Complementing our underwriting income, our investment group contributed $408 million of interest and dividend income, $224 million in realized gains, and about $115 million in unrealized gains for the year, reflecting a 4.5% total return on our $19 billion portfolio. The total return trailed last year’s equivalent, reflecting in large part market conditions, a less robust equities rally, and our continued disciplined fixed-income duration strategy.

The all-in measures of net income per share and, our preferred, comprehensive income per share were $2.15 and $2.27, both improvements over their equivalents last year by 11% and 10%. Our return on shareholders’ equity using both measures was a touch over 19% and 20%, results we would assess as very acceptable, while providing room for even superior outcomes, if and when financial market returns strengthen. Both results are approximately a point better than last year and an important con­tribution to our long-term track record on this critical financial dimension of our business.

We would welcome an improved investment environment with interest rates more comfortably matching our longer-term investment income preference, but, by design, we are not dependent on it. We enter 2015 with a strong, well-structured capital position, bolstered by a $350 million debt offering we completed early in 2014, for a 30-year term at a coupon interest rate of 4.35%. Our debt-to-total capital ratio ended the year at 23.8%, considerably below our self-imposed guideline of not to exceed 30% for any extended period of time and thus preserving significant debt capacity should we need or choose to use it. However, several actions late in 2014 will likely move the pieces and parts of our capital model early in 2015. The most significant was our December 16th announce­ment that we would be acquiring a controlling interest in ARX, the parent entity of our strategic homeowners’ provider ASI. Once the acquisition is complete, we expect to hold approximately two thirds of the equity and purchase the remainder over the next six years. Given our strong capital position, we will be paying for this transaction, which I’ll discuss in greater detail later, from current funds on-hand when it is expected to close in early April 2015.

We have consistently stated that capital in excess of regulatory requirements and any contingencies we can envision is available for share repurchases, acquisitions, or shareholder dividends. For 2014 we had some of each. We used $271 million to repurchase 11.1 million shares during the year, the anticipated close of the ARX transaction will require approximately $875 million, and, based on our 2014 underwriting performance and Gainshare score of 1.32, we will pay, in February 2015, a variable dividend of approx­imately $404 million, or about 69 cents per share.

As breaking news while drafting this letter in mid-January, we capitalized on our debt capacity flexibility and a very favorable interest rate environment, by issuing $400 million of 30-year bonds at a 3.70% coupon. Our strong capital position just got stronger.

A synopsis of our business model in a little more detail is provided in the Objectives and Policies section of this report.

Business update

With our commitment to monthly reporting, these numerical results are often well known before publication of this letter; however, a review of the market dynamics throughout the year may serve to throw additional light on them.

After an early continuation of the strong new business growth we ended with in 2013, the trajectories for our auto product in our Agency and Direct consumer offerings went in very different directions. By the third quarter, I had characterized our Agency auto growth as flat-out disappointing, with both new application levels and retention measures lagging our plans and expectations from early in the year. We ended the year with a 2% reduction in policyholders in the Agency channel with modest written premium growth. As noted often in this letter, our preferred measure of growth is policies and vehicles in force and, as such, this has our full attention. We are acutely aware of the contributing reasons and are responding with product design, underwriting, and ease-of-use modifications where it makes sense to do so. Our commitment to this channel, and to winning in this channel, should not be underestimated.

The Direct trajectory, predictable from the aggregate results, was much more pleasing. We sold over 2 million policies in 2014, a new high watermark for us. Our advertising expend­itures and consumer messaging have also produced prospects in numbers representing new highs. More importantly, our advertising effectiveness measures were strong, notably our incremental cost per sale, and thus very encouraging as we enter 2015. Simple math skills will quickly highlight the difference between additions and the net increase in policies and, while I can report meaningfully improved policy life extension for our Direct customers in 2014, based on the trailing 12-month measure, there remains significant opportunity to retain at levels we know are possible, but to-date have not been a hallmark of Progressive. Our Destination Era thinking will address this head-on for a class of customers who are most open to a longer-term relationship.

The rating environment in 2014, never easily summarized at other than at the state and coverage level, was not inconsistent with other sources of consumer inflation or wage growth and, for us, about 3–4%.

Our Special Lines and Commercial Lines prod­­ucts each had notable years and, in large part, contributed disproportionately to the overall outperformance on margin over our target 96.

