ITEM 1. BUSINESS

(a) General Development of Business

The Progressive insurance organization began business in 1937. The Progressive Corporation, an insurance holding company formed in 1965, currently has insurance and non-insurance subsidiaries and affiliates. Our insurance subsidiaries and affiliates provide personal and commercial auto insurance, residential property insurance, and other specialty property-casualty insurance and related services. Our vehicle insurance products protect our customers against losses due to physical damage to their motor vehicles, uninsured and underinsured bodily injury, and liability to others for personal injury or property damage arising out of the use of those vehicles. Our residential property insurance products protect our customers against losses due to damages to their structure or possessions within the structure, as well as liability for accidents occurring in the structure or on the property. Our non-insurance subsidiaries and affiliates generally support our insurance and investment operations. We operate our vehicle businesses and our property business in a majority of the United States. We also sell personal auto physical damage and auto property damage liability insurance in Australia.

The Progressive Corporation acquired a controlling interest in ARX Holding Corp. (“ARX”), the parent company of American Strategic Insurance and other insurance subsidiaries and affiliates (“ASI”) in April 2015, and we now write residential property insurance for homeowners, other property owners, and renters. As a result of this acquisition, we began reporting the Property business as a separate segment as of the acquisition date.

The Progressive Corporation and the other ARX stockholders and stock option holders are parties to a stockholders’ agreement, which addresses the parties’ respective rights and obligations. Among other provisions, the stockholders’ agreement allows, and in certain circumstances requires, The Progressive Corporation to acquire 100% of the outstanding equity of ARX by the end of 2021. These provisions are described in Note 15 – Redeemable Noncontrolling Interest to our financial statements included in our 2016 Annual Report to Shareholders, which is filed as Exhibit 13 to this Form 10-K (the “Annual Report”). Until The Progressive Corporation owns 100% of the outstanding equity of ARX, the interests of the minority stockholders in ARX’s income and assets are reflected in our financial statements as noncontrolling interest.

(b) Financial Information About Segments

Incorporated by reference from Note 10 – Segment Information in our Annual Report.

(c) Narrative Description of Business

We had net premiums written of $ 23.4 billion in 2016 , compared to $ 20.6 billion in 2015 , and $ 18.7 billion in 2014 . Our combined ratio, which we calculate by dividing the sum of our loss and loss adjustment expenses, policy acquisition costs, and other underwriting expenses, less fees and other revenues, by our net premiums earned, was 95.1 in 2016 , 92.5 in 2015 , and 92.3 in 2014 .

Organization

Our operations are run by our executive team, which consists of our Chief Executive Officer and the heads of our major business areas that report to the CEO, including a Chief Financial Officer, Chief Investment Officer, Chief Legal Officer, Chief Information Officer, Chief Human Resource Officer, and Chief Marketing Officer, along with the Presidents of Personal Lines, Commercial Lines, Claims, and Customer Relationships. Our Property business is headed by the President and Chief Executive Officer of ARX, who reports to the ARX Board of Directors; Progressive appoints three of the five members of the ARX Board. 

Our insurance and claims organizations are generally managed on a state-by-state basis, due to the nature of insurance, legal and regulatory requirements, and other local factors, and are supplemented by national operations and supported by our corporate functions. State-specific organizations typically report to a regional general manager, who then reports to the applicable group president. Separate managers and organizations are responsible for our California Agency and Australian operations.

Personal Lines

Our Personal Lines segment writes insurance for personal autos and recreational and other vehicles, which we refer to as our special lines products. This business generally offers more than one program in a single state, with each program targeted to a specific distribution channel, market, or customer group. As of December 31, 2016, we wrote personal auto insurance in all 50 states and the District of Columbia and we write the majority of our special lines products in all 50 states. We also write

personal auto insurance in Australia. The Personal Lines business accounted for 85% of total net premiums written in 2016, 86% in 2015, and 90% in 2014.

The Personal Lines segment consists of our personal auto insurance products, as well as our special lines products.

Our Personal Lines products are sold through both the Agency and Direct channels.

Our Personal Lines strategy is to be a competitively priced provider of a broad range of personal auto and special lines insurance products with distinctive service, distributed through whichever channel the customer prefers, and combined with property insurance and other products when appropriate to match our customers’ needs. Volume potential is driven by our price competitiveness, brand recognition, quality service, and the actions of our competitors, among other factors. See “Competitive Factors” below for further discussion.

