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SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
[x] Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the quarter ended June 30, 2002.
-------------
[ ] Transition Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the transition period from to
--------- ---------
Commission File Number 000-05544
OHIO CASUALTY CORPORATION
(Exact name of registrant as specified in its charter)
OHIO
(State or other jurisdiction of incorporation or organization)
31-0783294
(I.R.S. Employer Identification No.)
9450 Seward Road, Fairfield, Ohio
(Address of principal executive offices)
45014
(Zip Code)
(513) 603-2400
(Registrant's telephone number)
Securities registered pursuant to Section 12(g) of the Act:
Common Shares, Par Value $.125 Each
(Title of Class)
Common Share Purchase Rights
(Title of Class)
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
The aggregate market value as of August 1, 2002 of the voting stock held
by non-affiliates of the registrant was $1,019,172,690.
On August 1, 2002 there were 60,636,753 shares outstanding.
Page 1 of 21
==============================================================================
PART I
ITEM 1. FINANCIAL STATEMENTS
Ohio Casualty Corporation & Subsidiaries
CONSOLIDATED BALANCE SHEET
June 30, December 31,
(In thousands, except per share data) (Unaudited) 2002 2001
- ------------------------------------------------------------------------------
Assets
Investments:
Fixed maturities:
Available for sale, at fair value
(cost: $2,886,552 and $2,729,998) $2,953,178 $2,772,104
Equity securities, at fair value
(cost: $92,158 and $110,206) 403,544 488,988
Short-term investments, at fair value
(cost: $28,083 and $54,785) 28,083 54,785
- ------------------------------------------------------------------------------
Total investments 3,384,805 3,315,877
Cash 5,130 37,499
Premiums and other receivables, net of allowance
for bad debts of $6,800 and $8,400,
respectively 370,079 341,986
Deferred policy acquisition costs 175,834 166,759
Property and equipment, net of accumulated
depreciation of $139,834 and $133,213,
respectively 103,849 99,810
Reinsurance recoverable 307,990 237,688
Agent relationships, net of accumulated
amortization of $41,801 and $36,310,
respectively 227,888 241,022
Interest and dividends due or accrued 43,289 43,319
Other assets 25,379 40,659
- ------------------------------------------------------------------------------
Total assets $4,644,243 $4,524,619
==============================================================================
Liabilities
Insurance reserves:
Losses $1,823,418 $1,746,828
Loss adjustment expenses 422,706 403,894
Unearned premiums 688,593 666,739
Notes payable 198,902 210,173
California Proposition 103 reserve 7,780 7,816
Deferred income taxes 4,399 3,124
Other liabilities 400,022 406,013
- ------------------------------------------------------------------------------
Total liabilities 3,545,820 3,444,587
Shareholders' Equity
Common stock, $.125 par value
Authorized: 150,000; 150,000
Issued shares: 72,418; 94,418 9,052 11,802
Additional paid-in capital - 4,152
Common stock purchase warrants 21,138 21,138
Accumulated other comprehensive income 246,492 274,359
Retained earnings 977,601 1,221,447
Treasury stock, at cost:
(Shares: 11,809; 34,312) (155,860) (452,866)
- ------------------------------------------------------------------------------
Total shareholders' equity 1,098,423 1,080,032
- ------------------------------------------------------------------------------
Total liabilities and shareholders'
equity $4,644,243 $4,524,619
==============================================================================
Accompanying notes are an integral part of these financial statements. For
complete disclosures see Notes to Consolidated Financial Statements on
pages 49-63 of the Corporation's 2001 Form 10-K.
2
Ohio Casualty Corporation & Subsidiaries
STATEMENT OF CONSOLIDATED INCOME
Three Months
Ended June 30,
(in thousands, except per share data) (Unaudited) 2002 2001
- ----------------------------------------------------------------------------
Premiums and finance charges earned $364,708 $376,575
Investment income less expenses 50,700 52,120
Investment gains realized, net 9,491 42,419
- ----------------------------------------------------------------------------
Total revenues 424,899 471,114
Losses and benefits for policyholders 223,897 263,853
Loss adjustment expenses 53,553 43,704
General operating expenses 24,498 26,278
Amortization of agent relationships 2,742 2,855
Write-off of agent relationships 2,379 2,870
Early retirement charge - 9,600
Amortization of deferred policy acquisition costs 92,910 94,349
Depreciation expense 2,773 2,445
Amortization of software 1,548 1,190
- ----------------------------------------------------------------------------
Total expenses 404,300 447,144
- ----------------------------------------------------------------------------
Income before income taxes 20,599 23,970
Income tax expense:
Current 4,240 4,703
Deferred 3,295 2,616
- ----------------------------------------------------------------------------
Total income tax expense 7,535 7,319
- ----------------------------------------------------------------------------
Net income 13,064 16,651
============================================================================
Average shares outstanding - basic 60,442 60,072
============================================================================
Earnings per share - basic:
Net income, per share $ 0.22 $ 0.28
Average shares outstanding - diluted 61,496 60,089
============================================================================
Earnings per share - diluted:
Net income, per share $ 0.21 $ 0.28
============================================================================
Cash dividends, per share $ 0.00 $ 0.00
============================================================================
Accompanying notes are an integral part of these financial statements. For
complete disclosures see Notes to Consolidated Financial Statements on
pages 49-63 of the Corporation's 2001 Form 10-K.
3
Ohio Casualty Corporation & Subsidiaries
STATEMENT OF CONSOLIDATED INCOME
Six Months
Ended June 30,
(in thousands, except per share data) (Unaudited) 2002 2001
- ----------------------------------------------------------------------------
Premiums and finance charges earned $725,715 $760,070
Investment income less expenses 101,602 103,400
Investment gains realized, net 32,322 55,032
- ----------------------------------------------------------------------------
Total revenues 859,639 918,502
Losses and benefits for policyholders 435,666 531,526
Loss adjustment expenses 105,026 90,450
General operating expenses 50,742 57,905
Amortization of agent relationships 5,491 5,728
Write-off of agent relationships 7,644 7,274
Early retirement charge - 9,600
Amortization of deferred policy acquisition costs 185,134 190,560
Depreciation expense 5,145 4,746
Amortization of software 3,066 2,423
- ----------------------------------------------------------------------------
Total expenses 797,914 900,212
- ----------------------------------------------------------------------------
Income before income taxes 61,725 18,290
Income tax expense:
Current 5,507 4,703
Deferred 16,281 1,031
- ----------------------------------------------------------------------------
Total income tax expense 21,788 5,734
- ----------------------------------------------------------------------------
Net income 39,937 12,556
============================================================================
Average shares outstanding - basic 60,314 60,072
============================================================================
Earnings per share - basic:
Net income, per share $ 0.66 $ 0.21
Average shares outstanding - diluted 61,287 60,080
============================================================================
Earnings per share - diluted:
Net income, per share $ 0.65 $ 0.21
Cash dividends, per share $ 0.00 $ 0.00
============================================================================
Accompanying notes are an integral part of these financial statements. For
complete disclosures see Notes to Consolidated Financial Statements on
pages 49-63 of the Corporation's 2001 Form 10-K.
