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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, 2001
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
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(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
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(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
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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.
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On March 22, 2002, 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 $190,168,643.
Page 2
On March 22, 2002, the Registrant had 38,980,255 Common Shares
outstanding.
Page 3
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the Registrant's Proxy Statement relating to the annual
meeting of shareholders to be held May 23, 2002, which Proxy Statement
will be filed within 120 days of December 31, 2001, 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 nonstandard personal automobile
insurance.
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. SAIC currently
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 (defined below). See "Pooling Arrangement" in the "Narrative
Description of Business."
In 2000, Mutual entered into agreements with Meridian Mutual Insurance
Company ("Meridian Mutual"), an Indiana domiciled property and casualty
insurance company, and Meridian Insurance Group, Inc. ("MIGI"), an Indiana
domiciled publicly traded insurance holding company. In one transaction,
Meridian Mutual was merged with and into Mutual, with Mutual continuing as the
surviving corporation. In a substantially concurrent transaction, the
outstanding shares of MIGI were acquired by Mutual. The effective date of both
transactions was June 1, 2001. MIGI's wholly-owned insurance subsidiaries are
Meridian Security Insurance Company, an Indiana domiciled standard property
casualty insurer ("Meridian Security"), Meridian Citizens Security Insurance
Company, an Indiana domiciled standard property
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casualty insurer ("Meridian Citizens"), and Insurance Company of Ohio, an Ohio
domiciled standard property casualty insurer ("ICO"). MIGI is also party to an
affiliation agreement with Meridian Citizens Mutual Insurance Company, an
Indiana domiciled standard property casualty insurer ("Meridian Citizens
Mutual"). Meridian Security, Meridian Citizens, ICO and Meridian Citizens Mutual
are hereafter referred to collectively as the "Meridian Insurers", and together
with MIGI they are hereafter referred to collectively as the "Meridian
Companies."
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." State Auto P&C, Milbank,
Farmers Casualty and SAIC are collectively referred to hereafter as the "Pooled
Subsidiaries". See "Pooling Arrangement" in the "Narrative Description of
Business." The Pooled Companies, National, Mid-Plains and the Meridian Insurers
are collectively referred to as the "State Auto Group."
At this time, the insurers in the State Auto Group market their
insurance products through approximately 22,800 independent insurance agents
associated with approximately 3,800 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 commercial insurance customers of the State Auto Group. 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." ANY REFERENCE TO FINANCIAL
INFORMATION FOR 1999 EXCLUDES SAIC.
Since January 1, 1987, State Auto P&C has participated in a quota share
reinsurance pooling arrangement with Mutual (the "Pooling Arrangement"). While
it has been modified several times since 1987, 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 remained in effect through September 30, 2001. Effective October 1,
2001, the pooling percentages were modified as follows: Mutual (19%), State Auto
P&C (59%), Milbank (17%), Midwest Security (1%), Farmers Casualty (3%) and SAIC
(1%). 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."
Page 6
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). Mutual continues to provide facilities for
such entities under these new management agreements. Effective October 1, 2001,
the 2000 Management Agreement was amended as discussed below. See "Management
Agreement" in the "Narrative Description of Business."
(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. Prior to 2001, the Company operated in two
insurance segments, the standard insurance segment, consisting of the business
operations of the Pooled Subsidiaries and the nonstandard insurance segment,
consisting of the business operations of National and Mid-Plains. With the
merger of Meridian Mutual into Mutual and effective July 1, 2001, with the
addition of the former Meridian Mutual business to the Pooling Arrangement (see
"Pooling Arrangement" in "Narrative Description of Business"), the Company
renamed the two insurance segments that existed prior to 2001 to be the State
Auto standard segment and the State Auto nonstandard segment, and added two
additional insurance segments; the standard insurance business of the former
Meridian Mutual ("Meridian Standard Segment") and the nonstandard insurance
business of the former Meridian Mutual ("Meridian Nonstandard Segment").
Additional information regarding the Company's insurance as well as its
non-insurance 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 the
Pooling Arrangement. Under the terms of the Pooling Arrangement, State Auto P&C
cedes all of its insurance business to Mutual. All of Mutual's property and
casualty insurance business is also included in the pooled business. Mutual then
cedes a percentage of the pooled business to State Auto P&C and retains 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, effective January
1, 1999, it was added to the
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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 as
subsequently amended (the "2000 Pooling Agreement"). 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. Effective
June 1, 2001, with the merger of Meridian Mutual into Mutual, all insurance
business that had been written by Meridian Mutual became, legally, Mutual
business. For the period June 1, 2001 through June 30, 2001, the insurance
business formerly known as the Meridian Mutual business prior to the June 1
merger was excluded from the Pooling Arrangement. Effective July 1, 2001, the
insurance business of the former Meridian Mutual became part of the Pooling
Arrangement. The business written by the former Meridian Mutual includes both
standard and nonstandard personal lines and standard commercial lines. The
principal lines of business are standard personal and commercial automobile,
nonstandard personal automobile, homeowners, commercial multi-peril, workers'
compensation, general liability and fire insurance. The former Meridian Mutual
business represents approximately 20% of the Pooled Companies' business.
The former Meridian Mutual business continues to be processed primarily
through the former Meridian Mutual underwriting and claims system for both its
standard and nonstandard business. Management will monitor this former Meridian
Mutual business as a separate segment from the State Auto standard/nonstandard
business processed through State Auto's underwriting and claims systems.
Monitoring of these business segments separately is necessary in order to
facilitate the integration of the former Meridian Mutual business as it migrates
over time to the State Auto systems platform which fully implements State Auto
policies, pricing, underwriting and claims philosophies. Over time, it is
anticipated that the Meridian segments will decrease and eventually disappear as
those segments are fully integrated on the State Auto systems platform. See
"Standard Insurance Segment" and "Nonstandard Insurance Segment" in "Narrative
Description of Business". Effective October 1, 2001, the Pooling Arrangement was
amended again to change the pooling percentages of the participants to: Mutual
19%, Midwest Security 1%, State Auto P&C 59%, Milbank 17%, Farmers Casualty 3%
and SAIC 1%. This change in the Pooling Arrangement was part of a resolution
reached by the Company and the Ohio Department of Insurance ("ODI") as to the
disagreement between the Company and ODI relating to the service fee paid by
Mutual to State Auto P&C under the 2000 Management Agreement (See "Management
Agreement " in "Narrative Description of Business").
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. As a result
of the October 1, 2001 changes, it is not management's current intention to
recommend the Company adjust its aggregate pooling percentage in the foreseeable
future. Pooling changes generally can be 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 and surplus
of each participant, among other factors. Under revised procedures, management
of each of the Pooled Companies would make recommendations to an independent
committee of the Board of each of Mutual and STFC. These independent committees
would review and evaluate such factors as they deem relevant and recommend 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. None of the Pooled Companies currently
intends to terminate the Pooling Arrangement.
Page 8
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 underwriting 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 $115.0 million
in excess of $120.0 million as well as the premium for such exposures. State
Auto P&C is the reinsurer for each insurer in the State Auto Group for this
layer of reinsurance under a Catastrophe Assumption Agreement. Effective
November 2001, these limits in the Catastrophe Assumption Agreement were amended
to $100.0 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."
The business of the Meridian Insurers is not included in the Pooling
Arrangement and therefore does not affect the Company's insurance operations.
MANAGEMENT AGREEMENT
Prior to January 1, 2000, State Auto P&C provided executive management
services for all insurance affiliates within the State Auto Group pursuant to
the Amended and Restated Management Agreement, the Midwest Management Agreement,
and the Farmers Casualty Management Agreement. Mutual provided non-executive
employees and facilities for such entities through December 31, 1999. For its
performance of these services, State Auto P&C was paid a quarterly management
fee based on formulas outlined in the management agreements, provided certain
performance standards were achieved by the companies to which executive
management services were provided, as described in the agreements.
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 the 2000 Management
Agreement, the 2000 Midwest Management Agreement and the 2000 Farmers Casualty
Management Agreement. Mutual continues to provide facilities for such entities
under these new management agreements. Effective January 1, 2002, State Auto P&C
became the employer of record for those persons who had been employees of MIGI.
Under these management agreements put in place in January of 2000,
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 was paid a
quarterly management and operations services fee based on formulas outlined in
the agreements, to the extent certain performance standards were achieved, as
described in these agreements. The quarterly management and operations services
fee under the 2000 Management Agreement among State Auto P&C and Mutual, inter
alia, was based on a percentage of the three year average of each managed
company's adjusted surplus or equity. Under the 2000 Midwest Management
Agreement, among State Auto P&C, Mutual and Midwest Security, Midwest Security
pays 0.75% of direct written premium for management and operation services
performed by employees of State Auto P&C. The 2000 Farmers Casualty Management
Agreement is a management agreement among Farmers Casualty, Mid-Plains, State
Auto P&C and Mutual. Farmers Casualty and Mid-Plains pay 0.75% of direct written
premium for management and operations services performed by employees of State
Auto P&C.
