I. OVERVIEW

In the second quarter 2009, we achieved growth in both premiums and policies in force, and reported net income of $250.1 million, or $.37 per share, compared to $215.5 million, or $.32 per share, for the same period last year. During the quarter, The Progressive Corporation's insurance subsidiaries generated underwriting profitability of 7.4%, or $253.8 million on a pretax basis. Our investment operations experienced pretax net investment income of $135.4 million, after $30.0 million of write-downs of securities determined to be other-than-temporarily impaired. These write-downs primarily related to the decline in value due to credit losses on certain of our structured debt securities.

A. Operations

During the second quarter 2009, we realized a year-over-year increase of 1% in net premiums written, led by solid increases in our Direct auto business and despite the continued decline in our Commercial Auto business. Net premiums earned were also up 1% for the quarter, compared to last year. Companywide policies in force increased 3% over the second quarter last year. Policies in force grew 12% in our Direct auto business and 4% in our special lines products. On the other hand, our Agency auto and Commercial Auto businesses experienced decreases in policies in force of 1% and 5%, respectively.

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 were flat, while renewal applications increased 4%. Our Direct auto business experienced double-digit increases in both new and renewal applications, compared to the second quarter last year. The new business acquisition in our Agency auto business was up slightly for the quarter, while renewal business was down slightly. 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 have several initiatives underway aimed at providing consumers with distinctive new auto insurance options, including Name Your Price® (a program that provides Direct Internet consumers the opportunity to submit 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 quarter-over-prior-year-quarter basis, for the second quarter 2009, our total auto written premium per policy decreased 1.5% despite a slight increase in filed rates, reflecting shifts in the mix of business. We have seen average written premium per policy remain relatively flat for our Agency auto and special lines products, while premiums per policy are down in both Direct auto and Commercial Auto. We continue to evaluate future rate needs and intend to 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 4% and 7%, respectively, higher than at the end of the second quarter last year. Our special lines products retention was down 1%, while Commercial Auto's retention was down about 2%, compared to the same period last year.

Our 7.4% companywide underwriting profit margin for the second quarter 2009 exceeded our target of 4% and was a 1.0 point improvement over the second quarter last year. All businesses performed better than their profitability targets. As we entered the warmer weather months, our special lines products experienced higher losses than in the first quarter 2009. During the second quarter 2009, we experienced 1.0 point of unfavorable prior accident year development, compared to 0.2 points in the second quarter last year. The 2009 development was primarily in our personal auto business. During the second quarter 2009, as compared to the second quarter last year, our personal auto paid severity decreased about 1%. Our incurred accident frequency on a calendar year basis increased approximately 4% on a quarter-over-prior-year-quarter basis, primarily reflecting increases in our bodily injury and personal injury protection coverages; on a year-to-date basis, our frequency was relatively unchanged from last year.

B. Investments and Capital Management

The fair value of our investment portfolio was $13.6 billion at June 30, 2009. At the end of the second quarter 2009, our asset allocation strategy was to maintain 0-25% of our portfolio in Group I securities (i.e., common equities, redeemable and nonredeemable preferred stocks (preferred stocks), and non-investment-grade and non-rated fixed-maturity securities) with the balance (75%-100%) of our portfolio in Group II securities (i.e., all other fixed-income securities, including U.S. Treasury Notes, municipal bonds, asset-backed securities, corporate debt, and short-term investments). At June 30, 2009, our portfolio was allocated 17% to Group I and 83% to Group II.

For the second quarter 2009, we adopted the three FASB Staff Positions (FSPs) finalized in April 2009. FSP FAS 157-4, "Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions that Are Not Orderly," provides additional guidance on estimating fair value when the volume and level of activity for an asset or liability have significantly decreased in relation to normal market activity for the asset or liability and clarifies that the use of multiple valuation techniques may be appropriate. In addition, the FSP re-emphasized that fair value continues to be the exit price in an orderly market. The adoption of this FSP did not have an impact on our portfolio valuation, financial condition or results of operations, but will increase our quarterly and annual disclosures to show greater detail of our financial instruments (see Note 3 - Fair Value).

FSP FAS 107-1 and APB 28-1, "Interim Disclosures about Fair Value of Financial Instruments," requires companies to disclose the fair value of its financial instruments in its interim reports. Since we have always disclosed the fair value of financial instruments in our quarterly reports, the adoption of this FSP had no impact on us.

FSP FAS 115-2 and FAS 124-2, "Recognition and Presentation of Other-Than-Temporary Impairments," provides guidance in determining whether impairments in debt securities are other-than-temporary and requires additional disclosures relating to other-than-temporary impairments (OTI) and unrealized losses on investments in both quarterly and annual reports. Upon adoption of this FSP, we recorded a cumulative effect of change in accounting principle that resulted in a reclassification from retained earnings to accumulated other comprehensive income (loss) of $189.6 million (or $291.8 million on a pretax basis) for the non-credit portion of the OTI losses previously recognized in retained earnings, as of April 1, 2009. This reclassification had no effect on total shareholders' equity.

