Objectives

Profitability Progressive’s most important goal is for our insurance subsidiaries to produce an aggregate calendar-year underwriting profit of at least 4%. Our business is a composite of many product offerings defined in part by product type, distribution channel, geography, tenure of the customer and underwriting grouping. Each of these products has targeted operating parameters based on level of maturity, underlying cost structures, customer mix and policy life expectancy. Our aggregate goal is the balanced blend of these individual performance targets in any calendar year.

Growth Our goal is to grow as fast as possible, constrained only by our profitability objective and our ability to provide high-quality customer service. Progressive is a growth-oriented company and management incentives are tied to profitable growth.

We report Personal Lines and Commercial Auto results separately. We further break down our Personal Lines’ results by channel (Drive and Direct) to give shareholders a clearer picture of the business dynamics of each distribution method and their respective rates of growth. Aggregate expense ratios and aggregate growth rates disguise the true nature and performance of each business.

Financial Policies

Progressive balances operating risk with risk of investing and financing activities in order to have sufficient capital to support all the insurance we can profitably underwrite and service. Risks arise in all operational and functional areas, and therefore must be assessed holistically, accounting for the offsetting and compounding effects of the separate sources of risk within the Company.

We use risk management tools to quantify the amount of capital needed, in addition to surplus, to absorb consequences of foreseeable events such as unfavorable loss reserve development, litigation, weather-related catastrophes and investment market corrections. Our financial policies define our allocation of risk and we measure our performance against them. If, in our view, future opportunities meet our financial objectives and policies, we will invest capital in expanding business operations. Underleveraged capital will be returned to investors. We expect to earn a return on equity greater than its cost. Presented is an overview of Progressive’s Operating, Investing and Financing policies.

Achievements

We are convinced that the best way to maximize shareholder value is to achieve these financial objectives and policies consistently. A shareholder who purchased 100 shares of Progressive for $1,800 in our first public stock offering on April 15, 1971, owned 23,066 shares on December 31, 2005, with a market value of $2,693,650, for a 23.5% compounded annual return, compared to the 7.5% return achieved by investors in the Standard & Poor’s 500 during the same period. In addition, the shareholder received dividends of $2,768 in 2005, bringing total dividends received to $34,335 since the shares were purchased.

In the ten years since December 31, 1995, Progressive shareholders have realized compounded annual returns, including dividend reinvestment, of 22.0%, compared to 9.1% for the S&P 500. In the five years since December 31, 2000, Progressive shareholders’ returns were 27.8%, compared to .6% for the S&P 500. In 2005, the returns were 37.9% on Progressive shares and 4.9% for the S&P 500.

Over the years, when we have had adequate capital and believed it to be appropriate, we have repurchased our shares. In addition, as our Financial Policies state, we will repurchase shares to neutralize the dilution from equity-based compensation programs and return any underleveraged capital to investors. During 2005, the Company repurchased 5,197,686 Common Shares during the year at a total cost of $482.8 million with an average cost of $92.89 per share. Since 1971, we spent $3.4 billion repurchasing our shares, at an average cost of $14.24 per share.

Operations Summary

Drive® Insurance from Progressive In 2005, results for Drive Insurance from Progressive were mixed. Profit margins were very healthy, with a combined ratio of 89.3. We kept our overall expense ratio flat at 20.2, despite adding significant new expenditures related to building the Drive brand. On the other hand, growth was not as strong. Our auto policies in force count grew 6%, largely due to renewals and improvements in retention, while written premiums grew only 1%, as falling average premiums per policy offset unit growth. Relative to 2004, new auto applications were down despite a slight increase in the number of quotes.

Simply put, the auto insurance market is soft. As rates drop, consumers are given less reason to shop at renewal; our data, as well as competitors’, bear this out. This declining base of shoppers is being chased by an increasingly aggressive set of competitors applying rate reductions, redesigned underwriting, and enhanced marketing and producer compensation.

Despite the competitive market, there are successes to report. After a 20-year absence, we re-entered New Jersey with our auto product. Early results are very encouraging. In addition, we believe that market dislocation and our superior handling of catastrophe-related claims in the Gulf states are creating opportunities there. The portion of our business generated by alliances with other carriers is growing. And, our Special Lines business (primarily motorcycles, boats and recreational vehicles) grew 13% nearing the $800 million mark for premiums written in 2005.

We continued to build on the introduction of our new brand, Drive Insurance from Progressive. In 2005, nearly two million unique visitors came to our new Web site, driveinsurance.com. We continued to enhance functionality of our agency-dedicated Web site, ForAgentsOnly.com, and improved our interface with agency management and comparative rating systems, making it even easier for independent agents to quote and sell our products. We also concluded extensive testing of localized marketing tactics that will allow us to offer a broad array of co-branded marketing tools to agents in 2006. Agent acceptance of the new brand is strong; our biggest problem is meeting agents’ demand for more marketing materials—not altogether a bad problem to have.

Progressive DirectSM

Progressive Direct generated solid growth in 2005, with a combined ratio of 88.3. Our expense ratio declined .5 points, resulting from more renewals and a shift to more sales on the Internet vs. phone. Net premiums written grew 10%. Growth is a function of changes in prices, new sales and customer retention. Auto insurance prices, as measured by changes in our rating plans, were relatively stable, although average earned premiums per policy decreased about 2%. New sales were up 8% and auto policies in force grew 12%, despite a slight decline in retention. We were pleased with the growth in the sale of new policies particularly in light of the continued dramatic increase in advertising spend by our competitors in 2005. Our own advertising spend increased 14% despite a decrease in our use of direct mail. We are now making more use of media such as Internet and radio. We feel our advertising creative has become more distinctive and recognizable.

Our overall new business growth has come through Internet-sales platforms, as business generated entirely through telephone contact declined. We successfully introduced a next generation Web-quoting platform that offers a much faster online quoting experience and has led to an increase in our Web application completion rate. We introduced “talk to me” functionality, allowing Internet customers to instantly start a telephone conversation with a licensed professional who can access their quote real-time and provide them counsel.

In 2005, we launched a New Jersey product that has performed to our expectations, and we are continuing to see our Special Lines business grow.

Commercial Auto

From late 2004 and throughout 2005, the commercial auto market experienced broad rate decreases for the first time in six years. Although slight in nature, this rate action comes after the industry’s extremely profitable 2004 and is indicative of the continued soft market. Competitors have also become more active in the truck owner-operator market, one of our core strengths. However, because of our competitive position in the Gulf region and our product’s entry into North and South Dakota, New Hampshire and South Carolina in 2004 and early 2005, we gained moderate share last year. Net written premiums grew 11% to $1.8 billion and policies in force rose 11%. We ended the year still the third largest writer in the commercial auto industry.

During 2005, rates were reduced in selective states when there was an opportunity to grow or in response to a significant competitive threat. In addition, accident frequency was lower than expected. We also completed a transition from 6-month to 12-month policies to better align with commercial customer preference and to increase our retention on the renewal book. As a result, we enjoyed another year of strong profits.

While the coming year will be very competitive, several opportunities await. In December, we entered New Jersey, the 6th largest commercial auto market in the country, and have been warmly received by independent agents there. In addition, a foundation has been laid to significantly expand our agency presence in North Carolina and we expect to enter West Virginia in the first quarter 2006.