前進保險 (PGR) 2002 Q2 法說會逐字稿

Welcome to the Progressive corporation second quarter conference call. All participants will be able to listen only until the question-and-answer session. This conference is being recorded. If you have any objections, disconnect at this time. Acting as moderator will be Tom King. I will turn over to Mr. King.

Welcome to Progressive's quarterly conference call. Participating are Glenn Renwick, CEO, and Tom Forrester, CFO. Glenn will begin with comments on quarterly results and we will open for questions. The call will last about an hour. Statements that are not historical in nature are foreign- forward-looking statements (inaudible) differ materially from our projections. These risks and uncertainties include, without limitation, uncertainties related to estimates and projections generally, inflation and changes in interest rates and security prices. Rate changes by competitors, ability to obtain approval for request of rate changes, legislative developments, outcome of litigation pending against the company, weather conditions, changes in driving patterns and loss trends, acts of war and terrorist activities, court decisions, litigation and auto repair costs and other matters described from time to time in other releases. In addition, investors should be aware generally accepted accounting principles, including litigation exposure. Accordingly, results for a given period could be affected if and when reserve is established for a major contingency. Results may therefore appear to be volatile in certain accounting periods.

Good morning. Overall it was a good quarter for Progressive. I will comment on results and other market conditions and developments that were important during the quarter. I remain pleased with our margins which continue to run ahead of targets. All but two states, either of them in the top 15, are profitable for Personal Lines year to date, with almost all meeting or exceeding our combined ratio target. Growth remains solid both our agent and direct channels and person lines and commercial oil business continue to grow in favorable market conditions. Growth in new business applications and policies in force, particularly from agents is strong. The result of further rate increases, withdrawals and moratoriums by national conference. I will touch a few of them. Last month in Louisiana, state announced moratorium until a pending rate increase is approved. They found 35% market share in Louisiana. Volume decided to increase quickly right away. In Ohio, rate increases were approve indeed 5 to 6% range for State Farm Mutual and fire and casualty. In a stable, lower priced market like Ohio, this is a strong increase. In Florida, we are aware a rate increase has been filed for 8% and in Texas, State Farm is not accepting new customers who did not have prior insurance or those with more than one accident, creating more activity in the nonstandard market. I highlight State Farm's changes because other companies often use State Farm as the basis for their own rates for underwriting. In Florida, actions by regional carriers until 9% rate increase by one company, payment plan restrictions by another and complete withdrawal by a third. These actions are feeding the continued surge of new non-standard auto business in Florida. New business and specially non-standard growth brings a dynamic that tests rate adequacy and claims capacity. We continue monitoring of rate adequacy and remain confident in ours. The growth rate in direct, while less influenced by regional activity was strong in the second quarter. We are keeping pace by following modest rate increases where necessary and generally feel prepared for the growth. I mention the strong growth in commercial oil. Over fifty% year to date. Our commercial auto business ranks fifth nationally, with considerably faster growth and healthy margins than most. If our growth continues, it is possible that this business we ranked in the top three within a year or so. The commercial oil market is tighter than it has been since the mid-'80s. Competitor rate increases have slowed and companies are restrictive in underwriting. This allows us to feel comfortable with our rate level, product segments have been shifted to six-month policy terms this year. 50% of new commercial auto applications are being written for 6 months. Over time, we will review the need to shift the policy term back to annual, this is the norm for commercial business. The commercial business profitability is better than our target year to date. We had an unusual amount of large claim necessary June. Reserving for new claims and large loss development on losses with limits over $100,000, added 7 points to the loss ratio for June. Rapid growth is generally associated with business make shifts, changing limits profiles and new experience data. This is especially true in the commercial oil business and we manage it carefully to anticipate these changes. Building the claims organization that we will need for future growth is one of my top priorities. It is a different type of challenge for us. Market conditions are fluid right now, so product managers are updating their forecast every month. With each reforecast, the local claims managers reassess capacity in light of current inventory, style of 10ure and expected frequency. The challenge is to err conservatively. While oil policies in force are up 15% from the prior year, this is average number for countrywide experience. Growth is faster in certain local markets. For the most part, we are meeting targets for claims reps. It is a good time to be in the market. The quality of applications is very high and we are prepared to train new reps at an aggressive pace for the next 6 to 12 months. We have taken some actions to moderate extreme growth in several locations, but no significant constraints are in place. We will continue to be optimistic in seeking market share as we balance our willingness to grow profitably and maintain service quality. A few comments on loss trends. Consistent with first quarter, we experienced declining loss frequency in every coverage with no widespread increase in severity, leading to fairly stable loss ratios across the country. Our (inaudible) remains negative. Countered to the lack NAII numbers. Severity for collision and property damage is increasing at expected rates and bodily injury severity continues to fluctuate, as we commented on in the first quarter. Unlike last year at this time, catastrophic weather claims were moderate, $12 million, which is less than half of the $30.4 