financial review

Overview The Progressive Corporation is a holding company that does not have any revenue producing operations, property or employees of its own. The Progressive Group of Insurance Companies, together with our non-insurance subsidiaries and one mutual company affiliate, comprise what we refer to as Progressive. Progressive has been in business since 1937 and is the country’s third largest auto insurance group based on premiums written. 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. These underwriting operations, combined with our service and investment operations, make up the consolidated group.

The Progressive Corporation receives cash through subsidiary dividends, borrowings, equity 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 2006, the holding company received $1.5 billion of dividends from its subsidiaries, net of capital contributions. We used $1.2 billion to repurchase 39.1 million Progressive Common Shares, at an average cost of $24.98 per share, on a post-split basis. We also paid $25.0 million in shareholder dividends and $81.3 million in interest on our outstanding debt. On June 1, 2006, we retired our 7.30% Notes in the aggregate principal amount of $100 million at maturity. We did not issue any debt or equity securities during 2006. The holding company also has access to funds held in a non-insurance subsidiary to satisfy its obligations; at year-end 2006, $2.5 billion of marketable securities were available in this company.

On May 18, 2006, The Progressive Corporation split its Common Shares on a 4-for-1 basis in the form of a stock dividend. The purpose of the stock split was to increase the supply of our Common Shares and to improve the liquidity of the stock. We did not split our treasury shares. We ended the year with approximately 748.0 million shares outstanding, compared to approximately 789.3 million, split adjusted, at the beginning of 2006.

On a consolidated basis, we generated positive operating cash flows of $2.0 billion, portions of which were used during the year to repurchase our Common Shares, construct a data center, printing center and related facilities, and for other capital expenditures. In addition, we opened 29 new concierge-level claims service centers during the year, bringing the total number of such centers to 53. These centers are located in 41 metropolitan areas across the United States and represent our primary approach to damage assessment and facilitation of vehicle repairs in urban markets. As such, we will incorporate this approach into our product offerings in these markets and increase customers’ awareness of this distinct offering as part of our ongoing marketing and brand communication. Over the next two years, we are planning to open approximately 18 service centers, some of which will replace existing service centers. Two of these centers will be in additional urban markets while the remainder will expand our coverage in the current metropolitan areas where we have facilities.

In 2006, Progressive produced net income of $1.6 billion, or $2.10 per share, which was 18% and 21%, respectively, greater than what we earned in the prior year. Our insurance subsidiaries had a good, but not great, year during 2006. Our underwriting profitability remained exceptionally strong at 13.3%, 1.4 points better than 2005, but we experienced slow growth in premiums. In 2006, we experienced little catastrophic claims activity, compared to the significant hurricane losses incurred in 2005. Profitability for the year also benefited from 1.7 points of favorable loss reserve development from prior years, although the favorable development was .9 points less than in 2005. The expense ratio remained relatively flat, despite the environment of declining average premiums.

As discussed in prior communications, we expected that we would slowly return to more normal operating margins by allowing anticipated increases in severity, and potentially frequency, to absorb the margin in excess of our 96 combined ratio target rather than immediately price it away. Since no significant change in frequency or notable acceleration in severity appeared to emerge during the year, we re-evaluated our approach to pursuing our profitability and growth objectives. During the latter half of 2006, we began to reduce rates where we deemed appropriate. Since we are aware that not all price reductions result in good trade-offs, we assessed our market pricing relative to our goal of a 96 combined ratio. We believe that if executed effectively, we can achieve a good economic trade-off between increased retention and lower margins. Recognizing the importance of retention, we are placing increased emphasis on competitive pricing for our existing, as well as new, customers. To ensure that we stay focused, as we move forward, we will use policies in force as our preferred measure of growth. For 2006, policies in force grew 3% to 9.7 million for our Personal Lines Business and 7% to .5 million for our Commercial Auto Business.

Progressive was not alone in experiencing strong profitability on slow premium growth. It appears as if the private passenger insurance market will report its fourth consecutive year of underwriting profitability and that the industrywide earned premium for 2006 may well be lower than in 2005, something that has not happened in at least 25 years. We believe that this profitability trend is likely to continue into 2007, based on our early assessment of the marketplace.

Our Personal Lines net premiums written did not grow during 2006. With an approximate 7.6% share of the U.S. private passenger auto market, Progressive’s Personal Lines segment ranks third and competes with approximately 280 other insurance companies/groups with annual auto premiums greater than $5 million. The top 15 insurance groups account for about 75% of the estimated $161.1 billion total net premiums written in the U.S. personal auto insurance market. We are the number one writer of private passenger auto insurance through independent agencies and the third largest writer in the direct channel.

Our Commercial Auto net premiums written grew 5% in 2006. Our growth, coupled with our estimate that growth in the market remained relatively flat, leads us to believe that we are virtually tied with two other insurance company groups as the co-leaders in the commercial auto insurance market for 2006. As with the personal auto market, the commercial auto market is reporting its fourth consecutive year of underwriting profitability.

We realize that to remain competitive in the current marketplace, we not only need to continue to be good at allocating costs between consumers in ways that best match their expected costs, managing the claims and administrative costs that ultimately must be allocated, and providing superior consumer experiences, but we must become equally good at marketing our products and services. During 2006, our competitors’ stepped-up advertising increased the potential for our customers to search for lower prices in the marketplace. Toward the latter part of the year, we re-evaluated all our marketing and brand activities and made some necessary adjustments, including new advertising strategies and creative resources.

In addition to strong underwriting profitability, our investment portfolio also had a good year, with recurring investment income up 21%. Our average investment portfolio increased about 5% during the year and produced a fully taxable equivalent (FTE) total return of 7.4% for 2006, compared to 4.0% in 2005. The total return includes recurring investment income and both net realized gains (losses) and changes in unrealized gains (losses) on investment securities. By reporting on an FTE basis, we are adjusting our tax preferential securities (e.g., municipal bonds) to an equivalent measure when comparing results to taxable securities.

During the year, we maintained our asset allocation strategy of investing between 75% and 100% of our total portfolio in fixed-income securities with the balance in common equities. At December 31, 2006, 84% of the portfolio was invested in fixed-income securities and 16% was in common equities. Both asset classes performed well, with FTE total returns of 16.3% and 5.9% in the common stock and fixed-income portfolios, respectively, for 2006. Late in the second quarter, we increased the duration of our fixed-income portfolio modestly, but shortened the duration late in the year to end 2006 at a duration of 3.1 years, compared to 3.2 years at the end of 2005. The weighted average credit rating of the fixed-income portfolio increased from AA early in 2006 to AA+ at year end. 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.