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UNITED STATES 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 quarterly period ended March 31, 2005.
--------------
[ ] Transition Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the transition period from to
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Commission File Number 0-05544
OHIO CASUALTY CORPORATION
(Exact name of registrant as specified in its charter)
OHIO 31-0783294
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
9450 Seward Road, Fairfield, Ohio 45014
(Address of principal executive offices) (Zip Code)
(513) 603-2400
(Registrant's telephone number, including area code)
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
On April 26, 2005, there were __________ shares of common stock
outstanding.
Page 1 of 29
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INDEX
Page
----
PART I FINANCIAL INFORMATION
Item 1. Financial Statements 3
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 15
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 28
Item 4. Controls and Procedures 28
PART II OTHER INFORMATION
Item 6. Exhibits 28
Signature 29
Exhibit 31.1 Certification of Chief Executive Officer of
Ohio Casualty Corporation in accordance with SEC
Rule 13(a)-14(a) and Rule 15(d)-14(a)
Exhibit 31.2 Certification of Chief Financial Officer of
Ohio Casualty Corporation in accordance with SEC
Rule 13(a)-14(a) and Rule 15(d)-14(a)
Exhibit 32.1 Certification of Chief Executive Officer of
Ohio Casualty Corporation in accordance with
Section 1350 of the Sarbanes-Oxley Act of 2002
Exhibit 32.2 Certification of Chief Financial Officer of
Ohio Casualty Corporation in accordance with
Section 1350 of the Sarbanes-Oxley Act of 2002
2
PART I
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
(in millions, except share data) (Unaudited) 2005 2004
==========================================================================================
Assets
Investments, at fair value:
Fixed maturities:
Available-for-sale, at fair value
(amortized cost: $3,271.9 and $3,176.8) $ 3,376.8 $ 3,346.1
Held-to-maturity, at amortized cost
(fair value: $291.6 and $303.1) 294.2 301.4
Equity securities, at fair value
(cost: $98.6 and $98.9) 351.9 357.4
Short-term investments, at fair value 273.1 239.1
- -------------------------------------------------------------------------------------------
Total investments 4,296.0 4,244.0
Cash 11.4 13.5
Premiums and other receivables, net of allowance 327.7 350.8
Deferred policy acquisition costs 154.2 159.8
Property and equipment, net of accumulated depreciation 82.3 82.9
Reinsurance recoverable, net of allowance 701.4 666.5
Agent relationships, net of accumulated amortization 117.6 122.0
Interest and dividends due or accrued 46.7 49.9
Other assets 40.6 25.6
- -------------------------------------------------------------------------------------------
Total assets $ 5,777.9 $ 5,715.0
===========================================================================================
Liabilities
Insurance reserves:
Losses $ 2,318.5 $ 2,269.6
Loss adjustment expenses 492.7 486.8
Unearned premiums 698.1 715.5
Debt 378.9 383.3
Reinsuance treaty funds held 196.1 195.0
Deferred income taxes 3.9 21.9
Other liabilities 398.1 348.0
- -------------------------------------------------------------------------------------------
Total liabilities 4,486.3 4,420.1
Shareholders' Equity
Common stock, $.125 par value
Authorized: 150,000,000
Issued shares: 72,418,344; 72,418,344 9.0 9.0
Accumulated other comprehensive income 213.5 259.1
Retained earnings 1,198.6 1,161.5
Treasury stock, at cost:
(Shares: 9,785,978; 10,209,215) (129.5) (134.7)
- -------------------------------------------------------------------------------------------
Total shareholders' equity 1,291.6 1,294.9
- -------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 5,777.9 $ 5,715.0
===========================================================================================
Accompanying notes are an integral part of these consolidated financial
statements. For complete disclosures see Notes to Consolidated Financial
Statements on pages 54-71 of the Corporation's 2004 Form 10-K.
3
ITEM 1. Continued
CONSOLIDATED STATEMENTS OF INCOME
Three Months
Ended March 31,
(in millions, except share and per share data) (Unaudited) 2005 2004
- -------------------------------------------------------------------------------------------
Premiums and finance charges earned $ 362.3 $ 361.1
Investment income, less expenses 48.4 50.5
Investment gains realized, net - 3.7
- -------------------------------------------------------------------------------------------
Total revenues 410.7 415.3
Losses and benefits for policyholders 191.1 195.2
Loss adjustment expenses 42.9 41.2
General operating expenses 114.0 137.3
Amortization of agent relationships 1.6 1.8
Write-down of agent relationships 2.8 5.4
Amortization of deferred policy acquisition costs 87.1 92.3
Deferral of deferred policy acquisition costs (81.4) (91.0)
Depreciation and amortization expense 2.9 3.2
- -------------------------------------------------------------------------------------------
Total expenses 361.0 385.4
- -------------------------------------------------------------------------------------------
Income before income taxes 49.7 29.9
Income tax expense (benefit):
Current 5.6 11.3
Deferred 6.4 (2.2)
- -------------------------------------------------------------------------------------------
Total income tax expense 12.0 9.1
Income before cumulative effect of an accounting change 37.7 20.8
Cumulative effect of an accounting change, net of tax - (1.6)
- -------------------------------------------------------------------------------------------
Net income $ 37.7 $ 19.2
===========================================================================================
Average shares outstanding - basic 62,359,823 61,064,480
===========================================================================================
Earnings per share - basic:
Net income, per share $ 0.60 $ 0.31
===========================================================================================
Average shares outstanding - diluted 71,675,055 62,143,049
===========================================================================================
Earnings per share - diluted:
Net income, per share $ 0.55 $ 0.31
===========================================================================================
Accompanying notes are an integral part of these consolidated financial
statements. For complete disclosures see Notes to Consolidated Financial
Statements on pages 54-71 of the Corporation's 2004 Form 10-K.
4
ITEM 1. Continued
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Accumulated
other Total
(in millions, except Common comprehensive Retained Treasury shareholders'
share data) (Unaudited) Stock income earnings stock equity
- ------------------------------------------------------------------------------------------------------------
Balance
January 1, 2004 $ 9.0 $ 254.7 $ 1,033.4 $ (151.3) $ 1,145.8
Net income 19.2 19.2
Change in unrealized gain,
net of deferred income tax
benefit of $25.3 47.1 47.1
Change in minimum pension
liability, net of deferred income tax
benefit of $10.5 19.5 19.5
---------
Other comprehensive income 85.8
Net issuance of restricted stock
(20,000 shares) (0.3) 0.3 -
Net issuance of treasury
stock (244,748 shares) (0.1) 3.2 3.1
- ------------------------------------------------------------------------------------------------------------
Balance,
March 31, 2004 $ 9.0 $ 321.3 $ 1,052.2 $ (147.8) $ 1,234.7
============================================================================================================
Balance
January 1, 2005 $ 9.0 $ 259.1 $ 1,161.5 $ (134.7) $ 1,294.9
Net income 37.7 37.7
Change in unrealized gain,
net of deferred income tax
expense of $24.6 (45.6) (45.6)
----------
Other comprehensive income (7.9)
Net issuance of restricted stock
(8,664 shares) (0.1) 0.1 -
Net issuance of treasury
stock (414,573 shares) (0.5) 5.1 4.6
- ------------------------------------------------------------------------------------------------------------
Balance,
March 31, 2005 $ 9.0 $ 213.5 $ 1,198.6 $ (129.5) $ 1,291.6
============================================================================================================
Accompanying notes are an integral part of these consolidated financial
statements. For complete disclosures see Notes to Consolidated Financial
Statements on pages 54-71 of the Corporation's 2004 Form 10-K.
5
ITEM 1. Continued
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months
Ended March 31,
(in millions) (Unaudited) 2005 2004
- -------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities:
Operating Activities
Net income $ 37.7 $ 19.2
Adjustments to reconcile net income to cash
provided by operations:
Changes in:
Insurance reserves 37.4 69.9
Reinsurance treaty funds held 1.1 7.8
Income taxes 2.0 8.0
Premiums and other receivables 23.1 1.8
Deferred policy acquisition costs 5.6 1.3
Reinsurance recoverable (34.9) (39.3)
Other assets 1.1 (3.2)
Other liabilities (28.2) (16.4)
Amortization and write-down of agent relationships 4.4 7.2
Depreciation and amortization 6.9 4.9
Investment gains realized, net - (3.7)
- -------------------------------------------------------------------------------------------------
Net cash provided by operating activities 56.2 57.5
- -------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities:
Purchase of securities:
Fixed maturity, available-for-sale (221.5) (285.3)
Fixed maturity, held-to-maturity (0.2) (0.8)
Proceeds from sales of securities:
Fixed maturity, available-for-sale 177.7 139.6
Equity 0.6 1.9
Proceeds from maturities and calls of securities:
Fixed maturity, available-for-sale 15.1 62.5
Fixed maturity, held-to-maturity 6.6 13.5
Equity - 3.3
Property and equipment
Purchases (2.4) (0.9)
Sales - 0.2
- -------------------------------------------------------------------------------------------------
Net cash used in investing activities (24.1) (66.0)
- -------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities:
Debt repayments (4.7) (0.1)
Proceeds from exercise of stock options 4.5 3.0
- -------------------------------------------------------------------------------------------------
Net cash (used in) provided by financing activities (0.2) 2.9
- -------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 31.9 (5.6)
Cash and cash equivalents, beginning of period 252.6 56.9
- -------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 284.5 $ 51.3
=================================================================================================
Accompanying notes are an integral part of these consolidated financial
statements. For complete disclosures see Notes to Consolidated Financial
Statements on pages 54-71 of the Corporation's 2004 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). All
dollar amounts presented in the Notes to Consolidated Financial Statements
are in millions unless otherwise noted.