million we reported for the second quarter last year. On July first, we published a report on loss preserving practices, with new information about our release of actuarial data. I mention this to call your attention to the report, which is available on our investor relations website, but to highlight a fundamental guiding principle for me and Progressive, which is full, prompt disclosure of information. For us, this has never meant providing projections or earnings guidance, but means what we report to you as investors and interested parties will assess our best assessment of the current business situation, including liabilities and losses. One area that can be unpredictable at times is litigation. Particularly when class action status is being sought. Our practice is to establish reserves for those lawsuits for which the company is able to estimate probably, potential exposure. This quarter we made significant progress in several categories of pending class action litigation. We received decision from the Florida Supreme Court confirming that demolition of value is not covered by our auto policy in Florida, as we believed to be the case in almost all venues, except Georgia, the resolution of which we previously reported. We do have one open issue on demolition of value in the state of Texas. We are well positioned under several court of appeals decisions. The issue is yet to be resolved by Texas supreme court. We received positive decision denying class certification in our Ohio after-market parts case. That issue may ultimately be resolved by higher courts, but we believe the decision of the trial court properly recognizes the individualistic nature necessary to evaluate when and how after-market parts can be used appropriately. As reflected by accruals for this quarter totaling $35.5 million, we believe we made significant progress toward resolving a number of pending cases on two topics. First, charging battlement in first party physical damage claims and longstanding use of alternative commissions. These matters are not yet finally concluded. I cannot comment further other than to say we feel very good about the progress we have made during the quarter in moving toward final resolution of some areas of class action exposure. A few comments on investments. For the quarter ending June 30, the composite pre-tax total return for the portfolio was positive 1.3%. This figure combines recurring investment income with unrealized changes in securities prices. A fixed income portfolio, about 85% of the total portfolio, posted a positive 3.7 fully taxable equivalent total return for the quarter and 4.2 for a taxable equivalent year to date, ahead of our benchmark. A duration remains at 3.7 years, in the weighted average credit rating is AA. Less than 3% of the fixed income portfolio is in non-investment grade securities, including the recent reclassification of the likes of Tyco and Quest. As of June 30, about 30% of our fixed income portfolio is invested in corporate debt and preferred stocks. Of that, less than 2% of the fixed income portfolio is held in securities in the highly volatile telecommunications sector. Over 90% of our common equity portfolio is comprised of common stocks that are managed by State Street global advisors to track the index within 50 basis points. For the quarter, common stock portfolio posted negative 13.4 fully taxable equivalent total return. Within 1 basis point of the total return of the Russell benchmark. A point worth noting is that unlike index fund, we own the securities managed by State Street and therefore, include the common stocks in our other than temporarily impairment review process. As of June 30, it is our best estimate that any impairment issues are appropriately reflected in the income statement. All other unrealized gains are reflected in shareholder equity. During the quarter, we incurred $3 million of pre-tax realized losses. This was net of 33 million dollar gain from sale of securities and other than temporary impairment breakdown of $36 million. That included $15.1 million of securities subsequently sold in the quarter. Single largest loss was Worldcom debt. We sold our position in Worldcom in May, before the recent drop, but it is substantial pre-tax loss of $12.9 million. This was an active quarter for stock repurchases. There are two distinct reasons for stock repurchase. The first is to eliminate the dilutive effect from the exercise of stock options. The second is to repurchase when we determine through our capital planning process that we have capital there for the foreseeable future in excess of that required to support insurance operations, including each contingency and growth and when the market price does not exceed our estimates of value. In total during the quarter, we repurchased 145.8 million dollars of Progressive stock. Of this amount, $25.8 million was to eliminate the dilutive effect from the exercise of stock options, the remaining $120 million represented a general repurchase, most of which was done in May and June. Stock repurchase year to date total $169.4 million. A few summary comments. It is an interesting and unchallenging time for us at Progressive. Our personalized business, aging and direct, are profitable, growing and developing their own mixed characteristics. I feel good about the balance we are achieving between the two. Rates are keeping pace with inflation. We are also focused on anticipating those things that create fluctuation results including legal challenges. Most of all, hiring and training talented people for claims remains at the top of our list of opportunities. We won't sacrifice claims service for growth, but as you can imagine, it is a very fine line and we are obsessive about trying to get it right. Our claims model is showing progress necessary to meet acceptance criteria and service continues to delight customers. Our customer retention numbers show positive increases, customers are staying with us longer, assisted by market conditions and improvements in our business. With many things going, we must be doubly vigilant. They are an extrapolation of data, we will add 2 billion of direct premium this year, greater than the 2001 order rating of the top 15 company. This growth will almost certainly bring unexpected results. Our controls have never been greater. Our reporting continues to provide increased transparency to operations and management at all levels is stable and experienced. We are intensely focused on what it takes to move business forward profitably. Thanks, all. Take your questions.

