I. OVERVIEW

In the third quarter 2009, we achieved growth in both premiums and policies in force, and reported net income of $269.9 million, or $.40 per share. During the quarter, The Progressive Corporation's insurance subsidiaries generated underwriting profitability of 7.3%, or $249.8 million on a pretax basis. Our investment operations earned pretax net investment income of $158.5 million. During the third quarter last year, we incurred a net loss of $(684.2) million, or $(1.03) per share, reflecting over $1.4 billion of write-downs on securities determined to be other-than-temporarily impaired.

A. Operations

During the third quarter 2009, we realized a year-over-year increase of 1% in net premiums written, led by a solid increase in our Direct auto business, offset by 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 4% over the third quarter last year. Policies in force grew 13% in our Direct auto business and 3% in our special lines products, while 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 up 6%, while renewal applications increased 5%. Our Direct auto business experienced double-digit increases in both new and renewal applications, compared to the third quarter last year. The new business acquisition in our Agency auto business was up 7%, 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, with new and renewal applications decreasing 7% and 2%, respectively.

We have several initiatives underway aimed at providing consumers with distinctive new auto insurance options, including Name Your PriceŽ (a program that provides Direct auto consumers the opportunity to design a quote based on the price they would like to pay for auto insurance), a new product in our Agency auto business that is designed to help improve competitiveness through further price segmentation, and the expansion of MyRateŽ (our usage-based insurance product). These initiatives are being rolled out and may not be available in all states.

On a quarter-over-prior-year-quarter basis, for the third quarter 2009, our total auto written premium per policy decreased about 3% 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 continues to be higher on a year-over-year basis and is now about 2% and 5%, respectively, higher than at the end of the third quarter last year. Our special lines products policy life expectancy was down 1%, while Commercial Auto's policy life expectancy was about the same as in the third quarter last year.

Our 7.3% companywide underwriting profit margin for the third quarter 2009 exceeded our target of 4% and was a 2.4 point improvement over the third quarter last year. All businesses performed better than their profitability targets. During the third quarter 2009, we experienced 2.5 points of favorable prior accident year development, compared to 0.2 points in the third quarter last year. The third quarter 2009 development was primarily in our personal auto business; on a year-to-date basis, the favorable development of 0.7 points is split almost evenly between our Personal Lines and Commercial Auto products. During the third quarter 2009, as compared to the third quarter last year, our personal auto paid severity decreased about 3%. Our third quarter 2009 incurred auto accident frequency on a calendar-year basis increased nearly 5% over the third quarter 2008, reflecting increases in frequency in all of our coverages except collision; year-over-year, our frequency was up about 3% from last year.

B. Investments and Capital Management

The fair value of our investment portfolio was $14.7 billion at September 30, 2009. At the end of the third 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-maturity securities, including U.S. Treasury Notes, municipal bonds, asset-backed securities, corporate debt, as well as short-term investments). At September 30, 2009, our portfolio was allocated 18% to Group I and 82% to Group II.

During the third quarter 2009, we recorded $7.8 million of other-than-temporary impairment losses on our investment portfolio. The write-downs were within our nonredeemable preferred stock portfolio ($5.6 million) and our structured debt portfolio ($2.2 million).

As a result of the improved investment market conditions during the third quarter 2009, we reversed the remaining valuation allowance on our deferred tax asset, which reduced the provision for income taxes by $18.0 million. Management believes it is more likely than not that the deferred tax asset will be fully realized in future accounting periods.

Our overall capital position (debt and equity) increased $571.8 million during the quarter to $7.7 billion at September 30, 2009. The increase reflects our strong underwriting and investment results during the third 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 nine months ended September 30, 2009 and 2008, operations generated positive cash flows of $1,415.1 million and $1,438.5 million, respectively. During the third quarter 2009, we repurchased 4.5 million of our common shares at a total cost of $73.4 million (average cost of $16.29 per share). Year-to-date, we have repurchased 5.9 million common shares at a total cost of $93.4 million (average cost of $15.94 per share).

In June 2009, our Board of Directors approved a new authorization to repurchase up to 50 million 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 also may 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 first nine months of 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 nine 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.

Based upon our capital planning and forecasting efforts, 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 by a rating agency.

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 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. During the third quarter 2009, the insurance subsidiaries declared $250.0 million in dividends to the holding company; the dividends were paid in October 2009.