During the second quarter 2009, in accordance with FSP FAS 115-2 and FAS 124-2, we recorded $30.0 million of other-than-temporary impairment losses on our investment portfolio. The write-downs were primarily in our structured debt portfolio and reflected the portion of the impairment loss that was attributable to credit-related factors. The balance of the decline in fair value (i.e., the non-credit portion of the impairment loss) was reflected in accumulated other comprehensive income (loss).

As a result of the improved market conditions during the second quarter 2009, we revised our estimate of the valuation allowance on our deferred tax asset to $18.0 million by reversing $8.0 million out of "net unrealized gains (losses) on securities" and $9.0 million from our "provision for income taxes." Our current valuation allowance reflects our potential inability to realize the full amount of the deferred tax asset related to our unrealized losses on securities that were either determined to be fundamentally impaired or that we may not hold until recovery.

Our overall capital position (debt and equity) increased $622.2 million during the quarter to $7.1 billion at June 30, 2009. The increase reflects our strong underwriting and investment results due to improved market conditions during the second quarter 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 six months ended June 30, 2009 and 2008, operations generated a positive cash flow of $928.1 million and $939.7 million, respectively. During the second quarter 2009, we repurchased just over 1.0 million of our common shares at a total cost of $15.0 million (average cost of $14.83 per share). Year-to-date, we have repurchased 1.3 million common shares at a total cost of $20.0 million (average cost of $14.77 per share).

In June 2009, our Board of Directors approved a new authorization for the Company to repurchase up to 50 million of our common shares, beginning on July 1, 2009. This authorization replaced a 2007 Board authorization that expired on June 30, 2009. There is no expiration date for this new authorization. From time to time, we may also elect to repurchase our outstanding debt securities in the open market or in privately negotiated transactions, when management believes that such securities are attractively priced and capital is available for such purposes; we did not make any such debt repurchases during the second quarter 2009.

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 six months of 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.

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 either at the holding company or in our insurance entities, where it is potentially eligible for a dividend up 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.

At all times during 2008 and the first six months of 2009, our total capital exceeded the sum of our regulatory capital layer plus our self-constructed extreme contingency load. At June 30, 2009, we held total capital, debt plus equity, of $7.1 billion at book value.

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 June 30, 2009, we held approximately $6.4 billion in short-term investments and U.S. Treasury securities.

B. Commitments and Contingencies

During the first six months of 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 second 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                   Six Months Ended
                                                     June 30,                            June 30,
                                                                    %                                   %
(millions)                                  2009        2008      Change        2009        2008      Change
NET PREMIUMS WRITTEN
Personal Lines
Agency                                    $ 1,887.7   $ 1,908.3       (1 )    $ 3,734.5   $ 3,777.1       (1 )
Direct                                      1,217.7     1,118.3        9        2,482.7     2,278.3        9

Total Personal Lines                        3,105.4     3,026.6        3        6,217.2     6,055.4        3
Commercial Auto                               417.2       479.4      (13 )        823.4       936.6      (12 )
Other indemnity                                 6.0         4.7       28           10.9         9.1       20

Total underwriting operations             $ 3,528.6   $ 3,510.7        1      $ 7,051.5   $ 7,001.1        1

NET PREMIUMS EARNED
Personal Lines
Agency                                    $ 1,826.5   $ 1,848.0       (1 )    $ 3,643.8   $ 3,694.0       (1 )
Direct                                      1,205.6     1,113.1        8        2,376.7     2,207.1        8

Total Personal Lines                        3,032.1     2,961.1        2        6,020.5     5,901.1        2
Commercial Auto                               403.3       445.3       (9 )        815.6       890.0       (8 )
Other indemnity                                 6.0         4.8       25           11.9        10.1       18

Total underwriting operations             $ 3,441.4   $ 3,411.2        1      $ 6,848.0   $ 6,801.2        1

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.

Policies in force, our preferred measure of growth, represents all policies under which coverage is in effect as of the end of the period specified. As of June 30, our policies in force were:

               (thousands)              2009       2008     % Change
               POLICIES IN FORCE
               Personal Lines:
               Agency auto             4,345.9    4,411.2         (1 )
               Direct auto             3,040.9    2,716.7         12

               Total auto              7,386.8    7,127.9          4
               Special lines1          3,470.8    3,328.7          4

               Total Personal Lines   10,857.6   10,456.6          4

               Commercial Auto           531.3      556.8         (5 )

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

                                            Growth Over Prior Year
                                         Quarter            Year-to-date
                                     2009       2008       2009       2008
              Personal Lines:
              New applications         -  %       (5 )%       2 %       (6 )%
              Renewal applications      4 %        5 %        4 %        4 %
              Commercial Auto:
              New applications        (15 )%      (6 )%     (15 )%      (4 )%
              Renewal applications     -  %        6 %        2 %        4 %

During the second quarter 2009, new applications for our Personal Lines business remained relatively flat, compared to the second quarter last year, with growth in our personal auto business applications being offset by significant declines in our special lines products; on a year-to-date basis, total Personal Lines new applications increased slightly. Our Direct auto business continued to see double-digit increases in new applications, while Agency auto experienced a small increase in the second quarter, while still down slightly on a year-to-date basis. The significant decline in year-over-year motorcycle and scooter sales, reflecting lower gas prices in 2009 as compared to 2008, contributed to the large decrease in our new applications in our special lines products.

