose.
 
Based upon a recommendation from the Board’s Nominating and Governance Committee, the Board has nominated the four nominees named below for re-election to the Board. No shareholder nominations for the election of directors have been received within the time period specified by Section 13 of Article II of our Code of Regulations or pursuant to our Shareholder-Proposed Candidate Procedures (discussed below). Proxies cannot be voted at the Annual Meeting for a greater number of persons than the four nominees named in this Proxy Statement.
 
If written notice is given by any shareholder to the President, a Vice President or the Secretary not less than 48 hours before the time fixed for holding the Annual Meeting that he or she desires that the voting for election of directors shall be cumulative, and if an announcement of the giving of such notice is made at the meeting by the Chairman or Secretary or by or on behalf of the shareholder giving such notice, each shareholder shall have the right to cumulate his or her voting power in the election of directors. Under cumulative voting, each shareholder may give one nominee a number of votes equal to the number of directors to be elected multiplied by the number of shares he or she holds, or distribute such number of votes among two or more nominees, as the shareholder sees fit. If the enclosed proxy is executed and returned and voting for the election of directors is cumulative, the persons named in the enclosed proxy will have the authority to cumulate votes and to vote the shares represented by such proxy, and by other proxies held by them, so as to elect as many of the four nominees named below as possible.
 
Pursuant to our Corporate Governance Guidelines, if a nominee for director receives less than a majority of the votes cast in an uncontested election, although the nominee is elected as a director under Ohio law, he or she is expected to tender his or her resignation to the Board. In such an event, the Nominating and Governance Committee will consider the resignation offer and recommend to the Board whether to accept or reject it. The Board will then make the final decision whether to accept or reject the tendered resignation based on all the facts and circumstances then presented. (Note that if shareholders approve the proposals presented in this Proxy Statement as Item 2 (majority voting for directors in uncontested elections) and Item 3 (modifications to the definition of a director’s “term of office”), the Board expects to modify the procedures summarized in this paragraph as appropriate to reflect the amendments to our Amended Articles of Incorporation and Code of Regulations that are approved under those proposals.)
 
The Board currently has one vacancy. Under our Code of Regulations, the Board has the right to elect a new director to fill such a vacancy, but the new director so elected would serve for a term that expires on the date of the next shareholder meeting at which directors are to be elected. No decision has been made to fill the vacancy at this time.


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The following information is provided for each person nominated for election as a director and for those directors whose terms will continue after the Annual Meeting. Unless otherwise indicated, each such nominee or director has held the principal occupation indicated for more than the last five years. Each nominee is currently a director of Progressive.
 
Nominees for Election at the Annual Meeting
 
                                 
          Principal Occupation and
      Director
    Term
 
Name   Age     Last Five Years Business Experience   Other Directorships   Since     Expires  
   
Charles A. Davis

(Kohnstamm Photo)
    59     Chief Executive Officer, Stone Point Capital LLC, Greenwich, Connecticut (global private equity firm) since June 2005; Chairman and CEO, MMC Capital, Inc., Greenwich, Connecticut (global private equity firm) prior to June 2005; Vice Chairman, Marsh & McLennan Companies, Inc., New York, New York (financial services) prior to December 2004   AXIS Capital Holdings Limited, Media General, Inc., and The Hershey Company     1996       2011  
                                 
Bernadine P. Healy, M.D.

(Lewis Photo)
    63     Health Editor and Medical Columnist, U.S. News & World Report, Washington, D.C. (publishing)   Ashland Inc., Invacare Corporation and National City Corporation     2002       2011  
                                 
Jeffrey D. Kelly

(Lewis Photo)
    54     Chief Financial Officer, National City Corporation (“NCC”), Cleveland, Ohio (commercial banking); Vice Chairman of NCC since December 2004; Executive Vice President of NCC prior to December 2004   National City Corporation     2000       2011  
                                 
Abby F. Kohnstamm

(Lewis Photo)
    54     President and Chief Executive Officer, Abby F. Kohnstamm & Associates, Inc., New York, New York (marketing consulting firm) since January 2006; Senior Vice President of Marketing, IBM Corporation, Armonk, New York (information technology) prior to December 2005   Tiffany & Co.     2006       2011  


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Directors Whose Terms will Continue after the Annual Meeting
 
                                 
          Principal Occupation and
      Director
    Term
 
Name   Age     Last Five Years Business Experience   Other Directorships   Since     Expires  
   
Stephen R. Hardis

(Hardis Photo)
    72     Non-Executive Chairman of the Board, Marsh & McLennan Companies, Inc., New York, New York (financial services) since May 2006; Lead Director, Axcelis Technologies, Inc., Beverly, Massachusetts (semiconductor equipment manufacturing) since May 2005; Chairman of the Board, Axcelis Technologies, Inc. prior to May 2005   American Greetings Corporation, Axcelis Technologies, Inc., Lexmark International, Inc., Marsh & McLennan Companies, Inc. and Nordson Corporation     1988       2009  
                                 
Norman S. Matthews

(Matthews Photo)
    75     Consultant, New York, New York   Finlay Enterprises, Inc. and Henry Schein, Inc.     1981       2009  
                                 
Bradley T. Sheares, Ph.D.

(Sheares Photo)
    51     Formerly Chief Executive Officer, Reliant Pharmaceuticals, Inc., Liberty Corner, New Jersey (pharmaceutical products) from January 2007 to December 2007; President, U.S. Human Health Division of Merck & Co., Inc., Whitehouse Station, New Jersey (pharmaceutical products and services) prior to July 2006   Honeywell International, Inc.     2003       2009  
                                 
Peter B. Lewis

(Lewis Photo)
    74     Non-Executive Chairman of the Board of The Progressive Corporation since March 2003; Executive Chairman of the Board prior to March 2003   None     1965       2010  
                                 


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          Principal Occupation and
      Director
    Term
 
Name   Age     Last Five Years Business Experience   Other Directorships   Since     Expires  
   
Patrick H. Nettles, Ph.D.

(Lewis Photo)
    64     Executive Chairman of the Board of Directors, Ciena Corporation, Linthicum, Maryland (telecommunications)   Axcelis Technologies, Inc. and Ciena Corporation     2004       2010  
                                 
Glenn M. Renwick

(Lewis Photo)
    52     President and Chief Executive Officer of The Progressive Corporation; President, Chairman of the Board and Chief Executive Officer of Progressive Casualty Insurance Company (a Progressive subsidiary) prior to April 2004; officer and director of various other subsidiaries of Progressive   Fiserv, Inc.     1999       2010  
                                 
Donald B. Shackelford

(Lewis Photo)
    75     Chairman of the Board, Fifth Third Bank, Central Ohio (successor to State Savings Bank), Columbus, Ohio (commercial banking)   Diamond Hill Investment Group, Inc.     1976       2010  
                                 

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OTHER BOARD OF DIRECTORS INFORMATION
 
Board of Directors Independence Standards and Determinations
 
The Board of Directors has approved categorical independence standards which, if satisfied by a director, will permit a determination that such director is independent for purposes of the New York Stock Exchange (NYSE) Listing Standards. Under Progressive’s standards, an individual director may be determined to be “independent” only if he or she satisfies each of the following requirements, or if he or she is otherwise determined to be independent by a disinterested majority of the Board as provided below:
 
  •   He or she is not currently an officer or employee of The Progressive Corporation or any of its subsidiaries, and has not been an officer or employee of Progressive or any of its subsidiaries at any time during the past three years. For purposes of this requirement, “officer” does not include a non-executive Chairman of the Board who is otherwise independent under these standards.
 
  •   No member of his or her immediate family is an executive officer of Progressive or has been an executive officer of Progressive at any time during the past three years.
 
  •   Neither he or she, nor any member of his or her immediate family, receives, or has received during any twelve-month period within the past three years, more than $100,000 in direct compensation from Progressive or any of its subsidiaries, other than (i) retainer and meeting fees and equity grants for service as a director, and (ii) pension or other forms of deferred compensation for prior service (provided such compensation is not contingent on continued service). For purposes of this requirement, compensation received by an immediate family member for service as an employee of Progressive (other than as an executive officer) will not be considered.
 
  •   He or she (i) is not currently a partner or employee of a firm that is Progressive’s internal or external auditor, and (ii) was not at any time within the past three years a partner or employee of such a firm who personally worked on Progressive’s audit during that time.
 
  •   No member of his or her immediate family (i) is currently a partner in a firm that is Progressive’s internal or external auditor, (ii) is currently an employee of such firm who participates in the firm’s audit, assurance or tax compliance (but not tax planning) practice, or (iii) was at any time within the past three years a partner or employee of such firm and personally worked on Progressive’s audit during that time.
 
  •   Neither he or she, nor any member of his or her immediate family, is or has been at any time during the past three years, employed as an executive officer of another company where any of the present executive officers of Progressive at the same time serves or served on the compensation committee of such other company.
 
  •   Neither he or she, nor any member of his or her immediate family, has a direct business or other relationship with Progressive or any of its subsidiaries (as a lawyer, consultant or otherwise), other than as a director of Progressive, or has had any such business or other relationship with Progressive at any time during the past three years. For purposes of this requirement, service by an immediate family member as an employee of Progressive (other than as an executive officer) will not compromise the director’s independence.
 
  •   Neither he or she, nor any member of his or her immediate family, is a member of or counsel to any law firm that Progressive has retained during the last fiscal year or proposes to retain during the current fiscal year.
 
  •   Neither he or she, nor any member of his or her immediate family, is a partner or executive officer of any investment banking firm that has performed services for Progressive (other than as a participating underwriter in a syndicate) during the last fiscal year or that Progressive proposes to have perform such services during the current fiscal year.
 
  •   He or she is not a current employee of, and no member of his or her immediate family is a current executive officer of, and neither he or she nor any member of his or her immediate family holds a one percent or greater equity interest in, any other company or organization that has, or has had at any time within the past three years, a material business or other relationship with Progressive or any of its subsidiaries. For purposes of this standard, a relationship will be deemed to be material if the total amount of the payments made or received by Progressive or any of its subsidiaries in connection with such business or other relationship during the relevant fiscal year was, or for the current fiscal year is expected to be, more than the greater of (i) $1 million or (ii) two percent of the consolidated gross revenues of such other entity.
 
Contributions by Progressive to a charitable or non-profit organization in which a director or his or her spouse serves as a director, trustee or executive officer or in an equivalent position will be deemed immaterial under Progressive’s standards if Progressive’s contributions to such organization in any calendar year do not exceed $25,000 (excluding matching gifts made by The Progressive Insurance Foundation in response to employee contributions to such organization). If Progressive makes


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annual contributions in excess of the stated amount to any such organization, the effect, if any, on the director’s independence will be considered on a case-by-case basis.
 
If a director has one or more relationships with Progressive that fall outside of our categorical standards, the materiality of such other relationships will be determined by a disinterested majority of directors on a case-by-case basis. Material relationships can include commercial, industrial, banking, consulting, legal, accounting, charitable and familial relationships, among others. The ownership of even a significant amount of stock, by itself, however, is not a bar to a finding of independence.
 
The Board of Directors has considered the independence of each of the directors under the foregoing standards and, based on such considerations and the recommendations of the Nominating and Governance Committee of the Board of Directors, and after due inquiry into the facts and circumstances of each director’s relationships with Progressive (if any), has determined that each of our current directors, with the exception of Glenn M. Renwick as discussed further below, (i) satisfies Progressive’s independence standards as described above, (ii) has no relationship with Progressive or its subsidiaries or with any charitable organization that received a contribution from Progressive that would require an individual determination as to such director’s independence, and (iii) is independent under the applicable NYSE Listing Standards.
 
Mr. Philip Laskawy, who resigned from our Board in December 2007, had been determined by the Board to be independent in early 2007. Due to his resignation, his independence was not reconsidered in early 2008 along with our current directors, although management is aware of no facts or circumstances that would have changed his status prior to his resignation.
 
Mr. Glenn M. Renwick is not independent by virtue of his position as Progressive’s current President and Chief Executive Officer.
 
Meetings of the Board of Directors and Attendance
 
The Board of Directors held nine meetings during 2007, two of which were held by conference call.
 
All of the current directors were on the Board throughout 2007. All directors attended more than 75% of their scheduled Board and Committee meetings.
 
Pursuant to Progressive’s Corporate Governance Guidelines, directors are expected to attend Progressive’s Annual Meeting of Shareholders. Normally, a meeting of the Board will be scheduled on the date of the Annual Meeting. Progressive’s 2007 Annual Meeting of Shareholders was attended by 11 out of 12 of its then current directors. A full copy of our Corporate Governance Guidelines can be found on our Web site at progressive.com/governance, or may be requested in print by writing to: The Progressive Corporation, Investor Relations, 6300 Wilson Mills Road, Box W33, Mayfield Village, Ohio 44143.
 
Meetings of the Non-Management Directors
 
Pursuant to Progressive’s Corporate Governance Guidelines, our non-management directors meet in executive session at least quarterly. Each such meeting also constitutes a meeting of our independent directors. The Chairman of the Board, provided that he or she is not an executive officer of Progressive, presides at these meetings. In the event that a non-executive Chairman is not available to lead these meetings, the presiding director would be chosen by the non-management directors in attendance. In 2007, the non-management directors met in executive session six times.
 
Board Committees
 
The Board has named an Executive Committee, an Audit Committee, a Compensation Committee, an Investment and Capital Committee, and a Nominating and Governance Committee, as described below. The complete written charters for each of the Committees (other than the Executive Committee, which does not have a charter) can be found on our Web site at progressive.com/governance, or may be requested in print by writing to: The Progressive Corporation, Investor Relations, 6300 Wilson Mills Road, Box W33, Mayfield Village, Ohio 44143.
 
Executive Committee
 
Messrs. Hardis, Kelly, Lewis (Chairman) and Renwick are the current members of the Board’s Executive Committee, which exercises all powers of the Board between Board meetings, except the power to fill vacancies on the Board or its Committees. During 2007, the Executive Committee did not meet, but adopted resolutions by written action pursuant to Ohio corporation law on 13 occasions.


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Audit Committee
 
Drs. Healy and Nettles and Mr. Hardis (Chairman) are the current members of the Board’s Audit Committee, which assures that the organizational structure, policies, controls and systems are in place to monitor performance. The Audit Committee monitors the integrity of Progressive’s financial statements, our financial reporting processes and internal control over financial reporting, our compliance with legal and regulatory requirements and the public release of financial information. The Committee also is responsible for confirming the independence of, and the selection, appointment, compensation, retention and oversight of the work of, our independent registered public accounting firm. The Committee provides an independent channel to receive appropriate communications from employees, shareholders, auditors, legal counsel, bankers, consultants and other interested parties. The Board of Directors has determined that each of the members of the Audit Committee is financially literate, has no relationship to Progressive that may interfere with the exercise of his or her independence from management and Progressive, and is independent as defined in the applicable Securities and Exchange Commission (“SEC”) rules and NYSE Listing Standards. During 2007, the Audit Committee met in person seven times and participated in five conference calls to review our financial and operating results.
 
Audit Committee Financial Expert.  The Board of Directors has determined that Mr. Stephen R. Hardis, the Chairman of the Audit Committee, is an audit committee financial expert, as that term is defined in the applicable SEC regulations, and that he has accounting or related financial management expertise, as required by the NYSE Listing Standards. Mr. Hardis is a former Chairman and Chief Executive Officer of Eaton Corporation, where he served as Chief Financial and Administrative Officer before becoming CEO. He has served on the audit committees of a number of public companies through the years, including as a member of Progressive’s Audit Committee from April 1988 through December 1999. He is currently the chairman of the audit committee of one other public company, where he has also been named the audit committee financial expert. The Board has determined that through appropriate education and experience, Mr. Hardis has demonstrated that he possesses the following attributes:
 
  •   An understanding of accounting principles generally accepted in the United States of America and financial statements;
 
  •   The ability to assess the general application of such principles in connection with the accounting for estimates, accruals and reserves;
 
  •   Experience preparing, auditing, analyzing or evaluating financial statements that present a breadth and level of complexity of accounting issues that are generally comparable to the breadth and level of complexity that can reasonably be expected to be raised by Progressive’s financial statements, or experience actively supervising one or more persons engaged in such activities;
 
  •   An understanding of internal control over financial reporting; and
 
  •   An understanding of audit committee functions.
 
Compensation Committee
 
Messrs. Davis (Chairman) and Matthews and Dr. Sheares are the current members of the Board’s Compensation Committee. During 2007, the Compensation Committee met four times in person and three times by phone, and adopted resolutions by written action pursuant to Ohio corporation law on four occasions.
 
The Committee makes all final determinations regarding executive compensation, including salary, equity (restricted stock awards) and non-equity incentive compensation (cash incentive) targets, and related performance goals, formulae and procedures. The Committee (or in certain circumstances, the full Board of Directors, based on the Committee’s recommendation) also approves the terms of the various compensation and benefit plans in which executive officers and other employees may participate. Committee decisions are made after considering compensation data from comparable companies obtained by Progressive from independent third parties, internal analysis and/or recommendations presented by management. The executive compensation decisions represent the culmination of extensive analysis and discussion, which typically take place over the course of multiple Committee meetings and in meetings between the Committee and management, including our Chief Executive Officer, our Chief Human Resource Officer, members of the Human Resource and Law Departments, and other Progressive personnel. In addition, the Committee frequently consults with the full Board of Directors on executive compensation matters.
 
The Committee’s determinations regarding incentive compensation for executive level employees (for example, performance criteria and standards relating to annual cash bonus determinations) also apply to incentive plans covering non-executive employees. Under this arrangement, executives and non-executives alike are motivated to achieve the same


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performance objectives. The Committee has delegated to management, however, the authority to implement such plans, and make other compensation-related decisions (such as salary and restricted stock awards), for non-executive level employees.
 
The Committee has the authority under its Charter to hire its own compensation consultants, at Progressive’s expense. The Committee regularly assesses the need for a consultant, most recently considering the issue at its January 2008 meeting. The Committee decided that a consultant would not be hired at that time, in view of Progressive’s consistent compensation program, the program’s significant performance-based features that have been successfully tested in both good and bad performance years, and the availability of credible market data from independent third parties, among other factors. The Committee has clearly indicated that it remains open to hiring a consultant in the future should circumstances change, and that it will continue to monitor these and other relevant factors and reconsider the issue from time to time. For more information on executive compensation, see the “Compensation Discussion and Analysis” section beginning on page 22.
 
Investment and Capital Committee
 
Messrs. Kelly (Chairman), Lewis and Shackelford are the current members of the Board’s Investment and Capital Committee, which monitors and advises Progressive on its investment and capital management policies. During 2007, the Investment and Capital Committee met six times.
 
Nominating and Governance Committee
 
Messrs. Davis, Hardis and Matthews (Chairman) are the current members of the Board’s Nominating and Governance Committee. The Committee considers the qualifications of individuals who are proposed as possible nominees for election to the Board and makes recommendations to the Board with respect to such potential candidates.
 
The Committee also is responsible for monitoring corporate governance matters as they affect the Board and the company. The Committee regularly reviews Progressive’s Corporate Governance Guidelines and related matters to ensure that they continue to correspond to and support the Board’s governance philosophy. The Committee considers and, where appropriate, recommends to the Board for approval, changes to the Corporate Governance Guidelines based on suggestions from Board members or management. The Committee reviewed the Guidelines in 2007, and proposed several changes including, most significantly, the addition of stock ownership guidelines for the CEO and the executive officers who report directly to him. These changes were adopted by the Board during 2007.
 
In addition, the Nominating and Governance Committee led the Board’s consideration of issues relating to majority voting in uncontested director elections, due to a change in Ohio law on the subject, and proposed amendments to the company’s Amended Articles of Incorporation and Code of Regulations to adopt majority voting in uncontested directors elections and related modifications. These proposals were also adopted by the Board, subject to shareholder approval, and are included in this Proxy Statement as the proposals set forth in Items 2 and 3. Finally, in reviewing the operation of the Board and its flexibility to recruit and attract director candidates, the Committee determined that an increase in the size of the Board by one member would be desirable. The Board again agreed, and this issue is presented for shareholder approval below in Item 4.
 
Until December 2007, the Board had not had a vacancy in approximately 18 months, so an active search for new directors was not ongoing. In the past, a search firm had been retained to assist in such searches, and the Committee has the authority to retain such a firm to assist with the current vacancy, and future vacancies, if it so chooses.
 
During 2007, the Nominating and Governance Committee met four times. The Committee regularly reviews the qualifications of potential candidates for the Board. The Committee recommended the four nominees named above, each of whom is currently a director, for re-election to the Board.
 
Shareholder-Proposed Candidate Procedures.  Pursuant to the Nominating and Governance Committee’s Charter, the Board has adopted a policy of considering director candidates who are recommended by Progressive’s shareholders. In addition, the Committee has adopted Procedures for Shareholders to Propose Candidates for Directors (the “Shareholder-Proposed Candidate Procedures” or “Procedures”).
 
Any shareholder desiring to propose a candidate for election to the Board under these Procedures may do so by mailing to Progressive’s Secretary a written notice identifying the candidate. The written notice must also include the supporting information required by the Shareholder-Proposed Candidate Procedures, the complete text of which can be found on our Web site at progressive.com/governance. The notice and supporting information should be sent to the Secretary at the following address: Charles E. Jarrett, Secretary, The Progressive Corporation, 6300 Wilson Mills Road, Mayfield Village, Ohio 44143. Upon receipt, the Secretary will forward the notice, and the other information provided, to the Committee.


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The nominating shareholder may also include any additional information that the shareholder believes is relevant to the Committee’s consideration of the candidate. If a shareholder proposes a candidate without submitting all of the foregoing items, the Committee, in its discretion, may reject the proposed candidate, request more information from the nominating shareholder, or consider the proposed candidate while reserving the right to request more information. In addition, the Committee may further limit each shareholder to one proposed candidate in any calendar year and may refuse to consider any additional candidate(s) proposed by such shareholder or its affiliates during the calendar year.
 
Shareholders may propose candidates to the Committee pursuant to the Shareholder-Proposed Candidate Procedures at any time. However, to be considered by the Committee in connection with Progressive’s next Annual Meeting of Shareholders (held in April of each year), the Secretary must receive the shareholder’s proposal and the information required above on or before November 30th of the year immediately preceding such Annual Meeting.
 
It is the Committee’s policy to review and evaluate each candidate for nomination submitted by shareholders in accordance with the Shareholder-Proposed Candidate Procedures on the same basis as candidates who are suggested by our Board members, executive officers or other sources, which may include professional search firms retained by the Committee. The Committee will give strong preference to candidates who are likely to be deemed independent from Progressive under SEC and NYSE rules. As to shareholder-proposed candidates, the Committee may give more weight to candidates who are unaffiliated with the shareholder proposing their nomination and to candidates who are proposed by long-standing shareholders with significant share ownership (i.e., greater than 1% of Progressive’s common shares that have been owned for more than two years).
 
In considering director nominations, the Committee will consider: the current composition of the Board and how it functions as a group; the talents, personalities, strengths and weaknesses of current Board members; the value of contributions made by individual Board members; the need for a person with specific skills, experiences or background to be added to the Board; any available or anticipated vacancies due to retirement or other reasons; and other factors which may enter into the nomination decision. Upon the expiration of a director’s term on the Board, that director will be given preference for nomination when the director indicates his or her willingness to continue serving and, in the Committee’s judgment, the director has made and is likely to continue to make a significant contribution to the Board and Progressive.
 
When considering an individual candidate’s suitability for the Board, the Committee will evaluate each individual on a case-by-case basis. The Committee does not prescribe minimum qualifications or standards for directors, but instead looks for directors who have demonstrated the ability to satisfy the fundamental criteria set forth in the Committee’s Charter — integrity, judgment, commitment, preparation, participation and contribution. In addition, the Committee will review the extent of the candidate’s demonstrated excellence and success in his or her chosen business, profession or other career and the skills and talents that the candidate would be expected to add to the Board. The Committee may choose, in individual cases, to conduct interviews with the candidate and/or contact references, business associates, other members of boards on which the candidate serves or other appropriate persons to obtain additional information. Such background inquiries may also be conducted, in whole or in part, on the Committee’s behalf by third parties, such as professional search firms. The Committee will make its determinations on whether to nominate an individual candidate based on the Board’s then-current needs, the merits of that candidate and the qualifications of other available candidates. If a candidate is not nominated, the Committee will have the discretion to reconsider his or her candidacy in connection with future vacancies on the Board.
 
The Committee’s decision not to nominate a particular individual for election to the Board will not be publicized by Progressive, unless required by applicable laws or NYSE rules. The Committee will have no obligation to respond to shareholders who propose candidates that the Committee has determined not to nominate for election to the Board, but the Committee may choose to do so in its sole discretion.
 
These Shareholder-Proposed Candidate Procedures are in addition to any rights that a shareholder may have under our Code of Regulations or under any applicable laws or regulations in connection with the nomination of directors for our Board.
 
Communications with the Board of Directors
 
The Board of Directors has adopted procedures for shareholders to send written communications to the Board as a group. Such communications must be clearly addressed to the Board of Directors and sent to either of the following, at the election of the shareholder:
 
  •   Peter B. Lewis, Chairman of the Board, The Progressive Corporation, 6300 Wilson Mills Road, Mayfield Village, Ohio 44143 or e-mail: peter_lewis@progressive.com.
 
  •   Charles E. Jarrett, Secretary, The Progressive Corporation, 6300 Wilson Mills Road, Mayfield Village, Ohio 44143 or e-mail: chuck_jarrett@progressive.com.


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In addition, interested parties may contact the non-management directors as a group by sending a written communication to either of the above-named individuals. Such communication must be clearly addressed to the non-management directors.
 
The recipient will promptly forward communications so received to the full Board of Directors or to the non-management directors, as specified by the shareholder.
 
Certain Relationships and Related Transactions
 
Transactions between The Progressive Corporation or its subsidiaries and any director or executive officer, or any entity in which one or more of our directors or executive officers is a substantial owner, director or executive officer, must be disclosed to and, if appropriate, approved by, our Board of Directors. Our Code of Business Conduct and Ethics prohibits directors and executive officers from having a direct or indirect financial interest in any transaction involving Progressive, unless either: (i) the transaction is disclosed to and approved by a disinterested majority of the Board; or (ii) with respect to a transaction with another publicly held company, the transaction and the Progressive person’s status as a director, officer, consultant or advisor to such other company are known to the Board, a disinterested majority of the Board does not object to the person’s continued service to such other public company, and the annual payments to or from Progressive under the transaction do not exceed the lesser of 1% of Progressive’s or such other company’s consolidated revenues.
 
This policy is carried out by the Law Department as transactions with such persons or entities, or proposals for such transactions, are identified by management or disclosed by members of the Board. As indicated above, the policy applies to all transactions that occur between Progressive and the persons or entities described above. If a transaction with any such person or entity is proposed or entered into during the course of the year, the transaction is presented to the Board for consideration, typically at its next meeting. In addition, all previously approved transactions that are expected to continue into a new year are presented to the Board for review on an annual basis at the Board’s first meeting of the year (in January or February). This procedure further allows the Board to consider these relationships at the same time that it is considering whether directors are independent under applicable rules and regulations.
 
The following discussion sets forth the relationships and transactions known by management at this time to involve Progressive or its subsidiaries and such persons or entities. In each case, pursuant to the policies described above, these transactions have been disclosed to the Board of Directors and a disinterested majority of the Board approved the transaction or, in the case of ongoing relationships that were presented to the Board, permitted the continuation or renewal of the relationship.
 
  •   Mr. Jeffrey D. Kelly, a director of Progressive, is the Vice Chairman and Chief Financial Officer of National City Corporation, the parent company of National City Bank (“NCB”). Dr. Bernadine P. Healy, a director of Progressive, is also a director of National City Corporation. NCB is the Transfer Agent and Registrar for our common shares and received fees of $81,572 for such services for 2007. Additionally, we use NCB for commercial banking services and paid $1,303,367 to NCB in service charges during 2007. In each case, these charges represented NCB’s customary rates.
 
Progressive also has an uncommitted line of credit with NCB in the principal amount of $125 million. We do not incur any commitment fees for this arrangement and no borrowings were outstanding under this line of credit at any time during 2007. A subsidiary of Progressive has $125 million on deposit with NCB. These funds are invested in interest-bearing securities approved by us. This line of credit and the deposit are components of our cash contingency arrangement to ensure the availability of those funds in the event of certain emergencies affecting capital markets and banking operations.
 
We have established a $36 million trust on behalf of the policyholders of a nonconsolidated affiliate of Progressive, with NCB as trustee, in order to maintain the A.M. Best rating of the nonconsolidated affiliate. We incur an annual trustee fee of $15,000 in connection with this trust, which represents NCB’s customary rates.
 
  •   Mr. Stephen R. Hardis, a director of Progressive, is also a director and non-executive chairman of Marsh & McLennan Companies, Inc. (“Marsh”). Progressive pays commissions to various subsidiaries of Marsh for brokerage services in the ordinary course of our auto and non-auto insurance businesses, at customary rates for the services rendered. During 2007, we paid $1,057,506 for these services.
 
During 2007, we also paid $10,796 to a division of Mercer Management Consulting, Inc. (“Mercer”), a subsidiary of Marsh, for compensation and benefits surveys. The fees paid to Mercer were customary rates for the products purchased or services rendered.


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  •   Mr. Charles A. Davis, a director of Progressive, serves as a director of AXIS Capital Holdings Limited (“AXIS”). During 2007, AXIS reinsured part of the risk we have under the policies we wrote for directors’ and officers’ liability insurance, trust errors and omissions insurance and bond products. AXIS provides reinsurance coverage of $2.8 million on policy limits of $15 million, for losses incurred in excess of the first $1 million. During 2007, we paid $2,839,028 in premiums to AXIS, and collected $1,678,881 on paid losses related to, this coverage. At December 31, 2007, we had $2,797,757 of reinsurance recoverables on unpaid losses under this arrangement. AXIS is one of several companies that we use to reinsure this non-auto line of business. The terms of this reinsurance arrangement with AXIS are consistent with those between us and the other reinsurers.
 
  •   Mr. Philip A. Laskawy, a former director of Progressive, who left the Board in December 2007, is also a director of Cap Gemini, S.A., a French public company. In 2007, we paid $7,504,456 to Cap Gemini, S.A., for information technology consulting fees. These charges represent the customary rates for services provided.
 
  •   Mr. Glenn M. Renwick, President, Chief Executive Officer and a director of Progressive, is also a director of Fiserv, Inc. We paid $35,847 to Fiserv, Inc., or its subsidiaries, for comparative rating software during 2007. These charges represent the customary rates for the products purchased.
 
  •   In 2006, a subsidiary of Progressive and a company owned by Mr. Peter B. Lewis, Chairman of the Board, entered into a sublease for space at an airplane hangar leased by the subsidiary, to house the airplane owned by Mr. Lewis’s company and related personnel and equipment. The sublease has a 5-year term that commenced in October 2006, and Mr. Lewis’s company has options to extend the sublease for three additional 5-year terms. Under the sublease, Mr. Lewis’s company rents approximately two-thirds of the hangar space and one-half of the office space at the facility, and it further reimburses one-half of other occupancy costs (such as common area maintenance, insurance, taxes, etc.) and one-half of certain construction and capital expenses. In addition, Mr. Lewis’s company reimburses Progressive for fuel for its aircraft, based on actual fuel used, plus one-half of the fuel flow fee incurred by us under our lease for the hangar. During 2007, Mr. Lewis’s company paid Progressive’s subsidiary a total of $468,146 for rent and other occupancy expenses in accordance with the terms of the sublease, including its one-half share of the construction costs associated with tenant improvements.
 
  •   The following relatives of executive officers and directors worked for Progressive in 2007: the son of Mr. Forrester (retired CFO), Ian Forrester, as a product manager; the brother of Brian Domeck (CFO), John Domeck, as an attorney; and the son-in-law of Mr. Hardis (director), Stephen Ware, who works in our information technology area. The dollar value of each of these employment relationships for 2007 was less than $175,000. In determining the dollar value of these relationships, we used the same methodology that is used to determine compensation for named executive officers in the Summary Compensation Table below, under which total compensation includes, to the extent applicable to each individual, salary paid in 2007, Gainsharing and other bonuses earned in 2007, restricted stock expense recognized by Progressive during the year, company-matching contributions to retirement security (401k) accounts and other compensation, but excludes health and welfare benefits that are available generally to all salaried employees, as contemplated by the applicable regulations. In each case, we believe that the level of compensation is appropriate in view of the individual’s position, responsibilities and experience and is consistent with our companywide compensation structure.
 
Compensation Committee Interlocks and Insider Participation
 
Messrs. Davis and Matthews and Dr. Sheares served as members of Progressive’s Compensation Committee during 2007. There are no Compensation Committee interlocks.


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REPORT OF THE AUDIT COMMITTEE
 
The following Report of the Audit Committee does not constitute soliciting material and should not be deemed filed or incorporated by reference into any other Progressive filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent Progressive specifically incorporates this Report by reference therein.
 
The Audit Committee of the Board of Directors (the “Committee”) oversees Progressive’s financial reporting process on behalf of the Board. Progressive’s management has the primary responsibility for the financial statements and the reporting process, including the systems of internal control. In fulfilling its oversight responsibilities, the Committee reviewed and discussed with management Progressive’s audited financial statements for the year ended December 31, 2007, including a discussion of the quality, not just the acceptability, of the accounting principles, reasonableness of significant judgments and clarity of disclosures in the financial statements.
 
The Committee has discussed with PricewaterhouseCoopers LLC (“PWC”), Progressive’s independent registered public accounting firm, which is responsible for expressing an opinion on the conformity of the financial statements with accounting principles generally accepted in the United States of America, PWC’s judgment as to the quality, not just the acceptability, of Progressive’s accounting principles and such other matters as are required to be discussed with the Committee under Statement on Auditing Standards No. 61, as amended, “Communication with Audit Committees.” In addition, the Committee has received the written disclosures and letter from PWC required by Independence Standards Board Standard No. 1 and has discussed with PWC their independence from management and Progressive.
 
The Committee discussed with Progressive’s internal auditors and PWC the overall scope and plans for their respective audits. The Committee meets with the internal auditors and PWC, with and without management present, to discuss the results of their examinations, evaluations of Progressive’s internal controls and the overall quality of Progressive’s financial reporting. During 2007, the Committee held seven meetings and participated in five conference calls to review Progressive’s financial and operating results. Also, during 2007, the Committee reassessed the adequacy of the Audit Committee’s Charter, recommended certain minor modifications to the Charter and approved the Charter, as so modified, and recommended that the Charter be submitted for approval to the full Board of Directors. The Board approved the Charter, as so modified, on December 14, 2007, and it became effective as of January 1, 2008. A copy of the Charter, as so approved, is available on our Web site at progressive.com/governance.
 
Based on the reviews and discussions referred to above, the Committee recommended to the Board that the audited financial statements be included in The Progressive Corporation’s Annual Report on Form 10-K for the year ended December 31, 2007, for filing with the Securities and Exchange Commission.
 
The Committee has selected and retained PWC to serve as the independent registered public accounting firm for Progressive and its subsidiaries for 2008. Shareholders will be given the opportunity to express their opinion on ratification of this selection at the 2008 Annual Meeting of Shareholders.
 
On December 21, 2007, Philip A. Laskawy, then Chairman of the Audit Committee, resigned from Progressive’s Board of Directors and his position on the Audit Committee. He cited the reason for his resignation as his ongoing involvement as the Chairman of the International Accounting Standards Committee Foundation, whose meetings regularly conflict with scheduled meetings of the Progressive Board. On that same date, the Board of Directors appointed Stephen R. Hardis to replace Mr. Laskawy as Audit Committee Chairman.
 
AUDIT COMMITTEE
Stephen R. Hardis, Chairman
Bernadine P. Healy, M.D.
Patrick H. Nettles, Ph.D.


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SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT
 
Security Ownership of Certain Beneficial Owners
 
The following information is set forth with respect to persons known to management to be the beneficial owners, as of December 31, 2007, of more than 5% of Progressive’s Common Shares, $1.00 par value:
 
                 
Name and Address
  Amount and Nature of
    Percent
 
of Beneficial Owner   Beneficial Ownership1     of Class  
 
 
Davis Selected Advisers, L.P. 
    78,680,531 2     11.6 %
2949 East Elvira Road, Suite 101
               
Tucson, Arizona 85706
               
Peter B. Lewis
    49,033,333 3     7.2 %
6300 Wilson Mills Road
               
Mayfield Village, Ohio 44143
               
Ruane, Cunniff & Goldfarb Inc. 
    34,452,567 4     5.1 %
767 Fifth Avenue, Suite 4701
               
New York, New York 10153-4798
               
 
1 Except as otherwise indicated, the persons listed as beneficial owners of the common shares have sole voting and investment power with respect to those shares. Certain of the information contained in this table, including related footnotes, is based on the Schedule 13G filings made by the beneficial owners identified herein.
 
2 The common shares are held in investment accounts maintained with Davis Selected Advisers, L.P., as of December 31, 2007, and it disclaims any beneficial interest in such shares. Davis Selected Advisers, L.P. has advised that it has sole voting power as to 73,675,577 of these shares, no voting power as to the balance of these shares, and sole investment power as to all of these shares. Mr. Charles A. Davis, a director of Progressive, has no affiliation with Davis Selected Advisers, L.P.
 
3 Includes 220,019 common shares held for Mr. Lewis by a trustee under Progressive’s Retirement Security Program, 888,338 common shares subject to currently exercisable stock options and 8,548 restricted common shares granted to Mr. Lewis in his capacity as Chairman of the Board. Also includes 1,048,705 shares held by two charitable corporations which Mr. Lewis controls, but as to which he has no pecuniary interest.
 
4 The common shares are held in investment accounts maintained with Ruane, Cunniff & Goldfarb Inc., as of December 31, 2007, and it disclaims any beneficial interest in such shares. Ruane, Cunniff & Goldfarb Inc. has advised that it has sole voting power as to 21,807,850 of these shares, no voting power as to the balance of these shares, and sole investment power as to all of these shares.


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Security Ownership of Management
 
The following information summarizes the beneficial ownership of Progressive’s common shares as of December 31, 2007, by each director and nominee for election as a director of Progressive, each of the named executive officers (as identified on page 37) and by all directors and all other individuals who were our executive officers on December 31, 2007, as a group. In addition, to provide a more complete picture of certain individual’s financial interest in Progressive shares, the final two columns include share equivalent units held in our benefit plans that do not technically qualify as “beneficially owned” under the applicable regulations, also as of December 31, 2007.
 
                                                                   
   
    Common
    Common
    Beneficially
                              Total
 
    Shares
    Shares
    Owned
    Other
    Total
                  Interest
 
    Subject to
    Subject to
    Common
    Common
    Common
            Units
    in Common
 
    Restricted
    Currently
    Share
    Shares
    Shares
            Equivalent
    Shares
 
    Stock
    Exercisable
    Equivalent
    Beneficially
    Beneficially
    Percent
      to Common
    and Unit
 
Name   Awards1     Options2     Units3     Owned4     Owned     of Class5       Shares6     Equivalents  
                                                                   
Charles A. Davis
    7,052       99,945       11,877       147,837       266,711       *       13,429       280,140  
Brian C. Domeck
    57,495       96,992       0       4,282       158,769       *       0       158,769  
W. Thomas Forrester7
    74,740       864,790       71,644       228,687       1,239,861       *       20,580       1,260,441  
Stephen R. Hardis
    6,838       82,337       6,086       179,163       274,424       *       151,021       425,445  
Bernadine P. Healy, M.D. 
    6,624       0       0       44,611       51,235       *       4,011       55,246  
Charles E. Jarrett
    132,527       289,938       43,324       4,068       469,857       *       0       469,857  
Jeffrey D. Kelly
    6,624       65,493       6,421       50,820       129,358       *       15,227       144,585  
Abby F. Kohnstamm
    6,411       0       5,102       0       11,513       *       0       11,513  
Peter B. Lewis
    8,548       888,338       0       48,136,447 8     49,033,333       7.2 %       0       49,033,333  
Norman S. Matthews
    7,052       99,945       16,795       188,212       312,004       *       22,882       334,886  
Patrick H. Nettles, Ph.D. 
    6,624       0       11,462       0       18,086       *       0       18,086  
Brian J. Passell
    152,101       494,401       0       33,543 9     680,045       *       0       680,045  
Glenn M. Renwick
    1,316,034       2,110,042       443,880       896,971       4,766,927       *       0       4,766,927  
Donald B. Shackelford
    6,411       99,945       7,853       748,108       862,317       *       24,181       886,498  
Bradley T. Sheares, Ph.D. 
    6,411       0       3,276       0       9,687       *       13,105       22,792  
Raymond M. Voelker
    114,120       43,817       0       26,513       184,450       *       0       184,450  
                                                                   
All 22 Executive Officers and Directors as a Group
    2,310,089       5,630,534       675,313       50,939,938       59,555,874       8.7 %       264,436       59,820,310  
                                                                   
                                                                   
 
*Less than 1% of Progressive’s outstanding common shares.
 
1 Includes common shares held for executive officers and directors pursuant to unvested restricted stock awards issued under various incentive plans we maintain. The beneficial owner has sole voting power and no investment power with respect to these shares during the restriction period.
 
2 The beneficial owner has no voting power or investment power with respect to these shares prior to exercising the options.
 
3 These units have been credited to the individual’s account under certain of our deferred compensation plans and are included in shares beneficially owned due to the plan features described below. Each unit is equal in value to one Progressive common share.
 
  •  For non-employee directors, the number represents units that have been credited to his or her account under The Progressive Corporation Directors Restricted Stock Deferral Plan, as amended and restated (the “Directors Equity Deferral Plan”), under which each director has the right to defer restricted stock awards. Distributions from the Directors Equity Deferral Plan will be made in Progressive common shares at the expiration of the deferral period under the plan. Upon the termination of a director’s service as a director, the plan provides that certain shares would be distributed to the director promptly thereafter. As to the number of shares that would be distributed promptly upon a director’s termination of service, the director is considered to have investment power over those shares (although not voting power), and those shares are deemed beneficially owned. See page 50 for a description of the Directors Equity Deferral Plan.
 
  •  For executive officers, the number represents units that have been credited to the participant’s account under The Progressive Corporation Executive Deferred Compensation Plan (the “EDCP”), upon the deferral of cash bonus awards and restricted stock awards. As to these units, the participant has sole investment power but no voting power. In this case, the participant has investment power due to his or her ability to instruct the plan trustee to liquidate his or her deemed investment in Progressive stock and re-allocate those amounts into one of the other deemed investments that are available under the plan. See a description of the EDCP beginning on page 44.
 
4 Includes, among other shares, common shares held for executive officers (or, in certain cases, their spouses who are former employees) under The Progressive Retirement Security Program. Unless otherwise indicated below, beneficial ownership of the common shares reported in the table includes both sole voting power and sole investment power, or voting power and investment power that is shared with the spouse and/or minor children of the director or executive officer.
 
5 Percentage based solely on “Total Common Shares Beneficially Owned.”


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6 The units disclosed are in addition to common shares beneficially owned and have been credited to the individual’s account under one or more of our deferred compensation plans, as discussed below. Each unit is equal in value to one Progressive common share.
 
  •  For non-employee directors, the number represents units that have been credited under The Progressive Corporation Directors Deferral Plan, as amended and restated (“Directors Deferral Plan”) and certain amounts credited under the Directors Equity Deferral Plan. Each of our directors who is not an employee of Progressive (other than Mr. Peter B. Lewis) and was a director prior to April 2006 participates in Directors Deferral Plan, under which cash retainer and meeting fees were deferred. The amounts deferred under the Directors Deferral Plan are deemed invested in Progressive shares for the entire deferral period, and distributions from the plan will be made only in cash at the time selected by the participant or as otherwise required by the plan. As such, the investor has neither investment power or voting power over those units. See page 50 for a description of the Directors Deferral Plan. Deferrals of restricted stock under the Directors Restricted Stock Deferral Plan are included in this column to the extent that Progressive common shares would not be distributed promptly after the termination of the director’s service, in which case the director is not considered to have investment power or voting power over those shares (for example, distributions that would be made in future years under an installment distribution plan selected by the director in accordance with the plan); and
 
  •  For executive officers, the number represents units that have been credited to the executive officer under the EDCP upon the deferral of restricted shares that were awarded in or after March 2005. These deferral amounts are deemed to be invested in Progressive shares during the entire deferral, and no other deemed investments are available to the participant. In addition, the distribution of Progressive common shares to the executive under the EDCP would not be made until six months after the termination of his or her employment. As a result, the executive has neither investment power or voting power during the deferral period.
 
7 Mr. Forrester, our former CFO, retired in March 2007. Included in “Other Common Shares Beneficially Owned” are 72,000 common shares held by Mr. Forrester as trustee for two trusts established for the benefit of his children.
 
8 See Footnote 3 on page 19.
 
9 Includes 3,660 common shares held by Mr. Passell as trustee for a trust established for the benefit of his daughter. Mr. Passell’s employment with the Company terminated in February 2008.
 
Section 16(a) Beneficial Ownership Reporting Compliance
 
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our officers and directors, and persons who beneficially own more than 10% of our common shares, if any, to file reports of ownership and changes in ownership of Progressive stock with the Securities and Exchange Commission. Based on our review of Section 16 reports prepared by or furnished to Progressive and representations made by our officers and directors, we believe that all filing requirements were met on a timely basis during 2007.


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COMPENSATION DISCUSSION AND ANALYSIS
 
I.  GOALS OF EXECUTIVE COMPENSATION PROGRAM
 
Our compensation program for executives, including the “named executive officers” identified in the Summary Compensation Table on page 37, is designed and implemented under the direction and guidance of the Compensation Committee of the Board of Directors. Broadly stated, we seek to maintain a consistent compensation program with the following objectives:
 
  •   Attract and retain outstanding executives with the leadership skills and expertise necessary to drive results and build long-term shareholder value;
 
  •   Motivate executives to achieve the strategic goals of Progressive and their assigned business units;
 
  •   Reward and differentiate executive performance based on the achievement of challenging performance goals; and
 
  •   Align the interests of our executives with those of shareholders.
 
II.   OUR EXECUTIVE COMPENSATION PROGRAM
 
A.  Overview
 
1. The Compensation Committee
 
The Compensation Committee is comprised of three Directors who are independent from management. The Committee makes final executive compensation decisions regarding salary, cash bonus targets, equity awards and related performance goals, as they apply to executive officers. For additional information on Compensation Committee procedures, see the “Compensation Committee” discussion on page 12.
 
2. Primary Elements of Compensation
 
Our executive compensation program has retained the same basic format for more than a decade. We have three primary compensation elements, each of which involves annual decisions made by the Compensation Committee to ensure reasonable, competitive pay for our executives, with a balance of fixed and variable compensation. These elements are:
 
  •  Base salaries;
 
  •  Annual cash bonus potential, the amount of which is determined under our “Gainsharing” programs for our executives and employees, based on the performance of Progressive or a specific business-unit; and
 
  •  Equity-based compensation, which is currently awarded to executives in the form of both time-based and performance-based restricted stock.
 
Our compensation decisions (for executives and our other employees) are guided by the policies that individual base salaries should generally be within a range that is tied to the 50th percentile for similar jobs at comparable companies (with variations determined by individual factors, as described in more detail below), and that employees should also have the ability to earn above-average compensation when justified by the individual’s and Progressive’s performance. At executive levels, variable compensation (including annual cash bonus and restricted stock awards) accounts for a much greater portion of total potential compensation, providing tangible incentives to executives to drive business unit and company results and aligning executives’ interests with those of shareholders. As a result, total pay for our executives is heavily weighted in favor of performance-based compensation that is tied directly to the Company’s strategic goals, as well as to the performance of our common shares. These basic elements of our executive compensation program are discussed in greater detail below in Part B, “Elements of Compensation — Annual Decisions or Awards.”
 
