UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 1O-Q

(Mark One)

þ		Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2008

or

o		Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                      to                     

Commission File Number: 1-9518

(440) 461-5000

(Registrant’s telephone number, including area code)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ		Accelerated filer o		Non-accelerated filer o		Smaller reporting company o
				(Do not check if a smaller reporting company)

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

       Common Shares, $1.00 par value: 675,549,693 outstanding at July 31, 2008

 

 

TABLE OF CONTENTS

See notes to consolidated financial statements.

See notes to consolidated financial statements.

The Progressive Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(unaudited)

Note 1 Basis of Presentation — These financial statements and the notes thereto should be read in conjunction with The Progressive Corporation and subsidiaries’ audited financial statements and accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 2007.

The consolidated financial statements reflect all normal recurring adjustments which, in the opinion of management, were necessary for a fair statement of the results for the interim periods presented. The results of operations for the periods ended June 30, 2008, are not necessarily indicative of the results expected for the full year.

Certain prior year balances have been reclassified to conform with the current Balance Sheet presentation.

Note 2 Investments — The composition of the investment portfolio at June 30 was:

Our fixed-maturity securities include debt securities and redeemable preferred stocks. The preferred stock portfolio includes nonredeemable preferred stocks and certain perpetual preferred stocks that have call features with fixed-rate coupons, whereby the change in value of the call features is a component of the overall change in value of the preferred stocks (i.e., hybrid securities). At June 30, 2008 and 2007, our preferred stock portfolio included $116.8 million and $57.8 million, respectively, of such hybrid securities. Short-term investments can include auction rate securities (i.e., certain municipal bonds and preferred stocks) and other short-term investments. We held no auction rate securities at June 30, 2008 or 2007. Our other short-term investments include Eurodollar deposits, commercial paper and other investments which are expected to mature within one year. Common equities include common stocks and other risk investments (i.e., private equity investments and limited partnership interests in private equity and mezzanine funds).

Our securities are reported at fair value, with the changes in fair value of these securities (other than hybrid securities and derivative instruments) reported as a component of accumulated other comprehensive income, net of deferred income taxes. The change in fair value of the hybrid securities and derivative instruments is recorded as a component of net realized gains (losses) on securities.

During the second quarter and first six months of 2008, we wrote-down $42.8 million and $95.3 million, respectively, in securities determined to have an other-than-temporary decline in fair value. For the second quarter 2008, the write-downs included $25.5 million in preferred stocks, $6.4 million of common equities and $10.9 million of fixed-maturity asset-backed securities. For the first six months of 2008, the write-downs included $68.2 million in preferred stocks, $13.3 million of common equities and $13.8 million of fixed-maturity asset-backed securities. All of these write-downs were the result of fundamental issues with the underlying issuers. See the Other-Than-Temporary Impairment section in Management’s Discussion and Analysis of Financial Condition and Results of Operations for further discussion.

Note 3 Fair Value — We adopted Statement of Financial Accounting Standards (SFAS) 157, “Fair Value Measurements,” which was effective January 1, 2008, in the first quarter 2008, as it applies to our financial assets and liabilities. SFAS 157 defines fair value, establishes a framework for measuring fair value, establishes a fair value hierarchy based on inputs used to measure fair value and expands disclosure about fair value measurements. Adopting this statement has not had an effect on our financial condition, cash flows or results of operations.

In accordance with SFAS 157, we have categorized our financial instruments, based on the degree of subjectivity inherent in the valuation technique, into a fair value hierarchy of three levels as follows:

	•		Level 1 : Inputs are unadjusted, quoted prices in active markets for identical instruments at the measurement date (e.g., U.S. Government securities and active exchange-traded equity securities).
	•		Level 2 : Inputs (other than quoted prices included within Level 1) that are observable for the instrument either directly or indirectly. This includes: (i) quoted prices for similar instruments in active markets, (ii) quoted prices for identical or similar instruments in markets that are not active, (iii) inputs other than quoted prices that are observable for the instruments and (iv) inputs that are derived principally from or corroborated by observable market data by correlation or other means (e.g., certain corporate and municipal bonds and certain preferred stocks).
	•		Level 3 : Inputs that are unobservable. Unobservable inputs reflect the reporting entity’s subjective evaluation about the assumptions market participants would use in pricing the financial instrument (e.g., certain structured securities and privately held investments).

The composition of the investment portfolio as of June 30, 2008, was:

We currently have no material financial liabilities that would require categorization.

