EX-13 22 pgr-20171231exhibit13annua.htm EXHIBIT 13 Exhibit


Exhibit 13
 
 
 
THE PROGRESSIVE CORPORATION
2017 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)
2017

2016

2015

Revenues



Net premiums earned
$
25,729.9

$
22,474.0

$
19,899.1

Investment income
563.1

478.9

454.6

Net realized gains (losses) on securities:



Net impairment losses recognized in earnings
(64.5
)
(86.8
)
(23.8
)
Net realized gains (losses) on securities
114.1

137.9

136.5

Total net realized gains (losses) on securities
49.6

51.1

112.7

Fees and other revenues
370.6

332.5

302.0

Service revenues
126.8

103.3

86.3

Other gains (losses)
(1.0
)
1.6

(0.9
)
Total revenues
26,839.0

23,441.4

20,853.8

Expenses



Losses and loss adjustment expenses
18,808.0

16,879.6

14,342.0

Policy acquisition costs
2,124.9

1,863.8

1,651.8

Other underwriting expenses
3,480.7

2,972.0

2,712.1

Investment expenses
23.9

22.4

22.8

Service expenses
109.5

92.0

77.5

Interest expense
153.1

140.9

136.0

Total expenses
24,700.1

21,970.7

18,942.2

Net Income



Income before income taxes
2,138.9

1,470.7

1,911.6

Provision for income taxes
540.8

413.5

611.1

Net income
1,598.1

1,057.2

1,300.5

Net (income) loss attributable to noncontrolling interest (NCI)
(5.9
)
(26.2
)
(32.9
)
Net income attributable to Progressive
$
1,592.2

$
1,031.0

$
1,267.6

Other Comprehensive Income (Loss)



Changes in:
 
 
 
  Total net unrealized gains on securities
$
355.4

$
130.6

$
(212.9
)
Net unrealized losses on forecasted transactions
(5.4
)
(1.2
)
(9.7
)
Foreign currency translation adjustment
1.1

0.4

(1.2
)
Other comprehensive income (loss)
351.1

129.8

(223.8
)
Other comprehensive (income) loss attributable to NCI
(2.3
)
3.2

1.1

Comprehensive income attributable to Progressive
$
1,941.0

$
1,164.0

$
1,044.9

Computation of Per Share Earnings Attributable to Progressive



Average shares outstanding — Basic
580.8

581.7

585.5

Net effect of dilutive stock-based compensation
4.9

3.3

3.7

Total average equivalent shares — Diluted
585.7

585.0

589.2

Basic: Earnings per share
$
2.74

$
1.77

$
2.16

Diluted: Earnings per share
$
2.72

$
1.76

$
2.15

See notes to consolidated financial statements.

App.-A-2



The Progressive Corporation and Subsidiaries
Consolidated Balance Sheets
December 31,
(millions)
2017

 
2016

Assets

 

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

 

        Fixed maturities (amortized cost: $20,209.9 and $16,287.1)
$
20,201.7

 
$
16,243.8

     Equity securities:

 

    Nonredeemable preferred stocks (cost: $698.6 and $734.2)
803.8

 
853.5

    Common equities (cost: $1,499.0 and $1,437.5)
3,399.8

 
2,812.4

        Short-term investments (amortized cost: $2,869.4 and $3,572.9)
2,869.4

 
3,572.9

       Total investments
27,274.7

 
23,482.6

Cash and cash equivalents
265.0


211.5

Restricted cash
10.3


14.9

Total cash, cash equivalents, and restricted cash
275.3


226.4

Accrued investment income
119.7

 
103.9

Premiums receivable, net of allowance for doubtful accounts of $210.9 and $186.8
5,422.5

 
4,509.2

Reinsurance recoverables, including $103.3 and $83.8 on paid losses and loss adjustment expenses
2,273.4

 
1,884.8

Prepaid reinsurance premiums
203.3

 
170.5

Deferred acquisition costs
780.5

 
651.2

Property and equipment, net of accumulated depreciation of $940.6 and $845.8
1,119.6

 
1,177.1

Goodwill
452.7

 
449.4

Intangible assets, net of accumulated amortization of $175.7 and $109.5
366.6

 
432.8

Other assets
412.9

 
339.6

Total assets
$
38,701.2

 
$
33,427.5

Liabilities

 

Unearned premiums
$
8,903.5

 
$
7,468.3

Loss and loss adjustment expense reserves
13,086.9

 
11,368.0

Net deferred income taxes
135.0

 
111.3

Dividends payable
655.1

 
395.4

Accounts payable, accrued expenses, and other liabilities1
2,825.9

 
2,495.5

Debt2
3,306.3

 
3,148.2

Total liabilities
28,912.7

 
24,986.7

Redeemable noncontrolling interest (NCI)3
503.7

 
483.7

Shareholders’ Equity


 


Common shares, $1.00 par value (authorized 900.0; issued 797.5 including treasury shares of 215.8 and 217.6)
581.7

 
579.9

Paid-in capital
1,389.2

 
1,303.4

Retained earnings
6,031.7

 
5,140.4

Accumulated other comprehensive income:

 

Net unrealized gains (losses) on securities
1,295.0

 
939.6

Net unrealized losses on forecasted transactions
(14.8
)
 