NOTE I - INTERIM ADJUSTMENTS
We prepared the Consolidated Balance Sheet as of March 31, 2005 and the
Consolidated Statements of Income, Shareholders' Equity and Cash Flows all
for the three months ended March 31, 2005 and 2004, without an audit. In the
opinion of management, all adjustments necessary to fairly present the
financial position, results of operations and cash flows at March 31, 2005
and for all periods presented have been made.
We prepared the accompanying unaudited Consolidated Financial Statements in
accordance with accounting principles generally accepted in the United States
for interim financial information and with the instructions to the Quarterly
Report on Form 10-Q and Article 10 of Regulation S-X.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally
accepted in the United States have been omitted. The unaudited Consolidated
Financial Statements should be read together with the consolidated financial
statements and notes thereto included in the Corporation's 2004 Annual Report
on Form 10-K. The results of operation for the period ended March 31, 2005
are not necessarily indicative of the results of operation for the full year.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
To conform the three months ended March 31, 2004 presentation to the adjusted
presentation in the Annual Report on Form 10-K for the year ended December
31, 2004, $2.9 of underwriting expenses have been reclassified to loss
adjustment expenses for the period ending March 31, 2004.
The premiums receivable balance is presented net of bad debt allowances
determined by management of $4.3 at March 31, 2005 and December 31, 2004.
Property and equipment are carried at cost less accumulated depreciation of
$169.7 and $167.4 at March 31, 2005 and December 31, 2004, respectively.
Amounts recoverable from reinsurers are calculated in a manner consistent
with the reinsurance contract and are reported net of allowance of $2.3 at
March 31, 2005 and December 31, 2004.
NOTE II - STOCK OPTIONS
The Corporation accounts for stock options issued to employees and directors
in accordance with Accounting Principles Board Opinion (APB) No. 25,
"Accounting for Stock Issued to Employees." Under APB 25, the Corporation
recognizes expense based on the intrinsic value of options. Had the
Corporation adopted income statement recognition requirements of Financial
Accounting Standard Board (FASB) 123 "Accounting for Stock Based
Compensation," the Corporation's net income and earnings per share would have
been reduced to the pro forma amounts disclosed below:
7
Three Months Ended March 31
(in millions, except per share data) 2005 2004
- ---------------------------------------------------------------------------
Net income
As reported $37.7 $19.2
Add: Stock-based employee compensation
reported in net income, net of related
tax effect 0.1 -
Deduct: Total stock-based employee
compensation, net of related tax effects 1.0 1.3
----- -----
Pro forma $36.8 $17.9
Basic EPS
As reported $0.60 $0.31
Pro Forma $0.59 $0.29
Diluted EPS*
As reported $0.55 $0.31
Pro Forma $0.53 $0.29
===========================================================================
*Diluted EPS has been adjusted for the effect of EITF Issue No. 04-8 for the
three months ended March 31, 2005. Also See Note III.
See Note X - Recently Issued Accounting Standards for additional information
pertaining to FASB 123(R) - "Share-Based Payment."
NOTE III - EARNINGS PER SHARE
Basic and diluted earnings per share are summarized as follows:
Three Months Ended March 31
(in millions, except per share data) 2005 2004
- ---------------------------------------------------------------------------
Net income $37.7 $19.2
Weighted average common shares
outstanding - basic (thousands) 62,360 61,064
Income before cumulative effect of
an accounting change $0.60 $ 0.34
Cumulative effect of an accounting change $ - $(0.03)
Basic net income per weighted average share $0.60 $ 0.31
===========================================================================
Net income $37.7 $ 19.2
Effect of EITF 04-8 on net income using
"if-converted" method $ 1.6 $ -
Adjusted net income using "if-converted" method $39.3 $ -
Weighted average common shares
outstanding (thousands) 62,360 61,064
Effect of dilutive securities (thousands) 1,346 1,079
Effect of EITF 04-8 (thousands) 7,969 -
- ---------------------------------------------------------------------------
Weighted average common shares
outstanding - diluted (thousands) 71,675 62,143
Income before cumulative effect of
an accounting change $0.55 $ 0.34
Cumulative effect of an accounting change $ - $(0.03)
Diluted net income per weighted average share $0.55 $ 0.31
============================================================================
In accordance with Emerging Issues Task Force (EITF) 04-8 "The Effect of
Contingently Convertible Debt on Diluted Earnings Per Share," the earnings
per share treatment of those securities that contain a contingent conversion
feature require all of the shares underlying the convertible securities to be
treated as outstanding using the "if-converted" method. As required by the
EITF, all prior period earnings per share amounts would need to be restated
for periods presented subsequent to the March 2002 Convertible Notes
8
issuance. The "if-converted" method gives effect to the add back to net
income of interest expense and amortization of debt issuance costs, net of
tax, associated with the convertible instruments. However, for the three
months ended March 31, 2004, the impact would have been anti-dilutive,
accordingly these amounts were not restated.
NOTE IV -- SEGMENT INFORMATION
The Corporation has determined its reportable segments based upon its method
of internal reporting, which is organized by product line. The property and
casualty segments are Commercial, Specialty, and Personal Lines. These
segments generate revenues by selling a wide variety of commercial, surety
and personal 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
determined on a GAAP basis, which includes loss, loss adjustment and
underwriting expense ratios, combined ratio, premiums earned, underwriting
gain/loss and statutory premiums written. The following tables present
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.
Three Months Ended March 31
($ in millions)
Commercial Lines Segment 2005 2004
- ---------------------------------------------------------------------------
Net premiums written $205.6 $212.2
% Change (3.1)% 3.4%
Net premiums earned 205.6 197.8
% Change 3.9% 4.2%
Underwriting loss (before tax) (12.9) (5.7)
Specialty Lines Segment 2005 2004
- ---------------------------------------------------------------------------
Net premiums written $39.1 $34.8
% Change 12.4% 5.8%
Net premiums earned 35.1 41.7
% Change (15.8)% 8.6%
Underwriting gain (before tax) 1.3 4.1
Personal Lines Segment 2005 2004
- ---------------------------------------------------------------------------
Net premiums written $113.8 $117.0
% Change (2.7)% 2.5%
Net premiums earned 121.6 121.6
% Change - 0.4%
Underwriting gain/(loss) (before tax) 27.7 (12.3)
Total Property & Casualty 2005 2004
- ---------------------------------------------------------------------------
Net premiums written $358.5 $364.0
% Change (1.5)% 3.4%
Net premiums earned 362.3 361.1
% Change 0.3% 3.4%
Underwriting gain/(loss) (before tax) 16.1 (13.9)
All Other 2005 2004
- ---------------------------------------------------------------------------
Revenues $ 3.1 $ 1.5
Write-down and amortization of
agent relationships (4.4) (7.2)
Other expenses (10.4) (3.2)
- ----------------------------------------------------------------------------
Net loss before income taxes $(11.7) $(8.9)
9
Reconciliation of Revenues 2005 2004
- ---------------------------------------------------------------------------
Net premiums earned for
reportable segments $362.3 $361.1
Net investment income 44.2 49.6
Realized gains, net(a) 136.3 5.0
- ---------------------------------------------------------------------------
Total property and casualty revenues
(Statutory basis) 542.8 415.7
Property and casualty statutory to
GAAP adjustment (135.2) (1.9)
- ----------------------------------------------------------------------------
Total revenues property and casualty
(GAAP basis) 407.6 413.8
Other segment revenues 3.1 1.5
- ---------------------------------------------------------------------------
Total revenues $410.7 $415.3
===========================================================================
(a) The net realized gains reflected above on a statutory accounting basis
are the result of inter-company transfers of equity securities within the
Group, which for statutory purposes are recorded as if the securities were
sold. For GAAP accounting, the statutory realized gains/losses on inter-
company transfers of securities are not recognized until the security is
disposed of outside of the Corporation.
Reconciliation of Underwriting
Loss (before tax) 2005 2004
- ---------------------------------------------------------------------------
Property and casualty underwriting
gain/(loss) (before tax) (Statutory basis) $20.5 $ (3.9)
Statutory to GAAP adjustment (4.4) (10.0)
- ---------------------------------------------------------------------------
Property and casualty underwriting
gain/(loss) (before tax) (GAAP basis) 16.1 (13.9)
Net investment income 48.4 50.5
Realized gains, net - 3.7
Write-down and amortization of agent
relationships (4.4) (7.2)
Other expenses (10.4) (3.2)
- ---------------------------------------------------------------------------
Income before income taxes and cumulative
effect of an accounting change $49.7 $ 29.9
===========================================================================
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 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, the purchase price was allocated to agent relationships and
deferred policy acquisition costs. Agent relationships are evaluated
quarterly as events or circumstances indicate a possible inability to recover
their carrying amount. As a result of the evaluation, the agent relationship
asset was written down before tax by $2.8 and $5.4 in the first quarter of
2005 and 2004, respectively. The write-downs are a result of agency
cancellations and certain agents determined to be impaired based on updated
estimated future undiscounted cash flows that were insufficient to recover
the carrying amount of the asset for the agent. The remaining portion of the
agent relationships asset will be amortized on a straight-line basis over the
remaining useful period of approximately 19 years. At March 31, 2005 and
December 31, 2004, the unamortized carrying value of the agent relationships
asset was $117.6 and $122.0, respectively. The agent relationships asset is
recorded net of accumulated amortization of $42.1 and $41.4 at March 31, 2005
and December 31, 2004, respectively.
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.
