I. OVERVIEW

In the first quarter 2009, we achieved growth in both premiums and policies in force, and reported net income of $232.5 million, or $.35 per share, for the first quarter 2009, compared to $239.4 million, or $.35 per share, for the same period last year. The Progressive Corporation's insurance subsidiaries generated underwriting profitability of 10.5%, or $356.0 million, while our investment operations experienced $73.4 million of net realized losses on securities, reflecting further write-downs of securities determined to be other-than-temporarily impaired. These write-downs were primarily on our preferred stocks and the majority represented further write-downs on securities that were previously written down in the third and/or fourth quarters of 2008. Despite the additional losses generated in the investment portfolio, our total capital position increased $88.4 million during the quarter, to $6.5 billion at March 31, 2009.

A. Operations

During the first quarter 2009, we realized a year-over-year increase of 1% in net premiums written, despite the continued decline in our Commercial Auto business. Net premiums earned, which lags written premiums, remained relatively flat for the quarter compared to last year. Companywide policies in force increased 4% over the first quarter last year. Policies in force grew 10% in our Direct auto business and 7% in special lines. On the other hand, both our Agency auto and Commercial Auto businesses experienced a decrease in policies in force of 2%.

Premium growth reflects a combination of new business applications (i.e., issued policies), premium per policy (i.e., rates), and customer retention. On a year-over-year basis, companywide new business applications increased 3%, while renewal applications increased 4%. This is the first time we have seen an increase in companywide new business applications since the third quarter 2007. We believe that one factor that might be contributing to this growth is increased shopping on the part of consumers who are becoming more cost conscious and looking for greater value with their expenditures.

Our Direct auto business experienced double-digit increases in both new and renewal applications, compared to the first quarter last year. The new business acquisition in our Agency auto business was still down for the quarter, but to a much lesser extent than we experienced during all of 2008. Our Commercial Auto business continues to be a challenge, as it is still being adversely affected by the downturn in the economy, primarily in the housing and construction sectors.

We continue to have several initiatives underway aimed at providing consumers with distinctive new auto insurance options, including Name Your PriceŽ (a program that provides customers the opportunity to select the price they would like to pay for auto insurance), a new product in our Agency auto business which is designed to help improve competitiveness through further price segmentation, and the expansion of MyRatesm (our usage-based insurance product).

On a year-over-year basis, for the first quarter 2009, total auto written premium per policy decreased 1% despite a slight increase in rates, reflecting shifts in the mix of business. We have seen average written premium per auto policy remain relatively flat for our Agency auto and special lines products, while premiums per policy are down in both Direct and Commercial Auto. We continue to evaluate future rate needs and react quickly as we recognize changing trends.

To continue to grow policies in force, it is critical that we retain our customers for longer periods, which is why increasing retention continues to be one of our most important priorities. 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, 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 are now about 7% and 9%, respectively, higher than at the end of the first quarter last year. Our special lines products retention was flat, while Commercial Auto's retention was down 1%, compared to the same period last year.

Our 10.5% companywide underwriting profit margin for the first quarter 2009 exceeded our target of 4% and was a 5.1 point improvement over the first quarter last year. All of the businesses contributed to these strong results. During the first quarter 2009, we experienced .6 points of favorable prior accident year development, compared to unfavorable development of 1.0 point in the first quarter last year; the development for both years was primarily in the Commercial Auto business. During the first quarter, we experienced declines in both frequency and severity, compared to the first quarter last year.

The fair value of our investment portfolio was $12.8 billion at March 31, 2009, including $1.2 billion of redeemable and nonredeemable preferred stocks. At the end of the first quarter 2009, our asset allocation strategy was to maintain 0-25% of our portfolio in common equities (i.e., common stocks and alternative investments) with the balance (75%-100%) of our portfolio in fixed-income securities, which included preferred stocks. At March 31, 2009, our allocation was 97% to fixed-income securities and 3% to common equities.