The following tables provide a summary of changes in fair value associated with Level 3 assets for the three and six months ended June 30, 2008:

There were no purchases, sales or realized gains (losses) associated with the Level 3 securities during the three and six months ended June 30, 2008.

Note 5 Supplemental Cash Flow Information — We paid income taxes of $118.0 million and $235.0 million during the six months ended June 30, 2008 and 2007, respectively. Total interest paid was $72.3 million and $38.8 million for the six months ended June 30, 2008 and 2007, respectively. Non-cash activity includes changes in net unrealized gains (losses) on investment securities and declared, but unpaid, dividends to shareholders (see Note 8 – Dividends for further discussion).

Note 6 Segment Information — Our Personal Lines segment writes insurance for private passenger automobiles and recreational vehicles through the Agency and Direct channels. Our Commercial Auto segment writes primary liability and physical damage insurance for automobiles and trucks owned by small businesses in the specialty truck and business auto markets. Our other indemnity businesses primarily include writing professional liability insurance for community banks and managing our small run-off businesses. Our service businesses include providing insurance-related services, primarily policy issuance and claims adjusting services for Commercial Auto Insurance Procedures/Plans (CAIP), which are state-supervised plans serving the involuntary market. All segment revenues are generated from external customers.

Following are the operating results for the periods ended June 30:

Progressive’s management uses underwriting margin and combined ratio as primary measures of underwriting profitability. The underwriting margin is the pretax underwriting profit (loss) expressed as a percentage of net premiums earned (i.e., revenues). Combined ratio is the complement of the underwriting margin. Following are the underwriting margins/combined ratios for our underwriting operations for the periods ended June 30:

Note 7 Comprehensive Income — Total comprehensive income was $94.4 million and $301.5 million for the three months ended June 30, 2008 and 2007, respectively, and $3.8 million and $690.2 million for the six months ended June 30, 2008 and 2007, respectively.

Note 8 Dividends — In January 2008, Progressive paid dividends of $98.3 million, or $.1450 per common share, pursuant to a December 2007 declaration by the Board of Directors under our annual variable dividend policy.

Progressive’s policy is to pay an annual variable dividend, payable shortly after the close of each year. This annual dividend will be based on a target percentage of after-tax underwriting income, multiplied by a companywide performance factor (“Gainshare factor”). The Gainshare factor can range from zero to two and will be determined by comparing our operating performance for the year to certain predetermined profitability and growth objectives approved by the Board. This dividend program is aligned with the variable cash incentive program currently in place for our employees.

For 2008, the Board established that the variable dividend will be based on 20% of after-tax underwriting profit. Through the second quarter 2008, the Gainshare factor was .70. Since the final factor will be determined based on our results for the full year, the final factor may vary significantly from the factor at the end of any interim period. However, if the Gainshare factor is zero or if our after-tax comprehensive income (which includes net investment income, as well as both realized gains and losses in securities and the change in unrealized gains and losses during the period) is less than after-tax underwriting income, no dividend will be paid. For the six months ended June 30, 2008, our after-tax comprehensive income was $3.8 million, which is less than the $261.2 million of after-tax underwriting income for the same period. Based on results as of June 30, 2008, no dividend would be payable under our variable dividend policy.

Although it is our intent to calculate an annual dividend based on the policy outlined, the Board could decide to alter our policy or to not pay the annual dividend for 2008 or future years at any time prior to the declaration of the dividend for the year. While the declaration of the dividend remains within the Board’s discretion, the Board is expected to apply the provisions of the policy and, if appropriate, declare the 2008 annual dividend in December 2008 with a record date in January 2009 and payment shortly thereafter.

In June 2007, Progressive’s Board of Directors declared an extraordinary cash dividend of $2.00 per common share, payable on September 14, 2007 to shareholders of record at the close of business on August 31, 2007. This extraordinary cash dividend was accrued in the aggregate amount of approximately $1.4 billion based upon the number of common shares outstanding at June 30, 2007.

Note 9 Litigation — One or more of The Progressive Corporation’s insurance subsidiaries are named as a defendant in various lawsuits arising out of their insurance operations. All legal actions relating to claims made under insurance policies are considered in establishing our loss and loss adjustment expense reserves.

In addition, various Progressive entities are named as a defendant in a number of class action or individual lawsuits, the outcomes of which are uncertain at this time. These cases include those alleging damages as a result of our use of consumer reports (such as credit reports) in underwriting and related notice requirements under the federal Fair Credit Reporting Act, charging betterment in first party physical damage claims, the adjusting of personal injury protection and medical payment claims, the use of automated database vendors or products to assist in evaluating certain bodily injury claims, policy implementation, renewal and cancellation procedures and cases challenging other aspects of our claims and marketing practices and business operations.