NOTE VI - INTERNALLY DEVELOPED SOFTWARE
In accordance with Statement of Position 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use," the Corporation
capitalizes costs incurred during the application development stage for the
development of internal-use software. These costs primarily relate to
payroll and payroll-related costs for employees along with costs incurred for
external consultants who are directly associated with the internal-use
software project. Costs such as maintenance, training, data conversion,
overhead and general and administrative are expensed as incurred. Management
believes the expected future value of the asset exceeds the carrying value.
Management evaluates the asset on an annual basis for impairment. The costs
associated with the software are amortized on a straight-line basis over an
estimated useful life
10
of 10 years commencing when the software is substantially complete and ready
for its intended use. Capitalized software costs and accumulated
amortization in the consolidated balance sheets were $55.8 and $12.6 at March
31, 2005 and $55.2 and $11.4 at December 31, 2004, respectively.
NOTE VII - DEBT
On March 22, 2005 the Corporation exchanged $65.6 of its 5.00% Convertible
Notes due March 19, 2022 (Old Notes), for $65.6 of new 5.00% Convertible
Notes due March 19, 2022 (New Notes and collectively the Convertible Notes).
The only change in the New Notes was the incorporation of a net share
settlement feature. Also on this date, the Corporation announced its
intention to fully redeem before maturity its Old and New Notes at their
regular redemption price of 102% of the principal amount plus accrued
interest to, but excluding, the redemption date of May 2, 2005. Prior to
5:00 p.m. New York City time, on April 29, 2005, one business day prior to
the redemption date, holders of the Convertible Notes can elect to convert
such Convertible Notes in accordance with their terms. Upon conversion, the
Corporation will be obligated to pay the principal amount of the converted
New Notes in cash and any conversion consideration in excess of the principal
amount in the Corporation's common stock. Upon conversion of the Old Notes,
the Corporation will be obligated to deliver 44.2112 of its common stock for
each $1,000 principal amount of Old Notes surrendered for conversion. If all
the Old Notes were converted, total outstanding common shares would increase
by 5.2 million shares at March 31, 2005 and 8.3 million shares at December
31, 2004. On June 29, 2004, the Corporation issued $200.0 of 7.3% Senior
Notes due June 15, 2014 (Senior Notes) and received net proceeds after
related fees and discount of $198.0. The Corporation used part of the net
proceeds to repurchase $17.0 of the Old Notes ($4.5 in the first quarter of
2005 and $12.5 in the fourth quarter of 2004) in unsolicited negotiated
transactions and intends to use the remainder of the net proceeds to redeem
the balance of its Convertible Notes on May 2, 2005 at 102% of par. The
Corporation may also use the net proceeds to repurchase shares of its common
stock in an amount up to the equivalent number of shares issued if holders
convert their Convertible Notes into shares of the Corporation's common
stock. The redemption of the Convertible Notes will reduce future share and
earnings dilution. Interest is payable on the Convertible Notes on March 19
and September 19 and payable on the Senior Notes on June 15 and December 15.
The Convertible and Senior Notes are reported on the consolidated balance
sheets net of unamortized issuance-related costs and discount totaling $8.5
($6.1 related to the Convertible Notes and $2.4 related to the Senior Notes)
at March 31, 2005 and $8.7 ($6.3 related to the Convertible Notes and $2.4
related to the Senior Notes) at December 31, 2004. The Corporation uses the
effective interest rate method to record interest expense, amortization of
issuance-related costs and amortization of the discount.
The impact of the Convertible Notes on diluted earnings per share is based
upon the "if-converted" method. In accordance with EITF 04-8, all diluted
earnings per share amounts have been restated since the issuance of the
Convertible Notes in March 2002. See Note III - Earnings Per Share of this
Quarterly Report on Form 10-Q and Item 15, Notes to Consolidated Financial
Statements, Footnote 10 on pages 66 and 67 of the Corporation's 2004 Annual
Report on Form 10-K for further discussion.
On July 31, 2002, the Corporation entered into a revolving credit agreement
with an expiration date of March 15, 2005. In February 2005, the revolving
credit agreement was renewed, under substantially the same terms and
conditions, and will expire on March 15, 2006. Under the terms of the
revolving credit agreement, the lenders agreed to make loans to the
Corporation in an aggregate amount up to $80.0 for general corporate
purposes. Interest is payable in arrears, and the interest rate on
borrowings under the revolving credit agreement is based on a margin over
LIBOR or the LaSalle Bank Prime Rate, at the option of the Corporation. The
Corporation capitalized approximately $0.4 in fees related to establishing
the line of credit and amortized the fees over the term of the agreement. In
addition, the Corporation is obligated to pay agency fees and facility fees
of up to $0.2 annually. These fees are expensed when incurred by the
Corporation. The revolving credit agreement requires the Corporation to
maintain minimum net worth of $800.0. The credit agreement also includes a
minimum statutory surplus for the Company of $650.0. Additionally, other
financial covenants and other customary provisions, as defined in the
agreement, exist. At March 31, 2005, the Corporation was in compliance with
all financial covenants and other provisions of this agreement. There were
no amounts outstanding under this revolving credit agreement at either March
31, 2005 or December 31, 2004.
11
In addition to the debt described above, the Corporation has a $6.5 loan with
the State of Ohio that is secured by a mortgage on the Corporation's home
office property. As of and for the three months ended March 31, 2005, the
loan bears a fixed interest rate of 3%, compared to an interest rate of 2% as
of and for the three months ended March 31, 2004. The loan requires annual
principal payments of approximately $0.6 and expires in November 2009. The
remaining balance at March 31, 2005, was $3.1, compared to $3.2 at December
31, 2004.
Interest expense incurred for the period ending March 31, 2005 and 2004 was
$6.0 and $2.6, respectively.
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). The transaction effectively exited the Group from the New
Jersey private passenger auto market. The Group continues to write private
passenger auto in other markets. The contract stipulates that a premiums-to-
surplus ratio of 2.5 to 1 must be maintained on the transferred business
during the periods of March 2002 through December 2004. If this criteria is
not met, OCNJ will have to pay up to a maximum cumulative amount of $15.6 to
Proformance to maintain this premiums-to-surplus ratio. Based on data
provided by Proformance, the Group has paid $6.8 to Proformance in settlement
of this obligation through December 31, 2003. At December 31, 2004, based
upon information provided by Proformance, the Group had accrued $8.8 to cover
this estimated additional liability. Late in the first quarter of 2005, the
Group, based on revised information provided by Proformance subsequent to the
Corporation filing its 2004 Annual Report on Form 10-K, reduced its estimated
liability and related accrual to $4.4 at March 31, 2005. The Corporation
expects to resolve the final settlement to be paid to Proformance relative to
the surplus guarantee in the second quarter of 2005.
A proceeding entitled Carol Murray v. the Corporation, the Company, Avomark
Insurance Co., Ohio Security Insurance Co. (Ohio Security), West American
Insurance Co. (West American), American Fire and Casualty Insurance Co.
(American Fire), and OCNJ was filed in the United States District Court for
the District of Columbia on February 5, 2004. A motion to change venue was
granted on May 25, 2004 with the proceeding assigned to the U.S. District
Court for the Southern District of Ohio, Eastern Division, Columbus, Ohio.
The plaintiff, a former automobile physical damage claim adjuster, originally
sought to certify a nationwide collective action consisting of all current
and former salaried employees since February 5, 2001 who are/were employed to
process claims by policyholders and other persons for automobile property
damage. The plaintiff has filed motions to expand the definition to include
claim specialists, representative trainees, and representatives performing
claims adjusting services. The complaint seeks overtime compensation for the
plaintiff and the class of persons plaintiff seeks to represent. The
defendants deny the allegations made in the complaint and are vigorously
defending themselves.
A proceeding entitled Carol Lazarus v. the Group was brought against West
American in the Court of Common Pleas Cuyahoga County, Ohio on October 25,
1999. The Court ordered the case to proceed solely against West American on
July 10, 2003. The complaint alleges West American improperly charged for
uninsured motorists coverage following an October 1994 decision of the
Supreme Court of Ohio in Martin v. Midwestern Insurance Company. The Martin
decision was overruled legislatively in September 1997. West American filed
a motion for summary judgment on December 16, 2003. Plaintiff filed a motion
for class certification on February 23, 2004. West American has responded to
the motion for class certification stating the motion is untimely (filed more
than four years after the initial complaint) and that Carol Lazarus failed to
provide sufficient evidence to satisfy the requirements for class
certification.
A proceeding entitled Douglas and Carla Scott v. the Company, West American,
American Fire, and Ohio Security was filed in the District Court of Tulsa
County, State of Oklahoma and served on January 3, 2005. The proceeding
challenges the use of a certain vendor in valuing total loss automobiles.
Plaintiff alleges that use of the database results in valuations to the
detriment of the insureds. Plaintiff is seeking class status and alleges
breach of contract, fraud and bad faith. The lawsuit is in its early stages
and will be vigorously defended.
12
The proceedings described above and various other legal and regulatory
proceedings are currently pending that involve the Corporation and specific
aspects of the conduct of its business. The outcome of these proceedings is
currently unpredictable. However, at this time, based on their present
status, it is the opinion of management that the ultimate liability, if any,
in one or more of these proceedings in excess of amounts currently reserved
is not expected to have a material adverse effect on the financial condition,
liquidity or results of operation of the Corporation.
