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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 September 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
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act).
Yes X No
The aggregate market value as of November 1, 2002 of the voting stock
held by non-affiliates of the registrant was $710,725,172.
On November 1, 2002 there were 60,701,653 shares outstanding.
Page 1 of 24
==============================================================================
PART I
ITEM 1. FINANCIAL STATEMENTS
Ohio Casualty Corporation & Subsidiaries
CONSOLIDATED BALANCE SHEET
September 30, December 31,
(In thousands, except per share data) (Unaudited) 2002 2001
- --------------------------------------------------------------------------------
Assets
Investments:
Fixed maturities:
Available for sale, at fair value
(cost: $2,938,722 and $2,729,998) $3,109,358 $2,772,104
Equity securities, at fair value
(cost: $95,189 and $110,206) 327,297 488,988
Short-term investments, at fair value
(cost: $6,347 and $54,785) 6,347 54,785
- -------------------------------------------------------------------------------
Total investments 3,443,002 3,315,877
Cash 17,964 37,499
Premiums and other receivables, net of allowance
for bad debts of $5,300 and $8,400, respectively 332,789 341,986
Deferred policy acquisition costs 179,542 166,759
Property and equipment, net of accumulated
depreciation of $144,001 and $133,213,
respectively 103,136 99,810
Reinsurance recoverable 312,036 237,688
Agent relationships, net of accumulated
amortization of $33,738 and $36,310,
respectively 171,243 241,022
Interest and dividends due or accrued 39,098 43,319
Deferred income taxes 7,643 -
Other assets 33,040 40,659
- -------------------------------------------------------------------------------
Total assets $4,639,493 $4,524,619
===============================================================================
Liabilities
Insurance reserves:
Losses $1,864,948 $1,746,828
Loss adjustment expenses 454,689 403,894
Unearned premiums 688,584 666,739
Notes payable 198,302 210,173
California Proposition 103 reserve 7,775 7,816
Deferred income taxes - 3,124
Other liabilities 379,984 406,013
- -------------------------------------------------------------------------------
Total liabilities 3,594,282 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: 262,567 274,359
Retained earnings 907,690 1,221,447
Treasury stock, at cost:
(Shares: 11,761; 34,312) (155,236) (452,866)
- -------------------------------------------------------------------------------
Total shareholders' equity 1,045,211 1,080,032
- -------------------------------------------------------------------------------
Total liabilities and shareholders'
equity $4,639,493 $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 September 30,
(in thousands, except per share data) (Unaudited) 2002 2001
- --------------------------------------------------------------------------
Premiums and finance charges earned $ 356,959 $ 374,327
Investment income less expenses 51,767 53,068
Investment gains (losses) realized, net (5,539) 71,033
- ----------------------------------------------------------------------------
Total revenues 403,187 498,428
Losses and benefits for policyholders 250,314 252,249
Loss adjustment expenses 73,596 51,181
General operating expenses 31,470 23,378
Amortization of agent relationships 2,659 2,792
Write-off of agent relationships 53,985 1,267
Amortization of deferred policy acquisition costs 94,297 93,076
Depreciation expense 2,933 2,566
Amortization of software 1,621 1,246
- ----------------------------------------------------------------------------
Total expenses 510,875 427,755
- ----------------------------------------------------------------------------
Income/(loss) before income taxes (107,688) 70,673
Income tax (benefit) expense:
Current (17,057) 6,194
Deferred (20,696) 20,251
- ----------------------------------------------------------------------------
Total income tax (benefit) expense (37,753) 26,445
- ----------------------------------------------------------------------------
Net income/(loss) $ (69,935) $ 44,228
============================================================================
Average shares outstanding - basic* 60,643 60,076
============================================================================
Earnings per share - basic:*
Net income/(loss), per share $ (1.15) $ 0.74
Average shares outstanding - diluted* 61,422 60,400
============================================================================
Earnings per share - diluted:*
Net income/(loss), per share $ (1.14) $ 0.73
============================================================================
Cash dividends, per share $ - $ -
============================================================================
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
Nine Months
Ended September 30,
(in thousands, except per share data) (Unaudited) 2002 2001
- -----------------------------------------------------------------------------
Premiums and finance charges earned $1,082,674 $1,134,397
Investment income less expenses 153,369 156,468
Investment gains realized, net 26,783 126,065
- -----------------------------------------------------------------------------
Total revenues 1,262,826 1,416,930
Losses and benefits for policyholders 685,980 783,775
Loss adjustment expenses 178,622 141,632
General operating expenses 82,212 81,281
Amortization of agent relationships 8,150 8,520
