前進保險 (PGR) 2003 Q1 法說會逐字稿

Welcome to the Progressive Corporation's First 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 and if you have any objections you may disconnect at this time. Acting as moderator for the call will be Thomas King. At this time I'll turn the call over to Mr. King.

Welcome to Progressive's quarterly conference call participating are Glenn Renwick, CEO and Thomas Forrester, CFO. Glenn will begin the call with comments on quarterly results and then we'll open the call for questions. The call will last about an hour. Statements in this conference call that are not historical fact are forward-looking statements that are subject to certain risks and uncertainties that could cause actual events and results to differ materially from our projections.

These risks and uncertainties include, without limitation, uncertainties related to estimates, assumptions and projections generally, inflation and changes in interest rates and security prices, rate changes and other initiatives by competitors. Ability to obtain regulatory approval for requested rate changes, legislative and regulatory developments, the outcome of litigation pending against the company, weather conditions, changes in driving patterns and loss trends, acts of war and terrorist activities, court decisions, trends in litigation, health care and auto repair costs, and other matters described from time to time by the company in other releases and publications. In addition investors should be aware that generally accepted accounting principles prescribe when a company may reserve for particular risks including litigation exposures. Accordingly results for a given reporting period could be significantly affected if and when a reserve is established for a major contingency. Reported results may therefore appear to be volatile in certain accounting periods.

Good morning. What a remarkable first quarter, deserving of further explanation and comments. I'll highlight key points in four significant areas and then take your questions. First, profitability. All three major business units had extraordinary results for the quarter, accentuated by March results that produced the lowest monthly claims frequency in many years. While the lower claims frequency is very observable, it's less certain that its true causation is known. We believe, however, consistent with other retail trends, consumer behavior changed as a result of the war and related television coverage.

As such, we do not expect to see a continuation of this low frequency. In general, we believe frequency will increase to more historic levels.

Our book mix has a higher aggregate claims frequency than most of our large competitors. Accordingly, it is possible we might benefit more from a temporary reduction in frequency. Profitability was well balanced with all states profitable for the quarter, and all but one midsized state meeting or exceeding profitability targets. For the quarter, catastrophic losses and generally adverse weather conditions were relatively minimal and contributed to profitability levels better than target.

As we start the second quarter, we've already experienced an early hailstorm in Texas and similar weather related events in Missouri and Mississippi.

Continuing the favorable trend we experienced through most of last year, and consistent with our actions, we continue to see a lengthening of policy life expectancy for the quarter of about 3-6%. Trends for the remainder of the year may be different.

This is true with each distribution channel and within each care of business. This retention increase contributed to improved profitability in both channels, but the effect in the direct channel is considerably greater. As we see and believe in retention gains, they will ultimately be reflected in future pricing. Direct acquisition costs, cost per sale were favorable for the quarter. Sales conversion is holding at higher levels than the same time last year. And more consistent with the second through fourth quarters of 2002. Average talk time per sale and advertising costs per sale were both improving.

Home (ph) improvements and acquisition costs per sale will also ultimately be reflected in future pricing. Reducing calendar period profitability was an unfavorable loss development of $44.2 million on prior year reserves. This net development was driven largely by the emergence of IB&R at levels greater than anticipated. We have been increasing our focus on IB&R reserving and now recognize such emergence in the first quarter is not atypical. We've uncovered such a pattern for the last three years. The severity of IB&R emergence was about right but our frequency estimates were low. We continue to increase the analysis intensity in reserving, always looking to further explain our business.

Second area-growth, at 32% we're running about as fast as we can and think prudent. Growth is widespread with most states over 20%. Managing growth is largely a state by state issue and we have imposed our first constraint on growth potential in Texas. Our plans at the start of the year anticipated growth consistent with the low 30-something range being experienced country wide. During the first quarter it became clear we could easily exceed those growth rates and have now taken steps to control growth to levels consistent with our plans.

The issue is quality claims capacity. While we have the ability to hire, we want to ensure continuing improvement in handling quality and as such insist on management experience levels and scope of control within defined ranges. Our review of acceptable growth rates is a dynamic and formal process with forecasts well into the future. We have only one other large state that is close to its projected maximum growth rate. Although reversal in frequency trend above our estimates would be of significant concern in many states. During the quarter we had net additions to our claims staff, approximately 350 people and continue to be encouraged by the quality and availability of talent.

Our new model of physical damage handling continues to show the potential we had envisioned. Productivity and identity gains, along with improved customer satisfaction will be very critical to longer term growth and quality management. But at current scale, are not significant contributors to today's capacity planning. We continue to execute our rollout plans and opened a new Columbus center in the quarter and will follow with Atlanta and Richmond facilities soon.

We did have a modest stumble in policy services in January and February. We did not staff to meet our target service levels during peak demand periods. The reduced claims frequency seems to have an analog in phone calls, and March was a significant improvement. We're in the midst of addressing this and have an action plan.

In March we officially broke ground on a call center site in Colorado Springs, which will consolidate our current two sites there and provide for expansion of some 600 call center seats and a future home for approximately 250 technology staff.

