Annual Report (Form 10-K), fiscal year 1994

ITEM 1. BUSINESS
(a) General Development of Business
The Progressive Corporation, an insurance holding company formed in 1965, has 60 operating subsidiaries and one mutual insurance company affiliate. The Progressive Corporation's insurance subsidiaries (collectively, the "Insurance Group") provide personal automobile insurance and other specialty property-casualty insurance and related services throughout the United States and in Canada. The Company's property-casualty insurance products protect its customers against collision and physical damage to their motor vehicles and liability to others for personal injury or property damage.
Of the approximately 250 United States insurance company groups writing private passenger auto insurance, the Company estimates that Progressive ranks seventh in size for 1994. Except as otherwise noted, all industry data and Progressive's market share or ranking in the industry were derived either directly from data reported by A.M. Best Company Inc. ("A.M. Best") or were estimated using A.M. Best data as the primary source. For 1994, the estimated industry premiums written, which include personal auto insurance in the United States and Ontario, Canada, as well as insurance for commercial vehicles, were $119 billion, and Progressive's share of this market was approximately 2.0%.
(b) Financial Information About Industry Segments
Incorporated by reference from Note 12, SEGMENT INFORMATION, on page 47 of the Company's Annual Report.
(c) Narrative Description of Business
INSURANCE SEGMENT - -----------------
The Insurance Group underwrites a number of personal and commercial property-casualty insurance products primarily related to the use and operation of motor vehicles. Net premiums written were $2,457.2 million in 1994, compared to $1,819.2 million and $1,451.2 million in 1993 and 1992, respectively. The underwriting profit was 8.3% (11.5% including the elimination of the supplemental reserve; see MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS beginning on page 12 for further discussion) in 1994, compared to 10.7% in 1993 and 3.5% in 1992, respectively.
The Insurance Group's core business writes insurance for private passenger automobiles and small commercial and recreational vehicles. This business frequently has more than one program in a single state, with each targeted to a specific market segment. The core business accounted for 95% of the Company's 1994 total net premiums written.
The bulk of the Insurance Group's core business consists of nonstandard automobile insurance products for people cancelled or rejected by other insurers. The size of the nonstandard automobile insurance market changes with the insurance environment. Volume potential is influenced by the actions of direct competitors, writers of standard and preferred automobile insurance and state-mandated involuntary plans. The total 1994 nonstandard automobile insurance market was about $20 billion, compared to $18 billion in 1993 and $17 billion in 1992. Approximately 330 companies, many of which belong to the same insurance group, wrote an estimated $15 billion of nonstandard auto premiums in 1994. In this market, the Insurance Group ranked fourth in 1993 in direct premiums written and near the top in underwriting performance. Although final data has not been published, the Company estimates that its 1994 ranking and underwriting performance will be consistent with 1993.
The core business is continuing its experiment of writing standard and preferred automobile risks in many states. These experiments accounted for between five and ten percent of the Company's total private passenger auto premiums in 1994. The strategy is to build towards becoming a low-cost provider of a full line of auto insurance and related services, distributed through whichever channel the customer prefers. The Insurance Group's goal is to compete in the standard and preferred market, which comprises 80% of the personal automobile insurance market.
The Insurance Group's specialty personal lines' principal product is motorcycle insurance. Other products offered include recreational vehicle, mobile home and boat insurance. The Insurance Group's competitors are specialty companies and large multi-line insurance carriers. Although industry figures are not available, based on the Company's analysis of this market, the Company believes that it is a significant participant in this market.
Nonstandard commercial vehicle insurance covers commercial vehicle risks that are rejected or cancelled by other insurance companies. Based on the Company's analysis of this market, approximately 40 companies compete for this business on a nationwide basis. State assigned risk plans also provide this coverage.
The core business insurance products are marketed by thirteen divisions headquartered in or near the markets served: the Florida and Southeast divisions in Tampa, Florida; the North East, New York, Central States, Ohio, Commercial Vehicle and National Accounts divisions in Cleveland, Ohio; the South Central division in Austin, Texas; the Mountain division in Colorado Springs, Colorado; the Mid-Atlantic division in Richmond, Virginia; the Canada division in Ontario, Canada; and the West division in Sacramento, California. Each division is responsible for its own marketing, sales, processing and claims.
In 1994, over 90% of the core business' net premiums were written through a network of more than 30,000 independent insurance agents located throughout the United States and in Canada. Subject to compliance with certain Company-mandated procedures, these independent insurance agents have the authority to bind the Company to specified insurance coverages within prescribed underwriting guidelines. These guidelines prescribe the kinds and amounts of coverage that may be written and the premium rates that may be charged for specified categories of risk. The agents do not have authority on behalf of the Company to settle or adjust claims, establish underwriting guidelines, develop rates or enter into other transactions or commitments. The Company also markets its products through intermediaries such as employers, other insurance companies and national brokerage agencies, and direct to customers through employed sales people and owned insurance agencies. The core business currently markets personal automobile insurance directly to the public by direct mail, television and radio advertising throughout Florida and in Ohio and Texas.
The Insurance Group's diversified businesses - the United Financial Casualty Company (UFCC), Professional Liabilities Group (PLG) and Motor Carrier division - - accounted for 5% of total volume in 1994. These businesses, which are organized by customer group, are headquartered in Cleveland, Ohio. The choice of distribution channel is driven by each customer group's buying preference and service needs. Distribution channels include financial institutions, equipment lessors and vehicle dealers. Distribution arrangements are individually negotiated between such intermediaries and the
Company and are tailored to the specific needs of the customer group and the nature of the related financial or purchase transactions. The diversified businesses also market their products directly to their customers through company-employed sales forces.
UFCC provides physical damage insurance and related tracking services to protect the commercial or retail lender's interest in collateral which is not otherwise insured against these risks. The principal product is collateral protection for automobile lenders, which is sold to financial institutions and/or their customers. Commercial banks are UFCC's largest customer group for these services. This business also serves savings and loans, finance companies and credit unions. Based on the Company's analysis of this market, numerous companies offer these products, and none of them has a dominant market share.
PLG's principal customers are community banks. Its principal products are liability insurance for directors and officers and employee dishonesty insurance. Progressive shares the risk and premium on these coverages with a small mutual reinsurer controlled by its bank customers. The program is sponsored by the American Bankers Association. This program represented less than 1% of total 1994 net premiums written.
The Motor Carrier division primarily manages involuntary Commercial Auto Insurance Plans. See SERVICE OPERATIONS on page 6 for further discussion.