(9.4
)
Foreign currency translation adjustment
0

 
(1.1
)
Accumulated other comprehensive (income) loss attributable to NCI
2.0

 
4.3

 Total accumulated other comprehensive income attributable to Progressive
1,282.2

 
933.4

Total shareholders’ equity
9,284.8

 
7,957.1

Total liabilities, redeemable NCI, and shareholders’ equity
$
38,701.2


$
33,427.5

 
1 See Note 12 – Litigation and Note 13 – Commitments and Contingencies for further discussion.
2 Consists of both short-term and long-term debt. See Note 4 – Debt for further discussion.
3 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)
2017

2016

2015

Common Shares, $1.00 Par Value



Balance, Beginning of year
$
579.9

$
583.6

$
587.8

Treasury shares purchased
(1.5
)
(6.1
)
(7.3
)
Net restricted equity awards issued/vested
3.3

2.4

3.1

Balance, End of year
$
581.7

$
579.9

$
583.6

Paid-In Capital



Balance, Beginning of year
$
1,303.4

$
1,218.8

$
1,184.3

Tax benefit from vesting of equity-based compensation
0

9.2

16.8

Treasury shares purchased
(3.4
)
(13.4
)
(15.2
)
Net restricted equity awards issued/vested
(3.3
)
(2.4
)
(3.1
)
Amortization of equity-based compensation
92.9

80.9

64.5

Reinvested dividends on restricted stock units
8.0

6.1

5.7

Adjustment to carrying amount of redeemable noncontrolling interest
(8.4
)
4.2

(34.2
)
Balance, End of year
$
1,389.2

$
1,303.4

$
1,218.8

Retained Earnings



Balance, Beginning of year
$
5,140.4

$
4,686.6

$
4,133.4

Net income attributable to Progressive
1,592.2

1,031.0

1,267.6

Treasury shares purchased
(57.6
)
(173.0
)
(186.0
)
Cash dividends declared on common shares ($1.1247, $0.6808, and $0.8882 per share)
(654.2
)
(394.7
)
(520.5
)
Reinvested dividends on restricted stock units
(8.0
)
(6.1
)
(5.7
)
Other, net
18.9

(3.4
)
(2.2
)
Balance, End of year
$
6,031.7

$
5,140.4

$
4,686.6

Accumulated Other Comprehensive Income Attributable to Progressive



Balance, Beginning of year
$
933.4

$
800.4

$
1,023.1

Attributable to noncontrolling interest
(2.3
)
3.2

1.1

Other comprehensive income (loss)
351.1

129.8

(223.8
)
Balance, End of year
$
1,282.2

$
933.4

$
800.4

Total Shareholders’ Equity
$
9,284.8

$
7,957.1

$
7,289.4

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)
2017

2016

2015

Cash Flows From Operating Activities



Net income
$
1,598.1

$
1,057.2

$
1,300.5

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



Depreciation
169.9

137.4

103.7

Amortization of intangible assets
66.2

62.1

46.8

Net amortization of fixed-income securities
86.2

77.2

98.4

Amortization of equity-based compensation
95.4

85.2

66.2

Net realized (gains) losses on securities
(49.6
)
(51.1
)
(112.7
)
Net (gains) losses on disposition of property and equipment
7.2

6.6

2.0

Other (gains) losses
1.0

(1.6
)
0.9

Net loss on exchange transaction
0

4.5

0

Changes in:



Premiums receivable
(913.2
)
(518.5
)
(421.1
)
Reinsurance recoverables
(388.6
)
(388.2
)
(202.6
)
Prepaid reinsurance premiums
(32.8
)
48.8

32.5

Deferred acquisition costs
(129.3
)
(103.8
)
(42.3
)
Income taxes
(172.6
)
(55.7
)
(107.2
)
Unearned premiums
1,434.9

830.7

632.4

Loss and loss adjustment expense reserves
1,718.8

1,323.2

917.7

Accounts payable, accrued expenses, and other liabilities
400.0

308.9

37.9

Other, net
(134.8
)
(90.2
)
(60.2
)
Net cash provided by operating activities
3,756.8

2,732.7

2,292.9

Cash Flows From Investing Activities



Purchases:



Fixed maturities
(14,587.8
)
(11,610.6
)
(9,311.1
)
Equity securities
(255.6
)
(434.2
)
(647.1
)
Sales:



Fixed maturities
5,382.5

5,694.9

4,913.5

Equity securities
252.9

484.6

402.4

Maturities, paydowns, calls, and other:



Fixed maturities
5,215.8

4,907.4

3,579.5

Equity securities
50.0

0

12.0

Net sales (purchases) of short-term investments
727.6

(1,357.2
)
20.5

Net unsettled security transactions
(33.6
)
50.9

(8.2
)
Purchases of property and equipment
(155.7
)
(215.0
)
(130.7
)
Sales of property and equipment
15.3

6.2

10.6

Acquisition of an insurance company, net of cash acquired
(18.1
)
0

0

Net cash disposed in exchange transaction1
0

(7.7
)
0

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

0

(752.7
)
Acquisition of additional shares of ARX Holding Corp.
0

0

(12.6
)
Net cash used in investing activities
(3,406.7
)
(2,480.7
)
(1,923.9
)
Cash Flows From Financing Activities



Proceeds from exercise of equity options
0.5

0

0.2

Net proceeds from debt issuance
841.1

495.6

382.0

Payments of debt
(49.0
)
(25.5
)
(20.4
)
Redemption/reacquisition of subordinated debt
(635.6
)
(18.2
)
(19.3
)
Dividends paid to shareholders
(395.4
)
(519.0
)
(403.6
)
Acquisition of treasury shares for restricted stock tax liabilities
(57.6
)
(25.1
)
(30.6
)
Acquisition of treasury shares acquired in open market
(4.9
)
(167.4
)
(177.9
)
Tax benefit from vesting of equity-based compensation
0

9.2

16.8

Net cash used in financing activities
(300.9
)
(250.4
)
(252.8
)
Effect of exchange rate changes on cash
(0.3
)
0.4

(0.2
)
Increase in cash, cash equivalents, and restricted cash
48.9

2.0

116.0

Cash, cash equivalents, and restricted cash - Beginning of year
226.4

224.4

108.4

Cash, cash equivalents, and restricted cash - End of year
$
275.3

$
226.4

$
224.4

1See Note 1 – Reporting and Accounting Policies for further information.
See notes to consolidated financial statements.

