EX-13.0 14 exhibit13annualreport2016.htm EXHIBIT 13.0 Exhibit


Exhibit 13
 
 
 
THE PROGRESSIVE CORPORATION
2016 ANNUAL REPORT TO SHAREHOLDERS
 
 
 


App.-A-1




The Progressive Corporation and Subsidiaries
Consolidated Statements of Comprehensive Income
For the years ended December 31,
(millions—except per share amounts)
2016

2015

2014

Revenues



Net premiums earned
$
22,474.0

$
19,899.1

$
18,398.5

Investment income
478.9

454.6

408.4

Net realized gains (losses) on securities:



Net impairment losses recognized in earnings
(86.8
)
(23.8
)
(7.9
)
Net realized gains (losses) on securities
137.9

136.5

232.1

Total net realized gains (losses) on securities
51.1

112.7

224.2

Fees and other revenues
332.5

302.0

309.1

Service revenues
103.3

86.3

56.0

Gains (losses) on extinguishment of debt
1.6

(0.9
)
(4.8
)
Total revenues
23,441.4

20,853.8

19,391.4

Expenses



Losses and loss adjustment expenses
16,879.6

14,342.0

13,306.2

Policy acquisition costs
1,863.8

1,651.8

1,524.0

Other underwriting expenses
2,972.0

2,712.1

2,467.1

Investment expenses
22.4

22.8

18.9

Service expenses
92.0

77.5

50.9

Interest expense
140.9

136.0

116.9

Total expenses
21,970.7

18,942.2

17,484.0

Net Income



Income before income taxes
1,470.7

1,911.6

1,907.4

Provision for income taxes
413.5

611.1

626.4

Net income
1,057.2

1,300.5

1,281.0

Net (income) loss attributable to noncontrolling interest (NCI)
(26.2
)
(32.9
)
0

Net income attributable to Progressive
$
1,031.0

$
1,267.6

$
1,281.0

Other Comprehensive Income (Loss)



Changes in:
 
 
 
  Total net unrealized gains (losses) on securities
$
130.6

$
(212.9
)
$
74.9

Net unrealized losses on forecasted transactions
(1.2
)
(9.7
)
(2.6
)
Foreign currency translation adjustment
0.4

(1.2
)
(0.9
)
Other comprehensive income (loss)
129.8

(223.8
)
71.4

Other comprehensive (income) loss attributable to NCI
3.2

1.1

0

Comprehensive income attributable to Progressive
$
1,164.0

$
1,044.9

$
1,352.4

Computation of Per Share Earnings Attributable to Progressive



Average shares outstanding — Basic
581.7

585.5

590.6

Net effect of dilutive stock-based compensation
3.3

3.7

4.2

Total average equivalent shares — Diluted
585.0

589.2

594.8

Basic: Earnings per share
$
1.77

$
2.16

$
2.17

Diluted: Earnings per share
$
1.76

$
2.15

$
2.15

See notes to consolidated financial statements.

App.-A-2




The Progressive Corporation and Subsidiaries
Consolidated Balance Sheets
December 31,
(millions)
2016

 
2015

Assets

 

Investments - Available-for-sale, at fair value:

 

        Fixed maturities (amortized cost: $16,287.1 and $15,347.9)
$
16,243.8

 
$
15,332.2

     Equity securities:

 

    Nonredeemable preferred stocks (cost: $734.2 and $674.2)
853.5

 
782.6

    Common equities (cost: $1,437.5 and $1,494.3)
2,812.4

 
2,650.5

        Short-term investments (amortized cost: $3,572.9 and $2,172.0)
3,572.9

 
2,172.0

       Total investments
23,482.6

 
20,937.3

Cash
211.5

 
224.1

Restricted cash1
14.9


0.3

Accrued investment income
103.9

 
102.2

Premiums receivable, net of allowance for doubtful accounts of $186.8 and $164.8
4,509.2

 
3,987.7

Reinsurance recoverables, including $83.8 and $46.1 on paid losses and loss adjustment expenses
1,884.8

 
1,488.8

Prepaid reinsurance premiums
170.5

 
199.3

Deferred acquisition costs
651.2

 
564.1

Property and equipment, net of accumulated depreciation of $845.8 and $778.3
1,177.1

 
1,037.2

Goodwill
449.4

 
447.6

Intangible assets, net of accumulated amortization of $109.5 and $47.4
432.8

 
494.9

Other assets
339.6

 
335.8

Total assets
$
33,427.5

 
$
29,819.3

Liabilities

 

Unearned premiums
$
7,468.3

 
$
6,621.8

Loss and loss adjustment expense reserves
11,368.0

 
10,039.0

Net deferred income taxes
111.3

 
109.3

Dividends payable
395.4

 
519.2

Accounts payable, accrued expenses, and other liabilities2
2,495.5

 
2,067.8

Debt3
3,148.2

 
2,707.9

Total liabilities
24,986.7

 
22,065.0

Redeemable noncontrolling interest (NCI)4
483.7

 
464.9

Shareholders' Equity


 


Common shares, $1.00 par value (authorized 900.0; issued 797.5 and 797.6 including treasury shares of 217.6 and 214.0)
579.9

 
583.6

Paid-in capital
1,303.4

 
1,218.8

Retained earnings
5,140.4

 
4,686.6

Accumulated other comprehensive income:

 

Net unrealized gains (losses) on securities
939.6

 
809.0

Net unrealized losses on forecasted transactions
(9.4
)
 
(8.2
)
Foreign currency translation adjustment
(1.1
)
 
(1.5
)
Accumulated other comprehensive (income) loss attributable to NCI
4.3

 
1.1

 Total accumulated other comprehensive income attributable to Progressive
933.4

 
800.4

Total shareholders’ equity
7,957.1

 
7,289.4

Total liabilities, redeemable NCI, and shareholders’ equity
$
33,427.5


$
29,819.3

 
1 See Note 1 – Reporting and Accounting Policies - Supplemental Cash Flow information for further discussion.
2 See Note 12 – Litigation and Note 13 – Commitments and Contingencies for further discussion.
3 Consists of both short-term and long-term debt. See Note 4 – Debt for further discussion.
4 See Note 15 – Redeemable Noncontrolling Interest for further discussion.

See notes to consolidated financial statements.

App.-A-3




The Progressive Corporation and Subsidiaries
Consolidated Statements of Changes in Shareholders’ Equity
For the years ended December 31,
 
(millions — except per share amounts)
2016

2015

2014

Common Shares, $1.00 Par Value



Balance, Beginning of year
$
583.6

$
587.8

$
595.8

Treasury shares purchased
(6.1
)
(7.3
)
(11.1
)
Net restricted equity awards issued/vested/(forfeited)
2.4

3.1

3.1

Balance, End of year
$
579.9

$
583.6

$
587.8

Paid-In Capital



Balance, Beginning of year
$
1,218.8

$
1,184.3

$
1,142.0

Tax benefit from vesting of equity-based compensation
9.2

16.8

12.8

Treasury shares purchased
(13.4
)
(15.2
)
(21.6
)
Net restricted equity awards (issued)/(vested)/forfeited
(2.4
)
(3.1
)
(3.1
)
Amortization of equity-based compensation
80.9

64.5

51.4

Reinvested dividends on restricted stock units
6.1

5.7

2.8

Adjustment to carrying amount of redeemable noncontrolling interest
4.2

(34.2
)
0

Balance, End of year
$
1,303.4

$
1,218.8

$
1,184.3

Retained Earnings



Balance, Beginning of year
$
4,686.6

$
4,133.4

$
3,500.0

Net income attributable to Progressive
1,031.0

1,267.6

1,281.0

Treasury shares purchased
(173.0
)
(186.0
)
(238.7
)
Cash dividends declared on common shares ($0.6808, $0.8882, and $0.6862 per share)
(394.7
)
(520.5
)
(402.6
)
Reinvested dividends on restricted stock units
(6.1
)
(5.7
)
(2.8
)
Other, net
(3.4
)
(2.2
)
(3.5
)
Balance, End of year
$
5,140.4

$
4,686.6

$
4,133.4

Accumulated Other Comprehensive Income Attributable to Progressive



Balance, Beginning of year
$
800.4

$
1,023.1

$
951.7

Attributable to noncontrolling interest
3.2

1.1

0

Other comprehensive income (loss)
129.8

(223.8
)
71.4

Balance, End of year
$
933.4

$
800.4

$
1,023.1

Total Shareholders’ Equity
$
7,957.1

$
7,289.4

$
6,928.6

There are 20.0 million Serial Preferred Shares authorized; no such shares are issued or outstanding.
There are 5.0 million Voting Preference Shares authorized; no such shares have been issued.
See notes to consolidated financial statements.


