UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 1O-Q

(Mark One)

For the quarterly period ended September 30, 2004

or

For the transition period from                                        to                                       

Commission File Number 1-9518

THE PROGRESSIVE CORPORATION

(440) 461-5000

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [  ]

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [  ]

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common Shares, $1.00 par value: 200,204,259 outstanding at October 31, 2004

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PART I - FINANCIAL INFORMATION

Item 1. Financial Statements.

The Progressive Corporation and Subsidiaries
Consolidated Statements of Income
(unaudited)

NM = Not Meaningful

See notes to consolidated financial statements.

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The Progressive Corporation and Subsidiaries

See notes to consolidated financial statements.

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The Progressive Corporation and Subsidiaries

See notes to consolidated financial statements.

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The Progressive Corporation and Subsidiaries

Note 1 Basis of Presentation — These financial statements and the notes thereto should be read in conjunction with the Company’s audited financial statements and accompanying notes included in its Annual Report on Form 10-K for the year ended December 31, 2003.

The consolidated financial statements reflect all normal recurring adjustments which, in the opinion of management, were necessary for a fair statement of the results for the interim periods presented. The results of operations for the period ended September 30, 2004, are not necessarily indicative of the results expected for the full year.

Note 2 Stock-Based Compensation — The Company follows the provisions of Statement of Financial Accounting Standards (SFAS) 123, “Accounting for Stock-Based Compensation,” to account for its stock compensation activity in the financial statements. Prior to January 1, 2003, the Company followed the provisions of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” to account for its stock option activity.

The change to the fair value method of accounting under SFAS 123 was applied prospectively to all non-qualified stock option awards granted, modified or settled after January 1, 2003. No stock options were granted after December 31, 2002. As a result, there is no compensation cost for stock options included in net income for 2003 or 2004; however, compensation expense would have been recognized if the fair value method had been used for all awards since the original effective date of SFAS 123 (January 1, 1995). Prior to 2003, the Company granted all options currently outstanding at an exercise price equal to the market price of the Company’s Common Shares at the date of grant and, therefore, under APB 25, no compensation expense was recorded.

In 2003, the Company began issuing restricted stock awards. Compensation expense for restricted stock awards is recognized over their respective vesting periods. The current year expense is not representative of the effect on net income for future years since each subsequent year will reflect expense for additional awards.

See Item 5-Other Information in Part II of the Company’s Form 10-Q for the quarterly period ended March 31, 2004, for details regarding the annual restricted stock awards granted by the Company.

The following table is presented in accordance with SFAS 148, “Accounting for Stock-Based Compensation – Transition and Disclosure,” and shows the effects on net income and earnings per share had the fair value method been applied to all outstanding and unvested stock option awards for the periods presented. The Company used a modified Black-Scholes pricing model to calculate the fair value of the options awarded as of the date of grant.

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Note 3 Supplemental Cash Flow Information — The Company paid income taxes of $463.0 million and $304.0 million during the nine months ended September 30, 2004 and 2003, respectively. Total interest paid was $70.3 million and $77.6 million during the nine months ended September 30, 2004 and 2003, respectively.

Note 4 Debt — Debt at September 30 consisted of:

Note 5 Comprehensive Income — Total comprehensive income was $448.7 million and $307.9 million for the quarters ended September 30, 2004 and 2003, respectively, and $1,170.9 million and $1,058.0 million for the nine months ended September 30, 2004 and 2003, respectively.

Note 6 Dividends — On September 30, 2004, the Company paid a quarterly dividend of $.03 per Common Share to shareholders of record as of the close of business on September 10, 2004. The Board of Directors declared the dividend on August 20, 2004.

Note 7 Segment Information — The Company’s Personal Lines business units write insurance for private passenger automobiles and recreation vehicles. The Commercial Auto business unit writes primary liability, physical damage and other auto-related insurance for automobiles and trucks owned by small businesses. The Company’s other businesses principally include directors’ and officers’ liability insurance and processing business for Commercial Auto Insurance Procedures (CAIP), which are state-supervised plans serving the involuntary market. The “other businesses” also manage the run-off from discontinued product lines. All revenues are generated from external customers.