4
Ohio Casualty Corporation and Subsidiaries
STATEMENT OF CONSOLIDATED
SHAREHOLDERS' EQUITY AND
OTHER COMPREHENSIVE INCOME
Accumulated
Additional Common other Total
(in thousands, except per Common paid-in stock purchase comprehensive Retained Treasury shareholders'
share data) (Unaudited) Stock capital warrants income earnings stock equity
- --------------------------------------------------------------------------------------------------------------------------
Balance
January 1, 2001 $11,802 $ 4,180 $ 21,138 $ 409,904 $ 1,122,867 $ (453,300) $ 1,116,591
Net income 12,556 12,556
Net change in unrealized gain
net of deferred income tax
of $23,149 (42,992) (42,992)
-----------
Comprehensive loss (30,436)
Net issuance of stock
under stock aware
plan (0 shares) (7) 3 (4)
- --------------------------------------------------------------------------------------------------------------------------
Balance,
June 30, 2001 $11,802 $ 4,173 $ 21,138 $ 366,912 $ 1,135,423 $ (453,297) $ 1,086,151
==========================================================================================================================
Balance
January 1, 2002 $11,802 $ 4,152 $ 21,138 $ 274,359 $ 1,221,447 $ (452,866) $ 1,080,032
Net income 39,937 39,937
Net change in unrealized gain
net of deferred income tax
of $15,006 (27,867) (27,867)
-----------
Comprehensive income 12,070
Net issuance of stock
under stock award
plan (504 shares) (124) (186) 6,631 6,321
Retirement of treasury stock (2,750) (4,028) (283,597) 290,375 -
- --------------------------------------------------------------------------------------------------------------------------
Balance,
June 30, 2002 $ 9,052 $ - $ 21,138 $ 246,492 $ 977,601 $ (155,860) $ 1,098,423
==========================================================================================================================
Accompanying notes are an integral part of these financial statements. For
complete disclosures see Notes to Consolidated Financial Statements on pages
49-63 of the Corporation's 2001 Form 10-K.
5
Ohio Casualty Corporation and Subsidiaries
STATEMENT OF CONSOLIDATED CASH FLOWS
Six Months
Ended June 30,
(in thousands) (Unaudited) 2002 2001
- -----------------------------------------------------------------------------
Cash flows from:
Operations
Net income (loss) $ 39,937 $ 12,556
Adjustments to reconcile net income to
cash from operations:
Changes in:
Insurance reserves 117,256 82,843
Income taxes 25,487 30,790
Premiums and other receivables (28,093) (8,270)
Deferred policy acquisition costs (9,075) 2,656
Reinsurance recoverable (70,302) (46,190)
Other assets 1,208 2,762
Other liabilities (32,075) (15,644)
California Proposition 103 reserves (36) (8,717)
Amortization and write-off of agent
relationships 13,135 13,002
Depreciation and amortization 7,811 3,855
Investment (gains) losses (32,322) (55,032)
- -----------------------------------------------------------------------------
Net cash generated by operating
activities 32,931 14,611
- -----------------------------------------------------------------------------
Investing
Purchase of investments:
Fixed income securities - available for sale (651,729) (802,190)
Equity securities - (2,660)
Proceeds from sales:
Fixed income securities - available for sale 482,649 693,615
Equity securities 66,396 88,222
Proceeds from maturities and calls:
Fixed income securities - available for sale 27,835 50,640
Equity securities - -
Property and equipment
Purchases (12,260) (7,015)
Sales 216 588
- -----------------------------------------------------------------------------
Net cash generated (used) from investing
activities (86,893) 21,200
- -----------------------------------------------------------------------------
Financing
Notes payable:
Proceeds 194,042 -
Repayments (205,313) (10,312)
Proceeds from exercise of stock options 6,163 1
Dividends paid to shareholders - -
- -----------------------------------------------------------------------------
Net cash used in financing activities (5,108) (10,311)
- -----------------------------------------------------------------------------
Net change in cash and cash equivalents (59,070) 25,500
Cash and cash equivalents, beginning of period 92,284 90,044
- -----------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 33,214 $ 115,544
=============================================================================
Accompanying notes are an integral part of these financial statements. For
complete disclosures see Notes to Consolidated Financial Statements on
pages 49-63 of the Corporation's 2001 Form 10-K.
6
Ohio Casualty Corporation & Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Ohio Casualty Corporation (the Corporation) is the holding company of The
Ohio Casualty Insurance Company (the Company), which is one of six property-
casualty companies that make up the Ohio Casualty Group (the Group).
NOTE I - INTERIM ADJUSTMENTS
It is believed that all material adjustments necessary to present a fair
statement of the results of the interim period covered are reflected in this
report. The operating results for the interim periods are not necessarily
indicative of the results to be expected for the full year. These statements
should be read in conjunction with the financial statements and notes thereto
in the Corporation's 2001 Annual Report to Shareholders.
NOTE II - RECENTLY ISSUED ACCOUNTING STANDARDS
In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard (SFAS) 141, Business Combinations,
and SFAS 142, Goodwill and Other Intangible Assets, effective for fiscal
years beginning after December 15, 2001. Under these new rules, goodwill
will no longer be amortized but will be subject to annual impairment tests in
accordance with the standards. Other intangible assets will continue to be
amortized over their useful lives. The Corporation adopted the new rules on
accounting for goodwill and other intangible assets beginning in the first
quarter of 2002. The adoption of the statement did not have an impact on the
Corporation's financial position and results of operations. The
Corporation's only current intangible asset, agent relationships, is reported
on the balance sheet in accordance with the standards and is being amortized
over its useful life. The agent relationships intangible asset is evaluated
periodically for possible impairment.
In August 2001, the FASB issued SFAS 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets", which addresses financial accounting and
reporting for the impairment or disposal of long-lived assets and supersedes
SFAS 121, "Accounting for the Impairment of Long-Lived Assets and for Long-
Lived Assets to be Disposed Of", and the accounting and reporting provisions
of APB Opinion No. 30, Reporting the Results of Operations for a disposal of
a segment of a business. SFAS 144 is effective for fiscal years beginning
after December 15, 2001. The Corporation adopted the new rules for
accounting for the impairment or disposal of long-lived assets beginning in
the first quarter of 2002. The adoption of the statement did not impact the
Corporation's financial position and results of operations.
In July 2002, the FASB issued SFAS 146, "Accounting for Costs Associated with
Exit of Disposal Activities", which addresses recognizing costs associated
with exit or disposal activities when they are incurred rather than at the
date of a commitment to an exit or disposal plan. SFAS 146 is to be applied
prospectively to exit or disposal activities initiated after December 31,
2002. The Corporation does not expect that the adoption of the statement
will have a material impact on the Corporation's financial position and
results of operations.
