The Progressive Corporation | 2019 Shareholders’ Report

Our operating philosophy is to grow as fast as possible, subject to the constraints of our 96 combined ratio goal and our ability to provide excellent customer service. This philosophy is unwavering; however, overall market conditions, weather losses, and competitor actions can either help or hinder our profitable growth. Similar to 2017, we’re pleased to report that market conditions in 2018 were very favorable for profitable growth and those conditions, together with our competitively priced products, resulted in significant unit and premium growth at better than our target margins.

We entered 2018 confident that our rate level positioned us well to achieve both strong profitability and growth across products and channels. As such, during the year, we increased advertising spend in Direct and focused our Agency channel resources on prospect generation. The combination of risk selection/segmentation and about 35% lower weather-related losses than 2017, resulted in the Personal Lines business running more than 5 points more profitably than our stated targets during the year. In addition to delivering impressive profit margins, Personal Lines added over a million more new policy applications than we did in 2017, which translated to adding more than 1.5 million Personal Lines policies in force and over $4 billion of written premium during 2018. This combination of strong profitability concurrent with strong growth is incredibly rare and a testament to our disciplined strategy to leverage our leading brand, highly segmented and competitive rates, and expanding product breadth.

We continue to aspire to provide a rate for every risk and to leverage underwriting and verification to limit sales to a small percentage of consumers who don’t intend to use our products as designed. Preventing these risks from entering our book of business enables us to continue to offer more competitive prices for the vast majority of consumers, while creating the adverse selection that fuels the virtuous cycle of risk selection that we recently highlighted in our third quarter investor meeting. During 2018, we continued to invest in improving our risk selection and matching of rate to risk by advancing both our rating and underwriting models and moving variables from underwriting into rating over time. This approach ensures we can continue to rapidly bring new risk selection insights to market through blocking risk segments where we’re unable to deliver our target margins, then we follow up by pricing for many of these segments through opening up our accessibility in subsequent product releases.

In addition, matching rate to risk better than our competitors enables us to have highly competitive rates, while also delivering industry leading underwriting margins. We started deploying our latest auto product model, 8.5, early in 2018, and, by the end of the year, we had elevated this model in 20 states representing just over 60% of our eligible auto written premium. This new product model continues to improve the accuracy of our matching rate to risk and introduces new rating variables that improve our competitiveness, especially in more preferred segments. As we deploy this new product model, we observe higher new policy conversion rates across channels, with much larger increases in conversion on quotes sourced through comparative raters in Agency.

We often state that consumers rarely switch auto insurance companies to pay more for the same coverage, and that recognition drives an enhanced emphasis on providing consumers greater value for their premium dollar. In 2018, we continued to manage operating expenses while growing premiums, successfully reducing our Personal Lines non-acquisition expense ratio by about 7%. This relentless focus on leveraging our scale and investing to capitalize on consumer technology adoption to reduce operating expenses is an essential element of our long-term strategy.

Our Snapshot^® usage-based insurance program continues to grow and help safe drivers save even more with Progressive. Every year, we collect billions of additional miles of driving data, which helps us advance our segmentation and pricing sophistication. We leverage this rapidly growing treasure trove of driving data by continuing to invest to increase both the predictive power of our usage-based rating algorithms and to bring the savings available through these highly predictive offerings to more consumers. After deploying our mobile app-based Snapshot offering to the majority of the country in 2017, during 2018, we introduced a new algorithm for pricing mobile app Snapshot users that is currently available in 10 states with plans to roll out more broadly by year end. We expect the algorithm to provide more accurate pricing through a wider range of rates and new segmentation based on mobile device usage while driving. Additionally, we introduced larger participation discounts intended to drive greater adoption among new customers.

The powerful combination of lower operating expenses, more accurate and efficient claims handling, and better rate-to-risk matching enables us to keep prices low for our customers. We’re pleased to report that for the fifth year in a row, new customers who saved when switching to Progressive during 2018 reported saving more money doing so this year than in any previously reported period.