We have several initiatives underway aimed at providing consumers with distinctive new auto insurance options. During 2008, we introduced a program called Name Your Price® that allows Direct Internet consumers to submit 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 second quarter 2009, Name Your Price is available in 30 states, including six states that rolled-out during the second quarter. We plan to expand this program to the rest of the country during the remainder of 2009 and first quarter 2010.

We also continued the rollout of a new product model in our Agency auto business to nine additional states during the second quarter 2009, bringing the total number of states to 27 at quarter end. This product model is designed to help improve competitiveness through further price segmentation; we plan to increase the number of states offering this product to about 35 by year end. Even as we continue this rollout, we have already begun shifting our focus to an even newer product model, which further refines our segmentation and integrates the best of the Agency and Direct auto products; this latest product model has been elevated in one state.

In addition, during the second quarter 2009, we expanded MyRatesm, our usage-based insurance product into six additional states. This product is now available to auto customers in a total of 15 states, which includes 7 states that offer the product in both our Direct and Agency channels, 5 states that offer to Direct customers only, and 3 states that offer to Agency customers only. During the remainder of 2009, we plan to continue expansion of MyRate into additional states depending on regulatory approval and business results.

We are also continuing with our efforts to further penetrate customer households through cross-selling products. Progressive Home Advantage, where we "bundle" our auto product with homeowners insurance provided by an unaffiliated insurance carrier, is becoming an integral part of our consumer offerings. During the second half of 2009, we expect to add two additional homeowner carriers to continue to promote this program. In addition, we are focused on selling auto policies to our special lines customers and vice versa. These multi-product customers are an important part of our strategic agenda since they tend to stay with us longer and have better loss experience.

During both the second quarter and first six months of 2009, total personal auto written premium per policy decreased about 1%, despite a slight increase in rates in 2009, primarily reflecting shifts in the mix of business. On a year-over-year basis for both the three and six month periods ended June 30, 2009, our Agency auto business experienced a 2% increase in premium per policy on new business and was relatively flat on renewal business, while our Direct auto premium per policy was down about 8% on new business and about 3% on renewals. The decrease in our Direct auto premium per policy primarily reflects mix shifts (e.g., age of drivers, existence of prior insurance, and driving records). We believe 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 4% and 7%, respectively. Our policy life expectancy in our Commercial Auto business was down 2%, compared to the end of the second 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 respective periods our underwriting profitability measures were as follows:

                                              Three Months Ended                           Six Months Ended
                                                   June 30,                                    June 30,
                                          2009                  2008                  2009                  2008
                                      Underwriting          Underwriting          Underwriting          Underwriting
                                     Profit (Loss)         Profit (Loss)         Profit (Loss)         Profit (Loss)
(millions)                             $      Margin         $      Margin         $      Margin         $      Margin
Personal Lines
Agency                              $ 127.0     7.0  %    $  93.5     5.1  %    $ 309.8     8.5  %    $ 208.0     5.6  %
Direct                                 86.0      7.1         92.0      8.3        184.7      7.8        133.9      6.1

Total Personal Lines                  213.0      7.0        185.5      6.3        494.5      8.2        341.9      5.8
Commercial Auto                        38.7      9.6         33.9      7.6        112.5     13.8         59.8      6.7
Other indemnity1                        2.1       NM           .3       NM          2.8       NM           .2       NM

Total underwriting operations       $ 253.8     7.4  %    $ 219.7     6.4  %    $ 609.8     8.9  %    $ 401.9     5.9  %

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.

On a year-over-year basis, our strong underwriting profitability for both the second quarter and first six months of 2009 primarily reflects modest severity trends, favorable frequency levels, and lower catastrophic losses incurred in 2009.

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               Six Months Ended
                                                      June 30,                        June 30,
Underwriting Performance1                      2009     2008   Change           2009   2008   Change
Personal Lines - Agency
Loss & loss adjustment expense ratio            71.8    73.5     (1.7 ) pts.    70.4   73.0     (2.6 ) pts.
Underwriting expense ratio                      21.2    21.4      (.2 ) pts.    21.1   21.4      (.3 ) pts.

Combined ratio                                  93.0    94.9     (1.9 ) pts.    91.5   94.4     (2.9 ) pts.

Personal Lines - Direct
Loss & loss adjustment expense ratio            72.1    71.5      .6  pts.      71.5   73.1     (1.6 ) pts.
Underwriting expense ratio                      20.8    20.2      .6  pts.      20.7   20.8      (.1 ) pts.

Combined ratio                                  92.9    91.7     1.2  pts.      92.2   93.9     (1.7 ) pts.

. . .