7
NOTE III - EARNINGS PER SHARE
Basic and diluted earnings per share are summarized as follows (in thousands,
except per share data):
Three months ended Six months ended
June 30 June 30
2002 2001 2002 2001
---- ---- ---- ----
Income from continuing operations $13,064 $16,651 $39,937 $12,556
Weighted average common shares
outstanding - basic 60,442 60,072 60,314 60,072
Basic income from continuing
operations - per average share $ 0.22 $ 0.28 $ 0.66 $ 0.21
=================================================================================
Weighted average common shares
outstanding 60,442 60,072 60,314 60,072
Effect of dilutive securities 1,054 17 973 8
- ---------------------------------------------------------------------------------
Weighted average common shares
outstanding - diluted 61,496 60,089 61,287 60,080
Diluted income from continuing
operations - per average share $ 0.21 $ 0.28 $ 0.65 $ 0.21
=================================================================================
NOTE IV -- SEGMENT INFORMATION
The Corporation has determined its reportable segments based upon its method
of internal reporting, which were organized by product line prior to the
second quarter of 2001. The Corporation adopted a new Corporate Strategic
Plan in the second quarter of 2001 that realigned its method of internal
reporting during the quarter to three reportable segments. In accordance with
SFAS 131, the Corporation has elected to restate prior period segment
information in order to present comparable segment information. The new
property and casualty segments are Commercial Lines, Specialty Lines, and
Personal Lines. Commercial Lines includes workers' compensation, general
liability, CMP, fire, inland marine, and commercial auto. Specialty Lines
includes umbrella, fidelity and surety. Personal Lines includes private
passenger auto, homeowners, fire, inland marine, and umbrella. These segments
generate revenues by selling a wide variety of personal, commercial and
surety insurance products. The Corporation also has an all other segment
which derives its revenues from investment income.
Each segment of the Corporation is managed separately. The property and
casualty segments are managed by assessing the performance and profitability
of the segments through analysis of industry financial measurements including
statutory loss and loss adjustment expense ratios, statutory underwriting
expense ratio, statutory combined ratio, premiums written, premiums earned and
statutory underwriting gain (loss). The following tables present this
information by segment as it is reported internally to management. Asset
information by reportable segment is not reported, since the Corporation does
not produce such information internally.
8
Six Months Ended June 30
(in thousands)
Commercial Lines 2002 2001
- ---------------------------------------------------------------------
Net premiums written $399,057 $364,142
% Increase (decrease) 9.5% (5.1)%
Net premiums earned 353,321 359,438
% Increase (decrease) (1.7)% (0.5)%
Underwriting gain (loss)
(before tax) (40,306) (75,918)
Loss ratio 55.6% 70.2%
Loss expense ratio 16.4% 14.6%
Underwriting expense ratio 34.9% 35.9%
Combined ratio 106.9% 120.7%
Specialty Lines 2002 2001
- ---------------------------------------------------------------------
Net premiums written $84,766 $66,968
% Increase (decrease) 26.5% 26.7%
Net premiums earned 68,666 64,195
% Increase (decrease) 6.9% 30.8%
Underwriting gain (loss)
(before tax) 1,007 15,245
Loss ratio 37.5% 34.3%
Loss expense ratio 9.0% 5.1%
Underwriting expense ratio 42.2% 35.3%
Combined ratio 88.7% 74.7%
Personal Lines 2002 2001
- ---------------------------------------------------------------------
Net premiums written $266,324 $329,622
% Increase (decrease) (19.2)% (3.1)%
Net premiums earned 303,676 335,985
% Increase (decrease) (9.6)% (2.9)%
Underwriting gain (loss)
(before tax) (25,868) (46,687)
Loss ratio 70.2% 76.6%
Loss expense ratio 13.5% 10.3%
Underwriting expense ratio 28.3% 27.5%
Combined ratio 112.0% 114.4%
Total Property & Casualty 2002 2001
- ---------------------------------------------------------------------
Net premiums written $750,147 $760,732
% Increase (decrease) (1.4)% (2.1)%
Net premiums earned 725,663 759,618
% Increase (decrease) (4.5)% 0.4%
Underwriting gain (loss)
(before tax) (65,167) (107,360)
Loss ratio 60.0% 70.0%
Loss expense ratio 14.5% 11.9%
Underwriting expense ratio 33.3% 32.2%
Combined ratio 107.8% 114.1%
Impact of catastrophe losses
on combined ratio 1.8% 2.7%
All other 2002 2001
- ---------------------------------------------------------------------
Revenues $ (188) $ 3,411
Expenses 3,487 7,011
- ---------------------------------------------------------------------
Net loss $(3,675) $(3,600)
Reconciliation of Revenues 2002 2001
- ---------------------------------------------------------------------
Net premiums earned for
reportable segments $725,663 $759,618
Investment income 101,134 102,571
Realized gains (losses) 33,731 50,668
Miscellaneous income 51 352
- ---------------------------------------------------------------------
Total property and casualty
revenues (Statutory basis) 860,579 913,209
Property and casualty statutory
to GAAP adjustment (752) 1,882
- ---------------------------------------------------------------------
Total revenues property and
casualty (GAAP basis) 859,827 915,091
Other segment revenues (188) 3,411
- ---------------------------------------------------------------------
Total revenues $859,639 $918,502
=====================================================================
Reconciliation of underwriting
gain (loss) (before tax) 2002 2001
- ---------------------------------------------------------------------
Property and casualty under-
writing gain (loss) (before tax)
(Statutory basis) $(65,167) $(107,360)
Statutory to GAAP adjustment (1,519) (23,852)
- ---------------------------------------------------------------------
Property and casualty under-
writing gain (loss) (before tax)
(GAAP basis) (66,686) (131,212)
Net investment income 101,602 103,400
Realized gains (losses) 32,322 55,032
Other income (losses) (5,513) (8,930)
- ---------------------------------------------------------------------
Income (loss) from continuing
operations before income taxes $ 61,725 $ 18,290
=====================================================================
9
Three months ended June 30
(in thousands)
Commercial Lines 2002 2001
- ---------------------------------------------------------------------
Net premiums written $206,242 $185,719
% Increase (decrease) 11.1% (0.2)%
Net premiums earned 179,146 177,019
% Increase (decrease) 1.2% (0.6)%
Underwriting gain (loss)
(before tax) (19,134) (34,870)
Loss ratio 57.1% 67.0%
Loss expense ratio 14.7% 14.3%
Underwriting expense ratio 33.8% 36.6%
Combined ratio 105.6% 117.9%
Specialty Lines 2002 2001
- ---------------------------------------------------------------------
Net premiums written $45,316 $36,949
% Increase (decrease) 22.6% 33.9%
Net premiums earned 38,730 33,122
% Increase (decrease) 16.9% 30.1%
Underwriting gain (loss)
(before tax) 39 6,125
Loss ratio 38.3% 42.7%
Loss expense ratio 12.1% 5.6%
Underwriting expense ratio 42.3% 29.8%
Combined ratio 92.7% 78.1%
Personal Lines 2002 2001
- ---------------------------------------------------------------------
Net premiums written $123,688 $166,715
% Increase (decrease) (25.8)% (1.1)%
Net premiums earned 146,813 166,097
% Increase (decrease) (11.6)% (0.1)%
Underwriting gain (loss)
(before tax) (18,386) (24,366)
Loss ratio 72.8% 79.0%
Loss expense ratio 15.3% 9.9%
Underwriting expense ratio 29.0% 25.7%
Combined ratio 117.1% 114.6%
Total Property & Casualty 2002 2001
- ---------------------------------------------------------------------
Net premiums written $375,246 $389,383
% Increase (decrease) (3.6)% 1.9%
Net premiums earned 364,689 376,238
% Increase (decrease) (3.1)% 1.8%
Underwriting gain (loss)
(before tax) (37,481) (53,111)
Loss ratio 61.4% 70.1%
Loss expense ratio 14.7% 11.6%
Underwriting expense ratio 33.2% 31.3%
Combined ratio 109.3% 113.0%