Other types of compensation available to executives are comprised of health and welfare benefits, deferred compensation arrangements, severance payments and very limited perquisites. We do not provide a separate pension program, supplemental executive retirement plan or other post-retirement payments to executives, nor do we make tax “gross-up” payments to executives in connection with compensation received. These additional types of compensation are discussed in more detail below in Part C, “Elements of Compensation — Other.”


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As a result, the compensation that an executive can expect to earn at Progressive over his or her career will derive predominantly from our three annual compensation components, i.e., salary, cash bonus opportunity and equity awards, and the amount ultimately earned by executives will depend greatly on our operating performance, as well as the performance of our common shares.
 
3. Compensation Comparisons
 
The executive compensation program is market-based and is designed to be competitive with compensation opportunities available to executives in similar positions at comparable companies. If direct job comparisons are not available for an executive, we seek to match the executive with job classifications from comparable companies that most closely resemble the executive’s position and responsibilities.
 
Comparable companies include those from many industries in a revenue range that is comparable to our revenue, as indicated on compensation surveys that we obtain from independent third party vendors. Comparable companies are intentionally not limited to those in the insurance industry. This choice reflects: that there are a limited number of publicly held insurers that focus exclusively, or even primarily, on automobile insurance (and none with comparable revenue or market value characteristics); that we do not generally recruit senior management level talent from other insurance companies; and that our executives have employment opportunities with companies doing business in a variety of industries. As a result, we view the broader range of companies to be a better reflection of the marketplace for the services of our executives. We do not focus on the identity of any individual company, but are interested in the aggregate data and the percentile breakdowns, which are used as a guide (among other factors) in our executive compensation decisions, as discussed further below.
 
4. Internal Pay Equity
 
We do not use “internal pay equity” as a constraint on compensation paid to the Chief Executive Officer or other executives. Such systems typically put a ceiling on part or all of an executive’s compensation based on a specified multiple of compensation awarded to another executive or a class of employees of the company. Management and the Committee do not believe that such arbitrary limitations are an appropriate way to make compensation decisions for our executives. Instead, we rely on the judgment of the Committee, after considering recommendations from management (including the CEO), available market data and evaluations of executive performance.
 
5. No Tax “Gross-Up” Payments
 
We do not provide, and no executive officer is entitled to receive, any tax “gross-up” payments in connection with compensation, severance, perquisites or other benefits provided by Progressive, except that we pay all regular employees, including the named executive officers, 5-year anniversary awards (i.e., at their 5th, 10th, 15th, etc., anniversaries) in amounts not to exceed $300 on a net (after tax) basis. When such amounts are paid to named executive officers, the gross (pre-tax) amount is included in our Summary Compensation Table.
 
B. Elements of Compensation — Annual Decisions or Awards
 
This section summarizes our policies and plans relating to the basic elements of compensation, each of which is determined on an annual basis — salary, annual cash bonus opportunity and restricted stock awards (subsections 1-3 below). In subsection 4 below, we discuss details of the 2007 compensation decisions for the named executive officers1 and performance results. A number of changes that are being implemented for 2008 are also addressed in more detail at the end of this section (subsection 5 below).
 
1. Salary
 
Executive salaries are designed to attract and retain executive talent and to reward individual performance. As a general matter, executive salaries are set in a range around the 50th percentile for executives with similar responsibilities at comparable companies. Variations from this general rule can occur on a case-by-case basis for any number of reasons, including the nature of a specific executive’s position and responsibilities, our business needs, the tenure of an executive in his or her current position, individual performance and the executive’s future potential. The salary level for our CEO, Glenn Renwick, which has been maintained well below market at $750,000 per year since February 2002, is an exception to this general approach and is discussed separately below.
 
 
1 The discussion below excludes Mr. Forrester, other than matters related to his retirement in March 2007. Due to his impending retirement, Mr. Forrester’s salary rate did not change for 2007, and he did not participate in our Gainsharing or restricted stock programs for the year.


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Salary amounts then serve as the basis for determining annual cash bonus potential and the value of annual equity awards, as described in more detail in the following sections.
 
2. Cash Bonuses
 
Gainsharing Program.  Each executive has the opportunity to earn an annual, performance-based cash bonus under our 2007 Executive Bonus Plan or other bonus plans. The Executive Bonus Plan operates under the same performance criteria used in our 2007 Gainsharing Plan, which covers all of our non-executive employees (those plans are sometimes referred to together as “Gainsharing,” the “Gainsharing program” or the “Gainsharing plans”). Gainsharing bonuses are determined using the following formula:
 
                         
Paid
Salary
  X   Target Percentage   X   Performance Factor   =   Annual
Bonus
 
For each executive, his or her salary and target percentage are established by the Committee each year during the first calendar quarter. When the participant’s annual salary is multiplied by his or her assigned target percentage, the product is referred to as the participant’s “target bonus” or “target bonus amount” for the year. The performance factor can range from 0.0 to 2.0 each year, depending on the extent to which Progressive’s results, and/or the results of the executive’s assigned business unit, fall short of, meet or exceed the objective performance goals established in advance by the Committee. As a result, each participant can earn an annual cash bonus of between 0.0 and 2.0 times his or her target bonus amount (with an amount equal to 2.0 times an executive’s target bonus thus being the executive’s maximum potential bonus). The payment of the target bonus amount, which would result from a 1.0 performance factor under the plans, is typically expected to put an employee’s annual cash compensation (salary plus bonus) at approximately the 50th percentile of total cash compensation for similar jobs at comparable companies, although there is more variability at executive levels due to a number of factors, including lack of comparable data and individual factors such as tenure, responsibilities and our business needs. Note that all Gainsharing and other performance-based cash bonus awards for the named executive officers are reported on the Summary Compensation Table below as “Non-Equity Incentive Plan Compensation.”
 
Under the Gainsharing plans, the performance factor is determined after the end of each year based on actual operating performance for that year by our principal business units, when compared with growth and profitability criteria that were established by the Compensation Committee during the first quarter of the plan year. Generally, the performance factors under our Gainsharing plans are determined by reference to either (i) the overall operating performance of our core insurance businesses, excluding investment results (the “Core Business”), or (ii) a combination of the performance of the Core Business and the performance of the respective executive’s assigned business unit. For 2007, the Core Business was defined to include the Agency Auto, Direct Auto, Special Lines and Commercial Auto businesses.
 
The Gainsharing cash bonus is designed to reward executives based on the operating performance of Progressive’s insurance business as a whole and/or an executive’s assigned business unit, as compared with objective performance criteria that are established by the Committee during the first quarter of each year and are not thereafter modified. The purpose of the cash bonus program is to motivate executives to achieve and surpass current performance goals, which over time, should positively impact the returns of long-term shareholders. Additional discussion of the 2007 Gainsharing program, the operating results for the business units comprising the Core Business and the calculation of the Performance Factor for 2007 can be found below under “2007 Compensation Decisions and Results” and under “Narrative Disclosure to Summary Compensation Table and Grants of Plan-Based Awards Table” on page 39.
 
The Gainsharing performance factor for our Core Business is calculated on a monthly basis, using year-to-date results, and published in our regular, monthly earnings release. In addition, the final performance factor was used by the Company to calculate our annual dividend payment to shareholders for the first time in 2007. The annual dividend of $.1450 per share was paid on January 31, 2008 to shareholders of record on December 31, 2007. The Gainsharing factor and, as a result, the Company’s ongoing operating performance, are therefore monitored and disclosed to the public throughout the course of the year, and are ultimately used to reward both employees and shareholders.
 
Other Bonus Plans.  In 2007, our Chief Information Officer, Mr. Raymond Voelker, participated in The Progressive Corporation 2007 Information Technology Incentive Plan (the “IT Bonus Plan”) for 10% of his potential bonus, along with other employees who worked in this business area. This plan provides cash bonus opportunities to participants for satisfaction of pre-established performance criteria relating to the outage-free availability of certain information technology systems. For more information on Mr. Voelker’s bonus under the IT Bonus Plan, see the discussion below under “2007 Compensation Decision and Results; Cash Bonus — IT Plan.” In addition, the entire 2007 cash bonus for our Chief Investment Officer was determined under our Executive Bonus Plan based on the performance of our fixed-income investment portfolio when compared, on a


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risk-adjusted basis, with the performance achieved by a group of comparable money management firms, as determined by a third party vendor. Our equity portfolio is not included in this analysis because this portfolio tracks the Russell 1000 Index and is not actively managed by our investment group.
 
Recent Gainsharing Results.  Outstanding growth and profitability results in each of 2003 and 2004 were rewarded by a Core Business performance factor of 2.0, and the highest possible bonus under our Gainsharing plans, for most executive officers and other employees of Progressive. By contrast, a significant down year in our insurance operations in 2000 resulted in a performance factor of 0.0 for our Core Business, and no annual cash bonus, for most executive officers and employees. Performance factors for 2005, 2006 and 2007 were 1.539, 1.18 and .74, respectively, reflecting strong (but decreasing) profitability, but lagging growth compared to recent experience and our pre-established targets. Throughout the 14-year history of our company-wide Gainsharing program (including 2007), the performance factor for the Core Business has averaged about 1.34. These results confirm that our Gainsharing plans operate not only to reward excellent performance, but also to withhold or temper cash bonuses if our actual performance results fail to achieve pre-defined goals.
 
Effect of Any Future Financial Restatement.  Under the 2007 Executive Bonus Plan, bonuses paid to executives will be subject to recoupment by Progressive if operating or financial results that are used in the bonus calculation are later restated. If an executive engages in fraud or other misconduct leading to the restatement, he or she would be required to repay the entire bonus paid for the year(s) in question, plus interest and the costs of collection, and there is no time limit on our ability to recover such amounts other than limits imposed by law. In addition, we would have the right to require repayment from an executive who does not engage in misconduct, but nonetheless receives a bonus that was artificially high due to the use of incorrect financial results, but only to the extent that the potential recovery would exceed the lesser of 5% of the bonus paid or $20,000 and the restatement occurs within three years after the bonus is paid. Plans covering bonuses paid to executives in prior years do not include such a provision, however, and our ability to recoup any bonuses paid under the prior plans if such a restatement were to occur would depend on the availability of general legal and equitable remedies under state or federal law.
 
3.  Equity Awards
 
Restricted Stock Awards.  Our executive compensation program includes long-term incentives through an annual grant of restricted stock awards. Under a restricted stock grant, the executive receives an award of Progressive’s common shares, subject to restrictions on vesting and transferability. Annual awards of restricted stock to executive officers are intended to tie the amount of compensation ultimately earned by the executive to our long-term performance and the market value of our common shares. Until 2002, we issued stock options annually to our executives (and certain other employees), but that program was terminated in 2003 when the restricted stock program was instituted.
 
Each executive officer receives a restricted stock award on an annual basis. All executive officers receive a time-based restricted stock award that will vest in three equal installments in the third, fourth and fifth years after the grant. The value of these awards is based on a percentage of the individual’s salary at the time of the award, which is determined by the Committee on an annual basis. Time-based restricted stock awards align the interests of executives with our shareholders and serve as a strong retention device, encouraging our senior executives to stay with Progressive until future vesting dates occur.
 
In addition, our CEO and the executive officers who report directly to him, each receives an annual award of performance-based restricted stock. The number of shares granted to each executive, and the objective performance criteria that govern if and when the performance shares will vest, are approved each year by the Committee at the time the awards are granted and are not thereafter modified. The performance criteria are established by the Committee each year, with management’s input, based on then-current market conditions and our long-term strategic goals. If the applicable performance conditions are not satisfied within the time frame established by the Committee (typically 10 years), the awards will be forfeited by the executives. Performance-based awards operate as an additional incentive for executives to achieve long-term business objectives, thus further aligning the interests of shareholders and our executives, while also supporting retention of critical employees. In addition, these awards increase the “at risk” nature of our executives’ compensation.
 
Ownership Guidelines for Executives.  Under guidelines recently approved by our Board of Directors, within five years after becoming our CEO and at all times while serving as CEO thereafter, the CEO must acquire and hold Progressive stock (or equivalent vested interests, such as shares held on the CEO’s behalf in our 401(k) or equivalent units held in our executive deferred compensation plan, but excluding unexercised stock options and unvested restricted stock) with a minimum value of five times the CEO’s base salary. Executive officers who report directly to the CEO are expected to hold meaningful amounts of Progressive stock at levels that their respective compensation and financial circumstances permit. To support this goal, each executive’s annual compensation is heavily weighted towards equity compensation, such that 35% or more of the annual potential compensation for each executive is in the form of restricted stock, both time and performance based, typically valued at between 175-225% of the executive’s base salary. As a result, within three years of becoming an executive, each executive


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is expected to hold restricted or unrestricted stock with a value of at least three times his or her base salary, and potentially significantly more depending on the performance of the Company’s common shares. Management and the Committee believe that stock holdings under these guidelines, as well as executives’ additional, voluntary holdings in our stock option, 401(k) and deferral plans or in personal accounts, appropriately ensure that the interests of management will be aligned with those of our long-term shareholders.
 
Timing of Awards.  We expect that, consistent with our actions in recent years, annual restricted stock awards will be made in March of each year, unless a legal or plan requirement causes us to adopt a change for a specific year. We believe that the March timing is appropriate because it follows shortly after annual performance evaluations and salary adjustments for executives and other equity eligible employees, thus providing an administratively convenient time to calculate the awards and communicate them to the recipients. Historically, interim awards have been made to executive officers only at the time of his or her appointment to the executive team; any such interim award to an executive officer would require the approval of the Compensation Committee.
 
Qualified Retirement Rights.  Executive officers, along with other equity award recipients, are eligible for “qualified retirement” treatment (sometimes referred to as the “Rule of 70”) under our equity compensation plans. Under this arrangement, executives who leave their employment with Progressive after satisfying certain age and years-of-service requirements, generally (i) are permitted to exercise outstanding stock options (all of which are now vested) at any time prior to their stated expiration date (instead of being required to exercise such options within 60 days of the termination of employment, as is typically the case), (ii) receive 50% of the unvested time-based restricted shares then outstanding (with the remaining 50% being forfeited), and (iii) retain 50% of unvested performance-based restricted stock awards, although such awards will vest, if at all, only upon satisfaction of the performance objectives associated with those awards (and the other 50% of the performance-based shares are forfeited). The Rule of 70 provisions are intended to provide a limited benefit for long-tenured employees who retire from Progressive after satisfying the age and service requirements.
 
The named executive officers participate in these arrangements on the same terms and conditions as are available to other equity award participants, except that if the CEO or one of the executives who directly reports to him provides at least one full year of notice of his or her intention to leave employment after qualifying for a “qualified retirement,” he or she will retain 100% of his or her unvested performance-based restricted stock awards (not just 50% as stated above), although such performance-based shares still will vest only if and when the applicable performance goals are achieved prior to expiration. This advantage is available to executives in order to facilitate a smooth transition of personnel at the senior executive level of the company.
 
None of our current named executive officers was eligible for qualified retirement treatment at year end 2007. Mr. Renwick, our CEO, will become eligible for such treatment if he remains employed through May 2010. Mr. Forrester, our former Chief Financial Officer, retired in March 2007 after qualifying for Rule of 70 benefits and after giving more than one-year’s notice of his intent to leave the company. As a result, upon his retirement: (i) Mr. Forrester retained all of his outstanding stock options (all of which had previously vested and which entitled him to purchase 900,756 shares as of March 2007) through their respective termination dates; (ii) one-half of his time-based restricted shares (33,128 shares) were forfeited and the other half (33,128 shares) vested immediately; and (iii) all of his unvested performance-based restricted shares (74,740 shares) remained outstanding and will vest if the company satisfies the applicable performance criteria for each such award prior to the applicable expiration date for that award.
 
For additional information on the “qualified retirement” provisions, see “Potential Payments upon Termination or Change in Control” beginning on page 45.
 
Effect of Any Future Financial Restatement.  Under our 2003 Incentive Plan, as amended, performance-based restricted stock awards made in or after March 2007 will be subject to recoupment by Progressive in the event of a financial restatement of the operating or financial results which caused those performance-based shares to vest, in certain circumstances. An executive who engages in fraud or other misconduct leading to the restatement would be required to repay all such shares or an equivalent dollar amount, at our election, plus interest and the costs of collection, and there would be no time limit on our ability to recover those amounts other than limits imposed by law. In addition, we would have the right to require repayment from an executive who does not engage in misconduct, but nonetheless has his or her shares vest due to the use of incorrect financial results, but without interest and only if the restatement occurs within three years after the vesting date. Equity awards made prior to March 2007 are not subject to this plan amendment, and our ability to recoup any such awards that vest under similar circumstances would depend on the availability of general legal and equitable remedies under state or federal law.
 
Wealth Accumulation.  The Committee does not review “wealth accumulation” analyses from prior equity awards when making current compensation decisions. Such analyses have been advanced by some commentators as a way to determine when an executive has received “enough” equity compensation from Progressive and to justify limiting or eliminating future


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grants. Our focus, however, is to make appropriate executive compensation decisions annually, so that executives are paid at competitive levels with a significant component that is “at risk” and performance based. Given that, in general, at least 35% of each named executive officer’s potential annual compensation consists of equity awards, the elimination of such awards likely would make our current compensation uncompetitive, thus risking the loss of valuable executives or requiring us to make other compensation arrangements with individual executives to retain his or her services, which would be inconsistent with our compensation program and our company culture. If equity awards from prior years increase significantly in value in future years, we do not believe that this positive development, which rewards all of our long-term shareholders, should negatively impact current compensation decisions. Finally, since we do not provide separate pension or retirement benefits in addition to the executives’ annual compensation, we believe that the value of equity awards in many cases will be used by executives to fund their retirement, effectively replacing such benefits that other companies may offer. Under these circumstances, we do not believe that such artificial limitations on compensation levels are appropriate or in the best interests of Progressive or our shareholders.
 
4.  2007 Compensation Decisions and Results
 
Market Comparisons.  In the first quarter of 2007, the Compensation Committee set each named executive’s 2007 salary, bonus opportunity and restricted stock awards. For CEO comparisons, we used a group of 61 public companies with annual revenues from $10 billion to $20 billion, as identified in compensation surveys purchased by the Company from Towers Perrin. Given our 2006 revenue of approximately $14.8 billion, we believe that this range provided appropriate data for comparison purposes. The 2007 comparisons for our other named executive officers were taken from similar compensation surveys produced by Towers Perrin and Mercer Consulting (although the number of companies and revenue ranges varied from position to position based on responsibilities, availability of comparison matches and other factors).
 
The salaries of our named executive officers during 2007 were close to the median (50th percentile) for their respective comparison group, other than Mr. Renwick, whose situation is discussed in more detail below, and Mr. Domeck, whose salary reflected that he was in the first year of his new role as CFO. With the addition of variable compensation (i.e., the potential for cash bonuses and the possibility of restricted stock vesting in future years), one of our named executive officers had the opportunity to earn total potential compensation that would rank above the 50th percentile but below the 75th percentile of the comparison groups, while in three instances the total potential compensation could exceed the 75th percentile and in one instance it was below the 50th percentile based on the compensation survey information presented to the Committee when the decisions were made. Variations from the 50th to 75th percentile range were caused by a number of factors, including the length of the named executive’s tenure in the specific job, the absence of similar positions at comparable companies, individual performance and expected future contributions, as well as our business needs.
 
It must be emphasized, however, that other than the base salary comparisons, the percentile rankings set forth above assume that the executive would earn the maximum value of their cash bonus and equity awards and, therefore, may be overstated. Maximum cash bonuses have been earned under our Gainsharing program only twice in its 14-year history, and our final Gainsharing score for 2007 was .74 (as discussed in more detail below), or approximately 37% of the potential maximum (other than for 10% of the potential bonus for Mr. Voelker, our Chief Information Officer, which was determined under the IT Bonus Plan, as discussed below). Using this actual bonus data for 2007, Messrs. Domeck and Jarrett each earned total cash compensation (salary plus bonus) that was below the 50th percentile for their respective comparison group, while Mr. Passell2 was slightly above the 50th percentile, reflecting the company’s performance for the year. In addition, the vesting of the restricted stock awards, which is a large component of potential compensation, is not guaranteed. The named executive officer will receive the entire value of the time-based awards only if he remains with Progressive throughout the three, four and five year vesting periods (and, even then, only if the stock price does not decrease), and the performance-based awards will vest only if Progressive satisfies the performance criteria established by the Committee (which, as discussed below, are very aggressive performance targets). Thus, for each named executive officer, a substantial portion of the compensation used to establish his potential percentile rank will remain “at risk” for years before it is earned by the executive, and some of the restricted stock in fact may never vest.
 
Decisions Regarding CEO’s Compensation.  In the case of Glenn Renwick, our CEO, his salary level has been maintained at $750,000 since February 2002, a level estimated to be $470,000 below the 50th percentile of $1,220,000 for CEO salaries at comparable companies in 2007. Mr. Renwick’s cash bonus (Gainsharing) potential has also remained at the same level since February 2002. The Compensation Committee has determined that Mr. Renwick should receive, instead of additional cash compensation, a larger proportion of his potential compensation in the form of restricted stock and that his restricted stock awards should be equally weighted between time-based and performance-based shares. In this way, we are able to keep Mr. Renwick’s overall compensation at a competitive level, while further keeping a very high portion of his potential
 
 
2 Mr. Passell’s employment with the Company terminated in February 2008.


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compensation at risk and dependent on Progressive’s performance, increasing his equity participation and aligning his interests with those of long-term shareholders. The following table shows the development of Mr. Renwick’s compensation since 2001:
 
                                                         
    2001     2002     2003     2004     2005     2006     2007  
 
 
Base Salary
  $ 676,923     $ 744,231     $ 750,000     $ 750,000     $ 750,000     $ 750,000     $ 750,000  
Gainsharing Target1
    150%       150%       150%       150%       150%       150%       150%  
Time-Based Equity Target2
    230%       300%       300%       500%       500%       500%       500%  
Performance-Based Equity Target2
    120%       200%       300%       500%       500%       500%       500%  
 
1Percent of base salary. Actual Gainsharing payouts can vary from 0.0 to 2.0 times the target percentage in each year depending on operating results.
 
2 Percent of base salary. In 2003, we began awarding restricted stock as our equity form of compensation. Prior to 2003, equity awards were made in the form of stock options.
 
The result of these determinations for 2007 was that, despite his below median salary and bonus potential, Mr. Renwick’s total potential compensation was ranked above the 50th percentile and could approach the 75th percentile of comparable CEO compensation if performance-based compensation were to be maximized. However, with our Core Business achieving a Gainsharing performance score of .74, Mr. Renwick’s actual cash compensation (salary plus bonus) was $1,582,500 for 2007, which represents less than 55% of the average total cash compensation (50th percentile) of his comparison group based on the comparison data used by the Committee in early 2007. Although his restricted stock award potentially increases his total compensation to near the 50th percentile level, the ultimate value of the 2007 restricted stock awards will remain at risk for some time.
 
In the Compensation Committee’s and the Board’s view, Mr. Renwick’s performance as CEO clearly has justified the continuation of his pay package in the same format from prior years. Although he has the potential for above-market pay in the aggregate, the below-market base salary combined with the heavy reliance on performance-based bonus potential ties total cash compensation to our operating results, as was demonstrated in 2007. Moreover, the proportionately large restricted stock component, and the 50/50 split between time-based and performance-based restricted stock awards, was determined by the Committee to be an appropriate allocation to balance encouraging Mr. Renwick’s retention, providing incentives to drive company performance and maximizing the extent to which Mr. Renwick’s interests will be aligned with the interests of shareholders. If the aggressive performance growth target for the performance-based restricted stock award is not ultimately achieved, Mr. Renwick’s actual total compensation attributable to 2007 will be well below the median compensation for CEO’s at comparable companies. The Committee believes that this program presents a rational and strongly performance-based pay package for an outstanding CEO.
 
Salary for Other Named Executive Officers.  For the other named executive officers, their 2007 salaries reflected increases of between 3.5% and 6.7% when compared with the end of the prior year. These increases for Messrs. Jarrett and Passell were at the lower end of this range and were consistent with market-based salary increases for our employees as a whole. Mr. Voelker’s increase, which was approximately 6%, also resulted from market-based adjustments, as well as an effort to bring his compensation in a range reflecting the Chief Information Officer’s importance to the organization. Mr. Domeck’s salary increase from year end 2006 was about 6.7% and reflected the increased responsibilities and higher market comparisons for a chief financial officer, the new role he was starting in early 2007. In each case, the salary increases further evidenced continuing satisfactory performance and contribution to the executive team. Salaries were near the 50th percentile ranking for similarly situated executives at comparable companies, except that Mr. Domeck’s salary was well below the 50th percentile for CFO’s of comparable companies, due to the fact that 2007 was his first year in that role.
 
Gainsharing Bonuses — Core Business.  For 2007, Gainsharing target percentages for the named executive officers were determined by the Compensation Committee. Mr. Renwick’s target percentage was set at 150%, while each of the other named executive officers had his target set at 100%. In each case, under the Gainsharing plans, the actual bonus could vary from 0.0 to 2.0 times the targeted amount, depending on company performance.
 
The 2007 performance factors were determined using Gainsharing standards approved by the Compensation Committee for our Core Business, consisting of the Agency Auto, Direct Auto, Special Lines and Commercial Auto businesses, as described below under “Narrative Disclosure to Summary Compensation Table and Grants of Plan-Based Awards Table,” beginning on page 39. The 2007 growth and performance targets were tied to our companywide strategic goals of growing policies in force as fast as possible at a 96 combined ratio or better. For 2007, we adopted policies in force as the basis to measure growth for each of our businesses (as opposed to net premiums written, which had been used to measure growth in prior years), to better align our Gainsharing program with our companywide strategic goal of growing policies in force as fast as possible at a 96 combined ratio or better. Under these revised standards, a 2007 Gainshare performance factor of 1.0 for the


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Core Business as a whole would result from growth and profitability levels that met our expectations for the year, and which we believed were reasonably attainable results when these decisions were made in early 2007, which is consistent with how this program has operated historically.
 
For Messrs. Renwick, Domeck, Passell and Jarrett, as well as most of our other employees, 2007 bonuses were determined solely by the performance of the Core Business. For these executives and employees, the Gainsharing calculation resulted in a performance factor of .74 (out of a possible 2.0). Mr. Voelker’s bonus was determined by a weighted combination of the performance score of the Core Business (90%) and the performance score under the IT Bonus Plan (10%), as discussed in more detail below.
 
The following table presents the overall growth and profitability data for the businesses that comprised our Core Business in 2007. The growth figures were determined by the percentage change in policies in force at year end 2007, as compared with the 2006 year-end policy count for that business unit. Profitability was determined by the underwriting performance of the business unit, as measured by the applicable GAAP combined ratio.
 
         
    GAAP
  Growth of
    Combined
  Policies in Force
Business   Ratio1   Increase (Decrease)
 
Agency Auto
  93.5   (1)%2
Direct Auto
  92.2   7%2
Special Lines
    8%
Commercial Auto
  89.9   7%
 
1 Consistent with the presentation of underwriting results (i.e., combined ratio) of our Personal Lines segment in our monthly earnings releases and quarterly and annual reports, the combined ratio results for our Special Lines business unit are not presented separately and, instead, are included in either the Agency or Direct results in the table above, depending on whether the underlying policy is written through agents/brokers or directly by Progressive. See Note 9, “Segment Information,” in the 2007 Annual Report to Shareholders, which is attached as an appendix to this Proxy Statement, for how the combined ratio is calculated.
 
2Includes only Auto policies in force.
 
Based on performance results, we determined the performance score for each business unit comprising the Core Business, and those scores are set forth in the table below. See “Narrative Disclosure to Summary Compensation Table and Grants of Plan-Based Awards Table,” beginning on page 39, for a more detailed discussion of the Gainsharing matrices and the calculation of performance scores.
 
The business unit performance scores were then weighted, based on each business unit’s relative contribution to the overall net earned premium of the Core Business, and the weighted scores were added to determine the final performance factor for the Core Business, as follows:
 
       
    Weighted
    Performance
Business   Score
 
Agency Auto
    .21
Direct Auto
    .33
Special Lines
    .08
Commercial Auto
    .12
Performance Factor
    .74
     
 
As can be seen, our performance in 2007 resulted in a performance factor for our Core Business equal to .74 out of a possible 2.00. Although our profitability remained strong for another year (albeit with increasing combined ratios compared to the prior year), our growth rates failed to meet our goals, particularly in our Agency Auto business. Our performance failed to achieve a combination of growth and profitability that would produce a target 1.0 score, resulting in an overall Gainshare factor of less than 1.0 for the first time since 2000. Most Progressive employees, including the named executive officers (other than the 10% of Mr. Voelker’s bonus that was determined under the IT Bonus Plan, as described in the next section), thus earned a cash bonus equal to approximately 74% of their target bonus amount, in a year where our performance did not match our goals.
 
Cash Bonus — IT Bonus Plan.  For Raymond Voelker, our Chief Information Officer, 90% of his performance factor was determined by the Core Business performance score, as described above, and the remaining 10% was determined under our IT Bonus Plan, as approved by the Compensation Committee in early 2007. The performance score under the IT Bonus


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Plan was determined by the outage-free availability of certain significant computer and related systems during the course of the year, under specific rules established by the plan, as compared with performance standards established by the plan. The intent of the IT Bonus Plan was to motivate IT employees, including Mr. Voelker, to keep these systems operational on a 24 x 7 basis, subject to certain events specified in the plan, such as scheduled maintenance time.
 
For 2007, the IT Bonus Plan generated a performance score of 1.01 out of a possible 2.0, reflecting overall performance at the target level. When this result (for 10% of Mr. Voelker’s bonus) is combined with the result he earned under the Core Business Component (for the remaining 90%), his total cash compensation for the year (salary plus bonus) ranked him slightly above the 50th percentile for comparable positions, based on the comparison data presented to the Committee at the beginning of the year.
 
Restricted Stock Awards.  In 2007, two forms of restricted stock awards were granted to executive officers and certain other senior level employees. Time-based restricted stock awards were granted to all named executive officers and 846 other senior level employees. The time-based restricted stock awards will vest in three equal annual installments, on January 1 of 2010, 2011 and 2012, subject to the vesting and forfeiture provisions in the applicable plan and grant agreement. In addition, the named executive officers and 39 other senior managers received performance-based restricted stock grants, with the vesting date tied to the achievement of specific business results that are defined by our long-term growth and profitability objectives.
 
CEO Glenn Renwick received a time-based restricted stock award with a value equal to 500% of his salary and a performance-based restricted stock award equal in value to 500% of his salary. As indicated above, Mr. Renwick’s equity award was proportionally larger than other executives’ awards due, in part, to the below-market level of his base salary, putting more of his compensation at risk and dependent on Progressive’s operating performance over the next several years.
 
The other named executive officers received in 2007 time-based awards with a value equal to 100% of their respective salaries, and performance-based awards with a value of 100% of salary. Performance-based awards to the executives who report directly to the CEO typically range from 75% to 125% of salary per year. As with the CEO, in recent years we have increased the weighting of performance-based shares that are awarded to other senior executives to provide appropriate performance incentives to these executives. The Committee, after considering the recommendations of and discussions with the CEO and the Chief Human Resource Officer, determines the value of each executive’s performance-based award based on individual factors, such as past performance, skills and competencies and expected future contributions.
 
Performance-based restricted stock awarded in 2007 will vest only if Progressive’s insurance subsidiaries generate net earned premiums of $19.0 billion or more over a period of twelve (12) consecutive months while maintaining an average combined ratio of 96 or less over the same period. If we do not satisfy these criteria prior to December 31, 2016, the performance shares will be forfeited. While the profitability target of this standard is within our recent performance experience, the growth target was very aggressive when made (and remains very aggressive at this time). Our net earned premiums for 2007 were approximately $13.9 billion, and the $19.0 billion target thus represents about a 36.7% increase (or an annual increase of about 3.55%, on a compounded basis, from year-end 2007) from that level. It should be noted, however, that as of year-end 2006, shortly before these decisions were made, we had year-over-year growth of net earned premium of approximately 2.6%, and our net earned premiums decreased by approximately 1.7% in 2007 as compared with 2006. In view of these recent growth levels, therefore, there is a significant risk that the performance-based restricted shares will not vest prior to the end of their 10-year life.
 
5. Changes for 2008
 
Our compensation program for 2008 includes a number of changes from prior years. The changes are summarized as follows:
 
Salary Decisions.  Mr. Renwick’s salary for 2008, as well as his potential bonus and the value of his restricted stock awards, were maintained at the same levels as in 2007. Compensation decisions for the other named executive officers for 2008, other than Mr. Domeck, also have been in line with their historical compensation, with market adjustments. Salaries were increased from 3.4% to 4.3% for Messrs. Jarrett, Passell (whose employment has since terminated) and Voelker. Mr. Domeck’s salary has been increased by approximately 18.75%, reflecting a successful first year as our CFO and an attempt to bring his compensation more in line with CFO’s at comparable companies. Percentage targets for Gainsharing and restricted stock awards were not changed for those executive officers from the targets used in 2007.
 
Shareholders should note that the actual amounts to be paid in salary to the named executive officers (and all other salaried employees of the company) in 2008 will be higher than their respective annual salary figures, because we will issue 27


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paychecks in 2008 versus 26 paychecks in most years. Such a 27-paycheck year is a situation that arises in bi-weekly payroll systems, such as ours, about every 10 or 11 years.
 
Gainsharing Decisions.  In 2008, each executive officer will have his or her Gainsharing bonus determined 100% by the performance score of our Core Business (except for our Chief Investment Officer, who will continue to earn his bonus based on the relative performance of our fixed-income portfolio as compared with the designated benchmark). This same change was implemented for virtually all other employees of the company for 2008. In 2007 and recent years, certain executives (and other employees) would earn a bonus from a combination of the respective performance scores generated by the Core Business and by their assigned business units. With our changes to the structure of the Personal Lines group during 2007 and a desire to focus employees on the performance of the business as a whole, management and the Compensation Committee decided that this change would better reflect our current operational focus and our culture. Also for 2008, consistent with this focus on the overall business, we have terminated the IT Bonus Plan, which accounted for 10% of Mr. Voelker’s (and certain other IT employees’) potential bonuses in 2007 and prior years.
 
Additional Gainsharing Matrices.  For 2008, the Gainsharing program was also modified so that each of the business units comprising our Core Business (Agency Auto, Direct Auto, Commercial Auto and Special Lines) will be evaluated separately on their respective “new” and “renewal” businesses. This focus, which represents an extension of the program used in our Direct business in 2007 to the other business units, is intended to support our strategic initiatives to improve retention of current customers, while at the same time maintaining our ability to bring in new customers, which, if successful, would be expected to drive an increase in overall policy-in-force growth rates.
 
C.  Elements Of Compensation — Other
 
1. Perquisites
 
We provide limited perquisites to our executives and only do so when the Board or the Compensation Committee determines that such benefits are in the interests of Progressive and our shareholders. We own an aircraft that is used primarily for the CEO’s business travel, to maximize the efficiency of his travel and reduce his unproductive down-time, allow him to manage effectively our many remote locations, and to enhance his personal security and the confidentiality of his travel.
 
At the request of the Board of Directors, the CEO also uses the company aircraft for his personal travel and some of his spouse’s or other guest’s personal travel when they accompany him. Such personal use of the aircraft, which is a perquisite under SEC regulations to the extent of the incremental costs to the company for such travel, is provided to enhance the CEO’s and his family’s personal security and the confidentiality of their travel. Other executives occasionally accompany the CEO on his personal trips, at the CEO’s discretion, and such personal trips would likewise be a perquisite for a named executive officer traveling with the CEO, if we were to incur costs in addition to the costs for the CEO’s travel.
 
In addition, the CEO is provided with a company car and driver for his business needs to facilitate his transportation to and among our headquarters and many other local facilities, and to allow him to use that travel time for work purposes. To the extent that the CEO uses the company car for personal matters, including commuting to and from work, he receives a perquisite.
 
In 2007 and prior years, our directors, the named executive officers and certain other senior executives, and their spouses or guests, were invited to attend a 2-day off-site strategy session, which includes a series of meetings between management and the Board and a regular Board meeting, at an off-site location. Personal travel for the spouses and certain costs for meals and other activities during the retreat constitutes perquisites to the directors and executives who attend.
 
Otherwise, we do not provide perquisites to our executives. The required disclosure of the incremental costs of these perquisites to Progressive is included in the “All Other Compensation” column of the Summary Compensation Table on page 37.
 
2. Retirement
 
We do not provide a pension program, supplemental executive retirement plan or other post-retirement payments or benefits to executives. Executives are eligible to participate in our retirement security program (401(k) plan) on the same terms and conditions as are available to all other regular employees, subject to limitations under applicable law. Executives who satisfy certain age and years-of-service requirements when they retire may be eligible to receive 50% of their unvested time-based restricted stock awards at retirement and to retain rights under certain performance-based restricted stock awards, subject to the satisfaction of the applicable performance criteria, after retirement. These rights are described generally above


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under “Qualified Retirement Rights” and in greater detail below under “Potential Payments Upon Termination or Change in Control,” beginning on page 45.
 
3. Deferral Arrangements
 
The named executive officers and certain other senior-level employees are given the opportunity to defer the receipt of annual cash bonus awards and restricted stock awards under our Executive Deferred Compensation Plan (EDCP). This plan is made available to executives in order to keep our executive compensation program competitive and to allow executives to manage their receipt of compensation to better fit their life circumstances, to manage their tax obligations and to allow the executive to arrange for a portion of his or her income to be paid in post-employment years. In addition, to the extent that the top executives elect to defer time-based restricted stock until after they leave Progressive, we may benefit to the extent we otherwise might have lost a tax deduction upon the vesting of those shares under IRC § 162(m) (see related discussion under “Section 162(m) of the Internal Revenue Code” below).
 
These deferral mechanisms operate solely as a vehicle for the executive to delay receipt of bonus income or restricted stock awards that he or she otherwise would have earned as of a specific date under the applicable plan. We do not contribute additional amounts to an executive’s deferral accounts, either in the year of deferral or in future years. We also do not guaranty a specific investment return to executives who elect to participate in the deferral plan. Deferred amounts are deemed invested in specific investments selected by the executive, including an option to invest in Progressive shares (subject to limitations included in the deferral plan), except that deferrals of restricted stock awards made in or after March 2005 are required to be invested in Progressive shares throughout the deferral period. The value of each executive’s deferred account thus varies based on the executive’s investment choices and market factors; these deferred amounts are at risk and may decrease in value if the investments selected by the executive do not perform well during the deferral period. Additional details concerning this plan, including the named executive officers’ respective holdings in the plan, can be found under the “Nonqualified Deferred Compensation” table and related disclosures, beginning on page 44.
 
In March 2007, Mr. Thomas Forrester retired as the company’s CFO. At that time, Mr. Forrester had an EDCP balance of approximately $9,683,000. His retirement triggered the commencement of distributions under the plan and, accordingly, during 2007 he received cash distributions valued at approximately $996,000, plus the in-kind distribution of 2,054 shares of Progressive stock. The remainder of his account will be distributed in installments over the next 9 years in accordance with Mr. Forrester’s prior elections. These deferral arrangements were also affected by the enactment of Section 409A of the Internal Revenue Code and the recent promulgation of regulations under Section 409A by the Internal Revenue Service, as discussed below in more detail under “Related Considerations; Section 409A of the Internal Revenue Code.”
 
4. Severance and Change-in-Control Arrangements
 
Severance and change-in-control arrangements are intended to provide compensation and a fair financial transition for an executive when an adverse change in his or her employment situation is required due to our company needs or results from certain unexpected corporate events, and to recognize past contributions by such executives, who are typically long-tenured employees. These arrangements allow the executive to focus on performance, and not his or her personal financial situation, in the face of uncertain or difficult times or events beyond his or her control. Each of these programs is discussed in more detail immediately below and under “Potential Payments upon Termination or Change in Control” beginning on page 45.
 
Severance.  Our executive separation allowance plan is designed to provide executives with well-defined financial payments if the executive’s employment is terminated for any reason other than resignation (including retirement), death, disability, leave of absence or discharge for cause, if certain conditions are satisfied. For our executives, including the named executive officers, the severance payment would equal three years of the executive’s base salary only at the time of termination, plus medical, dental and vision benefits for up to 18 months at regular employee costs. This same level of benefits is payable to the named executives upon any qualifying separation from Progressive, whether in a change-in-control situation or otherwise.
 
We believe that this level of severance payment (equal to three times the executive’s base salary), whether or not triggered by a change in control, is well below the market averages based on available market data. The severance payments do not take into account the value of cash bonuses or equity-based awards in determining the executive’s severance payment, which substantially limits the amount of the severance payment when compared with severance plans offered by many other companies. In addition, an executive who qualifies for a severance payment under this plan does not receive accelerated vesting of equity awards (although, in a change-in-control scenario, those awards may vest separately under the terms of our equity incentive plans, as discussed immediately below). Finally, the executive will receive no tax “gross-up” payment to compensate him or her for any taxes which he or she may be required to pay in connection with such payment. Management and the Committee accordingly believe that such severance rights provide executives with a fair, but not excessive, financial transition when an executive is asked to leave the company.


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Change in Control Benefits under Equity Plans.  Benefits are also provided to named executive officers and other recipients of equity awards under our equity plans upon the occurrence of a “Change in Control” or a “Potential Change in Control,” as defined in those plans (collectively, a “Change in Control”). The Board of Directors has the authority under the plans to “override” the Change in Control benefits, in an appropriate case, if the Board gives its prior approval to a transaction that would have otherwise triggered the benefits to be paid. If the Board’s prior approval is not obtained, our equity plans include provisions providing for the immediate vesting of, and payments to the holders of equity awards in an amount equal to the value of, the outstanding equity awards upon the occurrence of one of the specified triggering events. These provisions apply to both outstanding stock options, which we issued prior to 2003, and unvested restricted stock awards, including both time-based and performance-based awards. The Change in Control benefits would be paid upon the occurrence of a triggering event, even if an executive’s continued employment with the company (or a successor company) is not terminated or threatened. Details concerning these provisions, including the definitions of “Change in Control” and “Potential Change in Control,” are provided beginning on page 46 under ‘‘Change in Control Provisions under Equity Plans.”
 
For restricted stock awards made in March 2007 or thereafter, the Board of Directors has modified our 2003 Incentive Plan (our only equity plan under which awards may currently be made to executives and other eligible employees) to remove from the definition of “Potential Change in Control” the approval by shareholders of an agreement that would give rise to a Change in Control. This change was viewed as appropriate by the Board and management for future awards to avoid a potential scenario in which rights are triggered under the plan, cash payouts are made as required, but the underlying transaction is not consummated as anticipated for some reason. This change was made on a going-forward basis only, and it does not affect rights under outstanding awards, which accrued under the plan before the change was made.
 
These Change in Control provisions have been included in our equity incentive plans since at least 1989. We believe that these provisions are similar to the change-in-control provisions included by many public companies in their equity plans. The provisions of our plans are designed to be triggered when a transaction occurs or is in process, without the prior approval of our Board of Directors that would be expected to result in an actual or effective change in control of the company. The Change in Control provisions are intended to protect the interests of the company if we are faced with such a Change in Control scenario.
 
Any such change, or the impending prospect of such a change, would likely result in a significant alteration of, or at a minimum, cause tremendous uncertainty regarding, the employment situations of the most senior executives in the company. The loss of executive talent at such a critical juncture could be problematic for the company and its shareholders. By removing the additional uncertainty regarding outstanding equity plan benefits, these provisions are designed to enhance retention of executives and keep them focused on their business responsibilities in the face of such uncertain corporate events. Moreover, this process would also avoid executives’ legitimate concerns that, after the Change in Control, they could be subject to adverse employment actions, such as possible job loss or other actions intended to induce the executive to resign and forego benefits under the equity plans. While some of these adverse actions might be readily identifiable, such as a significant decrease in compensation or change in responsibilities, others might be more subtle and difficult to prove, such as exclusion from management meetings and policy decision-making. For these reasons, we believe that Change in Control benefits triggered by the change-in-control event, without requiring prior job loss, is appropriate. If a new controlling person desires to retain the services one or more of the executives, it would be free to attempt to negotiate appropriate terms and conditions for their continuing employment.
 
Finally, it should be noted that although these provisions can operate automatically in a situation where the Change in Control is undertaken unilaterally, the Change in Control benefits may be withdrawn by the Board of Directors, in an appropriate case, if the persons seeking to acquire control of the company were to first come to the Board and negotiate to obtain the Board’s consent to the triggering transaction. In this way, the plan provisions are further intended to foster a consensual process and a more orderly change in control, if such consent is requested and the transaction is approved. The Board believes such a process would inure to the benefit of our shareholders, customers, employees and other interested parties.
 
5. Health and Welfare Benefits
 
Named executive officers are also eligible to participate in our health and welfare plans. These plans are available on the same basis to all of our regular employees who satisfy minimum eligibility requirements.
 
III.  RELATED CONSIDERATIONS
 
A.  Section 162(m) of the Internal Revenue Code
 
Section 162(m) of the Internal Revenue Code limits to $1 million per year (“Deduction Limit”) the deduction allowed for Federal income tax purposes for compensation paid to the chief executive officer and the three other most highly compensated executives of a public company other than the chief financial officer (“Covered Executives”). This Deduction Limit does not


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apply to compensation paid under a plan that meets certain requirements for “performance-based compensation.” Generally, to qualify for this exception: (a) the compensation must be payable solely on account of the attainment of one or more pre-established objective performance goals; (b) the performance goals must be established by a compensation committee of the board of directors that is comprised solely of two or more “outside directors”; (c) the material terms of the performance goals must be disclosed to and approved by shareholders before payment; and (d) the compensation committee must certify in writing prior to payment that the performance goals and any other material terms have been satisfied.
 
Our policy is to structure incentive compensation programs for Covered Executives to satisfy the requirements for the “performance-based compensation” exception to the Deduction Limit, and, thus, to preserve the deductibility of compensation paid to Covered Executives, to the extent practicable. Our equity incentive plans, as well as the 2004 and 2007 Executive Bonus Plans, have been submitted to and approved by Progressive’s shareholders. The applicable performance criteria (and in the case of cash bonuses, the amount of bonus payouts that would result from various levels of performance when measured against specific performance criteria) are approved in advance by the Committee each year and are thereafter not subject to change by Progressive or the Committee. Thus, performance-based restricted stock awards that vest, and cash bonus awards under the Executive Bonus Plans which are paid out, based on the achievement of such performance criteria are structured to be “performance-based compensation,” and compensation arising from such awards would not be subject to the Deduction Limit, provided that each of the other requirements described above are satisfied.
 
Compensation that is earned by the Covered Executives upon the exercise of stock option awards likewise has been designed to satisfy the requirements for “performance-based compensation,” based on how we implemented our stock option program prior to its termination in 2003.
 
Several elements of our compensation program, however, may give rise to income for a Covered Executive that is not considered “performance-based” and, therefore, subject to the Deduction Limitation, including the following:
 
  •   Salary;
 
  •   Bonuses earned under plans other than the 2004 and 2007 Executive Bonus Plans;
 
  •   The income recognized upon the vesting of time-based restricted stock awards (unless the executive defers the receipt of such awards under our executive deferral plan, described above);
 
  •   Income arising from perquisites;
 
  •   Dividends paid to Covered Executives on account of unvested restricted shares that have been awarded under our equity incentive plans; and
 
  •   Certain distributions made to a Covered Executive in the current year from our executive deferral plan (described above) arising from the executive’s deferral elections in prior years.
 