App.-A-5



The Progressive Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2017, 2016, and 2015

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.

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 69.0% of the outstanding capital stock of ARX at December 31, 2017 and 69.2% at December 31, 2016 and 2015. The decrease reflects ARX employee stock options that were exercised during 2017. 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 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. From time to time, we may also invest in municipal bonds that have maturity dates that are longer than one year, but have either liquidity facilities or mandatory put features within one year.



App.-A-6



Trading securities are securities bought principally for the purpose of sale in the near term. We do not hold any trading securities. 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).
We did not have any derivatives outstanding at December 31, 2017 and 2016. 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 statement, with the difference (i.e., non-credit related impairment) recognized as part of our net unrealized gains (losses) in

App.-A-7



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 accretion net of 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

2017
$
1,005.4

2016
756.2

2015
748.3

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 and transportation network company business written by our Commercial Lines segment. Prepaid reinsurance premiums are earned on a pro rata basis over the period of risk, based on a daily earnings convention, which is consistent with premiums written. See Note 7 – Reinsurance for further discussion.

App.-A-8




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. The effects of any changes in the tax rate are recorded to our provision for income taxes, including any changes on items initially recognized in accumulated other comprehensive income. 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 laptops and the straight-line method for all other fixed assets. We evaluate impairment whenever events or circumstances warrant such a review and write-off the impaired assets if appropriate. Land and buildings comprised 66% and 65% of total property and equipment at December 31, 2017 and 2016, respectively.
The useful lives for property and equipment at December 31, 2017, 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, 2017 and 2016, included in other assets in the consolidated balance sheets is $5.3 million and $8.7 million, respectively, 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

2017
$
2.8

2016
2.9

2015
2.4

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, 2017 and 2016, 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 that existed at the acquisition date. The majority of the intangible assets have finite lives, which, at December 31, 2017, had a remaining life range from 2 to 11 years. See Note 16 – Goodwill and Intangible Assets for further discussion.
We evaluate our goodwill for impairment at least annually using a qualitative approach. 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 using a quantitative approach.
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 ceding commissions in excess of acquisition costs, the sale of tax credits, referral fees, rental income, and other

App.-A-9



revenue transactions. Fees and other revenues are generally earned when collected, except for excess ceding commissions, which are earned over the policy period.
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 (including members of ARX and its subsidiaries in 2017) 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 stock 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 satisfies certain age and 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 the shares underlying these awards in 2018 and 2021. The vested stock options, and the shares issuable upon exercise of the stock options, are also subject to repurchase by ARX if the holder’s employment terminates. See Note 15 – Redeemable Noncontrolling Interest for further discussion. 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)
2017

2016

2015

Pretax expense
$
95.4

$
85.2

$
66.2

Tax benefit1
33.4

29.8

23.2

1Reflected at the 35% corporate federal tax rate; the revaluation to the 21% rate is reflected in the total revaluation adjustment recorded at December 31, 2017 (see Note 5 – Income Taxes for further discussion).
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 and cash equivalents include bank demand deposits and daily overnight reverse repurchase commitments of funds held in bank demand deposit accounts on ARX’s subsidiaries, which are primarily collateralized by U.S. Treasury notes. The amount of reverse repurchase commitments held by ARX’s subsidiaries at December 31, 2017, 2016, and 2015, were $247.2 million, $150.0 million, and $174.8 million, respectively. Restricted cash on our consolidated balance sheets at December 31, 2017 and 2016, represents cash that is restricted to pay flood claims under the National Flood Insurance Program’s “Write Your Own” program, for which American Strategic Insurance and other subsidiaries of ARX (ASI) are administrators. Non-cash activity includes declared but unpaid dividends.
The cash transferred in the exchange transaction, which occurred in June 2016, was revised to correct the reclassification of a

App.-A-10



non-cash transaction; there was no overall impact on the increase in cash, cash equivalents, and restricted cash that was reported in our consolidated statement of cash flows for the year ended December 31, 2016. See Note 16 – Goodwill and Intangible Assets for further discussion of the exchange transaction.
For the years ended December 31, we paid the following:
(millions)
2017

