SCHEDULE 14A INFORMATION

 

Proxy Statement Pursuant to Section 14(a) of the Securities

Exchange Act of 1934 (amendment no. )

 

Filed by the Registrant  þ

Filed by a Party other than the Registrant  o

Check the appropriate box:

 

o Preliminary Proxy Statement

o Confidential, for Use of the Commission Only (as permitted by Rule 14a-6(e)(2))

þ Definitive Proxy Statement

o Definitive Additional Materials

o Soliciting Material Pursuant to §240.14a -12

 

The Progressive Corporation

(Name of Registrant as Specified in its Charter)

 

(Name of Person(s) Filing Proxy Statement, if other than the Registrant)

 

Payment of Filing Fee (Check the appropriate box):

 

 

 

 

pursuant to Exchange Act Rule 0-11 (set

forth the amount on which the filing fee is calculated and state how it was determined):

 

 

 

 

 

 

 

 

NOTICE OF ANNUAL MEETING OF SHAREHOLDERS

TO BE HELD APRIL 20, 2007

 

Notice is hereby given that the Annual Meeting of Shareholders of The Progressive Corporation will be held at 6671 Beta Drive, Mayfield Village, Ohio, on Friday, April 20, 2007, at 10:00 a.m., Cleveland time, for the following purposes:

 

 

5. To transact such other business as may properly come before the meeting.

 

Only shareholders of record at the close of business on February 21, 2007, will be entitled to notice of and to vote at said meeting or any adjournment thereof.

 

By Order of the Board of Directors.

 

Charles E. Jarrett, Secretary

 

March 9, 2007

 

Shareholders who do not expect to attend the meeting in person are urged to date and sign the enclosed proxy and return it in the enclosed postage-paid envelope.

 

The Progressive Corporation

 

 

THE PROGRESSIVE CORPORATION

PROXY STATEMENT

 

This statement is furnished in connection with the solicitation of proxies for use at the Annual Meeting of Shareholders of The Progressive Corporation, an Ohio corporation (“Company”), to be held at 10:00 a.m., Cleveland time, on Friday, April 20, 2007, at 6671 Beta Drive, Mayfield Village, Ohio 44143, and at any adjournment thereof. This statement, the Company’s Annual Report to Shareholders for the fiscal year ended December 31, 2006, which is attached hereto as an Appendix, and the accompanying proxy will be sent to shareholders on or about March 12, 2007.

 

The close of business on February 21, 2007, has been fixed as the record date for the determination of shareholders entitled to notice of and to vote at the meeting. At that date, the Company had outstanding 743,715,680 Common Shares, each of which will be entitled to one vote.

ITEM 1:

ELECTION OF DIRECTORS

 

The Company’s Code of Regulations provides that the number of directors shall be fixed at no fewer than five or more than twelve. The number of directors has been fixed at twelve and there are currently twelve directors on the Board. The Code of Regulations provides that the directors are to be divided into three classes as nearly equal in number as possible and that the classes are to be elected for staggered terms of three years each. Directors of one class are elected annually, except as provided below. At the Annual Meeting, the shares represented by the proxies obtained hereby, unless otherwise specified, will be voted for the election as directors of the five nominees named below, four to serve for a three-year term and one to serve a one-year term, and until their respective successors are duly elected and qualified. If, by reason of death or other unexpected occurrence, any one or more of the nominees named below is not available for election, the proxies will be voted for such substitute nominee(s), if any, as the Board of Directors may propose.

 

Based upon a recommendation from the Nominating and Governance Committee, the Board has nominated the five nominees named below for re-election to the Board. Proxies cannot be voted at the Annual Meeting for a greater number of persons than the five nominees named in this proxy statement. No shareholder nominations for the election of directors have been received within the time period required by Section 13 of Article II of the Company’s Code of Regulations or pursuant to the Company’s Shareholder-Proposed Candidate Procedures discussed below.

 

If written notice is given by any shareholder to the President, a Vice President or the Secretary not less than 48 hours before the time fixed for holding the Annual Meeting that he or she desires that the voting for election of directors shall be cumulative, and if an announcement of the giving of such notice is made at such meeting by the Chairman or Secretary or by or on behalf of the shareholder giving such notice, each shareholder shall have the right to cumulate such voting power as he or she possesses at such election and to give one nominee a number of votes equal to the number of directors to be elected multiplied by the number of shares he or she holds, or to distribute such number of votes among two or more nominees, as he or she sees fit. If the enclosed proxy is executed and returned and voting for the election of directors is cumulative, the persons named in the enclosed proxy will have the authority to cumulate votes and to vote the shares represented by such proxy, and by other proxies held by them, so as to elect as many of the five nominees named below as possible.

 

Pursuant to the Company’s Corporate Governance Guidelines, if a nominee for director receives less than a majority of the votes cast in an uncontested election, although the nominee is elected as a director under Ohio law, he or she is expected to tender his or her resignation to the Board. In such an event, the Nominating and Governance Committee will consider the resignation offer and recommend to the Board whether to accept or reject it. The Board will then make the final decision whether to accept or reject the tendered resignation based on all the facts and circumstances then presented.

 

Under the Company’s Code of Regulations, to the extent a vacancy on the Board exists, the Board has the right to elect a new director to fill a vacancy, but the new director so elected would serve a term that expires on the date of the next shareholders meeting at which directors are to be elected. Class assignments would be made so that the directors are distributed among the several classes as nearly equally as possible. During 2006, Abby F. Kohnstamm was elected to the Board by the other directors, and her term expires at the Annual Meeting in 2007. As a result, Ms. Kohnstamm is a nominee for director, as set forth below, and, if elected, her term will expire in 2008, along with the class of directors to which she has been assigned. The Board currently has no vacancies.

 

The following information is set forth with respect to each person nominated for election as a director and for those directors whose terms will continue after the Annual Meeting. Unless otherwise indicated, each such nominee or director has held the principal occupation indicated for more than the last five years. Each such nominee is currently a director of the Company.

Nominees for Election at the Annual Meeting

 

Directors Whose Terms will Continue after the Annual Meeting

 

 

OTHER BOARD OF DIRECTORS INFORMATION

 

Determinations under Categorical Standards.   The Board of Directors has approved categorical independence standards which, if satisfied by a director, will permit a determination that such director is independent for purposes of the New York Stock Exchange (NYSE) Listing Standards. Under the Company’s standards, an individual director may be determined to be “independent” only if he or she satisfies each of the following requirements, or if he or she is otherwise determined to be independent by the disinterested majority of the Board as provided below:

 

 

 

Contributions by the Company to a charitable or non-profit organization in which a director or his or her spouse serves as a director, trustee or executive officer or in an equivalent position will be deemed immaterial under the Company’s standards if the Company’s contributions to such organization in any calendar year do not exceed $25,000 (excluding matching gifts made by The Progressive Insurance Foundation in response to employee contributions to such organization). If the Company makes annual contributions in excess of the stated amount to any such organization, the effect, if any, on the director’s independence will be considered on a case-by-case basis.

 

If a director has one or more relationships with the Company that fall outside our categorical standards, the materiality of such other relationships will be determined by a disinterested majority of directors on a case-by-case basis. Material relationships can include commercial, industrial, banking, consulting, legal, accounting, charitable and familial relationships, among others. The ownership of even a significant amount of stock, by itself, however, is not a bar to a finding of independence.

 

The Board of Directors has considered the independence of each of the directors under the foregoing standards and, based on such considerations and the recommendations of the Nominating and Governance

Committee of the Board of Directors, and after due inquiry into the facts and circumstances of each director’s relationships with the Company (if any), has determined that each of the following directors (i) satisfies the Company’s independence standards as described above, (ii) has no relationship with the Company or its subsidiaries or with any charitable organization that received a contribution from the Company that would require an individual determination as to such director’s independence, and (iii) is independent under the applicable NYSE Listing Standards:

 

Charles A. Davis
Stephen R. Hardis
Bernadine P. Healy, M.D.
Jeffrey D. Kelly
Abby F. Kohnstamm
Philip A. Laskawy
Norman S. Matthews
Patrick H. Nettles, Ph.D.
Donald B. Shackelford
Bradley T. Sheares, Ph.D.

 

Mr. Glenn M. Renwick is not independent by virtue of his position as the Company’s current President and Chief Executive Officer.

 

Individual Independence Determination.   The Board of Directors considered the independence of Peter B. Lewis, non-executive Chairman of the Board, for the first time at its February 2007 meeting. Mr. Lewis, who was the President of the Company prior to 2001 and its Chief Executive Officer prior to 2000, retired from the Company in February 2003. Other than his ongoing role as the Chairman of the Board (the only position he has held with the Company since 2003), his relationships with the Company during the immediately preceding 3-year period are as follows:

 

 

 

Based on the totality of the information presented, the disinterested members of the Board of Directors unanimously determined that Mr. Lewis does not have any material relationships with the Company, either directly or indirectly, that would call into question his independence from management. Accordingly, the Board determined that Mr. Lewis is independent from the Company under NYSE rules at this time.

 

Seven meetings of the Board of Directors were held during 2006, one of which was held by conference call.

 

Eleven of the current directors were on the Board throughout 2006. A new director, Abby F. Kohnstamm, was appointed on June 15, 2006. All directors, except one, attended more than seventy-five percent (75%) of their scheduled meetings. Dr. Sheares attended 73% of the meetings of the Board and the Committees on which he served.

 

Pursuant to the Company’s Corporate Governance Guidelines, directors are expected to attend the Company’s Annual Meeting of Shareholders. Normally, a meeting of the Board will be scheduled on the date of the Annual Meeting of Shareholders. The Company’s 2006 Annual Meeting of Shareholders was attended by 10 out of 11 of the Company’s then current directors. A full copy of the Company’s Corporate Governance Guidelines can be found on the Company’s Web site at progressive.com/governance, or may be requested in print by writing to: The Progressive Corporation, Investor Relations, 6300 Wilson Mills Road, Box W33, Mayfield Village, Ohio 44143.

 

Pursuant to the Company’s Corporate Governance Guidelines, the Company’s non-management directors meet in executive session at least quarterly. The Chairman of the Board, provided that he or she is not an executive officer of the Company, presides at these meetings. In the event that a non-executive Chairman is not available to lead these meetings, the presiding director would be chosen by the non-management directors. In 2006, the non-management directors met in executive session six times.

 

In addition, if there is at least one director among the non-management directors who does not meet the criteria for independence required by the NYSE, the independent non-management directors should meet in executive session at least once annually. Since Mr. Lewis was not determined to be independent until February 2007, the independent non-management directors met in executive session in February and December 2006.

 

the Board or its Committees. During 2006, the Executive Committee did not meet, but adopted resolutions by written action pursuant to Ohio corporation law on ten occasions.