Hail storms in the first half of the year were definitely notable and our claims response, as always, was our first priority, but the year overall would not be characterized by signif­icant catastrophes, especially the relative absence of hurricanes. With no major storms for boats and motorhomes to weather, and an unremarkable number of riding days for motorcycles, we benefitted from even stronger than planned margins on our special lines products. We take the good years knowing there will always be the exceptions. If the economy strengthens over time, we would hope to see and benefit from increasing sales of discretionary products like RVs, boats, motorcycles, and other “toy” like products where we hold signif­icant market shares and offer recognized market leading products.

At any point over the last couple of years, reading a summary of our Commercial Lines business, it may have appeared that we always had one stronger and one weaker factor in the ordered pair of balanced growth and profitability we seek. Weaker profitability and stronger growth, a dangerous combination, and stronger profitability, suggesting opportunities for growth, have all been experienced en route to our now reporting a very healthy balance. Our challenges, outlined in our investor meeting for the year, were in selected vehicle and use tiers of our broad commercial vehicle offerings and the solution, never as simple as the after-the-fact diagnosis, took some time, but we end 2014 with high confidence in our corrective actions and the emerging results. The year finished with very strong profitability, but equally with growth now beginning to follow.

Greater insights for the year in both our Personal and Commercial Lines are highlighted in the Operations Summary section of this report.

2014 was a year of some notable milestones and continued execution on several key initiatives I’ve outlined over the years in this letter. Here are a few of those milestones, at least the ones that top my list.

We ended the year with an expense ratio of 20% and, while not as regularly reported, our loss adjustment expense (LAE) was approx­imately 10%. Both of these measures will move by some basis points in any given time period, but the central message is that these measures respectively represent very significant accomplishments. It perhaps is a little embarrassing to say that these levels were envisioned some 20 plus years ago and at times it seemed that we would only approach them asymptotically from above. Now, like so many once held barriers or constraints, we see opportunities to break through to an even greater degree. Our LAE is certainly among the best and, similar to the expense ratio, has been attained by under­standing every aspect of our business and taking a process and quality driven approach to optimize operations, while holding customer service as an inviolate. Our expense ratio is among the top few in the industry, and with an even greater push on customer retention, we assuredly hold the potential for more. It goes without saying how important price is in our business. However, as with most things, there is a balance and efficient cost reductions are welcome, but we take extraordinary measures to be assured they are not traded-off against our commitment to customer care.

A second milestone of some note is that the superstore advertising campaign, starring “the now needs no introduction” Flo, created and débuted its 100th commercial. While the mile­stone itself is only of interest to a select audience, the commercial we chose to mark the event, we think, was quite fitting. Flo was not in the store at the time, but rather at home with her extended family for an evening dinner. Believing slightly dysfunctional families are something many can relate to, we see Flo expressing her accomplishments in auto insurance marketing to a somewhat disinterested family. I’ll leave the details to the commercial, but suffice it to say the actress playing Flo also played all the other family members in a marathon of make-up and filming. Quite a performance and one many have expressed to me as having taken them some number of viewings to catch onto — all part of the planned intrigue. Flo’s costume has become quite a “go-to” outfit for many on Halloween, with this year LeBron James donning the uniform and making the switch with Flo and perform­ing on-court antics that probably don’t get much air time in NBA practice sessions. The switch and the social media postings have received over three hundred million views — as Flo might say — Wow!

Rounding out my top milestones for the year would be two product initiatives. We entered Massachusetts with an Agency auto product, which we delayed after our Direct entry some years ago gave us good reason to further understand the market. This entry now has us with an Agency and Direct auto offering in every state in the nation. Massachusetts is one of the larger Independent Agent markets in the country and we are delighted to be out of the gates and serving those agents. The second was the introduction of a renters insurance product providing coverage for those of our auto customers wishing to protect assets, often prior to homeownership. More about renters when I discuss the Destination Era.