As periodically disclosed during early 2001, the ODI requested that
Mutual file an analysis with the ODI on a quarterly basis, starting with the
quarter beginning January 1, 2001, that justified the
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apportionment of the service fee paid by Mutual to State Auto P&C under the 2000
Management Agreement, under the accounting guidelines outlined in Statement of
Statutory Accounting Principle No. 70 - Allocation of Expenses. The Company
believed its accounting for such service fee was consistent with all statutory
accounting principles. After months of discussions, on October 24, 2001, the
Board of Directors of the Company and Mutual and Special Independent Committees
thereof approved a resolution of the disagreement between the Company and the
ODI regarding the service fee paid by Mutual to State Auto P&C. The disagreement
with ODI was resolved and ODI expressly did not take issue with Mutual's payment
of the service fee for the first three quarters of 2001, which amounted to $12.5
million pre-tax, nor with Mutual's accounting for the service fee in each of
those quarters. The ODI also approved regulatory filings, effective October 1,
2001, implementing a revised 2000 Management Agreement, changing the Pooling
Arrangement's participation percentages and implementing a Stop Loss Reinsurance
Arrangement between Mutual and certain of the Pooled Companies. See "Pooling
Arrangement" and "Reinsurance" in the "Narrative Description of Business".
As noted above, effective October 1, 2001, the 2000 Management
Agreement was amended to eliminate the service fee charged by State Auto P&C to
affiliates, including Mutual, that were party to the 2000 Management Agreement.
The 2000 Management Agreement continues to allocate costs and apportion those
costs among the parties to the 2000 Management Agreement in accordance with
terms outlined in the 2000 Management Agreement. Neither the 2000 Midwest
Management Agreement or the 2000 Farmers Casualty Management Agreement was
affected by the disagreement or its resolution with the ODI relative to the 2000
Management Agreement. As a result of the loss of the service fee under the 2000
Management Agreement, substantially all of State Auto P&C's insurance operations
management fee has been eliminated, effective October 1, 2001. Consequently,
beginning with the first quarter 2002, the management and operations services
segment will be included in the other category for segment reporting as the
results of this segment will no longer meet the quantitative thresholds for
separate presentation as a reportable segment.
The parties intend to also modify the conflict procedures addressed by
the 2000 Management Agreement. The Coordinating Committee has been replaced by
the Independent Committee of the Board of Directors of each of Mutual and State
Auto Financial. An amendment to the 2000 Management Agreement effecting this
change has been approved by the boards of directors and is subject to regulatory
approval. These committees review and evaluate business opportunities meeting
described criteria using such factors as they consider relevant. Based upon such
review and evaluation, these committees then make recommendations to their
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, although the Company does not
anticipate such termination.
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 State Auto and Meridian standard insurance segments as
well as the Meridian nonstandard segment. See "Nonstandard Insurance Segment" in
the "Narrative Description of Business". The standard segments include 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 segments and the nonstandard segments.
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 the State Auto and Meridian standard segments and nonstandard segments.
As mentioned above, the insurance business of Mutual, (including after
July 1, 2001, the business formerly known as the Meridian Mutual business),
State Auto P&C, Milbank, Midwest Security, Farmers Casualty, and 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. More than half of the Pooled Companies
State Auto standard segment products' sales are personal lines. The Meridian
standard segment is weighted toward commercial lines, though in recent years
Meridian's standard segment growth had been primarily in personal lines due to
Group Advantage(R) policies. The Group Advantage(R) program has been terminated.
A substantial proportion of that business has already been non-renewed in a
manner consistent with local law. The Company intends to non-renew all Group
Advantage(R) business.
The insurance businesses of National and Mid-Plains are not included in
the Pooling Arrangement; however, the Meridian nonstandard segment is included
in the Pooling Arrangement because the former Meridian Mutual's nonstandard
business was not written in a separate company. Except for reinsurance
arrangements between each of these companies and Mutual, 100% of each of these
companies' business remains in the Company. National's, Mid-Plains' and the
former Meridian Mutual's nonstandard segment are personal lines auto insurance
products written for nonstandard risks, with less restrictive underwriting
criteria and higher rates than those applicable to standard risks.
The Company uses computer-based underwriting procedures for its State
Auto standard 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 nonstandard risks. The Company has just begun a
project to update and enhance its computer assisted underwriting system. This
will extend over many months, but it is expected to enhance efficiency and
productivity, without impairing the quality of the Company's underwriting. While
personal lines specialists have had underwriting and sales responsibilities, the
Company has been expanding new sales efforts in personal lines. It has created
the Personal Lines Sales Specialist position, 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 tables set forth the statutory loss ratios by line of
insurance and the combined ratio for the standard insurance segments 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
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from underwriting operations, investments and management fees, although
management fee income is substantially reduced after October 1, 2001. See
"Management Agreement" in the "Narrative Description of Business".
The following table provides the aggregate statutory loss ratios by
line of insurance and the combined ratio for the Company's two standard
insurance segments, the State Auto standard insurance segment and beginning July
1, 2001, the Meridian standard insurance segment:
Standard Insurance Segments
Year Ended December 31(1)
-------------------------
2001 2000 1999
----- ---- ----
Loss ratios:
Automobile 73.9% 66.7% 65.2%
Homeowners and Farmowners 85.8% 78.8% 75.3%
Commercial multi-peril 100.4% 63.0% 69.9%
Workers' compensation 105.2% 65.2% 41.1%
Fire and allied lines 62.9% 58.8% 89.2%
Other commercial liability 58.2% 80.7% 61.4%
Other personal lines 42.5% 34.6% 36.3%
Other commercial lines 27.1% 9.7% 28.4%
----- ---- ----
Total loss ratio 76.2% 67.6% 67.0%
Expense ratio 28.3% 27.1% 29.5%
----- ---- ----
Combined ratio 104.5% 94.7% 96.5%
===== ==== ====
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(1) This reflects a combination of the loss experience of the Pooled
Subsidiaries after giving effect to reinsurance and the 2000 Pooling
Agreement and the Reinsurance Pooling Agreement, amended and restated as of
January 1, 1999, (the "99 Pooling Agreement"), respectively.
The following tables provide the statutory loss ratios by line of insurance
and the combined ratio for the State Auto and Meridian standard insurance
segments, respectively.
State Auto Standard Segment
Year Ended December 31(1)
------------------------
2001 2000 1999
---- ---- ----
Loss ratios:
Automobile 65.1% 66.7% 65.2%
Homeowners and Farmowners 79.5% 78.8% 75.3%
Commercial multi-peril 74.4% 63.0% 69.9%
Workers' compensation 69.9% 65.2% 41.1%
Fire and allied lines 62.8% 58.8% 89.2%
Other commercial liability 54.5% 80.7% 61.4%
Other personal lines 44.1% 34.6% 36.3%
Other commercial lines 27.8% 9.7% 28.4%
---- ---- ----
Total loss ratio 66.3% 67.6% 67.0%
Expense ratio 28.4% 27.1% 29.5%
---- ---- ----
Combined ratio 94.7% 94.7% 96.5%
==== ==== ====
- ------------------
(1) This reflects a combination of the loss experience of the Pooled
Subsidiaries after giving effect to reinsurance and the 2000 Pooling
Agreement and the 99 Pooling Agreement, respectively.
Page 12
Meridian Standard Segment
Year Ended December 31, 2001(1)
Loss ratios:
Automobile 131.30%
Homeowners and Farmowners 136.30%
Commercial multi-peril 171.60%
Workers' compensation 165.40%
Fire and allied lines 66.9%
Other commercial liability 214.5%
Other personal lines 27.1%
------
Total loss ratio 139.6%
Expense ratio 27.8%
------
Combined ratio 167.4%
======
------------------
(1) This reflects the loss experience of the Meridian standard segment
assumed by the Pooled Subsidiaries through the 2000 Pooling Agreement.
NONSTANDARD 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 19, having begun
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. During 2001, the Company began moving
the processing of Mid-Plains business to the National processing platform to
enhance operational efficiencies. Existing nonstandard auto risks that are in
the Meridian nonstandard segment will continue to be written by Mutual until
such policies terminate. During the fourth quarter of 2001, National's product
and system platform began to be introduced on a state by state basis to former
Meridian agents so that National will be used for all new nonstandard auto
business these agents place. It is envisioned that National will eventually be
the principal writer for all nonstandard auto risks within the State Auto Group.
Nonstandard automobile products provide insurance for private passenger
automobile risks that are typically not acceptable to standard market companies
because insureds have poor loss experience or driving record, a history of late
payments of premium, or relatively unfavorable insurance credit scores, or a
combination of these factors. Nonstandard products are priced to account for the
additional risk and expenses normally associated with this market.