We are continuously reviewing our real estate needs in light of growth and anticipated business shifts and productivity improvements. It is clear that if our growth continues at the recent pace we will need to expand our capacity more than our plans suggested even a year ago. At the end of the first quarter with over seven million policies in force and over eleven million ensured drivers. Managing growth at the current pace is likely as fast as we can handle, even if the market would allow us to grow faster. We make no forecast about the duration of current growth trends and remain influenced by competitor actions, as well as the quality of our products, customer service, agent relationships and brand awareness.

Third area-trend and reserving-bodily injury trends continue to be characterized by falling frequency and severity increase within expected ranges. Comparable industry data support the same trend patterns. Our pith trends are favorable as compared to industry numbers.

Of continuing note is an increase in the physical damage trend at rates higher than might be expected. This is of particular importance to us as it could signal the emergence of a reduction in claims quality as a result of our growth. We do not believe this is the case and remain pleased with the internal measures of higher quality and most recent data points.

General auto market trends in recent years have resulted in high levels of new vehicle sales, often with significant incentives, and a resulting high supply and low cost of used vehicles. We are observing a model year mix shift and a change in the threshold of total loss vehicles. Industry loss vehicles as a percent of damage claims have risen to 15%, considerably higher than our historic observations. One additional note on reserving. We reported in January and February the adjustments to our reserve balance made by our actuaries. These are based on the segment reviews we've discussed previously and have done a statistical level, not file specific. In March, we report on both the actuarial adjustments and other sources of development, usually a result of actual claims resolution or handling adjusted changes to specific claims files.

A quick review of each of these reports will show actuarial adjustments for January and February of a favorable 3.9 million and an unfavorable 3.3 million respectively and a derived favorable 3.8 million in March, for a total favorable adjustment for the quarter of 4.4 million.

This is reported as calendar actuarial adjustments and further allocated as a favorable 5.2 million to prior accident years and unfavorable 0.8 million for the current accident year. The all other (ph) development for prior accident years represents the unfavorable IB&R discussed earlier, netted against other favorable development from individual case reserves or settlements for the 44.2 million reported.

Fourth area would be investments and capital structure. We continue to manage our investment portfolio to maximize total return and continue to be comfortable with our short duration. Our portfolio produced a total return of 0.85% for the quarter with fixed income returning 1.4% and equities a negative 3.16%. We ended the quarter with duration of 2.99 years and portfolio allocation slightly heavier on municipal government bonds on five to ten maturity and slightly lighter on treasury notes.

We have no significant events in our equity portfolio to report. During the quarter we announced and sent to shareholders a management and director's incentive plan. We anticipate these will be passed at tomorrow's annual meeting of shareholders. An outcome will be the use of restricted stock on a going forward basis as a complete replacement of stock options for management and directors incentive programs. Senior management will have varying but significant percentages of any restrictive stock grant, passed only on attainment of specific business parameters, set to be consistent with our stated business goals. We remain committed to our strategy of not allowing management incentives to be dilutive to shareholders and will buy back sufficient stock to offset all restricted stock incentives at or around the time of grant.

The remaining stock options will be offset at or before exercise. Details of current option awards are provided in appendix B of this year's proxy. During the quarter we repurchased shares, both as part of our commitment to offset options and consistent with our practice that we will repurchase when we believe our capital position and view of the future makes it attractive to do so.

Just a quick summary. We are delighted by current results and even more enthused by our continuing progress on business strategies of improving claims quality, redefining the process, advancing our pricing and reserving skills, continuing to understand and approve the management of our two distribution channels and improving our retention and brand strength with consumers.

Growth is not overwhelming us. And we believe we are being appropriately balanced in our efforts to build a continuous business and capitalizing on current market conditions.

Before I open it up for questions, I'll answer one that I couldn't answer the last call. The question related to the use of credit in commercial auto rating by other companies. It turns out that we're relatively unique in this area. We are not aware of any other company that uses credit in their rating in a similar manner to us. We recognize the use of credit and underwriting acceptance for larger corporate accounts but that's a different use than ours. We do not use credit when the named insured is a corporation, about 40% of our policies. But are working to implement an acceptable alternative to most cases.

I might also note that current 2002 industry statistics confirmed Progressive is now the number three market share position for both private passenger auto and commercial auto. With that I'll take your questions.

Thank you. At this time we're 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 star one on your touchtone telephone. You may press star two 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 this function during the time your question is being answered to minimize any background noise. To the extent you have additional questions; you'll need to place your name back in the queue by selecting star one on your telephone.

Our first question comes from Ms. Nancy Benacci from McDonald Investments. Ma'am you may ask your question.

Good morning Glenn. Congratulations on a great start of 2003. I wanted to talk a little bit more about your comment on retention and specifically again on the direct channel. You did indicate that the PLE numbers are looking better. Could you give a better sense of, on a longer term basis, where the sustainability of the retention level, I think on the last call you went through a couple of different issues that have been favorably impacting retention and just give us a sense of where you see that going as we move forward.

I'll try. I don't know if there's new information there. The internal actions we've been taking, specifically things like pushing more of our customers to electronic funds transfer is something that's a very favorable contributor to the trend in increasing retention. Market conditions, clearly the same market conditions that are driving new business, are also allowing us to keep our current customers longer. So there are a host of other things we're doing internally which relate to retention and they all seem to be going very well. One that perhaps I haven't talked about before is that we've put more emphasis on getting information accurate at the point of sale so that when a price is quoted to an individual the likelihood of that changing becomes very low. That is another significant contributor. We're making nice progress on that over the last many months, actually probably more than that, a year or so. And so getting the price right, putting electronic funds transfer as at least a growing use of how people pay their bills. Those trends have continued and have been stronger. Market conditions are strong.