We seek to refine our personal auto segmentation, underwriting models, and pricing over time. In mid-2016, we introduced our next generation auto product and will continue to roll this product out during 2017. This product version expands our use of prior claims information, adds billing and vehicle history segmentation, and expands our tiering mechanisms to afford more competitive rates for new business while providing more stable rates for our longer-tenured customers.

We also continue to invest to bring Snapshot ^® , our usage-based insurance program, to more customers. Snapshot provides customers in both the Agency and Direct channels the opportunity to improve their auto insurance rates based on their personal driving behavior. During 2016, we launched the Snapshot mobile app, which supplements the current device that customers plug into their cars. This new app improves the user experience while also reducing monitoring costs. Snapshot is currently available to our auto customers nationwide, except in California and North Carolina due to the regulatory environment.

In addition, our Personal Lines business is focused on efforts to form deeper and longer-term relationships with our customers in a strategy we call the Destination Era. In this program, we seek to leverage our Property business and products offered by unaffiliated third parties, to offer our customers access to a range of products addressing their diverse insurance needs and, if the customer chooses, to “bundle” multiple products together. Bundled products are becoming an integral part of our consumer offerings and an important part of our strategic agenda. Customers who prefer to bundle represent a sizable segment of the

market, and our experience is that they tend to stay with us longer and generally have lower claims costs. Our Destination Era strategy involves a number of initiatives, including:

Commercial Lines

The Commercial Lines segment writes primary liability, physical damage, and other auto-related insurance for automobiles and trucks owned and/or operated predominately by small businesses as a part of the commercial auto market. We offer these products in 49 states; we do not currently write Commercial Lines products in Hawaii or the District of Columbia. This business represented 11% of our total net premiums written in 2016 and 2015 and 10% in 2014. Our Commercial Lines customers on average insure approximately two vehicles. Even though we continue to write over 90% of our Commercial Lines business through the Agency channel, we are seeing more small business owners purchasing their insurance on a direct basis. For 2016, net premiums written through the Direct channel increased by 14%.

The Commercial Lines business operates in the following business market targets:

Just as in the personal auto business, we also want to be the destination insurer for small business owners. Through our Progressive Advantage ^® program, we offer our commercial auto customers general liability and business owners' policies and workers' compensation coverage written by unaffiliated insurance companies or agencies. The products are generally offered throughout the continental United States.

During 2016, we provided commercial auto and claims service to an Uber Technologies subsidiary on a pilot basis in Texas. We are learning alongside a leading technology platform in the sharing economy, while simultaneously creating new auto insurance opportunities with ridesharing and other vehicle matching service models. We will continue to evaluate this relationship before we expand to other states.

There are approximately 325 competitors in the total U.S. commercial auto market. We primarily compete with about 45 other large companies/groups, each with about $150 million or more of commercial auto premiums written annually. These leading commercial auto insurers comprise about 80% of this market. Our Commercial Lines business ranked number one in the commercial auto insurance market for 2015 based on net premiums written, and we believe that we continued to hold that position for 2016.

Property

ASI, one of the 20 largest homeowners carriers in the United States, specializes in residential property insurance, personal umbrella insurance, and primary and excess flood insurance. There are approximately 375 competitors in the homeowners insurance market nationwide. The top 20 carriers comprise about 75% of the market.

Our Property segment writes homeowners and renters insurance, primarily in the Agency channel in 38 states and the District of Columbia. ASI also acts as a participant in the "Write Your Own" program for the National Flood Insurance Program under which they write flood insurance in 40 states and the District of Columbia. Property policies are generally written on a 12-month basis. As discussed above, ASI's Property business is an important component of our Destination Era strategy.

Our Property business represented about 4% of our total net premiums written in 2016 and 3% in 2015. We tend to see more business written during the second and third quarters based on the cyclical nature of property sales. Losses also tend to be higher during the warmer weather months when storms are more prevalent. For 2016, Texas and Florida comprised 56% of our Property business based on direct premiums written.

ASI has exposure to losses from catastrophes and other severe storms. To help mitigate these risks, ASI enters into reinsurance arrangements. See the "Reinsurance" section below for further discussion of our reinsurance programs.

Other Indemnity

Our other indemnity businesses consist of managing our run-off businesses, including the run-off of our professional liability business. We had only three professional liability policies in force as of December 31, 2016, although we continue to process claims on expired policies.