The following table provides the statutory loss ratios by line of
insurance for the Company's nonstandard insurance segments, which includes
National and Mid-Plains, and beginning July 1, 2001, the Meridian nonstandard
insurance segment:
Nonstandard Insurance Segments
Year Ended December 31
----------------------------------
2001(1) 2000 1999
----- ----- -----
Loss Ratio:
Automobile 92.0% 81.4% 71.7%
Expense Ratio 21.7% 25.2% 29.9%
----- ----- -----
Combined Ratio 113.7% 106.6% 101.6%
===== ===== =====
- ----------------------------------------
Page 13
(1) Reflects the combination of the loss experience of National and
Mid-Plains as well as the Meridian nonstandard segment assumed by the
Pooled Subsidiaries through the 2000 Pooling Agreement, beginning July
1, 2001.
The following tables set forth the statutory loss ratios and combined
ratios of National and Mid-Plains, which are engaged in the State Auto
nonstandard segment of the business, and the Meridian nonstandard
segment, respectively:
State Auto Nonstandard Segment
Year Ended December 31(1)
---------------------------------
2001 2000 1999
----- ----- -----
Loss Ratio:
Automobile 77.9% 81.4% 71.7%
Expense Ratio 21.9% 25.2% 29.9%
----- ----- -----
Combined Ratio 99.8% 106.6% 101.6%
===== ===== =====
(1) Reflects the combination of the loss experience of National and
Mid-Plains.
Meridian Nonstandard Segment
Year Ended December 31, 2001(1)
-------------------------------
Loss Ratio:
Automobile 168.2%
Expense Ratio 20.8%
------
Combined Ratio 189.0%
======
- ----------------------------------
(1) Reflects the loss experience of the Meridian nonstandard segment
assumed by the Pooled Subsidiaries through the 2000 Pooling Agreement,
beginning July 1, 2001.
MARKETING
In its 26 states of operation, the State Auto Group markets its
products through approximately 22,800 insurance agents associated with
approximately 3,800 independent insurance agencies. While the merger of Meridian
Mutual with and into State Auto Mutual did not add new, continuing states of
operation to the operating territory of the State Auto Group, it did increase
the number of agencies in its existing states of operation by approximately
1,600. In addition to agencies added as a result of the merger with Meridian
Mutual, 156 new agencies were appointed in 2001, exceeding the Company's goal of
108. Meridian Mutual was writing business in the State of Washington through its
internet Direct Response Program prior to its merger with Mutual. This business
is currently in run off. Mutual is not licensed to write business in the State
of Washington. The State Auto Group has offered all its agents a revised State
Auto Group agency agreement, which once fully implemented, will place all its
agencies, including those it refers to as former Meridian agencies, under the
same agreement.
Additionally, through the Group Advantage(R) programs, the former
Meridian Mutual made its personal lines products available to Sam's Club
Members. This program, while generating premium growth, consistently failed to
meet Meridian's management's profitability objectives. As a result, the former
Meridian Mutual had ceased writing new business in this program during 2000 and
commenced non-renewing all existing business written in the program. The losses
this business incurred are reflected in the Meridian standard segment, which
adversely affected the Company's 2001 results.
Page 14
None of the companies in the State Auto Group has any contracts with
managing general agencies.
State Auto National markets nonstandard products exclusively through
the Company's network of independent agents. As noted above, State Auto National
is licensed in 22 states and operated in 19 states in 2001. Mid-Plains writes
nonstandard auto insurance in Iowa and Kansas through the agency network of
Farmers Casualty in those states, but in 2001, the Mid-Plains business began to
be processed on State Auto National's system. The former Meridian Mutual
nonstandard products were also marketed through the Meridian independent agency
force, as well as agents specializing in nonstandard coverage only. As noted,
National's product is being introduced to these "former Meridian agents" on a
state by state basis. See "Nonstandard 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, including the following: 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)). The Company believes that, since agents and their
customers realize better service and efficiencies through automation, they value
their relationship with the Company. Automation can make it easier for the agent
to do business with the Company which helps to make the Company attractive to
prospective agents. This also enhances the existing agencies' relationship with
the Company.
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 2001, 257 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. On vesting, 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.
Page 15
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 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 Arkansas,
District of Columbia, Florida, Georgia, Idaho, Illinois, Indiana, Iowa, Kansas,
Kentucky, Maryland, Michigan, Minnesota, Mississippi, Missouri, North Carolina,
North Dakota, Ohio, Oklahoma, Pennsylvania, South Carolina, South Dakota,
Tennessee, Utah, Virginia, Washington, West Virginia and Wisconsin. During 2001,
the seven states that contributed the greatest percentage of direct premiums
written to the State Auto Group were North Carolina (3.5%), Pennsylvania (5.7%),
Minnesota (5.8%), Tennessee (6.8%), Indiana (9.6%), Kentucky (11.5%) and Ohio
(17.9%).
CLAIMS
Insurance claims on policies written by the Company are usually
investigated and settled by staff claims adjusters. The Company's claims
division 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. Achievement of these goals
supports the Company's marketing efforts by providing agents and policyholders
with prompt and effective 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 division is responsible for
reviewing the claim, obtaining necessary documentation and establishing loss and
expense reserves of certain claims. Property or casualty claims estimated to
reach $100,000 or above are sent to the home office to be supervised by claims
division 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 division
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 operations in Cleveland, Ohio and
Baltimore, Maryland, which represent insureds in third party litigation,
continue their operations. 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 division. The claims division
also provides 24 hour, 7 days a week claim service through associates in its
Contact Center. See "Management's Discussion and Analysis of Financial Condition
and Results of Operation" at "Item 7" for discussion regarding the Company's
response to the Meridian claims and reserving practices.
RESERVES
Loss reserves are management's best estimates at a given point in time
of what the Company expects to pay to claimants, based on facts, circumstances
and historical trends then known. It can be
Page 16
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 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. Case and formula
basis 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. See "Management's
Discussion and Analysis of Financial Condition and Results of Operation" at
"Item 7" for discussion regarding the Company's response to the Meridian claims
and reserving practices.
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, 2001, 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.
Page 17
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, 2001.
Year Ended December 31
--------------------------------------
2001 2000 1999
---- ---- ----
(in thousands)
Reserve for losses and loss expenses
at beginning of year (1) $ 236,653 $ 221,682 $ 205,034
--------- --------- ---------
Provision for losses and loss expenses occurring:
Current year 366,348 277,805 271,507
Prior years(2) 60,726 (5,638) (6,878)
--------- --------- ---------
Total 427,074 272,167 264,629
--------- --------- ---------
Loss and loss expense payments for claims occurring during:
Current year 240,508 164,620 168,512
Prior years 144,862 104,871 100,349
--------- --------- ---------
Total 385,370 269,491 268,861
--------- --------- ---------
Impact of acquisition of Farmers Casualty
and Mid-Plains, 1/1/99 -- -- 13,247
Impact of the addition of the former Meridian Mutual
business to the Pooling Arrangement, effective
7/1/01 75,575 -- --
Impact of pooling change 10/1/01, 1/1/00, and 1/1/99(3) 156,009 12,295 7,633
1/1/99/1/98 (3)
--------- --------- ---------
Reserve for losses and loss expenses at end of year (1) $ 509,941 $ 236,653 $ 221,682
========= ========= =========
- ---------------
(1) This line item is net of reinsurance recoverable on losses and loss
expenses payable of approximately, $13,919,000, $7,930,000, and
$10,807,000 for the years 2001, 2000, and 1999, respectively.
(2) This line item shows increases (decreases) in the current calendar year
in the provision for losses and loss expenses attributable to claims
occurring in prior years. The increase of $60,726,000 in 2001 for
claims occurring in prior years, is generally the result of reserve
strengthening that occurred on the former Meridian Mutual business in
order to bring these claim reserves in line with historic State Auto
adequacy levels as well as ongoing analysis of recent loss development
trends. The change in the decrease in the calendar year losses and loss
expenses over the two year period ending December 31, 2000 has resulted
primarily from developments 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 October 1, 2001, January 1, 2000, and January 1,
1999, respectively. See "Pooling Arrangement" in "Narrative Description
of Business".
- ----------------
The following table sets forth the development of reserves for losses
and loss expenses from 1991 through 2001 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.
Page 18
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, 2001, the Company had paid 66.1% 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
1991 reserve has developed a $13.0 million redundancy through December 31, 2001.
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 1996, but
incurred in 1993, will be included in the cumulative redundancy amount for years
1993, 1994 and 1995. 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 addition, in 1998,
1999, 2000 and 2001, 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, 2000 and 2001 in conjunction with each year's respective
pooling change. The amount of the assets transferred from Mutual in 1992, 1995,
1998, 1999, 2000 and 2001 has been netted against and has reduced the cumulative
amounts paid for years prior to 1992, 1995, 1998, 1999, 2000 and 2001,
respectively.
