前進保險 (PGR) 2002 Q3 法說會逐字稿

Welcome to the Progressive Corporation Third Quarter Conference Call. All participants will be able to listen only until the question-and-answer session. This conference is being recorded at the request of Progressive. If you have any objection, disconnect at this time. Acting as moderator will be Tom Forrester. I will turn over to Mr. King.

Welcome to Progressive's quarterly conference call. Participating today are Glenn Renwick, Chief Executive Officer, and Tom Forrester, Chief Financial Officer. Glenn will begin with comments on quarterly results and then we will open for questions. The call will last about an hour. Statements in this conference call that are not historical facts are forward-looking statements subject to risks and uncertainties that could cause actual results and events to differ materially from our projections. These risks and uncertainties include, without limitation, uncertainties related to projections generally, inflation and changes in interest rates, rate prices and other initiatives by competitors, ability to obtain regulatory approval for rate changes, regulatory developments, litigation pending against the company, weather conditions, changes in driving patterns, acts of war and terrorist activities, court decisions, litigation, healthcare and auto repair costs and other matters described from time to time in other releases and publications. Investors should be aware that generally accepted accounting principles are precscribed when a company may reserve particular risks, including litigation exposure. Results for a given period could be significantly effected if and when reserve is established for major contingency. Reported results may appear to be volatile in certain accounting periods. Over to Glenn.

Good morning. Another strong quarter for Progressive. Our Asia business had 27% growth in written premium, 19% policies in force and we are running ahead of targets on profitability. It is a great time for us. Direct business is equally as strong. 40% premium growth, 25% policy in force growth, rate loss results and continued efficiency is showing up in the expense ratio. Overall it really was a very good quarter for insurance operations.

Margins for the quarter were solid and well ahead of targets in personal lines and commercial order. Our top 10 states represent 57% of year-to-date written premiums for personal lines and each state is beating profit targets. Only one state in the top 20 is over 100 combined ratio and that is our 20th largest state, Kentucky, where we are addressing the need for more rates and may decide to slow growth in the short term. In Washington, we imposed moratorium on new business for 75% of our agents about 2 months ago until rate filing is approved, causing drop in agency new applications. We anticipate a positive response to the filing and return to growth there. We remain committed to rate adequacy in every segment and every state.

In Louisiana and surrounding states, the recent storms hurt results, but not to a great extent. The day before the first storm we set up cap response sites in New Orleans and Lafayette to handle the volume of vehicle inspections we expected based on our prediction models. and Tropical Storm Isador we had about 900 features, either paid or reserved, estimated exposure of $2.4 million. In October, the beaches opened so far from Tropical Storm Lily are around 400. This will likely have a minor effect on future results. We e-mailed customers in anticipation of a claim they may have with claim reporting and handling procedures. The response after Allison last year, this level of service was well received, most notably by those who did not have a claim, but appreciated notification from their insurance company.

In key states like Florida, Texas and California, we are meeting or exceeding profit targets and growth rate is better than 25% for the year. Even in New York, where we struggle to regain profitability last year, we are seeing strong margins and double-digit growth, primarily in upstate New York. The growth across the country is coming from new policies, as well as rate level increases and changes in mix of business. Market conditions and competitive rate levels combine to produce continued strong growth in the agent and direct channels, personal lines and commercial order. In Georgia, for example, State Farm announced a rate increase, Farmers notified agents they will no longer accept new order business and a number of other businesses are implementing underwriting conditions. In Texas, moratorium by farmers may effect the order of markets soon. We are seeing the same type of rate and underwriting activity in Arizona, Maryland and other states, where we are well positioned to take advantage of additional growth opportunities.

In the last call, we explained reserve for the settlement of two groups of class action litigation cases. One for Benement (ph) and the other for the alternative commissions. All and all, settlement process is going as expected. We anticipate that both settlements will receive final court approval by year end. Loss trends remain generally favorable, consistent with the first half of the year, we experienced declining loss frequency in every coverage. Severity trends were showing marginal increases, consistent across all classes of business. Our (inaudible) severity trend is close to zero. The comparable lag NAII data is around 5%. Severity trend for collision and property damage is in the 5 to 10% range. Bodily injury severity, not adjusted for claims, age or limit mix, is consistent with prior quarters for the year in 7 to 10% range.