We plan to contest the outstanding suits vigorously, but may pursue settlement negotiations where appropriate. In accordance with accounting principles generally accepted in the United States of America (GAAP), we have established accruals for lawsuits as to which we have determined that it is probable that a loss has been incurred and we can reasonably estimate our potential exposure. Pursuant to GAAP, we have not established reserves for those lawsuits where the loss is not probable and/or we are currently unable to estimate our potential exposure. If any one or more of these lawsuits results in a judgment against or settlement by us in an amount that is significantly in excess of the reserve established for such lawsuit (if any), the resulting liability could have a material effect on our financial condition, cash flows and results of operations.

For a further discussion on our pending litigation, see “Item 3-Legal Proceedings” in our Annual Report on Form 10-K for the year ended December 31, 2007.

Note 10 Subsequent Event — During July, our total investment portfolio generated $405.5 million of marked-to-market net losses reflecting significant market activity during the month. The largest decrease was in our preferred stock portfolio, resulting from further disruption in the mortgage and credit markets, reflecting the crisis of confidence regarding the Federal National Mortgage Association (FNMA, “Fannie Mae”) and the Federal Home Loan Mortgage Corporation (FHLMC, “Freddie Mac”), two government-sponsored enterprises, which hold about one-half of the country’s mortgage loans. The following table presents our Fannie Mae and Freddie Mac holdings as of June 30, 2008:

For July, our Fannie Mae and Freddie Mac securities contributed $157.2 million of the marked-to-market net losses. See the Results of Operations-Investments section of Management’s Discussion and Analysis of Financial Condition and Results of Operations for further discussion.

Based on our analysis of the issuers’ capital and liquidity positions, as well as current market conditions, we continue to believe that our preferred stock holdings will continue to make timely dividend payments and are likely to substantially recover their value. If and to the extent that this recovery does not occur and/or the issuers are unable to make timely payments, there could be an impact on our results of operations, cash flows and financial condition.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

I. OVERVIEW

For the second quarter 2008, The Progressive Corporation’s insurance subsidiaries generated underwriting profitability of 6.4%. Companywide policies in force increased 3% on a year-over-year basis, while net premiums written and earned decreased 1% and 3%, respectively, reflecting the impact of our prior rate decreases, which began in mid-2006 and continued until late 2007. For the second quarter 2008, net income was $215.5 million, or $.32 per share, compared to $283.7 million, or $.39 per share, for the same period last year. In addition to the impact of the prior rate decreases, the quarter-over-prior-year-quarter decrease in net income also reflects the larger catastrophe losses incurred in the second quarter 2008 and the higher realized losses on securities in the current year.

As highlighted above, our aggregate premium growth measures, both written and earned, were down for the second quarter 2008, compared to the same period last year, despite increases in policies in force. Premium growth can be explained by some combination of new business applications (i.e., issued policies), premium per policy (i.e., rates) and customer retention. On a quarter-over-prior-year-quarter basis, companywide new business applications decreased 5%, while renewal applications increased 5%. New business acquisition continues to be a challenge, especially in our Agency business. We currently have several initiatives underway aimed at spurring new business growth, including the expansion of our usage-based insurance product and the introduction of a program that provides customers the opportunity to select the price they would like to pay for auto insurance and we will tell them the level of coverage that the selected price will provide. In addition, during the quarter, we began offering our personal auto and boat insurance products in Massachusetts; we now offer personal auto in all 50 states and the District of Columbia.

On a year-over-year basis, for the second quarter 2008, we have seen an overall decrease in average written premium per auto policy of 3%. During the second quarter, we continued focusing our efforts on raising rates where necessary to meet our loss cost inflation expectations. We will continue to evaluate future rate needs and react quickly to changing trends.

Our effort to increase customer retention continues to be one of our most significant initiatives, and we are continuing to see the benefits. Policy life expectancy, which is our actuarial estimate of the average length of time that a policy will remain in force before cancellation or non-renewal, is one measure of customer retention. The policy life expectancy for our Agency and Direct auto businesses has been on a continuing upward trend over the past few quarters and is now about 11% and 13% higher, respectively, than the same measure a year ago. Commercial Auto’s retention has remained relatively flat over the same period last year.