COMPETITIVE FACTORS - -------------------
The automobile insurance and other property-casualty markets in which the Company operates are highly competitive. Property-casualty insurers generally compete on the basis of price, consumer recognition, coverages offered, claim handling, financial stability, customer service and geographic coverage. Vigorous competition is provided by large, well-capitalized national companies, some of which have broad distribution networks of employed or captive agents, and by smaller regional insurers. While the Company relies heavily on technology and extensive data gathering and analysis to segment and price markets according to risk potential, some competitors merely price their coverage at rates set lower than the Company's published rates. By avoiding extensive data gathering and analysis, these competitors incur lower underwriting costs. The Company has remained competitive by closely managing expenses and achieving operating efficiencies, and by refining its risk measurement and price segmentation skills. In addition, the Company offers prices for a wide spectrum of risks and seeks to offer a wider array of payment plans, limits of liability and deductibles than its competitors. Superior customer service and claim adjustment are also important factors in the Company's competitive strategy.
LICENSES - --------
The Insurance Group operates under licenses issued by various state or provincial insurance authorities. Such licenses may be of perpetual duration or renewable periodically, provided the holder continues to meet applicable regulatory requirements. The licenses govern the kind of insurance coverages which may be written in the issuing state. Such licenses are normally issued only after the filing of an appropriate application and the satisfaction of prescribed criteria. All licenses which are material to the Company's business are in good standing.
INSURANCE REGULATION - --------------------
The insurance subsidiaries are generally subject to regulation and supervision by insurance departments of the jurisdictions in which they are domiciled or licensed to transact business. One or more of the subsidiaries are licensed and subject to regulation in each of the 50 states, in each Canadian province and by Canadian federal authorities. The nature and extent of such regulation and
supervision varies from jurisdiction to jurisdiction. Generally, an insurance company is subject to a higher degree of regulation and supervision in its state of domicile. The Company's principal insurance subsidiaries are domiciled in the states of Florida, Mississippi, Missouri, New York, Ohio, Pennsylvania, Texas, Washington and Wisconsin. State insurance departments have broad administrative power relating to licensing insurers and agents, regulating premium rates and policy forms, establishing reserve requirements, prescribing accounting methods and the form and content of statutory financial reports and regulating the type and amount of investments permitted. Rate regulation varies from "file and use" to prior approval to mandated rates. Most jurisdictions prohibit rates that are "excessive, inadequate or unfairly discriminatory."
Insurance departments are charged with the responsibility to ensure that insurance companies maintain adequate capital and surplus and comply with a variety of operational standards. Insurance companies are generally required to file detailed annual and other reports with the insurance department of each jurisdiction in which they conduct business. Insurance departments are authorized to make periodic and other examinations of regulated insurers' financial condition, adherence to statutory accounting principles and compliance with state insurance laws and regulations.
Insurance holding company laws enacted in many jurisdictions grant to insurance authorities the power to regulate acquisitions and certain other transactions involving insurers and to require periodic disclosure of certain information. These laws impose prior approval requirements for certain transactions between regulated insurers and their affiliates and generally regulate dividend and other distributions, including loans and cash advances, between regulated insurers and their affiliates. See the "Dividends" discussion in Item 5(c) for further information on such dividend limitations.
Under state insolvency and guaranty laws, regulated insurers can be assessed for, or be required to contribute to state guaranty funds to cover policyholder losses resulting from insurer insolvencies. Insurers are also required by many states to provide coverage to certain risks as a condition of doing business in the state. Such programs generally specify the types of insurance and the level of coverage which must be offered to such involuntary risks, as well as the allowable premium.
Many states have laws and regulations that limit a company's ability to exit a market. For example, certain states limit an automobile insurer's ability to cancel and non-renew policies. Furthermore, certain states prohibit an insurer from withdrawing one or more lines of business from the state, except pursuant to a plan that is approved by the state insurance department. The state insurance department may disapprove a plan that may lead to market disruption. Laws and regulations that limit cancellation and non-renewal and that subject program withdrawals to prior approval requirements may restrict an insurer's ability to exit unprofitable markets.
Regulation of insurance constantly changes as real or perceived issues and developments arise. Some changes may be due to technical factors, such as changes in investment laws made to recognize new investment vehicles; other changes result from such general pressures as consumer resistance to price increases and concerns relating to insurer solvency. In recent years, legislation and voter initiatives have been introduced which deal with insurance rate development, rate determination and the ability of insurers to cancel or renew insurance policies, reflecting concerns about availability, prices and alleged discriminatory pricing.
In some states, such as California and Georgia, the automobile insurance industry has been under pressure in recent years from regulators, legislators or special interest groups to reduce, freeze or set rates at levels that are not necessarily related to underlying costs, including initiatives to roll back automobile and other personal lines rates. This activity has adversely affected, and may in the future adversely affect, the profitability and growth of the subsidiaries' automobile insurance business in those jurisdictions, and may limit the subsidiaries' ability to increase rates to compensate for increases in costs. Adverse legislative and regulatory activity limiting the subsidiaries' ability to adequately price automobile insurance may occur in the future. The impact of these regulatory changes on the subsidiaries' businesses cannot be predicted.
The state insurance regulatory framework has come under increased federal scrutiny, and certain state legislatures have considered or enacted laws that alter and, in many cases, expand state authority to regulate insurance companies and insurance holding company systems. Further, the National Association of Insurance Commissioners (NAIC) and state insurance regulators are re-examining existing laws and regulations, specifically focusing on insurance company investments, issues relating to the solvency of insurance companies and further limitations on the ability of regulated insurers to pay dividends. The NAIC also developed a risk-based capital (RBC) program to enable regulators to take appropriate and timely regulatory actions relating to insurers that show signs of weak or deteriorating financial conditions. RBC is a series of dynamic surplus-related formulas which contain a variety of factors that are applied to financial balances based on a degree of certain risks, such as asset, credit and underwriting risks. In addition, the United States Congress and certain federal agencies are investigating the current condition of the insurance industry to determine whether federal regulation is necessary.
STATUTORY ACCOUNTING PRINCIPLES - -------------------------------
The Insurance Group's results are reported in accordance with generally accepted accounting principles (GAAP), which differ from amounts reported under statutory accounting principles (SAP) prescribed by insurance regulatory authorities. Specifically, under GAAP:
1. Commissions, premium taxes and other costs incurred in connection with writing new and renewal business are deferred and amortized over the period in which the related premiums are earned, rather than expensed as incurred, as required by SAP.
2. Direct-response advertising costs, which consist primarily of direct mail, television and radio expenses, are capitalized and amortized over the estimated period of the benefits, rather than expensed as incurred, as required by SAP.
3. Certain assets are included in the consolidated balance sheets, rather than charged against retained earnings, as required by SAP. These assets consist primarily of premium receivables over 90 days old and furniture and fixtures.