In April 2009, the Investment and Capital Committee of our Board of Directors approved new guidelines for our portfolio allocation. Our asset allocation strategy now divides our portfolio into two groups. Group I includes common equities, redeemable and nonredeemable preferred stocks (preferred stocks), and non-investment-grade and non-rated fixed-maturity securities. Zero to 25% of our total portfolio will be allocated to Group I securities. The remainder of the portfolio is allocated to Group II securities. Group II includes all other fixed-maturity securities (e.g., U.S. Treasury Notes, municipal bonds, asset-backed securities, corporate debt) and our short-term investments. If the new guidelines had then been in effect, we would have reported at March 31, 2009 a portfolio allocation of 13% to Group I and 87% to Group II, compared to 18% and 82%, respectively, at December 31, 2008. Toward the latter part of the first quarter, we sold a portion of our common stocks to further restructure the portfolio to a lower risk profile.

Our investment portfolio produced a fully taxable equivalent (FTE) total return of (1.2)% for the first three months of 2009. We experienced losses in both our common stock and fixed-income portfolios, with FTE total returns of (10.3)% and
(.6)%, respectively. At March 31, 2009, the fixed-income portfolio duration was 3.0 years with a weighted average credit quality of AA+.

During the first quarter 2009, we recorded $223.4 million of other-than-temporary impairment losses on our investment portfolio. The write-downs resulted from fundamental matters related to either specific issues or issuers and/or because we were unable to objectively determine that these securities would substantially recover in the near term. About 90% of the quarter's write-downs were in our preferred stocks, the vast majority of which had been previously written-down in the third and/or fourth quarters of 2008.

As a result of the continued valuation declines on the common stocks and nonredeemable preferred stocks that we do not have the intent to hold until they substantially recover in value, we recorded a $35.0 million valuation allowance on our deferred tax asset during the quarter. As of quarter end, we did not believe that we had sufficient evidence to support recognizing the full tax benefit related to the decline in value of these securities.

Despite the reduction in value of our investment portfolio and the valuation allowance on our deferred tax asset, our overall capital position (debt and equity) increased $88.4 million during the quarter to $6.5 billion at March 31, 2009. 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.

II. FINANCIAL CONDITION

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 three months ended March 31, 2009 and 2008, operations generated a positive cash flow of $541.4 million and $461.4 million, respectively. During the first quarter 2009, we repurchased .3 million of our common shares at a total cost of $5.1 million (average cost of $14.60 per share); these shares were repurchased in conjunction with our equity compensation plans.

We also have the ability to borrow up to $125 million under a 364-Day Secured Liquidity Credit Facility with National City Bank (NCB). We entered into this agreement at the end of 2008 to provide liquidity in the event of a disruption in our cash management operations that could affect our ability to transfer or receive funds. We did not borrow under this agreement in the first quarter 2009. In addition, we deposited $125 million into an FDIC-insured deposit account at NCB during the first quarter 2009 to provide us with additional cash availability in the event of such a disruption to our cash management operations.

Our capital planning and forecasting efforts lead us to 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.

Management views our capital position as consisting of three layers, 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 state insurance regulatory requirements and support our objective of writing all the business we can write and service, 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, representing 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, among other purposes. This capital is largely held at the holding company.

The speed by which the market valuations of the assets held in our portfolio changed, and may continue to change, has our full attention and is a basis for our ongoing review of portfolio risk. To help manage these risks and preserve our capital base, as of March 31, 2009, we held approximately $5.8 billion in cash and U.S. Treasury securities.

B. Commitments and Contingencies

During the first quarter 2009, we completed construction of one new service center to provide concierge level claims service; this project was funded through operating cash flows and replaced a previously leased location. We currently have a total of 54 such centers that are located in 41 metropolitan areas across the United States and serve as our primary approach to damage assessment and coordination of vehicle repairs at authorized auto repair facilities in these markets.

There is currently no significant construction under way.

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 Note 2-Investments and of this Management's Discussion and Analysis for a summary of our derivative activity since year-end 2008. 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, 2008.

Contractual Obligations

During the first quarter 2009, our contractual obligations have not changed materially from those discussed in our Annual Report on Form 10-K for the year ended December 31, 2008.