NOTE IX - EMPLOYEE BENEFITS
The Corporation has a non-contributory defined benefit retirement plan and a
contributory health care plan. The net periodic pension cost as of March 31
is determined as follows:
Three Months Ended
March 31
(in millions) 2005 2004
- -------------------------------------------------------------------------
Service cost earned during the period $ 1.8 $ 2.1
Interest cost on projected benefit obligation 4.3 4.5
Expected return on plan assets (5.4) (5.3)
Amortization of accumulated losses 0.9 0.7
Amortization of unrecognized prior service cost (0.6) (0.1)
Curtailment - 0.1
- -------------------------------------------------------------------------
Net periodic pension cost $ 1.0 $ 2.0
=========================================================================
The Corporation contributed approximately $1.9 in the first quarter of 2005
to the defined benefit retirement plan. The Corporation expects to
contribute $8.0 during the fiscal year 2005.
In March 2004, the Corporation announced changes to the defined benefit
retirement plan which were effective June 30, 2004, which freezes accrued
benefits under the plan's current formula and incorporates a new benefit
formula beginning July 2004. As a result of these changes and staff
reductions announced in the first three months of 2004, the Corporation
recognized a curtailment charge of $0.1 in 2004.
The components of the Corporation's net periodic postretirement benefit cost
as of March 31:
Three Months Ended
March 31
(in millions) 2005 2004
- -------------------------------------------------------------------------
Service cost $ 0.1 $ 0.6
Interest cost 0.7 1.5
Amortization of loss - 0.1
Amortization of unrecognized prior service cost (1.5) (0.5)
Curtailment - 0.1
- -------------------------------------------------------------------------
Net periodic postretirement benefit cost $(0.7) $ 1.8
=========================================================================
In March 2004, the Corporation announced changes related to the
postretirement health care plan effective July 1, 2004 that limits
eligibility for subsidized retiree medical and dental coverage to then
current retirees and employees with 25 or more years of service. Other
employees are eligible for access to unsubsidized retiree dental coverage and
medical coverage up to age 65. As a result of these changes and staff
reductions, the Corporation recognized a curtailment charge of $0.1 in 2004.
NOTE X - RECENTLY ISSUED ACCOUNTING STANDARDS
In December 2004, the FASB finalized Statement 123(R), "Share-Based Payment."
On April 14, 2005, the Securities and Exchange Commission (SEC) announced a
phased-in implementation process that would allow the Corporation to defer
the implementation of the statement no later than the beginning of the first
fiscal year beginning after June 15, 2005. Statement 123(R) supersedes APB
Opinion No. 25, "Accounting for Stock Issued to Employees," and amends FASB
Statement No. 95, "Statement of Cash Flows." FASB
13
123(R) requires all share-based payments to employees, including grants of
employee stock options, to be recognized as compensation expense in the
income statement at fair value. Pro forma disclosure is no longer an
alternative. The Corporation currently intends to adopt the provisions of
FASB 123(R) effective July 1, 2005, prior to the required implementation
date, although it is evaluating its options under the phased-in
implementation process allowed by the SEC.
FASB 123(R) permits public companies to adopt its requirements using one of
two methods: (1) modified prospective or (2) modified retrospective. The
Corporation plans to adopt using the modified prospective method in which
compensation expense would be recognized beginning July 1, 2005 (a) based on
the requirements of FASB 123(R) for all share-based payments granted after
the July 1, 2005 and (b) based on the requirements of FASB 123 for all awards
granted to employees prior to July 1, 2005 that remain unvested on that date.
The adoption of FASB 123(R) fair value method is expected to increase the
Corporation's compensation expense by $3.0 to $4.0 in 2005, if the
Corporation elects to adopt FAS 123(R) on July 1, 2005. This impact could
change materially from the estimate based upon the Corporation's use of
share-based payments granted in the future. Had the Corporation adopted FASB
123(R) in prior periods, the impact of that standard would have approximated
the impact of FASB 123 as described in the disclosure of pro forma net income
and earnings per share in Note II.
FASB 123(R) also requires the benefits of tax deductions in excess of
recognized compensation expense to be reported as a financing cash flow,
rather than as an operating cash flow as required under current accounting
literature. This requirement will reduce net operating cash flows and
increase net financing cash flows in periods after the adoption.
In March 2004, the FASB approved the consensus reached on the EITF Issue No.
03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments." The objective of this consensus is to provide guidance
for identifying impaired investments. EITF 03-1 also provides new disclosure
requirements for investments that are deemed to be temporarily impaired.
Originally, the accounting provisions of EITF 03-1 were effective for all
reporting periods beginning after June 15, 2004, while the disclosure
requirements are effective only for annual periods ending after June 15,
2004. In September 2004, the FASB issued two FASB Staff Positions (FSP), FSP
EITF 03-1-a and FSP EITF 03-1-1, which delayed the measurement and
recognition paragraphs of the consensus for further discussion. The
disclosure requirements remain effective as originally issued under EITF 03-1
and have been adopted by the Corporation. The Corporation has evaluated the
impact of the adoption of EITF 03-1, as written, and does not believe the
impact is significant to the Corporation's overall results of operations or
financial position at March 31, 2005. However, as currently written, the
consensus could have a significant impact on future results. The
Corporation will continue to monitor the developments of the FASB and EITF
regarding the measurement and recognition paragraphs of this consensus.
NOTE XI - SUBSEQUENT EVENT
In connection with the transaction discussed in Note VIII - Contingencies,
wherein OCNJ entered into an agreement to transfer its obligation to renew
private passenger auto business in New Jersey to Proformance, the Corporation
acquired an approximate 19% interest (867,955 shares of class B non-voting
common stock) in National Atlantic Holding Corporation and subsidiaries
(NAHC), the parent of Proformance. On April 20, 2005, NAHC successfully
completed an initial public offering of its common stock (IPO). The
Corporation participated in this IPO as a selling stockholder. Accordingly,
the Corporation sold 665,000 shares at $12 per share and realized $7.4 as net
proceeds (net of underwriting discount) in connection with this offering.
Accordingly, the Corporation will realize a gain in the second quarter of
2005 on the sale of these securities in the amount of approximately $7.0
(before tax) on this sale.
14
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operation
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). All
dollar amounts in this Management Discussion and Analysis (MD&A) are in
millions unless otherwise noted.
RESULTS OF OPERATIONS
Net income
The Corporation reported net income of $37.7, or $0.55 per share for the
three months ending March 31, 2005, compared with $19.2, or $0.31 per share
in the same period of 2004.
Management of the Corporation believes the significant volatility of realized
investment gains and losses limits the usefulness of net income as a measure
of current operating performance. Therefore, management uses the non-GAAP
financial measure of operating income to further evaluate current operating
performance. Operating income is reconciled to net income in the table
below:
Three Months Ended
March 31
($ in millions) 2005 2004
- --------------------------------------------------------------------------
Operating income $37.7 $18.4
After-tax net realized gains - 2.4
Cumulative effect of accounting change - (1.6)
- --------------------------------------------------------------------------
Net income $37.7 $19.2
==========================================================================
Operating income per share - diluted $0.55 $0.30
After-tax net realized gains per share - diluted - 0.04
Cumulative effect of accounting change per
share - diluted - (0.03)
- --------------------------------------------------------------------------
Net income per share - diluted $0.55 $0.31
==========================================================================
Investment Results
For the three months ended March 31, 2005 and 2004, consolidated before-tax
net investment income was $48.4 ($35.4 after tax) and $50.5 ($33.9 after
tax), respectively. The increase in after-tax investment income is the
result of the change in investment strategy discussed below. The effective
tax rate on investment income for the first three months of 2005 was 26.9%,
compared with 32.9% for the same period of 2004. Before-tax and after-tax
investment income comparisons are impacted by investments in municipal bonds,
which provide tax exempt investment income. As a result of the Corporation's
return to profitability, management has invested more funds into tax exempt
securities to maximize after-tax income. This investment strategy results in
the Corporation's before-tax investment income declining when compared to
prior periods when the strategy was to invest in taxable securities. As a
result of this strategy, the Corporation's effective tax rate on investment
income is lower when compared to prior periods.
There were no net realized gains or losses recorded for the three months
ended March 31, 2005. Net realized gains for the three months ended March
31, 2004 were $3.7. The Corporation and the Group did not realize any
material losses on any securities sold during the first quarter of 2005 and
2004.
Invested assets comprise a majority of the consolidated assets.
Consequently, accounting policies related to investments are critical. For
further discussion of investment accounting policies, see the "Critical
Accounting Policies" section on pages 31 and 32 of the Corporation's 2004
Annual Report on Form 10-K. Investments are continually evaluated based on
current economic conditions, credit loss experience and other developments.
The difference between the cost/amortized cost and estimated fair value of
investments is continually evaluated to determine whether a decline in value
is temporary or other than temporary in nature. This determination involves
a degree of uncertainty. If a decline in the fair value of a
15
security is determined to be temporary, the decline is recorded as an
unrealized loss in shareholders' equity. If a decline in a security's fair
value is considered to be other than temporary, the security is written down
to the estimated fair value with a corresponding realized loss recognized in
the current consolidated statement of income.
The assessment of whether a decline in fair value is considered temporary or
other than temporary includes management's judgement as to the financial
position and future prospects of the entity issuing the security. It is not
possible to accurately predict when it may be determined that a specific
security will become impaired. Future impairment charges could be material
to the results of operations. There was no impairment charge recorded for
the three months ended March 31, 2005. The before-tax impairment charge
recorded in the first quarter of 2004 was $3.8.
Management believes that it will recover the cost basis in the securities
held with unrealized losses as it has both the intent and ability to hold the
securities until they mature or recover in value. Securities are sold to
achieve management's investment goals, which include the diversification of
credit risk, the maintenance of adequate portfolio liquidity, the generation
of a competitive investment yield and the management of interest rate risk.
In order to achieve these goals, sales of investments are based upon current
market conditions, liquidity needs and estimates of the future market value
of the individual securities.