4. Amounts related to ceded reinsurance are shown gross as prepaid reinsurance premiums and reinsurance recoverables, rather than netted against unearned premium reserves and loss and loss adjustment expense reserves, respectively, as required by SAP.
5. Fixed maturities securities, which are classified as available for sale, are reported at market values, rather than at amortized cost, or the lower of amortized cost or market depending on the specific type of security as required by SAP. Equity securities are reported at quoted market values which may differ from the NAIC market values as required by SAP.
The differing treatment of income and expense items results in a corresponding difference in Federal income tax expense.
During 1994, the insurance subsidiaries began to reduce loss reserves for anticipated salvage and subrogation recoveries in accordance with statutory accounting principles. Previously, salvage and subrogation was not reflected in the statutory financial statements until actually recovered.
SERVICE OPERATIONS - ------------------
The Motor Carrier division currently processes business for the Commercial Auto Insurance Plans (CAIP) in 28 states and the Florida Joint Underwriters Association (FAJUA), which are part of the involuntary residual market. As a CAIP servicing carrier, the division processes about one-third of the premiums in the involuntary residual market, without assuming the indemnity risk. It competes with approximately 17 other providers nationwide. In 1995, the division began processing business for the FAJUA and competes with approximately five other carriers in the state. The Company's subsidiaries also provide claim services to fleet owners and other insurance companies. Revenues from all service businesses are derived primarily from fees and commissions. Total service revenues were $41.9 million in 1994, compared to $43.7 million in 1993 and $53.3 million in 1992. Pretax operating profits were $10.0 million and $6.8 million in 1994 and 1993, respectively, compared to a pretax operating loss of $4.3 million in 1992.
INVESTMENTS - -----------
The Company's approach to investing is consistent with its need to maintain capital adequate to support the insurance premiums written. The Company's portfolio is invested primarily in short-term and intermediate-term, investment-grade fixed-income securities. The Company's investment portfolio, at market value, was $3,186.3 million at December 31, 1994, compared to $2,805.2 million at December 31, 1993. Investment income is affected by shifts in the types of investments in the portfolio, changes in interest rates and other factors. Investment income, including net realized gains (losses) on security sales, before expenses and taxes was $182.3 million in 1994, compared to $242.4 million in 1993 and $153.5 million in 1992. See MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, beginning on page 12 herein for additional discussion.
EMPLOYEES - ---------
The number of employees, excluding temporaries, at December 31, 1994, was 7,544.
LIABILITY FOR PROPERTY-CASUALTY LOSSES AND LOSS ADJUSTMENT EXPENSES - -------------------------------------------------------------------
The consolidated financial statements include the estimated liability for unpaid losses and loss adjustment expenses ("LAE") of the Company's property-casualty and life insurance subsidiaries. The life insurance operations are in run-off. Total loss reserves are established at a level that is intended to represent the midpoint of the reasonable range of loss reserves. The liabilities for losses and LAE are determined using actuarial and statistical procedures and represent undiscounted estimates of the ultimate net cost of all unpaid losses and LAE incurred through December 31 of each year. These estimates are subject to the effect of future trends on claim settlement. These estimates are continually reviewed and adjusted as experience develops and new information becomes known. Such adjustments, if any, are reflected in the current results of operations.
During 1994, based on a review of the adequacy of its total loss reserves, the Company eliminated its $71.0 million "supplemental reserve." See MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS beginning on page 12 for further discussion. The elimination of the supplemental reserve is reflected in the Reconciliation of Net Reserves for Losses and Loss Adjustment Expenses table on page 7 and the Analysis of Loss and Loss Adjustment Expenses Development table on page 8.
The accompanying tables present an analysis of property-casualty losses and LAE. The following table: (1) provides a reconciliation of beginning and ending estimated liability balances for 1994, 1993 and 1992, and (2) shows the difference between the estimated liability in accordance with GAAP and that reported in accordance with SAP.
1In 1993, the Company adopted Statement of Financial Accounting Standards (SFAS) 113, "Accounting and Reporting for Reinsurance of Short- Duration and Long-Duration Contracts"; prior years were not restated.
2During 1994, the Company changed its method of accounting for salvage and subrogation. See STATUTORY ACCOUNTING PRINCIPLES on page 5 for further discussion.
The reconciliation above shows a $142.5 million redundancy, which emerged during 1994, in the 1994 liability and a $98.5 million redundancy in the 1993 liability, based on information known as of December 31, 1994 and December 31, 1993, respectively.
The anticipated effect of inflation is explicitly considered when estimating liabilities for losses and LAE. While anticipated increases due to inflation are considered in estimating the ultimate claim costs, the increase in average severities of claims is caused by a number of factors that vary with the individual type of policy written. Future average severities are projected based on historical trends adjusted for anticipated changes in underwriting standards, inflation, policy provisions and general economic trends. These anticipated trends are monitored based on actual development and are modified if necessary.
The Company has not entered into any loss reserve transfers or similar transactions having a material effect on earnings or reserves.
The above table presents the development of balance sheet liabilities for 1984 through 1993. The top line of the table shows the estimated liability for unpaid losses and LAE recorded at the balance sheet date for each of the indicated years for the property-casualty insurance subsidiaries only. Similar reserves for the life insurance subsidiary, which are immaterial, are excluded. This liability represents the estimated amount of losses and LAE for claims arising in all prior years that are unpaid at the balance sheet date, including losses that had been incurred but not reported.
The upper section of the table shows the cumulative amount paid with respect to the previously recorded liability as of the end of each succeeding year. The lower portion of the table shows the re-estimated amount of the previously recorded liability based on experience as of the end of each succeeding year. The estimate is increased or decreased as more information becomes known about the frequency and severity of claims for individual years. For example, as of December 31, 1994, the companies had paid $191.6 million of the currently estimated $215.3 million of losses and LAE that had been incurred through the end of 1985; thus an estimated $23.7 million of losses incurred through 1985 remain unpaid as of the current financial statement date.
The "Cumulative Redundancy (Deficiency)" represents the aggregate change in the estimates over all prior years. For example, the 1984 liability has developed a $6.5 million deficiency over ten years. That amount has been reflected in income over the ten years and did not have a significant effect on the income of any one year. The effects on income during the past three years due to changes in estimates of the liabilities for losses and LAE is shown in the reconciliation table on page 7 as the "prior years" provision for incurred losses and LAE.
In evaluating this information, note that each cumulative redundancy (deficiency) amount includes the effects of all changes in amounts during the current year for prior periods. For example, the amount of the redundancy related to losses settled in 1987, but incurred in 1984, will be included in the cumulative deficiency or redundancy amount for years 1984, 1985 and 1986. Conditions and trends that have affected development of the liability in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based on this table.