Write-off of agent relationships 61,629 8,541
Early retirement charge - 9,600
Amortization of deferred policy acquisition costs 279,431 283,636
Depreciation expense 8,078 7,312
Amortization of software 4,687 3,670
- -----------------------------------------------------------------------------
Total expenses 1,308,789 1,327,967
- -----------------------------------------------------------------------------
Income/(loss) before income taxes (45,963) 88,963
Income tax (benefit) expense:
Current (11,550) 10,897
Deferred (4,415) 21,282
- -----------------------------------------------------------------------------
Total income tax (benefit) expense (15,965) 32,179
- -----------------------------------------------------------------------------
Net income/(loss) $ (29,998) $ 56,784
=============================================================================
Average shares outstanding - basic* 60,425 60,074
=============================================================================
Earnings per share - basic:*
Net income/(loss), per share $ (0.50) $ 0.95
Average shares outstanding - diluted* 61,334 60,146
=============================================================================
Earnings per share - diluted:*
Net income/(loss), per share $ (0.49) $ 0.94
=============================================================================
Cash dividends, per share $ - $ -
=============================================================================
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 56,784 56,784
Net change in unrealized gain
net of deferred income tax
of $49,133 (91,246) (91,246)
-----------
Comprehensive loss (34,462)
Net issuance of stock
under stock aware
plan (5 shares) (1) 61 60
- --------------------------------------------------------------------------------------------------------------------------
Balance,
September 30, 2001 $11,802 $ 4,179 $ 21,138 $ 318,658 $ 1,179,651 $ (453,239) $ 1,082,189
==========================================================================================================================
Balance
January 1, 2002 $11,802 $ 4,152 $ 21,138 $ 274,359 $ 1,221,447 $ (452,866) $ 1,080,032
Net income (29,998) (29,998)
Net change in unrealized gain
net of deferred income tax
of $6,350 (11,792) (11,792)
-----------
Comprehensive income (41,790)
Net issuance of stock
under stock award
plan (551 shares) (124) (162) 7,255 6,969
Retirement of treasury stock (2,750) (4,028) (283,597) 290,375 -
- --------------------------------------------------------------------------------------------------------------------------
Balance,
September 30, 2002 $ 9,052 $ - $ 21,138 $ 262,567 $ 907,690 $ (155,236) $ 1,045,211
==========================================================================================================================
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
Nine Months
Ended September 30,
(in thousands) (Unaudited) 2002 2001
- --------------------------------------------------------------------------------
Cash flows from:
Operations
Net income (loss) $ (29,998) $ 56,784
Adjustments to reconcile net income
to cash from operations:
Changes in:
Insurance reserves 190,761 134,279
Income taxes (12,265) 57,235
Premiums and other receivables 9,197 (8,296)
Deferred policy acquisition costs (12,783) 5,881
Reinsurance recoverable (74,349) (68,667)
Other assets 5,813 5,440
Other liabilities (26,030) 660
California Proposition 103 reserves (42) (9,649)
Amortization and write-off of agent
relationships 69,779 17,061
Depreciation and amortization 11,939 6,095
Investment (gains) losses (26,783) (126,065)
- ----------------------------------------------------------------------------------
Net cash generated by operating activities 105,239 70,758
- ----------------------------------------------------------------------------------
Investments
Purchase of investments:
Fixed income securities - available for sale (923,775) (1,129,122)
Equity securities (3,216) (6,787)
Proceeds from sales:
Fixed income securities - available for sale 667,555 897,689
Equity securities 66,881 177,520
Proceeds from maturities and calls:
Fixed income securities - available for sale 40,279 66,011
Equity securities - -
Property and equipment:
Purchases (16,037) (15,506)
Sales 268 674
- ----------------------------------------------------------------------------------
Net cash generated (used) from investing
activities (168,045) (9,521)
- ----------------------------------------------------------------------------------
Financing
Notes payable:
Proceeds 194,042 -
Repayments (205,916) (10,468)
Proceeds from exercise of stock options 6,708 66
Dividends paid to shareholders - -
- ----------------------------------------------------------------------------------
Net cash used in financing activities (5,166) (10,402)
- ----------------------------------------------------------------------------------
Net change in cash and cash equivalents (67,972) 50,835
Cash and cash equivalents, beginning of period 92,283 90,044
- ----------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 24,311 $ 140,879
==================================================================================
Accompanying notes are an integral part of these financial statements.
For complete disclosures see Notes to Consolidated Financial Statements on
pages 45-85 of the Corporation's 2000 Form 10-K, Item 14.
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 materially impact the
Corporation's financial position and results of operations.