As we analyze loss reserves during the year, we seek opportunities for enhanced segmentation, just as we do in pricing. This year we expanded our segmentation of loss reserves based on policy limits on commercial auto business and enhanced limits profile reserve for bodily injury and uninsured motorist losses in the auto products. The development of higher limits losses significantly different from lower limits. The additional segmentation is focused on providing increased accuracy. We will expand on this further in next year's report on Loss Reserve Practices. Overall, prior accident year development continues to be slightly favorable, with a 1-10th of a percent favorable impact on combined ratio for the year.

Growth and profitability in commercial auto remains strong. Still over 50% year-to-date on 10 point profit margin. With this release, we provided separate financial breakdown for commercial auto, including policies in force to allow clear review of this growing business. Last quarter, I mentioned that the June results included development on large losses, contributing over 7 points in loss ratio for that month. Fortunately, we did not see this continuing into the third quarter and concluded it was normal variation versus a strong trend. As you would expect, our scrutiny of the business is high and I am pleased with what I see. While commercial auto is a different business from personal lines auto, it requires the same fundamental skill that is drive auto business, disciplined pricing and excellent claims service. The results show we are delivering on both fronts.

We continue to feel good about our ability to hire claims representatives. In many locations we are staffing offices ahead of our requirements and the quality of new hires is very high. Advanced hiring gives management time to focus intensely on training in the field, once the classroom training is completed and claims reps are more successful and have the personal attention of a team leader day-to-day. Net increase in claims staffing of 650 people. Claims reps who are joining Progressive right now are working in environment that is more customer focused, more interesting and more satisfying than any time in our history.

We have been piloting, testing and fine tuning improvements to our claims model for two years. These improvements focus on assigning the right person to the right claim, creating personal accountability for loss handling and communication and significantly improved process resolution. We are now starting to prepare broader expansion plans for end-to-end claims model, sometimes called Concierge service and will announce our plans at the end of the quarter. I will not give you hard numbers, I do want to emphasize a fundamental point about acceptance criteria. End-to-end claims service must be more efficient and positive for stake holders, payments, repair shops and Progressive. If we are not taking both cost and time out of the process while improving satisfaction, we simply won't proceed. All indications are very positive.

Comments on investments. For the quarter ending September 30th, the composite fully taxable equivalent total return for entire portfolio was 1.67%. This figure combines recurring investment income with realized and unrealized changes in security prices and reflects 85/15 fixed income to equity portfolio allocation strategy. In the current environment of large equity market declines and falling interest rates our portfolio allocation result is a net positive change and realized and unrealized gain and a loss of $10 million for the quarter. We continue to manage to the 85/15 target. Our fixed income portfolio posted 4.42% fully taxable equivalent total return for the quarter and 8.76% fully taxable equivalent and total return year-to-date, ahead of our benchmark. Our duration is shorter than at the end of last quarter, down to 3.5 years from 3.7. As of September 30th, the weighted average credit quality of fixed income portfolio remains at double A. As interest rates decline, we have held the course on investing on total return basis. We continue to evaluate risk of the portfolio in relation to our business objectives and will not sacrifice quality or extend duration to chase yield. Our best estimate for the yield of new assets added to the portfolio is market rate for double A 3 and-a-half year securities.

We are up 2% of the fixed income portfolio is held in securities classified as non-investment grade. Over 90% of common equity portfolio is comprised of common stock and managed by state street global advisors to track the index within 50 basis points. For the quarter, common stock portfolio posted negative 17.08 fully taxable equivalent total return within 16 basis points of the total return of the Russell 1000 benchmark.

As mentioned in prior calls, we own the individual securities of the equity index and are required by GAAP to review common stocks for other than temporary impairments. It is our best estimate that any impairment issues, whether issue or specific or market or sector related, are appropriately reflected in the income statement as realized loss. All other unrealized gains or losses are reflected in shareholders equity. September 30th, fixed income portfolio had $400 million of net unrealized gains and equity portfolio had $263 million of unrealized losses for a net of $137 million in unrealized gains on the entire portfolio, a net increase of $34 million from the end of the first quarter - excuse me, from the end of last quarter.

For the third quarter, our review process for other than temporary impairment resulted in write-down of $62.1 million. Including net gains on sale of securities of $38.4 million, we incurred $23.7 million of net pre-tax realized losses. We continue to repurchase stock to eliminate the dilutive effect from exercise of stock options. We repurchased 900,000 shares during the quarter and 1.8 million shares year-to-date. This represents our best estimate of the total expected option exercise in 2002 and concludes our dilution repurchase for the year. Total stock repurchases year-to-date are $214 million including repurchase of $97.3 million. The structure and accounting for long-term compensation is under internal review. And I expect to provide comments on our plans for next year in the January call.