App.-A-4




The Progressive Corporation and Subsidiaries
Consolidated Statements of Cash Flows
For the years ended December 31,
(millions)
2016

2015

2014

Cash Flows From Operating Activities



Net income
$
1,057.2

$
1,300.5

$
1,281.0

Adjustments to reconcile net income to net cash provided by operating activities:



Depreciation
137.4

103.7

97.1

Net amortization of intangible assets
62.1

46.8

0

Net amortization of fixed-income securities
77.2

98.4

78.2

Amortization of equity-based compensation
85.2

66.2

51.4

Net realized (gains) losses on securities
(51.1
)
(112.7
)
(224.2
)
Net (gains) losses on disposition of property and equipment
6.6

2.0

5.4

(Gains) losses on extinguishment of debt
(1.6
)
0.9

4.8

Net loss on exchange transaction
4.5

0

0

Changes in:



Premiums receivable
(518.5
)
(421.1
)
(227.1
)
Reinsurance recoverables
(388.2
)
(202.6
)
(141.7
)
Prepaid reinsurance premiums
48.8

32.5

(10.4
)
Deferred acquisition costs
(103.8
)
(42.3
)
(9.6
)
Income taxes
(55.7
)
(107.2
)
97.5

Unearned premiums
830.7

632.4

266.4

Loss and loss adjustment expense reserves
1,323.2

917.7

378.0

Accounts payable, accrued expenses, and other liabilities
308.9

37.9

92.0

Restricted cash
(14.6
)
(0.3
)
0

Other, net
(106.4
)
(60.2
)
(13.2
)
Net cash provided by operating activities
2,701.9

2,292.6

1,725.6

Cash Flows From Investing Activities



Purchases:



Fixed maturities
(11,610.6
)
(9,311.1
)
(7,967.5
)
Equity securities
(434.2
)
(647.1
)
(369.7
)
Sales:



Fixed maturities
5,694.9

4,913.5

5,637.5

Equity securities
484.6

402.4

560.1

Maturities, paydowns, calls, and other:



Fixed maturities
4,907.4

3,579.5

2,296.6

Equity securities
0

12.0

14.3

Net sales (purchases) of short-term investments
(1,357.2
)
20.5

(876.0
)
Net unsettled security transactions
50.9

(8.2
)
(30.0
)
Purchases of property and equipment
(215.0
)
(130.7
)
(108.1
)
   Sales of property and equipment
6.2

10.6

5.9

Net cash acquired in exchange transaction
8.5

0

0

Acquisition of ARX Holding Corp., net of cash acquired
0

(752.7
)
0

Acquisition of additional shares of ARX Holding Corp.
0

(12.6
)
0

Net cash used in investing activities
(2,464.5
)
(1,923.9
)
(836.9
)
Cash Flows From Financing Activities



Proceeds from exercise of equity options
0

0.2

0

Tax benefit from vesting of equity-based compensation
9.2

16.8

12.8

Net proceeds from debt issuance
495.6

382.0

344.7

Payments of debt
(25.5
)
(20.4
)
0

Reacquisitions of debt
(18.2
)
(19.3
)
(48.9
)
Dividends paid to shareholders
(519.0
)
(403.6
)
(892.6
)
Acquisition of treasury shares
(192.5
)
(208.5
)
(271.4
)
Net cash used in financing activities
(250.4
)
(252.8
)
(855.4
)
Effect of exchange rate changes on cash
0.4

(0.2
)
0

Increase (decrease) in cash
(12.6
)
115.7

33.3

Cash, Beginning of year
224.1

108.4

75.1

Cash, End of year
$
211.5

$
224.1

$
108.4


See notes to consolidated financial statements.

App.-A-5




The Progressive Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2016, 2015, and 2014

1.  REPORTING AND ACCOUNTING POLICIES
Nature of Operations  The Progressive insurance organization began business in 1937. The Progressive Corporation, an insurance holding company, was formed in 1965. The financial results of The Progressive Corporation include its subsidiaries and affiliates (references to “subsidiaries” in these notes include affiliates as well). Our insurance subsidiaries (collectively the Progressive Group of Insurance Companies) provide personal and commercial auto insurance, residential property insurance, and other specialty property-casualty insurance and related services. Our Personal Lines segment writes insurance for personal autos and recreational vehicles, which we refer to as our special lines products, through both an independent insurance agency channel and a direct channel. Our Commercial Lines segment writes primary liability and physical damage insurance for automobiles and trucks owned and/or operated predominantly by small businesses through both the independent agency and direct channels. Our Property segment writes residential property insurance for homeowners, other property owners, and renters, primarily through the independent insurance agency channel. We operate our businesses throughout the United States; we also sell personal auto physical damage and auto property damage liability insurance in Australia.

Basis of Consolidation and Reporting The accompanying consolidated financial statements include the accounts of The Progressive Corporation and ARX Holding Corp. (ARX), and their respective wholly owned insurance and non-insurance subsidiaries and affiliates, in which Progressive or ARX has a controlling financial interest.  The Progressive Corporation owned 69.2% of the outstanding capital stock of ARX at December 31, 2016 and 2015. All intercompany accounts and transactions are eliminated in consolidation.
Estimates  We are required to make estimates and assumptions when preparing our financial statements and accompanying notes in conformity with accounting principles generally accepted in the United States of America (GAAP). As estimates develop into fact (e.g., losses are paid), results may, and will likely, differ from those estimates.
Investments  Our fixed-maturity securities, equity securities, and short-term investments are accounted for on an available-for-sale basis. See Note 2 – Investments for details regarding the composition of our investment portfolio.
Fixed-maturity securities include debt securities and redeemable preferred stocks, which may have fixed or variable principal payment schedules, may be held for indefinite periods of time, and may be used as a part of our asset/liability strategy or sold in response to changes in interest rates, anticipated prepayments, risk/reward characteristics, liquidity needs, or other economic factors. These securities are carried at fair value with the corresponding unrealized gains (losses), net of deferred income taxes, reported in accumulated other comprehensive income. Fair values are obtained from recognized pricing services or are quoted by market makers and dealers, with limited exceptions discussed in Note 3 – Fair Value.
Included in the fixed-maturity portfolio are asset-backed securities. The asset-backed securities are generally accounted for under the retrospective method. The retrospective method recalculates yield assumptions (based on changes in interest rates or cash flow expectations) historically to the inception of the investment holding period, and applies the required adjustment, if any, to the cost basis, with the offset recorded to investment income. The prospective method is used primarily for interest-only securities, non-investment-grade asset-backed securities, and certain asset-backed securities with sub-prime loan exposure or where there is a greater risk of non-performance and where it is possible the initial investment may not be substantially recovered. The prospective method requires a calculation of expected future repayments and resets the yield to allow for future period adjustments; no current period impact to investment income or the security’s cost is made based on the cash flow update. Prepayment assumptions are based on market expectations and are updated quarterly.
Equity securities include common stocks, nonredeemable preferred stocks, and other risk investments, and are reported at fair values. Changes in fair value of these securities, net of deferred income taxes, are reflected as unrealized gains (losses) in accumulated other comprehensive income. To the extent we hold any foreign equities or foreign currency hedges, any change in value due to exchange rate fluctuations would be limited by foreign currency hedges, if any, and would be recognized in income in the current period.
Short-term investments may include Eurodollar deposits, commercial paper, repurchase transactions, and other securities expected to mature within one year. In addition, short-term investments can include auction rate securities (i.e., certain municipal bonds and preferred stocks). Due to the nature of auction rate securities, these securities are classified as short-term based upon their expected auction date (generally 7-49 days) rather than on their contractual maturity date (which is greater than one year at original issuance). In the event that an auction fails, the security may need to be reclassified from short-term.

App.-A-6




Changes in fair value of these securities, net of deferred income taxes, are reflected as unrealized gains (losses) in accumulated other comprehensive income.
Trading securities are securities bought principally for the purpose of sale in the near term. To the extent we have trading securities, changes in fair value would be recognized in income in the current period. Derivative instruments, which may be used for trading purposes or classified as trading derivatives due to the characteristics of the transaction, are discussed below.
Derivative instruments may include futures, options, forward positions, foreign currency forwards, interest rate swap agreements, and credit default swaps and may be used in the portfolio for general investment purposes or to hedge the exposure to:
Changes in fair value of an asset or liability (fair value hedge),
Foreign currency of an investment in a foreign operation (foreign currency hedge), or
Variable cash flows of a forecasted transaction (cash flow hedge).
To the extent we have derivatives held for general investment purposes, these derivative instruments are recognized as either assets or liabilities and measured at fair value, with changes in fair value recognized in income as a component of net realized gains (losses) on securities during the period of change.
Derivatives designated as hedges are required to be evaluated on established criteria to determine the effectiveness of their correlation to, and ability to reduce the designated risk of, specific securities or transactions. Effectiveness is required to be reassessed regularly. Hedges that are deemed to be effective would be accounted for as follows:
Fair value hedge:  changes in fair value of the hedge, as well as the hedged item, would be recognized in income in the period of change while the hedge is in effect.
Foreign currency hedge:  changes in fair value of the hedge, as well as the hedged item, would be reflected as a change in translation adjustment as part of accumulated other comprehensive income. Gains and losses on the foreign currency hedge would offset the foreign exchange gains and losses on the foreign investment as they are recognized into income.
Cash flow hedge:  changes in fair value of the hedge would be reported as a component of accumulated other comprehensive income and subsequently amortized into earnings over the life of the hedged transaction.
If a hedge is deemed to become ineffective or discontinued, the following accounting treatment would be applied:
Fair value hedge:  the derivative instrument would continue to be adjusted through income, while the adjustment in the change in value of the hedged item would be reflected as a change in unrealized gains (losses) as part of accumulated other comprehensive income.
Foreign currency hedge:  changes in the value of the hedged item would continue to be reflected as a change in translation adjustment as part of accumulated other comprehensive income, but the derivative instrument would be adjusted through income for the current period.
Cash flow hedge:  changes in fair value of the derivative instrument would be reported in income for the current period.
For all derivative positions, net cash requirements are limited to changes in fair values, which may vary as a result of changes in interest rates, currency exchange rates, and other factors. Exposure to credit risk is limited to the carrying value; collateral may be required to limit credit risk. We have elected not to offset fair value amounts that arise from derivative positions with the same counterparty under a master netting arrangement.
Investment securities are exposed to various risks such as interest rate, market, credit, and liquidity risk. Fair values of securities fluctuate based on the nature and magnitude of changing market conditions; significant changes in market conditions could materially affect the portfolio’s value in the near term. We regularly monitor our portfolio for price changes, which might indicate potential impairments, and perform detailed reviews of securities with unrealized losses. In such cases, changes in fair value are evaluated to determine the extent to which such changes are attributable to: (i) fundamental factors specific to the issuer, such as financial condition, business prospects, or other factors, (ii) market-related factors, such as interest rates or equity market declines, or (iii) credit-related losses, where the present value of cash flows expected to be collected are lower than the amortized cost basis of the security.