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Periods ended September 30,

¹Personal automobile insurance accounted for 92% of the total Personal Lines segment net premiums earned in the third quarter of 2004 and 93% for all other periods presented.

²Includes the other indemnity businesses as well as the Company’s service business operations. For 2003, other businesses included $30.8 million of estimated interest income related to the income tax refund the Company received in February 2004.

³Revenues represent recurring investment income and net realized gains (losses) on securities; pretax profit is net of investment expenses.

Note 8 Litigation — The Company is named as defendant in various lawsuits arising out of its insurance operations. All legal actions relating to claims made under insurance policies are considered by the Company in establishing its loss and loss adjustment expense reserves.

In addition, the Company is named as defendant in a number of class action or individual lawsuits, the outcomes of which are uncertain at this time. These cases include those alleging damages as a result of the Company’s total loss evaluation methodology, use of after-market parts, use of consumer reports (such as credit reports) in underwriting and related notice requirements under the federal Fair Credit Reporting Act, charging betterment in first party physical damage claims, the adjusting of personal injury protection and medical payment claims, the use of preferred provider rates for payment of personal injury protection claims, the use of automated database vendors to assist in evaluating certain first party bodily injury claims, and cases challenging other aspects of the Company’s claims and marketing practices and business operations, including worker classification issues.

The Company plans to contest the outstanding suits vigorously, but may pursue settlement negotiations in appropriate cases. In accordance with generally accepted accounting principles (GAAP), the Company has established accruals for lawsuits as to which the Company has determined that it is probable that a loss has been incurred and the Company can reasonably estimate its potential exposure. Pursuant to GAAP, the Company has not established reserves for those lawsuits where the loss is not probable and/or the Company is currently unable to estimate the potential exposure. If any one or more of these lawsuits results in a judgment against or settlement by the Company in an amount that is significantly in excess of the reserve established for such lawsuit (if any), the resulting liability could have a material impact on the Company’s financial condition, cash flows and results of operations.

For further discussion on the Company’s pending litigation, see Item 3-Legal Proceedings in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

Note 9 Reclassifications — Certain amounts in the financial statements for prior periods were classified to conform to the 2004 presentation.

Note 10 Subsequent Event — On October 22, 2004, the Company repurchased 16.9 million of its Common Shares, $1.00 par value, as part of a modified “Dutch auction” tender offer, at a purchase price of $88 per share, for a total cost of $1.5 billion.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

OVERVIEW

The Progressive Corporation and subsidiaries (the “Company”) continued the success achieved in 2003 and the first half of 2004. The Company had an underwriting profit margin of 13.7% and net income of $388.9 million in the third quarter 2004. Growth continued to slow as the Company’s net premiums written grew 9% in the third quarter 2004, as compared to the same period last year. All areas of the Company continued to function well, especially product pricing and claims resolution, as highlighted in the Company’s 2003 Annual Report to Shareholders. On the other hand, market conditions continue to change and most of the Company’s competitors now have rates that appear to be adequate. As a result, consumers generally are not being dislocated by rate or underwriting shocks, thereby reducing the number of new applications the Company is receiving. The Company, along with the rest of the industry, continued to benefit from the low level of automobile accident frequency during the quarter.

At September 30, 2004, the Company had 9.0 million policies in force on a companywide basis, 12% more than at the same time last year. New business applications are about on pace with last year, while strong renewal business is helping to support growth and is becoming an increasing percentage of the Company’s premiums. The Company has seen its retention measures fall somewhat despite its expectation that its average retention period per customer would increase given the rate stability in the industry. The Company is continuing to refine its measurement and methodology with regards to retention. Given its continued strong underwriting margins, the Company remains in a position where it can focus on retaining customers and introduce new product improvements faster.