Policies in force, our primary growth metric, increased 3% on a companywide basis since the second quarter last year. We achieved policy growth in Personal Auto, Special Lines and Commercial Auto. Direct auto, which currently represents about 38% of our auto policies in force, grew 7%, while the Agency auto business declined 2%. Our fastest personal auto growth area continues to be in our Internet-produced business.

Our second quarter 2008 profit margin was 6.4%. Our profitability goal remains an aggregate companywide underwriting margin of 4%. We realize that there may be some variance around this target, at both the product and state levels and even in the short term at the aggregate level. Nevertheless, this remains our long-term goal, and we will react quickly to change rates if frequency or severity trends vary from our expectations.

Our loss and loss adjustment expense ratio was 1.6 points higher in the second quarter 2008, as compared to the same period last year. The increase was driven by higher catastrophe losses in 2008 than in 2007, as well as lower average earned premiums on a year-over-year basis. On the other hand, we experienced a decrease in auto accident frequency, which reflects less miles driven, possibly due to the spike in gas prices during the period. On a quarter-over-prior-year-quarter basis, total auto paid severity was relatively flat, with increases in bodily injury and personal injury protection severity offset by a decrease in collision coverage severity.

We are continuing to see efficiency gains as a result of the organizational changes made during the second half of 2007. Bringing our Agency and Direct businesses together under one Personal Lines organization and streamlining this group, along with our information technology area, has allowed us to reduce redundancy that had developed in areas such as product design, management and policy servicing, as well as to improve our ability to execute on our most significant challenges. These changes have contributed to a 5% increase in the number of companywide policies in force per employee on a year-over-year basis.

During the quarter, we made no substantial changes in the allocation of our investment portfolio and maintained our target allocation between fixed-income securities and common equities. Our investment portfolio produced a fully taxable equivalent total return of (.2)%, with a .1% total return in our fixed-income securities and a (2.1)% total return in our common stock portfolio. At June 30, 2008, the fixed-income portfolio duration was 3.0 years with a weighted average credit quality of AA-.

Our pretax net unrealized gains on investment securities decreased $691.7 million from year-end 2007, bringing our total net unrealized gains to $23.7 million at June 30, 2008. The decrease was primarily related to our financial sector redeemable and nonredeemable preferred stocks, which comprise approximately two-thirds of our preferred stock holdings. The unrealized losses on these securities primarily reflect the market-related issues associated with the disruption in the mortgage and other credit markets. We will continue to be diligent in our process for reviewing such securities for indications that the impairment has become other-than-temporary. Consistent with our process for reviewing securities with declines in fair value, during the quarter, we recognized $42.8 million of losses on securities determined to be other-than-temporarily impaired. For each of the securities that were written down, we determined that fundamental issues existed for the issuer in addition to the effects of current market conditions, and it was not clear at that time that we would hold the securities for a period of time necessary to recover a substantial portion of their values.

II. FINANCIAL CONDITION

A. Capital Resources and Liquidity

We believe we have sufficient capital resources, cash flows from operations and borrowing capacity to support our current and anticipated business, scheduled principal and interest payments on our debt, expected dividends and other capital requirements. Our existing debt covenants do not include any rating or credit triggers.

Progressive’s insurance operations create liquidity by collecting and investing premiums from new and renewal business in advance of paying claims. For the six months ended June 30, 2008 and 2007, operations generated a positive cash flow of $939.7 million and $1,203.5 million, respectively. The decrease primarily reflects the lower income earned during the first six months of 2008. During the second quarter 2008, we repurchased 3.3 million common shares at a total cost of $61.4 million (average cost of $18.90 per share), bringing the total year-to-date repurchases to 9.8 million common shares, at a total cost of $177.5 million (average cost of $18.13 per share).

In January 2008, we paid shareholder dividends of $98.3 million, or $.1450 per common share, pursuant to a December 2007 declaration by the Board under our annual variable dividend policy (see Note 8 – Dividends for further discussion of our policy).

B. Commitments and Contingencies

During the first quarter 2008, we completed construction of one new service center that provides our concierge level of claims service, which replaced a previously leased service center location. In total, we have 54 service centers in 41 metropolitan areas across the United States serving as our primary approach to damage assessment and coordination of vehicle repairs at authorized repair facilities in these markets. We expect to construct a total of two new service centers to replace existing leased facilities during the remainder of 2008 and in 2009.

There is currently no other significant construction under way. We own additional land in both Colorado Springs, Colorado and Mayfield Village, Ohio for possible future development; both properties are near current corporate operations.

All such construction projects have been funded internally through operating cash flows.