 

Dr. Healy, Mr. Laskawy (Chairman) and Dr. Nettles are the current members of the Board’s Audit Committee, which assures that the organizational structure, policies, controls and systems are in place to monitor performance. The Audit Committee monitors the integrity of the Company’s financial statements, the Company’s financial reporting processes and internal control over financial reporting, compliance by the Company with legal and regulatory requirements and the public release of financial information. The Committee also is responsible for confirming the independence of, and for the appointment, compensation, retention and oversight of the work of, the Company’s independent registered public accounting firm. The Committee provides an independent channel to receive appropriate communications from employees, shareholders, auditors, legal counsel, bankers, consultants and other interested parties. The Board of Directors has determined that each of the members of the Audit Committee has no relationship to the Company that may interfere with the exercise of his or her independence from management and the Company, and is independent as defined in the applicable Securities and Exchange Commission (“SEC”) rules and NYSE Listing Standards. During 2006, the Audit Committee met in person six times and participated in four conference calls to review the Company’s financial and operating results.

 

Audit Committee Financial Expert.   The Board of Directors has determined that Mr. Philip A. Laskawy, the Chairman of the Audit Committee, is an audit committee financial expert, as that term is defined in the applicable SEC regulations, and that he has accounting or related financial management expertise, as required by the NYSE Listing Standards. Mr. Laskawy is a former Chairman and CEO of Ernst & Young LLP, and is a member or chairman of the audit committees of four other public companies. The Board has determined that through appropriate education and experience, Mr. Laskawy has demonstrated that he possesses the following attributes:

 

 

Effectiveness of Mr. Philip A. Laskawy.   The Board of Directors does not have a policy limiting the number of public company audit committees on which a director may serve. Mr. Philip A. Laskawy, the Chairman of the Audit Committee, also serves on the audit committees of four other public companies. The Board has determined, however, that Mr. Laskawy’s simultaneous service on multiple audit committees does not impair Mr. Laskawy’s ability to serve effectively on the Company’s Audit Committee. Among other factors, the Board considered that, since he was appointed as Chairman of the Audit Committee in April 2003, Mr. Laskawy has: participated in the planning of Committee meetings; actively led the Committee’s meetings in a professional and efficient manner, asking insightful questions, covering all agenda items and reporting effectively to the Board; consulted frequently with the Company’s inside and outside auditors regarding accounting and financial reporting matters, including the Company’s compliance with internal control review and reporting requirements under Section 404 of the Sarbanes-Oxley Act of 2002 and applicable SEC regulations; and helped lead the Company’s compliance with other provisions of the Sarbanes-Oxley Act, SEC regulations and NYSE Listing Standards and the periodic review

and updating of the Committee’s Charter. The Board believes that Mr. Laskawy’s participation on the audit committees of four other public companies enhanced, and likely will continue to enhance, his knowledge and understanding of the responsibilities and functioning of audit committees in general, the issues faced by such committees and various approaches to accounting, financial reporting, internal control, compliance and corporate governance matters. The Board determined that Mr. Laskawy’s professional, energetic and thorough approach to the Chairman’s duties, as well as the auditing, accounting and financial reporting experience that he possesses, are significant benefits to the Committee and to the Company.

 

Messrs. Davis (Chairman) and Matthews and Dr. Sheares are the current members of the Board’s Compensation Committee. The Board has determined that each of the members of the Committee is independent under applicable NYSE Listing Standards. During 2006, the Compensation Committee met five times in person, twice by phone and adopted resolutions by written action pursuant to Ohio corporation law on five occasions.

 

The Committee makes all final determinations regarding executive compensation, including salary, equity (restricted stock awards) and non-equity incentive compensation (cash bonus) targets, and related performance goals, formulae and procedures. The Committee (or in certain circumstances, the full Board of Directors) also approves the terms of the various compensation and benefit plans that affect executive officers and other employees. Each of the Committee’s decisions is made after considering comparable compensation data obtained by the Company from independent third parties, internal analysis and/or recommendations presented by management. The executive compensation decisions represent the culmination of extensive analysis and discussion, which typically take place over the course of multiple Committee meetings and in meetings between the Committee and management, including the Company’s Chief Human Resource Officer, members of the Human Resource and Law Departments, other Company personnel and, when requested by the Committee, the Company’s Chief Executive Officer. In addition, the Committee frequently consults with the full Board of Directors on executive compensation matters. For more information on executive compensation, see the “Compensation Discussion and Analysis” section beginning on page 21 below.

 

The Committee’s determinations regarding incentive compensation for executive level employees (for example, performance criteria and standards relating to annual cash bonus determinations) also apply to incentive plans covering non-executive employees. Under this arrangement, executives and non-executives alike are motivated to achieve the same performance objectives. The Committee has delegated to management, however, the authority to implement such plans, and make other compensation-related decisions (such as salary and restricted stock awards), for the non-executive level employees.

 

The Committee has the authority under its Charter to hire its own compensation consultants, at the Company’s expense. The Committee frequently assesses the need for a consultant, most recently considering the issue at its December 2006 meeting. The Committee decided that a consultant would not be hired at that time, in view of the Company’s consistent compensation program, the program’s significant performance-based features that have been successfully tested in both good and bad performance years, and the availability of credible market data from independent third parties, as well as the Company’s solid operating performance in recent years, among other factors. The Committee has clearly indicated that it remains open to hiring a consultant in the future should circumstances change, and that it will continue to monitor these and other relevant factors and reconsider the issue from time to time.

 

Messrs. Hardis, Kelly (Chairman) and Shackelford are the current members of the Board’s Investment and Capital Committee, which monitors and advises the Company on its investment and capital management policies. During 2006, the Investment and Capital Committee met five times.

 

Messrs. Davis, Hardis and Matthews (Chairman) are the current members of the Board’s Nominating and Governance Committee and have been determined by the Board to be independent as defined in the applicable NYSE Listing Standards. The Committee considers the qualifications of individuals who are proposed as possible nominees for election to the Board and makes recommendations to the Board with respect to such possible nominees, and corporate governance issues.

 

The Committee also regularly reviews the Company’s Corporate Governance Guidelines and related matters to ensure that they continue to correspond to the Board’s governance philosophy. The Committee considers and, where appropriate, recommends to the Board for approval, changes to the Corporate Governance Guidelines based on suggestions from Board members or management. The Committee reviewed and made modest changes to the Guidelines in 2006, but no significant modifications were proposed.

 

The Committee continued to work with an executive search firm during 2006 to assist in identifying and evaluating potential nominees for director. The search firm was retained in 2004 to identify and narrow the pool of potential nominees, to investigate potential nominees’ willingness to serve and otherwise to investigate and make recommendations to the Committee on the talents, background or other factors entering into the Committee’s consideration of potential nominees.

 

During 2006, the Nominating and Governance Committee met four times. The Committee regularly reviewed the qualifications of potential candidates for the Board. The Committee recommended Abby F. Kohnstamm to fill the vacancy on the Board that existed in 2006. Ms. Kohnstamm was identified for the Committee’s consideration by a search firm and was elected by the Board to fill the vacancy, effective June 15, 2006. In addition, the Committee recommended the five nominees named above, each of whom is currently a director, for re-election to the Board.

Shareholder-Proposed Candidate Procedures.   Pursuant to the Nominating and Governance Committee’s Charter, the Board has adopted a policy of considering director candidates who are recommended by shareholders of the Company. In addition, the Committee has adopted Procedures for Shareholders to Propose Candidates for Directors (the “Shareholder-Proposed Candidate Procedures” or “Procedures”).

 

Any shareholder desiring to propose a candidate for election to the Board under these Procedures may do so by mailing to the Company’s Secretary a written notice identifying the candidate. The written notice must also include the supporting information required by the Shareholder-Proposed Candidate Procedures, the complete text of which can be found on the Company’s Web site at progressive.com/governance. The notice and supporting information should be sent to the Secretary at the following address:

 

Charles E. Jarrett, Secretary
The Progressive Corporation
6300 Wilson Mills Road
Mayfield Village, Ohio 44143

 

Upon receipt, the Secretary will forward to the Committee the notice and the other information provided.

 

The nominating shareholder may also include any additional information that the shareholder believes is relevant to the Committee’s consideration of the candidate. If a shareholder proposes a candidate without submitting all of the foregoing items, the Committee, in its discretion, may reject the proposed candidate, request more information from the nominating shareholder, or consider the proposed candidate while reserving the right to request more information. In addition, the Committee may further limit each shareholder to one (1) proposed candidate in any calendar year and may refuse to consider any additional candidate(s) proposed by such shareholder or its affiliates during the calendar year.

 

Shareholders may propose candidates to the Committee pursuant to the Shareholder-Proposed Candidate Procedures at any time. However, to be considered by the Committee in connection with the Company’s next Annual Meeting of Shareholders (held in April of each year), the Secretary must receive the shareholder’s proposal and the information required above on or before November 30th of the year immediately preceding such Annual Meeting.

 

It is the policy of the Committee to review and evaluate each candidate for nomination submitted by shareholders in accordance with the Shareholder-Proposed Candidate Procedures on the same basis as candidates who are suggested by the Company’s Board members, executive officers or other sources, which may include professional search firms retained by the Committee. The Committee will give strong preference to candidates who are likely to be deemed independent from the Company under SEC and NYSE rules. As to shareholder-proposed candidates, the Committee may give more weight to candidates who are unaffiliated with the shareholder proposing their nomination and to candidates who are proposed by long-standing shareholders with significant share ownership (i.e., greater than 1% of the Company’s Common Shares that have been owned for more than 2 years).

 

In considering director nominations, the Committee will consider: the current composition of the Board and how it functions as a group; the talents, personalities, strengths and any weaknesses of current Board members; the value of contributions made by individual Board members; the need for a person with specific skills, experiences or background to be added to the Board; any available or anticipated vacancies due to retirement or other reasons; and other factors which may enter into the nomination decision. Upon the expiration of a director’s term on the Board, that director will be given preference for nomination when the director indicates his or her willingness to continue serving and, in the Committee’s judgment, the director has made and is likely to continue to make a significant contribution to the Board and the Company.

 

When considering an individual candidate’s suitability for the Board, the Committee will evaluate each individual on a case-by-case basis. The Committee does not prescribe minimum qualifications or standards for directors, but instead looks for directors who have demonstrated the ability to satisfy the fundamental criteria set forth in the Committee’s Charter — integrity, judgment, commitment, preparation, participation and contribution. In addition, the Committee will review the extent of the candidate’s demonstrated excellence and success in his or her chosen business, professional or other career and the skills and talents which the candidate would be expected to add to the Board. The Committee may choose, in individual cases, to conduct interviews with the candidate and/or contact references, business associates, other members of boards on which the candidate serves or other appropriate persons to obtain additional information. Such background inquiries may also be conducted, in whole or in part, on the Committee’s behalf by third parties, such as professional search firms. The Committee will make its determinations on whether to nominate an individual candidate based on the Board’s then-current needs, the merits of such candidate and the qualifications of other available candidates. If a candidate is not nominated, the Committee will have the discretion to reconsider his or her candidacy in connection with future vacancies on the Board.