The Company experienced favorable reserve development of 1.9 points for the third quarter and .8 points for the first nine months of 2004. The Company continued to experience a decline in accident frequency in every coverage on a quarter over prior year quarter basis. This low frequency, coupled with no notable escalating trends in claim costs and continuous improvement in claims settlement quality, helped contribute to the Company’s favorable loss results during the quarter.

The Company will continue to assess market conditions on a state-by-state basis. The Company has taken some rate reductions in selected states and is considering more to maintain attractive combinations of profit and growth. In the short term, the Company’s strategy is to maintain rate stability, with some margin reduction by absorbing future cost trends. The Company remains focused on building sustainable competitive advantages, generally through initiatives that reduce cost or increase segmentation, while providing longer-term price stability for customers.

The Company made no substantial changes in the allocation of its investment portfolio during the quarter, with the exception of the asset movement at quarter end in anticipation of the settlement of the Company’s tender offer (discussed below). Overall, the total portfolio had a positive return for the third quarter, driven by a positive return in the fixed-income securities, partially offset by negative total returns in the common stock portfolio. Year-to-date, both the fixed-income and common stock portfolios generated positive total returns. The Company continued to keep its credit quality high and exposure to interest rate risk low. At September 30, 2004, the fixed-income portfolio duration was 2.9 years with a weighted average credit quality of AA+.

During the third quarter 2004, the Board of Directors of the Company determined that the Company had a significant amount of capital on hand in excess of what was needed to support its insurance operations, fund its corporate obligations and prepare for various contingencies. In response, the Company conducted a modified “Dutch auction” tender offer to repurchase up to 17.1 million of its outstanding Common Shares, $1.00 par value, at prices ranging from $78 to $88 per share. See Financial Condition section for further information.

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FINANCIAL CONDITION

Capital Resources and Liquidity

During the third quarter 2004, The Progressive Corporation received $979.6 million of dividends from its insurance subsidiaries, net of cash capital contributions made to such subsidiaries, which were approved by the Ohio Department of Insurance. These dividends were invested in the portfolio of a consolidated, non-insurance subsidiary of the Company until needed to fund the “Dutch auction” tender offer discussed below.

Progressive’s insurance operations create liquidity by collecting and investing premiums written from new and renewal business in advance of paying claims. For the nine months ended September 30, 2004, operations generated positive cash flows of $2.4 billion.

On October 22, 2004, the Company repurchased 16.9 million of its Common Shares, $1.00 par value, as part of a modified “Dutch auction” tender offer, at a purchase price of $88 per share, for a total cost of $1.5 billion. The Company believes that, after completing the tender offer, its remaining capital on hand and cash flows from operations will be sufficient to support the Company’s insurance operations, corporate obligations and risk contingencies, including catastrophic, weather-related losses.

During the second quarter 2004, the Company entered into an uncommitted line of credit with National City Bank in the principal amount of $100 million. The Company entered into the line of credit as part of a contingency plan to help the Company maintain liquidity in the unlikely event that it experiences conditions or circumstances that affect the Company’s ability to transfer or receive funds. The Company had no borrowings under this arrangement at September 30, 2004.

During the first quarter 2004, the Company retired all $200 million of its 6.60% Notes at their maturity using part of the proceeds from the $400 million of its 6.25% Senior Notes issued in November 2002; the remainder of the proceeds from that offering are available for general corporate purposes.

The Company has substantial capital resources and believes it has sufficient borrowing capacity and other capital resources to support current and anticipated growth and scheduled principal and interest payments. The Company’s existing debt covenants do not include any rating or credit triggers.

Commitments and Contingencies

The Company is currently constructing a call center in Tampa, Florida, which is expected to be completed during the fourth quarter of 2004. In addition, construction was completed on a call center in Colorado Springs, Colorado and an office building in Mayfield Village, Ohio in the second and third quarters of 2004, respectively. The total cost for these three projects is estimated to be $130 million. During the third quarter 2004, the Company announced plans to construct a data center in Colorado Springs, Colorado, at an estimated cost of $50 million. Construction is expected to begin on this data center in April 2005 with completion estimated for 2006. All projects are funded through operating cash flows.