The data in the Analysis of Loss and Loss Adjustment Expenses Development table on page 8 are constructed slightly differently than the data in the Current Estimate of Total Redundancy column in the chart on page 48 of the Company's Annual Report. The data in the former table are based on Schedule P from the 1990 through 1994 Consolidated Annual Statements, as filed with state insurance departments, and Schedules O and P filed for years prior to 1989. The reserve accuracy percentages reported in this table differ from the percentages reported in the Annual Report. The primary reason for the difference is the method of apportioning loss adjustment expenses to accident years. The Consolidated Annual Statement, Schedule P, Part-1, specifies how to distribute unallocated loss adjustment expenses to accident years. The Company disagrees with this arbitrary approach and, therefore, uses a different approach for the Annual Report. It believes that both apportionment methods give the same result when viewed over several years.
A second reason is that the data reported in the Annual Report includes results for life insurance products previously sold by the Company's life insurance subsidiary. Life insurance reserves are less than 1% of total reserves. Given the uncertainty inherent in establishing life insurance loss reserves, the Company's life insurance reserves have proven to be quite accurate.
In addition, the development table on page 8 differs from the development displayed in Schedule P, Part-2. Schedule P, Part-2, excludes unallocated loss adjustment expenses and reflects the change in the method of accounting for salvage and subrogation.
(d) Financial Information about Foreign and Domestic Operations
The Company operates throughout the United States and in Canada. The amount of Canadian revenues and assets are approximately two percent of the Company's consolidated revenues and assets. The amount of operating income (loss) generated by its Canadian operations is immaterial with respect to the Company's consolidated operating income.
ITEM 2.



ITEM 2. PROPERTIES
OWNED PROPERTIES - ----------------
In 1994, the Company completed its new corporate office complex on a 42-acre parcel in Mayfield Village, Ohio, owned by a subsidiary. The new facility consists of 517,800 square feet of space and replaces office space held under leases in a number of locations in the Cleveland, Ohio area. The cost of the project is $75.5 million and is being funded through operating cash flows. As of December 31, 1994, $71.7 million of the project's costs had been paid. The Company's central data processing facility occupies a modern, three-story brick building containing approximately 107,000 square feet of office space on this same parcel.
The Company owns two adjacent two-story brick buildings in Highland Heights, Ohio, which contain an aggregate of 233,000 square feet of office and warehouse space. The property was purchased in August 1994 for approximately $6.7 million. The buildings are currently being leased to a third party until late 1995, at which time the buildings will be renovated to accommodate the Company's operations.
The Company owns a modern three-story building containing approximately 96,700 square feet of office space in Mayfield Heights, Ohio. The property was purchased in December 1993 for approximately $6.5 million, and is occupied by the Company's Northeast Division.
The Company's Florida Division is headquartered in a modern, two-story building containing approximately 60,000 square feet of office space in Tampa, Florida. The property was financed with, and is held subject to a mortgage granted in connection with, industrial development revenue bonds bearing interest equal to 79.45% of a specified prime commercial lending rate. The remaining annual principal amounts payable are $368,000 in each of 1995 through 1997 and $92,000 in 1998.
The Company owns a modern, two-story building containing approximately 39,000 square feet of office space in Tampa, Florida; this building is leased to a non-affiliated tenant.
The Company also owns a one-story brick building containing approximately 92,000 square feet of training facilities, office and warehouse space in Mayfield Village, Ohio.
LEASED PROPERTIES - -----------------
The Company leases approximately 660,000 square feet of modern office space at various locations throughout the United States for its other business units and staff functions. In addition, the Company leases approximately 261 processing and claim offices at various locations throughout the United States. Two offices are leased in Canada. These leases are generally short-term to medium-term leases of standard commercial office space.
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS
Incorporated by reference from Note 6, LITIGATION, on page 43 of the Company's Annual Report.
ITEM 4.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated by reference from information with respect to executive officers of The Progressive Corporation and its subsidiaries set forth in Item 10 of this Annual Report on Form 10-K.
PART II -------
ITEM 5.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(a) Market Information
The Company's Common Shares are traded on the New York Stock Exchange under the symbol PGR. The high and low prices set forth below are as reported on the New York Stock Exchange.
The closing price of the Company's Common Shares on February 28, 1995 was $38 7/8.
(b) Holders
There were 4,871 shareholders of record on February 28, 1995.
(c) Dividends
Statutory policyholders' surplus was $949.2 million and $701.9 million at December 31, 1994 and 1993, respectively. Generally, under state insurance laws, the net admitted assets of insurance subsidiaries available for transfer to a corporate parent are limited to those net admitted assets, as determined in accordance with SAP, which exceed minimum statutory capital requirements. At December 31, 1994, $102.1 million of statutory policyholders' surplus represents net admitted assets of the insurance subsidiaries that are required to meet minimum statutory surplus requirements in the subsidiaries' states of domicile. Furthermore, state insurance laws limit the amount that can be paid as a dividend or other distribution in any given year without prior regulatory approval and adequate policyholders' surplus must be maintained to support premiums written. Based on the dividend laws currently in effect, the insurance subsidiaries may pay aggregate dividends of $177.0 million in 1995 out of statutory policyholders' surplus, without prior approval by regulatory authorities.
ITEM 7.


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FINANCIAL CONDITION
The Progressive Corporation is a holding company and does not have any revenue producing operations of its own. It receives cash through borrowings, equity sales, subsidiary dividends and other transactions, and may use the proceeds to contribute to the capital of its insurance subsidiaries in order to support premium growth, to repurchase its Common Shares and other outstanding securities, to redeem debt and for other business purposes. In 1994, the Company sold $200.0 million of its 6.60% Notes due 2004. During 1994, the Company repurchased .1 million of its Serial Preferred Shares, Series A, at a cost of $2.3 million and 1.1 million of its Common Shares at a cost of $34.0 million.
During the three-year period ended December 31, 1994, the Company sold 4,950,000 Common Shares for net proceeds of $177.0 million and repurchased 3.1 million Common Shares at a total cost of $142.3 million (average cost of $24.21 per share, split adjusted) and .5 million Serial Preferred Shares at a total cost of $12.1 million (average cost $27.37 per share). The Company also sold $350 million of notes, repaid $170.0 million borrowed under its credit facilities, and redeemed the entire $70.0 million of its 8 3/4% Debentures. During the same period, The Progressive Corporation received $299.8 million from its insurance subsidiaries, net of capital contributions made to these subsidiaries. The regulatory restrictions on subsidiary dividends are described in Item 5(c) on page 11 herein.