 

The Committee’s decision not to nominate a particular individual for election to the Board will not be publicized by the Company, unless required by applicable laws or NYSE rules. The Committee will have no obligation to respond to shareholders who propose candidates that the Committee has determined not to nominate for election to the Board, but the Committee may choose to do so in its sole discretion.

 

These Shareholder-Proposed Candidate Procedures are in addition to any rights that a shareholder may have under the Company’s Code of Regulations or under any applicable laws or regulations in connection with the nomination of directors for the Company’s Board.

 

The Board of Directors has adopted procedures for security holders to send written communications to the Board as a group. Such communications must be clearly addressed to the Board of Directors and sent to any of the following, at the election of the security holder:

 

Peter B. Lewis
Chairman of the Board
The Progressive Corporation
6300 Wilson Mills Road
Mayfield Village, OH 44143
E-mail: peter_lewis@progressive.com

 

Philip A. Laskawy
Chairman of the Audit Committee
The Progressive Corporation
c/o Ernst & Young
5 Times Square
New York, New York 10036
E-mail: philip_laskawy@progressive.com

 

Charles E. Jarrett
Secretary
The Progressive Corporation
6300 Wilson Mills Road
Mayfield Village, OH 44143
E-mail: chuck_jarrett@progressive.com

 

In addition, interested parties may contact the non-management directors as a group by sending a written communication to any of the above-named individuals. Such communication must be clearly addressed to the non-management directors.

 

Communications so received will be promptly forwarded by the recipient to the full Board of Directors or to the non-management directors, as appropriate.

Certain Relationships and Related Transactions

 

Transactions between the Company or its subsidiaries and any director or executive officer, or any entity in which one or more of the Company’s directors or executive officers is a substantial owner, director or executive officer, must be disclosed to and, if appropriate, approved by, the Company’s Board of Directors. The Company’s Code of Business Conduct and Ethics prohibits directors and executive officers from having a direct or indirect financial interest in any transaction involving the Company, unless either: (i) the transaction is disclosed to and approved by a disinterested majority of the Board; or (ii) with respect to a transaction with another publicly held company, the transaction and the Progressive person’s status as a director, officer, consultant or advisor to such other company are known to the Board, a disinterested majority of the Board does not object to the person’s continued service to such other public company, and the annual payments to or from Progressive under the transaction do not exceed the lesser of 1% of Progressive’s or such other company’s consolidated revenues.

 

This policy is carried out by the Law Department as transactions with such persons or entities, or proposals for such transactions, are identified by management. As indicated above, the policy applies to all transactions that occur between the Company and the persons or entities described above. If a transaction with any such person or entity is proposed or entered into during the course of the year, the transaction is presented to the Board for consideration, typically at its next meeting. In addition, all previously approved transactions that are expected to

continue into a new year are presented to the Board for review on an annual basis at the Board’s first meeting of the year (in January or February). This procedure further allows the Board to consider these relationships at the same time that it is considering whether directors are independent under applicable rules and regulations.

 

The following discussion sets forth the relationships and transactions known by management at this time to involve the Company or its subsidiaries and such persons or entities. In each case, pursuant to the policies described above, these transactions have been disclosed to the Board of Directors and the Board has approved the transaction or, in the case of ongoing relationships that were presented to the Board, permitted the continuation or renewal of the relationship.

 

Mr. Jeffrey D. Kelly, a director of the Company, is the Vice Chairman and Chief Financial Officer of National City Corporation, the parent company of National City Bank (“NCB”). Dr. Bernadine P. Healy, a director of the Company, is also a director of National City Corporation. NCB is the Transfer Agent and Registrar of the Company’s Common Shares and received fees for 2006 of $113,031 for such services. Additionally, the Company uses NCB for commercial banking services and paid $1,325,468 to NCB in service charges during 2006. In each case, these charges represented NCB’s customary rates.

 

The Company also has an uncommitted line of credit with NCB in the principal amount of $125 million. The Company incurs no commitment fees for this arrangement and no borrowings were outstanding under this line of credit at any time during 2006. A subsidiary of the Company has $125 million on deposit with NCB. These funds are invested in interest-bearing securities approved by the Company. This line of credit and the deposit are components of the Company’s cash contingency arrangement to ensure the availability of those funds in the event of certain emergencies affecting capital markets and banking operations.

 

The Company has established a $36 million trust on behalf of the policyholders of a nonconsolidated affiliate of the Company, with NCB as trustee, in order to maintain the A.M. Best rating of the nonconsolidated affiliate. The Company incurs an annual trustee fee of $15,000 in connection with this trust, which represents NCB’s customary rates.

 

Mr. Stephen R. Hardis, a director of the Company, is also a director of Marsh & McLennan Companies, Inc. (“Marsh”). The Company pays commissions to various subsidiaries of Marsh for brokerage services in the ordinary course of the Company’s auto and non-auto insurance businesses, at customary rates for the services rendered. During 2006, the Company paid $1,647,329 for these services. No contingent commissions will be paid to Marsh in connection with policies written in 2006.

 

During 2006, the Company paid $9,321 to a division of Mercer Management Consulting, Inc. (“Mercer”), a subsidiary of Marsh, for compensation and benefits surveys. The fees paid to Mercer were customary rates for the products purchased or services rendered.

 

Mr. Charles A. Davis, a director of the Company, serves as a director of AXIS Capital Holdings Limited (“AXIS”). Mr. W. Thomas Forrester, the Company’s Chief Financial Officer, also served as a director of AXIS prior to June 2006. During 2006, AXIS reinsured part of the Company’s outstanding risks under its directors’ and officers’ liability insurance, trust errors and omissions insurance, and bond products. AXIS provides reinsurance coverage of $3.5 million on policy limits of $15 million, for losses incurred in excess of the first $1 million. AXIS is one of several companies that the Company uses to reinsure this non-auto line of business. During 2006, the Company ceded $3,916,984 in premiums to AXIS for this coverage. At December 31, 2006, the Company had $1,678,987 of reinsurance recoverables on paid losses and $2,731,191 of reinsurance recoverables on unpaid losses under this arrangement. The terms of this reinsurance arrangement are consistent with those between the Company and other reinsurers.

 

Mr. Philip A. Laskawy, a director of the Company, is also a director of Cap Gemini, S.A., a French public company. In 2006, the Company paid $2,290,042 to Cap Gemini, S.A., for information technology consulting fees. These charges represent the customary rates for services provided.

 

Mr. Glenn M. Renwick, President, Chief Executive Officer and a director of the Company, is also a director of Fiserv, Inc. The Company paid $43,394 to Fiserv, Inc., for comparative rating software during 2006. These charges represent the customary rates for the products purchased.

 

In the third quarter 2006, a subsidiary of the Company and a company owned by Mr. Peter B. Lewis, Chairman of the Board, entered into a sublease for space at an airplane hangar leased by the subsidiary, to house the airplane owned by Mr. Lewis’s company and related personnel and equipment. The sublease has a 5-year term that commenced in October 2006, and Mr. Lewis’s company has options to extend the sublease for three additional 5-year terms. Under the sublease, Mr. Lewis’s company rents approximately two-thirds of the hangar space and one-half of the office space at the facility, and it further reimburses one-half of other occupancy costs (such as common area maintenance, insurance, taxes, etc.), and one-half of certain construction and capital expenses. In addition, Mr. Lewis’s company reimburses the Company for fuel for its aircraft, based on actual fuel used, plus one-half of the fuel flow fee incurred by the Company under its lease for the hangar. During 2006, Mr. Lewis’s company paid the Company’s subsidiary a total of $20,600 for rent and other occupancy expenses in accordance with the terms of the sublease. Initial tenant improvements were completed in December 2006, and in 2007 Mr. Lewis’s company is expected to pay approximately $250,000 under the sublease, as its one-half share of the construction costs.

 

The following relatives of executive officers and directors worked for the Company in 2006: the son of Mr. Forrester (CFO), Ian Forrester, as a product manager; the brother of Brian Domeck (who was named to be our CFO, effective March 2007), John Domeck, as an attorney; and the son-in-law of Mr. Hardis (director), Stephen Ware, who works in our information technology area. The approximate dollar value of these employment relationships for 2006 were $132,000 for Ian Forrester, $173,000 for John Domeck and $115,000 for Stephen Ware. In reporting these amounts, we are using the same methodology that is used to determine compensation for named executive officers in the Summary Compensation Table below, under which total compensation includes, to the extent applicable to each individual, salary paid in 2006, Gainsharing and other bonuses earned in 2006, restricted stock and stock option expense recognized by the Company during the year, Company-matching contributions to retirement security (401k) accounts and other compensation, but excludes health and welfare benefits that are available generally to all salaried employees, as contemplated by the applicable regulations. In each case, the Company believes that the level of compensation is appropriate in view of the individual’s position, responsibilities and experience.

Compensation Committee Interlocks and Insider Participation

 

Messrs. Davis and Matthews and Drs. Healy and Sheares served as members of the Company’s Compensation Committee during 2006. There are no Compensation Committee interlocks.

REPORT OF THE AUDIT COMMITTEE

SECURITY OWNERSHIP OF CERTAIN

BENEFICIAL OWNERS AND MANAGEMENT

 

All share and per share amounts in the following tables were adjusted for the May 18, 2006, 4-for-1 stock split.

Security Ownership of Certain Beneficial Owners.   The following information is set forth with respect to persons known to management to be the beneficial owners, as of December 31, 2006, of more than 5% of the Company’s Common Shares, $1.00 par value:

Name and Address		Amount and Nature of				Percent
of Beneficial Owner		Beneficial Ownership(1)				of Class
Davis Selected Advisers, L.P.			80,633,776	(2)			10.8	%
2949 East Elvira Road, Suite 101
Tucson, Arizona 85706
Ruane, Cunniff & Goldfarb Inc.			77,070,821	(3)			10.3	%
767 Fifth Avenue, Suite 4701
New York, New York 10153-4798
Peter B. Lewis			49,443,738	(4)			6.6	%
6300 Wilson Mills Road
Mayfield Village, Ohio 44143
The TCW Group, Inc.			45,508,904	(5)			6.1	%
865 South Figueroa Street
Los Angeles, California 90017

 

 

Security Ownership of Management.   The following information is set forth with respect to the Company’s Common Shares beneficially owned as of December 31, 2006 (including stock options exercisable within 60 days thereafter), by all directors and nominees for election as directors of the Company, each of the named executive officers (as identified on page 40) and by all directors and all individuals who were executive officers of the Company on December 31, 2006, as a group:

 

 

 

 

Securities Authorized for Issuance under Equity Compensation Plans.    The following information is set forth with respect to the equity compensation plans maintained by the Company and is reported as of December 31, 2006.