For notable continued execution in 2014, my list would start with Snapshot^®, our in-vehicle data collection initiative, reporting individual driving behavior that takes a giant step from classical group statistics to the “statistics of one.” Our numerical milestones continue to click-up (over 12 billion miles of recorded driving data and 2.5 million participants), but much more so the growing acceptance in society, and within the industry, that this type of data collection is becoming more the norm versus the exception. We remain extraordinarily bullish on Snapshot and whatever forms it will evolve into over time, simply based on the quality of the data, the more direct and less proxy association with the risk, and the costs and availability curves all bending in our favor. Taken alone, the data collected provides significant insight, but in a world of “Big Data” where data set size, data source, and processing complexity all seem almost trivial compared to just a few years ago, the power is dramatically enhanced. We con­catenate our collected data with external data sets, that range from historical accident frequency by GPS location, to matching speed limits and daily local weather data. While not every insight is directly transferable to the product, the analysis and underwriting curiosity is in a different league than when I once fancied myself doing similar work. Our Big Data initiatives now include media analysis and fraud detection, in addition to our vehicle usage-based data, and the methods and tools are emerging as an essential skill to contemporary analysis.

Destination Era

We have been communicating for some time what we mean by our consumer “Destination Strategy,” and made the topic the exclusive highlight of our 2014 Investor Relations Meeting in May. During my introduction to that meeting, I very clearly reinforced our commitment to current market segments where we over-index and expect continued future growth. But we decided to dedicate the meeting content to a customer segment we intend to make a meaningful addition to the future Progressive. For simplicity, we called them the “Robinsons,” in a high-level segmentation model, and sized the segment at over 40% of measured auto premium. Historically, our focused product strategy was not well matched to the evolving life cycle needs of these customers, who typically are multi-insurance product customers, more loyal, less price sensitive, and a lower loss frequency book of business. In and of itself that was not our greatest concern, since those consumers are relatively inert and highly retentive in their current situations. Our far greater interest was that we have for many years been what I referred to as the “Prep School” for these customers. Those future Robinsons, for whom we are a leading supplier given the auto product is often the first need met, have often felt the subsequent need to shop for additional products as their lives and needs change, terminating their tenure with Progressive for reasons far from product quality or satisfaction concerns.

For perspective, we have just short of 9% share of the U.S. auto insurance market, but our share of Robinsons is less than 1%. We are confident we can serve a greater share of this segment and continue to earn the financial returns we expect of ourselves.

Most of you are well aware of our efforts over the last several years to become a distributor of those additional insurance products, primarily renters, home, umbrella, classic car, event, collectibles, mechanical break­down, identity theft, term life, and a long list of other low frequency products, which we continue to round out and, by virtue of those actions, remove a point of inflection for our customers as they become Robinsons and retain them as our customers. Simply put, while we may not choose to manufacture the product, we never want to send our customers off looking for solutions to fulfill their needs — if they wish, we will do the looking for them.

We know after several years of in-market testing that:

Customers are very willing to combine their product needs under the Progressive brand, a brand which for currently emerging Robinsons has real meaning. This is more so to date in the Direct channel, but the ASI transaction should allow us to build on our desire to match our bundling success in the Agency channel.

Retention of multi-product customers is, as has been shown in so many other circumstances, meaningfully extended by bundling and, while we observe this in our current measures, our results may well yet be underestimating the long-term potential and cost advantages.

Progressive has become an important contemporary brand for a new generation of consumers and our matching that brand with distinctive and exemplary customer service for claims and policy matters will continue to have Progressive, and in my opinion few others, feature disproportionately in consumers’ selection of auto insurance.

We like our current product focus and fully intend to maintain it. We also like having other focused providers, such as Homesite and Ameriprise along with the other homeowners insurance companies we currently work with, to provide an underwriting and channel distribution breadth to the products we do not intend to produce. Thus, an integral part of our business model will be to continue to invite and attract participation from other quality providers of products our consumers will want and need, all a privilege derived from the consumer brand asset we can now leverage. And while commission income is important, the currency of success for the targeted segment is Policy Life Extension and a longer tenured customer relationship with auto at the core. Just one month of book-level policy life extension represents significant premium, underwriting profit, and cost leverage. I want to stress the point — ours is a market-segmented strategy. We love and expect to grow our traditional segments and have the economic model and all the assets we need to do that, but with this strategy extension, we expect to significantly penetrate an additional larger market segment, and our success will be dependent on a brand and product offerings that result in long-lasting customer relationships. Our long-held goal to be consumers’ #1 choice for auto insurance has not changed.