Accordingly, if the total of any Covered Executive’s compensation that does not satisfy the “performance-based compensation” exception exceeds $1 million in any year, Progressive will not be entitled to deduct the amount that exceeds $1 million. Progressive and the Committee will continue to monitor the actual tax impact of such compensation strategies each year and consider such impact in making compensation decisions. We will not necessarily discontinue a compensation plan, however, that has a potential negative tax impact under Section 162(m). If we believe that the program in question (e.g., the use of time-based restricted stock) is appropriate and in the interest of shareholders, we will continue to use that type of compensation even though there are potential tax disadvantages to Progressive.
 
In 2007, the non-performance-based compensation earned by each of the Covered Executives was less than $1 million, except that for the CEO the Deduction Limit was exceeded by an amount currently estimated to total $1,840,000, all of which resulted from the company’s payment of a $2 per share extraordinary dividend in September 2007, which resulted in non-performance-based compensation to executives to the extent that the dividend was paid on unvested restricted stock. Other than this overage, all compensation earned by the Covered Executives was fully deductible for Federal income tax purposes. For 2008, we are currently estimating that the CEO may exceed the $1,000,000 limit by an amount of under $75,000.
 
B.  Section 409A of the Internal Revenue Code
 
Section 409A of the Internal Revenue Code sets forth requirements for non-qualified deferred compensation arrangements. The new requirements apply to deferrals of compensation earned or vested after 2004. If deferrals do not comply with


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the new requirements, the amount deferred is immediately includable in taxable income, subject to an additional 20% tax and interest.
 
Section 409A generally requires that elections to defer compensation must be made no later than the end of the year preceding the year the compensation is earned. Distributions of deferred compensation may be made only upon certain specified events, including death, disability, separation from service, unforeseeable emergency, change in control of the employer and expiration of a fixed deferral period. Section 409A also includes provisions restricting a deferred compensation plan participant’s ability to accelerate, delay or change the form of a scheduled distribution of deferred compensation.
 
Deferred compensation arrangements that meet certain conditions may qualify for an exemption from Section 409A requirements. For example, an arrangement is exempt from Section 409A if it requires all payments to be made to a participant no later than 21/2 months following the end of the year in which the right to the payments was earned and vested. In addition, the arrangement will qualify for exemption if payments under the arrangement do not exceed certain limits and are payable no later than the end of the second year following the year the participant involuntarily separates from service.
 
All of our compensation plans, programs and arrangements either qualify for exemption from Section 409A or have been amended to comply with Section 409A requirements. During 2007, we modified our executive deferred compensation plan and our director deferral plans so that all deferrals of compensation earned or vested after 2004 satisfy Section 409A, and to implement certain features permitted by the regulations with respect to such deferrals. For our executive deferred compensation plan, these changes included the following:
 
  •   The definition of “change in control” (the occurrence of which would trigger certain distributions under the plan) was modified to comply with the requirements of Section 409A. Significant aspects of this change included:
 
  —   a change in control will occur if 30% of our shares are acquired, as opposed to the 20% standard in our prior plan;
 
  —   a change in control will occur if the majority of our Board of Directors is replaced during a 12-month period, instead of the 24-month period imposed by the prior plan;
 
  —   The Board has no discretion to override change-in-control events under the revised plan, whereas it did have such discretion under the prior plan; and
 
  —   The concept of “potential change in control,” which under the prior plan could include shareholders’ approval of certain transaction or the Board’s determination that the acquisition of 5% ownership by a third party constituted a potential change in control, has been removed from the plan;
 
  •   The definition of “disability” was conformed to Section 409A’s definition, which is somewhat more strict than the prior definition;
 
  •   Early withdrawals (which were permitted under the prior plan, with a 10% penalty) are no longer allowed;
 
  •   Unscheduled withdrawals are permitted in the event of certain unforeseeable emergencies;
 
  •   Participants are permitted to change certain distribution schedules if they do so with at least 12 months notice and delay distributions for at least 5 years; and
 
  •   Distributions made on account of termination of employment will not be made until 6 months after the date of termination.
 
The modifications to our director deferral plans involved some of the same topics, including implementation of the new change-in-control definitions, the addition of a change-in-control distribution event to one of the plans, provisions allowing distribution schedules to be changed (at least 12 months in advance with a 5-year or longer delay in distributions) and certain administrative changes.
 
Prior to the effectiveness of these amendments, we had operated our deferral plans in good faith compliance with Section 409A as to all deferrals made after 2004.


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COMPENSATION COMMITTEE REPORT
 
The following Compensation Committee Report does not constitute soliciting material and should not be deemed filed or incorporated by reference into any other Progressive filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent Progressive specifically incorporates this Report by reference therein.
 
The Compensation Committee (the “Committee”) of the Board of Directors of The Progressive Corporation (“Progressive”) has reviewed and discussed with Progressive’s management the Compensation Discussion and Analysis set forth above. Based on the review and discussions noted above, the Committee recommended to the Board that the Compensation Discussion and Analysis be included in Progressive’s Proxy Statement for 2008, and incorporated by reference into Progressive’s Annual Report on Form 10-K for the year ended December 31, 2007.
 
COMPENSATION COMMITTEE
 
Charles A. Davis, Chairman
Norman S. Matthews
Bradley T. Sheares, Ph.D.


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EXECUTIVE COMPENSATION
 
The following information is set forth with respect to the total compensation of our named executive officers (NEOs) for 2007, who include each person who served as the Chief Executive Officer (CEO) or the Chief Financial Officer (CFO) during the year and our three other most highly compensated executive officers. The titles set forth below reflect positions held at December 31, 2007.
 
SUMMARY COMPENSATION TABLE
­ ­
                                             
                      Non-Equity
       
                      Incentive
       
            Stock
    Option
  Plan
  All Other
   
Name and
      Salary
  Awards1
    Awards2
  Compensation3
  Compensation4
  Total
Principal Position   Year   ($)   ($)     ($)   ($)   ($)   ($)
 
Glenn M. Renwick
    2007   $ 750,000   $ 3,309,221     $   $ 832,500   $ 102,400   $ 4,994,121
President and Chief     2006     750,000     3,144,318       132,052     1,327,500     81,009     5,434,879
Executive Officer                                            
 
 
Brian C. Domeck
    2007   $ 317,693   $ 229,395     $   $ 235,092   $ 11,625   $ 793,805
Vice President and     2006     259,655     126,691       6,288     216,095     10,660     619,389
Chief Financial Officer                                            
 
 
W. Thomas Forrester5
    2007   $ 197,013   $ (23,228 )   $   $   $ 10,785   $ 184,570
Former Vice President and     2006     500,002     384,734       13,166     590,002     11,310     1,499,214
Chief Financial Officer                                            
 
 
Brian J. Passell6
    2007   $ 438,270   $ 523,435     $   $ 324,319   $ 12,059   $ 1,298,083
Claims Group President     2006     422,693     465,021       21,121     498,777     11,310     1,418,922
 
 
Raymond M. Voelker
    2007   $ 347,692   $ 400,972     $   $ 268,071   $ 11,625   $ 1,028,360
Chief Information Officer     2006     328,269     352,715       16,143     398,190     11,310     1,106,627
 
 
Charles E. Jarrett
    2007   $ 393,269   $ 332,225     $   $ 291,019   $ 8,700   $ 1,025,213
Vice President, Secretary and     2006     378,269     318,337       19,083     446,358     8,484     1,170,531
Chief Legal Officer                                            
 
 
 
1 Represents expense recognized with respect to restricted stock awards granted from 2003 through 2007, in accordance with Statement of Financial Accounting Standards 123 (revised 2004) (SFAS 123(R)), “Share-Based Payment.” For awards granted in 2007, see the “Grants of Plan-Based Awards” table below.
 
Messrs. Renwick, Forrester and Jarrett, elected to defer the receipt of their 2003 and 2004 restricted stock awards pursuant to The Progressive Corporation Executive Deferred Compensation Plan (“EDCP”), under which such awards are accounted for as liability awards during the period prior to vesting. Under liability award accounting, the amount expensed reflects the fluctuations in the market price during the year, which results in a reduction in expense in years in which the stock price declines, such as in 2006 and 2007.
 
See “Narrative Disclosure to Summary Compensation Table and Grants of Plan-Based Awards Table” for a description of the timing and vesting terms of the 2007 restricted stock awards. Also see the “Compensation Discussion and Analysis” beginning on page 22, as well as Note 8 — Employee Benefit Plans in Progressive’s 2007 Annual Report to Shareholders included as an appendix to this Proxy Statement, for further discussion of the restricted stock awards and our recognition of expense relating to such awards.
 
2 Represents expense recognized in accordance with SFAS 123(R) for nonqualified stock option awards granted in 2002. In 2003, we began granting restricted stock awards in lieu of stock options. All remaining stock options vested on January 1, 2007. Unless there is a modification to the unexercised stock option awards, we will not incur any additional expense relating to currently outstanding stock options in years subsequent to 2006.
 
3 2007 amounts were earned under The Progressive Corporation 2007 Executive Bonus Plan (the “2007 Executive Plan”), except that for Mr. Voelker, a portion was earned under The Progressive Corporation 2007 Information Technology Incentive Plan (the “2007 IT Bonus Plan”). As discussed in more detail below, Mr. Voelker’s opportunity to earn non-equity incentive compensation was allocated between the 2007 Executive Plan (90%) and the 2007 IT Bonus Plan (10%).
 
2006 amounts were earned under The Progressive Corporation 2004 Executive Bonus Plan (the “2004 Executive Plan”) for Messrs. Renwick, Forrester and Passell; The Progressive Corporation 2006 Gainsharing Plan (“2006 Gainsharing Plan”) for Messrs. Domeck and Jarrett; and The Progressive Corporation 2006 Information Technology Incentive Plan (the “2006 IT Bonus Plan”) and the 2006 Gainsharing Plan for Mr. Voelker under a 90/10 split as described above.
 
Payments under the 2007 Executive Plan and the 2004 Executive Plan were made entirely in the year after the bonus amounts were earned (i.e., amounts earned for 2007 were paid in 2008). For the 2007 IT Bonus Plan, the 2006 IT Bonus Plan and the 2006 Gainsharing Plan, 75% of an estimated amount of the award was paid in the year earned and the balance was paid in the next year. Amounts reported include, if any, non-equity incentive plan compensation that will be deferred under the EDCP in 2008 when the bonuses would otherwise be paid.


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4All Other Compensation is comprised of the following:
 
                         
    Employer
  Anniversary
        Total All Other
Name   Contributionsa   Awardsb   Perquisitesc     Compensation
 
Glenn M. Renwick
  $ 11,625   $   $ 90,775 d   $102,400
Brian C. Domeck
    11,625             11,625
W. Thomas Forrester
    10,785             10,785
Brian J. Passell
    11,625     434         12,059
Raymond M. Voelker
    11,625             11,625
Charles E. Jarrett
    8,700             8,700
 
  a Represents employer contributions made during 2007 under our Retirement Security Program. Amounts contributed vary based on level of employee contribution and years of service, with a maximum annual employer contribution of $11,625.
 
  b Represents service anniversary awards paid to all employees upon every five-year anniversary of employment with Progressive. The maximum service anniversary award is $300, on a post-tax basis, for 25 years of service and each 5-year increment thereafter.
 
  c For further information on the limited perquisites we offered to our NEOs, see the “Perquisites” discussion in “Compensation and Discussion Analysis” on page 31.
 
  d Includes $86,713 in incremental costs for his personal use of our company airplane. We calculate incremental costs to include the cost of fuel and oil per flight; trip related inspections, repairs and maintenance; crew travel expenses; on-board catering; trip related flight planning services; landing, parking and hangar fees; supplies; passenger ground transportation; and other variable costs. Since the airplane is used primarily for business travel, we do not include the fixed costs that do not change based on personal usage, such as pilots’ salaries, the depreciation of the airplane and the cost of maintenance not related to personal trips. In addition, the perquisite amount includes the incremental costs attributable to: (i) Mr. Renwick’s personal use of a company car, which is primarily limited to commuting to and from work; and (ii) non-business related activities associated with an annual retreat attended by the Board of Directors and senior executives in 2007, including the NEOs (e.g., meals for his spouse and other activities).
 
5 W. Thomas Forrester, our former CFO, retired in March 2007 and was eligible for the Rule of 70 benefits contained in our equity incentive plans. See “Potential Payments upon Termination or Change in Control; Qualified Retirement Provisions under Equity Plans,” beginning on page 47, for a discussion of the Rule of 70 benefits. Accordingly, when he retired, Mr. Forrester received 50% of his unvested time-based restricted shares (33,128 shares, valued at $756,147 as of his retirement date), and the other 50% were forfeited, which resulted in a reversal of prior expense recognized by the company and accounted for the negative “stock award” value for 2007 in the Summary Compensation Table to the extent such amounts were previously reported as an expense in the Summary Compensation Table in 2006. In addition, he retained 100% of his unvested performance-based restricted shares (74,740 shares), which are valued at approximately $1.4 million as of December 31, 2007, but each of which will vest (if at all) only when we achieve the required performance objectives for each outstanding award. Further, pursuant to the provisions of our stock option plan, Mr. Forrester will be allowed to retain his outstanding stock options, all of which had previously vested, until their scheduled expiration. At retirement, Mr. Forrester held options covering 900,756 shares, with an average exercise price of $8.40 per share; the options are scheduled to expire in annual increments between December 31, 2007 and December 31, 2011, unless exercised before their scheduled expiration dates.
 
6 Mr. Passell’s employment terminated in February 2008.


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Grants of Plan-Based Awards
 
The following table summarizes awards that were eligible to be earned during 2007 under the 2007 Executive Bonus Plan, as well as restricted shares awarded in 2007 under the 2003 Incentive Plan, including both time-based and performance-based awards (equity incentive plan awards).
 
GRANTS OF PLAN-BASED AWARDS IN 2007
 
                                       
                    Estimated Future
     
                    Payouts Under
     
        Estimated Possible Payouts Under Non-Equity
  Equity Incentive
    Grant Date Fair
        Incentive Plan Awards1   Plan Awards
    Value of Stock
        Threshold
  Target
  Maximum
  Target
    Awards2
Name   Grant Date   ($)   ($)   ($)   (#)     ($)
 
Glenn M. Renwick
    N/A   $ 0   $ 1,125,000   $ 2,250,000              
      3/15/2007                       178,659 3   $ 3,750,052
      3/15/2007                       178,655 4     3,749,968
Brian C. Domeck
    N/A   $ 0   $ 317,693   $ 635,386              
      3/15/2007                       15,246 3   $ 320,014
      3/15/2007                       15,245 4     319,993
W. Thomas Forrester5
    N/A                      
Brian J. Passell
    N/A   $ 0   $ 438,270   $ 876,540              
      3/15/2007                       20,964 3   $ 440,034
      3/15/2007                       20,965 4     440,055
Raymond M. Voelker
    N/A   $ 0   $ 347,692   $ 695,384              
      3/15/2007                       16,677 3   $ 350,050
      3/15/2007                       16,675 4     350,008
Charles E. Jarrett
    N/A   $ 0   $ 393,269   $ 786,538              
      3/15/2007                       18,819 3   $ 395,011
      3/15/2007                       18,820 4     395,032
 
N/A = Grant Date is not applicable to non-equity incentive plan awards.
 
1 Non-equity incentive plan awards were earned in 2007 under The 2007 Executive Bonus Plan for all executives except Mr. Voelker, 90% of whose potential bonus derived from this plan and the remaining 10% derived from the 2007 IT Bonus Plan. Payments under these plans can range from 0.0 to 2.0 times the targeted amount. The targeted amount represents the product of the executive’s salary and his target percentage, both of which are set by the Compensation Committee at the beginning of the plan year. The actual amount of non-equity incentive plan compensation earned by the NEOs during 2007 is included in the Summary Compensation Table on page 37. Further description of these plans is provided in the “Compensation Discussion and Analysis” beginning on page 22 and the accompanying Narrative Disclosure.
 
2Awards are valued at the closing price on the date of grant, March 15, 2007, of $20.99.
 
3Represents number of shares covered by time-based restricted stock awards.
 
4Represents number of shares covered by performance-based restricted stock awards.
 
5 Mr. Forrester retired on March 2, 2007. As a result, he did not earn, nor was he awarded, any plan-based awards during 2007.
 
Narrative Disclosure to Summary Compensation Table and Grants of Plan-Based Awards Table
 
Employment Agreements.  As of December 31, 2007, none of the named executive officers had employment agreements with Progressive.
 
Summary Compensation Comments.  In total, salary and non-equity incentive plan compensation comprised approximately 60% to 70% of total compensation for the named executive officers other than Mr. Renwick, whose salary and non-equity incentive compensation comprised 32% of his total compensation for the year and Mr. Forrester who retired in March 2007. For additional discussion of our compensation policies, 2007 compensation decisions, and non-equity incentive plans and the performance criteria thereunder, see the “Compensation Discussion and Analysis” beginning on page 22.


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Non-Equity Incentive Compensation.  Non-equity incentive compensation for the NEOs is available under the company’s 2007 Executive Bonus Plan (except as noted below) and is determined using the following formula:
 
                         
Paid
Salary
  X   Target
Percentage
  X   Performance
Factor
  =   Annual
Bonus
 
For each executive, the salary and the target percentage (as a percent of salary) are established by the Compensation Committee on an annual basis during the first quarter of the year. When the participant’s annual salary is multiplied by his or her assigned target percentage, the product is referred to as the participant’s “target bonus” or “target bonus amount” for the year. For 2007, Mr. Renwick’s target percentage for non-equity incentive compensation was 150% of salary and for Messrs. Domeck, Passell, and Jarrett, the target percentage was 100% of salary. Mr. Voelker’s target percentage was 100% of salary; however, only 90% of his potential bonus was calculated under the 2007 Executive Bonus Plan. The remaining 10% of his potential bonus was calculated under the 2007 IT Bonus Plan.
 
Under the 2007 Executive Bonus Plan, the performance factor is determined for all NEOs after the end of each year based on the actual operating performance of our principal business units for that year, when compared to growth and profitability criteria that were established by the Compensation Committee during the first quarter of the year. The performance factor can range from 0.0 to 2.0 each year, depending on the extent to which Progressive and/or assigned business unit results meet, exceed or fall short of the objective performance goals established by the Committee. As a result, each participant can earn an annual cash bonus of between 0.0 and 2.0 times his or her target bonus amount (with an amount equal to 2.0 times an executive’s target bonus thus being the executive’s maximum potential bonus). The executive’s annual cash bonus would equal the target bonus amount if the applicable performance factor equals a 1.0 for the year.
 
Generally, the performance factors for executives (and most other employees) under our Gainsharing plans, including the 2007 Executive Bonus Plan, are determined by reference to either (i) the overall operating performance of our core insurance businesses, excluding our investment results (the “Core Business”), or (ii) a combination of the performance of the Core Business and the performance of the respective executive’s assigned business unit. For 2007, each of the NEOs earned his bonus under the 2007 Executive Bonus Plan solely under the Core Business calculation (other than that portion of Mr. Voelker’s bonus that was determined under the 2007 IT Bonus Plan, as described below). The Core Business was defined to include the Agency Business, the Direct Business, the Special Lines Business and Commercial Auto Business. The performance factor for the Core Business for 2007 was calculated as follows:
 
  •   Separate “Gainsharing matrices” were established for the Agency, Direct, Commercial Auto and Special Lines business units (or an applicable sub-unit) by the Committee in the first quarter of 2007. Each matrix assigned a performance score between 0.0 and 2.0 to various combinations of growth and profitability in the applicable business unit or sub-unit, as follows:
 
  —   For the Agency and Special Lines units, growth was measured by the change in policies in force for the business unit as compared with the prior year, and profitability was measured by the calendar year combined ratio determined in accordance with accounting principles generally accepted in the United States of America (“GAAP”).
 
  —   For the Direct business, two matrices were used. One was based on new policy growth and the GAAP combined ratio (Direct-New), and the other was based on the retention rate for policies in existence at the beginning of the year and the GAAP combined ratio (Direct-Renewal).
 
  —   For the Commercial Auto business, two matrices also were used, one for the Light Local market and one for the Specialty business, in each case measuring growth in policies in force over the prior year and the GAAP combined ratio.
 
  •   Actual growth and profitability performance results for each business unit were determined after year-end and then compared to the applicable matrix to produce a performance score for the business unit. Where more than one matrix was used for a business unit, the results were combined based on a formula pre-established by the Committee to calculate the overall score for the applicable business unit.
 
  •   The performance scores achieved by each of the business units were weighted, based on the percentage of net premiums earned in the respective business unit during the year as compared to the Core Business as a whole.
 
  •   The weighted scores for the business units were then added together to produce a performance factor for the Core Business as a whole.


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In 2007, the performance factor for the Core Business determined according to these criteria was .74, which was used to calculate the annual bonus for Messrs. Renwick, Domeck, Passell and Jarrett.
 
For Mr. Voelker, our Chief Information Officer, 90% of his performance factor was determined by the Core Business performance score (.74 as described above), and the remaining 10% was determined under our 2007 IT Bonus Plan, as approved by the Compensation Committee in early 2007. The performance score under the 2007 IT Bonus Plan was determined by the outage-free availability of certain significant computer and related systems during the course of the year, under specific rules established by the plan, as compared with performance standards established by the plan. System downtime resulted in a lower performance score under this plan. The intent of the 2007 IT Bonus Plan was to motivate IT employees, including Mr. Voelker, to keep these systems operational on a 24x7 basis, subject to certain events specified in the plan, such as scheduled maintenance time.
 
For 2007, the 2007 IT Bonus Plan generated a performance score of 1.01 out of a possible 2.0, reflecting overall performance at about the target level. When this result (for 10% of Mr. Voelker’s potential bonus) was combined with the result he earned under the Core Business Component (for the remaining 90%), Mr. Voelker’s overall performance factor for the year was .77.
 
Equity Incentive Plan Awards.  In 2007, all of the equity incentive plan awards were granted pursuant to the 2003 Incentive Plan. We granted both time-based and performance-based restricted stock awards to the named executive officers. All restricted stock awards for 2007 have voting rights equivalent to those of our other outstanding common shares. Restricted stock awards made in March 2007 and thereafter will not entitle the holder to receive dividend payments at the time those payments are made to other common shareholders. Instead, the dividend payments will be retained by the company and will be paid to the NEOs (and other recipients), with interest, only if and when the restricted shares vest. Awards made prior to March 2007 have dividend and voting rights equivalent to those of our other outstanding common shares.
 
In 2007, we granted time-based restricted stock awards to the named executive officers, based on a percentage of the individual’s salary at the time of grant, as determined by the Compensation Committee. The time-based awards will vest in three equal installments in the third, fourth and fifth years after the date of grant (i.e., January 1, 2010, 2011 and 2012 for awards granted in 2007).
 
We also granted performance-based restricted stock awards to the named executive officers in 2007. The value of the performance-based awards was determined by the Compensation Committee, also based on a percentage of the individual’s annual salary. The performance-based awards will vest upon the satisfaction of objective performance criteria. For 2007 awards, vesting will occur only if Progressive’s insurance subsidiaries generate net premiums earned of $19 billion or more over a period of 12 consecutive months, while maintaining an average combined ratio of 96 or less over the same period. If the objectives are not achieved by December 31, 2016, the awards will be forfeited.
 
All restricted stock awards are made subject to accelerated vesting pursuant to the “qualified retirement” (also known as the Rule of 70) and “change in control” provisions in the 2003 Incentive Plan (see “Potential Payments Upon Termination or Change in Control” beginning on page 45).
 
Further discussion of our compensation strategy and plans can be found in the “Compensation Discussion and Analysis” beginning on page 22.


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Outstanding Equity Awards at Fiscal Year-End
 
The following table summarizes stock option awards exercisable and outstanding under the 1995 Incentive Plan, as well as the unvested restricted stock awards outstanding under the 2003 Incentive Plan. The value of the stock awards is calculated using $19.16, which represents the closing price of Progressive shares on the last business day of 2007.
 
OUTSTANDING EQUITY AWARDS AT DECEMBER 31, 2007
 
                                   
    Option Awards1     Stock Awards
                  Equity
    Equity
                  Incentive Plan
    Incentive Plan
    Number of
            Awards:
    Awards: Market
    Securities
            Number of
    Value of
    Underlying
            Unearned
    Unearned
    Unexercised
  Option
        Shares That
    Shares That
    Options
  Exercise
  Option
    Have Not
    Have Not
    (#)
  Price
  Expiration
    Vested
    Vested
Name   Exercisable   ($)   Date     (#)     ($)
Glenn M. Renwick
    147,505   $ 10.78     12/31/2008       651,199 3   $ 12,476,973
      653,029     4.38     12/31/2009       664,835 4     12,738,239
      712,123     6.99     12/31/2010                
      597,385     11.86     12/31/2011                
Brian C. Domeck
    33,329     4.38     12/31/2009       34,330 3     657,763
      41,986     6.99     12/31/2010       23,165 4     443,841
      21,677     11.86     12/31/2011                
W. Thomas Forrester
    138,286     10.78     12/31/2008       0 3    
      332,441     4.38     12/31/2009       74,740 4     1,432,018
      249,956     6.99     12/31/2010                
      144,107     11.86     12/31/2011                
Brian J. Passell2
    205,450     4.38     12/31/2009       74,976 3     1,436,540
      185,527     6.99     12/31/2010       77,125 4     1,477,715
      103,424     11.86     12/31/2011                
Raymond M. Voelker
    43,817     11.86     12/31/2011       58,525 3     1,121,339
                          55,595 4     1,065,200
Charles E. Jarrett
    52,140     7.22     12/31/2009       67,387 3     1,291,135
      139,905     6.99     12/31/2010       65,140 4     1,248,082
      97,893     11.86     12/31/2011                
 
 
1 All awards are exercisable at December 31, 2007. We stopped issuing stock option awards after December 31, 2002. In conjunction with the $2.00 per common share special dividend paid in September 2007 and pursuant to the antidilution provisions of our incentive plans, we were required to increase the number of shares and reduce the exercise price of any of the then outstanding stock option awards.
 
2 All of Mr. Passell’s unvested restricted stock awards were forfeited upon his termination of employment in February 2008.
 
3 Represents time-based restricted stock awards. In conjunction with the qualified retirement provisions of the incentive plans, Mr. Forrester’s time-based restricted stock awards either vested or were forfeited upon his retirement in March 2007. Following are the applicable vesting dates for the other NEO awards:
 
                                                 
Name   1/1/2008     1/1/2009     1/1/2010     1/1/2011     1/1/2012     Total  
 
 
Glenn M. Renwick
    160,616       162,064       162,197       106,769       59,553       651,199  
Brian C. Domeck
    5,928       6,212       9,450       7,658       5,082       34,330  
Brian J. Passell
    19,800       17,520       18,328       12,340       6,988       74,976  
Raymond M. Voelker
    15,312       13,568       14,371       9,715       5,559       58,525  
Charles E. Jarrett
    17,864       15,732       16,457       11,061       6,273       67,387  


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4 Represents performance-based restricted stock awards. Performance-based restricted stock awards vest upon Progressive’s insurance subsidiaries achieving both a minimum level of net premiums earned (NPE) and a predetermined combined ratio (CR) over the same period of 12 consecutive months. Following are the performance criteria that must be achieved to enable the performance-based restricted stock awards to vest for the year of grant indicated:
 
  •  2004 — NPE of $15.0 billion and CR of 97
 
  •  2005 — NPE of $17.5 billion and CR of 96
 
  •  2006 — NPE of $20.0 billion and CR of 96
 
  •  2007 — NPE of $19.0 billion and CR of 96
 
If these objectives are not achieved by December 31, 2013, 2014, 2015 or 2016 for the 2004, 2005, 2006 and 2007 awards, respectively, the awards will be forfeited. The number of performance-based restricted shares awarded to each of the NEOs for such years are as follows:
 
                                         
Name   2004     2005     2006     2007     Total  
 
 
Glenn M. Renwick
    178,260       166,280       141,640       178,655       664,835  
Brian C. Domeck
    2,760       2,800       2,360       15,245       23,165  
W. Thomas Forrestera
    25,640       25,500       23,600       0       74,740  
Brian J. Passell
    18,740       19,760       17,660       20,965       77,125  
Raymond M. Voelker
    13,820       13,260       11,840       16,675       55,595  
Charles E. Jarrett
    15,780       16,180       14,360       18,820       65,140  
 
  a Pursuant to the retirement provisions under the incentive plans, Mr. Forrester retained his performance-based restricted stock awards upon his qualified retirement, which remain subject to the same vesting provisions as the other executive’s awards.
 
Option Exercises and Stock Vested
 
The following table summarizes the exercise of stock options and the vesting of restricted stock awards during 2007. The stock options were exercised at various dates during the year, while all of the restricted stock awards vested on January 1, 2007, at a price of $24.32 per common share, except for Mr. Forrester, who had additional restricted stock awards vest upon his retirement on March 2, 2007 at a price of $22.825.
 
                             
OPTION EXERCISES AND STOCK VESTED DURING 2007
    Option Awards     Restricted Stock Awards
    Number of
        Number of
     
    Shares
  Value
    Shares
    Value
    Acquired on
  Realized on
    Acquired on
    Realized on
    Exercise 
  Exercise
    Vesting
    Vesting
Name   (#)   ($)     (#)     ($)
Glenn M. Renwick
    123,799   $ 1,057,838       105,188 1   $ 2,558,172
Brian C. Domeck
              4,136       100,588
W. Thomas Forrester
    112,800     1,507,967       50,556 1     1,179,996
Brian J. Passell
              13,812       335,908
Raymond M. Voelker
              10,656       259,154
Charles E. Jarrett
              12,468 1     303,222
 
1 Represents restricted stock awards that were deferred in their entirety pursuant to the EDCP immediately prior to the vesting event. These deferred awards are deemed invested in one or more investment funds, including Progressive’s common shares, as recommended by the NEO, and are eligible to be transferred among the funds in the EDCP, except that deferrals of restricted stock awarded in March 2005 or thereafter are automatically deemed invested in Progressive common shares and are not eligible to be transferred to other investments. Distribution of these deferred awards will be made in cash, based on the election of the participant, except that distributions attributable to restricted stock awards made in or after March 2005 will be made in Progressive common shares. Mr. Renwick elected to receive payment of this deferred award in a lump sum upon separation from Progressive. Mr. Forrester elected to receive payment in 10 installments on the earlier of reaching age 59 or the date he separated from Progressive. Mr. Jarrett elected to receive payment of this deferred award in 10 installments upon separation from Progressive. The deferred amounts are included in the Nonqualified Deferred Compensation table below.


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Nonqualified Deferred Compensation
 
The following table summarizes amounts contributed to, earned within and distributed from The Progressive Corporation Executive Deferred Compensation Plan (EDCP) during 2007, as well as the aggregate ending balance in the EDCP at December 31, 2007.
 
NONQUALIFIED DEFERRED COMPENSATION DURING 2007
                                 
    Executive
  Registrant
  Aggregate
        Aggregate
    Contributions
  Contributions
  Earnings in
    Aggregate
  Balance at
    in Last Fiscal
  in Last Fiscal
  Last Fiscal
    Withdrawals/
  Last Fiscal
    Year1
  Year2
  Year
    Distributions3
  Year-end1
Name   ($)   ($)   ($)     ($)   ($)
 
Glenn M. Renwick
  $ 3,885,672   $ 0   $ (571,554 )   $ 165,986   $ 24,155,129
Brian C. Domeck
    50,877     0     97,522       0     1,451,427
W. Thomas Forrester
    1,769,998     0     340,466       1,035,912     9,835,314
Brian J. Passell
    0     0     33,593       0     487,084
Raymond M. Voelker
    0     0     0       0     0
Charles E. Jarrett
    390,224     0     73,826       0     3,549,621
 
1 The table below identifies amounts of deferred compensation reported as compensation for the 2007 fiscal year in the Summary Compensation Table in this Proxy Statement, as well as the aggregate amount of deferred compensation reported in the Summary Compensation Tables in our proxy statements for all prior years, including this Proxy Statement. Prior to 2007, non-equity incentive compensation awards were disclosed as “Bonus” in the Annual Compensation Section of the Summary Compensation Table. Under our plans, the non-equity incentive plan compensation that was earned in 2007 (which is shown in the Summary Compensation Table in this Proxy Statement) will not be paid until 2008. As a result, the deferral of the amounts earned in 2007 also will not occur until 2008, and no amounts are shown below as “Contributions Reported in Current Summary Compensation Table Earned in Last Fiscal Year.”
 
             
    Contributions
   
    Reported in
  Aggregate Balance
    Current Summary
  (Contributions
    Compensation
  Reported in Prior Years
    Table Earned
  Summary Compensation
Name   in 2007   Tables)
 
 
Glenn M. Renwicka
  $   —   $ 12,680,334
W. Thomas Forresterb
        6,345,152
Brian J. Passellc
        333,806
Charles E. Jarrettd
        357,086
 
  a Mr. Renwick has deferred receipt of his non-equity incentive plan awards in their entirety since 1995, the year the EDCP began. All awards have been disclosed when earned in the applicable Summary Compensation Tables for prior years.
 
  b Mr. Forrester has deferred receipt of his non-equity incentive plan awards in their entirety since 1995, the year the EDCP began. All awards have been disclosed when earned in the applicable Summary Compensation Tables for prior years.
 
  c Mr. Passell has deferred a portion of his non-equity compensation at various times since 1995. All deferred awards since 2000 have been disclosed in the applicable Summary Compensation Tables for prior years.
 
  d Mr. Jarrett has deferred a portion of his non-equity compensation at various times since 2001. All deferred awards since 2006 have been disclosed in the applicable Summary Compensation Tables for prior years.
 
2 Progressive makes no supplemental contributions to the EDCP in the year of deferral or in subsequent years.
 
3 Represents scheduled distributions based on the executives’ elections in prior years, except that as to Mr. Forrester, distributions resulted from his retirement in March 2007.
 
The named executive officers are eligible to defer all or part of the non-equity incentive compensation earned under either the Executive Plan, Gainsharing Plan, IT Bonus Plan or other similar plans, as well as their restricted stock awards that were deferred immediately prior to vesting, in full, granted under the 2003 Incentive Plan. We have established an irrevocable grantor trust to provide a source of funds to assist us in meeting our liabilities under the EDCP. The trust has 18 mutual funds, as well as Progressive common shares, as deemed investment choices under the plan. The participant recommends the deemed investment choices for contributions and transfers. Fund transfers are limited to twice per quarter. All deferrals are eligible for transfer, except that deferrals of restricted stock awarded in March 2005 or thereafter are automatically deemed invested in Progressive common shares until the date of distribution under the plan.


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Amounts equal to the deferred cash bonuses or restricted stock grants are deposited by Progressive into the trust at the time that the bonus or grant otherwise would have been earned by the participant; we make no matching contributions or additional deposits on behalf of any participant. To secure our future payment obligations to participants, the trust holds investments equivalent in kind and number to the aggregate deemed investment elections selected by participants. Participants have no proprietary rights or interests in the trust’s assets, including such securities, all of which remain subject to the claims of our general creditors. The rights of participants and their beneficiaries under the EDCP are merely unsecured contractual rights against us. We do not guaranty any specific rate of return to participants who defer amounts into the EDCP. Following is a listing of deemed investment choices including the annual rate of return on each investment alternative during 2007:
 
         
    One-Year
 
    Performance
 
    As of 12/31/07
 
Fund   (%)  
   
 
American Advantage Small Cap Value
    (6.64 )
Fidelity Diversified International Fund
    16.03  
Fidelity Dividend Growth Fund
    1.11  
Fidelity Mid-Cap Stock Fund
    8.20  
Fidelity Retirement Money Market
    5.12  
FMA Small Company Portfolio
    .61  
Janus Worldwide Fund
    9.23  
Oakmark Equity and Income Fund
    11.97  
PIMCO Total Return Fund
    8.81  
Templeton World Fund — Class A
    8.50  
The Progressive Corporation
    (12.60 )
Vanguard Growth Index Fund — Institutional Class
    12.73  
Vanguard Institutional Index Fund
    5.47  
Vanguard Mid-Cap Index Fund — Institutional Class
    6.22  
Vanguard Small-Cap Index Fund — Institutional Class
    1.29  
Vanguard Total International Stock Fund — Investor Class
    15.52  
Vanguard Value Index Fund — Institutional Class
    .21  
Wasatch Small Cap Growth Fund
    8.36  
Washington Mutual Investors Fund — Class A
    3.97  
 
Distributions from the EDCP are made in accordance with an irrevocable election made by the participant prior to earning the deferred award. Distributions are made in a lump-sum or in three, five or ten annual installments at the earlier of the date selected by the participant or upon his or her termination from Progressive. For deferrals made after 2004, distributions resulting from termination of employment will be made six months after the participant leaves the company. In addition, distributions may be triggered by certain “change in control” events. For deferrals occurring in and prior to 2004, the events triggering such distributions would be the same as the events triggering change-in-control payments under our equity incentive plans, as described in the next section. For post-2004 deferrals, the plan has been revised to reflect the change-in-control definition required by Section 409A of the Internal Revenue Code. See “Section 409A of the Internal Revenue Code,” beginning on page 34, for a further discussion of the change in control events under Section 409A, and certain other changes to the plan that were recently implemented. Participants are permitted to change the schedule for certain distributions if they give at least 12 months notice and, with respect to post-2004 deferrals, they delay those distributions by at least five years. All distributions are made in cash, with the exception of deferred restricted stock awards granted in or after March 2005, which awards will be deemed invested in Progressive common shares for the entire deferral period and distributed in common shares. The participants’ respective rights and interests under the plan may not be assigned or transferred under any circumstances.
 
Potential Payments Upon Termination or Change In Control
 
Under our executive separation allowance plan, a unified approach has been taken to potential severance payments and other benefits payable to named executive officers (and other covered employees) upon certain termination events, including a change-in-control scenario. In addition, our equity plans include separate “change-in-control” and “qualified retirement” provisions for equity award holders, including named executive officers. Details concerning these plan provisions are discussed below. Payments to be made under our executive deferred compensation plan upon an executive’s termination of employment or a “change in control” are discussed under the “Nonqualified Deferred Compensation” section above.


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Severance.  Our executive separation allowance plan is designed to provide executives with defined financial payments if we ask the executive to leave under certain circumstances. The plan covers our CEO, other NEOs and executive officers and all other equity-eligible employees of Progressive. Among other terms and conditions, we will pay a separation allowance (severance) payment to an executive if (i) his or her employment terminates for reasons other than resignation (including retirement), death, disability, leave of absence or discharge for Cause (as defined in the plan), and (ii) the employee signs a termination and release agreement as required by the plan. The amount of the severance payment will vary among employees based on position and years of service. For the named executive officers, the severance payment would equal three years of the executive’s base salary only, at the time of termination. In addition, under the plan, the executive would be entitled to continue medical, dental and vision benefits for a period not to exceed eighteen months at our cost, except that the terminated executive would be required to make contributions to the cost of those benefits to the same extent as he or she did prior to termination.
 
In addition, the plan provides that executives and other covered employees will have the right to receive a severance payment in accordance with the formula described above, if during the three-year period after any Change in Control of Progressive, either (i) the participant’s employment is terminated for reasons other than resignation (including retirement), death, disability, leave of absence or discharge for Cause, or (ii) the participant resigns due to a Job Change (defined below). For purposes of the plan, the definition of “Change in Control” incorporates the definition of that term from our equity incentive plans for employees (described below). The term “Job Change” is defined as either a decrease in the individual’s total pay package, whether in the same job or after a job transfer, or the imposition of significantly different job duties, shift, work location or number of scheduled work hours. Upon the occurrence of either of such events, each named executive officer would be entitled to receive a severance payment equal to three years of base salary and the continuation of health benefits, on the same basis as described above.
 
The following table summarizes the severance payments that would have been made to the named executive officers, and the estimated value of health and welfare benefits for which the executive would have been eligible, if the executive had separated from Progressive at December 31, 2007, under circumstances requiring payments under the executive separation allowance plan (whether as a result of a Change in Control or otherwise):
 
             
    Amount of
  Estimated Value of
Name   Severance Payment   Health Benefits
 
 
Glenn M. Renwick
  $ 2,250,000   $ 13,817
Brian C. Domeck
    960,000     19,158
Brian J. Passell
    1,320,000     13,816
Raymond M. Voelker
    1,095,000     19,159
Charles E. Jarrett
    1,185,000     19,159
 
Change in Control Provisions under Equity Plans.  Benefits are also provided to NEOs and other holders of equity awards under our equity plans upon the occurrence of a Change in Control or a Potential Change in Control, as defined in those plans (described below). The Board of Directors has the authority under the plans to “override” the Change in Control benefits, however, if the Board has given its prior approval to a transaction that would otherwise trigger the benefits to be paid. If the Board’s prior consent is not obtained, our equity plans include provisions providing for the immediate vesting of, and payments to the holders of equity awards in an amount equal to the value of, the outstanding equity awards upon the occurrence of any of the specified triggering events. These provisions apply to both outstanding stock options, which we issued prior to 2003, and unvested restricted stock awards, including both time-based and performance-based awards. The triggering events are described below.
 
A Change in Control would be deemed to occur under our equity incentive plans upon the occurrence of any of the following events, unless the Board approves the change prior to either (i) the commencement of the applicable event, or (ii) the commencement of a tender offer for our stock:
 
  •   Acquisition of 20% or more of the voting power of our outstanding shares, with certain exceptions including acquisitions by a passive investor with only an investment intent;
 
  •   Turnover of a majority of the Board of Directors during a 24-month period, without the approval of the prior Board members; or
 
  •   Occurrence of a transaction requiring shareholder approval for the acquisition of Progressive, or any portion of our shares, through purchase of shares or assets, by merger or otherwise.


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Except as noted below with respect to awards of restricted shares granted in or after March 2007, a Potential Change in Control would be deemed to occur upon:
 
  •   The approval by shareholders of an agreement, the consummation of which would constitute a Change in Control (as described above), unless the Board approved such change prior to the commencement thereof; or
 
  •   Acquisition of 5% or more of Progressive’s voting power, together with a resolution by the Board of Directors that a Potential Change in Control has occurred.
 
For restricted stock awards made in March 2007 or thereafter, the Board modified our 2003 Incentive Plan (our only equity plan under which awards may currently be made to executives and other eligible employees) to remove from the definition of “Potential Change in Control” the language described in the first bullet in the immediately preceding paragraph. This change was made on a going forward basis only, and it does not affect rights under outstanding awards that were granted under the plan before the change was made.
 
The following table quantifies the payments that would have been made to the NEOs under our equity incentive plans if a Change in Control had occurred on December 31, 2007:
 
                   
    Payments on Unvested
  Payments on
   
    Restricted Stock
  Outstanding Stock
   
Name   Awards1   Options2   Total Payments
 
 
Glenn M. Renwick
  $ 25,993,312   $ 23,915,308   $ 49,908,620
Brian C. Domeck
    1,168,003     1,161,814     2,329,817
W. Thomas Forrester
    1,432,018     10,166,260     11,598,278
Brian J. Passell
    3,005,561     6,049,410     9,054,971
Raymond M. Voelker
    2,259,168     319,864     2,579,032
Charles E. Jarrett
    2,621,182     3,039,814     5,660,996
 
1 Includes, with respect to restricted stock awards made in or after March 2007, amount equal to dividends paid on common shares, plus accrued interest, which amounts will be paid under the plan only upon the vesting of the underlying restricted stock awards.
 
2 As of January 1, 2007, all stock options are vested.
 
Qualified Retirement Provisions under Equity Plans.  Executive officers, along with other equity award recipients, are eligible for the “qualified retirement” treatment (sometimes referred to as the “Rule of 70”) under our incentive compensation plans. Under this arrangement, executives who leave their employment with Progressive after satisfying certain age and years-of-service requirements (described below), generally (i) are permitted to exercise outstanding stock options (all of which are now vested) at any time prior to their stated expiration date (instead of being required to exercise such options within 60 days of the termination of employment, as is typically the case), (ii) receive 50% of unvested time-based restricted shares then outstanding (with the remaining 50% being forfeited), and (iii) retain 50% of unvested performance-based restricted stock awards which will vest, if at all, only upon satisfaction of the performance objectives associated with those awards (and the other 50% of the performance-based shares are forfeited). For all awards made prior to March 2008, a “qualified retirement” requires an executive to be age 55 or older, and the total of his or her age plus years of service with Progressive must be at least 70, at the time of retirement. Under an amendment to our restricted stock plan approved by the Committee in February 2007, for awards made in or after March 2008, the qualification standard was changed to require the employee to be age 55 or over and have at least 15 years of service with Progressive at the time of retirement.
 
Generally, an executive’s participation in these arrangements is on the same terms and conditions as are available to other equity award participants, except that if the CEO or one of the executives who directly reports to him provides at least one full year of notice of his or her intention to leave employment after qualifying for the “Rule of 70,” he or she will retain 100% of his or her unvested performance-based restricted stock awards (not just 50% as stated above), although such performance-based shares will vest only if and when the applicable performance goals are achieved prior to expiration. During 2007, Mr. Forrester retired from the company with full Rule of 70 benefits. See Note 5 to the Summary Compensation Table for specific information concerning these benefits to Mr. Forrester. As of December 31, 2007, no other NEO is eligible for Rule of 70 treatment under our plans.
 
The rights conferred by these provisions may be limited or forfeited if the Committee determines that the executive has engaged in any “disqualifying activity,” which is defined to include, among other activities, the following:
 
  •   directly or indirectly being an owner, officer, employee, advisor or consultant to a company that competes with Progressive or its subsidiaries or affiliates to an extent deemed material by the Committee;


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  •   disclosure to third parties or misuse of any confidential information or trade secrets of Progressive, its subsidiaries or affiliates;
 
  •   any material violation of Progressive’s Code of Business Conduct and Ethics or any other agreement between Progressive and the executive; or
 
  •   failing in any material respect to perform the executive’s assigned responsibilities as an employee of Progressive or any of its subsidiaries or affiliates, as determined by the Committee, in its sole judgment, after consulting with the Chief Executive Officer.
 
The ownership of less than 2% of the outstanding voting securities of a publicly traded corporation which competes with Progressive or any of its subsidiaries or affiliates will not constitute a disqualifying activity.
 
Compensation of Directors
 
Total compensation of our non-employee directors for the year ended December 31, 2007 was comprised only of restricted stock awards.
 
Director Compensation
Year ended December 31, 2007
 
                   
 
    Restricted Stock
       
    Awards1
  Option Awards1
  Total
Name   ($)   ($)   ($)
 
 
Charles A. Davis
  $ 164,646   $   $ 164,646
Stephen R. Hardis
    159,651         159,651
Bernadine P. Healy, M.D. 
    154,967         154,967
Jeffrey D. Kelly
    154,656         154,656
Abby F. Kohnstamm
    158,831         158,831
Philip A. Laskawy2
    43,363         43,363
Peter B. Lewis
    199,579         199,579
Norman S. Matthews
    164,646         164,646
Patrick H. Nettles, Ph.D. 
    154,656         154,656
Donald B. Shackelford
    149,678         149,678
Bradley T. Sheares, Ph.D. 
    150,917         150,917
 
 
1 Represents expense recognized with respect to restricted stock awards in accordance with SFAS 123(R).
 
All non-employee director stock option awards vested in or prior to March 2003; therefore, no expense was recognized under SFAS 123(R) in 2007.