The Company has substantial capital resources and is unaware of any trends, events or circumstances that are reasonably likely to affect its capital resources in a material way. The Company also has available a $20.0 million revolving credit agreement. The Company believes it has sufficient borrowing capacity and other capital resources to support current and anticipated growth.
The Company's insurance operations create liquidity by collecting and investing premiums from new and renewal business in advance of paying claims. For the three years ended December 31, 1994, operations generated a positive cash flow of $925.4 million, and cash flow is expected to be positive in both the short-term and reasonably foreseeable future. The Company's substantial investment portfolio is highly liquid, consisting almost entirely of readily marketable securities. The Company does not expect any material changes in its cash requirements and is not aware of any trends, events or uncertainties that are reasonably likely to have a material effect on its liquidity.
Capital expenditures for the three years ended December 31, 1994, aggregated $130.3 million. In 1994, the Company completed its new corporate office complex in Mayfield Village, Ohio. The new facility consists of 517,800 square feet of space and replaces office space held under expiring leases in a number of locations in the Cleveland area. The cost of the project was $75.5 million and is being funded through operating cash flows. As of December 31, 1994, $71.7 million of the project's cost had been paid.
In June 1992, the Company reached an agreement with the California Department of Insurance to refund approximately $50 million of premiums (including interest) on business written between November 8, 1988 and November 7, 1989 to approximately 260,000 policyholders, thereby settling all rollback and refund exposure since Proposition 103 was adopted in November 1988. As a result, the Proposition 103 premium refund and rollback reserve was reduced by $106.0 million.
During 1992, the Company changed its financial arrangement with Progressive Partners Limited Partnership (Progressive Partners), its investment manager, as part of its strategy to compete more effectively for private passenger auto insurance by lowering costs. Under the new arrangement, Progressive Partners' people, now employed by a wholly-owned Progressive subsidiary, continue to provide the Company with investment and capital management. The transaction involved paying Progressive Partners a one-time fee for terminating the investment management contract, and an additional incentive fee for the period ended June 30, 1992, in the aggregate amount of $54.6 million. This transaction reduced the Company's costs for investment and capital management.
In December 1992, Mr. Alfred Lerner, then Chairman of the Company, converted his $75.0 million Floating Rate Convertible Subordinated Debenture due 2008 into 9,000,000 Common Shares and sold 5,175,000 of those Common Shares in an underwritten public offering. The public offering was completed pursuant to the registration rights provisions of the convertible debenture, under which the Company paid $5.1 million in underwriting and other expenses of the offering. These expenses were charged directly to shareholders' equity in accordance with generally accepted accounting principles. On the same date, Mr. Lerner agreed to a termination of his employment agreement with the Company, and, in connection with these transactions, the Company paid Mr. Lerner $10.0 million.
INVESTMENTS - -----------
The Company invests in fixed maturity, short-term and equity securities. The Company's investment strategy recognizes its need to maintain capital adequate to support its insurance operations. Therefore, the Company evaluates the risk/reward trade-offs of investment opportunities, measuring their effects on stability, diversity, overall quality and liquidity of the investment portfolio. The majority ($2,319.4 million, or 72.9%, in 1994 and $2,135.1 million, or 76.6%, in 1993) of the portfolio was in short-term and intermediate-term, investment-grade fixed-income securities. A relatively small portion ($476.3 million, or 15.0%, in 1994 and $453.9 million, or 16.3%, in 1993) of the investment portfolio was invested in preferred and common equity securities providing risk/reward balance and diversification. The remainder of the portfolio was invested in long-term investment-grade fixed-income securities ($245.0 million, or 7.7%, in 1994 and $77.6 million, or 2.8%, in 1993) and non-investment-grade fixed-income securities ($139.3 million, or 4.4%, in 1994 and $119.8 million, or 4.3%, in 1993). The non-investment-grade fixed-income securities, although constituting only a small portion of the portfolio, offer the Company high returns and added diversification without a significant adverse effect on the stability and quality of the investment portfolio as a whole. These securities may involve greater risks often related to creditworthiness, solvency and relative liquidity of the secondary trading market. Financial instruments with off-balance-sheet risk are used to manage the risks and enhance the yields of the available-for-sale portfolio. This is accomplished by modifying the basis, duration or interest rate characteristics of the portfolio, or hedging securities. Net cash requirements are limited to changes in market values which may vary based upon changes in interest rates and other factors. Exposure to credit risk is limited to the carrying value; unless otherwise noted, collateral is not required to support the credit risk. The weighted average fully taxable equivalent book yield of the portfolio was 6.7%, 6.8%, and 7.9% for the years ended December 31, 1994, 1993 and 1992, respectively.
As of December 31, 1994, the Company's portfolio had $41.1 million in unrealized losses, compared to $70.2 million in unrealized gains in 1993. This decrease was due largely to the adverse impact on the Company's fixed-income portfolio of rapidly rising interest rates throughout 1994.
As of December 31, 1994, the Company held $154.6 million of Collateralized Mortgage Obligations ("CMOs"), which represented 4.9% of the total investment portfolio. There are two types of securities held in the CMO Portfolio. As of December 31, 1994, sequential bonds represented 61.3% of the portfolio ($94.8 million) and had an average life of 2.1 years. Planned Amortization Class bonds represented 38.7% of the portfolio ($59.8 million) and had an average life of 2.0 years. The portfolio contains no residual interests.
CMOs held by the Company are highly liquid with readily available quotes and, at December 31, 1994, had an average life of 2.0 years. Eighty- five percent of the CMOs held by the Company are rated AAA by Moody's or Standard & Poor's. As of December 31, 1994, the Company's total CMO portfolio had an unrealized loss of $6.6 million. The single largest unrealized loss in any CMO security was $.9 million, or only 9.2% of such position.
Investments in the Company's portfolio have varying degrees of risk. Equity securities generally have greater risks than the non-equity portion of the portfolio since these securities are subordinate to rights of debt holders and other creditors of the issuer. As of December 31, 1994, the mark-to-market net losses in the Company's equity portfolio were $4.7 million ($3.1 million, net of taxes), as compared to net gains of $20.7 million ($13.5 million, net of taxes) in 1993.
The 1994 marketable equity portfolio consisted of three principal components: (i) $15.6 million, or 3.3%, of standard adjustable rate preferreds, (ii) $338.0 million, or 71.0%, of perpetual preferreds with mechanisms that may provide an opportunity to liquidate at par, and (iii) $122.7 million, or 25.7%, of common stocks. The 1993 marketable equity portfolio consisted of three principal components; (i) $73.0 million, or 16.1%, of standard adjustable rate preferreds, (ii) $283.4 million, or 62.4%, of perpetual preferreds with mechanisms that may provide an opportunity to liquidate at par, and (iii) $97.5 million, or 21.5%, of common stocks.