The forecast of sorter longer term, clearly our intention and it has always been our intention as we move into the standard and preferred risk, is to have a retention profile that is somewhat more consistent with; perhaps, carriers that have only build a book out of standard preferred customers. So we have hopes that the retention trends we see will continue. But this is one where, not to be coy, I think we just have to measure it, and report it as we see it. So I've been trying to open up a little bit more on the reporting of retention. I commented on in the annual report and now through the first quarter we are continuing to see a nice lengthening of those policy life expectancies and the measurement on that is tricky. We are seeing it in all tiers, which is a good sign. It's not dominated by any one tier and we're seeing it in both channels. So I think the outlook is good but I'm not going to make any forecasts of where we will end up as a steady state.

That's helpful. Along those lines, with that explanation, if you could just make some general comments on the profitability metrics of the direct channel, based on what those numbers have been, say two years ago, in terms of the run rate of what your combined would be when you book to policy year one versus the profitability when you retain it for a year or two. Obviously you probably don't want to get specific numbers but just maybe an indication of those combines have gotten much better.

Again, I don't want to be hauling back stuff. We've been focusing on that very intently. We've targeted loss ratios, targeted expense ratios, for new business, for renewal business and as that mix changes, clearly it's a significant driver of combined ratio. So you can take a look even at something as straightforward as our expense ratio indirect and while we've been applying a great deal of intensity to improving our science and our use of advertising dollars and so on so forth a large and significant driver of that is clearly the mix of business. So if you compared us to perhaps another direct writer that maybe had a heavily weighted renewal book, you have to do a weighted average of new and renewal to get to the equivalent expense ratio, but the rate of decline in our expense ratio is somewhat proportional to the mix of business being now more skewed towards renewal.

Thanks very much.

Alison Jacobowitz from Merrill Lynch, you may ask your question.

Thanks. Just a two-part question. Allstate complained some about the PIP situation in Florida, so I was wondering what you were seeing there. And as you were talking about that I was wondering if you could talk a little bit about the competitive landscape and if you've seen any changes, et cetera.

I think I commented a little bit last time in the PIP situation in Florida that our approach to PIP claims there has been a little bit different than the industry, and I would just as soon not go into that in any great detail, other than to say that we believe there is abuse in PIP claims in Florida, at all levels. We've taken a very strong approach to those. In some cases spending a little more on loss adjustment expense, to get the right outcomes. So I'm not going to go into great detail on that because that's actually important claim strategy for us. But certainly PIP in Florida is a very notable issue. The system appears to be under great stress and obviously they're looking at reform in the legislature as well.

With regard to the competitive landscape, I actually don't have huge items to report there in the first quarter. There's really a continuation of the same kind of patterns that we've seen. The business through independent agents has been very healthy. The reduction in availability from other carriers has sort of continued on to the first quarter. But I can't -- I'm going to look around to my colleagues here--I can't think of any major event that I would sort of jump out and comment on. Pretty much the same as the second half of last year.

Thanks

Ron Frank from Salomon Smith Barney. You may ask your question.

Good morning. One clarification and one question, if I may. The clarification is, Glenn, you made a comment regarding, I think, the likelihood that you would tend to benefit more than peers from a decline in frequency at this stage. And I was wondering if you could just return to there because I think it got away from me. And the question is, you made mention twice of the notion that as you gain confidence in various aspects of the business profitability that that would find its way into pricing. And I'm wondering, am I over-reading that, with the market as it is and with the issue being more born, as I gather, of controlling growth than otherwise, why would you even consider backing off on pricing here in any sense? Would it be a matter of just avoiding adverse selection or what have you?

Two different topics there. The first is something I’ll always try to give you what's on my mind about frequency. When I think about frequency, and let's just choose sort of a nonstandard mid-market kind of book. Typically the tiers are segmented by frequency. So we would have higher frequency business even though we have some of the low frequency business as well. So our aggregate frequency is probably higher. What I was suggesting there and cannot prove to you is that there's certainly an infrastructural frequency that everybody observes, and if the marginal frequency of people who are perhaps out at night entertaining, movies, bars, whatever it might be, I think we see a fair amount of that frequency in our book of business. That appears to us. And again this is very soft science, that appears to be the place where the usage changed dramatically. People didn't stop going to work, but they did stop doing certain things afterwards. So at a high aggregate frequency, we may have seen that piece of traffic congestion, and so on and so forth, be reduced during the times that we might otherwise or some part of our book might otherwise have incurred auto accidents.

That was more of an observation than a projection going forward?

Absolutely it is. It's only to extent that we observed and I made note of it. This was the lowest frequency month in many years. And when you have that sort of observation, it begs the question, why. And we will never be able to answer that with definitively, but I think we're on the right track with just sort of the marginal frequency went away on some of the discretionary use.