One concluding comment. Over the past month I participated in six regional meetings across the country, getting a chance to share my congratulations for what we have accomplished this year and discuss my view of the future and our action agenda. My message is clear. Our business model is solid. I am very happy with our execution on the agenda. We must avoid complacency and pay close attention to all things that can go wrong, especially when everything seems to be going right. What is so exciting to me is hear the enthusiastic response from 1000 or so senior management when we review plans for next year. This huge momentum across the country from Progressive people with continued strong execution toward their goals of becoming the consumer number one choice for auto insurance. I look forward to next quarter, next year and several years out. So, it has been a great year. We will open up for questions.

Thank you. 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, press * 1 on your touch-tone phone. You may press * 2 to withdraw your question. To allow the company to respond to as many callers as possible, you will be limited to one initial question and one follow-up question per request. If your telephone has a mute capability, we ask that you use the function during that time your question is being answered to minimize background noise. To the extent you have additional questions, you will need to place your name back in the queue by selecting * 1 on your telephone. One moment, please. Our first question comes Michael Lewis (ph) from UBS Warburg. You may ask your question.

Thank you. Good morning, Glenn. My question has to do with the rate of policy in force growth that you feel is handled - not that you can sustain, but what you can handle? Is there a difference between the policy in force growth of the agency business versus direct, as far as the ability to handle it? I mean, you seem to be continuing to increase the pith (ph) growth. I am wondering what kind of volume you are comfortable with? That's my first question, thanks.

Yeah, that is certainly one we think about a lot. I will take the easy part, agents and direct. Not fundamentally a great deal of difference. We have given piths (ph), perhaps the appropriate way to look at that is the vehicles and vehicles per policy between agency and direct is not fundamentally different. There is not a split there in terms of capacity. The capacity issues that I think about a lot really come down to claims. So, the constriction points in the company are claims and policy services.

Again, I will start with the easy one. Policy services, I do not expect that to be a primary governor of our growth. We have done a lot of things over the past couple of years, most of which we talked about on our calls in New York. Especially in the agency business, we have been able to share with our agents more technology, allowing them to do the work on policy or endorsement, shifting the load back to the agent, but welcomed by them. So, in fact, we have been able to grow quickly this year, the outlook and staffing on policy services area actually has remained relatively under control and is a nonlinear growth our premium. We expect that to continue. We have got technology that continues to help us there. But, that is not a big concern for me.

Obviously, the concern is in claims. When I mentioned the Concierge expansion, one critical element is that this is our best attempt -I will not outline all details here, because they are proprietary here - it is our best attempt to be able to create a new system of claims management and claims handling that actually increases productivity. We can put more claims through the system than we ever have before. We have proven that in our prototype locations. That is our hope for claims capacity for the future.

In order of the specifics of day-to-day, we are running at 30%, say, for a round number, growth. Is that the upper bound? It may be close to upper bound of growth. I will not signal this is not capacity for us to take it. I have been clear saying we will stop growth in the locations we feel we put claims under pressure and sacrificed quality. The issue of capacity has to be taken market-by-market. There is no clear nationwide number that, I would say, stops. We have one or two states where we have ongoing concerns for claims. One probably more so than any other. We feel good about what we are doing there. I observe and we take into account things like staff turnover, quality of claims resolution. When those things start to give us some indication, we know we are at the upper bound. We have one state absolutely on that screen in that regard. We have a few other states where we have work wide claims gym manager and marketing general manager to occasionally pull back, even if it is for a month or two, advertising. We have done that in limited cases, nothing hugely notable. With controlled volume, if it was short-term ,and I needed to get 10 people or another number of people up to speed in claims and get them comfortable. We have been able to do that and manage it. I expect we will continue to manage it ongoing. Claims constraint is biggest for us.

Quick follow-up. Is it possible for you to tell at this point if the profitability of the new business you are putting on is remaining close to as profitable as the business that is on the books? Or is that still a situation that will take further before you can ascertain that?

No, that is something that we are incredibly focused on. I think I may have covered this a little bit in the New York session. I will try to cast your memory back to that. We talked about individual targets for not only tiers or classes of business, but also new and renewal business. We really don't measure business in aggregate. We look at every segment. I will take a segment, it might be non-standard tier, non-standard new business in Alabama. And that segment has to meet its targets. So, we look at new business results very intently. Quite frankly, if you get off on new business, this relatively low challenge will renew and be better. It might get marginal improvement. We don't want to see us put on new business not meeting targets. We have formal targets for new business. They are not same as renewal targets. We understand the differences and expenses that go with that. We hit targets and monitor against them in every state every month.