Impact of catastrophe losses on
combined ratio 2.8% 5.0%
All other 2002 2001
- ---------------------------------------------------------------------
Revenues $ 260 $ 2,385
Expenses 2,145 3,431
- ---------------------------------------------------------------------
Net loss $(1,885) $(1,046)
Reconciliation of Revenues 2002 2001
- ---------------------------------------------------------------------
Net premiums earned for
reportable segments $364,689 $376,238
Investment income 50,434 51,848
Realized gains (losses) 11,222 40,318
Miscellaneous income 21 306
- ---------------------------------------------------------------------
Total property and casualty
revenues (Statutory basis) 426,366 468,710
Property and casualty statutory to
GAAP adjustment (1,727) 19
- ---------------------------------------------------------------------
Total revenues property and
casualty (GAAP basis) 424,639 468,729
Other segment revenues 260 2,385
- ---------------------------------------------------------------------
Total revenues $424,899 $471,114
=====================================================================
Reconciliation of underwriting
gain (loss) (before tax) 2002 2001
- ---------------------------------------------------------------------
Property and casualty under-
writing gain (loss) (before tax)
(Statutory basis) $(37,481) $(53,111)
Statutory to GAAP adjustment 903 (13,462)
- ---------------------------------------------------------------------
Property and casualty under-
writing gain (loss) (before tax)
(GAAP basis) (36,578) (66,573)
Net investment income 50,700 52,120
Realized gains (losses) 9,491 42,419
Other income (losses) (3,014) (3,996)
- ---------------------------------------------------------------------
Income (loss) from continuing
operations before income taxes $ 20,599 $ 23,970
=====================================================================
10
NOTE V - AGENT RELATIONSHIPS
The agent relationship asset is an identifiable intangible asset acquired in
connection with the 1998 Great American Insurance Company (GAI) commercial
lines acquisition. The Corporation follows the practice of allocating
purchase price to specifically identifiable intangible assets based on their
estimated values as determined by appropriate valuation methods. In the GAI
acquisition, allocation of the purchase price was made to agent relationships
and deferred policy acquisition costs as the Corporation believes it did not
acquire any other significant specifically identifiable intangible assets.
Periodically, agent relationships are evaluated for possible inability to
recover their carrying amount. In the second quarter of 2002, the
Corporation wrote off the agent relationships asset by $2.4 million before tax
for agency cancellations. The second quarter of 2001 included a before-tax
write-off of $2.9 million to the agent relationship asset for agency
cancellations. Over the remaining 21 years, the Corporation anticipates
that based on new events or circumstances additional write-offs for
impairment will be made. The remaining portion of the agent relationships
asset will be amortized on a straight-line basis over the remaining
amortization period of approximately 21 years. Additional information
related to agent relationships is included in Note 1G, Agent Relationships
on page 29 of the Corporation's 2001 Annual Report to Shareholders.
NOTE VI - INTERNALLY DEVELOPED SOFTWARE
In 2001, the Group introduced into limited production a new internally
developed application, which the Company has named P.A.R.I.S.sm, a policy
administration, rating and issuance system. The Group continued the roll out
of the new application for additional lines of business in 2002. The Group
is capitalizing the costs incurred to develop this software used in the
Group's operations. The cost associated with this application is amortized
on a straight-line basis over the estimated useful life of ten years from the
date placed into service. Recently the Group decided to convert Personal
Lines to P.A.R.I.S.sm. Therefore, full implementation is not anticipated to
occur until 2004. The expected impact on results in 2003 is approximately
$4 to $5 million before tax in amortization expense. Although management
believes the carrying value of the asset represents its fair value, the
useful life of the internally developed software was determined by using
certain assumptions and estimates. Changes in these assumptions could result
in an immediate impairment to the asset and a corresponding charge to net
income. For all internally developed software, unamortized software costs
and accumulated amortization in the consolidated balance sheet were $47.8
million and $2.1 million at June 30, 2002, and $41.4 million and $1.0
million at December 31, 2001.
NOTE VII - CONVERTIBLE DEBT
In 2002, the Corporation completed an offering of 5.00% convertible notes, in
an aggregate principal amount of $201.3 million, due March 19, 2022 and
generated net proceeds of $194.0 million. The issuance and related costs are
being amortized over the life of the bonds and are being recorded as related
fees. The Corporation uses the effective interest rate method to record the
interest and related fee amortization. Interest is payable on March 19 and
September 19 of each year, beginning September 19, 2002. The notes may be
converted into shares of the Corporation's common stock under certain
conditions, including: if the sale price of the Corporation's common stock
reaches specific thresholds; if the credit rating of the notes is below a
specified level or withdrawn, or if the notes have no credit rating during
any period; or if specified corporate transactions have occurred. The
conversion rate is 44.2112 shares per each $1,000 principal amount of notes,
subject to adjustment in certain circumstances. The convertible debt impact
on earnings per share will be based on the "if-converted" method. The impact
on diluted earnings per share is contingent on whether or not certain
criteria has been met for conversion. As of June 30, 2002, the common share
price criterion had not been met and, therefore, no adjustment to the number
of diluted shares on the earnings per share calculation was made for this
convertible debt. On or after March 23, 2005, the Corporation has the option
to redeem all or a portion of the notes that have not been previously
converted at the following redemption prices (expressed as percentage of
principal amount):
During the twelve months commencing Redemption Price
- ----------------------------------- ----------------
March 23, 2005 102%
March 19, 2006 101%
March 19, 2007 until maturity of the notes 100%
11
The holders of the notes have the option to require the Corporation to
purchase all or a portion of their notes on March 19 of 2007, 2012 and 2017
at 100% of the principal amount of the notes. In addition, upon a change in
control of the Corporation occurring anytime prior to maturity, holders may
require the Corporation to purchase for cash all or a portion of their notes
at 100% of the principal amount.
NOTE VIII - CONTINGENCIES
In the fourth quarter of 2001, Ohio Casualty of New Jersey, Inc. (OCNJ)
entered into an agreement to transfer its obligations to renew private
passenger auto business in New Jersey to Proformance Insurance Company
(Proformance). Under the terms of the transaction, OCNJ may have a
contingent liability of up to $15.6 million to be paid to Proformance to
maintain a premiums-to-surplus ratio of 2.5 to 1 on the transferred business
during the next three years. As of June 30, 2002, the Corporation has
evaluated the contingency and although the Group's remaining New Jersey
private passenger auto business has produced poor results, Proformance's
ability to charge different rates and other factors have caused the
Corporation to conclude that the likelihood of this liability is not possible
to determine at this time and, therefore, has not recognized a liability in
the financial statements. The Corporation will continue to monitor the
contingency for any future liability recognition.