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The following table presents the time-based restricted stock awards granted to non-employee directors in 2007, along with the grant date fair value of such awards, and the antidilution adjustments made to the outstanding option awards in connection with our $2.00 per common share special dividend paid in September 2007. The final two columns show the aggregate number of common shares covered by time-based restricted stock awards outstanding and the aggregate number of shares covered by stock option awards at December 31, 2007:
 
                             
          Aggregate Number of
 
          Shares at December 31,
 
    Awarded in 2007     2007  
       
    Restricted
        Restricted
     
    Stock
  Grant Date
    Stock
  Option
 
    Awards
  Fair Value
    Awards
  Awardsa
 
Name   (#)   ($)     (#)   (#)  
   
Charles A. Davis
    7,052   $ 165,017       7,052     99,945  
Stephen R. Hardis
    6,838     160,009       6,838     82,337  
Bernadine P. Healy, M.D. 
    6,624     155,002       6,624      
Jeffrey D. Kelly
    6,624     155,002       6,624     65,493  
Abby F. Kohnstamm
    6,411     150,017       6,411      
Philip A. Laskawy
    7,479     175,009           11,497  
Peter B. Lewis
    8,548     200,023       8,548     b
Norman S. Matthews
    7,052     165,017       7,052     99,945  
Patrick H. Nettles, Ph.D. 
    6,624     155,002       6,624      
Donald B. Shackelford
    6,411     150,017       6,411     99,945  
Bradley T. Sheares, Ph.D. 
    6,411     150,017       6,411     —   
 
  a Reflects an increase in the number of shares subject to options outstanding under the antidilution provisions of the 1998 Directors Incentive Plan in conjunction with the $2.00 per common share special dividend that was paid in September 2007. A corresponding decrease in the exercise price for each option was also made.
 
  b Mr. Lewis did not receive stock options as a director of Progressive. His option awards were granted prior to February 2003 when he was an executive officer of Progressive. His outstanding option awards are set forth in Note 3 on page 19.
 
  2 Mr. Laskawy resigned from our Board in December 2007.
 
Narrative Disclosure to Director Compensation Table
 
Equity-based Awards.  Each non-employee director is eligible to receive awards under The Progressive Corporation 2003 Directors Equity Incentive Plan (the “Directors Equity Plan”). The Directors Equity Plan originally authorized the issuance of up to 350,000 common shares. After adjusting for prior awards granted and our 4-for-1 stock split in May 2006, 1,101,754 shares remained available for issuance at December 31, 2007. The restricted stock grant value per common share equals the fair market value of the common shares awarded on the date of grant. Restricted stock awards vest on the date established by the Compensation Committee for the respective awards and are not transferable. Upon the death of a participating director, his or her estate will be entitled to receive any unvested restricted stock held by such director at the time of his or her death, which stock will vest on the vesting dates specified in the related agreements.
 
Currently, our non-employee directors are compensated only by time-based restricted stock awards. Each non-employee director (other than Mr. Lewis) receives an annual award of restricted stock, which is valued to include a specified retainer amount plus a variable component tied to such director’s Committee assignments. Mr. Lewis receives a lump sum restricted stock award as his sole compensation for service as Chairman. Restricted stock awards to directors are made under The Directors Equity Plan and are expected to be made in April of each year with an 11-month vesting period. If a new director is appointed to the Board or a director changes Committee assignments during the year, appropriate adjustments to his or her award may be made. The following table sets forth targeted compensation for each component in 2007:
 
         
Compensation Component   Dollar Value  
   
 
Board Retainer
  $ 110,000  
Audit Committee Chair Retainer
    65,000  
Audit Committee Member Retainer
    45,000  
Compensation Committee Chair Retainer
    45,000  
Compensation Committee Member Retainer
    40,000  
Investment Committee Chair Retainer
    45,000  
Investment Committee Member Retainer
    40,000  
Additional Committee Chair Retainer1
    15,000  
Additional Committee Member Retainer1
    10,000  
Chairman of the Board
    200,000  
 
1Excludes Executive Committee


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Directors Equity Deferral Plan.  Directors receiving awards of restricted stock under the Directors Equity Plan also have the right to defer the receipt of the common shares covered by each such award under The Progressive Corporation Directors Restricted Stock Deferral Plan (the “Directors Equity Deferral Plan”). If a director elects to defer a restricted stock award under this plan, immediately prior to vesting of the applicable award, the restricted shares are converted to units equivalent in value to Progressive common shares and credited to the participating director’s plan account. The participating director’s plan account will further be credited with amounts equal to dividends and other distributions, if and when authorized by the Board, which are paid on Progressive common shares. There are no other investment options under the Directors Equity Deferral Plan. All such accounts will be distributed in common shares (with any partial shares being distributed in cash), in a lump sum or installments, at the time(s) designated by the participating director at the time of election, subject to accelerated distribution provisions under the plan in the event of the participant’s death, the participant leaving Progressive, or a change in control of Progressive. Participating directors are permitted to change the schedule for certain distributions if they give at least 12 months notice and they delay those distributions by at least five years.
 
Directors Deferral Plan.  Seven non-employee directors participate in The Progressive Corporation Directors Deferral Plan, as amended (the ‘‘Directors Deferral Plan”). Each participant in the Directors Deferral Plan was a director prior to April 2006 and elected to defer receipt of all or a portion of his or her meeting fees until the date designated by the director in accordance with the plan. Deferred meeting fees were credited into a stock account under which the units are equivalent in value and dividend rights to Progressive common shares. All such accounts will be distributed in cash, in a lump sum or installments, when and as designated by the participating director at the time of election or, if earlier, upon the death of the director or upon a change in control of the company. All retainer fees were deferred, credited to a stock account and will be distributed in cash on a date designated by the participating director in accordance with the terms of the plan. All account balances of a director will be distributed to a designated beneficiary upon his or her death. However, if any director ceases to serve as such for any reason other than death, disability or removal without cause prior to the expiration of his or her current term, all retainer fees credited to his or her stock account for the unexpired portion of his or her term are forfeited. Participating directors are permitted to change the schedule for certain distributions if they give at least 12 months notice and they delay those distributions by at least five years.
 
Perquisites.  In 2007, directors and their spouses or guests were invited to attend an annual retreat with management at an off-site location. Personal travel for a spouse or guest and the costs of certain other activities held during the retreat may constitute perquisites to the attending directors. Otherwise, we do not provide perquisites to our non-employee directors.


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ITEM 2: APPROVAL OF AMENDMENTS TO THE COMPANY’S AMENDED ARTICLES OF INCORPORATION AND CODE OF REGULATIONS TO ADOPT A MAJORITY VOTING STANDARD IN UNCONTESTED ELECTIONS OF DIRECTORS
 
Our Board of Directors has approved, subject to the approval of our shareholders, amendments to our Amended Articles of Incorporation and Code of Regulations to adopt a majority voting standard in uncontested elections of directors. The Board of Directors recommends that shareholders vote FOR this proposal.
 
The full text of new Article TENTH of the Amended Articles of Incorporation and revised Section 2 of Article II of the Code of Regulations reflecting these amendments are attached to this Proxy Statement as Exhibit A. The following description of the amendments is qualified in its entirety by reference to Exhibit A.
 
Current Election Standard; Proposed Amendments
 
Section 2 of Article II of our Code of Regulations currently provides for a plurality voting standard in all director elections. Prior to 2008, Ohio law required that the plurality standard apply in all such elections. Under the plurality voting standard, a candidate for director is elected to the Board so long as he or she receives more votes cast “for” his or her election than the number of votes cast “for” any other candidate. Our Articles of Incorporation currently do not address the voting standard that applies in director elections.
 
Effective January 1, 2008, Ohio Revised Code § 1701.55(B) was amended to give Ohio corporations discretion to adopt alternative voting standards for director elections by modifying their Articles of Incorporation. Due to this change in Ohio law, the Board of Directors proposes to add a new Article TENTH to the Articles of Incorporation and amend existing Section 2 of Article II of our Code of Regulations to adopt a majority voting standard in uncontested elections of directors. The Board of Directors believes that adopting this majority voting standard will give shareholders a greater voice in determining the composition of our Board of Directors and, therefore, recommends that our shareholders adopt this majority standard.
 
Reasons for and Effects of Proposed Amendments
 
This recent change in Ohio law now allows Ohio corporations to adopt an alternative voting standard for director elections. Currently, our Articles of Incorporation are silent regarding the voting standard that applies to elections of directors. The Code of Regulations, however, provides for a plurality voting standard in all director elections. In an uncontested election (an election in which the number of candidates equals or is less than the number of available director seats), plurality voting results in a candidate being elected if he or she receives even a single “for” vote. Thus, under the plurality standard, “withhold” votes have no effect on the election, except in the unlikely event that no votes “for” the candidate are cast.
 
Under our proposed majority voting standard, in order for a candidate to be elected to the Board in an uncontested election, the number of votes cast “for” the candidate must exceed the number of votes cast “against” his or her election. Shareholder abstentions would not count either “for” or “against” a candidate. The Board of Directors believes that the adoption of this majority voting standard will give shareholders a greater voice in determining the composition of the Board of Directors by giving effect to shareholder votes “against” a candidate for a Board seat, and by requiring a higher level of shareholder votes for a candidate to obtain or retain a seat on the Board. The adoption of this more challenging standard in uncontested elections is thus intended to make the Board of Directors more accountable to shareholders.
 
The Board of Directors believes, however, that the plurality voting standard should still apply in all contested director elections (elections in which the number of candidates exceeds the number of available director seats), as reflected in the proposed amendment to our Articles of Incorporation in Exhibit A. Employing a majority voting standard in a contested election could make it more difficult for any candidate, whether proposed by the Board or by a shareholder, to obtain the number of votes necessary to secure a seat on the Board. If there were a close vote in such a contested election, it is possible that no candidate would achieve the requisite majority. Accordingly, our proposal retains plurality voting in those circumstances to avoid such a result.
 
If the proposed amendment to our Articles of Incorporation addressing the election of directors is adopted, our Code of Regulations also must be amended to prevent the Code from conflicting with the Articles. To ensure conformity, the attached Exhibit A reflects amendments to the text of the relevant provisions of both our Articles of Incorporation and Code of Regulations regarding the adoption of the proposed majority voting standard.
 
The adoption of a majority voting standard for uncontested director elections raises an issue with respect to the continued service of any incumbent director who fails to win re-election by receiving the requisite majority vote. Together, Ohio


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corporation law and our current Code of Regulations provide that each director serves for his or her term and until his or her successor is elected and qualified. As such, if a director candidate fails to achieve a majority vote and then fails to tender his or her resignation, the director’s term would still continue until his or her successor were elected and qualified. To address this possibility, we are also proposing to amend our Code of Regulations, as described in Item 3 of this Proxy Statement, to provide that if an unsuccessful director candidate fails to tender his or her resignation within 10 days after such an election, the director’s term will end, at the latest, on the last day of such 10-day period. The effectiveness of the amendment set forth in Item 3 of this Proxy Statement is expressly conditioned upon shareholders’ approval of this Item 2.
 
Vote Required for Approval
 
Under our Amended Articles of Incorporation and Code of Regulations, the vote of a majority of our outstanding common shares is required for approval of this proposal to amend the Amended Articles of Incorporation and Section 2 of Article II of the Code of Regulations.
 
The Board of Directors recommends that shareholders vote FOR this proposal.


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ITEM 3: APPROVAL OF AN AMENDMENT TO THE COMPANY’S CODE OF REGULATIONS TO MODIFY THE DEFINITION OF A DIRECTOR’S “TERM OF OFFICE”
 
Our Board of Directors has approved, subject to the approval of our shareholders, an amendment to our Code of Regulations to modify the definition of a director’s term of office. The Board of Directors recommends that shareholders vote FOR this proposal.
 
The full text of revised Section 3 of Article II of the Code of Regulations reflecting this amendment is attached to this Proxy Statement as Exhibit B. The following description of the amendment is qualified in its entirety by reference to Exhibit B.
 
Current Code of Regulations Term of Office Definition; Proposed Amendment
 
Section 3 of Article II of our Code of Regulations currently provides that each director shall hold office until the annual meeting of shareholders coinciding with the expiration of the term of the class of directors to which the director was elected and until his or her successor is elected and qualified, or until his or her earlier resignation, removal from office, or death. Under such a provision, a director who is not re-elected at a shareholder meeting at which his or her term expires remains a director until a successor is elected and qualified. This is sometimes referred to as a “holdover period.”
 
If shareholders approve the majority voting standard proposed in Item 2 of this Proxy Statement, the Board of Directors recommends that the shareholders also approve this proposal to amend our Code of Regulations to modify the definition of a director’s term of office. This amendment would prevent a director candidate’s term from continuing indefinitely in the event that the director fails to achieve the requisite majority vote and fails to resign pursuant to the resignation requirement to be established by the Board (described in greater detail below).
 
The effectiveness of shareholders’ approval of this proposal is expressly conditioned upon the concurrent approval by the shareholders of the proposal described in Item 2 of this Proxy Statement.
 
Reasons for and Effects of Proposed Amendment
 
Our Code of Regulations currently creates the possibility of a holdover period if an existing director is not re-elected at the end of his or her term and no successor is elected at that time. Historically, the possible occurrence of a director holdover has been only a remote concern, because the plurality voting standard in uncontested director elections virtually ensures that a director, once nominated, will in fact be elected. If we move to a majority voting standard in uncontested director elections, as proposed above in Item 2, however, a holdover situation could arise if an existing director fails to win re-election by receiving less than a majority vote in such an election. Specifically, if the director-nominee does not resign after failing to achieve the requisite majority vote, the director’s term nevertheless would continue, perhaps for an extended period, until his or her successor was elected and qualified.
 
To address this unintended consequence of the operation of the holdover period in the majority voting system, the Board plans to adopt a procedure in the Company’s Corporate Governance Guidelines by which the director who fails to receive the required majority vote would be required to tender his or her resignation to the Board within 10 days after the election. After receiving the resignation, the Board would have a specified amount of time to consider the resignation and to determine whether any circumstances existed that would justify the retention of the director until his or her successor was elected and qualified. This procedure would provide the Board with the flexibility to retain a director whose continued service may be important to the Board and the Company, even though he or she did not achieve the required majority vote, until a successor could be elected.
 
To ensure that the term of a director who fails to achieve the requisite majority vote would not continue indefinitely if the director does not comply with the resignation requirement described above, the Board is proposing to amend the definition of a director’s term of office in Section 3 of Article II of the Code of Regulations. Similar to our current Code provisions, the proposed amendment would provide that a director’s term continues until the next annual meeting of shareholders at which the director’s term ends or until the director otherwise is scheduled to stand for re-election (each, an “End-of-Term Date”), and until that director’s successor is elected, unless the director first resigns, is removed or dies. The proposed amendment also provides a mechanism to address the holdover scenario, however, as follows:
 
  •   if a director is nominated for re-election in an election in which a majority voting standard applies, and
 
  •   he or she fails to achieve a majority of votes cast but does not tender his or her resignation within 10 days after the election in accordance with the Board-established procedures, then
 
  •   that director’s term will end on the earlier of the date on which a successor is elected or the expiration of the 10-day period.


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Under this provision, the holdover portion of the term of a director who fails to resign in accordance with the Board’s requirement could not extend for more than 10 days after the shareholder meeting. The Board of Directors believes that this combination of a director resignation requirement and modified definition of a director’s term of office is the appropriate mechanism to give effect to shareholder votes under a majority voting standard, provide the Board with the flexibility it may need and prevent a recalcitrant director from holding over.
 
In addition, the proposed amendment would add a second exception to the definition of a director’s term of office by providing that if a director is not nominated for re-election by the Board of Directors, his or her term will continue only until his or her End-of-Term Date. The purpose of this second exception is to clarify that the term of office of any incumbent director who has not been nominated for re-election will expire on his or her End-of-Term Date, with no possibility of a holdover period, even if a successor is not elected at that time.
 
If shareholders approve this proposal to amend Section 3 of Article II of the Code of Regulations, the approval will not take effect unless the shareholders concurrently approve the proposal set forth in Item 2 of this Proxy Statement.
 
Vote Required for Approval
 
Under Ohio corporation law and the Company’s Code of Regulations, the affirmative vote of 75% of the outstanding common shares is required for approval of the proposal to amend Section 3 of the Code of Regulations.
 
The Board of Directors recommends that shareholders vote FOR this proposal.


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ITEM 4: PROPOSAL TO APPROVE AN AMENDMENT TO THE COMPANY’S CODE OF REGULATIONS TO INCREASE THE MAXIMUM NUMBER OF DIRECTOR POSITIONS FROM 12 TO 13 AND TO FIX THE NUMBER OF DIRECTORS AT 13
 
Our Board of Directors has approved, subject to the approval of our shareholders, amendments to our Code of Regulations to increase the maximum number of director positions from 12 to 13 and seeks to have shareholders fix the number of directors at 13. The Board of Directors recommends that shareholders vote FOR this proposal.
 
The full text of revised Section 1 of Article II of the Code of Regulations reflecting this amendment is attached to this Proxy Statement as Exhibit C. The following description of the amendment is qualified in its entirety by reference to Exhibit C.
 
Proposed Amendment
 
Our Board of Directors currently has 12 positions, the number previously fixed by shareholders and the maximum number allowed by our Code of Regulations. In reviewing the needs of the Board, our directors have determined that an increase in the number of director positions from 12 to 13 would provide an appropriate level of flexibility to recruit new director candidates, while at the same time maintaining an effective number of experienced directors on the Board.
 
As stated in our Corporate Governance Guidelines, the Board believes that its current size (12 members) is about the right number for our company. Approval of this proposal will result in there being 13 positions on our Board. Nonetheless, the Board expects that even if this proposal is approved, there will be periods when the Board operates with at least one vacancy.
 
Having such a vacancy available will provide the Board’s Nominating and Governance Committee with the ability to recruit one or more new director candidates, even at times when we have 12 experienced directors. The ability to add a Board member in these circumstances could prove advantageous, for example, if the Committee learns of an exceptional candidate who has specific talents or experiences that the Board values, and the Board deems it prudent to add the candidate to the Board without waiting for a Board seat to become vacant or for a shareholder vote to expand the Board. Similarly, if we are expecting a director to retire or not to stand for re-election in the foreseeable future, the Board may desire to recruit and elect a new director prior to such a vacancy being created, in order to smooth the transition for the new director and keep the Board running at full capacity. Such flexibility may be critical to attracting new directors in this very competitive market for quality candidates.
 
It has also been the Board’s experience that new directors, particularly those from outside the industry, tend to require several years of experience on the Board to develop a full understanding of our insurance businesses and begin to maximize their contributions to the Board and its committees. The Board believes that the ability to have a new director begin this development process while we retain our base of 12 more seasoned directors will benefit the company and its shareholders.
 
In addition, it should be noted that, if a new director is elected by the Board to fill a vacancy between our annual meetings of shareholders, our Code of Regulations requires that the director’s term will end at the next annual meeting, at which time (assuming that the Board were to nominate the new director for re-election), he or she would be required to stand for a shareholder vote to continue in office.
 
If shareholders approve this proposal, the Board will temporarily have two vacancies. At this time, the Board does not have an individual in mind to fill either of those vacancies. However, a search process is underway, and one or both of the vacancies could be filled by the Board in accordance with the provisions of the Code of Regulations. Alternatively, the Board could choose to nominate new candidates to be voted on by shareholders at a future shareholder meeting. Any new director who is so elected would be added by the Board to one of its three classes of directors, as appropriate to keep the number of each class as nearly equal as possible.
 
Vote Required for Approval
 
Under Ohio corporation law and the Company’s Code of Regulations, the affirmative vote of 75% of the outstanding common shares is required for approval of this proposal.
 
The Board of Directors recommends that shareholders vote FOR this proposal.


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ITEM 5: PROPOSAL TO RATIFY THE APPOINTMENT OF PRICEWATERHOUSECOOPERS LLP AS THE COMPANY’S INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM FOR 2008
 
On March 6, 2008, the Audit Committee of the Board of Directors appointed PricewaterhouseCoopers LLP (PWC) as the independent registered public accounting firm to examine the financial statements of The Progressive Corporation and its subsidiaries for the year ending December 31, 2008. Pursuant to this proposal, we are asking shareholders to ratify the Audit Committee’s selection of PWC. If shareholders do not ratify the appointment of PWC, the selection of the independent registered public accounting firm will be reconsidered by the Audit Committee, but the Committee may decide to continue the engagement of PWC for 2008, due to difficulties in making such a transition after the year has begun.
 
Vote Required for Approval
 
The affirmative vote of a majority of the votes cast on this proposal, provided the total number of votes cast represents a majority of the outstanding common shares, is required for approval. Broker non-votes will not be treated as votes cast. Abstentions will be treated as votes cast and, consequently, will have the same effect as votes against the proposal.
 
The Board of Directors recommends that shareholders vote FOR this proposal.
 
OTHER INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM INFORMATION
 
Approval of Audit and Non-Audit Services
 
The Audit Committee of the Board of Directors requires that each engagement of PWC to perform any audit or non-audit services, including the fees and terms of the engagement, must be approved by the Committee, or by the Chairman of the Committee (who has authority to approve engagements not to exceed $50,000 in the aggregate between Committee meetings), before we engage PWC for the particular service. The Committee has not adopted any other policies or procedures that would permit us to engage PWC for non-audit services without the specific prior approval of the Committee or the Chairman.
 
Independent Registered Public Accounting Firm Fees
 
Following are the aggregate fees billed to us by PWC during the fiscal years ended December 31, 2007 and 2006:
 
                 
Fees   2007     2006  
 
 
Audit
  $ 1,481,160     $ 1,760,955  
Audit-related
    83,827       27,261  
Tax
    61,915       50,093  
All other
    0       0  
Total
  $ 1,626,902     $ 1,838,309  
   
 
Audit fees.  Includes professional services rendered for the audit of Progressive’s consolidated financial statements, statutory audits and the audit of our internal control over financial reporting. Prior year audit fees are often billed in the subsequent year.
 
Audit-related fee.  Includes assistance in the assessment of Progressive’s internal control structure and the issuance of our 6.70% Fixed-to-Floating Rate Junior Subordinated Debentures due 2067.
 
Tax fees.  Includes fees for tax planning, consultation and advice.
 
All of these fees were pre-approved by the Audit Committee pursuant to the procedures described above.
 
Representatives of PWC are expected to be present at the Annual Meeting with the opportunity to make a statement about Progressive’s financial condition, if they desire to do so, and to respond to appropriate questions.


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SHAREHOLDER PROPOSALS
 
Any shareholder who intends to present a proposal at the 2009 Annual Meeting of Shareholders for inclusion in the Proxy Statement and form of proxy relating to that meeting may do so in accordance with Securities and Exchange Commission Rule 14a-8 and is advised that the proposal must be received by the Secretary at the Company’s principal executive offices located at 6300 Wilson Mills Road, Mayfield Village, Ohio 44143, not later than November 10, 2008. For those shareholder proposals that are not submitted in accordance with Rule 14a-8, the proxies designated by the Board may exercise their discretionary voting authority, without any discussion of the proposal in the Company’s proxy materials, with respect to any proposal that is received by the Company after January 24, 2009.
 
HOUSEHOLDING
 
Securities and Exchange Commission regulations permit a single set of the Annual Report to Shareholders and Proxy Statement to be sent to any household at which two or more shareholders reside if they appear to be members of the same family. Each shareholder will continue to receive a separate proxy card. This procedure, referred to as householding, reduces the volume of duplicate information shareholders receive and reduces our mailing and printing costs. A number of brokerage firms have also instituted householding procedures. In accordance with a notice sent to certain beneficial shareholders who share a single address, only one copy of this Proxy Statement and the attached Annual Report will be sent to that address, unless any shareholder residing at that address gives contrary instructions.
 
We will deliver promptly, upon written or oral request, a separate copy of this Proxy Statement and the attached Annual Report to a shareholder at a shared address to which a single copy of the documents was delivered. A shareholder who wishes to receive a separate copy of the Proxy Statement and Annual Report, now or in the future, should submit this request by calling toll-free 1-800-542-1061, or by writing to The Progressive Corporation, Investor Relations, at 6300 Wilson Mills Road, Box W33, Mayfield Village, Ohio 44143. Shareholders sharing an address who are receiving multiple copies of these materials may request to receive a single copy of such materials in the future by contacting us at the phone number or address provided above.
 
CHARITABLE CONTRIBUTIONS
 
Within the preceding three years, Progressive has not made a contribution to any charitable organization in which any of our directors serves as an executive officer. The Progressive Insurance Foundation, which is a charitable foundation that receives contributions from Progressive, contributes to the Insurance Institute for Highway Safety and to qualified tax-exempt organizations that are financially supported by our employees. These contributions are made on a matching basis, and for 2007 did not exceed $5,000 for each employee in the aggregate. Thus, in matching an employee’s gift, the Foundation may have contributed to charitable organizations in which one or more of our directors may be affiliated as an executive officer, director or trustee.
 
OTHER MATTERS
 
The cost of this solicitation, including the reasonable expenses of brokerage firms and other record holders for forwarding these proxy materials to beneficial owners, will be paid by Progressive. In addition to solicitation by mail, proxies may be solicited by telephone, facsimile, other electronic means or in person. We have engaged the firm of Morrow & Co., New York, New York, to assist us in the solicitation of proxies at an estimated cost of $15,000. Proxies may also be solicited by our directors, officers and employees without additional compensation.
 
If any other matters shall properly come before the meeting, the persons named in the proxy, or their substitutes, will vote thereon in accordance with their judgment. The Board of Directors does not know at this time of any other matters that will be presented for action at the meeting.


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AVAILABLE INFORMATION
 
Progressive’s Corporate Governance Guidelines, Board of Director Committee Charters and Code of Business Conduct and Ethics for directors, officers and employees is available at progressive.com/governance, or may be requested in print by writing to The Progressive Corporation, Investor Relations, 6300 Wilson Mills Road, Box W33, Mayfield Village, Ohio 44143.
 
We will furnish, without charge, to each person to whom a Proxy Statement is delivered, upon oral or written request, a copy of our Annual Report on Form 10-K for 2007 (other than certain exhibits). Requests for such documents should be submitted in writing to Jeffrey W. Basch, Chief Accounting Officer, The Progressive Corporation, 6300 Wilson Mills Road, Box W33, Mayfield Village, OH 44143, by telephone at (440) 395-2258 or e-mail at investor_relations@progressive.com.
 
By Order of the Board of Directors,
 
Charles E. Jarrett, Secretary
March 7, 2008


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EXHIBIT A
 
The following is the full text of new Article TENTH of the Amended Articles of Incorporation of The Progressive Corporation, as amended, and revised Section 2 of Article II of the Code of Regulations of The Progressive Corporation, reflecting the proposed amendments described in Item 2 of the Company’s Proxy Statement dated March 7, 2008.
 
Article TENTH of the Amended Articles of Incorporation, as amended:
 
At each meeting of shareholders for the election of directors, each nominee who receives a majority of the votes cast with respect to his or her nomination shall be elected as a director; provided, however, that, in the event the number of nominees exceeds the number of directors to be elected, the nominees receiving the greatest number of votes shall be elected. In determining which voting standard will apply in an election of directors, the number of nominees and number of directors to be elected at such meeting shall be determined as of the date that is fourteen (14) days prior to the date the corporation files its definitive proxy statement relating to such meeting (regardless of whether or not thereafter revised or supplemented) with the Securities and Exchange Commission. For purposes of this Article TENTH, a majority of votes cast means that the number of shares voted “for” a director’s election must exceed the number of shares voted “against” his or her election.
 
Section 2 of Article II of the Code of Regulations
 
Section 2.  Election of Directors.  Directors shall be elected at the annual meeting of shareholders, but when the annual meeting is not held or directors are not elected thereat, they may be elected at a special meeting called and held for that purpose. Such election shall be by ballot whenever requested by any shareholder entitled to vote at such election; but, unless such request is made, the election may be conducted in any manner approved at such meeting.
 
Article TENTH of the Company’s Amended Articles of Incorporation, as amended, sets forth voting standards applicable in the election of directors at each meeting of shareholders to elect directors.


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EXHIBIT B
 
The following is the full text of revised Section 3 of Article II of the Code of Regulations of The Progressive Corporation, reflecting the proposed amendments described in Item 3 of the Company’s Proxy Statement dated March 7, 2008.
 
Section 3.  Term of Office.  The term of office for each director shall be three years, and the members of one class of directors shall be elected annually to serve for such term; except that (i) initially or whenever necessary, a director may be elected for a shorter term in order to provide for a proper rotation of directors, and (ii) a director elected to fill a vacancy pursuant to Section 5 of this Article shall serve for the term specified therein. Each director shall hold office until the date of the annual meeting of shareholders coinciding with the termination of the term of the class of directors to which he or she was elected, or until the termination of the period specified in Section 5 of this Article (if applicable), (“End-of-Term Date”) and until his or her successor shall be elected or until his or her earlier resignation, removal from office or death; provided that:
 
(a) a director that has not been nominated by the Board of Directors for re-election in an election of directors at an annual meeting of shareholders coinciding with his or her End-of-Term Date (“End-of-Term Election”) shall hold office only until such End-of-Term Date; and
 
(b) a director that has been nominated for re-election by the Board of Directors in an End-of-Term Election in which a majority vote is required for his or her re-election by the Amended Articles of Incorporation, as amended, but such director fails to achieve a majority of votes cast with respect to his or her nomination and fails to tender his or her resignation to the Board of Directors or an appropriate committee thereof, in accordance with applicable procedures adopted by the Board of Directors or a committee thereof, within 10 days after the results of the vote have been certified, shall hold office only until the earlier of (i) the date that his or her successor shall be elected or (ii) the expiration of such 10 day period.


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EXHIBIT C
 
The following is the full text of revised Section 1 of Article II of the Code of Regulations of The Progressive Corporation, reflecting the proposed amendments described in Item 4 of the Company’s Proxy Statement dated March 7, 2008.
 
Section 1.  Number and Classification of Directors.  The number of directors of the corporation, none of whom need to be a shareholder or resident of the State of Ohio, shall be thirteen, and such directors shall be divided into three classes as nearly equal in number as possible, to be known as Class I, Class II and Class III. The classes shall be elected to staggered terms. The shareholders, acting by the affirmative vote of the holders of record of shares representing 75% of the voting power of the corporation on such proposal, may, from time to time, increase or decrease the number of directors, but in no case shall the number of directors be fewer than five or more than thirteen, nor shall any decrease in the number of directors shorten the term of any director then in office. In case of any increase in the number of directors, the directors then in office may select the class or classes to which the additional directors shall be assigned, provided that the directors shall be distributed among the several classes as nearly equally as possible.


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THE PROGRESSIVE CORPORATION
 
2007 ANNUAL REPORT TO SHAREHOLDERS


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The Progressive Corporation and Subsidiaries
Consolidated Statements of Income
For the years ended December 31,
 
                         
(millions — except per share amounts)   2007     2006     2005  
 
 
Revenues
                       
Net premiums earned
  $ 13,877.4     $ 14,117.9     $ 13,764.4  
Investment income
    680.8       647.8       536.7  
Net realized gains (losses) on securities
    106.3       (9.7 )     (37.9 )
Service revenues
    22.3       30.4       40.2  
Total revenues
    14,686.8       14,786.4       14,303.4  
Expenses
                       
Losses and loss adjustment expenses
    9,926.2       9,394.9       9,364.8  
Policy acquisition costs
    1,399.9       1,441.9       1,448.2  
Other underwriting expenses
    1,526.2       1,402.8       1,312.2  
Investment expenses
    12.4       11.9       12.1  
Service expenses
    20.5       24.4       24.6  
Interest expense
    108.6       77.3       82.6  
Total expenses
    12,993.8       12,353.2       12,244.5  
Net Income
                       
Income before income taxes
    1,693.0       2,433.2       2,058.9  
Provision for income taxes
    510.5       785.7       665.0  
Net income
  $ 1,182.5     $ 1,647.5     $ 1,393.9  
   
Computation of Earnings Per Share
                       
Basic:
                       
Average shares outstanding
    710.4       774.3       787.7  
   
Per share
  $ 1.66     $ 2.13     $ 1.77  
   
Diluted:
                       
Average shares outstanding
    710.4       774.3       787.7  
Net effect of dilutive stock-based compensation
    8.1       9.5       11.6  
Total equivalent shares
    718.5       783.8       799.3  
   
Per share
  $ 1.65     $ 2.10     $ 1.74  
   
 
All share and per share amounts were adjusted for the May 18, 2006, 4-for-1 stock split.
 
See notes to consolidated financial statements.


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The Progressive Corporation and Subsidiaries
Consolidated Balance Sheets
December 31,
 
                 
(millions)   2007     2006  
 
 
Assets
               
Investments - Available-for-sale, at fair value:
               
Fixed maturities (amortized cost: $9,135.6 and $9,959.6)
  $ 9,184.9     $ 9,958.9  
Equity securities:
               
Preferred stocks (cost: $2,578.1 and $1,761.4)
    2,270.3       1,781.0  
Common equities (cost: $1,361.0 and $1,469.0)
    2,327.5       2,368.1  
Short-term investments (amortized cost: $382.4 and $581.0)
    382.4       581.2  
Total investments
    14,165.1       14,689.2  
Cash
    5.8       5.6  
Accrued investment income
    142.1       134.4  
Premiums receivable, net of allowance for doubtful accounts of $118.1 and $122.0
    2,395.1       2,498.2  
Reinsurance recoverables, including $47.6 and $72.4 on paid losses
    335.1       433.8  
Prepaid reinsurance premiums
    69.8       89.5  
Deferred acquisition costs
    426.3       441.0  
Income taxes
    106.0       16.8  
Property and equipment, net of accumulated depreciation of $605.7 and $557.0
    1,000.4       973.4  
Other assets
    197.4       200.2  
Total assets
  $ 18,843.1     $ 19,482.1  
   
Liabilities and Shareholders’ Equity
               
Unearned premiums
  $ 4,210.4     $ 4,335.0  
Loss and loss adjustment expense reserves
    5,942.7       5,725.0  
Accounts payable, accrued expenses and other liabilities1
    1,580.6       1,390.0  
Debt2
    2,173.9       1,185.5  
Total liabilities
    13,907.6       12,635.5  
Shareholders’ equity:
               
Common Shares, $1.00 par value (authorized 900.0; issued 798.1 and 798.7,
including treasury shares of 117.9 and 50.7)
    680.2       748.0  
Paid-in capital
    834.8       847.4  
Accumulated other comprehensive income:
               
Net unrealized gains on securities
    465.0       596.8  
Net unrealized gains on forecasted transactions
    27.8       7.5  
Retained earnings
    2,927.7       4,646.9  
Total shareholders’ equity
    4,935.5       6,846.6  
Total liabilities and shareholders’ equity
  $ 18,843.1     $ 19,482.1  
   
 
 
1See Note 11 — Litigation and Note 12 — Commitments and Contingencies for further discussion.
 
2Consists of long-term debt. See Note 4 — Debt for further discussion.
 
See notes to consolidated financial statements.


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The Progressive Corporation and Subsidiaries
Consolidated Statements of Changes in Shareholders’ Equity
For the years ended December 31,
 
                                                 
(millions — except per share amounts)   2007     2006     2005  
 
 
Retained Earnings
                                               
Balance, Beginning of year
  $ 4,646.9             $ 4,726.0             $ 3,812.9          
Net income
    1,182.5     $ 1,182.5       1,647.5     $ 1,647.5       1,393.9     $ 1,393.9  
             
             
             
 
Cash dividends declared on Common Shares ($2.1450, $.0325 and $.0300 per share)1
    (1,507.6 )             (25.0 )             (23.7 )        
Treasury shares purchased2
    (1,388.4 )             (1,111.6 )             (457.0 )        
Capitalization of stock split
                  (585.9 )                      
Other, net3
    (5.7 )             (4.1 )             (.1 )        
Balance, End of year
  $ 2,927.7             $ 4,646.9             $ 4,726.0          
Accumulated Other Comprehensive Income (Loss), Net of Tax
                                               
Balance, Beginning of year
  $ 604.3             $ 398.7             $ 444.8          
Changes in:
                                               
Net unrealized gains on securities
            (131.8 )             206.7               (45.0 )
Net unrealized gains on forecasted transactions
            20.3               (1.1 )             (1.1 )
             
             
             
 
Other comprehensive income
    (111.5 )     (111.5 )     205.6       205.6       (46.1 )     (46.1 )
Balance, End of year
  $ 492.8             $ 604.3             $ 398.7          
Comprehensive Income
          $ 1,071.0             $ 1,853.1             $ 1,347.8  
             
             
             
 
             
             
             
 
Common Shares, $1.00 Par Value
                                               
Balance, Beginning of year
  $ 748.0             $ 197.3             $ 200.4          
Stock options exercised
    3.4               3.7               1.6          
Treasury shares purchased2
    (72.9 )             (39.1 )             (5.2 )        
Restricted stock issued, net of forfeitures
    1.7               .2               .5          
Capitalization of stock split
                  585.9                        
Balance, End of year
  $ 680.2             $ 748.0             $ 197.3          
Paid-In Capital
                                               
Balance, Beginning of year
  $ 847.4             $ 848.2             $ 743.3          
Stock options exercised
    27.4               39.6               42.6          
Tax benefits from exercise/vesting of stock-based compensation
    15.5               38.8               41.2          
Treasury shares purchased2
    (87.1 )             (63.8 )             (20.6 )        
Restricted stock issued, net of forfeitures
    (1.7 )             (.2 )             41.7          
Amortization of stock-based compensation
    28.0               27.8                        
SFAS 123(R) reclass4
                  (51.5 )                      
Other3
    5.3               8.5                        
Balance, End of year
  $ 834.8             $ 847.4             $ 848.2          
Unamortized Restricted Stock
                                               
Balance, Beginning of year
  $             $ (62.7 )           $ (46.0 )        
Restricted stock issued, net of forfeitures
                                (42.2 )        
Restricted stock market value adjustment
                                (8.2 )        
Amortization of restricted stock
                                33.7          
SFAS 123(R) reclass4
                  62.7                        
Balance, End of year
  $             $             $ (62.7 )        
Total Shareholders’ Equity
  $ 4,935.5             $ 6,846.6             $ 6,107.5          
   
 
1All per share amounts were adjusted for the May 18, 2006, 4-for-1 stock split.
 
2Progressive did not split its treasury shares in conjunction with the May 18, 2006, 4-for-1 stock split. In 2006, we repurchased 3,182,497 common shares prior to the stock split and 35,887,246 common shares subsequent to the stock split.
 
3Primarily reflects activity associated with our deferred compensation plans.
 
4 Upon adoption of SFAS 123(R), companies were required to eliminate any unearned compensation (i.e., contra-equity) accounts against the appropriate equity accounts. As a result, as of January 1, 2006, we were required to reclassify $62.7 million of “Unamortized restricted stock,” of which $51.5 million related to equity awards and $11.2 million related to liability awards.
 
There are 20.0 million Serial Preferred Shares authorized; no such shares are issued or outstanding.
 
There are 5.0 million Voting Preference Shares authorized; no such shares have been issued.
 
See notes to consolidated financial statements.


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The Progressive Corporation and Subsidiaries
Consolidated Statements of Cash Flows
For the years ended December 31,
 
                         
(millions)   2007     2006     2005  
 
 
Cash Flows From Operating Activities
                       
Net income
  $ 1,182.5     $ 1,647.5     $ 1,393.9  
Adjustments to reconcile net income to net cash provided by operating activities:
                       
Depreciation
    106.9       103.4       92.4  
Amortization of fixed maturities
    284.1       225.6       189.6  
Amortization of stock-based compensation
    26.5       27.6       33.7  
Net realized (gains) losses on securities
    (106.3 )     9.7       37.9  
Net loss on disposition of property and equipment
    .4       .9        
Changes in:
                       
Premiums receivable
    103.1       2.5       (213.5 )
Reinsurance recoverables
    98.7       (28.1 )     (24.1 )
Prepaid reinsurance premiums
    19.7       14.2       16.1  
Deferred acquisition costs
    14.7       3.8       (12.6 )
Income taxes
    (30.3 )     10.1       (140.0 )
Unearned premiums
    (124.6 )     (.1 )     227.1  
Loss and loss adjustment expense reserves
    217.7       64.7       374.7  
Accounts payable, accrued expenses and other liabilities
    2.4       7.1       49.5  
Tax benefits from exercise/vesting of stock-based compensation1
                41.2  
Other, net
    (4.5 )     (64.3 )     (71.9 )
Net cash provided by operating activities
    1,791.0       2,024.6       1,994.0  
Cash Flows From Investing Activities
                       
Purchases:
                       
Fixed maturities
    (8,184.6 )     (6,294.9 )     (9,154.4 )
Equity securities
    (1,490.3 )     (1,131.6 )     (852.9 )
Short-term investments — auction rate securities
    (7,156.6 )     (2,999.3 )     (7,935.3 )
Sales:
                       
Fixed maturities
    8,327.6       5,668.2       7,068.6  
Equity securities
    775.2       323.1       152.3  
Short-term investments — auction rate securities
    7,325.4       3,215.5       8,053.4  
Maturities, paydowns, calls and other:
                       
Fixed maturities
    557.9       686.1       572.6  
Equity securities
    10.7       223.5       114.4  
Net sales (purchases) of short-term investments — other
    30.0       (22.3 )     491.8  
Net unsettled security transactions
    35.1       (116.6 )     126.6  
Purchases of property and equipment
    (136.3 )     (334.3 )     (219.3 )
Sale of property and equipment
    2.0       15.4       36.1  
Net cash provided by (used in) investing activities
    96.1       (767.2 )     (1,546.1 )
Cash Flows From Financing Activities
                       
Proceeds from exercise of stock options
    30.8       43.3       44.2  
Tax benefits from exercise/vesting of stock-based compensation1
    15.5       38.8        
Proceeds from debt2
    1,021.7              
Payment of debt
          (100.0 )      
Dividends paid to shareholders
    (1,406.5 )     (25.0 )     (23.7 )
Acquisition of treasury shares
    (1,548.4 )     (1,214.5 )     (482.8 )
Net cash used in financing activities
    (1,886.9 )     (1,257.4 )     (462.3 )
Increase (decrease) in cash
    .2             (14.4 )
Cash, Beginning of year
    5.6       5.6       20.0  
Cash, End of year
  $ 5.8     $ 5.6     $ 5.6  
   
 
1Reclassified as required under SFAS 123(R).
 
2Includes a $34.4 million pretax gain received upon closing a forecasted debt issuance hedge. See Note 4 — Debt for further discussion.
 
See notes to consolidated financial statements.


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The Progressive Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2007, 2006 and 2005
 
1. REPORTING AND ACCOUNTING POLICIES
 
Nature of Operations The Progressive Corporation, an insurance holding company formed in 1965, owned 64 subsidiaries and had 1 mutual insurance company affiliate as of December 31, 2007. Our insurance subsidiaries provide personal and commercial automobile insurance and other specialty property-casualty insurance and related services throughout the United States. Our Personal Lines segment writes insurance for private passenger automobiles and recreational vehicles through both an independent insurance agency channel and a direct channel. Our Commercial Auto segment writes primary liability and physical damage insurance for automobiles and trucks owned by small businesses through both the independent agency and direct channels.
 
Basis of Consolidation and Reporting The accompanying consolidated financial statements include the accounts of The Progressive Corporation, its subsidiaries and affiliate. All of the subsidiaries and the mutual company affiliate are wholly owned or controlled. We achieve control of our mutual company affiliate through a 100% reinsurance contract and a management service contract between a wholly-owned insurance subsidiary and such affiliate. All intercompany accounts and transactions are eliminated in consolidation.
 
Estimates We are required to make estimates and assumptions when preparing our financial statements and accompanying notes in conformity with accounting principles generally accepted in the United States of America (GAAP). As estimates develop into fact (e.g., losses are paid), results may, and will likely, differ from those estimates.
 
Investments Progressive’s fixed-maturity, equity securities and short-term investments are accounted for on an available-for-sale basis.
 
Fixed-maturity securities include debt securities and redeemable preferred stocks, which may have fixed or variable principal payment schedules, may be held for indefinite periods of time, and may be used as a part of our asset/liability strategy or sold in response to changes in interest rates, anticipated prepayments, risk/reward characteristics, liquidity needs or other economic factors. These securities are carried at fair value with the corresponding unrealized gains (losses), net of deferred income taxes, reported in accumulated other comprehensive income. Fair values are obtained from recognized pricing services or other quoted sources. The asset-backed portfolio is accounted for under the retrospective method; prepayment assumptions are based on market expectations. The prospective method is used for interest-only and non-investment-grade asset-backed securities.
 
Equity securities include common stocks, nonredeemable preferred stocks and other risk investments and are reported at quoted fair values. Changes in fair value of these securities, net of deferred income taxes, are reflected as unrealized gains (losses) in accumulated other comprehensive income. Changes in value of foreign equities due to foreign currency exchange rates would be limited by foreign currency hedges, if any, and would be recognized in income in the current period. We held no foreign equities or foreign currency hedges during 2007 or 2006.
 
Short-term investments include auction rate securities (i.e., certain municipal bonds and preferred stocks). Due to the nature of auction rate securities, these securities are classified as short-term based upon their expected auction date (generally 7-49 days) rather than on their contractual obligation (which are greater than one year at original issuance). We held no auction rate securities at December 31, 2007. In addition to auction rate securities, short-term investments include Eurodollar deposits, commercial paper and other securities expected to mature within one year. Changes in fair value of these securities, net of deferred income taxes, are reflected as unrealized gains (losses) in accumulated other comprehensive income.
 
We did not hold any trading securities at December 31, 2007 or 2006. Trading securities are securities bought principally for the purpose of sale in the near term. To the extent we have trading securities, changes in fair value would be recognized in income in the current period. Derivative instruments which may be used for trading purposes or classified as trading derivatives due to the characteristics of the transaction are discussed below.
 
Derivative instruments may include futures, options, forward positions, foreign currency forwards, interest rate swap agreements and credit default swaps and may be used in the portfolio for general investment purposes or to hedge the exposure to:
 
•   Changes in fair value of an asset or liability (fair value hedge);


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•   Foreign currency of an investment in a foreign operation (foreign currency hedge); or
 
•   Variable cash flows of a forecasted transaction (cash flow hedge).
 
To the extent we have derivatives held or issued for general investment purposes, these derivative instruments are recognized as either assets or liabilities and measured at fair value with changes in fair value recognized in income as a component of net realized gains (losses) on securities during the period of change. At December 31, 2007, we held one credit default swap position and two interest rate swap positions, compared to one credit default swap position at December 31, 2006.
 
Derivatives designated as hedges are required to be evaluated on established criteria to determine the effectiveness of their correlation to, and ability to reduce the designated risk of specific securities or transactions. Effectiveness is required to be reassessed regularly. Hedges that are deemed to be effective would be accounted for as follows:
 
•   Fair value hedge:  changes in fair value of the hedge, as well as the hedged item, would be recognized in income in the period of change while the hedge was in effect.
 
•   Foreign currency hedge:  changes in fair value of the hedge, as well as the hedged item, would be reflected as a change in translation adjustment as part of accumulated other comprehensive income. Gains and losses on the foreign currency hedge would offset the foreign exchange gains and losses on the foreign investment as they are recognized into income.
 
•   Cash flow hedge:  changes in fair value of the hedge would be reported as a component of accumulated other comprehensive income and subsequently amortized into earnings over the life of the hedged transaction.
 