 

 

 

Section 16(a) Beneficial Ownership Reporting Compliance.   Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the Company’s officers and directors, and persons who beneficially own more than ten percent of our Common Shares, if any, to file reports of ownership and changes in ownership of Company stock with the Securities and Exchange Commission. Based on our review of Section 16 reports prepared by or furnished to the Company and representations made by our officers and directors, we believe that all filing requirements were met during 2006, except as set forth below.

 

In a Form 5 filed on February 12, 2007, Donald B. Shackelford, a director of the Company, reported that a trust for which he served as Trustee distributed all of its Progressive Common Shares to the beneficiary of the trust on August 10, 2006. This transaction should have been reported on a Form 4 by August 14, 2006.

 

The Company granted Raymond M. Voelker, Progressive’s Chief Information Officer, stock option awards on March 15 and May 1, 2000. Due to administrative errors on the part of the Company: (i) the initial statement of share ownership (Form 3) filed for Mr. Voelker in April of 2000 did not include the March 15, 2000 stock option grant; and (ii) the May 1, 2000 stock option grant was not reported on a Form 4 at that time. On March 6, 2006, Mr. Voelker’s Form 3 was amended to report the March 15, 2000, stock option grant, and a Form 4 was filed to report the May 1, 2000, stock option grant.

 

I.  Goals of Executive Compensation Program

 

Our compensation program for executives, including the “named executive officers” identified in the Summary Compensation Table on page 40 below, is designed and implemented under the direction and guidance of the Compensation Committee of the Board of Directors. Broadly stated, the objectives of the program are to:

 

 

We further seek to maintain a consistent compensation program from year to year, with a limited number of compensation elements that can be clearly understood by our executives and shareholders.

 

II.  The Executive Compensation Program

 

A.  Overview

 

The Compensation Committee.   The Compensation Committee is comprised of three Directors who are independent from management. The Committee makes final executive compensation decisions regarding salary, cash bonus targets, equity awards and related performance goals, as they apply to executive officers. For additional information on Compensation Committee procedures, see the “Compensation Committee” discussion on page 10 above.

 

Primary Elements of Compensation.   The overriding policies that govern our compensation decisions, for executives and non-executives alike, are that individual base salaries generally should be within a range that is tied to the 50th percentile for similar jobs at comparable companies (with variations above or below the 50th percentile determined by individual factors, as described in more detail below), and that employees should have the ability to earn above-average compensation when justified by the individual’s and the Company’s performance. At executive levels, variable compensation (including annual cash bonus and restricted stock awards) accounts for a much greater portion of total potential compensation, providing tangible incentives to executives to drive business unit and Company results and aligning executives’ interests with those of shareholders. The individual elements of our compensation program are highlighted in this section and are discussed in more detail below.

 

Our executive compensation program has retained the same basic components for more than a decade. Its three primary elements involve annual decisions made by the Compensation Committee to ensure competitive pay for our executives, with an appropriate balance of fixed and variable compensation. These elements are:

 

 

Other types of compensation that are available to our executives are limited. Executives are entitled to participate in our health, welfare and 401k plans on the same terms and conditions as other employees. Executives may also participate in a deferred compensation plan, which allows executives to defer the receipt of (and thus defer certain taxes on) Gainsharing bonuses or equity awards (at vesting) and to invest those deferred amounts in Company stock or a number of mutual fund alternatives, without further contributions from the Company. We provide severance payments in certain circumstances when an executive’s employment is terminated, but in an amount believed to be in the lower range of severance payments that are offered by comparable companies to their departing executives. The Company does not provide a separate pension program, supplemental executive retirement plan or other post-retirement payments to executives, nor do we make tax “gross-up” payments to executives in connection with compensation received. Perquisites are very limited in scope.

 

As a result, virtually all of the compensation an executive can expect to earn at Progressive over his or her career will derive from our three annual compensation components (i.e., salary, cash bonus opportunity and equity awards), and the amount ultimately earned by executives will depend greatly on the Company’s operating performance, as well as the performance of the Company’s Common Shares. It is imperative, therefore, that our annual executive compensation decisions be competitive and include performance criteria that will support the achievement of the Company’s strategic goals.

 

Compensation Comparisons.   The executive compensation program is market-based and is designed to be competitive with compensation opportunities available to executives in similar positions at comparable companies. If direct job comparisons are not available for an executive, we seek to match the executive with job classifications from comparable companies that most closely resemble the executive’s position and responsibilities.

 

Comparable companies include those from many industries in a revenue range that is comparable to the Company’s revenue, as indicated on compensation surveys that we obtain from independent third party vendors. Comparable companies are intentionally not limited to the insurance industry. This choice of comparable companies reflects the realities that there are a limited number of publicly held insurers that focus exclusively, or even primarily, on automobile insurance (and none with comparable revenue or market value characteristics); that we do not generally recruit senior management level talent from other insurance companies; and that our executives have employment opportunities with companies doing business in a variety of industries. As a result, we view the broader range of companies to be a better reflection of the marketplace for the services of our executives.

 

For 2006, in making the compensation decisions for our Chief Executive Officer (CEO), the comparable group of companies was determined principally from Towers Perrin and Mercer Consulting compensation surveys, which included approximately 200 public companies with revenues generally starting at $5 billion. The Company’s revenue in 2005 was approximately $14.3 billion. The compensation comparisons for our other named executive officers were determined from similar Towers Perrin and Mercer surveys (although the number of companies and revenue ranges varied from position to position based on responsibilities, available comparison matches, and other factors), other than William Cody, our Chief Investment Officer, whose comparison group was determined from industry specific information for fixed-income money managers. We do not focus on the identity of any individual company, but are interested in the aggregate data and the percentile breakdowns, which are used as a guide (among other factors) in our executive compensation decisions, as discussed further below.

 

Internal Pay Equity.   We do not use “internal pay equity” as a constraint on compensation paid to the CEO or other executives. Such systems typically put a ceiling on part or all of an executive’s compensation based on a specified multiple of compensation awarded to another executive or a class of employees of the company. Management and the Committee do not believe that such arbitrary limitations are an appropriate way to make

compensation decisions for executives. Instead, we rely on the judgment of the Committee, after considering recommendations from management, available market data and evaluations of executive performance, in the context of a program that is weighted heavily in favor of performance-based compensation for executive officers.

 

No Tax “Gross-Up” Payments.   Prior to December 2006, our CEO and certain other executives had employment agreements with the Company that would have provided tax “gross-up” payments to reimburse executives for tax obligations incurred in connection with severance payments and other benefits that would have been received after a “change of control” of the Company. No “gross-up” payments were ever made under the employment agreements, however, and these agreements were terminated in December 2006. As a result, we do not provide, and no executive officer is entitled to receive, any tax “gross-up” payments in connection with compensation, severance, perquisites or other benefits provided by the Company.

 

B.  Elements of Compensation — Annual Decisions or Awards

 

This section summarizes our policies and plans relating to the basic elements of compensation, each of which is determined on an annual basis — salary, annual cash bonus and restricted stock awards. At the end of this section, we discuss details of the 2006 compensation decisions for the named executive officers and performance results. A number of changes that are being implemented for 2007 are also addressed in more detail at the end of this section.

 

1. Salary

 

Executive salaries are designed to attract and retain executive talent and to reward individual performance. As a general matter, executive salaries are set in a range around the 50th percentile for executives with similar responsibilities at comparable companies. Variations from this general rule can occur on a case-by-case basis for any number of reasons, including the nature of a specific executive’s position and responsibilities, the Company’s business needs, the tenure of an executive in his or her current position, individual performance and the executive’s future potential. The salary level for the Company’s CEO, Glenn Renwick, which has been maintained well below market at $750,000 per year since 2003, is an exception to this general approach and is discussed separately below.

 

Salary amounts then serve as the basis for determining annual cash bonus potential and the value of annual equity awards, as described in more detail in the following sections.

 

2. Cash Bonuses

 

Gainsharing Program.   Each executive has the opportunity to earn an annual, performance-based cash bonus under the Company’s 2004 Executive Bonus Plan, 2006 Gainsharing Plan or other bonus plans. The Executive Bonus Plan and the Gainsharing Plan operated under the same performance criteria in 2006, and they are sometimes referred to collectively as “Gainsharing” or as the “Gainsharing plans.” The Gainsharing cash bonus is designed to reward executives based on the operating performance of the Company’s insurance business as a whole and/or an executive’s assigned business unit, as compared with objective performance criteria that are established by the Committee during the first quarter of each year and not thereafter modified. The purpose of the cash bonus program is to motivate executives to achieve and surpass current performance goals, which over time, should positively impact the returns of long-term shareholders. Note that all Gainsharing and other performance-based cash bonus awards for the named executive officers are reported on the Summary Compensation Table below as “Non-Equity Incentive Plan Compensation.”

 

 

The Committee decides at the beginning of each year the plan or plans in which each executive will participate. Generally, an executive participates in either the Executive Bonus Plan or the Gainsharing Plan in a given year, although the head of the our information technology group participates in an IT-specific plan for 10% of his annual bonus, and our Chief Investment Officer has his bonus determined based solely on certain investment results (as described in more detail below). If an executive participates in more than one plan, the executive’s bonus will not increase, but his or her maximum potential bonus (also described below) will be divided by the Committee between the plans in which he or she participates. Virtually all of our employees have their annual cash bonus determined under the Gainsharing Plan.

 

Gainsharing bonuses are determined using the following formula:

 

Annual Salary

X

Target Percentage

X

Performance Factor

=

Annual Bonus

 

For each executive, the annual salary and the target percentage are established by the Committee on an annual basis during the first quarter of the plan year. When the participant’s annual salary is multiplied by his or her assigned target percentage, the product is referred to as the participant’s “target bonus” or “target bonus amount” for the year. The target bonus amount would thus be paid as the executive’s annual cash bonus if the applicable performance factor equals a 1.0 at the end of the year. A 1.0 performance factor represents management’s and the Committee’s assessment of a performance outcome (in terms of growth and profitability, as described below, for the applicable business unit) that would justify a Gainsharing payout of 1.0 times an executive’s target bonus amount. Under our compensation program, a 1.0 Gainsharing payout is generally expected to put the annual cash compensation (salary plus bonus) for most executives (and other regular employees of the Company) above the 50th percentile of total cash compensation for similar jobs at comparable companies.

 

Under the Gainsharing plans, the performance factor is determined after the end of each year based on actual operating performance for that year by our principal business units, when compared to growth and profitability criteria that were established by the Compensation Committee during the first quarter of the year. The performance factor can range from zero (0.0) to two (2.0) each year, depending on the extent to which the Company and/or assigned business unit results meet, exceed or fall short of the objective performance goals established by the Committee. As a result, each participant can earn an annual cash bonus of between zero (0.0) and two (2.0) times his or her target bonus amount (with an amount equal to 2.0 times an executive’s target bonus thus being the executive’s maximum potential bonus).

