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Every area of the Company functioned extraordinarily well and our fundamental strategy of seeking continuous, incremental gains on all business agendas is working. However, there are some conditions so critical to attaining the combination of growth and profit we have achieved that they deserve highlighting.
Improved Claims Quality Claims represent three-quarters of our cost structure. Maintaining accurate, timely loss settlements becomes an increasing challenge in the face of rapid growth. We entered 2003 with over 3,000 recently hired claim representatives and hiring rates continued at a torrid pace through mid-2003. We were determined not to allow the quality of claim handling to deteriorate. Our pricing assumes that future claim handling quality will be consistent with that which produced historical data. If future claim handling quality cannot support pricing assumptions, we simply cannot grow profitably -- and for Progressive there is no alternative. Our appetite for future growth will always be regulated by our most current assessment of claim handling quality.

During 2003, we hired and trained another 3,300 new claims resolution representatives, refined almost all aspects of our claims experience and, by our own demanding calibration, improved the handling on our nearly 3.3 million claim features. It was not all clear sailing. Early in the year we determined that the rate of available growth in Texas had the potential to outpace our ability to maintain consistent claim quality. Consistent with our growth objective, grow as fast as possible, constrained only by our profit objective and our ability to provide high quality service, we constrained growth in Texas for six months while we deployed additional staff and management to ensure the level of quality we expect. The action plan and employee response was Progressive at its best. We lifted growth restrictions by mid-year and completed the year with NWP growth in excess of 30% in Texas. I believe it is fair to say, thus far, our insistence on growth with no give back in quality has been a good bet.
The Product Management System Our product management system is responsible for achieving our most important objective, at least a 4% underwriting profit on all products. Individual product managers typically manage a product offering in one or two states (e.g., commercial auto in Florida, or agency auto in Arizona). These managers receive support from dedicated product design and pricing groups. In 2003, we performed over 200 rate and program revisions designed to maintain rate adequacy and reflect our best rating science in the markets we serve.

Their collective actions are impressive:
Agency Auto 45 out of 48 states were profitable; only three of the profitable states did not meet our profit objective.
Direct Auto All states were profitable; only one failed to meet our profit objective.
Special Lines (motorcycle, recreation vehicles and watercraft insurance) Offered in 48 states, had two unprofitable states and two additional states not meeting our profitability objective.
Commercial Auto Offered in 42 states and was profitable in 37 states with only one other not meeting our profitability objective.

In no state was there reason for extra concern. I share this information to highlight the operating discipline we bring to all products. We never use one state or product to subsidize another, which is central to the quality of our results and their ability to be reproduced.

In 2003, with the advantage of increasing size, we refined the controls used to evaluate intra-product performance. Our focus on clear goals, execution at the product manager level, along with continuing advances in rating and product diagnostics, allow us to feel comfortable with rapid growth. The responsibilities and challenges in the product manager role that first attracted me to the Company in 1986 are today more complex, analytically challenging, visible, and I believe, rewarding. This key role at Progressive allows us to attract and retain talented people who may not otherwise have chosen the insurance field.
Improved Customer Retention The combined growth in Progressive policies in force over the past three years is 57% -- a lot of new customers. Our goal to be Consumers' No. 1 Choice for Auto Insurance demands that we not only attract new customers, but also that we make it attractive for them to stay. The economics of growth through retention increases, which fueled part of our 2003 performance, are some of the most compelling in our business model. Answering the question, "Are customers staying with Progressive longer?" seems simple. It is not. An apparent increase in retention could represent selling proportionately more policies to a class of customers more likely to stay with us. Much like the focus on profitability targets, meaningful information is only available through analysis at the detail level. We intensely review retention data and have taken numerous actions to encourage customers to stay with us. We can happily conclude that during this cumulative growth period, the propensity for customers to stay with us has increased. Recent data suggest the rate of increase from 2002 through the first half 2003 has flattened some, and this issue has our full attention. Understanding retention behavior, measuring it, and estimating policy life and lifetime premium at an ever-increasing level of detail and accuracy provides us with ongoing opportunities for improvements.

We seek to become Consumers' No. 1 Choice for Auto Insurance through creation of a consumer proposition that is faster, fairer and better than any competitive offering. As such, Progressive remains a work in progress. Our history has been built around a clear focus on our goals, an understanding of the priority among them and a determination to improve the auto insurance experience for customers. The symbolism of a "To Do List" on the cover of this report conveys some of the many opportunities yet available to us.

In its simplest form, our business model must do two important things:
Reduce Costs and Allocate Costs Accurately Our product-focused business units continue to seek ways to advance the science of rate making to get accurate cost-based pricing at the lowest level our data will support. Sophisticated pricing allows us to grow quickly while avoiding adverse selection. Accurate cost allocation within our Agency and Direct businesses maximize the advantages of both distribution channels.

In 2003, we made significant progress in our Claims Service Center model, designed to provide end-to-end resolution for auto physical damage losses, by opening 12 new centers for a total of 19. I believe these centers are a credit to the organization, and have produced some superior outcomes. There is little question in my mind that these centers will positively change auto insurance and our cost structure. We expected and are finding benefits from improved efficiency, increased accuracy, reduced rework, improvements in repair cycle time and greater brand distinction.

There is an interesting relationship between total loss costs and the level of loss adjustment expense that is difficult to define accurately. We will be obsessive about seeking the appropriate balance as we pace our expansion. More now than ever, we are solving the right problem for consumers-- getting them back to pre-accident condition versus just paying the cost to repair their car. Our ability to do this will improve with scale.