If a hedge is deemed to become ineffective, it would be accounted for as follows:
 
•   Fair value hedge:  the derivative instrument would continue to be adjusted through income, while the adjustment in the change in value of the hedged item would be reflected as a change in unrealized gains (losses) as part of accumulated other comprehensive income.
 
•   Foreign currency hedge:  changes in the value of the hedged item would continue to be reflected as a change in translation adjustment as part of accumulated other comprehensive income, but the derivative instrument would be adjusted through income for the current period.
 
•   Cash flow hedge:  changes in fair value of the derivative instrument would be reported in income for the current period.
 
We had no fair value or foreign currency hedges during 2007 or 2006. During May 2007, we entered into a forecasted debt issuance hedge (cash flow hedge) that was deemed effective to hedge against possible rises in interest rates in conjunction with the prospective issuance of our debentures in June 2007 (see Note 4 — Debt for further discussion); we had no cash flow hedges in 2006.
 
For all derivative positions, net cash requirements are limited to changes in fair values, which may vary based upon changes in interest rates, currency exchange rates and other factors. Exposure to credit risk is limited to the carrying value; collateral may be required to limit credit risk.
 
Investment securities are exposed to various risks such as interest rate, market and credit risk. Fair values of securities fluctuate based on the nature and magnitude of changing market conditions; significant changes in market conditions could materially affect the portfolio’s value in the near term. We continually monitor our portfolio for price changes, which might indicate potential impairments, and perform detailed reviews of securities with unrealized losses based on predetermined criteria. In such cases, changes in fair value are evaluated to determine the extent to which such changes are attributable to (i) fundamental factors specific to the issuer, such as financial conditions, business prospects or other factors, or (ii) market-related factors, such as interest rates or equity market declines. When a security in our investment portfolio has an unrealized loss in fair value that is deemed to be other than temporary, we reduce the book value of such security to its current fair value, recognizing the decline as a realized loss in the income statement. Any future changes in fair value, either increases or decreases, are reflected as changes in unrealized gains (losses) as part of accumulated other comprehensive income.
 
Realized gains (losses) on securities are computed based on the first-in first-out method and also include write-downs on available-for-sale securities considered to have other-than-temporary declines in fair value, as well as holding period valuation changes on derivatives.


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Property and Equipment Property and equipment are recorded at cost, less accumulated depreciation. Depreciation is recognized over the estimated useful lives of the assets using accelerated methods for computer equipment and the straight-line method for all other fixed assets. The useful lives range from 3 to 4 years for computer equipment, 10 to 40 years for buildings and improvements, and 3 to 10 years for all other property and equipment. Land and buildings comprised 80% of total property and equipment at both December 31, 2007 and 2006. Property and equipment include capitalized software developed or acquired for internal use. Total interest capitalized was $2.4 million in both 2007 and 2006, and $1.3 million in 2005, relating to construction projects and capitalized computer software costs.
 
Insurance Premiums and Receivables Insurance premiums written are earned into income on a pro rata basis over the period of risk, based on a daily earnings convention. Accordingly, unearned premiums represent the portion of premiums written that is applicable to the unexpired risk. We provide insurance and related services to individuals and small commercial accounts throughout the United States, and offer a variety of payment plans. Generally, premiums are collected prior to providing risk coverage, minimizing our exposure to credit risk. We perform a policy level evaluation to determine the extent to which the premiums receivable balance exceeds the unearned premiums balance. We then age this exposure to establish an allowance for doubtful accounts based on prior experience.
 
Income Taxes The income tax provision is calculated under the balance sheet approach. Deferred tax assets and liabilities are recorded based on the difference between the financial statement and tax bases of assets and liabilities at the enacted tax rates. The principal assets and liabilities giving rise to such differences are net unrealized gains (losses) on securities, loss reserves, unearned premiums reserves, deferred acquisition costs and non-deductible accruals. We review our deferred tax assets for recoverability. At December 31, 2007, we were able to demonstrate that the benefit of our deferred tax assets was fully realizable and, therefore, no valuation allowance was recorded.
 
Loss and Loss Adjustment Expense Reserves Loss reserves represent the estimated liability on claims reported to us, plus reserves for losses incurred but not recorded (IBNR). These estimates are reported net of amounts estimated to be 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 are susceptible to change in the near term.
 
Reinsurance Our reinsurance transactions primarily include premiums written under state-mandated involuntary plans for commercial vehicles (Commercial Auto Insurance Procedures/Plans — “CAIP”) and premiums ceded to state-provided reinsurance facilities, for which we retain no loss indemnity risk (see Note 6 — Reinsurance for further discussion). We also cede a portion of the premiums in our non-auto programs to limit our exposure in those particular markets. Prepaid reinsurance premiums are earned on a pro rata basis over the period of risk, based on a daily earnings convention, which is consistent with premiums written. Our primary line of business, auto insurance, is written at relatively low limits of liability; as such, we do not believe that we need to mitigate this risk through voluntary reinsurance.
 
Deferred Acquisition Costs Deferred acquisition costs include commissions, premium taxes and other variable underwriting and direct sales costs incurred in connection with writing business. These costs are deferred and amortized over the policy period in which the related premiums are earned. We consider anticipated investment income in determining the recoverability of these costs. Management believes that these costs will be fully recoverable in the near term. We do not defer any direct-response advertising costs.
 
Guaranty Fund Assessments We are subject to state guaranty fund assessments, which provide for the payment of covered claims or other insurance obligations of insurance companies deemed insolvent. These assessments are accrued after a formal determination of insolvency has occurred, and we have written the premiums on which the assessments will be based.
 
Service Revenues and Expenses Our service businesses provide insurance-related services. Service revenues consist primarily of fees generated from processing business for involuntary CAIP plans and are earned on a pro rata basis over the term of the related policies. Service expenses include acquisition expenses for the involuntary plans, which are deferred and amortized over the period in which the related revenues are earned, and costs associated with our other service products.
 
Stock-Based Compensation As of January 1, 2006, we adopted the provisions of Statement of Financial Accounting Standards 123 (revised 2004), “Share-Based Payment” (SFAS 123(R)), which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors, using the modified prospective method. As a result, our consolidated financial statements for the year ended December 31, 2006, reflected


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the effect of SFAS 123(R), including the reclassification of any unamortized restricted stock (i.e., unearned compensation) against paid-in capital for restricted stock awards accounted for as “equity awards” and against other liabilities for the restricted stock awards accounted for as “liability awards” (i.e., 2003 and 2004 restricted stock awards deferred pursuant to our deferred compensation plans). In accordance with the modified prospective transition method, our consolidated financial statements for prior periods have not been restated to reflect, and do not include, the effect of SFAS 123(R).
 
Pursuant to the modified prospective application, we were required to expense the fair value at the grant date of our unvested outstanding stock options. No stock options have been granted after December 31, 2002. We did not incur any additional expense relating to currently outstanding stock options subsequent to 2006, since the final vesting date of stock options previously granted was January 1, 2007. Beginning in 2003, we began issuing restricted stock awards as our form of equity compensation to key members of management and non-employee directors in lieu of stock options; our current equity compensation program does not contemplate the issuance of stock options. Compensation expense for restricted stock awards is recognized over the respective vesting periods. Beginning in 2007, the expense for restricted stock is representative of the effect on net income for future periods.
 
For the years ended December 31, 2007 and 2006, the pretax expense of our stock-based compensation was $26.5 million and $27.6 million, respectively, (tax benefit of $9.3 million and $9.7 million), of which $1.3 million of the 2006 expense related to our unvested outstanding stock options. The following table shows the effects on net income and earnings per share for prior periods had the fair value based method been applied to all outstanding and unvested stock option awards for the year ended December 31, 2005. We used a modified Black-Scholes pricing model to calculate the fair value of the options awarded as of the date of grant.
 
         
(millions, except per share amounts)   2005  
 
 
Net income, as reported
  $ 1,393.9  
Deduct: Total stock-based employee compensation expense determined under the fair value based method for all stock option awards, net of related tax effects
    (2.6 )
Net income, pro forma
  $ 1,391.3  
     
 
Earnings per share
       
Basic — as reported
  $ 1.77  
Basic — pro forma
    1.77  
Diluted — as reported
  $ 1.74  
Diluted — pro forma
    1.74  
 
In addition, in conjunction with the Financial Accounting Standards Board (FASB) Staff Position No. FAS 123(R)-3, “Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards,” we elected to adopt the alternative transition method for calculating the tax effects of stock-based compensation pursuant to SFAS 123(R). The alternative transition method includes simplified methods to establish the beginning balance of the additional paid-in capital pool related to the tax effects of employee stock-based compensation, and to determine the subsequent effect on the paid-in capital pool and the consolidated statements of cash flows of the tax effects of employee stock-based compensation awards that were outstanding upon the adoption of SFAS 123(R).
 
In 2006, under SFAS 123(R), we began to record an estimate for expected forfeitures of restricted stock based on our historical forfeiture rates. Prior to adoption, we accounted for forfeitures as they occurred, as permitted under accounting standards then in effect. In addition, we shortened the vesting periods of certain stock-based awards based on the “qualified retirement” provisions in our incentive compensation plans, under which (among other provisions) the vesting of 50% of outstanding time-based restricted stock awards will accelerate upon retirement if the participant is 55 years of age or older and satisfies certain years-of-service requirements. The cumulative effect of adopting these changes under SFAS 123(R) was not material to our financial condition, cash flows or results of operations for the year ended December 31, 2006.
 
Earnings Per Share Basic earnings per share are computed using the weighted average number of common shares outstanding, excluding both time-based and performance-based unvested restricted stock awards. Diluted earnings per share include common stock equivalents assumed outstanding during the period. Our common stock equivalents include stock options and time-based restricted stock awards accounted for as equity awards. In determining the denominator for our diluted earnings per share, we include the impact of pro forma deferred tax assets pursuant to the alternative transition method under SFAS 123(R) for purposes of calculating assumed proceeds under the treasury stock method.


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Supplemental Cash Flow Information Cash includes only bank demand deposits. We paid income taxes of $526.0 million, $739.0 million and $767.0 million in 2007, 2006 and 2005, respectively. Total interest paid was $110.1 million during 2007, $81.3 million during 2006 and $85.0 million during 2005. Non-cash activity includes declared but unpaid dividends, the liability for deferred restricted stock compensation (prior to the adoption of SFAS 123(R)) and the changes in net unrealized gains (losses) on investment securities.
 
Progressive effected a 4-for-1 stock split in the form of a stock dividend to shareholders on May 18, 2006. We reflected the issuance of the additional common shares by transferring $585.9 million from retained earnings to the common stock account. All share, per share and equivalent share amounts and stock prices were adjusted to give effect to the split. Treasury shares were not split.
 
New Accounting Standards In February 2007, the FASB issued SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” which permits entities to choose to measure certain financial assets and financial liabilities at fair value and recognize the unrealized gains and losses on such items in earnings. SFAS 159 is effective for fiscal years beginning after November 15, 2007 (January 1, 2008 for calendar year companies). We do not plan to elect the provisions of SFAS 159, and, therefore, this pronouncement will have no impact on our financial condition, cash flows or results of operations.


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2.  INVESTMENTS
 
The composition of the investment portfolio at December 31 was:
 
                                         
          Gross
    Gross
          % of
 
          Unrealized
    Unrealized
    Fair
    Total
 
(millions)   Cost     Gains     Losses     Value     Portfolio  
 
 
2007
                                       
Fixed maturities:
                                       
U.S. government obligations1
  $ 1,166.7     $ 40.4     $     $ 1,207.1       8.5 %
State and local government obligations
    3,706.3       44.0       (5.2 )     3,745.1       26.5  
Foreign government obligations
    29.9       .3             30.2       .2  
Corporate and U.S. agency debt securities
    1,075.0       12.1       (8.7 )     1,078.4       7.6  
Asset-backed securities
    2,503.6       35.9       (27.9 )     2,511.6       17.7  
Redeemable preferred stock
    654.1       4.4       (46.0 )     612.5       4.3  
Total fixed maturities
    9,135.6       137.1       (87.8 )     9,184.9       64.8  
Short-term investments:
                                       
Other short-term investments
    382.4                   382.4       2.7  
Preferred stocks2
    2,578.1       6.0       (306.4 )     2,270.3       16.0  
Common equities
    1,361.0       986.8       (20.3 )     2,327.5       16.5  
Total portfolio2, 3
  $ 13,457.1     $ 1,129.9     $ (414.5 )   $ 14,165.1       100.0 %
   
2006
                                       
Fixed maturities:
                                       
U.S. government obligations
  $ 3,195.1     $ 23.3     $ (15.0 )   $ 3,203.4       21.8 %
State and local government obligations
    3,124.2       18.4       (22.9 )     3,119.7       21.2  
Foreign government obligations
    29.8       .1       (.1 )     29.8       .2  
Corporate and U.S. agency debt securities
    1,125.0       5.6       (13.8 )     1,116.8       7.6  
Asset-backed securities
    2,387.4       24.0       (21.3 )     2,390.1       16.3  
Redeemable preferred stock
    98.1       3.4       (2.4 )     99.1       .7  
Total fixed maturities
    9,959.6       74.8       (75.5 )     9,958.9       67.8  
Short-term investments:
                                       
Auction rate municipal obligations
    99.4                   99.4       .7  
Auction rate preferred stocks
    69.2       .2             69.4       .5  
Other short-term investments
    412.4                   412.4       2.8  
Total short-term investments
    581.0       .2             581.2       4.0  
Preferred stocks
    1,761.4       31.5       (11.9 )     1,781.0       12.1  
Common equities
    1,469.0       904.0       (4.9 )     2,368.1       16.1  
Total portfolio3
  $ 13,771.0     $ 1,010.5     $ (92.3 )   $ 14,689.2       100.0 %
   
 
1 Includes $53.8 million of gains on our open interest rate swap positions. Also includes $34.1 million of collateral, in the form of Treasury Notes that were delivered to the counterparty on our open credit default swaps. See the Derivative Instruments section below for further discussion.
 
2 At December 31, 2007, the fair value included a $7.4 million change in certain hybrid securities that was recognized as a realized loss.
 
3Includes net unsettled security acquisitions of $77.0 million and $41.9 million at December 31, 2007 and 2006, respectively.
 
Our fixed-maturity securities include debt securities and redeemable preferred stocks. The preferred stock portfolio includes nonredeemable preferred stocks, which contain certain securities that have call features with fixed-rate coupons (i.e., hybrid securities), whereby the change in value of the call features is a component of the overall change in value of the preferred stocks. Other short-term investments include Eurodollar deposits, commercial paper and other investments which are expected to mature within one year. Common equities include common stock and other risk investments.
 
Our securities are reported at fair value, with the changes in fair value of these securities (other than hybrid securities) reported as a component of accumulated other comprehensive income, net of deferred income taxes. The change in fair value of the hybrid securities discussed above is recorded as a component of net realized gains (losses) on securities. See Note 10-Other Comprehensive Income for changes in net unrealized gains (losses) during the period.


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At December 31, 2007, bonds in the principal amount of $121.5 million were on deposit to meet state insurance regulatory and/or rating agency requirements. We did not have any securities of any one issuer with an aggregate cost or fair value exceeding 10% of total shareholders’ equity at December 31, 2007 or 2006. At December 31, 2007, we had fixed-maturity securities with a fair value of $1.1 million that were non-income producing during the preceding 12 months.
 
Net Investment Income The components of net investment income for the years ended December 31 were:
 
                         
(millions)   2007     2006     2005  
 
 
Fixed maturities
  $ 478.6     $ 481.7     $ 399.0  
Preferred stocks
    126.9       84.4       61.5  
Common equities
    46.2       43.1       37.2  
Short-term investments:
                       
Auction rate municipal obligations
    2.6       1.8       5.4  
Auction rate preferred stocks
    .8       5.8       6.8  
Other short-term investments
    25.7       31.0       26.8  
Investment income
    680.8       647.8       536.7  
Investment expenses
    (12.4 )     (11.9 )     (12.1 )
Net investment income
  $ 668.4     $ 635.9     $ 524.6  
   
 
Net Realized Gains (Losses) The components of net realized gains (losses) for the years ended December 31 were:
 
                         
(millions)   2007     2006     2005  
 
 
Fixed maturities
  $ 113.3     $ 37.9     $ 47.4  
Preferred stocks
    3.1       .6        
Common equities
    55.4       24.7       15.6  
Short-term investments:
                       
Auction rate municipal obligations
    .1       .1       .1  
Derivatives
    63.1       10.0        
Total gross realized gains
    235.0       73.3       63.1  
Fixed maturities
    (23.6 )     (62.4 )     (68.6 )
Preferred stocks
    (28.0 )     (11.1 )     (2.3 )
Common equities
    (33.7 )     (9.2 )     (22.5 )
Short-term investments:
                       
Auction rate municipal obligations
          (.1 )      
Auction rate preferred stocks
          (.2 )      
Derivatives
    (43.4 )           (7.6 )
Total gross realized losses
    (128.7 )     (83.0 )     (101.0 )
Fixed maturities
    89.7       (24.5 )     (21.2 )
Preferred stocks
    (24.9 )     (10.5 )     (2.3 )
Common equities
    21.7       15.5       (6.9 )
Short-term investments:
                       
Auction rate municipal obligations
    .1             .1  
Auction rate preferred stocks
          (.2 )      
Derivatives
    19.7       10.0       (7.6 )
Total net realized gains (losses) on securities
  $ 106.3     $ (9.7 )   $ (37.9 )
   
Per share (diluted basis)
  $ .10     $ (.01 )   $ (.03 )
   


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For 2007, 2006 and 2005, net realized gains (losses) on securities include $19.6 million, $1.9 million and $16.4 million, respectively, of write-downs in securities determined to have had an other-than-temporary decline in fair value for securities held at December 31.
 
Gross Unrealized Losses The components of gross unrealized losses at December 31, 2007 and 2006 were:
 
                                 
    Total
    Unrealized Losses  
    Fair
          Less than 12
    12 Months or
 
(millions)   Value     Total     Months     Greater1  
 
 
2007
                               
Fixed maturities
  $ 2,509.3     $ (87.8 )   $ (51.4 )   $ (36.4 )
Preferred stocks
    1,975.3       (306.4 )     (245.3 )     (61.1 )
Common equities
    160.5       (20.3 )     (18.3 )     (2.0 )
Total
  $ 4,645.1     $ (414.5 )   $ (315.0 )   $ (99.5 )
   
2006
                               
Fixed maturities
  $ 6,128.4     $ (75.5 )   $ (6.7 )   $ (68.8 )
Preferred stocks
    494.3       (11.9 )     (.4 )     (11.5 )
Common equities
    97.2       (4.9 )     (4.3 )     (.6 )
Total
  $ 6,719.9     $ (92.3 )   $ (11.4 )   $ (80.9 )
   
 
1 The fair value for securities in an unrealized loss position for 12 months or greater was $2,038.9 million at December 31, 2007 and $4,832.2 million at December 31, 2006.
 
We completed a thorough review of the securities presented in the table above and determined that none of the securities was deemed to have any fundamental issues which would lead us to believe that any were other-than-temporarily impaired. Approximately two-thirds of the losses that are 12 months or greater have had a decrease of less than 15% of their original value; the remaining one-third experienced a significant loss in value during the fourth quarter 2007, reflecting the financial market disruption relating to the sub-prime mortgage market that impacted the financial services sector. During the fourth quarter 2007, the issuers of these securities began efforts to stabilize their balance sheets by raising additional capital. These issuers continue to pay periodic dividends and we believe there is no evidence that their liquidity is a concern. The significant increase in unrealized losses less than one year occurred primarily during the fourth quarter 2007. The increase was mainly in the preferred stock portfolio and reflects the same issues discussed above regarding the financial market disruption relating to the sub-prime mortgage market.
 
We have the intent and ability to hold the fixed-maturity securities and preferred stocks, and will do so, as long as the securities continue to remain consistent with our investment strategy. We may retain the common stocks to maintain correlation to the Russell 1000 Index as long as the portfolio and index correlation remain similar. If our strategy was to change and these securities were determined to be other-than-temporarily impaired, we would recognize a write-down in accordance with our stated policy.
 
Trading Securities At December 31, 2007 and 2006, we did not hold any trading securities. We did not have any net realized gains (losses) on trading securities for the years ended December 31, 2007, 2006 and 2005.
 
Derivative Instruments From time to time we invest in derivative instruments. At December 31, 2007, we held interest rate swaps to receive fixed interest rates for 5 years and 10 years with a combined notional value of $1.3 billion. For 2007, the interest rate swap positions generated net realized gains, including net interest expense, of $53.1 million. We held no interest rate swaps in 2006 or 2005. The carrying value of the derivative positions are immaterial to our financial condition, cash flows and results of operations and are reported as part of the available-for-sale portfolio, with the net gain reported as a component of net realized gains (losses) on securities.
 
During 2007, we closed $210 million of notional credit default exposure on a corporate non-investment-grade index and $40 million of notional exposure on a corporate investment-grade index. During 2006, we held $40 million of notional exposure on the same corporate investment-grade index. The combined positions generated net realized gains of $10.0 million and $.1 million for 2007 and 2006, respectively. We held no corporate non-investment-grade or investment-grade index derivatives in 2005. The carrying value of the derivative positions are immaterial to our financial condition, cash flows and results of operations and are reported as part of the available-for-sale portfolio, with the net gain reported as a component of net realized gains (losses) on securities.
 
Additionally, during 2007, we sold credit default protection using credit default swap derivatives on an investment-grade asset-backed index with a credit quality of BBB-, comprised of 20 bonds in the sub-prime mortgage sector, with a


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notional amount of $140 million. We matched these notional amounts with Treasury Notes with the same maturity and principal value to cover our off-balance-sheet exposure. During 2006, we closed our credit default protection derivatives sold on four separate corporate issuers which were also matched with equivalent Treasury Notes. The combined positions generated a net gain (loss) of $(43.4) million in 2007, compared to $9.9 million and $(7.6) million for 2006 and 2005, respectively. The carrying value of the derivative and Treasury positions are immaterial to our financial condition, cash flows and results of operations and are reported as part of the available-for-sale portfolio, with the net gain reported as a component of net realized gains (losses) on securities.
 
Fixed Maturities The composition of fixed maturities by maturity at December 31, 2007, was:
 
                 
(millions)   Cost     Fair Value  
 
 
Less than one year
  $ 527.1     $ 529.0  
One to five years
    5,723.3       5,750.6  
Five to ten years
    2,678.8       2,701.0  
Ten years or greater
    152.6       150.5  
Total
  $ 9,081.8     $ 9,131.1  
   
 
The table above excludes $53.8 million of gains on open interest rate swap positions.
 
Asset-backed securities are classified in the maturity distribution table based upon their projected cash flows. All other securities which do not have a single maturity date are reported at expected average maturity. Contractual maturities may differ from expected maturities because the issuers of the securities may have the right to call or prepay obligations.
 
3.  INCOME TAXES
 
The components of our income tax provision were as follows:
 
                         
(millions)   2007     2006     2005  
 
 
Current tax provision
  $ 503.7     $ 798.6     $ 696.7  
Deferred tax expense (benefit)
    6.8       (12.9 )     (31.7 )
Total income tax provision
  $ 510.5     $ 785.7     $ 665.0  
   
 
The provision for income taxes in the accompanying consolidated statements of income differed from the statutory rate as follows:
 
                                                         
($ in millions)   2007     2006     2005        
 
 
Income before income taxes
  $ 1,693.0             $ 2,433.2             $ 2,058.9                  
     
             
             
                 
     
             
             
                 
Tax at statutory rate
  $ 592.6       35 %   $ 851.6       35 %   $ 720.6       35 %        
Tax effect of:
                                                       
Exempt interest income
    (40.3 )     (3 )     (35.9 )     (2 )     (34.8 )     (2 )        
Dividends received deduction
    (35.4 )     (2 )     (27.2 )     (1 )     (22.2 )     (1 )        
Other items, net
    (6.4 )           (2.8 )           1.4                
Total income tax provision
  $ 510.5       30 %   $ 785.7       32 %   $ 665.0       32 %        
   


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Table of Contents

Deferred income taxes reflect the effect 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, 2007 and 2006, the components of the net deferred tax assets were as follows:
 
                 
(millions)   2007     2006  
 
 
Deferred tax assets:
               
Unearned premiums reserve
  $ 293.2     $ 300.7  
Non-deductible accruals
    149.7       145.8  
Loss reserves
    121.7       120.6  
Write-downs on securities
    12.7       13.9  
Other
    7.9       5.2  
Deferred tax liabilities:
               
Deferred acquisition costs
    (149.2 )     (154.4 )
Net unrealized gains on securities
    (250.4 )     (321.4 )
Hedges on forecasted transactions
    (15.0 )     (4.0 )
Depreciable assets
    (63.7 )     (52.4 )
Other
    (14.7 )     (15.0 )
Net deferred tax assets
    92.2       39.0  
Net income taxes (payable) recoverable
    13.8       (22.2 )
Income taxes
  $ 106.0     $ 16.8  
   
 
In July 2006, FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” was issued, which provides guidance for recognizing and measuring the financial statement impact of tax positions taken or expected to be taken in a tax return. This interpretation was effective beginning January 1, 2007. As of January 1, 2007, we had no unrecognized tax benefits. We analyzed our tax positions in accordance with this interpretation and determined that it did not result in any changes to our uncertain tax positions. As a result, no adjustment to January 1, 2007 retained earnings was required.
 
We recognize interest and penalties, if any, related to unrecognized tax benefits as a component of income tax expense. As of January 1, 2007, we had not accrued any interest or penalties related to unrecognized tax benefits.
 
The statute of limitations remains open with respect to our federal income tax returns for tax years 2004 and later. The 2004 through 2006 returns are currently under examination. We have entered into the Compliance Assurance Program (CAP) for the 2007 tax year. Under the CAP program, the Internal Revenue Service begins its examination process for the tax year before the tax return is filed, by examining significant transactions and events as they occur. The goal of the CAP program is to expedite the exam process and to reduce the level of uncertainty regarding a taxpayer’s tax filing positions.
 
There have been no changes to our liability for unrecognized tax benefits, interest and penalties during the year ended December 31, 2007.
 
4.  DEBT
 
Debt at December 31 consisted of:
 
                                 
    2007     2006  
    Carrying
    Fair
    Carrying
    Fair
 
(millions)   Value     Value     Value     Value  
 
 
6.375% Senior Notes due 2012 (issued: $350.0, December 2001)
  $ 348.6     $ 367.8     $ 348.3     $ 365.4  
7% Notes due 2013 (issued: $150.0, October 1993)
    149.2       162.9       149.1       163.2  
65/8% Senior Notes due 2029 (issued: $300.0, March 1999)
    294.4       311.8       294.3       325.2  
6.25% Senior Notes due 2032 (issued: $400.0, November 2002)
    393.9       397.6       393.8       414.0  
6.70% Fixed-to-Floating Rate Junior Subordinated Debentures due 2067 (issued: $1,000.0, June 2007)
    987.8       936.5              
Total
  $ 2,173.9     $ 2,176.6     $ 1,185.5     $ 1,267.8  
   


App.-A-15


Table of Contents

Debt includes amounts we have borrowed and contributed to the capital of our insurance subsidiaries or used for other business purposes. Fair values are obtained from publicly quoted sources. There are no restrictive financial covenants or credit rating triggers on our debt.
 
Interest on all debt is payable semiannually at the stated rates. However, the 6.70% Fixed-to-Floating Rate Junior Subordinated Debentures due 2067 (the “Debentures”) will only bear interest at this fixed annual rate through, but excluding, June 15, 2017. Thereafter, the Debentures will bear interest at a rate equal to the three-month LIBOR plus 2.0175%, and the interest will be payable quarterly. In addition, subject to certain conditions, Progressive has the right to defer the payment of interest on the Debentures for one or more periods not exceeding ten consecutive years each. During any such deferral period, among other conditions, interest would continue to accrue, including interest on the deferred interest, and we generally would not be able to declare or pay any dividends on, or repurchase any of, our common shares.
 
Except for the Debentures, all principal is due at the maturity stated in the table above. The Debentures will become due on June 15, 2037, the scheduled maturity date, but only to the extent that we have received sufficient net proceeds from the sale of certain qualifying capital securities. Progressive must use its commercially reasonable efforts, subject to certain market disruption events, to sell enough qualifying capital securities to permit repayment of the Debentures in full on the scheduled maturity date or, if sufficient proceeds are not realized from the sale of such qualifying capital securities by such date, on each interest payment date thereafter. Any remaining outstanding principal will be due on June 15, 2067, the final maturity date.
 
The 7% Notes are noncallable. The 6.375% Senior Notes, the 65/8% Senior Notes and the 6.25% Senior Notes (collectively, “Senior Notes”) may be redeemed in whole or in part at any time, at the option of Progressive, subject to a “make-whole” provision. Subject to the Replacement Capital Covenant discussed below, the Debentures may be redeemed, in whole or in part, at any time: (a) prior to June 15, 2017, at a redemption price equal to the greater of (i) 100% of the principal amount of the Debentures being redeemed, or (ii) a “make-whole” amount, in each case plus any accrued and unpaid interest; or (b) on or after June 15, 2017, at a redemption price equal to 100% of the principal amount of the Debentures being redeemed, plus any accrued and unpaid interest. In connection with the issuance of the Debentures, Progressive entered into a Replacement Capital Covenant in which we agreed, for the benefit of the holders of a senior debt security, that we will not repay, redeem, defease or purchase all or part of the Debentures before June 15, 2047, unless, subject to certain limitations, we have received proceeds from the sale of certain replacement capital securities, as defined in the Replacement Capital Covenant.
 
Prior to issuance of the Senior Notes and Debentures, we entered into forecasted debt issuance hedges against possible rises in interest rates. Upon issuance of the applicable debt securities, the hedges were closed. At that time, we recognized, as part of accumulated other comprehensive income, unrealized gains (losses) of $18.4 million, $(4.2) million, $5.1 million and $34.4 million associated with the 6.375% Senior Notes, the 65/8% Senior Notes, the 6.25% Senior Notes and the Debentures, respectively. The gains (losses) on these hedges are deferred and are being recognized as adjustments to interest expense over the life of the related debt issuances for the Senior Notes, and over the 10-year fixed interest rate term for the Debentures.
 
In December 2005, we entered into an uncommitted line of credit with National City Bank in the principal amount of $125 million. No commitment fees are required to be paid. There are no rating triggers under this line of credit. We had no borrowings under this arrangement during 2007, 2006 or 2005. Interest on amounts borrowed would generally accrue at the one-month LIBOR plus .375%.
 
Aggregate principal payments on debt outstanding at December 31, 2007, are $0 for 2008, 2009, 2010 and 2011, $350.0 million for 2012 and $1.85 billion thereafter.


App.-A-16


Table of Contents

5.  LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
 
Activity in the loss and loss adjustment expense reserves is summarized as follows:
 
                         
(millions)   2007     2006     2005  
 
 
Balance at January 1
  $ 5,725.0     $ 5,660.3     $ 5,285.6  
Less reinsurance recoverables on unpaid losses
    361.4       347.2       337.1  
Net balance at January 1
    5,363.6       5,313.1       4,948.5  
Incurred related to:
                       
Current year
    9,845.9       9,641.8       9,720.7  
Prior years
    80.3       (246.9 )     (355.9 )
Total incurred
    9,926.2       9,394.9       9,364.8  
Paid related to:
                       
Current year
    6,737.2       6,682.3       6,644.7  
Prior years
    2,897.4       2,662.1       2,355.5  
Total paid
    9,634.6       9,344.4       9,000.2  
Net balance at December 31
    5,655.2       5,363.6       5,313.1  
Plus reinsurance recoverables on unpaid losses
    287.5       361.4       347.2  
Balance at December 31
  $ 5,942.7     $ 5,725.0     $ 5,660.3  
   
 
Our objective is to establish case and IBNR reserves that are adequate to cover all loss costs, while sustaining minimal variation from the date that the reserves are initially established until losses are fully developed. Our reserves developed unfavorably in 2007, compared to favorable development in 2006 and 2005. Total development consists of net changes made by our actuarial department on prior accident year reserves, based on regularly scheduled reviews, claims settling for more or less than reserved, emergence of unrecorded claims at rates different than reserved and changes in reserve estimates by claim representatives. The estimated severity for prior accident years, primarily 2006 and 2005, increased from our estimate as of the end of 2006, which was the basis for the unfavorable development in 2007.
 
Because we are primarily an insurer of motor vehicles, we have limited exposure to environmental, asbestos and general liability claims. We have established reserves for such exposures, in amounts that we believe to be adequate based on information currently known. These claims are not expected to have a material effect on our liquidity, financial condition, cash flows or results of operations.
 
We write personal and commercial auto insurance in the coastal states, which could be exposed to hurricanes or other natural catastrophes. Although the occurrence of a major catastrophe could have a significant effect on our monthly or quarterly results, we believe that, based on historical performance, such an event would not be so material as to disrupt the overall normal operations of Progressive. We are unable to predict the frequency or severity of any such events that may occur in the near term or thereafter.
 
6.  REINSURANCE
 
The effect of reinsurance on premiums written and earned for the years ended December 31 was as follows:
 
                                                 
    2007     2006     2005  
(millions)   Written     Earned     Written     Earned     Written     Earned  
 
 
Direct premiums
  $ 13,982.4     $ 14,107.0     $ 14,386.2     $ 14,386.3     $ 14,293.4     $ 14,066.2  
Ceded
    (209.9 )     (229.6 )     (254.2 )     (268.4 )     (285.8 )     (301.8 )
Net premiums
  $ 13,772.5     $ 13,877.4     $ 14,132.0     $ 14,117.9     $ 14,007.6     $ 13,764.4  
   
 
Our ceded premiums are primarily attributable to premiums written under state-mandated involuntary Commercial Auto Insurance Procedures/Plans (CAIP) and premiums ceded to state-provided reinsurance facilities, for which we retain no loss indemnity risk.
 
Reinsurance contracts do not relieve us from our obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to Progressive. We evaluate the financial condition of our reinsurers and monitor concentrations of credit risk to minimize our exposure to significant losses from reinsurer insolvencies.


App.-A-17


Table of Contents

At December 31, 2007, approximately 40% of the “prepaid reinsurance premiums” were comprised of CAIP, compared to about 50% at December 31, 2006. As of December 31, 2007 and December 31, 2006, approximately 40% of the “reinsurance recoverables” were comprised of CAIP. The remainder of the “prepaid reinsurance premiums” and “reinsurance recoverables” was primarily related to state-mandated and non-auto programs.
 
Losses and loss adjustment expenses were net of reinsurance ceded of $109.6 million in 2007, $196.3 million in 2006 and $197.9 million in 2005.
 
7.  STATUTORY FINANCIAL INFORMATION (unaudited)
 
At December 31, 2007, $470.2 million of consolidated statutory policyholders’ surplus represented net admitted assets of our insurance subsidiaries and affiliate that are required to meet minimum statutory surplus requirements in such entities’ states of domicile. The companies may be licensed in states other than their states of domicile, which may have higher minimum statutory surplus requirements. Generally, the net admitted assets of insurance companies that, subject to other applicable insurance laws and regulations, are available for transfer to the parent company cannot include the net admitted assets required to meet the minimum statutory surplus requirements of the states where the companies are licensed.
 
During 2007, the insurance subsidiaries paid aggregate cash dividends of $1,484.8 million to the parent company. Based on the dividend laws currently in effect, the insurance subsidiaries may pay aggregate dividends of $974.6 million in 2008 without prior approval from regulatory authorities, provided the dividend payments are not within 12 months of previous dividends paid by the applicable subsidiary.
 
Consolidated statutory policyholders’ surplus was $4,587.3 million and $4,963.7 million at December 31, 2007 and 2006, respectively. Statutory net income was $1,105.2 million, $1,612.4 million and $1,393.5 million for the years ended December 31, 2007, 2006 and 2005, respectively.
 
8.  EMPLOYEE BENEFIT PLANS
 
Retirement Plans Progressive 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. Company contributions vary from 1% to 5% of annual eligible compensation up to the Social Security wage base, based on years of eligible service and may be invested by a participant in any of the investment funds available under the plan. Company contributions were $22.5 million in 2007, $21.9 million in 2006 and $19.5 million in 2005.
 
The second tier is a long-term savings plan under which Progressive matches, up to a maximum of 3% of the employee’s eligible compensation, amounts contributed to the plan by an employee. Company matching contributions may be invested by a participant in any of the investment funds available under the plan. Company matching contributions were $29.3 million in 2007, $29.6 million in 2006 and $26.8 million in 2005.
 
Postemployment Benefits Progressive 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 for specified limited periods. The liability for these benefits was $24.8 million at December 31, 2007, compared to $23.2 million in 2006.
 
Postretirement Benefits We provide postretirement health and life insurance benefits to all employees who met requirements as to age and length of service at December 31, 1988. There are approximately 100 people in this group of employees. Our funding policy for the benefits is to contribute annually the maximum amount that can be deducted for federal income tax purposes.
 
Incentive Compensation Plans — Employees Our incentive compensation includes both non-equity incentive plans (cash) and equity incentive plans (stock-based). The cash incentive compensation includes a cash bonus program for a limited number of senior executives and Gainsharing programs for other employees; the bases of these programs are similar in nature. The stock-based incentive compensation plans provide for the granting of restricted stock awards to key members of management. Prior to 2003, we granted non-qualified stock options as stock-based incentive compensation (see below). The amounts charged to income for the incentive compensation plans for the years ended December 31 were:
 
                         
(millions)   2007     2006     2005  
 
 
Cash
  $ 126.2     $ 197.7     $ 235.9  
Stock-based
    26.5       27.6       33.7  


App.-A-18


Table of Contents

Our 2003 Incentive Plan, which provides for the granting of stock-based awards, including restricted stock awards, to key employees of Progressive, has 19.0 million shares currently authorized, net of restricted stock awards cancelled; 11.3 million shares remain available for future restricted stock grants. Our 1995 Incentive Plan has expired; however, awards made under that plan prior to its expiration are still in effect.
 
In 2003, we began issuing restricted stock awards in lieu of stock options. The restricted stock awards are issued as either time-based or performance-based awards. The time-based awards vest in equal installments upon the lapse of specified periods of time, typically three, four and five years. The vesting period (i.e., requisite service period) must be a minimum of six months and one day. The performance-based awards vest upon the achievement of predetermined performance goals. The performance-based awards are granted to approximately 50 executives and senior managers, in addition to their time-based awards, to provide additional compensation for achieving pre-established profitability and growth targets. Generally, the restricted stock awards are expensed pro rata over their respective vesting periods based on the market value of the awards at the time of grant. However, restricted stock awards granted in 2003 and 2004, that were deferred pursuant to our deferred compensation plan, are accounted for as liability awards, since distributions from the deferred compensation plan for these awards will be made in cash; accordingly, we record expense on a pro rata basis based on the current market value of common shares at the end of the reporting period.
 
Prior to 2003, we granted nonqualified stock options for periods up to ten years. These options became exercisable at various dates not earlier than six months after the date of grant, and remain exercisable for specified periods thereafter. All remaining options vested on January 1, 2007. All options granted had an exercise price equal to the market value of the common shares on the date of grant and, under the then applicable accounting guidance, no compensation expense was recorded prior to 2006. Pursuant to the adoption of SFAS 123(R), on January 1, 2006, we began expensing the remaining unvested stock option awards (see Note 1 — Reporting and Accounting Policies, “Stock-Based Compensation,” for further discussion). All option exercises are settled in Progressive common shares from either existing treasury shares or newly issued shares.
 
A summary of all employee restricted stock activity during the years ended December 31 follows:
 
                                                 
    2007     2006     2005  
          Weighted
          Weighted
          Weighted
 
    Number
    Average
    Number
    Average
    Number
    Average
 
    of
    Grant Date
    of
    Grant Date
    of
    Grant Date
 
Restricted Shares   Shares     Fair Value     Shares     Fair Value     Shares     Fair Value  
 
 
Beginning of year
    6,232,522     $ 22.27       5,442,988     $ 20.21       3,663,364     $ 18.89  
Add (deduct):
                                               
Granted
    2,318,637       21.01       1,828,198       26.50       1,942,784       22.62  
Vested
    (1,005,680 )     18.80       (567,824 )     16.60       (2,728 )     18.45  
Forfeited
    (676,629 )     22.44       (470,840 )     21.74       (160,432 )     19.37  
End of year
    6,868,850     $ 22.33       6,232,522     $ 22.27       5,442,988     $ 20.21  
   
Available, end of year1
    11,287,225               13,448,514               15,276,712          
           
             
         
     
             
             
         
 
1 Represents shares available under the 2003 Incentive Plan. The 1995 Incentive Plan expired in February 2005, and the remaining shares thereunder are no longer available for future issuance.
 
Of the 1,005,680 restricted stock awards that vested during the year ended December 31, 2007, 788,560 shares were not deferred under our deferred compensation plans and 217,120 were deferred (see discussion of deferred compensation plans below). The aggregate pretax intrinsic value of the non-deferred awards, based on the average of the high and low stock price on the day prior to vesting, was $4.3 million. There was no intrinsic value attributed to the shares which were deferred, since, as previously discussed, these awards were granted in 2003 or 2004 and, therefore, were expensed based on the current market value at the end of each reporting period.


App.-A-19


Table of Contents

During the year ended December 31, 2007, we recognized $26.5 million, or $17.2 million after taxes, of compensation expense related to our outstanding unvested restricted stock. During the year ended December 31, 2006, we recognized $27.6 million, or $17.9 million after taxes, of compensation expense related to our outstanding unvested restricted stock and stock option awards. At December 31, 2007, the total compensation cost related to unvested restricted stock awards not yet recognized was $76.5 million. This compensation expense will be recognized into the income statement over the weighted average vesting period of 2.51 years.
 
A summary of all employee stock option activity during the years ended December 31 follows:
 
                               
    2007   2006  
          Weighted
        Weighted
 
    Number
    Average
  Number
    Average
 
    of
    Grant Date
  of
    Grant Date
 
Nonvested Stock Options Outstanding   Shares     Fair Value   Shares     Fair Value  
 
 
Beginning of year
    1,087,866     $ 5.82     4,232,220     $ 4.76  
Deduct:
                             
Vested1
    (1,087,866 )     5.82     (3,053,352 )     4.36  
Forfeited
              (91,002 )     5.81  
End of year
        $     1,087,866     $ 5.82  
   
 
1 All remaining stock option awards vested on January 1, 2007.
 
In September 2007, we paid a $2.00 per common share special dividend to shareholders of record at the close of business on August 31, 2007. Since the holders of the outstanding stock option awards were not entitled to receive the cash dividend, we were required to increase the number of shares and reduce the exercise price of any of our then outstanding stock option awards in accordance with the antidilution provisions of our incentive plans; prior year information was not adjusted. This adjustment is reflected in the tables below for both our employees and directors.
 
                                                 
    2007     2006     2005  
          Weighted
          Weighted
          Weighted
 
    Number
    Average
    Number
    Average
    Number
    Average
 
    of
    Exercise
    of
    Exercise
    of
    Exercise
 
Options Outstanding   Shares     Price     Shares     Price     Shares     Price  
 
 
Beginning of year
    13,747,221     $ 8.75       19,621,476     $ 8.44       26,358,004     $ 8.01  
Add:
                                               
Antidilution adjustment
    1,201,984       NM                          
Deduct:
                                               
Exercised
    (3,208,873 )     9.10       (5,649,193 )     7.55       (6,581,264 )     6.67  
Forfeited
    (1,830 )     11.78       (225,062 )     12.09       (155,264 )     10.82  
End of year
    11,738,502     $ 7.75       13,747,221     $ 8.75       19,621,476     $ 8.44  
   
Exercisable, end of year
    11,738,502     $ 7.75       12,659,355     $ 8.38       15,389,256     $ 7.82  
   
 
NM=not meaningful
 
The total pretax intrinsic value of options exercised during the year ended December 31, 2007, was $37.1 million, based on the actual stock price at time of exercise.
 
The following employee stock options were outstanding and exercisable as of December 31, 2007:
 
                             
                  Weighted
 
      Weighted
          Average
 
Number
    Average
    Aggregate
    Remaining
 
of
    Exercise
    Intrinsic Value
    Contractual
 
Shares     Price     (in millions)     Life  
 
 
  11,738,502     $ 7.75     $ 133.9       2.74 years  
 
The aggregate intrinsic value in the preceding table represents the total pretax intrinsic value, based on the difference between our closing stock price of $19.16 on December 31, 2007, and the exercise price of the options, which is the amount that would have been received by the option holders had all option holders exercised their options as of that date. All of the exercisable options at December 31, 2007, were “in-the-money.”
 
Incentive Compensation Plans — Directors Our 2003 Directors Equity Incentive Plan, which provides for the granting of stock-based awards, including restricted stock awards to non-employee directors of Progressive, has 1.4 million


App.-A-20


Table of Contents

shares currently authorized, net of restricted stock awards cancelled; 1.1 million shares remain available for future restricted stock grants. Our 1998 Directors’ Stock Option Plan, under which additional awards are not expected to be made, will expire on April 24, 2008; however, awards made under this plan prior to its expiration are still in effect.
 
In 2003, we began issuing restricted stock awards to non-employee directors as the equity component of their compensation. The restricted stock awards are issued as time-based awards. The vesting period (i.e., requisite service period) must be a minimum of six months and one day. The time-based awards granted to date have included vesting periods of eleven months from the date of each grant. The restricted stock awards are expensed pro rata over their respective vesting periods based on the market value of the awards at the time of grant.
 
Prior to 2003, we granted nonqualified stock options as the equity component of the directors compensation. These options were granted for periods up to ten years, became exercisable at various dates not earlier than six months after the date of grant, and remain exercisable for specified periods thereafter. All options granted had an exercise price equal to the market value of the common shares on the date of grant and, under the then applicable accounting guidance, no compensation expense was recorded. All option exercises are settled in Progressive common shares from either existing treasury shares or newly issued shares.
 
In April 2006, we began granting restricted stock awards to non-employee directors as their sole compensation as a member of the Board of Directors. From April 2003 through April 2006, we issued restricted stock awards in addition to other retainer and meeting fees. A summary of all directors restricted stock activity during the years ended December 31 follows:
 
                                                 
    2007     2006     2005  
          Weighted
          Weighted
          Weighted
 
    Number
    Average
    Number
    Average
    Number
    Average
 
    of
    Grant Date
    of
    Grant Date
    of
    Grant Date
 
Restricted Shares   Shares     Fair Value     Shares     Fair Value     Shares     Fair Value  
 
 
Beginning of year
    66,031     $ 26.64       50,244     $ 21.91       48,968     $ 22.47  
Add (deduct):
                                               
Granted
    76,074       23.52       66,031       26.64       50,244       21.91  
Vested
    (66,031 )     26.64       (50,244 )     21.91       (48,968 )     22.47  
Forfeited
    (7,479 )     23.52                          
End of year
    68,595     $ 23.52       66,031     $ 26.64       50,244     $ 21.91  
   
Available, end of year1
    1,094,275               1,170,349               1,236,380          
           
             
         
     
             
             
         
 
1 Represents shares available under the 2003 Directors Equity Incentive Plan.
 
A summary of all stock option activity for both current and former directors during the years ended December 31 follows:
 
                                                 
    2007     2006     2005  
          Weighted
          Weighted
          Weighted
 
    Number
    Average
    Number
    Average
    Number
    Average
 
    of
    Exercise
    of
    Exercise
    of
    Exercise
 
Options Outstanding   Shares     Price     Shares     Price     Shares     Price  
 
 
Beginning of year
    772,664     $ 8.59       873,108     $ 8.20       969,108     $ 7.79  
Add:
                                               
Antidilution adjustment
    55,851       NM                          
Deduct:
                                               
Exercised
    (199,702 )     8.16       (100,444 )     5.18       (96,000 )     4.06  
End of year
    628,813     $ 7.97       772,664     $ 8.59       873,108     $ 8.20  
   
Exercisable, end of year1
    628,813     $ 7.97       772,664     $ 8.59       873,108     $ 8.20  
   
 
NM=not meaningful
 
1 There are 1,730,708 shares available under the 1998 Directors’ Stock Option Plan.
 
Deferred Compensation We maintain The Progressive Corporation Executive Deferred Compensation Plan (Deferral Plan), that permits eligible executives to defer receipt of some or all of their annual bonuses or all of their annual restricted stock awards. Deferred cash compensation is deemed invested in one or more investment funds, including common


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shares of Progressive, offered under the Deferral Plan and elected by the participant. All distributions from the Deferral Plan pursuant to deferred cash compensation will be paid in cash.
 