[See table on following page.]
Page 19
State Auto Financial Corp.
Years Ended December 31
1991 1992 1993 1994 1995
(Dollars in Thousands)
Net liability for losses
and loss expenses payable $ 71,139 $ 119,044 $ 123,337 $ 126,743 $ 206,327
Paid (cumulative)
as of:
One year later 12.2% 41.3% 42.2% 1.5% 38.2%
Two years later 43.0% 60.9% 41.3% 29.1% 55.4%
Three years later 58.7% 60.6% 55.6% 44.5% 63.3%
Four years later 58.4% 68.0% 64.5% 51.0% 67.7%
Five years later 63.9% 71.9% 67.2% 54.6% 71.9%
Six years later 67.5% 72.5% 69.0% 58.8% 67.1%
Seven years later 67.7% 73.7% 72.1% 52.3%
Eight years later 69.0% 75.2% 67.0%
Nine years later 70.2% 71.5%
Ten years later 66.1%
Net liability re-estimate
as of:
One year later 91.2% 92.7% 93.7% 87.4% 87.0%
Two years later 87.2% 90.5% 90.0% 77.1% 86.4%
Three years later 85.4% 87.6% 85.0% 77.0% 83.2%
Four years later 84.5% 85.6% 86.3% 72.9% 81.6%
Five years later 82.3% 87.3% 82.8% 70.9% 81.3%
Six years later 86.7% 84.5% 81.6% 70.0% 83.6%
Seven years later 83.1% 83.0% 80.8% 72.6%
Eight years later 81.0% 82.0% 83.6%
Nine years later 79.4% 84.7%
Ten years later 81.7%
Cumulative redundancy (deficiency) $ 13,038 $ 18,201 $ 20,269 $ 34,787 $ 33,848
Cumulative redundancy (deficiency) 18.3% 15.3% 16.4% 27.4% 16.4%
Gross* liability - end of year $ 224,771 $ 245,929 $ 277,783 $ 412,553
Reinsurance receivable $ 105,727 $ 122,591 $ 151,040 $ 206,226
Net liability - end of year $ 119,044 $ 123,337 $ 126,743 $ 206,327
Gross liability re-estimated - latest 96.4% 100.6% 93.0% 84.8%
Reinsurance receivable re-estimated -
latest 109.6% 117.8% 110.2% 86.1%
Net liability re-estimated - latest 84.7% 83.6% 72.6% 83.6%
State Auto Financial Corp.
Years Ended December 31
1996 1997 1998 1999 2000 2001
(Dollars in Thousands)
Net liability for losses
and loss expenses payable $ 199,480 $ 194,155 $ 205,034 $ 221,682 $ 236,657 $509,941
Paid (cumulative)
as of:
One year later 39.4% 32.7% 35.4% 41.8% 5.9% --
Two years later 54.1% 54.6% 61.6% 43.0%
Three years later 65.0% 70.1% 62.1%
Four years later 73.2% 69.2%
Five years later 69.8%
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Net liability re-estimate
as of:
One year later 91.3% 93.0% 96.6% 97.5% 125.7% --
Two years later 87.3% 92.0% 96.7% 119.1%
Three years later 86.7% 91.9% 111.9%
Four years later 87.0% 102.0%
Five years later 92.6%
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Cumulative redundancy (deficiency) $ 14,755 ($3,924) $(24,335) $(42,279) $(60,726) --
Cumulative redundancy (deficiency) 7.4% -2.0% -11.9% -19.1% -25.7% --
Gross* liability - end of year $ 410,658 $ 402,718 $ 414,268 $ 438,748 $ 457,202
Reinsurance receivable $ 211,178 $ 208,563 $ 209,234 $ 217,065 $ 220,544
Net liability - end of year $ 199,480 $ 194,155 $ 205,034 $ 221,682 $ 236,657
Gross liability re-estimated - latest 92.9% 98.3% 107.2% 108.1% 112.5%
Reinsurance receivable re-estimated -
latest 93.1% 94.9% 102.6% 96.9% 98.3%
Net liability re-estimated - latest 92.6% 102.0% 111.9% 119.1% 125.7%
* Gross liability includes: Direct & assumed losses & loss expenses payable.
Page 20
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"):
2001 2000 1999
---- ---- ----
(in thousands)
GAAP losses and loss
expenses payable $523,960 $244,583 $232,489
Less: ceded reinsurance recoverable
on losses and loss expenses payable 13,919 7,930 10,807
Add: salvage and subrogation
recoverable 26,216 13,402 13,505
-------- -------- --------
STAT losses and loss
expenses payable $536,157 $250,055 $235,187
======== ======== ========
REINSURANCE
Members of the State Auto Group 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. The Meridian Insurers do not participate in the
Pooling Arrangement. Although reinsurance does not legally discharge the
individual members of the State Auto Group 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 is party to 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 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
million of 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, uninsured motorists, and personal
injury protection are covered by an arrangement that 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.
The rates for this reinsurance are negotiated annually.
Effective July 1, 2001, the State Auto Group entered into a new
reinsurance treaty for the workers compensation exposure, where each member is
responsible for the first $2.0 million of covered loss. The reinsurers are
responsible for 100% of the loss excess of $2.0 million and up to $10 million.
Net retentions under this contract may be submitted to the casualty excess of
loss program, subject to a limit of $2 million per person. This exposure was
previously covered in the casualty excess of loss treaty. .
In addition, the State Auto Group has secured other reinsurance to
limit the net cost of large loss events for certain types of coverage. 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.
The members of the State Auto Group combined retain the first $40
million of each property catastrophe occurrence that affects more than those two
individual risks. Eighty ($80) million dollars of
Page 21
traditional reinsurance is available above the $40 million retention with a
co-participation of the above named companies of 5%.
In the event the State Auto Group incur 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 $100.0 million
to be used to cover such catastrophe losses. This arrangement, effective
November 16, 2001, replaced the prior structured contingent financing
transaction State Auto Financial had with Bank One effective November 17, 2000.
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, SAIC,
Meridian Citizens Mutual, and Meridian Security pursuant to a Catastrophe
Assumption Agreement in the amount of $100.0 million excess $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 redeem the preferred shares by making periodic
payments to the SPC. The SPC would use these payments to repay the Lenders, over
a five year period. This layer of $100.0 million 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 either
purchase the preferred shares from the SPC or repay the SPC for the loan(s)
outstanding. In February of 2002, the FASB initiated a project to consider
guidance related to the issue of special purpose entity consolidation.
Specifically, the FASB discussed issues related to identifying and accounting
for special purpose entities as part of the FASB's Consolidation Project. The
results of these deliberations could negatively impact the Company's accounting
approach for the structured contingent financing transaction, if an event
triggering this cover were to occur. Management will continue to monitor this
guidance and its potential impact on the Company.
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.
For the period October 1, 2001 through December 31, 2003, Mutual
entered into a Stop Loss Reinsurance Arrangement (the "Stop Loss") with certain
of the Pooled Companies. Under the Stop Loss, Mutual has agreed to participate
in the Pooling Arrangement's quarterly underwriting losses and gains, in the
manner described. If the Pooling Arrangement statutory loss and loss adjustment
expense ratio (the "Loss Ratio") is between 70.75% and 80.00%, Mutual will
reinsure certain of the Pooled Companies 27% of the Pooling Arrangements' losses
in excess of a Loss Ratio of 70.75% up to 80.00%. Certain of the Pooled
Companies would be responsible for its share of the Pooling Arrangements' losses
over the 80.00% threshold. Also, Mutual will have the right to participate in
the profits of the Pooling Arrangement. Mutual will assume 27% of the Pooling
Arrangement's underwriting profits attributable to loss ratios less than 69.25%,
but more than 59.99%.
REGULATION
Most states have enacted legislation that regulates insurance holding
company systems. Ohio, the domiciliary state of Mutual, National, SAIC and ICO,
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
Page 22
which regulates Farmers Casualty and Mid-Plains. The same is true in Indiana
which is the domiciliary regulator for Meridian Security, Meridian Citizens, and
Meridian Citizens Mutual. 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, Mid-Plains and the
Meridian Insurers, 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, Mid-Plains or any of the Meridian Insurers, 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, SAIC and ICO, as does South Dakota for Milbank,
Wisconsin for Midwest Security, Iowa for Farmers Casualty and Mid-Plains, and
Indiana as respects Meridian Insurers other than ICO.
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
Page 23
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 $25.1 million is available for
payment to State Auto Financial as a dividend from State Auto P&C, Milbank,
Farmers Casualty, SAIC and National during 2002 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 was adopted by any state where the Company did
business during 2001 which would present material obstacles to the Company's
overall business. Several states where the Company does business have passed or
are considering more strict regulation of the use of credit scoring in rating
and/or risk selection in personal lines of business. This could have an adverse
impact on the Company as it has adopted credit scoring as an underwriting tool.