Thank you very much.

Nancy Benacci (ph) from McDonald Investments. You may ask your question.

Good morning. Congratulations on a great quarter. Let's talk more on the growth side and on the direct channel. If we look at combined ratio on direct channel at 90.7 for the quarter and nine months at 90.9 in good strong volume coming through, can we interpret that as seeing better retention coming through? In other quarters you mentioned indications have been it is looking better, is that reflected more in this quarter?

I will give you a positive answer to that question that we have been hesitant to jump. The answer is yes. We have been seeing the trends. I have been reluctant to sort of say, even on the conference calls, that is a sure indication. We have enough months under our belt to believe that we have a measurable increase in retention in both channels and almost all tiers. So, in fact, our retention and one shouldn't be surprised about this, obviously we are working hard. I would attribute some of that to our own actions. But, clearly the hard market is another factor here that has changed perhaps people's options when they may be considering shopping. We may very well be the price that is still beating anybody else in the market for them and retention absolutely has gone up and we are delighted with that.

Second question is regarding your comments on loss severity. You indicated you are starting to see little bit of upturn there. One, is it enough that you are starting to get concerned? Secondly, what are you doing with rates right now - what did you do through the third quarter? Can you continue to raise rates enough to overcome increase in severity and still get those approved by the regulators?

Two things. Go back to my comments on trend. Actually, someone called me out about my reading and competence. Apparently I stated dilution repurchase was $97.3 million. In fact, it was 93.7. Anyone taking note on that, please make that change.

Uh, the question to trend. When I give those trend numbers, they clearly are our trend numbers, but we have to take those with some degree of caution. Let me see if I can explain both of the ranges that I gave. The fiscal damage and collision 7 to 10, understand we typically have been below NAII severity, reflecting somewhat our book. Even if we see a trend going up, it may very well be mix in the kind of customer that we are insuring. The trend may not be inflation on normalized book. We will always price our business to reflect the business that we're seeing and getting. But, the average trend may start to go up. I don't feel that that is a concern from our price level. We anticipate those things on an individual state and coverage level.

I mentioned before, the VI (ph) trend is difficult to take in aggregate because there is the issue of the age of the claim when paid and as we look through that and normalize for those things, we don't see trends different than we priced for. To the question of rate need. We do both ingrate great and more particularly state-by-state processes all the time. My comment earlier that even though things are good, we will take action such as we did in Washington to slow business down, put a moratorium on. Or like in Kentucky, if we need to do that. Things are good in aggregate. We are looking at every piece of the business and it's the responsibility of product manager in the states, for the channel agency or direct, to make sure that part of the business is running well. We have every reason to believe that we will get rates when we need it. We have recently gotten rates in Louisiana, where we absolutely needed it. I mentioned that on the previous call. We are delighted to have appropriate rate there. We have additional rates in New York. We are very happy with that. We are hopeful that the Washington State situation we will resolved very soon and Kentucky similarly.

In aggregate rate need, we are actually in a very attractive position. We do not on aggregate basis, need a lot of rates. I see no reason why we won't be able to keep up with the trends we see. I think regulators are aware of market conditions. They are seeing a lot of companies exit markets and are willing to and generally want to make sure responsible companies get rates they need to keep rate level at a place they are profitable.

Thank you very much.

One note of cautionary note on retention. That is we actually expected to see our margins degrade a little bit because of the increase in new apps. We thought relatively of new apps would increase substantially. Because retention increase as much as it did, that number did not increase in the way we expected. Therefore, margins stayed at levels they have been. However, a lot of the retention - there are two components, things we can do and things competitors do, that help us. There is a question that the competition help may actually abate over time. So, the increase that we are seeing in the retention may not continue at the pace we have seen because of competition gets stabilized and their help to us may not be as great as in the past. So, I wouldn't read into it that we are going to continue to see the kinds of increase in retention we have seen in the past year, which have been pretty good.

Thanks for clarification.

Mr. Michael Smith (ph) from Bear Stearns.

Thank you. Glenn, you mentioned favorable reserve development on prior years. You mentioned favorable frequency statistics. The severity does not seem to be out of control. Yet, sequentially, your accident year loss ratio is moving higher. What is driving this?

I would be comfortable if the loss ratio continued to move higher if it was because we had lower expenses and still meeting our targets. That is not necessarily a bad outcome.

Is there intention to allow it to move higher as much as we saw from Progressive a few years ago when combined ratio got to similar level where it is now?