We analyze our debt securities that are in a loss position to determine if we intend to sell, or if it is more likely than not that we will be required to sell, the security prior to recovery and, if so, we write down the security to its current fair value, with the entire amount of the write-down recorded to earnings. To the extent that it is more likely than not that we will hold the debt security until recovery (which could be maturity), we determine if any of the decline in value is due to a credit loss (i.e., where the present value of future cash flows expected to be collected is lower than the amortized cost basis of the security) and, if so, we recognize that portion of the impairment as a component of net realized gains (losses) in the comprehensive income

App.-A-7




statement, with the difference (i.e., non-credit related impairment) recognized as part of our net unrealized gains (losses) in accumulated other comprehensive income. When an equity security (common equity and nonredeemable preferred stock) in our investment portfolio has an unrealized loss in fair value that is deemed to be other-than-temporary, we reduce the book value of such security to its current fair value, recognizing the decline as a realized loss in the comprehensive income statement. Any future changes in fair value, either increases or decreases, are reflected as changes in unrealized gains (losses) as part of accumulated other comprehensive income.

Investment income consists of interest, dividends, and amortization. In addition to the discussion above for asset-backed securities, interest is recognized on an accrual basis using the effective yield method. Depending on the nature of the equity instruments, dividends are recorded at either the ex-dividend date or on an accrual basis.
Realized gains (losses) on securities are computed based on the first-in first-out method and include write-downs on available-for-sale securities considered to have other-than-temporary declines in fair value (excluding non-credit related impairments), as well as holding period valuation changes on derivatives, trading securities, and hybrid instruments (e.g., securities with embedded options, where the option is a feature of the overall change in the value of the instrument).
Insurance Premiums and Receivables  Insurance premiums written are earned into income on a pro rata basis over the period of risk, based on a daily earnings convention. Accordingly, unearned premiums represent the portion of premiums written that are applicable to the unexpired risk. We provide insurance and related services to individuals and small commercial accounts and offer a variety of payment plans. Generally, premiums are collected prior to providing risk coverage, minimizing our exposure to credit risk.
For our vehicle businesses, we perform a policy level evaluation to determine the extent to which the premiums receivable balance exceeds the unearned premiums balance. We then age this exposure to establish an allowance for doubtful accounts based on prior experience.
For our Property business, we do not establish an allowance for doubtful accounts since the risk of uncollectibility is relatively low. If premiums are unpaid by the policy due date, we provide advance notice of cancellation in accordance with each state's requirements and, if the premiums remain unpaid after receipt of notice, cancel the policy and write off any remaining balance.
Deferred Acquisition Costs  Deferred acquisition costs include commissions, premium taxes, and other variable underwriting and direct sales costs incurred in connection with the successful acquisition or renewal of insurance contracts. These acquisition costs, net of ceding allowances, are deferred and amortized over the policy period in which the related premiums are earned. We consider anticipated investment income in determining the recoverability of these costs. Management believes that these costs will be fully recoverable in the near term.
We do not defer any advertising costs. Total advertising costs, which are expensed as incurred, for the years ended
December 31, were:
(millions)
Advertising Costs

2016
$
756.2

2015
748.3

2014
681.8

Loss and Loss Adjustment Expense Reserves  Loss reserves represent the estimated liability on claims reported to us, plus reserves for losses incurred but not recorded (IBNR). These estimates are reported net of amounts estimated to be recoverable from salvage and subrogation. Loss adjustment expense reserves represent the estimated expenses required to settle these claims and losses. The methods of making estimates and establishing these reserves are reviewed regularly, and resulting adjustments are reflected in income in the current period. Such loss and loss adjustment expense reserves are susceptible to change in the near term.

Reinsurance  Our reinsurance transactions include premiums ceded to “Regulated” plans and “Non-Regulated” plans. The  Regulated plans in which we participate are governed by insurance regulations and include state-provided reinsurance facilities (Michigan Catastrophic Claims Association, Florida Hurricane Catastrophe Fund, North Carolina Reinsurance Facility), as well as state-mandated involuntary plans for commercial vehicles (Commercial Automobile Insurance Procedures/Plans “CAIP”) and federally regulated plans for flood (National Flood Insurance Program “NFIP”); we act as a servicing agent for CAIP and as a participant in the “Write Your Own” program for the NFIP. The Non-Regulated plans are voluntary contractual arrangements and primarily relate to our Property business. Prepaid reinsurance premiums are earned on a pro rata basis over

App.-A-8




the period of risk, based on a daily earnings convention, which is consistent with premiums written. See Note 7 – Reinsurance for further discussion.

Income Taxes  The income tax provision is calculated under the balance sheet approach. Deferred tax assets and liabilities are recorded based on the difference between the financial statement and tax bases of assets and liabilities at the enacted tax rates. The principal items giving rise to such differences are investment securities (e.g., net unrealized gains (losses), write-downs on securities determined to be other-than-temporarily impaired), loss and loss adjustment expense reserves, unearned premiums reserves, deferred acquisition costs, property and equipment, intangible assets, and non-deductible accruals. We review our deferred tax assets regularly for recoverability. See Note 5 – Income Taxes for further discussion.
Property and Equipment  Property and equipment are recorded at cost, less accumulated depreciation, and include capitalized software developed or acquired for internal use. Depreciation is recognized over the estimated useful lives of the assets using accelerated methods for computer equipment and the straight-line method for all other fixed assets. We evaluate impairment whenever events or circumstances warrant such a review. Land and buildings comprised 65% and 75% of total property and equipment at December 31, 2016 and 2015, respectively.
The useful lives for property and equipment at December 31, 2016, were:
 
Useful Lives
Computer equipment and laptops
3 years
Software licenses (internal use)
1-5 years
Capitalized software
3-10 years
Buildings, improvements, and integrated components
7-40 years
All other property and equipment
3-15 years
At December 31, 2016 and 2015, included in other assets in the consolidated balance sheets is $8.7 million of "held for sale" property, which represents the fair value of this property less the estimated costs to sell.
Total capitalized interest, which primarily relates to capitalized software projects, for the years ended December 31, was:
(millions)
Capitalized
Interest

2016
$
2.9

2015
2.4

2014
1.3

Goodwill and Intangible Assets Goodwill is the excess of the purchase price over the estimated fair value of the assets and liabilities acquired and represents the future economic benefits arising from other assets acquired that could not be individually identified and separately recognized. Substantially all of the goodwill recorded as of December 31, 2016 and 2015, relates to the April 1, 2015 acquisition of a controlling interest in ARX.
Intangible assets primarily arose through the acquisition of ARX and mainly represent the future premiums that will be recognized from the policies and agency relationships, the value of software acquired, and the value of its trade name, "American Strategic Insurance," in the marketplace at the acquisition date. The majority of the intangible assets have finite lives ranging from 7 to 14 years. See Note 16 – Goodwill and Intangible Assets for further discussion.
We evaluate our goodwill for impairment at least annually. If events or changes in circumstances indicate that the carrying value of goodwill or intangible assets may not be recoverable, we will evaluate such items for impairment.
Guaranty Fund Assessments  We are subject to state guaranty fund assessments, which provide for the payment of covered claims or other insurance obligations of insurance companies deemed insolvent. These assessments are accrued after a formal determination of insolvency has occurred, and we have written the premiums on which the assessments will be based. Assessments that are available for recoupment from policyholders are capitalized when incurred; all other assessments are expensed.
Fees and Other Revenues  Fees and other revenues primarily represent fees collected from policyholders relating to installment charges in accordance with our bill plans, as well as late payment and insufficient funds fees. Other revenues may include revenue from the sale of tax credits, rental income, and other revenue transactions.