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 nine months of 2009, our total capital exceeded the sum of our regulatory capital layer plus our self-constructed extreme contingency load. At September 30, 2009, we held total capital, debt plus equity, of $7.7 billion at book value.

B. Commitments and Contingencies

During the first nine 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 first nine months of 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 September 30,             Nine Months Ended September 30,
                                                                       %                                          %
(millions)                              2009             2008        Change          2009            2008       Change
NET PREMIUMS WRITTEN
Personal Lines
Agency                              $     1,873.1    $     1,884.5       (1 )    $     5,607.6    $   5,661.6       (1 )
Direct                                    1,316.5          1,211.0        9            3,799.2        3,489.3        9

Total Personal Lines                      3,189.6          3,095.5        3            9,406.8        9,150.9        3
Commercial Auto                             360.5            409.8      (12 )          1,183.9        1,346.4      (12 )
Other indemnity                               3.4              6.1      (44 )             14.3           15.2       (6 )

Total underwriting operations       $     3,553.5    $     3,511.4        1      $    10,605.0    $  10,512.5        1

NET PREMIUMS EARNED
Personal Lines
Agency                              $     1,819.3    $     1,840.5       (1 )    $     5,463.1    $   5,534.5       (1 )
Direct                                    1,224.9          1,129.1        8            3,601.6        3,336.2        8

Total Personal Lines                      3,044.2          2,969.6        3            9,064.7        8,870.7        2
Commercial Auto                             395.4            441.1      (10 )          1,211.0        1,331.1       (9 )
Other indemnity                               5.8              5.5        5               17.7           15.6       13

Total underwriting operations       $     3,445.4    $     3,416.2        1      $    10,293.4    $  10,217.4        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.

               (thousands)              2009       2008     % Change
               POLICIES IN FORCE
               Personal Lines:
               Agency auto             4,324.1    4,348.1         (1 )
               Direct auto             3,122.2    2,770.9         13

               Total auto              7,446.3    7,119.0          5
               Special lines1          3,493.1    3,400.6          3

               Total Personal Lines   10,939.4   10,519.6          4

               Commercial Auto           524.9      554.4         (5 )

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

To analyze growth, we review growth in new policies, rate levels, and the retention characteristics of our books of business. During the third quarter and year-to-date periods, we experienced the following growth in new and renewal applications:

                                            Growth Over Prior Year
                                         Quarter            Year-to-date
                                     2009       2008       2009       2008
              Personal Lines:
              New applications         7  %       (4 )%      4  %       (6 )%
              Renewal applications     5  %       5  %       4  %       4  %
              Commercial Auto:
              New applications         (7 )%      (9 )%     (12 )%      (6 )%
              Renewal applications     (2 )%      3  %       1  %       4  %

During the third quarter 2009, new applications for our Personal Lines business experienced a solid increase, compared to the third quarter last year, with significant growth in our personal auto business applications, slightly offset by declines in our special lines products; on a year-to-date basis, total Personal Lines new applications increased 4%. Our Direct auto business continued to see double-digit increases in new applications during both the third quarter and year-to-date. Our Agency auto business also experienced an increase in both the third quarter and first nine months of 2009, albeit to a lesser extent than Direct. The decrease in our new applications in our special lines products partially resulted from the significant decline in year-over-year motorcycle and scooter sales, which reflected higher gas prices in 2008, as compared to 2009. The decline in new applications for our Commercial Auto business reflects the economic downturn, particularly in the housing and construction sectors.

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 auto consumers to design a quote based on the 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 third quarter 2009, Name Your Price is available in 32 states, including two states that rolled-out during the third quarter. We plan to expand this program to the rest of the country during the remainder of 2009 and 2010.

We also continued the rollout of a new product model in our Agency auto business to five additional states during the third quarter 2009, bringing the total number of states to 32 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 early 2010. 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 incorporates the best design elements of the Agency and Direct auto products. During the third quarter 2009, we introduced this latest product model in one state and we plan to introduce the product in three additional states late in the fourth quarter 2009.

In addition, during the third quarter 2009, we expanded MyRateŽ, our usage-based insurance product, into one additional state. This product is now available to auto customers in a total of 16 states, which includes 8 states that offer the product in both our Direct and Agency channels, 6 states that offer to Direct customers only, and 2 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.