For all restricted stock awards granted on or after March 17, 2005, and deferred pursuant to the Deferral Plan, the deferred amounts are deemed invested in common shares and are ineligible for transfer to other investment funds in the Deferral Plan; all distributions will be made in common shares. For all awards granted prior to March 17, 2005, the deferred amounts are eligible to be transferred to any of the funds in the Deferral Plan; distributions of these deferred awards will be made in cash.
 
We reserved 3.6 million common shares for issuance under the Deferral Plan. An irrevocable grantor trust has been established to provide a source of funds to assist us in meeting our liabilities under the Deferral Plan. At December 31, 2007 and 2006, the trust held assets of $93.3 million and $85.9 million, respectively, of which $15.0 million and $13.1 million were held in Progressive’s common shares.
 
9.  SEGMENT INFORMATION
 
We write personal automobile and other specialty property-casualty insurance and provide related services throughout the United States. Our Personal Lines segment writes insurance for private passenger automobiles and recreational vehicles. The Personal Lines segment is comprised of both the Agency and Direct businesses. The Agency business includes business written by our network of more than 30,000 independent insurance agencies, including brokerages in New York and California, and strategic alliance business relationships (other insurance companies, financial institutions and national agencies). The Direct business includes business written online and by phone.
 
Our Commercial Auto segment writes primary liability and physical damage insurance for automobiles and trucks owned by small businesses in the specialty truck and business auto markets. This segment is distributed through both the independent agency and direct channels.
 
Our other indemnity businesses primarily include writing professional liability insurance for community banks and managing a small amount of run-off business.
 
Our service businesses include providing insurance-related services, primarily processing CAIP business.
 
All revenues are generated from external customers and we do not have a reliance on any major customer.
 
We evaluate segment profitability based on pretax underwriting profit (loss) for the Personal Lines and Commercial Auto Businesses. In addition, we use underwriting profit (loss) for the other indemnity businesses and pretax profit (loss) for the service businesses. Pretax underwriting profit (loss) is calculated as follows:
 
 
Net premiums earned
Less: Losses and loss adjustment expenses
Policy acquisition costs
Other underwriting expenses
Pretax underwriting profit (loss)
 
Service business profit (loss) is the difference between service business revenues and service business expenses.
 
Expense allocations are based on certain assumptions and estimates primarily related to revenue and volume; stated segment operating results would change if different methods were applied. We do not allocate assets or income taxes to operating segments. In addition, we do not separately identify depreciation and amortization expense by segment and such disclosure would be impractical. Companywide depreciation expense was $106.9 million in 2007, $103.4 million in 2006 and $92.4 million in 2005. The accounting policies of the operating segments are the same as those described in Note 1 — Reporting and Accounting Policies.


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Following are the operating results for the years ended December 31:
 
                                                 
    2007     2006     2005  
          Pretax
          Pretax
          Pretax
 
          Profit
          Profit
          Profit
 
(millions)   Revenues     (Loss)     Revenues     (Loss)     Revenues     (Loss)  
 
 
Personal Lines
                                               
Agency
  $ 7,636.4     $ 500.2     $ 7,903.6     $ 936.7     $ 7,993.1     $ 857.6  
Direct
    4,372.6       339.9       4,337.4       568.6       4,076.2       475.7  
Total Personal Lines1
    12,009.0       840.1       12,241.0       1,505.3       12,069.3       1,333.3  
Commercial Auto
    1,846.9       185.7       1,851.9       366.5       1,667.8       298.0  
Other indemnity
    21.5       (.7 )     25.0       6.5       27.3       7.9  
Total underwriting operations
    13,877.4       1,025.1       14,117.9       1,878.3       13,764.4       1,639.2  
Service businesses
    22.3       1.8       30.4       6.0       40.2       15.6  
Investments2
    787.1       774.7       638.1       626.2       498.8       486.7  
Interest expense
          (108.6 )           (77.3 )           (82.6 )
Consolidated total
  $ 14,686.8     $ 1,693.0     $ 14,786.4     $ 2,433.2     $ 14,303.4     $ 2,058.9  
   
 
1 Private passenger automobile insurance accounted for 91% of the total Personal Lines segment net premiums earned in both 2007 and 2006, and 92% in 2005; our special lines products accounted for the balance of the Personal Lines net premiums earned.
 
2 Revenues represent recurring investment income and net realized gains (losses) on securities; pretax profit is net of investment expenses.
 
Progressive’s management uses underwriting margin and combined ratio as primary measures of underwriting profitability. The underwriting margin is the pretax underwriting profit (loss) expressed as a percentage of net premiums earned (i.e., revenues). Combined ratio is the complement of the underwriting margin. Following are the underwriting margins/combined ratios for our underwriting operations for the years ended December 31:
 
                                                 
    2007     2006     2005  
    Underwriting
    Combined
    Underwriting
    Combined
    Underwriting
    Combined
 
    Margin     Ratio     Margin     Ratio     Margin     Ratio  
 
 
Personal Lines
                                               
Agency
    6.5 %     93.5       11.9 %     88.1       10.7 %     89.3  
Direct
    7.8       92.2       13.1       86.9       11.7       88.3  
Total Personal Lines
    7.0       93.0       12.3       87.7       11.0       89.0  
Commercial Auto
    10.1       89.9       19.8       80.2       17.9       82.1  
Other indemnity1
    NM       NM       NM       NM       NM       NM  
Total underwriting operations
    7.4       92.6       13.3       86.7       11.9       88.1  
 
1 Underwriting margins/combined ratios are not meaningful (NM) for our other indemnity businesses due to the low level of premiums earned by, and the variability of losses in, such businesses.


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10.  OTHER COMPREHENSIVE INCOME
 
The components of other comprehensive income for the years ended December 31 were as follows:
 
                                                                         
    2007     2006     2005  
          Tax
                Tax
                Tax
       
          (Provision)
    After
          (Provision)
    After
          (Provision)
    After
 
(millions)   Pretax     Benefit     Tax     Pretax     Benefit     Tax     Pretax     Benefit     Tax  
 
 
Unrealized gains (losses) arising during period:
                                                                       
Fixed maturities
  $ 52.1     $ (18.2 )   $ 33.9     $ 10.7     $ (3.7 )   $ 7.0     $ (138.7 )   $ 48.6     $ (90.1 )
Equity securities
    (189.2 )     66.2       (123.0 )     292.3       (102.3 )     190.0       135.8       (47.5 )     88.3  
Reclassification adjustment:1
                                                                       
Fixed maturities
    (2.3 )     .8       (1.5 )     27.5       (9.7 )     17.8       (12.0 )     4.2       (7.8 )
Equity securities
    (63.4 )     22.2       (41.2 )     (12.4 )     4.3       (8.1 )     (54.4 )     19.0       (35.4 )
Change in unrealized gains
    (202.8 )     71.0       (131.8 )     318.1       (111.4 )     206.7       (69.3 )     24.3       (45.0 )
Net unrealized gains on forecasted transactions2
    31.2       (10.9 )     20.3       (1.8 )     .7       (1.1 )     (1.7 )     .6       (1.1 )
Other comprehensive income
  $ (171.6 )   $ 60.1     $ (111.5 )   $ 316.3     $ (110.7 )   $ 205.6     $ (71.0 )   $ 24.9     $ (46.1 )
   
 
1 Represents adjustments for gains (losses) realized in net income for securities held in the portfolio at December 31 of the preceding year.
 
2 Entered into for the purpose of managing interest rate risk associated with our debt issuances. See Note 4 — Debt for further discussion. We expect to reclassify $4.6 million into income within the next 12 months.
 
11.  LITIGATION
 
The Progressive Corporation and/or its insurance subsidiaries are named as a defendant in various lawsuits arising out of claims made under insurance policies in the ordinary course of our business. All legal actions relating to such insurance claims are considered by us in establishing our loss and loss adjustment expense reserves.
 
In addition, The Progressive Corporation and/or its insurance subsidiaries are named as a defendant in a number of class action or individual lawsuits arising out of the operation of the insurance subsidiaries. Other insurance companies face many of these same issues. The lawsuits discussed below are in various stages of development. We plan to contest these suits vigorously, but may pursue settlement negotiations in some cases, if appropriate. The outcomes of these cases are uncertain at this time.
 
In accordance with GAAP, we are only permitted to establish loss reserves for a lawsuit when it is probable that a loss has been incurred and we can reasonably estimate its potential exposure (referred to as a loss that is both “probable and estimable” in the discussion below). Certain of the cases for which we have established reserves under this standard are mentioned in the discussion below. Based on currently available information, we believe that our reserves for these lawsuits are reasonable and that the amounts reserved did not have a material effect on our consolidated financial condition or results of operations. However, if any one or more of these cases results in a judgment against, or settlement by, our insurance subsidiaries for an amount that is significantly greater than the amount so reserved, the resulting liability could have a material effect on our consolidated financial condition, cash flows and results of operations.
 
As to lawsuits that do not satisfy both parts of this GAAP standard (i.e., the loss is not both probable and estimable), we have not established reserves at this time. In the event that any one or more of these cases results in a substantial judgment against, or settlement by, Progressive, the resulting liability could also have a material effect on our consolidated financial condition, cash flows and results of operations.
 
Following is a discussion of potentially significant pending cases at December 31, 2007 and certain cases resolved during 2007, 2006 and 2005.
 
There are three putative class action lawsuits and one certified class action lawsuit challenging our insurance subsidiaries’ use of certain automated database vendors or software to assist in the adjustment of bodily injury claims. A fifth putative class action lawsuit was voluntarily dismissed by the plaintiff in 2007. In each of these lawsuits, the plaintiffs allege that these databases or software systematically undervalue the claims. With respect to the three pending putative class action lawsuits, we do not consider a loss from these cases to be probable and estimable, and are unable to estimate a range of loss, if any, at this time. With respect to the one certified class action lawsuit, we engaged in extensive settlement negotiations and reached a settlement on a nationwide basis, and a reserve was established accordingly. The settlement


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received preliminary approval from the court in November 2007, at which time the court certified the class action for settlement purposes only. No payments have been made yet under the settlement. The amount of the settlement is not material to our consolidated financial condition, cash flows or results of operations.
 
There are eight class action lawsuits challenging certain aspects of our insurance subsidiaries use of credit information and compliance with notice requirements under the federal Fair Credit Reporting Act. During 2004, we entered into a settlement agreement to resolve these cases, had received preliminary court approval of the settlement and had established a reserve accordingly. In 2005, the court denied final approval of the proposed settlement. In 2006, an amended settlement received trial court approval, and the loss reserve was adjusted accordingly. The adjustment was not material to our financial condition, cash flows and results of operations in 2006. Individuals who objected to trial court approval of the settlement have appealed the approval, and that appeal is currently pending. There also are six individual actions against our insurance subsidiaries that challenge our use of credit information. The six individual actions are stayed pending the outcome of the class actions. We do not consider a loss from these cases to be probable and estimable, and are unable to estimate a range of loss, if any, at this time.
 
There is one putative class action lawsuit challenging the installment fee program used by our insurance subsidiaries. We have successfully defended similar cases in the past, including one case that was dismissed in 2007 and another that was dismissed in 2005. We do not consider a loss from the currently pending case to be probable and estimable, and are unable to estimate a range of loss, if any, at this time.
 
There is one putative class action lawsuit challenging our insurance subsidiaries’ practice of specifying aftermarket (non-original equipment manufacturer) replacement parts in the repair of insured or claimant vehicles. Plaintiffs in such cases generally allege that aftermarket parts are inferior to replacement parts manufactured by the vehicle’s original manufacturer and that the use of such parts fails to restore the damaged vehicle to its “pre-loss” condition, as required by their insurance policies. We do not consider a loss from this case to be probable and estimable, and are unable to estimate a range of loss, if any, at this time.
 
There is one certified class action lawsuit and one putative class action lawsuit alleging that the insurance subsidiaries’ rating practices at renewal are improper. We prevailed in a similar putative class action in December 2004. With respect to the putative class action lawsuit, we do not consider a loss to be probable and estimable, and are unable to estimate a range of loss, if any, at this time. With respect to the certified class action lawsuit, we engaged in extensive settlement negotiations and reached a settlement on a statewide basis. The settlement received trial court approval in December 2007 but will not be paid until 2008. The amount of the settlement, which has been reserved, is not material to our consolidated financial condition, cash flows and results of operations.
 
There are three certified class action lawsuits and three putative class action lawsuits pending against our insurance subsidiaries, alleging that we failed to adjust MRI bills to a consumer price index in violation of a statute. With respect to the three certified class action lawsuits, we engaged in extensive settlement negotiations and reached a settlement on a statewide basis. The settlement received trial court approval in May 2007 and was paid during 2007. The amount of the settlement was not material to our consolidated financial condition, cash flows and results of operations. With respect to the three putative class action lawsuits, we do not consider a loss from these cases to be probable and estimable, and we are unable to estimate a range of loss, if any, at this time.
 
Progressive’s insurance subsidiaries are defending a putative class action claim alleging that we violate the “make-whole” and “common-fund” doctrines. Specifically, it is alleged that we may obtain reimbursement of medical payments made on behalf of an insured only when the insured has been made whole by a third-party tortfeasor and that we further must deduct from the reimbursement amount a proportionate share of the insured’s legal fees for pursuing the third-party tortfeasor. We do not consider a loss from this case to be probable and estimable, and are unable to estimate a range of loss, if any, at this time.
 
There is one certified nationwide class action lawsuit challenging our insurance subsidiaries’ practice of taking betterment on boat repairs. While we consider a loss from this case to be probable, it is not currently estimable. As a result, we are unable to estimate a range of loss, if any, at this time.
 
There is one putative class action lawsuit, brought on behalf of insureds, challenging the labor rates our insurance subsidiaries pay to auto body repair shops. We do not consider a loss from this case to be probable and estimable, and are unable to estimate a range of loss, if any, at this time.
 
There are four putative class action lawsuits challenging Progressive’s insurance subsidiaries’ practice in Florida of paying personal injury protection (“PIP”) and first-party medical payments at 200% of the amount allowed by Medicare. We do not consider a loss from this case to be probable and estimable, and are unable to estimate a range of loss, if any, at this time.


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There is one putative class action lawsuit alleging that Progressive’s insurance subsidiaries used non-conforming underinsured motorist rejection forms. We have engaged in extensive settlement negotiations and reached a settlement on a statewide basis. The settlement has not yet been presented to the court for approval; however, a loss reserve has been established in connection with the settlement. The amount of the loss reserve is not material to our consolidated financial condition, cash flows and results of operations.
 
In July 2005, we settled a state class action lawsuit alleging that Progressive’s insurance subsidiaries used non-conforming uninsured/underinsured (UM/UIM) motorist rejection forms. The settlement received trial court approval in October 2005, and was paid during 2006. The amount of the settlement was not material to our consolidated financial condition, cash flows and results of operations.
 
There is one certified class action lawsuit seeking refunds of all UIM premiums and certain UM premiums on grounds that the coverages were illusory. We have engaged in extensive settlement negotiations and reached a settlement on a statewide basis. The settlement received preliminary approval from the court in December 2007. No payments have been made yet under the settlement. The amount of the settlement, which has been reserved, is not material to our consolidated financial condition, cash flows and results of operations.
 
There is one certified class action lawsuit alleging that Progressive’s insurance subsidiaries failed to offer certain enhanced PIP benefits. We do not consider a loss from this case to be probable and estimable, and are unable to estimate a range of loss, if any, at this time.
 
There is one certified class action lawsuit seeking interest on PIP payments that allegedly were late. We understand that there are a number of similar class actions against others in the insurance industry. We do not consider a loss from this case to be probable and estimable, and are unable to estimate a range of loss, if any, at this time.
 
In 2006, we settled two state class action lawsuits pending against Progressive’s insurance subsidiaries in Florida, challenging the legality of our payment of preferred provider rates on PIP claims. The settlement received trial court approval in August 2006 and was paid in 2006. The amount of the settlement was not material to our consolidated financial condition, cash flows and results of operations.
 
In 2006, we settled a nationwide class action lawsuit challenging our insurance subsidiaries’ use of certain automated database vendors to assist in the evaluation of total loss claims. The settlement received trial court approval and was paid during 2006. The amount of the settlement was not material to our consolidated financial condition, cash flows and results of operations.
 
Progressive’s subsidiaries are also named as a defendant in individual lawsuits related to employment issues. The outcomes of these cases are uncertain, but we do not believe that they will have a material impact on our financial condition, cash flows and results of operations.
 
12.  COMMITMENTS AND CONTINGENCIES
 
We have certain noncancelable operating lease commitments with lease terms greater than one year for property and computer equipment. The minimum commitments under these agreements at December 31, 2007, were as follows:
 
(millions)
 
         
Year   Commitment  
 
 
2008
  $ 94.3  
2009
    69.0  
2010
    46.9  
2011
    25.2  
2012
    15.6  
Thereafter
    25.3  
Total
  $ 276.3  
     
 


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Some of the leases have options to renew at the end of the lease periods. The expense we incurred for the leases disclosed above, as well as other operating leases that may be cancelable or have terms less than one year, was:
 
(millions)
 
         
Year   Expense  
 
 
2007
  $ 139.5  
2006
    138.8  
2005
    126.4  
 
As of December 31, 2007, we had open investment funding commitments of $.2 million; we had no uncollateralized lines or letters of credit as of December 31, 2007 or 2006.
 
13.  FAIR VALUE OF FINANCIAL INSTRUMENTS
 
Information about specific valuation techniques and related fair value detail is provided in Note 1 — Reporting and Accounting Policies, Note 2 — Investments and Note 4 — Debt. The cost and fair value of the financial instruments as of December 31 are summarized as follows:
 
                                 
    2007     2006  
          Fair
          Fair
 
(millions)   Cost     Value     Cost     Value  
 
 
Investments — Available-for-sale:
                               
Fixed maturities
  $ 9,135.6     $ 9,184.9     $ 9,959.6     $ 9,958.9  
Preferred stocks
    2,578.1       2,270.3       1,761.4       1,781.0  
Common equities
    1,361.0       2,327.5       1,469.0       2,368.1  
Short-term investments
    382.4       382.4       581.0       581.2  
Debt
    (2,173.9 )     (2,176.6 )     (1,185.5 )     (1,267.8 )
 
The value of our investment portfolio, excluding short-term investments, is obtained through market level sources for 99.8% of the securities. Pursuant to SFAS 157, “Fair Value Measurements,” approximately 98% of these securities would be classified as either Level 1 or Level 2 hierarchy. This statement is effective for fiscal years beginning after November 15, 2007 (January 1, 2008 for calendar-year companies) and will not have a significant effect on our financial condition, cash flows or results of operations. In addition, SFAS 157 will not require any significant changes in our disclosure of fair value for our investment portfolio.


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Management’s Report on Internal Control over Financial Reporting
 
Progressive’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. Our internal control structure was designed under the supervision of our Chief Executive Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.
 
Our internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect our transactions and dispositions of assets; provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and our directors; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements.
 
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our evaluation under the framework in Internal Control - Integrated Framework, management concluded that our internal control over financial reporting was effective as of December 31, 2007.
 
There was, however, a material weakness identified during July 2007, whereby effective controls were not maintained to ensure that dividends were accurately accrued on the declaration date in accordance with GAAP. New controls were promptly implemented in response to this issue. Management concluded that the issue was remediated prior to the filing of our Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2007.
 
During the fourth quarter 2007, there were no changes in our internal control over financial reporting identified in the internal control review process that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
The effectiveness of our internal control over financial reporting as of December 31, 2007, has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.
 
CEO and CFO Certifications
 
Glenn M. Renwick, President and Chief Executive Officer of The Progressive Corporation, and Brian C. Domeck, Vice President and Chief Financial Officer of The Progressive Corporation, have issued the certifications required by Sections 302 and 906 of The Sarbanes-Oxley Act of 2002 and applicable SEC regulations with respect to Progressive’s 2007 Annual Report on Form 10-K, including the financial statements provided in this Report. Among other matters required to be included in those certifications, Mr. Renwick and Mr. Domeck have each certified that, to the best of his knowledge, the financial statements, and other financial information included in the Annual Report on Form 10-K, fairly present in all material respects the financial condition, results of operations and cash flows of Progressive as of, and for, the periods presented. See Exhibits 31 and 32 to Progressive’s Annual Report on Form 10-K for the complete Section 302 and 906 certifications, respectively.
 
In addition, Mr. Renwick submitted his annual certification to the New York Stock Exchange (NYSE) on May 18, 2007, stating that he was not aware of any violation by Progressive of the NYSE corporate governance listing standards, as required by Section 303A.12(a) of the NYSE Listed Company Manual.


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Report of Independent Registered Public Accounting Firm
 
 
To the Board of Directors and Shareholders
of The Progressive Corporation:
 
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, changes in shareholders’ equity and cash flows present fairly, in all material respects, the financial position of The Progressive Corporation and its subsidiaries at December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included 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. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
 
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
 
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
 

Cleveland, Ohio
February 27, 2008


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The Progressive Corporation and Subsidiaries
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The consolidated financial statements and the related notes, together with the supplemental information, should be read in conjunction with the following discussion and analysis of the consolidated financial condition and results of operations.
 
I.  OVERVIEW
The Progressive Corporation is a holding company that does not have any revenue producing operations, physical property or employees of its own. The Progressive Group of Insurance Companies, together with our non-insurance subsidiaries, comprise what we refer to as Progressive. Progressive has been in business since 1937 and is estimated to be in a virtual tie as the country’s third largest private passenger auto insurer based on premiums written during 2007. Through our insurance companies, we offer personal automobile insurance and other specialty property-casualty insurance and related services throughout the United States. Our Personal Lines segment writes insurance for private passenger automobiles and recreational vehicles through more than 30,000 independent insurance agencies and directly to consumers online and over the phone. Our Commercial Auto segment, which writes through both the independent agency and direct channels, offers insurance for cars and trucks (e.g., pick-up or panel trucks) owned by small businesses and is estimated to rank third in its industry. These underwriting operations, combined with our service and investment operations, make up the consolidated group.
 
The Progressive Corporation receives cash through subsidiary dividends, borrowings, security sales and other transactions, and uses these funds to contribute to its subsidiaries (e.g., to support growth), to make payments to shareholders and debt holders (e.g., dividends and interest, respectively), to repurchase its common shares and for other business purposes that might arise. In 2007, the holding company received $1.5 billion of dividends from its subsidiaries, net of capital contributions, and $1 billion from the issuance of subordinated debentures (see Note 4 — Debt to the consolidated financial statements, and the Capital Resources and Liquidity section below for additional details). During the year, we paid a $1.4 billion special dividend to shareholders and used $1.5 billion to repurchase 72.9 million Progressive common shares, at an average cost of $21.24 per share. The debt issuance, special dividend and share repurchases were part of a plan to restructure our capital position during the year. In addition, we paid $110.1 million in interest on our outstanding debt in 2007. No debt matured during the year. The holding company also has access to funds held in a non-insurance subsidiary; at year-end 2007, $2.1 billion of marketable securities were available in this company. On a consolidated basis, we generated positive operating cash flows of $1.8 billion in 2007.
 
In 2007, our insurance subsidiaries generated underwriting profitability of 7.4%. On a consolidated basis, net income was nearly $1.2 billion, or $1.65 per share. Companywide policies in force, our preferred measure of growth, increased 4%, while net premiums written and earned decreased 3% and 2%, respectively. Even though profitability exceeded our target of a 4% underwriting margin, both profitability and premium growth were down from last year, primarily reflecting the pricing strategies we started in mid-2006, when we began reducing prices in an effort to spur growth. Our transition from the wide margins we generated in prior years to our current results did not produce the aggregate revenue growth in 2007 that we had hoped for.
 
Market conditions in 2007, defined by relative rate stability or reduction, continue to influence our aggregate net premium growth measure, which was down in Agency auto and Commercial Auto, flat in Direct auto and up in our special lines products (e.g., motorcycles, watercraft and RVs), compared to the prior year. Changes in net premiums written are a function of new business applications (i.e., issued policies), premium per policy and retention.
 
During 2007, we saw an increase in both our new and renewal applications in our Personal Lines Business, primarily driven by Direct auto, as well as in our Commercial Auto Business. We continue to evaluate new business application growth on a state-by-state basis. For 2007, 31 of our states experienced growth in new personal auto applications, with two of our largest volume states, Florida and Texas, returning to positive growth in new applications during the second half of the year. We partially restricted our Agency auto new business in New York and California until we return to an acceptable level of profitability in the affected areas.
 
Because we believe that the loss trends of recent years, driven largely by reduced frequency, were more systemic than cyclical, since mid-2006 we have been adjusting our pricing to reflect our consistently stated goal of growing as fast as possible at a 96 combined ratio. Our auto products, both personal and commercial, are priced at lower average written premium per policy than at this time a year ago. Total personal auto average written premium per policy decreased about 5% during 2007 and Commercial Auto decreased about 6% for the same period. Earned premium per earned car year, another measure of rate change, lags the written premium measure. For 2007, as compared to 2006, earned premium per earned car year decreased about 4% in both our personal and commercial auto products. Although adjusting rates is a continuous process, we believe that we are closer to our targeted margins in most states and products and have now almost fully adjusted pricing to reflect the favorable accident frequency of the past several years.


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In light of the soft market conditions, we have focused our attention on unit growth. The rating changes implemented over the last year and a half have been an explicit trade-off of margin for longer-term customer growth. Companywide policies in force have increased 4% on a year-over-year basis since December 31, 2006. Policies in force are 1% lower than at year-end 2006 in Agency auto, while Direct auto and Commercial Auto are each up 7% and special lines is up 8%. To continue to grow policies in force, it is critical that we retain our customers for longer periods, which is why retention continues to be one of our most significant initiatives. During 2007, we believe we made strides in addressing issues that will support our efforts to meet the long-term rate expectations of our customers. As a result, internal retention measures, defined as policy life expectancy, increased in every tier for our private passenger auto business, and increased in most tiers in our Commercial Auto business, compared to year-end 2006.
 
The 7.4% companywide underwriting profit margin for 2007 indicates the closure of the gap between our reaffirmed target of a 4% underwriting margin and the double-digit margins we experienced over the last several years. Reflected in our 2007 results are .6 points of unfavorable prior accident year development, primarily driven by our field claims representatives’ evaluation of larger individual bodily injury, as well as uninsured motorist, case reserves. During 2007, we experienced flattening auto frequency trends, while severity increased, reflecting increases in bodily injury and personal injury protection severity.
 
We announced organizational changes in 2007 designed to increase our ability to execute on key strategies, lower our non-claims expense ratio and foster growth through more competitive pricing, improved customer retention and an increased focus on brand development. These changes brought our Agency and Direct auto, as well as our special lines products, together under one Personal Lines organization. We will continue to price products based, in part, on how they are distributed to reflect the applicable channel cost. We believe this structure will reduce the cost of redundancy that had developed in areas such as product design, management and policy servicing, as well as improve our ability to execute on our most significant challenges. By the end of the year, we had largely merged our Agency and Direct product and information technology organizations. In conjunction with the reorganization, we reviewed our current segment reporting and determined that it was not impacted by this organizational change.
 
Within our investment portfolio, we maintained our asset allocation strategy of investing between 75-100% of our total portfolio in fixed-income securities and 0-25% in common equities. At the end of 2007, our portfolio was allocated 83% to fixed-income securities and 17% to common equities.
 
Our investment portfolio produced a fully taxable equivalent (FTE) total return of 4.7% for 2007. Both asset classes contributed positively to the overall result, with FTE total returns of 6.2% and 4.4% in the common stock and fixed-income portfolios, respectively. We continue to maintain our fixed-income portfolio strategy of investing in high-quality, shorter-duration securities in the current investment environment. Our common equity investment strategy remains an index replication approach using the Russell 1000 Index as the benchmark. We increased the duration of our fixed-income portfolio modestly during the year to end 2007 at 3.5 years, compared to 3.1 years at the end of 2006. The weighted average credit rating of our fixed-income portfolio ranged from AA+ early in 2007 to AA later in the year. Our portfolio decreased to $14.2 billion from $14.7 billion last year. Strong cash flows from operations and proceeds from the issuance of $1 billion of subordinated debentures were offset by a return of capital to shareholders in the form of $1.5 billion in share repurchase activity and the payment of a $1.4 billion special dividend to shareholders.
 
During the year, financial markets suffered significant turbulence, triggered by a sharp weakening of the housing market. Credit spreads on risk assets across substantially all asset classes increased sharply, with even some AAA rated securities, previously considered to be highly unlikely to suffer a capital loss, plummeting in value. Financial institutions bore the brunt of the losses and many were forced to raise new capital. The Federal Open Market Committee lowered the overnight Federal Funds rate by 1.00% to 4.25% during the second half of the year. Yields on longer maturity U.S. Treasury bonds decreased by less than the Federal Funds rate decreased. At year-end 2007, two-year notes and ten-year notes were yielding 3.06% and 4.03%, respectively, compared to 4.84% and 4.71% at the end of 2006. The economy expanded briskly at the start of 2007, but slowed during the fourth quarter as the impact of the housing and financial market deterioration rippled through to the larger economy.
 
In light of these market conditions, during 2007, we performed a detailed review of our asset-backed securities to identify the extent to which our asset values may have been impacted by direct exposure to the sub-prime mortgage loan disruption, as well as broader credit market events. At year-end 2007, we held approximately $148.7 million of sub-prime mortgage bonds, classified as home equity bonds. In addition, we held $52.3 million of non-prime collateralized mortgage obligations (Alt-A securities). Together, these securities had unrealized losses of $12.3 million for 2007. During 2007, we realized $1.7 million of losses related to other-than-temporarily impaired sub-prime securities. In addition, we had a credit default swap derivative on an investment-grade asset-backed index, comprised of 20 bonds in the sub-prime mortgage sector, with a notional amount of $140 million. In conjunction with this derivative, we received $43.3 million of upfront


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cash, which effectively reduced our maximum economic exposure on this position to $96.7 million at December 31, 2007. For 2007, this derivative position generated a loss of $51.3 million.
 
In addition, we considered the indirect effects the sub-prime market issues had on our redeemable and nonredeemable preferred stocks. Roughly two-thirds of our preferred stock holdings are obligations of financial sector issuers. During the year, preferred stocks generated gross unrealized losses of $338.1 million, of which $271.2 million occurred in the fourth quarter. Based on a review of these securities, we determined that none of them were deemed to have any fundamental issues which would lead us to believe that any were other-than-temporarily impaired. This determination was based on several factors, including: the relatively short duration that these securities have been in a significant loss position; the continuance by the issuers to pay periodic dividends; the raising of additional capital by the issuers; and, our intent and ability to hold these securities.
 
II.  FINANCIAL CONDITION
A.  Holding Company
In 2007, The Progressive Corporation, the holding company, received $1.5 billion of dividends from its subsidiaries, net of capital contributions made to subsidiaries. For the three-year period ended December 31, 2007, The Progressive Corporation received $4.4 billion of dividends from its subsidiaries, net of capital contributions. Regulatory restrictions on subsidiary dividends are described in Note 7 — Statutory Financial Information.
 
In June 2007, we announced a plan to restructure our capital position, which included issuing debt securities and returning capital to shareholders through share repurchases and a special dividend (see the Capital Resources and Liquidity section below for details).
 
As part of the capital restructuring plan in 2007, The Progressive Corporation issued $1 billion of 6.70% Fixed-to-Floating Rate Junior Subordinated Debentures due 2067. In 2006, no debt or equity instruments were issued; however, we retired $100 million principal amount of our 7.30% Notes on their maturity date. See Note 4 — Debt for further discussion of our current outstanding debt. Progressive’s debt-to-total capital (debt plus equity) ratios at December 31, 2007 and 2006 were 30.6% and 14.8%, respectively. The increase primarily reflects the new debt issuance and the nearly $3 billion that was returned to shareholders during the year as part of the recapitalization plan.
 
During 2007, we repurchased 72,886,215 of our common shares pursuant to the recapitalization plan. The total cost to repurchase these shares was $1.5 billion, with an average cost of $21.24 per share. During the three-year period ended December 31, 2007, we repurchased 117,153,644 of our common shares at a total cost of $3.2 billion (average cost of $22.81 per share, on a split-adjusted basis).
 
Lastly, as part of the recapitalization plan during 2007, we returned $1.4 billion to shareholders via an extraordinary cash dividend of $2.00 per share. During the last three years, total cash dividends paid, including the extraordinary dividend, were $1.5 billion.
 
Beginning in 2007, we are no longer paying a quarterly dividend on our outstanding common shares. In February 2006, the Board of Directors approved a plan to replace our previous quarterly dividend policy with an annual variable dividend, using a target percentage of after-tax underwriting income multiplied by a companywide performance factor, referred to as the “Gainshare factor.” The target percentage is determined by our Board of Directors on an annual basis and announced to shareholders and the public. For 2007 and 2008, the Board determined the target percentage to be 20% of annual after-tax underwriting income.
 
The Gainshare factor can range from 0 to 2 and is determined by comparing our operating performance for the year to certain predetermined profitability and growth objectives approved by the Board. This dividend program is consistent with the variable cash incentive program currently in place for our employees (referred to as our “Gainsharing Program”). Although recalibrated every year, the structure of the Gainsharing Program generally remains the same. For 2007, the Gainshare factor was .74.
 
Based on after-tax underwriting income of $666.3 million, a 20% target percentage and the Gainshare factor of .74, in December 2007, the Board declared a dividend of $.1450 per share, which was paid on January 31, 2008. In comparison, our full year 2006 and 2005 shareholder dividends were $.0325 per share and $.03 per share, respectively.
 
B.  Capital Resources and Liquidity
Progressive has substantial capital resources and we are unaware of any trends, events or circumstances not disclosed herein that are reasonably likely to affect our capital resources in a material way.


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In an effort to restructure our capital position, in June 2007, we announced a recapitalization plan, which included the following components:
 
  •   The payment of an extraordinary cash dividend of $2.00 per common share. This extraordinary cash dividend, which aggregated to $1.4 billion, was declared by the Board on June 13, 2007, and was paid on September 14, 2007, to shareholders of record at the close of business on August 31, 2007.
 
  •   A new Board authorization for us to repurchase up to 100 million of our common shares over the course of the next 24 months, expiring June 30, 2009. This authorization was in addition to the approximately 4 million shares that remained available for repurchase at the end of the second quarter 2007 under the Board’s April 2006 share repurchase authorization.
 
  •   The issuance of $1 billion of 6.70% Fixed-to-Floating Rate Junior Subordinated Debentures due 2067 (the “Debentures”) on June 18, 2007. The proceeds of the offering were $987.3 million, before $1.5 million of expenses related to the issuance. In addition, upon issuance of the Debentures, we closed a forecasted debt issuance hedge, which was entered into to hedge against a possible rise in interest rates, and recognized a $34.4 million pretax gain as part of shareholders’ equity; this gain is being recognized as an adjustment to interest expense and amortized over 10 years, which represents the fixed interest rate period of the Debentures. See Note 4 — Debt for further discussion of the terms of the Debentures.
 
In connection with the issuance of the Debentures, we also entered into a Replacement Capital Covenant for the benefit of the holders of our 6.25% Senior Notes due 2032 (the “Covered Debt”). Under the Replacement Capital Covenant, we may not repay, redeem or repurchase any of the Debentures prior to June 15, 2047 (or, if earlier, prior to the occurrence of certain events specified in the Replacement Capital Covenant), except to the extent that (subject to certain limitations) the amount to be repaid, redeemed or purchased does not exceed a specified percentage of net cash proceeds from the sale to third parties of certain replacement capital securities (as defined in the Replacement Capital Covenant) plus the proceeds from the sale or issuance of common shares or certain qualifying warrants. The identity of the Covered Debt may be changed from time to time by the company upon the occurrence of certain events specified in, and in accordance with the requirements of, the provisions of the Replacement Capital Covenant. See our Current Report on Form 8-K, filed on June 22, 2007, for additional information and a copy of the Replacement Capital Covenant.
 
Progressive maintains an uncommitted line of credit with National City Bank in the principal amount of $125 million as part of a contingency plan to help maintain liquidity in the unlikely event that we experience conditions or circumstances that affect our ability to transfer or receive funds. We have not borrowed under this arrangement to date.
 
At December 31, 2007, our debt-to-total capital ratio was 30.6%, which is slightly over Progressive’s financial policy to maintain this ratio below 30%. We expect this ratio to fluctuate somewhat as our capital changes, but our policy continues to remain our benchmark. Our existing debt covenants do not include any rating or credit triggers.
 
Progressive’s insurance operations create liquidity by collecting and investing premiums from new and renewal business in advance of paying claims. As an auto insurer, our claims liabilities, by their very nature, are generally short in duration. Approximately 50% of our outstanding reserves are paid within one year and less than 15% are still outstanding after three years. See Claims Payment Patterns, a supplemental disclosure provided in this Annual Report, for further discussion on the timing of claims payments. For the three years ended December 31, 2007, operations generated positive cash flows of $5.8 billion, and cash flows are expected to remain positive in both the short-term and reasonably foreseeable future. In addition, our investment portfolio is highly liquid and consists substantially of readily marketable, investment-grade securities. As of December 31, 2007, 83% of our portfolio was invested in fixed-income securities with a weighted average credit quality of AA and duration of 3.5 years. We believe that we have sufficient readily marketable securities to cover our claims payments without having a negative effect on our cash flows from operations.
 
Progressive seeks to deploy capital in a prudent manner and uses multiple data sources and modeling tools to estimate the frequency, severity and correlation of identified exposures, including, but not limited to, catastrophic losses and the business interruptions discussed below, to estimate our potential capital needs. Based on this analysis, as well as the information reported above, we believe that we have sufficient capital resources, cash flows from operations and borrowing capacity to support our current and anticipated growth, scheduled principal and interest payments on our debt, expected dividends and other capital requirements.
 
C.  Commitments and Contingencies
We completed construction of four new claims service centers in 2007, 29 in 2006 and six in 2005 (discussed below). During 2006, we also constructed a data center, printing center and related facilities in Colorado Springs, Colorado, at a total cost of $64.2 million, and acquired additional land for future development to support corporate operations in


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Colorado Springs, Colorado and Mayfield Village, Ohio, near our current corporate facilities, at a total cost of $16.2 million. In 2005, we completed the conversion of a building in Austin, Texas, into a call center at a total acquisition and development cost of $40.6 million. In 2009, we expect to begin a multi-year project to construct up to three buildings and three parking garages, together with associated facilities, in Mayfield Village at a currently estimated total construction cost of $200 million. All such construction projects have been, and will continue to be, funded through operating cash flows.
 
As of December 31, 2007, we have a total of 54 centers that are available to provide concierge level claims service, compared to 53 in 2006 and 26 in 2005. Three of the four centers opened during 2007, and two of the centers built in 2006, replaced previously leased service center locations. The service centers are located in 41 metropolitan areas across the United States and serve as our primary approach to damage assessment and coordination of vehicle repairs at authorized auto repair facilities in these markets. Over the next two years, we expect to complete construction of five new service centers, three of which will replace existing leased facilities. The cost of these facilities, excluding land, is estimated to average $4 to $7 million per center, depending on a number of variables, including the size and location of the center.
 
We maintain insurance on our real property and other physical assets, including coverage for losses due to business interruptions caused by covered property damage. However, the insurance will not compensate us for losses that may occur due to disruptions in service as a result of a computer, data processing or telecommunications systems failure that is unrelated to covered property damage, nor will the insurance necessarily compensate us for all losses resulting from covered events. To help maintain functionality and reduce the risk of significant interruptions of our operations, we maintain back-up systems or facilities for certain of our principal systems and services. We still may be exposed, however, should these measures prove to be unsuccessful or inadequate against severe, multiple or prolonged service interruptions or against interruptions of systems where no back-up currently exists. In addition, we have established emergency management teams, which are responsible for responding to business disruptions and other risk events. The teams’ ability to respond successfully may be limited depending on the nature of the event, the completeness and effectiveness of our plans to maintain business continuity upon the occurrence of such an event, and other factors beyond our control.
 
Off-Balance-Sheet Arrangements
Our off-balance-sheet leverage includes derivative positions and open investment funding commitments (as disclosed in Note 2 — Investments, Note 12 — Commitments and Contingencies and the Derivative Instruments section of this Management’s Discussion and Analysis). It also includes operating leases and purchase obligations (disclosed in the table below).
 
Contractual Obligations
A summary of our noncancelable contractual obligations as of December 31, 2007, follows:
 
                                         
    Payments due by period  
          Less than
    1-3
    3-5
    More than
 
(millions)   Total     1 Year     Years     Years     5 Years  
 
 
Debt
  $ 2,200.0     $     $     $ 350.0     $ 1,850.0  
Interest payments on debt
    1,852.2       144.7       289.4       278.2       1,139.9  
Operating leases
    276.3       94.3       115.9       40.8       25.3  
Purchase obligations
    94.5       65.7       28.7       .1        
Loss and loss adjustment expense reserves
    5,942.7       3,173.0       2,146.2       477.3       146.2  
Total
  $ 10,365.7     $ 3,477.7     $ 2,580.2     $ 1,146.4     $ 3,161.4  
   
 
Purchase obligations represent our noncancelable commitments for goods and services. Unlike many other forms of contractual obligations, loss and loss adjustment expense (LAE) reserves do not have definitive due dates and the ultimate payment dates are subject to a number of variables and uncertainties. As a result, the total loss and LAE reserve payments to be made by period, as shown above, are estimates based on our recent payment patterns. To further understand our claims payments, see Claims Payment Patterns, a supplemental disclosure provided in this Annual Report. In addition, we annually publish a comprehensive Report on Loss Reserving Practices, which was filed with the SEC on a Form 8-K on June 28, 2007, that further discusses our claims payment development patterns.


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In January 2008, we entered into a 16-year contract for the ballpark naming rights and a sponsorship deal with the Cleveland Indians Major League Baseball team. Over the contract term, Progressive will pay an average of approximately $3.6 million per year. This expenditure is a reallocation of a small percentage of our annual media spend and is intended to generate greater exposure for us by reaching an estimated 120 million baseball fans each year.
 
As discussed in the Capital Resources and Liquidity section above, we believe that we have sufficient borrowing capacity, cash flows and other capital resources to satisfy these contractual obligations.
 
III.  RESULTS OF OPERATIONS — UNDERWRITING
A.  Growth
 
                                 
(millions)   2007     2006     2005        
 
 
NET PREMIUMS WRITTEN
                               
Personal Lines
                               
Agency
  $ 7,549.4     $ 7,854.3     $ 8,005.6          
Direct
    4,371.8       4,354.5       4,177.3          
Total Personal Lines
    11,921.2       12,208.8       12,182.9          
Commercial Auto
    1,828.9       1,898.0       1,801.2          
Other indemnity
    22.4       25.2       23.5          
Total underwriting operations
  $ 13,772.5     $ 14,132.0     $ 14,007.6          
   
Growth over prior years
    (3 )%     1 %     5 %        
   
NET PREMIUMS EARNED
                               
Personal Lines
                               
Agency
  $ 7,636.4     $ 7,903.6     $ 7,993.1          
Direct
    4,372.6       4,337.4       4,076.2          
Total Personal Lines
    12,009.0       12,241.0       12,069.3          
Commercial Auto
    1,846.9       1,851.9       1,667.8          
Other indemnity
    21.5       25.0       27.3          
Total underwriting operations
  $ 13,877.4     $ 14,117.9     $ 13,764.4          
   
Growth over prior years
    (2 )%     3 %     5 %        
   
 
Net premiums written represent the premiums generated from policies written during the period less any premiums ceded to reinsurers. Net premiums earned, which are a function of the premiums written in the current and prior periods, are earned as revenue over the life of the policy using a daily earnings convention. Policies in force, our preferred measure of growth, represents all policies under which coverage is in effect as of the end of the period specified. As of December 31, our policies in force were:
 
                                 
(thousands)   2007     2006     2005        
 
 
POLICIES IN FORCE
                               
Personal Lines
                               
Agency auto
    4,396.8       4,433.1       4,491.4          
Direct auto
    2,598.5       2,428.5       2,327.7          
Total auto
    6,995.3       6,861.6       6,819.1          
Special lines1
    3,120.3       2,879.5       2,674.9          
Total Personal Lines
    10,115.6       9,741.1       9,494.0          
   
Growth over prior year
    4 %     3 %     9 %        
   
Commercial Auto
    539.2       503.2       468.2          
   
Growth over prior year
    7 %     7 %     11 %        
   
 
1Includes insurance for motorcycles, recreational vehicles, mobile homes, watercraft, snowmobiles and similar items, as well as a personal umbrella product.


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Progressive experienced a decline in total written and earned premiums during 2007, as compared to the positive growth rates achieved in 2006 and 2005, reflecting market conditions in which rates are stable or decreasing. Competitors’ actions, such as rate reductions, increased advertising, higher commission payments to agents and brokers and a relaxation of underwriting standards, continued to have a significant impact on the marketplace in 2007. We are continuing to focus on further developing the Progressive brand and will continue to work with our advertising agency to identify compelling ways to help consumers understand what sets Progressive apart.
 
To analyze growth, we review new policies, rate levels, and the retention characteristics of our books of business. During the last three years, we experienced the following growth in new and renewal applications:
 
                                                 
    Growth Over Prior Year  
    Personal Lines     Commercial Auto  
    2007     2006     2005     2007     2006     2005  
 
 
New applications
    2 %     (7 )%     %     3 %     1 %     3 %
Renewal applications
    3 %     7 %     11 %     5 %     4 %     8 %
 
We began reducing rates in mid-2006 and into 2007. These rate reductions, coupled with shifts in the mix of business, contributed to a 5% decrease in total auto written premium per policy in 2007, compared to declines of 2% in 2006 and 4% in 2005. Our current pricing levels are closely aligned with our profitability targets. As such, we expect that future rate actions will be driven by net loss and expense trend projections which, at this time, we view as slightly positive.
 
Another important element affecting growth is customer retention. One measure of retention is policy life expectancy, which is an estimate of the average length of time that a policy will remain in force before cancellation or non-renewal. By the end of 2007, we achieved policy life expectancy greater than the prior year in both our Agency and Direct auto businesses, but still had not returned to the levels we had at year-end 2005. Our policy life expectancies in our Commercial Auto Business remained relatively flat overall on a year-over-year basis, but were up slightly from year-end 2005. Realizing the importance that retention has on our ability to continue to grow profitably, we continue to place increased emphasis on competitive pricing and other retention initiatives for our current customers.
 
