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. OVERVIEWThe 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 the country’s fourth largest private passenger auto insurer based on net premiums written during 2009. Our insurance companies, offer personal automobile insurance and other specialty property-casualty insurance and related services throughout the United States. In December 2009, we began selling personal auto insurance in Australia. 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 be in the top four 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 2009, the holding company received $1.1 billion from its subsidiaries, net of capital contributions. In December 2009, the Board declared a dividend of $.1613 per share, or $108.5 million, which was paid to shareholders in February 2010. This dividend was pursuant to our annual variable dividend policy and was based on 2009 underwriting results. No dividend was paid for 2008 reflecting the comprehensive loss we reported for that year, as discussed in Financial Condition below. During 2009, we used $180.6 million to repurchase 11.1 million Progressive common shares, at an average cost of $16.34 per share. We had no debt that matured in 2009. The holding company also has access to funds held in a non-insurance subsidiary; at year-end 2009, $2.2 billion of marketable securities were available in this company. On a consolidated basis, we generated positive operating cash flows of $1.5 billion in 2009.

For 2009, Progressive generated net income of $1.1 billion, or $1.57 per share, driven by strong underwriting profitability and solid investment returns. Our insurance operations generated 3% growth in written and earned premiums and 4% growth in policies in force, and produced an 8.4% underwriting profit margin. We continued to make progress on several initiatives intended to help spur our personal auto growth. Our Commercial Auto business continues to feel the effect of the weakened economy and competitive pressures on its ability to generate both premium and policy growth, but contributed to profitability with a 14.2% underwriting margin.

During 2009, our investment portfolio generated investment income of $507.0 million with net realized gains of $27.1 million. This was a significant change from the $1.4 billion of net realized losses we recognized in 2008, driven by significant other-than-temporary impairments, as a result of market declines, primarily in our preferred stock holdings. We ended 2009 with $7.9 billion of total capital (debt and equity), $1.5 billion more than at the start of the year. We continue to manage our investing and financing activities in order to maintain sufficient capital to support all the insurance we can profitably underwrite and service.

A. Operations In 2009, our insurance subsidiaries generated underwriting profitability of 8.4%, which exceeded our targeted profitability objective of 4%. Both our Personal Lines and Commercial Auto businesses contributed to our strong profitability. In Personal Lines, only eight states did not meet or exceed their target profitability, with only three of those states actually recording an underwriting loss for the year. In Commercial Auto, only five states did not generate an underwriting profit.

We realized $136.0 million of favorable prior accident year development, which increased our profitability for 2009 by one percentage point. This development was primarily from the cost of claims settling at amounts lower than originally estimated. Just over half of this development was in our Personal Lines business, with almost all of the balance in Commercial Auto. For the year, our overall incurred auto accident frequency and severity remained relatively flat compared to the prior year, despite changes in the individual coverages. We saw a decrease in both frequency and severity in the property coverages, while both frequency and severity increased in our personal injury protection coverage. For bodily injury, we saw frequency increase in 2009 compared to 2008, and severity remain relatively flat year-over-year.

On a year-over-year basis, net premiums written and earned both increased 3%. Changes in net premiums written are a function of new business applications (i.e., issued policies), premium per policy, and retention.

During 2009, we saw total new auto applications increase 11%, primarily driven by a 20% increase in our Direct business. For the year, our Agency auto business generated a 3% increase in new applications, despite starting 2009 with significant declines. When evaluating new business application growth on a state-by-state basis, only 12 states did not see total auto applications increase in 2009. In Agency auto, 29 states saw new applications increase. For our Direct business, all but two states saw new auto applications increase on a year-over-year basis. Our Commercial Auto and special lines products both saw new applications decline about 9%. The weakened economy contributed to the decline in our Commercial Auto business, while the surge in new motorcycle and scooter business in 2008, when gas prices were at an all-time high in the United States, drove the 2009 decrease in special lines new applications on a year-over-year basis.

We are continuing with our efforts to spur personal auto growth through several initiatives underway aimed at providing consumers with distinctive new business options. These include the countrywide rollout of Name Your Price®, a program that provides Direct auto consumers the opportunity to select the price they would like to pay for auto insurance; the rollout of new product models, designed to improve competitiveness through further price segmentation; and the expansion of our usage-based insurance product, referred to as MyRate®. We are also continuing to increase our focus on the segment of customers who like to combine their auto and homeowners insurance policies, and we now have relationships with three homeowner carriers to pursue this sizeable market. In addition, in continuing to build options for the future that are in line with our strategic goals, we launched an Internet-only personal auto product in Australia during December 2009.

During 2009, on a year-over-year basis, our monthly average written premium per policy fluctuated from slightly negative to slightly positive in our Agency auto business, and ended the year relatively flat. The Direct auto business was a different story. We continued to see average written premium per policy lower than the prior year for a total decrease of 4% for the year, thus tempering the total written premium growth to 11%. The decrease in the Direct auto business written premium per policy primarily reflects the shifts in the mix of our business relating to the age of the drivers, the proof of prior insurance, and the driving records of our customers. Commercial Auto continued to see declines in premiums per policy, reflecting the continued impact of the economy on our commercial customers who are selecting less coverage and insuring fewer vehicles. The special lines products average written premiums were relatively flat year-over-year. Adjusting rates is a continuous process and we will continue to evaluate future rate needs and react quickly as we recognize changing trends.