In July 2002, the FASB issued SFAS 146, "Accounting for Costs Associated with
Exit or 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 Nine months ended
September 30 September 30
2002 2001 2002 2001
---- ---- ---- ----
Income (loss) from continuing
operations $(69,935) $44,228 $(29,998) $56,784
Weighted average common shares
outstanding - basic 60,643 60,076 60,425 60,074
Basic income (loss) from continuing
operations - per average share $ (1.15) $ 0.74 $ (.50) $ 0.95
===============================================================================
Weighted average common shares
outstanding 60,643 60,076 60,425 60,074
Effect of dilutive securities 779 324 909 72
- -------------------------------------------------------------------------------
Weighted average common shares
outstanding - diluted 61,422 60,400 61,334 60,146
Diluted income (loss) from
continuing operations - per
average share $ (1.14) $ 0.73 $ (.49) $ 0.94
===============================================================================
NOTE IV -- SEGMENT INFORMATION
The Corporation has determined its reportable segments based upon its method
of internal reporting. The 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
Nine Months Ended September 30
(in thousands)
Commercial Lines 2002 2001
- ------------------------------------------------------------------
Net premiums written $ 579,923 $ 528,850
% Increase (decrease) 9.7% (6.2)%
Net premiums earned 535,273 533,956
% Increase (decrease) 0.3% (3.8)%
Underwriting gain (loss)
(before tax) (112,878) (103,480)
Loss ratio 61.6% 68.9%
Loss expense ratio 19.9% 14.8%
Underwriting expense ratio 36.5% 36.0%
Combined ratio 118.0% 119.7%
Specialty Lines 2002 2001
- ------------------------------------------------------------------
Net premiums written $132,672 $105,461
% Increase (decrease) 25.8% 32.1%
Net premiums earned 111,351 99,166
% Increase (decrease) 12.3% 31.1%
Underwriting gain (loss)
(before tax) (10,763) 16,638
Loss ratio 43.2% 40.3%
Loss expense ratio 14.8% 6.3%
Underwriting expense ratio 43.4% 34.4%
Combined ratio 101.4% 81.0%
Personal Lines 2002 2001
- ------------------------------------------------------------------
Net premiums written $388,224 $494,247
% Increase (decrease) (21.4)% (4.4)%
Net premiums earned 435,988 500,774
% Increase (decrease) (12.9)% (3.6)%
Underwriting gain (loss)
(before tax) (40,880) (65,143)
Loss ratio 70.5% 75.1%
Loss expense ratio 12.8% 11.2%
Underwriting expense ratio 29.3% 27.1%
Combined ratio 112.6% 113.4%
Total Property & Casualty 2002 2001
- ------------------------------------------------------------------
Net premiums written $1,100,819 $1,128,558
% Increase (decrease) (2.5)% (2.7)%
Net premiums earned 1,082,612 1,133,896
% Increase (decrease) (4.5)% (1.4)%
Underwriting gain (loss)
(before tax) (164,521) (151,985)
Loss ratio 63.3% 69.1%
Loss expense ratio 16.5% 12.5%
Underwriting expense ratio 34.8% 31.9%
Combined ratio 114.6% 113.5%
Impact of catastrophe losses
on combined ratio 1.6% 2.9%
All other 2002 2001
- ------------------------------------------------------------------
Revenues $ 614 $ 6,197
Expenses 6,717 10,107
- ------------------------------------------------------------------
Net loss $(6,103) $(3,910)
Reconciliation of Revenues 2002 2001
- ------------------------------------------------------------------
Net premiums earned for
reportable segments $1,082,612 $1,133,896
Investment income 152,577 155,336
Realized gains (losses) 27,275 119,961
Miscellaneous income 59 392
- ------------------------------------------------------------------
Total property and casualty
revenues (Statutory basis) 1,262,523 1,409,585
Property and casualty statutory
to GAAP adjustment (311) 1,148
- ------------------------------------------------------------------
Total revenues property and
casualty (GAAP basis) 1,262,212 1,410,733
Other segment revenues 614 6,197
- ------------------------------------------------------------------
Total revenues $1,262,826 $1,416,930
==================================================================
Reconciliation of underwriting
gain (loss) (before tax) 2002 2001
- ------------------------------------------------------------------
Property and casualty under-
writing gain (loss) (before tax)
(Statutory basis) $(164,521) $(151,985)
Statutory to GAAP adjustment (53,019) (29,172)
- ------------------------------------------------------------------
Property and casualty under-
writing gain (loss) (before tax)
(GAAP basis) (217,540) (181,157)
Net investment income 153,369 156,468
Realized gains (losses) 26,783 126,065
Other income (losses) (8,575) (12,413)
- ------------------------------------------------------------------
Income (loss) from continuing
operations before income taxes $ (45,963) $ 88,963
==================================================================
9
Three months ended September 30
(in thousands)
Commercial Lines 2002 2001
- ------------------------------------------------------------------
Net premiums written $180,865 $164,709
% Increase (decrease) 9.8% (8.4)%
Net premiums earned 181,952 174,518
% Increase (decrease) 4.3% (9.9)%
Underwriting gain (loss)
(before tax) (72,091) (27,562)
Loss ratio 73.2% 66.3%
Loss expense ratio 26.4% 15.3%
Underwriting expense ratio 40.2% 36.2%
Combined ratio 139.9% 117.8%
Specialty Lines 2002 2001
- ------------------------------------------------------------------
Net premiums written $ 47,905 $ 38,492
% Increase (decrease) 24.5% 42.7%
Net premiums earned 42,685 34,971
% Increase (decrease) 22.1% 31.8%
Underwriting gain (loss)
(before tax) (11,723) 1,393
Loss ratio 52.3% 51.6%
Loss expense ratio 23.9% 8.3%
Underwriting expense ratio 45.7% 32.8%
Combined ratio 121.9% 92.7%
Personal Lines 2002 2001
- ------------------------------------------------------------------
Net premiums written $121,900 $164,625
% Increase (decrease) (26.0)% (6.8)%
Net premiums earned 132,312 164,789
% Increase (decrease) (19.7)% (5.1)%
Underwriting gain (loss)
(before tax) (15,540) (18,456)
Loss ratio 71.2% 71.8%
Loss expense ratio 11.6% 13.1%
Underwriting expense ratio 31.4% 26.3%
Combined ratio 114.2% 111.2%
Total Property & Casualty 2002 2001
- ------------------------------------------------------------------
Net premiums written $350,670 $367,826
% Increase (decrease) (4.7)% (4.1)%
Net premiums earned 356,949 374,278
% Increase (decrease) (4.6)% (5.0)%
Underwriting gain (loss)
(before tax) (99,354) (44,625)
Loss ratio 70.0% 67.4%