During the first quarter 2004, the Company opened one additional claims service center, bringing the total number of sites offering this concierge level of service to 20; no sites were added during the second or third quarters. During the third quarter 2004, the Company achieved the performance standards necessary to satisfy the expansion criteria of its concierge claims strategy. As a result, the Company plans to open several additional claims service centers in 2005.

On October 22, 2004, the Company received interrogatories and a subpoena from the Connecticut Attorney General’s Office seeking information as part of its investigation into possible violations of antitrust laws by unnamed persons. The Company understands that the Connecticut Attorney General has issued numerous subpoenas to members of the insurance industry and that Connecticut is one of several states investigating allegations of price-fixing, bid-rigging and other unlawful conduct by certain insurers, brokers or other industry participants. Accordingly, many companies in our industry have received such subpoenas and more

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may be expected in the future if other states initiate similar investigations. The Company intends to cooperate fully with these investigations. The Company has not been notified by any governmental or regulatory authority that it is the target of any such investigation.

The Company understands that these investigations are focused, in part, on contingent commission arrangements between certain insurers and brokers. Producers (agents and brokers) are due a commission of approximately 10% on business written on Progressive’s behalf. This commission is paid monthly. A contingent commission contract provides a producer the opportunity to earn additional commission based on annual production, if specified goals are met. These goals may include the volume of business placed by the producer with the insurer, the profitability of such business or other criteria. Any such payments are made once per year.

The Company’s Personal and Commercial Auto Lines businesses market their products through approximately 34,000 independent agencies throughout the United States. The Company also markets products through approximately 2,000 brokerage firms in California and New York. All commissions paid by the Company’s insurance subsidiaries are reported in the financial data filed with the insurance departments of the various states in which they operate.

For 2003, the Company paid approximately $850 million in commissions to producers. Approximately $30 million, or 3.5% of the total commissions paid, was in the form of contingent payments. The Company has similar arrangements in effect for 2004 and expects to pay contingent commissions for this year in approximately the same proportion to total commissions as the Company paid in 2003. The Company believes that its contingent commission agreements comply with applicable law.

Off-Balance-Sheet Arrangements

With the exception of the open investment funding commitment and operating leases and service agreements discussed in the notes to the financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003, the Company does not have any off-balance-sheet arrangements.

Contractual Obligations

During the third quarter 2004, the Company’s aggregate contractual obligations have not changed materially from those discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

RESULTS OF OPERATIONS

Underwriting Operations

Growth

Companywide net premiums written, which represent the premiums generated from policies written during the period less any reinsurance, increased 9% and 11% during the third quarter and first nine months of 2004, respectively, over the same periods last year. Net premiums earned, which are a function of the premiums written in the current and prior periods, increased 12% and 16% during the third quarter and first nine months of 2004, respectively, over the same periods last year. Insurance premiums written in 2004 and forward are being earned into income using a daily earnings convention, as compared to a mid-month convention used previously; there was no effect from this change on amounts reported in prior periods. The change to a daily earnings method will improve the precision of the Company’s premium recognition on a monthly basis.

The Company analyzes its growth by reviewing rate levels, new customers and the retention characteristics of its books of business. During the third quarter 2004, the Company implemented 29 auto rate revisions in various states, bringing the total to 83 for the year. The overall effect of these revisions was a slight reduction in rates for the year. The Company will continue to assess market conditions on a state-by-state basis and will consider rate reductions in states in which it will be able to maintain an attractive combination of profit and growth while still maintaining service quality and will seek selective rate increases where necessary to maintain rate adequacy.

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Growth in new business applications in the Company’s Personal Lines business has been relatively flat during 2004. The Company continues to experience a shift in its mix of business from new to renewal policies. Given the current competitive environment, the Company does not expect to produce significant year-over-year growth in new business in the near term.

