The Company leases 703,000 square feet of office and warehouse space at various locations throughout the United States for its other business units and staff functions. In addition, the Company leases 347 claim offices, consisting of 1,431,000 square feet, at various locations throughout the United States. These leases are generally short-term to medium-term leases of standard commercial office space. Two offices totaling 16,000 square feet are leased in Canada.
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, to retire its outstanding indebtedness, to pay dividends and for other business purposes.
During 1999, the Company repurchased 6,044 of its Common Shares at a total cost of $.6 million (average $93.25 per share) to satisfy obligations under the Company's benefit plans. During the three-year period ended December 31, 1999, the Company repurchased 440,316 of its Common Shares at a total cost of $46.0 million (average $104.57 per share). During the same period, The Progressive Corporation made $82.5 million of capital contributions to its subsidiaries, net of dividends received from these subsidiaries. The regulatory restrictions on subsidiary dividends are described in Item 5(c) herein.
Total capital expenditures for the three years ended December 31, 1999, aggregated $443.6 million. In December 1997, the Company purchased approximately 72 acres in Tampa, Florida to construct a three-building, 307,000 square foot, regional call center. The final cost of the project was $45.5 million. The first two buildings were completed during 1998. The third building was completed in February 1999. In addition, in November 1997, the Company purchased 91 acres in Mayfield Village, Ohio to construct an office complex, near the site of its corporate headquarters. This office complex is part of a five-year cooperative effort with Mayfield Village to develop over 300 acres. Progressive will serve as the anchor corporate user, with additional business users and recreational facilities on the site. The Company is constructing five buildings, containing a total of approximately 770,000 square feet, on the site, and a parking garage, at an estimated cost of $132.5 million. As of December 31, 1999, $65.8 million has been paid. The first building was completed in May 1999. The next two buildings were completed in the first quarter of 2000. The parking garage and fourth building are scheduled to be completed in October 2000. The fifth building is scheduled to be completed in the first quarter of 2001. The construction projects are being funded through operating cash flows.
INVESTMENTS The Company invests in fixed-maturity, equity and short-term securities. The Company's investment strategy recognizes its need to maintain capital adequate to support its insurance operations. The Company evaluates the risk/reward tradeoffs of investment opportunities, measuring their effects on stability, diversity, overall quality and liquidity of the investment portfolio. At December 31, 1999, the Company's portfolio was $6,427.7 million, compared to $5,674.3 million in 1998.
The majority of the portfolio is invested in high-grade, fixed-maturity securities, of which short- and intermediate-term securities represented $4,417.7 million, or 68.7% of the portfolio, at the end of 1999, compared to $4,439.4 million, or 78.3%, at the end of 1998. Long-term investment-grade securities, including those principal paydowns from asset-backed securities that are greater than 10-years, were $96.0 million, or 1.5% of the portfolio, at the end of 1999, compared to $93.5 million, or 1.6%, at the end of 1998. Non-investment-grade fixed-maturity securities were $248.0 million, or 3.9% of the portfolio, at the end of 1999, compared to $128.0 million, or 2.3%, at the end of 1998, and offer the Company higher returns and added diversification without a significant adverse effect on the stability and quality of the investment portfolio as a whole. Non-investment-grade securities may involve greater risks often related to creditworthiness, solvency and relative liquidity of the secondary trading market. The duration of the fixed-income portfolio was 3.0 years at December 31, 1999, compared to 2.8 years at December 31, 1998.
As of December 31, 1999, the Company held $1,831.1 million of asset-backed securities, which represented 28.5% of the total investment portfolio. The asset-backed portfolio included collateralized mortgage obligations (CMO) and commercial mortgage-backed obligations (CMB) totaling $612.0 million and $649.7 million, respectively. The remainder of the asset-backed portfolio was invested primarily in auto loan and other asset-backed securities. As of December 31, 1999, the CMO portfolio included sequential bonds, representing 68.3% of the CMO portfolio ($417.7 million), and planned amortization class bonds, representing 31.7% of the CMO Portfolio ($194.3 million). At December 31, 1999, the CMO portfolio had an average life of 3.88 years and a weighted average Moody's or Standard & Poor's rating of AAA. The CMB portfolio had an average life of 5.75 years and a weighted average Moody's or Standard & Poor's rating of AA. At December 31, 1999, the CMO and CMB portfolios had unrealized losses of $13.0 million and $45.1 million, respectively. The single largest unrealized loss in any individual CMO security was $1.3 million and in any CMB security was $6.9 million, at December 31, 1999. The CMB portfolio includes $106.6 million of CMB interest-only certificates, which had an average life of 6.45 years and a weighted average Moody's or Standard & Poor's rating of AAA at December 31, 1999. Both the CMO and CMB portfolios are liquid with available market 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 Statement of Financial Accounting Standards (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 of the resecuritized debt, which was subsequently sold in 1998 for a net gain of $3.5 million. This portion of the transaction was not accounted for as a sale in 1998 in accordance with SFAS 125.