2016

2015

Income taxes
$
715.6

$
459.4

$
701.8

Interest
146.3

139.2

132.0


New Accounting Standards
Issued
In January 2018, the Financial Accounting Standards Board (FASB) proposed an Accounting Standards Update (ASU), which would provide targeted improvements to the new lease accounting guidance issued by the FASB in February 2016 (the “2016 ASU”). The 2016 ASU, which eliminates the off-balance-sheet accounting for leases, will require lessees to report their operating leases as both an asset and liability on the statement of financial position and to disclose key information about leasing arrangements in the financial statement footnotes. Under the 2016 ASU, there will be no change to the recognition of lease expense in our results of operations. The ASU will be effective for fiscal years (including interim periods within those fiscal years) beginning after December 15, 2018 (2019 for calendar-year companies). Under the proposed guidance, companies would have the option to apply the new lease requirements either as of the effective date (i.e., January 1, 2019), with comparative information presented in accordance with the previous standard, or on a modified restrospective basis, which would restate all financial statement information as of the beginning of the earliest period presented and is the transition method under the 2016 ASU. Based on our lease portfolio at December 31, 2017, and in accordance with the accounting elections available in the ASU, we would have recorded an increase to assets and liabilities of approximately $140 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 March 2017, the FASB issued an ASU related to premium amortization on purchased callable debt securities. The intent of the standard is to shorten the amortization period for certain purchased callable debt securities held at a premium. Under the ASU, the premium is required to be amortized to the earliest call date. The ASU more closely aligns interest income recorded on bonds held at a premium with the economics of the underlying instrument. The ASU, which is required to be applied on a modified retrospective basis, is effective for fiscal years beginning after December 15, 2018 (2019 for calendar-year companies), and interim periods within those fiscal years. Since we have historically used a yield-to-worst scenario for our securities that were purchased at a premium, and the first call on a premium security most often produces the lowest and most conservative yield, we do not expect this standard to have a significant impact on our financial condition, cash flows, or results of operations.
In January 2017, the FASB issued an ASU, which eliminates the requirement to determine the implied value of goodwill in measuring an impairment loss. Upon adoption, the measurement of a goodwill impairment will represent the excess of the reporting unit’s carrying value over fair value, limited to the carrying value of goodwill. This ASU is effective for goodwill impairment tests in fiscal years beginning after December 15, 2019 (2020 for calendar-year companies), with early adoption permitted. We do not expect this standard to have a material impact on our financial position or results of operations.

In June 2016, the FASB issued an 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 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

App.-A-11



ASU is effective for fiscal years beginning after December 15, 2017 (2018 for calendar-year companies) and requires the prospective method of adoption with a cumulative-effect adjustment recorded to beginning retained earnings upon adoption. In January 2018, we recorded a cumulative-effect adjustment of $1.3 billion, which is net of taxes at the 35% tax rate. The cumulative-effect adjustment represents the amount of after-tax net unrealized gains on equity securities that was recorded as part of accumulated other comprehensive income at December 31, 2017. This ASU will have no impact on comprehensive income.
Adopted
For the year ended December 31, 2017, we adopted the ASU related to the statement of cash flows and the classification and presentation of changes in restricted cash. This update requires that the statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts described as restricted cash. This ASU, which is required to be applied on a retrospective basis, is effective for fiscal years beginning after December 15, 2017, with early adoption permitted. We elected to early adopt this ASU. Since this standard only affected classification and presentation, there was no impact on our results of operations, financial condition, or cash flows.
On January 1, 2017, we adopted the ASU to simplify the accounting for employee share-based payment transactions. There were several provisions that could be adopted under this ASU. We did not elect to make any changes to our method of recording forfeitures and are continuing to withhold taxes at the minimum statutory tax rate. We did elect, on a retrospective basis, to disclose the payment of cash to a taxing authority for which we withheld shares for this purpose as a financing activity. Lastly, during the year ended December 31, 2017, we recognized $25.1 million of excess tax benefits as an income tax benefit in our consolidated statements of comprehensive income; this provision was adopted on a prospective basis.

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 (see discussion below).
 
($ in millions)
Cost

Gross Unrealized Gains

Gross Unrealized Losses

Net Realized Gains (Losses)

Fair Value

% of Total Fair Value

December 31, 2017
 
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
 
U.S. government obligations
$
6,688.8

$
1.1

$
(44.0
)
$
0

$
6,645.9

24.4
%
State and local government obligations
2,285.6

20.7

(9.3
)
0.1

2,297.1

8.4

Foreign government obligations
0

0

0

0

0

0

Corporate debt securities
4,997.2

14.8

(14.4
)
0.1

4,997.7

18.3

Residential mortgage-backed securities
828.8

11.3

(3.4
)
0

836.7

3.1

Commercial mortgage-backed securities
2,760.1

11.8

(13.3
)
0

2,758.6

10.1

Other asset-backed securities
2,454.5

4.5

(4.5
)
0.2

2,454.7

9.0

Redeemable preferred stocks
194.9

17.8

(1.5
)
(0.2
)
211.0

0.8

Total fixed maturities
20,209.9

82.0

(90.4
)
0.2

20,201.7

74.1

Equity securities:
 
 
 
 
 
 
Nonredeemable preferred stocks
698.6

114.0

(8.8
)
0

803.8

2.9

Common equities
1,499.0

1,901.0

(0.2
)
0

3,399.8

12.5

Short-term investments
2,869.4

0

0

0

2,869.4

10.5

Total portfolio1,2
$
25,276.9

$
2,097.0

$
(99.4
)
$
0.2

$
27,274.7

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, 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
1,489.7

23.7

(15.6
)
1.5

1,499.3

6.4

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
%

1 Our portfolio reflects the effect of unsettled security transactions and collateral on any open derivative positions; at December 31, 2017, $5.8 million was included in “other assets,” compared to $27.8 million in “other liabilities” at December 31, 2016.
2 The total fair value of the portfolio at December 31, 2017 and 2016 included $1.6 billion and $1.3 billion, respectively, of securities held in a consolidated, non-insurance subsidiary of the holding company, net of any unsettled security transactions.
The increase in fixed-maturity securities, primarily U.S. government obligations, and decrease in short-term investments since December 31, 2016, was due to a decision to slightly lengthen the average maturity of the portfolio late in the fourth quarter 2017 in response to the rising interest rate environment.
At December 31, 2017, bonds and certificates of deposit in the principal amount of $222.6 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, 2017 or 2016. At December 31, 2017, 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 or are redeemable within one year. We did not hold any treasury bills issued by the Australian government at December 31, 2017 or 2016.
We did not have any open repurchase or reverse repurchase transactions in our short-term investment portfolio at December 31, 2017 or 2016. To the extent we had any repurchase and reverse repurchase transactions 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.
Hybrid Securities Included in our fixed maturities are hybrid securities, which are reported at fair value at December 31:
 