 

Generally, the performance factors for executives (and most other employees) under our Gainsharing plans are determined by reference to either (i) the overall operating performance of our core insurance businesses, excluding the Company’s investment results (the “Core Business”), or (ii) a combination of the performance of the Core Business and the performance of the respective executive’s assigned business unit. For 2006, the Core Business was defined to include the Agency Business, the Direct Business and the Commercial Auto Business.

 

Consistent with how the Gainsharing program has operated in recent years, the performance factor for the Core Business for 2006 was calculated as follows:

 

 

 

 

 

Additional discussion of the 2006 Gainsharing program, the operating results for the business units comprising the Core Business and the calculation of the Performance Factor for 2006 can be found below under “2006 Compensation Decisions and Results.”

 

Other Bonus Plans.   In addition, in 2006, our Chief Information Officer participated in The Progressive Corporation 2006 Information Technology Incentive Plan (the “IT Bonus Plan”), and the Company’s Chief Investment Officer participated in the 2006 Progressive Capital Management Bonus Plan (the “PCM Bonus Plan”), in each case along with other employees who worked in these business areas. These plans provide cash bonus opportunities to participants for satisfaction of pre-established performance criteria relating, in the case of the IT Bonus Plan, to the outage-free availability of certain information technology systems and, in the case of the PCM Bonus Plan, to the performance of the Company’s fixed-income investment portfolio in relation to a designated benchmark.

 

Recent Bonus Experience.   The effectiveness of this Gainsharing bonus system has been shown in recent years. Outstanding growth and profitability results in each of 2003 and 2004 were rewarded by a Core Business performance factor of 2.0, and the highest possible bonus, for most executive officers and other employees of the Company. At the other end of the spectrum, a significant down year in our insurance operations in 2000 resulted in a performance factor of 0.0 — and no annual cash bonus — for most executive officers and other employees. Performance factors for 2005 and 2006 were 1.539 and 1.18, respectively, reflecting very strong profitability, but lagging growth compared to recent experience and our pre-established targets. Throughout the 13-year history of the Gainsharing program (including 2006), the performance factor for the Core Business has averaged about 1.4. These results confirm that the Company’s various cash bonus plans operate not only to reward excellent performance, but also to withhold or temper cash bonuses if the Company’s actual performance results fail to achieve pre-defined goals.

 

Recoupment Rights.   Under the 2007 Executive Bonus Plan, which was approved by the Compensation Committee in February 2007 but remains subject to shareholder approval, bonuses paid to executives under that plan will be subject to recoupment by the Company if operating or financial results that are a part of the bonus calculation are later restated. Under this provision, an executive who engages in fraud or other misconduct leading to the restatement would be required to repay all of his or her bonus paid for the year(s) in question, plus interest

and the costs of collection, and there is no time limit on our ability to recover (without interest) such amounts other than limits imposed by law. In addition, we would have the right to require repayment from an executive who does not engage in misconduct, but nonetheless receives a bonus that was artificially high due to the use of incorrect financial results, but only to the extent that the bonus paid was too high, if the excess to be recovered exceeds the lesser of 5% of the bonus paid or $20,000 and the restatement occurs within three years after the bonus is paid. Plans covering bonuses paid to executives in prior years do not include such a provision, however, and our ability to recoup any bonuses paid under similar circumstances would depend on the availability of general legal and equitable remedies under state or federal law.

 

3. Equity Awards

 

Restricted Stock Awards.   Our executive compensation program includes long-term incentives through an annual grant of restricted stock awards. Under a restricted stock grant, the executive is awarded shares of the Company’s common stock, subject to restrictions on vesting and transferability. Annual awards of restricted stock (“equity awards”) to executive officers are intended to tie the amount of compensation ultimately earned by the executive to the long-term performance of the Company and its Common Shares. Until 2002, we issued stock options annually to our executives (and certain other employees), but that program was terminated in 2003 when the restricted stock program was instituted. Option awards made prior to 2003 have all vested and, if not yet exercised, will remain outstanding until they are exercised by the holder, they are forfeited pursuant to the applicable plan or they expire at the end of their 10-year term. A portion of the currently outstanding option awards, if not exercised prior to the applicable expiration date, will expire on December 31 of each year through 2011, at which point all options either will have been exercised or will expire.

 

Each executive officer receives a restricted stock award on an annual basis. All executive officers receive a time-based restricted stock award that will vest in 3 equal installments in the third, fourth and fifth years after the grant. The value of these awards is based on a percentage of the individual’s salary at the time of the award, which is determined by the Committee on an annual basis. Time-based restricted stock awards serve as a strong retention device, encouraging our senior executives to stay with the Company until future vesting dates occur and align the interests of executives with our shareholders.

 

In addition, our CEO, and each executive officer who reports directly to him, receives an annual award of performance-based restricted stock. The number of shares granted to each executive, and the objective performance criteria that govern if and when the performance shares will vest, are approved each year by the Committee at the time the awards are granted and are not thereafter modified. The performance criteria are established by the Committee each year, with management’s input, based on then-current market conditions and the Company’s long-term strategic goals. Performance-based awards operate as an additional incentive for executives to achieve long-term business objectives, thus further aligning the interests of shareholders and our executives, while also supporting retention of critical employees. In addition, these awards increase the “at risk” nature of our executives’ compensation. If the applicable performance conditions are not satisfied within the 10-year time frame established by the Committee, the awards will be forfeited by the executives.

 

Timing of Awards.   Since 1997, we have made an annual award of equity-based compensation in March of each year to our executives and other eligible employees, with Committee approval. This consistent grant date has been maintained except for 2003, when the annual award was delayed until after our Annual Meeting of Shareholders in April of that year, at which the shareholders approved a new equity incentive plan proposed by the Company in connection with our shift from stock options to restricted shares. We believe that the March timing is appropriate because it follows shortly after annual performance evaluations and salary adjustments for executives and other equity eligible employees, thus providing an administratively convenient time to calculate the awards and communicate them to the recipients. Management also has the ability to issue restricted shares (up to a maximum number set by the Committee each year) to non-executives at the beginning of each quarter for new

hires, promotions, performance and similar reasons that occurred during the immediately preceding quarter. Historically, interim awards have been made to executive officers only at the time of his or her appointment to the executive team; any interim award to an executive officer would require approval of the Compensation Committee. We expect that the March timing of annual restricted stock awards will be maintained in the future, unless a legal or plan requirement causes us to adopt a change for a specific year.

 

Review of Prior Stock Option Awards.   Due to media reports of stock option irregularities at other companies, the Committee requested that management conduct a comprehensive review of our historical option practices. We accordingly undertook an internal review of the Company’s prior stock option program, pursuant to which options were awarded to executives and other employees in 1989 through 2002. Our review of the Company’s records and interviews with Company personnel found no evidence of backdating or other manipulations of our stock options program before it was discontinued in 2002.

 

Qualified Retirement Rights.   Executive officers, along with other equity award recipients, are eligible for “qualified retirement” treatment (sometimes referred to as the “Rule of 70”) under our equity compensation plans. Under this arrangement, executives who leave their employment with the Company after satisfying certain age and years-of-service requirements, generally (i) are permitted to exercise outstanding stock options (all of which are now vested) at any time prior to their stated expiration date (instead of being required to exercise such options within 60 days of the termination of employment, as is typically the case), (ii) receive 50% of the unvested time-based restricted shares then outstanding (with the remaining 50% being forfeited), and (iii) retain 50% of unvested performance-based restricted stock awards which will vest, if at all, only upon satisfaction of the performance objectives associated with those awards (and the other 50% of the performance-based shares are forfeited). For all awards made prior to March 2008, a “qualified retirement” requires an executive to be age 55 or older, and the total of his or her age plus years of service with the Company must be at least 70. Under an amendment to our restricted stock plan approved by the Committee in February 2007, for awards made in or after March 2008, the qualification standard was changed to require the employee to be age 55 or over and have at least 15 years of service with the Company at the time of retirement.

 

The named executive officers participate in these arrangements on the same terms and conditions as are available to other equity award participants, except that if the CEO or one of the executives who directly reports to him provides at least one full year of notice to the Company of his or her intention to leave employment after qualifying for a “qualified retirement,” he or she will retain 100% of his or her unvested performance-based restricted stock awards (not just 50% as stated above), although such performance-based shares will vest only if and when the applicable performance goals are achieved prior to expiration. This advantage is available to executives in order to facilitate a smooth transition for the Company when replacing a senior executive. The Rule of 70 provisions are intended to provide a limited benefit for long-tenured employees who retire from the Company after satisfying the age and service requirements.

 

W. Thomas Forrester, the Company’s CFO during 2006, is the only named executive officer who was eligible to take advantage of qualified retirement treatment at year end 2006. Mr. Renwick, the Company’s CEO, will become eligible for such treatment if he remains employed by the Company through May 2010. For additional information on the “qualified retirement” provisions, see “Potential Payments upon Termination or Change-in-Control” beginning on page 48 below.

 

Dilution Mitigation.   To avoid dilution of the interests of the Company’s shareholders as a result of equity awards to executive officers and other employees, as we have previously announced, we intend to repurchase, in the year of grant, an amount of our Common Shares at least equal to the amount of equity so awarded, subject to applicable law. These repurchases may be in addition to other share repurchases that are made by the Company from time to time.

 

Ownership Guidelines for Executives; Wealth Accumulation.   We do not require executives to retain any specified portion of equity awards or to own a specified number of the Company’s Common Shares. As a practical matter, however, due to the operation of our restricted stock program, under which executives who report to the CEO currently receive an annual award of restricted shares with a value from 175% to 225% of their respective salaries, any executive who stays in his or her position for three years or more will acquire an ownership position that we view as meaningful. In addition, it should be noted that most of our executives currently retain additional interests in the Company’s shares under our stock option program (which was discontinued in 2002, but under which options may remain outstanding through December 2011), and many of our executives have also elected to hold Progressive shares in their 401k plans, executive deferred compensation accounts or other investment accounts. In view of this situation, the Company has not seen the need to impose additional stock ownership requirements on its executives.

 

The Committee also does not review “wealth accumulation” analyses from prior equity awards when making current compensation decisions. Such analyses have been advanced by some commentators as a way to determine when an executive has received “enough” equity compensation from the Company and, as a result, to justify the limitation or elimination of future grants. Our focus, however, is to make appropriate executive compensation decisions annually, so that executives are paid at competitive levels with a significant component that is “at risk” and performance based. Given that, in general, at least 35% of each named executive officer’s potential annual compensation consists of equity awards, the elimination of such awards based on a theory of wealth accumulation likely would make our current compensation uncompetitive, thus risking the loss of valuable executives, or requiring us to make other compensation arrangements with individual executives to retain his or her services, which would be contrary to our program and the Company’s culture. If equity awards from prior years increase significantly in value in future years, we do not believe that this positive development, which rewards all of our long-term shareholders, should negatively impact current compensation decisions. Finally, since we do not provide separate pension or retirement benefits in addition to the executives’ annual compensation, we expect that the value of equity awards in many cases will be used by executives effectively to replace such benefits that other companies may offer and thus to fund retirement. Under these circumstances, we do not believe that such artificial limitations on compensation levels are appropriate or in the best interests of the Company or its shareholders.