The Company continually evaluates the creditworthiness of each issuer for all securities held in its portfolio. Changes in market value are evaluated to determine the extent to which such changes are attributable to: (i) interest rates, (ii) market-related factors other than interest rates and (iii) financial conditions, business prospects and other fundamental factors specific to the issuer.
Declines attributable to issuer fundamentals are reviewed in further detail. Available evidence is considered to estimate the realizable value of the investment. Evidence reviewed may include the recent operating results and financial position of the issuer, information about its industry, recent announcements and other information. The Company retains a staff of experienced security analysts to compile, review and evaluate such information.
When a security in the Company's investment portfolio has a decline in market value which is other than temporary, the Company is required by GAAP to reduce the carrying value of such security to its net realizable value. It is the Company's general policy to dispose of securities when the Company determines that the issuer is unable to reverse its deteriorating financial condition and the prospects for its business within a reasonable period of time. In less severe circumstances, the Company may decide to dispose of a portion of its holdings in a specific issuer when the risk profile of the investment becomes greater than its tolerance for such risk.
RESULTS OF OPERATIONS
Operating income, which excludes realized gains and losses and one-time items, was $212.7 million, or $2.76 per share, in 1994, $197.3 million, or $2.61 per share, in 1993 and $129.8 million, or $1.72 per share, in 1992. The GAAP combined ratio was 91.7 (88.5 including the elimination of the supplemental reserve discussed below) in 1994, 89.3 in 1993 and 96.5 in 1992.
Direct premiums written increased 35% to $2,645.1 million in 1994, compared to $1,966.4 million in 1993 and $1,636.8 million in 1992. Net premiums written increased 35% to $2,457.2 million, compared to $1,819.2 million in 1993 and $1,451.2 million in 1992. The difference between direct and net premiums written is largely attributable to premiums written under state-mandated involuntary Commercial Auto Insurance Plans (CAIP), for which the Company retains no indemnity risk, of $115.4 million in 1994, $98.0 million in 1993 and $142.2 million in 1992. The Company provided policy and claim processing services to 28 state CAIPs in 1994 and 1993, compared to 26 in 1992. Premiums earned, which are a function of the amount of premiums written in the current and prior periods, increased 31% in 1994, compared to 17% in 1993 and 11% in 1992.
The Company's core divisions' net premiums written grew 38%, 25% and 18% for 1994, 1993 and 1992, respectively, driven by an increase in unit sales, resulting from the Company's ability to keep rates relatively flat over the last three years. The Company continues to experiment with writing standard and preferred auto risks which represented between five and ten percent of total core business volume in 1994. The Company anticipates continued growth in its core business in 1995, which could result from an increase in the number of states where the Company seeks to insure all auto risks, from working with independent agents dedicated to regaining market share and from integrating other buying options. The core divisions generated underwriting profits of 7% in 1994, 10% in 1993 and 8% in 1992. The Company's strategy is to achieve a four percent underwriting margin; the Company cannot predict the timing and pace of the decrease in underwriting margins, nor the rate of growth, but monitors each program to ensure that rates are adjusted promptly and adequately.
Claim costs, the Company's most significant expense, represent actual payments made and changes in estimated future payments to be made to or on behalf of its policyholders, including expenses required to settle claims and losses. These costs include a loss estimate for future assignments and assessments, based on current business, under state-mandated involuntary automobile programs. Claims costs are influenced by inflation and loss severity and frequency, the impact of which is mitigated by adequate pricing. Increases in the rate of inflation increase loss payments, which are made after premiums are collected. Accordingly, anticipated rates of inflation are taken into account when the Company establishes premium rates and loss reserves. Claim costs, expressed as a percentage of premiums earned, were 64% in 1994, compared to 62% in 1993 and 65% in 1992.
During 1994, based on a review of the adequacy of its total loss reserves, the Company eliminated its $71.0 million "supplemental reserve," resulting in a one-time increase in earnings of $.62 per share, a 3.2 percentage point increase in the underwriting profit margin and a $46.2 million increase in capital. The Company historically established case and IBNR reserves by product with the objective of being accurate to within plus or minus 2%. Pricing has been based on these estimates of reserves by product. Because the Company desired a very high degree of comfort that aggregate reserves were adequate, aggregate reserves were established near the upper end of the reasonable range of reserves, and the difference between such aggregate reserves and the midpoint of the reasonable range of case and IBNR reserves was called the "supplemental reserve." The Company concluded, after examining its historical aggregate reserves, that the practice of setting aggregate reserves at the upper end of the range of reasonable reserves provided an unnecessarily high level of comfort. Even without the high level of comfort provided by the "supplemental reserve," the Company's reserves have historically been redundant by approximately 2% to 4% over the most recent 5 years. The Company believes that this change in the estimate of its reserves will place it more in line with the practices of other companies in the industry.
Because the Company is primarily an insurer of motor vehicles, it has limited exposure for environmental, product and general liability claims. The Company has established reserves for these exposures, in amounts which it believes to be adequate based on information currently known by it. The Company does not believe that these claims will have a material impact on the Company's liquidity, results of operations or financial condition.
During 1994, the Company settled the dispute, arising out of its 1985 acquisition of American Star Insurance Company (since renamed National Continental Insurance Company), over the seller's refusal to pay certain losses on pre-sale business written by American Star. Under the settlement, National Continental received $10.1 million from the seller and agreed to be solely responsible for the next $20 million of gross losses. The seller will thereafter be responsible for half the losses, net of reinsurance, if it achieves certain minimum net worth requirements. In addition to the $10.1 million, National Continental will be entitled to the proceeds of various treaty and facultative reinsurance policies that had been purchased by American Star. National Continental has established reserves for these exposures, which are mainly for product liability and environmental claims, in amounts it believes to be adequate based on information currently available to it, including a recent study by independent actuaries. Total reserves on this business are $29.7 million, of which $9.9 million is
recoverable from reinsurers. The Company will continue to monitor these exposures, adjust the related reserves appropriately as additional information becomes known and disclose any material developments.
Policy acquisition and other underwriting expenses as a percentage of premiums earned were 25% in 1994, compared to 28% in 1993 and 31% in 1992. The decrease reflects cost-cutting measures, as well as process improvements, changed workflows and lower commission programs.
Service businesses generated a pretax operating profit of $10.0 million in 1994, compared to a pretax profit of $6.8 million in 1993 and a pretax loss of $4.3 million in 1992.