NOTE IX - TREASURY STOCK
In the first quarter of 2002, the Corporation retired 22 million shares of
its treasury stock. The retirement did not have a net impact on total
shareholders' equity.
NOTE X - REINSURANCE
The Group purchases reinsurance coverage to protect against large or
catastrophic losses. The reinsurance recoverable asset reflects amounts
currently due from reinsurers and significant amounts of reserves for future
claims that are expected to be recoverable from reinsurers. The reserves are
estimates of ultimate claim costs, including claims incurred but not
reported, salvage and subrogation and inflation without discounting. Amounts
recoverable from reinsurers are estimated in a manner consistent with
reinsurance contracts. The Group continues to update its estimate of the
reserves, reflecting significant premium growth in the commercial umbrella
line of business, which is the most heavily reinsured line of business.
Additionally, the Group continues to evaluate the financial condition of its
reinsurers and monitors concentrations of credit risk to minimize exposure to
significant losses from reinsurer insolvencies. For the reinsurance
recoverable asset, reserves for losses and loss adjustment expense were
$243.2 million at June 30, 2002 and $168.7 million at December 31, 2001.
NOTE XI - SUBSEQUENT EVENTS
On July 31, 2002, the Corporation entered into a revolving credit agreement
with LaSalle Bank National Association as lender and agent, and certain other
lenders. Under the terms of the credit agreement, the lenders agreed to make
loans to the Corporation in an aggregate amount up to $80 million to meet
general corporate needs. The credit agreement will expire on March 15, 2005.
The credit agreement is included as an exhibit to this Form 10-Q.
12
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Ohio Casualty Corporation (the Corporation) is the holding company of The
Ohio Casualty Insurance Company (the Company), which is one of six property-
casualty companies that make up the Ohio Casualty Group (the Group).
RESULTS OF OPERATIONS
Net income
The Corporation reported net income of $39.9 million, or $0.65 per share for
the six months ending June 30, 2002, compared with $12.6 million, or $0.21
per share in the same quarter of 2001. For the second quarter of 2002, net
income was $13.1 million, or $0.21 per share, compared with $16.7 million, or
$0.28 per share in the second quarter of 2001.
Operating Income
For the first six months of 2002, the Corporation reported net operating
income, which differs from net income by the exclusion of realized investment
gains (losses), of $18.9 million, or $0.31 per share, compared with an
operating loss of $23.2 million, or $0.39 per share for the first six months
of 2001. Underwriting actions and improved pricing led to overall improved
loss results and operating income. Improved loss results are discussed
further in the Statutory Results section below and improved pricing is
discussed further in the Segment Discussion section below. The Corporation
reported net operating income of $6.9 million, or $0.11 per share for the
second quarter of 2002, compared with an operating loss of $10.9 million, or
$0.18 per share in the comparable period of 2001.
Premium Revenue Results
The Group's premiums are earned principally on a monthly pro rata basis over
the term of the policy. Management analyzes premium revenues primarily by
premiums written in the current period. Net premiums written differs from
gross premiums written by premiums ceded to reinsurers.
The table below summarizes the increase (decrease) in property and casualty
premium results compared with same period prior year results:
2002 increase (decrease) from 2001 ($ in millions)
Gross Premiums Written Net Premiums Written
Second Year Second Year
Quarter To Date Quarter To Date
------- ------- ------- -------
Business Units
- --------------
Commercial Lines $ 20.1 $ 33.4 $ 20.5 $ 34.9
Specialty Lines 12.3 25.3 8.4 17.8
Personal Lines (47.8) (67.6) (43.0) (63.3)
------- ------- ------- -------
All Lines $(15.4) $ (8.9) $(14.1) $(10.6)
The expected decrease in Personal Lines premiums written was driven by
actions to cancel the most unprofitable agents and withdraw from selected
states, including the exit from the New Jersey private passenger auto market.
These actions contributed to the $42.6 million decrease in Personal Lines net
premiums written in the second quarter of 2002. The Group's exit from the
New Jersey private passenger auto market, which began in March 2002, made up
$30.3 million of the decrease. The Commercial Lines increase was driven by
renewal price increases. Renewal price increases in the umbrella line of
business in the Specialty Lines contributed to the increase in premiums in
the current quarter. Renewal price increase means the average increase in
premium for policies renewed by the Group. The average increase in premium
for each renewed policy is calculated by comparing the total expiring premium
for the policy with the total renewal premium for the same policy. Renewal
price increases include, among other things, the effects of rate increases
and changes in the underlying insured exposures of the policy. Only policies
13
issued by the Group in the previous policy term with the same policy
identification codes are included. Therefore, renewal price increases do not
include changes in premiums for newly issued policies or business assumed
through reinsurance agreements, including policies previously issued through
Great American's systems. Renewal price increases also do not reflect the
cost of any reinsurance purchased on the policies issued.
New Jersey is the Group's largest state with 14.1% of the total net premiums
written in the first six months of 2002, compared with 17.5% of the Group's
total net premiums written for the same period of 2001. For the second
quarter of 2002, 10.8% of the Group's total net premiums written were for
policyholders in New Jersey, compared with 17.4% of the Group's total net
premiums written in the same quarter of 2001. In recent years, New Jersey's
legislative and regulatory environments have become less favorable to the
Group. The state requires insurance companies to accept all risks that meet
underwriting guidelines for private passenger automobile. In the fourth
quarter of 2001, OCNJ entered into an agreement to transfer its New Jersey
private passenger auto renewal obligations to Proformance Insurance Company.
The Group began to cease writing new and renewal business in the New Jersey
private passenger auto and personal umbrella markets in March 2002. New
Jersey private passenger auto and personal umbrella made up 24.9% of the
Group's New Jersey net premiums written in the first six months of 2002 and
4.3% in the second quarter of 2002. The Group continues to write all of its
other lines of business in the state.
Investment Results
Year-to-date consolidated before-tax investment income was $101.6 million, or
$1.66 per share, decreasing from $103.4 million, or $1.72 per share, for the
same period last year. The investment income effective tax rate for the
first six months of 2002 was 33.4% compared with 33.2% for the comparable
period in 2001. Second quarter consolidated before-tax investment income was
$50.7 million, or $0.82 per share, compared with $52.1 million, or $0.86 per
share for the same period last year. The investment income effective tax
rate for the second quarter of 2002 was 33.9%, compared with 33.6% in the
second quarter of 2001. Although fixed income assets have increased over the
past year, a decline in interest rates on high quality fixed income
investments led to the decrease in investment income.
Year-to-date 2002 consolidated after-tax realized gains were $21.0 million,
or $0.34 per share, compared with $35.8 million, or $0.60 per share, for the
same period of 2001. Consolidated after-tax realized gains amounted to $6.2
million, or $0.10 per share for the quarter ended June 30, 2002, compared
with $27.6 million, or $0.46 per share in the second quarter of 2001. Over
the past 18 months, the Group has reduced its equity holdings through the
sale of equity securities. By the end of the second quarter of 2002, the
Group was close to its objective of reducing the effect on statutory surplus
of future stock market volatility by attaining a 50% ratio of equity
securities to statutory surplus.