 

Recoupment Rights.   Under an amendment to our 2003 Incentive Plan, which was approved by the Board of Directors in February 2007, performance-based restricted stock awards made in or after March 2007 will be subject to recoupment by the Company in the event of a financial restatement of the operating or financial results which caused those performance-based shares to vest, in certain circumstances. An executive who engages in fraud or other misconduct leading to the restatement would be required to repay all such shares or an equivalent dollar amount, at the Company’s election, plus interest and the costs of collection, and there would be no time limit on our ability to recover those amounts other than limits imposed by law. In addition, we would have the right to require repayment from an executive who does not engage in misconduct, but nonetheless has his or her shares vest due to the use of incorrect financial results, but without interest and only if the restatement occurs within three years after the vesting date. Equity awards made prior to March 2007 are not subject to this plan amendment, and our ability to recoup any such awards that vest under similar circumstances would depend on the availability of general legal and equitable remedies under state or federal law.

 

4. 2006 Compensation Decisions and Results

 

Market Comparisons.   In the first quarter of 2006, the Compensation Committee set each named executive’s 2006 salary, bonus opportunity and restricted stock awards. These decisions are discussed in more detail in the sections immediately following. The decisions were each made in a framework in which the executive’s total potential compensation (salary, bonus opportunity and restricted stock) is evaluated in comparison to executives at similarly sized companies (based on revenue) from a wide range of industries that are identified through compensation surveys. These comparisons are presented to the Committee as part of the compensation decision

process, among other factors, to ensure that the Company’s executive compensation levels are competitive but not excessive.

 

With the exception of Mr. Renwick, the salaries of our named executive officers during 2006 were close to the median (50th percentile) for their respective comparison group. As to Mr. Renwick, as discussed in more detail below, his base salary has been maintained well below the median level for several years. With the addition of variable compensation (i.e., the potential for cash bonuses and the possibility of restricted stock vesting in future years), the total potential compensation for three of our named executive officers ranked above the 50th percentile but below the 75th percentile of the comparison groups, while in one instance the total potential compensation exceeded the 75th percentile and in one instance it was below the 50th percentile based on the compensation survey information presented to the Committee when the decisions were made. Variations from the 50th to 75th percentile range were caused by a number of factors, including the length of the named executive’s tenure in the specific job, the absence of similar positions at comparable companies, individual performance and expected future contributions, as well as the Company’s business needs.

 

It should be noted, however, that these percentile rankings attributed to our named executive officers’ compensation for 2006 are potentially inflated, perhaps significantly, since they assume that each executive will receive the entire benefit of his 2006 restricted stock awards. The vesting of the restricted stock awards, however, is not guaranteed: (i) the named executive officer will receive the entire value of the time-based awards only if he remains with the Company throughout the three, four and five year vesting periods, and (ii) the performance-based awards will vest only if the Company satisfies the performance criteria established by the Committee, which are discussed in more detail below. Thus, for each named executive officer, a substantial portion of the compensation used to establish his percentile rank will remain “at risk” for years before it is earned by the executive, and some of the restricted stock in fact may never vest.

 

CEO’s Compensation.   As mentioned above, in the case of Glenn Renwick, the Company’s CEO, his salary level has been maintained at $750,000 since 2003, a level estimated to be $216,000 below the 50th percentile of $966,000 for CEO salaries at comparable companies in 2006. Mr. Renwick’s cash bonus (Gainsharing) potential has also remained at the same level since 2003. The Compensation Committee has determined in recent years that Mr. Renwick should receive, instead of additional cash compensation, a larger proportion of his compensation in the form of restricted stock and that his restricted stock awards should be weighted more heavily in favor of performance-based shares. In this way, the Committee is able to keep Mr. Renwick’s overall compensation at a competitive level, while further keeping a very high portion of his potential compensation at risk and dependent on the Company’s performance, increasing his equity participation and aligning his interests with those of long-term shareholders.

 

The following table shows the development of Mr. Renwick’s compensation since 2001, with his salary being capped at $750,000 since 2003, his Gainsharing target staying constant at 150% of salary, and his equity awards increasing through 2004. In addition, the level of performance-based restricted shares was increased from about one-third of the total equity awarded to him in 2001 to one-half in 2003 through 2006:

 

 

 

 

The result of these determinations for 2006 was that, despite his below median salary and bonus potential, Mr. Renwick’s total potential compensation was ranked above the 50th percentile and could approach the 75th percentile of comparable CEO compensation if performance-based compensation were to be maximized. In this regard, it should be noted that at the time these decisions were made, the Company was completing a 5-year period (2001-2005) of outstanding performance under Mr. Renwick’s leadership, during which the Company’s revenues grew at an average annual rate of 16.1%, on a very profitable basis, and shareholders were rewarded with an average annual compounded return of 27.8%. In addition, according to data filed with insurance regulators during those five years of Mr. Renwick’s tenure as CEO, Progressive had achieved the highest written premium growth, and second lowest combined ratio, of the 10 largest U.S. private passenger auto insurers. As compared to the entire private passenger auto industry over the same 5-year period, Progressive had grown at a rate of 2.5 times the competition at a combined ratio that was 10.3 points lower than the industry.

 

In the Compensation Committee’s view, Mr. Renwick’s performance as CEO clearly has justified this above-median pay package. Moreover, the proportionately large restricted stock component, and the 50/50 split between time-based and performance-based restricted stock awards, was determined by the Committee to be an appropriate allocation to balance encouraging Mr. Renwick’s retention, providing incentives to maximize Company performance and maximizing the extent to which Mr. Renwick’s interests will be aligned with the interests of shareholders. If the restricted shares do not ultimately vest, Mr. Renwick’s actual total compensation will be well below the median compensation for CEO’s at comparable companies.

 

The Committee believes that this program presents a rational and strongly performance-based pay package for an outstanding CEO who has led a management team that has provided exceptional results for long-term shareholders.

 

Salary for Other Named Executive Officers.   For the other named executive officers, their 2006 salaries reflected increases of between 0% and 7.7% when compared with the prior year. These increases were consistent, as a group, with salary increases for the Company’s employees as a whole.

 

Gainsharing and Other Cash Bonuses.   For 2006, Gainsharing target percentages for the named executive officers were determined by the Compensation Committee, as disclosed in the following table. The resulting lowest and highest potential bonus payments for the year are also shown (using the minimum and maximum Gainsharing Factor of 0.0 and 2.0, respectively).

 

 

 

The 2006 performance factors were determined using Gainsharing matrices, as approved by the Compensation Committee, for each of the Company’s three principal business units, as described above under “Cash Bonuses.” The 2006 growth and performance targets were tied to our companywide strategic goals of growing as fast as possible at a 96 combined ratio or better. For 2006, consistent with the historical usage of the Gainsharing matrices, the 1.0 anchor in each business unit matrix was viewed as an achievable result, and performance factors in excess of 1.0 were considered to represent more aggressive combinations of growth and profitability for the applicable business unit.

 

For Messrs. Renwick, Forrester, Passell and Jarrett, as well as virtually all of the Company’s other employees, 2006 bonuses were determined solely by the performance of the Core Business. For these executives and employees, the calculation described above resulted in a performance factor of 1.18 (out of a possible 2.0), calculated as follows:

 

 

 

The results of our insurance operations, as set forth in the table above, were good but not great for 2006. Although variations were evident among the business units and individual markets during the year, the overall growth rates for net earned premiums (revenues) reflected the “soft” market for auto insurance, evidenced by price cutting and increased marketing efforts by our competitors and decreased shopping by consumers, among other factors. Profitability, on the other hand, remained very strong as shown in our combined ratio performance. On balance, although growth did not meet our objectives, our continued high level of profitability justified an overall Gainsharing Factor slightly in excess of a 1.0 for the year.

 

For William Cody, the head of our investment operations, his performance factor was determined under the PCM Bonus Plan. Under the PCM Bonus Plan, Mr. Cody’s performance factor was determined by the performance of the Company’s fixed-income investment portfolio when compared, on a risk-adjusted basis, with a defined benchmark of 134 comparable money management firms. The firms comprising the benchmark managed similar fixed-income portfolios in 2006, as determined by an independent third party vendor. The vendor further collects and provides to us the appropriate performance data for the benchmark firms, and this data forms the basis for the calculation of the percentile ranking of our fixed-income portfolio against the benchmark firms. The Company’s equity portfolio is not included in this analysis because this portfolio tracks the Russell 1000 Index and is not actively managed by Mr. Cody’s group.

 

Under the PCM Bonus Plan, a performance score of 1.0 would result (and Mr. Cody would earn a bonus of 1.0 times his target bonus amount), if his group’s investment performance ranked at the 50th percentile of the benchmark money management firms. Performance below the median level of the benchmark would result in a performance score of less than 1.0, while performance above the median level would give rise to a score in excess of 1.0, with a maximum of 2.0. For 2006, Mr. Cody earned a performance factor of 2.0 under the PCM Bonus Plan. This score resulted from his group’s ranking in the top 5% when compared with the results of the money management firms included in the benchmark.

 

Restricted Stock Awards.   In 2006, two forms of restricted stock awards were granted to executive officers and certain other senior level employees. Time-based restricted stock awards were granted to all named executive officers and approximately 780 other senior level employees. The time-based restricted stock awards will vest in three equal annual installments, on January 1 of 2009, 2010 and 2011, subject to the vesting and forfeiture provisions in the applicable plan and grant agreement. In addition, the named executive officers and 41 other senior managers received performance-based restricted stock grants, with the vesting date tied to the achievement of specific business results that are defined by our long-term growth and profitability objectives.

 

CEO Glenn Renwick received a time-based restricted stock award with a value equal to 500% of his salary and a performance-based restricted stock award equal in value to 500% of his salary. As indicated above, Mr. Renwick’s equity award was proportionally larger than other executives’ awards due, in part, to the below-market level of his base salary, putting more of his compensation at risk and dependent on the Company’s operating performance over the next several years.

 

The other named executive officers received time-based awards with a value equal to 100% of their respective salaries, and performance-based awards ranging in value from 100% to 120% of salary. Performance-based awards to the executives who report directly to the CEO can range from 75% to 125% of salary per year. As with the CEO, the Company has increased the weighting of performance-based shares in recent years to other senior executives to provide appropriate performance incentives to executives. The Committee, after considering the recommendations of and discussions with the CEO and the Chief Human Resource Officer, determines the value of each executive’s performance-based award based on individual factors, such as past performance, skills and competencies and expected future contributions.