Our skill in acquiring new customers is not yet matched by an equivalent intensity around designing policies to best meet customers' evolving needs. We recognize well the economic leverage of further retention improvements and perhaps more importantly the negative brand costs of any failure to meet customer expectations. Competitive prices are a necessary condition but alone are not sufficient to achieve the retention levels we believe are possible. We are committed to understanding the subtleties of this opportunity.

Our growing number of Progressive employee customers (myself included) are, with my encouragement, becoming our toughest critics on product and service details that could enhance the customer experience. We aspire to be recognized as the preeminent consumer franchise in auto insurance and understand this requires an extraordinary commitment to service delivery. Our surveys all show improving customer service, but valid complaints and certain survey data tell us our task is still far from done. We have committed a significant amount of talent and resources to improving all of our customer contacts.

I have often described Progressive as a technology company in the auto insurance business. Much of what we have achieved has been made possible by our talented information technology staff, and we certainly would not have been able to support our growth without extraordinary commitment to our technology capacity and capabilities. We see the future with our agents being very dependent on technology and are developing applications that allow us and our agents to do more, easier and at less cost. We are placing equal emphasis on infrastructure platforms to maintain strategic or cost advantages. For example, we are months away from replacing a billing system that does not provide the flexibility we need in today's world of bill payment options. Within 2004, our claims group will deploy new technology that better reflects the process and workflow of our claims handling. Our continuous investment in technology over the past several years has positioned us well to remain a leader in technology solutions for service delivery to both our customers and agents, and we are committed to a level of technology investment that ensures we never constrain the business.

Market conditions evolved dramatically in 2003. Competitors enjoyed the benefits of reduced frequency and generally improved pricing. We expect the 2003 industry-wide combined ratio for personal auto will be less than 100%--the second time in 25 years. We cannot predict future accident frequency rates, just as we failed to predict the extent to which frequency has fallen. However, the outlook appears generally favorable and accident severity is well in check. Given this scenario, we expect the advantages we have enjoyed due to our early positioning and rate adequacy will diminish to some degree. Nevertheless, we believe we are well positioned to advance our game plan and grow at several times the industry growth rate. Our strong margins will allow us to focus on retaining customers and to introduce new product improvements faster. Our business goals remain the same and over time we expect to see our underwriting margins moving closer to our planned 4%. Our focus remains on auto insurance and striving to be the best auto insurance choice for all consumers.

We believe the U.S. personal auto insurance market will continue to consolidate with the top 15 or 20 players growing at the expense of smaller players. Success in the auto sector will increasingly require scale and superior execution in information technology, pricing segmentation, claims handling and brand development. Progressive, the #1 writer of auto insurance through independent agencies, the #3 direct writer and #3 overall, is well positioned to execute on these requirements for success, allowing us to build sustainable margin advantages over many competitors and to reduce our exposure to the amplitude of industry profit and growth cyclicality.

Our investment and capital management strategy remains squarely focused on ensuring insurance operations have sufficient capital to support all the insurance we can profitably underwrite and service. We ended 2003 with $12.5 billion in invested assets, up from $10.3 billion in December 2002. On the same basis, shareholders' equity was $5 billion, up from $3.8 billion.

We revised two Financial Policies this year.

We restated our position on financial leverage to maintain debt below 30% of total capital, rather than between 20% and 30%. With a January 2004 repayment of $200 million of maturing debt and strong cash flow from operations, our debt level will soon drop below our previously established 20% floor. We believe we have sufficient capital to support our anticipated immediate growth.

We will begin a process in 2004 to slowly increase operating leverage through higher premiums-to-surplus ratios in our agency, direct and commercial insurance subsidiaries where permitted. We are more skilled at underwriting and believe the trade off between lower financial leverage and increased operating leverage will lead to more efficient capital usage with less risk. We will revise our policy from a simple 3:1 premiums-to-surplus ratio in favor of sustaining the ratio at efficient levels and below applicable state regulations.

Throughout the year, we reaffirmed our position that we would repurchase shares when our capital position, view of the future and the stock's price make it attractive to do so. We also repurchase shares to neutralize the dilution from stock options exercised since 2000, and restricted stock issued, which replaced the use of non-qualified stock options for long-term compensation of senior management beginning in 2003. During the year, we repurchased 5 million shares and ended the year with 216.4 million shares outstanding as compared with 218.0 million at year-end 2002.

Our reporting of results monthly is the norm for us and we continuously strive to enhance the quality of the communication. During the course of 2003, we enhanced our monthly reporting by including investment income, net income and earnings per share figures. In addition, we included a condensed GAAP balance sheet, monthly share repurchase activity and the fully taxable equivalent total return on investments. We expect our monthly releases to supplant the importance of quarterly reports in 2004. We will offer brief management analyses each month to anticipate owners' and analysts' questions.

From one perspective, Progressive has changed significantly from only a few years ago: new products, new means of distribution, new services, new facilities, and many new faces--there are now over 25,000 Progressive people. What hasn't changed are our objectives and values. In 1974, then CEO and now Chairman, Peter Lewis wrote "There is a simpler, easier way--but it's not the Progressive way. Our way is not easy and we may even be crazy--but we are going to do it and we will be proud." Today, as then, our culture is defined by people who enjoy working hard, growing constantly, performing well and being rewarded competitively. Our objectives are demanding and hard to achieve, and our organization is proud when we do so.

This year was special in so many ways, but for some, the highlight was surpassing the $10 billion premium milestone, an event that seemed so Herculean when first targeted in the early 1990s. We celebrated companywide and quickly resumed work on the next items on our list. As good as 2003 was, I look forward to 2004 and continuing to build toward our aspiration of being Consumers' No.1 Choice for Auto Insurance.

We deeply appreciate the customers we are privileged to serve, the Progressive people who serve them, the agents who choose to represent us and the shareholders who believe in what we are doing.

Glenn M. Renwick
President and Chief Executive Officer

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