Loss expense ratio 20.6% 13.7%
Underwriting expense ratio 37.9% 31.4%
Combined ratio 128.5% 112.5%
Impact of catastrophe losses on
combined ratio 1.0% 3.2%
All other 2002 2001
- ------------------------------------------------------------------
Revenues $ 802 $2,786
Expenses 3,230 3,096
- ------------------------------------------------------------------
Net loss $(2,428) $ (310)
Reconciliation of Revenues 2002 2001
- ------------------------------------------------------------------
Net premiums earned for
reportable segments $356,949 $374,278
Investment income 51,443 52,765
Realized gains (losses) (6,456) 69,293
Miscellaneous income 8 40
- ------------------------------------------------------------------
Total property and casualty
revenues (Statutory basis) 401,944 496,376
Property and casualty statutory to
GAAP adjustment 441 (734)
- ------------------------------------------------------------------
Total revenues property and
casualty (GAAP basis) 402,385 495,642
Other segment revenues 802 2,786
- ------------------------------------------------------------------
Total revenues $403,187 $498,428
==================================================================
Reconciliation of underwriting
gain (loss) (before tax) 2002 2001
- ------------------------------------------------------------------
Property and casualty under-
writing gain (loss) (before tax)
(Statutory basis) $ (99,354) $(44,625)
Statutory to GAAP adjustment (51,500) (5,320)
- ------------------------------------------------------------------
Property and casualty under-
writing gain (loss) (before tax)
(GAAP basis) (150,854) (49,945)
Net investment income 51,767 53,068
Realized gains (losses) (5,539) 71,033
Other income (3,062) (3,483)
- ------------------------------------------------------------------
Income (loss) from continuing
operations before income taxes $(107,688) $ 70,673
==================================================================
10
NOTE V - AGENT RELATIONSHIPS
The agent relationships asset is an identifiable intangible asset acquired in
connection with the 1998 Great American Insurance Company (GAI) commercial
lines acquisition. The Corporation followed 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. Generally Accepted Accounting Principles
require the Corporation to perform a periodic comparison of estimated future
cash flows to the carrying value of the intangible asset. If the estimated
future cash flows are less than the carrying value for any individual agent
included in the asset, that portion of the asset must be written down to its
estimated fair value. During the third quarter of 2002, the Group used
updated premium information plus combined ratio assumptions for purposes of
estimating future cash flows for these agents and concluded certain agents had
become impaired, resulting in a $54.0 million before-tax asset write down.
The third quarter of 2001 included a $1.3 million before-tax write-off of the
agent relationships asset for agency cancellations. The Corporation
anticipates that based on future events or circumstances additional write-offs
for impairment will be made in future periods. Unless additional impairment
write downs are taken, the agent relationships asset will be amortized on a
straight-line basis over the remaining amortization period currently estimated
at 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
policies to P.A.R.I.S.sm. Completion of the application development stage for
applicable lines, therefore, is not anticipated to occur until 2004. The roll
out of P.A.R.I.S.sm is expected to increase software amortization expense in
2003 approximately $4 to $5 million before tax. Management believes the
expected future cash flows of the asset exceed the carrying value. The
expected future cash flows are determined using various 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 $51.4 million and $2.8
million at September 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 Corporation made
the first scheduled interest payment of $5.0 million in the third quarter
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 September
30, 2002, the common share price criterion had not been met and, therefore, no
adjustment to the number of diluted
11
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%
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 plus accrued interest.
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 September 30, 2002, the Group has evaluated the
contingency based upon financial data provided by Proformance. The Group has
concluded that it is not probable the liability will be incurred and,
therefore, has not recognized a liability in the financial statements. The
Group will continue to monitor the contingency for any future liability
recognition.
NOTE IX - 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, losses and loss adjustment expense reserves were $245.4
million at September 30, 2002 and $168.7 million at December 31, 2001.
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 a net loss of $30.0 million, or $.49 per share for
the nine months ending September 30, 2002, compared with net income of $56.8
million, or $.94 per share in the same period of 2001. For the third quarter
of 2002, the net loss was $69.9 million, or $1.14 per share, compared with net
income of $44.2 million, or $.73 per share in the third quarter of 2001.
Operating Income
Operating income differs from net income by the exclusion of realized
investment gains (losses). For the first nine months of 2002, the Corporation
reported a net operating loss, of $47.4 million, or $.77 per share, compared
with a net operating loss of $25.2 million, or $.42 per share for the first
nine months of 2001. The Corporation reported a net operating loss of $66.3
million, or $1.08 per share for the third quarter of 2002, compared with a net
operating loss of $1.9 million, or $.03 per share in the comparable period of
2001. An increase in loss and loss adjustment expenses for prior accident
years and an impairment write down of the Corporation's agent relationships
intangible asset negatively impacted after-tax operating results by $75.8
million, or $1.23 per share, during the third quarter 2002. Adverse
development on loss and loss adjustment expenses for prior accident years
impacted third quarter 2001 results by $4.7 million after tax, or $.08 per
share. Results are discussed further in the Statutory Results and Segment
Discussion sections below.