Service Businesses

Our service businesses, which represent less than 1% of our total revenues and do not have a material effect on our overall operations, primarily include:

In our Direct business, we offer home, condominium, and renters insurance, among other products, written by unaffiliated insurance companies on a nationwide basis. We receive commissions for policies written under this program, all of which are used to offset the expenses associated with maintaining this program.

In our Commercial Lines business, we offer our customers the ability to package their auto coverage with other commercial coverages that are written by unaffiliated insurance companies or placed with additional companies through unaffiliated insurance agencies. This program offers general liability and business owners policies throughout the continental United States and workers’ compensation coverage in 44 states as of December 31, 2016. We receive commissions for the policies written under this program, all of which are used to offset the expenses associated with maintaining this program.

Reinsurance

We cede a portion of our direct premiums written to reinsurance plans. We participate in several mandatory state pools, including the Michigan Catastrophic Claims Association, Florida Hurricane Catastrophe Fund, and North Carolina Reinsurance Facility, as well as act as a servicing agent for state-mandated involuntary plans for commercial vehicles (CAIP plans) and as a participant in the "Write Your Own" program for federally regulated plans for flood (National Flood Insurance Program), all of which are governed by insurance regulations. We also have voluntary contractual arrangements that primarily relate to the Property business underwritten by insurance subsidiaries of ARX.

The reinsurance program in our Property business is designed to reduce overall risk while, to an extent, protecting capital from the costs associated with catastrophes. This reinsurance program has two parts:  an occurrence excess of loss program and an aggregate stop-loss agreement, generally from unaffiliated reinsurance companies, most of which are "A" rated by A.M. Best. The occurrence excess of loss program supports the goal of maintaining adequate capital within ARX’s insurance subsidiaries

while sustaining at least two one-in-one hundred year events in a single contract period. It contains several layers: privately-placed reinsurance, a catastrophe bond, and coverage obtained through the Florida Hurricane Catastrophe Fund, among other arrangements. ARX is responsible for all losses where the losses and loss adjustment expenses (LAE) do not reach the reinsurance threshold of $50 million, and for the first $50 million in loss and LAE from each of the first and second events in the same contract period that exceed the threshold. ASI may be responsible for additional losses if we experience more than two such events or if claims incurred exceed the maximum limits of the reinsurance coverage.

ARX also entered into an aggregate stop-loss agreement, effective January 1, 2017, that covers all losses except those from named storms (both hurricanes and tropical storms) and liability claims. This agreement provides $200 million of coverage if ARX’s insurance subsidiaries net loss and LAE ratio for the full year exceeds 63%. The aggregate stop-loss agreement reduces the likelihood that ARX will experience a net underwriting loss in 2017 for reasons other than named storms.

See Note 7 – Reinsurance in our Annual Report for further discussion.

Claims

We manage our vehicle claims handling on a companywide basis through approximately 200 stand-alone claims offices located throughout the United States. In addition, we operate 68 Service Centers in 51 metropolitan areas across the country, of which 55 have combined claims offices and Service Centers to improve our efficiency and manage costs. Insureds and other claimants can elect to have their vehicles repaired by repair shops of their choosing, have their vehicles repaired by one of our network shops, or have the entire repair process coordinated by representatives in one of our Service Centers. If a customer elects to repair their vehicle through a Service Center, we provide end-to-end resolution for auto physical damage losses. Customers can choose to bring their vehicles to one of these sites, where they can pick up a rental vehicle. Our representatives will arrange the repair, including pick-up and delivery of the vehicle, and inspect the vehicle once the repairs are complete. This innovative, patented approach to the vehicle repair process increases consumer satisfaction and our productivity and improves the cycle time in comparison to our other claims settlement processes. Under the Service Center and network shop options, we guarantee the repairs for as long as the customer owns or leases their car. If a customer decides not to repair their vehicle, our representatives will write an estimate and the customer can receive payment on the spot. ASI handles property claims separately through a network primarily of independent claims adjusters.

