Prepared and Positioned

In past letters I’ve outlined key elements of our strategic agenda and progress on each. While far from complete, our progress has been substantial and helped position us to take advantage of the market conditions.

Our intense focus on leading in the online space has resulted in a Web site that has consistently been recognized as the industry leader. Additional recognition was expressed by Forrester Research in the third quarter as they named our Web site the best Brand Building Web site across all financial services sectors.

We feel the real power of the online experience is changing it to involve the customer in respectful and engaging ways. This year, we substantially completed the countrywide roll-out of our “Name Your Price®” offering, which invites the customer to participate in the quoting process by telling us how much they would like to pay. The timing was perfect and the symbolism of a low-tech price gun provided an interesting juxtaposition that consumers had no trouble understanding. We see this as a perfect example of the changing customer experiences that are possible and, by our measures, welcomed and business generating. We clearly need to do more and have plans to do so, but 2009 was an encouraging year online.

Increasing our focus on target consumer segments over the past several years has resulted in notable improvements in customer retention and care. The largest segment of consumers, as we use that term, is one that purchases multiple personal lines products for the household. We have low penetration in this sizable segment and see greater penetration as the best way to achieve our internal organic growth ambition of doubling the premium of the company. We are now far better positioned to serve the needs of those consumers wishing to combine a renters or homeowners policy with their auto selection and have consistently expanded this capability, ending the year with three meaningful relationships for companion products.

This effective expansion of our target market is an exciting prospect for further growth and consistent with the notion of positioning Progressive as a “destination” insurer. While noting my rearview mirror analogy, our growth in policies in this target segment in both our Agency and Direct businesses was over 100% in 2009. “Small with potential” is an exciting positioning for us but will not distract us from our commitment to segments we currently serve well.

A stronger brand communicated well is an action call that has been part of this letter for some time and represents an earnest aspiration. The last two years have been confirming of the effort and more importantly have provided a glimpse of what’s possible with a strong brand to unify the other skills we value. Consumers have responded well to our messages and market innovations, but the buzz seems to stem from “Flo” — our self-constructed employee of the Superstore. Consumer recognition and appeal is high, and we have exciting plans to keep the campaign fresh and relevant. At the same time, we acknowledge that we have a significant gap yet to close relative to the best-in-class recognition.

Clearly, the consumer demand generation objective of a brand is essential and, in 2009, we were served well, but for me there is an even bigger contribution to our customer care culture that has been served by our brand-building efforts. Employees at every level identify with Flo, and with the positive brand characteristics she demonstrates to customers and shoppers — even her quirkiness. When we challenge ourselves with the question — “Who does the customer expect to answer the phone or settle a claim?,” the immediate answer is clear and, while common sense suggests it will not be Flo, the expectations are unchanged.

Our customer-focused agenda has been a source of some pride for us over the past several years but the model of brand ambassadorship exhibited by Flo, and accepted by all employees with similar enthusiasm, ensures the critical congruence of brand messaging and brand execution.

Late in the second quarter, and continuing through the second half of the year, we saw the emergence of stronger new application growth in our Agency business. This was a very positive sign we had not seen for some time. While net growth in Agency auto policies in force for the year was slight, it reversed a multi-year declining trend. We always have theories on the pricing adequacy of our competitors and were not surprised when some increased rates in amounts that outstripped our estimates of loss-cost trends. Relative positioning on price is an important consideration in the Agency business and being comfortable with our rate level when others need additional rate is a position we like to be in. We have also taken additional measures to present our rates to agents such that they can ensure the consumer is offered the best options we can make available.

We consider our access to consumers via independent agents and directly, now primarily via the Internet, to be a significant strategic advantage over many in our space. The strategies are largely the same in each channel and, although our advertising is designed to incent consumers to shop with us directly, our recognition and support of consumer choice is unwavering. Agents have consistently expressed support for, and excitement about, our brand-building efforts and the positive reflection it has on their business.

Our Agency business remains the larger portion of our Personal Lines business and the dominant part of our Commercial Auto production. The Direct business, which perhaps reflects consumers’ changing buying habits, is now substantial. Against the relatively flat growth in customers in Agency, Direct grew 13% for the year and is now about 43% of our personal auto policies in force. Both businesses produced combined ratios between 93 and 94 for personal auto for the year. Of some note is that the annual trend in average written premium is relatively flat for the Agency business, and still quite negative for Direct, at -4%, tempering Direct’s top line growth to 11%.

Aggregate measures of combined ratio ultimately are most important, and our goal of an aggregate companywide 96 in any calendar year is unchanged. With room for some debate, the Agency auto business, along with the special lines and Commercial Auto businesses, are best thought of as variable cost acquisition businesses for which calendar-year combined ratio is an accurate assessment.

The key to controlling the Direct business is having a very clear understanding of target margins during the life of a policy, based on an accepted recognition period for acquisition costs, and an ability to predict policy life expectancy by consumer segment with some reliability. With a substantial base of renewal business in the Direct book, our calendar combined ratios have been consistently below 96. However, under certain high growth new business scenarios, we would be happy to see the reported monthly and calendar-year combined ratios go above 96 for our Direct business, as long as our new and renewal business consistently meets predefined targets that ensure a lifetime result at or below 96.

