During the three-year period ended December 31, 1997, the Company repurchased 1.0 million of its Common Shares at a total cost of $44.8 million (average $43.37 per share), .3 million of its 9 3/8% Serial Preferred Shares, Series A, at a total cost of $8.3 million (average $25.62 per share) and redeemed its remaining Preferred Shares at a total cost of $82.1 million ($25.00 per share). The Company also sold $100.0 million of Notes. During the same period, The Progressive Corporation received $50.8 million from its subsidiaries, net of capital contributions made to these subsidiaries. The regulatory restrictions on subsidiary dividends are described in Item 5(c) on page 12 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 $10.0 million revolving credit agreement. With its 27% debt to capital ratio, management believes the Company 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, 1997, operations generated a positive cash flow of $1,917.5 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.
Total capital expenditures for the three years ended December 31, 1997, aggregated $196.0 million. During 1997, the Company made substantial investments in property and equipment to support its infrastructure. In December 1997, the Company purchased approximately 72 acres in Tampa, Florida to construct a three-building regional call center. It is estimated that, when completed, this facility will consist of approximately 307,000 square feet of space. The cost of the project is currently estimated at $42.0 million and $8.3 million has been paid as of December 31, 1997. The project is scheduled to be completed by the end of 1998. In addition, in November 1997, the Company purchased 91 acres in Mayfield Village, Ohio to construct an office complex, near the site of its current corporate headquarters. This office complex is part of a five-year cooperative effort with Mayfield Village to develop over 300 acres -- Progressive would serve as the anchor corporate user with additional business users and recreational facilities on the site. The Company plans to construct three buildings containing a total of approximately 485,000 square feet, in 1998, and could build up to three additional buildings, containing about 500,000 additional square feet in total, in the future. The first phase of this project is estimated to cost $63.5 million. As of December 31, 1997, $5.3 million has been paid. The construction projects will be funded through operating cash flows or the issuance of new debt securities.
A portion of the investment portfolio was invested in marketable equity securities. Common stocks represented $620.8 million, or 11.8% of the portfolio, at the end of 1997, compared to $540.1 million, or 12.1%, a year earlier. Foreign equities, which may include stock index futures and foreign currency forwards, comprised $106.0 million of the common stock portfolio at the end of 1997, and $149.5 million at the end of 1996. As of December 31, 1997, the Company's Japanese equity holdings represented 1.5% of the common stock portfolio. The remainder of the equity portfolio of $348.8 million, or 6.6%, at the end of 1997, compared to $341.6 million, or 7.7%, at the end of 1996, was comprised of over 80% of fixed-rate preferred stocks with mechanisms that are expected to provide an opportunity to liquidate at par.
As of December 31, 1997, the Company's portfolio had $188.4 million in unrealized gains, compared to $114.1 million a year earlier. This increase in value was the result of increased stock prices as the S&P 500 index rose from 740.7 to 970.4 and decreased interest rate levels as evidenced by the .3% decrease in the 3-year treasury note.
The weighted average fully taxable equivalent book yield of the portfolio was 6.6%, 6.7% and 6.9% for the years ended December 31, 1997, 1996 and 1995, respectively.
As of December 31, 1997, the Company held $1,520.0 million of asset-backed securities, which represented 28.8% of the total investment portfolio. The portfolio included collateralized mortgage obligations (CMO) and commercial mortgage-backed obligations (CMB) totaling $283.2 million and $776.7 million, respectively. The remainder of the asset-backed portfolio was invested primarily in auto loan and other asset-backed securities. As of December 31, 1997, the CMO portfolio included busted planned amortization class bonds and sequential bonds representing 94.1% of the CMO portfolio ($266.4 million) with an average life of 3.0 years, and planned amortization class bonds representing 5.9% of the CMO portfolio ($16.8 million) with an average life of .5 years.
At December 31, 1997, the CMO portfolio had a weighted average Moody's or Standard & Poor's rating of AAA and the CMB portfolio had an average life of 7.4 years and a weighted average Moody's or Standard & Poor's rating of AA. At December 31, 1997, the CMO and CMB portfolios had unrealized gains of $1.6 million and $14.0 million, respectively. The single largest unrealized loss in any individual CMO security was $.2 million and in any CMB security was $1.1 million, at December 31, 1997. The CMB portfolio includes $149.6 million of CMB interest-only certificates, which had an average life of 6.9 years and a weighted average Moody's or Standard & Poor's rating of AAA at December 31, 1997. Both the CMO and CMB portfolios are highly liquid with readily available quotes and contain no residual interests. During 1997, the Company sold $178.4 million (proceeds of $200.8 million) of non-investment-grade CMB securities to a third-party purchaser. The purchaser subsequently transferred the securities to a trust as collateral in a resecuritized debt offering. The transaction was accounted for as a sale under SFAS 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," resulting in a net gain of $22.4 million. A bankruptcy remote subsidiary of the Company acquired $22.8 million (market value of $25.9 million) of the resecuritized debt. This portion of the transaction was not accounted for as a sale in accordance with SFAS 125.
Derivative instruments are primarily used to manage the risks and enhance the returns of the available-for-sale portfolio. This is accomplished by modifying the basis, duration, interest rate or foreign currency characteristics of the portfolio or
Direct premiums written increased 33% to $4,825.2 million in 1997, compared to $3,638.4 million in 1996 and $3,068.9 million in 1995. Net premiums written increased 36% to $4,665.1 million in 1997, compared to $3,441.7 million in 1996 and $2,912.8 million in 1995. The difference between direct and net premiums written is largely attributable to premiums written under state-mandated involuntary Commercial Auto Insurance Procedures (CAIP), for which the Company retains no indemnity risk, of $78.4 million in 1997, $99.5 million in 1996 and $105.4 million in 1995. The Company provided policy and claim processing services to 27 state CAIPs in 1997 and 1996, compared to 28 in 1995. Premiums earned, which are a function of the amount of premiums written in the current and prior periods, increased 31% in 1997, compared to 17% in 1996 and 24% in 1995.
Policy acquisition and other underwriting expenses as a percentage of premiums earned were 23% in 1997, compared to 22% in 1996 and 23% in 1995. In 1997, the Company incurred additional expenses to support its infrastructure and to hire and train people in anticipation of growth. The Company also introduced its advertising campaign to 13 states during 1997, bringing the total number of states where the Company advertises to 19 (40 markets).
Safe Harbor statement under the Private Securities Litigation Reform Act of 1995: Except for historical information, the matters discussed in this annual report on Form 10-K are forward-looking statements that are subject to certain risks and uncertainties that could cause the actual results to differ materially from those projected, including acceptance of the products, pricing competition, market conditions and other risks detailed from time to time in the Company's SEC reports. The Company assumes no obligation to update the information in this annual report.
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 1997 Annual Report, pages 35 through 48 and pages 53 through 59.
NEW ACCOUNTING STANDARDS - In March 1998, the American Institute of Certified Public Accountants issued Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," which is effective for fiscal years beginning after December 15, 1998, with early adoption permitted. SOP 98-1 provides guidance on accounting for the costs of computer software developed or obtained for internal use, identifying when such costs should be capitalized rather than expensed as incurred. The Company currently expenses all computer software costs. The Company is planning to early adopt SOP 98-1 in the first quarter 1998 and is currently quantifying the impact to its financial condition and results of operations.