App.-A-9




Service Revenues and Expenses  Our service businesses provide insurance-related services. Service revenues and expenses from our commission-based businesses are recorded in the period in which they are earned or incurred. Service revenues generated from processing business for involuntary CAIP plans are earned on a pro rata basis over the term of the related policies. Service expenses related to these CAIP plans are expensed as incurred.

Equity-Based Compensation  We issue time-based and performance-based restricted stock unit awards to key members of management (other than management of ARX and its subsidiaries) as our form of equity compensation, and time-based restricted stock awards to non-employee directors. Collectively, we refer to these awards as “restricted equity awards.” Compensation expense for time-based restricted equity awards with installment vesting is recognized over each respective vesting period. For performance-based restricted equity awards, compensation expense is recognized over the respective estimated vesting periods. Dividend equivalent units are credited to outstanding restricted unit awards, both time-based and performance-based, at the time a dividend is paid to shareholders.
We record an estimate for expected forfeitures of restricted equity awards based on our historical forfeiture rates. In addition, we shorten the vesting periods of certain time-based restricted equity awards based on the “qualified retirement” provisions in our equity compensation plans, under which (among other provisions) if the participant is 55 years of age or older and satisfies certain years-of-service requirements, the vesting and distribution of 50% of outstanding time-based restricted equity awards accelerates upon reaching eligibility for a qualified retirement and shortly after the grant date for each subsequent award.
ARX has nonqualified and incentive stock options outstanding that were issued prior to April 2015 as a form of equity compensation to certain of the officers and employees of ARX and its subsidiaries. These outstanding stock options are subject to the put/call features contained in the current stockholders' agreement, pursuant to which The Progressive Corporation has the right, and can be required, to purchase a portion or all of the shares underlying these awards in 2018 and 2021. See Note 15 – Redeemable Noncontrolling Interest. These stock options, which are treated for accounting purposes as liability awards, are expensed over the respective vesting periods based on the Black-Scholes value determined at period end.
The total compensation expense recognized for equity-based compensation, both our equity and liability awards, for the years ended December 31, was:
(millions)
2016

2015

2014

Pretax expense
$
85.2

$
66.2

$
51.4

Tax benefit
29.8

23.2

18.0

Earnings Per Share  Net income attributable to Progressive is used in our calculation of the per share amounts. Basic earnings per share is computed using the weighted average number of common shares outstanding during the reporting period, excluding unvested time-based and performance-based restricted equity awards that are subject to forfeiture. Diluted earnings per share includes common stock equivalents assumed outstanding during the period. Our common stock equivalents include the incremental shares assumed to be issued for:
earned but unvested time-based restricted equity awards, and
certain unvested performance-based restricted equity awards that satisfied contingency conditions for common stock equivalents during the period.
Supplemental Cash Flow Information  Cash includes only bank demand deposits. Non-cash activity includes declared but unpaid dividends. For the years ended December 31, we paid the following:
 
(millions)
2016

2015

2014

Income taxes
$
459.4

$
701.8

$
515.0

Interest
139.2

132.0

116.0


Restricted cash on our consolidated balance sheets at December 31, 2016 and 2015, represents cash received from the National Flood Insurance Program, which is restricted to pay flood claims under the "Write Your Own" program, for which American Strategic Insurance and other subsidiaries of ARX (ASI) is an administrator.


App.-A-10




New Accounting Standards
Issued
In June 2016, Financial Accounting Standards Board (FASB) issued an accounting standard update (ASU) intended to improve the timing, and enhance the accounting and disclosure, of credit losses on financial assets. Additionally, this update will modify the existing accounting guidance related to the impairment evaluation for available-for-sale debt securities and will result in the creation of an allowance for credit losses as a contra asset account. The ASU will require cumulative-effect changes to retained earnings in the period of adoption, if any occur, and will also require prospective changes on previously recorded impairments. This ASU is effective for fiscal years (including interim periods within those fiscal years) beginning after December 15, 2019 (2020 for calendar-year companies), with early adoption permissible (including interim periods within that fiscal year) beginning after December 15, 2018 (2019 for calendar-year companies). While the ASU creates additional accounting complexities related to the recognition of the impairment losses, and subsequent recoveries, through an allowance for credit losses account, we do not expect that the ASU will have a material impact on our current method of evaluating securities for credit losses or the timing or recognition of the amounts of the impairment losses.
In March 2016, the FASB issued an ASU to simplify the accounting for employee share-based payment transactions. This ASU is effective for fiscal years beginning after December 15, 2016 (2017 for calendar-year companies), with early adoption permitted. Several aspects of the ASU include income tax consequences, classification of awards as either equity or liability, and classification on the statement of cash flows. Under provisions of the ASU:
All excess tax benefits and tax deficiencies should be recognized as income tax benefit or expense in the comprehensive income statement (applied prospectively) and classified in the statement of cash flows as an operating activity (applied using either a prospective or retrospective transition method).
Companies are allowed to decide whether or not to record forfeitures of share-based awards when the forfeiture occurs or to record compensation expense over the vesting period net of estimated forfeitures (applied using a modified retrospective transition method by means of a cumulative-effect adjustment to equity upon adoption).
Companies are permitted to withhold up to the maximum statutory tax rate and still maintain equity classification of share-based awards (applied using a modified retrospective transition method by means of a cumulative-effect adjustment to equity upon adoption).
Companies are required to classify as a financing activity in the statement of cash flows the payment of cash to a taxing authority when the company withholds shares for such purpose (applied retrospectively).

We expect the change in the accounting for the excess tax benefits/deficiencies to impact our results of operations. Over the last three years, the tax benefit, which was recorded in paid in capital through December 31, 2016, was $9.2 million in 2016, $16.8 million in 2015, and $12.8 million in 2014. We currently record estimated forfeitures over the vesting period and withhold at the minimum statutory tax rate, and we do not anticipate making any changes with respect to these items, upon adoption of the ASU.

In February 2016, the FASB released an ASU intended to eliminate the off-balance-sheet accounting for leases. The new guidance will require lessees to report their operating leases as both an asset and liability on the statement of financial position and disclose key information about leasing arrangements; the expense recognition will be consistent with existing guidance. The ASU, which is required to be applied on a modified retrospective basis, will be effective for fiscal years (including interim periods within those fiscal years) beginning after December 15, 2018 (2019 for calendar-year companies). Based on our lease portfolio at December 31, 2016, and in accordance with the accounting elections available in the ASU, the increase to assets and liabilities would have been approximately $150 million, and there would have been no impact on our results of operations or cash flows. Therefore, we do not expect this standard to have a material impact on our financial condition.
In January 2016, the FASB released an ASU intended to improve the recognition and measurement of financial instruments. The new guidance will require the changes in fair value of equity securities to be recognized as a component of net income. The ASU will be effective for fiscal years beginning after December 15, 2017 (2018 for calendar-year companies) and requires prospective method of adoption with a cumulative-effect adjustment recorded to beginning retained earnings upon adoption. Although we are unable to predict the impact that this ASU will have upon adoption, had this guidance been effective for calendar year 2016, we would have recorded a cumulative-effect adjustment (i.e., reclass from accumulated other comprehensive income to retained earnings) of approximately $821 million and, on a quarterly basis during 2016, recognized after-tax net realized gains ranging from approximately $12 million to $69 million. This ASU will have no impact on comprehensive income.

In May 2014, the FASB issued an ASU related to the accounting for revenue from contracts with customers. This standard is intended to help reduce diversity in practice and enhance comparability between entities related to revenue recognition and is

App.-A-11




effective for fiscal years beginning after December 15, 2016 (2017 for calendar-year companies). Since the accounting for insurance contracts is outside of the scope of this ASU, we do not expect this standard to have a significant impact on our financial condition, cash flows, or results of operations. We are still evaluating the impact the standard might have on our service business operations, which represents less than 0.5% of our total revenues for 2016.

Adopted
In 2016, we adopted the following accounting standard updates that became effective for fiscal years beginning after December 15, 2015.
We adopted the ASU that clarified guidance regarding accounting for fees paid in a cloud computing arrangement and amended the accounting treatment for the acquisition of licenses from third-parties for internal use software. We adopted this ASU on a prospective basis and will apply the guidance for future cloud computing arrangements that we enter into.  Upon adoption, we began including the costs of our fixed-term licenses as part of the total amount of capitalized software developed or acquired for internal use, rather than recording them as prepaid assets, when applicable, and established a liability for the unpaid portion of our licenses. At December 31, 2016, we have $94 million of fixed-term licenses in our property and equipment, on a net basis, and have $75 million in other liabilities. This standard did not have a material impact on our results of operations. A technical correction was issued in December 2016 that will not change our software accounting treatment.
Another ASU adopted is related to the accounting for share-based payments when the terms of an employee award can be achieved after the requisite service period. To the extent an equity award contains provisions that permit an employee who leaves the company before the performance targets are reached to receive some or all of the benefits of the award if and as the award later vests, this standard requires companies to recognize the compensation cost during the employee's remaining service period. Since we adopted this ASU prospectively, the requirements only apply to the performance-based restricted stock unit awards granted by Progressive to its executive officers and other select senior managers after January 1, 2016. The amount of expense that was accelerated pursuant to this ASU did not have a material impact on our financial condition, cash flows, or results of operations for 2016.
Lastly, we adopted the ASU that required additional disclosures about short-duration contracts. The additional disclosures are intended to provide users of financial statements with more transparent information about an insurance entity's initial claim estimates and subsequent adjustments to those estimates, the methodologies and judgments used to estimate claims, and the timing, frequency, and severity of claims. Other than the new disclosures added to Note 6 – Loss and Loss Adjustment Expense Reserves, there was no additional impact from this standard.