Without diminishing any of the prior statements, we needed to “ensure the success” of our long-term business expansion strategy. The single most important component for this strategy is a reliable and continuous relationship for home insurance — all other products, as impor­tant as they may be in their own right, are in a different league in the overall “Progressive Advantage” strategy. If we were in manufacturing, the analogue might be a reliable supply of quality raw materials that may or may not be from an exclusive provider, or some form of hedge to build greater certainty. In ASI, we found not only a great producer of a product some of our customers need in their transition to Robinson status, but a rare example of the fanatical focus we admire, a demonstrated ability to produce strong returns on equity, and a culture that fits hand in glove with Progressive.

Establishing a balance between our focused business model and the now established need for quality, reliable homeowner’s capacity to expand our market relevance, for me had only one solution, and we are delighted that collectively we could make that happen. I should note here that we have no intention of changing critical attributes of the ASI business model — their reinsurance philosophy will continue to be designed to expose only a prudent percentage of ASI’s surplus and, by definition, much less of the combined entity; we want their underwriting focus to remain as is and produce results similar to their track record. We intend to actively use and grow with other homeowner product providers, all doing what they do best. ASI will, however, be our exclusive provider in the Agency channel.

Our comfort with ASI, and I believe theirs with us, comes from a long-standing relationship, which has included shared design and sales efforts, healthy exchanges of market perceptions and needs, joint expansion planning, as the servicing carrier for our Agency renters product mentioned earlier, operational reviews of claims handling, and full access to their financials since our initial investment. Consistently, this has confirmed our unqualified respect for ASI’s operations and management. Progressive is an unusual organization, and I am unaware of very many firms that offer the same prospects of working so effectively with us.

We view the success of this transaction to be measured by increased success and penetration of multi-product customers and notably so in the Agency channel. Making a better product bundle for consumers, and one agents will want to sell, is the game plan. Thinking and acting fast is a quality we both admire, and I’m con­fident we can learn from one another without losing the benefits of both organizations.

We approach 2015 and beyond with a wider aperture for growth and the long-term position­ing of Progressive.

Our People and Culture

The formulation of a future era for Progressive is an exciting step in our consumer evolution. However, the foundations of Progressive’s success have always been our Vision, Values, and Objectives and they will continue to guide our evolution as a company. Our Vision is squarely focused on our aspiration to become Consumers’ #1 Choice for Auto Insurance; our Values guide our behavior; and our Objectives allow us to attract special people who enjoy working hard, performing well, and constantly growing. Our people, culture, and aspirations are what make us special. Our work environment is continuously evolving with a shared goal of also being a Destination, and one that others want to join.

Nothing we have achieved has been without the efforts of so many. I deeply appreciate the people of Progressive, our agents and brokers, customers, and shareholders for their support in making all this possible.

Thanks for making Progressive, progressive.

Glenn M. Renwick
President and Chief Executive Officer

One further note we’re happy to share around our Agency distribution is that during the year we began selling our auto program through independent agents in Massachusetts, adding to our previously introduced Commercial and Special Lines products. This completes our distribution framework in all 51 U.S. jurisdictions for auto. Growth since our entry has been modestly behind expectations and something we expect to improve over time.

We achieved 12% premium growth in our Direct channel, driven by increases in the number of consumers quoting with us, the conversion rate of those shoppers, the length of time our customers stay with us, and the average amount they pay. Needless to say, this is a nice combination of results.

We increased our advertising spend close to 10% during 2014 and, if current yield conditions continue, we have room to increase it more. We also continued to invest heavily in our mobile experience for current and prospective cus­tomers. Given the continued and fairly dramatic shift to mobile usage, we are pleased that our experience and metrics for mobile users now approximate those for more mature avenues, such as the phone and desktop Internet.

We believe we are the leader in the U.S. in initiating quotes for residential property insurance online. We also provide quotes over the phone, predominantly through third-party carriers. In addition, to better meet the broad needs of our customers, we built an in-house agency of Progressive employees to offer a suite of property products written by other insurance carriers. This helps ensure our strategy of being able to meet all of our customers’ personal insurance needs.

The majority of preferred customers in the U.S. buy their personal insurance through agents. As yet, our bundling position with our agents has not been all we aspire to. One step we have taken to address this is to offer renters insurance through the majority of our agency force. A significant portion of our historical customer set is renters and bundling renters with auto is the first step on the journey of being the destination for these customers. As of year-end, we underwrote renters in three states and expect to introduce this program in another eight states in the first quarter of 2015.