Competitive Factors

The automobile insurance and other property-casualty insurance markets in which we operate are highly competitive. Property-casualty insurers generally compete on the basis of price, agent commission rates, consumer recognition and confidence, coverages offered and other product features, claims handling, financial stability, customer service, and geographic coverage. Vigorous competition is provided by large, well-capitalized national companies in both the Agency and Direct channels, and by smaller regional insurers. In the Agency channel, some of our competitors have broad distribution networks of employed or captive agents. With widely available comparative rating services, consumers can easily compare prices among competitors. Many competitors invest heavily in advertising and marketing efforts and/or expanding their online or mobile service offerings. Over the past decade, these changes have further intensified the competitive nature of the property-casualty insurance markets in which we operate.

We rely heavily on technology and extensive data gathering and analysis to segment markets and price accurately according to risk potential. We have remained competitive by refining our risk measurement and price segmentation skills, closely managing expenses, and achieving operating efficiencies. High-quality customer service, fair and accurate claims adjusting, and strong brand recognition are also important factors in our competitive strategy. Competition in our insurance markets is affected by the pace of technological developments. An insurer’s ability to adapt to change, innovate, develop, and implement new applications and other technologies can affect its competitive position. 

In addition, there has been a proliferation of patents related to new ways in which technologies can affect competitive positions in the insurance industry. Some of our competitors have many more patents than we do. We hold a U.S. patent (expiring in 2021), and have a U.S. patent application pending, on the innovative approach to vehicle repair service used in our Service Centers, as described above, and two U.S. patents (expiring in 2028) on the Name Your Price ^® functionality on our website. In addition, we hold two patents (expiring in 2019) related to our online policy self-service technology.

We have a substantial amount of “know-how” developed from years of experience with usage-based insurance, and from analyzing the data from over 18 billion driving miles derived from usage-based devices. We believe this intellectual property provides us with a competitive advantage in the usage-based insurance market. 

State Insurance Licenses

Our insurance subsidiaries operate under licenses issued by various state insurance authorities. These licenses may be of perpetual duration or renewable periodically, provided the holder continues to meet applicable regulatory requirements. Our licenses govern the kinds of insurance coverages that may be written by our insurance subsidiaries in the issuing state. Such licenses are normally issued only after the filing of an appropriate application and the satisfaction of prescribed criteria. All licenses that are material to our subsidiaries’ businesses are in good standing.

Insurance Regulation 

Our insurance subsidiaries are generally subject to regulation and supervision by insurance departments of the jurisdictions in which they are domiciled or licensed to transact business. At least one of our insurance subsidiaries is licensed and subject to regulation in each of the 50 states and the District of Columbia. The nature and extent of such regulation and supervision varies from jurisdiction to jurisdiction. Generally, an insurance company is subject to a higher degree of regulation and supervision in its state of domicile. Our insurance subsidiaries and our mutual insurance company and Lloyds (together our mutual insurance company affiliates) are domiciled in the states of Delaware, Florida, Indiana, Louisiana, Michigan, New Jersey, New York, Ohio, Texas, and Wisconsin. In addition, California and Florida treat certain of our subsidiaries as domestic insurers for certain purposes under their “commercial domicile” laws.

State insurance laws impose numerous requirements, conditions, and limitations on the operations of insurance companies. Insurance departments have broad regulatory powers relating to those operations. Regulated areas include, among others:

Insurance departments are authorized to conduct periodic and other examinations of regulated insurers’ financial condition and operations to monitor the financial stability of the insurers and to ensure adherence to statutory accounting principles and compliance with state insurance laws and regulations. In addition, in some states, the attorney general’s office may exercise certain supervisory authority over insurance companies and, from time to time, may investigate certain insurance company practices.

Insurance departments establish and monitor compliance with capital and surplus requirements. Although the ratio of written premiums to surplus that the regulators will allow is a function of a number of factors (including applicable law, the type of business being written, the adequacy of the insurer’s reserves, and the quality of the insurer’s assets), the annual net premiums that an insurer may write historically have been perceived to be limited to a specified multiple of the insurer’s total surplus, generally 3 to 1 for property and casualty insurance, which is the target for our vehicle businesses; our Property business maintains a lower premiums-to-surplus ratio. Thus, the amount of an insurer’s statutory surplus, in certain cases, may limit its ability to grow its business. At year-end 2016 , we had net premiums written of $ 23.4 billion and statutory surplus of $8.6 billion . The combined premiums-to-surplus ratio for all of our insurance companies was 2.7 to 1. In addition, as of December 31, 2016 , we had access to $1.3 billion of securities held in a non-insurance subsidiary, portions of which could be contributed to the capital of our insurance subsidiaries to support growth or for other purposes. The National Association of Insurance Commissioners (NAIC) also has developed a risk-based capital (RBC) program to enable regulators to identify and take appropriate and timely regulatory actions relating to insurers that show signs of weak or deteriorating financial condition. RBC is a series of dynamic surplus-related formulas that contain a variety of factors that are applied to financial balances based on the degree of certain risks, such as asset, credit, and underwriting risks. At December 31, 2016 , our RBC ratios were well in excess of minimum requirements.