It would be helpful if someone would put loss ratios in front of me. There is really no plan to do anything on aggregate level here. Let me simplify it. If we continue and have taken specifically in direct, an opportunity to be able to reduce our expense ratio, if we can continue to do that and holding margin costs down, I am going to be allowed more in the loss ratio and would be favorable to that as long as we make our price margin. That gives us pricing design we look for to grow the business. There is obviously a constraint to that. On top of loss and LAE, if we can hold margin constant, I will put that point back into loss cost as an opportunity to grow the market.

Okay. It sounds like you lowered combined ratio targets from your historic 96%, is that because of the low yield environment?

Uh, no. Let me comment on that. Our long-term goal of 96 is our long-term goal, period. We are in a very interesting situation in the market place. The market is hard, certainly growing at the kind of pace we are growing, I would want to feel and do feel we should take additional margin there. But, I am not signaling to you that we will change our long-term combined ratio or do simply because of the investment side. Our long-term goal remains 96. We will continue to turn the price for that. If we feel there are opportunities in the market place and especially when we are growing at the rate we are growing, some of our control is on pricing. We will achieve lower than 96, if in fact the market remains hard. You heard both Tom and I say renewal book has been very favorable this year. Most of you know the dynamics for margins on renewal are favorable more than new business. We had the ability to blend that in with the book and achieved the results we have got. This is not a long-term signaling of the change in our goal for combined ratio. As market conditions change, and I don't expect them to change quickly, but over time, I think we will be consistent on our statement that we shoot for 96.

Okay. Thank you very much.

Mr. Kenneth Zuckerberg (ph) from Lazar (ph)Asset Management.

Wanted to zero in on commercial auto book for a minute. Number one, thanks for the pith (ph) disclosure. It represents 10 or 11% of the book, but obviously the growth there is noticeable and you have been mentioning it repeatedly in calls. Just wondered if you can give us comfort about underwriting controls on that line? Can you tell us little bit about how the business is coming to you? Is it a question of National Writers getting pulling out after getting stung in that line? Is some of this the old Reliance business as they exited the market? Any thoughts would be helpful.

I appreciate the comment on breaking it out. I think this is more of just a maturation of the business. Obviously it has always been important business to us. The size has not been quite what it is. The people, types of individuals running the business, are similar to the types of people that came up through the auto business. It is treated similar to auto business. I mentioned that the skills and disciplines are very parallel. The fact it is, it is getting to be a billion dollar run rate business and those businesses get more scrutiny than before. It doesn't suggest they weren't getting scrutiny. They will get scrutiny and every time we break things out, we are glad it is valuable to you, you can assume it is being broken out and scrutinized internally to a greater degree. Not only is it large, it carry with it the one dimension that most passenger auto doesn't carry, and that is higher percentage of higher limit business. And that is something we have to keep our eye on the ball. We have a fair amount of experience in that at this time. But, I suspect that we will learn things as we grow both that book and our more preferred book in order with higher limits.

So, we will continue to run that where the business is coming from. We distribute through the independent agency channel and do direct to consumer on the commercial, but mostly through the independent agent. You have a relatively small number of carriers with similar size positions and, based on their underwriting restrictions, and there have been many of those, some of them are starting to lift now. I think the hard market will come off sooner in the commercial zone. We may see more slowing in the growth there, which wouldn't be terrible from our perspective. But, most of the business is coming from the carriers that are in the independent agency channels putting additional restrictions on or had significant rate increases. The story isn't too dramatically different than the auto story. I don't know of a particular carrier that we have taken business from to a greater degree than anyone else.

We have no groups like Public Liberty, so half of the business is light local, pickup trucks used by plumbers or landscapers. It is a business we look at hard. It is what we have been for 20 years.

Tom, thanks for that point. I guess thinking back to early '90s, just wondering if this is a line now where to the extent that loss severity picks up on the commercial piece, is there - do you find there is enough reinsurance that you could utilize or have you thought about it no need at this point?

Contract business dramatically to the '90s long-haul trucking business. We are not doing long-haul trucking. We surrendered. We don't think we are good at it and we don't think we need to do that. We are not going into that business or doing workman's comp or commercial coverages. What we are doing is extension of the skill sets we have to apply to our business, light local. A lot of policies are up. New vehicles, there are policies in force with small fleets, but a lot is extension of auto skills and we don't plan and have no plans - I am not thinking about plans - to do additional commercial coverages at this time.

Thanks very much.

Mr. Charlie Gates (ph) from Credit Suisse First Boston, you may ask your question.

Good morning. My first question, could you elaborate on the environment in the state of California?

In what way?

The key trends in that market place as you currently review it, sir.