Such regulation would limit the Company's ability to take advantage of this
tool.
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, 2001, each
insurer affiliated with the Company exceeded all standards tested by the formula
applying risk-based capital requirements.
While the insurance business has for years been subject to state
regulation, the regulatory landscape has been affected by the federal financial
services reform legislation, the Gramm Leach Bliley Act ("GLB"), signed into law
in 1999. It is still difficult to specifically identify the impact of this new
law on the Company, except in the area of privacy protection. New internal
procedures have been created to comply with the new requirements imposed by GLB.
Otherwise, at least as respects the Company, the strategic impact of GLB has not
yet manifested itself.
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 DEPARTMENT OF INSURANCE DISPUTE
See "Management Agreement" in the "Narrative Description of Business."
Page 24
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. Stateco performs investment
management services for the Company and Mutual and its subsidiaries, although
investment policies 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 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
as available for sale for the purpose of providing greater flexibility in the
investment portfolio and these are carried at fair value. Fixed maturities
available-for-sale totaled $1,051.4 million and $653.3 million at December 31,
2001, and December 31, 2000, respectively. 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 categorized as
hold-to-maturity totaled $27.4 million and $39.3 million at December 31, 2001,
and December 31, 2000, respectively.
At December 31, 2001 and 2000, respectively, the Company's equity
portfolio totaled $59.8 million and $58.3 million.
The table below provides information about the quality of the Company's
fixed maturity portfolio:
Bond Portfolio Quality
Investment Grade Corporates
and Municipals 89.1%
(Rated AA or better)
U.S. Governments 7.0%
U.S. Government Agencies 3.9%
Page 25
The following table sets forth the Company's investment results for the
periods indicated:
Year Ended December 31
--------------------------------------
2001 2000 1999
---- ---- ----
(Dollars in thousands)
Average invested assets (1) $870,864 $712,627 $633,989
Net investment income (2) $ 47,375 $ 38,915 $ 34,262
Average yield 5.4% 5.5% 5.4%
- --------------
(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, Mid-Plains and the Meridian Insurers. Stateco
has entered into an Investment Management Agreement with each of these entities,
(except ICO) pursuant to which Stateco manages the investment portfolios of
these companies and receives an investment management fee 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., a wholly owned subsidiary of STFC, develops and sells 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. 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. It has
approximately 800 Semci Partner(R) systems in place, and of these, 75% are with
agents who represent State Auto, while the remainder are in agencies that have
no other business relationship with State Auto. S.I.S.' revenue from SEMCI
Partner(R) and other S.I.S. software sales is not material to the Company at
this time.
Page 26
PROPERTY LEASING BUSINESS
518 PML is an Ohio limited liability company. The members of 518 PML
are Stateco and State Auto P&C. Its business is owning office buildings and
certain personal property which it leases to Mutual at what it believes are
market rates. Revenue from 518 PML is not material to the Company at this time.
COMPETITION
The property and casualty insurance industry is highly competitive.
While it appears that in certain lines of business prices are firming for the
first time in years, which has had a positive impact on sales revenue, the fact
remains that as a whole, the industry is over-capitalized based on historical
norms. While competition is not currently as price driven as it had been for
years, it is impossible to predict how long this harder market will last. There
has been added uncertainty in the marketplace since the events of September
11th. The issue of terrorism coverage has been more highly publicized,
particularly as respects the coverage reinsurers will make available to primary
insurers. Some in the industry have lobbied for the federal government to
address the issue to avoid severe market dislocation. As respects the Company,
since its CAT reinsurance program with traditional cover renews on July 1, 2002,
it has not had to face yet the loss of terrorism cover in its reinsurance, nor
is it certain what the market for reinsurance will be at the time the cover
renews. There is significant uncertainty in the marketplace about terrorism
cover although it appears to be available albeit at a higher price. The Company
intends to exclude terrorism in commercial policies. It will file exclusions
with state insurance departments as soon as practicable, although not all states
are approving such filings.
Another underwriting and claims issue the Company is confronting is
"toxic mold". This source of loss has received significant publicity in recent
months and indications exist that mold claims will become an ever increasing
problem The Company believes the contract was not written or priced to address
this kind of commonly occurring condition, particularly when remediation costs
are extreme. Hence, to protect its current rate structure, the Company is also
moving to file mold exclusions on homeowner policies in all states that will
accept such filings.
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.
EMPLOYEES
As of March 8, 2002, the Company had 2,042 employees. This includes 565
employees who had been employees of MIGI until January 1, 2002. 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.
Page 27
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, 58 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, 50 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
Steven J. Johnston, 42 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, 51 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 3/01
and of Mutual 8/89 to 3/01
James E. Duemey, 55 Vice President and Investment Officer 1991
Vice President of STFC and Mutual, 5/91 to present
and Investment Officer
William D. Hansen, 36 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
Steven R. Hazelbaker 46 Vice President of Mutual 6/01 to 2001
Vice President present; Vice President of STFC 6/01 to
present; CFO and Treasurer of Meridian
Insurance Group, Inc. (MIGI) and
Meridian Mutual Insurance Company
("Meridian Mutual") 1994 to 6/01; Vice
President of MIGI and Meridian Mutual
1995 to 6/01
Noreen W. Johnson, 53 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, 62 Vice President of STFC, 3/98 to 1994
Vice President present; Vice President of Mutual, 2/88
to present
John B. Melvin, 52 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
Page 28
Name of Executive Officer and Age Principal Occupation(s) An Executive Officer
Position(s) with Company --- During the Past Five Years of the Company Since (1)
------------------------- -------------------------- ------------------------
Cathy B. Miley, (2) 52 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) 48 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, 43 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
Cynthia A. Powell, 41 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 executive 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 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. Mutual also now owns an office building in
Indianapolis, Indiana which was the corporate headquarters of the former
Meridian Mutual and its affiliates. This now serves as the location of the State
Auto Indianapolis Regional Office.
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.
Page 29
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, 2002, there were 948 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:
2000 HIGH LOW DIVIDEND
---- ---- --- --------
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
2001
----
First Quarter $17.688 $13.313 $ 0.300
Second Quarter 17.340 12.833 0.300
Third Quarter 17.800 12.300 0.0325
Fourth Quarter $17.500 $13.100 $0.0325
(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.
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.
Page 30
ITEM 6. SELECTED FINANCIAL DATA
"Selected Consolidated Financial Data" is as follows:
SELECTED CONSOLIDATED FINANCIAL DATA
YEAR ENDED DECEMBER 31
2001* 2000* 1999* 1998* 1997 1996 1995* 1994
------------------------------------------------------------------------------------
STATEMENTS OF INCOME DATA: (Dollars in thousands, except per share data)
Earned premiums $ 555,207 397,967 392,058 356,210 320,050 304,472 296,364 225,297
Net investment income $ 47,375 38,915 34,262 32,506 31,107 29,863 28,461 22,189
Management services income $ 15,586 17,594 8,727 7,945 7,367 6,774 6,377 5,170
Net realized gains on investments $ 1,962 5,255 2,555 2,925 3,043 2,788 1,758 1,595
Other income $ 3,142 3,043 3,269 2,473 1,409 1,200 525 147
------------------------------------------------------------------------------------
Total revenues $ 623,272 462,774 440,871 402,059 362,976 345,097 333,485 254,398
====================================================================================
Income before federal income taxes $ 17,976 61,444 56,985 49,605 56,638 34,792 40,953 20,294
====================================================================================
Net income $ 20,615 47,714 42,816 37,497 40,998 26,407 29,894 15,835
====================================================================================
Earnings per common share(1)(2):
Basic $ 0.53 1.24 1.05 0.89 0.99 0.64 0.73 0.39
====================================================================================
Diluted $ 0.52 1.21 1.03 0.87 0.97 0.63 0.72 0.39
====================================================================================
Cash dividends per common share(1) $ 0.13 0.12 0.11 0.10 0.09 0.08 0.07 0.06
====================================================================================
BALANCE SHEET DATA AT YEAR END:
Total investments $ 1,138,656 750,870 627,305 579,966 526,363 499,277 479,908 350,639
Total assets $ 1,367,496 898,106 759,945 717,520 664,384 605,385 579,194 487,282
Note payable to affiliate $ 45,500 45,500 45,500 -- -- -- -- --
Total stockholders' equity $ 400,193 386,059 317,687 340,824 297,258 247,619 225,763 175,852
Book value per common share(1) $ 10.28 10.01 8.29 8.11 7.11 5.98 5.48 4.29
STATUTORY RATIOS:
Loss ratio 77.4 68.5 67.4 68.4 65.2 72.7 68.6 75.4
Expense ratio 27.8 27.0 29.5 29.4 28.9 27.3 31.0 28.2
Combined ratio 105.2 95.5 96.9 97.8 94.1 100.0 99.6 103.6
Industry combined ratio(3) 118.0 110.5 107.7 105.6 101.6 105.8 106.5 108.5
Ratio of net premiums written to
statutory capital and surplus 1.81 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 2001 from A.M. Best.