During both the third quarter and first nine months of 2009, total personal auto written premium per policy decreased 2%-3%, despite a slight increase in rates in 2009, primarily reflecting shifts in the mix of business. On a year-over-year basis, our Agency auto business experienced a 1% increase in premium per policy on new business for both the third quarter and year-to-date and was down about 1% on renewal business for both periods. Our Direct auto premium per policy was down about 7% on new business for both the third quarter and the first nine months and 3%-4% on renewals for both periods, as compared to the same periods last year. 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 2% and 5%, respectively, while the special lines products policy life expectancy was down 1%. Our policy life expectancy in our Commercial Auto business remained relatively flat, compared to the end of the third 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.

B. Profitability

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 September 30,               Nine Months Ended September 30,
                                          2009                    2008                   2009                   2008
                                      Underwriting            Underwriting           Underwriting           Underwriting
(millions)                            Profit (Loss)          Profit (Loss)          Profit (Loss)          Profit (Loss)
                                       $        Margin         $      Margin          $       Margin         $      Margin
Personal Lines
Agency                             $   110.0      6.1  %    $  75.7     4.1  %    $   419.8     7.7  %    $ 283.7     5.1  %
Direct                                  86.0       7.0         77.3      6.8          270.7      7.5        211.2      6.3

Total Personal Lines                   196.0       6.4        153.0      5.2          690.5      7.6        494.9      5.6
Commercial Auto                         50.4      12.7         13.6      3.1          162.9     13.5         73.4      5.5
Other indemnity1                         3.4        NM           .8       NM            6.2       NM          1.0       NM

Total underwriting operations      $   249.8      7.3  %    $ 167.4     4.9  %    $   859.6     8.4  %    $ 569.3     5.6  %

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 third quarter and first nine months of 2009 primarily reflects fewer catastrophe losses in 2009 and greater favorable prior accident year development. In addition, our property damage frequency, along with our bodily injury severity, were better than expected for both the third quarter and year-to-date 2009, partially offset by an increase in bodily injury frequency in both periods.

                                                 Three Months Ended               Nine Months Ended
                                                   September 30,                    September 30,
Underwriting Performance 1                     2009     2008   Change           2009    2008   Change
Personal Lines - Agency
Loss & loss adjustment expense ratio            72.5    74.5     (2.0 ) pts.     71.1   73.5     (2.4 ) pts.
Underwriting expense ratio                      21.4    21.4       -   pts.      21.2   21.4      (.2 ) pts.

Combined ratio                                  93.9    95.9     (2.0 ) pts.     92.3   94.9     (2.6 ) pts.

Personal Lines - Direct
Loss & loss adjustment expense ratio            71.8    72.1      (.3 ) pts.     71.6   72.8     (1.2 ) pts.
Underwriting expense ratio                      21.2    21.1       .1  pts.      20.9   20.9       -   pts.

Combined ratio                                  93.0    93.2      (.2 ) pts.     92.5   93.7     (1.2 ) pts.

Total Personal Lines
Loss & loss adjustment expense ratio            72.3    73.5     (1.2 ) pts.     71.3   73.2     (1.9 ) pts.
Underwriting expense ratio                      21.3    21.3       -   pts.      21.1   21.2      (.1 ) pts.

Combined ratio                                  93.6    94.8     (1.2 ) pts.     92.4   94.4     (2.0 ) pts.

Commercial Auto
Loss & loss adjustment expense ratio            65.9    75.1     (9.2 ) pts.     65.2   73.0     (7.8 ) pts.
Underwriting expense ratio                      21.4    21.8      (.4 ) pts.     21.3   21.5      (.2 ) pts.

Combined ratio                                  87.3    96.9     (9.6 ) pts.     86.5   94.5     (8.0 ) pts.

Total Underwriting Operations2
Loss & loss adjustment expense ratio            71.4    73.7     (2.3 ) pts.     70.5   73.1     (2.6 ) pts.
Underwriting expense ratio                      21.3    21.4      (.1 ) pts.     21.1   21.3      (.2 ) pts.

Combined ratio                                  92.7    95.1     (2.4 ) pts.     91.6   94.4     (2.8 ) pts.

Accident year loss & loss adjustment expense
ratio3                                          73.9    73.9       -   pts.      71.2   72.8     (1.6 ) pts.

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

2 Combined ratios for the other indemnity businesses are not presented . . .