The following table summarizes, for all available-for-sale securities and
held-to-maturity securities, the total gross unrealized losses, excluding
gross unrealized gains, by investment category and length of time the
securities have continuously been in an unrealized loss position as of March
31, 2005:
Available-for-sale with unrealized losses:
(in millions) Less than 12 months 12 months or longer Total
------------------- ------------------- -------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
------------------- ------------------- -------------------
Securities:
U.S. government $ 9.3 $ (0.2) $ - $ - $ 9.3 $ (0.2)
States, municipalities
and political
subdivisions 699.0 (9.2) - - 699.0 (9.2)
Corporate securities 254.4 (5.9) 9.5 (0.5) 263.9 (6.4)
Mortgage-backed
securities 194.1 (2.2) 3.4 (0.1) 197.5 (2.3)
- ------------------------------------------------------------------------------------------------------
Total fixed maturities 1,156.8 (17.5) 12.9 (0.6) 1,169.7 (18.1)
Equity securities 22.6 (2.0) - - 22.6 (2.0)
- ------------------------------------------------------------------------------------------------------
Total temporarily impaired
securities $1,179.4 $(19.5) $12.9 $(0.6) $1,192.3 $(20.1)
======================================================================================================
Held-to-maturity with unrealized losses:
(in millions) Less than 12 months 12 months or longer Total
------------------- ------------------- -------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
------------------- ------------------- -------------------
Securities:
Corporate securities $125.3 $(3.3) $ - $ - $125.3 $(3.3)
Mortgage-backed
securities 84.7 (1.6) 9.9 (0.1) 94.6 (1.7)
- -----------------------------------------------------------------------------------------------------
Total temporarily impaired
securities $210.0 $(4.9) $9.9 $(0.1) $219.9 $(5.0)
=====================================================================================================
16
As part of the evaluation of the entire $25.1 aggregate unrealized loss on
the investment portfolio, management performed a more intensive review of
securities with a relatively higher degree of unrealized loss. Based on a
review of each security, management believes that unrealized losses on these
securities were temporary declines in value at March 31, 2005. In the tables
above, there are approximately 415 securities represented. Of this total, 14
securities have unrealized loss positions greater than 5% of their book
values at March 31, 2005, two of which are equity securities with unrealized
loss positions exceeding 20% of their book value. This group represents
$3.5, or 13.9% of the total unrealized loss position. Of this group, 9
securities, representing approximately $3.2 in unrealized losses, have been
in an unrealized loss position for less than twelve months. Of the remaining
5 securities, which have been in an unrealized loss position for longer than
twelve months and total $0.3, management believes that it is probable that
all contract terms of the security will be satisfied; the unrealized loss
position is due to the changes in the interest rate environment; and that it
has positive intent and the ability to hold the securities until they mature
or recover in value. As noted above, two equity securities had unrealized
loss positions that exceeded 20% at March 31, 2005. These securities were
issued by two large companies that operate in the pharmaceutical industry,
which has seen specific product news negatively impact all companies in the
industry. Based on the strong financial position, solid earnings and strong
product development pipelines of the two companies noted above, management
believes that current decline in market value of the two companies does not
represent an other than temporary decline in value.
All securities are monitored by portfolio managers who consider many factors
such as an issuer's degree of financial flexibility, management competence
and industry fundamentals in evaluating whether the decline in fair value is
temporary. In addition, management considers whether it is probable that all
contract terms of the security will be satisfied and whether the unrealized
loss position is due to changes in the interest rate environment. Should
management subsequently conclude the decline in fair value is other than
temporary, the book value of the security is written down to fair value with
the realized loss being recognized in the then current consolidated statement
of income.
The amortized cost and estimated fair value of available-for-sale and held-
to-maturity fixed maturity securities in an unrealized loss position at March
31, 2005, by contractual maturity are shown below. Expected maturities will
differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without call or prepayment penalties.
Available-for-sale: Amortized Estimated Unrealized
Cost Fair Value Loss
- --------------------------------------------------------------------------------------
Due in one year or less $ 0.6 $ 0.6 $ -
Due after one year through five years 68.0 66.7 (1.3)
Due after five years through ten years 547.7 538.6 (9.1)
Due after ten years 371.7 366.3 (5.4)
Mortgage-backed securities 199.8 197.5 (2.3)
- --------------------------------------------------------------------------------------
Total $1,187.8 $1,169.7 $(18.1)
======================================================================================
Held-to-maturity: Amortized Estimated Unrealized
Cost Fair Value Loss
- --------------------------------------------------------------------------------------
Due in one year or less $ 2.1 $ 2.1 $ -
Due after one year through five years 24.0 23.3 (0.7)
Due after five years through ten years 99.3 96.9 (2.4)
Due after ten years 3.2 3.0 (0.2)
Mortgage-backed securities 96.3 94.6 (1.7)
- ------------------------------------------------------------------------------------
Total $224.9 $219.9 $(5.0)
====================================================================================
For additional discussion relative to the Corporation's investment portfolio,
see the "Investment Portfolio" section under "Liquidity and Capital
Resources" on pages 23 and 24 of this MD&A.
17
Agent Relationships
The agent relationships asset is an identifiable intangible asset
representing the excess of cost over fair value of net assets acquired in
connection with the acquisition of the commercial lines business from Great
American Insurance Company (GAI) in 1998. Generally Accepted Accounting
Principles (GAAP) requires 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. For the first quarter of 2005, the
before-tax agent relationship impairment charge was $2.8, compared to $5.4
for the first quarter of 2004. The before-tax amortization charge was $1.6
for the first quarter of 2005, compared to $1.8 for the first quarter of
2004. The calculation of impairment follows accounting guidelines that do
not permit increasing the intangible value for agents who are 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 the remaining acquired agents assigned an intangible value exceed
the remaining asset book value of $117.6 recorded at March 31, 2005. The
determination of impairment involves the use of management estimates and
assumptions. Due to the inherent uncertainties and judgments involved in
developing assumptions for each agent and the fact that the asset cannot be
increased for any agent, further reductions in the valuation of the agent
relationships asset are likely to occur in the future. These reductions
could be significant if actual agent revenue production or profitability
differ materially from current assumptions. Management has considered these
and other factors in determining the remaining useful life of 19 years for
this asset.
Operating Results
Insurance industry regulators require the Group to report its financial
condition and results of operations, among other things, using statutory
accounting principles. Management uses industry standard financial measures
determined on a statutory basis, as well as those determined on a GAAP basis
to analyze the Group's property and casualty operations. These insurance
industry financial measures include loss and loss adjustment expense (LAE)
ratios, underwriting expense ratio, combined ratio, net premiums written and
net premiums earned. The combined ratio is a commonly used gauge of
underwriting performance measuring the percentage of premium dollars used to
pay insurance losses and related expenses. The combined ratio is the sum of
the loss, LAE and underwriting expense ratios. All references to combined
ratio or its components in this MD&A are calculated on a GAAP basis, unless
otherwise indicated, and are calculated on a calendar year basis unless
specified as calculated on an accident year basis. Insurance industry
financial measures are included in the next several sections of this MD&A
that discuss results of operations. A discussion of the differences between
statutory accounting and generally accepted accounting principles in the
United States is included in Item 15, page 69 of the Corporation's 2004
Annual Report on Form 10-K.
At March 31, 2005 and December 31, 2004, statutory surplus, a financial
measure that is required by insurance regulators and used to monitor
financial strength, was $914.5 and $972.0, respectively. The ratio of twelve
months ended net premiums written to statutory surplus as of March 31, 2005
was 1.6 to 1.0 compared to 1.5 to 1.0 at December 31, 2004. The decrease in
statutory surplus during the first quarter of 2005 is primarily a result of
an $81.6 dividend paid by the Company to the Corporation partially offset by
statutory net income.
Premium Revenue Results
Premium revenue reflects premiums earned by the Group. The Group's premiums
are earned principally on a monthly pro rata basis over the term of the
policy. Management analyzes premium revenues primarily by premiums written
in the current period. Net premiums written differs from gross premiums
written by premiums ceded to reinsurers.
18
The table below summarizes property and casualty premium on a gross and net
basis compared with the same period of the prior year:
Three months ended March 31,
($ in millions) 2005 2004 % Chg
Gross Premiums Written
- ----------------------------------------------------------------------------
Commercial Lines $211.2 $220.4 (4.2)%
Specialty Lines 53.2 61.8 (13.9)%
Personal Lines 114.9 118.9 (3.4)%
------ ------
All Lines $379.3 $401.1 (5.4)%
====== ======
Three months ended March 31,
($ in millions) 2005 2004 % Chg
Net Premiums Written
- ----------------------------------------------------------------------------
Commercial Lines $205.6 $212.2 (3.1)%
Specialty Lines 39.1 34.8 12.4%
Personal Lines 113.8 117.0 (2.7)%
------ ------
All Lines $358.5 $364.0 (1.5)%
====== ======
Gross and net premiums written for the Commercial and Personal Lines segments
declined primarily as a result of a reduction in new business premium
production for both segments, partially offset by a slight increase in
renewal rates. The Group is devoting more attention in 2005 to identifying
opportunities in new markets to enhance premium growth through establishment
of regional service centers, enhancing sales force efficiencies and
facilitating agency management system interfaces into the Policy
Administration Rating and Issuance System (P.A.R.I.S.(sm)). Specialty Lines
gross premiums written declined as a result of lower new business production,
while net premiums written increased as a result of lower reinsurance costs
due to increases in reinsurance retention in 2005, as discussed in greater
detail in the Corporation's 2004 Annual Report on Form 10-K Item 7,
Reinsurance Programs on page 42.
Commercial Lines renewal price increases averaged 2.0% in the first quarter
2005 compared to 6.9% in the first quarter 2004. The decrease in the renewal
price increase period over period is the result of a broad market trend
indicating that competitive pricing pressure is increasing. 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 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.
Renewal price increases also do not reflect the cost of any reinsurance
purchased on the policies issued.
All Lines Discussion
The following table provides key financial measures for All Lines:
Three Months Ended
March 31
2005 2004
All Lines ($ in millions) ---- ----
- -------------------------
Loss ratio 52.8% 54.0%
Loss adjustment expense ratio 11.9% 11.4%
Underwriting expense ratio 30.9% 38.4%
------ ------
Combined ratio 95.6% 103.8%
====== ======
The All Lines combined ratio improved 8.2 points driven by a 7.5 point
improvement in the underwriting ratio. The underwriting ratio improvement is
described below and includes the full impact of staff reductions related to
the 2004 Cost Structure Efficiency (CSE) Initiative. The improved loss ratio
is the result of the Group's continued focus on underwriting quality,
improved pricing levels and favorable prior year reserve development, as
reflected below.
19
The table below summarizes the impact of changes in provision for all prior
accident year losses and LAE:
Three Months Ended March 31
($ in millions) 2005 2004
- ----------------------------------------------------------------------------
Statutory net liabilities,
beginning of period $2,183.8 $2,128.9
Decrease in provision for prior
accident year claims $(3.8) $(2.5)
Decrease in provision for prior accident
year claims as % of premiums earned (1.0)% (0.7)%
Catastrophe losses for the first quarter 2005 were similar to the first
quarter 2004, with a combined ratio impact of 0.7 points, a decrease of 0.1
points from the first quarter of 2004. The effect of future catastrophes on
the Corporation's results of operations cannot be accurately predicted. As
such, severe weather patterns, acts of war or terrorist activities could have
a material adverse impact on the Corporation's results of operations,
reinsurance pricing and availability of reinsurance. During the first
quarter of 2005, there were eight catastrophes with the largest catastrophe
generating $1.1 in incurred losses as compared with five catastrophes in the
first quarter of 2004 with the largest catastrophe generating $0.8 in
incurred losses. For additional disclosure of catastrophe losses, refer to
Item 15, Losses and LAE Reserves in the Notes to the Consolidated Financial
Statements on page 66 of the Corporation's 2004 Annual Report on Form 10-K.
The deterioration in the loss adjustment expense ratio is related to adverse
development on prior year reserves, primarily in the casualty lines, a change
in the mix of premium, as commercial lines grows as a percent of the
portfolio and bear a higher LAE ratio, and higher reinsurance retention and
costs compared to last year.
The table below summarizes the variance in the underwriting expense ratio for
the first quarter 2004 compared to the first quarter 2005:
Underwriting expense ratio variance
-----------------------------------
Underwriting expense ratio - first
quarter 2004 38.4%
Contingent liability to Proformance (3.7)%
Decrease in commissions (0.6)%
Reduction in personnel related expenses (0.9)%
Decrease to professional fees (0.5)%
Severance related expense due to work
force reduction (0.5)%
Impact of all other underwriting expense
ratio items (1.3)%
-------
Underwriting expense ratio - first
quarter 2005 30.9%
=======
The underwriting expense ratio for 2005 includes a $4.4 reduction to the
surplus guarantee accrual recorded at December 31, 2004 related to
Proformance, as a result of a revised estimate based on new information
provided by Proformance to the Group subsequent to the Corporation's filing
of its 2004 Annual Report on Form 10-K. The underwriting ratio for the first
quarter of 2004 included a $9.0 increase related to establishing an accrual
related to the Proformance liability. The changes in the accrual for the
surplus guarantee favorably impacted 2005 results 1.2 points and increased
last year's ratio 2.5 points. See Note VIII - Contingencies on pages 12 and
13 of this Quarterly Report on Form 10-Q.
The remainder of the improvement in the underwriting expense ratio
demonstrates the benefit of the CSE initiative that began in 2003 and is
continuing. Processing efficiencies developed under the initiative led to
the elimination of 322 staff positions in the first quarter of 2004 and
nearly 500 positions for the calendar year 2004.
The employee count remained relatively flat when compared to December 31,
2004. As of March 31, 2005, the employee count was 2,197, compared with
2,190 at December 31, 2004 and 2,361 at March 31, 2004.
20
In both the first quarter 2005 and 2004, underwriting expenses included $0.8
of software amortization expense before tax, related to the rollout of
P.A.R.I.S.(sm). On a GAAP accounting basis, the new application is being
amortized over a ten-year period. This amortization expense is expected to
be offset in part by reduced labor costs related to underwriting and policy
processing.
In 2001, the Group introduced into operation, P.A.R.I.S.(sm) for Commercial
Lines. At the end of 2004, P.A.R.I.S.(sm) was deployed for the Specialty Lines
commercial umbrella excess capacity product line. Further implementation for
other Specialty and Personal Lines products is expected during 2005 and 2006.
The P.A.R.I.S.(sm) system provides the policy administration environment used
internally by the Group's associates. An extension of P.A.R.I.S.(sm) called
P.A.R.I.S. Express(sm) leverages the P.A.R.I.S.(sm) system to provide
underwriting, rating, inquiry and policy processing functionality to our
agents. P.A.R.I.S. Express(sm) is a proprietary internet interface that uses
the P.A.R.I.S.(sm) system to provide real-time functionality through a web
browser to our agents. In addition, the Group is simultaneously introducing
P.A.R.I.S. Connect(tm) which allows agents to transact with the Group directly
from their agency management system without requiring re-entering of customer
or agency information.
For Commercial Lines, P.A.R.I.S. Express(sm) and P.A.R.I.S. Connect(tm)
currently provide agents with on-line quoting capability. In February of
2005, P.A.R.I.S. Express(sm) was extended to support issuance and endorsement
processing for selected pilot agents; nationwide rollout is expected during
2005. Personal Lines currently offers on-line and real time quoting and
issuance for new business and endorsements through existing (non-
P.A.R.I.S.(sm)) systems.
Agents want a cost effective, timely and simple system for issuing and
maintaining insurance policies. P.A.R.I.S. Express(sm) and P.A.R.I.S.
Connect(tm) are the cornerstone in the Group's strategy of focusing on
superior agent service. The success of this strategic plan depends in part
on the ability to provide agents with the technological advantages of these
tools. If they do not work as expected, or fail to satisfy agents' needs,
the Group may lose business to insurers with preferred technologies.
Segment Discussion
The Corporation's organizational structure consists of three operating units:
Commercial, Specialty and Personal Lines. The Corporation also has an all
other segment, which derives its revenue from investment income. The
following tables provide key financial measures for each of the property and
casualty reportable segments:
Commercial Lines Segment
Commercial Lines Segment ($ in millions) 2005 2004
- ---------------------------------------------------------------------------
Net premiums written $205.6 $212.2
Net premiums earned 205.6 197.8
Loss ratio 57.2% 52.3%
Loss adjustment expense ratio 15.2% 12.0%
Underwriting expense ratio 33.9% 38.5%
Combined Ratio 106.3% 102.9%
The combined ratio for the three month period ended March 31, 2005
deteriorated, compared to the same period last year, primarily due to adverse
loss and LAE reserve development concentrated in the workers' compensation
and commercial multi-peril product lines. The adverse prior year reserve
development added 5.9 points to the first quarter 2005 loss and LAE ratios
compared to favorable development of 3.3 points in the first quarter 2004.
The Group continues to focus on improving profitability in the general
liability and workers' compensation product lines. The Group has restricted
writings in states where the workers' compensation product line has
historically been unprofitable and is focused on growing this product line in
profitable states. The first quarter 2005 Commercial Lines loss ratio
included 0.6 points related to catastrophe losses compared to 0.8 points in
the first quarter of 2004. The 4.6 point improvement in the underwriting
expense ratio is the result of CSE initiatives and decreases in premium taxes
and assessments.
21
Specialty Lines Segment
Specialty Lines Segment ($ in millions) 2005 2004
- ----------------------------------------------------------------------------
Net premiums written $39.1 $34.8
Net premiums earned 35.1 41.7
Loss ratio 43.0% 40.0%
Loss adjustment expense ratio 8.0% 4.0%
Underwriting expense ratio 45.3% 46.1%
Combined Ratio 96.3% 90.1%
The Specialty Lines combined ratio increased as a result of higher loss and
LAE ratios related to increased retention on commercial umbrella risks and
higher bond loss and LAE ratios primarily related to one large loss. The
Specialty Lines loss and LAE ratios were favorably impacted by prior year
reserve development of 8.0 points in first quarter 2005 compared to 7.4
points in first quarter 2004.
Personal Lines Segment
Personal Lines Segment ($ in millions) 2005 2004
- ---------------------------------------------------------------------------
Net premiums written $113.8 $117.0
Net premiums earned 121.6 121.6
Loss ratio 48.0% 61.6%
Loss adjustment expense ratio 7.4% 13.0%
Underwriting expense ratio 21.8% 35.5%
Combined Ratio 77.2% 110.1%
All of the key ratios of the first quarter 2005 combined ratio improved when
compared to first quarter 2004. The loss and LAE ratio improvements were
driven by favorable development on prior years reserves, increased pricing
and improved underwriting (e.g., increasing deductibles on homeowners
policies) and favorable claims frequency trends. In 2005, favorable
development on prior year reserves lowered the loss and LAE ratio by 10.9
points compared to 5.9 points of adverse prior year reserve development in
2004. The first quarter 2005 Personal Lines loss ratio included 1.0 point of
catastrophe losses compared to 1.2 points in the first quarter of 2004. The
2005 underwriting expense ratio includes a 3.6 point reduction related to the
surplus guarantee contingency related to the Proformance transaction compared
to a 7.4 point increase in the first quarter of 2004. The remainder of the
improvement in the underwriting expense ratio is primarily related to the
recognition of the full benefit of the CSE initiative staff reductions
implemented in the first half of 2004.
Statutory Earned Premium and Combined Ratios
Combined Ratios
---------------------------------------------------------
Earned Premium Calendar Year Accident Year
Year to Date Year to Date Year to Date Calendar Accident
March 31, March 31, March, Year Year
(By operating segment) 2005 2005 2005(a) 2004 2004(a)
- ---------------------------------------------------------------------------------------------------
Commercial Lines $205.6 105.9% 100.0% 99.3% 100.6%
Specialty Lines 35.1 86.5% 94.6% 97.2% 103.0%
Personal Lines 121.6 77.3% 88.1% 97.6% 96.2%
Total All Lines $362.3 94.7% 95.7% 98.4% 99.2%
(a) The loss and LAE ratio component of the accident year combined ratio
measures losses and LAE arising from insured events that occurred in the
respective accident year. The current accident year excludes losses and LAE
for insured events that occurred in prior accident years. The measurement
date for accident year data is March 31, 2005. Partial and complete accident
periods may not be comparable due to seasonality, claim reporting and
development patterns, claim settlement rates and other factors.
22
LIQUIDITY AND CAPITAL RESOURCES
Investment Portfolio
The following table sets forth the distribution and other data of investments
at March 31, 2005 and December 31, 2004, respectively.
March 31, 2005 December 31, 2004
-------------- -----------------
Average Amortized Carrying % of Amortized Carrying % of
Rating Cost Value Total Cost Value Total
------------------------------------------------------------------------------
U.S Government:
Available-for-sale AAA $ 35.8 $ 36.7 0.9 $ 31.9 $ 33.4 0.8
States, municipalities,
and political
subdivisions:
Investment grade:
Available-for-sale AA+ 1,118.7 1,115.3 26.0 1,018.4 1,034.6 24.4
Corporate securities:
Investment grade:
Available-for-sale A 1,571.7 1,658.5 38.6 1,562.8 1,686.4 39.7
Held-to-maturity A+ 164.4 164.4 3.8 164.7 164.7 3.9
Below Investment grade:
Available-for-sale BB- 51.6 57.1 1.3 51.6 58.4 1.4
- ---------------------------------------------------------------------------------------------------------
Total corporate
securities 1,787.7 1,880.0 43.7 1,779.1 1,909.5 45.0
- ---------------------------------------------------------------------------------------------------------
Mortgage-backed securities:
Investment grade:
Available-for-sale AAA 487.1 500.7 11.7 505.2 524.7 12.4
Held-to-maturity AAA 129.9 129.9 3.0 136.7 136.7 3.2
Below Investment grade:
Available-for-sale CCC+ 6.9 8.4 0.2 6.9 8.6 0.2
- ---------------------------------------------------------------------------------------------------------
Total mortgage-backed
securities 623.9 639.0 14.9 648.8 670.0 15.8
- ---------------------------------------------------------------------------------------------------------
Total fixed maturities 3,566.1 3,671.0 85.5 3,478.2 3,647.5 86.0
Equity securities 98.6 351.9 8.2 98.9 357.4 8.4
Short-term investments 273.4 273.1 6.3 239.9 239.1 5.6
- ---------------------------------------------------------------------------------------------------------
Total investment portfolio $3,938.1 $4,296.0 100.0 $3,817.0 $4,244.0 100.0
=========================================================================================================
The fixed maturity portfolio is allocated between investment grade and
below investment grade as follows:
March 31, 2005 December 31, 2004
-------------- -----------------
Amortized Carrying % of Amortized Carrying % of
Cost Value Fixed Cost Value Fixed
-------------------------------------------------------------------
Total investment grade $3,507.6 $3,605.5 98.2 $3,419.7 $3,580.5 98.2
Total below investment
grade 58.5 65.5 1.8 58.5 67.0 1.8
The fixed maturity portfolio is allocated between available-for-sale and
held-to-maturity as follows:
Total available-for-sale
fixed securities $3,271.9 $3,376.8 92.0 $3,176.8 $3,346.1 91.7
Total held-to-maturity
fixed securities 294.2 294.2 8.0 301.4 301.4 8.3
The excess of market value over cost was $357.9 at March 31, 2005, compared
with $427.0 at December 31, 2004. The decrease in 2005 was attributable to
an increase in interest rates for fixed maturity securities and the decline
in the market value of certain equity securities. This decline in the excess
of market value over cost during the quarter decreased the Corporation's book
value by $0.75 per share during the quarter, which was partially offset by
the improved profitability of the Corporation. See page 27 for
reconciliation of book value per share from December 31, 2004 to March 31,
2005.
23
The consolidated fixed maturity portfolio, including short-term securities,
has an intermediate duration and a laddered maturity structure. The duration
of the fixed maturity portfolio was approximately 5.1 years at both March 31,
2005 and December 31, 2004. The Corporation and the Group remain fully
invested and do not time markets.
Fixed maturity securities are classified as investment grade or non-
investment grade based upon the higher of the ratings provided by S&P and
Moody's. When a security is not rated by either S&P or Moody's, the
classification is based on other rating services, including the Securities
Valuation Office of the National Association of Insurance Commissioners. The
market value of available-for-sale split-rated fixed maturity securities
(i.e., those having an investment grade rating from one rating agency and a
below investment grade rating from another rating agency) was $40.3 and $31.5
at March 31, 2005 and December 31, 2004, respectively.
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.
Following is a table displaying available-for-sale non-investment grade and
non-rated securities in an unrealized loss position at March 31, 2005 and
December 31, 2004:
Amortized Fair Unrealized
Cost Value Loss
- ------------------------------------------------------------------------
March 31, 2005 $3.2 $3.1 $(0.1)
December 31, 2004 1.5 1.4 (0.1)
Equity securities are carried at fair market value on the consolidated
balance sheets. As a result, shareholders' equity and statutory surplus
fluctuate with changes in the value of the equity portfolio. As of March 31,
2005, the equity portfolio consisted of stocks in a total of 50 separate
entities in 9 different industries. Of this total, 31.5% were invested in
five companies and the largest single position was 9.9% of the equity
portfolio. At December 31, 2004, the equity portfolio consisted of stocks in
50 separate entities in 9 different industries. Of this total, 31.2% were
invested in five companies and the largest single position was 7.3% of the
equity portfolio.
In June 2004, the Corporation invested the proceeds of the Senior Note
offering in short-term investments, see Liquidity and Capital Resources -
Debt for additional information pertaining to this offering. Short-term
investments are carried at fair market value on the consolidated balance
sheets and produce a lower yield.
The investment portfolio also includes non-publicly traded securities such as
private placements, non-exchange traded equities and limited partnerships
which are carried at fair value. Fair values are based on valuations from
pricing services, brokers and other methods as determined by management to
provide the most accurate price. The carrying value of this portfolio at
March 31, 2005, was $296.6 compared to $310.8 at December 31, 2004.
The Corporation and Group use assumptions and estimates when valuing certain
investments and related income. These assumptions include estimations of
cash flows and interest rates. Although the Corporation and Group believe
the values of its investments represent fair value, certain estimates could
change and lead to changes in fair values due to the inherent uncertainties
and judgements involved with accounting measurements.
Loss and Loss Adjustment Expenses
The Group's largest liabilities are reserves for losses and LAE. Loss and
LAE reserves are established for all incurred claims without discounting for
the time value of money and before credit for reinsurance recoverable. Loss
and LAE reserves are adjusted upward or downward as new information is
received.
24
These reserves amounted to $2.8 billion at both March 31, 2005 and December
31, 2004. As of March 31, 2005, the reserves by operating segment were as
follows: $1.7 billion in Commercial Lines, $0.7 billion in Specialty Lines
and $0.4 billion in Personal Lines.
The Group's actuaries conduct a reserve study using generally accepted
actuarial methods each quarter from which point estimates of ultimate losses
and LAE by product line or coverage within product line are selected. In
selecting the point estimates, thousands of data points are reviewed and the
judgment of the actuaries is applied broadly. Each quarter management
records its best estimate of the liability for loss and LAE reserves by
considering the actuaries' point estimates. Management's best estimate
recognizes that there is uncertainty underlying the actuarial point
estimates.
Estimating the ultimate cost of claims is a complex process. This estimation
process is based largely on the assumption that actuarial reserving methods,
using historical loss experience applied by experienced reserving actuaries,
produces reasonable estimates of future losses on prior insured events.
Reserve estimates can change over time because of unexpected changes in the
internal and/or external environment. Assumptions internal to company
operations include: recording of premium and loss statistics in the
appropriate detail is accurate and consistent; claims handling, including the
recording of claims, payment and closure rates, and case reserving is
consistent; the quality of business written and the mix of business (e.g.
states, limits, coverages and deductibles) have been consistent; rate changes
and changes in policy provisions have been measured accurately; reinsurance
coverage has been consistent and reinsured losses are collectible.
Assumptions related to the external environment include: tort law and the
legal environment have been and remain consistent; coverage interpretation by
the courts has been and remains consistent; regulations regarding coverage
provisions have been consistent; and loss inflation is relatively stable. To
the extent any of the above factors have changed over time, attempts are made
to adjust for the changes.
Adjustments to losses and LAE for prior accident years favorably impacted
results of operations for the three month periods in 2005 and 2004 by $3.8
and $2.5, respectively. These amounts and those stated below are net of
reinsurance, including the allowance for uncollectible reinsurance
recoverables. The following table provides the before-tax amount of prior
accident years' loss and LAE reserve development by reportable segment:
Three Months Ended
March 31 Year
2005 2004 2004
------------------ ----
(Favorable)/Unfavorable
- -----------------------
Commercial Lines $ 12.2 $(6.6) $(15.0)
Specialty Lines (2.8) (3.1) (9.4)
Personal Lines (13.2) 7.2 2.6
------- ------ -------
Total Prior Accident
Years' Development $ (3.8) $(2.5) $(21.8)
For the Commercial Lines operating segment, the adverse loss and LAE reserve
development for prior accident years recorded during the three month period
of 2005 was concentrated in the workers compensation and commercial multi-
peril product lines; these were partially offset by favorable development in
the commercial automobile product line. Favorable loss and LAE reserve
development for Commercial Lines for the three month period of 2004 was
concentrated in the commercial automobile and commercial multi-peril product
lines.
For the Specialty Lines operating segment, the favorable loss and LAE reserve
development for prior accident years recorded during the three month period
of 2005 was concentrated in the commercial umbrella product line. For 2004
first quarter, the favorable development was concentrated in both the bond
and commercial umbrella product lines.
For the Personal Lines operating segment, the favorable loss and LAE reserve
development for prior accident years recorded during the three month period
ending March 31, 2005 was concentrated in the personal automobile and
homeowners product lines. The adverse loss and LAE reserve development for
prior accident years recorded during the three month period ending March 31,
2004 was concentrated in the personal automobile product line.
25
The following table provides prior accident years' development for loss and
LAE by accident year:
Three Months Ended
March 31 Year
2005 2004 2004
------------------ ----
(Favorable)/Unfavorable
- -----------------------
Accident Year 2004 $ (9.3) $ - $ -
Accident Year 2003 (10.8) (14.1) (36.9)
Accident Year 2002 and Prior 16.3 11.6 15.1
------- ------- -------
Total Prior Accident
Years' Development $ (3.8) $ (2.5) $(21.8)
In the opinion of management, the reserves recorded at March 31, 2005
represent the Group's best estimate of its ultimate liability for losses and
LAE. However, due to the inherent complexity of the estimation process and
the potential variability of the assumptions used, final claim settlements
may vary significantly from the amounts recorded. Furthermore, the timing,
frequency and extent of adjustments to the estimated liabilities cannot be
predicted since conditions and events which established loss and LAE reserve
development and which serve as the basis for estimating ultimate claim costs
may not occur in exactly the same manner in the future, if at all.
Cash Flow
Net cash generated from operations was $56.2 for the first quarter of 2005
remaining relatively flat when compared with $57.5 for the same period in
2004. Net cash used in investing was $24.1 in the first quarter of 2005
compared with $66.0 during the first quarter of 2004. The decline in net
cash used for investing is primarily related to a decrease in net proceeds
from sales and maturities of investments when compared to the same period in
2004. Cash used in financing operations was $0.2 in the first quarter of
2005 compared with cash generated of $2.9 in the first quarter of 2004.
Liquidity needs of the Group are expected to be met by net cash generated
from operations, maturities of investments, interest and dividend receipts
and current cash balances. For additional information regarding Liquidity of
the Corporation, please refer to the following Debt section in this Quarterly
Report on Form 10-Q.
Debt
On March 22, 2005 the Corporation exchanged $65.6 of its 5.00% Convertible
Notes due March 19, 2022 (Old Notes), for $65.6 of new 5.00% Convertible
Notes due March 19, 2022 (New Notes and collectively the Convertible Notes).
The only change in the New Notes was the incorporation of a net share
settlement feature. Also on this date, the Corporation announced its
intention to fully redeem before maturity its Old and New Notes at their
regular redemption price of 102% of the principal amount plus accrued
interest to, but excluding, the redemption date of May 2, 2005. Prior to
5:00 p.m. New York City time, on April 29, 2005, one business day prior to
the redemption date, holders of the Convertible Notes can elect to convert
such Convertible Notes in accordance with their terms. Upon conversion, the
Corporation will be obligated to pay the principal amount of the converted
New Notes in cash and any conversion consideration in excess of the principal
amount in the Corporation's common stock. Upon conversion of the Old Notes,
the Corporation will be obligated to deliver 44.2112 of its common stock for
each $1,000 principal amount of Old Notes surrendered for conversion. On
June 29, 2004, the Corporation issued $200.0 of 7.3% Senior Notes due June
15, 2014 (Senior Notes) and received net proceeds after related fees and
discount of $198.0. The Corporation used part of the net proceeds to
repurchase $17.0 of the Old Notes ($4.5 in the first quarter of 2005 and
$12.5 in the fourth quarter of 2004) in unsolicited negotiated transactions
and intends to use the remainder of the net proceeds to redeem the balance of
its Convertible Notes on May 2, 2005 at 102% of par. The Corporation may
also use the net proceeds to repurchase shares of its common stock in an
amount up to the equivalent number of shares issued if holders convert their
Convertible Notes into shares of the Corporation's common stock. The
redemption of the Convertible Notes will reduce future share and earnings
dilution. Interest is payable on the Convertible Notes on March 19 and
September 19 and payable on the Senior Notes on June 15 and December 15.
For additional information regarding Debt of the Corporation, please refer to
Note VII in the Notes to the Consolidated Financial Statements on pages 11
and 12 of this Quarterly Report on Form 10-Q.
26
At March 31, 2005, the Corporation had cash, short term and marketable fixed
maturity investments totaling $394.3, which compared to $320.3 at December
31, 2004. In addition to investment income, the Corporation is dependent on
dividend payments from the Company for additional liquidity. Insurance
regulatory authorities impose various restrictions on the payment of
dividends by insurance companies. During 2005, dividend payments from the
Company to the Corporation are limited to approximately $138.3 without prior
approval of the Ohio Insurance Department. During the first quarter of 2005,
the Company paid a dividend of $81.6 to the Corporation resulting in a
dividend payment limitation of $56.7 for the remainder of 2005.
Book Value Per Share
For the quarter ended March 31, 2005, the Corporation experienced a decline
in book value of $0.20 per share from $20.82 per share to $20.62 per share.
This decline is principally the result of the decline in the excess of market
value over cost, see Liquidity and Capital Resources - Investment Portfolio,
partially offset by net income generated during the quarter. Below is a
table reconciling the changes in book value per share from December 31, 2004
to March 31, 2005.
Book Value
Book excluding
Value Unrealized Gains
----- ----------------
December 31, 2004 $20.82 $16.35
Activity for quarter ended March 31, 2005:
Net income 0.60 0.60
Change in unrealized gains (0.75) -
Impact of increase in actual shares
outstanding (0.05) (0.04)
------- -------
March 31, 2005 $20.62 $16.91
======= =======
Rating Agencies
Regularly the financial condition of the Corporation and the Group is
reviewed by four independent rating agencies, A. M. Best Company (A.M. Best),
Fitch, Inc. (Fitch), Moody's and S&P. These agencies assign ratings and
rating outlooks reflecting the agencies' opinions of the Group's financial
strength and the ability of the Corporation to meet its financial obligations
to its debt security holders. Following are the Corporation's current
ratings and rating outlooks.
A.M. Best Fitch Moody's S&P
--------- ----- ------- ---
Financial strength rating A- A- A3 BBB
Senior unsecured debt rating bbb- BBB- Baa3 BB
Rating outlook Stable Stable Stable Positive
For more information on the most recent rating agency actions, please refer
to Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations in the Corporation's 2004 Annual Report on Form 10-K
for the year ended December 31, 2004.
Forward Looking Statements
Ohio Casualty Corporation publishes 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 that are not historical
information, are forward-looking statements within the meaning of The Private
Securities Litigation Reform Act of 1995. The operations, performance and
development of the Corporation's business are subject to risks and
uncertainties which may cause actual results to differ materially from those
contained in or supported by the 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;
27
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; rating agency actions; acts of war and terrorist activities;
ability to achieve targeted expense savings; ability to appoint and retain
agents; 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 2004 Annual Report on Form 10-K.
ITEM 4. Controls and Procedures
(a) The Corporation's Chief Executive Officer and Chief Financial
Officer evaluated the disclosure controls and procedures (as
defined under Rules 13a-15(e) and 15d-15(e) of the Securities
Exchange Act of 1934, as amended) as of the end of the period
covered by this report. Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer have concluded
that the Corporation's disclosure controls and procedures are
effective.
(b) There were no significant changes in the Corporation's internal
control over financial reporting identified in connection with
the foregoing evaluation that occurred during the Corporation's
last fiscal quarter that have affected, or are reasonably
likely to materially affect, the Corporation's internal control
over financial reporting.
PART II
ITEM 6. Exhibits
Exhibits:
31.1 Certification of Chief Executive Officer of Ohio Casualty
Corporation in accordance with SEC Rule 13(a)-14(a) and
Rule 15(d)-14(a)
31.2 Certification of Chief Financial Officer of Ohio Casualty
Corporation in accordance with SEC Rule 13(a)-14(a) and
Rule 15(d)-14(a)
32.1 Certification of Chief Executive Officer of Ohio Casualty
Corporation in accordance with Section 1350 of the
Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer of Ohio Casualty
Corporation in accordance with Section 1350 of the
Sarbanes-Oxley Act of 2002
28
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)
April 27, 2005 /s/Michael A. Winner
--------------------------------
Michael A. Winner, Executive Vice
President and Chief Financial
Officer
29