The Commercial Lines business continued the growth momentum of the past few years recording 2018 net premiums written of $4 billion, an increase of 28% over the prior year. Premium growth in for-hire transportation and transportation network company business were each a significant contributor, though we experienced growth across all commercial auto market tiers in both premium and vehicles insured. We continue to receive tremendous support from the independent insurance agency channel, which grew premium 25%, while our direct channel business grew a solid 20%, excluding premium retained from our transportation network company business. The compounded annual growth rate for Commercial Lines over the last four years has been a robust 23%.

The U.S. commercial auto insurance industry continued to struggle with profitability in 2018 and is expected to produce its eighth consecutive calendar-year combined ratio greater than 100 when final results are in. Nonetheless, many of our key competitors are realizing the effects of corrective action and have achieved, or are close to achieving, underwriting profitability. We believe we are well positioned with adequate rates, competitive pricing, and improved segmentation to fare well in what we anticipate will be a more competitive 2019 market environment.

While we celebrate growth, and are proud to have increased our commercial auto market share by more than 50% since 2014, our top priority remains earning an acceptable underwriting profit consistent with our targets. The 2018 calendar year combined ratio was 86.7, an impressive result given record growth in premium and an influx of much new business. The contribution of prior year favorable development to the combined ratio was modest, $4.4 million, or about one tenth of a point.

The higher policy limit profile and smaller scale of our Commercial Lines business leads to much greater loss ratio volatility at the individual state level than we experience in personal auto. Even with that, 39 of our 50 states were at or better than their combined ratio target in 2018 and only two states had consecutive year misses. Our commitment to monitoring loss trends, development, and market dynamics at the granular state and business market target level continued to serve us well, ensuring that we could react quickly and appropriately to changes in our loss costs or the demand function.

With current rate levels viewed as adequate, our planned program rate changes for the first half of 2019 will focus on introducing new segmentation and product features designed to improve competitiveness for preferred business. Of course, we retain the capacity to make rapid rate level adjustments if we experience any unanticipated changes in market conditions.

2018 was the first full year of deployment of our Smart Haul^® telematics-based insurance product for trucking risks using an electronic logging device (ELD), with the program now available in 46 states. The market response has been quite positive, leading to substantially higher sales conversion for prospects that choose to share a retrospective view of their ELD data with us when they quote. Not surprisingly, the business mix for quoted and sold Smart Haul policies skews heavily toward preferred risks, as measured by our proprietary risk scoring model. Beyond the predictive power of the behavioral and usage data provided by the ELD, we are excited about the acquisition potential of being able to target the very best risks. We have entered into a cooperative marketing agreement with the leading provider of ELDs to owner/operator and small fleet trucking businesses and believe this and similar efforts can be a significant driver of future demand and a positive disrupter in the truck space.

In addition to the positive market response to Smart Haul, we were pleased with the overall progress made in our two truck-oriented business market targets, for-hire transportation and for-hire specialty. Considerable headway was made in penetrating the preferred truck insurance market. Preferred, for us, represents a $4 billion addressable market comprised of tenured, financially responsible operators with strong safety records, and one where we have considerable opportunity to grow. Preferred truck policies in force grew by 25% year over year and, when combined with a modest increase in insured vehicles per policy and a positive rate environment, produced a 45% year-over-year gain in preferred truck written premium. The growth was encouraging as it reflects improvements made in rate segmentation and greater acceptance by agents of Progressive as a favored market for preferred risks. We are optimistic that additional product enhancements scheduled for 2019 should keep this momentum going.

In 2018, we expanded our insurance relationship with Uber beyond the state of Texas to the additional states of Arizona, Colorado, and Florida. The business is meeting our internal expectations and we see considerable upside. We share Uber’s strong commitment to using data and technology to better manage risk, improve driver and rider safety, and reduce loss costs. We look forward to deepening this relationship and expanding to additional states in 2019.