Insurance companies are generally required to file detailed annual and other reports with the insurance department of each jurisdiction in which they conduct business. These reports include:

State insurance laws and insurance departments also regulate investments that insurers are permitted to make. Limitations are placed on the amounts an insurer may invest in a particular issuer, as well as the aggregate amount an insurer may invest in certain types of investments. Certain investments are prohibited.

Insurance holding company laws enacted in many jurisdictions authorize insurance departments to regulate acquisitions of insurers and certain other transactions and to require periodic disclosure of specified information. These laws impose prior approval requirements for certain transactions between insurers and their affiliates and generally regulate dividend and other distributions, including loans and cash advances, between insurers and their affiliates. See the “Dividends” discussion in Item 5(c) below for further information on these dividend limitations. The scope of insurance holding company regulation has expanded as states have adopted the revised model holding company act promulgated by the NAIC in 2010.

Under state insolvency and guaranty laws, insurers can be assessed or required to contribute to state guaranty funds to cover policyholder losses resulting from the insolvency of other insurers. Insurers are also required by many states, as a condition of doing business in the state, to provide coverage to certain risks that cannot find coverage in the voluntary market. These “assigned risk” plans generally specify the types of insurance and the level of coverage that must be offered to such involuntary risks, as well as the allowable premium. Many states also have involuntary market plans, which hire a limited number of servicing carriers to provide insurance to involuntary risks. These plans, through assessments, pass underwriting and administrative expenses on to insurers that write voluntary coverages in those states.

Many states have laws and regulations that limit an insurer’s ability to exit a market. For example, certain states limit an automobile insurer’s ability to cancel or non-renew policies. Certain states also prohibit an insurer from withdrawing one or more lines of business from the state, except pursuant to a plan that is approved by the state insurance department. The state insurance department may disapprove a plan that may lead to market disruption. Laws and regulations that limit the cancellation or non-renewal of policies, or that subject program withdrawals to prior approval requirements, may restrict an insurer’s ability to exit unprofitable markets or businesses.

As mentioned above, insurance departments have regulatory authority over many other aspects of an insurer’s insurance operations, including coverages, forms, rating criteria, and rate levels. The ability to implement changes to these items on a timely basis is critical to our ability to compete effectively in the marketplace. Rate regulation varies from “use and file,” to “file and use,” to prior approval.

Regulation of insurance constantly changes as real or perceived issues and developments arise. Some changes may be due to economic developments, such as changes in investment laws made to recognize new investment products or to respond to perceived investment risks, while others reflect concerns about consumer privacy, insurance availability, prices, allegations of discriminatory pricing, underwriting practices, and solvency. In recent years, legislation, regulatory measures, and voter initiatives have been introduced, and in some cases adopted, which deal with use of non-public consumer information, cybersecurity, use of credit information in underwriting and rating, insurance rate development, rate of return limitations, and the ability of insurers to cancel or non-renew insurance policies. In addition, from time to time, the United States Congress and certain federal agencies investigate the current condition of the insurance industry to determine whether federal regulation is necessary. Since 2010, the Federal Insurance Office has been required to collect information about the insurance industry and monitor the industry for systemic risk.

In addition to our U.S. operations, we write personal auto physical damage and auto property damage liability insurance in Australia through a branch of one of our U.S. insurance subsidiaries. This insurance is primarily offered through the Internet. We do not write auto bodily injury liability or medical payment insurance in Australia. There are two primary agencies that regulate insurance in Australia: the Australian Securities and Investment Commission, which regulates consumer disclosures, and the Australian Prudential Regulatory Authority, which regulates solvency. Both agencies enforce laws within their jurisdictions, issue regulations, take enforcement actions, and, in general, have broad regulatory powers. Progressive Direct Insurance Company has been issued licenses by both agencies and the licenses are in good standing.