Premium Revenue Results
The Group's premiums are earned principally on a monthly pro rata basis over
the term of the policy. Management analyzes premium revenues primarily by
premiums written in the current period. Net premiums written differs from
gross premiums written by the amount of premiums ceded to reinsurers.
The table below summarizes the increase (decrease) in property and casualty
premium results compared with same period prior year results:
2002 increase (decrease) from 2001 ($ in millions)
Gross Premiums Written Net Premiums Written
Third Year Third Year
Quarter To Date Quarter To Date
------- ------- ------- -------
Business Units
Commercial Lines $ 18.9 $ 52.3 $ 16.2 $ 51.1
Specialty Lines 18.7 44.1 9.4 27.2
Personal Lines (43.6) (111.2) (42.7) (106.0)
------- -------- ------- --------
All Lines $ (6.0) $ 14.8 $(17.1) $ (27.7)
The expected decrease in Personal Lines premiums written was driven by actions
to cancel unprofitable agents and withdraw from selected states, including the
exit from the New Jersey private passenger auto market. These actions caused
a decrease of $39.0 million in Personal Lines net premiums written in the
third quarter of 2002. The Group's exit from the New Jersey private passenger
auto market, which began in March 2002, made up $31.5 million of the decrease.
Personal lines new business production is up considerably in active states and
active agents with a year-to-date increase in new business policy counts of
29% over the prior period. The policy retention rate for Personal Lines,
excluding cancelled agents and withdrawals, is essentially unchanged from
prior years. The Commercial Lines increase was driven by renewal price
increases.
13
Renewal price increases in the umbrella line of business in the Specialty
Lines business segment was the primary contributor to the increase in premiums
in the current quarter. Renewal price increase means the average increase in
premium, including exposure changes, 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 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 Insurance Company'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 13.2% of the total net premiums
written in the first nine months of 2002, compared with 17.2% of the Group's
total net premiums written for the same period of 2001. For the third quarter
of 2002, 11.3% of the Group's total net premiums written were from
policyholders in New Jersey, compared with 17.3% of the Group's total net
premiums written in the same quarter of 2001. In recent years, New Jersey's
legislative and regulatory environments, particularly for private passenger
auto, 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, Ohio Casualty of New
Jersey, Inc. entered into an agreement to transfer its New Jersey private
passenger auto renewal obligations to Proformance Insurance Company. The
Group ceased writing new and renewal business in the New Jersey private
passenger auto and personal umbrella markets in March 2002. The Group
continues to write its other lines of business in the state. New Jersey
private passenger auto and personal umbrella made up 17.1% of the Group's New
Jersey net premiums written in the first nine months of 2002.
Investment Results
Year-to-date consolidated before-tax investment income was $153.4 million, or
$2.50 per share, decreasing from $156.5 million, or $2.60 per share, for the
same period last year. The investment income effective tax rate for the first
nine months of 2002 and 2001 was 33.3%. Third quarter consolidated before-tax
investment income was $51.8 million, or $.84 per share, compared with $53.1
million, or $.88 per share for the same period last year. The investment
income effective tax rate for the third quarter of 2002 was 33.1%, compared
with 33.6% in the third 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 $17.4 million, or
$.28 per share, compared with $81.9 million, or $1.36 per share, for the same
period of 2001. Consolidated after-tax realized losses amounted to $3.6
million, or $.06 per share for the quarter ended September 30, 2002, compared
with realized gains of $46.2 million, or $.76 per share in the third quarter
of 2001. Over the past 18 months, the Group has reduced its equity holdings
through the sale of equity securities. The Group continues to manage the
effect on statutory surplus of future stock market volatility by maintaining
approximately a 50% ratio of equity securities to statutory surplus.
Agent Relationships
The agent relationships asset is an identifiable intangible asset acquired in
connection with the acquisition of the commercial lines business from Great
American Insurance Company in 1998. Generally Accepted Accounting Principles
require the Corporation to perform a periodic comparison of estimated future
cash flows to the carrying value of the intangible asset. If the estimated
future cash flows are less than the carrying value for any individual agent
included in the asset, that portion of the asset must be written down to its
estimated fair value. During the third quarter of 2002, the Group used
updated premium information plus combined ratio assumptions for purposes of
estimating future cash flows for these agents and concluded that certain
agents had become impaired, resulting in a $54.0 million before-tax asset
write down for those agents. The calculation of impairment follows accounting
guidelines that do not permit increasing the intangible value for agents who
are now projected to generate more profit than was expected at the time of the
initial assignment of the intangible value to each agent. Overall, the
estimated future cash flows for
14
the remaining acquired agents exceed the remaining current asset book value of
$171.2 million by a significant amount. Based on historical data the
remaining agents have been profitable. Future cancellation of agents included
in the agent relationships intangible asset or a diminution of certain former
Great American agents' estimated future revenues or profitability is likely to
cause further impairment losses beyond the quarterly amortization of the
remaining asset value over the remaining useful lives.