At this time, we are ready to begin the formal question and answer session. Anyone previously in the queue has been purged. If you would like to ask a question, you may press * 1 on your touchtone phone. Press * 2 to withdraw. To allow the company to respond to as many caller as possible, you will be limited to one initial question and one follow-up question per request. If your telephone has mute capability, use this function during the time your question is being answered to minimize background noise. To the extent you have additional questions, you need to place your name back in the queue by selecting * 1 on your telephone. Our first question comes from Nancy Benacci from McDonald.

Congratulations, Glenn, on another good quarter. Want to comment on the $35.5 million on accrual. You don't want to get into too much detail, would you have accrued all you anticipate you would have to pay for particular suits such as the specific one in Ohio? Along with that, if we were to back out that $35.5 million from the aging channel, the overall combined ratio for the company would have more like 91 7 versus 93 4, is that correct?

Two comments. I think you know I hate saying I can't comment further on stuff when it is important. Let me be as forth right as I can. The - at all times we are going to have some exposure. I wish that wasn't the case. But we will from time to time. Some are long-standing and happen to have been right for settlement negotiations in this quarter. We are going to make and always will make an accrual when we think it is at the point it is truly probably and estimatable. To the extent you can suggest from that, we have made an accrual absolutely best based on our best judgment as of this moment. That is true. I quite frankly, this will be a nice thing to have beyond us to the extent of how to break it apart, the number we have released and I think it is appropriate for us to do that at this stage. I will be happy to comment further after developments have taken place and it is appropriate to do so. 35.5 is a composite number for two significant actions, one with regard to the Battlement issue we face, first party claimants have perhaps issues with betterment practices. The second is with alternative commissions. To the extent the alternative commissions is an agency issue, that would be correct to apply to agency. I haven't given sufficient information for you to determine how much is one versus the other. It applies to both channels and you could assume it flies proportion atly on premium basis.

On overall basis for the company just to pull that amount out of expense ratio would be accurate assumption?

Yeah. We are not anticipating those things.

I wanted to double check. My follow-up question, if you could comment in more detail on the sense of retention in both the direction and agent channel as you look at the second quarter in comparison to the first quarter. You indicate things seem to be good. I need more detail, it would be greatly appreciated.

It is fine. We talked about retention on several occasions and have had moving numbers. In New York, I tried to give you a way of how we think about it. It is still not something you get to easily. I think I can comment clearly that each tier of business, non-standard to ultrapreferred has showed measurable improvement in retention that is very healthy. Unfortunately, as much as we like to know cause and effect for everything, I am at a loss to be able to tell you how much is a result of actions we have taken. I like to believe a lot of it. Clearly market conditions are making people stickier with us or the ability to switch the cost of switching is considerably higher. Those things are all very real. I can't quantify them, but in our retention numbers, measured in several different ways, our policy life expectancy or short-term retention, which might be full-one statistic, are here in the fourth month. If they were in the first, our point of first renewal, the metrics are looking healthy and positive.

Thank you very much. Appreciate your comments.

Mr. Ron Frank from Salomon Smith Barney, you may ask your question.

Good morning. I have two questions regarding the regulatory environment. One, can you give us a sense of whether you have observed any meaningful change qualitatively and the receptivity to needed rate changes over the last six months or so? Second, how concerned, if at all, are you about the current scrutiny of credit scoring as regards pricing by some of the states? I mean, your model is more complex than many, but I was wondering what your view of that was?