California remains sort of a state that is going back with a huge part of Progressive. Now, we have 1.8% market share in California. So, it is way below our average market share. A state we are no longer dominant in. Some things we struggle with in California, sort of the number of companies we can use, price levels, we have recently - up until recently, had two price levels, two companies we used. We consolidated that into one company writing in the agency channel. That was the right move. We have had lack of clarity in understanding how to use certain features of our product in California. For the most part, we cannot use credit and some of the things we had in our products.

The product line in California is different. One of the trends that we noticed in our current book of business is that the direct channel probably has the highest penetration of any state in California. So, we tend to be more skewed toward direct in California than agent. As we look to the future, there are issues with the Department of Insurance. We have had currently a market conduct exam going on that in and of itself was not a problem, but raises the issue of lack of clarity. There are pre-prescribed factors that will go into rate setting. Some are under hearing right now. Obviously, we don't agree with a lot of those. Some of them from our perspective - I am sure don't make entire sense. We will live to work with them. The rate filing environment is difficult. Certainly we are seeing in the last year, the California DOI improved rate increases relative to prior years. We see that being healthy that rates are able to be achieved. We have rate cases and still have opportunities where we have rate in front of the department board and not been able to get it.

For us, California is really still a tough environment. It is tough to be sure that you are going to get rates when you need it. We are comfortable we have a better agency strategy now around one-company strategy. We will continue to do direct business there and that seems to be an opportunity for us to perhaps get greater penetration than we have in other states relative to the agent direct share. Clearly, we are watching the and have reasonable expectations of what the election will bring from the new insurance commissioner. We will see what happens, specifically around pre-prescribed factors that may or may not be coverage specific.

One follow-up questions, sir. One of you alluded to the fact that you were not writing - I believe it was public livery business, what is public livery?

I said that last time or Tom said it. That is limousines. You know, for-hire limousines. I don't know if we include taxies in there, but at one time in our past, we had a specialty group that wrote for-hire livery business. That group doesn't exist any more in any way, shape or form and not coming back.

Thank you.

Mr. William Wilk (ph) from Morgan Stanley. You may ask your question.

Good morning. Some questions have been answered. Let me ask you, if I may, about premiums and surplus. If I did the math right, looks like premium to surplus ratio reached the 3-to-1 level. I am wondering if you will do anything to bring that back down in line?

This is Tom King. I will take a stab. We have 35 insurance companies. Our stated goal is to maintain surplus ratio below 3-to-1 for each company. The reason we do 3-to-1 is a magic number for regulators and we want to preserve to make upstream dividends to make interest principle and dividend payments debt and equity investors. Keep in mind that we have a fair amount of capital that had not been deployed into our insurance companies. We have non-insurance holding companies where we pulled capital that we have in excess of 3-to-1 cap that we have. One way of trying to estimate this would be to look at debt and shareholders equity that we have, on a GAAP basis, total capital I would reduce that for deferred acquisition costs and that showed basically a crude measure of statutory surplus like money that is available in aggregate. 3-to-1 ratio for the IRIS (ph) and regulatory community applies on calendar year basis. We are confident we will not breech 3-to-1 ratio for regulatory purposes for calendar year 2002.

That is helpful. Thanks. Would the change, if you were to move money into the statutory to bring back in line, would that mandate a change in investment strategy for that money that is moved?

No. We are very comfortable with our 85/15 method allocation of fixed income 85 percent and 15 percent common equities. And we are confident - we believe in a short-term hike rate fixed income portfolio. So, we - some states do have restrictions, but concentration or unusual classes, but they don't affect our operation.

That is helpful. Quick follow-up, if I may. Expense ratio in the personal lines direct ticked down this quarter. Wondering if you could comment on that, whether your view of whether that is sustainable decline or just temporary given the spurt in growth and premium in that sector?

I think it is not only sustainable, but able to be improved over time. Let me give you little bit more of perhaps a caution of interpreting that. Expense ratio in direct will be the most difficult of our expense ratios needed to fully appreciate, unless you normalized it for new and renewal, recognizing that the new expense ratio is very large. So, as we continue to grow, more new business we put on, you will see variability in the expense ratio, perpetuated by the new business that we put on and obviously softened a great deal by renewal business.

