Progressive 2003 Annual Report Download - page 29

- APP.-B-29 -
Loss and Loss Adjustment Expense Reserves Claims costs,the Company’s most significant expense,represent payments made
and estimated future payments to be made to or on behalf of its policyholders for incurred losses,including adjusting expenses
needed to settle claims.These costs include a loss estimate for future involuntary market assignments, based on current
business,under state-mandated automobile insurance programs.Claims costs are defined by loss severity and frequency,and
influenced by the rate of inflation.Anticipated changes in these factors are taken into account when the Company establishes
premium rates and loss reserves.
The Company has seen a decline in frequency rates throughout 2003, similar to what has been experienced by the rest of
the industry.The Company’s experience may differ from that of the industry due to changes in its mix of business.For example,
during 2003, the Company had a shift in the policies in force in its Direct business from nonstandard auto and mid-market
to standard and preferred.As a result, the Company analyzes trends to distinguish changes in its experience from external
factors versus shifts in the mix of its business.
The Company’s pure premium (i.e. frequency times severity) trend was notably lower than the industry’s, driven by the
Company’s paid severity. Bodily injury severity is highly variable, but changes in severity over the last several quarters were
better than the Company had expected.The Company continues to monitor physical damage trend in evaluating its claims
handling performance and capacity.The Company is comfortable with its claims handling quality, as indicated by the
Company’s internal audit of claims files,and has increased its claims staff to enhance capacity.During the year,the Company
hired and trained 3,300 new claims resolution representatives.The Company plans to be diligent in its efforts to recognize
changes in trend and costs when setting rates and establishing loss reserves.
During 2003,the Company experienced $56.1million of favorable loss reserve development,compared to $3.5 million of
unfavorable development in 2002 and $99.0 million of favorable development in 2001.The favorable prior year development
recognized in 2003 was primarily attributable to the Company’s assigned risk reserves.The favorable assigned risk development
reflects a change in the Company’s estimate of its future operating losses due to business assigned from the New York
Automobile Insurance Plan for 2003.Starting in the second half of 2002,the Company began participating in the expanded
take-out program as designed by the governing committee of the plan and has managed its writings to maximize the assigned
risk credits.The realization of these changes,combined with a lower than expected overall plan size,has resulted in a much
lower than expected number of future assignments to the Company from the plan.The Company will continue to study the
environment in New York.
The remaining development for 2003,along with 2002 and 2001,was primarily attributable to the settlement of claims at
amounts that differed from the established reserves.The Company continues to increase the analysis intensity of its loss
reserves to improve accuracy and further enhance the Company’s understanding of its loss costs.The Company conducts
extensive reviews on a monthly basis on portions of its business to help ensure that the Company is meeting its objective of
always having reserves that are adequate, with minimal variation. Results would differ if different assumptions were made.
See the Critical Accounting Policies section of Management’s Discussion and Analysis for a discussion of the effect of changing estimates.
Adetailed discussion of the Company’s loss reserving practices can be found in its Report on Loss Reserving Practices,which was
released via Form 8-K in June 2003.
Because the Company is primarily an insurer of motor vehicles, it has limited exposure as an insurer of environmental,
asbestos and general liability claims.The Company has established reserves for these exposures in amounts that it believes to
be adequate based on information currently known.These exposures are not expected to have a material effect on the
Company’s liquidity,financial condition,cash flows or results of operations.
Underwriting Expenses Policy acquisition costs and other underwriting expenses as a percentage of premiums earned were
19.9% in 2003, 21.5% in 2002 and 21.7% in 2001. Policy acquisition costs are amortized over the policy period in which the
related premiums are earned (see Note 1 – Reporting and Accounting Policies). The increase in “other underwriting expenses,” as
shown in the 2003 income statement, primarily reflects increases in salaries and other infrastructure costs driven by the
growth in the business; 2002 results also included the cost of settling certain class action lawsuits (see Note 11 – Litigation).
During 2003,the Company incurred $12.2 million of guaranty fund assessments,compared to $21.2 million in 2002 and $14.6
million in 2001.The 2003 expense was spread across numerous states and was not attributable to any one particular insolvency,
while the 2002 expense was primarily related to the Reliance Insurance Company and Aries Insurance Company insolvencies,
and the 2001expense primarily related to Reliance.The Company believes that any assessment for known insolvencies in excess
of its current reserves will not materially affect the Company’s financial condition,cash flows or results
of operations.