Yeah. For the first, issue of rate actions. I wouldn't say it is necessarily any higher than it has been in the past. I think our ability to get rate action through is predicated in our ability to present facts accurately to the department. I know of limited cases where we couldn't get rate actions through. I think I am speculating here, speculation would be probably I am sure a lot of regulators are seeing that the rate actions are really required, given you have a market leader - at least in market share. Are starting to file significant rating actions. Their underwriting losses have become (inaudible). I don't think the regulators are aware of the fact many companies do need rate. It is a very real basis for rate filings. We really have not had significant problem. We will always have issues from time to time, there is no question about that. In different states we have to make our case. We have to make it multiple times in some cases. Receptivity to rate changes is not something that is a significant issue right now. We have been able to get what we need. On the issue of credit scoring, it is a broader issue. It has been relatively widely recognized within the industry, Progressive's use of credit is perhaps the most forthright and leading use of credit and we don't do a lot of the things that are considered to be at the root of great consumer content. I won't write you because of certain situations. We have led the way with white papers and with testimony to try to state the true merits of credit and would be supportive of actions taken by regulators and legislators to eliminate the things that are the greatest consumer discontent with credit. Having said all of that, credit is an issue, it is going to be an issue on multiple fronts, both regulatory and legislative for sometime. It will, if you ask me for absolute projection, probably be weakened over time relative to current use. We will adapt to that. We believe firmly it is a very powerful and predictive variable in being able to segment the loss characteristics. We would like to see it retained. We are publicly being advocates for the greater transparency in filing. The appropriate and responsible use of credit. We think if we keep pushing the industry and I am not suggesting that comments of others. We are pushing within our industry to make that standard and we hope by doing that, we will get the long-term use of the variable.

May I follow-up by asking if the current turmoil in the homeowners market is close to attempting you back in?

You could ask.

I guess I deserved that.

I feel good about some additions and have never had a bad night's sleep about pulling out of homeowners. I think quite frankly, being more serious here. I hope the tone of today's comments, yes, we have a significant accrual and it came this month. It could come another month. The fact is we are putting close to 30% top line growth and pulling 93 margin out. We are on route to doing what we set out to do and what we planned to do as a company. My challenge and most of my time is not spent worrying about sideline issues. They are important, but we have to make sure infrastructure is right in place. Not having a current concurrent development effort in homeowners right now has not been something I have lost sleep at. I will tell you, you could be holding your breath for a long time before we are back.

Thanks.

Mr. Michael Lewis from UBS Warburg, you may ask your question.

Good morning. Nice results. The June commercial lines losses, could you go into more detail? Is this operation? Give us more detail what actually happened in June. Is this a one-month wonder? My follow-up, question, in 96 target ratio, with the changes going on in State Farm and you are addressing it in this conference call in a greater way than in the past, do you think that opportunity and the business that flows to you and their raising rates gives you the chance to put business on with greater margins than originally assumed? Again, in that context, comment on the overall situation you see developing from your point of view on the State Farm and how they have changed and what that means for Progressive going forward?

Sure. I put it in my formal comments for two reasons. I wanted to bring out more than I did in the past, the relative importance of CB to the business of Progressive. It is commercial autos. It is very auto-like business, but sold under commercial policy. And I think probably little knowing we were quite as significant in market share as we perhaps are. Also, important is to realize that the results have been extraordinary. The third thing, which is why I commented on June results, when you have 50% growth, mixed changes, new experience data, different limits profiles, those are the things we really have to stay on top of. A good example of some of the implications of that, you will get a month-to-month increase, what we call shock losses. The issue is making sure they are shock losses, not a prelude to continuing set of losses like that. My best answer with regard to June, yes, it was a series of individual losses we recognized and hope to next month we don't have expectation of seeing those again. I will tell you antennas go up high when we start seeing that. The obvious question is sure. The explanation could be one month. If you get six one months in a row that is a trend. We like to catch that earlier. I would tell you so far I have no reason to believe it is other than just the insurance business, one month kind of issues. We do see a lot of traffic on the roads in the mid-year issue with some of the types of commercial vehicles we are insuring. There is seasonality to that. No, I am not suggesting a big concern. If I saw something, I would talk about that on the next conference call. With regard to the State Farm comment, I want to be careful. I recognize State Farm is the market leader. I can't disclose more of their strategy than you know. But, it is a very interesting dynamic when the market leader starts to take significant rate changes, apply significant restrictions, because they certainly are a bell weather for many companies. As restrictions come and take full effect in the marketplace, we are uniquely positioned in many respects to be able to take that business. We will also consider that to be a trend. We will sort of price for that trend, as well. That is not necessarily saying it will be widening, but when you grow, you always have a new mix of business, generally it brings especially non-standard frequency change. We will price aggressively, especially if the demand function for the product is healthy. We will try to keep that in balance. The other element we can never push back is we will price and moderate our actions based on our ability to be able to maintain quality claims service. The demand function is strong and we will act as responsibly as we can, maintaining profit margins.

Quick follow-up there. If you want to maintain the fact you don't want to overgrow business. You want to be able to service it. Then, I would believe you take advantage of the State Farm situation by pricing accordingly to get maybe less business, but better margins on the business. I would assume you are pricing for better margins trying to avoid overwriting the business?

We are a regulated business and filings are with regulators based on facts and data we have. I understand the point you are making. It has one significant point of balance.

We also talked about this in the last conference call. There are implicit actions to the extent that competitors raised rates and then extends our retention. That, because renewal business is slightly higher margin business, that tends to keep margins higher over time.