App.-A-12




2.  INVESTMENTS
Our securities are reported at fair value, with the changes in fair value of these securities (other than hybrid securities and derivative instruments) reported as a component of accumulated other comprehensive income, net of deferred income taxes. The changes in fair value of the hybrid securities and derivative instruments are recorded as a component of net realized gains (losses) on securities.
The following tables present the composition of our investment portfolio by major security type, consistent with our internal classification of how we manage, monitor, and measure the portfolio. The net holding period gains (losses) represent the
amounts realized on our hybrid securities only.
 
($ in millions)
Cost

Gross Unrealized Gains

Gross Unrealized Losses

Net Realized Gains (Losses)

Fair Value

% of Total Fair Value

December 31, 2016
 
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
 
U.S. government obligations
$
2,899.2

$
0

$
(29.1
)
$
0

$
2,870.1

12.2
%
State and local government obligations
2,509.5

13.8

(20.7
)
0

2,502.6

10.7

Foreign government obligations
24.5

0

0

0

24.5

0.1

Corporate debt securities
4,557.8

17.3

(24.3
)
0.1

4,550.9

19.4

Residential mortgage-backed securities
1,448.5

23.7

(15.0
)
1.5

1,458.7

6.2

Agency residential pass-through obligations
41.2

0

(0.6
)
0

40.6

0.2

Commercial mortgage-backed securities
2,266.9

12.0

(25.5
)
0

2,253.4

9.6

Other asset-backed securities
2,350.7

4.6

(4.4
)
0.2

2,351.1

10.0

Redeemable preferred stocks
188.8

5.1

(2.0
)
0

191.9

0.8

Total fixed maturities
16,287.1

76.5

(121.6
)
1.8

16,243.8

69.2

Equity securities:
 
 
 
 
 
 
Nonredeemable preferred stocks
734.2

135.4

(16.1
)
0

853.5

3.6

Common equities
1,437.5

1,377.0

(2.1
)
0

2,812.4

12.0

Short-term investments
3,572.9

0

0

0

3,572.9

15.2

Total portfolio1,2
$
22,031.7

$
1,588.9

$
(139.8
)
$
1.8

$
23,482.6

100.0
%

App.-A-13




($ in millions)
Cost

Gross Unrealized Gains

Gross Unrealized Losses

Net Realized Gains (Losses)

Fair Value

% of Total Fair Value

December 31, 2015
 
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
 
U.S. government obligations
$
2,425.4

$
4.4

$
(0.6
)
$
0

$
2,429.2

11.6
%
State and local government obligations
2,677.6

47.5

(3.7
)
0

2,721.4

13.0

Foreign government obligations
18.6

0

0

0

18.6

0.1

Corporate debt securities
3,713.2

11.3

(33.0
)
0.1

3,691.6

17.6

Residential mortgage-backed securities
1,726.0

22.1

(20.6
)
(0.8
)
1,726.7

8.3

Agency residential pass-through obligations
90.3

0.1

(1.1
)
0

89.3

0.4

Commercial mortgage-backed securities
2,665.7

16.9

(29.4
)
0

2,653.2

12.7

Other asset-backed securities
1,771.1

1.4

(5.1
)
0.5

1,767.9

8.4

Redeemable preferred stocks
260.0

17.6

(43.3
)
0

234.3

1.1

Total fixed maturities
15,347.9

121.3

(136.8
)
(0.2
)
15,332.2

73.2

Equity securities:
 
 
 
 
 
 
Nonredeemable preferred stocks
674.2

122.8

(15.7
)
1.3

782.6

3.7

Common equities
1,494.3

1,170.4

(14.2
)
0

2,650.5

12.7

Short-term investments
2,172.0

0

0

0

2,172.0

10.4

Total portfolio1,2
$
19,688.4

$
1,414.5

$
(166.7
)
$
1.1

$
20,937.3

100.0
%

1 Our portfolio reflects the effect of unsettled security transactions and collateral on any open derivative positions; at December 31, 2016, $27.8 million was included in "other liabilities," compared to $23.1 million in "other assets" at December 31, 2015.
2 The total fair value of the portfolio at both December 31, 2016 and 2015 included $1.3 billion of securities held in a consolidated, non-insurance subsidiary of the holding company, net of any unsettled security transactions.
At December 31, 2016, bonds and certificates of deposit in the principal amount of $206.6 million were on deposit to meet state insurance regulatory and/or rating agency requirements. We did not hold any securities of any one issuer, excluding U.S. government obligations, with an aggregate cost or fair value exceeding 10% of total shareholders’ equity at December 31, 2016 or 2015. At December 31, 2016, we did not hold any debt securities that were non-income producing during the preceding 12 months.
Short-Term Investments Our short-term investments may include commercial paper and other investments that are expected to mature within one year. We did not hold any treasury bills issued by the Australian government at December 31, 2016, compared to $2.5 million at December 31, 2015, which were included in short-term investments. We did not hold any repurchase transactions where we lent collateral at December 31, 2016 or 2015. During 2016, we entered into repurchase commitment transactions, which were open for a total of three days. In these transactions, we loaned U.S. Treasury securities to internally approved counterparties in exchange for cash equal to the fair value of the securities. These transactions were entered into as overnight arrangements. On the days that we invested in repurchase transactions, the largest single outstanding balance was $240.0 million, which was open for two days; the average daily balance was $217.0 million.
Also included in short-term investments are reverse repurchase commitment transactions, where we loan cash to approved counterparties and receive U.S. Treasury Notes pledged as collateral against the cash borrowed. Our exposure to credit risk is limited due to the nature of the collateral (i.e., U.S. Treasury Notes) received. We have counterparty exposure on these trades in the event of a counterparty default to the extent the general collateral security's value is below the amount of cash we delivered to acquire the collateral. The short-term duration of the transactions (primarily overnight) reduces that exposure.
We had no open reverse repurchase commitments at December 31, 2016 or December 31, 2015. During 2016, our largest outstanding balance of reverse repurchase commitments was $265.0 million, which was open for one day. For the 38 days we invested in these transactions, the average daily balance of reverse repurchase commitments was $113.8 million.
To the extent our repurchase and reverse repurchase transactions were with the same counterparty and subject to an enforceable master netting arrangement, we could elect to offset these transactions. Consistent with past practice, we have elected not to offset these transactions and therefore report these transactions on a gross basis on our balance sheets.


App.-A-14




Hybrid Securities Included in our fixed-maturity and equity securities are hybrid securities, which are reported at fair value at December 31:
 
(millions)
2016

 
2015

Fixed maturities:
 
 
 
Corporate debt securities
$
40.1

 
$
49.1

Residential mortgage-backed securities
170.5

 
144.3

Commercial mortgage-backed securities
0

 
17.3

Other asset-backed securities
8.9

 
11.3

Total fixed maturities
219.5

 
222.0

Equity securities:
 
 
 
Nonredeemable preferred stocks
0

 
50.7

Total hybrid securities
$
219.5

 
$
272.7

Certain corporate debt securities are accounted for as hybrid securities since they were acquired at a substantial premium and contain a change-in-control put option (derivative) that permits the investor, at its sole option if and when a change in control is triggered, to put the security back to the issuer at a 1% premium to par. Due to this change-in-control put option and the substantial market premium paid to acquire these securities, there is the potential that the election to put, upon the change in control, would result in an acceleration of the recognition of the remaining premium paid on these securities in our results of operations. This would result in a loss of $3.0 million as of December 31, 2016, if all of these bonds experienced a simultaneous change in control and we elected to exercise all of our put options. The put feature limits the potential loss in value that could be experienced in the event a corporate action occurs that results in a change in control that materially diminishes the credit quality of the issuer. We are under no obligation to exercise the put option we hold if a change in control occurs.
The residential mortgage-backed securities accounted for as hybrid securities are obligations of the issuer with payments of principal based on the performance of a reference pool of loans. This embedded derivative results in the securities incorporating the risk of default from both the issuer and the related loan pool.
During 2016, we sold the commercial mortgage-backed securities referred to in the table above. These securities contained fixed interest rate reset features that would have increased the coupons in the event the securities were not fully paid off on the anticipated repayment date. These reset features had the potential to more than double our initial purchase yield for each security.
The other asset-backed security in the table above represents one hybrid security that was acquired at a deep discount to par due to a failing auction, and contains a put option that allows the investor to put that security back to the auction at par if the auction is restored. This embedded derivative had the potential to more than double our initial investment yield at acquisition.
During 2016, we sold the remaining nonredeemable preferred stocks referred to in the table above. These securities were perpetual preferred stocks with fixed-rate coupons that have call features, whereby the change in value of the call features is a component of the overall change in value of the preferred stocks.
Fixed Maturities  The composition of fixed maturities by maturity at December 31, 2016, was:
 
(millions)
Cost

 
Fair Value

Less than one year
$
3,680.5

 
$
3,682.1

One to five years
9,324.7

 
9,298.2

Five to ten years
3,226.9

 
3,197.3

Ten years or greater
55.0

 
66.2

Total
$
16,287.1

 
$
16,243.8

Asset-backed securities are classified in the maturity distribution table based upon their projected cash flows. All other securities that do not have a single maturity date are reported based upon expected average maturity. Contractual maturities may differ from expected maturities because the issuers of the securities may have the right to call or prepay obligations.