Another important element affecting growth is customer retention. The Company has seen modest declines in its observed retention measures despite its expectation that the average retention period per customer would increase given the rate stability in the marketplace. With an increasing percentage of the Company’s premium coming from renewal business, increasing retention remains an area where the Company is continuing to focus its efforts.

Profitability

For the third quarter and first nine months of 2004, the Company’s net income increased 22% and 38%, respectively, compared to last year. The Company’s pretax underwriting profit increased 26% for the third quarter 2004 and 42% year-to-date, primarily driven by lower losses and loss adjustment expenses. Recurring investment income increased 8% and 6% for the third quarter and first nine months of 2004, respectively, primarily reflecting an increase in average invested assets partially offset by lower yields. Interest expense decreased 16% for both the third quarter and first nine months, due to the retirement of all $200 million of the Company’s 6.60% Notes during the first quarter 2004. In addition, the Company recognized net realized gains on securities of $23.9 million, or $.07 per share, for the third quarter 2004, and $80.0 million, or $.24 per share, for the first nine months of 2004. Third quarter and nine months 2003 results included net realized gains (losses) on securities of $(4.3) million, or $(.01) per share, and $15.7 million, or $.05 per share, respectively.

During the first quarter 2004, the Company reduced its tax liability $7.1 million, or $.02 per share, for tax years 1993-1998, which years were settled concurrently with the receipt of a $58 million tax refund from the IRS during the first quarter. Overall, the Company’s income taxes shifted to a net liability as of September 30, 2004, as compared to the same period last year, primarily driven by the receipt of the above-mentioned tax refund; in addition to the tax refund, the shift from year-end was primarily due to the increase in the net provision for income taxes. For the third quarter and first nine months of 2003, “other income” reflected the Company’s estimate of interest to be received from the IRS in conjunction with the $58 million tax refund previously mentioned.

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     Underwriting results for the Company’s Personal Lines, including its channel components, the Commercial Auto business and other businesses were as follows:

NM = Not Meaningful

¹ Represents the net changes made by the Company’s actuarial staff to both current and prior accident year reserves based on regularly scheduled reviews. See the Company’s “Report on Loss Reserving,” filed in the Company’s Current Report on Form 8-K on June 29, 2004, for further discussion.

² Includes insurance for motorcycles, recreation vehicles, mobile homes, watercraft, snowmobiles, homeowners and similar items.

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Loss and Loss Adjustment Expense Reserves

Claims costs, the Company’s most significant expense, represent payments made, and estimated future payments to be made, by the Company to or on behalf of its policyholders, including adjusting expenses needed to settle claims. These costs include an estimate for costs related to assignments, based on current business, under state-mandated automobile insurance programs. Claims costs are influenced by loss severity and frequency and inflation, among other factors. Accordingly, anticipated changes in these factors are taken into account when the Company establishes premium rates and loss reserves.

During the third quarter and first nine months of 2004, the Company continued to report favorable loss ratios, as compared to the prior year, despite the catastrophic losses incurred during the quarter. On a quarter over prior year quarter basis, the Company experienced a decline in frequency in every coverage that was greater than anticipated in its prior pricing actions. During the third quarter 2004, the Company had catastrophic losses of $53.8 million, 1.6 points, primarily related to the hurricanes, compared to $13.3 million, .5 points, for the same period last year. Year-to-date, the Company’s total catastrophic losses were $73.5 million, .8 points, compared to $49.9 million, ..6 points, last year.

In contrast to frequency trend, the Company saw severity rise slightly during the third quarter 2004, as expected. The Company’s increase in severity was lower than that reported for the industry by the Property Casualty Insurers Association of America (comparing information through the second quarter 2004 on a trailing 12-month basis). For bodily injury, the Company experienced a quarter over prior year quarter increase in severity for the third quarter in a row, following a year in which the severity declined each quarter. Personal injury protection severity continues to increase as it had for most of 2003. For the third quarter 2004, property coverages’ severity was up slightly as compared with the prior periods. The Company plans to continue to be diligent about recognizing trend when setting rates.