Thank you.

Mr. Charlie Gates from Credit Suisse, you may ask your question.

Two questions. My first question. I am looking at litigation section of 10-k. I can easily see the commentary about the commission structure. Could you elaborate briefly with regard to what you meant by betterment, simply identifying what you are referring to in the 10-k, sir?

I have legal counsel in the room, I will let him, Chuck, would you address that? We are not getting outside the issue of multiple people talking.

This is Chuck Jarrett. We are charging (inaudible) referred to as depreciation. It is deduction from the amount of money a claimant would receive. They get a car back in better condition than when they were in an accident. That is enlisted in litigation disclosure as betterment claims. They have been out there for sometime. That is also not unusual in the industry for those claims to be raised.

That was my first question. My second question, with regard to the strategy of building the commercial lines business, to what extent was the - what occurred 1987 '88, an issue you thought about? What I refer to '87 and '88, Peter was telling people he would build a long haul truck and bus business and it didn't work.

Yes. We remember that one very well. It is probably continues to be a very significant moderator of what we do. Let me be careful to describe our commercial vehicle and commercial auto as something completely other than long-haul trucking. There is no long-haul trucking. There is not a limits profile on commercial auto book that you might associate with perhaps others in the commercial auto. Our commercial auto book is for the most part, light local commercial book, with some specialty niches. Our cartage, we have some dump truck business. We have some smaller fleets of tow trucks. Our concentration is on fleets under 20. And we do not expose any individual risk with greater than a million dollars of bodily injury limits. So, while you might take the commercial auto market share in total, we have to subtract a fair amount before we get to what we consider available market share. We do not do delivery, taxis, long-haul and we don't tend to go beyond those parameters. The parameters we are working with have been the long-standing parameters for that business. It behaves more like personnel auto than it does a long-haul trucking business. So, this is quite a different business and we will remain the high frequency relatively low-severity type business we have said.

Thank you.

Bob Glasspiegel from Lehman Brothers. Ask your question.

Could you give us more color on what is going on with the personalized uptake sequentially specifically what is going on with advertising within the component?

With regard to the expense ratio, just across the board, recognize at least for this quarter, there is going to be and we put in our release about the accrual. It is going to be reflected in the underwriting expenses. That certainly is one of the uptakes. With regard to direct expense ratios, I really don't have any significant issue. It is higher than 6 months, but we are continuing to advertise quite aggressively. We also recently introduced a new campaign for advertising. We are showing early signs of success. But, we are attracting right now, partly through market conditions, our conversion rates are quite strong in our direct business. So, we are advertising at a fairly healthy clip, with only a moderate number of constraints, that I mentioned earlier where we have claims capacity. Those are moderate and not really one that we need to go into right now. So, the underwriting expenses indirect really are about in line with our expectations. I recognize it looks close to 26 this month. It is an uptake. I don't think that is significant.

There is a piece of the 35 in the expense ratio, is that what you said?

A piece of the 35.5 is in the expense ratio, primarily in the agency expense ratio.

My follow-up, you are sending cautionary notes on, yes, you have great growth opportunities but want to be sure you are not outgrowing infrastructure and assessing new risks prudently. Maybe I am misreading that. What is the growth you could feel comfortable managing and above which, we have to slow it down?

You are reading the cautionary note correctly. When you have the kind of growth we are looking at, it would be (inaudible) not to balance with that caution. I don't believe there is anybody more aggressive than I am in terms of wanting growth. I know what the repercussions are if you grow and pay for it later. It will be in future years. We saw that movie and talked about it in 2000. So, the upper pith limit and an aggregate doesn't make as much sense to talk about as in a local state environment. I mentioned it briefly, literally on a continuous basis, this is not something month by month, but continuous. We have a diagnostic of claims capacity in a state-by-state basis. I will tell you today, Texas is very different than Iowa in terms of size, but in its needs. So, we look at this very much on state-by-state basis. We have several states growing greater than 15% predicted clip rate in policies in force. We are handling it. There are upper limits and we have that exact limit as a determinant of when a state goes from what we call green, open, with no constraints, to yellow, which is supervisory control. Those are policies in force. None of them are exactly the same. The question - I am not sure in numerical response, but it depends on the state. It depends on the relative 10ure of people in the state, current conditions of inventory. It also will depend on the nature of the claims that we handle, whether first party pith state or not and depends on recent development that is proven to be positive from a productivity view, such as our driver program. But in states we will introduce concierges, (inaudible) better allocation in use. That is paramount in my mind is taking ways and finding way that is we can create nonlinear growth of our claims capacity to meet projected policies in force growth. The concept is absolutely showing signing of doing that and will continue to do it. Where we have opportunities to roll that out, we may do that in locations where we need that extension of capacity most. Net-net, best I can do on this one is tell you from quarter-to-quarter when I think we are actually hitting a constraint. I think right now we have constraints we are brushing up against in several states, nothing that has gone into a no stop, this is as much as we can take. It is moderated by our ability to put people on. We have hired over 600 people in the last quarter. That is one number. The issue is what is the net gain? We want to make sure we are keeping our people and being able to train them sufficiently. 15% on aggregate policy, we are doing. I think we will do higher than that.