App.-A-15




Gross Unrealized Losses  As of December 31, 2016, we had $137.7 million of gross unrealized losses in our fixed-income securities (i.e., fixed-maturity securities, nonredeemable preferred stocks, and short-term investments) and $2.1 million in our common equities. We currently do not intend to sell the fixed-income securities and determined that it is more likely that we will not be required to sell these securities for the period of time necessary to recover their cost bases. A review of our fixed-income securities indicated that the issuers were current with respect to their interest obligations and that there was no evidence of deterioration of the current cash flow projections that would indicate we would not receive the remaining principal at maturity. For common equities, 95% of our common stock portfolio was indexed to the Russell 1000; as such, this portfolio may contain securities in a loss position for an extended period of time, subject to possible write-downs, as described below. We may retain these securities as long as the portfolio and index correlation remain similar. To the extent there is issuer-specific deterioration, we may write-down the securities of that issuer. The remaining 5% of our common stocks were part of a managed equity strategy selected and administered by an external investment advisor. If our review of loss position securities were to indicate there was a fundamental, or market, impairment on these securities that was determined to be other-than-temporary, we would recognize a write-down in accordance with our stated policy.
The following tables show the composition of gross unrealized losses by major security type and by the length of time that individual securities have been in a continuous unrealized loss position:
 
 
Total No. of Sec.

Total
Fair
Value
Gross Unrealized Losses

Less than 12 Months
 
12 Months or Greater
($ in millions)
No. of Sec.

Fair
Value

Unrealized Losses

 
No. of Sec.

Fair
 Value

Unrealized Losses

December 31, 2016
 
 
 
 
 
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
 
 
 
 
 
U.S. government obligations
30

$
2,774.0

$
(29.1
)
30

$
2,774.0

$
(29.1
)
 
0

$
0

$
0

State and local government obligations
618

1,497.9

(20.7
)
584

1,404.3

(19.6
)
 
34

93.6

(1.1
)
Corporate debt securities
184

2,615.1

(24.3
)
175

2,559.9

(24.0
)
 
9

55.2

(0.3
)
Residential mortgage-backed securities
178

917.7

(15.0
)
69

175.8

(1.1
)
 
109

741.9

(13.9
)
Agency residential pass-through obligations
55

36.0

(0.6
)
48

33.9

(0.6
)
 
7

2.1

0

Commercial mortgage-backed securities
111

1,347.3

(25.5
)
85

1,061.2

(22.9
)
 
26

286.1

(2.6
)
Other asset-backed securities
103

1,605.2

(4.4
)
89

1,423.3

(3.9
)
 
14

181.9

(0.5
)
Redeemable preferred stocks
2

31.0

(2.0
)
0

0

0

 
2

31.0

(2.0
)
Total fixed maturities
1,281

10,824.2

(121.6
)
1,080

9,432.4

(101.2
)
 
201

1,391.8

(20.4
)
Equity securities:


 
 
 
 
 
 
 
 
 
Nonredeemable preferred stocks
13

329.6

(16.1
)
8

175.2

(3.8
)
 
5

154.4

(12.3
)
Common equities
75

22.1

(2.1
)
69

19.7

(1.7
)
 
6

2.4

(0.4
)
Total equity securities
88

351.7

(18.2
)
77

194.9

(5.5
)
 
11

156.8

(12.7
)
Total portfolio
1,369

$
11,175.9

$
(139.8
)
1,157

$
9,627.3

$
(106.7
)
 
212

$
1,548.6

$
(33.1
)
 

App.-A-16




 
Total No. of Sec.

Total
Fair
Value

Gross
Unrealized
Losses

Less than 12 Months
 
12 Months or Greater
($ in millions)
No. of Sec.

Fair
Value

Unrealized
Losses

 
No. of Sec.

Fair
Value

Unrealized
Losses

December 31, 2015
 
 
 
 
 
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
 
 
 
 
 
U.S. government obligations
22

$
897.1

$
(0.6
)
22

$
897.1

$
(0.6
)
 
0

$
0

$
0

State and local government obligations
290

606.7

(3.7
)
264

500.7

(2.6
)
 
26

106.0

(1.1
)
Corporate debt securities
215

2,580.6

(33.0
)
197

2,294.6

(25.2
)
 
18

286.0

(7.8
)
Residential mortgage-backed securities
188

1,294.7

(20.6
)
115

493.4

(3.7
)
 
73

801.3

(16.9
)
Agency residential pass-through obligations
61

84.9

(1.1
)
61

84.9

(1.1
)
 
0

0

0

Commercial mortgage-backed securities
207

2,046.5

(29.4
)
171

1,694.6

(25.8
)
 
36

351.9

(3.6
)
Other asset-backed securities
101

1,548.6

(5.1
)
92

1,472.0

(4.5
)
 
9

76.6

(0.6
)
Redeemable preferred stocks
9

199.4

(43.3
)
6

119.4

(14.5
)
 
3

80.0

(28.8
)
Total fixed maturities
1,093

9,258.5

(136.8
)
928

7,556.7

(78.0
)
 
165

1,701.8

(58.8
)
Equity securities:
 
 
 
 
 
 
 
 
 
 
Nonredeemable preferred stocks
10

301.8

(15.7
)
5

124.2

(1.7
)
 
5

177.6

(14.0
)
Common equities
64

164.8

(14.2
)
60

161.4

(14.2
)
 
4

3.4

0

Total equity securities
74

466.6

(29.9
)
65

285.6

(15.9
)
 
9

181.0

(14.0
)
Total portfolio
1,167

$
9,725.1

$
(166.7
)
993

$
7,842.3

$
(93.9
)
 
174

$
1,882.8

$
(72.8
)

During 2016, the number of securities in our fixed-maturity portfolio with unrealized losses increased, primarily in the less than 12 month segment of the table, as a result of rising interest rates since December 31, 2015. We had no material decreases in valuation as a result of credit rating downgrades on our fixed-maturity securities during the year. All of the fixed-maturity securities in an unrealized loss position at December 31, 2016 in the table above are current with respect to required principal and interest payments. Unrealized losses on our nonredeemable preferred stocks related to 13 issues with unrealized losses, averaging approximately 5% of our total cost of those securities. We reviewed these securities and concluded that the unrealized losses are market-related adjustments to the values, which were determined not to be other-than-temporary; we expect to recover our initial investments on these securities. The number of issuers with unrealized losses in our common stock portfolio increased during 2016. A review of the securities in a loss position did not uncover fundamental issues with the issuers that would indicate other-than-temporary impairments existed. Additionally, market expectations for recovery in the next 12 months would put the fair values at or above our current book values. Lastly, we determined, as of the balance sheet date, that it was not likely these securities would be sold prior to that recovery.

Other-Than-Temporary Impairment (OTTI)  The following table shows the total non-credit portion of the OTTI recorded in accumulated other comprehensive income, reflecting the original non-credit loss at the time the credit impairment was determined (i.e., unadjusted for valuation changes subsequent to the original write-down):
 
 
December 31,
(millions)
2016

2015

Fixed maturities:
 
 
Residential mortgage-backed securities
$
(43.3
)
$
(43.3
)
Commercial mortgage-backed securities
(0.6
)
(0.6
)
Total fixed maturities
$
(43.9
)
$
(43.9
)

App.-A-17




The following tables provide rollforwards of the amounts related to credit losses recognized in earnings for the periods ended December 31, 2016, 2015, and 2014, for which a portion of the OTTI losses were also recognized in accumulated other comprehensive income at the time the credit impairments were determined and recognized:
 
(millions)
Residential
Mortgage-
Backed

Commercial
Mortgage-
Backed

Total

Total at December 31, 2015
$
12.4

$
0.4

$
12.8

Reductions for securities sold/matured
0

0

0

Change in recoveries of future cash flows expected to be collected1,2
(1.3
)
0

(1.3
)
Total at December 31, 2016
$
11.1

$
0.4

$
11.5

(millions)
Residential
Mortgage-
Backed

Commercial
Mortgage-
Backed

Total

Total at December 31, 2014
$
12.7

$
0.4

$
13.1

Reductions for securities sold/matured
(1.4
)
0

(1.4
)
Change in recoveries of future cash flows expected to be collected1,2
1.1

0

1.1

Total at December 31, 2015
$
12.4

$
0.4

$
12.8


(millions)
Residential
Mortgage-
Backed

Commercial
Mortgage-
Backed

Total

Total at December 31, 2013
$
19.2

$
0.4

$
19.6

Reductions for securities sold/matured
(0.1
)
0

(0.1
)
Change in recoveries of future cash flows expected to be collected1,2
(6.4
)
0