 

Performance-based restricted stock awarded in 2006 will vest only if the Company’s insurance subsidiaries generate net earned premiums of $20 billion or more over a period of twelve (12) consecutive months while maintaining an average combined ratio of 96 or less over the same period. If we do not satisfy these criteria prior to December 31, 2015, the performance shares will be forfeited. While the profitability target of this standard is within the Company’s recent performance experience, the growth target was very aggressive when made (and remains aggressive at this writing). Our net earned premiums for 2005 were approximately $13.8 billion, and the $20 billion target thus represents about a 45% increase from that level. Moreover, as of year-end 2005, the Company had year-over-year growth of net earned premium of just 4.5%, and the net earned premium growth decreased to approximately 3% in 2006 as compared with 2005. At these growth levels, there is a significant risk that the performance-based restricted shares will not vest prior to the end of their 10-year life. Moreover, in order for the awards to vest within 5 years from the date of award, a result more in line with our growth focus, growth from January 2007 through March 2011 would have to increase to 8.5% per year on a compounded basis. The growth target used in the 2006 performance-based shares, therefore, is a very challenging one.

 

5. Changes for 2007

 

Our compensation program for 2007 includes a number of significant changes from prior years. The changes are summarized as follows:

 

Comparable Companies.   The Company changed the group of comparable companies used to determine the relevant market information for executive compensation. In setting 2006 compensation for our CEO, the group of comparable companies included approximately 200 public companies with annual revenues generally starting at $5 billion. For 2007, we used a group of 61 public companies for CEO comparisons with annual revenues from $10 billion to $20 billion, as identified in compensation surveys purchased by the Company from Towers Perrin. Given our 2006 revenue of approximately $14.8 billion, we believe that this change will provide a more accurate reflection of the Company’s competition for executive level talent. As with our 2006 decisions, the 2007 comparisons for our other named executive officers were taken from compensation surveys from Towers Perrin and Mercer Consulting (although the number of companies and revenue ranges varied from position to position based on responsibilities, availability of comparison matches and other factors), except that for Mr. Cody, the comparison group was determined from industry specific information for fixed-income money managers, and for Mr. Forrester, no comparisons were made since he is retiring in March 2007.

 

Growth Targets.   We will begin using “policies in force” (or PIFs) to define the growth criteria for Gainsharing bonus payouts in 2007. Policies in force is a figure that represents the total number of insurance policies that the Company has outstanding at a given time. The use of PIFs for the growth measure in our compensation program is

appropriate to align the Company’s compensation policies with our recently revised strategic goal of growing PIFs as fast as possible at an aggregate combined ratio of 96 or below. In addition, it provides an appropriate mechanism to focus the named executive officers and other employees on the importance of retaining existing customers, in addition to generating new business. This change thus further aligns the compensation program with the Company’s strategic goal of improving retention. This change is being implemented for employees generally under the terms of the 2007 Gainsharing Plan, which has been approved by the Committee. In order to make this change applicable to executive bonuses for 2007, the Committee has also approved The Progressive Corporation 2007 Executive Bonus Plan, which includes PIFs as one of the permissible performance measures, and that plan is being submitted to shareholders for approval pursuant to Item 2 of this Proxy Statement.

 

In addition, the growth targets incorporated into the Gainsharing matrices for the various business units (see more on this below) have been made much more aggressive in 2007, in order to drive long-term growth of the Company. We expect that, if recent growth rates continue, 2007 Gainsharing targets will result in significantly lower payouts to employees, including most executive officers, as compared with 2006.

 

In future years, we also may use PIFs to define growth targets for performance-based restricted stock, although we are required to obtain shareholder approval of the necessary modifications to our 2003 Incentive Plan to implement this change. The Board of Directors has approved this change, and the request for approval is being submitted to shareholders pursuant to Item 3 of this Proxy Statement.

 

Additional Gainsharing Matrices.   Beginning in 2007, the Company will also expand the number of business units and matrices used to evaluate the Company’s operating performance for Gainsharing purposes, as follows:

 

 

Deferral of Dividends on New Restricted Stock Awards.   Beginning with restricted stock awards to be made in March 2007, we will not pay dividends to holders of unvested restricted stock awards on a current basis. Instead, such dividends will be deferred and held by the Company during the vesting period, and will then be paid out to the executive plus interest at a market rate, only if the underlying restricted shares vest. If the restricted shares are

forfeited (e.g., if the executive were to leave the Company, in certain circumstances, prior to vesting, or if performance targets are not achieved for performance-based restricted shares prior to expiration), then the deferred dividends and any accrued interest likewise would be forfeited. Employees, including the named executives officers, who hold unvested restricted stock issued prior to March 2007 currently receive dividends on those shares when and as declared by the Board of Directors, and those rights will continue through the applicable vesting date of those outstanding awards.

 

Decisions Regarding Named Executive Officers.   Mr. Renwick’s salary for 2007, as well as his potential bonus and the value of his restricted stock awards, were maintained at levels equal to the amounts paid or awarded in 2006. These decisions were made by the Committee in view of the Company’s strong profitability and its history of outstanding performance under Mr. Renwick’s leadership, as discussed above. Moreover, Mr. Renwick has set aggressive growth goals for the Company, and these accelerated growth objectives have been incorporated into the 2007 Gainsharing targets. As mentioned above, the 2007 Gainsharing targets are considered extremely aggressive, which has the potential to significantly reduce his actual compensation if the Company does not achieve the specified growth goals.

 

Compensation decisions for the other named executive officers for 2007 also have been in line with their historical compensation. Salaries have been increased from 3.5% to 4.3%, and percentage targets for Gainsharing and restricted stock awards were not changed for those executive officers from the targets used in 2006.

 

C.  Elements of Compensation — Other

 

1. Perquisites

 

We provide limited perquisites to our executives and only do so when the Board or the Compensation Committee determines that such benefits are in the interests of the Company and its shareholders. The Company owns an aircraft that is used primarily for the CEO’s business travel, to maximize the efficiency of his travel and reduce his unproductive down-time, allow him to manage effectively our many remote locations, and to enhance his personal security and the confidentiality of his travel.

 

At the request of the Board of Directors, the CEO also uses the Company aircraft for his personal travel and some of his spouse’s and other guest’s personal travel when they accompany him. Such personal use of the aircraft, which is a perquisite under SEC regulations to the extent of the Company’s incremental costs therefor, is provided to enhance the CEO’s and his family’s personal security and the confidentiality of their travel. Other executives occasionally accompany the CEO on his personal trips, at the CEO’s discretion, and such personal trips would likewise be a perquisite for a named executive officer traveling with the CEO if the Company were to incur costs in addition to the costs for the CEO’s travel. On one occasion in 2006, Mr. Forrester, our CFO, took a business trip on the aircraft and was accompanied by two members of his family; such use of the aircraft is a perquisite to Mr. Forrester to the extent of the Company’s incremental costs.

 

In addition, the CEO is provided with a Company car and driver for his business needs to facilitate his transportation to and among our headquarters and many other local facilities, and to allow him to use that travel time for work purposes. To the extent that the CEO uses the Company car for personal matters, including commuting to and from work, he receives a perquisite from the Company.

 

Our directors, the named executive officers and certain other senior executives, and their spouses or guests, are invited to attend an annual retreat, which includes a series of meetings between management and the Board and a regular Board meeting, at an off-site location. Personal travel for the spouses and certain costs for meals and other activities during the retreat may constitute perquisites to the directors and executives who attend.

 

Otherwise, we do not provide perquisites to our executives. The incremental costs of these perquisites to the Company is disclosed, to the extent required, in the “All Other Compensation” column of the Summary Compensation Table below.

 

2. Retirement

 

We do not provide a pension program, supplemental executive retirement plan or other post-retirement payments or benefits to executives. Executives are eligible to participate in our retirement security program (401k plan) on the same terms and conditions as are available to all other regular employees, subject to limitations under applicable law. As described above under “Qualified Retirement Rights”, executives who satisfy certain age and years-of-service requirements when they retire may be eligible to receive 50% of their unvested time-based restricted stock awards at retirement and to retain rights under certain performance-based restricted stock awards, subject to the applicable performance-based vesting requirements, after retirement.

 

3. Deferral Arrangements

 

The named executive officers and certain other senior-level employees are given the opportunity to defer the receipt of annual cash bonus awards and restricted stock awards under our Executive Deferred Compensation Plan. This plan is made available to executives in order to keep the Company’s executive compensation program competitive and to allow executives to manage their receipt of compensation to better fit their life circumstances, to manage the timing and amount of taxes that they pay and to allow the executive to arrange for a portion of his or her income to be paid in post-employment years. In addition, to the extent that the top executives elect to defer time-based restricted stock until after they leave the Company, the Company may benefit to the extent it otherwise might have lost a tax deduction upon the vesting of those shares under IRC § 162(m) (see related discussion under “Section 162(m) of the Internal Revenue Code” below).

 

These deferral mechanisms operate solely as a vehicle for the executive to delay receipt of bonus income or restricted stock awards that he or she would otherwise have earned as of a specific date under the applicable bonus or equity plan. The Company does not contribute additional amounts to an executive’s deferral accounts, either in the year of deferral or in future years. The Company also does not guaranty a specific investment return to executives who elect to participate in the deferral plan. Deferred amounts are deemed invested in specific investments selected by the executive, including an option to invest in Company shares (subject to limitations included in the deferral plan). The value of each executive’s deferred account thus varies based on the executive’s investment choices and market factors; in fact, these deferred amounts are at risk and may decrease in value if the investments selected by the executive (including Company shares) do not perform well during the deferral period. Additional details concerning this plan can be found under the Nonqualified Deferred Compensation table and related disclosures, beginning on page 46 of this report.

 

4. Severance and Change of Control Arrangements

 

Severance and change-of-control arrangements are intended to provide compensation and a fair financial transition for an executive when an adverse change in his or her employment status is required due to the needs of the Company or as a result of certain unexpected corporate events. Such arrangements also recognize past contributions by the executives, who are typically long-tenured employees of the Company, when they are asked to leave. These arrangements allow the executive to focus on performance, and not his or her personal financial situation, in the face of uncertain or difficult times or events beyond his or her control.

 

 

Prior to December 2006, the named executive officers were parties to employment agreements with the Company that provided specified benefits in the event of a change in control of the Company. The employment agreements were terminated in December 2006, however, and now a unified executive separation allowance plan is applicable to all separation events for all executive officers, including a “change in control” scenario. In addition, our equity plans provide for acceleration of vesting and immediate cash payout upon a change in control. Each of these programs is discussed in more detail below under “Potential Payments upon Termination or Change-in-Control” beginning on page 48.