We continued to expand in the non-auto, small business insurance space as we seek to become a destination insurer for the small business owner. In the third quarter 2018, we had a successful soft launch of BusinessQuote Explorer^® (BQX), a digital application that allows small business owners to easily and confidently obtain quotes for general liability, business owners policies (BOP), workers compensation, and professional liability insurance from a select group of unaffiliated partner carriers. Policy sales generated through BQX are supported by our in-house agency and, in some cases, directly by the partner’s service center. The retention benefits of multi-product sales are well established, and meeting more of our business customers’ insurance needs increases our addressable market for auto while generating additional revenue from non-auto lines. We are early in the development of BQX and have several enhancements already in process to improve the customer experience, provide more products and options, and increase the efficiency of our in-house agency. We anticipate that fulfilling the vision for this platform will create a virtuous cycle where success fosters greater consumer insight and relevancy, improves customer retention, funds additional marketing, and grows future demand.

Our Property strategy is meant to complement our multi-channel auto offerings with leading property products in order to increase our share of the bundled home and auto market. In the agency channel, we offer residential property insurance for homeowners, other property owners, and renters through our majority-owned insurance company, American Strategic Insurance (ASI). In the direct channel, we distribute residential property insurance policies written by ASI and other non-affiliated carriers directly to consumers both on and offline.

During 2018, our Property business had net premiums written of $1.5 billion, an increase of 33% over last year. New Property applications increased by about 50%, with policies in force ending the year at 1.9 million. Part of the year-over-year increase reflects business we began writing when an unaffiliated carrier stopped offering homeowners insurance through our in-house agency during 2018.

The Property business combined ratio for 2018 was 106.9, which includes 5.6 points of amortization expense related to Progressive’s acquisition of a majority interest in ASI in 2015. Underwriting expenses and non-catastrophe losses were close to our expectations but retained catastrophe losses were higher than expected. We benefited from our purchases of substantial levels of reinsurance to protect our capital against unlikely severe catastrophe events, reduce volatility, and increase the likelihood of achieving target profit margins. In 2018, we ceded $70 million in Hurricane Michael incurred losses and loss adjustment expenses to reinsurers in our catastrophe reinsurance program. Our total incurred losses and loss adjustment expenses from Hurricane Florence were $6 million, well below the $60 million catastrophe reinsurance attachment point, so none of that cost was recoverable under our reinsurance program. Our total in retained losses from both storms added 5.1 points to the 2018 Property combined ratio.

The combination of ASI property (now branded as Progressive Home) and Progressive auto insurance in states beyond ASI’s original coastal states is producing a continued shift in the state mix of our Property business. For 2018, Florida accounted for 13% of new homeowners policies and Texas accounted for 12%, with the remaining states accounting for the balance. As of year-end 2018, the mix of homeowners policies in force was 27% in Florida, 16% in Texas, and 57% in other states.

The four key priorities for our Property strategy remain the same as last year: 1) expanding Progressive Home’s product availability and agent distribution in new and recently entered states; 2) increasing the competitiveness of Progressive auto and home bundles, while still meeting our underwriting profit objectives for each product; 3) improving agent ease of use for quoting and selling Progressive Home policies; and 4) expanding our direct property offering through investing resources to increase consumer awareness and maximize sales yield. We made significant progress against these goals during 2018.

We now have just over 3,300 Platinum agents, up 45% from the end of 2017. Auto and home bundles from Platinum agents were up about 40% in 2018.

The new Portfolio agent quoting platform makes it much easier for agents to quote and sell auto and home policy bundles. This system is now live for agents in three states and will be rolled out more broadly during 2019.

In the direct channel, we introduced online buying for homeowner shoppers in four states, with plans for further expansion during 2019. This allows users of our HomeQuote Explorer^® shopping service to purchase their policy online, often without needing to talk with a sales representative. Direct channel sales of home and renters policies now account for 30% of new policies sold (excluding book rolls from competitors, which don’t reflect natural consumer shopping activity).

We feel good about our progress in 2018 in expanding the capacity of our Property offerings in both the agency and direct channels. We met our customer service goals despite very strong new sales growth, and we have strengthened the organization to prepare for continued growth. We entered 2019 with strong momentum and optimism about our ability to return the Property business to profitability and continue to attract bundled auto and home customers.