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. The combined ratio is the sum of the loss ratio, the loss
adjustment expense ratio and the underwriting expense ratio. The loss ratio
is losses incurred as a percentage of premiums earned. The loss adjustment
expense ratio is loss adjustment expenses incurred as a percentage of premiums
earned. The underwriting expense ratio is underwriting expenses incurred as a
percentage of written premiums. A discussion of the differences between
statutory accounting and accounting principles generally accepted in the
United States is included in Item 14 on 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 nine months ending September 30, 2002 was
114.6%, increasing from 113.5% in the same period of 2001. For the third
quarter of 2002, the statutory combined ratio was 128.5%, compared with 112.5%
in the same quarter of 2001. The increase in the third quarter statutory
combined ratio is primarily related to an increase in loss and loss adjustment
expenses for prior accident years as discussed further in Segment Discussion
below.
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 specified accident year. Therefore,
the current accident year excludes losses and claims expenses for insured
events from prior accident years. 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. Therefore, 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.
The statutory loss ratio was 63.3% for the first nine months of 2002, compared
with 69.1% for the comparable period of 2001. For the third quarter of 2002,
the statutory loss ratio was 70.0%, compared with 67.4% in the third quarter
of 2001. The increase in third quarter statutory loss ratio is driven by
losses for prior accident years related to construction defect claims,
commercial automobile business and New Jersey private passenger automobile
business.
The year-to-date 2002 catastrophe losses were $17.3 million and accounted for
1.6 points on the statutory combined ratio, compared with $32.7 million and
2.9 points in the same period of 2001. The third quarter catastrophe losses
were $3.7 million and accounted for 1.0 point on the statutory combined ratio.
This compares with $12.0 million and a 3.2 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 third quarter of 2002, there were 7
catastrophes with the largest catastrophe generating $1.1 million in incurred
losses as compared with 4 catastrophes in the third quarter of 2001 with the
largest catastrophe generating $7.0 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.
15
The statutory loss adjustment expense ratio for year-to-date 2002 was 16.5%,
4.0 points higher than the same period of 2001 loss adjustment expense ratio
of 12.5%. The third quarter 2002 loss adjustment expense ratio was 20.6%,
compared with 13.7% in the same quarter of 2001. The increase is due
primarily to increased estimates of legal costs related to claims from prior
years.
The statutory loss and loss adjustment expense ratios were impacted negatively
in the first nine months of 2002 by adjustments to the provision for prior
years' business. In the first six months of 2002, the adverse development
from prior years was concentrated in the general liability and workers'
compensation product lines. In the third quarter 2002, the adverse
development was concentrated in the general liability, commercial multiple
peril, commercial umbrella, commercial auto and New Jersey private passenger
automobile product lines. In total, this adverse development added,
respectively, 17.4 and 7.0 points to the third quarter 2002 and year-to-date
2002 statutory combined ratios.
The year-to-date 2002 statutory underwriting expense as a percent of net
premiums written was 34.8%, compared with 31.9% in the same period of 2001.
Third quarter 2002 statutory underwriting expense ratio was 37.9%, compared
with 31.4% in third quarter of 2001. Increases in commission expense as a
percent of net premiums written and the writeoff of approximately $4 million
before tax in past due receivables account for most of the increase in the
third quarter 2002 statutory underwriting ratio. Also contributing to the
year-to-date increase is the exit from the New Jersey private passenger auto
market, which had relatively low commissions and low variable costs and the
elimination of ceding commissions received on umbrella premiums ceded to
reinsurers, as previously announced. 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 3,034 at September 30, 2002 was
down from 3,365 at year-end 2001 and down from 3,402 at September 30, 2001.
Segment Discussion
The Corporation's organizational structure is based on three operating
business units: Commercial Lines, Specialty Lines, and Personal Lines.
Commercial Lines
Commercial Lines statutory combined ratio for the first nine months of 2002
decreased 1.7 points to 118.0% from 119.7% in the same period of 2001. The
third quarter of 2002 statutory combined ratio was 139.9%, compared with
117.8% in the third quarter of 2001. This increase is due primarily to the
impact of loss and loss adjustment expenses for prior accident years. The
third quarter 2002 Commercial Lines loss and loss adjustment expense ratios
increased 18.0 points over the same quarter last year. The third quarter 2002
Commercial Lines results were impacted negatively by adverse development in
the general liability, commercial multiple peril, and commercial auto product
lines. Construction defect claims caused the adverse development in the
general liability and commercial multiple peril lines. The negative impact of
the third quarter 2002 is reduced on a year-to-date basis by the achievement
of price increases, elimination and cancellation of unprofitable business and
a focus on underwriting targeted business. The Commercial Lines average
renewal price increases for direct premiums written were 16.4%, including
exposure changes, in the first nine months of 2002, compared with 14.9% in the
same period of 2001. Renewal price increases were 14.8% in the third quarter.
The general liability statutory combined ratio increased in the first nine
months of 2002 to 195.7% from 131.3% in the same period of 2001. For the
third quarter of 2002, the statutory combined ratio was 325.4% compared to
157.3% in the same quarter of 2001. This line of business was impacted by
significant additions to construction defect related reserves, increased
estimates of legal costs on claims from prior years and increased loss
adjusting costs for prior years. Construction defect claims filed under
general liability insurance policies, primarily for real estate developers and
residential general contractors, 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 121.4%, 74.3 points lower than the calendar year
results.