Statutory Results
Management uses statutory financial criteria to analyze the property and
casualty results. Management analyzes statutory results through the use of
insurance industry financial measures including statutory loss and loss
adjustment expense ratios, statutory underwriting expense ratio, statutory
combined ratio, net premiums written and net premiums earned. The statutory
combined ratio is a commonly used gauge of underwriting performance measuring
the percentages of premium dollars used to pay insurance losses and related
expenses. A discussion of the differences between statutory accounting and
accounting principles generally accepted in the United States is included in
Item 14 pages 59 and 60 of the Corporation's Form
10-K for the year ended December 31, 2001.
All Lines Discussion
The statutory combined ratio for the six months ending June 30, 2002 was
107.8%, decreasing from 114.1% in the same period of 2001. For the second
quarter of 2002, the statutory combined ratio was 109.3%, compared with
113.0% in the same quarter of 2001. The improvement in the statutory
combined ratio is attributable primarily to price increases and more
favorable loss results as discussed further in Segment Discussion below.
14
The statutory loss ratio was 60.0% for the first six months of 2002, compared
with 70.0% for the comparable period of 2001. For the second quarter of
2002, the statutory loss ratio was 61.4%, compared with 70.1% in the second
quarter of 2001. The improvement in the statutory loss ratio is primarily
driven by improved loss results in the Commercial Lines.
The year-to-date 2002 catastrophe losses were $13.6 million and accounted for
1.9 points on the statutory combined ratio, compared with $20.7 million and
2.7 points in the same period of 2001. The second quarter catastrophe losses
were $10.3 million and accounted for 2.8 points on the statutory combined
ratio. This compares with $18.9 million and a 5.0 point catastrophe impact
on the statutory combined ratio for the same period in 2001. The effect of
future catastrophes on the Corporation's results cannot be accurately
predicted. Severe weather patterns can have a material adverse impact on the
Corporation's results. During the second quarter of 2002, there were 8
catastrophes with the largest catastrophe generating $6.1 million in incurred
losses as compared with 9 catastrophes in the second quarter of 2001 with the
largest catastrophe generating $12.4 million in incurred losses. For
additional disclosure of catastrophe losses, refer to Item 14, Losses and
Loss Reserves in the Notes to the Consolidated Financial Statements on pages
56 and 57 of the Corporation's 2001 Form 10-K.
The statutory loss adjustment expense ratio for year-to-date 2002 was 14.5%,
2.6 points higher than the same period of 2001 loss adjustment expense ratio
of 11.9%. The second quarter 2002 loss adjustment expense ratio was 14.7%,
compared with 11.6% in the same quarter of 2001. The increase in 2002 is
partially the result of expenditures made to implement loss cost savings
initiatives in order to improve loss results. A portion of the increase in
2002 is also due to increased estimates of legal costs on claims from prior
years.
The statutory loss and loss adjustment expense ratios were impacted
negatively in the first six months of 2002 for adjustments to the provision
for prior years' business, primarily for workers' compensation and general
liability. In total, this adverse development for prior years' losses and
loss adjustment expenses added 1.8 points to the year-to-date 2002 statutory
combined ratio.
The year-to-date 2002 statutory underwriting expense as a percent of net
premiums written was 33.3% compared with 32.2% in the same period of 2001.
Second quarter 2002 statutory underwriting expense ratio was 33.2% compared
with 31.3% in second quarter of 2001. The exit from the New Jersey private
passenger auto market, which had relatively low commissions and low variable
costs, has caused an expected increase to the underwriting expense ratio.
The elimination of ceding commissions received on umbrella premiums ceded to
reinsurers, as previously announced in the 2002 Corporate Strategic Plan
update, also contributed to the increase in the underwriting expense ratio.
A decrease in policyholder dividends positively impacted the second quarter
2001 underwriting expense ratio. These factors were the primary reasons for
the increase in underwriting expense ratios in 2002. The employee count
continues to decline. The employee count of 3,127 at June 30, 2002 was down
from 3,365 at year-end 2001 and down from 3,459 at June 30, 2001.
Segment Discussion
In June of 2001, the Corporation introduced an organizational structure
around three business units: Commercial Lines, Specialty Lines, and Personal
Lines.
Commercial Lines
Commercial Lines statutory combined ratio for the first six months of 2002
decreased 13.8 points to 106.9% from 120.7% in the same period of 2001. The
second quarter of 2002 statutory combined ratio was 105.6%, compared with
117.9% in the second quarter of 2001. The 2002 statutory combined ratio
improvement was due to favorable loss results. The second quarter 2002
Commercial Lines loss ratio improved 9.9 points compared with the same period
of 2001. Achieving price increases, eliminating and canceling unprofitable
business and focusing on underwriting targeted business contributed to the
Commercial Lines statutory loss ratio improvement. The Commercial Lines
average renewal price increases for direct premiums written were 15.5% in the
first half of 2002, compared with 13.9% in the same period of 2001. Renewal
price increases were 14.5% in the current quarter.
15
Negatively impacting the Commercial Lines results were increases in
provisions for the general liability and workers' compensation lines of
business.
The general liability statutory combined ratio increased in the first half of
2002 to 131.1% from 120.2% in the same period of 2001. For the second
quarter of 2002, the statutory combined ratio was 118.5% compared to 135.4%
in the same quarter of 2001. The line of business was impacted in year-to-
date 2002 by additions to construction defect related reserves and increased
estimates of legal costs on claims from prior years. Construction defect
claims filed under general liability insurance policies involve allegations
of defective work on construction projects, such as condominiums, apartment
complexes, housing developments, and office buildings. These claims usually
involve multiple parties and carriers. The loss estimates for these claims
are based on currently available information. However, given the expansion
of coverage and liability by the courts and legislatures, there is
substantial uncertainty as to the ultimate liability. The 2002 accident year
statutory combined ratio for general liability was 104.1%, 27.0 points lower
than the calendar year results. The loss and loss adjustment expense (LAE)
ratio component of the all lines statutory accident year combined ratio
measures losses and claims expenses arising from insured events during the
year. The loss and LAE ratio component of the all lines statutory calendar
year combined ratio includes loss and LAE payments made during the current
year and changes in the provision for future loss and LAE payments. The All
Lines statutory calendar year combined ratio includes losses and claims
expenses arising from insured events in both the current year and in prior
years.
Workers' compensation statutory combined ratio for the first six months of
2002 was 130.7%, compared with 152.8% during the same period last year. The
second quarter 2002 statutory combined ratio was 130.1%, compared to 138.1%
in 2001. Although the Group has taken actions to improve workers'
compensation results, adverse development for prior years' losses and loss
adjustment expenses continue to impact results.