III. RESULTS OF OPERATIONS - UNDERWRITING

A. Growth



                                             Three Months Ended March 31,
          (millions)                         2009         2008      % Change
          NET PREMIUMS WRITTEN
          Personal Lines
          Agency                          $   1,846.8   $ 1,868.8         (1 )
          Direct                              1,265.0     1,160.0          9

          Total Personal Lines                3,111.8     3,028.8          3
          Commercial Auto                       406.2       457.2        (11 )
          Other indemnity                         4.9         4.4         11

          Total underwriting operations   $   3,522.9   $ 3,490.4          1

          NET PREMIUMS EARNED
          Personal Lines
          Agency                          $   1,817.3   $ 1,846.0         (2 )
          Direct                              1,171.1     1,094.0          7

          Total Personal Lines                2,988.4     2,940.0          2
          Commercial Auto                       412.3       444.7         (7 )
          Other indemnity                         5.9         5.3         11

          Total underwriting operations   $   3,406.6   $ 3,390.0         -

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.

                (thousands)              2009       2008     % Change
                POLICIES IN FORCE
                Personal Lines
                Agency auto             4,348.7    4,442.6         (2 )
                Direct auto             2,954.0    2,679.4         10

                Total auto              7,302.7    7,122.0          3
                Special lines1          3,377.8    3,151.8          7

                Total Personal Lines   10,680.5   10,273.8          4

                Commercial Auto           532.6      545.4         (2 )

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

To analyze growth, we review new policies, rate levels, and the retention characteristics of our books of business. During the first quarter, we experienced the following growth in new and renewal applications:

                                            Growth Over Prior
                                               Year Quarter
                                            2009           2008
                    Personal Lines:
                    New applications             5 %         (8 )%
                    Renewal applications         4 %          3 %
                    Commercial Auto:
                    New applications           (15 )%        (3 )%
                    Renewal applications         4 %          3 %

During the first quarter 2009, our Personal Lines business experienced positive growth in new applications. Our Direct auto business saw a double-digit increase in new applications, while our Agency auto business continued to experience modest declines, compared to more significant declines experienced in 2008.

We have several initiatives underway aimed at providing consumers with distinctive new auto insurance options. During 2008, we introduced a program called Name Your PriceŽ that allows Direct Internet 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. As of the end of the first quarter 2009, Name Your Price is available in 24 states. We plan to expand this program to the rest of the country during the year.

In the first quarter 2009, we also continued the roll-out of a new product model in our Agency auto business to five additional states, bringing the total number of states to 18. This product model is designed to help improve competitiveness through further price segmentation; we plan to almost double the number of states offering this product during the remainder of 2009.

In addition, during the first quarter 2009, we expanded MyRatesm, our Pay As You DriveŽ usage-based insurance product, to Agency auto customers in two additional states; we now offer this product to our Direct auto customers in nine states and our Agency auto customers in six of the nine states. During the remainder of 2009, we plan to continue expansion of MyRate into additional states depending on regulatory approval and business results.

On a year-over-year basis, total personal auto written premium per policy decreased 1%, despite a slight increase in rates in the first quarter 2009, primarily reflecting shifts in the mix of business. Our Agency auto business experienced a slight increase in premium per policy on both new business and in total, while our Direct auto premium per policy was down 9% on new business and 3% in total. Our pricing levels are aligned with our profitability targets, but we remain ready to react quickly, and as often as necessary, should trends change.

Another important element affecting growth is customer retention. One measure of 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. Our policy life expectancy measures for our Agency and Direct private passenger auto products are now higher than the same measures a year ago by approximately 7% and 9%, respectively. Our policy life expectancy in our Commercial Auto business was down 1%, compared to the end of the first quarter 2008. Realizing the importance that retention has on our ability to continue to grow profitably, we continue to emphasize competitive pricing, quality service, and other retention initiatives for our current customers.

Profitability in 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 three months ended March 31, our underwriting profitability measures were as follows:

                                                      2009                                 2008
                                           Underwriting Profit (Loss)           Underwriting Profit (Loss)
(millions)                                      $             Margin               $                Margin
Personal Lines
Agency                                    $       182.8            10.1 %    $       114.5                6.2 %
Direct                                             98.7             8.4               41.9                3.8

Total Personal Lines                              281.5             9.4              156.4                5.3
Commercial Auto                                    73.8            17.9               25.9                5.8
Other indemnity1                                     .7              NM                (.1 )               NM

Total underwriting operations             $       356.0            10.5 %    $       182.2                5.4 %

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

All of our businesses contributed to the strong underwriting profitability in the first quarter 2009. Favorable prior accident year development in the first quarter 2009, compared to unfavorable development for the same period last year, along with favorable frequency and severity trends this year, contributed to the improvement over the first quarter last year.