16
Workers' compensation statutory combined ratio for the first nine months of
2002 was 129.3%, compared with 140.1% during the same period last year. Both
2001 year-to-date and 2002 year-to-date results were negatively impacted by
adverse development for prior years' losses and loss adjustment expenses. The
third quarter 2002 statutory combined ratio was 126.8%, compared with 112.7%
in 2001. The Group has taken actions to improve workers' compensation
results, including renewal price increases and non-renewal of unprofitable
business.
The statutory combined ratio for commercial muliple peril, fire and inland
marine was 95.8% for the first nine months of 2002, compared with 109.4% for
the same period in 2001. For the third quarter 2002, the combined ratio was
106.0%, compared with 114.3% for the same period in 2001. The improvement in
the combined ratio is due to improved underwriting efforts and renewal price
increases.
Specialty Lines
Specialty Lines statutory combined ratio for the first nine months of 2002 was
101.4%, compared with 81.0% in the same period of 2001. The third quarter
2002 statutory combined ratio was 121.9%, an increase of 29.2 points from the
third quarter 2001 ratio of 92.7%. The increase in the third quarter
statutory combined ratio is driven by an increase in the Specialty Lines loss
adjustment ratio of 15.6 points compared to the third quarter 2001. This
increase is a result of reserve increases due to construction defect claims in
the commercial umbrella product line. The Specialty Lines statutory
underwriting expense ratio increased 12.9 points in the third quarter 2002 due
primarily to the elimination of the commercial umbrella reinsurance ceding
commission. 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 39.4% in the first nine months of 2002,
compared with 19.7% in the same period of 2001.
Personal Lines
The Personal Lines statutory combined ratio decreased to 112.6% year-to-date
September 30, 2002, from 113.4% in the first nine months of 2001. For the
third quarter of 2002, the Personal Lines statutory combined ratio was 114.2%,
an increase from the third quarter 2001 ratio of 111.2%.
The first nine months of 2002 statutory combined ratio for homeowners
decreased 9.8 points to 114.9% from 124.7%. The third quarter homeowners
combined ratio increased to 118.8% in 2002, compared to 114.2% for the same
period of 2001. The underlying trends for homeowners are still poor and rate
increases taken on this line are not fully earned. The Group is filing for an
additional round of rate increases and will also be transitioning the business
to higher deductibles in conjunction with the rate increases. In addition,
the Group has filed for new policy limits relating to mold exposure in 25
states of which 18 have approved the new limits. Catastrophe losses added 5.3
points to the statutory combined ratio in the third quarter of 2002, and 10.5
points in the same period of 2001.
Private passenger auto results were impacted by poor results in the New Jersey
private passenger auto market. New Jersey results added 9.7 points to the
third quarter Personal Lines combined ratio of 114.2% and 15.5 points to the
private passenger auto combined ratio of 113.0%, compared with increasing the
2001 third quarter Personal Lines combined ratio by 1.3 points to 111.2% and
the third quarter 2001 private passenger auto by 2.2 points to 110.6%. New
Jersey results were impacted by an increase in losses from prior accident
years as well as poor performance in the current accident year. There was
approximately $5.5 million before tax in adverse development for New Jersey
personal auto this quarter adding approximately 42 points to the combined
ratio for personal auto - New Jersey and direct operations. The volume of
incurred losses and earned premium is dropping as this business runs off and
its impact on the Group's overall results should continue to diminish with
time. The continued non-renewal of this business, which is scheduled to be
completed in March, 2003, is expected to reduce the negative impact of this
17
business on the overall combined ratio in subsequent quarters. The claims
department has completed a review of the New Jersey operation, augmenting
existing staff with additional, highly experienced staff. In addition, the
Group has seen the closure rate for these claims increase in the third quarter
of 2002. Agency produced private passenger auto business, excluding New
Jersey, recorded a 2002 nine-month statutory combined ratio of 100.7%,
decreasing from 105.9% in the same period last year. The third quarter 2002
private passenger auto-agency combined ratio, excluding New Jersey, decreased
11.5 points to 96.8% from 108.3% 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, price increases 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 September
30, 2002, the Group has written $1.9 million year to date in UEZ premiums,
with $1.8 million in additional assigned premiums compared with $6.5 million
in UEZ premiums and $3.5 million in additional assigned premiums through the
first nine months of 2001. The 2002 nine-month loss ratio on the UEZ premiums
was 225.9% and the loss ratio on the assigned business was 257.2%, compared
with a loss ratio of 165.3% on UEZ premiums and 234.0% on assigned business
for the same period last year. Under the terms of the agreement with
Proformance Insurance Company, all future renewal or new business related to
UEZ or related assigned policies are the responsibility of Proformance.
LIQUIDITY AND FINANCIAL STRENGTH
Investments
At September 30, 2002, the fixed income portfolio of the Corporation and the
Group had a market value of $3.1 billion, which consisted of 96.5% investment
grade and 3.5% below investment grade securities. The market value of the
below investment grade portfolio was $107.9 million at September 30, 2002,
compared with $94.3 million at December 31, 2001. The Corporation and the
Group 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 one rating
agency and a below investment grade rating from another rating agency) was
$52.5 million at September 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, changes in control of the issuer or worse than previously expected
operating results. In most instances, investors are unprotected with respect
to these risks, the effects of which can be substantial.