We’ve now committed to taking a bigger step in becoming the destination carrier for our agents with the announced acquisition of a controlling interest in the parent of American Strategic Insurance (ASI), which is expected to close in April 2015. Together with ASI, today we have around 2,000 Progressive Home Advantage agencies that sell our products as a bundle in 26 states and D.C. We are working on expanding this set of agents and providing them a unique, very user-friendly, and more competitive bun­dling offering for their customers. Our market share in the monoline, more nonstandard end of the spectrum with our agents is around 25%. For the preferred and bundled segment, it approximates 1%. We look forward to working with ASI and our agents to grow our preferred market share.

Commercial Lines

Progressive’s Commercial Lines business in 2014 achieved broad-based growth in net premiums written, which accelerated on a quarter-to-quarter basis. The growth was welcome and not unexpected, though the timing and amplitude can be hard to predict. We began the year confronted by different challenges and opportunities in each of our target business markets and, accordingly, responded with different product, pricing, and marketing actions to address them.

Foremost in our execution mindset was ensuring rate adequacy and appropriate underwriting standards were in place for what was clearly a marketplace that was losing capacity and becoming more restrictive in our for-hire transportation and for-hire specialty markets. Our decisive early actions, while initially a drag on policy and revenue growth, ultimately yielded low double-digit growth in written premium and better-than-target profitability for the year in these important business market targets (BMTs) and we are now well positioned for 2015 and beyond. The insurance market for these two BMTs remains relatively con­strained as evidenced by the substantial increase in quote submissions we experienced toward the end of 2014. Our focus for this year is managing growth to levels we can continue to service well and improving our competitiveness on the most preferred trucking risks.

Our newest and sixth BMT, for-hire livery (FHL), moved from pilot phase to rollout phase and we finished 2014 with active programs in 22 states. The program is focused on small owner/operators in the taxi cab and black car service space. Underwriting results have been favorable with all key metrics in line with expectations. We continue to add distribution points for FHL within our independent agency system and intend to add additional states in 2015. This is an example of how we continue to use our targeted business market approach to understand distinct customer groups and enter new markets in a measured and responsible way.

Our Direct Commercial Lines business had a solid year building on our position as the #1 commercial auto brand and it remains a strategically important and differentiating part of what we do. Direct channel written premium increased by 13% with growth across all five major BMTs. Sluggish Direct new business sales in the early part of the year rebounded nicely reaching low double-digit growth in the fourth quarter as our Commercial Lines Direct marketing gained traction and our competitive position improved. Over the course of the year, we realized substantial gains in website traffic, online quoting, and sales efficiency. Internet-sourced business grew much faster than the Direct business in total, an encouraging development as small business owners migrate to that channel. We also see the Direct channel contributing to operational improvements and savings that can be reinvested in marketing.

The growing influence of the Progressive brand with small business customers, objectively measured for awareness and resonance with key purchasing attributes, is now a distinctive business generating asset. In our quest to better meet small business customers’ other insurance needs, we continue to improve Progressive Commercial Advantage^SM (PCA), our platform for providing product access for general liability, worker’s compensation, and business owners insurance through unaffiliated insurers. Strong growth, particularly in the second half of the year, allowed us to expand staff in our Colorado Springs location. PCA product quotes and sales were up 23% and 24%, respectively, year over year, though those numbers somewhat mask the strong second half gains. In 2014, we added three new business providers to our network. These additions increased product choice and competitiveness while improving the overall economics of the platform. Our commitment to PCA remains strong as we seek to extend Commercial Lines policy life expectancy through the bundling of PCA products.

To ensure we continue to deliver great value to small business owners, can react with speed and dexterity to changes in market conditions, and maintain our low cost position for commercial auto, we initiated a multi-year effort to replace and modernize our core Com­mercial Lines processing and policy issuance system. While this effort will require sustained management attention and draw on subject matter expertise and other resources across our Commercial Lines business, we are confident in our ability to manage this significant investment without disruption to our business, agents, or customers. When completed, the new system will be an essential component of what we expect will be an industry leading platform for small business insurance. With new or improved capabilities and greater efficiency, this technology will support our Commercial Lines growth, enhance customer experiences, and further enable our strategic partnering capabilities. This is another important investment in our journey to becoming a destination insurer for small business owners.