Surpassing aggregate written premium of $14 billion in 2009 was welcomed, but it’s not the first time we have crossed that threshold. Aggregate premiums in 2005 and 2006 were at comparable levels. There are, however, notable differences which speak to both successes and challenges of the past several years. We now serve over a million more Personal Lines policies than in 2006 when we achieved our highest ever premium of $14.1 billion. 639,000 of these additional policies are auto customers with the rest consumers of our special lines products. Our state and customer mix has changed, and the composition of our book of active policies between Direct and Agency is very different with Direct having increased some 773,000 policies offset by a loss of 134,000 Agency policies.

I offer this multi-year view to provide some perspective of the past several years. We have healthy growth in Personal Lines customers, which for me is the best form of growth, but battled a headwind of declining average premium per customer. Our growth has clearly come from our Direct business during that time. Our policy counts in Commercial Auto are up slightly from 2006 levels, but premiums are down in total more than $360 million. The macro industry conditions of the last few years become a little starker cast in this light.

While there are no guarantees, the forward-looking picture may be somewhat different. I expect continued growth in our Direct offerings, with added fuel from our multi-product consumer segment. Similarly, I expect our Agency business to continue to benefit from our competitive positioning and expanded multi-product offering. A return to greater employment levels, which is harder to predict, will almost certainly have an across-the-board effect and most importantly in our Commercial Auto products. I believe 2010 will be a year to build on the momentum from 2009 and all the initiatives that unquestionably have made Progressive an even better consumer and agent proposition.

Although a relatively minor premium contributor, we were very proud of our Professional Liability Group and its highly consistent track record of performance. However, we increasingly saw a mismatch with our long-term strategic interests and decided during the year to initiate a sale of our interest in the program to an affiliate of our partner, the American Bankers Association.

Building options for the future that are in line with our strategic interests, we launched our Internet-only personal auto insurance business in Australia just before year end. While there is little market activity to report yet, if it matches the effort expended by the new market entry team, we should have more to report next year.

Acknowledging our emerging strengths and their potential is appropriate, but it should be in balance with some commentary about other skills we hold central to our business model such as Claims and Information Technology.

In Claims, 2009 was a milestone year, but not without some pain. Our Claims strategy has been evolving over the past decade. Starting with a simple premise, “It’s Cars not Cash,” which reflects our customer’s preference for a repaired vehicle over just the financial compensation, we built and expanded our patented Concierge Service Centers approach, and a proxy in areas of lower policy concentration.

This type of change starts the first domino and invites rethinking of what’s possible in all aspects of our claims process. A simple set of Guiding Principles designed to maximize the accuracy and quality of settlement, the efficiency and cost effectiveness of resolution, along with the highest satisfaction of customers and our people has and will be a constant.

Continuous process improvement for us led to greater recognition that, to achieve all the benefits available, more structural change would be needed. In the second quarter, we made a significant change to our Claims management infrastructure, reducing the size and increasing the scope of management to better fit with the cumulative process improvements. I have seen more than a few cost benefit analyses that in retrospect seem to be clearer on the costs than the attainment of benefits. For our Claims organization, 2009 was a year in which many of the intended benefits from nearly a decade of continuous improvement in claims response and accuracy were fully realized.

We ended the year with our run rate Loss Adjustment Expense ratio approximately one point lower than the prior year, improved on what was already our highest attained quality of settlement measure, and added considerable emphasis to our focus on employee and customer satisfaction expecting future measures to reflect the efforts. Key to success is attaining the delicate balance between all four guiding principles; however, a point of LAE reduction, with a very realistic goal of more, helps in no small way to keep our prices lower longer and below external trends wherever possible. It is certainly not out of place to extend a special recognition to the 11,500 claims employees who, through their patience, flexibility, openness, and nimbleness in the midst of some substantial changes, made these results possible.

Focus on non-claims costs is every bit as important to increasing market competitiveness. While, on a relative basis, we may be very good, we see opportunity and we’re going after it in ways that count. Last year, commenting on our Information Technology Group’s process agenda to re-think just about every aspect of what we do and how we do it, I expressed an expectation that their efforts would result in increased leverage and greater accountability to market priorities. Suffice it to say that through terrific commitment by the whole organization, expectations are being met. Our expected IT spending level for 2010 is lower than the comparable number for 2006. Of special note, our multi-year effort to develop a replacement for our policy processing system went live in its first state during the year, with excellent quality.

Changing things that work because there is a better way is difficult and requires a special mindset and leadership. Relentlessly improving our products and services and providing reasons for customers to stay, in addition to eliminating reasons they leave, is never ending. Innovating in ways that matter to customers, and better defining target segments and our appeal to each, is exciting. This is what we do. I like the changes we’ve made and am genuinely excited about the prospects for 2010. We remain continuously motivated by our aspiration of becoming Consumers’ #1 Choice for Auto Insurance.

Our Culture and Credits

Nothing we have achieved has been without the efforts of so many and our single most important initiative, especially in current times, is ensuring Progressive is a great place to work. Creating an environment where all of us enjoy working hard, are motivated to do our best, can grow constantly, and one that others want to join is a never-ending challenge. Our people and culture are what makes us special.

Consistent with our culture and values is the simplest of notions to just do the right thing, and in a world that is fast recognizing that we must all up our game on social responsibility, Progressive is actively reviewing our business practices to further increase our social and environmental responsibility. A report on our actions is available online.

To the people who make all this possible — our employees, the customers we are privileged to serve, the agents and brokers who choose to represent us, and shareholders who support what we are doing — Thank you.

Glenn M. Renwick
President and Chief Executive Officer