A portion of the investment portfolio is invested in marketable equity securities. Common stocks represented $1,243.6 million, or 19.3% of the portfolio, at the end of 1999, compared to $636.9 million, or 11.2%, a year earlier. The majority of the common stock portfolio is invested in domestic equities traded on nationally recognized securities exchanges. The common stock portfolio also includes term trust certificates, the common shares of closed-end bond funds, which have the risk and reward characteristics of the underlying bonds and comprised $230.2 million of the common stock portfolio at the end of 1999; no term trust securities were held at the end of 1998. Foreign equities, which may include stock index futures and foreign currency forwards, comprised $84.2 million of the common stock portfolio at the end of 1999,
compared to $130.7 million last year, and partnership investments comprised $104.0 million of the common stock portfolio at the end of 1999, compared to $63.7 million last year. Preferred stocks represented $422.4 million, or 6.6% of the portfolio, at the end of 1999, compared to $376.5 million, or 6.6%, a year earlier, and was comprised of over 89% of fixed-rate preferred stocks with mechanisms that are expected to provide an opportunity to liquidate at par.
Included in the Company's fixed-maturity and equity portfolios are $195.8 million, or 3.0%, of other risk assets. These include high yield and distressed debt, private equities and warrants, and mezzanine investments. No individual security in this category comprised more than 1% of the Company's total investment portfolio. The total return on this asset class in 1999 was 7.1% with a total net unrealized gain of $20.5 million.
Direct premiums written increased 16% to $6,305.3 million in 1999, compared to $5,451.3 million in 1998 and $4,825.2 million in 1997. Net premiums written increased 16% to $6,124.7 million in 1999, compared to $5,299.7 million in 1998
pricing exceeded estimates. Similarly, the emerging loss development is greater than anticipated primarily for the 1999 losses, which led to the Company experiencing approximately 6 points of adverse development during the first two months of 2000. During March 2000, the Company undertook a comprehensive review of those reserve segments that have shown the most development and intends to adjust the reserves accordingly.
The Company's other lines of business include writing insurance for small fleets of commercial vehicles, collateral protection and loan tracking for auto lenders and financial institutions, directors' and officers' liability and fidelity coverage for American Bankers Association member community banks and independent credit unions, and providing related claim, underwriting and system services. Revenues in these businesses were $437.0 million in 1999, compared to $405.5 million in 1998 and $402.1 million in 1997. Pretax operating profit was $41.8 million in 1999, compared to $61.9 million in 1998 and $36.6 million in 1997.
Recurring investment income (interest and dividends) increased 16% to $340.7 million in 1999, compared to $294.8 million in 1998 and $274.9 million in 1997, primarily due to an increase in the size of the investment portfolio. Net realized gains on security sales were $47.2 million in 1999, $11.4 million in 1998 and $98.5 million in 1997. Investment expenses were $9.5 million in 1999, compared to $7.4 million in 1998 and $9.9 million in 1997.
The Company continually evaluates computer hardware and software upgrades for enhancements and, therefore, many of the costs to replace these items to be year 2000 compliant were not incremental costs to the Company.
In preparing for the rollover to the 21st century, the Company's process teams and business groups identified potential year 2000 scenarios. For those scenarios deemed to be both probable and with a potentially significant business impact, the Company developed contingency plans. These plans were reviewed by the Company's chief financial and technology officers throughout 1999. It has not been necessary to execute any of the contingency plans to date.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995: CERTAIN MATTERS IN THIS ANNUAL REPORT ON FORM 10-K MAY BE CONSIDERED FORWARD-LOOKING STATEMENTS THAT ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL EVENTS AND RESULTS TO DIFFER MATERIALLY FROM THOSE DISCUSSED HEREIN. THESE RISKS AND UNCERTAINTIES INCLUDE, WITHOUT LIMITATION, UNCERTAINTIES RELATED TO ESTIMATES, ASSUMPTIONS AND PROJECTIONS GENERALLY; CHANGES IN ECONOMIC CONDITIONS (INCLUDING CHANGES IN INTEREST RATES AND FINANCIAL MARKETS); PRICING COMPETITION AND OTHER INITIATIVES BY COMPETITORS; LEGISLATIVE AND REGULATORY DEVELOPMENTS; WEATHER CONDITIONS (INCLUDING THE SEVERITY AND FREQUENCY OF STORMS, HURRICANES, SNOWFALLS, HAIL AND WINTER CONDITIONS); CHANGES IN DRIVING PATTERNS AND LOSS TRENDS; COURT DECISIONS AND TRENDS IN LITIGATION AND HEALTH CARE COSTS; UNFORESEEN TECHNOLOGICAL ISSUES ASSOCIATED WITH THE YEAR 2000 COMPLIANCE EFFORTS AND THE EXTENT TO WHICH VENDORS, PUBLIC UTILITIES, GOVERNMENTAL ENTITIES AND OTHER THIRD PARTIES THAT INTERFACE WITH THE COMPANY MAY FAIL TO ACHIEVE YEAR 2000 COMPLIANCE; AND OTHER MATTERS DESCRIBED FROM TIME TO TIME BY THE COMPANY IN OTHER DOCUMENTS FILED WITH THE UNITED STATES SECURITIES AND EXCHANGE COMMISSION. THE COMPANY ASSUMES NO OBLIGATION TO UPDATE THE INFORMATION IN THIS ANNUAL REPORT.