(6.4
)
Total at December 31, 2014
$
12.7

$
0.4

$
13.1


1 Reflects expected recovery of prior period impairments that will be accreted into income over the remaining life of the security.
2 Includes $1.9 million, $2.9 million, and $4.3 million at December 31, 2016, 2015, and 2014, respectively, recognized in income in excess of the cash flows expected to be collected at the time of the write-downs.
During 2016, we recorded $25.4 million in write-downs on securities in our redeemable preferred stock portfolio. These securities had been in an unrealized loss position for greater than 12 months. During the year, we determined that we did not intend to hold these securities for the period of time necessary to recover their respective cost bases, given our evaluation of the length of time for such recovery.
For the remaining securities in our fixed-income portfolio, although we determined it is more likely that we will not be required to sell the securities prior to the recovery of their respective cost bases (which could be maturity), we are required to measure the amount of potential credit losses on the securities that were in an unrealized loss position. In that process, we considered a number of factors and inputs related to the individual securities. The methodology and significant inputs used to measure the amount of credit losses in our portfolio included: current performance indicators on the business model or underlying assets (e.g., delinquency rates, foreclosure rates, and default rates); credit support (via current levels of subordination); historical credit ratings; and updated cash flow expectations based upon these performance indicators. In order to determine the amount of credit loss, if any, the net present value of the cash flows expected (i.e., expected recovery value) was calculated using the current book yield for each security, and was compared to its current amortized value. In the event that the net present value was below the amortized value, a credit loss would be deemed to exist, and the security would be written down. We did not have any credit impairment write-downs for the periods ended December 31, 2016, 2015 or 2014.

App.-A-18




Realized Gains (Losses)  The components of net realized gains (losses) for the years ended December 31, were:
 
(millions)
2016

2015

2014

Gross realized gains on security sales
 
 
 
Fixed maturities:
 
 
 
U.S. government obligations
$
24.6

$
17.5

$
24.0

State and local government obligations
16.0

7.8

9.3

Corporate and other debt securities
43.3

31.2

37.2

Residential mortgage-backed securities
2.4

4.9

2.7

Agency residential pass-through obligations
0.1

0

0

Commercial mortgage-backed securities
13.3

15.7

17.0

Redeemable preferred stocks
20.9

0.1

2.7

Total fixed maturities
120.6

77.2

92.9

Equity securities:
 
 
 
Nonredeemable preferred stocks
11.9

65.3

90.0

Common equities
61.3

50.4

107.3

         Short-term investments
0.1

0

0

Subtotal gross realized gains on security sales
193.9

192.9

290.2

Gross realized losses on security sales
 
 
 
Fixed maturities:
 
 
 
U.S. government obligations
(2.4
)
(0.9
)
(7.6
)
State and local government obligations
(1.6
)
(0.3
)
(0.5
)
Corporate and other debt securities
(2.5
)
(5.0
)
(2.8
)
Residential mortgage-backed securities
0

(0.4
)
(0.2
)
Agency residential pass-through obligations
(0.2
)
(0.4
)
0

Commercial mortgage-backed securities
(5.6
)
(1.3
)
(8.3
)
Redeemable preferred stocks
(6.6
)
0

(3.2
)
Total fixed maturities
(18.9
)
(8.3
)
(22.6
)
Equity securities:
 
 
 
Nonredeemable preferred stocks
(5.3
)
(3.2
)
0

Common equities
(15.7
)
(38.4
)
(7.3
)
         Short-term investments
(0.1
)
0

0

Subtotal gross realized losses on security sales
(40.0
)
(49.9
)
(29.9
)
Net realized gains (losses) on security sales
 
 
 
Fixed maturities:
 
 
 
U.S. government obligations
22.2

16.6

16.4

State and local government obligations
14.4

7.5

8.8

Corporate and other debt securities
40.8

26.2

34.4

Residential mortgage-backed securities
2.4

4.5

2.5

Agency residential pass-through obligations
(0.1
)
(0.4
)
0

Commercial mortgage-backed securities
7.7

14.4

8.7

Redeemable preferred stocks
14.3

0.1

(0.5
)
Total fixed maturities
101.7

68.9

70.3

Equity securities:
 
 
 
Nonredeemable preferred stocks
6.6

62.1

90.0

Common equities
45.6

12.0

100.0

Subtotal net realized gains (losses) on security sales
153.9

143.0

260.3

Other-than-temporary impairment losses
 
 
 
Fixed maturities:
 
 
 
Redeemable preferred stocks
(25.3
)
0

0

Total fixed maturities
(25.3
)
0

0

Equity securities:
 
 
 
Common equities
(0.3
)
(8.7
)
(7.2
)
Subtotal investment other-than-temporary impairment losses
(25.6
)
(8.7
)
(7.2
)
Other asset impairment
(59.7
)
0

0

       Subtotal other-than-temporary impairment losses
(85.3
)
(8.7
)
(7.2
)
Other gains (losses)
 
 
 
Hybrid securities
2.1

(1.3
)
30.5

Derivative instruments
(20.0
)
(20.7
)
(64.1
)
Litigation settlements
0.4

0.4

4.7

Subtotal other gains (losses)
(17.5
)
(21.6
)
(28.9
)
Total net realized gains (losses) on securities
$
51.1

$
112.7

$
224.2


Gross realized gains and losses were predominantly the result of sales transactions in our fixed-income portfolio related to

App.-A-19




movements in credit spreads and interest rates and sales from our equity portfolios. In addition, gains and losses reflect
recoveries from litigation settlements related to investments and holding period valuation changes on hybrids and derivatives. Also included are write-downs for securities determined to be other-than-temporarily impaired. The other asset impairment relates to renewable energy investments, which are reflected in "other assets" on the balance sheet, under which the future pretax cash flows are expected to be less than the carrying value of the assets.
Net Investment Income  The components of net investment income for the years ended December 31, were:
 
(millions)
2016

2015

2014

Fixed maturities:
 
 
 
U.S. government obligations
$
18.2

$
28.3

$
46.2

State and local government obligations
52.3

60.7

50.1

Foreign government obligations
0.4

0.4

0.4

Corporate debt securities
110.7

102.4

82.1

Residential mortgage-backed securities
46.1

52.2

44.9

Agency residential pass-through obligations
1.2

2.1

0

Commercial mortgage-backed securities
81.6

74.6

66.0

Other asset-backed securities
28.0

22.0

16.7

Redeemable preferred stocks
14.9

15.0

15.5

Total fixed maturities
353.4

357.7

321.9

Equity securities:
 
 
 
Nonredeemable preferred stocks
48.6

43.7

38.6

Common equities
57.2

51.0

46.6

Short-term investments
19.7

2.2

1.3

Investment income
478.9

454.6

408.4

Investment expenses
(22.4
)
(22.8
)
(18.9
)
Net investment income
$
456.5

$
431.8

$
389.5


The amount of investment income (interest and dividends) we recognize varies from year to year based on the average assets during the year and the book yields of the securities in our portfolio. In addition to proceeds from debt offerings in each of the last three years, the increase in our portfolio’s average assets in 2016, compared to 2015, was the result of strong underwriting premium growth. The increase in investment income from our portfolio’s growth was slightly offset by a lower portfolio yield due to the sharp decline in interest rates (which was prevalent during most of 2016), affecting investment yields on new cash and portfolio turnover, as well as our decision to shorten our portfolio duration early in the year and invest in a higher amount of short-term paper which have lower overall yields. The increase in income in 2015 over 2014 reflects the acquisition of a controlling interest in ARX, strong underwriting profitability, and a slight increase in portfolio yields compared to 2014.
Trading Securities  At December 31, 2016 and 2015, we did not hold any trading securities and we did not have any net realized gains (losses) on trading securities for the years ended December 31, 2016, 2015, and 2014.
Derivative Instruments  For all derivative positions discussed below, realized holding period gains and losses are netted with any upfront cash that may be exchanged under the contract to determine if the net position should be classified either as an asset or liability. To be reported as a net derivative asset and a component of the available-for-sale portfolio, the inception-to-date holding period (realized) gain on the derivative position at period end would have to exceed any upfront cash received. On the other hand, a net derivative liability would include any inception-to-date realized loss plus the amount of upfront cash received (or netted, if upfront cash was paid) and would be reported as a component of other liabilities. These net derivative assets/liabilities are not separately disclosed on the balance sheet due to their immaterial effect on our financial condition, cash flows, and results of operations.