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

                                                             Three Months Ended March 31,
Underwriting Performance1                                  2009      2008         Change
Personal Lines - Agency
Loss & loss adjustment expense ratio                        69.0      72.5         (3.5) pts.
Underwriting expense ratio                                  20.9      21.3          (.4) pts.

Combined ratio                                              89.9      93.8         (3.9) pts.

Personal Lines - Direct
Loss & loss adjustment expense ratio                        71.0      74.7         (3.7) pts.
Underwriting expense ratio                                  20.6      21.5          (.9) pts.

Combined ratio                                              91.6      96.2         (4.6) pts.

Total Personal Lines
Loss & loss adjustment expense ratio                        69.8      73.4         (3.6) pts.
Underwriting expense ratio                                  20.8      21.3          (.5) pts.

Combined ratio                                              90.6      94.7         (4.1) pts.

Commercial Auto
Loss & loss adjustment expense ratio                        60.8      73.2        (12.4) pts.
Underwriting expense ratio                                  21.3      21.0           .3  pts.

Combined ratio                                              82.1      94.2        (12.1) pts.

Total Underwriting Operations2
Loss & loss adjustment expense ratio                        68.6      73.3         (4.7) pts.
Underwriting expense ratio                                  20.9      21.3          (.4) pts.

Combined ratio                                              89.5      94.6         (5.1) pts.

Accident year-Loss & loss adjustment expense ratio3         69.2      72.3         (3.1) 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 loss costs in, such businesses. For the three months ended March 31, 2009 and 2008, these businesses generated an underwriting profit (loss) of $.7 million and $(.1) million, respectively.

3 The accident year ratio includes only the losses that occurred during the period noted. As a result, accident period results will change over time as our estimates of loss costs improve or deteriorate when payments are made or reserves for that accident period are reviewed.

Losses and Loss Adjustment Expenses (LAE)



                                                Three Months Ended March 31,
       (millions)                                 2009                 2008
       Change in net loss and LAE reserves   $        (99.4 )     $         17.5
       Paid losses and LAE                          2,436.4              2,466.5

       Total incurred losses and LAE         $      2,337.0       $      2,484.0

Claims costs, our most significant expense, represent payments made, and estimated future payments to be made, to or on behalf of our policyholders, including expenses needed to adjust or settle claims. These costs include an estimate for costs related to assignments, based on current business, under state-mandated automobile insurance programs. Claims costs are a function of loss severity and frequency and are influenced by inflation and driving patterns, among other factors. Accordingly, anticipated changes in these factors are taken into account when we establish premium rates and loss reserves. Our reserves would differ if the underlying assumptions were changed.

During the first quarter 2009, our loss and LAE ratio decreased 4.7 points over the first quarter last year, reflecting lower overall frequency and severity for both Personal and Commercial Auto, as well as favorable prior accident year development for the first quarter 2009, compared to unfavorable development for the same period last year.

Total personal auto paid severity (i.e., average cost per claim) decreased about 1.5% on a quarter-over-prior-year quarter basis driven by a decrease for the property coverages in total, partially offset by increases in severity for both our personal injury protection (PIP)(+12%) and bodily injury (+1%) coverages. It is difficult to estimate future severity, especially for injury claims, but we continue to monitor changes in the underlying costs, such as medical costs, jury verdicts, and regulatory changes, which may affect severity. The severity we experience will also vary relative to the change in our mix of business by limit.

We also experienced a decline in auto accident frequency in the first quarter 2009, compared to the first quarter last year. We cannot predict with any certainty the degree or direction of frequency change that we will experience in the future. We continue to analyze trends to distinguish changes in our experience from external factors, such as changes in the number of vehicles per household, greater vehicle safety, and unemployment rates, versus those resulting from shifts in the mix of our business.

The table below presents the actuarial adjustments implemented and the loss reserve development experienced in the three months ended March 31:

   (millions)                                              2009            2008
   Actuarial Adjustments
   Favorable/(Unfavorable)
   Prior accident years                                  $    (2.0 )   $       (8.1 )
   Current accident year                                     (10.2 )            (.1 )

   Calendar year actuarial adjustment                    $   (12.2 )   $       (8.2 )

   Prior Accident Years Development
   Favorable/(Unfavorable)
. . .