With regard to the comment, I did put the word in there ultimately. Recognize that strategically what we try to do all the time is find ways to advance our products and if that means getting a lower price to market or an advantage price to market, then that's success for us. I wouldn't necessarily interpret that as a timing comment. To the extent we can acquire business at a lower rate because of our cost per sale going down, our conversion rates going up, our retentions- those bode well for us for the future. Right now, you should take that in constant with my comment that I feel like we're on aggregate, growing about as fast as we can. I did say we weren't overwhelmed by it but I wouldn't look necessarily for an immediate reduction or transfer of those costs into pricing right away. But it's nice to feel like we are right on track for where we need to be to sustain a good growth rate.

Okay. That's all very helpful. Thank you.

Jeff Thompson from KEEFE, BRUYETTE AND WOODS, Inc., you may ask your question.

You mentioned you added 350 new claims adjuster this quarter. I wanted to make sure that was right. And can you update us with what you added in 2002?

Sure. I did say 350. And for 2002, we had new hires of 3,006 if memory serves me right. We have people looking through numbers and they're going to see if my memory is as good as it is, with a net in the claims area of about 1500. Recognized on the base that we do have turnover, of course. So the net was about 1500, the new hires about 3,000.

Okay. Then this is a follow-up on related. Statutory surplus had looked like in the quarter was down a little bit from year-end. And I was wondering what caused that. And then with that it looks like your annualized premium to surplus ratio is just over three to one. Do you think you need capital or what's your view of capital adequacy?

Tom, do you want to take the statutory --

Steven Peterson, our treasurer, has one comment on the statutory surplus

It's really just a product of, as you're aware, our investment portfolio is linked between fixed income and equity securities. Any unrealized losses on equity securities will lower that surplus, whereas the gains we've seen in the bonds do not get added into the surplus. Bonds are carried at their book value.

That was everything

That is the biggest single driver. Investment grade bonds are carried at amortized costs on statutory books. And non-investment grade is the lower cost of market.

No, I understand. I thought maybe there was something else in there. Can you comment on your capital adequacy?

All of our models would suggest that -- and we run these monthly, that we absolutely will meet all Irish ratios and have adequate capital to run our business.

So three to one is a target for you, then?

That's correct.

Good. Thanks.

And debt to total capital which we said will stay between 20 and 30 is running about 27.4 something like that so we're right in that range.

Okay. Thank you.

Charles Gates from Credit Suisse First Boston. You may ask your question.

Good morning. My first question, Allstate has shared its change in nonstandard auto policy count and I believe it's down some basically 20% both in 2001 and 2002. Could you elaborate on what portion of this very important growth that you were enjoying, is in nonstandard auto.

That's a question and I don't have really good statistics right -- I mean I do have statistics. I don't have them right off the top of my head. But our growth has been widespread across all tiers. So if your implication with that question is it's simply a nonstandard fueling the growth --

I didn't mean that, sir. I just wondered what portion of the very important sales growth the company is enjoying is from this class of driver.

This is Thomas King. We do look at mix of business of new applications we get every week. And the mix has been consistent across our tiers. So we can't say that the growth has been disproportionate.

This is Thomas forest. Part of the problem is definitional. If you try to track our nonstandard tier their nonstandard tier it might not be as pure of tracking as you like. Our greatest growth happened to come in the past year in the standard tier on a percent basis with ultimate preferred being second. Actually, nonstandard was the lowest but that doesn't necessarily suggest there's a one-to-one tracking. So we're seeing pretty much uniform growth across all tiers, and as we look where the business comes from it comes from a lot of different places.

One thing, I know we've said this before and I almost apologize for it. I apologize for our use of it, which happened several years ago, is the nomenclature for describe be tiers and how we have subsequently used it with credit and other rate order calculations that differ from, may have been traditional market use or industry use really has made that a really meaningless comparison. And I almost regret that we have labeled our tiers the way we did.

My follow-up question, in form 10-K you indicated that one of your commercial lines risk, I believe, one class of commercial lines risk were logging trucks. If logging trucks hits a school bus and many people were injured, what is the maximum possible loss to Progressive of that kind of an event?

It's one million dollars, Charlie.

So under no circumstance, with regard to your commercial lines business, is the potential loss to the company greater than a million dollars?

That's correct. We sell the combined single limit there.

That's the difference versus 1987, or one of them?

That definitely is a big one. There is long haul trucking we had limits which I almost don't want to think about anymore. But they were a lot bigger than that, relied on other parties and reinsurance and so on so forth. This business model is exactly the way we have portrayed it and I care about this. I think about as much as you do. It's one million dollars. No reinsurance, and that's a profile that we're comfortable with. We are not comfortable with any more at this time. If we ever got to be comfortable, we would make a very open disclosure of that.

Thank you, sir

Ira Zuckerman from Nutmeg Securities, you may ask your question.

More of a longer term, philosophical question. Given the low level of interest rates, and your portfolio sort of demonstrates it, have you rethought the long-term target combined ratio to reflect that? In other words, would you use a higher target or better target to produce the typical returns that you've been getting rather than the current 96?

Tom’s been looking at the formula in the report. Tom, why don't you talk about that?

Remember that in tend report, what we say is that we will hit at least a 96 calendar in the current quarter. A lot of what we do is dependent upon what competitors do. To the extent we continue to be in a very low interest rate environment, the likelihood is that competitors will also have to make money on underwriting, not on investments. As then occurs, that may give us an opportunity to do better than 96. And we certainly would take advantage of that.

Over long periods of time our goal continues to be, presuming we have historic norms of investment returns, a 96 combined ratio. But we do react to market actions, sort of in both ways.