B.  Profitability
Profitability for our underwriting operations is defined by pretax underwriting profit, which is calculated as net premiums earned less losses and loss adjustment expenses, policy acquisition costs and other underwriting expenses. We also use underwriting profit margin, which is underwriting profit expressed as a percentage of net premiums earned, to analyze our results. For the three years ended December 31, our underwriting profitability was as follows:
 
                                                         
    2007     2006     2005        
    Underwriting Profit     Underwriting Profit     Underwriting Profit        
($ in millions)   $     Margin     $     Margin     $     Margin        
 
 
Personal Lines
Agency
  $ 500.2       6.5 %   $ 936.7       11.9 %   $ 857.6       10.7 %        
Direct
    339.9       7.8       568.6       13.1       475.7       11.7          
Total Personal Lines
    840.1       7.0       1,505.3       12.3       1,333.3       11.0          
Commercial Auto
    185.7       10.1       366.5       19.8       298.0       17.9          
Other indemnity1
    (.7 )     NM       6.5       NM       7.9       NM          
Total underwriting operations
  $ 1,025.1       7.4 %   $ 1,878.3       13.3 %   $ 1,639.2       11.9 %        
   
 
1 Underwriting margins for our other indemnity businesses are not meaningful (NM) due to the low level of premiums earned by, and the variability of losses in, such businesses.
 
The decrease in underwriting margins in 2007 primarily reflects the rate reductions we began in mid-2006. Underwriting margins for 2005 reflect the higher losses incurred as a result of the major hurricanes experienced during the latter part of 2005, which lowered the underwriting margin by 2.4 percentage points.


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Further underwriting results for our Personal Lines Business, including its channel components, the Commercial Auto Business and other indemnity businesses, as defined in Note 9 — Segment Information, were as follows:
 
                         
Underwriting Performance1   2007     2006     2005  
 
 
Personal Lines — Agency
                       
Loss & loss adjustment expense ratio
    72.1       67.8       69.1  
Underwriting expense ratio
    21.4       20.3       20.2  
Combined ratio
    93.5       88.1       89.3  
   
Personal Lines — Direct
                       
Loss & loss adjustment expense ratio
    71.3       66.8       68.4  
Underwriting expense ratio
    20.9       20.1       19.9  
Combined ratio
    92.2       86.9       88.3  
   
Total Personal Lines
                       
Loss & loss adjustment expense ratio
    71.8       67.4       68.9  
Underwriting expense ratio
    21.2       20.3       20.1  
Combined ratio
    93.0       87.7       89.0  
   
Commercial Auto
                       
Loss & loss adjustment expense ratio
    69.7       61.0       62.4  
Underwriting expense ratio
    20.2       19.2       19.7  
Combined ratio
    89.9       80.2       82.1  
   
Total Underwriting Operations2
                       
Loss & loss adjustment expense ratio
    71.5       66.5       68.0  
Underwriting expense ratio
    21.1       20.2       20.1  
Combined ratio
    92.6       86.7       88.1  
   
Accident year — Loss & loss adjustment expense ratio
    70.9       68.2       70.6  
   
 
1 Ratios are expressed as a percentage of net premiums earned.
 
2 Combined ratios for the other indemnity businesses are not presented separately due to the low level of premiums earned by, and the variability of losses in, such businesses. For the years ended December 31, 2007, 2006 and 2005, these businesses generated an underwriting profit (loss) of $(.7) million, $6.5 million and $7.9 million, respectively.
 
Losses and Loss Adjustment Expenses (LAE)
 
                         
(millions)   2007     2006     2005  
 
 
Change in net loss and LAE reserves
  $ 291.6     $ 50.5     $ 364.6  
Paid losses and LAE
    9,634.6       9,344.4       9,000.2  
Total incurred losses and LAE
  $ 9,926.2     $ 9,394.9     $ 9,364.8  
   
 
Claims costs, our most significant expense, represent payments made, and estimated future payments to be made, to or on behalf of our policyholders, including expenses needed to adjust or settle claims. These costs include an estimate for costs related to assignments, based on current business, under state-mandated automobile insurance programs. Claims costs are defined by loss severity and frequency and are influenced by inflation and driving patterns, among other factors. Accordingly, estimated changes in these factors are taken into account when we establish premium rates and loss reserves. Results would differ if different assumptions were made. See the Critical Accounting Policies for a discussion of the effect of changing estimates.
 
During 2007, our loss and LAE ratio increased 5.0 points, primarily reflecting increasing severity during the year, unfavorable prior accident year reserve development, compared to favorable development in 2006, as well as lower average earned premium due to recent rate reductions. Catastrophe losses from 2007 storms contributed .3 points to our loss ratio, compared to .5 points and 2.4 points from catastrophes in 2006 and 2005, respectively. The large amount of catastrophe losses in 2005 primarily related to Hurricanes Katrina and Wilma.


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Auto accident frequency for the trailing 12 months was slightly less than the prior year periods; however, the rate of change is less than that experienced in the prior two years. We cannot predict the degree or direction of frequency change that we will experience in the future. We continue to analyze trends to distinguish changes in our experience from external factors, such as changes in the number of vehicles per household and greater vehicle safety, versus those resulting from shifts in the mix of our business.
 
We experienced an increase in total auto paid severity of about 3.5% during 2007. The increase was primarily from our bodily injury and personal injury protection coverages, with a decrease in collision. During 2005 and 2006, Progressive’s severity increased modestly, after adjusting for the significant hurricanes in 2005.
 
The table below presents the actuarial adjustments implemented and the loss reserve development experienced in the years ended December 31:
 
                         
($ in millions)   2007     2006     2005  
 
 
Actuarial Adjustments
                       
Favorable/(Unfavorable)
                       
Prior accident years
  $ 37.3     $ 158.3     $ 127.2  
Current accident year
    (37.1)       57.8       78.4  
Calendar year actuarial adjustment
  $ .2     $ 216.1     $ 205.6  
   
Prior Accident Years Development
                       
Favorable/(Unfavorable)
                       
Actuarial adjustment
  $ 37.3     $ 158.3     $ 127.2  
All other development
    (117.6)       88.6       228.7  
Total development
  $ (80.3)     $ 246.9     $ 355.9  
   
(Increase) decrease to calendar year combined ratio
    (.6) pts.       1.7 pts.       2.6 pts.  
   
 
Total development consists both of actuarial adjustments and “all other development.” The actuarial adjustments represent the net changes made by our actuarial department to both current and prior accident year reserves based on regularly scheduled reviews. “All other development” represents claims settling for more or less than reserved, emergence of unrecorded claims at rates different than reserved and changes in reserve estimates on specific claims. Although we believe that the development from both the actuarial adjustments and “all other development” generally results from the same factors, as discussed below, we are unable to quantify the portion of the reserve adjustments that might be applicable to any one or more of those underlying factors.
 
As reflected in the table above, we experienced unfavorable total development in 2007, compared to favorable development in 2006 and 2005. For 2007, the total prior year’s loss reserve development was unfavorable in our Commercial Auto Business for both the specialty truck and business auto products, primarily reflecting a higher than expected number of large case reserve changes associated with prior accident years, as well as an increase in the number and severity of late reported claims in excess of our original estimate. The development on our total Personal Lines Business netted to no overall impact for the year as the development for the two channels offset each other.
 
For 2006 and 2005, the favorable total prior year loss reserve development was generally consistent across our business (e.g., product, distribution channel and state). These changes in estimates were made based on our actual loss experience involving the payment of claims, along with our evaluation of the needed reserves during these periods, as compared with the prior reserve levels for those claims.
 
The prior year loss reserve development for 2007 primarily reflected unfavorable development from accident years greater than one year old (i.e., accident year 2005 and prior) as discussed below. For 2006 and 2005, slightly more than half of the development related to the immediately preceding accident year (i.e., 2005 and 2004, respectively), with the remainder primarily affecting the preceding two accident years at a declining rate.
 
Changes in our estimate of severity from what we originally expected when establishing the reserves is the principal cause of prior accident year development. These changes in estimate are the result of what we are observing in the underlying data as it develops. During 2007, we experienced unfavorable reserve development after several years of recognizing favorable development. This development was driven by the unfavorable settlement of several outstanding lawsuits, the emergence of more than expected large losses from prior years, along with the reviews of larger bodily injury and uninsured motorist claims. In 2006 and 2005, we saw severity estimates develop more favorably than what was originally expected, and although we were unable to quantify the contribution of each factor to the overall favorable


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reserve development, we believe that the favorable changes in these estimates were related to factors as diverse as improved vehicle safety, more conservative jury awards, better fraud control and tenure of our claims personnel.
 
We are seeing our accident year severity trends following historical patterns. We continue to focus on our loss reserve analysis, attempting to enhance accuracy and to further our understanding of our loss costs. A detailed discussion of our loss reserving practices can be found in our Report on Loss Reserving Practices, which was filed in a Form 8-K on June 28, 2007.
 
Because we are primarily an insurer of motor vehicles, our exposure as an insurer of environmental, asbestos and general liability claims is limited. We have established reserves for these exposures in amounts that we believe to be adequate based on information currently known. These exposures do not have a material effect on our liquidity, financial condition, cash flows or results of operations.
 
Underwriting Expenses
Other underwriting expenses and policy acquisition costs as a percentage of premiums earned were up about one point over both 2006 and 2005. The increase primarily reflects lower average earned premium per policy due to recent rate reductions and an increase in advertising expenditures, primarily in our Direct channel. In accordance with GAAP, policy acquisition costs are amortized over the policy period in which the related premiums are earned (see Note 1 – Reporting and Accounting Policies).
 
C.  Personal Lines
 
                         
    Growth Over Prior Year  
    2007     2006     2005  
 
 
Net premiums written
    (2 )%     %     4 %
Net premiums earned
    (2 )%     1 %     4 %
Policies in force
    4 %     3 %     9 %
 
Progressive’s Personal Lines Business writes insurance for private passenger automobiles and recreational vehicles, and represented approximately 87% of our total net premiums written for the last three years. We currently write our Personal Lines products in 49 states and our personal auto product in the District of Columbia. In 2008, we are looking to expand these offerings into Massachusetts.
 
Private passenger auto represented slightly more than 90% of our total Personal Lines net premiums written in each of the past three years, with the special lines products (e.g., motorcycles, watercraft, and RVs) making up the balance. Net premiums written for private passenger auto declined 3% in 2007, was flat in 2006 and increased 3% in 2005; special lines net written premiums grew 5%, 7% and 14%, respectively, in each of the last three years. In 2007, 2006 and 2005, policies in force grew 2%, 1% and 8%, respectively, for private passenger auto, while policies in force for the special lines products grew 8% in both 2007 and 2006 and 14% in 2005. The special lines products had a favorable effect on the total Personal Lines combined ratio of about one point in both 2007 and 2006 and had little effect in 2005.
 
During 2007, we reorganized and brought our Agency and Direct businesses together under one Personal Lines organization to increase our ability to execute on key strategies, lower our non-claims expense ratio and foster growth through more competitive pricing, improved customer retention and an increased focus on brand development. Nevertheless, we will continue to report our Agency and Direct business results separately as a component of our Personal Lines segment to provide further understanding of our products by channel.
 
The Agency Business
 
                         
    Growth Over Prior Year  
    2007     2006     2005  
 
 
Net premiums written
    (4 )%     (2 )%     1 %
Net premiums earned
    (3 )%     (1 )%     1 %
Auto: policies in force
    (1 )%     (1 )%     6 %
 new applications
    (1 )%     (10 )%     (5) %
 renewal applications
    %     4 %     9 %
 
The Agency business includes business written by the more than 30,000 independent insurance agencies that represent Progressive, as well as brokerages in New York and California. During 2007, we saw new Agency auto application growth in 28 states. Two of our largest volume states, Florida and Texas, experienced positive new application growth in the


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second half of 2007; however, some of our other big states have not yet seen this growth, thus hindering our overall Agency auto growth.
 
Written premium per policy on total Agency auto business was down about 4% from year-end 2006, driven by decreases of written premium per policy in both new and renewal auto business, reflecting our recent rate reductions. For 2006 and 2005 written premium per policy was down about 3% and 6%, respectively, as compared to the prior year.
 
The rate of conversion (i.e., converting a quote to a sale) was down in 2007 and 2006 and relatively flat in 2005, on an increase each year in the number of auto quotes. Within the Agency business, we are continuing to see a shift from traditional agent quoting, where the conversion rate is remaining stable, to quotes generated through third-party comparative rating systems, where the conversion rate is lower.
 
Our Agency business expense ratio increased about one point in 2007, compared to both 2006 and 2005, primarily the result of lower average earned premium per policy due to our recent rate reductions.
 
The Direct Business
 
                         
    Growth Over Prior Year  
    2007     2006     2005  
 
 
Net premiums written
    %     4 %     10 %
Net premiums earned
    1 %     6 %     10 %
Auto: policies in force
    7 %     4 %     12 %
 new applications
    5 %     (4) %     8 %
 renewal applications
    7 %     9 %     14 %
 
The Direct business includes business written directly by Progressive online and over the phone. In 2007, we experienced an increase in Direct auto new applications in 30 states. Internet sales continue to be the most significant source of new business that is initiated in the Direct channel.
 
Written premium per policy for total Direct auto business was down 6% during 2007, compared to decreases of 1% in 2006 and 2% in 2005. In each of the last three years, the decreases were driven by declines in written premium per policy for both new and renewal business.
 
The number of total quotes decreased in the Direct business in both 2007 and 2006, as compared to the prior year. The rate of conversion increased during 2007, after being relatively flat during 2006. Conversion rates for both Internet-initiated business and phone-initiated business increased during both years. However, in 2006, we experienced a proportional increase in Internet business, which has a lower conversion rate than phone. In 2005, the overall conversion rate was down slightly on a significant increase in quotes, reflecting the Internet business becoming a bigger portion of the total Direct business.
 
The Direct expense ratio increased .8 points in 2007, compared to 2006, primarily due to increased advertising expenditures during the year and the lower average earned premium per policy. Advertising expenditures also increased year-over-prior year in 2006 and 2005. We are continuing to work with the advertising agency we hired in 2006, to find compelling ways to help consumers understand what sets us apart and to communicate our brand promise.
 
D.  Commercial Auto
 
                         
    Growth Over Prior Year  
    2007     2006     2005  
 
 
Net premiums written
    (4) %     5 %     11 %
Net premiums earned
    %     11 %     9 %
Policies in force
    7 %     7 %     11 %
New applications
    3 %     1 %     3 %
Renewal applications
    5 %     4 %     8 %
 
Progressive’s Commercial Auto Business writes primary liability and physical damage insurance for automobiles and trucks owned by small businesses, with the majority of our customers insuring three or fewer vehicles. Commercial Auto Business represented about 13% of our total net premiums written for the last three years. The Commercial Auto Business is primarily distributed through independent agents, but we are starting to see growth in the direct channel. The Commercial Auto Business operates in the specialty truck and business auto markets. The specialty truck commercial auto market, which accounts for slightly more than half of the total Commercial Auto premiums and approximately 40%


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of the vehicles we insure in this business, includes dump trucks, logging trucks, tow trucks, local cartage and other short-haul commercial vehicles. The remainder is in the business auto market, which includes autos, vans and pick-up trucks used by artisans, such as contractors, landscapers and plumbers, and a variety of other small businesses.
 
We currently write our Commercial Auto Business in 49 states; we do not write Commercial Auto in Hawaii or the District of Columbia. We entered Massachusetts early in 2007, West Virginia in early 2006 and New Jersey in late 2005.
 
As compared to the prior year, total written premium per policy decreased about 6% in 2007, compared to increases of 5% in 2006 and 6% in 2005. The increases in 2006 and 2005 partially reflect Commercial Auto’s shift from 6-month to 12-month policies, which had a favorable impact on premium per policy. This shift started at the end of the first quarter 2004 and was substantially completed in the second quarter 2005.
 
Commercial Auto’s expense ratio increased one point during 2007, resulting from significant investments in agency distribution and direct marketing capability, as well as reduced premiums.
 
Although Commercial Auto differs from Personal Lines auto in its customer base and products written, both businesses require the same fundamental skills, including disciplined underwriting and pricing, as well as excellent claims service. Since the Commercial Auto policies have higher limits (up to $1 million) than Personal Lines auto, we analyze the large loss trends and reserving in more detail to allow us to react quickly to changes in this exposure.
 
E.  Other Indemnity
Progressive’s other indemnity businesses, which represent less than 1% of our net premiums earned, primarily include professional liability insurance for community banks and a small amount of run-off business. The underwriting profit (loss) in these businesses may fluctuate widely due to the low premium volume, variability in losses, and the run-off nature of some of these products.
 
We reinsure the majority of the risk on our professional liability insurance, principally directors’ and officers’ liability insurance, with a small mutual reinsurer controlled by its bank customers and various other reinsurance entities. In light of the sub-prime mortgage “crisis,” we reviewed our community bank program and believe that we do not have any significant direct exposure to claims arising from this issue. From a strategic perspective, community banks tend not to generate sub-prime mortgages or invest in sub-prime securities. To date, we have not received any directors or officers liability claims related to sub-prime mortgages.
 
F.  Service Businesses
Our service businesses provide insurance-related services and represented less than 1% of revenues for each of the last three years. Our principal service business is providing policy issuance and claims adjusting services for the Commercial Auto Insurance Procedures/Plans (CAIP), which are state-supervised plans serving the involuntary markets in 27 states. We currently process approximately half of the premiums in the CAIP market, which is down slightly from the prior two years. There are two other CAIP service providers nationwide and one of these carriers has indicated that it will cease writing new business in 2008; we expect our market share of this business will increase as a result.
 
As a service provider, we collect fee revenue that is earned on a pro rata basis over the term of the related policies. We cede 100% of the premiums and losses to the plans. Reimbursements to us from the CAIP plans are required by state laws and regulations. Material violations of contractual service standards can result in ceding restrictions for the affected business. We have maintained, and plan to continue to maintain, compliance with these standards. Any changes in our participation as a CAIP service provider would not materially affect our financial condition, results of operations or cash flows.
 
Service business revenues decreased 27% in 2007. The decrease reflects the continuing cyclical downturn in the involuntary commercial auto market. At the same time, however, expenses are not decreasing at the same rate, primarily due to the fixed costs associated with our total loss replacement program, which is another one of our service businesses. This program is primarily a customer-service initiative, through which we help policyholders and claimants find and purchase a replacement vehicle when their automobile is declared to be a total loss. We evaluated the benefits of maintaining this service in-house and concluded that contracting with third-party providers to deliver this service will continue to meet our customers’ needs and reduce our costs; transition of the program is expected to be completed in the second quarter 2008.


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G.  Litigation
The Progressive Corporation and/or its subsidiaries are named as a defendant in a number of putative class action or other lawsuits, such as those alleging damages as a result of our use of after-market parts; total loss evaluation methodology; use of credit in underwriting and related requirements under the federal Fair Credit Reporting Act; installment fee programs; practices in evaluating or paying medical or injury claims or benefits, including, but not limited to, personal injury protection, medical payments, uninsured motorist/underinsured motorist (UM/UIM), and bodily injury benefits; rating practices at policy renewal; the utilization, content, or appearance of UM/UIM rejection forms; the practice of taking betterment on boat repairs; labor rates paid to auto body repair shops; and cases challenging other aspects of our claims or marketing practices or other business operations. Other insurance companies face many of these same issues. During 2007, we settled a nationwide class action challenging our use of software to assist in the adjustment of bodily injury claims, a state class action challenging payments of certain medical benefits, and a state class action challenging the amount charged for UIM premiums. During 2006, we settled nationwide claims challenging our use of credit information and notice requirements under the federal Fair Credit Reporting Act; statewide class action lawsuits that challenged our payment of preferred provider rates on personal injury protection claims; and certain statewide class action lawsuits challenging our payments of MRI bills under personal injury protection coverage. In 2005, we settled nationwide claims challenging our use of certain automated database vendors to assist in the evaluation of total loss claims and a state class action challenging our UM/UIM rejection form. These settlements did not have a material impact on our financial condition, cash flows or results of operations. See Note 11 — Litigation for a more detailed discussion.
 
H.  Income Taxes
As reported in the balance sheet, income taxes are comprised of net income taxes payable and net deferred tax assets and liabilities. A deferred tax asset/liability is a tax benefit/expense that will be realized in a future tax return. At December 31, 2007 and 2006, our income taxes were in a net asset position. The increase in our net asset position during 2007 primarily reflected a decrease in our net unrealized gains on securities. See Note 3 — Income Taxes for further information.


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IV.  RESULTS OF OPERATIONS — INVESTMENTS
A.  Portfolio Allocation
Progressive’s investment strategy targets a range of between 75% and 100% in fixed-income securities with the balance in common equities. This strategy is based on our need to maintain capital adequate to support our insurance operations, recognizing that our reserves are short in duration. Investments in our portfolio have varying degrees of risk. We evaluate the risk/reward trade-offs of investment opportunities, measuring their effects on stability, diversity, overall quality and liquidity, and the potential return of the investment portfolio. We also monitor the value at risk of the portfolio to evaluate the maximum potential loss (see the Quantitative Market Risk Disclosures, a supplemental schedule provided in this Annual Report, for further information). The composition of the investment portfolio at December 31 was:
 
                                                         
          Gross
    Gross
          % of
             
          Unrealized
    Unrealized
    Fair
    Total
    Duration
       
($ in millions)   Cost     Gains     Losses     Value     Portfolio     (years)     Rating5  
 
 
2007
                                                       
Fixed maturities1
  $ 9,135.6     $ 137.1     $ (87.8 )   $ 9,184.9       64.8 %     4.0       AA  
Preferred stocks2
    2,578.1       6.0       (306.4 )     2,270.3       16.0       1.9       A-  
Short-term investments:
                                                       
Other short-term investments
    382.4                   382.4       2.7       <1       AA+  
               
Total fixed income
    12,096.1       143.1       (394.2 )     11,837.6       83.5       3.5       AA  
Common equities
    1,361.0       986.8       (20.3 )     2,327.5       16.5       na       na  
               
Total portfolio2,3,4
  $ 13,457.1     $ 1,129.9     $ (414.5 )   $ 14,165.1       100.0 %     3.5       AA  
               
   
               
2006
                                                       
Fixed maturities
  $ 9,959.6     $ 74.8     $ (75.5 )   $ 9,958.9       67.8 %     3.6       AAA-  
Preferred stocks
    1,761.4       31.5       (11.9 )     1,781.0       12.1       1.5       A-  
Short-term investments:
                                                       
Auction rate municipal obligations
    99.4                   99.4       .7       <1       AAA-  
Auction rate preferred stocks
    69.2       .2             69.4       .5       <1       A-  
Other short-term investments
    412.4                   412.4       2.8       <1       A+  
               
Total short-term investments
    581.0       .2             581.2       4.0       <1       A+  
               
Total fixed income
    12,302.0       106.5       (87.4 )     12,321.1       83.9       3.1       AA+  
Common equities
    1,469.0       904.0       (4.9 )     2,368.1       16.1       na       na  
               
Total portfolio3,4
  $ 13,771.0     $ 1,010.5     $ (92.3 )   $ 14,689.2       100.0 %     3.1       AA+  
               
   
               
 
na = not applicable
 
1 Includes $53.8 million of gains on our open interest rate swap positions. Also includes $34.1 million of collateral, in the form of Treasury Notes that were delivered to the counterparty on our open credit default swaps. See the Derivative Instruments section below for further discussion.
 
2 At December 31, 2007, the fair value included a $7.4 million change in certain hybrid securities that was recognized as a realized loss.
 
3 Includes net unsettled security acquisitions of $77.0 million and $41.9 million at December 31, 2007 and 2006, respectively.
 
4 December 31, 2007 and 2006 totals include $2.1 billion and $2.5 billion, respectively, of securities in the portfolio of a consolidated, non-insurance subsidiary of the holding company.
 
5 Credit quality ratings are assigned by nationally recognized securities rating organizations. To calculate the weighted average credit quality ratings, we weight individual securities based on fair value and assign a numeric score to each credit rating based on a scale from 0-5.
 
Unrealized Gains and Losses
During 2007, we experienced a $202.8 million pretax decrease in net unrealized gains, which was largely the result of modest positive returns in our fixed maturities and equity-indexed common stock portfolios, offset by a significant decline in our redeemable and nonredeemable preferred stocks. The decline in our preferred stocks was primarily the result of recent financial market disruptions relating to the sub-prime mortgage market. See the “Gross Unrealized Losses” section of Note 2 — Investments for further discussion.


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Fixed-Income Securities
The fixed-income portfolio is managed internally and includes fixed-maturity securities, short-term investments and preferred stocks. The fixed-maturity securities and short-term securities, as reported on the balance sheets at December 31, were comprised of the following:
 
                                     
($ in millions)   2007     2006      
 
Investment-grade fixed maturities:1
                                   
Short/intermediate term
  $ 9,084.2       95.0 %   $ 10,381.9       98.5 %    
Long term
    147.0       1.5       70.9       .7      
Non-investment-grade fixed maturities2
    336.1       3.5       87.3       .8      
Total
  $ 9,567.3       100.0 %   $ 10,540.1       100.0 %    
   
 
1 Long term includes securities with expected liquidation dates of 10 years or greater. Asset-backed securities are reported at their weighted average maturity based upon their projected cash flows. All other securities that do not have a single expected maturity date are reported at average maturity. See Note 2 — Investments for further discussion.
 
2 Non-investment-grade fixed-maturity securities are non-rated or have a quality rating of an equivalent BB+ or lower, classified by the lowest rating from a nationally recognized rating agency.
 
A primary exposure for the fixed-income portfolio is interest rate risk, which is managed by maintaining the portfolio’s duration between 1.8 to 5 years. Interest rate risk includes the change in value resulting from movements in the underlying market rates of debt securities held. The fixed-income portfolio had a duration of 3.5 years at December 31, 2007, compared to 3.1 years at December 31, 2006. The distribution of duration and convexity (i.e., a measure of the speed at which the duration of a security is expected to change based on a rise or fall in interest rates) are monitored on a regular basis.
 
Another exposure related to the fixed-income portfolio is credit risk, which is managed by maintaining a minimum average portfolio credit quality rating of A+, as defined by nationally recognized rating agencies, and limiting non-investment-grade securities to a maximum of 5% of the fixed-income portfolio. Pursuant to guidelines established by our Board of Directors, concentration in a single issuer’s bonds and preferred stocks is limited to no more than 6% of our shareholders’ equity, except for U.S. Treasury and agency bonds; any state’s general obligation bonds are limited to 12% of shareholders’ equity.
 
The credit quality distribution of the fixed-income portfolio at December 31 was as follows:
 
                     
Rating   2007     2006      
 
AAA
    49.4 %     61.1 %    
AA
    20.6       15.0      
A
    16.2       14.4      
BBB
    10.6       8.3      
Non Rated/Other
    3.2       1.2      
Total
    100.0 %     100.0 %    
   
 
During 2007, the AAA rating category decreased while the remaining ratings categories increased, representing our decision to take advantage of better valuations in some lower-rated securities, compared to certain existing higher credit-rated assets.


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ASSET-BACKED SECURITIES
Included in the fixed-income portfolio are asset-backed securities, which were comprised of the following at December 31:
 
                                 
          % of Asset-Backed
    Duration
       
($ in millions)   Fair Value     Securities     (years)     Rating  
 
 
2007
                               
Collateralized mortgage obligations1
  $ 611.4       24.3 %     1.2       AAA-  
               
Commercial mortgage-backed obligations
    914.7       36.5       2.7       AA  
Commercial mortgage-backed obligations: interest only
    759.1       30.2       1.9       AAA-  
               
Subtotal commercial mortgage-backed obligations
    1,673.8       66.7       2.3       AA+  
               
Other asset-backed securities:
                               
Home equity2
    148.7       5.9       .1       AA  
Other
    77.7       3.1       1.1       A  
               
Subtotal other asset-backed securities
    226.4       9.0       .4       AA-  
               
Total asset-backed securities
  $ 2,511.6       100.0 %     1.9       AA+  
               
   
               
2006
                               
Collateralized mortgage obligations1
  $ 575.9       24.1 %     1.8       AAA  
               
Commercial mortgage-backed obligations
    770.4       32.2       3.1       AAA-  
Commercial mortgage-backed obligations: interest only
    893.7       37.4       2.2       AAA-  
               
Subtotal commercial mortgage-backed obligations
    1,664.1       69.6       2.6       AAA-  
               
Other asset-backed securities:
                               
Home equity2
    23.0       1.0       .5       AAA  
Other
    127.1       5.3       1.2       AA-  
               
Subtotal other asset-backed securities
    150.1       6.3       1.1       AA-  
               
Total asset-backed securities
  $ 2,390.1       100.0 %     2.3       AAA-  
               
   
               
 
1 Includes $52.3 million of Alt-A, non-prime bonds (low document/no document or non-conforming prime loans) with a net unrealized loss of $.1 million and a credit quality of AAA for 2007; 2006 included $63.1 million of Alt-A bonds that had a net unrealized loss of $.3 million and a credit quality of AAA.
 
2 Represents sub-prime bonds with a net unrealized loss of $12.2 million and $.1 million for 2007 and 2006, respectively; these bonds are unrelated to the asset-backed derivative position discussed below.
 
Substantially all of the asset-backed securities are liquid with available market quotes and contain no residual interests (the most subordinated class in a pool of securitized assets). As of December 31, 2007, 8% of our asset-backed securities are exposed to sub-prime mortgage loans. We reviewed these securities for other-than-temporary impairment and yield or asset valuation adjustments, and we realized $1.7 million in write-downs on sub-prime securities during 2007. The securities with sub-prime exposure are paying their principal and periodic interest timely, and we continue to have the intent and ability to hold these securities.


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The following table shows the credit quality rating of our home equity securities by deal origination year, along with a comparison of the fair value at December 31, 2007, to our original investment value (adjusted for returns of principal and amortization).
 
Home Equity Securities
                                                                 
($ in millions)
  Deal Origination Year                 % of Home
 
Rating (date acquired)   2007     2006     2005     2004     2003     Total           Equity Loans  
 
 
AAA (October 2003-December 2007)1
  $     $ 59.9     $ 4.9     $     $ .1     $ 64.9               43.7 %
Increase (decrease) in value
          (1.2 )%     (.4 )%                 (1.1 )%                
                                                                 
AA (August 2007-October 2007)
  $ 3.1           $ 23.2     $ 14.5           $ 40.8               27.4 %
Increase (decrease) in value
    (37.0 )%           (13.6 )%     .3 %           (11.7 )%                
                                                                 
A (August 2007)
              $ 34.0     $ 6.3           $ 40.3               27.1 %
Increase (decrease) in value
                (13.9 )%     2.2 %           (11.7 )%                
                                                                 
BBB (March 2007)
                    $ 2.7           $ 2.7               1.8 %
Increase (decrease) in value
                      (21.4 )%           (21.4 )%                
                                                                 
Total
  $ 3.1     $ 59.9     $ 62.1     $ 23.5     $ .1     $ 148.7                100.0 %
   
Increase (decrease) in value
    (37.0 )%     (1.2 )%     (12.8 )%     (2.3 )%     %     (7.6 )%                
       
   
       
 
1The entire $59.9 million balance of our 2006 AAA securities was added to the portfolio in December 2007.
 
At December 31, 2007, 36.5% of our asset-backed securities were commercial mortgage-backed obligations (CMBS). The following table details the credit quality rating and fair value of our CMBS portfolio by year of deal origination and reflects the high quality of these securities.
 
Commercial Mortgage-Backed Obligations
                                                         
    Rating              
($ in millions)
                          Non-Investment
          % of Total
 
Deal Origination Year   AAA     AA     A     BBB     Grade     Fair Value     Exposure  
 
 
Pre-2000
  $ 6.1     $     $     $ 40.4     $ 23.5     $ 70.0       7.6 %
2000
    53.2       24.5                         77.7       8.5  
2001
    140.2       27.5       7.4                   175.1       19.1  
2002
    43.1                               43.1       4.7  
2003
    155.3       13.5                         168.8       18.5  
2004
    78.9       8.8       4.8             7.1       99.6       10.9  
2005
    71.0                               71.0       7.8  
2006
    145.5                         25.2       170.7       18.7  
2007
                      6.9       31.8       38.7       4.2  
Total Fair Value
  $ 693.3     $ 74.3     $ 12.2     $ 47.3     $ 87.6     $ 914.7       100.0 %
                                                     
 
% of Total Fair Value
    75.8 %     8.1 %     1.3 %     5.2 %     9.6 %     100.0 %        
       
   
       
 
Approximately 15% of our CMBS portfolio is rated BBB or lower with an average duration of 2.4 years, compared to 2.7 years for the entire CMBS portfolio. In addition, we believe the non-investment-grade securities which we hold that originated in 2006 and 2007 will have lower frequency of default than those generally originated in that class of issuance due to the underlying strength of the single transaction borrowers.


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We also held CMBS interest only (IO) securities at December 31, 2007. The IO portfolio had a credit quality of AAA- and a duration of 1.9 years. The following table quantifies the fair value and total exposure of these securities by the year of deal origination.
 
Commercial Mortgage-Backed Obligations: Interest Only
                 
($ in millions)
        % of Total
 
Deal Origination Year   Fair Value     Exposure  
 
 
Pre-2000
  $ 7.3       1.0 %
2000
    38.4       5.0  
2001
    29.0       3.8  
2002
    33.1       4.4  
2003
    115.5       15.2  
2004
    119.9       15.8  
2005
    192.0       25.3  
2006
    223.9       29.5  
Total Fair Value
  $ 759.1       100.0 %
   
 
The IO portfolio is 92% comprised of planned amortization class IOs, which provides bondholders greater protection against loan prepayment or default risk inherent with these types of securities. Since 2004, 100% of the IO securities we have purchased were made up of this more protected class.


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MUNICIPAL SECURITIES
At December 31, 2007, we held $3,745.1 million of state and local government obligations with an overall credit quality of AA+. About one-third, or $1,163.3 million, of these securities were general obligation or revenue bonds that had a credit quality of AAA due to the fact that they were insurance enhanced. The following table shows the composition and credit quality of these municipal obligations by monoline insurer at December 31, 2007. The credit rating represents the quality of the underlying security, excluding credit insurance, based on ratings by nationally recognized rating agencies.
 
Insurance Enhanced Municipal Securities
                         
(millions)
                 
Monoline Insurer/
  General
             
Rating   Obligations     Revenue Bonds     Total  
 
 
FGIC
                       
AA
  $ 149.0     $ 113.1     $ 262.1  
A
    77.5       36.6       114.1  
    $ 226.5     $ 149.7     $ 376.2  
AMBAC
                       
AA
  $ 129.1     $ 71.6     $ 200.7  
A
    38.7       2.1       40.8  
BBB
          4.5       4.5  
Non-rated
          2.4       2.4  
    $ 167.8     $ 80.6     $ 248.4  
MBIA
                       
AA
  $ 95.3     $ 78.1     $ 173.4  
A
    44.0       58.8       102.8  
BBB
          5.3       5.3  
    $ 139.3     $ 142.2     $ 281.5  
FSA
                       
AA
  $ 97.7     $ 131.5     $ 229.2  
A
          23.5       23.5  
BBB
          4.5       4.5  
    $ 97.7     $ 159.5     $ 257.2  
TOTAL
                       
AA
  $ 471.1     $ 394.3     $ 865.4  
A
    160.2       121.0       281.2  
BBB
          14.3       14.3  
Non-rated
          2.4       2.4  
    $ 631.3     $ 532.0     $ 1,163.3  
   
 
As of December 31, 2007, the insurance enhanced general obligation or revenue bonds had a combined net unrealized gain of $12.5 million. We believe that the valuation of these securities is related to the credit rating of the underlying municipal bonds with only a small adjustment related to the credit insurance. Our policy does not require us to liquidate securities should the insurance provided by the monoline insurers cease to exist.


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CORPORATE SECURITIES
Included in our fixed-income securities at December 31, 2007, are $1.1 billion of fixed-rate corporate securities which have a duration of 4.4 years and an overall credit quality rating of A-. The table below shows the exposure breakdown by rating and sector.
 
Corporate Securities Rating By Sector
                                         
Sector   AAA     AA     A     BBB     % of Portfolio  
 
 
Financial
    2.7 %     16.4 %     21.6 %     3.3 %     44.0 %
Agency
                             
Industrial
                4.7       49.5       54.2  
Utility
                1.8             1.8  
Total
    2.7 %     16.4 %     28.1 %     52.8 %     100.0 %
   
 
PREFERRED STOCKS — REDEEMABLE AND NONREDEEMABLE
Included in fixed-income securities are redeemable and nonredeemable preferred stocks, which represented approximately 20% of our total investment portfolio at December 31, 2007, and had an overall credit quality rating of A-. The table below shows the exposure breakdown by rating and sector.
 
Preferred Stocks Rating By Sector
                                         
                      Non-Investment
       
Sector   AA     A     BBB     Grade     % of Portfolio  
 
 
Financial
    7.1 %     40.9 %     13.8 %     3.8 %     65.6 %
Agency
    15.7                         15.7  
Industrial
          4.0       4.4       5.3       13.7  
Utility
          1.5       3.5             5.0  
Total
    22.8 %     46.4 %     21.7 %     9.1 %     100.0 %
   
 
Approximately half of these securities pay dividends which have tax preferential characteristics, while the balance are fully taxable. In addition, all of our non-investment-grade preferred stocks were with issuers who maintain investment-grade senior debt ratings.
 
For these preferred securities, approximately two-thirds are fixed-rate securities and one-third are floating-rate securities. All of our preferred securities have call or mandatory redemption features. Most of the securities are structured to provide some protection against extension risk in the event the issuer elects not to call such securities at their initial call date by either paying a higher dividend amount or by paying floating-rate coupons. Of our fixed-rate securities, approximately 85% will convert to floating-rate dividend payments if not called at their initial call date.
 
As shown in the table, the majority of this portfolio is in the financial services sector, reflecting both the composition of the preferred market, which is dominated by financial issuers, as well as our belief that there is better relative economic value in the preferred stock market than in the comparable debt market without significantly increasing our investment risk. Within the financial sector, approximately 60% of our holdings are in large capitalization banks and 20% are in U.S. broker/dealers.
 
Common Equities
Common equities, as reported in the balance sheets at December 31, were comprised of the following:
 
                                         
($ in millions)   2007     2006        
 
 
Common stocks
  $ 2,313.8       99.4 %   $ 2,352.0       99.3 %        
Other risk investments
    13.7       .6       16.1       .7          
Total common equities
  $ 2,327.5       100.0 %   $ 2,368.1       100.0 %        
   
 
Common equities, which generally have greater risk and volatility of fair value than fixed-income securities, may range from 0% to 25% of the investment portfolio. Common stocks are managed externally to track the Russell 1000 Index with an anticipated annual tracking error of +/- 50 basis points. During 2007, the GAAP basis total return was within our tracking error.


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Our common equity allocation is intended to enhance the return of, and provide diversification for, the total portfolio. To maintain high correlation with the Russell 1000, we held 655 out of 1,000, or approximately 66%, of the common stocks comprising the index at December 31, 2007. Our individual holdings are selected based on their contribution to the correlation with the index.
 
Other risk investments include private equity investments and limited partnership interests in private equity and mezzanine investment funds which have no off-balance-sheet exposure or contingent obligations, except for the $.2 million of open funding commitments.
 
Trading Securities
Trading securities may be entered into from time to time for the purpose of near-term profit generation. We have not entered into any trading securities in the last three years.
 
Derivative Instruments
From time to time we invest in derivative instruments. At December 31, 2007, we held interest rate swaps to receive fixed interest rates for 5 years and 10 years with a combined notional value of $1.3 billion. In January 2008, we closed a 5-year swap with a notional value of $.3 billion and recognized a gain of $15.1 million. For 2007, the interest rate swap positions generated net realized gains of $53.8 million. Total net realized gains, including interest expense, were $53.1 million for 2007. We had no interest rate swaps during 2006 or 2005.
 
During 2007, we opened and closed $210 million of notional credit default exposure on a corporate non-investment-grade index and closed $40 million of notional exposure on a corporate investment-grade index, which we held in 2006. The combined positions generated net realized gains of $10.0 million and $.1 million for 2007 and 2006, respectively. We held no corporate non-investment-grade or investment-grade index derivatives in 2005.
 
Additionally, during 2007, we sold credit default protection using credit default swap derivatives on an investment-grade asset-backed index with a credit quality of BBB-, comprised of 20 bonds in the sub-prime mortgage sector, with a notional amount of $140 million. We matched these notional amounts with Treasury Notes with the same maturity and principal value to cover our off-balance-sheet exposure. We received upfront cash payments of $43.3 million on these open swap positions, effectively reducing our maximum exposure of loss to $96.7 million. During 2007, this derivative position generated a net loss of $51.3 million. As required by the counterparty contract, we delivered $34.1 million of collateral in the form of U.S. Treasury Notes to reduce counterparty credit risk. During 2006, we closed credit default protection derivatives sold on four separate corporate issuers, which were also matched with equivalent Treasury Notes.
 
Following is a summary of our net realized gains (losses) on the credit default protection we sold using credit default swaps and matched with Treasury Notes for the years ended December 31:
 
                         
(millions)   2007     2006     2005  
 
 
Credit default swap
  $ (51.3 )   $ 9.9     $ (6.8 )
Treasury Notes
    7.9             (.8 )
Combined gain (loss)
  $ (43.4 )   $ 9.9     $ (7.6 )
   
 
For all of the derivative positions discussed above, realized holding period gains and losses are netted with any upfront cash that may be exchanged under the contract to determine if the net position should be classified either as an asset or a liability. To be reported as a component of the available-for-sale portfolio, the realized gain on the derivative position at period end would have to exceed any upfront cash received (net derivative asset). On the other hand, a net derivative liability would reflect realized losses plus the amount of upfront cash received (or netted if upfront cash was paid) and would be reported as a component of other liabilities. These net derivative assets/liabilities are not separately disclosed on the balance sheet due to the immaterial effect on our financial condition, cash flows and results of operations.
 
In addition, during the second quarter 2007, we entered into a forecasted debt issuance hedge against a possible rise in interest rates in anticipation of issuing $1 billion of our 6.70% Fixed-to-Floating Rate Junior Subordinated Debentures due 2067 (the “Debentures”). The hedge was designated as, and qualified for, cash flow hedge accounting treatment. Upon issuance of the Debentures, the hedge was closed, and we recognized a pretax gain of $34.4 million, which is recorded as part of accumulated other comprehensive income. The $34.4 million gain is deferred and is being recognized as an adjustment to interest expense over the 10-year fixed interest rate term of the Debentures. During 2007, we recognized $1.3 million as an adjustment to interest expense.


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B.  Investment Results
Recurring investment income (interest and dividends, before investment and interest expenses) increased 5% in 2007, 21% in 2006 and 11% in 2005. The increase in 2007 was primarily the result of a decision to take advantage of attractive opportunities in certain higher-yielding, though lower-rated, assets. These lower-rated assets provided additional income over our previous investments. The increase in investment income during 2006 was primarily the result of an increase in investment yields, with a small growth in average assets providing the balance of the increase. In 2005, the increase in investment income was a more balanced combination of yield and portfolio growth in average assets.
 
Investment expenses were $12.4 million in 2007, compared to $11.9 million in 2006 and $12.1 million in 2005. Interest expense in 2007 was $108.6 million, compared to $77.3 million in 2006 and $82.6 million in 2005. The increase in 2007 reflects the June 2007 issuance of our $1 billion Debentures, while the decrease in 2006 reflects the retirement in June 2006 of our $100 million 7.30% Notes at maturity.
 
We report total return to reflect more accurately the management philosophy governing the portfolio and our evaluation of investment results. The fully taxable equivalent (FTE) total return includes recurring investment income, net realized gains (losses) on securities and changes in unrealized gains (losses) on investment securities. By reporting on an FTE basis, we are adjusting our tax preferential securities to an equivalent measure when comparing results to taxable securities. We reported the following investment results for the years ended December 31:
 
                         
    2007     2006     2005  
 
 
Pretax recurring investment book yield
    4.8%       4.6%       4.1%  
Weighted average FTE book yield
    5.6%       5.3%       4.7%  
FTE total return:
                       
Fixed-income securities
    4.4%       5.9%       3.4%  
Common stocks
    6.2%       16.3%       7.1%  
Total portfolio
    4.7%       7.4%       4.0%  
 
Realized Gains/Losses
Gross realized gains and losses were the result of customary investment sales transactions in our fixed-income portfolio, affected by movements in credit spreads and interest rates, rebalancing of our equity-indexed portfolio and holding period valuation changes on derivatives. In addition, in 2007, gains and losses also reflected the sale of securities to fund our $1.4 billion extraordinary dividend payment in September 2007. From time to time, gross realized losses also include write-downs for securities determined to be other-than-temporarily impaired in our fixed-income and/or equity portfolios. Disclosure related to these write-downs is provided below. As of December 31, 2007, realized losses also included $7.4 million of net losses related to certain hybrid securities within our preferred stock portfolio that are reported at fair value.
 
OTHER-THAN-TEMPORARY IMPAIRMENT
Included in the net realized gains (losses) on securities for the years ended December 31, 2007, 2006 and 2005, are write-downs on securities determined to have had an other-than-temporary decline in fair value. We routinely monitor our portfolio for pricing changes that might indicate potential impairments, and perform detailed reviews of securities with unrealized losses based on predetermined criteria. In such cases, changes in fair value are evaluated to determine the extent to which such changes are attributable to (i) fundamental factors specific to the issuer, such as financial conditions, business prospects or other factors or (ii) market-related factors, such as interest rates or equity market declines (i.e., negative returns at either a sector index level or the broader market level).
 
Fixed-income and equity securities with declines attributable to issuer-specific fundamentals are reviewed to identify all available evidence, circumstances and influences to estimate the potential for, and timing of, recovery of the investment’s impairment. An other-than-temporary impairment loss is deemed to have occurred when the potential for, and timing of, recovery does not satisfy the criteria set forth in the current accounting guidance (see Critical Accounting Policies, Other-than-Temporary Impairment for further discussion).
 
For fixed-income investments with unrealized losses due to market or industry-related declines where we have the intent and ability to hold the investment for the period of time necessary to recover a significant portion of the investment’s impairment and collect the interest obligation, declines are not deemed to qualify as other than temporary. Our policy for common stocks with market-related declines is to recognize impairment losses on individual securities with losses that are not reasonably expected to be recovered under historical market conditions when the security has been in such a loss position for three consecutive quarters.


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When a security in our investment portfolio has an unrealized loss in fair value that is deemed to be other than temporary, we reduce the book value of such security to its current fair value, recognizing the decline as a realized loss in the income statement. All other unrealized gains or losses are reflected in shareholders’ equity. The write-down activity for the years ended December 31 was as follows:
 
                     
          Write-downs
  Write-downs
    Total
    on Securities
  on Securities
    Write-
    Subsequently
  Held at Period
(millions)   downs     Sold   End
 
2007
                   
Fixed income1
  $ 19.3     $   $ 19.3
Common equities
    2.4       2.1     .3
Total portfolio
  $ 21.7     $ 2.1   $ 19.6
   
2006
                   
Fixed income
  $ 1.8     $ .3   $ 1.5
Common equities
    2.4       2.0     .4
Total portfolio
  $ 4.2     $ 2.3   $ 1.9
   
2005
                   
Fixed income
  $ 14.6     $ 5.3   $ 9.3
Common equities
    7.1           7.1
Total portfolio
  $ 21.7     $ 5.3   $ 16.4
   
 
1Includes $1.7 million related to a sub-prime mortgage debt security determined to be other-than-temporarily impaired.
 