One number from you, even though it wasn't the one I was asking. Appreciate it.

Mr. Vinay Saqi from Morgan Stanley, you may ask your question.

Two quick questions. One, could you address for me how you guys look at retention in terms of willingness to grow business faster? If you are getting higher retention rates today that should be more profitable than new business? Does that increase your appetite to grow and how should we look at that going forward? Second question, have you made decisions on stock options in terms of expense? You disclosed the amount, but you have made a decision of including it in earnings?

The first question was sort of I believe, does the change in retention increase our appetite for new business? The answer is actually yes. In a way that is not quite as obvious as it might be. I will focus on direct, for example here. The same thing is true, but I will use direct as an example. To the extent retention is increased and we believe that increase is reliable and permanent, is a big issue. Then it changes the amortization period of our acquisition costs. When we then put a new piece of business on, we expect to harvest, if you like, a greater net present value of the earned premium. To the extent we push that out, it allows us to then create prices that are more attractive for new business. So, increased retention absolutely will influence the cost per sale we will consider to be allowable or target cost per sale. The feedback there is pretty direct, pretty consistent - not consistent, but looked at on month-to-month basis. The answer is yes, retention is always a good thing. It is absolutely good for margin, as Tom addressed. Margins are typically wider on renewal business. It widening the aggregate margin and allows us to be more aggressive on new business.

Before Glenn takes the next question. (inaudible) understand we flush that through the income statement right away. This is just our modeling of what we can afford.

Have you reached a period where you believe retention is a permanent state or reached a new level of retention where you feel comfortable growing faster?

Our process there is that we look for policy life expectancy at all different segments of the business. That is a continuous issue. So, every month we will look at it and we will accept, if you like, an indication of what we believe is the true future life expectancy influenced by history. Absolutely, we do move that number and have been moving it as we see positive trends.

Okay.

Second issue of stock options, sort of is something we have thought about a lot. I am happy to answer that and suspect it is on the minds of others and certainly in the press. It is a valid issue. Let me start by suggesting that two things. Progressive absolutely thinks options are a form of compensation. There is really no debate on that in my mind at all. It should be fully reflected in some way, shape or form to owners and those interested in analyzing our company. The second, Progressive does believe itself and I firmly believe that we have been a leader in transparancy in lots of ways and this would be one we would like to be equally as much a leader. I think we have been. I will allow myself to be liberal in comments in a few seconds. But, we may not choose to be necessarily a leader in terms of saying we will expense options in the current format. We will, however, do what is required. I would like to tell you what we have done and then suggest as ongoing issue, we will continue to look at it. First of all, there are two significant things I think are possibly overlooked in our response to the options issue. Since 1997, we have reported in our quarterly releases, the impact of options under the SFAS 123. The fair value of option compensation. At least I am told that is not a common practice to do that on a quarter-by-quarter basis. We have consistently done that. Anyone that would like to make a comparison of earnings or earnings per share, they can go back for any given period from 1997 on and get it from the operation summary we provide. That has been a cautious decision for Progressive to do that. The second - I will note that is an estimate of the value of the options when exercised for terminations or whatever. It is a measure. The second measure that we believe and I talked about in the annual report and in New York, that we believe is very interesting, admittedly this is the period of exercise. We have adopted a policy of nondilution. We will buy back as much stock in any given year as we believe will be exercised through stock options. This is clearly reflected in the balance sheet, not in the income statement. However, this by our reasoning, this anti-dilution is perhaps the best way to reflect the true economic cost of options. So, we have done two things that in some sense book-end the problem. We have recognized the one, two three statement what the true cost of options are at the value when issued. We have done that since 1997. We have done something further and that is recognition that perhaps the true economic cost of options is ultimately the impact to owners in terms of dilution. We have made a conscious effort to say we will neutralize that. So, while there is sure to be a flurry of responses to the recent headlines, I would put a plug for Progressive in have being taken a lead position and in the spirit of healthy debate, perhaps these two issues have a very, very real response to the current issue. Perhaps neither is perfect. A third issue, since we thought about this a little bit will be to perhaps give you color on numerically what the impact to earnings would have been had we expensed them, versus what we believe the true economic impact would be. Tom, I know you worked up numbers on that.