* Reflects change in Pooling Arrangement, effective October 1, 2001, January 1,
2000, 1999, 1998 and 1995.
Page 31
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 central 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 is a majority-owned subsidiary of State Automobile Mutual Insurance
Company ("Mutual"), an Ohio domiciled property and casualty insurer. 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 was paid quarterly a management and operations
services fee based on formulas outlined in the 2000 Management Agreement. This
fee from a managed company would be withheld if a managed company's performance
did not meet performance criteria set forth in the 2000 Management Agreement. In
early 2001, the Ohio Department of Insurance (the "ODI") requested that Mutual
file an analysis with the ODI on a quarterly basis, starting with the quarter
beginning January 1, 2001, that justified the apportionment of the service fee
paid by Mutual to State Auto P&C under the Mutual Management Agreement under
accounting guidance outlined in Statement of Statutory Accounting Principles No.
70 - Allocation of Expenses ("SSAP No. 70"). The Company believed its accounting
for such service fee was consistent with all statutory accounting principals. On
October 24, 2001, the board of directors of the Company and Mutual and special
independent committees thereof approved a resolution of the disagreement between
the Company and the ODI regarding the service fee paid by Mutual to State Auto
P&C. The disagreement with ODI was resolved and ODI expressly did not take issue
with Mutual's payment of the service fee for the first three quarters of 2001,
which amounted to $12.5 million, pre-tax, nor with Mutual's accounting for the
service fee in each of those quarters. The ODI also approved regulatory filings,
effective October 1, 2001, implementing a revised Mutual Management Agreement,
changing the Pooled Subsidiaries (defined below) pooling participation
percentages and implementing a stop loss reinsurance arrangement.
Effective October 1, 2001, the Mutual Management Agreement was amended
to eliminate the management and operations service fee charged by State Auto P&C
to participants to the agreement, including Mutual. The Mutual Management
Agreement continues to allocate costs and apportion those costs among the
parties to the agreement in accordance with terms outlined therein. As a result
of the loss of the management and operations services income under the Mutual
Management Agreement, substantially all of State Auto P&C's services income has
been eliminated effective October 1, 2001. Consequently, beginning with the
first quarter 2002, the management and operations services segment
Page 32
will be included in the other category for segment reporting as the results of
this segment will no longer meet the quantitative thresholds for separate
presentation as a reportable segment. See "Reportable Segments" included herein
and footnote 14 regarding the Company's operating segments included in the
consolidated financial statements of the Company.
As noted above, as part of the resolution of the service fee
disagreement with ODI, ODI approved an amendment to the Pooling Arrangement
(defined below) in which the Pooled Subsidiaries aggregate participation was
increased from 53% to 80% effective October 1, 2001. In conjunction with this
change in pool participation, the Pooled Subsidiaries received cash of $2.2
million and fixed maturities totaling $236.3 million from Mutual, which related
to the additional net insurance liabilities assumed by the Pooled Subsidiaries
on October 1, 2001. Additionally, for the period October 1, 2001 through
December 31, 2003, Mutual entered into a stop loss reinsurance arrangement (the
"Stop Loss") with the Pooled Subsidiaries. Under the Stop Loss, Mutual has
agreed to participate in the Pooling Arrangement's quarterly underwriting losses
and gains in the manner described. If the Pooling Arrangement's statutory loss
and loss adjustment expense ratio (the "loss ratio") is between 70.75% and
80.00% (after the application of all available reinsurance), Mutual will
reinsure the Pooled Subsidiaries 27% of the Pooling Arrangement's losses in
excess of a loss ratio of 70.75% up to 80.00%. The Pooled Subsidiaries would
be responsible for their share of the Pooling Arrangement's losses over the
80.00% threshold. Also, Mutual will have the right to participate in the profits
of the Pooling Arrangement. Mutual will assume 27% of the Pooling Arrangement's
underwriting profits attributable to loss ratios less than 69.25%, but more
than 59.99%.
The Midwest Management Agreement and the Farmers Casualty Management
agreement were not affected by the disagreement with the ODI or its resolution.
Pursuant to the 2000 Management Agreement, in 2000, the Company
received cash of $28.1 million equal to the net pension and post-retirement plan
benefit liabilities assumed relating to the above described transfer of those
individuals who were employees of Mutual as of December 31, 1999. 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.
In 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 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.
Page 33
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.
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 commercial
policyholders 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 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"), State Auto Financial's 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. As noted above, the Pooling Arrangement changed again effective
October 1, 2001 with the Pooled Subsidiaries aggregate participation increasing
to 80% ( State Auto P&C - 59%, Milbank - 17%, Farmers Casualty - 3% and SAIC -
1%). All parties that participate in the Pooling Arrangement have an A. M. Best
rating of A+ (Superior).
In October of 2000, Mutual entered into an agreement with Meridian
Mutual Insurance Company ("Meridian Mutual"), an Indiana domiciled property and
casualty insurance company, pursuant to which Meridian Mutual would be merged
with and into Mutual, with Mutual continuing as the surviving corporation. The
effective date of the merger transaction was June 1, 2001. With the merging of
Meridian Mutual into Mutual, all insurance business that had been written by
Meridian Mutual became, legally, Mutual business. For the period June 1, 2001
through June 30, 2001, the insurance business formerly known as the Meridian
Mutual business prior to the June 1 merger transaction was excluded from the
Pooling Arrangement. Effective July 1, 2001, the insurance business of the
former Meridian Mutual became part of the Pooling Arrangement and the Pooled
Subsidiaries assumed 53% of the Meridian Mutual business on this same date.
Concurrent with this transaction, the Pooled Subsidiaries received cash of $6.4
million and fixed maturities totaling $109.7 million from Mutual, which related
to the additional net insurance liabilities assumed by the Pooled Subsidiaries
on July 1, 2001.
Page 34
The business written by the former Meridian Mutual provides both
standard and nonstandard personal lines and standard commercial lines to its
policyholders. The principal lines of business include standard personal and
commercial automobile, nonstandard personal automobile, homeowners, commercial
multi-peril, workers' compensation, general liability and fire insurance. The
former Meridian Mutual business represents approximately 20% of the Pooled
Companies business.
As the former Meridian Mutual business continues to be written and
processed through the underwriting and claims system for both the standard and
nonstandard business on the Meridian systems platform, management will monitor
this business as a separate segment from the State Auto standard and nonstandard
processed business. Monitoring of these segments separately is necessary in
order to facilitate the integration of the business as it migrates through new
policies and renewals to the State Auto systems platform where State Auto
policies, pricing, underwriting , and claims philosophies will be fully
integrated. Over time, it is anticipated that the Meridian operating segments
will decrease and eventually disappear as they become fully integrated on to the
State Auto systems platform. Consequently, with the addition of the former
Meridian Mutual business to the Pooling Arrangement, the Company renamed the two
insurance segments that existed prior to 2001 to be the "State Auto standard
segment" and the "State Auto nonstandard segment" and that business consisting
of the business known formerly as the Meridian Mutual business to be the
"Meridian standard segment" and "Meridian nonstandard segment."
In discussing Results of Operations for 2001 and 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. The Pooled Subsidiaries, Mutual and Midwest are collectively
referred to below as the "Pooled Companies."
CRITICAL ACCOUNTING POLICIES
The Company's significant accounting policies are more fully described
in note 1 to the Company's consolidated financial statements. 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 financial entries in 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 therein.
Losses and loss expenses payable are management's best estimates at a
given point in time of what the Company 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
estimate of liability. 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
provision 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. Case and formula
basis 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.
Acquisition costs, consisting of commissions, premium taxes, and
certain underwriting expenses relating to the production of property and
casualty business, are deferred and amortized ratably over the contract period.
The method followed computing the acquisition costs limits the amount of such
deferred
Page 35
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. These amounts are based on estimates and accordingly, the
actual realizable value may vary from the estimated realizable value.
Investments are either classified as held to maturity, and carried at
amortized cost, or available for sale, and carried at fair value. For
investments classified as available for sale, the net 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. Investment income is
recognized when earned, and capital gains and losses are recognized when
investments are sold. The Company regularly reviews its investments based on
current economic conditions, credit loss experience and other factors. If there
is a decline in an investment's fair value that is determined to be other than
temporary, this decline is treated as a realized loss and the cost basis of the
investment is reduced to its estimated fair value at the date of determination.
Review for impairment of investments requires significant management judgment.
See a discussion of other factors that may have an impact on
management's best estimates at "Impact of Significant External Factors" included
herein.