Okay. Thank you.

Chris Winans from Williams Capital. You may ask your question.

Could you talk about what you expect to be happening in the residual markets. Do you see a deep population of that beginning especially in New York State and I have a follow-up question?

Yeah, I don't have great information for you there. But it would appear that the residual market specifically in New York is slowing. And that's not an unexpected outcome. And we were certainly growing there. But I don't think that's a huge contributor to it. But I don't see any runaway in New York and haven't observed that in the last year or so.

Does anyone else have a comment on any other residual markets? Florida is I don’t think is doing anything great.

This is Al Nisaur, actuary. Reserve markets actuarial markets have started to see a growth rate in the last year that the personal auto saw a year earlier. Personal auto has slowed it's still growing but it's much slower than it was a year ago and there's probably more growth in the future in the commercial auto residual market right now.

And my follow-up question is you talked about your long range outlook in terms of what your acceptable growth rates-You talked about them being forecasted well into the future. What is your long-term, what is the future for you? In other words, is it a five-year plan or in regard to that, what do you factor into that outlook in terms of demographic changes in terms of the aging of the driving population.

The comment I made with regard to the forecast being dynamic is a process that we have been doing now for over a year in more formal details, it’s obviously been done informally as long as we've been doing business. It really is driven entirely by asking the question what claims capacity or what growth rate could we accept in claims given that we don't want to degrade quality? . Given that we don't want to degrade quality then has to be made contingent on what does that mean. And it's an issue of do you have enough team leaders. Will you have enough tenure and experience? So it is not an issue of can we get enough head counts. We can get enough head count even in the one state that we've capped now. But you may not have enough experience to be able to make the next level of management the next level of management. So think of this as a transition state and it's how fast you can transition people through your system. That's what I meant with looking out and that lookout is about an 18 month to two-year lookout because in sort of that one year, 18 month, two-year, are interesting sort of periods from an experience level for an adjuster. After one year we know roughly what they can do. After 18 months and two years. So we don't want to have a disproportionate distribution of low tenured people in a claims organization with relatively minimal supervision and poaching. So that particular comment was directed at what is the constraining factor to growth versus a market projection based on demographics or own ability to grow. We, for our own internal purposes, always have projections well out into the future. If we had provided those three years ago we would have been wrong. Market conditions change. We take advantage of those market conditions. We clearly have a guidance for the use in terms of capital and general infrastructure planning. But the most critical thing that we do, and we do on a very dynamic basis, is this look ahead in the claims organization and ask if we will have the appropriate balance of experience and tenure. And I'm going to really make that that the key thing here-It's the office not the head count what's the prudent growth rate that we can support. This is the primary constraint to growth for us is well balanced claims management and that's what it's all about. That's our single greatest constraint. There certainly are other constraints. There's real estate, there’s capital, all sorts of things. By not mentioning those or not saying those are slack right now this is the constraint.

Well, on the second part of my question, long-term outlook, as a personal lines writer, you're basically a one product company. What I'm asking is do you see looking out ahead, you know, beyond two years, do you see a limit to the growth, irrespective of your ability to handle it from a claims adjustment perspective?

I see. I will answer that with a somewhat shorter time frame than you might be looking for. So two to five years, I put in the annual report letter that, in fact, focus and becoming extremely good at every single skill set that drives our business is what I believe will give us the greatest marginal return of the foreseeable future. So the answer to your question is I have no intention of taking a different course on either products or extension of product lines and do things like home loans which we've talked about previously for at least the foreseeable future and I have it defined as two to five years. Valid question. Clearly a strategic question we keep looking at. But focus and market share gains are our primary objectives for two to five years.

Thanks a lot

Robert Glasspiegel from Langen McAlenny. You may ask your question.

Good morning. I'm very impressed with your agency expense ratio being under 20 in a period where gain sharing could have been a significant factor. I was wondering if maybe you could drive through that number a little bit deeper and give us the sort of commission component. Some of the other drivers and how you were able to get under 20.

If you flip open to the components. Let me head with the commission. That expense ratio I'm also extremely pleased with. No question. And we have really been hitting around that for the last couple of years, if you look at our results. There have been some situations that popped it up a little bit even last year. We did have a situation where we had a class action settlement that was included in the expense ratio. So knitting some things out it's not that wildly different.

With an 86 combined, though, if the gain sharing factor should be a bigger pressure, no?

There's a couple points in there for gain sharing. No question, gain sharing is good but the driver of that is commission. Over the last year or so, we've reduced the commission levels in the agency business from three commission levels down to one. That commission level for all intents and purposes, there's some variation by state, but 10% will get you right on the money for commission than you take on top of that taxes so on so forth. And our leverage on internal operations policy services, those numbers are favorable for us. We're getting a little bit of nice leverage on scale there. So the kinds of numbers we're turning in sort of 20 and just a smidgen below 20 seems to be a rate that we can run at even with new business because our commission level now is not quite as stratified as it was once was with new being significantly greater than renewal. It's a little closer.

Robert some of those costs are variable. Some of the commission cost premium tax, but in general staff increase has lagged PIP.

Gotcha. Just outlook for advertising expenses in '03 versus '02, directionally.