App.-A-20




The following table shows the status of our derivative instruments at December 31, 2016 and 2015, and for the years ended December 31, 2016, 2015, and 2014:
 
(millions)
 
Balance Sheet2
Comprehensive
Income Statement
 
Notional Value1
 
 
Assets
(Liabilities)
Fair Value
Pretax Net Realized
Gains (Losses)
 
 
 
 
 
Years ended
 
December 31,
 
 
December 31,
December 31,
Derivatives
designated as:
2016

2015

2014

Purpose
Classification
2016

2015

2016

2015

2014

Hedging instruments
 
 
 
 
 
 
 
 
 
 
Closed:
 
 
 
 
 
 
 
 
 
 
Ineffective cash flow hedge
$
370

$
18

$
44

Manage
interest
rate risk
NA
$
0

$
0

$
(1.3
)
$
0.2

$
0.5

Non-hedging instruments
 
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
0

750

750

Manage
portfolio
duration
Investments - fixed
maturities
0

4.4

0

(23.4
)
(64.6
)
Closed:
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
750

0

0

Manage
portfolio
duration
NA
0

0

(19.0
)
0

0

U.S. Treasury Note futures
135

691

0

Manage
portfolio
duration
NA
0

0

0.3

2.5

0

Total
NA

NA

NA

 
 
$
0

$
4.4

$
(20.0
)
$
(20.7
)
$
(64.1
)

1 The amounts represent the value held at year end for open positions and the maximum amount held during the year for closed positions.
2 To the extent we held both derivative assets and liabilities with the same counterparty that were subject to an enforceable master netting arrangement, we reported them on a gross basis on our balance sheets, consistent with our historical presentation.
NA = Not Applicable
CASH FLOW HEDGES

During 2016, we entered into a $350 million forecasted transaction to hedge against a possible rise in interest rates in anticipation of a debt offering under which we issued $500 million of 2.45% Senior Notes due 2027. When the contract was closed, the $1.4 million loss on the derivative was immediately recognized as a realized loss.
The remaining portion of our ineffective cash flow hedge, which is reflected in the table above, resulted from the repurchase of a portion of our 6.70% Fixed-to-Floating Rate Junior Subordinated Debentures due 2067 during all three years presented, and we reclassified the unrealized gain on forecasted transactions to net realized gains on securities.
During 2016, we reclassified $1.9 million from accumulated other comprehensive income to interest expense on our closed debt issuance cash flow hedges, compared to $1.8 million during 2015 and $2.0 million during 2014.
See Note 4 – Debt for further discussion.
INTEREST RATE SWAPS and U.S. TREASURY FUTURES

We use interest rate swaps and treasury futures contracts from time to time to manage the fixed-income portfolio duration. During 2016, we closed all of our remaining interest rate swap positions and, at December 31, 2016, did not have a cash collateral balance. At December 31, 2015 and 2014, we held interest rate swap positions for which we were paying a fixed rate and receiving a variable rate, effectively shortening the duration of our fixed-income portfolio. As of December 31, 2015 and 2014, the balance of the cash collateral that we had received from the applicable counterparty on our then open positions was $4.9 million and $16.1 million, respectively. We opened and closed treasury futures during 2016 and 2015; no positions were outstanding at either year end. 


App.-A-21




3. FAIR VALUE
We have categorized our financial instruments, based on the degree of subjectivity inherent in the method by which they are valued, into a fair value hierarchy of three levels, as follows:

Level 1:  Inputs are unadjusted, quoted prices in active markets for identical instruments at the measurement date (e.g., U.S. government obligations, active exchange-traded equity securities, and certain short-term securities).
Level 2:  Inputs (other than quoted prices included within Level 1) that are observable for the instrument either directly or indirectly (e.g., certain corporate and municipal bonds and certain preferred stocks). This includes: (i) quoted prices for similar instruments in active markets, (ii) quoted prices for identical or similar instruments in markets that are not active, (iii) inputs other than quoted prices that are observable for the instruments, and (iv) inputs that are derived principally from or corroborated by observable market data by correlation or other means.
Level 3:  Inputs that are unobservable. Unobservable inputs reflect our subjective evaluation about the assumptions market participants would use in pricing the financial instrument (e.g., certain structured securities and privately held investments).

Determining the fair value of the investment portfolio is the responsibility of management. As part of the responsibility, we evaluate whether a market is distressed or inactive in determining the fair value for our portfolio. We review certain market level inputs to evaluate whether sufficient activity, volume, and new issuances exist to create an active market. Based on this evaluation, we concluded that there was sufficient activity related to the sectors and securities for which we obtained valuations.

App.-A-22




The composition of the investment portfolio by major security type and our outstanding debt was:
 
 
Fair Value
 
(millions)
Level 1

Level 2

Level 3

Total

Cost

December 31, 2016
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
U.S. government obligations
$
2,870.1

$
0

$
0

$
2,870.1

$
2,899.2

State and local government obligations
0

2,502.6

0

2,502.6

2,509.5

Foreign government obligations
24.5

0

0

24.5

24.5

Corporate debt securities
0

4,550.9

0

4,550.9

4,557.8

Subtotal
2,894.6

7,053.5

0

9,948.1

9,991.0

Asset-backed securities:
 
 
 
 
 
Residential mortgage-backed
0

1,458.7

0

1,458.7

1,448.5

Agency residential pass-through obligations
0

40.6

0

40.6

41.2

Commercial mortgage-backed
0

2,253.1

0.3

2,253.4

2,266.9

Other asset-backed
0

2,351.1

0

2,351.1

2,350.7

Subtotal asset-backed securities
0

6,103.5

0.3

6,103.8

6,107.3

Redeemable preferred stocks:
 
 
 
 
 
Financials
0

59.5

0

59.5

59.8

Utilities
0

30.9

0

30.9

30.5

Industrials
0

101.5

0

101.5

98.5

Subtotal redeemable preferred stocks
0

191.9

0

191.9

188.8

Total fixed maturities
2,894.6

13,348.9

0.3

16,243.8

16,287.1

Equity securities:
 
 
 
 
 
Nonredeemable preferred stocks:
 
 
 
 
 
Financials
138.1

715.4

0

853.5

734.2

Subtotal nonredeemable preferred stocks
138.1

715.4

0

853.5

734.2

Common equities:
 
 
 
 
 
Common stocks
2,812.0

0

0

2,812.0

1,437.1

Other risk investments
0

0

0.4

0.4

0.4

Subtotal common equities
2,812.0

0

0.4

2,812.4

1,437.5

Total fixed maturities and equity securities
5,844.7

14,064.3

0.7

19,909.7

18,458.8

Short-term investments
3,009.3

563.6

0

3,572.9

3,572.9

Total portfolio
$
8,854.0

$
14,627.9

$
0.7

$
23,482.6

$
22,031.7

Debt
$
0

$
3,188.5

$
127.3

$
3,315.8

$
3,148.2



App.-A-23




 
Fair Value
 
(millions)
Level 1

Level 2

Level 3

Total

Cost

December 31, 2015
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
U.S. government obligations
$
2,429.2

$
0

$
0

$
2,429.2

$
2,425.4

State and local government obligations
0

2,721.4

0

2,721.4

2,677.6

Foreign government obligations
18.6

0

0

18.6

18.6

Corporate debt securities
0

3,691.6

0

3,691.6

3,713.2

Subtotal
2,447.8

6,413.0

0

8,860.8

8,834.8

Asset-backed securities:
 
 
 
 
 
Residential mortgage-backed
0

1,726.7

0

1,726.7

1,726.0

Agency residential pass-through obligations
0

89.3

0

89.3

90.3

Commercial mortgage-backed
0

2,643.3

9.9

2,653.2

2,665.7

Other asset-backed
0

1,767.9

0

1,767.9

1,771.1

Subtotal asset-backed securities
0

6,227.2

9.9

6,237.1

6,253.1

Redeemable preferred stocks:
 
 
 
 
 
Financials
0

92.0

0

92.0

76.8

Utilities
0

51.2

0

51.2

65.1

Industrials
0

91.1

0

91.1

118.1

Subtotal redeemable preferred stocks
0

234.3

0

234.3

260.0

Total fixed maturities
2,447.8

12,874.5

9.9

15,332.2

15,347.9

Equity securities:
 
 
 
 
 
Nonredeemable preferred stocks:
 
 
 
 
 
Financials
154.9

627.7

0

782.6

674.2

Subtotal nonredeemable preferred stocks
154.9

627.7

0

782.6

674.2

Common equities:
 
 
 
 
 
Common stocks
2,650.2

0

0

2,650.2

1,494.0

Other risk investments
0

0

0.3

0.3

0.3

Subtotal common equities
2,650.2

0

0.3

2,650.5

1,494.3

Total fixed maturities and equity securities
5,252.9

13,502.2

10.2

18,765.3

17,516.4

Short-term investments
2,056.3

115.7

0

2,172.0

2,172.0

Total portfolio
$
7,309.2

$
13,617.9

$
10.2

$
20,937.3

$
19,688.4

Debt
$
0

$
2,722.9

$
164.9

$
2,887.8

$
2,707.9

Our portfolio valuations, excluding short-term investments, classified as either Level 1 or Level 2 in the above tables are priced exclusively by external sources, including: pricing vendors, dealers/market makers, and exchange-quoted prices. During 2016 and