Recurring investment income (interest and dividends) increased 18% to $158.5 million in 1994, compared to $134.5 million in 1993 and $139.0 million in 1992, primarily due to an increase in the average investment portfolio. Net realized gains on security sales were $23.8 million in 1994, $107.9 million in 1993 and $14.5 million in 1992. A significant portion of the 1993 realized gains resulted from the sale of certain equity securities held in the Company's investment portfolio.
President Clinton signed the Omnibus Budget Reconciliation Act of 1993, which, among other items, increased the statutory tax rate to 35%. Effective January 1, 1992, the Company adopted SFAS 109. The cumulative effect of adopting SFAS 109 increased net income $14.2 million, or $.20 per share. The Company is able to demonstrate that the benefit of deferred tax assets is fully realizable.
ITEM 8.


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements of the Company, along with the related notes, supplementary data and report of independent accountants, are incorporated by reference from the Company's 1994 Annual Report, pages 33 through 53.
ITEM 9.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III --------
ITEM 10.



ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
A description of the directors, including those nominated for election as directors at the 1995 Annual Meeting of Shareholders of the Registrant, is incorporated herein by reference from the section entitled "Election of Directors" in the Proxy Statement, pages 2 through 4.
A description of the executive officers of the Registrant and its subsidiaries follows. These descriptions reflect the Company's termination of its officership program and consequent elimination of many officer positions, effective December 31, 1993. Unless otherwise indicated, the executive officer has held the position(s) indicated for the last five years.
SECTION 16(A) REPORTING
Under the Federal securities laws, the directors and certain officers of the Company, and holders of 10% or more of the Company's Common Shares, are required to report their ownership of the Company's Common Shares, and any changes in such ownership to the Securities and Exchange Commission ("SEC") and New York Stock Exchange ("NYSE") within specified timeframes. David M. Schneider inadvertently omitted to include in his Section 16(a) reports 8,697 Common Shares that were transferred in March 1990 from his father's estate to a trust of which he is a co- trustee, and 1,500 Common Shares with respect to which he had a beneficial interest that were sold by that trust in April 1990. Corrective filings were made with the SEC and NYSE, on behalf of both Mr. Schneider and the trust, promptly after this oversight was discovered. The plan administrator of the Company's Long-Term Savings Plan furnished erroneous information to Charles B. Chokel and Jeffrey W. Basch concerning allocations of shares to their plan accounts during 1993. As a result, the allocations reported in their Form 5s for 1993 were overstated by approximately 69 shares and 224 shares, respectively. Both individuals filed amended Form 5s promptly after receiving revised information from the plan administrator. Also, Mr. Basch's wife acquired 40 shares in an intraplan transfer to her Long-Term Savings Plan account which Mr. Basch inadvertently failed to report on Form 4. This transaction was later reported on Mr. Basch's Form 5 for 1994. Tiona M. Thompson inadvertently underreported by 13,000 shares the number of shares subject to stock options granted to her on April 14, 1994 under the Company's 1989 Incentive Plan. She filed an amended Form 4 for April 1994 promptly after this oversight was discovered.
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION
Incorporated by reference from the section of the Proxy Statement entitled "Executive Compensation," pages 8 through 17.
ITEM 12.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference from the section of the Proxy Statement entitled "Security Ownership of Certain Beneficial Owners and Management," pages 5 through 7.
ITEM 13.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None
PART IV -------
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a)(1) Listing of Financial Statements
The following consolidated financial statements of the Registrant and its subsidiaries, included in the Registrant's Annual Report, are incorporated by reference in Item 8:
Report of Independent Accountants
Consolidated Statements of Income - December 31, 1994, 1993 and 1992
Consolidated Balance Sheets - December 31, 1994 and 1993
Consolidated Statements of Changes in Shareholders' Equity - December 31, 1994, 1993 and 1992
Consolidated Statements of Cash Flows - December 31, 1994, 1993 and 1992
Notes to Consolidated Financial Statements
Supplemental Information*
*Not covered by Report of Independent Accountants.
(a)(2) Listing of Financial Statement Schedules
The following financial statement schedules of the Registrant and its subsidiaries, Report of Independent Accountants and Consent of Independent Accountants are included in Item 14(d):
Schedules ---------
Report of Independent Accountants
Consent of Independent Accountants
Schedule I - Summary of Investments - Other than Investments in Related Parties
Schedule III - Condensed Financial Information of Registrant
Schedule V - Supplementary Insurance Information
Schedule VI - Reinsurance
Schedule X - Supplemental Information Concerning Property-Casualty Insurance Operations
No other schedules are required to be filed herewith pursuant to Article 7 of Regulation S-X.
(a)(3) Listing of Exhibits
See exhibit index contained herein at pages 37 through 40. Management contracts and compensatory plans and arrangements are identified in the Exhibit Index as Exhibit Nos. (10)(A) through (10)(M).
(b) Reports on Form 8-K
On January 3, 1995, the Company filed a Form 8-K to report the elimination of its "supplemental reserve" during the fourth quarter 1994, resulting in a one-time increase in earnings of approximately $71 million, or $.63 per share for the quarter and $.62 per share for the year. The Company's combined ratio was reduced by 11.8 points for the quarter and 3.2 points for the year.
(c) Exhibits
The exhibits in response to this portion of Item 14 are submitted concurrently with this report.
(d) Financial Statement Schedules
The response to this portion of Item 14 is located at pages 27 through 36.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
THE PROGRESSIVE CORPORATION
March 28, 1995 BY: /s/ Peter B. Lewis ------------------------------ Peter B. Lewis Chairman, President and Chief Executive Officer of the Registrant
ANNUAL REPORT ON FORM 10-K
ITEM 14(D)
FINANCIAL STATEMENT SCHEDULES
YEAR ENDED DECEMBER 31, 1994
THE PROGRESSIVE CORPORATION
MAYFIELD VILLAGE, OHIO
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders, The Progressive Corporation:
Our report on the consolidated financial statements of The Progressive Corporation and subsidiaries has been incorporated by reference in this Form 10-K from page 33 of the 1994 Annual Report to Shareholders of The Progressive Corporation. In connection with our audits of such financial statements, we have also audited the related financial statement schedules listed in the index on pages 20 and 21 of this Form 10-K.
In our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.
COOPERS & LYBRAND L.L.P.