During the third quarter and first nine months of 2004, the Company experienced favorable loss reserve development. For the third quarter, about 9% of the total favorable development of $61.2 million resulted from favorable actuarial adjustments, with the remainder due to favorable “all other development” (e.g., claims settling for more or less than reserved, emergence of unreported claims at rates different than reserved and changes in reserve estimates by claims representatives). On a year-to-date basis, the Company had $75.4 million of total favorable development, with $31.1 million attributable to actuarial adjustments and the balance from favorable “all other development.” For both the quarter and year-to-date, the favorable “all other development” reflects the continued recognition of lower severity for prior accident years than had been previously estimated. The year-to-date favorable results are partially offset by the unfavorable development the Company experienced primarily in the first quarter 2004 (e.g., two class action lawsuit settlements, unfavorable personal injury protection development and higher than expected emergence of late reported features). The Company continues to increase the analysis intensity in its loss reserving process to increase accuracy and to understand its business in greater detail. See the Company’s “Report on Loss Reserving,” filed in the Company’s Current Report on Form 8-K on June 29, 2004, for further discussion of the Company’s reserving practices.

Underwriting Expenses

Policy acquisition costs and other underwriting expenses were 20.0% and 20.1% of premiums earned for the third quarters 2004 and 2003, respectively, and 20.2% and 19.9% for the first nine months of 2004 and 2003, respectively. Overall, the Company is benefiting from scale efficiencies and from the shift in its mix of business from new to renewal, which has lower acquisition costs. On a year-to-date basis, the results of these efficiencies were offset by an increase in the Company’s advertising expenditures, as well as the accrual for the settlement of several pending class action lawsuits. The increase in the “other underwriting expenses” was primarily attributable to the aforementioned items, as well as costs incurred to support the Company’s growing infrastructure.

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Personal Lines

The Company’s Personal Lines business units write insurance for private passenger automobiles and recreation vehicles, and represent 88% of the Company’s total year-to-date net premiums written. Personal Lines net premiums written grew 8% and 11% in the third quarter and first nine months of 2004, respectively, and net premiums earned grew 11% and 15%, compared to the same periods last year. Policies in force grew 12%, while the Personal Lines new business applications increased only modestly in both the third quarter and first nine months of 2004, as compared to the same periods last year. The Personal Lines business is generated either by an agency or other intermediary or written directly by the Company. The Agency channel includes business written by our network of more than 30,000 independent insurance agencies, insurance brokers in several states and through strategic alliance business relationships (other insurance companies, financial institutions, employers and national brokerage agencies). The Direct business includes business written through 1-800-PROGRESSIVE, online at progressive.com and on behalf of affiliates.

The Agency Channel

NM = Not Meaningful

The Agency auto business new applications decreased slightly in the third quarter (about 3%), as compared to the same period last year. The Company believes that this decrease was partially caused by the fact that, in 2004, fewer customers were in the marketplace shopping for insurance, since it appears as if competitors have achieved more rate adequacy. Conversions (i.e., converting a quote to a sale) for the third quarter 2004 were down compared to previous quarters. Year-to-date, conversions were consistent with the same period last year.

The Direct Channel

NM = Not Meaningful

In the Direct channel, new applications continued to increase in the third quarter 2004 (about 7%), as the Company is experiencing an increase in the conversion rate on fewer overall quotes. Total quotes are decreasing despite the Company’s consistent advertising spending, reflecting the fact that the Company’s competitors are increasing advertising at a greater pace, thus reducing the Company’s share of the total voice, and that fewer customers are shopping. The use of the Internet, both for complete or partial quoting, continues to grow and is the most significant driver of new business activity in the Direct channel.

Advertising costs for the third quarter 2004 were consistent with recent quarters and 4% greater than in the same period last year. On a year-to-date basis, advertising costs are 33% greater than in the same period last year. The Company began increasing its radio and television advertising in the third quarter 2003. The Company advertises on a national basis and supplements that coverage by local market media campaigns in over 100 designated market areas.