That, unfortunately, depends, if in fact we have gotten a rate of growth in certain states that we feel is very comfortable, then we would actually reduce our advertising expenditure. So I mentioned taxes and I said we're taking steps to constrain. So in fact local advertising in Texas, you can assume has been constrained also. So our outlook at the beginning of the year and maybe it's the best general direction is probably a little bit up over 2002. But that will be mitigated on a literally, a month-by-month, almost week-by-week basis, as sure as we can control our buys such we don't overly strain any particular state where business might be coming in through even the other channel.

What was the mystery second state you might be slowing down.

I don't believe I named that one.

Right.

No, I really try to give you as much information as much as possible but also not so much that it could be a preannouncement to any of our staff agents or any otherwise. It's in control. I'm just suggesting to you that if we have a process, there's one that is sort of triggered. There's one other that is sort of in that state of immediate watch. That could change. If I told you that the state, it literally could be different a month from now.

Thank you very much

Adam Engelberg from Silver Crest Asset Management. You may ask your question.

Good morning. My question is sort of along the lines of the earlier capital adequacy question. But I guess the direction I wanted to go in was, do you compare share repurchases with the marginal return on the business because if you're going to use up capital to purchase stock but you're writing business at a 20% or better ROE, I'm just wondering how you weigh those factors or is it just a case you have so much capital now you don't have to worry about it.

Our position on this has been I think pretty clear. That is simply that whenever we have more capital than we think we might necessarily need for business, we'll look at the alternative of buying back stock, are we doing it at the moment because we made a commitment to defease (ph) basically all the options. So we make no announcements here about the timing of that. But at the moment we do have a commitment that says we will not allow options to dilute current shareholders. We've been pursuing that in periods that we think are attractive to us.

And Thomas King here. The monitor internally in our financial policies is for financing we want to position capital support underwriting operations. We're an underwriter.

Since we're buying back stock you can assume we have adequate capital to continue as the growth levels that we anticipate.

All right. Thank you

Michael Lewis from UBS Warburg. You may ask your question.

Good morning. There's not so much questions you can ask when you produce numbers the way you produce them. Certainly nothing negative. I'm just trying to figure out at this point, if you look at your unit growth, and you look at your premium growth, it seems you're still getting some rate increases. And I'm just wondering how can you get rate increases when you're producing underwriting results like this, how much of your business do you have to get prior approval from and are you truly getting rate increases that seem to be pretty steady as what you were generating in the last few quarters? I guess what I'm really asking and going forward is it seems like you have a lot of room to move around this rate action and certainly maintain this kind of growth for an extended period of time without sacrificing much on the margins. Is that right?

To your first point, yes we're still getting some rate increase there. So your derived difference of rate between rate and unit is fair. It's not exact, but that’s a fair assessment. I think I would caution everybody to realize that rate filings are clearly state by state issues. So even macro numbers here may be misleading. When we file for rate action, it is always based obviously on the conditions in that state and the most important thing is future trends. So while it is on aggregate a fair statement to say that we have priced and achieved results better than our estimates for pricing, and we will likely, in many cases, be able to extend the life of current rate revisions, one of the strengths of Progressive and where I would feel very good, is if we continue to do just as many rate changes, mostly increases, but ultimately did them at smaller increments, so that we will keep making sure that our rates stay adequate and responsive to trend. So it isn't an issue of current performance. It's always an issue of current trends. There's no question that when we file, we have to file our data absolutely as the facts lie. But that future trend is the key. If we see, I don't want to be negative on this, but if we see a reversal in frequency, that would be substantial across the book. We benefited from that for quite some time, for most of last year, and certainly pay lot in this first quarter. If that were to change, then we would be in a very different position with our future rate need. And I'm very happy that we're well get up to be able to take small rate changes. You asked how many states would be prior approval. I do not know that number right off the top of my head. Would I estimate about 50%.

Just a quick follow-up. Going into an election year next year, do you think that auto pricing in general and rates in general will be any kind of a ground swell movement saying look at the margins? You're not alone here, there's other companies starting to show some very nice underwriting margins. Could there be any kickback here just from kind of the cost of insurance, of auto insurance and the kind of margins that the industry is starting to generate and could that have any kind of ramifications on how rates are affected going forward?

I wouldn't discount that entirely. Absolutely it could. Slight different answer. Certainly we see in the Texas Legislature right now that probably one of the most top level issues is in fact insurance legislation. And I believe it's on emergency status there, because obviously of the homeowners crisis that was created, there are many legislatures that realize they have an obligation to make sure that they do something about insurance reform, and there are clearly bills in the Texas Legislature right now. Senate Will14, I believe,. I spent some time with a senator there not long ago, that will include reform in auto insurance as well. But that's driven a little bit more from the homeowners situation. So given that was very notable, yes, it drove legislative action. Pricing at least for auto insurance, I mean it's possible that we will see with some of these improved results the rate of change of price may in fact stabilize. That's not a projection. That's just if everybody starts to now feel like they've got rate adequacy, you might see the price sensitivity slow down or the price change to the consumer slow down. I think typically you'll see more action when consumers are getting large rate increases, and we may be going into a period where in fact the increases are not so great.

Two other questions. One Ira Zuckerman brought up the issue of interest rate environment. Obviously if the regulatory agencies realize that interest rates are extremely low, then companies will be forced to return a rate one way or the other the trade off doesn't end up being an adverse one from the consumer standpoint. It's a fair return. I think that the other issue is that some of these profitability issues may be from temporary outcomes. As Glenn pointed out it's only when we recognize a permanent change that we'll probably change our pricing. So if frequency has dropped just because of the war or some other issue it might give people a temporary boost but it may not be longer term.