Cleveland, Ohio January 26, 1995
CONSENT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders, The Progressive Corporation:
We consent to the incorporation by reference in the Registration Statement of The Progressive Corporation on Form S-8 (File No. 33-57121) filed December 29, 1994, the Registration Statement on Form S-8 (File No. 33-64210) filed June 10, 1993, the Registration Statement on Form S-8 (File No. 33-51034) filed August 20, 1992, the Registration Statement on Form S-8 (File No. 33-46944) filed April 3, 1992, the Registration Statement on Form S-8 (File No. 33-38793) filed February 4, 1991, the Registration Statement on Form S-8 (File No. 33-38464) filed December 28, 1990, the Registration Statement on Form S-8 (File No. 33-38107) filed December 6, 1990, the Registration Statement on Form S-8 (File No. 33-37707) filed November 9, 1990, the Registration Statement on Form S-8 (File No. 33-33240) filed January 31, 1990, and the Registration Statement on Form S-8 (File No. 33-16509) filed August 14, 1987 of our report dated January 26, 1995, on our audits of the consolidated financial statements and financial statement schedules of The Progressive Corporation and subsidiaries as of December 31, 1994 and 1993, and for each of the three years in the period ended December 31, 1994, which report is included in this Annual Report on Form 10-K.
COOPERS & LYBRAND L.L.P.
Cleveland, Ohio March 27, 1995
The Company did not have any securities of one issuer with an aggregate cost or market value exceeding 10% of total shareholders' equity at December 31, 1994.
SCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
NOTES TO CONDENSED FINANCIAL STATEMENTS - --------------------------------------------------------------------
The accompanying condensed financial statements of The Progressive Corporation (the "Registrant") should be read in conjunction with the consolidated financial statements and notes thereto of The Progressive Corporation and subsidiaries included in the Registrant's 1994 Annual Report.
STATEMENTS OF CASH FLOWS -- For the purpose of the Statements of Cash Flows, cash includes only bank demand deposits. The Registrant paid Federal income taxes of $89.8 million, $91.0 million and $4.0 million in 1994, 1993 and 1992, respectively. Total interest paid was $49.8 million for 1994, $40.9 million for 1993 and $44.3 million for 1992. During 1992, the $75.0 million Floating Rate Convertible Subordinated Debenture due 2008 was converted into 9.0 million Common Shares.
The Registrant effected a 3-for-1 stock split in the form of a dividend to shareholders on December 8, 1992. The Registrant issued its Common Shares by transferring $38.5 million from retained earnings to the common stock account. All per share and share amounts and stock prices were adjusted to give effect to the split. Treasury shares were not split.
Funded debt is the amount the Registrant has borrowed and contributed to the capital of its insurance subsidiaries or borrowed for other long-term purposes.
In May 1990, the Registrant entered into a revolving credit arrangement with National City Bank, which is reviewed by the bank annually. Under this agreement, the Registrant had the right to borrow up to $50.0 million. In February 1994, the Registrant reduced this revolving credit arrangement to $20.0 million. By selecting from available credit options, the Registrant may elect to pay interest at rates related to the London interbank offered rate, the bank's base rate or at a money market rate. A commitment fee is payable on any unused portion of the committed amount at the rate of .125% per annum. At December 31, 1994 and 1993, the Registrant had no borrowings under this arrangement.
In February 1994, the Registrant terminated a four-year credit facility with Morgan Guaranty Trust Company of New York, originally entered into in May 1990, under which the Registrant had the right to borrow up to $75.0 million.
In February 1994, the Registrant terminated a five-year credit facility agreement with a group of banks, originally entered into in October 1989, under which the Registrant secured the right to borrow up to $235.0 million and request an additional $235.0 million.
SCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued)
NOTES TO CONDENSED FINANCIAL STATEMENTS - -----------------------------------------------------------------
In January 1994, the Registrant sold $200.0 million of its 6.60% Notes due 2004. The Notes are noncallable, and interest is payable semiannually. The fair value of the Notes was $174.2 million at December 31, 1994.
In October 1993, the Registrant sold $150.0 million of noncallable 7% Notes due 2013 with interest payable semiannually. The fair value of these Notes was $124.6 million and $145.3 million at December 31, 1994 and 1993, respectively.
In May 1989, the Registrant issued $30.0 million of 8 3/4% Notes due 1999 in exchange for $30.0 million of the 8 3/4% Debentures due 2017. These Notes are noncallable, and interest is payable semiannually. The fair value of these Notes was $30.3 million and $33.7 million at December 31, 1994 and 1993, respectively.
In December 1988, the Registrant sold $150.0 million of 10% Notes due 2000, and $150.0 million of 10 1/8% Subordinated Notes due 2000. All the Notes are noncallable. Interest is payable semiannually on both issues. The fair value of the 10% Notes and 10 1/8% Subordinated Notes were $159.8 million and $159.7 million, respectively, at December 31, 1994, and $180.6 million and $181.2 million, respectively, at December 31, 1993.
In February 1987, the Registrant sold $100.0 million, $70.0 million after the May 1989 debt exchange, of 8 3/4% Debentures due 2017 with interest payable semiannually. In December 1993, the Registrant redeemed the entire $70.0 million principal amount of these Debentures. The Registrant redeemed the Debentures at 105.425% of the principal amount, plus accrued interest, with the proceeds of the sale of certain securities in its investment portfolios. A $4.0 million charge on debt extinguishment was recorded as a "non-recurring item."
As of December 31, 1994, the Registrant was in compliance with its debt covenants.
Aggregate principal payments on funded debt outstanding at December 31, 1994 are $0 for 1994 through 1998, $30.0 million for 1999 and $650.0 million thereafter.
FEDERAL INCOME TAXES -- The Registrant files a consolidated Federal income tax return with all subsidiaries. The Federal income taxes in the accompanying Condensed Balance Sheets represent amounts recoverable from the Internal Revenue Service by the Registrant as agent for the consolidated tax group. The Registrant and its subsidiaries have adopted, pursuant to a written agreement, a method of allocating consolidated Federal income taxes. Amounts allocated to the subsidiaries under the written agreement are included in Intercompany Receivable from/Payable to Subsidiaries in the accompanying Condensed Balance Sheets.
Effective January 1, 1992, the Registrant adopted Statement of Financial Accounting Standards (SFAS 109) "Accounting for Income Taxes", which changes the method of accounting for income taxes. Under SFAS 109, the Registrant is able to demonstrate that the benefit of deferred tax assets is fully realizable. The cumulative effect of adopting SFAS 109 was to restore the deferred tax assets and increase net income $14.2 million, or $.20 per share, in 1992.
SCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued)
OTHER MATTERS -- The information relating to incentive compensation plans and related party transactions is incorporated by reference from Note 9, EMPLOYEE BENEFIT PLANS, "Incentive Compensation Plans" and Note 11, RELATED PARTY TRANSACTIONS, on pages 45 through 47 of the Registrant's 1994 Annual Report.