The following is a summary of the 2007 equity security write-downs by sector (both market-related and issuer specific):
 
                                     
        Equity Portfolio
    Russell 1000
    Russell 1000
    Remaining Gross
    Amount of
  Allocation at
    Allocation at
    Sector
    Unrealized Loss at
($ in millions)
  Write-down
  December 31,
    December 31,
    Return
    December 31,
Sector   in 2007   2007     2007     in 2007     2007
 
Auto and Transportation
  $     2.5 %     2.3 %     %   $ 1.2
Consumer Discretionary
    .3     11.7       12.9       (3.2 )     2.8
Consumer Staples
        8.3       7.3       8.6       .1
Financial Services
    .6     17.9       18.6       (16.9 )     10.3
Health Care
    .4     11.4       11.9       7.5       3.2
Integrated Oil
        8.4       6.6       29.8      
Materials and Processing
    .1     4.7       5.2       27.7       .3
Other Energy
        4.3       5.5       42.0       .2
Producer Durables
    .9     5.6       5.0       13.3       .2
Technology
        13.7       13.7       16.7       1.1
Utilities
    .1     6.9       7.1       9.6       .7
Other Equities
        4.6       3.9       1.0       .1
Total Common Stocks
  $ 2.4     100.0 %     100.0 %     5.8 %   $ 20.2
         
     
Other Risk Assets
                                .1
                               
                               
                                     
                                     
Total Common Equities
  $ 2.4                           $ 20.3
                                     
 
See Critical Accounting Policies, Other-than-Temporary Impairment for further discussion.
 
C. Repurchase Transactions
During each of the last three years, we entered into repurchase commitment transactions, whereby we loaned U.S. Treasury or U.S. Government agency securities to accredited brokerage firms in exchange for cash equal to the fair value of the securities. These internally managed transactions were typically overnight arrangements. The cash proceeds were invested in Eurodollar and commercial paper obligations issued by large, high-quality institutions with yields that exceeded our interest obligation on the borrowed cash. We are able to borrow the cash at low rates since the securities


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loaned are in either short supply or high demand. Our interest rate exposure does not increase or decrease since the borrowing and investing periods match. During the year ended December 31, 2007, our largest single outstanding balance of repurchase commitments was $2.4 billion, which was open for four consecutive days; the average daily balance of repurchase commitments was $.7 billion for 2007. During 2006, the largest single outstanding balance of repurchase commitments was $2.6 billion, which was open for five consecutive days; the average daily balance of repurchase commitments was $1.2 billion for 2006. We had no open repurchase commitments at December 31, 2007 and 2006. We earned income of $3.7 million during both 2007 and 2006, and $4.5 million during 2005, on repurchase commitments.
 
V. CRITICAL ACCOUNTING POLICIES
Progressive is required to make certain estimates and assumptions when preparing its financial statements and accompanying notes in conformity with GAAP. Actual results could differ from those estimates in a variety of areas. The two areas that we view as most critical with respect to the application of estimates and assumptions are the establishment of our loss reserves and the method of determining impairments in our investment portfolio.
 
A. Loss and LAE Reserves
Loss and loss adjustment expense (LAE) reserves represent our best estimate of our ultimate liability for losses and LAE relating to events that occurred prior to the end of any given accounting period but have not yet been paid. At December 31, 2007, we had $5.7 billion of net loss and LAE reserves, which included $4.5 billion of case reserves and $1.2 billion of incurred but not recorded (IBNR) reserves.
 
Progressive’s actuarial staff reviews over 350 subsets of the business, which are at a combined state, product and line coverage level (the “products”), to calculate the needed loss and LAE reserves. We begin our review of a set of data by producing six different estimates of needed reserves, three using paid data and three using incurred data, to determine if a reserve change is required. In the event of a wide variation among results generated by the different projections, our actuarial group will further analyze the data using additional techniques. Each review develops a point estimate for a relatively small subset of the business, which allows us to establish meaningful reserve levels for that subset. In addition, the actuarial staff completes separate projections of needed case and IBNR reserves.
 
We review a large majority of our reserves by product/state combination on a quarterly time frame, with almost all the remaining reserves reviewed on a semiannual basis. A change in our scheduled reviews of a particular subset of the business depends on the size of the subset or emerging issues relating to the product or state. By reviewing the reserves at such a detailed level, we have the ability to identify and measure variances in trend by state, product and line coverage that would not otherwise be seen on a consolidated basis. Our intricate process of reviewing over 350 subsets makes compiling a companywide roll up to generate a range of needed loss reserves not meaningful. We do not review loss reserves on a macro level and, therefore, do not derive a companywide range of reserves to compare to a standard deviation.
 
In analyzing the ultimate accident year loss experience, our actuarial staff reviews in detail, at the subset level, frequency (number of losses per earned car year), severity (dollars of loss per each claim) and average premium (dollars of premium per earned car year). The loss ratio, a primary measure of loss experience, is equal to the product of frequency times severity divided by the average premium. The average premium for personal and commercial auto businesses is known and, therefore, is not estimated. The projection of frequency for these lines of business is usually stable in the short term, because a large majority of the parties involved in an accident report their claims within a short time period after the occurrence. The actual frequency experienced will vary depending on the change in mix of class of drivers insured by Progressive, but the accuracy of the projected level is considered to be reliable. The severity experienced by Progressive, which is much more difficult to estimate, especially for injury claims, is affected by changes in underlying costs, such as medical costs, jury verdicts and regulatory changes. In addition, severity will vary relative to the change in our mix of business by limit.
 
Assumptions regarding needed reserve levels made by the actuarial staff take into consideration influences on available historical data that reduce the predictiveness of our projected future loss cost. Internal considerations that are process-related, which generally result from changes in our claims organization’s activities, include claim closure rates, the number of claims that are closed without payment and the level of the claims representatives’ estimates of the needed case reserves for each claim. We study these changes and their effect on the historical data at the state level versus on a larger, less indicative, countrywide basis.


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External items considered include the litigation atmosphere, state-by-state changes in medical costs and the availability of services to resolve claims. These also are better understood at the state level versus at a more macro countrywide level.
 
The manner in which we consider and analyze the multitude of influences on the historical data, as well as how loss reserves affect our financial results, is discussed in more detail in our Report on Loss Reserving Practices, which was filed on June 28, 2007 via Form 8-K.
 
At December 31, 2007, Progressive’s carried net reserve balance of $5.7 billion implicitly assumes that the loss and LAE severity will increase for accident year 2007 over accident year 2006 by 2.6% and 2.2% for personal auto liability and commercial auto liability, respectively. Personal auto liability and commercial auto liability reserves represent approximately 98% of our total carried reserves. As discussed above, the severity estimates are influenced by many variables that are difficult to quantify and which influence the final amount of claims settlement. That, coupled with changes in internal claims practices, the legal environment and state regulatory requirements, requires significant judgment in the estimate of the needed reserves to be carried.
 
The following table highlights what the impact would be to our carried loss and LAE reserves, on a net basis, as of December 31, 2007, if during 2008 we were to experience the indicated change in our estimate of severity for the 2007 accident year (i.e., claims that occurred in 2007):
 
                                                   
      Estimated Changes in Severity for Accident Year 2007  
(millions)     -2%       -1%       As Reported       +1%       +2%  
Personal Auto Liability
    $ 4,125.4       $ 4,177.2       $ 4,229.0       $ 4,280.8       $ 4,332.6  
Commercial Auto Liability
      1,291.5         1,300.4         1,309.3         1,318.2         1,327.1  
Other1
      116.9         116.9         116.9         116.9         116.9  
                                                   
Total
    $ 5,533.8       $ 5,594.5       $ 5,655.2       $ 5,715.9       $ 5,776.6  
                                                   
                                                   
 
1 Includes reserves for personal and commercial auto physical damage claims and our non-auto lines of business; no change in estimates is presented due to the immaterial level of these reserves.
 
Note: Every percentage point change in our estimate of severity for the 2007 accident year would impact our personal auto liability reserves by $51.8 million and our commercial auto liability reserves by $8.9 million.
 
Our 2007 year-end loss and LAE reserve balance also includes claims from prior years. Claims that occurred in 2007, 2006 and 2005, in the aggregate, accounted for approximately 91% of our reserve balance. If during 2008 we were to experience the indicated change in our estimate of severity for the total of the prior three accident years (i.e., 2007, 2006 and 2005), the impact to our year-end 2007 reserve balances would be as follows:
 
                                                   
      Estimated Changes in Severity for Accident Years 2007, 2006 and 2005  
(millions)     -2%       -1%       As Reported       +1%       +2%  
Personal Auto Liability
    $ 3,924.0       $ 4,076.5       $ 4,229.0       $ 4,381.5       $ 4,534.0  
Commercial Auto Liability
      1,257.1         1,283.2         1,309.3         1,335.4         1,361.5  
Other1
      116.9         116.9         116.9         116.9         116.9  
                                                   
Total
    $ 5,298.0       $ 5,476.6       $ 5,655.2       $ 5,833.8       $ 6,012.4  
                                                   
                                                   
 
1 Includes reserves for personal and commercial auto physical damage claims and our non-auto lines of business; no change in estimates is presented due to the immaterial level of these reserves.
 
Note: Every percentage point change in our estimate of severity for the total of accident years 2007, 2006 and 2005 would impact our personal auto liability reserves by $152.5 million and our commercial auto liability reserves by $26.1 million.


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Our best estimate of the appropriate amount for our reserves as of year-end 2007 is included in our financial statements for the year. Our goal is to ensure that total reserves are adequate to cover all loss costs, while sustaining minimal variation from the time reserves are initially established until losses are fully developed. At the point in time when reserves are set, we have no way of knowing whether our reserve estimates will prove to be high or low (and, thus, whether future reserve development will be favorable or unfavorable), or whether one of the alternative scenarios discussed above is “reasonably likely” to occur. During 2007, our estimate of the needed reserves at the end of 2006 increased 1.5%. The following table shows how we have performed against this goal over the last ten years.
 
                                                                                         
($ in millions)
                                                                 
For The Years Ended
                                                                 
December 31,   1997     1998     1999     2000     2001     2002     2003     2004     2005     2006     2007  
 
 
Loss and LAE Reserves1
  $ 1,867.5     $ 1,945.8     $ 2,200.2     $ 2,785.3     $ 3,069.7     $ 3,632.1     $ 4,346.4     $ 4,948.5     $ 5,313.1     $ 5,363.6     $ 5,655.2  
Re-estimated reserves as of:
                                                                                       
One year later
    1,683.3       1,916.0       2,276.0       2,686.3       3,073.2       3,576.0       4,237.3       4,592.6       5,066.2       5,443.9          
Two years later
    1,668.5       1,910.6       2,285.4       2,708.3       3,024.2       3,520.7       4,103.3       4,485.2       5,130.5                
Three years later
    1,673.1       1,917.3       2,277.7       2,671.2       2,988.7       3,459.2       4,048.0       4,501.6                      
Four years later
    1,669.2       1,908.2       2,272.3       2,666.9       2,982.7       3,457.8       4,070.0                            
Five years later
    1,664.7       1,919.0       2,277.5       2,678.5       2,993.7       3,475.4                                  
Six years later
    1,674.5       1,917.6       2,284.9       2,683.7       3,002.5                                        
Seven years later
    1,668.4       1,921.9       2,287.4       2,688.4                                              
Eight years later
    1,673.9       1,923.4       2,291.9                                                    
Nine years later
    1,675.5       1,928.5                                                          
Ten years later
    1,680.8                                                                
Cumulative Development:
                                                                                       
Favorable/(unfavorable)
  $ 186.7     $ 17.3     $ (91.7 )   $ 96.9     $ 67.2     $ 156.7     $ 276.4     $ 446.9     $ 182.6     $ (80.3 )        
Percentage2
    10.0       .9       (4.2 )     3.5       2.2       4.3       6.4       9.0       3.4       (1.5 )        
 
1 Represents loss and LAE reserves net of reinsurance recoverables on net unpaid losses at the balance sheet date.
 
2 Cumulative development ¸ loss and LAE reserves.
 
Note: The chart above represents the development of the property-casualty loss and LAE reserves for 1997 through 2006. The last line in the triangle for each year represents the following:
 
Re-estimated reserves = Total amount paid to-date + Total remaining case reserves on unsettled claims.
 
Changes in the estimated severity and the actual number of late reported claims are the cause of the change in our re-estimated reserves from year to year. The cumulative development represents the aggregate change in our estimates over all years.
 
We experienced significant favorable reserve development through the mid-1990’s until 1997, primarily due to decreasing bodily injury severity, while the carried reserves anticipated an increasing severity. From 1998 through 2001, we experienced an increase in bodily injury severity and, as a result, saw our reserve development much closer to our original estimates. The bodily injury severity change was much lower than we expected between 2002 and 2006. As a result, the reserve run-off for these years was very favorable. In 2007, the realization of higher prior years’ severity than anticipated resulted in our reserves developing unfavorably by 1.5%. Not only did this development impact 2006, but also impacted the run-off of most of the past year-end reserves. In 2007, the estimated severity for accident years 2005 and 2006, was higher than our estimated severity at the end of 2006 by 1.0% and .7%, respectively, for our personal auto products and by 4.0% and 7.7% for our commercial auto products.
 
Because Progressive is primarily an insurer of motor vehicles, we have minimal exposure as an insurer of environmental, asbestos and general liability claims.
 
B.  Other-than-Temporary Impairment
Companies are required to perform periodic reviews of individual securities in their investment portfolios to determine whether a decline in the value of a security is other than temporary. A review for other-than-temporary impairment (OTI) requires companies to make certain judgments regarding the materiality of the decline; its effect on the financial statements; the probability, extent and timing of a valuation recovery; and the company’s ability and intent to hold the security. The scope of this review is broad and requires a forward-looking assessment of the fundamental characteristics of a security, as well as market-related prospects of the issuer and its industry.
 
Pursuant to these requirements, we assess valuation declines to determine the extent to which such changes are attributable to (i) fundamental factors specific to the issuer, such as financial conditions, business prospects or other factors, or (ii) market-related factors, such as interest rates or equity market declines (i.e., negative returns at either a sector index level or the broader market level). This evaluation reflects our assessment of current conditions, as well as


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predictions of uncertain future events, that may have a material effect on the financial statements related to security valuation.
 
For fixed-income investments with unrealized losses due to market- or industry-related declines where we have the intent and ability to hold the investment for the period of time necessary to recover a significant portion of the investment’s impairment and collect the interest obligation, declines are not deemed to qualify as other than temporary. Our policy for common stocks with market-related declines is to recognize impairment losses on individual securities with losses that are not reasonably expected to be recovered under historical market conditions when the security has been in such a loss position for three consecutive quarters.
 
When persuasive evidence exists that causes us to evaluate a decline in fair value to be other than temporary, we reduce the book value of such security to its current fair value, recognizing the decline as a realized loss in the income statement. All other unrealized gains (losses) are reflected in shareholders’ equity.
 
The following table stratifies the gross unrealized losses in our portfolio at December 31, 2007, by duration in a loss position and magnitude of the loss as a percentage of the cost of the security. The individual amounts represent the additional OTI loss we would have recognized in the income statement if our policy for market-related declines was different from what is stated above.
 
                                             
          Total Gross
                       
          Unrealized
  Decline of Investment Value  
(millions)   Fair Value     Losses   >15%     >25%     >35%     > 45%  
 
 
Unrealized loss for 1 quarter
  $ 1,198.1     $110.3   $ 67.8     $ 8.0     $ 6.8     $ .7  
Unrealized loss for 2 quarters
    826.6     159.7     133.3       33.7       16.8        
Unrealized loss for 3 quarters
    581.5     45.0     17.9       7.0       .3        
Unrealized loss for 1 year or longer
    2,038.9     99.5     33.6       24.6              
Total
  $ 4,645.1     $414.5   $ 252.6     $ 73.3     $ 23.9     $ .7  
   
 
We determined that none of the securities represented by the table above met the criteria for other-than-temporary impairment write-downs. However, if we had decided to write down all securities in an unrealized loss position for one year or longer where the securities decline in value exceeded 25%, we would have recognized an additional $24.6 million of OTI losses in the income statement.
 
Of the $99.5 million of unrealized losses existing for a period of one year or longer, $33.6 million of the losses had a decline in value greater than 15% of our initial investment; these losses included $24.6 million with a greater than 25% decline in value. These losses are contained to five issuers within the financial services sector that have significant exposure to sub-prime loans and securities backed by sub-prime loans. Prior to the fourth quarter, these securities were trading at relatively modest losses. As early as the third quarter, the losses related to our sub-prime exposure ranged between 5% and 10% of our original investment. The remaining $65.9 million of losses for a period of one year or longer had declines in value of less than 15%, of which $32.3 million were related to three securities in the financial sector.
 
We completed a thorough review of the securities in this loss category and determined that there was not enough evidence to conclude that these securities were other-than-temporarily impaired. We will continue to closely monitor these securities to determine if a future impairment write-down is necessary.
 
We have the intent and ability to hold these investments for the period of time necessary to recover a significant portion of the investments’ impairment and collect the interest obligations, and will do so, as long as the securities continue to be consistent with our investment strategy. We will retain the common stocks to maintain correlation to the Russell 1000 Index as long as the portfolio and index correlation remain similar. If our strategy were to change and these securities were impaired, we would recognize a write-down in accordance with our stated policy.
 
Since total unrealized losses are already a component of our shareholders’ equity, any recognition of additional OTI losses would have no effect on our comprehensive income or book value.


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Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995: Statements in this report that are not historical fact are forward-looking statements that are subject to certain risks and uncertainties that could cause actual events and results to differ materially from those discussed herein. These risks and uncertainties include, without limitation, uncertainties related to estimates, assumptions and projections generally; inflation and changes in economic conditions (including changes in interest rates and financial markets); the accuracy and adequacy of our pricing and loss reserving methodologies; the competitiveness of our pricing and the effectiveness of our initiatives to retain more customers; initiatives by competitors and the effectiveness of our response; our ability to obtain regulatory approval for requested rate changes and the timing thereof; the effectiveness of our brand strategy and advertising campaigns relative to those of competitors; legislative and regulatory developments; disputes relating to intellectual property rights; the outcome of litigation pending or that may be filed against us; weather conditions (including the severity and frequency of storms, hurricanes, snowfalls, hail and winter conditions); changes in driving patterns and loss trends; acts of war and terrorist activities; our ability to maintain the uninterrupted operation of our facilities, systems (including information technology systems) and business functions; court decisions and trends in litigation and health care and auto repair costs; and other matters described from time to time in our releases and publications, and in our periodic reports and other documents filed with the United States Securities and Exchange Commission. In addition, investors should be aware that generally accepted accounting principles prescribe when a company may reserve for particular risks, including litigation exposures. Accordingly, results for a given reporting period could be significantly affected if and when a reserve is established for one or more contingencies. Reported results, therefore, may appear to be volatile in certain accounting periods.


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The Progressive Corporation and Subsidiaries
Ten Year Summary - Financial Highlights
(unaudited)
 
(millions - except ratios, per share amounts and number of people employed)
 
                                         
    2007     2006     2005     2004     2003  
 
 
Insurance Companies Selected Financial Information and Operating Statistics — Statutory Basis
                                       
Net premiums written
  $ 13,772.5     $ 14,132.0     $ 14,007.6     $ 13,378.1     $ 11,913.4  
Growth
    (3 )%     1 %     5 %     12 %     26 %
Policyholders’ surplus
  $ 4,587.3     $ 4,963.7     $ 4,674.1     $ 4,671.0     $ 4,538.3  
Net premiums written to policyholders’ surplus ratio
    3.0       2.8       3.0       2.9       2.6  
Loss and loss adjustment expense ratio
    71.6       66.6       68.1       65.0       67.4  
Underwriting expense ratio
    21.1       19.9       19.3       19.6       18.8  
Statutory combined ratio
    92.7       86.5       87.4       84.6       86.2  
Selected Consolidated Financial Information — GAAP Basis
                                       
Total assets
  $ 18,843.1     $ 19,482.1     $ 18,898.6     $ 17,184.3     $ 16,281.5  
Total shareholders’ equity
    4,935.5       6,846.6       6,107.5       5,155.4       5,030.6  
Common Shares outstanding
    680.2       748.0       789.3       801.6       865.8  
Common Share price:
                                       
High
  $ 25.16     $ 30.09     $ 31.23     $ 24.32     $ 21.17  
Low
    17.26       22.18       20.35       18.28       11.56  
Close (at December 31)
    19.16       24.22       29.20       21.21       20.90  
Market capitalization
  $ 13,032.6     $ 18,116.6     $ 23,040.7     $ 17,001.9     $ 18,088.9  
Book value per Common Share
    7.26       9.15       7.74       6.43       5.81  
Return on average common shareholders’ equity
    19.5 %     25.3 %     25.0 %     30.0 %     29.1 %
Debt outstanding
  $ 2,173.9     $ 1,185.5     $ 1,284.9     $ 1,284.3     $ 1,489.8  
Ratios:
                                       
Debt to total capital
    30.6 %     14.8 %     17.4 %     19.9 %     22.8 %
Price to earnings
    11.6       11.5       16.7       11.1       14.7  
Price to book
    2.6       2.6       3.8       3.3       3.6  
Earnings to fixed charges
    13.5x       24.7x       21.3x       27.1x       18.8x  
Net premiums earned
  $ 13,877.4     $ 14,117.9     $ 13,764.4     $ 13,169.9     $ 11,341.0  
Total revenues
    14,686.8       14,786.4       14,303.4       13,782.1       11,892.0  
Underwriting margins:1
                                       
Personal Lines
    7.0 %     12.3 %     11.0 %     14.1 %     12.1 %
Commercial Auto
    10.1 %     19.8 %     17.9 %     21.1 %     17.5 %
Other indemnity2
    NM       NM       NM       NM       NM  
Total underwriting operations
    7.4 %     13.3 %     11.9 %     14.9 %     12.7 %
Net income
  $ 1,182.5     $ 1,647.5     $ 1,393.9     $ 1,648.7     $ 1,255.4  
Per share (diluted basis)
    1.65       2.10       1.74       1.91       1.42  
Dividends declared per share
    2.1450       .0325       .0300       .0275       .0250  
Number of people employed
    26,851       27,778       28,336       27,085       25,834  
 
All share and per share amounts were adjusted for the May 18, 2006, 4-for-1 stock split and the April 22, 2002, 3-for-1 stock split.
 
1 Underwriting margins are calculated as pretax underwriting profit (loss), as defined in Note 9 — Segment Information, as a percentage of net premiums earned.
 
2 In 2003, we ceased writing business for our lender’s collateral protection program. As a result, underwriting margin is not meaningful (NM) for our other indemnity businesses due to the low level of premiums earned by, and the variability of losses in, such businesses after that date.


App.-A-58


Table of Contents

 
(millions - except ratios, per share amounts and number of people employed)
 
                                         
    2002     2001     2000     1999     1998  
 
 
Insurance Companies Selected Financial Information and Operating Statistics — Statutory Basis
                                       
Net premiums written
  $ 9,452.0     $ 7,260.1     $ 6,196.1     $ 6,124.7     $ 5,299.7  
Growth
    30 %     17 %     1 %     16 %     14 %
Policyholders’ surplus
  $ 3,370.2     $ 2,647.7     $ 2,177.0     $ 2,258.9     $ 2,029.9  
Net premiums written to policyholders’ surplus ratio
    2.8       2.7       2.8       2.7       2.6  
Loss and loss adjustment expense ratio
    70.9       73.6       83.2       75.0       68.5  
Underwriting expense ratio
    20.4       21.1       21.0       22.1       22.4  
Statutory combined ratio
    91.3       94.7       104.2       97.1       90.9  
Selected Consolidated Financial Information — GAAP Basis
                                       
Total assets
  $ 13,564.4     $ 11,122.4     $ 10,051.6     $ 9,704.7     $ 8,463.1  
Total shareholders’ equity
    3,768.0       3,250.7       2,869.8       2,752.8       2,557.1  
Common Shares outstanding
    871.8       881.2       882.2       877.1       870.5  
Common Share price:
                                       
High
  $ 15.12     $ 12.65     $ 9.25     $ 14.52     $ 14.33  
Low
    11.19       6.84       3.75       5.71       7.83  
Close (at December 31)
    12.41       12.44       8.64       6.09       14.11  
Market capitalization
  $ 10,819.3     $ 10,958.6     $ 7,616.8     $ 5,345.4     $ 12,279.7  
Book value per Common Share
    4.32       3.69       3.25       3.14       2.94  
Return on average common shareholders’ equity
    19.3 %     13.5 %     1.7 %     10.9 %     19.3 %
Debt outstanding
  $ 1,489.0     $ 1,095.7     $ 748.8     $ 1,048.6     $ 776.6  
Ratios:
                                       
Debt to total capital
    28.3 %     25.2 %     20.7 %     27.6 %     23.3 %
Price to earnings
    16.6       27.2       164.5       18.5       27.7  
Price to book
    2.9       3.4       2.7       1.9       4.8  
Earnings to fixed charges
    13.2x       10.7x       1.3x       5.7x       10.2x  
Net premiums earned
  $ 8,883.5     $ 7,161.8     $ 6,348.4     $ 5,683.6     $ 4,948.0  
Total revenues
    9,294.4       7,488.2       6,771.0       6,124.2       5,292.4  
Underwriting margins:1
                                       
Personal Lines
    7.5 %     4.5 %     (5.2 )%     1.2 %     7.9 %
Commercial Auto
    9.1 %     8.3 %     3.3 %     8.4 %     17.6 %
Other indemnity2
    7.2 %     7.0 %     13.6 %     10.8 %     8.6 %
Total underwriting operations
    7.6 %     4.8 %     (4.4 )%     1.7 %     8.4 %
Net income
  $ 667.3     $ 411.4     $ 46.1     $ 295.2     $ 456.7  
Per share (diluted basis)
    .75       .46       .05       .33       .51  
Dividends declared per share
    .0240       .0233       .0225       .0218       .0208  
Number of people employed
    22,974       20,442       19,490       18,753       15,735  


App.-A-59


Table of Contents

The Progressive Corporation and Subsidiaries
Quantitative Market Risk Disclosures
(unaudited)
 
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, 2007, and the potential for near-term losses from reasonably possible near-term changes in market rates or prices. We had no trading financial instruments at December 31, 2007.
 
OTHER-THAN-TRADING FINANCIAL INSTRUMENTS
 
Financial instruments subject to interest rate risk were:
 
                                         
    Fair Value  
    -200 bps
    -100 bps
          +100 bps
    +200 bps
 
(millions)   Change     Change     Actual     Change     Change  
 
 
U.S. government obligations
  $ 1,519.5     $ 1,358.0     $ 1,207.1     $ 1,066.9     $ 937.4  
State and local government obligations
    3,974.0       3,856.0       3,745.1       3,641.8       3,545.5  
Asset-backed securities
    2,612.4       2,562.4       2,511.6       2,461.6       2,413.8  
Corporate securities
    1,179.9       1,127.5       1,078.4       1,032.5       989.4  
Preferred stocks
    2,375.6       2,323.8       2,270.3       2,228.3       2,184.0  
Other debt securities1
    706.1       673.2       642.7       614.5       588.6  
Short-term investments
    382.4       382.4       382.4       382.4       382.4  
Balance as of December 31, 2007
  $ 12,749.9     $ 12,283.3     $ 11,837.6     $ 11,428.0     $ 11,041.1  
   
Balance as of December 31, 2006
  $ 13,110.5     $ 12,707.5     $ 12,321.1     $ 11,954.2     $ 11,608.4  
   
 
1 Includes $612.5 million in redeemable preferred stocks.
 
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, which includes any issuer-specific features, such as a call option. Asset-backed securities, including state and local government housing securities, are priced assuming deal-specific prepayment scenarios, considering the deal structure, prepayment penalties, yield maintenance agreements and the underlying collateral.
 
Financial instruments subject to equity market risk were:
 
                         
          Hypothetical
 
    Fair
    Market Changes  
(millions)   Value     +10%     -10%  
 
 
Common equities as of December 31, 2007
  $ 2,327.5     $ 2,560.3     $ 2,094.8  
Common equities as of December 31, 2006
  $ 2,368.1     $ 2,604.9     $ 2,131.3  
 
The model represents the estimated value of our common equity portfolio given a +/- 10% change in the market, based on the common stock portfolio’s weighted average beta of 1.0. The beta is derived from recent historical experience, using the S&P 500 as the market surrogate. The historical relationship of the common stock portfolio’s beta to the S&P 500 is not necessarily indicative of future correlation, as individual company or industry factors may affect price movement. Betas are not available for all securities. In such cases, the change in fair value reflects a direct +/- 10% change; the number of securities without betas is approximately 1%, and the remaining 99% of the equity portfolio is indexed to the Russell 1000.


App.-A-60


Table of Contents

As an additional supplement to the sensitivity analysis, we present results from a value-at-risk (VaR) analysis used to estimate and quantify our market risks. VaR is the expected loss, for a given confidence level, of our portfolio due to adverse market movements in an ordinary market environment. The VaR estimates below are used as a risk measurement and reflect an estimate of potential reductions in fair value of our portfolio for the following 66 trading days (three-month intervals) at the 99th percentile loss. We use the 66-day VaR for contingency capital planning. During the year, we changed from reporting the 95th percentile loss to the 99th percentile loss to align with the current trends in risk management; prior periods were restated. Under the 99th percentile analysis, we would expect the stated VaR for a 66-day horizon to be exceeded once in 100 quarters.
 
                                         
    December 31,
    September 30,
    June 30,
    March 31,
    December 31,
 
($ in millions)   2007     2007     2007     2007     2006  
 
 
66-day VaR
                                       
Fixed-income portfolio
  $ (358.5 )   $ (324.5 )   $ (279.7 )   $ (210.5 )   $ (234.1 )
% of portfolio
    (3.0 )%     (2.6 )%     (2.0 )%     (1.7 )%     (1.9 )%
% of shareholders’ equity
    (7.3 )%     (6.1 )%     (5.1 )%     (3.0 )%     (3.4 )%
Common equity portfolio
  $ (449.5 )   $ (440.9 )   $ (319.1 )   $ (316.5 )   $ (196.5 )
% of portfolio
    (19.3 )%     (18.0 )%     (12.6 )%     (13.2 )%     (8.3 )%
% of shareholders’ equity
    (9.1 )%     (8.3 )%     (5.8 )%     (4.6 )%     (2.9 )%
Total portfolio
  $ (387.8 )   $ (470.0 )   $ (465.5 )   $ (337.1 )   $ (300.9 )
% of portfolio
    (2.7 )%     (3.2 )%     (2.9 )%     (2.2 )%     (2.0 )%
% of shareholders’ equity
    (7.9 )%     (8.8 )%     (8.5 )%     (4.9 )%     (4.4 )%
 
Our VaR results are based on a stochastic simulation where all securities are marked to market under 10,000 scenarios. Fixed-income securities are priced off simulated term structures and risk is calculated based on the volatilities and correlations of the points on those curves. Equities are priced off each security’s individual pricing history. The model uses an exponentially weighted moving average methodology to forecast variance and covariance over a two-year time horizon for each security. In estimating the parameters of the forecast model, the sample mean is set to zero and the weight applied in the exponential moving average forecasts are set at .97, making the model more sensitive to recent volatility and correlations. The VaR of the total investment portfolio is less than the sum of the two components (fixed income and common equity) due to the benefit of diversification.
 
The increase in the 66-day VaR from December 31, 2006 to December 31, 2007, primarily results from volatility in the market in 2007.


App.-A-61


Table of Contents

The Progressive Corporation and Subsidiaries
Claims Payment Patterns
(unaudited)
 
The Progressive Group of Insurance Companies is primarily an insurer of automobiles and recreational vehicles owned by individuals, and trucks owned by small businesses. As such, our claims liabilities, by their very nature, are short in duration. Since our incurred losses consist of both payments and changes in the reserve estimates, it is important to understand our paid development patterns. The charts below show our personal auto claims payment patterns, reflecting both dollars and claims counts paid, for auto physical damage and bodily injury claims, as well as on a total auto basis. Since physical damage claims pay out so quickly, the chart is calibrated on a monthly basis, as compared to a quarterly basis for the bodily injury and total auto payments.
 
GRAPH
 
GRAPH
 


App.-A-62


Table of Contents

GRAPH
 
Note: The above graphs are presented for our personal auto products on an accident period basis and are based on three years of actual experience for physical damage and nine years for bodily injury and total auto.

App.-A-63


Table of Contents

The Progressive Corporation and Subsidiaries
Quarterly Financial and Common Share Data
(unaudited)
 
(millions - except per share amounts)
 
                                                                 
          Net Income     Stock Price1     Dividends
 
    Total
          Per
                      Rate of
    Declared
 
Quarter   Revenues     Total     Share2     High     Low     Close     Return3     Per Share4  
 
 
2007
                                                               
1
  $ 3,686.8     $ 363.5     $ .49     $ 24.75     $ 20.91     $ 21.82             $  
2
    3,675.9       283.7       .39       25.16       21.55       23.93               2.0000  
3
    3,709.6       299.2       .42       24.10       18.88       19.41                
4
    3,614.5       236.1       .34       20.50       17.26       19.16               .1450  
    $ 14,686.8     $ 1,182.5     $ 1.65     $ 25.16     $ 17.26     $ 19.16       (12.6 )%   $ 2.1450  
   
   
2006
                                                               
1
  $ 3,660.9     $ 436.6     $ .55     $ 30.09     $ 25.25     $ 26.07             $ .00750  
2
    3,707.9       400.4       .51       27.86       25.25       25.71               .00750  
3
    3,723.8       409.6       .53       25.84       22.18       24.54               .00875  
4
    3,693.8       400.9       .53       25.54       22.19       24.22               .00875  
    $ 14,786.4     $ 1,647.5     $ 2.10     $ 30.09     $ 22.18     $ 24.22       (17.0 )%   $ .03250  
   
   
2005
                                                               
1
  $ 3,491.8     $ 412.7     $ .51     $ 23.12     $ 20.35     $ 22.94             $ .00750  
2
    3,590.1       394.3       .49       25.22       21.88       24.70               .00750  
3
    3,622.5       305.3       .38       26.83       23.43       26.19               .00750  
4
    3,599.0       281.6       .35       31.23       25.76       29.20               .00750  
    $ 14,303.4     $ 1,393.9     $ 1.74     $ 31.23     $ 20.35     $ 29.20       37.9 %   $ .03000  
   
   
 
All per share amounts and stock prices were adjusted for the May 18, 2006, 4-for-1 stock split.
 
1 Prices as reported on the consolidated transaction reporting system. Progressive’s Common Shares are listed on the New York Stock Exchange under the symbol PGR.
 
2 Presented on a diluted basis. The sum may not equal the total because the average equivalent shares differ in the periods.
 
3 Represents annual rate of return, assuming dividend reinvestment, including the $2.00 per share extraordinary cash dividend paid in September 2007.
 
4 Progressive transitioned to an annual variable dividend policy beginning in 2007; the annual dividend of $.1450 per common share was declared by the Board of Directors in December 2007 and paid on January 31, 2008. In addition, in June 2007, Progressive’s Board declared an extraordinary cash dividend payable September 14, 2007 to shareholders of record at the close of business on August 31, 2007.


App.-A-64


Table of Contents

The Progressive Corporation and Subsidiaries
Performance Graph
(unaudited)
 
The following performance graph compares the performance of Progressive’s Common Shares (“PGR”) to the Standard & Poor’s Index (“S&P Index”) and the Value Line Property/Casualty Industry Group (“P/C Group”) for the last five years.
 
Cumulative Five-Year Total Return*
PGR, S&P Index, P/C Group (Performance Results through 12/31/07)
 
GRAPH
 
Cumulative Total Return as of December 31 of each year
(assumes $100 was invested at the close of trading on December 31, 2002)
 
                                         
    2003     2004     2005     2006     2007  
 
 
PGR
  $ 168.75     $ 171.52     $ 236.38     $ 196.35     $ 171.54  
S&P Index
    128.69       142.69       149.70       173.34       182.86  
P/C Group
    126.49       141.36       156.80       179.48       218.55  
 
Assumes reinvestment of dividends.
 
Source: Value Line, Inc.


App.-A-65


Table of Contents

The Progressive Corporation and Subsidiaries
Net Premiums Written by State
(unaudited)
 
                                                                                         
($ in millions)             2007               2006               2005               2004            2003        
 
 
Florida
  $ 1,656.9       12.0 %   $ 1,811.5       12.8 %   $ 1,774.2       12.7 %   $ 1,522.6       11.4 %   $ 1,338.2       11.2 %        
California
    1,106.4       8.0       1,085.1       7.7       982.8       7.0       892.7       6.7       736.2       6.2          
Texas
    1,072.0       7.8       1,096.0       7.8       1,126.8       8.0       1,181.1       8.8       1,126.4       9.4          
New York
    847.9       6.2       930.6       6.6       968.8       6.9       935.7       7.0       808.3       6.8          
Georgia
    748.9       5.4       751.0       5.3       749.5       5.4       733.2       5.5       614.4       5.2          
Ohio
    655.9       4.8       693.7       4.9       736.0       5.3       754.2       5.6       712.1       6.0          
Pennsylvania
    610.5       4.4       642.1       4.5       659.1       4.7       634.4       4.7       589.3       4.9          
All other
    7,074.0       51.4       7,122.0       50.4       7,010.4       50.0       6,724.2       50.3       5,988.5       50.3          
Total
  $ 13,772.5       100.0 %   $ 14,132.0       100.0 %   $ 14,007.6       100.0 %   $ 13,378.1       100.0 %   $ 11,913.4       100.0 %        
   


App.-A-66


Table of Contents

Directors
 
         
Charles A. Davis3,5,6
Chief Executive Officer,
Stone Point Capital LLC
(private equity investing)

Stephen R. Hardis1,2,5,6
Lead Director,
Axcelis Technologies, Inc.
(manufacturing)

Bernadine P. Healy, M.D.1,6
Health Editor and Medical Columnist,
U.S. News & World Report
(publishing)

Jeffrey D. Kelly2,4,6
Vice Chairman
and Chief Financial Officer,
National City Corporation
(commercial banking)

Abby F. Kohnstamm6
President and Chief Executive Officer,
Abby F. Kohnstamm & Associates, Inc.
(marketing consulting)
 
Peter B. Lewis2,4,6,7
Chairman of the Board

Norman S. Matthews3,5,6
Consultant,
formerly President,
Federated Department Stores, Inc.
(retailing)

Patrick H. Nettles, Ph.D.1,6
Executive Chairman,
Ciena Corporation
(telecommunications)

Glenn M. Renwick2
President and Chief Executive Officer

Donald B. Shackelford4,6
Chairman,
Fifth Third Bank, Central Ohio
(commercial banking)

Bradley T. Sheares, Ph.D.3,6
formerly Chief Executive Officer,
Reliant Pharmaceuticals, Inc.
(pharmaceuticals)
  1Audit Committee member
2Executive Committee member
3Compensation Committee member
4Investment and Capital
 Committee member
5Nominating and Governance
 Committee member
6Independent director
7Non-executive chairman
 
     
Corporate Officers   Other Executive Officers
 
Glenn M. Renwick
President and Chief Executive Officer

Brian C. Domeck
Vice President and Chief Financial Officer

Charles E. Jarrett
Vice President, Secretary
and Chief Legal Officer

Thomas A. King
Vice President and Treasurer

Jeffrey W. Basch
Vice President and Chief Accounting Officer

Peter B. Lewis
Chairman of the Board
(non-executive)
 
John A. Barbagallo
Commercial Lines Group President

William M. Cody
Chief Investment Officer

Susan Patricia Griffith
Chief Human Resource Officer

John P. Sauerland
Personal Lines Group President

Raymond M. Voelker
Chief Information Officer


App.-A-67


Table of Contents

Contact Non-Management Directors Interested parties have the ability to contact the non-management directors as a group by sending a written communication clearly addressed to the non-management directors and sent to any of the following:
 
Peter B. Lewis, Chairman of the Board, The Progressive Corporation, 6300 Wilson Mills Road, Mayfield Village, Ohio 44143 or e-mail: peter_lewis@progressive.com.
 
Charles E. Jarrett, Corporate Secretary, The Progressive Corporation, 6300 Wilson Mills Road, Mayfield Village, Ohio 44143 or e-mail: chuck_jarrett@progressive.com.
 
The recipient will forward communications so received to the non-management directors.
 
Accounting Complaint Procedure Any employee or other interested party with a complaint or concern regarding accounting, internal accounting controls or auditing matters relating to Progressive may report such complaint or concern directly to the Chairman of the Audit Committee, as follows: Stephen R. Hardis, Chairman of the Audit Committee, stephen_hardis@progressive.com.
 
Any such complaint or concern also may be reported anonymously over the following toll-free Alert Line: 1-800-683-3604. Progressive will not retaliate against any individual by reason of his or her having made such a complaint or reported such a concern in good faith. View the complete procedures at progressive.com/governance.
 
Whistleblower Protections Progressive will not retaliate against any officer or employee of Progressive because of any lawful act done by the employee to provide information or otherwise assist in investigations regarding conduct that the employee reasonably believes to be a violation of Federal Securities Laws or of any rule or regulation of the Securities and Exchange Commission or Federal Securities Laws relating to fraud against shareholders. View the complete Whistleblower Protections at progressive.com/governance.
 
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 18, 2008, at 10 a.m. eastern time. There were 3,851 shareholders of record on December 31, 2007.
 
Principal Office
The Progressive Corporation
6300 Wilson Mills Road
Mayfield Village, Ohio 44143
440-461-5000
progressive.com
 
24-Hour Claims Reporting and Customer Service
 
         
    Private passenger autos, motorcycles and
   
    recreational vehicles   Commercial autos/trucks
 
To report a claim
  1-800-274-4499   1-800-274-4499
For customer service        
If you bought your policy through an independent agent or broker   1-800-925-2886 (1-800-300-3693 in California) progressiveagent.com   1-800-444-4487
progressivecommercial.com
If you bought your policy directly through Progressive online or by phone   1-800-PROGRESSIVE (1-800-776-4737) progressive.com   1-800-895-2886
progressivecommercial.com
 
Common Shares The Progressive Corporation’s common shares (symbol PGR) are traded on the New York Stock Exchange. Progressive currently has an annual variable dividend policy. We expect the Board to declare the next annual variable dividend in December 2008, with a record date in January 2009 and payment shortly thereafter.
 
A complete description of our annual variable dividend policy can be found at: progressive.com/dividend.
 
Corporate Governance Progressive’s Corporate Governance Guidelines and Board Committee Charters are available at: progressive.com/governance, or may be requested in print by writing to: The Progressive Corporation, Investor Relations, 6300 Wilson Mills Road, Box W33, Mayfield Village, Ohio 44143.
 
Charitable Contributions Progressive contributes annually to The Progressive Insurance Foundation, which provides: (i) financial support to the Insurance Institute for Highway Safety to further its work in reducing the human trauma and economic costs of auto accidents, and (ii) matching funds to eligible 501(c)(3) charitable organizations to which Progressive employees contribute.


App.-A-68


Table of Contents

Counsel Baker & Hostetler LLP, Cleveland, Ohio
 
Transfer Agent and Registrar Registered Shareholders: If your Progressive shares are registered in your name, contact National City Bank regarding questions or changes to your account: National City Bank, Shareholder Services Operations Dept. 5352, P.O. Box 92301, Cleveland, Ohio 44193-0900. Phone: 1-800-622-6757 or e-mail: shareholder.inquiries@nationalcity.com.
 
Beneficial Shareholders:  If your Progressive shares are held in a brokerage or other financial institution account, contact your broker or financial institution directly regarding questions or changes to your account.
 
Shareholder/Investor Relations Progressive does not maintain a mailing list for distribution of shareholders’ reports. To view Progressive’s publicly filed documents, shareholders can access our Web site: progressive.com/sec. To view our earnings and other releases, access progressive.com/investors.
 
To request copies of Progressive’s publicly filed documents free of charge, write to: The Progressive Corporation, Investor Relations, 6300 Wilson Mills Road, Box W33, Mayfield Village, Ohio 44143, e-mail: investor_relations@progressive.com or call: 440-395-2258.
 
For financial-related information, call: 440-395-2222 or e-mail: investor_relations@progressive.com.
 
For all other Company information, call: 440-461-5000 or e-mail: webmaster@progressive.com.
 
Registered Trademarks Progressive® is a registered trademark. Net Promoter® is a registered trademark of Satmetrix Systems, Inc.
 
Online Annual Report and Proxy Statement Our 2007 Annual Report to Shareholders, in an interactive format, can be found at: progressive.com/annualreport.
 
We have also posted copies of our 2008 Proxy Statement and 2007 Annual Report to Shareholders, in a “PDF” format, at: progressiveproxy.com.
 
©2008 The Progressive Corporation


App.-A-69


Table of Contents

THE PROGRESSIVE CORPORATION
Proxy Solicited on Behalf of the Board of Directors for the 2008 Annual Meeting of Shareholders
     The undersigned hereby appoints Brian C. Domeck, Charles E. Jarrett and David M. Coffey, and each of them, with full power of substitution, as proxies for the undersigned to attend the Annual Meeting of Shareholders of The Progressive Corporation, to be held at 6671 Beta Drive, Mayfield Village, Ohio, at 10:00 a.m., local time, on April 18, 2008, and thereat, and at any adjournment thereof, to vote and act with respect to all of The Progressive Corporation Common Shares, $1.00 par value per share, which the undersigned would be entitled to vote, with all power the undersigned would possess if present in person, as follows:
1.   [ ] WITH authority to vote (except as marked to the contrary below), or

[ ] WITHOUT authority to vote,

for the election as directors of all four nominees listed below, each to serve for a term of three years.
Charles A. Davis, Bernadine P. Healy, M.D., Jeffrey D. Kelly, Abby F. Kohnstamm
(INSTRUCTION: To withhold authority to vote for any individual nominee, print that nominee’s name on the space provided below.)
 
2.   Proposal to approve amendments to the Company’s Amended Articles of Incorporation and Code of Regulations to adopt a majority voting standard in uncontested elections of directors.
[ ] FOR          [ ] AGAINST          [ ] ABSTAIN
3.   Proposal to approve an amendment to the Company’s Code of Regulations to modify the definition of a director’s “term of office.”
[ ] FOR          [ ] AGAINST          [ ] ABSTAIN
4.   Proposal to approve an amendment to the Company’s Code of Regulations to increase the maximum number of director positions from 12 to 13 and to fix the number of directors at 13.
[ ] FOR          [ ] AGAINST          [ ] ABSTAIN
5.   Proposal to ratify the appointment of PricewaterhouseCoopers LLP as the Company’s independent registered public accounting firm for 2008.
[ ] FOR          [ ] AGAINST          [ ] ABSTAIN
6.   In their discretion, to vote upon such other business as may properly come before the meeting.
This proxy, when properly executed, will be voted as specified by the shareholder. If no specifications are made, this proxy will be voted to elect the nominees identified in Item 1 above and to approve the Proposals described in Items 2, 3, 4 and 5 above.
Receipt of Notice of Annual Meeting of Shareholders and the related Proxy Statement dated March 7, 2008, is hereby acknowledged.
                     
 
  Date:          , 2008      
 
                   
 
                   
           
 
                   
           
 
                   
           
 
      Signature of Shareholder(s)            
Please sign as your name or names appear hereon. If shares are held jointly, all holders must sign. When signing as attorney, executor, administrator, trustee or guardian, please give your full title. If a corporation, please sign in full corporate name by the president or other authorized officer. If a partnership, please sign in partnership name by an authorized person.