RESULTS OF OPERATIONS
2001 COMPARED TO 2000
Net income for the Company decreased 56.8% in 2001.
Contributing to this decease was an increase in the Company's statutory combined
ratio to 105.2% from 95.5% in 2000. Negatively impacting the Company's insurance
operations in 2001 were the loss results of the former Meridian Mutual business,
assumed by the Pooled Subsidiaries beginning in July 2001, and a decrease in the
Company's management and operations service fee income. See discussion below.
Consolidated earned premiums increased 39.5%. This increase was
principally the result of the addition of the former Meridian Mutual business to
the Pooling Arrangement, effective July 1, 2001, and a change in the Pooled
Subsidiaries' aggregate pooling participation percentage from 53% to 80%,
effective October 1, 2001 (see discussion above regarding these two
transactions). These actions increased consolidated earned premiums 30.9%. The
internal growth of the State Auto standard segment's earned premiums increased
consolidated earned premiums 6.8%. This increase has been largely driven by
growth in commercial lines of business over the last twelve months; however,
during the last half of the calendar year, personal lines of business began to
experience sales increases. Management believes the personal lines sales
increases are due to changes in the market place and to its establishing the
position of Personal Lines Sales Specialist. The internal growth of the State
Auto nonstandard segment earned premiums increased consolidated earned premiums
2.0%. Production levels in this segment continued to improve during 2001 as
a result of improved processing routines for agents and the easing of
competitive pricing pressures it had felt from certain market leaders in the
first half of 2000. The internal growth of both the Meridian standard and
nonstandard segment on consolidated earned premium was flat. See discussion
below regarding management's action during 2001 on the Group Advantage(R)
Program as well as management's response to adequacy of premium rate levels
within the standard segment and the Company's plan on integration with regard to
the Meridian nonstandard segment.
Net investment income increased $8.5 million (21.7%) in 2001.
Contributing to the increase over the previous year was an increase in
investable assets due to the transfer of cash and fixed maturity securities from
Mutual totaling $354.6 million to the Pooled Subsidiaries in conjunction with
the Pooled Subsidiaries assuming 53% of the former Meridian Mutual business on
July 1, 2001 and the change in the Pooled Subsidiaries pooling participation
percentages, effective October 1, 2001, from 53% to 80%. Total cost of
investable assets at December 31, 2001 and 2000, was $1,150.3 million and $741.1
million, respectively.
Page 36
The investment yields, based on fixed and equity securities at cost,
were 5.4% and 5.5% for the annual periods ending 2001 and 2000, respectively.
During 2001, the Company experienced an increase in the number of calls over
prior years on higher yielding fixed maturities. Monies from these calls were
reinvested at lower rates. See further discussion regarding investments at the
"Liquidity and Capital Resources", "Investments" and "Market Risk" sections,
included herein.
Management services income, including investment management
fees, decreased $2.0 million to $15.6 million for the year ended December 31,
2001. This decrease is attributable to the resolution of the disagreement
between the Company and ODI regarding the recognition of the service fee paid by
Mutual to State Auto P&C. The service fee under the 2000 Mutual Management
Agreement paid by Mutual in 2001 was $12.5 million down from $14.5 million in
2000. See "Overview" included herein, for discussion of the resolution regarding
the management and operations service fee. See "Liquidity and Capital Resources"
included herein, for discussion of the overall impact of the loss of the
management and operations service fee on the Company's cash flow and operations.
Losses and loss expenses, as a percentage of earned premiums (the "loss
ratio"), were 76.9% and 68.4% for the years 2001 and 2000, respectively. During
the fourth quarter of 2001, the Pooled Subsidiaries produced a loss ratio under
the Stop Loss (described above) that exceeded the 80% threshold, thereby
recovering the full layer of $6.2 million from Mutual. Adversely impacting the
current year results were the loss results of the former Meridian Mutual
business assumed by the Pooled Subsidiaries. For discussion purposes, the
following table provides comparative statutory loss and loss adjustment expense
ratios ("Statutory Loss Ratio"), net of the Stop Loss recovery, for the
Company's insurance operating segments:
2001 2000
----- ----
State Auto standard segment 66.3 67.6
State Auto nonstandard segment 77.9 81.4
Meridian standard segment 139.6 -
Meridian nonstandard segment 168.2 -
----- ----
Total Statutory Loss Ratio 77.4 68.5
The Company's State Auto standard segment reflected an improvement in
its loss ratio in 2001 to 66.3 from 67.6 in 2000. This segment's largest line of
business, automobile, reflected a 1.6 point improvement in its loss ratio in
2001 from 2000. This segment's next largest line of business, homeowners, has
experienced some deterioration in its loss ratio over the last several years.
Management has been monitoring this line of business and has taken some
corrective action through rate increases and improved underwriting techniques
such as credit scoring. The Company's State Auto nonstandard segment experienced
an improvement in its loss ratio in 2001 to 77.9 from 81.4 in 2000. In 2000,
this segment began experiencing some volatility in loss activity in those states
where National began operations in 1999. Consequently, management began
monitoring the premium rate adequacy in these new states and reacted accordingly
throughout 2000 and 2001 by increasing rates in these new states. Additionally,
this segment has implemented a number of underwriting tools, including
"point-of-sale" underwriting as well as the use of credit scoring. Management
believes these two tools have contributed to this segment's profit improvement.
The former Meridian Mutual business has historically produced poorer
loss results than the State Auto book. Through the integration process, several
areas within the Meridian Mutual book are being strengthened that should produce
improved long term results. The most notable improvement was management's focus
on reviewing the Meridian segments' case reserves during the second half of 2001
to ensure that the claims were reserved in a manner consistent with State Auto
practices. During the review, it became apparent that case reserves on the
Meridian segments for claims occurring in prior accident periods were not
reserved consistently with historic State Auto adequacy levels. Nearly 14,000
open claims were reviewed, adding approximately $36 million to known case
reserves on claims occurring in prior periods. Irrespective of this reserve
strengthening, the Meridian segments' business continues to produce results that
are not acceptable to management.
Page 37
Corrective action is taking place in both the standard and nonstandard
segments. Group Advantage(R) was a program within Meridian's standard segment
where Meridian made its personal lines products available to Sam's Club members
through insurance kiosks located in Sam's Club retail outlets. While this
program generated significant premium growth, it consistently failed to meet
profitability objectives. As a result, in late 2000, the former Meridian Mutual
stopped writing new Group Advantage(R) business and began to terminate existing
business as permitted by law. At the end of 2000, there were approximately
15,000 Group Advantage(R) policies in force. At year end 2001, there are
approximately 800 of such policies in force. These remaining policies are
expected to non-renew over the course of 2002.
During 2001, management also focused on strengthening the Meridian
standard segment's adherence to underwriting guidelines in a manner consistent
with State Auto practices, as well as analyzing the adequacy of prices relative
to risks written. Consequently, management is in the process of re-underwriting
100% of the commercial renewals to be certain they fall within the State Auto
guidelines. State Auto also has a practice of reviewing the rate level for each
line of business in each operating state each year. Concurrent with these
reviews, the Meridian standard segment's rate levels on its commercial book of
business are being adjusted to the State Auto rate level. Implementing the
Company's underwriting and pricing discipline within the Meridian standard
segment is anticipated to have an adverse effect on top line growth of the
Meridian standard segment. This may be partially offset by new business being
written within the State Auto standard segment by those agencies previously
representing the former Meridian Mutual but not State Auto.
The Meridian nonstandard segment produced significant underwriting
losses generating a loss ratio for the six months ended December 31, 2001 of
168.2%. An integration plan is currently in place to write all new nonstandard
auto business produced by former Meridian agents through National on the
National system platform. The National system provides several enhancements that
management anticipates will improve the nonstandard loss ratio for new risks
written. Most notably, the National system uses credit scoring and
"point-of-sale" underwriting tools. The order of integration has been
prioritized such that the states with the most need for profit improvement are
migrating to National first. New business for six of the 12 states that the
Meridian nonstandard segment operates in is currently being written through
National, with the remaining six states to follow throughout 2002.
Acquisition and operating expenses, as a percentage of earned premiums
(the "expense ratio"), were 30.1% and 30.0% for the years 2001 and 2000,
respectively. Impacting the current year expenses was approximately $1.3 million
(0.2%) related to the Company's estimate of its future guaranty fund assessments
related to the Reliance Insurance Company insolvency that was announced during
the fourth quarter of 2001.
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, as a percentage of earned premiums, were 1.6% and 1.7%
for the year 2001 and 2000, respectively. Other expense for 2000 included
$530,000 in interest relating to the return of premiums to the policyholders in
the state of North Carolina as discussed under "2000 Compared to 1999" in
"Results of Operations" included herein. Absent this interest charge in 2000,
other expense, as a percentage of earned premiums, was comparable between the
two time periods.