We took a quick look and this is disclosed in the annual report on page 30, 41 and 40. In the year 2001, we would have had an after-tax impact of 15.4 million dollars. $23.7 million on pre-tax basis, which is three-tenths of a point of combined ratio. It is three-tenths of a point. From an accounting standpoint, if you were to compare after-tax cost on accounting basis of $15.4 million during the same year, a rough estimate after tax was $62 million. A company like Progressive has had a lot of success. If the stock continues to rise, the economic impact is greater. Black Shoals has sick variables, only the strike remains constant. The others change. In our case, they floated upwards. We are concerned if we go to expensing options under SFAS 123, it will actually be a misstatement. Not the best statement, but the true impact is accounting number, but doesn't affect the true economics. We are reluctant to say that is the true number.

Would you say the current statement is understatement of economic impact?

Under or overstatement, depending. For us it has been an understatement.

Right. Okay.

The issue remains Progressive will do whatever gives the most transparency to our owners and those interested in analyzing the company. There is really no issue from our perspective on that. We are not entirely sure that what we have been doing is perhaps a better representation. It becomes a GAAP requirement or if we get a feeling perhaps it is better to do expensing from an owner's perspective, then we will act accordingly. We will keep it under study. I caution you to look at both disclosures as a better form of disclosure than even what is proposed today.

Thank you very much. That is helpful.

(inaudible) from Merrill Lynch, ask your question.

My questions have been answered. Thank you.

Mr. Michael Paisan, from Williams Capital you may ask your question.

My questions have been answered.

I suspect that was the options question.

Mr. Kenneth Zuckerberg, you may ask your question.

You guessed right. Mine, too.

If any of you actually have proposals other than the popular press kind of issue, which we understand and are not knocking that, but I wouldn't mind feedback on this very issue. Our interest - it doesn't really matter to us per se as long as our financial statement and balance sheet accurately reflect the company and our actions at all times. If you have ideas we are not seeing or if you through contact with other companies, if you are hearing something that is a great idea, we are open.

Mr. Larry (inaudible) from Fairhome Capital.

I joined the call late. I apologize. Can you talk about the environment in California specifically competitively?

I hadn't discussed the California environment. It remains somewhat difficult and volatile from our perspective. We have got some difficulty, I mentioned an earlier question. We typically have had no great difficulty in rate changes or getting rates filed. That probably is not as true in California as most other places. We continue to have issues with getting rate filings through in California. The market in California is extremely volatile, especially the non-standard carriers and agency distribution. A lot of carriers are pulling out in California. Our volume is becoming quite strong in California. We feel like we have got rates adequate for now. We do have some concerns long-term about whether we will be able to keep our rates consistently at or ahead of trend. So, it is a little bit more volatile for us. There is not much more specifics to report there. We continue to take a look at product structure and the companies we use there and perhaps are moving to simplified product structure so that we can be cleaner and more consistent with distribution channel. The environment is such many are pulling out in California. Again, the demand is strong there.

Has there been a change in how the commissioner's office is looking at rate relief from a year ago?

Uh, no, there may be a more detailed answer that deserves. From my take and I was just down in California two weeks ago. I don't think I would say a major change. It has always been high scrutiny since the prior approval. It has been a high scrutiny environment. We have had at different points in time receptivity to changes.

Thank you.

Mr. Todd Combs from KBW.

Actually this is Jeff Thompson. Can you comment on non-standard auto growth? Last quarter you mentioned it was picking up in Florida and maybe New York and other states. Can you update us there?

Florida continues to be absolutely true. And I was searching for numbers. I probably wouldn't give out state numbers per se. In Florida, continues to be true. New York is an interesting situation. I think I reported before we have self-imposed constraints in the New York market, where we felt it was prudent, given a lot of our experience of 18 months to two years ago. We are starting to see signs and are responding to those signs, the marketplace is more healthy. The risk plan is healthier. There are changes in the take-out credits environment that are favorable to us. The number of carriers operating the non-standard market place in New York has changed and diminished. Demand is stronger in New York and we will likely pick up a little bit more of the demand more probably in the northern versus down state part of New York. Strong in both of those places. But, our openness has been different. We have been open in Florida and are still remaining cautious, but more aggressive in New York.

Other states we are seeing non-standard auto growth?

Probably the other notable one of the big - you can assume it is widespread phenomenon in that sector with the market conditions. The one that may be more noteworthy than the other two is Texas. Texas has a lot of county mutuals. It has a lot of perhaps naught as well funded and operated experience companies. There tends to be a lot of market disruption in the Texas market. Right now, we are seeing that and benefiting from a very strong demand function there.