(millions)
2017

 
2016

State and local government obligations
$
6.1

 
$
0

Corporate debt securities
99.8

 
40.1

Residential mortgage-backed securities
0

 
170.5

Other asset-backed securities
6.7

 
8.9

Redeemable preferred stocks
30.3

 
0

Total hybrid securities
$
142.9

 
$
219.5



App.-A-14



Certain securities in our portfolio are accounted for as hybrid securities because they contain embedded derivatives that are not deemed to be clearly and closely related to the host investments. Since the embedded derivative does not have an observable intrinsic value (e.g., change-in-control put options, debt-to-equity conversion, or any other feature unrelated to the credit quality or risk of default of the issuer that could impact the amount or timing of our expected future cash flows), we have elected to record the change in fair value of the entire security through income as a realized gain or loss.
Fixed Maturities  The composition of fixed maturities by maturity at December 31, 2017, was:
 
(millions)
Cost

 
Fair Value

Less than one year
$
3,964.1

 
$
3,980.0

One to five years
12,706.5

 
12,671.3

Five to ten years
3,294.4

 
3,306.9

Ten years or greater
244.9

 
243.5

Total
$
20,209.9

 
$
20,201.7

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.

Gross Unrealized Losses  As of December 31, 2017, we had $99.2 million of gross unrealized losses in our fixed-income securities (i.e., fixed-maturity securities and nonredeemable preferred stocks) and $0.2 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, 96% 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 4% 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, 2017
 
 
 
 
 
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
 
 
 
 
 
U.S. government obligations
58

$
5,817.0

$
(44.0
)
41

$
4,869.3

$
(34.6
)
 
17

$
947.7

$
(9.4
)
State and local government obligations
358

1,200.3

(9.3
)
230

737.6

(4.4
)
 
128

462.7

(4.9
)
Corporate debt securities
222

2,979.4

(14.4
)
171

2,072.9

(9.1
)
 
51

906.5

(5.3
)
Residential mortgage-backed securities
201

300.9

(3.4
)
30

75.1

(0.2
)
 
171

225.8

(3.2
)
Commercial mortgage-backed securities
105

1,682.3

(13.3
)
63

1,221.2

(5.9
)
 
42

461.1

(7.4
)
Other asset-backed securities
197

1,837.3

(4.5
)
134

1,377.8

(3.3
)
 
63

459.5

(1.2
)
Redeemable preferred stocks
2

21.8

(1.5
)
1

10.8

(0.1
)
 
1

11.0

(1.4
)
Total fixed maturities
1,143

13,839.0

(90.4
)
670

10,364.7

(57.6
)
 
473

3,474.3

(32.8
)
Equity securities:


 
 
 
 
 
 
 
 
 
Nonredeemable preferred stocks
4

127.8

(8.8
)
1

56.5

(0.5
)
 
3

71.3

(8.3
)
Common equities
19

13.4

(0.2
)
18

13.4

(0.2
)
 
1

0

0

Total equity securities
23

141.2

(9.0
)
19

69.9

(0.7
)
 
4

71.3

(8.3
)
Total portfolio
1,166

$
13,980.2

$
(99.4
)
689

$
10,434.6

$
(58.3
)
 
477

$
3,545.6

$
(41.1
)
 

App.-A-15



 
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
233

953.7

(15.6
)
117

209.7

(1.7
)
 
116

744.0

(13.9
)
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
)

During 2017, the number of securities in our fixed-maturity portfolio with unrealized losses decreased, primarily the result of a narrowing of credit spreads during the year. We had no material decreases in valuation as a result of credit rating downgrades during the year. All of the fixed-maturity securities in an unrealized loss position at December 31, 2017 in the table above are current with respect to required principal and interest payments.

Since December 31, 2016, our nonredeemable preferred stocks with unrealized losses decreased to four securities, averaging approximately 6% of their total cost. The decrease in the number of securities was the result of valuation increases in the portfolio. 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 decreased during 2017. 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, consensus analyst 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)
2017

2016

Fixed maturities:
 
 
Residential mortgage-backed securities
$
(19.7
)
$
(43.3
)
Commercial mortgage-backed securities
(0.3
)
(0.6
)
Total fixed maturities
$
(20.0
)
$
(43.9
)

App.-A-16



The following tables provide rollforwards of the amounts related to credit losses recognized in earnings for the periods ended December 31, 2017, 2016, and 2015, 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, 2016
$
11.1

$
0.4

$
11.5

Credit losses for which an OTTI was not previously recognized
0

0.4

0.4

Reductions for securities sold/matured
(10.9
)
(0.3
)
(11.2
)
Change in recoveries of future cash flows expected to be collected1
(0.2
)
0

(0.2
)
Total at December 31, 2017
$
0

$
0.5

$
0.5

(millions)
Residential
Mortgage-
Backed

Commercial
Mortgage-
Backed

Total

Total at December 31, 2015
$
12.4

$
0.4

$
12.8

Credit losses for which an OTTI was not previously recognized
0

0

0

Reductions for securities sold/matured
0

0

0

Change in recoveries of future cash flows expected to be collected1
(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

Credit losses for which an OTTI was not previously recognized
0

0

0

Reductions for securities sold/matured
(1.4
)
0

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

0

1.1

Total at December 31, 2015
$
12.4

$
0.4

$
12.8


1 Reflects expected recovery of prior period impairments that will be accreted into income over the remaining life of the security.
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. During the period ended December 31, 2017, we recorded a credit impairment write-down of $0.4 million. We did not have any credit impairment write-downs for the periods ended December 31, 2016 or 2015.