At September 30, 2002, the Corporation's and the Group's equity portfolios had
a market value of $327.3 million, or 9.5% of the total invested assets. The
Corporation and the Group mark the value of its equity portfolios 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
September 30, 2002, the equity portfolio consisted of stocks of 47 companies
in 36 industries. As of September 30, 2002, 35.6% of the Corporation's and
the Group's equity portfolios were invested in five companies and the largest
single position was 10.9% of the total equity portfolio.
For a further discussion of the Corporation's and the Group's investments, see
Item 1 pages 8 through 10 of the Corporation's Form 10-K for the year ended
December 31, 2001.
18
Cash Flow
Net cash generated by operations was $105.2 million for the first nine months
of the year compared with $70.8 million for the same period in 2001. 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 $5.2 million in the first nine months of
2002 compared with cash used of $10.4 million in the first nine months of
2001. The 2002 cash flow 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.
Debt
As of September 30, 2002, the Corporation had $198.3 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 an 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 Corporation made
the scheduled interest payment of $5.0 million in the third quarter 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%
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 plus accrued interest.
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 outstanding loan amount of the revolving line of credit was zero at
September 30, 2002.
The Corporation also had $4.7 million of debt at September 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 October 31, 2002, Standard & Poor's Rating Services revised its outlook to
negative from stable based upon the Corporation's announcement of third
quarter 2002 results. On March 13, 2002,
19
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. Following the Corporation's announcement of third quarter 2002
results, Moody's Investor Services indicated the rating would be reviewed for
possible downgrade. 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 and affirmed the rating and the outlook on
November 5, 2002. On September 6, 2002, A.M. Best Company affirmed its
financial strength rating of "A-" and assigned a positive outlook for the
Group's rating. In addition, A.M. Best assigned an initial rating of "bbb" to
Ohio Casualty Corporation's convertible notes. A.M. Best indicated that the
ratings and the outlook did not change as a result of the Corporation's
announcement of third quarter 2002 results.
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 expense 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.
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 September 30,
2002. The settlement agreement requires that in the fourth quarter of 2002
this remaining liability, which represents any unclaimed payments to customers
that cannot be located, will be escheated to the state of California.
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.
20
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.
ITEM 4. Controls and Procedures
Within the 90 days prior to the filing date of this Form 10-Q, the
Corporation carried out an evaluation, under the supervision and
with the participation of the Corporation's management, including
the Corporation's Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of the
Corporation's disclosure controls and procedures as defined in
Rule 13a-14 of the Securities Exchange Act of 1934. Based upon
that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that the Corporation's disclosure controls and
procedures are effective in timely alerting them to material
information relating to the Corporation (including its
consolidated subsidiaries) required to be included in this
Quarterly Report on Form 10-Q. There have been no significant
changes in the Corporation's internal controls or in other factors
which could significantly affect internal controls subsequent to
the date the Corporation carried out its evaluation.
PART II
ITEM 1. Legal Proceedings
Refer to Legal Proceedings as described on Page 20 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 - None
ITEM 6. Exhibits and reports on Form 8-K -
I. Reports on Form 8-K:
(a) The Corporation filed a Form 8-K on July 15, 2002 to report
on Items 5 and 7, the filing of a press release announcing
the resignation of Edward T. Roeding as a director of Ohio
Casualty Corporation. Exhibits to the Form 8-K consisted of
Edward T. Roeding's letter of resignation dated July 15, 2002
and the press release dated April 17, 2002.
(b) The Corporation filed a Form 8-K on August 1, 2002 to report
under Items 5 and 7, the filing of a press release announcing
the Corporation's second quarter 2002 results; a press
release reporting historical catastrophe earnings per share
impacts on an after-tax basis, and updated projected 2002 net
income. Exhibits to the Form 8-K consisted of the press
releases dated July 30, 2002 and August 1, 2002.
(c) The Corporation filed a Form 8-K on August 13, 2002 to report
under Item 9, the filing of the statements under oath of Dan
R. Carmichael, Chief Executive Officer and Donald F. McKee,
Chief Financial Officer, pursuant to SEC Order No. 4-460.
Exhibits to the Form 8-K consisted of those statements dated
August 13, 2002.
21
(d) The Corporation filed a Form 8-K on September 13, 2002 to
report on Items 5 and 7, the filing of a press release
announcing The Ohio Casualty Insurance Company Employee
Retirement Plan's intent to sell up to 1,150,000 shares of
Ohio Casualty Corporation common stock. Exhibits to the
Form 8-K consisted of the press release dated
September 6, 2002.
II. Exhibits:
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.
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)
November 14, 2002 /s/ Donald F. McKee
-----------------------------------
Donald F. McKee, Chief Financial
Officer (on behalf of Registrant
and as Principal Accounting Officer)
22
CERTIFICATION
I, Dan R. Carmichael, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Ohio Casualty
Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including
its consolidated subsidiaries, is made known to us by others
within those entities, particularly during the period in which
this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: November 14, 2002 /s/Dan R. Carmichael
-----------------------------
Dan R. Carmichael
President and Chief Executive
Officer
23
CERTIFICATION
I, Donald F. McKee, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Ohio Casualty
Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including
its consolidated subsidiaries, is made known to us by others
within those entities, particularly during the period in which
this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: November 14, 2002 /s/Donald F. McKee
-----------------------------
Donald F. McKee
Chief Financial Officer
24