Specialty Lines
Specialty Lines statutory combined ratio for the first six months of 2002 was
88.7%, compared with 74.7% in the same period of 2001. The second quarter
2002 statutory combined ratio was 92.7%, an increase of 14.6 points from the
second quarter 2001 ratio of 78.1%. Although the statutory combined ratio
increased in 2002, the results are still favorable. Because of the nature of
the liabilities insured under policies issued through Specialty Lines, the
ultimate cost of settlement is more difficult to estimate. Each quarter as
the Group re-estimates the ultimate cost to settle the claim, the change in
estimates impacts the current quarterly results for each line of business.
This change often impacts the Specialty Lines more than the other lines.
Renewal price increases in the umbrella line of business averaged 42.0% in
the first half of 2002, compared with 19.5% in the same period of 2001.
Personal Lines
The Personal Lines statutory combined ratio decreased to 112.0% year-to-date
June 30, 2002, from 114.4% in the first six months of 2001. For the second
quarter of 2002, the Personal Lines statutory combined ratio was 117.1%, a
slight increase from the second quarter 2001 ratio of 114.6%.
The first half of 2002 statutory combined ratio for homeowners decreased 16.9
points to 113.0% from 129.9%. The second quarter combined ratio decreased
18.0 points from the same period of 2001. The improvement in the homeowners
line of business results is partially due to the favorable catastrophe
results, introduction of insurance scoring, elimination of unprofitable
business, improved claims practices and the implementation of rate increases
where possible. Catastrophe losses added 14.3 points to the statutory
combined ratio in the second quarter of 2002, and 26.0 points in the same
period of 2001.
Private passenger auto results were impacted by poor results in the New
Jersey private passenger auto market. Poor New Jersey results added 6.6
points to the second quarter Personal Lines combined ratio and 10.6 points to
the private passenger auto combined ratio, compared with lowering the 2001
second quarter Personal Lines ratio by 0.9 points and the second quarter 2001
private passenger auto by 1.1 points. Private passenger auto-agency
excluding New Jersey recorded a 2002 six-month statutory
16
combined ratio of 102.9%, decreasing from 105.1% in the same period last
year. The second quarter 2002 private passenger auto-agency excluding New
Jersey ratio decreased 1.4 points to 104.5% from 105.9% in the same quarter
of 2001. The Private passenger auto line of business is benefiting from the
implementation of insurance scoring, elimination of unprofitable business and
targeted underwriting.
Since 1999, New Jersey has required insurance companies to write a portion of
their personal auto premiums in Urban Enterprise Zones (UEZ). These zones
are generally higher risk urban areas. The Group is required to write one
policy in an UEZ for every seven policies written outside an UEZ. The Group
is assigned policies if it does not write the required quota. As of June 30,
2002, the Group has written $1.8 million year to date in UEZ premiums, with
$1.7 million in additional assigned premiums compared with $4.7 million in
UEZ premiums and $3.4 million in additional assigned premiums through the
first six months of 2001. The 2002 six-month loss ratio on the UEZ premiums
was 205.9% and the loss ratio on the assigned business was 236.4%, compared
with a loss ratio of 178.1% on UEZ premiums and 247.8% on assigned business
for the same period last year.
LIQUIDITY AND FINANCIAL STRENGTH
Investments
At June 30, 2002, the fixed income portfolio of the Corporation totaled $2.95
billion, which consisted of 96.6% investment grade and 3.4% below investment
grade securities. The market value of the below investment grade portfolio
was $99.6 million at June 30, 2002, compared with $94.3 million at December
31, 2001. The Corporation classify securities as below investment grade
based upon the higher of the ratings provided by Standard & Poor's Ratings
Group (S&P) and Moody's Investors Service (Moody's), and upon other rating
agencies, including the National Association of Insurance Commissioners, when
a security is not rated by either S&P or Moody's. The market value of split-
rated fixed income investments (i.e., those having an investment grade rating
from either S&P or Moody's and a below investment grade rating from the other
agency) was $60.3 million at June 30, 2002 and $30.2 million at December 31,
2001.
Investments in below investment grade securities have greater risks than
investments in investment grade securities. The risk of default by borrowers
that issue below investment grade securities is significantly greater because
these borrowers are often highly leveraged and more sensitive to adverse
economic conditions, including a recession or a sharp increase in interest
rates. Additionally, investments in below investment grade securities are
generally unsecured and subordinate to other debt. Investment grade
securities are also subject to significant risks, including additional
leveraging or changes in control of the issuer. In most instances, investors
are unprotected with respect to these risks, the effects of which can be
substantial.
At June 30, 2002, the Corporation's equity portfolio was $403.5 million, or
11.9% of the total invested assets. The Corporation marks the value of its
equity portfolio to fair value on its balance sheet. As a result,
shareholders' equity and statutory surplus fluctuate with changes in the
value of the equity portfolio. As of June 30, 2002, the equity portfolio
consisted of stocks of 47 separate entities in 35 different industries. As
of June 30, 2002, 35.9% of the Corporation's equity portfolio was invested in
five companies and the largest single position was 10.9% of the equity
portfolio.
For a further discussion of the Corporation's investments, see Item 1 pages 8
through 10 of the Corporation's Form 10-K for the year ended December 31,
2001.
Cash Flow
Net cash generated by operations was $32.9 million for the first six months
of the year compared with $14.6 million for the same period in 2001.
Improved underwriting profitability contributed to the increase in 2002.
Current operational liquidity needs of the Group are expected to be met by
scheduled bond maturities, dividend payments, interest payments, and cash
balances. Cash used in financing operations was $5.1 million in the first
six months of 2002 compared with cash used of $10.3 million in the first six
months of 2001. The 2002 cash includes the repayment of the Corporation's
$205.0 million credit facility and issuance of new convertible debt with net
proceeds of $194.0 million.
17
Debt
As of June 30, 2002, the Corporation had $198.9 million of notes payable,
compared with $210.2 million at year-end 2001. On March 19, 2002, the
Corporation completed an offering of 5.00% convertible notes, in an aggregate
principal amount of $201.3 million, due March 19, 2022. The net proceeds of
the offering, along with $10.5 million of cash, were used to pay off the
balance of the outstanding credit facility. In addition, the Corporation
terminated the credit facility that made available a $250.0 million revolving
line of credit. Interest on the convertible notes is payable on March 19 and
September 19 of each year, beginning September 19, 2002. The notes may be
converted into shares of the Corporation's common stock under certain
conditions, including: if the sale price of the Corporation's common stock
reaches specific thresholds; if the credit rating of the notes is below a
specified level or withdrawn, or in which the notes have no credit rating
during any period; or if specified corporate transactions have occurred. The
conversion rate is 44.2112 shares per each $1,000 principal amount of notes,
subject to adjustment in certain circumstances. On or after March 23, 2005,
the Corporation has the option to redeem all or a portion of the notes that
have not been previously converted at the following redemption prices
(expressed as percentage of principal amount):
During the twelve months commencing Redemption Price
- ----------------------------------- ----------------
March 23, 2005 102%
March 19, 2006 101%
March 19, 2007 until maturity of the notes 100%
On July 31, 2002, the Corporation entered into a revolving credit agreement
with LaSalle Bank National Association as lender and agent, and certain other
lenders. Under the terms of the credit agreement, the lenders agreed to make
loans to the Corporation in an aggregate amount up to $80 million to meet
general corporate needs. The credit agreement will expire on March 15, 2005.