App.-A-17



Realized Gains (Losses)  The components of net realized gains (losses) for the years ended December 31, were:
 
(millions)
2017

2016

2015

Gross realized gains on security sales
 
 
 
Fixed maturities:
 
 
 
U.S. government obligations
$
6.2

$
24.6

$
17.5

State and local government obligations
10.5

16.0

7.8

Corporate and other debt securities
20.3

43.3

31.2

Residential mortgage-backed securities
23.8

2.5

4.9

Commercial mortgage-backed securities
4.9

13.3

15.7

Other asset-backed securities
0.3

0

0

Redeemable preferred stocks
8.5

20.9

0.1

Total fixed maturities
74.5

120.6

77.2

Equity securities:
 
 
 
Nonredeemable preferred stocks
58.4

11.9

65.3

Common equities
43.0

61.3

50.4

         Short-term investments
0

0.1

0

Subtotal gross realized gains on security sales
175.9

193.9

192.9

Gross realized losses on security sales
 
 
 
Fixed maturities:
 
 
 
U.S. government obligations
(28.7
)
(2.4
)
(0.9
)
State and local government obligations
(0.1
)
(1.6
)
(0.3
)
Corporate and other debt securities
(5.1
)
(2.5
)
(5.0
)
Residential mortgage-backed securities
(0.4
)
(0.2
)
(0.8
)
Commercial mortgage-backed securities
(5.3
)
(5.6
)
(1.3
)
Other asset-backed securities
(0.4
)
0

0

Redeemable preferred stocks
(6.4
)
(6.6
)
0

Total fixed maturities
(46.4
)
(18.9
)
(8.3
)
Equity securities:
 
 
 
Nonredeemable preferred stocks
(5.9
)
(5.3
)
(3.2
)
Common equities
(12.2
)
(15.7
)
(38.4
)
         Short-term investments
(0.2
)
(0.1
)
0

Subtotal gross realized losses on security sales
(64.7
)
(40.0
)
(49.9
)
Net realized gains (losses) on security sales
 
 
 
Fixed maturities:
 
 
 
U.S. government obligations
(22.5
)
22.2

16.6

State and local government obligations
10.4

14.4

7.5

Corporate and other debt securities
15.2

40.8

26.2

Residential mortgage-backed securities
23.4

2.3

4.1

Commercial mortgage-backed securities
(0.4
)
7.7

14.4

Other asset-backed securities
(0.1
)
0

0

Redeemable preferred stocks
2.1

14.3

0.1

Total fixed maturities
28.1

101.7

68.9

Equity securities:
 
 
 
Nonredeemable preferred stocks
52.5

6.6

62.1

Common equities
30.8

45.6

12.0

         Short-term investments
(0.2
)
0

0

Subtotal net realized gains (losses) on security sales
111.2

153.9

143.0

Other-than-temporary impairment losses
 
 
 
Fixed maturities:
 
 
 
Commercial mortgage-backed securities
(0.4
)
0

0

Redeemable preferred stocks
0

(25.3
)
0

Total fixed maturities
(0.4
)
(25.3
)
0

Equity securities:
 
 
 
Common equities
(11.2
)
(0.3
)
(8.7
)
Subtotal investment other-than-temporary impairment losses
(11.6
)
(25.6
)
(8.7
)
Other asset impairment
(49.6
)
(59.7
)
0

       Subtotal other-than-temporary impairment losses
(61.2
)
(85.3
)
(8.7
)
Other gains (losses)
 
 
 
Hybrid securities
(1.6
)
2.1

(1.3
)
Derivative instruments
0

(20.0
)
(20.7
)
Litigation settlements
1.2

0.4

0.4

Subtotal other gains (losses)
(0.4
)
(17.5
)
(21.6
)
Total net realized gains (losses) on securities
$
49.6

$
51.1

$
112.7


App.-A-18




Gross realized gains and losses were predominantly the result of sales transactions in our fixed-income portfolio related to
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)
2017

2016

2015

Fixed maturities:
 
 
 
U.S. government obligations
$
72.7

$
18.2

$
28.3

State and local government obligations
51.5

52.3

60.7

Foreign government obligations
0.3

0.4

0.4

Corporate debt securities
125.2

110.7

102.4

Residential mortgage-backed securities
34.7

47.3

54.3

Commercial mortgage-backed securities
79.6

81.6

74.6

Other asset-backed securities
47.1

28.0

22.0

Redeemable preferred stocks
11.8

14.9

15.0

Total fixed maturities
422.9

353.4

357.7

Equity securities:
 
 
 