Companywide policies in force have increased 4% on a year-over-year basis since December 31, 2008. This increase reflects about 476,000 additional Personal Lines policies and 27,000 fewer Commercial Auto policies. The biggest contributor to this growth was our Direct auto business where policies in force grew 13%, or 377,000 policies. Agency auto policies in force were relatively flat year-over-year, while our special lines products saw an increase of about 3%. The effects of the economy continued to negatively impact our Commercial Auto business as policies in force decreased 5%.

To continue to grow policies in force, it is critical that we retain our customers for longer periods, which is why increasing retention continues to be one of our most important priorities. In 2009, we continued to see an increase in customer retention. Total personal auto policy life expectancy increased 3% on a year-over-year basis, with our Agency and Direct auto policy life expectancies increasing 2% and 3%, respectively. Our Commercial Auto business policy life expectancy remained relatively flat, while our special lines products experienced a 3% decrease from the prior year. Realizing the importance that retention has on our ability to continue to grow profitably, we continue to emphasize competitive pricing, quality service, and other retention initiatives for our current customers.

B. Investments and Capital Management The fair value of our investment portfolio was $14.7 billion at December 31, 2009. During 2009, our asset allocation strategy was to maintain 0-25% of our portfolio in Group I securities (i.e., common equities, redeemable and nonredeemable preferred stocks (preferred stocks), and non-investment-grade and non-rated fixed-maturity securities), with the balance (75%-100%) of our portfolio in Group II securities (i.e., all other fixed-maturity securities, including U.S. Treasury Notes, municipal bonds, asset-backed securities, and corporate debt, as well as short-term investments). At December 31, 2009, our portfolio was allocated 20% to Group I and 80% to Group II.

Our investment portfolio produced a fully taxable equivalent (FTE) total return of 12.5% for 2009. We experienced positive FTE total returns in the fixed-income portfolio (i.e., fixed maturities, redeemable and nonredeemable preferred stocks, and short-term investments) of 12.2% and common stock portfolio of 29.5% in 2009. We continue to maintain our fixed-income portfolio strategy of investing in high-quality, shorter-duration securities given the current investment environment. We decreased the duration of our fixed-income portfolio during the year to end 2009 at 2.3 years, compared to 3.2 years at the end of 2008. The weighted average credit rating of our fixed-income portfolio ranged from AA+ early in 2009 to AA at the end of the year. Our common equity investment strategy remains an index replication approach using the Russell 1000 Index as the benchmark.

The first quarter 2009 marked the depths of the current financial crisis. A government administered bank stress test, the results of which were released in May, served as an effective tool to restore investor confidence in the solvency of the financial system. Many banks used the stress test results to raise equity capital to restore their balance sheet strength and improve their ability to weather a severe economic downturn. The recapitalization of the banking system, combined with significant liquidity injections and asset purchases by the Federal Reserve and a meaningful fiscal stimulus program, sparked a virtuous cycle of asset and economic recovery during the balance of 2009. Valuations improved for nearly all risk assets. The market values of common and preferred stock improved dramatically, credit spreads returned to within sight of their pre-crisis levels for corporate bonds, and liquidity improved markedly across all markets. Access to the capital markets returned for most issuers, alleviating fears of liquidity driven defaults. Housing markets arrested their rapid declines and, by late in the year, showed signs of improving in some regions. Although these were positive developments, significant risks remain in the financial markets and U.S. economy. Employment markets weakened sharply early in the year and remained soft at year end. Inflation readings were subdued, as low levels of resource utilization and high unemployment provided no pressure for higher wages or prices. The Federal Reserve maintained their target of 0-0.25% for the overnight funds rate and stated that it was likely to remain at an exceptionally low level for an extended period. At year-end 2009, two-year and ten-year U.S. Treasury Notes were yielding 1.11% and 3.88%, respectively, compared to 0.74% and 2.21% at the end of 2008.

Approximately 75% of our preferred stock holdings are obligations of financial sector issuers. During 2009, we recorded $213.2 million of other-than-temporary impairment losses on our redeemable and nonredeemable preferred stocks. The write-downs were due to a combination of issuer fundamentals and severe market declines where we were unable to objectively determine that the securities would substantially recover in the near term. At year-end, we had a net unrealized gain of $555.0 million in our redeemable and nonredeemable financial sector preferred stock portfolio.

At December 31, 2009, we held approximately $164.4 million of sub-prime mortgage bonds, classified as home-equity bonds. In addition, we held $28.7 million of non-prime collateralized mortgage obligations (Alt-A securities). Together, these securities had net unrealized losses of $54.8 million at year-end 2009. During 2009, we recorded other-than-temporary impairment losses of $23.7 million on home-equity securities and $4.0 million on our Alt-A securities.

Our investment results provided a substantial contribution to the increase in our capital position. We ended 2009 with $7.9 billion of total capital (debt plus equity). We continue to manage our investing and financing activities in order to maintain sufficient capital to support all the insurance we can profitably underwrite and service.


The Progressive Corporation   6300 Wilson Mills Road   Mayfield Village, Ohio 44143   440.461.5000