If you took comparison, industry comparison against GEICO, the net expense ratio delta is 6 or 7 points. If you normalize that to new and renewal percentages, you will find that delta to be considerably smaller. However, through acquisition science, our better understanding of allowable acquisition costs, our better understanding and improving all the time, understanding of how to buy media efficiently, better understanding of trying to get that elusive point of marginal revenue to marginal cost equilibrium. If we can keep working on our science and get to those sort of things in a way that - quite frankly, is exciting inside the company. We have a lot of people thinking about it and making improvement. I would tell you, you could probably look at declining rate, but still continue improvement expense ratio on direct. But, it is going to be largely function of new and renewal business and improvement in techniques. Most of our expenses we have on an ongoing book of business, policy side of the business, look attractive. We have done very well on that expense ratio on renewal is about where I hoped it would get. We may see slight improvement, but most from media efficiency.

Tom King here. I want to mention, our numbers are clean. Those are all expense, as you heard.

That is helpful. Thanks very much.

Mr. Jeff Thompson (ph) from KBW Inc., you may ask your question.

Actually the question is more broader on the expense ratio. The 20.5 percent in the quarter, can you talk roughly - I know you're - I understand your comments on direct side. More generally, is that going to be sustainable? Is it being driven by premium growth or sort of what is happening there and what is your view into the next year?

Let me take both pieces of it. I think the agency deserves comment, as well. You will see an up-tick in agency expense ratio. There are two valid reasons we should be comfortable with the up-tick. We tend to pay higher commission on new business than on renewal. Any state split by one or two points , a 10/8 or 12/10 or something like that, so, when we are in the mode we are in this year, even though we had a good year last year, remember the units in force ended in agency down 1%. It wasn't a year we were putting on a lot of new business. In 19/9 or there abouts, expense ratio is going to pick up this year with new business, largely driven by new business commission rate. Second, quite frankly cause for that is our own internal gain sharing system. When we have a good year, gain sharing accrual, which is accounted for in the expense ratio, is another driver of slight up-tick. So, those are two acceptable reasons for agency expense ratio going up.

The question on direct is question of sustainability, yes, I believe what you are seeing is sustainable. I would caution you not to look for huge continued degradation. That will be the slowing rate. It is new renewal mix. As long as we can continue to attract new business at - I want to be clear about this - every piece of business we put on direct basis has targeted acquisition cost that we work out ahead of time. We then monitor closely to make sure that we haven't misjudge that targeted acquisition cost. So, we absolutely have clear targets to acquire business at a certain rate or certain cost, but no more. And that varies by state, by class of business. That is the real discipline we have to worry about, the aggregate expense ratio. If every piece of new business is at or below targeted acquisition cost and our policy life expectancy estimate is built into the target are not exceeded - and the fact we try to be conservative, we are in a very healthy position. If any one of those two things break, either policy life expectancy shortens up on us more than we expected, then that is a very bad outcome. Mostly on direct, we worry about targeted acquisition on firm policy basis, versus aggregate expense ratio.

Follow-up on contingency commissions. What is sort of basically the range on those? You know, can it go as high as 2 points or 1 and-a-half? Secondly, is that a sliding scale over the next three years or how is that accrued?

You mentioned contingency commissions - profit commissions. We do not have a broad-based contingent commission for our agents period. We have local control with general managers being able to set a small contingency commission program. They do exist around the country. They are not hugely material in dollar numbers. I would be surprised if it is more than a couple of percent. I know of none that is sliding scale or even projected or committed to over greater than one calendar period.

Great. Thank you.

Mr. Bob Glasspiegel (ph) from Langen McAlen (ph). You may ask your question.

Good morning. Glenn, it seems like you described a near nirvana scenario that I haven't seen in my career. You have got growth and profitability at above targeted levels in a hard market. I think you have talked to this, but could you expand? What really drives the pricing decision on the margin in such a positive environment? Is it - you are at growth limit or close to it. Your profitability is where you want it to be. You continue to take rate as the market allows you or what drives it?

Very good question, Bob. Let me continue you, in pure economics, I will just pull on the margin. We are a regulated business. So, everything we file and we have equal obligation to file and report to you accurate numbers. We report in our indication of state filings very accurate numbers and our estimates of trend. So, while this is favorable environment and we may target healthier margins, remember this is not go be ting infinite scale we can keep pushing down because we have obligation to file regulatory approval for our rates.

We will, no question, in this market, we are very well aware of our opportunities to take market share, to do so at the rates we are doing, I will not feel as happy if we are running at 97 or 96 at this kind of margin because it is risk premium in there. So, yes, we are very, very happy we are able to get lower than that. We are being conservative, but not extreme. We are not trying to file something we don't believe in. We will file conservative. The hard market has brought a strange confluence of different issues. We have gone through, and I reported in my prepared comments, a period that I don't remember, at least, a period of declining frequency as rapidly as we have had. In fact, you say the word nirvana. I feel good about results, but I worry more when things are good. I think frequency will have to turn. I can't believe that it keeps going down. If it turns, for whatever reason, the economy improves or whatever it might be, then we have to stay on top of the trend.