The Corporation also had $4.9 million of debt at June 30, 2002 related to a
low interest loan with the state of Ohio used in conjunction with the
purchase of the home office located in Fairfield, Ohio.
Rating Agencies
Regularly the Group's financial strength is reviewed by independent rating
agencies. These agencies may upgrade, downgrade, or affirm their previous
ratings of the Group. These agencies may also place an outlook on the
Group's rating. On March 11, 2002, Standard & Poor's Rating Services removed
its negative outlook and placed a stable outlook on the Group's "BBB"
financial strength rating. Standard and Poor's Rating Services also
announced that it assigned its "BB" senior debt rating on the Corporation's
convertible notes. On March 13, 2002, Moody's Investor Services confirmed
the Group's "A2" financial strength rating and placed a stable outlook on the
Group's rating. Moody's Investor Services also announced that it placed a
"Baa2" rating on the Corporation's convertible notes. On March 14, 2002,
Fitch, Inc. announced that it placed a "BBB-" rating on the Corporation's
convertible notes. Fitch, Inc. also placed a stable outlook on its rating.
Reinsurance
The Group purchases reinsurance coverage for protection against large or
catastrophic losses. The reinsurance recoverable asset reflects the amounts
currently due from reinsurers and significant amounts of reserves for future
claims that are expected to be recovered from reinsurers. The Group
evaluates the financial condition of its reinsurers and monitors
concentrations of credit risk to minimize exposure to significant losses from
reinsurer insolvencies. The Group continues to update its estimate of loss
and loss adjustment reserves related to anticipated reinsured claims. The
growth in these reserves and the related reinsurance recoverable asset,
reflect significant growth in the commercial umbrella line of business, which
is the Group's most heavily reinsured line of business.
18
Legal Proceedings
California voters passed Proposition 103 in 1988 in an attempt to legislate
premium rates for that state. The proposition required premium rate
rollbacks for 1989 California policyholders while allowing for a "fair"
return for insurance companies. On October 25, 2000, the Group announced a
settlement agreement for California Proposition 103 that was approved by the
California Insurance Commissioner. Under the terms of the settlement, the
members of the Group agreed to pay $17.5 million in refunded premiums to
eligible 1989 California policyholders. The Group began to make payments in
the first quarter of 2001. The remaining liability was $7.8 million as of
June 30, 2002.
Forward Looking Statements
The Corporation may publish forward looking statements relating to such
matters as anticipated financial performance, business prospects and plans,
regulatory developments and similar matters. The statements contained in
this Management's Discussion and Analysis of Financial Condition and Results
of Operations that are not historical information, are forward looking
statements. The Private Securities Litigation Reform Act of 1995 provides a
safe harbor under the Securities Act of 1933 and the Securities Exchange Act
of 1934 for forward-looking statements. In order to comply with the terms of
the safe harbor, the Corporation notes that a variety of factors could cause
the Corporation's actual results and experience to differ materially from the
anticipated results or other expectations expressed in the Corporation's
forward-looking statements.
The risks and uncertainties that may affect the operations, performance,
development and results of the Corporation's business, include the following:
changes in property and casualty reserves; catastrophe losses; premium and
investment growth; product pricing environment; availability of credit;
changes in government regulation; performance of financial markets;
fluctuations in interest rates; availability and pricing of reinsurance;
litigation and administrative proceedings; acts of war and terrorist
activities; rating agency actions; ability of Ohio Casualty to retain the
business acquired from the Great American Insurance Company; ability to
achieve targeted expense savings; ability to achieve premium targets and
profitability goals; and general economic and market conditions.
ITEM 3. Quantitative And Qualitative Disclosures About Market Risk - There
have been no material changes in the information about market
risk set forth in the Corporation's Annual Report on Form 10-K.
PART II
ITEM 1. Legal Proceedings - Refer to Legal Proceedings as described on
Page 14 of this Form 10-Q regarding California Proposition 103.
ITEM 2. Changes in Securities - None
ITEM 3. Defaults Upon Senior Securities - None
ITEM 4. Submission of Matters to a Vote of Security Holders - None
ITEM 5. Other Information - On July 31, 2002, the Corporation entered
into a revolving credit agreement with LaSalle Bank National
Association as lender and agent, and various other lenders.
Under the terms of the credit agreement, the lenders agreed to
make loans to the Corporation in an aggregate amount up to $80
million to meet general corporate needs. The credit agreement
will expire on March 15, 2005. The credit agreement is included
as an exhibit to this Form 10-Q.
19
ITEM 6. Exhibits and reports on Form 8-K -
I. Reports on Form 8-K:
(a) The Corporation filed a Form 8-K on April 1, 2002 to
report under Items 5 and 7, the Corporation's Indenture
dated March 19, 2002, between the Company and HSBC Bank
USA. An exhibit to the Form 8-K consisted of the
Indenture for the convertible Notes offering.
(b) The Corporation filed a Form 8-K on April 17, 2002 to
report on Items 5 and 7, the filing of a press release
announcing the election of new directors to the Board of
Directors. An exhibit to the Form 8-K consisted of that
press release dated April 17, 2002.
(c) The Corporation filed a Form 8-K on May 8, 2002 to report
under Items 5 and 7, the filing of a press release
announcing the Corporation's first quarter 2002 results.
An exhibit to the Form 8-K consisted of that press release
dated May 1, 2002.
(d) The Corporation filed a Form 8-K on May 30, 2002 to report
under Items 5 and 7, the filing of a press release
announcing the filing of Form S-3 registering the
Corporation's convertible notes due 2022. An exhibit to
the Form 8-K consisted of that press release dated May 30,
2002.
(e) The Corporation filed a Form 8-K on June 5, 2002 to report
under Items 5 and 7, the filing of a press release
announcing the Corporation's Form S-3 (File No. 333-88532)
was declared effective. An exhibit to the Form 8-K
consisted of that press release dated June 5, 2002.
(f) The Corporation filed a Form 8-K on June 5, 2002 to report
under Item 7, the Corporation's Safe Harbor statement. An
exhibit to the Form 8-K consisted of that statement.
II. Exhibits:
10 Credit Agreement dated as of July 31, 2002 between Ohio
Casualty Corporation and LaSalle Bank National
Association and certain other lenders.
99.1 Certification of Chief Executive Officer of Ohio Casualty
Corporation in accordance with Section 906 of the
Sarbanes-Oxley Act of 2002.
99.2 Certification of Chief Financial Officer of Ohio Casualty
Corporation in accordance with Section 906 of the
Sarbanes-Oxley Act of 2002.
20
SIGNATURE
Pursuant to the requirements 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.
OHIO CASUALTY CORPORATION
-------------------------------
(Registrant)
August 14, 2002 /s/ Donald F. McKee
--------------------------------
Donald F. McKee, Chief Financial
Officer
(on behalf of Registrant and as
Principal Accounting Officer).
21