Nonredeemable preferred stocks
44.1

48.6

43.7

Common equities
58.3

57.2

51.0

Short-term investments
37.8

19.7

2.2

Investment income
563.1

478.9

454.6

Investment expenses
(23.9
)
(22.4
)
(22.8
)
Net investment income
$
539.2

$
456.5

$
431.8


The amount of investment income 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 investment income in both 2017 and 2016, as compared to their prior respective years, reflects an increase in average assets of the portfolio due to the strong underwriting growth and profitability. During 2017, an additional increase was due to a slight increase in overall portfolio yield on new cash and portfolio turnover from our decision to lengthen our portfolio’s duration during the year. The increase in income in 2016 over 2015 also reflects a slight offset due to a lower portfolio yield as a result of 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 2016 and invest in a higher amount of short-term paper, which had lower overall yields.
Trading Securities  At December 31, 2017 and 2016, 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, 2017, 2016, and 2015.
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-19



The following table shows the status of our derivative instruments at December 31, 2017 and 2016, and for the years ended December 31, 2017, 2016, and 2015:
 
(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:
2017

2016

2015

Purpose
Classification
2017

2016

2017

2016

2015

Hedging instruments
 
 
 
 
 
 
 
 
 
 
Closed:
 
 
 
 
 
 
 
 
 
 
Ineffective cash flow hedge
$
31

$
370

$
18

Manage
interest
rate risk
NA
$
0

$
0

$
0

$
(1.3
)
$
0.2

Non-hedging instruments
 
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
0

0

750

Manage
portfolio
duration
Investments - fixed
maturities
0

0

0

0

(23.4
)
Closed:
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
0

750

0

Manage
portfolio
duration
NA
0

0

0

(19.0
)
0

U.S. Treasury Note futures
0

135

691

Manage
portfolio
duration
NA
0

0

0

0.3

2.5

Total
NA

NA

NA

 
 
$
0

$
0

$
0

$
(20.0
)
$
(20.7
)

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 March 2017, we entered into a forecasted debt issuance hedge, against a possible rise in interest rates, in conjunction with the $850 million of 4.125% Senior Notes due 2047 issued in April 2017. Upon issuance, we closed the hedge and recognized, as part of accumulated other comprehensive income, a pretax loss of $8.0 million in April 2017.

During the third quarter 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 $31 million in 2017, the $18 million in 2015, and the remaining $20 million in 2016, out of the $370 million disclosed in the table above, of our ineffective cash flow hedge resulted from the repurchase of a portion of our 6.70% Fixed-to-Floating Rate Junior Subordinated Debentures due 2067, and we reclassified the unrealized gain on forecasted transactions to net realized gains on securities. The portion repurchased in 2017 resulted in an immaterial gain.
During 2017, we reclassified $0.3 million from accumulated other comprehensive income to interest expense on our closed debt issuance cash flow hedges, compared to $1.9 million during 2016 and $1.8 million during 2015.
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. We did not hold any interest rate swap positions at December 31, 2017 or 2016. At December 31, 2015, 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, the balance of the cash collateral that we had received from the applicable

App.-A-20



counterparty on our then open positions was $4.9 million. We did not open any U.S. treasury futures during 2017. We opened and closed treasury futures during 2016 and 2015; no positions were outstanding at either year end. 

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, which are continually priced on a daily basis, 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-21



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, 2017
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
U.S. government obligations
$
6,645.9

$
0

$
0

$
6,645.9

$
6,688.8

State and local government obligations
0

2,297.1

0

2,297.1

2,285.6

Foreign government obligations
0

0

0

0

0

Corporate debt securities
0

4,997.7

0

4,997.7

4,997.2

Subtotal
6,645.9

7,294.8

0

13,940.7

13,971.6

Asset-backed securities:
 
 
 
 
 
Residential mortgage-backed
0

836.7

0

836.7

828.8

Commercial mortgage-backed
0

2,758.6

0

2,758.6

2,760.1

Other asset-backed
0

2,454.7

0

2,454.7

2,454.5

Subtotal asset-backed securities
0

6,050.0

0

6,050.0

6,043.4

Redeemable preferred stocks:
 
 
 
 
 
Financials
0

64.1

0

64.1

61.3

Utilities
0

11.4

0

11.4

10.1

Industrials
0

135.5

0

135.5

123.5

Subtotal redeemable preferred stocks
0

211.0

0

211.0

194.9

Total fixed maturities
6,645.9

13,555.8

0

20,201.7

20,209.9

Equity securities:
 
 
 
 
 
Nonredeemable preferred stocks:
 
 
 
 
 
Financials
80.6

718.2

0

798.8

693.6

Industrials
0

0

5.0

5.0

5.0

Subtotal nonredeemable preferred stocks
80.6

718.2

5.0

803.8

698.6

Common equities:
 
 
 
 
 
Common stocks
3,399.5

0

0

3,399.5

1,498.7

Other risk investments
0

0

0.3

0.3

0.3

Subtotal common equities
3,399.5

0

0.3

3,399.8

1,499.0

Total fixed maturities and equity securities
10,126.0

14,274.0

5.3

24,405.3

22,407.5

Short-term investments
1,824.4

1,045.0

0

2,869.4

2,869.4

Total portfolio
$
11,950.4

$
15,319.0

$
5.3

$
27,274.7

$
25,276.9

Debt
$
0

$
3,606.5

$
37.1

$
3,643.6

$
3,306.3



App.-A-22



 
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

1,499.3

0

1,499.3

1,489.7

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

Industrials
0

0

0

0

0

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

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 2017 and 2016, we did not have any transfers between Level 1 and Level 2.