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Commercial Auto

NM = Not Meaningful

The Company’s Commercial Auto business unit writes primary liability, physical damage and other auto-related insurance for automobiles and trucks owned by small businesses, with the majority of its customers insuring three or fewer vehicles. The Commercial Auto business represents 12% of the Company’s total year-to-date net premiums written. Although the Commercial Auto business differs from Personal Lines auto in its customer base and products written, both businesses require the same fundamental skills, including disciplined underwriting and pricing, as well as excellent claims service. The Company’s Commercial Auto business is primarily distributed through independent agencies.

As with Personal Lines, the Company is also beginning to see growth slow in its Commercial Auto business as fewer people are shopping due to rate stability and the increase in acceptance of business by the Company’s competitors. Approximately 50% of the Company’s year-to-date Commercial Auto net premiums written were generated in the light local commercial auto market, which includes autos, vans and pick-up trucks used by contractors, landscapers and other artisans, and a variety of other small businesses. The remainder of the business was written in the specialty commercial auto market, which includes dump trucks, logging trucks and other short-haul commercial vehicles. Since the commercial auto policies have higher limits than personal auto, the Company continues to monitor this segment closely.

Other Businesses

The Company’s other businesses, which represents less than 1% of year-to-date net premiums written, primarily include writing directors’ and officers’ liability insurance and processing business for Commercial Auto Insurance Procedures (CAIP), which are state-supervised plans serving the involuntary market. The other businesses are also managing the wind-down of the Company’s lender’s collateral protection program, which the Company decided to cease writing as of September 30, 2003, and other run-off businesses. The ongoing indemnity products in the Company’s other businesses are growing profitably.

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Investments

Portfolio Allocation

The composition of the investment portfolio at September 30 was:

NM = Not Meaningful

¹ Credit quality ratings are assigned by nationally recognized securities rating organizations. To calculate the weighted average credit quality ratings, the Company weights individual securities based on market value and assigns a numeric score to each credit rating based on a scale from 0-5.

² Short-term investments include Eurodollar deposits, commercial paper and other securities purchased with a maturity within one year.

³ The Company had net unsettled security acquisitions of $101.3 million and $315.0 million at September 30, 2004 and 2003, respectively.

⁴ September 30, 2004 and 2003, totals include $2.1 billion and $1.1 billion, respectively, of securities in the portfolio of a consolidated, non-insurance subsidiary of the holding company; increase reflects securities held pending the settlement of the Company’s tender offer.

As of September 30, 2004, the Company’s portfolio had $545.5 million of net unrealized gains, compared to $496.4 million of net unrealized gains at September 30, 2003. The Company’s fixed income portfolio experienced a decline in net unrealized gains of $148.6 million, to $170.9 million at September 30, 2004, from $319.5 million at September 30, 2003, due to an increase in interest rates since third quarter of 2003, as well as sales of fixed-income securities, generating $71.3 million in net realized gains during the first nine months of 2004. The Company’s common equity portfolio experienced an increase in net unrealized gains of $197.7 million, to $374.6 million at September 30, 2004, from $176.9 million at September 30, 2003, primarily the result of significant price appreciation in the equity market since September 30, 2003, as corporate earnings improved along with general economic conditions.

Fixed-Income Securities

The fixed-income portfolio, which includes fixed-maturity securities, preferred stocks and short-term investments, had a duration of 2.9 years at September 30, 2004, and 3.3 years at September 30, 2003. After adjustments to exclude net unsettled security transactions, the allocation of fixed-income securities at September 30, 2004, was 88.1% of the total portfolio, slightly higher than our 85% target in anticipation of the cash required to settle the Company’s tender offer.

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The fixed-maturity securities, including short-term investments, as reported in the balance sheets, were comprised of the following:

¹Based on a duration of seven years or longer.