Thanks very much

Alain Karaoglan from Deutsche Bank, you may ask your question.

Good morning. If you think about the 96% combined ratio and this quarter we did 86.7 and it's a quarterly number. It's 9.2 points better than the long-term goal. What would you attribute that to frequency clearly is one of the items. But if we were to think about the difference, how would you allocate it to different factors? And I want to make sure that I understood your comments with respect to the IB&R development. Was it frequency that was greater than anticipated that led to an increase in that? I just want to make sure I didn't hear properly. I just want to make sure I understand that. And on the capital front, do you have investments outside of the insurance companies, either at the holding company or in another subsidiary?

Three things there. The delta between 96 and current run rate. What I did in my formal comments was give you five or six contributing factors. While it is a very good question and not one that we don't care about, I would like to stop short of providing you what I believe is sort of a contributing factor. So I'll just quickly go through them again. There's no question that our profitability margins are better than a 96. That's obvious. If you think of a distribution of outcomes, these are all points that are relevant. 86 and a 32 is certainly in the thin tail of the distribution of outcomes and we're happy to have it but it's not likely to be an every quarter event. Certainly the low frequency is a significant contributor. I mentioned that first, I would say that it is the most heavily weighted contributor. The fact we didn't have catastrophic losses and catastrophic losses by the way we price are in previous data they're baked in. Very hard to say. We put on a specific load for that, but it is reflected in data. I gave you a caution not to be anything other than factual that we have already seen a fairly significant hailstorm come through Texas. We had over 6000 features there, that's a big event, this is an April, second quarter. So while they didn't happen in that period and contribute to that period's numbers, let's not get away from the fact that they will happen. This is the hail season in that part of the country, and we saw one early and it was big.

Certainly the policy life expectancy trend is one that is much more difficult to assume. We obviously make estimates of severity and so on and so forth for the future. We don't make a lot of estimates out of policy life expectancy until we really see it emerge. This is one we have to watch. It's not one you can take an industry statistic on it has to be very specific to our own book of business and we measure it with great intensity and what I'm saying there is that as that lengthens and as we believe that is a permanent thing. We can put it into our future pricing. Missing that, or overestimating that, can be disastrous in the direct but it's very nice when it happens and you hadn't anticipated exactly those levels.

In the direct channel, the cost of sale is down. So those were at least four factors that really contributed to profitability in excess of our own goals.

The IB&R comment you interpreted correctly. It is a frequency issue. So we have seen in this period a higher frequency of IB&R emergence than we had expected. We are on it. I'm not really very happy about that. That's something that we take great pride in being very good in our reserving. We've done an awful lot over the last several years to continually refine our reserving. We talked about our change in commercial limits in November where we saw something. We adapted and we changed. I love the fact that that's our intensity. We will keep finding ways to describe our business better. When we find them we're not always happy right away. But this is long-term. I think a good indicator of just how we go about it and we tell you when we see it.

On the capital issue, why don't we talk about PICKY a little bit and the holding company.

Thomas King here. Let me answer this. We have a non-insurance subsidiary called Progressive Investment Company, Inc., PICKY. We disclosed in our proxy that we had about $1.3 billion in securities in the portfolio at year-end 2002. And a crude way to monitor this going forward is to look at how much GAAP capital that we have. So we had about 3.9 billion of shareholders equity and about 1.5 billion of debt at March 31, 2003 and then subtract out the deferred acquisition cost, which is a non-admitted asset. And that will give you, take that total, subtract out the strategy surplus we have invested in the insurance companies and that would give a crude estimate of the assets available in the non-insurance subsidiary.

So that capital can be downstream or these investments can be downstreamed to the subsidiary to support business if need be.

Absolutely. The issue is we have 40 odd insurance companies and we want to maintain the three to one premium to surplus ratio. And we don't know ahead of time where the growth is going to come or where a weather-related event will happen. So as a precautionary measure we hold this capital at the holding company level and invest it as needed to keep any -- all insurance companies at the three to one premium surplus ratio.

Thank you very much

Will Wilt from Morgan Stanley, you may ask your question.

Good morning. I'll keep it to one pointed question. On the reserve development, I think it's a two-pronged question, I'm struggling to see or to differentiate the all other development between an actuarial adjustments and a claims adjustment. I can't quite figure out which side of that equation it comes down on. And part two is, the commercial auto versus personal auto component of that. Is it skewed more toward one over the other?

Why don't you take the reserving. I think sort of maybe go back and do the reconciliation of what's considered all other business actuarial.

If you happen to have it in front of you the supplemental information talks about reserving.

I do.