Our short-term security holdings classified as Level 1 are highly liquid, actively marketed, and have a very short duration, primarily 90 days or less to redemption. These securities are held at their original cost, adjusted for any accretion of discount, since that value very closely approximates what an active market participant would be willing to pay for such securities. The remainder of our short-term securities are classified as Level 2 and are not priced externally since these securities continually trade at par value. These securities are classified as Level 2 since they are primarily longer-dated auction securities issued by municipalities that contain a redemption put feature back to the auction pool with a redemption period typically less than seven days. The auction pool is created by a liquidity provider and if the auction is not available at the end of the seven days, we have the right to put the security back to the issuer at par.

 

App.-A-23



At December 31, 2017, vendor-quoted prices represented 66% of our Level 1 classifications (excluding short-term investments), compared to 52% at December 31, 2016. The securities quoted by vendors in Level 1 primarily represent our holdings in U.S. Treasury Notes, which are frequently traded and the quotes are considered similar to exchange-traded quotes. The balance of our Level 1 pricing comes from quotes obtained directly from trades made on active exchanges.
At December 31, 2017, vendor-quoted prices comprised 98% of our Level 2 classifications (excluding short-term investments), while dealer-quoted prices represented 2%, compared to 99% and 1% at December 31, 2016, respectively. In our process for selecting a source (e.g., dealer, pricing service) to provide pricing for securities in our portfolio, we reviewed documentation from the sources that detailed the pricing techniques and methodologies used by these sources and determined if their policies adequately considered market activity, either based on specific transactions for the particular security type or based on modeling of securities with similar credit quality, duration, yield, and structure that were recently transacted. Once a source is chosen, we continue to monitor any changes or modifications to their processes by reviewing their documentation on internal controls for pricing and market reviews. We review quality control measures of our sources as they become available to determine if any significant changes have occurred from period to period that might indicate issues or concerns regarding their evaluation or market coverage.

As part of our pricing procedures, we obtain quotes from more than one source to help us fully evaluate the market price of securities. However, our internal pricing policy is to use a consistent source for individual securities in order to maintain the integrity of our valuation process. Quotes obtained from the sources are not considered binding offers to transact. Under our policy, when a review of the valuation received from our selected source appears to be outside of what is considered market level activity (which is defined as trading at spreads or yields significantly different than those of comparable securities or outside the general sector level movement without a reasonable explanation), we may use an alternate source’s price. To the extent we determine that it may be prudent to substitute one source’s price for another, we will contact the initial source to obtain an understanding of the factors that may be contributing to the significant price variance, which often leads the source to adjust their pricing input data for future pricing.

To allow us to determine if our initial source is providing a price that is outside of a reasonable range, we review our portfolio pricing on a weekly basis. We frequently challenge prices from our sources when a price provided does not match our expectations based on our evaluation of market trends and activity. Initially, we perform a review of our portfolio by sector to identify securities whose prices appear outside of a reasonable range. We then perform a more detailed review of fair values for securities disclosed as Level 2. We review dealer bids and quotes for these and/or similar securities to determine the market level context for our valuations. We then evaluate inputs relevant for each class of securities disclosed in the preceding hierarchy tables.
For our structured debt securities, including commercial, residential, and asset-backed securities, we evaluate available market-related data for these and similar securities related to collateral, delinquencies, and defaults for historical trends and reasonably estimable projections, as well as historical prepayment rates and current prepayment assumptions and cash flow estimates. We further stratify each class of our structured debt securities into more finite sectors (e.g., planned amortization class, first pay, second pay, senior, subordinated, etc.) and use duration, credit quality, and coupon to determine if the fair value is appropriate.
For our corporate debt and preferred stock (redeemable and nonredeemable) portfolios, as well as the notes and debentures issued by The Progressive Corporation (see Note 4 – Debt), we review securities by duration, coupon, and credit quality, as well as changes in interest rate and credit spread movements within that stratification. The review also includes recent trades, including: volume traded at various levels that establish a market, issuer specific fundamentals, and industry specific economic news as it comes to light.
For our municipal securities (e.g., general obligations, revenue, and housing), we stratify the portfolio to evaluate securities by type, coupon, credit quality, and duration to review price changes relative to credit spread and interest rate changes. Additionally, we look to economic data as it relates to geographic location as an indication of price-to-call or maturity predictors. For municipal housing securities, we look to changes in cash flow projections, both historical and reasonably estimable projections, to understand yield changes and their effect on valuation.
Lastly, for our short-term securities, we look at acquisition price relative to the coupon or yield. Since our short-term securities are typically 90 days or less to maturity, with the majority listed in Level 2 being seven days or less to redemption, we believe that acquisition price is the best estimate of fair value.
We also review data assumptions as supplied by our sources to determine if that data is relevant to current market conditions. In addition, we independently review each sector for transaction volumes, new issuances, and changes in spreads, as well as the overall movement of interest rates along the yield curve to determine if sufficient activity and liquidity exists to provide a credible source for our market valuations.

App.-A-24



During each valuation period, we create internal estimations of portfolio valuation (performance returns), based on current market-related activity (i.e., interest rate and credit spread movements and other credit-related factors) within each major sector of our portfolio. We compare our internally generated portfolio results with those generated based on quotes we received externally and research material valuation differences. We compare our results to index returns for each major sector adjusting for duration and credit quality differences to better understand our portfolio’s results. Additionally, we review on a monthly basis our external sales transactions and compare the actual final market sales price to a previous market valuation price. This review provides us further validation that our pricing sources are providing market level prices, since we are able to explain significant price changes (i.e., greater than 2%) as known events occur in the marketplace and affect a particular security’s price at sale.
This analysis provides us with additional comfort regarding each source’s process, the quality of its review, and its willingness to improve its analysis based on feedback from clients. We believe this effort helps ensure that we are reporting the most representative