Off-Balance-Sheet Arrangements

Our off-balance-sheet leverage includes derivative positions, open investment funding commitments and operating leases and purchase obligations. See the Derivative Instruments section of this Management’s Discussion and Analysis for a summary of our derivative activity since year-end 2007. There have been no material changes in the other off-balance-sheet items since the discussion in the notes to the financial statements in Progressive’s Annual Report on Form 10-K for the year ended December 31, 2007.

Contractual Obligations

During the first six months of 2008, our contractual obligations have not changed materially from those discussed in our Annual Report on Form 10-K for the year ended December 31, 2007.

During the first quarter 2008, we entered into two contracts to expand our brand building efforts. In January 2008, we entered into a 16-year contract for the ballpark naming rights and a sponsorship deal with the Cleveland Indians Major League Baseball team. Over the contract term, Progressive will pay an average of approximately $3.6 million per year. In addition, in March 2008, we announced our title sponsorship of the Progressive Insurance Automotive X PRIZE competition. The Automotive X PRIZE is a two and one half year international competition designed to inspire a new generation of safe, low emissions vehicles capable of achieving the equivalent of at least 100 miles per gallon in fuel efficiency. The total cost of the sponsorship is expected to be approximately $12.5 million, which includes the prize for the winning team, as well as the funding of some operational expenses over the course of the competition.

III. RESULTS OF OPERATIONS – UNDERWRITING

Net premiums written represent the premiums generated from policies written during the period less any premiums ceded to reinsurers. Net premiums earned, which are a function of the premiums written in the current and prior periods, are earned as revenue over the life of the policy using a daily earnings convention. The decrease in premiums primarily reflects the impact of the prior year rate decreases we had taken.

Policies in force represents all policies under which coverage is in effect as of the end of the periods specified.

To analyze growth, we review new policies, rate levels and the retention characteristics of our books of business. During the second quarter and year-to-date period, we experienced the following growth in new and renewal applications:

Returning to positive growth in new business remains a significant challenge. We have several initiatives underway aimed at spurring new growth. During the second quarter 2008, we entered Massachusetts with an Internet-only personal auto product. We plan to expand the distribution methods to include independent agents and direct via the phone in this $4 billion market over time. We also recently expanded our usage-based insurance product into one additional state, bringing the total number of states offering this product to four, and plan continued expansion throughout the remainder of the year. In addition, during the third quarter, we are planning to introduce a program called “Name Your Price” that allows consumers to select a price they would like to pay for their auto insurance and we will tell them the level of coverage that price provides.

During the second quarter and first six months of 2008, total auto written premium per policy decreased 3% and 4%, respectively, compared to the prior year periods. In order to meet our loss cost inflation expectations, we continued to raise rates during the second quarter, averaging more than one auto rate revision per day. We are ready to react quickly, and as often as necessary, should our expectations change.

Another important element affecting growth is customer retention. One measure of customer retention is policy life expectancy, which is our actuarial estimate of the average length of time that a policy will remain in force before cancellation or non-renewal. Efforts at increasing growth from customer retention have continued to produce positive outcomes. Our policy life expectancy measures for our Agency and Direct private passenger auto products have been on a continuing upward trend and are now approximately 11% and 13% higher, respectively, than the same measures a year ago. In our Commercial Auto Business, the policy life expectancy has remained relatively flat since the second quarter 2007. Realizing the importance that retention has on our ability to grow profitably, we continue to place increased emphasis on competitive pricing and other retention initiatives for our current customers.

B. Profitability

Profitability for our underwriting operations is defined by pretax underwriting profit, which is calculated as net premiums earned less losses and loss adjustment expenses, policy acquisition costs and other underwriting expenses. We also use underwriting profit margin, which is underwriting profit expressed as a percentage of net premiums earned, to analyze our results. For the periods ended June 30, our underwriting profitability measures were as follows:

On a quarter-over-prior-year-quarter basis, the decrease in underwriting profitably primarily reflects the higher catastrophe losses in 2008 as compared to 2007 and the lower earned premiums per policy in 2008, which was partially offset by lower unfavorable prior accident year development. We incurred .2 points of unfavorable prior accident year development in 2008, compared to 2.0 points for the same period last year. On a year-to-date basis, the lower underwriting profitability reflects greater catastrophe losses and the impact of prior rate reductions; the prior accident year development was comparable in both periods.

Further underwriting results for our Personal Lines Businesses, including its channel components, the Commercial Auto Business and other indemnity businesses, were as follows: