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1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[x] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the fiscal year ended December 31, 2000
or
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 (no fee required)
For the transition period from ___________ to _____________
Commission File Number 0-19289
STATE AUTO FINANCIAL CORPORATION
--------------------------------
(exact name of Registrant as specified in its charter)
Ohio 31-1324304
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
518 East Broad Street, Columbus, Ohio 43215-3976
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(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (614) 464-5000
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Shares, without par value
--------------------------------
(Title of class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes __X__ No ____
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. _____
On March 16, 2001, the aggregate market value (based on the closing
sales price on that date) of the voting stock held by non-affiliates of the
Registrant was $197,499,763.
On March 16, 2001, the Registrant had 38,694,461 Common Shares
outstanding.
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DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the Registrant's Proxy Statement relating to the annual
meeting of shareholders to be held May 25, 2001, which Proxy Statement
will be filed within 120 days of December 31, 2000, are incorporated by
reference in Part III, Items 10, 11, 12 and 13 of this report.
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PART I
ITEM 1. BUSINESS
(A) GENERAL DEVELOPMENT OF BUSINESS
State Auto Financial Corporation, an Ohio corporation formed April 18,
1990 ("State Auto Financial" or "STFC"), is an insurance holding company
headquartered in Columbus, Ohio, which engages, through its subsidiaries,
primarily in the property and casualty insurance business. State Auto Financial
is approximately 68% owned by State Automobile Mutual Insurance Company, an Ohio
property and casualty insurance company formed in 1921 ("Mutual").
State Auto Financial owns 100% of the outstanding shares of State Auto
Property and Casualty Insurance Company, a South Carolina corporation ("State
Auto P&C"), Milbank Insurance Company, a South Dakota corporation ("Milbank"),
Farmers Casualty Insurance Company, an Iowa corporation ("Farmers Casualty"),
State Auto Insurance Company, an Ohio corporation ("SAIC"), and State Auto
National Insurance Company, an Ohio corporation ("National"). State Auto P&C,
Milbank and Farmers Casualty are regional standard insurers engaged primarily in
writing personal and commercial automobile, homeowners, commercial multi-peril,
workers' compensation and fire insurance. SAIC provides standard personal
insurance to its policyholders through the use of leading edge technology within
the independent agency system. National writes non-standard personal automobile
insurance in 18 states.
While Mutual originally acquired Milbank, Mutual sold Milbank to STFC
in July 1998. State Auto Financial issued approximately 5.1 million common
shares of STFC to Mutual in exchange for 100% of the outstanding shares of
Milbank and as a result, Milbank became a wholly owned subsidiary of State Auto
Financial. Since the transaction was a combination of entities under common
control, it has been accounted for similar to a pooling of interest.
On January 1, 1999, Farmers Casualty, an Iowa domiciled standard
property casualty insurer writing in Iowa and Kansas, became a wholly owned
subsidiary of STFC, following completion of its plan of conversion from a mutual
insurer. In August 1998, STFC contributed $9.0 million in capital to Farmers
Casualty in the form of a surplus note. On completion of Farmers Casualty's
conversion, STFC exchanged the surplus note for all the issued and outstanding
shares of Farmers Casualty. Farmers Casualty owns 100% of the outstanding shares
of Mid-Plains Insurance Company ("Mid-Plains"), an Iowa based insurer which
principally writes nonstandard auto insurance in Iowa and Kansas.
In May 1999, SAIC was formed by STFC. It began operations in Ohio upon
receiving its Ohio certificate of authority in January 2000. Initially, SAIC
writes standard personal lines in Ohio utilizing leading edge technology to the
maximum extent feasible.
In addition to the above-described insurers, effective as of January 1,
1997, Mutual acquired 100% of the outstanding shares of Midwest Security
Insurance Company ("Midwest Security"), a Wisconsin domiciled standard personal
lines property and casualty insurer. Midwest Security participates in the
pooling arrangement discussed below. See "Pooling Arrangement" in the "Narrative
Description of Business." In addition, in connection with this transaction,
Mutual and State Auto Financial entered into an Option Agreement whereby,
subject to the approval of the Office of the Insurance Commissioner of the State
of Wisconsin, State Auto Financial may purchase Midwest Security at any time
over the option term of five years at a price calculated pursuant to a formula
set forth in the Option Agreement.
State Auto P&C, Mutual, Milbank, Midwest Security, Farmers Casualty and
SAIC, all of which participate in a pooling arrangement, are collectively
referred to hereafter as the "Pooled Companies." See "Pooling Arrangement" in
the "Narrative Description of Business." The Pooled Companies, National, and
Mid-Plains are collectively referred to as the "State Auto Group."
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At this time, the insurers in the State Auto Group market their
insurance products through approximately 14,000 independent insurance agents
associated with approximately 2,200 agencies in 26 states. The State Auto
Group's insurance products are marketed primarily in the central and eastern
part of the United States, excluding New York, New Jersey and the New England
States.
Another wholly owned subsidiary of State Auto Financial, Stateco
Financial Services, Inc., an Ohio corporation ("Stateco"), provides investment
management services to affiliated insurance companies and insurance premium
finance services to customers of State Auto P&C, Mutual and Milbank. See
"Investment Management Services" and "Insurance Premium Finance Services" in the
"Narrative Description of Business."
Strategic Insurance Software, Inc. ("S.I.S."), an Ohio corporation
wholly owned by STFC, develops and sells software for the processing of
insurance transactions, management of insurance policy data and electronic
interfacing of insurance policy information between insurance companies and
agencies. See "Insurance Software Business" in the "Narrative Description of
Business."
518 Property Management and Leasing, LLC ("518 PML"), an Ohio limited
liability company, engages in the business of owning and leasing real and
personal property to affiliated companies. The members of 518 PML are State Auto
P&C and Stateco. See "Property Leasing Business" in the "Narrative Description
of Business."
State Auto Financial and its subsidiaries, State Auto P&C, Milbank,
Farmers Casualty, SAIC, National, Mid-Plains, Stateco, S.I.S., and 518 PML, are
collectively referred to as the "Company." IN ANY REFERENCE TO FINANCIAL
INFORMATION FOR 1998 AND PRIOR PERIODS, IT IS UNDERSTOOD THAT, UNLESS OTHERWISE
STATED, ALL REFERENCES TO THE COMPANY INCLUDE ONLY STATE AUTO P&C, STATECO,
MILBANK, NATIONAL, S.I.S. AND 518 PML, AND EXCLUDE FARMERS CASUALTY AND
MID-PLAINS WHILE FINANCIAL INFORMATION FOR 1999 EXCLUDES ONLY SAIC.
Since January 1, 1987, State Auto P&C has participated in a quota share
reinsurance pooling arrangement with Mutual. While it has been modified several
times since 1987, as of January 1, 1999, the then current pool participants and
percentages of participation were State Auto Mutual (49%), State Auto P&C (37%),
Milbank (10%), Midwest Security (1%), and Farmers Casualty (3%). As of January
1, 2000, it was further amended adding SAIC as a participant and modifying the
pooling percentages as follows: Mutual (46%), State Auto P&C (39%), Milbank
(10%), Midwest Security (1%), Farmers Casualty (3%), and SAIC (1%), and those
percentages remain in effect. See "Pooling Arrangement" in the "Narrative
Description of Business."
Prior to January 1, 2000, State Auto P&C provided executive management
services for all insurance affiliates within the State Auto Group pursuant to an
Amended and Restated Management Agreement dated April 1, 1994 (the "Amended and
Restated Management Agreement"), the Midwest Management Agreement (defined
below), and the Farmers Casualty Management Agreement (defined below). Mutual
provided non-executive employees and facilities for such entities through
December 31, 1999. See "Management Agreement" in the "Narrative Description of
Business."
Effective January 1, 2000, any individuals providing services to any of
the companies in the State Auto Group who were not already employees of State
Auto P&C became employees of State Auto P&C. In conjunction with this change,
the foregoing management agreements were replaced with a Management and
Operations Agreement dated January 1, 2000 (the "2000 Management Agreement"), a
2000 Midwest Management Agreement (as defined below) and a 2000 Farmers Casualty
Management Agreement (defined below). See "Management Agreement" in the
"Narrative Description of Business."
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(B) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS.
See Note 14 to the Company's Consolidated Financial Statements,
included in Item 8, "Financial Statements and Supplementary Data" regarding the
Company's reportable segments. Additional information regarding the Company's
segments is provided in the "Narrative Description of Business."
(C) SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM
ACT OF 1995.
Statements contained in this Form 10-K which are not historical in
nature may be "forward-looking" within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements are subject to
certain risks and uncertainties that could cause the Company's actual results to
differ materially from those projected. Forward-looking statements may be
identified, preceded by, followed by, or otherwise include, without limitation,
words such as "plans," "believes," "expects," "anticipates," "intends,"
"estimates," or similar expressions. For a discussion of certain risks and
uncertainties that could cause the Company's actual results to differ materially
from those projected, see Item 7 - Forward-Looking Statements; Certain Factors
Affecting Future Results.
(D) NARRATIVE DESCRIPTION OF BUSINESS.
PROPERTY AND CASUALTY INSURANCE
POOLING ARRANGEMENT
Since January 1987, State Auto P&C and Mutual have participated in a
quota share reinsurance pooling arrangement (the "Pooling Arrangement"). Under
the terms of the Pooling Arrangement, State Auto P&C ceded all of its insurance
business to Mutual. All of Mutual's property and casualty insurance business was
also included in the pooled business. Mutual then ceded a percentage of the
pooled business to State Auto P&C and retained the balance. From January 1987
through December 31, 1991, State Auto P&C assumed 20% of the pooled business.
Effective January 1, 1992, State Auto P&C increased its percentage of the pool
to 30%. Effective January 1, 1995, the Pooling Arrangement was amended to
include all of the property and casualty business of Milbank. Concurrently with
the inclusion of Milbank, the participation percentages were amended as follows:
Mutual 55%, State Auto P&C 35% and Milbank 10%. Effective January 1, 1998,
Midwest Security was added to the Pooling Arrangement and concurrently the
participation percentages were amended as follows: Mutual 52%, State Auto P&C
37%, Milbank 10%, and Midwest Security 1%. With the addition of Farmers Casualty
to the State Auto Group, it was added to the Pooling Arrangement and
concurrently the pooling percentages were also amended as follows: Mutual 49%,
State Auto P&C 37%, Milbank 10%, Midwest Security 1% and Farmers Casualty 3%.
Effective January 1, 2000, the Pooling Arrangement was amended through
the Reinsurance Pooling Agreement Amended and Restated as of January 1, 2000
(the "2000 Pooling Agreements"). The 2000 Pooling Agreement: 1) added SAIC as a
party; 2) modified the pooling percentages to: Mutual 46%, State Auto P&C 39%,
Milbank 10%, Midwest Security 1%, Farmers Casualty 3% and SAIC 1%; 3) increased
the exclusion for the Catastrophe Assumption Agreement written by State Auto P&C
from $100.0 million excess of $120.0 million to $135.0 million excess of $120.0
million (see "Reinsurance" in the "Narrative Description of Business"); and 4)
excluded voluntary assumed reinsurance from third parties underwritten by Mutual
from and after January 1, 2000.
The pooling percentages are reviewed by management at least annually,
and more often if deemed appropriate by management or the Board of Directors of
each company, to determine whether any adjustments should be made. Future
adjustments in the pooling percentages are expected to be based on the
performance of the insurance operations of the current pool participants, the
growth in direct premiums written of each company as it relates to the pooling
percentages, the combined ratio of the pooled business and the net premiums
written of the pooled business in relation to the statutory capital
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and surplus of each participant, among other factors. Management of each of the
Pooled Companies makes recommendations to a four-member coordinating committee
consisting of two members of Mutual's Board of Directors and two members of
State Auto Financial's Board of Directors. The coordinating committee reviews
and evaluates various factors relevant to the pooling percentages and recommends
any appropriate pooling change to the Boards of both Mutual and State Auto
Financial. See "Management Agreement" in the "Narrative Description of
Business." The Pooling Arrangement is terminable by any party on 90 days notice
or by mutual agreement of the parties. Neither Mutual, State Auto P&C, Milbank,
Farmers Casualty, Midwest Security, nor SAIC currently intends to terminate the
pooling arrangement.
The Pooling Arrangement is designed to produce more uniform and stable
underwriting results for each of the Pooled Companies than any one company would
experience individually by spreading the risk among each of the participants.
Under the terms of the Pooling Arrangement, all premiums, incurred losses, loss
expenses and other underwriting expenses are prorated among the companies on the
basis of their participation in the pool. One effect of the Pooling Arrangement
is to provide each participant with an identical mix of property and casualty
insurance business on a net basis.
The 2000 Pooling Agreement contains a provision which excludes from the
scope of the Pooling Arrangement catastrophic loss claims and loss adjustment
expenses incurred by State Auto P&C, Mutual, Milbank, National, Midwest
Security, Farmers Casualty, SAIC, and Mid-Plains in the amount of $135.0 million
in excess of $120.0 million as well as the premium for such exposures. State
Auto P&C has become the reinsurer for each insurer in the State Auto Group for
this layer of reinsurance under a Catastrophe Assumption Agreement. Effective
November 2000, these limits in the Catastrophe Assumption Agreement were amended
to $115.0 million excess of $120.0 million, which layer of reinsurance continues
to be excluded from the 2000 Pooling Agreement. See "Reinsurance" in the
"Narrative Description of Business."
MANAGEMENT AGREEMENT
Prior to January 1, 2000, the Company operated and managed its business
in conjunction with Mutual under a management agreement which was restructured
pursuant to an Amended and Restated Management Agreement effective April 1,
1994. Under this agreement, State Auto P&C provided executive management
services for Mutual, Milbank, and National, overseeing the insurance operations
of these companies. A management fee was paid by Mutual, Milbank, and National
for the services provided by State Auto P&C equal to 2% of the five year average
of annual statutory statement "surplus as regards policyholders," less
valuations for managed subsidiaries, of each managed company. The Amended and
Restated Management Agreement also imposed a performance standard which could
result in State Auto P&C not being entitled to the fee for a particular quarter
if a managed company's performance did not meet the standard incorporated in the
agreement. In 1999, the managed companies paid a management fee of $7.1 million
to State Auto P&C.
In addition to the above-described Amended and Restated Management
Agreement, State Auto P&C and Mutual entered into a Management Agreement with
Midwest Security effective as of January 1, 1997 (the "Midwest Management
Agreement"), and with Farmers Casualty and Mid-Plains effective as of January 1,
1999 (the "Farmers Casualty Management Agreement"). Effective January 1, 2000,
each of these agreements was replaced (see below). Under each of these prior
agreements, Mutual provided clerical and non-executive employees to Midwest
Security, Farmers Casualty and Mid-Plains. Under the Midwest Management
Agreement, the Company provided executive management services to Midwest
Security in return for a management fee. Under this agreement, the Company's
management fee was based on direct written premium of Midwest Security. The fee
set for 1999 was 0.75% of direct written premium of Midwest Security and
included a performance standard, as well. In 1999, Midwest Security paid a
management fee of $131,000 to State Auto P&C. Under the Farmers Casualty
Management Agreement, specific services were assignable to State Auto P&C by
resolution of the Boards of Farmers Casualty and Mid-Plains. The fee due was
dependent on the scope of the services assigned but it was capped at 0.75% of
direct written premium.
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As mentioned above, as of January 1, 2000, the 2000 Management
Agreement (the "2000 Management Agreement") (became effective among State
Auto P&C, Mutual, Milbank, National, SAIC, Stateco, S.I.S. and 518 PML. The
2000 Midwest Management Agreement (the "2000 Midwest Management Agreement")
became effective among State Auto P&C, Mutual and Midwest Security, while the
2000 Farmers Casualty Management Agreement (the "2000 Farmers Casualty
Management Agreement") became effective among State Auto P&C, Mutual, Farmers
Casualty and Mid-Plains. Under these management agreements, every person
providing services to the Company, Mutual and Midwest Security is specifically
designated an employee of State Auto P&C. Under these management agreements,
employees of State Auto P&C perform every service required in the management
and operation of each party to the agreement. All costs incurred by Mutual with
respect to underwriting expenses and loss expenses incurred on behalf of
Mutual, State Auto P&C, Milbank, Midwest Security, Farmers Casualty and SAIC
are shared through the 2000 Pooling Agreement. See "Pooling Arrangement" in the
"Narrative Description of Business". For those insurers not party to the 2000
Pooling Agreement, National and Mid-Plains, expenses directly attributable to a
particular company continue to be charged to that company and expenses of
personnel who are not dedicated entirely to work for a particular company are
allocated among the companies based on an estimate of time devoted by such
personnel to each company for which services are rendered. Each party to the
2000 Management Agreement pays State Auto P&C a quarterly fee equal to 4% of
the three year average of the Managed Companies' surplus (less other Managed
Companies). Under the 2000 Midwest Management Agreement, Midwest Security pays
State Auto P&C a fee equal to 0.75% of its direct written premium of Midwest
Security and Farmers Casualty and Mid-Plains pay 0.75% of direct written
premium under the 2000 Farmers Casualty Agreement. The 2000 Management
Agreement imposes a performance standard which could result in State Auto P&C
not being entitled to the fee for a particular quarter if a managed company's
performance does not meet the performance standard incorporated in the
agreement. In 2000, the managed companies paid a management fee of $19.0
million to State Auto P&C.
The Ohio Department of Insurance (the "Department") has requested that,
beginning in 2001, Mutual file an analysis on a quarterly basis with the
Department that justifies the apportionment of the service fee paid by Mutual to
State Auto P&C under the 2000 Management Agreement under the accounting guidance
outlined in Statement of Statutory Accounting Principles No. 70 - Allocation of
Expenses ("SSAP No. 70"). The Company believes its accounting for such service
fee is consistent with all statutory accounting principles. However, there can
be no assurance that all or any part of the service fee paid by Mutual will be
justified to the Department's satisfaction, which may affect the amount of such
fee recognized as revenue by Company.
The 2000 Management Agreement and 2000 Midwest Management Agreement set
forth procedures for potential conflicts of interest. Generally, business
opportunities presented to the common officers of the companies, other than
business opportunities that meet certain criteria, must be presented to a
four-member coordinating committee consisting of two directors of Mutual, who
represent the interests of Mutual and its subsidiary, and two directors of the
Company, who represent the interests of State Auto Financial and its
subsidiaries. This committee reviews and evaluates the business opportunity
using such factors as it considers relevant. Based upon such review and
evaluation, this committee then makes recommendations to the respective boards
of directors as to whether or not such business opportunity should be pursued
and if so, by which company. The Boards of Directors of Mutual, State Auto
Financial and, when appropriate, a subsidiary, must then act on the
recommendation of the committee after considering all other factors they deem
relevant.
Each of the 2000 Management Agreement, the 2000 Midwest Management
Agreement and the 2000 Farmers Casualty Management Agreement has a ten-year term
ending December 31, 2009, and automatically renews for an additional ten-year
term unless sooner terminated in accordance with its terms. The 2000 Management
Agreement may also be terminated by any of the managed companies upon events
constituting a change of control or potential change of control (as defined in
the 2000 Management Agreement) of the Company, upon agreement between a managed
company and State Auto P&C and, the agreement is terminated automatically with
respect to a party if it is subject to insolvency proceedings. If the 2000
Management Agreement is terminated for any reason, the Company would have to
locate facilities to continue its operations.
Investment management services are provided by Stateco. See "Investment
Management Services" in the "Narrative Description of Business."
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STANDARD INSURANCE SEGMENT
The Company's share of the business written by the Pooled Companies
constitutes the Company's standard insurance segment. This includes personal and
commercial property and casualty insurance lines, including automobile,
homeowners, commercial multi-peril, workers' compensation, liability, fire and
other lines of business. Independent insurance agencies constitute the Company's
sales force for both the standard insurance products and the non-standard
insurance products. Footnote 14 in the Company's Consolidated Financial
Statements included herewith sets forth the amount of the Company's net earned
premiums by line of insurance for both standard lines and nonstandard lines.
As mentioned above, the insurance business of Mutual, State Auto P&C,
Milbank, Midwest Security, Farmers Casualty, and as of January 1, 2000, SAIC, is
combined through the Pooling Arrangement. This Pooling Arrangement effectively
gives each of the Pooled Companies an identical mix of personal and commercial
business as written by all six insurers. The Pooled Companies products' sales
are predominantly personal lines.
The insurance businesses of National and Mid-Plains, are not included
in the Pooling Arrangement. Except for reinsurance arrangements between each of
these companies and Mutual, 100% of each Company's business remains in the
Company. Both National's and Mid-Plains' products are personal lines auto
insurance products written for non-standard risks, with less restrictive
underwriting criteria and higher rates than those applicable to standard risks.
The Company uses computer-based underwriting procedures for its
personal lines business. Under such procedures, applications for such business
may be accepted or rejected based upon established underwriting guidelines.
Applications that do not meet guidelines for automated acceptance are referred
to personal lines specialists who review the applications and assess exposure.
During the underwriting process, risks are also reviewed to determine whether or
not they are acceptable as submitted by the independent agents as preferred,
standard or non-standard risks. While personal lines specialists have
underwriting and sales responsibilities, the Company has begun experimenting
with a new sales effort in personal lines. It has created a position called
Personal Lines Sales Specialist, whose primary responsibilities are to have
regular personal contact with a group of agencies for the purpose of making
those agencies more aware of the Company's personal lines product portfolio.
The following table sets forth the statutory loss ratios by line of
insurance and the combined ratio for the standard insurance segment of the
Company's business, prepared in accordance with accounting practices prescribed
or permitted by state insurance authorities, for the periods indicated. The loss
ratio is the ratio of incurred losses and associated expenses to net earned
premiums ("loss ratio"). The combined ratio is a traditional measure of
underwriting profitability. The combined ratio is the sum of (a) the loss ratio;
and (b) the ratio of expenses incurred for commissions, premium taxes,
administrative and other underwriting expenses, to net written premium ("expense
ratio"). When the combined ratio is under 100%, underwriting results are
generally considered profitable. Conversely, when the combined ratio is over
100%, underwriting results are generally considered unprofitable. The combined
ratio does not reflect investment income or federal income taxes. The Company's
operating income depends on income from underwriting operations, investments and
management fees.
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Year Ended December 31(1)
-----------------------------------------
2000 1999 1998
---- ---- ----
Loss ratios:
Automobile...................................... 66.7% 65.2% 65.7%
Homeowners and Farmowners.................. 78.8% 75.3% 86.0%
Commercial multi-peril..................... 63.0% 69.9% 57.1%
Workers' compensation...................... 65.2% 41.1% 51.1%
Fire and allied lines...................... 58.8% 89.2% 81.8%
Other commercial liability................. 80.7% 61.4% 61.2%
Other personal lines....................... 34.6% 36.3% 32.3%
Other commercial lines..................... 9.7% 28.4% 20.0%
---- ---- ----
Total loss ratio................................ 67.6% 67.0% 67.9%
Expense ratio................................... 27.1% 29.5% 29.8%
---- ---- ----
Combined ratio.................................. 94.7% 96.5% 97.7%
==== ==== ====
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(1) This reflects a combination of the loss ratios of State Auto P&C, Milbank,
Farmers Casualty and SAIC after giving effect to reinsurance and the 2000
Pooling Agreement, the 99 Pooling Agreement and the Amended and Restated
Reinsurance Pooling Agreement effective January 1, 1998 (the "98 Pooling
Agreement"), respectively.
- ------------------
NON-STANDARD INSURANCE SEGMENT
In October 1991, State Auto Financial formed National to write personal
automobile insurance for nonstandard risks. National began writing insurance in
Ohio in 1992. It is now licensed in 22 states and active in 18, and is scheduled
to begin operations in Florida during 2001. In addition to National, as of
January 1, 1999, the Company writes nonstandard auto insurance through
Mid-Plains. Mid-Plains operates in Kansas and Iowa. The Company currently does
not contemplate combining the operations of Mid-Plains and National. Nonstandard
automobile products provide insurance for private passenger automobile risks
that are typically rejected or canceled by standard market companies because
insureds have poor loss experience or a history of late payments of premium.
Nonstandard products are priced to account for the additional risk and expenses
normally associated with this market.
The following table sets forth the statutory loss ratios and combined
ratios of National and Mid-Plains, which are engaged in the nonstandard segment
of the business.
Year Ended December 31
------------------------------------------
2000 1999 1998
---- ---- ----
Loss Ratio
Automobile 81.4% 71.7% 75.0%
Expense Ratio 25.2% 29.9% 25.0%
----- ----- -----
Combined Ratio 106.6% 101.6% 100.0%
===== ===== =====
MARKETING
In its 26 states of operation, the State Auto Group markets its
products through approximately 14,000 insurance agents associated with
approximately 2,200 independent insurance agencies. State Auto Financial's
acquisition of Farmers Casualty gave the Company the opportunity to enter its
25th and 26th states of operation effective January 1, 1999, adding
approximately 200 agencies and 1,200 agents to market its products. Prior to
1999, Farmers Casualty marketed personal lines only; the Company introduced
commercial lines to Farmers Casualty's agents in Kansas during 1999 and Iowa
agents during 2000.
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None of the companies in the State Auto Group has any contracts with
managing general agencies.
State Auto National markets non-standard products exclusively through
the Company's network of independent agents. As noted above, State Auto National
is licensed in 22 states and operates in 18 states in 2000. Mid-Plains markets
nonstandard auto insurance in Iowa and Kansas through the agency network of
Farmers Casualty in those states. See "Non-Standard Automobile Insurance" in the
"Narrative Description of Business."
Because independent insurance agents significantly influence which
insurance company their customers select, management views the Company's
independent insurance agents as its primary customers. Management strongly
supports the independent agency system and believes that maintenance of a strong
agency system is essential for the Company's present and future success. As
such, the Company continually develops programs and procedures to enhance agency
relationships. Examples include regular travel by senior management and branch
office staff to meet with agents, in person, in their home states, training
opportunities, an agent stock purchase plan and an agent stock option plan.
The Company actively helps its agencies develop professional sales
skills within their staff. The training programs include both products and sales
training in concentrated programs in the Company's home office. Further, the
training programs include disciplined follow-up and coaching for an extended
time.
The Company takes a leadership role in the insurance industry with
respect to agency automation, promoting single entry multi-company interface
using industry standards, especially through software developed and marketed by
S.I.S. (SEMCI Partner(R)). Since agents and their customers realize better
service and efficiencies through automation, they value their relationship with
the Company and it makes the Company attractive to new agency appointments.
The Company shares the cost of approved advertising with selected
agencies. The Company provides agents with certain travel and cash incentives if
they achieve certain sales and underwriting profit levels. Further, the Company
recognizes its very top agencies as Inner Circle Agents. Inner Circle Agents are
rewarded with additional trip and financial incentives, including additional
profit sharing bonus and additional contributions to their Inner Circle Agent
Stock Purchase Plan, which is part of the Agent Stock Purchase Plan described
below.
To strengthen agency commitment to producing profitable business and
further develop its agency relationships, the Company's Agent Stock Purchase
Plan offers its agents the opportunity to use commission income to purchase the
Company's stock. The Company's transfer agent administers the plan using
commission dollars assigned by the agents to purchase shares on the open market
through a broker. As of year-end 2000, 278 agencies participated in this agent
stock purchase plan.
In addition to the Agent Stock Purchase Plan, the Company has created
an Agent Stock Option Plan incentive for a select group of agencies which
represent the Company. If an agent/agency meets specific annual production and
profitability requirements during a five-year period the agent participates in
the plan, that agent/agency vests State Auto Financial stock options granted
annually at the market price on the day of the grant. Vested options are
exercisable and have a 10-year term from date of grant.
Under the Company's agency agreements with its independent insurance
agencies, each agent the Company licenses is authorized to sell and bind
coverage in accordance with established procedures. They are also authorized to
collect and remit premiums. The authority of agents to bind an insurance company
is common practice in the property and casualty insurance industry. The Company
controls risk by its right to terminate coverage on a policy bound by the agent.
In addition, the Company does not grant binding authority for risks it considers
to present a greater than normal exposure to loss. Each agency receives a
percentage of direct premiums written as a commission. As bonus compensation,
the
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agency receives a share of the underwriting profits generated by their
policies. This is subject to certain qualifying conditions as set forth in the
agency agreement.
The Company receives premiums on products marketed in Alabama,
Arkansas, Florida, Georgia, Illinois, Indiana, Iowa, Kansas, Kentucky, Maryland,
Michigan, Minnesota, Mississippi, Missouri, North Carolina, North Dakota, Ohio,
Oklahoma, Pennsylvania, South Carolina, South Dakota, Tennessee, Utah, Virginia,
West Virginia and Wisconsin. During 2000, the seven states that contributed the
greatest percentage of direct premiums written to the State Auto Group were Ohio
(21.0%), Kentucky (11.0%), Tennessee (7.0%), South Carolina (6.0%), Pennsylvania
(5.0%), North Carolina (5.0%) and Maryland (4.0%).
CLAIMS
Insurance claims on policies written by the Company are usually
investigated and settled by staff claims adjusters. The Company's claims policy
emphasizes timely investigation of claims, settlement of meritorious claims for
equitable amounts, maintenance of adequate reserves for claims, and control of
external claims adjustment expenses. This claims policy is designed to support
the Company's marketing efforts by providing agents and policyholders with
prompt service.
Claim settlement authority levels are established for each adjuster,
supervisor and manager based on his or her level of expertise and experience.
Upon receipt, each claim is reviewed and assigned to an adjuster based upon its
type, severity and class of insurance. The claims department is responsible for
reviewing the claim, obtaining necessary documentation and establishing loss and
expense reserves of certain claims. Any property or casualty claims estimated to
reach $100,000 or above are sent to the home office to be supervised by claims
department specialists. In territories in which there is not sufficient volume
to justify having full-time adjusters, the Company uses independent appraisers
and adjusters to evaluate and settle claims under the supervision of claims
department personnel.
The Company attempts to minimize claims costs by settling as many
claims as possible through its internal claims staff and, if possible, by
settling disputes regarding automobile physical damage and property insurance
claims (first party claims) through arbitration. In addition, selected agents
have authority to settle small first party claims which improves claims service.
The Company's in-house trial counsel operation in Cleveland, Ohio, which
represents insureds in third party litigation, continues its operation, having
added a fourth attorney in 1998. The Company also has added a third lawyer to
the in-house trial counsel's office in Baltimore, Maryland. It has no immediate
plans to add in-house trial counsel in any other territories where it operates.
The third party, proprietary bodily injury evaluation software which
claims representatives use to help them value bodily injury claims, except for
the most severe injury cases, continues to be a valuable tool for the Company.
The Central Claims Department ("CCD") created in the Company's home office in
1998 has expanded in size since its inception, both in terms of the volume of
claims handled and the number of individuals working in the unit without a net
increase in the number of employees in the Claims Department. The Claims
Department also provides 24 hour, 7 days a week claim service through associates
in the home office.
RESERVES
Loss reserves are management's best estimates at a given point in time
of what an insurer expects to pay to claimants, based on facts, circumstances
and historical trends then known. It can be expected that the ultimate liability
will exceed or be less than such estimates. During the loss settlement period,
additional facts regarding individual claims may become known, and consequently
it often becomes necessary to refine and adjust the estimates of liability.
The Company maintains reserves for the eventual payment of losses and
loss expenses for both reported claims and incurred claims that have not yet
been reported. Loss expense reserves are intended
12
to cover the ultimate costs of settling all losses, including investigation and
litigation costs from such losses.
Reserves for reported losses are established on either a case-by-case
or formula basis depending on the type and circumstances of the loss. The
case-by-case reserve amounts are determined based on the Company's reserving
practices, which take into account the type of risk, the circumstances
surrounding each claim and policy provisions relating to types of loss. The
formula reserves are based on historical paid loss data for similar claims with
provisions for trend changes caused by inflation. Loss and loss expense reserves
for incurred claims that have not yet been reported are estimated based on many
variables including historical and statistical information, inflation, legal
developments, storm loss estimates, and economic conditions. Loss reserves are
reviewed on a regular basis and as new data becomes available, estimates are
updated resulting in adjustments to loss reserves. Although management uses many
resources to calculate reserves, there is no precise method for determining the
ultimate liability. The Company does not discount loss reserves for financial
statement purposes.
Mutual has guaranteed the adequacy of State Auto P&C's loss and loss
expense reserves as of December 31, 1990. Pursuant to the guarantee, Mutual has
agreed to reimburse State Auto P&C for any losses and loss expenses in excess of
State Auto P&C's December 31, 1990 reserves ($65.5 million) that may develop
from claims that have occurred on or prior to that date. This guarantee ensures
that any deficiency in the reserves of State Auto P&C as of December 31, 1990,
under the Pooling Arrangement percentages effective on December 31, 1990 will be
reimbursed by Mutual. As of December 31, 2000, there has been no adverse
development of these reserves. In the event Mutual becomes financially impaired,
and subject to regulatory restrictions, it may be unable to make any such
reimbursement.
The following table presents one-year development information on
changes in the reserve for loss and loss expenses of the Company for the three
years ended December 31, 2000.
Year Ended December 31
--------------------------------------------
2000 1999 1998
--------- --------- ---------
(in thousands)
Reserve for losses and loss expenses
At beginning of year (1) $ 221,682 $ 205,034 $ 194,155
--------- --------- ---------
Provision for losses and loss
Expenses occurring:
Current year 277,805 271,507 255,885
Prior years(2) (5,638) (6,878) (13,591)
--------- --------- ---------
Total 272,167 264,629 242,294
--------- --------- ---------
Loss and loss expense payments
For claims occurring during:
Current year 164,620 168,512 157,988
Prior years 104,871 100,349 86,671
--------- --------- ---------
Total 269,491 268,861 244,659
--------- --------- ---------
Impact of acquisition of Farmers Casualty
and Mid-Plains, 1/1/99 -- 13,247 --
Impact of pooling change 1/1/00, 1/1/99 and 1/1/98 (3) 12,295 7,633 13,244
--------- --------- ---------
Reserve for losses and loss expenses at end of year (1) $ 236,653 $ 221,682 $ 205,034
========= ========= =========
- ---------------
(1) This line item is net of reinsurance recoverable on losses and loss
expenses payable of approximately, $7,930,000, $10,807,000, and $12,416,000
for the years 2000, 1999, and 1998, respectively.
13
(2) This line item shows redundancies in the provision for losses and loss
expenses attributable to prior years in the amounts of approximately
$5,638,000, $6,878,000, and $13,591,000 for the years 2000, 1999, and 1998,
respectively. The change in the redundancy over the three year period
ending December 31, 2000 has resulted primarily from less favorable
development in the long-tail lines such as general liability, commercial
auto liability, workers' compensation and no-fault insurance.
(3) This line item represents the increase in loss and loss expense reserves
due to the Company's change in pooling participation percentages effective
January 1, 2000, 1999 and 1998, respectively.
- ----------------
The following table sets forth the development of reserves for losses
and loss expenses from 1990 through 2000 for the Company. "Net liability for
losses and loss expenses payable" sets forth the estimated liability for unpaid
losses and loss expenses recorded at the balance sheet date, net of reinsurance
recoverables, for each of the indicated years. This liability represents the
estimated amount of losses and loss expenses for claims arising in the current
and all prior years that are unpaid at the balance sheet date, including losses
incurred but not reported to the Company.
The lower portion of the table shows the re-estimated amounts of the
previously reported reserve based on experience as of the end of each succeeding
year. The estimate is increased or decreased as more information becomes known
about the claims incurred.
The upper section of the table shows the cumulative amounts paid with
respect to the previously reported reserve as of the end of each succeeding
year. For example, through December 31, 2000, the Company had paid 70.2% of the
currently estimated losses and loss expenses that had been incurred, but not
paid, as of December 31, 1991.
The amounts on the "cumulative redundancy (deficiency)" line represent
the aggregate change in the estimates over all prior years. For example, the
1990 reserve has developed a $9.2 million redundancy through December 31, 2000.
That amount has been included in operations over the ten years and did not have
a significant effect on income of any one year. The effects on income caused by
changes in estimates of the reserves for losses and loss expenses for the most
recent three years are shown in the foregoing three-year loss development table.
In evaluating the information in the table, it should be noted that
each amount includes the effects of all changes in amounts for prior periods.
For example, the amount of the redundancy related to losses settled in 1995, but
incurred in 1992, will be included in the cumulative redundancy amount for years
1992, 1993 and 1994. The table does not present accident or policy year
development data, which readers may be more accustomed to analyzing. Conditions
and trends that have affected the development of the liability in the past may
not necessarily occur in the future. Accordingly, it may not be appropriate to
extrapolate future redundancies or deficiencies based on this table.
Effective January 1, 1992, the pooling percentage was changed whereby
State Auto P&C increased its share in the pooled losses and loss expenses from
20% to 30%. This increase is reflected in the 1992 column. Effective January 1,
1995, the pooling percentage was again changed adding Milbank to the pool and
increasing State Auto P&C's share in the pooled losses and loss expenses from
30% to 35%. This increase is reflected in the 1995 column. In 1998, 1999 and
2000, the pooling arrangement was amended to increase the Company's share of
premiums, losses and expenses. An amount of assets equal to the increase in net
liabilities was transferred to the Company from Mutual in 1992, 1995, 1998, 1999
and 2000 in conjunction with each year's respective pooling change. The amount
of the assets transferred from Mutual in 1992, 1995, 1998, 1999 and 2000 has
been netted against and has reduced the cumulative amounts paid for years prior
to 1992, 1995, 1998, 1999 and 2000, respectively.
[See table on following page.]
14
State Auto Financial Corp.
Years Ended December 31
------------------------------------------------------------------------------------------------------
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
(Dollars in Thousands)
Net liability for losses
and loss expenses payable $65,464 $71,139 $119,044 $123,337 $126,743 $206,327 $199,480 $194,155 $205,034 $221,682 $236,657
Paid (cumulative)
as of:
One year later 43.3% 12.2% 41.3% 42.2% 1.5% 38.2% 39.4% 32.7% 35.4% 41.8% --
Two years later 46.1% 43.0% 60.9% 41.3% 29.1% 55.4% 54.1% 54.6% 61.6%
Three years later 62.9% 58.7% 60.6% 55.6% 44.5% 63.3% 65.0% 70.1%
Four years later 71.8% 58.4% 68.0% 64.5% 51.0% 67.7% 73.2%
Five years later 72.1% 63.9% 71.9% 67.2% 54.6% 71.9%
Six years later 75.5% 67.5% 72.5% 69.0% 58.8%
Seven years later 77.8% 67.7% 73.7% 72.1%
Eight years later 77.1% 69.0% 75.2%
Nine years later 77.5% 70.2%
Ten years later 78.5%
Net liability re-estimate
as of:
One year later 95.4% 91.2% 92.7% 93.7% 87.4% 87.0% 91.3% 93.0% 96.6% 97.5% --
Two years later 92.1% 87.2% 90.5% 90.0% 77.1% 86.4% 87.3% 92.0% 96.7%
Three years later 89.7% 85.4% 87.6% 85.0% 77.0% 83.2% 86.7% 91.9%
Four years later 88.1% 84.5% 85.6% 86.3% 72.9% 81.6% 87.0%
Five years later 89.7% 82.3% 87.3% 82.8% 70.9% 81.3%
Six years later 88.4% 86.7% 84.5% 81.6% 70.0%
Seven years later 93.2% 83.1% 83.0% 80.8%
Eight years later 89.5% 81.0% 82.0%
Nine years later 87.2% 79.4%
Ten years later 85.9%
Cumulative redundancy
(deficiency) $9,239 $14,671 $21,371 $23,701 $38,042 $38,624 $25,919 $15,696 $6,812 $5,638 --
Cumulative redundancy
(deficiency) 14.1% 20.6% 18.0% 19.2% 30.0% 18.7% 13.0% 8.1% 3.3% 2.5% --
Gross* liability -
end of year $224,771 $245,929 $277,783 $412,553 $410,658 $402,718 $414,268 $438,747
Reinsurance receivable $105,727 $122,591 $151,040 $206,226 $211,178 $208,563 $209,234 $217,065
Net liability - end of year $119,044 $123,337 $126,743 $206,327 $199,480 $194,155 $205,034 $221,682
Gross liability
re-estimated - latest 94.9% 97.4% 92.0% 83.7% 89.3% 92.3% 98.2% 96.0%
Reinsurance receivable
re-estimated - latest 109.4% 114.1% 110.4% 86.1% 91.5% 92.7% 99.7% 94.6%
Net liability re-estimated
- latest 82.1% 80.8% 70.0% 81.3% 87.0% 91.9% 96.7% 97.5%
* Gross liability includes: Direct & assumed losses & loss expenses payable.
15
The following table is a reconciliation as of each December 31 of
losses and loss expenses payable, computed under generally accepted accounting
principles ("GAAP"), to losses and loss expenses payable, computed under
statutory accounting principles used by insurance companies for reporting to
state insurance regulators ("STAT"):
2000 1999 1998
---- ---- ----
(in thousands)
GAAP losses and loss
expenses payable $244,583 $232,489 $217,450
Less: ceded reinsurance recoverable
on losses and loss expenses payable 7,930 10,807 12,416
Add: salvage and subrogation
Recoverable 13,402 13,505 12,817
-------- -------- --------
STAT losses and loss
expenses payable $250,055 $235,187 $217,851
======== ======== ========
REINSURANCE
The Company, Mutual and Midwest Security follow the customary industry
practice of reinsuring a portion of their exposures and paying to the reinsurers
a portion of the premiums received on all policies. Insurance is ceded
principally to reduce net liability on individual risks or for individual loss
occurrences, including catastrophic losses. Effective January 1, 2000,
reinsurance premiums and reimbursements are allocated among State Auto P&C,
Milbank, Mutual, Midwest Security, Farmers Casualty and SAIC according to their
relative pooling percentages. National and Mid-Plains do not directly
participate in the Pooling Arrangement. Although reinsurance does not legally
discharge State Auto P&C, Mutual, National, Milbank, Midwest Security, Farmers
Casualty, Mid-Plains or SAIC from primary liability for the full amount of
limits applicable under their policies, it does make the assuming reinsurer
liable to the extent of the reinsurance ceded.
Each member of the State Auto Group has separate working reinsurance
treaties for property and casualty lines with several reinsurers arranged
through a reinsurance broker. Under the property excess of loss treaty, each
member of the State Auto Group is responsible for the first $2.0 million of each
defined loss and the reinsurers are responsible for 100% of the excess over $2.0
million up to $10.0 million of such defined loss, depending upon the nature of
the injury or damage. The rates for this reinsurance are negotiated annually.
The terms of the casualty excess of loss program provide that each
company in the State Auto Group is responsible for the first $2.0 million of a
covered loss. The reinsurers are responsible for 100% of the loss excess of $2.0
million and up to $5.0 million. Also, certain unusual claim situations involving
bodily injury liability, property damage liability, uninsured motorist, personal
injury protection and workers' compensation insurance are covered by an
arrangement which provides for $10.0 million of coverage above a $5.0 million
retention for each loss occurrence. This layer of reinsurance sits above the
$3.0 million excess of $2.0 million arrangement.
In addition, the State Auto Group has secured other reinsurance to
limit the net cost of large loss events for certain types of coverages. Included
are umbrella liability losses which are reinsured up to a limit of $15.0 million
above a maximum $600,000 retention. The State Auto Group also makes use of the
facultative market for unique risk situations and participates in involuntary
pools and associations in certain states.
State Auto P&C, Mutual, Milbank, Midwest Security, National, Farmers
Casualty, Mid-Plains and SAIC combined retain the first $40 million of each
occurrence. Eighty ($80) million dollars of traditional reinsurance is available
above the $40 million retention with a co-participation of the above named
companies of 5%.
16
In the event the State Auto Group incurs catastrophe losses in excess
of $120.0 million, State Auto Financial has implemented a structured contingent
financing transaction with Bank One ("Bank One") to provide up to $115.0 million
to be used to cover such catastrophe losses. This arrangement, effective
November 17, 2000, replaced the prior structured contingent financing
transaction State Auto Financial had with Bank One effective November 19, 1999.
Under this arrangement, in the event of such a loss, State Auto Financial would
issue and sell redeemable preferred shares to SAF Funding Corporation, a special
purpose company ("SPC"), which will borrow the money necessary for such purchase
from Bank One and a syndicate of other lenders (the "Lenders"). State Auto
Financial will contribute to State Auto P&C the proceeds from the sale of its
preferred shares. State Auto P&C has assumed catastrophe reinsurance from
Mutual, Milbank, Midwest Security, National, Farmers Casualty, Mid-Plains, and
SAIC, pursuant to a Catastrophe Assumption Agreement in the amount of $115.0
million excess of $120.0 million. State Auto P&C will use the contributed
capital to pay its direct catastrophe losses and losses assumed under the
Catastrophe Assumption Agreement. State Auto Financial is obligated to repay SPC
(which will repay the Lenders) by redeeming the preferred shares over a six-year
period. This layer of $115.0 million in excess of $120.0 million has been
excluded from the Pooling Arrangement as well by virtue of the 2000 Pooling
Agreement. See "Pooling Arrangement" in the "Narrative Description of Business."
In addition, State Auto Financial's obligation to repay SPC has been secured by
a Put Agreement among State Auto Financial, Mutual and the Lenders, under which,
in the event of a default by State Auto Financial as described in the Credit
Agreement or in the Put Agreement, Mutual would be obligated to put either the
preferred shares or the loan(s) outstanding.
National has a reinsurance agreement with Mutual pursuant to which
Mutual assumes all liability losses in excess of National's first $50,000 of
retention. Mutual further provides National with an 8.5% quota share within the
$50,000 retention on liability coverages and a 20% quota share on physical
damage coverages. Mid-Plains also has a reinsurance agreement with Mutual
pursuant to which Mutual reinsures Mid-Plains for $450,000 in excess of
Mid-Plains' first $50,000 of retention on liability coverages.
REGULATION
Most states have enacted legislation that regulates insurance holding
company systems. Ohio, the domiciliary state of Mutual, National, and SAIC, has
adopted legislation regulating the activities of those companies. South Carolina
has adopted legislation regulating the activities of State Auto P&C as the South
Carolina domiciled member of the holding company system, as have South Dakota
and Wisconsin, which are the domiciliary regulators of Milbank and Midwest
Security, respectively, and Iowa which regulates Farmers Casualty and
Mid-Plains. Each insurance company in the holding company system is required to
register with the insurance supervisory agency of its state of domicile and
furnish information concerning the operations of companies within the holding
company system that may materially affect the operations, management or
financial condition of the insurers within the system. Pursuant to these laws,
the respective insurance departments may examine Mutual, State Auto P&C,
Milbank, Midwest Security, Farmers Casualty, SAIC, National and Mid-Plains at
any time, require disclosure of material transactions involving insurer members
of the holding company system and require prior notice and an opportunity to
disapprove of certain "extraordinary" transactions, including, but not limited
to, extraordinary dividends from State Auto P&C, Milbank, Farmers Casualty, SAIC
and National to State Auto Financial. Pursuant to these laws, all transactions
within the holding company system affecting Mutual, State Auto P&C, Milbank,
Midwest Security, Farmers Casualty, SAIC, National or Mid-Plains must be fair
and equitable. In addition, approval of the applicable Insurance Commissioner is
required prior to the consummation of transactions affecting the control of an
insurer.
South Carolina insurance law provides that no person may acquire direct
or indirect control of State Auto P&C unless that person has obtained the prior
written approval of the Chief Insurance Commissioner of South Carolina for such
acquisition. Ohio has similar statutory provisions in place which would be
applicable to National and SAIC, as does South Dakota for Milbank, Wisconsin for
Midwest Security and Iowa for Farmers Casualty and Mid-Plains.
17
In addition to being regulated by the insurance department of its state
of domicile, each insurance company is subject to supervision and regulation in
the states in which it transacts business, and such supervision and regulation
relate to numerous aspects of an insurance company's business operations and
financial condition. The primary purpose of such supervision and regulation is
to ensure financial stability of insurance companies for the protection of
policyholders. The laws of the various states establish insurance departments
with broad regulatory powers relative to granting and revoking licenses to
transact business, regulating trade practices, licensing agents, approving
policy forms, setting reserve requirements, determining the form and content of
required statutory financial statements, prescribing the types and amount of
investments permitted and requiring minimum levels of statutory capital and
surplus. Although premium rate regulation varies among states and lines of
insurance, such regulations generally require approval of the regulatory
authority prior to any changes in rates. In addition, all of the states in which
the State Auto Group transacts business have enacted laws which restrict these
companies' underwriting discretion. Examples of these laws include restrictions
on policy terminations, restrictions on agency terminations and laws requiring
companies to accept any applicant for automobile insurance. These laws may
adversely affect the ability of the insurers in the State Auto Group to earn a
profit on their underwriting operations.
Insurance companies are required to file detailed annual reports with
the supervisory agencies in each of the states in which they do business and
their business and accounts are subject to examination by such agencies at any
time.
There can be no assurance that such regulatory requirements will not
become more stringent in the future and have an adverse effect on the operations
of the State Auto Group.
Dividends. State Auto P&C, Milbank, Farmers Casualty, SAIC and National
are subject to regulations and restrictions under which payment of
non-extraordinary dividends from statutory surplus can be made to State Auto
Financial during the year without prior approval of regulatory authorities.
State Auto Financial's insurer subsidiaries are permitted to pay
dividends without prior approval from their respective domiciliary insurance
departments unless the dividend is an "extraordinary dividend." While the
statutes affecting each insurer subsidiary of State Auto Financial have
different words, there is a common thread that runs through each state's statute
regulating extraordinary dividends. That thread is the basic definition of an
extraordinary dividend which is the greater of 10% of the insurer's surplus or
net income. In three states, Ohio, South Carolina and South Dakota, there is
excluded from the net income of the insurer a distribution of the insurers own
securities. In South Carolina, net realized capital gains and losses are
excluded from the calculation of annual net income. In South Dakota, annual net
income excludes net realized capital gains that exceed 20% of net unrealized
capital gains.
The laws of South Carolina, Iowa and Ohio also require advance notice
of payment of an ordinary dividend. In addition, by acting within a statutory
time frame, the insurance commissioner in each state has the authority to limit
ordinary dividends if an insurer's surplus as regards policyholders is not
reasonable in relation to the insurer's outstanding liabilities and adequate to
its financial needs.
Pursuant to these rules, a total of $44.9 million is available for
payment to State Auto Financial as a dividend from State Auto P&C, Milbank,
Farmers Casualty, SAIC and National during 2001 without prior approval from the
South Carolina, South Dakota, Iowa and Ohio Insurance Departments, respectively,
under current law.
Rate and Related Regulation. The Company is not aware of any adverse
legislation or regulation that has been adopted by any state where the Company
did business during 2000 which would present material obstacles to the Company's
overall business.
In an attempt to make capital and surplus requirements more accurately
reflect the underwriting risk of different lines of insurance as well as
investment risks that attend insurers' operations, the NAIC has tested insurer's
risk-based capital requirements since 1994. As of December 31, 2000, each
insurer
18
affiliated with the Company exceeded all standards tested by the formula
applying risk-based capital requirements.
While the insurance industry is regulated by the states, federal
financial services reform legislation enacted into law in late 1999 will likely
affect the property casualty insurance business. This federal legislation, known
as the Gramm Leach Bliley Act, generally permits "financial holding companies"
to own insurers. This new law is expected to have an impact on the property
casualty industry marketplace, although the nature and extent of the impact is
yet uncertain. It could increase the level of competition; it could bring
additional capital into the insurance marketplace, which could have a negative
impact on product pricing. It also is unclear how insurers owned by "financial
holding companies" will be regulated as compared with other insurers. The
legislation could have an adverse affect on state regulation, which has its own
set of uncertain consequences. This change in the federal law will have
ramifications on the Company as well as the insurance business as a whole. The
Company is still assessing the impact of this law change on its business.
Enhanced privacy regulation is one consequence of Gramm Leach Bliley. Virtually
every state has sought to impose additional restrictions on insurers in sharing
information among affiliates which could increase the Company's expenses.
The property and casualty insurance industry is also affected by court
decisions. Premium rates are actuarially determined to enable an insurance
company to generate an underwriting profit. These rates contemplate a certain
level of risk. The courts may modify, in a number of ways, the level of risk
which insurers had expected to assume including eliminating exclusions,
multiplying limits of coverage, creating rights for policyholders not intended
to be included in the contract and interpreting applicable statutes expansively
to create obligations on insurers not originally considered when the statute was
passed. Courts have also undone legal reforms passed by legislatures, which
reforms were intended to reduce a litigant's rights of action or amounts
recoverable and so reduce the costs borne by the insurance mechanism. These
court decisions can adversely affect an insurer's profitability. They also
create pressure on rates charged for coverages adversely affected and this can
cause a legislative response resulting in rate suppression that can adversely
affect an insurer. The Ohio Supreme Court has issued several decisions expanding
the scope of uninsured and underinsured motorists coverage for policies issued
in Ohio beyond what the insurance industry expected or intended. Much of this
expansion has had retroactive effect. The Company has reviewed these court
decisions and determined their impact not to be material to the Company's
financial position. It is not possible to anticipate the impact of future
decisions affecting this coverage.
INVESTMENTS
The Company's investment portfolio is managed to provide growth of
statutory surplus in order to facilitate increased premium writings over the
long term while maintaining the ability to service current insurance operations.
The primary objectives are to generate income, preserve capital and maintain
liquidity. The Company's investment portfolio is managed separately from that of
Mutual and its affiliates and investment results are not shared by each of the
Pooled Companies through the pooling arrangement. The investment management
services on behalf of the Company and Mutual and its subsidiaries are performed
by Stateco, although investment policies to be implemented by Stateco continue
to be set for each company through the Investment Committee of its Board of
Directors. See "Investment Management Services" in the "Narrative Description of
Business."
The Company's decision to make a specific investment is influenced
primarily by the following factors: (a) investment risks; (b) general market
conditions; (c) relative valuations of investment vehicles; (d) general market
interest rates; (e) the Company's liquidity requirements at any given time; and
(f) the Company's current federal income tax position and relative spread
between after tax yields on tax-exempt and taxable fixed income investments. The
Company has investment policy guidelines with respect to purchasing fixed income
investments which preclude investments in bonds that are rated below investment
grade by a recognized rating service. The maximum investment in any single note
or bond is limited to 5.0% of assets, other than obligations of the U.S.
government or government agencies, for which there is no limit. Investments in
equity securities are selected based on their potential for
19
appreciation as well as ability to continue paying dividends. (See discussion
regarding Market Risk included in Part II - Item 7 "Management's Discussion and
Analysis of Financial Condition and Results of Operations").
Strategies as to specific investments can change depending on the
Company's current federal tax position, market interest rates and general market
conditions. Consequently, pursuant to the Statement of Financial Accounting
Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," the Company segregates a portion of its fixed maturity investments
for the purpose of providing greater flexibility in the investment portfolio.
Fixed maturities that are purchased with the intention and ability of holding
them until maturity are categorized as held-to-maturity and carried at amortized
cost. Fixed maturities that may be sold, thereby providing the Company the
flexibility noted above, are categorized as available-for-sale and are carried
at fair value. Fixed maturities available-for-sale totaled $653.3, and $527.8
million at December 31, 2000 and 1999, respectively.
During 1997, the Company began a program to build on the equity
portfolio to enhance growth of surplus over the long term. At December 31, 2000
and 1999, respectively, the equity portfolio totaled $58.3 and $55.5 million.
The table below provides information about the quality of the Company's
fixed maturity portfolio:
Bond Portfolio Quality
Investment Grade Corporates
and Municipals 81.9%
(Rated AA or better)
U.S. Governments 13.3%
U.S. Government Agencies 4.8%
The following table sets forth the Company's investment results for the
periods indicated:
Year Ended December 31
-------------------------------------
2000 1999 1998
---- ---- ----
(Dollars in thousands)
Average invested assets (1) $712,627 $633,989 $571,152
Net investment income (2) $38,915 $34,262 $32,506
Average yield 5.5% 5.4% 5.7%
- --------------
(1) Average of the aggregate invested assets at the beginning and end of each
period. Invested assets include fixed maturities at amortized cost, equity
securities at cost and cash equivalents.
(2) Net investment income is net of investment expenses and does not include
realized or unrealized investment gains or losses or provision for income
taxes.
- --------------
INVESTMENT MANAGEMENT SERVICES
Stateco has been providing investment management services since 1993.
These services are provided to all insurance companies affiliated with the
Company or Mutual, including Mutual, Midwest Security, State Auto P&C, Milbank,
Farmers Casualty, SAIC, National and Mid-Plains. Stateco has entered into an
Investment Management Agreement with each of these entities, pursuant to which
Stateco manages the investment portfolios of these companies and receives an
investment management fee
20
based on performance and the size of the portfolio managed for each affiliate.
The Investment Committee of each insurer's Board of Directors sets investment
policies to be followed by Stateco.
INSURANCE PREMIUM FINANCE SERVICES
Through Stateco, the Company provides insurance premium finance
services to certain policyholders of Mutual, State Auto P&C and Milbank.
Premiums for property and casualty insurance are typically payable at the time a
policy is placed in force or renewed. On certain large commercial policies, the
premium cost may be difficult for a policyholder to pay in one sum. Stateco
makes loans to commercial insurance policyholders for the term of an insurance
policy to enable them to pay the insurance premium in installments over the term
of the policy, and retains a contractual right to cancel the insurance policy if
the loan installment is not paid on a timely basis. Stateco's revenue from its
insurance premium finance services is not material to the Company at this time.
INSURANCE SOFTWARE BUSINESS
S.I.S. is developing and selling software used by insurance companies
and agencies to allow more efficient and effective electronic management and
communication of policyholder data from insurers to agents (download) and from
agents to insurers (upload). S.I.S.' principal product, SEMCI Partner(R), is an
alternative to significantly more costly agency management systems. S.I.S.
believes SEMCI Partner(R), will be attractive to a substantial segment of
independent insurance agencies. While S.I.S.' principal customer from a revenue
standpoint is Mutual, it has sold and continues to sell SEMCI Partner(R)
directly to agents, including agents who do not represent the State Auto Group.
S.I.S.' revenue from SEMCI Partner(R) and other S.I.S. software sales is not
material to the Company at this time. S.I.S, which had been a majority-owned
subsidiary of the Company through December 31, 1999, is now a wholly owned
subsidiary, after it repurchased shares owned by employees and officers of
S.I.S.
PROPERTY LEASING BUSINESS
As noted above, the Company formed 518 PML, an Ohio limited liability
company, in December 1997. The members of 518 PML are Stateco and State Auto
P&C. Stateco contributed $7.0 million in cash and a parcel of real property
located in Goodlettsville, Tennessee, while State Auto P&C contributed real
property located in Greer, South Carolina. 518 PML constructed an office
building on the real estate in Goodlettsville, which it leased to Mutual
commencing in May 1999, for Mutual's Nashville Regional Office facility. 518 PML
has leased the Greer property to Mutual to use as its Southern Regional Office
facility. In December 2000, 518 PML acquired an office building in West Des
Moines, Iowa, that Farmers Casualty had leased for its insurance operations. 518
PML has leased the West Des Moines property to Mutual to use as its Des Moines
Regional Office facility. In late 1999, it also began to lease motor vehicles to
Mutual for use in its business operations. Revenue from 518 PML is not material
to the Company at this time.
COMPETITION
The property and casualty insurance industry is highly competitive.
Price competition has been very intense during recent years. This continued to
be true in regards to both commercial lines and personal lines, particularly
auto insurance in 2000. Several "national" carriers' active marketing efforts
with respect to personal lines auto insurance have had an impact on the market
for this coverage. The Company competes with numerous insurance companies, many
of which are substantially larger and have considerably greater financial
resources. In addition, because the Company's products are marketed exclusively
through independent insurance agencies, most of which represent more than one
company, the Company faces competition within each agency. See "Marketing" in
the "Narrative Description of Business." The Company competes through
underwriting criteria, appropriate pricing, and quality service to the
policyholder and the agent and through a fully developed agency relations
program.
21
PROPOSED TRANSACTIONS WITH MERIDIAN MUTUAL AND MIGI
On October 25, 2000, Mutual entered into agreements with Meridian
Mutual Insurance Company, an Indiana mutual insurance company ("Meridian
Mutual"), and Meridian Insurance Group, Inc., an Indiana corporation ("MIGI"),
pursuant to which Meridian Mutual will be merged with and into Mutual, with
Mutual continuing as the surviving corporation of the merger (the "Mutual
Merger"), and MIGI will be acquired by Mutual through the merger of a wholly
owned subsidiary of Mutual with and into MIGI (the "MIGI Merger"). The public
shareholders of MIGI will receive $30.00 per share in cash in connection with
the MIGI Merger. Each merger is conditioned upon the consummation of the other
merger, the receipt of all insurance regulatory approvals, and receipt of
antitrust clearance. In addition, the MIGI Merger must be approved by the
shareholders of MIGI, and the Mutual Merger must be approved by the
policyholders of both Meridian Mutual and Mutual and reapproved by the board of
directors of each of Meridian Mutual and Mutual. Meridian Mutual and Mutual have
each agreed to vote all MIGI common shares owned by them in favor of the MIGI
Merger. Together, these two mutual companies own approximately 57% of MIGI's
outstanding common shares. It is anticipated that the Mutual Merger and the MIGI
Merger will be completed during the first half of 2001.
Meridian Mutual is the controlling company of the "Meridian Mutual
Group," which group consists of the following: (i) Meridian Mutual; (ii) MIGI, a
publicly traded corporation which is approximately 48.3% owned by Meridian
Mutual; (iii) MIGI's direct and indirect subsidiaries, which are Meridian
Security Insurance Company, an Indiana-domiciled insurance company ("Meridian
Security"), Meridian Citizens Security Insurance Company, an Indiana-domiciled
insurance company ("Meridian Citizens Security"), and Insurance Company of Ohio,
an Ohio-domiciled insurance company ("ICO"); and (iv) Meridian Citizens Mutual
Insurance Company, an Indiana-domiciled mutual insurance company ("Meridian
Citizens Mutual"). As of December 31, 2000, the Meridian Mutual Group had
approximately 610 employees. The Meridian Mutual Group markets its insurance
products through approximately 8,300 independent insurance agents associated
with approximately 1,400 agencies in 18 states. Additionally, these insurance
products are marketed directly to consumers in two states. The Meridian Mutual
Group's insurance products are marketed primarily in the east, mid, and
west-central parts of the United States.
The following describes certain matters which will occur in the event
that the Mutual Merger and the MIGI Merger are consummated:
o Through the merger of Meridian Mutual with and into Mutual, the
insurance business of Meridian Mutual will become part of the
pooling arrangement with the other Pooled Companies. See "Pooling
Arrangement" in the "Narrative Description of Business" included
elsewhere in this Item 1. Meridian Mutual had approximately $252.3
million in total direct written premiums in 2000. The principal
lines of business of Meridian Mutual, based upon direct written
premiums for the year ended December 31, 2000, were personal and
commercial automobile (approximately 54%), commercial multi-peril
(approximately 16%), homeowners and farmowners multi-peril
(approximately 14%), and workers' compensation (approximately 11%).
o The independent agency system of the Meridian Mutual Group will
become part of the independent agency system of the State Auto
Group. See "Marketing" in the "Narrative Description of Business"
included elsewhere in this Item 1.
o As soon as practicable, it is anticipated that all of the employees
of the Meridian Mutual Group will become employees of State Auto
P&C. Subject to receipt of the regulatory approvals, it is
anticipated that MIGI and its insurance subsidiaries and affiliates
will enter into agreements with State Auto P&C and Mutual pursuant
to which State Auto P&C would perform various functions on behalf of
these companies in exchange for a fee and
22
Mutual would provide the use of certain facilities and equipment in
exchange for the reimbursement of the costs associated with such
usage. See "Management Agreement" in the "Narrative Description of
Business" included elsewhere in this Item 1.
o Subject to receipt of regulatory approvals, it is anticipated that
MIGI's insurance subsidiaries and affiliates will enter into an
investment management agreement with Stateco pursuant to which
Stateco would manage the investment portfolios of these companies in
exchange for an investment management fee. See "Investment
Management Services" in the "Narrative Description of Business"
included elsewhere in this Item 1.
o Subject to receipt of regulatory approvals, it is anticipated that
MIGI's insurance subsidiaries and affiliates will become part of the
State Auto Group's reinsurance arrangements, including the
structured contingent financing arrangements with Bank One. See
"Reinsurance" in the "Narrative Description of Business" included
elsewhere in this Item 1.
EMPLOYEES
As of February 27, 2001, the Company had 1,375 employees. Employees of
the Company are not covered by any collective bargaining agreement. Management
of the Company considers its relationship with its employees to be excellent.
EXECUTIVE OFFICERS OF THE REGISTRANT
Name of Executive Officer and Principal Occupation(s) An Executive Officer
Position(s) with Company Age During the Past Five Years of the Company Since (1)
------------------------- --- -------------------------- ------------------------
Robert H. Moone, 57 Chairman of the Board of STFC and 1991
Chairman, President and Mutual, 1/1/01 to present; Chief
Chief Executive Officer Executive Officer of STFC and Mutual,
5/99 to present; President of STFC
and Mutual, 5/96 to present;
Executive Vice President, 11/93 to
5/96 and prior thereto Vice
President of STFC and Mutual
Mark A. Blackburn, 49 Senior Vice President of STFC and 1999
Senior Vice President Mutual, 3/01 to present; Vice President
of STFC and Mutual, 8/99 to 3/01;
Executive Vice President of Grange
Mutual Casualty Insurance Company
4/96 to 4/99; and for more than
five years prior thereto, Vice
President of General Reinsurance
Corporation
Michael F. Dodd, 63 Senior Vice President of STFC, 5/91 to 1991
Senior Vice President present; Senior Vice President of
Mutual, 2/89 to present
Steven J. Johnston, 41 Senior Vice President of STFC and 1994
Senior Vice President, Mutual, 8/99 to present; Treasurer and
Treasurer and Chief Chief Financial Officer of STFC and
Financial Officer Mutual, 4/97 to present; Vice President
of STFC and Mutual, 5/95 to 8/99
John R. Lowther, 50 Senior Vice President of STFC and 1991
Senior Vice President, Mutual, 3/01 to present; Secretary and
Secretary and General Counsel of STFC, 5/91 to
General Counsel present and of Mutual 8/89 to present;
Vice President of STFC, 5/91 to 3/00
and of Mutual 8/89 to 3/00
23
Name of Executive Officer and Principal Occupation(s) An Executive Officer
Position(s) with Company Age During the Past Five Years of the Company Since (1)
------------------------- --- -------------------------- ------------------------
Terrence L. Bowshier, 48 Vice President of STFC and Mutual, 3/00 1991
Vice President to present; Vice President and
Comptroller of STFC and Mutual, 5/91 to
3/00
James E. Duemey, 54 Vice President and Investment Officer 1991
Vice President of STFC and Mutual, 5/91 to present
and Investment Officer
William D. Hansen, 35 Vice President of Mutual, 3/00 to 2000
Vice President present; Vice President of STFC, 5/00 to
present; Assistant Vice President of
Mutual 5/95 to 3/00
Terrence P. Higerd, 56 Vice President of STFC, 5/91 to 1991
Vice President present; Vice President of Mutual, 6/87
to present
Noreen W. Johnson, 52 Vice President of STFC and Mutual, 3/98 1998
Vice President to present; Assistant Vice President of
Mutual, 3/97 to 3/98; employee of
Mutual since 9/92
Robert A. Lett, 61 Vice President of STFC, 3/98 to 1994
Vice President present; Vice President of Mutual, 2/88
to present
John B. Melvin, 51 Vice President of STFC, 3/98 to 1994
Vice President present; Vice President of Mutual,
11/93 to present; and prior thereto an
officer of Mutual
Cathy B. Miley, (2) 51 Vice President of STFC, 3/98 to 1995
Vice President present; Vice President of Mutual, 3/95
to present; Assistant Vice President of
Mutual, 8/92 to 3/95
Richard L. Miley, (2) 47 Vice President of STFC, 3/98 to 1995
Vice President present; Vice President of Mutual, 5/95
to present; Assistant Vice President of
Mutual, 8/87 to 5/95
John M. Petrucci, 42 Vice President of Mutual, 3/00 to 2000
Vice President present; Vice President of STFC, 5/00 to
present; employee of Mutual since 9/96;
employee of Allstate Insurance
Companies, 9/85 to 9/96
Cynthia A. Powell, 40 Vice President of Mutual, 3/00 to 2000
Vice President present; Assistant Vice President, 8/96
to 3/00; Vice President of STFC
5/00 to present; Assistant Vice
President of STFC, 4/97 to 5/00;
employee of Mutual since 6/90
(1) Each of the foregoing executive officers has been designated by the
Company's Board of Directors as an officer for purposes of Section 16 of
the Securities Exchange Act of 1934.
(2) Richard L. Miley and Cathy B. Miley are husband and wife.
ITEM 2. PROPERTIES
Because the operations of the Company and Mutual are integrated with
one another pursuant to the terms of the 2000 Management Agreement, the Company
and Mutual share their operating facilities. See Item 1, "Management Agreement"
in the "Narrative Description of Business." The Company's and Mutual's corporate
headquarters are located in Columbus, Ohio in buildings owned by Mutual that
contain
24
approximately 270,000 square feet of office space. The Company and
Mutual also have regional underwriting and claims office facilities, including a
6,600 square foot branch office in Cleveland, Ohio, owned by Mutual, and a
29,000 square foot branch office in Cincinnati, Ohio, owned by Mutual. In May
1999, an office building constructed by 518 PML containing 38,000 square feet
was completed and leased to Mutual as its Nashville Regional Office. Mutual also
leases the regional office facility in Greer, South Carolina, from 518 PML.
Milbank owns an office facility in Milbank, South Dakota, where Company
employees provide services to Milbank agents and policyholders. Midwest Security
leases an office facility in Onalaska, Wisconsin, where Company employees
service Midwest Security's agents and policyholders. In December 2000, 518 PML
acquired a 21,600 square foot office building in West Des Moines, Iowa, that is
now leased to Mutual as its Des Moines Regional Office. Mutual also leases a
number of small offices throughout its operating area for the claims operations
of Mutual and the Company.
ITEM 3. LEGAL PROCEEDINGS
The Company is a party to a number of lawsuits arising in the ordinary
course of its insurance business. Management of the Company believes that the
ultimate resolution of these lawsuits will not, individually or in the
aggregate, have a material, adverse effect on the financial condition of the
Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS
STOCK TRADING
Common shares are traded in the Nasdaq National Market System under the
symbol STFC. As of March 8, 2001, there were 920 shareholders of record of the
Company's common shares.
MARKET PRICE RANGE, COMMON STOCK(1)
Initial Public Offering -- June 28, 1991, $2.25(1). The high and low
sale prices for each quarterly period for the past two years as reported by
Nasdaq are:
1999 HIGH LOW DIVIDEND
---- ---- --- --------
First Quarter $12.375 $10.250 $0.0250
Second Quarter 13.875 9.375 0.0250
Third Quarter 13.625 9.563 0.0275
Fourth Quarter $11.750 $ 8.875 $0.0275
2000
First Quarter $ 9.750 $ 7.125 $0.0275
Second Quarter 12.125 7.938 0.0275
Third Quarter 13.625 10.438 0.0300
Fourth Quarter $18.000 $11.250 $0.0300
(1) Adjusted for a March 1993 two-for-one, a July 1996 three-for-two common
stock split effected in the form of a stock dividend and a July 1998
two-for-one common stock split, respectively.
25
Additionally, see Liquidity and Capital Resources section of
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included in Item 7 of this Form 10-K Annual Report for a discussion
of regulatory restrictions of applicable dividends payable by the Company's
insurance subsidiaries.
ITEM 6. SELECTED FINANCIAL DATA
"Selected Consolidated Financial Data" is as follows:
YEAR ENDED DECEMBER 31
----------------------
2000* 1999* 1998* 1997 1996 1995* 1994
----- ----- ----- ---- ---- ----- ----
STATEMENTS OF INCOME DATA: (Dollars in thousands, except per share data)
Earned premiums $397,967 392,058 356,210 320,050 304,472 296,364 225,297
Net investment income $ 38,915 34,262 32,506 31,107 29,863 28,461 22,189
Management services income $ 17,594 8,727 7,945 7,367 6,774 6,377 5,170
Net realized gains on investments $ 5,255 2,555 2,925 3,043 2,788 1,758 1,595
Other income $ 3,043 3,269 2,473 1,409 1,200 525 147
--------------------------------------------------------------------------
Total revenues $462,774 440,871 402,059 362,976 345,097 333,485 254,398
--------------------------------------------------------------------------
Income before federal income taxes $ 61,444 56,985 49,605 56,638 34,792 40,953 20,294
--------------------------------------------------------------------------
Net income $ 47,714 42,816 37,497 40,998 26,407 29,894 15,835
--------------------------------------------------------------------------
Earnings per common share (1)(2):
Basic $ 1.24 1.05 .89 .99 .64 .73 .39
--------------------------------------------------------------------------
Diluted $ 1.21 1.03 .87 .97 .63 .72 .39
--------------------------------------------------------------------------
Cash dividends per common share (1) $ .12 .11 .10 .09 .08 .07 .06
--------------------------------------------------------------------------
BALANCE SHEET DATA AT YEAR END:
Total investments $750,870 627,305 579,966 526,363 499,277 479,908 350,639
Total assets $898,106 759,945 717,520 664,384 605,385 579,194 487,282
Note payable to affiliate $ 45,500 45,500 -- -- -- -- --
Total stockholders' equity $386,059 317,687 340,824 297,258 247,619 225,763 175,852
Book value per common share (1) $ 10.01 8.29 8.11 7.11 5.98 5.48 4.29
STATUTORY RATIOS:
Loss ratio 68.5 67.4 68.4 65.2 72.7 68.6 75.4
Expense ratio 27.0 29.5 29.4 28.9 27.3 31.0 28.2
Combined ratio 95.5 96.9 97.8 94.1 100.0 99.6 103.6
Industry combined ratio (3) 109.2 107.7 105.6 101.6 105.8 106.5 108.5
Ratio of net premiums written to
statutory capital and surplus 1.32 1.47 1.63 1.71 1.91 2.12 1.77
(1) Adjusted for a July 1998 2-for-1 common stock split as well as a July
1996 3-for-2 common stock split effected in the form of a stock
dividend.
(2) The earnings per share amounts prior to 1997 have been restated as
required to comply with SFAS No. 128.
(3) Preliminary industry information for 2000 from A.M. Best.
* Reflects change in pooling arrangement, effective January 1, 2000, 1999, 1998
and 1995.
26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
"Management's Discussion and Analysis of Financial Condition and
Results of Operations" is as follows:
OVERVIEW
State Auto Financial Corporation ("State Auto Financial"), through its
principal insurance subsidiaries, State Auto Property and Casualty Insurance
Company ("State Auto P&C"), Milbank Insurance Company ("Milbank"), Farmers
Casualty Insurance Company ("Farmers Casualty") and State Auto Insurance Company
("SAIC"), provides personal and commercial insurance for the standard insurance
market primarily in the Midwest and eastern United States, excluding New York,
New Jersey, and the New England states. Their principal lines of business
include personal and commercial auto, homeowners, commercial multi-peril,
workers' compensation, general liability and fire insurance. State Auto National
Insurance Company ("National") and Mid-Plains Insurance Company ("Mid-Plains")
write personal automobile insurance for risks in the nonstandard insurance
market. State Auto P&C, Milbank, Farmers Casualty, SAIC, National and Mid-Plains
products are marketed through independent agents. State Auto Financial and its
subsidiaries are referred to collectively herein as the "Company."
Through State Auto P&C, the Company provides management and operations
services under the Midwest Management Agreement (as defined below), the Farmers
Casualty Management Agreement (as defined below) and the Mutual Management
Agreement (as defined below) each effective as of January 1, 2000 (collectively
the "2000 Management Agreement"), for insurance and noninsurance affiliates. As
of January 1, 2000, all individuals providing services to any of the State Auto
Companies who were not already employees of State Auto P&C became employees of
State Auto P&C. Under the 2000 Management Agreement, State Auto P&C through its
employees, is responsible for performing all organizational, operational, and
management functions for each of the managed companies. For its performance of
these services, State Auto P&C is paid quarterly a management and operations
services fee based on formulas outlined in the 2000 Management Agreement. This
fee from a managed company may be deferred or withheld if a managed company's
performance does not meet performance criteria set forth in the 2000 Management
Agreement. The Ohio Department of Insurance (the "Department") has requested
that State Automobile Mutual Insurance Company ("Mutual") file an analysis on a
quarterly basis, starting with the quarter beginning January 1, 2001, with the
Department that justifies the apportionment of the service fee paid by Mutual to
State Auto P&C under the 2000 Management Agreement under the accounting guidance
outlined in Statement of Statutory Accounting Principles No. 70 - Allocation of
Expenses ("SSAP No. 70"). The Company believes its accounting for such service
fee is consistent with all statutory accounting principles. However, there can
be no assurance that all or any part of the service fee paid by Mutual will be
justified to the Department's satisfaction, which may affect the amount of such
fee recognized as revenue by the Company. See Item 7-Forward-Looking Statements;
Certain Factors Affecting Future Results. Pursuant to the 2000 Management
Agreement, the Company received cash of $28.1 million equal to the net plan
benefit liabilities assumed relating to the above described transfer of those
individuals who were employees of Mutual as of January 1, 2000. Prior to January
1, 2000, State Auto P&C provided only executive management services to all
insurance affiliates. The Midwest Management Agreement is a management agreement
under which State Auto P&C provides management and operations services to
Midwest Security Insurance Company, a Wisconsin domiciled, wholly owned
subsidiary of Mutual ("Midwest Security"). The Farmers Casualty Management
Agreement is a management agreement under which State Auto P&C provides
management and operations services to Farmers Casualty and Mid-Plains. The
Mutual Management Agreement is a management agreement under which State Auto P&C
provides management and operations services to Mutual, Milbank, National and
SAIC, and other non-insurance affiliates.
SAIC was formed in 1999 to engage in the business of providing standard
personal insurance to its policyholders through the use of leading edge
technology within the independent agency system. Effective January 1, 2000, SAIC
became licensed as a property and casualty insurer and began operating in the
state of Ohio.
On July 7, 1998, State Auto Financial acquired all of the outstanding
shares of Milbank from Mutual pursuant to the Option Agreement dated August
1993. The purchase price of Milbank was approximately $81.9 million. The
transaction was effected through an exchange with Mutual of
27
approximately 5.1 million State Auto Financial common shares for all the issued
and outstanding capital stock of Milbank. This exchange of Milbank shares for
State Auto Financial common shares increased Mutual's ownership of State Auto
Financial to approximately 70% of its issued and outstanding shares. Since the
transaction was a combination of entities under common control, it has been
accounted for similar to a pooling of interests.
In August 1998, State Auto Financial purchased $9.0 million of surplus
notes from Farmers Casualty Company Mutual ("FCCM"), an Iowa domiciled property
casualty insurer for the standard insurance market. In 1998, a plan to convert
FCCM into a stock insurance company was approved by the board of FCCM, its
policyholders and the Iowa Division of Insurance. The plan of conversion
provided that State Auto Financial, in exchange for the redemption of the
surplus notes, would acquire the newly issued shares of Farmers Casualty.
Effective January 1, 1999, FCCM, renamed Farmers Casualty Insurance Company,
became a wholly owned subsidiary of State Auto Financial. In addition, Farmers
Casualty owns 100% of the outstanding shares of Mid-Plains, an Iowa domiciled
property casualty insurer, which principally writes nonstandard auto insurance.
Through Stateco Financial Services, Inc. ("Stateco"), a wholly owned
subsidiary, the Company provides investment management services to affiliated
companies and also provides insurance premium finance services to customers of
State Auto P&C, Milbank and Mutual.
Through Strategic Insurance Software, Inc. (S.I.S.), a wholly owned
subsidiary, the Company develops and sells software for the processing of
insurance transactions, database management systems for insurance agents and
electronic interfacing of information between insurance companies and agents.
S.I.S. sells its services and products to affiliated companies and their agents
and markets similar services and products to nonaffiliated insurers and their
agencies.
518 Property and Management and Leasing, LLC (518 PML), an Ohio limited
liability company, is engaged in the business of owning and leasing real and
personal property to affiliated companies. The members of 518 PML are State Auto
P&C and Stateco.
State Auto P&C, Milbank, Farmers Casualty and SAIC (the "Pooled
Subsidiaries"), the companies comprising the standard insurance segment,
participate in a quota share reinsurance pooling arrangement (the "Pooling
Arrangement") with Mutual. The Pooling Arrangement provides that the Pooled
Subsidiaries cede to Mutual all of their insurance business and assume from
Mutual an amount equal to their respective participation percentages as outlined
in the Pooling Arrangement. Effective January 1, 1998, the Pooled Subsidiaries
aggregate participation in the Pooling Arrangement increased from 45% to 47%
(State Auto P&C - 37% and Milbank - 10%) and Midwest Security became a
participant in the Pooling Arrangement. On January 1, 1999, Farmers Casualty was
acquired by State Auto Financial and became a participant in the Pooling
Arrangement on that same date, at which time the Pooled Subsidiaries' aggregate
participation increased to 50% (State Auto P&C - 37%, Milbank - 10% and Farmers
Casualty - 3%). In conjunction with these changes in pool participation, the
Pooled Subsidiaries received cash from Mutual of $11.4 million and $19.7
million, which related to the additional net insurance liabilities assumed by
the Pooled Subsidiaries on January 1, 1999 and 1998, respectively. Effective
January 1, 2000, the Pooling Arrangement was amended to make SAIC a participant
in the Pooling Arrangement and the Pooled Subsidiaries aggregate participation
increased to 53% (State Auto P&C - 39%, Milbank - 10%, Farmers Casualty - 3% and
SAIC - 1%). In conjunction with this change in pool participation, the Pooled
Subsidiaries received cash from Mutual of $18.6 million, which related to the
additional net insurance liabilities assumed by the Pooled Subsidiaries on
January 1, 2000. All parties that participate in the Pooling Arrangement have an
A. M. Best rating of A+ (Superior).
In discussing Results of Operations for 2000, State Auto P&C, Milbank,
Farmers Casualty, SAIC, National, Mid-Plains, Mutual and Midwest Security are
referred to collectively as the "State Auto Insurance Companies", while for
1999, the State Auto Insurance Companies and Pooled Subsidiaries exclude SAIC.
State Auto P&C, Milbank, Farmers Casualty and SAIC are collectively referred to
below as
28
the "Pooled Subsidiaries", while the Pooled Subsidiaries, Mutual and Midwest are
collectively referred to below as the "Pooled Companies."
RESULTS OF OPERATIONS
2000 COMPARED TO 1999
Net income for the Company increased 11.4% in 2000. Contributing to
this increase was an improvement in the Company's statutory combined ratio to
95.5% in 2000 from 96.9% in 1999. Positively impacting the Company's operations
in 2000 was a change in the services provided by State Auto P&C that generated
an increase in management services income. See discussion below.
Consolidated earned premiums increased 1.5% in 2000. This increase
was principally the result of the change in the Pooled Subsidiaries' aggregate
pooled participation percentage from 50% to 53% (referred to above). This action
increased consolidated earned premiums 5.5%. The standard insurance segment's
internal growth, as written by the Pooled Companies, excluding the impact of the
change in the Pooling Arrangement, decreased consolidated earned premiums by
2.8%. The Company's nonstandard insurance segment's internal growth also
decreased consolidated earned premiums by approximately 0.9%. Also negatively
impacting the Company's consolidated earned premiums by approximately 0.3%, was
a return of premiums to the policyholders in the state of North Carolina as a
result of a rate reduction dating back to 1994 that was mandated by the
Insurance Department of that state. In 1994 and 1996, the North Carolina Rate
Bureau ("NCRB") filed an auto rate increase which was challenged by the North
Carolina Insurance Department. The parties agreed to a settlement of the dispute
in late March 2000, which resulted in a rate reduction for the 1994 rate filing
and the 1996 rate filing being approved as originally filed by the NCRB.
Consequently, the Company was required to return approximately $1.1 million in
disputed premiums, plus $530,000 in interest. The interest portion of the
returned premium has been reflected in the miscellaneous expense line item.
As noted in prior reports, during 1999, the underwriting performance
of the Companies' commercial lines book of business written by its standard
segment began to evidence deterioration from previous performance levels. This
prompted management to commence a careful review of its underwriters' adherence
to the Company's underwriting guidelines for commercial lines. This action had
a negative impact on direct written premiums in 1999 that continued into the
first half of 2000.
During the latter half of 2000, the Company saw commercial lines
sales activity increase over 1999 levels. The Pooled Companies experienced 6.0%
growth in its commercial lines direct written premiums over 1999. The Company's
personal lines of business within its standard segment continued to feel the
effects of extreme price competition even though, during the first half of
2000, there was some evidence that an increasing number of companies were
reacting to continuing underwriting losses by increasing rates. The Company's
rate of decline in internal growth in these lines has diminished in the last
half of 2000, but internal growth remained negative. The Company believes that
its underwriting and pricing discipline was a key factor in the Company's
underwriting results for the year, particularly as compared to other property
casualty insurers. The Company believes that its strategy of taking modest
price increases on a regularly scheduled basis and continuing its diligence in
risk selection has positioned it to take advantage of this change in the market
that the Company perceives is occurring. The Company is active in the personal
and commercial lines markets, developing new products to enhance its product
portfolio; appointing new agents in its operating territories; and refining its
pricing levels for the markets and lines it believes offer the most profit
potential.
The Company's nonstandard insurance segment (National and
Mid-Plains) earned premium was $27.4 million in 2000 and $30.9 million in 2000,
an 11.3% decrease. Intense price competition by certain market leaders is
generally believed to be responsible for the internal growth performance for the
year 2000. Production levels in this segment did begin to improve over the last
half of 2000 but that improvement was not sufficient to make internal growth
positive for the year.
29
Net investment income increased $4.7 million (13.6%) in 2000.
Contributing to the increase over the previous year was the cash transfers to
the Company in conjunction with the change in the Pooling Arrangement and
transfer of employees to State Auto P&C referred to above. Total cost of
investable assets at December 31, 2000 and 1999, respectively was $741.1 million
and $651.9 million.
The investment yield, based on fixed and equity securities at cost,
were 5.5% and 5.4% for the annual periods ending 2000 and 1999, respectively.
The Company continued to shift the composition of its fixed maturity portfolio
from taxables to tax-exempt fixed maturities. At December 31, 2000 and 1999,
respectively, tax exempt securities comprised approximately 82% and 76% of the
fixed maturity portfolio. Additionally, during 2000 the Company continued to
experience a number of calls on its higher yielding fixed maturities. Monies
from these calls were reinvested at the then lower yielding rates. See further
discussion regarding investments at the Liquidity and Capital Resources and
Investments and Market Risk sections included herein.
Management services income increased $8.9 million to $17.6 million
for the year ended December 31, 2000. This increase is largely attributable to
the change in the nature of the management services provided by State Auto P&C
as discussed above. The Department has requested that, beginning in 2001, Mutual
file an analysis on a quarterly basis with the Department that justifies the
apportionment of the service fee paid by Mutual to State Auto P&C under
statutory accounting guidance outlined in SSAP No. 70. See "Overview."
Losses and loss expenses, as a percentage of earned premiums (the
"loss ratio"), were 68.4% and 67.5% for the years 2000 and 1999, respectively.
The increase in the current year loss ratio was largely the result of the
Company experiencing a relatively small number of large unusual commercial
claims in its standard insurance segment. Management noted that these large
commercial losses did not impact any one line of business or geographic region
and does not believe the nature of these claims indicates deterioration in core
underwriting operations. See discussion above regarding management's response to
its perception of the current underwriting environment. Additionally, the
Company's nonstandard segment experienced an increase in its losses over 1999
levels particularly in those states where National began operations in 1999. The
nonstandard segment is particularly volatile for new states due to the
relatively small level of premium earned in the initial years of operation.
Management has been monitoring the premium rate adequacy in these new states and
has reacted throughout 2000 accordingly by increasing rates in these new states.
Acquisition and operating expenses, as a percentage of earned
premiums (the "expense ratio"), were 28.8% and 28.5% for the years 2000 and
1999, respectively. The increase in the expense ratio is impacted by the fixed
costs such as salaries, depreciation and utilities which comprised a larger
portion of earned premiums in 2000 than they did in 1999 as a result of the
Company's less than anticipated premium writings in 2000.
Interest expense relates to the line of credit agreement the Company
entered into with Mutual during the second quarter of 1999 to assist in the
funding of its stock repurchase program. See additional discussion in the
"Liquidity and Capital Resources" section included herein.
Other expense increased $0.3 million to $6.9 million for the year
ending December 31, 2000. Other expense for 2000 included the interest the
Company paid on the North Carolina premium rate refunds, discussed above.
The effective federal tax rate was 22% and 25% for the years ended
2000 and 1999, respectively. During 2000, the Company continued to shift its
fixed maturity portfolio from taxable to tax-exempt securities. As a result of
this continued shift, tax exempt income comprised a larger proportion of income
before federal income taxes in 2000 than in 1999. For additional clarification,
see the reconciliation between actual federal income taxes and the amount
computed at the statutory rate as detailed in footnote 7 in the notes to the
Company's consolidated financial statements.
30
1999 COMPARED TO 1998
Net income for the Company increased 14.1% in 1999. The Company's
statutory combined ratios for 1999 and 1998 were 96.9% and 97.8%, respectively.
A decrease in the level of catastrophe losses for 1999 compared to 1998
positively impacted the Company's results.
Consolidated earned premiums increased 10.1% in 1999. This increase
was principally the result of the change in the Pooled Subsidiaries aggregate
pooled participation percentage from 47% to 50% (discussed above) and the
addition of Farmers Casualty to the pool. These actions increased consolidated
earned premiums by 8.6%. The standard insurance segment's internal growth, as
written by the Pooled Companies, excluding the impact of the changes in the
Pooling Arrangement and the addition of Farmers Casualty to the pool, decreased
consolidated earned premiums by 0.10%. The addition of Mid-Plains to the
nonstandard insurance segment increased consolidated earned premiums 2.1%.
However, the nonstandard insurance segment decreased consolidated earned
premiums by 0.50%.
Like many other insurers in its industry, 1999 was a difficult year for
so-called internal growth for the Company. In its standard insurance segment,
management continued to stress responsible pricing and sound underwriting
despite a significant increase in aggressive price competition in both personal
and commercial lines. The Company's personal lines program, Prime of Life, that
targets the 50 and over age group, continues to generate approximately 25% of
the Company's new homeowner and automobile lines of business. This age group
also typically exhibits a significantly higher than average retention rate as a
whole among all policyholders in a group than any other age group. The Company's
underwriting experience in commercial lines showed some deterioration during
1999, which prompted management to commence a careful review of adherence to its
underwriting guidelines in these lines of business.
This same approach to underwriting also had an impact on the Company's
nonstandard insurance segment, which experienced a decrease in its earned
premiums in 1999. This was the continuing result of significant auto physical
damage rate increases, the continuation of a more restrictive underwriting
posture first implemented by the Company in this segment throughout most of its
operating states in 1998 and increased competition in this market segment during
1999. While these actions have resulted in a decrease in the volume of business
over the last several reporting periods, this segment's statutory loss
experience continued to improve over comparative prior periods. The statutory
loss ratio for the year ended December 31, 1999 decreased to 71.7% from 75.0%
for the same period in 1998. Offsetting the decrease in earned premium was
National's entry into three new states of operation during 1999: South Carolina
in the first quarter; Maryland in the second quarter; and South Dakota in the
fourth quarter.
Net investment income increased 5.4% in 1999. Contributing to the
increase over the previous year was the transfer to the Company of approximately
$11.4 million in conjunction with the change in the Pooling Arrangement, the
addition of Farmers Casualty and Mid-Plains to the Company's operations and a
general increase in investable assets over the previous 1998 period. Total cost
of investable assets at December 31, 1999 and 1998, respectively was $651.9
million and $590.8 million.
The investment yields, based on fixed and equity securities at cost,
were 5.4% and 5.7% for the annual periods ending 1999 and 1998, respectively.
Contributing to the decrease in the 1999 yield was the continual shift in the
composition of the fixed maturity portfolio from taxable to tax-exempt fixed
maturities. At December 31, 1999 and 1998, respectively, tax exempt securities
comprised approximately 76% and 71% of the fixed maturity portfolio.
Additionally, in 1999, the Company continued to experience a number of calls on
its higher yielding fixed maturities. Monies from these calls were reinvested at
the then lower yielding rates. Another contributing factor was the Company
continuing to build on its equity portfolio to enhance growth of statutory
surplus over the long term, a program that began in late 1997. See further
discussion regarding investments at the "Investments and Market Risk" sections
included herein.
Management services income, which includes income generated from the
investment management services segment and executive management services
provided to affiliated companies by
31
Stateco and State Auto P&C, respectively, increased $0.8 million in 1999. The
executive management services provided by State Auto P&C primarily generated the
increase.
Other income includes revenue primarily from sales of software products
to affiliates and third parties by the Company's insurance software subsidiary,
S.I.S., as well as leasing revenue on real and personal property leased by 518
PML to affiliates. During 1999, other income increased 32.2%. Revenue generated
from sales of software to third parties increased other income during 1999 by
approximately 18.0%, while revenue generated through leasing transactions with
affiliates increased other income by approximately 12.0%.
Losses and loss expenses, as a percentage of earned premiums, were
67.5% and 68.0% for the years 1999 and 1998, respectively. As previously noted,
during 1999, the Company experienced a decrease in the level of catastrophe
losses compared to the same 1998 periods. The impact of the 1999 catastrophe
losses amounted to 4.7 GAAP loss ratio points whereas catastrophe losses in 1998
totaled 8.1 GAAP loss ratio points. Offsetting the improvement in the 1999
catastrophe levels was an increase in the amount of commercial claims impacting
the year to date results. This is being addressed in the manner described above
in the discussion concerning commercial lines underwriting.
Acquisition and operating expenses, as a percentage of earned premiums
(the "expense ratio"), were 28.5% and 29.3% for the years 1999 and 1998,
respectively. The decrease in the expense ratio in 1999 can be attributed to a
reduced amount of Quality Performance Bonus earned by employees compared to that
earned in 1998.
The Company continued in 1999 to make strides in the use of technology
to streamline its personal and commercial operations as more agencies
participated in electronic upload and download using the APT industry standard.
Additionally, in 1999, the Company began the use of electronic funds transfer
(EFT) between the Company and the insured in several operating states for
personal automobile business.
In 1998, the Company realigned its claims procedures by establishing a
Central Claims Department (the "Department") staffed by trained claim
representatives who focus exclusively on losses that are small and routine in
nature. The establishment of the Department has allowed for quicker response
time to the insured and allows the fully trained claims representative to focus
on the more serious claims, thereby reducing the use of independent adjusters.
During 1999, the staffing in this Department was expanded as it began handling
claims for additional states of operation.
Interest expense relates to the line of credit agreement State Auto
Financial entered into with Mutual during the second quarter of 1999 to assist
in the funding of its repurchase program. See additional discussion in the
Liquidity and Capital Resources section below.
Other expense includes those operating expenses associated with general
corporate expenses, S.I.S., 518 PML and Stateco's investment management services
(the investment management services segment). In 1999, other expense increased
10.0%, which is primarily attributable to an increase in S.I.S.'s operating
expenses from 1998.
The effective Federal tax rate was 25% and 24% for the years ended 1999
and 1998, respectively. In 1999, income before federal income taxes increased
due to an increase in income from operations compared to 1998. Additionally,
during 1999 the Company continued to shift its fixed maturity portfolio from
taxable to tax-exempt securities. (See related net investment income discussion
above.) As a result of this continued shift, tax exempt income comprised a
similar proportion of income before federal income taxes in 1999 to that of
1998. For additional clarification, see the reconciliation between actual
federal income taxes and the amount computed at the statutory rate as detailed
in footnote 7 in the notes to the Company's consolidated financial statements.
32
REPORTABLE SEGMENTS
The Company's segment profits of the standard insurance segment, the
non-standard insurance segment, and the investment management services segment,
are monitored by management on an unconsolidated basis, as reflected in footnote
14 on Reportable Segments in the Company's consolidated financial statements and
therefore do not reflect adjustments for transactions with other segments. The
following table reflects segment profit or loss for these three segments for the
years ended 2000, 1999, and 1998:
2000 1999 1998
---- ---- ----
(in thousands)
Standard insurance $35,579 $41,146 $34,341
Nonstandard insurance (116) 1,647 1,313
Investment management services 5,354 5,191 4,908
Management and Operations services $17,552 $ 6,330 $ 5,290
The fluctuations in segment profit for the standard insurance segment,
as discussed above, is due to a decline in its underwriting income due to an
increase in the level of commercial losses, as discussed above. The improvement
in segment profit in 1999 compared to 1998 was the result of a decrease in
the level of catastrophe losses for this year. Prior to 1997, the nonstandard
segment focused on improving its loss experience through implementation of a
more restrictive underwriting posture and rate increases in several operating
states. While this segment showed improvement as a result of these actions,
2000 experienced significant losses in several of its new states of operation.
As discussed above, management continually monitors this segment's premium rate
adequacy given the nature of the risks that are written through the nonstandard
market. The investment management services segment profit increased slightly
due to increasing market rates within the fixed maturity market. This segment's
revenue is based on the average market value of the portfolio of the companies
managed, which is largely comprised of fixed maturities. With the change in the
interest rate environment throughout 2000, the average market value of the
portfolio of the companies managed increased throughout 2000. The increase in
the investment management services segment's profit from 1998 to 1999 was
primarily the result of the acquisition of Farmers Casualty and Mid-Plains,
effective January 1, 1999, at which time this segment began providing
investment management services to these companies. Segment profits related to
management and operations services has increased from that in previous years
due to the change in the management and operations agreement as discussed in
Note 1 (j) in the consolidated financial statements. For additional information
on the Company's reportable segments, see footnote 14 on "Reportable Segments"
in the Company's consolidated financial statements.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity refers to the ability of a company to generate adequate
amounts of cash to meet its needs for both long and short-term cash obligations
as they come due. The Company's significant sources of cash are premiums,
investment income and investments as they mature. The Company continually
monitors its investment and reinsurance programs to ensure they are
appropriately structured to enable the insurance subsidiaries to meet
anticipated and unanticipated short and long-term cash requirements without the
need to sell investments to meet fluctuations in claim payments.
In 2000, net cash provided by operating activities increased to $87.7
million from $48.9 million in 1999. This increase was due to a cash transfer of
$18.6 million to the Pooled Subsidiaries in connection with the 2000 amended
Pooling Arrangement, as well as a cash transfer of $28.1 million to State Auto
P&C relating to the net plan benefit liabilities assumed in connection with the
2000 Management Agreement. In 1999, net cash provided by operating activities
decreased to $48.9 million from $56.7 million in 1998. The 1999 decrease was due
to the cash transfer of $11.4 million to the Pooled Subsidiaries in connection
with the 1999 amended Pooling Arrangement, as discussed above, whereas in
33
1998, the cash transfer relating to the 1998 amended Pooling arrangement was
$19.7 million. Over the last three years, operating cash flows have been
sufficient to meet the operating needs of the Company while providing
opportunities for increased investment and financing needs. Management does not
anticipate any significant changes in its operating cash flow.
Net cash used in investing activities reflects cash flows used in
purchases of fixed maturity and equity securities, respectively, of $187.7
million and $15.8 million in 2000, $207.8 million and $25.6 million in 1999, and
$193.9 million and $17.1 million in 1998. During 1998 and continuing into 2000,
market interest rates on fixed maturities declined from previous years' levels,
and the Company experienced a significantly higher number of calls on fixed
maturities than in previous years. During 2000, this call activity slowed
somewhat from previous year's levels. Cash flows provided by maturities, calls
and principal reductions of fixed maturities were $27.0 million in 2000, $37.3
million in 1999 and $47.8 million in 1998. During 1998, 518 PML began
construction of a building in Goodlettsville, Tennessee that was completed in
1999. The building is currently being leased to Mutual. The total construction
cost of the building, including land cost, was approximately $6.4 million.
Overall, net cash used in investing activities was $90.9 million in 2000, $56.9
million in 1999 and $55.6 million in 1998. The increase in the 2000 investing
activities was the result of the Company investing the proceeds received on the
cash transfers discussed under cash flows from operating activities.
Net cash provided by or used in financing activities consists of
proceeds from issuance of common stock and payment of dividends to shareholders.
Mutual, whose ownership in State Auto Financial is approximately 68%, has waived
its right to receipt of the dividends declared by State Auto Financial in an
effort to enhance the statutory surplus of the insurance subsidiaries of State
Auto Financial for use in support of underwriting operations. Prior to the
declaration of each dividend by State Auto Financial, Mutual's directors review
the facts and circumstances then present in deciding whether to waive such
dividend.
Impacting cash used in financing activities during 2000 was State Auto
Financial's Board of Directors approving a plan to repurchase up to 1.0 million
shares of its common stock from the public over a period ending December 31,
2001. Through March 15, 2001, State Auto Financial repurchased 25,122 shares.
Impacting 1999 was a previous repurchase program of State Auto Financial's
common stock. During the second quarter of 1999, State Auto Financial's Board of
Directors approved a plan to repurchase up to 4.0 million shares of its
outstanding common stock over a period ending December 31, 2000. Repurchases
were transacted to maintain the same ownership ratios between Mutual and the
public as it existed in May 1999, with 69% repurchased from Mutual and 31% from
the public. Through December 31, 1999, all 4.0 million shares were repurchased,
with approximately 2.7 million shares repurchased from Mutual and 1.3 million
shares from the public. In conjunction with the stock repurchase plan, State
Auto Financial entered into a line of credit agreement with Mutual for $45.5
million, at an interest rate of 6.0%. The interest rate adjusts each January 1
based on a formula set forth in the note. During 2001 the interest rate is 5.0%.
Commencing in 2001, principal is due upon demand from Mutual.
In 1996, the State Auto Insurance Companies negotiated a change in
their catastrophe reinsurance program. In 1998, Midwest Security, 1999, Farmers
Casualty and Mid-Plains, and 2000, SAIC, became parties to the catastrophe
reinsurance program. The amount retained by the State Auto Insurance Companies
is $40.0 million for each occurrence. For up to $80.0 million in losses, excess
of $40.0 million, traditional reinsurance coverage is provided. Effective
November 1999, State Auto P&C assumed catastrophe reinsurance from Mutual,
Milbank, Midwest Security, Farmers Casualty, SAIC, National and Mid-Plains in
the amount of $135 million excess of $120 million. Effective November 2000, the
catastrophe reinsurance program was renegotiated whereby State Auto P&C now
assumes $115 million excess of $120 million. This layer of $115 million in
excess of $120 million has been excluded from the Pooling Arrangement. There
have been no losses assumed under this agreement.
To provide funding if the State Auto Insurance Companies were to incur
catastrophe losses in excess of $120.0 million, State Auto Financial entered
into a structured contingent financing transaction with a financial institution
and a syndicate of other lenders (the Lenders) to provide up to $115.0 million
for
34
reinsurance purposes. In the event of such a loss, this arrangement provides
that State Auto Financial would sell redeemable preferred shares to SAF Funding
Corporation, a special purpose company (SPC), which would borrow the money
necessary for such purchase from the Lenders. State Auto Financial would then
contribute to State Auto P&C the funds received from the sale of its preferred
shares. State Auto P&C would use the contributed capital to pay its direct
catastrophe losses and losses assumed under the catastrophe reinsurance
agreement. State Auto Financial is obligated to repay SPC (which would repay the
Lenders) by redeeming the preferred shares over a six-year period. In the event
of a default by State Auto Financial, the obligation to repay SPC has been
secured by a Put Agreement among State Auto Financial, Mutual and the Lenders,
under which Mutual would be obligated to put either the preferred shares or the
loan(s) outstanding.
On March 11, 1997, Mutual acquired 100% of the outstanding shares of
Midwest Security, effective as of January 1, 1997. In connection with this
purchase, Mutual and State Auto Financial entered into an Option Agreement
granting State Auto Financial the right to purchase Midwest Security from Mutual
within five years at a price determined by a formula set out in the Option
Agreement. As of March 23, 2001, State Auto Financial has not exercised its
right to acquire Midwest Security.
On March 2, 2001, the Board of Directors of State Auto Financial
declared a quarterly cash dividend of $0.03 per common share, payable on March
30, 2001, to shareholders of record on March 15, 2001. This is the 39th
consecutive cash dividend declared by State Auto Financial's Board since State
Auto Financial had its initial public offering of common stock on June 28, 1991.
State Auto Financial has increased cash dividends to shareholders for eight
consecutive years.
The maximum amount of dividends that may be paid to State Auto
Financial during 2001 by its insurance subsidiaries without prior approval under
current law is limited to $44.9 million. The Company is required to notify the
insurance subsidiaries' respective State Insurance Commissioner within five
business days after declaration of all dividends and at least ten days prior to
payment. Additionally, the domiciliary Commissioner of each insurer subsidiary
has the authority to limit a dividend when the Commissioner determines, based on
factors set forth in the law, that an insurer's surplus is not reasonable in
relation to the insurer's outstanding liabilities and adequate to its financial
needs. Such restrictions are not expected to limit the capacity of State Auto
Financial to meet its cash obligations.
The National Association of Insurance Commissioners (NAIC) maintains
risk-based capital requirements for property and casualty insurers. Risk-based
capital is a formula that attempts to evaluate the adequacy of statutory capital
and surplus in relation to investment and insurance risks such as asset quality,
loss reserve adequacy and other business factors. Applying the risk-based
capital requirements as of December 31, 2000, each of the State Auto Insurance
Companies exceeded all standards established by the formula.
OTHER DISCLOSURES
INVESTMENTS
Stateco performs investment management services (the investment
management services segment) on behalf of the Company and Mutual and its
subsidiary. The Investment Committee of each insurer's Board of Directors sets
investment policies to be followed by Stateco.
The primary investment objectives of the Company are to generate
income, preserve capital and maintain adequate liquidity for the payment of
claims. Fixed maturities that are purchased with the intention and ability of
holding them until maturity are categorized as held to maturity and carried at
amortized cost. Fixed maturities that may be sold due to changing investment
strategies are categorized as available for sale and are carried at fair value.
At December 31, 2000, the Company had no fixed maturity investments rated below
investment grade, nor any mortgage loans.
35
As of December 31, 2000, the Company had fixed maturities with a fair
value of $653.3 million designated as available for sale compared to $527.8
million at December 31, 1999. During 2000, the Company continued its program to
increase its equity portfolio to enhance growth of statutory surplus over the
long term. At December 31, 2000 and 1999, respectively, the equity portfolio
totaled $58.3 and $55.5 million, respectively.
The Company's current investment strategy does not rely on the use of
derivative financial instruments.
MARKET RISK
Investable assets comprise approximately 86% of the Company's total
assets. Of the total investments, 90% are invested in fixed maturities, 7.6% in
equity securities and the remaining in cash and cash equivalents.
The Company's decision to make a specific investment is influenced
primarily by the following factors: (a) investment risks; (b) general market
conditions; (c) relative valuations of investment vehicles; (d) general market
interest rates; (e) the Company's liquidity requirements at any given time; and
(f) the Company's current federal income tax position and relative spread
between after tax yields on tax-exempt and taxable fixed income investments.
The fixed maturity portfolio is managed in a ladder-maturity style and
considers business mix and liability payout patterns to ensure adequate cash
flow to meet claims as they are presented. At December 31, 2000, the Company's
fixed maturity portfolio had an average maturity of 12.5 years and a duration of
5.6 years. For the insurance subsidiaries, the maximum investment in any single
note or bond is limited to 5.0% of statutory assets, other than obligations of
the U.S. government or government agencies, for which there is no limit. The
fixed maturity portfolio is very high in quality with all holdings either in
Government obligations, municipal, or corporate obligations rated AA or better
by the major bond rating agencies. The Company does not intend to change its
investment policy on the quality of its fixed maturity investments. Investments
in equity securities are selected based on their potential for appreciation as
well as ability to continue paying dividends. Additional information regarding
the composition of investments, along with maturity schedules regarding
investments in fixed maturities, is included in footnote 2 of the consolidated
financial statements.
The Company's primary market risk exposures are to changes in market
prices for equity securities and changes in interest rates and credit ratings
for fixed maturity securities. In 2000, market conditions were characterized by
decreasing equity market prices and increasing fixed maturity market prices. The
Company's equity portfolio increased from $55.5 million at December 31, 1999 to
$58.3 million at December 31, 2000 as new monies were allocated during the year
to acquire new equity positions. Though the Company continued to hold unrealized
gains on this portfolio, equity securities held at year end experienced a $2.1
million decrease in unrealized holding gains from December 31, 1999. The market
value of the available for sale fixed maturity portfolio was positively impacted
during the year as a result of declining interest rates. In 2000, the fixed
maturity security market experienced a significant decline in interest rates in
response to the Federal Reserve Board's monetary policy and easing inflationary
pressures. As a result of these market conditions, the Company experienced an
increase of $33.2 million on the market value of its available for sale fixed
maturity portfolio through December 31, 2000.
As previously discussed, in order to maximize investment income the
Company manages its fixed maturity portfolio in a ladder-maturity style to
ensure adequate cash flow to meet claims as they are presented for payment. It
is not anticipated that fixed maturity investments would need to be sold in
order to meet claim payments in the future. In fact, the Company has never had
to sell assets to meet payment of its claims.
36
To provide the Company greater flexibility in order to manage its
market risk exposures, the Company has segregated a portion of its fixed
maturity portfolio, approximately 94% at December 31, 2000, in accordance with
SFAS No. 115, as available for sale. Also, the Company does not maintain a
trading portfolio.
The following table provides information about the Company's fixed
maturity investments used for purposes other than trading that are sensitive to
changes in interest rates. The table presents principal cash flows from
maturities, anticipated calls and estimated prepayments, or pay downs from
holdings in mortgage backed securities. The table also presents the average
interest rate for each period presented.
PRINCIPAL AMOUNT MATURING IN:
(Dollars in thousands)
2001 2002 2003 2004 2005 Thereafter Total Fair Value
---- ---- ---- ---- ---- ---------- ----- ----------
Fixed interest
rate securities $41,814 36,120 17,485 26,202 21,581 525,365 668,567 $692,558
Average
Interest rate 6.3% 6.2% 5.5% 5.6% 6.6% 6.0% 6.0%
IMPACT OF SIGNIFICANT EXTERNAL CONDITIONS
Inflation can have a significant impact on property and casualty
insurers because premium rates are established before the amount of losses and
loss expenses are known. When establishing rates, the Company attempts to
anticipate increases from inflation subject to limitations imposed for
competitive pricing. Inflation has been modest over the last several years
thereby allowing pricing of premiums to keep pace with inflation on certain
lines of business.
The Company considers inflation when estimating liabilities for losses
and loss expenses, particularly for claims having a long period between
occurrence and settlement. The liabilities for losses and loss expenses are
management's estimates of the ultimate net cost of underlying claims and
expenses and are not discounted for the time value of money. In times of high
inflation, the normally higher yields on investment income may partially offset
potentially higher claims and expenses.
FORWARD-LOOKING STATEMENTS; CERTAIN FACTORS AFFECTING FUTURE RESULTS
Statements contained in this Form 10-K or any other reports or
documents prepared by the Company or made by management may be "forward-looking"
within the meaning of the Private Securities Litigation Reform Act of 1995. Such
forward-looking statements are subject to certain risks and uncertainties that
could cause the Company's actual results to differ materially from those
projected. Forward-looking statements may be identified, preceded by, followed
by, or otherwise include, without limitation, words such as "plans," "believes,"
"expects," "anticipates," "intends," "estimates," or similar expressions. The
following factors, among others, in some cases have affected and in the future
could affect the Company's actual financial performance.
o As discussed in Item 1 of this Form 10-K, Mutual has entered into
agreements with Meridian Mutual and MIGI pursuant to which Meridian
Mutual will be merged with and into Mutual, with Mutual continuing
as the surviving corporation of the merger, and MIGI will be
acquired by Mutual. In addition, during the past several years,
Mutual and the Company have acquired other insurance companies, such
as Milbank, Farmers Casualty, and Midwest Security, and it is
anticipated that Mutual and the Company will continue to pursue
acquisitions of other insurance companies in the future.
Acquisitions involve numerous risks and uncertainties, including the
following: obtaining necessary regulatory approvals of the
acquisition may prove to be more difficult than anticipated;
integrating the acquired business may prove to be
37
more costly or difficult than anticipated; integrating the acquired
business without material disruption to existing operations may
prove to be more difficult than anticipated; anticipated cost
savings may not be fully realized (or not realized within the
anticipated time frame) or additional or unexpected costs may be
incurred; and retaining key employees of the acquired business may
prove to be more difficult than anticipated. In addition, other
companies in the insurance industry have similar acquisition
strategies. There can be no assurance that any future acquisitions
will be successfully integrated into the Company's operations, that
competition for acquisitions will not intensify or that the Company
will be able to complete such acquisitions on acceptable terms and
conditions. In addition, the costs of unsuccessful acquisition
efforts may adversely affect the Company's financial performance.
o The Company's financial results are subject to the occurrence of
weather-related and other types of catastrophic events, none of
which are within the Company's control.
o The Company's operations are subject to changes occurring in the
legislative, regulatory and judicial environment, including but not
limited to changes related to the implementation of the Gramm Leach
Bliley Act of 1999. Risks and uncertainties related to the
legislative, regulatory, and judicial environment include, but are
not limited to, legislative changes at both the state and federal
level, state and federal regulatory rulemaking promulgations and
adjudications that may affect the Company specifically, its
affiliates or the industry generally, class action and other
litigation involving the insurance industry and judicial decisions
affecting claims, policy coverages and the general costs of doing
business. Many of these changes are beyond the Company's control.
o The laws of the various states establish insurance departments with
broad regulatory powers relative to approving intercompany
arrangements, such as management, pooling, and investment management
agreements, granting and revoking licenses to transact business,
regulating trade practices, licensing agents, approving policy
forms, setting reserve requirements, determining the form and
content of required statutory financial statements, prescribing the
types and amount of investments permitted and requiring minimum
levels of statutory capital and surplus. The Ohio Department of
Insurance (the "Department") has requested that, beginning in 2001,
Mutual file an analysis on a quarterly basis with the Department
that justifies the apportionment of the service fee paid by Mutual
to State Auto P&C under the 2000 Management Agreement under
statutory accounting guidance outlined in SSAP No. 70. The Company
believes that its accounting for such service fee is consistent with
all statutory accounting principles. However, there can be no
assurance that all or any part of the service fee paid by Mutual
will be justified to the Department's satisfaction, which may affect
the amount of such fee recognized as revenue by Company. In
addition, although premium rate regulation varies among states and
lines of insurance, such regulations generally require approval of
the regulatory authority prior to any changes in rates. Furthermore,
all of the states in which the State Auto Group transacts business
have enacted laws which restrict these companies' underwriting
discretion. Examples of these laws include restrictions on agency
terminations and laws requiring companies to accept any applicant
for automobile insurance. These laws may adversely affect the
ability of the insurers in the State Auto Group to earn a profit on
their underwriting operations.
o The property and casualty insurance industry is highly competitive.
Price competition has been very intense during recent years. This
continued to be true in regards to both commercial lines and
personal lines, particularly auto insurance in 2000. Several
"national" carriers' active marketing efforts with respect to
personal lines auto insurance have had an impact on the market for
this coverage. The Company competes with numerous insurance
companies, many of which are substantially larger and have
considerably greater financial resources. In addition, because the
Company's products are marketed exclusively through independent
insurance agencies, most of which represent more than one company,
the Company faces competition within each agency. The Company
competes through
38
underwriting criteria, appropriate pricing, and quality service to
the policyholder and the agent and through a fully developed agency
relations program. See "Marketing" in the "Narrative Description of
Business" in Item 1.
o The Company is subject to numerous other factors which effects its
operations, including, without limitation, the development of new
insurance products, geographic spread of risk, fluctuations of
securities markets, economic conditions, technological difficulties
and advancements, availability of labor and materials in storm hit
areas, late reported claims, previously undisclosed damage,
utilities and financial institution disruptions, and shortages of
technical and professional employees.
ITEM 7(A). QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
"Qualitative and Quantitative Disclosures About Market Risk" is
included in Item 7 "Management's Discussion and Analysis of Financial Condition
and Results of Operations" under Market Risk.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements, including the Notes to
Consolidated Financial Statements and the Report of Independent Auditors are as
follows:
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
State Auto Financial Corporation
We have audited the accompanying consolidated balance sheets of State Auto
Financial Corporation and subsidiaries as of December 31, 2000 and 1999 and the
related consolidated statements of income, stockholders' equity and cash flows
for each of the three years in the period ended December 31, 2000. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of State
Auto Financial Corporation and subsidiaries as of December 31, 2000 and 1999,
and the consolidated results of their operations and their cash flows for each
of the three years in the period ended December 31, 2000, in conformity with
accounting principles generally accepted in the United States.
/s/ Ernst & Young LLP
Columbus, Ohio
February 20, 2001, except for
Note 17, as to which the date
is March 30, 2001
39
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
DECEMBER 31
-----------
2000 1999
---- ----
(dollars in thousands,
except share data)
ASSETS
Fixed maturities:
Held to maturity, at amortized cost (fair value
$40,225 and $44,051, respectively) .............................. $ 39,307 43,981
Available for sale, at fair value (amortized cost
$636,302 and $544,051, respectively) ............................ 653,251 527,806
Equity securities, available for sale, at fair value
(cost $44,220 and $39,303, respectively) .......................... 58,312 55,518
----------------------
Total Investments ................................................... 750,870 627,305
Cash and cash equivalents ........................................... 21,305 24,560
Deferred policy acquisition costs ................................... 32,458 28,936
Accrued investment income and other assets .......................... 19,795 17,977
Due from affiliate .................................................. 1,405 --
Net prepaid pension expense ......................................... 37,738 18,931
Reinsurance recoverable on losses and loss expenses payable ......... 7,930 10,807
Prepaid reinsurance premiums ........................................ 11,575 15,784
Deferred federal income taxes ....................................... -- 1,828
Property and equipment, at cost, net of accumulated
depreciation of $2,785 and $2,191, respectively ................... 12,760 11,288
Goodwill ............................................................ 2,270 2,529
----------------------
Total assets ........................................................ $ 898,106 759,945
======================
LIABILITIES AND STOCKHOLDERS' EQUITY
Losses and loss expenses payable .................................... $ 244,583 232,489
Unearned premiums ................................................... 160,387 153,570
Note payable to affiliate ........................................... 45,500 45,500
Postretirement benefit liabilities .................................. 55,841 2,498
Federal Income Taxes:
Current ........................................................... 2,903 1,322
Deferred .......................................................... 1,490 --
Other liabilities ................................................... 1,343 1,543
Due to affiliates ................................................... -- 5,336
----------------------
Total liabilities ................................................... 512,047 442,258
----------------------
Commitments and contingencies ....................................... -- --
Stockholders' equity:
Class A Preferred stock (nonvoting), without par value ............
Authorized 2,500,000 shares; none issued ........................ -- --
Class B Preferred stock, without par value. Authorized
2,500,000 shares; none issued ................................... -- --
Common stock, without par value. Authorized 100,000,000 shares;
42,625,723 and 42,355,438 shares issued, respectively, at
stated value of $2.50 per share ................................. 106,564 105,888
Less 4,071,012 and 4,034,342 treasury shares, respectively, at cost (47,038) (46,588)
Additional paid-in capital ........................................ 44,208 42,562
Accumulated other comprehensive income ............................ 20,317 156
Retained earnings ................................................. 262,008 215,669
----------------------
Total stockholders' equity .......................................... 386,059 317,687
----------------------
Total liabilities and stockholders' equity .......................... $ 898,106 759,945
======================
See accompanying notes to consolidated financial statements.
40
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
CONSOLIDATED STATEMENTS OF INCOME
- --------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31
-----------------------
2000 1999 1998
---- ---- ----
(dollars in thousands, except per share amount)
Earned premiums ............................................... $ 397,967 392,058 356,210
Net investment income ......................................... 38,915 34,262 32,506
Management services income from affiliates .................... 17,594 8,727 7,945
Net realized gains on investments ............................. 5,255 2,555 2,925
Other income (includes $1,546, $1,676 and $1,316,
respectively, from affiliates) .............................. 3,043 3,269 2,473
---------------------------------------
Total revenues ................................................ 462,774 440,871 402,059
---------------------------------------
Losses and loss expenses ...................................... 272,167 264,628 242,294
Acquisition and operating expenses ............................ 119,569 111,772 104,224
Interest expense to affiliate ................................. 2,730 955 --
Other expenses ................................................ 6,864 6,531 5,936
---------------------------------------
Total expenses ................................................ 401,330 383,886 352,454
---------------------------------------
Income before federal income taxes ............................ 61,444 56,985 49,605
---------------------------------------
Federal income tax expense (benefit):
Current ..................................................... 14,408 12,136 12,271
Deferred .................................................... (678) 2,033 (163)
---------------------------------------
Total federal income taxes .................................... 13,730 14,169 12,108
---------------------------------------
Net income .................................................... $ 47,714 42,816 37,497
=======================================
Earnings per common share:
Basic ....................................................... $ 1.24 1.05 .89
=======================================
Diluted ..................................................... $ 1.21 1.03 .87
=======================================
Dividends paid per common share ............................... $ .12 .11 .10
=======================================
See accompanying notes to consolidated financial statements.
41
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS)
- --------------------------------------------------------------------------------
ACCUMULATED
ADDITIONAL OTHER
COMMON COMMON TREASURY TREASURY PAID-IN COMPREHENSIVE RETAINED
SHARES STOCK SHARES STOCK CAPITAL INCOME EARNINGS TOTAL
------ -------- --------- -------- --------- ------------ --------- --------
BALANCE-DECEMBER 31, 1997 41,829 $104,572 8 $ (90) $40,210 $14,761 $137,805 $297,258
------ -------- ----- -------- ------- ------- -------- --------
Net income 37,497 37,497
Unrealized gains, net of tax
and reclassification
adjustment 5,515 5,515
--------
Comprehensive income 43,012
--------
Issuance of common stock 211 528 1,295 1,823
Tax benefit from stock
options exercised 34 34
Treasury shares acquired on
stock option exercises 5 (77) (77)
Change in minority interest
of subsidiary (7) (7)
Cash dividends paid (1,219) (1,219)
------ -------- ----- -------- ------- ------- -------- --------
BALANCE-DECEMBER 31, 1998 42,040 105,100 13 (167) 41,539 20,276 174,076 340,824
------ -------- ----- -------- ------- ------- -------- --------
Net income 42,816 42,816
Unrealized losses, net of
tax and reclassification
adjustment (20,120) (20,120)
--------
Comprehensive income 22,696
--------
Issuance of common stock 315 788 1,139 1,927
Tax benefit from stock
options exercised 258 258
Treasury shares acquired
on stock option exercises 21 (222) (222)
Treasury shares acquired
under repurchase program 4,000 (46,199) (46,199)
Stock options granted 242 242
Change in minority interest
of subsidiary (616) 92 (524)
Cash dividends paid (1,315) (1,315)
------ -------- ----- -------- ------- ------- -------- --------
BALANCE-DECEMBER 31, 1999 42,355 105,888 4,034 (46,588) 42,562 156 215,669 317,687
------ -------- ----- -------- ------- ------- -------- --------
Net income 47,714 47,714
Unrealized gains, net of
tax and reclassification
adjustment 20,161 20,161
--------
Comprehensive income 67,875
--------
Issuance of common stock 271 676 1,120 1,796
Tax benefit from stock
options exercised 189 189
Treasury shares acquired
on stock option exercises 12 (149) (149)
Treasury shares acquired
under repurchase program 25 (301) (301)
Stock options granted 524 524
Change in minority interest
of subsidiary (187) 22 (165)
Cash dividends paid (1,397) (1,397)
------ -------- ----- -------- ------- ------- -------- --------
BALANCE-DECEMBER 31, 2000 42,626 $106,564 4,071 $(47,038) $44,208 $20,317 $262,008 $386,059
====== ======== ===== ======== ======= ======= ======== ========
42
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31
----------------------
2000 1999 1998
---- ---- ----
(in thousands)
Cash flows from operating activities:
Net income .......................................... $ 47,714 42,816 37,497
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization, net ................. 3,548 3,257 2,666
Net realized gains on investments .................. (5,255) (2,555) (2,925)
Changes in operating assets and liabilities:
Deferred policy acquisition costs ................. (1,756) (2,159) (1,151)
Accrued investment income and other assets ........ (2,480) 1,218 (2,232)
Net prepaid pension expense ....................... (4,168) (2,116) (1,029)
Postretirement benefit liabilities ................ 3,746 654 173
Reinsurance recoverable on losses and loss
expenses payable and prepaid reinsurance premiums (763) (4,721) 272
Other liabilities and due to/from affiliates, net . (7,106) 2,900 4,373
Losses and loss expenses payable .................. (440) (7,099) (3,258)
Unearned premiums ................................. 6,817 4,031 2,449
Federal income taxes .............................. 1,093 1,290 167
Cash provided from the change in the reinsurance pool
participation percentage .......................... 18,617 11,419 19,708
Cash provided from transfer of employees ............ 28,098 -- --
---------------------------------------
Net cash provided by operating activities ............. 87,665 48,935 56,710
---------------------------------------
Cash flows from investing activities:
Purchase of fixed maturities - available for sale ... (187,724) (207,768) (193,881)
Purchase of equity securities ....................... (15,783) (25,567) (17,051)
Maturities, calls and principal reductions of fixed
maturities - held to maturity ...................... 4,600 11,776 23,106
Maturities, calls and principal reductions of fixed
maturities - available for sale .................... 22,355 25,516 24,654
Sale of fixed maturities - available for sale ....... 71,530 113,671 111,085
Sale of equity securities ........................... 16,158 17,369 8,306
Purchase of surplus notes receivable ................ -- -- (9,000)
Net cash acquired on acquisition of Farmers
Casualty Insurance Company ......................... -- 11,568 --
Net additions of property and equipment ............. (2,066) (3,459) (2,816)
---------------------------------------
Net cash used in investing activities ................. (90,930) (56,894) (55,597)
---------------------------------------
Cash flows from financing activities:
Net proceeds from issuance of debt to affiliate ..... -- 45,500 --
Net proceeds from issuance of common stock .......... 1,708 1,928 1,780
Payments to acquire treasury shares ................. (301) (46,199) --
Payment of dividends ................................ (1,397) (1,315) (1,219)
---------------------------------------
Net cash provided by (used in) financing activities ... 10 (86) 561
---------------------------------------
Net increase (decrease) in cash and cash equivalents .. (3,255) (8,045) 1,674
---------------------------------------
Cash and cash equivalents at beginning of year ........ 24,560 32,605 30,931
---------------------------------------
Cash and cash equivalents at end of year .............. $ 21,305 24,560 32,605
=======================================
See accompanying notes to consolidated financial statements.
43
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements of State Auto Financial Corporation
include State Auto Financial Corporation (State Auto Financial) and its
wholly-owned subsidiaries that consist of:
- - State Auto Property and Casualty Insurance Company (State Auto P&C), a
South Carolina corporation
- - Milbank Insurance Company (Milbank), a South Dakota corporation
- - Farmers Casualty Insurance Company (Farmers Casualty), an Iowa
corporation
- - State Auto Insurance Company (SAIC), an Ohio corporation
- - State Auto National Insurance Company (National), an Ohio corporation
- - Stateco Financial Services, Inc. (Stateco), an Ohio corporation
- - Strategic Insurance Software, Inc. (S.I.S.), an Ohio corporation.
Mid-Plains Insurance Company (Mid-Plains), an Iowa corporation, is a
wholly-owned subsidiary of Farmers Casualty. The financial statements also
include the operations and financial position of 518 Property Management and
Leasing, LLC (518 PML), whose members are State Auto P&C and Stateco.
On July 7, 1998, State Auto Financial exercised its option with State
Automobile Mutual Insurance Company (Mutual), pursuant to the Option Agreement
dated August 20, 1993, by acquiring the outstanding shares of Milbank. Milbank
had been a wholly-owned subsidiary of Mutual since July 1, 1993, but as a result
of this transaction, is now a wholly-owned subsidiary of State Auto Financial.
The purchase price of Milbank was approximately $81.9 million. The transaction
was effected through an exchange with Mutual of approximately 5.1 million
State Auto Financial common shares for all the issued and outstanding capital
stock of Milbank. Since the transaction was a combination of entities under
common control it has been accounted for similar to a pooling-of-interests.
State Auto Financial and subsidiaries are referred to herein as "the
Companies" or "the Company." State Auto Financial, an Ohio corporation, is a
majority-owned subsidiary of Mutual. All significant inter-company balances
and transactions have been eliminated in consolidation.
(b) DESCRIPTION OF BUSINESS
The Company, through State Auto P&C, Milbank, Farmers Casualty and SAIC,
provides standard personal and commercial insurance to its policyholders.
Their principal lines of business include personal and commercial automobile,
homeowners, commercial multi-peril, workers' compensation, general liability
and fire insurance. National and Mid-Plains provide nonstandard automobile
insurance. State Auto P&C, Milbank, Farmers Casualty, SAIC, National, and
Mid-Plains operate primarily in the midwest and eastern United States, excluding
New York, New Jersey, and the New England states, through the independent
insurance agency system. State Auto P&C, Milbank, Farmers Casualty, SAIC,
National and Mid-Plains are chartered and licensed as property and casualty
insurers in the states of South Carolina, South Dakota, Iowa, Ohio (SAIC and
National) and Iowa, respectively, and are licensed in various other states. As
such, they are subject to the regulations of the applicable Departments of
Insurance of their respective states of domicile (the Departments) and the
regulations of each state in which they operate. These property and casualty
insurance companies undergo periodic financial examination by the Departments
and insurance regulatory agencies of the states that choose to participate.
Through State Auto P&C, effective January 1, 2000, the Company provides
management and operation services under new management agreements for all
insurance and non-insurance affiliates. Pursuant to these agreements, the
Company received approximately $28.1 million equal to the net plan benefit
liabilities assumed relating to the transfer to the Company of all employees
from Mutual and other affiliated companies. Prior to January 1, 2000, the
Company, through State Auto P&C, provided executive insurance management
services to all insurance affiliates.
SAIC was formed in 1999 to engage in the business of providing standard
personal insurance to its policyholders through the use of leading edge
technology within the independent agency system. Effective January 1, 2000, SAIC
was chartered and licensed as a property and casualty insurer in the state of
Ohio and began operations at that time.
Through Stateco, the Company provides investment management services to
affiliated companies and also provides insurance premium finance services
44
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
to customers of State Auto P&C, Mutual and Milbank.
The Company, through S.I.S., develops and sells software for the
processing of insurance transactions, database management for insurance agents
and electronic interfacing of information between insurance companies and
agencies. S.I.S. sells services and products to affiliated companies and their
agents and markets similar services and products to nonaffiliated insurers and
their agencies.
518 PML, an Ohio limited liability company, was formed to engage in the
business of owning and leasing real and personal property to affiliated
companies. As of January 1, 1998, State Auto P&C and Stateco became initial
members of 518 PML.
(c) BASIS OF PRESENTATION
The consolidated financial statements have been prepared in conformity
with accounting principles generally accepted in the United States, which vary
in certain respects from statutory accounting practices followed by State Auto
P&C, Milbank, Farmers Casualty, SAIC, National and Mid-Plains that are
prescribed or permitted by the Departments.
In preparing the consolidated financial statements, management is required
to make estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the balance sheet, revenues and expenses for the
period then ended and the accompanying notes to the financial statements. Such
estimates and assumptions could change in the future as more information becomes
known which could impact the amounts reported and disclosed herein.
Material estimates that are particularly susceptible to significant change
in the near term relate to the determination of losses and loss expenses
payable. In connection with the determination of this estimate, management uses
historical data and current business conditions to formulate estimates
including assumptions related to the ultimate cost to settle claims. These
estimates by their nature are subject to uncertainties for various reasons. The
Company's results of operations and financial condition could be impacted in the
future should the ultimate payments required to settle claims vary from the
liability currently provided.
(d) DEFERRED POLICY ACQUISITION COSTS
Acquisition costs, consisting of commissions, premium taxes, and certain
underwriting expenses related to the production of property and casualty
business, are deferred and amortized ratably over the contract period. The
method followed in computing deferred policy acquisition costs limits the amount
of such deferred costs to their estimated realizable value. In determining
estimated realizable value, the computation gives effect to the premium to be
earned, losses and loss expenses to be incurred, and certain other costs
expected to be incurred as premium is earned, without credit for anticipated
investment income. These amounts are based on estimates and accordingly, the
actual realizable value may vary from the estimated realizable value. Net
deferred policy acquisition costs were:
YEAR ENDED DECEMBER 31
----------------------
2000 1999 1998
---- ---- ----
(dollars in thousands)
Balance, beginning of year ....... $ 28,936 24,799 22,440
Acquisition costs deferred ....... 101,305 96,578 87,573
Amortized to expense
during the year .................. 97,783 92,441 85,214
-------- -------- --------
Balance, end of year ............. $ 32,458 28,936 24,799
======== ======== ========
(e) INVESTMENTS
Investments in fixed maturities, where the Companies have the ability
and intent to hold to maturity, are carried at amortized cost. Mortgage-backed
securities are carried at amortized cost using the scientific method of
amortization including anticipated prepayments. Prepayment assumptions are
obtained from a pricing service and are based on the current interest rate and
economic environment. The retrospective adjustment method is used to value all
such securities. For fixed maturities classified as held to maturity, unrealized
holding gains or losses are not reflected in the accompanying consolidated
financial statements. Investments in fixed maturity and equity securities held
as available for sale are carried at fair value. The unrealized holding gains or
losses, net of applicable deferred taxes, are shown as a separate component of
stockholders' equity as accumulated other comprehensive income and as such are
not included in the determination of net income. Gains and losses on the sale of
equity securities are computed using the first-in, first-out method.
45
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(f) SURPLUS NOTE RECEIVABLE
In August 1998, State Auto Financial purchased $9.0 million of surplus
notes from Farmers Casualty Company Mutual (FCCM), an Iowa domiciled standard
property casualty insurer. In 1998, a plan to convert FCCM into a stock
insurance company was approved by the board of FCCM, its policyholders and the
Iowa Division of Insurance. The plan of conversion contemplated that State Auto
Financial, in exchange for the redemption of the surplus notes, would acquire
the newly issued shares of Farmers Casualty. Effective January 1, 1999, FCCM,
renamed Farmers Casualty Insurance Company, became a wholly owned subsidiary of
State Auto Financial.
(g) GOODWILL
Goodwill represents the excess of cost of acquisition over the fair
value of the net assets acquired and is being amortized using the straight-line
method over 15 years. Accumulated amortization is $1,605,000 and $1,347,000 at
December 31, 2000 and 1999, respectively.
(h) LOSSES AND LOSS EXPENSES PAYABLE
Losses and loss expenses payable are based on formula and case-basis
estimates for reported claims, and on estimates, based on experience and
perceived trends, for unreported claims and loss expenses. The liability for
unpaid losses and loss expenses, net of estimated salvage and subrogation
recoverable of $13,403,000 and $13,505,000 at December 31, 2000 and 1999,
respectively, has been established to cover the estimated ultimate cost of
insured losses. The amounts are necessarily based on estimates of future rates
of inflation and other factors, and accordingly there can be no assurance that
the ultimate liability will not vary from such estimates. The estimates are
continually reviewed and adjusted as necessary; such adjustments are
included in current operations (see note 4). Salvage and subrogation
recoverables are estimated using historical experience.
(i) PREMIUM REVENUES
Premiums are recognized as earned using the monthly pro rata method over
the contract period.
(j) MANAGEMENT SERVICES INCOME
Management services income includes income for management and operations
services provided by State Auto P&C in 2000 and executive insurance management
services provided in 1999 and 1998 and income for investment management services
provided by Stateco. Management and operations services income, to the extent
certain operational ratios are achieved, is recognized quarterly based on a
percentage of the three year average of each managed company's adjusted surplus
or equity, whereas in 1999 and 1998 executive management income was based on a
five year average of each managed insurer's adjusted statutory surplus. Midwest
Security Insurance Company (Midwest Security), a wholly-owned subsidiary of
Mutual, is an exception to this, calculating its fee based on a percentage of
quarterly direct premiums written. Investment management income is recognized
quarterly based on a percentage of the average fair value of investable assets
and the performance of the equity portfolio of each company managed.
(k) SOFTWARE REVENUE RECOGNITION
S.I.S. recognizes revenue from license fees when the product is delivered
and service revenue when services are performed. Costs of developing and
testing new or enhanced software products are capitalized and are amortized on a
product-by-product basis utilizing the straight-line method over a period not to
exceed three years. Unamortized software development costs of $626,000 and
$1,248,000 are included in accrued investment income and other assets at
December 31, 2000 and 1999, respectively. Software amortization, included in
other expenses, was $622,000, $614,000 and $673,000 in 2000, 1999 and 1998,
respectively.
(l) FEDERAL INCOME TAXES
The Company files a consolidated federal income tax return and pursuant to
an agreement, each entity within the consolidated group pays its share of
federal income taxes based on separate return calculations. Milbank filed a
consolidated federal income tax return with the Company for periods subsequent
to July 1, 1998. Prior to this time, Milbank was included in the consolidated
federal income tax return of Mutual.
Farmers Casualty and Mid-Plains file a consolidated federal income tax
return with the Company for periods subsequent to January 1, 1999. Prior to this
time, Farmers Casualty and Mid-Plains filed their own consolidated return.
Income taxes are accounted for using the liability method. Using this
method, deferred tax assets and liabilities are determined based on differences
between financial reporting and tax bases of assets
46
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
and liabilities and are measured using the enacted tax rates and laws that will
be in effect when the differences are expected to reverse.
(m) CASH EQUIVALENTS
The Company considers all highly liquid debt instruments with a maturity
of three months or less to be cash equivalents.
(n) OTHER COMPREHENSIVE INCOME
Comprehensive income is defined as all changes in an enterprise's equity
during a period other than those resulting from investments by owners and
distributions to owners. Comprehensive income includes net income and other
comprehensive income. Other comprehensive income includes all other non-owner
related changes to equity and includes net unrealized gains and losses on
available-for-sale fixed maturities and equity securities.
Separate presentation of the accumulated balance of other comprehensive
income within the equity section of the statement of financial position is also
required. The Company has presented the required displays of total comprehensive
income and its components, within the "Consolidated Statements of Stockholders'
Equity." See additional disclosures at note 13.
(o) RECLASSIFICATIONS
Certain items in the 1999 and 1998 consolidated financial statements and
notes thereto have been reclassified to conform with the 2000 presentation.
(2) INVESTMENTS
Realized and unrealized gains and losses are summarized as follows:
YEAR ENDED DECEMBER 31
----------------------
2000 1999 1998
---- ---- ----
(dollars in thousands)
Realized gains:
Fixed maturities available for sale ...................... $ 791 1,336 1,588
Equity securities ........................................ 5,959 3,642 1,449
------------------------------------
Total realized gains ........................................ 6,750 4,978 3,037
------------------------------------
Realized losses:
Fixed maturities available for sale ...................... 827 488 32
Equity securities ........................................ 668 1,896 80
Other .................................................... -- 39 --
------------------------------------
Total realized losses ....................................... 1,495 2,423 112
------------------------------------
Net realized gains on investments ........................... $ 5,255 2,555 2,925
====================================
Increase (decrease) in unrealized holding gains - Fixed
maturities held to maturity .............................. $ 848 (1,830) (371)
====================================
Increase (decrease) in unrealized holding gains - Equity
securities ............................................... $ (2,123) 3,252 6,014
Increase (decrease) in unrealized holding gains - Fixed
maturities available for sale at fair value .............. 33,195 (34,081) 2,657
Change in deferred unrealized gain .......................... (55) (125) (186)
Deferred federal income taxes thereon ....................... (10,856) 10,834 (2,970)
------------------------------------
Increase (decrease) in net unrealized holding gains or losses $ 20,161 (20,120) 5,515
====================================
47
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The Company's investments in held to maturity and available for sale securities
are summarized as follows:
COST OR GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
HELD TO MATURITY AT DECEMBER 31, 2000: COST HOLDING GAINS HOLDING LOSSES VALUE
---- ------------- -------------- -----
(dollars in thousands)
U.S. Treasury securities and obligations of U.S.
government corporations and agencies ......... $ 2,276 38 -- 2,314
Obligations of states and political subdivisions 7,026 354 -- 7,380
Mortgage-backed securities ..................... 30,005 555 29 30,531
-----------------------------------------------
Total .......................................... $ 39,307 947 29 40,225
===============================================
AVAILABLE FOR SALE AT DECEMBER 31, 2000:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies ......... $ 66,434 1,250 648 67,036
Obligations of states and political subdivisions 513,311 15,634 874 528,071
Corporate securities ........................... 33,259 897 266 33,890
Mortgage-backed securities ..................... 23,298 978 22 24,254
-----------------------------------------------
Total fixed maturities ....................... 636,302 18,759 1,810 653,251
Equity securities .............................. 44,220 17,768 3,676 58,312
-----------------------------------------------
Total .......................................... $680,522 36,527 5,486 711,563
===============================================
COST OR GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
HELD TO MATURITY AT DECEMBER 31, 1999: COST HOLDING GAINS HOLDING LOSSES VALUE
---- ------------- -------------- -----
(dollars in thousands)
U.S. Treasury securities and obligations of U.S.
government corporations and agencies ......... $ 2,887 -- 13 2,874
Obligations of states and political subdivisions 7,041 205 -- 7,246
Mortgage-backed securities ..................... 34,053 372 494 33,931
-----------------------------------------------
Total .......................................... $ 43,981 577 507 44,051
===============================================
AVAILABLE FOR SALE AT DECEMBER 31, 1999:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies ......... $ 73,866 388 2,673 71,581
Obligations of states and political subdivisions 439,241 3,550 17,998 424,793
Corporate securities ........................... 7,496 214 339 7,371
Mortgage-backed securities ..................... 23,448 789 176 24,061
-----------------------------------------------
Total fixed maturities ....................... 544,051 4,941 21,186 527,806
Equity securities .............................. 39,303 18,925 2,710 55,518
-----------------------------------------------
Total .......................................... $583,354 23,866 23,896 583,324
===============================================
Deferred federal income taxes on the net unrealized holding gain for available
for sale investments was $10,940,000 and $84,000 at December 31, 2000 and 1999,
respectively.
48
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The amortized cost and fair value of fixed maturities segregated by held to
maturity and available for sale, at December 31, 2000, by contractual maturity,
are summarized as follows:
HELD TO MATURITY AVAILABLE FOR SALE
---------------- ------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
---- ----- ---- -----
(dollars in thousands)
Due after 1 year or less ......... $ 254 254 15,508 15,578
Due after 1 year through 5 years . 2,022 2,060 43,342 44,648
Due after 5 years through 10 years 7,026 7,380 133,504 137,875
Due after 10 years ............... -- -- 420,650 430,896
-------------------------------------------
9,302 9,694 613,004 628,997
Mortgage-backed securities ....... 30,005 30,531 23,298 24,254
-------------------------------------------
$39,307 40,225 636,302 653,251
===========================================
Expected maturities may differ from contractual maturities because the issuers
may have the right to call or prepay the obligations with or without call or
prepayment penalties.
Fixed maturities with carrying values of approximately $21,633,000 and
$20,473,000 were on deposit with regulators as required by law or specific
escrow agreement at December 31, 2000 and 1999, respectively.
Components of net investment income are summarized as follows:
YEAR ENDED DECEMBER 31
----------------------
2000 1999 1998
---- ---- ----
(dollars in thousands)
Fixed maturities .................. $36,568 32,096 30,182
Equity securities ................. 848 678 477
Surplus note receivable ........... -- -- 235
Cash and cash equivalents ......... 1,926 1,707 1,908
-------------------------------------
Investment income ................. 39,342 34,481 32,802
-------------------------------------
Investment expenses ............... 427 219 296
-------------------------------------
Net investment income ............. $38,915 34,262 32,506
=====================================
The Company's current investment strategy does not rely on the use of derivative
financial instruments.
See note 3 for additional fair value disclosures.
(3) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
Investment securities:Fair values for investments in fixed maturities
are based on quoted market prices, where available. For fixed
maturities not actively traded, fair values are estimated using values
obtained from independent pricing services. The fair values for equity
securities are based on quoted market prices.
Cash and cash equivalents:The carrying amounts reported in the balance
sheets for these instruments approximate their fair value.
49
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(4) LOSSES AND LOSS EXPENSES PAYABLE
Activity in the liability for losses and loss expenses is summarized as
follows:
YEAR ENDED DECEMBER 31
----------------------
2000 1999 1998
---- ---- ----
(dollars in thousands)
Losses and loss expenses payable, net of
reinsurance recoverables, at beginning of year ........ $ 221,682 205,034 194,155
Incurred related to:
Current year .......................................... 277,805 271,507 255,885
Prior years ........................................... (5,638) (6,878) (13,591)
---------------------------------------
Total incurred .......................................... 272,167 264,629 242,294
---------------------------------------
Paid related to:
Current year .......................................... 164,620 168,512 157,988
Prior years ........................................... 104,871 100,349 86,671
---------------------------------------
Total paid .............................................. 269,491 268,861 244,659
---------------------------------------
Impact of pooling change, January 1, 2000, 1999 and
1998 (note 6) ......................................... 12,295 7,633 13,244
Impact of acquisition of Farmers Casualty and Mid-Plains,
January 1, 1999 (note 1(f)) ........................... -- 13,247 --
---------------------------------------
Losses and loss expenses payable, net of
reinsurance recoverables, at end of year .............. $ 236,653 221,682 205,034
=======================================
The liability for losses and loss expenses decreased by $5,638,000 in
2000, $6,878,000 in 1999 and $13,591,000 in 1998, for claims that had occurred
in prior years. The change in the redundancy over the three year period ending
December 31, 2000 has resulted primarily from less favorable development in the
long-tail lines such as general liability, commercial auto liability, workers'
compensation and no-fault insurance. Because of the nature of the business
written over the years, the Company's management believes that the Company has
limited exposure to environmental claim liabilities.
50
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
(5) REINSURANCE
In the ordinary course of business, the Company assumes and cedes
reinsurance with other insurers and reinsurers and are members in various pools
and associations. See Note 6(a) for discussion of reinsurance with affiliates.
The voluntary arrangements provide greater diversification of business and
limit the maximum net loss potential arising from large risks and catastrophes.
Most of the ceded reinsurance is effected under reinsurance contracts known as
treaties; some is by negotiation on individual risks. Although the ceding of
reinsurance does not discharge the original insurer from its primary liability
to its policyholder, the insurance company that assumes the coverage assumes the
related liability.
Amounts recoverable from reinsurers are estimated in a manner consistent
with the claim liability associated with the reinsured business. The
recoverability of these assets depends on the reinsurers' ability to perform
under the reinsurance agreements. The Company evaluates and monitors the
financial condition and concentrations of credit risk associated with its
reinsurers under voluntary reinsurance arrangements to minimize its exposure to
significant losses from reinsurer insolvencies. The Company has reported ceded
losses and loss expenses payable and prepaid reinsurance premiums with other
insurers and reinsurers as assets. All reinsurance contracts provide
indemnification against loss or liability relating to insurance risk and have
been accounted for as reinsurance. Prior to the reinsurance transaction with
Mutual under the pooling arrangement, as discussed in note 6(a), the effect of
the Company's reinsurance on its balance sheets and income statements, is as
follows:
DECEMBER 31
-----------
2000 1999
---- ----
(dollars in thousands)
Losses and loss expenses payable:
Direct ..................................... $ 229,422 222,152
Assumed .................................... 5,035 7,710
Ceded ...................................... (7,930) (10,807)
--------------------------
Net losses and loss expenses payable ...... $ 226,527 219,055
==========================
Unearned premiums:
Direct ..................................... $ 159,173 151,867
Assumed .................................... 1,214 1,703
Ceded ...................................... (3,131) (3,090)
--------------------------
Net unearned premiums ..................... $ 157,256 150,480
==========================
YEAR ENDED DECEMBER 31
----------------------
2000 1999 1998
---- ---- ----
(dollars in thousands)
Written premiums:
Direct ............................... $ 439,623 436,150 387,762
Assumed .............................. 4,678 8,281 13,942
Ceded ................................ (10,905) (11,216) (16,731)
---------------------------------------
Net written premiums ................ $ 433,396 433,215 384,973
=======================================
Earned premiums:
Direct ............................... $ 432,318 429,577 384,869
Assumed .............................. 5,166 10,822 14,386
Ceded ................................ (10,864) (13,698) (17,026)
---------------------------------------
Net earned premiums ................. $ 426,620 426,701 382,229
=======================================
Losses and loss expenses incurred:
Direct ............................... $ 297,757 289,162 266,160
Assumed .............................. 3,726 10,803 13,644
Ceded ................................ (2,165) (9,736) (8,355)
---------------------------------------
Net losses and loss expenses incurred $ 299,318 290,229 271,449
=======================================
51
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(6) TRANSACTIONS WITH AFFILIATES
(a) REINSURANCE
State Auto P&C, Milbank, Farmers Casualty and SAIC (the Pooled
Subsidiaries) participate in a quota share reinsurance pooling arrangement
(the Pooling Arrangement) with Mutual whereby the Pooled Subsidiaries cede to
Mutual all of their insurance business and assume from Mutual an amount equal to
their respective participation percentages in the Pooling Arrangement. All
premiums, losses and loss expenses and underwriting expenses are allocated
among the participants on the basis of each company's participation percentage
in the Pooling Arrangement. The Pooling Arrangement provides indemnification
against loss or liability relating to insurance risk and has been accounted for
as reinsurance.
Since 1995, State Auto P&C and Milbank have participated in the Pooling
Arrangement with Mutual. Effective January 1, 1998, the Pooled Subsidiaries
aggregate participation in the Pooling Arrangement increased from 45% to 47% and
Midwest Security Insurance Company (Midwest), a wholly-owned subsidiary of
Mutual, became a participant in the Pooling Arrangement. On January 1, 1999,
Farmers Casualty was acquired by State Auto Financial and became a participant
in the Pooling Arrangement on that same date, at which time the Pooled
Subsidiaries' aggregate participation increased to 50%. In conjunction with
these changes in pool participation, the Pooled Subsidiaries received cash from
Mutual of $11.4 million and $19.7 million, which related to the additional net
insurance liabilities assumed by the Pooled Subsidiaries on January 1, 1999 and
1998, respectively. Effective January 1, 2000, the Pooling Arrangement was
amended to make SAIC a participant in the Pooling Arrangement and the Pooled
Subsidiaries aggregate participation increased to 53%. In conjunction with this
change in pool participation, the Pooled Subsidiaries received cash from Mutual
of $18.6 million, which related to the additional net insurance liabilities
assumed by the Pooled Subsidiaries on January 1, 2000. All parties that
participate in the Pooling Arrangement have an A. M. Best rating of A+
(Superior).
The Pooling Arrangement does not relieve each individual pooled subsidiary
of its primary liability as the originating insurer, consequently, there is a
concentration of credit risk arising from business ceded to Mutual. As the
Pooling Arrangement provides for the right of offset, the Company has reported
losses and loss expenses payable and prepaid reinsurance premiums to Mutual as
assets only in situations when net amounts ceded to Mutual exceed that assumed.
The following provides a summary of the reinsurance transactions on the
Company's balance sheets and income statements for the Pooling Arrangement
between the Pooled Subsidiaries and Mutual:
DECEMBER 31
-----------
2000 1999
---- ----
(dollars in thousands)
Losses and loss expenses payable:
Ceded ............................... $(212,614) (206,258)
Assumed ............................. 222,740 208,885
------------------------------
Net assumed (ceded) ................ $ 10,126 2,627
==============================
Unearned premiums:
Ceded ............................... $(149,854) (143,514)
Assumed ............................. 141,410 130,820
------------------------------
Net ceded .......................... $ (8,444) (12,694)
==============================
52
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
YEAR ENDED DECEMBER 31
----------------------
2000 1999 1998
---- ---- ----
(dollars in thousands)
Written premiums:
Ceded ........................... $(405,397) (403,679) (359,590)
Assumed ......................... 370,576 356,609 330,410
Earned premiums:
Ceded ........................... $(399,057) (395,698) (356,638)
Assumed ......................... 367,275 358,700 328,144
Losses and loss expenses incurred:
Ceded ........................... $(277,340) (268,536) (252,795)
Assumed ......................... 250,189 242,935 223,641
During 1996, Mutual, State Auto P&C, Milbank and National negotiated a
change in their catastrophe reinsurance program. In 1998, Midwest Security,
1999, Farmers Casualty and Mid-Plains, and 2000, SAIC, became parties to the
catastrophe reinsurance program. Collectively, these participants in the
catastrophe reinsurance program are referred to as the "State Auto Insurance
Companies." State Auto P&C assumed catastrophe reinsurance from Mutual, Milbank,
Midwest Security, Farmers Casualty, SAIC, National and Mid-Plains in the amount
of $135 million excess of $120 million. Effective November 2000, the catastrophe
reinsurance program was renegotiated whereby State Auto P&C assumed $115 million
excess of $120 million. Under this agreement, the Company has assumed from
Mutual and its affiliate premiums written and earned of $3,129,000, $2,355,000
and $2,475,000 for 2000, 1999 and 1998, respectively. There have been no losses
assumed under this agreement. The catastrophe reinsurance program with State
Auto P&C has been excluded from the Pooling Arrangement.
To protect against a catastrophe loss event, in which the State Auto
Insurance Companies would incur catastrophe losses in excess of $120 million,
State Auto Financial entered into a structured contingent financing transaction
with a financial institution and a syndicate of other lenders (the Lender) to
provide (effective November 2000) up to $115 million for reinsurance purposes.
In the event of such a loss, this arrangement provides that State Auto Financial
would sell redeemable preferred shares to SAF Funding Corporation, a special
purpose company (SPC), which would borrow the money necessary for such purchase
from the Lenders. This arrangement with the Lenders, SPC and State Auto
Financial is a financing arrangement, whereby State Auto Financial would receive
cash funding in the event of a catastrophe event as described above. State Auto
Financial would then contribute to State Auto P&C the funds received from the
sale of its preferred shares. State Auto P&C would use the contributed capital
proceeds to pay its direct catastrophe losses and losses assumed under the
catastrophe reinsurance agreement. State Auto Financial is obligated to repay
SPC by redeeming the preferred shares over a six-year period. In the event of a
default by State Auto Financial, the obligation to repay SPC has been secured by
a Put Agreement among State Auto Financial, Mutual and the Lenders, under which
Mutual would be obligated to put either the preferred shares or the loan(s)
outstanding.
(b) INTERCOMPANY BALANCES
Pursuant to the Pooling Arrangement, Mutual is responsible for the
collection of premiums and payment of losses, loss expenses and underwriting
expenses of the Pooled Subsidiaries. Unpaid balances are reflected in due to or
due from affiliates in the accompanying consolidated balance sheets. Settlements
of the intercompany account are made quarterly. No interest is paid on this
account. All premium balance receivables and reinsurance recoverable on paid
losses from unaffiliated reinsurers are carried by Mutual. The Company had
off-balance-sheet credit risk of approximately $60 million and $47 million
related to premium balances due to Mutual from agents and insureds at December
31, 2000 and 1999, respectively.
53
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(c) NOTE PAYABLE
State Auto Financial entered into a line of credit agreement with Mutual
for $45.5 million in conjunction with its stock repurchase program, at an
interest rate of 6.0%. See related footnote at note 9 (b). Principal payment is
due on demand after December 31, 2000, with final payment to be received on or
prior to December 31, 2005. The interest rate is adjustable annually after the
year 2000 to reflect adjustments in the then current prime lending rate as well
as State Auto Financial's current financial position. Interest rate for the year
2001 is 5.0%. Interest expense on the loan from Mutual was $2,730,000 and
$955,000 in 2000 and 1999, respectively.
(d) MANAGEMENT SERVICES
Effective January 1, 2000, State Auto P&C began providing management and
operation services to Mutual and its insurance affiliate. Revenue relating to
these services amounted to $14,654,000 in 2000. Prior to 2000, State Auto P&C
provided Mutual and its insurance affiliate executive management services to
oversee the insurance operations of these companies. Revenue relating to these
services amounted to $4,908,000 and $4,563,000 in 1999 and 1998, respectively.
Stateco provides Mutual and its affiliate investment management services.
Revenue related to these services amount to $2,940,000, $3,099,000 and
$3,037,000 in 2000, 1999 and 1998, respectively.
(e) OTHER TRANSACTIONS
S.I.S. provides insurance software products and services to Mutual and its
affiliate. Revenue relating to these services amount to $900,000, $1,109,000 and
$1,048,000 in 2000, 1999 and 1998, respectively, and is included in other
income. Effective January 1, 1998, 518 PML began leasing assets to Mutual and
its affiliate. Revenue relating to these services amount to $646,000, $567,000
and $268,000 in 2000, 1999 and 1998, respectively and is included in other
income.
State Auto P&C's December 31, 1990 liability for losses and loss expenses
of $65,464,000 has been guaranteed by Mutual. Pursuant to the guaranty
agreement, all ultimate adverse development of the December 31, 1990 liability,
if any, is to be reimbursed by Mutual to State Auto P&C in conformance with
pooling percentages in place at that time. As of December 31, 2000, there has
been no adverse development of the liability.
(7) FEDERAL INCOME TAXES
A reconciliation between actual federal income taxes and the amount
computed at the indicated statutory rate is as follows:
YEAR ENDED DECEMBER 31
----------------------
2000 1999 1998
AMOUNT % AMOUNT % AMOUNT %
------ --- ------ --- ------ ---
(dollars in thousands)
Amount at statutory rate ......................... $ 21,505 35 19,947 35 17,361 35
Tax-free interest and dividends received deduction (7,918) (13) (6,315) (11) (5,423) (11)
Other, net ....................................... 143 -- 537 1 170 --
-------- ----- ------- ----- ------- -----
Effective tax rate ............................... $ 13,730 22 14,169 25 12,108 24
======== ===== ======= ===== ======= =====
54
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets and deferred tax liabilities are presented
below:
DECEMBER 31
-----------
2000 1999
---- ----
(dollars in thousands)
Deferred tax assets:
Unearned premiums not deductible ................... $ 10,385 9,597
Losses and loss expenses payable discounting ....... 9,219 8,375
Postretirement benefit liabilities ................. 13,035 --
Other .............................................. 2,110 2,229
----------------------
Total deferred tax assets ........................ 34,749 20,201
----------------------
Deferred tax liabilities:
Deferral of policy acquisition costs ............... 11,360 10,128
Net pension expense ................................ 12,628 6,631
Unrealized holding gain on investments ............. 10,940 84
Other .............................................. 1,311 1,530
----------------------
Total deferred tax liabilities ................... 36,239 18,373
----------------------
Net deferred tax assets (liabilities) ............ $ (1,490) 1,828
======================
The Company is required to establish a valuation allowance for any portion
of the deferred tax asset that management believes will not be realized. In
the opinion of management, it is more likely than not that the Company will
realize the benefit of the deferred tax assets and, therefore, no such
valuation allowance has been established.
Federal income taxes paid during 2000, 1999 and 1998 were $12,638,000,
$12,621,000 and $11,768,000, respectively.
(8) (a) PENSION BENEFIT PLANS
Prior to 2000, State Auto P&C, Stateco and S.I.S., pursuant to an
intercompany agreement, were participants, together with Mutual, in a defined
benefit pension plan and a defined contribution plan that covered substantially
all employees of Mutual and the Company.
Effective January 1, 2000, all employees of Mutual, Stateco and S.I.S.,
became employees of State Auto P&C, under new management agreements effective on
that same date. See related discussion at Note (1)(b). Pursuant to the new
management agreements, the Company paid cash of approximately $14.6 million to
Mutual, equal to the net prepaid pension asset received.
The assets of the defined benefit pension plan are represented primarily
by U.S. government and agency obligations, bonds, and common stocks. The
Company's policy is to fund pension costs in accordance with the requirements
of the Employee Retirement Income Security Act of 1974. Benefits are determined
by applying factors specified in the plan to a participant's defined average
annual compensation.
55
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Information regarding the funded status and net periodic pension benefit for the
Company's participation in the defined benefit pension plan is as follows:
DECEMBER 31
-----------
2000 1999
---- ----
(in thousands)
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of year .................................... $ 44,016 44,758
Transfer in benefit obligation at beginning of year due to employee transfer 39,586 --
Transfer in benefit obligation at beginning of year due to pooling change .. -- 2,615
Service cost ............................................................... 3,339 2,047
Interest cost .............................................................. 6,728 3,278
Changes in plan provisions ................................................. 1,205 --
Actuarial loss ............................................................. (438) (4,286)
Benefits paid .............................................................. (7,343) (4,396)
-------- ------
Benefit obligation at end of year .......................................... $ 87,093 44,016
-------- ------
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year ............................. $ 84,883 75,453
Transfer in plan assets at beginning of year due to employee transfer ...... 76,340 --
Transfer in plan assets at beginning of year due to pooling change ......... -- 4,313
Actual return on plan assets ............................................... 8,778 9,513
Benefits paid .............................................................. (7,343) (4,396)
--------------------
Fair value of plan assets at end of year ................................... $162,658 84,883
--------------------
Funded status .............................................................. $ 75,565 40,867
Unrecognized net actuarial gain ............................................ (846) (22,441)
Unrecognized prior service cost ............................................ 2,470 1,472
Unrecognized transition asset .............................................. (39,451) (967)
--------------------
Net prepaid pension expense ................................................ $ 37,738 18,931
====================
YEAR ENDED DECEMBER 31
----------------------
2000 1999 1998
---- ---- ----
(in thousands)
COMPONENTS OF NET PERIODIC BENEFIT
Service cost ............................ $ 3,339 2,047 1,686
Interest cost ........................... 6,728 3,278 2,977
Expected return on plan assets .......... (13,391) (6,125) (5,430)
Amortization of prior service cost ...... 207 114 114
Amortization of transition asset ........ (121) (124) (121)
Amortization of net (gain) or loss ...... (930) 7 (8)
---------------------------------
Net periodic benefit .................... $(4,168) (803) (782)
=================================
YEAR ENDED DECEMBER 31
----------------------
2000 1999 1998
---- ---- ----
WEIGHTED-AVERAGE ASSUMPTIONS AS OF DECEMBER 31
Discount rate ................................ 8.00% 8.00% 7.00%
Expected long-term rate of return on assets .. 9.00% 9.00% 9.00%
Rates of increase in compensation levels ..... 5.00% 5.00% 4.50%
56
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Effective January 1, 2000, the net prepaid pension expense is carried on
the financial statements of the Company and the annual periodic pension benefit
or cost is allocated to affiliated companies based on allocations pursuant to
intercompany management agreements. The Company's share of the 2000 net periodic
benefit was $2.5 million.
The Company maintains a defined contribution plan that covers
substantially all employees of the Company. Contributions to the plan are based
on employee contributions and the level of Company match. The Company's share of
the expense under the plan totaled $890,000, $852,000 and $782,000 for the years
2000, 1999 and 1998, respectively.
(b) POSTRETIREMENT BENEFITS
In addition to pension benefits, the Company provides certain health care
and life insurance benefits for its eligible retired employees. Substantially
all of the Company's employees may become eligible for these benefits if they
retire between age 55 and 65 with 15 years or more of service or if they retire
at age 65 or later with 5 years or more of service.
Prior to 2000, State Auto P&C, Stateco and S.I.S., pursuant to an
intercompany agreement, were participants, together with Mutual, in a
postretirement medical and life insurance benefit plan. The postretirement
benefit obligation was immaterial to the consolidated balance sheet prior to
2000.
Effective January 1, 2000, all employees of Mutual, Stateco and S.I.S.,
became employees of State Auto P&C, under new management agreements effective on
that same date. See related discussion at Note (1)(b). Pursuant to the new
management agreements, the Company received cash of approximately $49.6 million
from Mutual, equal to the funded status of the postretirement obligation
assumed.
Plan assets are primarily composed of mutual funds and government
securities.
The following table presents the funded status for the Company's
postretirement benefit obligation and the amounts recognized in the
consolidated balance sheet as of December 31, 2000 (in thousands):
2000
----
CHANGE IN BENEFIT OBLIGATION
Obligation at January 1 .................................................... $ 1,064
Transfer in benefit obligation at beginning of
year due to employee transfer ............................................. 46,045
Service cost ............................................................... 1,242
Interest cost .............................................................. 3,205
Actuarial gain ............................................................. (5,247)
Employee contributions ..................................................... (1,400)
--------
Obligation at December 31 .................................................. $ 44,909
========
CHANGE IN FAIR VALUE OF PLAN ASSETS
Fair value of plan assets at January 1 ..................................... $ --
Transfer of plan assets at beginning of year due to employee transfer ...... 1,479
Expected return on assets .................................................. 126
Loss on assets ............................................................. (37)
--------
Fair value of plan assets at December 31 ................................... $ 1,568
========
FUNDED STATUS
Funded status at December 31 ............................................... $(43,341)
Unrecognized transition asset .............................................. (41)
Unrecognized gain .......................................................... (12,099)
--------
Accrued liability at December 31 ........................................... $(55,841)
========
57
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
An 8.0% weighted average discount rate was used for 2000 to determine the
accumulated postretirement benefit obligation. An 8.5% weighted average rate was
used for 2000 to determine the long-term rate of return on plan assets. Net
periodic pension costs for the postretirement plan for the year ended December
31, 2000 include the following components:
2000
----
Service cost ............................................... $ 1,242
Interest cost .............................................. 3,205
Expected return on assets .................................. (126)
Amortization of unrecognized amounts ....................... (495)
--------
Net periodic benefit cost .................................. $ 3,826
========
The assumed rate of future increases in per capita cost of health care
benefits was 10% for the first year and grading down 1% per year to an ultimate
rate of 5%. The health care cost trend rate assumption affects the amounts
reported. For example, increasing the assumed health care cost trend rate by one
percentage point would increase the accumulated postretirement benefit
obligation by approximately $6,100,000 and would increase the medical service
and interest cost by approximately $800,000.
(9) STOCKHOLDERS' EQUITY
(a) STOCK SPLIT
On June 2, 1998, State Auto Financial's authorized capital was increased
to 100,000,000 shares of common stock and State Auto Financial's Board of
Directors declared a two-for-one common stock split. The financial statements,
notes and other references to share information and per share data have been
given retroactive effect to reflect the stock split for all periods presented.
(b) TREASURY SHARES
In May 1999, State Auto Financial's Board of Directors approved a plan to
repurchase up to 4.0 million shares of its outstanding common stock over a
period ending December 31, 2000. Repurchases were transacted to maintain the
same ownership ratios between Mutual and the public as it existed in May 1999,
with 69% repurchased from Mutual and 31% from the public. Through December 31,
1999 all 4.0 million shares have been repurchased, with approximately 2.7
million shares repurchased from Mutual and 1.3 million shares from the public.
In conjunction with the stock repurchase plan, State Auto Financial entered into
a line of credit agreement with Mutual. See related footnote at note 6 (c).
In May 2000, State Auto Financial's Board of Directors approved a plan to
repurchase up to 1.0 million shares of its common stock from the public over a
period ending December 31, 2001. Through December 31, 2000, State Auto Financial
has repurchased 25,122 shares from the public. Repurchases during 2000 were
funded through dividends from subidiaries.
(c) DIVIDEND RESTRICTIONS AND STATUTORY FINANCIAL
INFORMATION
State Auto P&C, Milbank, Farmers Casualty, SAIC and National are subject
to regulations and restrictions under which payment of dividends from statutory
surplus can be made to State Auto Financial during the year without prior
approval of regulatory authorities. Pursuant to these rules, approximately $44.9
million is available for payment to State Auto Financial in 2001 without prior
approval.
58
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Reconciliations of statutory capital and surplus and net income, as
determined using statutory accounting practices, to the amounts included in the
accompanying consolidated financial statements are as follows:
DECEMBER 31
-----------
2000 1999
---- ----
(dollars in thousands)
Statutory capital and surplus of insurance subsidiaries ...... $ 325,532 283,233
Net assets of noninsurance parent and affiliates ............. (25,744) (21,378)
------------------------
299,788 261,855
Increases (decreases):
Deferred policy acquisition costs .......................... 32,458 28,936
Losses and loss expenses payable ........................... 13,403 13,505
Net prepaid pension expense ................................ 37,738 18,945
Postretirement benefit liability ........................... (18,478) --
Deferred federal income taxes .............................. (1,854) 1,636
Excess of statutory loss liabilities over case basis amounts 2,567 4,856
Fixed maturities at fair value ............................. 17,250 (15,204)
Goodwill ................................................... 2,270 2,529
Other, net ................................................. 917 629
------------------------
Stockholders' equity per accompanying consolidated
financial statements ..................................... $386,059 317,687
=======================
YEAR ENDED DECEMBER 31
----------------------
2000 1999 1998
------ ------ ------
(dollars in thousands)
Statutory net income of insurance subsidiaries . $ 43,991 36,601 28,696
Net income of noninsurance parent and affiliates 1,125 2,944 3,227
------------------------------------
45,116 39,545 31,923
Increases (decreases):
Deferred policy acquisition costs ............ 3,522 3,407 2,359
Losses and loss expenses payable ............. (103) 15 1,947
Net prepaid pension expense .................. 640 2,578 1,791
Postretirement benefit expense ............... (1,150) -- --
Deferred federal income taxes ................ 401 (2,265) 279
Goodwill amortization ........................ (258) (258) (198)
Other, net ................................... (454) (206) (604)
------------------------------------
Net income per accompanying consolidated
financial statements ........................ $ 47,714 42,816 37,497
====================================
In March 1998, the National Association of Insurance Commissioners revised
the Accounting Practices and Procedures Manual for insurance companies in a
process referred to as Codification. The revised manual became effective January
1, 2001. The revised manual has changed, to some extent, prescribed statutory
insurance accounting practices and will result in changes to the accounting
practices that the insurance subsidiaries of State Auto Financial use to prepare
its statutory-basis financial statements. The cumulative effect of changes in
accounting principles adopted to conform to the revised Accounting Practices and
Procedures Manual will be reported as an adjustment to statutory surplus as of
January 1, 2001. The Company estimates that the adoption of Codification, as of
January 1, 2001, will increase statutory surplus of the insurance subsidiaries
of State Auto Financial by approximately $26.8 million.
59
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(10) PREFERRED STOCK
State Auto Financial has authorized two classes of preferred stock. For both
classes, upon issuance, the Board of Directors has authority to fix and
determine the significant features of the shares issued, including, among other
things, the dividend rate, redemption price, redemption rights, conversion
features and liquidation price payable in the event of any liquidation,
dissolution, or winding up of the affairs of State Auto Financial. See note 6
(a) regarding State Auto Financial's obligation to issue redeemable preferred
shares to SPC in connection with its catastrophic reinsurance arrangements with
a financial institution.
The Class A preferred stock is not entitled to voting rights until, for any
period, dividends are in arrears in the amount of six or more quarterly
dividends.
(11) STOCK INCENTIVE PLANS
The Company follows Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees" (APB 25) and related Interpretations in
accounting for its employee stock incentive plans. For stock options granted to
employees of Mutual in 1999, the Company also followed APB 25 and related
Interpretations, as the Company deemed such employees to be common law employees
of the Company. Compensation cost charged against operations in 2000 and 1999
were $31,000 and $137,000, respectively, for those employee stock options
granted where the exercise price was less than the market price of the
underlying stock on the date of grant. Had compensation cost for the Company's
plans been determined based on the fair values at the grant dates consistent
with the method of SFAS No. 123, "Accounting for Stock-Based Compensation,"
(SFAS No. 123), the Company's pro forma net earnings and net earnings per share
information would have been as follows:
2000 1999 1998
---- ---- ----
(in thousands, except
per share figures)
Pro forma net earnings ....................... $ 45,784 41,414 35,700
Pro forma net earnings per common share
Basic .................................... $ 1.19 1.02 0.85
Diluted .................................. $ 1.17 1.00 0.83
The fair value of options granted in 2000, 1999 and 1998 were estimated at
the date of grant using the Black-Scholes option-pricing model. The weighted
average fair values and related assumptions for options granted were as follows:
2000 1999 1998
---- ---- ----
Fair value .............................. $4.66 $4.49 $6.10
Dividend yield .......................... .90% .90% .75%
Risk free interest rate ................. 6.51% 5.77% 5.31%
Expected volatility factor .............. .34 .32 .31
Expected life (years) ................... 7.2 5.7 6.6
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
The Company has stock option plans for certain directors and key employees.
The nonemployee directors' plan provides each nonemployee director an option to
purchase 1,500 shares of common stock following each annual meeting of the
shareholders at an option price equal to the fair market value at the last
business day prior to the annual meeting. The Company has reserved 300,000
shares of common stock under this plan. These options are exercisable at
issuance to 10 years from date of grant. The key employee's plan provides that
qualified stock options
60
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
may be granted at an option price not less than fair market value at date of
grant and that nonqualified stock options may be granted at any price determined
by the options committee of the Board of Directors. The Company has reserved
5,000,000 shares of common stock under this plan. These options are exercisable
at such time or times as may be determined by a committee of the Company's Board
of Directors. Normally, for certain employees these options are exercisable from
1 to 10 years from date of grant and 3 to 10 years for remaining employees.
The Company has an employee stock purchase plan with a dividend reinvestment
feature, under which employees of the Company may choose at two different
specified time intervals each year to have up to 6% of their annual base
earnings withheld to purchase the Company's common stock. The purchase price of
the stock is 85% of the lower of its beginning-of-interval or end-of-interval
market price. The Company has reserved 2,400,000 shares of common stock under
this plan. At December 31, 2000, 1,699,000 shares have been purchased under this
plan.
The Company has a stock option incentive plan for certain designated
independent insurance agencies that represent the Company and its affiliates.
The Company has reserved 400,000 shares of common stock under this plan. The
plan provides that the options become exercisable on the first day of the
calendar year following the agency's achievement of specific production and
profitability requirements over a period not greater than two calendar years
from date of grant or a portion thereof in the first calendar year in which an
agency commences participation under the plan. Options granted and vested under
this plan have a 10-year term. The Company has accounted for the plan in its
accompanying financial statements at fair value. The fair value of options
granted was estimated at the reporting date or vesting date using the
Black-Scholes option-pricing model. The weighted average fair value and related
assumptions for 2000 and 1999, respectively, were as follows: fair value of
$10.91 and $4.02; dividend yield of .90% for both years; expected volatility
factor of .32 and .30; risk-free interest rate of 5.19% and 6.80%; and expected
life of the option of 9.0 and 9.7 years. Expense of $493,000 and $105,000
associated with this plan was recognized in 2000 and 1999, respectively.
A summary of the Company's stock option activity and related information for
these plans for the years ended December 31, 2000, 1999 and 1998, follows:
2000 1999 1998
-------------------------- -------------------------- --------------------------
WEIGHTED - AVERAGE WEIGHTED - AVERAGE WEIGHTED - AVERAGE
OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE
------- -------------- ------- -------------- ------- --------------
(numbers in thousands, except per share figures)
Outstanding, beginning
of year 2,546 $ 7.76 2,272 $ 6.76 2,019 $ 5.04
Granted 492 10.29 453 11.24 339 16.31
Exercised (129) 4.32 (165) 3.34 (86) 4.02
Canceled (57) 11.15 (14) 10.52 -- --
------ ----- -----
Outstanding, end of year 2,852 8.28 2,546 7.76 2,272 6.76
====== ===== =====
A summary of information pertaining to options outstanding and exercisable as of
December 31, 2000 follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------- ----------------------------
WEIGHTED - AVERAGE
REMAINING WEIGHTED - AVERAGE WEIGHTED - AVERAGE
RANGE OF EXERCISE PRICES NUMBER CONTRACTUAL LIFE EXERCISE PRICE NUMBER EXERCISE PRICE
- ------------------------ ------ ---------------- -------------- ------ --------------
(numbers in thousands, except per share figures)
Less than $5.00 734 2.0 $ 3.98 734 $ 3.98
$5.01 - $10.00 1,004 4.9 6.66 961 6.56
Greater than $10.01 1,114 8.5 12.58 537 13.89
----- -----
2,852 5.5 8.28 2,232 7.47
===== =====
61
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(12) NET EARNINGS PER COMMON SHARE
The following table sets forth the compilation of basic and diluted net
earnings per common share:
YEAR ENDED DECEMBER 31
----------------------
2000 1999 1998
---- ---- ----
(in thousands,
except per share data)
Numerator:
Net earnings for basic and diluted earnings
per common share .................................. $47,714 42,816 37,497
-----------------------
Denominator:
Weighted average shares for basic net earnings
per common share .................................. 38,427 40,780 41,887
Effect of dilutive stock options .................... 693 746 1,014
-----------------------
Adjusted weighted average shares for
diluted net earnings per common share ............. 39,120 41,526 42,901
=======================
Basic net earnings per common share ................... $ 1.24 1.05 0.89
=======================
Diluted net earnings per common share ................. $ 1.21 1.03 0.87
=======================
(13) OTHER COMPREHENSIVE INCOME
The related federal income tax effects of each component of other comprehensive
income (loss) are as follows:
YEAR ENDED DECEMBER 31, 2000
----------------------------
BEFORE-TAX TAX (EXPENSE) NET-OF-TAX
AMOUNT OR BENEFIT AMOUNT
------ ---------- ------
(in thousands)
Net unrealized holding gains on
securities:
Unrealized holding gains arising
during 2000 ........................... $36,272 (12,695) 23,577
Reclassification adjustments for gains
realized in net income ................ (5,255) 1,839 (3,416)
---------------------------------
Net unrealized holding gains ............ 31,017 (10,856) 20,161
---------------------------------
Other comprehensive income ................ $31,017 (10,856) 20,161
=================================
YEAR ENDED DECEMBER 31, 1999
----------------------------
BEFORE-TAX TAX (EXPENSE) NET-OF-TAX
AMOUNT OR BENEFIT AMOUNT
------ ---------- ------
(in thousands)
Net unrealized holding losses on
securities:
Unrealized holding losses arising
during 1999 ........................... $(28,361) 9,926 (18,435)
Reclassification adjustments for gains
realized in net income ................ (2,593) 908 (1,685)
-----------------------------------
Net unrealized holding losses ........... (30,954) 10,834 (20,120)
-----------------------------------
Other comprehensive loss .................. $(30,954) 10,834 (20,120)
===================================
YEAR ENDED DECEMBER 31, 1998
----------------------------
BEFORE-TAX TAX (EXPENSE) NET-OF-TAX
AMOUNT OR BENEFIT AMOUNT
------ ---------- ------
(in thousands)
Net unrealized holding gains on
securities:
Unrealized holding gains arising
during 1998 ........................... $11,410 (3,993) 7,417
Reclassification adjustments for gains
realized in net income ................ (2,925) 1,023 (1,902)
----------------------------------
Net unrealized holding gains ............ 8,485 (2,970) 5,515
----------------------------------
Other comprehensive income ................ $ 8,485 (2,970) 5,515
==================================
62
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(14) REPORTABLE SEGMENTS
The Company has four reportable segments: standard insurance, nonstandard
insurance, investment management services and management and operations services
(prior to 2000, executive insurance management services). The standard insurance
segment provides personal and commercial insurance to its policyholders. Its
principal lines of business include personal and commercial automobile,
homeowners, commercial multi-peril, workers' compensation, general liability and
fire insurance. The nonstandard insurance segment provides personal automobile
insurance to policyholders that are typically rejected or canceled by standard
insurance carriers because of poor loss experience or a history of late payment
of premiums. Both the standard and nonstandard insurance segments operate
primarily in the Midwest and Eastern United States, excluding New York, New
Jersey, and the New England states, through the independent insurance agency
system. The investment management services segment manages the investment
portfolios of affiliated insurance companies. The management and operations
services segment provides employee services and manages the day to day
operations of all affiliated Companies.
The Company evaluates performance and allocates resources based on profit or
loss from operations, excluding net realized gains on investments on the
Company's investment portfolio, before federal income taxes. The Company does
not allocate assets to the management and operations services segment. The
accounting policies of the reportable segments are the same as those described
in the summary of significant accounting policies.
Intersegment sales and transfers are priced at estimated market value.
The reportable segments are business units that are each managed separately
because of the differences in products or service they offer and type of
customer they serve.
Revenue from segments in the other category is attributable to three other
operating segments of the Company; an insurance software development and resale
segment, a premium finance segment and a property management and leasing
segment. These segments have never met the quantitative thresholds for
individual presentation as reportable segments.
The following provides financial information regarding the Company's reportable
segments:
2000 1999 1998
---- ---- ----
(in thousands)
REVENUES FROM EXTERNAL CUSTOMERS:
Standard insurance ...................... $406,602 392,557 360,601
Nonstandard insurance ................... 29,595 32,973 27,064
Investment management services .......... 3,360 3,371 3,328
Management and operations services ...... 14,654 5,628 4,909
All other ............................... 3,227 3,537 2,906
--------------------------------
Total revenues from external customers .... 457,438 438,066 398,808
Intersegment revenues:
Standard insurance ...................... 162 120 90
Investment management services .......... 2,884 2,575 2,363
Management and operations services ...... 4,303 1,451 1,060
All other ............................... 1,744 1,676 1,167
--------------------------------
Total intersegment revenues ............... 9,093 5,822 4,680
--------------------------------
Total revenue ............................. 466,531 441,578 403,488
--------------------------------
Reconciling items:
Intersegment revenues ................... (9,093) (5,822) (4,680)
Corporate revenues ...................... 81 250 326
Net realized gains on investment ........ 5,255 2,555 2,925
--------------------------------
Total consolidated revenues ............... $462,774 440,871 402,059
================================
63
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
2000 1999 1998
---- ---- ----
(in thousands)
SEGMENT PROFIT (LOSS):
Standard insurance ......................... $ 35,579 41,146 34,341
Nonstandard insurance ...................... (116) 1,647 1,313
Investment management services ............. 5,354 5,191 4,908
Management and operations services ......... 17,552 6,330 5,290
All other .................................. 905 1,238 1,323
------------------------------
Total segment profit ....................... 59,274 55,552 47,175
Reconciling items:
Corporate expenses ......................... (3,085) (1,122) (495)
Net realized gains on investment ........... 5,255 2,555 2,925
------------------------------
Total consolidated income before federal
income taxes ............................... $ 61,444 56,985 49,605
==============================
NET INVESTMENT INCOME:
Standard insurance ......................... $ 33,436 29,060 27,710
Nonstandard insurance ...................... 1,899 1,839 1,383
Investment management services ............. 360 272 292
All other .................................. 244 268 432
------------------------------
Total net investment income .................. 35,939 31,439 29,817
Reconciling items:
Corporate net investment income ............ 81 249 326
Reclassification adjustments in
consolidation ............................ 2,895 2,574 2,363
------------------------------
Total consolidated net investment income ..... $ 38,915 34,262 32,506
==============================
SEGMENT ASSETS:
Standard insurance ......................... $850,080 708,384 641,195
Nonstandard insurance ...................... 48,811 44,670 37,997
Investment management services ............. 6,879 6,367 7,449
All other .................................. 15,543 14,940 15,741
-------- ------- -------
Total segment assets ....................... 921,313 774,361 702,382
Reconciling items:
Corporate assets ........................... 1,150 1,223 10,979
Reclassification adjustments in
consolidation ............................ (24,357) (15,639) (3,583)
-------- ------- -------
Total consolidated assets .................... $898,106 759,945 709,778
======== ======= =======
64
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Revenues from external customers include the following products and services:
2000 1999 1998
---- ---- ----
(in thousands)
Earned premiums
Standard insurance:
Automobile ........................................................ $203,967 204,155 186,283
Homeowners and farmowners ......................................... 67,247 63,666 57,983
Commercial multi-peril ............................................ 25,349 23,902 21,791
Workers' compensation ............................................. 10,628 10,764 12,006
Fire and allied ................................................... 27,848 25,763 23,698
Other and products liability ...................................... 21,924 20,052 17,313
Other lines ....................................................... 13,603 12,873 11,545
--------------------------------------------------
Total standard insurance earned premiums ............................ 370,566 361,175 330,619
Total nonstandard insurance earned premiums ......................... 27,401 30,883 25,591
--------------------------------------------------
Total earned premiums ............................................... 397,967 392,058 356,210
Investment management services ...................................... 2,940 3,099 3,036
Management and operations services .................................. 14,654 4,908 4,563
Net investment income ............................................... 38,834 34,012 32,180
Other income ........................................................ 3,043 3,989 2,819
--------------------------------------------------
Total revenues from external customers .............................. $457,438 438,066 398,808
==================================================
The standard insurance segment participates in a reinsurance pooling agreement
with other standard insurance affiliates. For discussion regarding this
arrangement and the segment's contribution to the pool and participation in the
pool, see note 6.
Revenues from external customers are derived entirely within the United States.
Also, all long-lived assets are located within the United States.
(15) QUARTERLY FINANCIAL DATA (UNAUDITED)
2000
----
FOR THREE MONTHS ENDED
----------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
--------- -------- ------------- ------------
(dollars in thousands, except per share amounts)
Total revenues ............................................ $116,461 113,953 116,328 116,032
Income before federal income taxes ........................ 18,584 16,512 9,131 17,217
Net earnings .............................................. 13,683 12,494 8,006 13,531
Net earnings per common share (note 9a):
Basic .................................................. 0.35 0.33 0.21 0.35
Diluted ................................................ 0.35 0.32 0.20 0.34
==============================================================
65
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
1999
----
FOR THREE MONTHS ENDED
----------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
--------- -------- ------------- ------------
(dollars in thousands, except per share amounts)
Total revenues ............................................. $110,931 111,186 110,469 108,294
Income before federal income taxes ......................... 14,661 13,767 10,666 17,891
Net earnings ............................................... 10,880 10,369 8,532 13,035
Net earnings per common share (note 9a):
Basic ................................................... 0.25 0.25 0.22 0.33
Diluted ................................................. 0.25 0.25 0.21 0.32
==============================================================
(16) CONTINGENCIES
The Company's insurance subsidiaries are involved in litigation and may
become involved in potential litigation arising in the ordinary course of
business. Additionally, the insurance subsidiaries may be impacted by adverse
court decisions where insurance coverages are expanded beyond the scope
originally contemplated in the policy(ies). In the opinion of management, the
effects, if any, of such litigation and published court decisions are not
expected to be material to the consolidated financial statements.
(17) SUBSEQUENT EVENT
The Ohio Department of Insurance (the "Department") has requested that
Mutual, starting with the quarter beginning January 1, 2001, file an analysis on
a quarterly basis with the Department that justifies the apportionment of the
service fee paid by Mutual to State Auto P&C under the accounting guidance
outlined in Statement of Statutory Accounting Principles No. 70 - Allocation of
Expenses. The Company believes that its accounting for such service fee is
consistent with all statutory accounting principles. However, there can be no
assurance that all or any part of the service fee paid by Mutual will be
justified to the Department's satisfaction, which may affect the amount of such
fee recognized as revenue by Company.
During 2000, service fee revenue, included in management services income
from affiliates in the accompanying financial statements, paid by Mutual
accounted for $14,538,000 or 3.1 percent of total revenues and $0.24 on a basic
and diluted earnings per share, after tax, basis.
66
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required under this Item with respect to directors will be
contained in the Company's proxy statement to be filed within 120 days of
December 31, 2000, and is hereby incorporated herein by reference.
Information required under this Item with respect to executive officers
is contained under the heading "Executive Officers of the Registrant" in Item 1
of this Form 10-K report.
ITEM 11. EXECUTIVE COMPENSATION
Information required under this Item will be contained in the Company's
proxy statement to be filed within 120 days of December 31, 2000, and is hereby
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required under this Item will be contained in the Company's
proxy statement to be filed within 120 days of December 31, 2000, and is hereby
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required under this Item will be contained in the Company's
proxy statement to be filed within 120 days of December 31, 2000, and is hereby
incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) LISTING OF FINANCIAL STATEMENTS
The following consolidated financial statements of the Company, are
filed as part of this Form 10-K Report and are included in Item 8:
Report of Independent Auditors
Consolidated Balance Sheets as of
December 31, 2000 and 1999
Consolidated Statements of Income for
each of the three years in the
period ended December 31, 2000
Consolidated Statements of Stockholders'
Equity for each of the three years in
the period ended December 31, 2000
Consolidated Statements of Cash Flows for
each of the three years in the period
ended December 31, 2000
Notes to Consolidated Financial Statements
67
(a)(2) LISTING OF FINANCIAL STATEMENT SCHEDULES
The following financial statement schedules of the Company for the
years 2000, 1999, and 1998, are included in Item 14(d), following the
signatures, and should be read in conjunction with the consolidated
financial statements contained in this Form 10-K Annual Report.
SCHEDULE
NUMBER SCHEDULE
------ --------
I(a) & I(b). Summary of Investments - Other Than Investments in
Related Parties
II. Condensed Financial Information of Registrant
III. Supplementary Insurance Information
IV. Reinsurance
All other schedules are omitted because they are not applicable or the
required information is included in the consolidated financial statements or
notes thereto.
68
(a)(3) LISTING OF EXHIBITS
If incorporated by reference document
Exhibit No. Description of Exhibit with which Exhibit was previously filed with SEC
- ----------- ---------------------- ----------------------------------------------------------
3(A)(1) State Auto Financial Corporation's Amended and Restated 1933 Act Registration Statement No. 33-40643 on Form S-1
Articles of Incorporation (see Exhibit 3(a) therein)
3(A)(2) State Auto Financial Corporation's Amendment to the 1933 Act Registration Statement No. 33-89400 on Form S-8
Amended and Restated Articles of Incorporation (see Exhibit 4(b) therein)
3(A)(3) State Auto Financial Corporation Certificate of Form 10-K Annual Report for the year ended December 31,
Amendment to the Amended and Restated Articles of 1998 (see Exhibit 3(A)(3) therein)
Incorporation as of June 2, 1998
3(B) State Auto Financial Corporation's Amended and Restated 1933 Act Registration Statement No. 33-40643 on Form S-1
Code of Regulations (see Exhibit 3(b) therein)
4 State Auto Financial Corporation's Amended and Restated Form 10-K Annual Report for the year ended December 31,
Articles of Incorporation, and Articles 1, 3, 5 and 9 of 1992 (see Exhibit 3(A) and 3(B) therein)
the Company's Amended and Restated Code of Regulations
10(A) Guaranty Agreement between State Automobile Mutual 1933 Act Registration Statement No. 33-40643 on Form S-1
Insurance Company and State Auto Property and Casualty (see Exhibit 10 (d) therein)
Insurance Company dated as of May 16, 1991
10(B) Form of Indemnification Agreement between State Auto 1933 Act Registration Statement No. 33-40643 on Form S-1
Financial Corporation and each of its directors (see Exhibit 10 (e) therein)
10(C)* State Auto 1991 Quality Performance Bonus Plan 1933 Act Registration Statement No. 33-40643 on Form S-1
(see Exhibit 10 (f) therein)
10(D)* Non-Qualified Deferred Compensation Plan 1933 Act Registration Statement No. 33-40643 on Form S-1
(see Exhibit 10 (g) therein)
10(E)* 1991 Stock Option Plan 1933 Act Registration Statement No. 33-40643 on Form S-1
(see Exhibit 10 (h) therein)
10(F)* Amendment Number 1 to the 1991 Stock Option Plan 1933 Act Registration Statement No. 33-89400 on Form S-8
(see Exhibit 4 (a) therein)
10(G)* 1991 Directors' Stock Option Plan 1933 Act Registration Statement No. 33-40643 on Form S-1
(see Exhibit 10 (i) therein)
- ---------------------------------
*Constitutes either a management contract or a compensatory plan or arrangement
required to be filed as an Exhibit
69
If incorporated by reference document
Exhibit No. Description of Exhibit with which Exhibit was previously filed with SEC
- ----------- ---------------------- ----------------------------------------------------------
10(H) License Agreement between State Automobile Mutual 1933 Act Registration Statement No. 33-40643 on Form S-1
Insurance Company and Policy Management Systems (see Exhibit 10 (k) therein)
Corporation dated December 28, 1984
10(I) Investment Management Agreement between Stateco Form 10-K Annual Report for the year ended December 31,
Financial Services, Inc. and State Automobile Mutual 1992 (see Exhibit 10 (N) therein)
Insurance Company, effective April 1, 1993
10(J)* Supplemental Executive Retirement Income Plan effective Form 10-K Annual Report for the year ended December 31,
December 1, 1992 1992 (see Exhibit 10(O) therein)
10(K)* State Auto Insurance Companies Directors' Deferred Form 10-K Annual Report for year ended December 31, 1995
Compensation Plan (see Exhibit 10(S) therein)
10(L)* State Auto Insurance Companies Amended and Restated Registration Statement on Form S-8, File
Non-Qualified Incentive Deferred Compensation Plan No. 333-56338 (see Exhibit 4(e) therein)
10(M)* Amendment Number 2 to the 1991 Stock Option Plan Form 10-K Annual Report for the year ended December 31,
1996 (see Exhibit 10(DD) therein)
10(N)* Amendment Number 1 to the 1991 Directors' Stock Form 10-K Annual Report for the year ended December 31,
Option Plan 1996 (see Exhibit 10(EE) therein)
10(O) Option Agreement between State Auto Mutual and State Form 10-K Annual Report for the year ended December 31,
Auto Financial dated March 11, 1997 1996 (see Exhibit 10(FF) therein)
10(P) Agreement and Plan of Reorganization dated July 7, Form 8-K filed on July 7, 1998 (see Exhibit 10(JJ)
1998, by and among State Auto Financial Corporation, therein)
SAF Acquisition Corp., State Automobile Mutual
Insurance Company and Milbank Insurance Company and
the Closing Agreement dated July 7, 1998
10(Q) Credit Agreement dated as of June 1, 1999 between Form 10-Q for the period ended June 30, 1999 (see
State Auto Financial Corporation and State Automobile Exhibit 10(LL) therein)
Mutual Insurance Company
10(R) $135,000,000 Credit Agreement among SAF Funding Form 10-K Annual Report for the year ended December 31,
Corporation, as Borrower, the Lenders and Bank One, 1999 (see Exhibit 10(T) therein)
NA as Agent dated as of November 19, 1999
10(S) Put Agreement among State Automobile Mutual Insurance Form 10-K Annual Report for the year ended December 31,
Company, State Auto Financial Corporation and Bank 1999 (see Exhibit 10(U) therein)
One, NA as Agent dated as of November 19, 1999
10(T) Standby Purchase Agreement between State Auto Form 10-K Annual Report for the year ended December 31,
Financial Corporation and SAF Funding Corporation 1999 (see Exhibit 10(V) therein)
dated as of November 19, 1999
- ---------------------------------
*Constitutes either a management contract or a compensatory plan or
arrangement required to be filed as an Exhibit
70
If incorporated by reference document
Exhibit No. Description of Exhibit with which Exhibit was previously filed with SEC
- ----------- ---------------------- ----------------------------------------------------------
10(U) Reinsurance Pooling Agreement amended and restated as Form 10-K Annual Report for the year ended December 31,
of January 1, 2000 by and among State Automobile 1999 (see Exhibit 10(W) therein)
Mutual Insurance Company, State Auto Property and
Casualty Insurance Company, Milbank Insurance
Company, Midwest Security Insurance Company, Farmers
Casualty Insurance Company and State Auto Insurance
Company
10(V) Management and Operations Agreement as of January 1, Form 10-K Annual Report for the year ended December 31,
2000 among State Automobile Mutual Insurance Company, 1999 (see Exhibit 10(X) therein)
State Auto Financial Corporation, State Auto Property
and Casualty Insurance Company, State Auto National
Insurance Company, Milbank Insurance Company, State
Auto Insurance Company, Stateco Financial Services,
Inc., Strategic Insurance Software, Inc., 518
Property Management and Leasing, LLC
10(W) Property Catastrophe Overlying Excess of Loss Form 10-K Annual Report for the year ended December 31,
Reinsurance contract issued to State Automobile 1999 (see Exhibit 10(Y) therein)
Mutual Insurance Company, State Auto National
Insurance Company, Milbank Insurance Company, Midwest
Security Insurance Company, Farmers Casualty
Insurance Company, Mid-Plains Insurance Company by
State Auto Property and Casualty Insurance Company
10(X) First Amendment to the Management and Operations Form 10-K Annual Report for the year ended December 31,
Agreement effective January 1, 2000 among State 1999 (see Exhibit 10(Z) therein)
Automobile Mutual Insurance Company, State Auto
Financial Corporation, State Auto Property and
Casualty Insurance Company, State Auto National
Insurance Company, Milbank Insurance Company, State
Auto Insurance Company, Stateco Financial Services,
Inc., Strategic Insurance Software, Inc. and 518
Property Management and Leasing, LLC
10(Y) First Amendment to the June 1, 1999 Credit Agreement Form 10-K Annual Report for the year ended December 31,
dated November 1, 1999 between State Auto Financial 1999 (see Exhibit 10(AA) therein)
Corporation and State Automobile Mutual Insurance
Company
10(Z) Second amendment to the June 1, 1999 Credit Agreement Form 10-Q for the period ended March 31,
dated December 1, 1999 between State Auto Financial 2000 (see Exhibit 10(BB) therein)
Corporation and State Automobile Mutual Insurance
Company
10(AA) Audit Committee Charter Included herein
10(BB)* Employment Agreement and Executive Agreement between Included herein
State Auto Financial Corporation and Robert H. Moone
10(CC)* Form of Executive Agreement between State Auto Included herein
Financial Corporation and certain executive officers
10(DD) First Amendment to the Reinsurance Pooling Agreement Included herein
Amended and Restated as of January 1, 2000 by and
among State Auto Property and Casualty Insurance
Company, State Automobile Mutual Insurance Company,
Milbank Insurance Company, Midwest Security Insurance
Company, Farmers Casualty Insurance Company and State
Auto Insurance Company
- ---------------------------------
*Constitutes either a management contract or a compensatory plan or
arrangement required to be filed as an Exhibit
71
If incorporated by reference document
Exhibit No. Description of Exhibit with which Exhibit was previously filed with SEC
- ----------- ---------------------- ----------------------------------------------------------
10(EE) Addendum No. 1 of the Property Catastrophe Overlying Included herein
Excess of Loss Reinsurance Contract by and among
State Auto Property and Casualty Insurance Company,
State Automobile Mutual Insurance Company, State Auto
National Insurance Company, Milbank Insurance
Company, Midwest Security Insurance Company, Farmers
Casualty Insurance Company, Mid-Plains Insurance
Company and State Auto Insurance Company dated
November 17, 2000
10(FF)* 2000 Stock Option Plan Definitive Proxy Statement on Form DEF 14A, File No.
000-19289, for Annual Meeting of Shareholders held on May
26, 2000 (see Appendix A therein)
10(GG)* 2000 Directors Stock Option Plan Definitive Proxy Statement on Form DEF 14A, File No.
000-19289, for Annual Meeting of Shareholders held on May
26, 2000 (see Appendix B therein)
21 List of Subsidiaries of State Auto Financial Included herein
Corporation
23 Consent of Independent Auditors Included herein
24(A) Powers of Attorney - William J. Lhota, Urlin G. Form 10-Q for the period ended June 30, 1997 (see
Harris, Jr., Paul W. Huesman, George R. Manser, and Exhibit 24(C) therein)
David J. D'Antoni
24(B) Power of Attorney - John R. Lowther Form 10-Q for the period ended March 31, 1998 (see
Exhibit 24(D) therein)
24(C) Power of Attorney - Robert H. Moone Form 10-K Annual Report for the year ended December 31,
1998 (see Exhibit 24(E) therein)
24(D) Power of Attorney - Richard K. Smith Included herein
- ---------------------------------
*Constitutes either a management contract or a compensatory plan or arrangement
required to be filed as an Exhibit
(b) REPORTS ON FORM 8-K
The Company did not file any Form 8-K current reports during the fourth
quarter of the Company's fiscal year ended December 31, 2000.
(c) EXHIBITS
The exhibits have been submitted as a separate section of this report
following the financial statement schedules.
(d) FINANCIAL STATEMENT SCHEDULES
The financial statement schedules have been submitted as a separate
section of this report following the signatures.
72
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
STATE AUTO FINANCIAL CORPORATION
Dated: April 2 2001 /s/Robert H. Moone
----------------------------------
Robert H. Moone
Chairman, President and Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed by the following persons on behalf of the Registrant
and in the capacities and on the dates indicated.
Name Title Date
---- ----- ----
/s/Steven J. Johnston Chief Financial Officer, April 2, 2001
- ------------------------------------- Senior Vice President, Treasurer
Steven J. Johnston (principal financial officer
and principal accounting
officer)
John R. Lowther* Secretary and Director April 2, 2001
- ------------------------------------
John R. Lowther
Urlin G. Harris, Jr.* Director April 2, 2001
- ------------------------------------
Urlin G. Harris, Jr.
David J. D'Antoni* Director April 2, 2001
- ------------------------------------
David J. D'Antoni
Paul W. Huesman* Director April 2, 2001
- ------------------------------------
Paul W. Huesman
William J. Lhota* Director April 2, 2001
- ------------------------------------
William J. Lhota
George R. Manser* Director April 2, 2001
- ------------------------------------
George R. Manser
Richard K. Smith* Director April 2, 2001
- ------------------------------------
Richard K. Smith
/s/Robert H. Moone Chairman, President and April 2, 2001
- ------------------------------------ Chief Executive Officer
Robert H. Moone (principal executive officer)
73
*Steven J. Johnston by signing his name hereto, does sign this document
on behalf of the person indicated above pursuant to a Power of Attorney duly
executed by such person.
/s/ Steven J. Johnston April 2, 2001
- ------------------------------------
Steven J. Johnston
Attorney in Fact
74
Item 14(c)
Exhibit Index
(a)(3) LISTING OF EXHIBITS
-------------------
If incorporated by reference document with
Exhibit No. Description of Exhibit which Exhibit was previously filed with SEC
- ----------- ---------------------- -------------------------------------------
3(A)(1) State Auto Financial Corporation's Amended and Restated 1933 Act Registration Statement No.
Articles of Incorporation 33-40643 on Form S-1 (see Exhibit 3(a)
therein)
3(A)(2) State Auto Financial Corporation's Amendment to the 1933 Act Registration Statement No.
Amended and Restated Articles of Incorporation 33-89400 on Form S-8 (see Exhibit 4(b)
therein)
3(A)(3) State Auto Financial Corporation Certificate of Form 10-K Annual Report for the year
Amendment to the Amended and Restated Articles of ended December 31, 1998 (see Exhibit
Incorporation as of June 2, 1998 3(A)(3) therein)
3(B) State Auto Financial Corporation's Amended and Restated 1933 Act Registration Statement No.
Code of Regulations 33-40643 on Form S-1 (see Exhibit 3(b)
therein)
4 State Auto Financial Corporation's Amended and Restated Form 10-K Annual Report for the year
Articles of Incorporation, and Articles 1, 3, 5 and 9 of ended December 31, 1992 (see Exhibit
the Company's Amended and Restated Code of Regulations 3(A) and 3(B) therein)
10(A) Guaranty Agreement between State Automobile Mutual 1933 Act Registration Statement No.
Insurance Company and State Auto Property and Casualty 33-40643 on Form S-1 (see Exhibit 10
Insurance Company dated as of May 16, 1991 (d) therein)
10(B) Form of Indemnification Agreement between State Auto 1933 Act Registration Statement No.
Financial Corporation and each of its directors 33-40643 on Form S-1 (see Exhibit 10
(e) therein)
10(C)* State Auto 1991 Quality Performance Bonus Plan 1933 Act Registration Statement No.
33-40643 on Form S-1 (see Exhibit 10
(f) therein)
10(D)* Non-Qualified Deferred Compensation Plan 1933 Act Registration Statement No.
33-40643 on Form S-1 (see Exhibit 10
(g) therein)
10(E)* 1991 Stock Option Plan 1933 Act Registration Statement No.
33-40643 on Form S-1 (see Exhibit 10
(h) therein)
10(F)* Amendment Number 1 to the 1991 Stock Option Plan 1933 Act Registration Statement No.
33-89400 on Form S-8 (see Exhibit 4 (a)
therein)
10(G)* 1991 Directors' Stock Option Plan 1933 Act Registration Statement No.
33-40643 on Form S-1 (see Exhibit 10
(i) therein)
- ----------
*Constitutes either a management contract or a compensatory plan or arrangement
required to be filed as an Exhibit
75
10(H) License Agreement between State Automobile Mutual 1933 Act Registration Statement No.
Insurance Company and Policy Management Systems 33-40643 on Form S-1 (see Exhibit 10
Corporation dated December 28, 1984 (k) therein)
10(I) Investment Management Agreement between Stateco Form 10-K Annual Report for the year
Financial Services, Inc. and State Automobile Mutual ended December 31, 1992 (see Exhibit 10
Insurance Company, effective April 1, 1993 (N) therein)
10(J)* Supplemental Executive Retirement Income Plan effective Form 10-K Annual Report for the year
December 1, 1992 ended December 31, 1992 (see Exhibit 10(O)
therein)
10(K)* State Auto Insurance Companies Directors' Deferred Form 10-K Annual Report for year ended
Compensation Plan December 31, 1995 (see Exhibit 10(S)
therein)
10(L)* State Auto Insurance Companies Amended and Restated Registration Statement on Form S-8,
Non-Qualified Incentive Deferred Compensation Plan File No. 333-56338 (see Exhibit 4(e)
therein)
10(M)* Amendment Number 2 to the 1991 Stock Option Plan Form 10-K Annual Report for the year
ended December 31, 1996 (see Exhibit
10(DD) therein)
10(N)* Amendment Number 1 to the 1991 Directors' Stock Option Form 10-K Annual Report for the year
Plan ended December 31, 1996 (see Exhibit
10(EE) therein)
10(O) Option Agreement between State Auto Mutual and State Form 10-K Annual Report for the year
Auto Financial dated March 11, 1997 ended December 31, 1996 (see Exhibit
10(FF) therein)
10(P) Agreement and Plan of Reorganization dated July 7, 1998, Form 8-K filed on July 7, 1998 (see
by and among State Auto Financial Corporation, SAF Exhibit 10(JJ) therein)
Acquisition Corp., State Automobile Mutual Insurance
Company and Milbank Insurance Company and the Closing
Agreement dated July 7, 1998
10(Q) Credit Agreement dated as of June 1, 1999 between State Form 10-Q for the period ended June 30,
Auto Financial Corporation and State Automobile Mutual 1999 (see Exhibit 10(LL) therein)
Insurance Company
10(R) $135,000,000 Credit Agreement among SAF Funding Form 10-K Annual Report for the year
Corporation, as Borrower, the Lenders and Bank One, NA ended December 31, 1999 (see Exhibit
as Agent dated as of November 19, 1999 10(T) therein)
10(S) Put Agreement among State Automobile Mutual Insurance Form 10-K Annual Report for the year
Company, State Auto Financial Corporation and Bank One, ended December 31, 1999 (see Exhibit
NA as Agent dated as of November 19, 1999 10(U) therein
10(T) Standby Purchase Agreement between State Auto Financial Form 10-K Annual Report for the year
Corporation and SAF Funding Corporation dated as of ended December 31, 1999 (see Exhibit
November 19, 1999 10(V) therein
- ----------
*Constitutes either a management contract or a compensatory plan or arrangement
required to be filed as an Exhibit
76
10(U) Reinsurance Pooling Agreement amended and restated as Form 10-K Annual Report for the year
of January 1, 2000 by and among State Automobile Mutual ended December 31, 1999 (see Exhibit
Insurance Company, State Auto Property and Casualty 10(W) therein)
Insurance Company, Milbank Insurance Company, Midwest
Security Insurance Company, Farmers Casualty Insurance
Company and State Auto Insurance Company
10(V) Management and Operations Agreement as of January 1, Form 10-K Annual Report for the year
2000 among State Automobile Mutual Insurance Company, ended December 31, 1999 (see Exhibit
State Auto Financial Corporation, State Auto Property 10(X) therein)
and Casualty Insurance Company, State Auto National
Insurance Company, Milbank Insurance Company, State
Auto Insurance Company, Stateco Financial Services,
Inc., Strategic Insurance Software, Inc., 518 Property
Management and Leasing, LLC
10(W) Property Catastrophe Overlying Excess of Loss Form 10-K Annual Report for the year
Reinsurance contract issued to State Automobile Mutual ended December 31, 1999 (see Exhibit
Insurance Company, State Auto National Insurance 10(Y) therein)
Company, Milbank Insurance Company, Midwest Security
Insurance Company, Farmers Casualty Insurance Company,
Mid-Plains Insurance Company by State Auto Property and
Casualty Insurance Company
10(X) First Amendment to the Management and Operations Form 10-K Annual Report for the year
Agreement effective January 1, 2000 among State ended December 31, 1999 (see Exhibit
Automobile Mutual Insurance Company, State Auto 10(Z) therein)
Financial Corporation, State Auto Property and Casualty
Insurance Company, State Auto National Insurance
Company, Milbank Insurance Company, State Auto
Insurance Company, Stateco Financial Services, Inc.,
Strategic Insurance Software, Inc. and 518 Property
Management and Leasing, LLC
10(Y) First Amendment to the June 1, 1999 Credit Agreement Form 10-K Annual Report for the year
dated November 1, 1999 between State Auto Financial ended December 31, 1999 (see Exhibit
Corporation and State Automobile Mutual Insurance 10(AA) therein)
Company
10(Z) Second amendment to the June 1, 1999 Credit Agreement Form 10-Q for the period ended March
dated December 1, 1999 between State Auto Financial 31, 2000 (see Exhibit 10(BB) therein)
Corporation and State Automobile Mutual Insurance
Company
10(AA) Audit Committee Charter Included herein
10(BB) Employment Agreement and Executive Agreement between Included herein
State Auto Financial Corporation and Robert H. Moone
10(CC) Form of Executive Agreement between State Auto Included herein
Financial and certain executive officers
10(DD) First Amendment to the Reinsurance Pooling Agreement Included herein
Amended and Restated as of January 1, 2000 by and among
State Auto Property and Casualty Insurance Company,
State Automobile Mutual Insurance Company, Milbank
Insurance Company, Midwest Security Insurance Company,
Farmers Casualty Insurance Company and State Auto
Insurance Company
10(EE) Addendum No. 1 of the Property Catastrophe Overlying Included herein
Excess of Loss Reinsurance Contract by and among State
Auto Property and Casualty Insurance Company, State
Automobile Mutual Insurance Company, State Auto
National Insurance Company, Milbank Insurance Company,
Midwest Security Insurance Company, Farmers Casualty
Insurance Company, Mid-Plains Insurance Company and
State Auto Insurance Company
77
10(FF)* 2000 Stock Option Plan Definitive Proxy Statement on Form DEF
14A, File No. 000-19289, for Annual
Meeting of Shareholders held on May 26,
2000 (see Appendix A therein)
10(GG)* 2000 Directors Stock Option Plan Definitive Proxy Statement on Form DEF
14A, File No. 000-19289, for Annual
Meeting of Shareholders held on May 26,
2000 (see Appendix B therein)
21 List of Subsidiaries of State Auto Financial Corporation Included herein
23 Consent of Independent Auditors Included herein
24(A) Powers of Attorney - William J. Lhota, Urlin G. Harris, Form 10-Q for the period ended June 30,
Jr., Paul W. Huesman, George R. Manser, and David J. 1997 (see Exhibit 24(C) therein)
D'Antoni
24(B) Power of Attorney - John R. Lowther Form 10-Q for the period ended March
31, 1998 (see Exhibit 24(D) therein)
24(C) Power of Attorney - Robert H. Moone Form 10-K Annual Report for the year
ended December 31, 1998 (see Exhibit
24(E) therein)
24(D) Power of Attorney - Richard K. Smith Included herein
- ----------
*Constitutes either a management contract or a compensatory plan or arrangement
required to be filed as an Exhibit
78
Item 14(d)
Financial Statement
Schedules
79
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
SCHEDULE I(a) - SUMMARY OF INVESTMENTS - OTHER THAN
INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 2000
Column A Column B Column C Column D
-------- -------- -------- --------
HELD TO MATURITY Amount at
which shown
in the
Type of Investment Cost Value balance sheet
------------------ ---- ----- -------------
(in thousands)
Fixed maturities:
Bonds:
United States Government and
government agencies and authorities $32,281 $32,845 $32,281
States, municipalities and
political subdivisions 7,026 7,380 7,026
------- ------- -------
Total fixed maturities - held to maturity $39,307 $40,225 $39,307
======= ======= =======
SCHEDULE I(b) - SUMMARY OF INVESTMENTS - OTHER THAN
INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 2000
Column A Column B Column C Column D
-------- -------- -------- --------
AVAILABLE FOR SALE Amount at
which shown
in the
Type of Investment Cost Value balance sheet
------------------ ---- ----- -------------
(in thousands)
Fixed maturities:
Bonds:
United States Government and
government agencies and authorities $ 89,732 $ 91,290 $ 91,290
States, municipalities and
political subdivisions 513,311 528,071 528,071
Public utilities 7,807 7,835 7,835
All other corporate bonds 25,452 26,055 26,055
-------- -------- --------
Total fixed maturities $636,302 $653,251 $653,251
-------- -------- --------
Equity securities:
Public utilities 2,340 2,791 2,791
Banks, trust and insurance companies 7,654 8,538 8,538
Industrial, miscellaneous and all
other 34,226 46,983 46,983
-------- -------- --------
Total equity securities 44,220 58,312 58,312
-------- -------- --------
Total investments - available for sale $680,522 $711,563 $711,563
======== ======== ========
80
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEETS
December 31
-------------------
ASSETS 2000 1999
---- ----
(dollars in thousands)
Investments in common stock of subsidiaries
(equity method) $428,591 $360,974
Cash 591 650
Real estate 425 444
Other assets 559 578
Federal income tax benefit 1,945 1,034
-------- --------
Total assets $432,111 $363,680
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Note payable to affiliate $ 45,500 $ 45,500
Due to affiliates 102 167
Accrued expenses 450 325
-------- --------
Total liabilities 46,052 45,992
STOCKHOLDERS' EQUITY
Class A Preferred stock (nonvoting), without
par value. Authorized 2,500,000 shares;
none issued -- --
Class B Preferred stock, without par value
Authorized 2,500,000 shares; none issued -- --
Common stock, without par value. Authorized
100,000,000 shares; 42,625,723 and 42,355,438 shares
issued, respectively, at stated value of $2.50 per share 106,564 105,888
Less 4,071,012 and 4,034,342 treasury shares, respectively, at cost (47,038) (46,588)
Additional paid-in capital 44,208 42,562
Accumulated other comprehensive income 20,367 211
Retained earnings 261,958 215,614
-------- --------
Total stockholders' equity 386,059 317,687
-------- --------
Total liabilities and stockholders' equity $432,111 $363,679
======== ========
81
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONTINUED
CONDENSED STATEMENTS OF INCOME
Year ended December 31
---------------------------------
2000 1999 1998
---- ---- ----
(in thousands)
Investment income $ 81 $ 249 $ 326
Rental income 37 37 33
Net realized gains on investments -- 1 2
------- ------- -------
Total revenue 118 287 361
------- ------- -------
Interest expense to affiliate 2,730 955 --
Total operating expenses 1,859 1,176 1,456
------- ------- -------
Loss before federal income taxes (4,471) (1,844) (1,095)
Federal income tax benefit (1,573) (645) (394)
------- ------- -------
Net loss before equity in undistributed
net earnings of subsidiaries (2,898) (1,199) (701)
Equity in undistributed net earnings of subsidiaries 50,612 44,015 38,198
------- ------- -------
Net Income $47,714 $42,816 $37,497
======= ======= =======
82
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONTINUED
CONDENSED STATEMENTS OF CASH FLOWS
Year Ended December 31
--------------------------------
2000 1999 1998
---- ---- ----
(in thousands)
Cash flows from operating activities:
Net income $ 47,714 $ 42,816 $ 37,497
-------- -------- --------
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation and amortization, net 484 102 17
Equity in undistributed earnings of subsidiaries (50,612) (43,957) (38,198)
Changes in operating assets and liabilities:
Change in accrued expenses and due to affiliates 60 125 58
Change in other assets (19) 185 (505)
Change in federal income taxes (721) (387) 305
-------- -------- --------
Net cash used in operating activities (3,094) (1,116) (826)
-------- -------- --------
Cash flows from investing activities:
Capitalization of subsidiary -- (12,030) --
Dividends received from subsidiaries 3,025 12,663 9,004
Purchase of surplus notes receivable -- -- (9,000)
Additions to real estate -- (1) (20)
-------- -------- --------
Net cash (used in) provided by investing activities 3,025 632 (16)
-------- -------- --------
Cash flows from financing activities:
Proceeds from issuance of debt to affiliate -- 45,500 --
Net proceeds from sale of common stock 1,707 1,928 1,780
Payments to acquire treasury stock (300) (46,199) --
Payment of dividends (1,397) (1,315) (1,219)
-------- -------- --------
Net cash provided by (used in) financing activities 10 (86) 561
-------- -------- --------
Net increase (decrease) in cash and invested cash (59) (570) (281)
-------- -------- --------
Cash and cash equivalents at beginning of year 650 1,220 1,501
-------- -------- --------
Cash and cash equivalents at end of year $ 591 $ 650 $ 1,220
======== ======== ========
Supplemental Disclosures:
- -------------------------
Federal income taxes received $ 852 $ 517 $ 902
======== ======== ========
83
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONTINUED
NOTE A - BASIS OF PRESENTATION
In the parent company-only financial statements, State Auto Financial
Corporation's investment in subsidiaries is stated at cost plus equity in
undistributed earnings of subsidiares and net unrealized gains and losses on
investments. The parent company-only financial statements should be read in
conjunction with the Company's consolidated financial statements.
Note B - Stock Repurchase Plan
During the second quarter 2000, State Auto Financial's Board of Directors
approved a plan to repurchase up to 1.0 million shares of its common stock from
the public over a period ending December 31, 2001. Through December 31, 2000,
State Auto Financial has repurchased 25,122 shares.
In May 1999, State Auto Financial's Board of Directors approved a plan to
repurchase up to 4.0 million shares of its outstanding common stock over a
period ending December 31, 2000. Repurchases were transacted to maintain the
same ownership ratios between Mutual and the public as it existed in May 1999,
with 69% repurchased from Mutual and 31% from the public. Through December 31,
1999 all 4.0 million shares have been repurchased, with approximately 2.7
million shares repurchased from Mutual and 1.3 million shares from the public.
In conjunction with the stock repurchase plan, State Auto Financial entered into
a line of credit agreement with Mutual for $45.5 million, at an interest rate of
6.0%. The interest rate adjusts each January 1 based on a formula set forth in
the note. During 2001 the interest rate is 5.0%. Principal payment is due on
demand from Mutual after December 31, 2000, with final payment to be received on
or prior to December 31, 2005.
84
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION
YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(in thousands)
Column A Column B Column C Column D Column E Column F
-------- -------- -------- -------- -------- --------
Future policy Other policy
benefits, losses, claims and
Deferred policy claims and Unearned benefits Premium
Segment acquisition cost loss expenses premiums payable revenue
------- ---------------- ------------- -------- ------- -------
Year ended December 31, 2000
Standard insurance segment $31,292 $228,516 $151,781 -- $370,566
Nonstandard insurance segment 1,166 16,067 8,606 -- 27,401
----------------- ---------------- --------------- ---------------- ----------------
Total 32,458 244,583 160,387 -- 397,967
================= ================ =============== ================ ================
Year ended December 31, 1999
Standard insurance segment $27,877 $217,149 $145,462 -- $361,175
Nonstandard insurance segment 1,059 15,340 8,108 -- 30,883
----------------- ---------------- --------------- ---------------- ----------------
Total 28,936 232,489 153,570 -- 392,058
================= ================ =============== ================ ================
Year ended December 31, 1998
Standard insurance segment $330,619
Nonstandard insurance segment 25,591
----------------
Total 356,210
================
Column G Column H Column I Column J Column K
-------- -------- -------- -------- --------
Amortization
Benefits,claims, of deferred
losses and policy
Net investment settlement acquisition Other operating Premiums
income expenses costs expenses written
------ -------- ----- -------- -------
Year ended December 31, 2000
Standard insurance segment $33,436 $250,071 $92,955 $19,122 $373,867
Nonstandard insurance segment 1,899 22,096 4,828 1,259 27,837
Investment management services 360 -- -- -- --
All other 244 -- -- -- --
Corporate 81 -- -- 1,405 --
Reclassification adjustments in consolidation 2,895 -- -- -- --
------- -------- ------- ------- --------
Total 38,915 272,167 97,783 21,786 401,704
======= ======== ======= ======= ========
Year ended December 31, 1999
Standard insurance segment $29,060 $242,409 $86,609 $16,716 $359,084
Nonstandard insurance segment 1,839 22,219 5,832 1,866 29,416
Investment management services 272 -- -- -- --
All other 268 -- -- -- --
Corporate 249 -- -- 749 --
Reclassification adjustments in consolidation 2,574 -- -- -- --
------- -------- ------- ------- --------
Total 34,262 264,628 92,441 19,331 388,500
======= ======== ======= ======= ========
Year ended December 31, 1998
Standard insurance segment $27,710 $223,311 $80,766 $17,124 $332,975
Nonstandard insurance segment 1,383 18,983 4,448 1,208 25,292
Investment management services 292 -- -- -- --
All other 432 -- -- -- --
Corporate 326 -- -- 678 --
Reclassification adjustments in consolidation 2,363 -- -- -- --
------- -------- ------- ------- --------
Total 32,506 242,294 85,214 19,010 358,267
======= ======== ======= ======= ========
85
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
SCHEDULE IV - REINSURANCE
YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(in thousands, except percentages)
Column A Column B Column C Column D Column E Column F
-------- -------- -------- -------- -------- --------
Percentage
Ceded to Assumed from of amount
Outside Affiliated Outside Affiliated assumed
Gross Amount Companies Companies(1) Companies Companies(1) Net Amount to net(2)
------------ --------- ------------ --------- ------------ ---------- ---------
Year ended 12-31-00
property-casualty earned premiums $432,318 $10,864 $399,057 $ 5,166 $370,404 $397,967 1.3%
Year ended 12-31-99
property-casualty earned premiums $429,577 $13,698 $395,698 $10,822 $361,055 $392,058 2.8%
Year ended 12-31-98
property-casualty earned premiums $384,869 $17,026 $356,638 $14,386 $330,619 $356,210 4.0%
- ----------
(1) These columns include the effect of intercompany pooling.
(2) Calculated as earned premiums assumed from outside companies to net amount.