You've got the -- we basically have continued to look at reserves all the time. In November of last year we actually looked at the commercial group and we determined that, with the increase in limits we tried to break out the limit reserving there differently. When we did that, it appears that the highest load business in commercial auto was slightly unreserved. We made an adjustment there for about $10 million in the month of November. At that time we realized that it would not be so clear to reserve financials as to what was happening so we started to institute the practice of listing our actuarial adjustments. So you could see literally what was sort of the error flux in the change and that's what you see up at the top, which is the total calendar year actuarial adjustment of 4.4. We tried to break that down for you later on, into what was prior year and what was current year. Under the prior year accident, as you get the 5.2, the 5.2 represents simply the error functions or the monthly reviews we do segment reviews every month. We have 250 segments. And so Al and his group reviews these periodically, usually two, three, four times a year. And out of that comes development. The all other development can be multiple things. It can be a case reserves to settle for better than or worse than what the reserve was. And also this case, if there is an IB&R component. And we talked about, because we really characterized this as precisely as we want to, since there is an IB&R component here that one could construe to be actuarial. We'll probably talk about this in more length at the meeting in May. But what happened here was simply there was an offset, the IB&R was slightly larger than in the all other development and we had favorable reserving that offset that. As we look at it per history, we have seen that history emerge for sort of a three-year period and that surprised us and in the past the offsets had been about equal. Now they were slightly unfavorable. So as you might guess we're looking at this in great detail and we'll probably have more news for you later.

Okay. That's great. Is it skewed more toward commercial then?

Not at all.

Very good. The philosophical aspect of this then would just be, in your view with the growth in commercial auto qualitatively or quantitatively if you can, at least qualitatively how much variability does that add to your loss reserves, to the process and to the way you think about the certainty with which you can nail loss reserves each quarter or each year-end?

Over time we expected to have very little impact I suspect. However, in the short run what happened was that we've seen a shift higher limits, we're not as familiar with the development patterns and higher limits as we are in auto. So therefore we expect to see some slight variability in that. I've recently attended the reserve of the commercial reserving and I feel very comfortable with your processes there and will likely be a little more conservative until we have a complete understanding of development patterns. But I really don't anticipate over time there will be a material impact.

That's great. Thanks a lot.

We'd like one more question, please

Our last question comes from Mr. Barry Cohen (ph) from Maverick Capital you may ask your question.

This is an educational question. Given the decline in secondary market prices for cars over the last year and a half, what impact, if anything, does this have on your business?

Actually, it has a significant impact on the business. It's not entirely easy to describe it. When we have a used car market that falls in price as it has, the threshold for whether or not you repair a vehicle or replace it with a like-vehicle from the secondary market changes. One would like to think that we and the industry are good enough to make that indifference curve of repair versus replace or, in the industry term, total-the-car, such that there really isn't a step function in there. It's always a dynamic threshold and you never sort of overpay. That's not quite how it happens in reality, unfortunately. And we generally set a threshold for when we total a car. And the data by which we get is somewhat lagged. So as you're all familiar with sort of sources of data, the actual cash values that we have are often based on sales that have already taken place as opposed to exactly what is available in the marketplace today.

So describing that suggests we're very interested in making sure that our processes and our claims settlement and indemnity reflect current reality. I can't tell you for sure we're absolutely there. And I suspect we are not totally indifferent when we total a car versus repair it. And what has happened with the used car market is really that threshold has come down. And you have to be very careful to again watch this (ph) trend because if that reverses, then you've got the opposite. So it's very important as we become somewhat expert in this area, that we can make sure we get that total repair replace decision in a severe accident exactly right. But that dynamic is external and we've got to really measure it very closely. Our total loss percentage has gone up about a point and a half over the last year. And as I mentioned in my formal comments, industry estimates are about 15% of vehicles that are damaged in an accident are now being totaled. That's actually considerably higher than historic numbers which are a little bit closer to about 11. So you are seeing -- that's a significant shift and a lot of dollars. It's very important that we get that right or that becomes a driver of indemnity trend.

So let me see if I can understand, make sure -- I think about it this way. On a dollar basis, when you cross those two lines between essentially paying for repair versus totaling a car and letting someone purchase it in the secondary market or you purchasing it for them, I don't know how exactly you would do it, when that line crosses, when totaling a car is actually cheaper, I guess is the best way to think about it, than repairing it, are you suggesting that your loss content is actually higher on an aggregate basis or lower on an aggregate basis?

Typically higher for totaling the car.

Right.

And I recognize what -- it should be indifferent but I'm telling you it's typically higher for totaling the car.

Okay. Just as a matter of course when you're trying to understand the overall trends in your business. When do you think you roughly first started noticing the marginal impact really picking up? Was it the six months ago, nine months ago, this quarter, a year ago, when do you think you started recognizing this differential in your own ratios.

Most of last year we reported physical damage trends running fairly hot. I'll have to go back and look at all my notes. But most of last year we noticed this trend in physical damage both in collision and PD. I would say that what I've just described, and you can talk about accurately is clearly a contributor to that trend. But there's also another trend in there that I mentioned. That's the mix shift because there are now more newer vehicles being purchased. So both of those are trends that are out there that drive costs. So if it's a new vehicle being purchased on the road and therefore the threshold for totaling is considerably higher, more of those are getting repaired. So both of those are in there. We have some more work than I'm signaling at this point because that trend is critically important to us. But frankly there's still a lot of work for us to do there to totally explain exactly what is going on and it's an important trend. It's important that we don't get caught with higher indemnity costs by not recognizing the underlying change in cost of orders.

I appreciate you helping explain that to me.

Well, we thank you very much for the call and we'll see you soon.

That concludes the Progressive Corporation First Quarter Conference call. An instant replay of the call will be available until May 2nd by calling 1-800-947-6599. Thank you.