The non-investment-grade fixed-maturity securities offer the Company higher returns and added diversification, but may involve greater risks related to creditworthiness and liquidity in the secondary trading market.

Included in the fixed-income portfolio are $2.5 billion of asset-backed securities. These asset-backed securities are comprised of residential mortgage-backed ($.7 billion), commercial mortgage-backed ($.9 billion) and other asset-backed ($.9 billion) securities, with a total duration of 2.5 years and a weighted average credit quality of AAA-. The largest components of other asset-backed securities are automobile receivable loans ($.4 billion) and home equity loans ($.3 billion). Substantially all asset-backed securities are liquid with available market quotes and contain no residual interests (i.e., the most subordinated class in a pool of securitized assets).

Common Equities

Common equities, as reported in the balance sheets, were comprised of the following:

Common equities comprised 11.9% of the total portfolio, excluding the net unsettled security transactions, at September 30, 2004. Common stocks are the majority of the common equity portfolio and are managed externally to track the Russell 1000 Index. The Company’s common equity allocation and management strategy are intended to provide diversification for the total portfolio and focuses on changes in value of the equity portfolio relative to the change in value of the index. To maintain high correlation with the Russell 1000, within an annualized +/- 50 basis points, the Company holds approximately 650 of the common stocks comprising the index. The following table shows the total returns based on market values at September 30, 2004:

¹ Includes gross dividends reinvested and price appreciation/depreciation.

Other risk investments include private equity investments and limited partnership interests in private equity and mezzanine investment funds, which have no off-balance-sheet exposure or contingent obligations, except for the $5.5 million of open funding commitments at September 30, 2004.

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Trading Securities

Trading securities are entered into for the purpose of near-term profit generation. At September 30, 2004 and 2003, the Company did not have any trading securities, with the exception of the derivatives classified as trading as discussed below. The Company had no trading security gains or losses during the first nine months of 2004, compared to $.1 million of gains for the first nine months of 2003. Gains from trading securities are immaterial to the financial condition, cash flows and results of operations of the Company.

Derivative Instruments

Derivative instruments may be used for trading purposes or classified as trading derivatives due to the characteristics of the transaction. During the third quarter, the Company closed all of its credit default protection derivatives, with a combined notional value of $128.5 million, along with the underlying Treasury Notes of the same maturity and principal value. Consequently, as of September 30, 2004, the Company had no open derivative positions classified as trading, compared to two at September 30, 2003, with a market value of $1.8 million. At September 30, 2004, the combined Treasury and derivative positions generated a $1.7 million net gain and $1.4 million net loss for the third quarter and nine months, respectively, compared to net losses of $2.1 million and $2.0 million for the same periods of 2003. The results of the derivative and Treasury positions are immaterial to the financial condition, cash flows, and results of operations of the Company and are reported as part of the available-for-sale portfolio, with the gains (losses) reported as a component of net realized gains (losses) on securities.

Derivative instruments may also be used to manage the risks of the available-for-sale portfolio. This would be accomplished by modifying the basis, duration, interest rate or foreign currency characteristics of the portfolio, hedge securities or hedge cash flows. The Company had no risk management derivatives at September 30, 2004 or 2003. The Company recognized no gains or losses during the third quarter and first nine months of 2004 or 2003 on risk management derivatives.

Investment Income

Recurring investment income (interest and dividends) increased 8% for the third quarter and 6% for the first nine months of 2004, compared to the same periods last year, reflecting an increase in the average assets invested, partially offset by a reduction in yields due to investing new cash in securities with yields lower than that of the investment portfolio’s average book yield. The Company is reporting total return to more accurately reflect the management philosophy of the portfolio and evaluation of the investment results. The fully taxable equivalent (FTE) total return includes recurring investment income, net realized gains (losses) on securities and changes in unrealized appreciation/depreciation on investment securities. The Company reported the following investment results for the periods ended September 30:

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Realized Gains/Losses

The components of net realized gains (losses) for the periods ended September 30 were: