I. OVERVIEW

The third quarter 2008 results reflected solid returns in The Progressive Corporation's subsidiaries' underwriting operations, but significant losses in our investment portfolio, which led to a net loss for the quarter of $684.2 million, or $1.03 per share, compared to net income of $299.2 million, or $.42 per share, in the same period last year. Our insurance operations generated $167.4 million of pretax underwriting profitability, despite $82.4 million of weather-related catastrophe losses. However, we recognized nearly $1.4 billion of net losses on our investment portfolio driven by write-downs in securities (primarily preferred stocks) that were determined to be other-than-temporarily impaired.

A. Operations

During the third quarter 2008, we realized a year-over-year increase of 3% in our companywide policies in force and 1% in net premiums written. This quarter marks the first time in the past eight quarters in which both of these growth measures were positive. Net premiums earned, which lags written premiums, decreased 1% for the quarter.

Premium growth reflects a combination of new business applications (i.e., issued policies), premium per policy (i.e., rates) and customer retention. On a quarter-over-prior-year-quarter basis, companywide new business applications decreased 4%, while renewal applications increased 5%. New business acquisition continues to be a challenge, especially in our Agency and Commercial Auto businesses. Our Commercial Auto business is being adversely affected by the downturn in the economy, primarily the housing and construction sectors.

We currently have several initiatives underway aimed at providing distinctive new auto business options, including the expansion of our usage-based insurance product, referred to as MyRatesm, the introduction of Name Your Price ®, a program that provides customers the opportunity to select the price they would like to pay for auto insurance, and the roll-out of a new product in our Agency auto business which is designed to help improve competitiveness.

On a year-over-year basis, for the third quarter 2008, we have seen an overall decrease in average written premium per auto policy of 1%. The rate of decrease declined over the past year, as we started to raise rates where necessary to meet our loss cost inflation expectations. We will continue to evaluate future rate needs and react quickly as we recognize changing trends.

Our effort to increase customer retention continues to be one of our most significant initiatives, and we are continuing to see the benefits. Policy life expectancy, which is our actuarial estimate of the average length of time that a policy will remain in force before cancellation or non-renewal, is one measure of customer retention. The policy life expectancy for our Agency and Direct auto businesses has been on a continuing upward trend over the past few quarters and is now about 12% and 13% higher, respectively, than at the end of the third quarter last year. Commercial Auto's retention is relatively flat compared to the same period last year.

Policies in force, our primary growth metric, increased 3% on a companywide basis since the third quarter last year, reflecting the strides we have made in our retention efforts. We achieved policy growth in Personal Auto, Special Lines and Commercial Auto. Direct auto, which currently represents about 39% of our Personal Auto policies in force, increased 8%, while the Agency auto business decreased 2%. Our fastest Personal Auto growth area continues to be our Internet-produced business.

Our third quarter 2008 profit margin was 4.9%, which exceeded our profitability goal of an aggregate companywide underwriting margin of 4%. During the quarter, we incurred 2.4 points of weather-related catastrophe losses, primarily related to hurricanes Ike and Gustav and tropical storm Fay, compared to only .3 points of catastrophe losses for the third quarter last year. The higher catastrophe losses were partially offset by a decrease in auto accident frequency, which likely reflects fewer miles driven, due primarily to relatively higher gas prices during the period. On a quarter-over-prior-year-quarter basis, total auto paid severity was relatively flat, with increases in bodily injury and personal injury protection severity and a decrease in collision coverage severity.

The fair value of our investment portfolio was $12.7 billion at September 30, 2008, including $1.8 billion of redeemable and nonredeemable preferred stocks ($.5 billion and $1.3 billion, respectively). During the quarter, our investment portfolio produced a fully taxable equivalent total return of (6.9)%, with a
(6.6)% total return in our fixed-income portfolio, which include both redeemable and nonredeemable preferred stocks, and a (8.7)% total return in our common stock portfolio, primarily reflecting overall market value declines. At September 30, 2008, the fixed-income portfolio duration was 2.8 years with a weighted average credit quality of AA.

The price of most risk assets declined during the quarter, in some cases materially. Our portfolio's fair value, especially the value of our preferred stocks, was negatively affected by a series of shocks to the financial markets, including the decision to place Fannie Mae and Freddie Mac in conservatorship, the failure of Lehman Brothers and the near collapse of American International Group, as well as several major financial firms suffering a crisis of confidence. As a result, during the third quarter 2008, we recognized $1.4 billion in net realized losses, primarily the result of write-downs of securities determined to have had other-than-temporary declines in fair value. The majority of the affected securities had been in a decline for three quarters or more and, based on the market declines that occurred during the quarter, we were unable to objectively determine that the securities would substantially recover in the near term.

In addition to reducing the value of our investment portfolio, the investment losses during the quarter, which include both those that we have incurred through security sales, as well as through changes in the fair value of the securities we continue to hold, reduced our overall capital position. We continue to manage our investing and financing activities in order to maintain sufficient capital to support all the insurance we can profitably underwrite and service. As of September 30, 2008, we had total capital (debt plus equity) of $6.4 billion to meet our capital requirements, as described below.

In an effort to manage this risk, beginning in September and concluding in the early part of October, we adjusted the allocation of our investment portfolio and reduced our exposure to common equities. We continue to maintain our financial policy, which targets an allocation of 75% to 100% for fixed-income securities, with the balance in common equities. At September 30, 2008, our common equities represented 10.4% of the total portfolio, whereas they previously represented about 15%.

We continued to feel the effect of these highly volatile market conditions during October, particularly in the equity markets. While the high credit quality and short duration of our fixed-income portfolio, as well as our reduced exposure to common stocks, should provide some protection from market volatility, any extreme swings in market prices could further affect our results going forward. Should economic conditions deteriorate further, the credit quality and value of our portfolio could decline. However, the vast majority of our asset-backed securities are senior positions with a substantial buffer of junior, subordinated securities to help protect us from loss and the credit quality of our corporate holdings is high. In addition, the majority of our bank preferred stock holdings are in eight of the firms that the U.S. Treasury Department has deemed to be systemically important and these banks have agreed to receive preferred capital from the Treasury Department at a seniority level equal or subordinate to our holdings. While these factors should provide some protection against possible future losses, we cannot be certain that there will be sufficient protection if the credit crisis deepens or in a deep and protracted recession.

A. Liquidity and Capital Resources

Progressive's insurance operations create liquidity by collecting and investing premiums from new and renewal business in advance of paying claims. For the nine months ended September 30, 2008 and 2007, operations generated positive cash flow of $1,438.5 million and $1,677.2 million, respectively. The decrease primarily reflects the lower underwriting income earned during the first nine months of 2008. During the third quarter 2008, we did not repurchase any of our common shares outside of our equity compensation plans. Year-to-date, we have repurchased 9.8 million common shares, at a total cost of $177.5 million (average cost of $18.13 per share).

In January 2008, we paid shareholder dividends of $98.3 million, or $.1450 per common share, pursuant to a December 2007 declaration by our Board of Directors under our annual variable dividend policy (see Note 8-Dividends for further discussion of our policy). Based on our results as of September 30, 2008, no dividend would be payable under our variable dividend policy for 2008.

We believe that we have sufficient capital resources, cash flows from operations and borrowing capacity to support our current and anticipated business, scheduled principal and interest payments on our debt and expected capital requirements. The covenants on our existing debt securities do not include any rating or credit triggers that would require an adjustment of the interest rate or an acceleration of principal payments in the event our securities are downgraded.

Continuing volatility in the capital markets presents challenges to us as we seek to manage our portfolio and our capital position. See Item 1A below, "Risk Factors," for a discussion of certain matters that may affect our portfolio and capital position.

Management views our capital structure as consisting of three levels, each with a specific size and purpose. The first layer of capital, which we refer to as "regulatory capital," is the amount of capital we need to satisfy regulatory requirements and support our objective of writing all the business we can write, consistent with our underwriting discipline of achieving a 96 combined ratio. This capital is held largely within our various insurance entities.

The second layer of capital we call "extreme contingency." While our regulatory capital is, by definition, a cushion for absorbing financial consequences of adverse events such as loss reserve development, litigation, weather catastrophes or investment market corrections, we view that as a base and hold additional capital for even more extreme conditions. The modeling used to quantify capital needs for these conditions is quite extensive, including tens of thousands of simulations, but it still represents our best estimates of such contingencies based on historical experience. This capital is held at the holding company and, at times, in our insurance entities potentially eligible for a dividend to the holding company.

The third layer of capital is capital in excess of the sum of the first two layers and provides maximum flexibility to repurchase stock, consider acquisitions and pay dividends to shareholders and for other purposes. This capital is largely held at the holding company.

At all times during the third quarter 2008, and throughout October, our total capital exceeded the sum of our regulatory capital layer plus our self-constructed extreme contingency load. However, due to the recent significant declines in the valuation of our investment portfolio, the third layer has been diminished, along with the flexibility provided by that level of capital.

The speed by which the market valuations changed, and continue to change, is of great concern and a basis for our ongoing review of portfolio risk. To help manage these risks and preserve our capital base, as of October month end, we held approximately $4 billion in cash and treasury bonds, double the amount we held at the start of the third quarter, as we have sought to reduce overall risk and volatility in the portfolio.

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

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

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

Off-Balance-Sheet Arrangements

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

Contractual Obligations

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

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

III. RESULTS OF OPERATIONS-UNDERWRITING

A. Growth



                                             Three Months Ended                    Nine Months Ended
(millions)                                     September 30,                         September 30,
                                        2008        2007      % Change        2008         2007      % Change
NET PREMIUMS WRITTEN
Personal Lines
Agency                                $ 1,884.5   $ 1,908.1         (1 )   $  5,661.6   $  5,860.5         (3 )
Direct                                  1,211.0     1,131.8          7        3,489.3      3,375.9          3

Total Personal Lines                    3,095.5     3,039.9          2        9,150.9      9,236.4         (1 )
Commercial Auto                           409.8       437.0         (6 )      1,346.4      1,435.0         (6 )
Other indemnity                             6.1         6.3         (3 )         15.2         17.2        (12 )

Total underwriting operations         $ 3,511.4   $ 3,483.2          1     $ 10,512.5   $ 10,688.6         (2 )

NET PREMIUMS EARNED
Personal Lines
Agency                                $ 1,840.5   $ 1,900.5         (3 )   $  5,534.5   $  5,772.3         (4 )
Direct                                  1,129.1     1,091.6          3        3,336.2      3,285.3          2

Total Personal Lines                    2,969.6     2,992.1         (1 )      8,870.7      9,057.6         (2 )
Commercial Auto                           441.1       464.3         (5 )      1,331.1      1,391.0         (4 )
Other indemnity                             5.5         5.4          2           15.6         16.2         (4 )

Total underwriting operations         $ 3,416.2   $ 3,461.8         (1 )   $ 10,217.4   $ 10,464.8         (2 )

Net premiums written represent the premiums generated from policies written during the period less any premiums ceded to reinsurers. Net premiums earned, which are a function of the premiums written in the current and prior periods, are earned as revenue over the life of the policy using a daily earnings convention. During the third quarter, we experienced positive written premium growth, reflecting the effect of the rate changes we have been taking over the past year and our efforts to increase retention, as well as other initiatives we have underway to provide distinctive new auto business options (discussed below).

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

                (thousands)                   At September 30,
                                         2008       2007     % Change
                POLICIES IN FORCE
                Personal Lines
                Agency auto             4,348.1    4,459.2         (2 )
                Direct auto             2,770.9    2,571.9          8

                Total auto              7,119.0    7,031.1          1
                Special lines1          3,400.6    3,140.4          8

                Total Personal Lines   10,519.6   10,171.5          3

                Commercial Auto           554.4      540.9          2

1 Includes insurance for motorcycles, recreational vehicles, mobile homes, watercraft, snowmobiles and similar items, as well as a personal umbrella product.

                                             Growth Over Prior Year
                                          Quarter          Year-to-date
                                       2008      2007     2008       2007
                Personal Lines:
                New applications         (4 )%      5 %      (6 )%      3 %
                Renewal applications      5 %       4 %       4 %       3 %
                Commercial Auto:
                New applications         (9 )%      6 %      (6 )%      2 %
                Renewal applications      3 %       5 %       4 %       6 %

Returning to positive growth in new business remains a significant challenge. We have several initiatives underway aimed at providing distinctive new auto business options. During the third quarter 2008, we expanded our usage-based insurance product, "MyRate," into four additional states. We now offer this product to our Direct auto customers in eight states and our Agency auto customers in four of the eight states; continued expansion is planned throughout the remainder of the year and during 2009. In addition, during the third quarter, we introduced a program called "Name Your Price" in four states that allows consumers to select a price they would like to pay for their auto insurance; we then will tell them the level of coverage that price provides. During the second quarter 2008, we entered Massachusetts with our Internet-only personal auto and boat products. We plan to expand the distribution methods to include independent agents and direct via the phone in this $4 billion market over time. We are also rolling out a new product model in our Agency auto business which is designed to help improve competitiveness.

During the third quarter and first nine months of 2008, total personal auto written premium per policy decreased 1% and 3%, respectively, compared to the prior year periods. We started to raise rates during the latter part of 2007 in order to meet our loss cost inflation expectations, and continued to raise rates during 2008. During the quarter, our rate activity slowed as we are getting closer to our desired rate levels. We remain ready to react quickly, and as often as necessary, should our expectations change.

Another important element affecting growth is customer retention. One measure of customer retention is policy life expectancy, which is our actuarial estimate of the average length of time that a policy will remain in force before cancellation or lapse in coverage. Efforts at increasing growth from customer retention have continued to produce positive outcomes. Our policy life expectancy measures for our Agency and Direct private passenger auto products have been on a continuing upward trend and are now approximately 12% and 13% higher, respectively, than the same measures a year ago. We are continuing to monitor our renewal acceptance rates in light of the rate increases we have taken earlier this year, as well as the overall economic conditions. In our Commercial Auto Business, the policy life expectancy has remained relatively flat as compared to the third quarter 2007. Realizing the importance that retention has on our ability to grow profitably, we continue to place increased emphasis on competitive pricing, quality service and other retention initiatives for our current customers.

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

                                                  Three Months                               Nine Months
(millions)                                  2008                 2007                 2008                 2007
                                        Underwriting         Underwriting         Underwriting         Underwriting
                                       Profit (Loss)        Profit (Loss)        Profit (Loss)        Profit (Loss)
                                         $      Margin        $      Margin        $      Margin        $      Margin
Personal Lines
Agency                                $  75.7      4.1 %   $ 110.8      5.8 %   $ 283.7      5.1 %   $ 406.6      7.0 %
Direct                                   77.3      6.8        67.9      6.2       211.2      6.3       284.4      8.7

Total Personal Lines                    153.0      5.2       178.7      6.0       494.9      5.6       691.0      7.6
Commercial Auto                          13.6      3.1        38.1      8.2        73.4      5.5       161.0     11.6
Other indemnity1                           .8       NM         1.0       NM         1.0       NM         2.4       NM

Total underwriting operations         $ 167.4      4.9 %   $ 217.8      6.3 %   $ 569.3      5.6 %   $ 854.4      8.2 %

1 Underwriting margins are not meaningful (NM) for our other indemnity businesses due to the low level of premiums earned by, and the variability of losses in, such businesses.

On a quarter-over-prior-year-quarter basis, the decrease in underwriting profitably reflects the catastrophe losses we incurred in 2008, primarily from hurricanes Ike and Gustav and tropical storm Fay. On a year-to-date basis, in addition to the catastrophe losses, we are seeing the effect of 2007 rate reductions on our underwriting profitability.

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

                                                       Three Months Ended         Nine Months Ended
                                                          September 30,             September 30,
                                                     2008   2007    Change     2008   2007    Change
Underwriting Performance1
Personal Lines-Agency
Loss & loss adjustment expense ratio                 74.5   73.0    1.5 pts.   73.5   71.7    1.8 pts.
Underwriting expense ratio                           21.4   21.2     .2 pts.   21.4   21.3     .1 pts.

Combined ratio                                       95.9   94.2    1.7 pts.   94.9   93.0    1.9 pts.

Personal Lines-Direct
Loss & loss adjustment expense ratio                 72.1   71.9     .2 pts.   72.8   70.2    2.6 pts.
Underwriting expense ratio                           21.1   21.9   (.8) pts.   20.9   21.1   (.2) pts.

Combined ratio                                       93.2   93.8   (.6) pts.   93.7   91.3    2.4 pts.

Total Personal Lines
Loss & loss adjustment expense ratio                 73.5   72.6     .9 pts.   73.2   71.2    2.0 pts.
Underwriting expense ratio                           21.3   21.4   (.1) pts.   21.2   21.2      - pts.

Combined ratio                                       94.8   94.0     .8 pts.   94.4   92.4    2.0 pts.

Commercial Auto
Loss & loss adjustment expense ratio                 75.1   72.3    2.8 pts.   73.0   68.1    4.9 pts.
Underwriting expense ratio                           21.8   19.5    2.3 pts.   21.5   20.3    1.2 pts.

Combined ratio                                       96.9   91.8    5.1 pts.   94.5   88.4    6.1 pts.

Total Underwriting Operations2
Loss & loss adjustment expense ratio                 73.7   72.5    1.2 pts.   73.1   70.7    2.4 pts.
Underwriting expense ratio                           21.4   21.2     .2 pts.   21.3   21.1     .2 pts.

Combined ratio                                       95.1   93.7    1.4 pts.   94.4   91.8    2.6 pts.

Accident year-Loss & loss adjustment expense ratio   73.9   72.0    1.9 pts.   72.8   70.1    2.7 pts.

1 Ratios are expressed as a percentage of net premiums earned.

2 Combined ratios for the other indemnity businesses are not presented separately due to the low level of premiums earned by, and the variability of losses in, such businesses. These businesses generated an underwriting profit of $.8 million and $1.0 million for the three months ended September 30, 2008 and 2007, respectively, and $1.0 million and $2.4 million for the nine months ended September 30, 2008 and 2007, respectively.

Losses and Loss Adjustment Expenses (LAE)



                                            Three Months Ended       Nine Months Ended
    (millions)                                September 30,            September 30,
. . .