 

Severance.   Our executive separation allowance plan is designed to provide executives with well-defined financial payments if the executive is asked to leave by the Company under defined circumstances. For executives of the Company, including the named executive officers, the severance payment would equal three years of the executive’s base salary only at the time of termination, plus up to eighteen months of health and welfare benefits. This same level of benefits is payable to the named executives upon any qualifying separation from the Company, whether in a change-in-control situation or otherwise.

 

The Company believes that this level of severance payment (three times annual salary only), whether or not triggered by a change in control of the Company, is well below the market averages based on available market data. The severance payments do not take into account the value of cash bonuses or equity-based awards in determining the executive’s severance payment, which substantially limits the amount of the payment when compared with similar plans offered by many other companies. In addition, and also unlike many companies, an executive who qualifies for a severance payment under this plan does not receive accelerated vesting of equity awards (unless those awards vest under the terms of our equity incentive plans due to a change in control, and the Board has not exercised its discretion under those plans to override the change in control event, as discussed immediately below). Finally, the executive will receive no tax “gross-up” payment to compensate him or her for any taxes which he or she may be required to pay in connection with such payment (although the Company withholds taxes as required by law).

 

Change in Control Provisions under Equity Plans.   Benefits are also provided to named executive officers and other recipients of equity awards under our equity plans upon the occurrence of a “Change in Control” or a “Potential Change in Control”, as defined in those plans. The Board of Directors has the authority under the plans to “override” the Change in Control benefits, if the Board gives its prior approval to a transaction that would have otherwise triggered the benefits to be paid. If the Board’s prior consent is not obtained, our equity plans include provisions providing for the immediate vesting of, and payments to the holders of equity awards in an amount equal to the value of, the outstanding equity awards upon the occurrence of one of the specified triggering events. These provisions apply to both outstanding stock options, which were issued by the Company prior to 2003, and unvested restricted stock awards, including both time-based and performance-based awards. Details concerning these provisions, including the definitions of “Change in Control” and “Potential Change in Control”, are provided beginning on page 48 below under “Potential Payments upon Termination or Change-in-Control.”

 

These Change in Control provisions have been included in our equity incentive plans since at least 1989. The Company believes that these provisions are similar to the change-in-control provisions included by many public companies in their equity plans. The change-in-control provisions of our plans are designed to be triggered only when a transaction occurs or is in process, without the prior approval of our Board of Directors, and that transaction has changed or is expected to change the control or effective control of the Company. In each case, however, the plans provide the Board with the flexibility to avoid the application of the Change in Control or Potential Change in Control provisions, if appropriate, when a consensual transaction is negotiated.

 

For restricted stock awards made in March 2007 or thereafter, the Board of Directors has modified the Company’s 2003 Incentive Plan (our only equity plan under which awards may currently be made to executives and other eligible employees) to remove from the definition of “Potential Change in Control”, as described above, the

approval by shareholders of an agreement that would give rise to a Change in Control. This change was viewed as appropriate by the Board and management for future awards to avoid a potential scenario in which rights are triggered under the plan, cash payouts are made as required, but the underlying transaction does not then close as anticipated for some reason. This change was made on a going forward basis only, and it does not affect rights under outstanding awards, which accrued under the plan before the change was made.

 

5. Health and Welfare Benefits

 

Named executive officers are also eligible to participate in our health and welfare plans. These plans are available on the same basis to all of our regular employees who satisfy minimum eligibility requirements.

 

D.  Related Considerations

 

1. Section 162(m) of the Internal Revenue Code

 

Section 162(m) of the Internal Revenue Code limits to $1 million per year (“Deduction Limit”) the deduction allowed for Federal income tax purposes for compensation paid to the chief executive officer and the four other most highly compensated executive officers of a public company (“Covered Executives”). This Deduction Limit does not apply to compensation paid under a plan that meets certain requirements for “performance-based compensation.” Generally, to qualify for this exception: (a) the compensation must be payable solely on account of the attainment of one or more pre-established objective performance goals; (b) the performance goals must be established by a compensation committee of the board of directors that is comprised solely of two or more “outside directors”; (c) the material terms of the performance goals must be disclosed to and approved by shareholders before payment; and (d) the compensation committee must certify in writing prior to payment that the performance goals and any other material terms have been satisfied.

 

Our policy is to structure incentive compensation programs for Covered Executives to satisfy the requirements for the “performance-based compensation” exception to the Deduction Limit, and, thus, to preserve the deductibility of compensation paid to Covered Executives, to the extent practicable. Our equity incentive plans, as well as the 2004 Executive Bonus Plan, have been submitted to and approved by the Company’s shareholders. The Company’s 2007 Executive Bonus Plan has been submitted to shareholders for approval with this Proxy Statement. The applicable performance criteria (and in the case of cash bonuses, the amount of bonus payouts that would result from various levels of performance when measured against specific performance criteria) are approved in advance by the Committee each year and are thereafter not subject to change by the Company or the Committee. Thus, performance-based restricted stock awards which vest, and cash bonus awards under the Executive Bonus Plans (assuming that the 2007 Executive Bonus Plan is approved by shareholders) which are paid out, based on the achievement of such performance criteria are structured to be “performance-based compensation,” and compensation arising from such awards would not be subject to the Deduction Limit, provided that each of the other requirements described above are satisfied.

 

Compensation that is earned by the Covered Executives upon the exercise of stock option awards likewise has been designed to satisfy the requirements for “performance-based compensation”, based on how the Company implemented its stock option program prior to its termination in 2003.

 

Several elements of our compensation program, however, may give rise to income for a Covered Executive that is not considered “performance-based” and, therefore, subject to the Deduction Limitation, including the following:

 

 

 

Accordingly, if the total of any Covered Executive’s compensation that does not satisfy the “performance-based compensation” exception exceeds $1 million in any year, the Company will not be entitled to deduct the amount that exceeds $1 million. The Company and the Committee will continue to monitor the actual tax impact on the Company of such compensation strategies each year and consider such impact in making compensation decisions. We will not necessarily discontinue a compensation plan, however, that has a potential negative tax impact on the Company under Section 162(m). If we believe that the program in question (e.g., the use of time-based restricted stock) is appropriate and in the interest of shareholders, we will continue to use that type of compensation even though there are potential tax disadvantages to the Company.

 

In 2006, the non-performance-based compensation earned by each of the Covered Executives was less than $1 million, except that for one executive the Deduction Limit was exceeded by an amount currently estimated to be less than $500. Accordingly, other than that small overage, all compensation earned by the Covered Executives was fully deductible for Federal income tax purposes. For 2007, we are currently estimating that one or more executives may exceed the $1,000,000 limit by an aggregate amount of under $100,000.

 

 

COMPENSATION COMMITTEE REPORT

 

The following information is set forth with respect to the total compensation of our named executive officers (or NEOs), who include the Chief Executive Officer (CEO), the Chief Financial Officer (CFO) and our three other most highly compensated executive officers, in 2006. The titles set forth below reflect positions held at December 31, 2006. All share and per share amounts have been adjusted for the May 18, 2006, 4-for-1 stock split.

 

 

 

 

 

The following table summarizes awards eligible to be earned during 2006 under the Executive Plan, the PCM Plan and the Gainsharing Plan (collectively, non-equity incentive plan awards), as well as restricted shares awarded in 2006 under the 2003 Incentive Plan, including both time-based and performance-based awards (equity incentive plan awards).

 

N/A = Grant Date is not applicable to non-equity incentive plan awards.

 

 

Employment Agreements.   As of December 31, 2006, none of the named executive officers had employment agreements with the Company.

 

Summary Compensation Comments.   In total, salary and non-equity incentive plan compensation comprised approximately 65% to 80% of total compensation for the named executive officers other than Mr. Renwick, whose salary and non-equity incentive compensation comprised 38% of his total compensation for the year. For additional discussion of the Company’s compensation policies, 2006 compensation decisions, and non-equity incentive plans and the performance criteria thereunder, see the “Compensation Discussion and Analysis” beginning on page 21 of this report.

 

Non-Equity Incentive Compensation.   Salaries for named executive officers are set each year by the Compensation Committee. In addition, the Compensation Committee sets the target percentage, as a percent of salary, for the named executive officers for non-equity incentive compensation during the year. For 2006, Mr. Renwick’s target percentage for non-equity incentive compensation was 150% of salary and for Messrs. Forrester, Passell, Cody and Jarrett, the target percentage was 100% of salary. To determine the final non-equity incentive compensation earned in 2006, the target amount (i.e., salary x target percentage) is multiplied by a factor based on our success in achieving certain performance criteria established by the Compensation Committee at the beginning of the plan year. Non-equity incentive compensation could be earned under the Executive Plan for Messrs. Renwick, Forrester and Passell, the PCM Plan for Mr. Cody and the Gainsharing Plan for Mr. Jarrett. Under these plans, the award of compensation paid to each named executive officer was based on either the performance of the Company’s insurance operations as a whole during 2006, or in Mr. Cody’s case, on the performance of a portion of the Company’s investment portfolio for the year. In 2006, the performance factor was 1.18 for Messrs. Renwick, Forrester, Passell and Jarrett, and 2.0 for Mr. Cody.

 

Equity Incentive Plan Awards.   In 2006, all of the equity incentive plan awards were granted pursuant to the 2003 Incentive Plan. Progressive grants both time-based and performance-based restricted stock awards to named executive officers. All restricted stock awards for 2006 and prior years have dividend and voting rights equivalent to the Company’s other common shareholders.

 

Progressive granted time-based restricted stock awards to the named executive officers in 2006, based on a percentage of the individual’s salary at the time of grant. The time-based awards will vest in three equal installments in the third, fourth and fifth years after the date of grant (i.e., January 1, 2009, 2010 and 2011 for awards granted in 2006).

 

We also granted performance-based restricted stock awards to the named executive officers in 2006. The value of the performance-based awards is determined on an annual basis by the Compensation Committee. The performance-based awards vest upon the satisfaction of objective performance criteria. For 2006 awards, vesting will occur only if the Company’s insurance subsidiaries generate net premiums earned of $20 billion or more over a period of 12 consecutive months while maintaining an average combined ratio of 96 or less over the same period. If the objectives are not achieved by December 31, 2015, the awards will be forfeited.

 

All restricted stock awards are made subject to accelerated vesting pursuant to the “qualified retirement” and “change in control” provisions in the 2003 Incentive Plan (see discussion beginning on page 48).

 

Further discussion of Progressive’s compensation strategy and plans can be found in the “Compensation Discussion and Analysis” beginning on page 21 of this report.

 

The following table summarizes stock option awards exercisable and outstanding under the 1995 Incentive Plan, as well as the unvested restricted stock awards issued under the 2003 Incentive Plan. The value of the stock awards is calculated using the market value on the last business day of 2006.