One follow-up, if I may. On the commercial auto shock losses, can you give an example of what a shock loss might be? Is this a dump truck running into a doctor in a Lexus or what kind of things are going on?

I would take your example on that one. You know, that absolute is the kind of thing. It is really when you have got a limits exposed profile that comes into play in the nature of the loss. You can have a million dollar limit expense, but if the loss is $9000, then we don't hear about it. If the loss turned into instead of a minor whiplash issue, but a serious dismemberment, then you get that situation. I think the doctor in the Lexus is not as relevant. It is a matter of the limits exposed by our insured.

Are you taking action or still looking to see or are you going to change your reinsurance or assume profile in that business?

We don't insure or write any limits above one million there entry. That is not trivial limit by any means, but certainly not high-end limit from a commercial vehicle point of view. That is our niche. We are going to stay within that relatively low limit kind of business to the extent that is still very important to us, we have pricing factors we call increased limit factors. We have reserve income by limits. There is a great deal more focus both from reserving and pricing perspective on the experienced data at the higher bodily injury limits.

Perfect. Thank you.

This is one month at 101 combined actually 101.6 combined. The other months have been 80s or 90s. This is a combination of losses and reserve changes in the same month. Because it was significant, we thought we would report it.

Okay. Actually if I can ask one more. You added 600 claims people in the quarter?

We hired 600 claims people.

How many are in the organization in total?

About 8500. See how close I am in two seconds. If I am materially off more than 100 or 2, I will give you a number in a few seconds.

Close enough. Thank you.

8581.

Terrific.

Our last question is from Nancy Benacci from McDonald.

(inaudible) again, just to clarify in terms of the risk of higher limits, more importantly, any of the issues in some states like Ohio UM UIM. I assume you are writing this business to be at 96 or below, is that correct?

That is correct. Maybe I created this by bringing CV out more openly. This is the kind of reporting I think we should do. It is an important part of the business. Take a look there and recognize it is a large part of the commercial line we report. I think it is important. I wanted to feature it this month. It is fabulous. I mean, it is growing and has healthy margins. We expect at least and usually better than targets of 96.

In terms of growth expectations for that particular line going forward, based on comments on the other questions today, I am assuming you will be as focused on doing it profitably. The spike we saw this month - or for the June month is more sort of the aberration than the norm?

Absolutely correct. I mean, the - this business will not grow through expanding the market, which it seems to ensure and won't grow by increasing greater limits, both of which would be fine. We could grow by offering what is (inaudible). We won't do that either. There are lots of way we could grow the commercial business that are not in our sector. Within the sector, we will apply every discipline we have ever talked about and in fact today, you heard me reference something that might have been confusing. We are moving in some cases to 6 month policies. The commercial vehicle policies is almost standard industry standard 12-month policy. We are not reluctant at a time when volume is coming our way, to do something we think is in the best interest from pricing perspective. We talked about that at length from the auto a couple of years ago and a move we don't intend to go back on in auto. Whether you go back in commercial will be review of the need at the time. We can do things that are exactly the same discipline we apply to auto business.

I don't mean to beat a dead horse, but just to clarify on the issue of the ability to grow the business in terms of how much you can put on is going to be constrained by the claims infrastructure where you indicated you added 600 claims people within the last quarter. What is the ramp-up time from when that group comes in and when they are productive? With the concern being are you bumping up against the ability to not really slow down the growth? It sounded like in a couple markets there, but not across the board. Will you clarify that again is this

That is a fair statement. The number actually was closer to 640 or something like that. Most of our forecasts or all of our forecasts are forward-looking. We are not trying to hire because we have the need today. We are hiring in anticipation of the need. We have training facilities in Phoenix, Tampa and Cleveland. The minimum training that someone gets before they are competent to do much at all is two months. In that two months they will get an initial three-week class in casualty after a week or so at the local office doing computer-based training and getting a feel for the environment. They will do at least a course of three weeks and take a couple of weeks ago and do physical damage training. At that time, are they even prepared to start think being looking at specific files and working with their team leaders and so on. The ramp-up time is significant and that is built into hiring.

Go back and look at LAE and the last five or six conference calls, five or six quarters ago LAE was high. We were overstaffed, but didn't aggressively act because we knew we would need that in the future. We were over capacity in claims. This has been managed for the long-term always and it is not as if there were an immediate ramp-up date.

Thanks for the clarification.

That concludes our call. We have run over. We thank you for your interest.

That concludes the Progressive Corporation second quarter conference call. Instant replay of the call will be available until August 2, by calling 1-800-568-5006. Thank you.