Generally, we have been conservative in our frequency trends. It has been more conservative than we had predicted giving us some additional margin. So, I know that is not a direct answer to your question, but in a regulated environment, it is not always going to be price. But, we have been conservative in our trend picks and specifically on frequency. It has been incredibly favorable for us.

You are forced to take price. If you don't, you would grow that much faster and then your bumping up against your managed growth issues. To some extent, does the market force you to take rate here?

No question that we are taking as much rate as we feel we can take and both the margin and our regulators. Yeah, no question right now we are being as conservative on trend or aggressive on trend, whichever way you want to put it, to get highest possible margin. We want to stay as open as possible for our agents and for our direct. Right now, we are being feeling pretty good about the rate of growth we are maintaining. We haven't broken it between one or two situations where we put initial constraints on advertising, minimal. And, if it gets to be any worse, we will look at other things to slow the business down. That is not the forecast that I see for the immediate future at all.

Thank you, Glenn. Those are nice problems.

Mr. Ronald Frank (ph) from Salomon Smith Barney, you may ask your question.

Glenn, I want to follow-up on Bob's question and explore the nice problem, frequency. You probably know a number of large companies are commenting similarly to yourself that frequency is trending very, very well. Could you give us your view of the forces behind that and the perspective longevity of that trend and also, you mentioned how you're being aggressive on trend or conservative, depending how you term it, but what are you assuming in your pricing vis-a-vis frequency versus the way it is currently trending?

On to the last part, I am not sure I have words of wisdom on first part. But, in our indication process, first of all, we take a trend for frequency and severity or combined for premium. We do it coverage by coverage, state by state. What I report when I say frequency going down is very much a macro situation. But, our trends that we put into rate indication have been relative to my experience, sort of pretty flat and low, certainly compared to what we were coming off of in late 1999 or early 2000. The numbers in terms of PD severity and BI severity has to be blended with overall observed decrease in frequency of about 5%.

So, starting to look at very low numbers in terms of trends, maybe 1 and-a-half to 4% on any coverage. Most of our rate filings would reflect that kind of trend. Our reserve rate need, regardless of channel, but I think I said earlier, it is actually very low in aggregate. There are a few states that we need rate, Washington and Kentucky. Aggregate rate need is low.

Why frequency has gone down - uh, I quite frankly have been surprised at it. I think we predicted frequency might fall off a little bit because of fewer miles driven and 9/11 event and maybe people drive more. We postulated several things. Quite frankly, I am not sure I want to speculate on things I don't feel there is a good quantitative understanding of.

Glenn, as follow-up, if the trend is surprising to you, why are you building that trend into pricing assumptions?

It is just magnitude of the trend that is surprising to us. I don't believe for a second that frequency will continue to go down. I would have said that six months ago and been wrong. And the key is, if you missed that, if that starts to turn and we are not priced for it, then you have the kind of problems we are talking about 2 and-a-half years ago and catching up our trend is the last place you want to be. So, we're not going to believe that what we're observing is sort of a long, permanent, sustainable increase in frequency. Take it, it is coming into margin. It is one of the explanation why the margins are wired right now. In terms of pricing, we will price for targets and assume the frequency has every chance of turning back up.

Okay. Thanks.

One more question, please.

Last from Ira Zuckerman (ph) from Nutmeg Securities.

Are we doing this alphabetically, again? Most questions have been answered. One question is the balance sheet. Historically, you're at the low end of your debt to total capital relationship. Given the current relatively low interest rates available in the market, do you have any ability to issue more debt and/or to refinance the debt that is on the books?

Let me suggest to you that those observations are obviously accurate. We have said the same things. We have a very intensive planning process that improved over the last couple of years. We look at capital need on a regular basis. With the kind of growth that we have been experiencing, obviously you should imagine we would be looking at what we think we need for capital as we few favorably the next year or two, to the extent we have anything to add on capital or debt or anything like that, we will add that when it is appropriate and discuss at the board level or whatever we need to do. Nothing to announce today.

Okay. Thank you and keep up the good work. Thanks.

Well, thank you very much. That concludes our call. We appreciate your time.

Thank you. That concludes the Progressive Corporation third quarter conference call. Instant replay of the call will be available until November 1st, by calling 800-348-3538. Once again, replay will be available until November 1st by calling 800-348-3538.