During 2001, the Company experienced an underwriting loss on its
insurance operations, largely due to the loss results of the former Meridian
Mutual business assumed by the Pooled Subsidiaries. This underwriting loss,
coupled with net investment income being largely comprised of tax-exempt income,
produced an effective tax rate in 2001 of (15%) versus 22% in 2000. 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.
Page 38
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 North
Carolina Insurance Department. 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 1999,
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.
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.
Page 39
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",
"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 30.0% 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.
REPORTABLE SEGMENTS
The Company's segment profits (losses) of the State Auto standard
insurance segment, the State Auto nonstandard insurance segment, the Meridian
standard insurance segment, the Meridian nonstandard insurance segment and the
investment management services segment, are monitored by
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management on an unconsolidated basis, as reflected in footnote 14, 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 segments for the years ended
2001, 2000, and 1999:
2001 2000 1999
---- ---- ----
(In thousands)
State Auto standard insurance $ 45,664 $ 35,579 $ 41,146
State Auto nonstandard insurance 1,378 (116) 1,647
Meridian standard insurance (44,397) -- --
Meridian nonstandard insurance (5,933) -- --
Investment management services 5,965 5,354 5,191
Management and operations services $ 15,322 $ 17,552 $ 6,330
Improvement in the Company's current year segment profit within the
State Auto standard and nonstandard insurance segments is primarily due to an
improvement in these segments' current year loss experience and management's
response to premium rate inadequacy as discussed at "2001 Compared to 2000" in
"Results of Operations." The fluctuation in segment profit for the State Auto
standard insurance segment in 2000 compared to 1999 is due to a decline in its
underwriting income resulting from an increase in the level of commercial
losses, as discussed above. Prior to 1997, the State Auto 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. Meridian standard and nonstandard insurance segments' operational loss
reflects the impact of State Auto management's integration plan, which included
the Company's review of Meridian's case reserves during the second half of 2001
as described more fully above at "2001 Compared to 2000" in "Results of
Operations". The increase in segment profit of the investment management
segment in 2001 is the result of this segment providing its services to the
MIGI Insurers beginning June 1, 2001. This segment's profits increased slightly
in 2000 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.
Segment profits related to management and operations services decreased in 2001
as a result of the resolution of the disagreement between the Company and ODI
regarding the service fee paid by Mutual to the Company in 2001. See discussion
at "Overview" as well as "2001 Compared to 2000" in "Results of Operations".
Segment profits related to management and operations services increased in 2000
from 1999 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 2001, net cash provided by operating activities decreased to $63.5
million from $87.7 million in 2000. This decrease was due to a cash transfer in
2000 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 Mutual
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Management Agreement, whereas in 2001, the settlement of approximately $355.0
million between the Company and Mutual due to the impact on the Pooled
Subsidiaries from adding the Meridian Mutual business to the Pooling Arrangement
and changing the pooling participation percentages was $8.6 million in cash and
the balance in fixed maturity securities. Absent the impact of these
transactions, net cash provided by operating activities was $54.9 million in
2001 versus $40.9 million in 2000. The increase in cash flow from operations in
2001 is largely attributable to the increase in premium writings and net
investment income over the same time period in 2000. In 2000, net cash provided
by operating activities increased to $87.7 million from $48.9 million in 1999.
Absent the cash provided from the January 1, 2000 and January 1, 1999 Pooled
Subsidiaries pooling participation percentage changes, cash provided from
operating activities was $40.9 million in 2000 and $37.5 million in 1999,
respectively. This 2000 increase in cash flow from operations was largely
attributable to an increase in the management and operation services fee and net
investment income over 1999 levels. 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. The
combination of the elimination of the relatively consistent cash flow from the
management and operations services fee from Mutual in 2001 along with a
significantly larger insurance segment, is expected to result in more volatility
going forward but will also provide opportunity for increased earnings and cash
flows from operations.
Net cash used in investing activities reflects cash flows used in
purchases of fixed maturity and equity securities, respectively, of $246.3
million and $16.4 million in 2001, $187.7 million and $15.8 million in 2000, and
$207.8 million and $25.6 million in 1999. The fluctuation in the purchase of
fixed maturity securities between years has been largely driven by the call
activity in response to the changes in the interest rate environment over the
last three years. During 1999, 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. The activity in
the call level increased again during 2001 with another decline in market
interest rates in response to the Federal Reserve Board's monetary policy and
easing inflationary pressure. Cash flows provided by maturities, calls and
principal reductions of fixed maturities were $50.2 million in 2001, $27.0
million in 2000 and $37.3 million in 1999. Overall, net cash used in investing
activities was $55.3 million in 2001, $90.9 million in 2000 and $56.9 million in
1999. 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 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. Beginning in 2002, dividend waiver decisions will be made by the
Independent Committee of the Mutual board of directors. The Independent
Committee has met and determined that it would review dividend waiver decisions
on an annual basis from this point forward. It decided to waive Mutual's
dividends that might be declared by the board of directors of the Company for
the year 2002 in order to take better advantage of the investment opportunity
STFC represents for Mutual.
Impacting cash used in financing activities during 2001 and 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 December 31, 2001, State Auto Financial repurchased
50,522 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
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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.
The interest rate was 5.0% during 2001 and will be 4.75% for 2002. Commencing in
2001, principal is due upon demand, with final payment to be received on or
prior to December 31, 2005. On March 1, 2002, the Board of Directors of State
Auto Financial again approved a plan to repurchase up to 1.0 million shares of
its common stock over a period extending to and through December 31, 2003 from
the public.
Effective with the June 1, 2001 merger transaction between Meridian
Mutual and Mutual, Mutual acquired all of the outstanding shares of Meridian
Insurance Group, Inc. ("MIGI"), an Indiana domiciled insurance holding company.
MIGI's wholly owned insurance subsidiaries are Meridian Security Insurance
Company ("Meridian Security"), an Indiana domiciled property and casualty
insurer, Meridian Citizens Security Insurance Company ("Meridian Citizens
Security"), an Indiana domiciled property and casualty insurer, and Insurance
Company of Ohio ("ICO), an Ohio domiciled property and casualty insurer. MIGI is
also party to an affiliation agreement with Meridian Citizens Mutual Insurance
Company ("Meridian Citizens Mutual"), an Indiana domiciled property and casualty
insurer. Meridian Security, Meridian Citizens Security, ICO and Meridian
Citizens Mutual are collectively referred to hereafter as the "Meridian
Insurers."
Mutual, State Auto P&C, Milbank, Midwest Security, Farmers Casualty,
SAIC, National, Mid-Plains, and effective June 1, 2001, the Meridian Insurers,
are participants in a catastrophe reinsurance program. Collectively, these
participants in the catastrophe reinsurance program are referred to as the
"State Auto Insurance Companies." 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. At the beginning of 2001, State Auto P&C was assuming catastrophe
reinsurance from Mutual, Milbank, Midwest Security, Farmers Casualty, SAIC,
National, Mid-Plains and the Meridian Insurers, beginning June 1, 2001, in the
amount of $115 million excess of $120 million. Effective November 2001, the
catastrophe reinsurance program was renegotiated whereby State Auto P&C now
assumes $100 million excess of $120 million. This layer of $100 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 $100.0 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. 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 five-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 either purchase the preferred shares
from the SPC or repay the SPC for the loan(s) outstanding. In February of 2002,
the FASB initiated a project to consider guidance related to the issue of
special purpose entity consolidation. Specifically, the FASB discussed issues
related to identifying and accounting for special purpose entities as part of
the FASB's Consolidation Project. The results of these deliberations could
negatively impact the Company's accounting approach for the structured
contingent financing transaction, if an event triggering this cover were to
occur. Management will continue to monitor this guidance and its potential
impact on the Company.
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. State Auto Financial did not exercise this right to acquire Midwest
Security.
Page 43
State Auto P&C's December 31, 1990 liability for losses and loss
expenses of $65.5 million 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,
2001, there has been no adverse development of the liability.
On March 1, 2002, the Board of Directors of State Auto Financial
declared a quarterly cash dividend of $0.0325 per common share, payable on March
29, 2002, to shareholders of record on March 14, 2002. This is the 43rd
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 2002 by its insurance subsidiaries without prior approval under
current law is limited to $25.1 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, 2001, each of the State Auto Insurance
Companies exceeded all standards established by the formula.
As discussed above, there was particular emphasis throughout 2001 on
improving the former Meridian Mutual book of business. That is expected to
continue in 2002. The Company believes its underwriting and pricing discipline,
as well as its commitment to delivering its products as effectively and
efficiently as possible, have been key factors in the Company's underwriting
results over the last several years. The Company remains active in the personal
and commercial 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 of business it believes offer the most
profit potential.
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, 2001, the Company had no fixed maturity investments rated below
investment grade, nor any mortgage loans.
As of December 31, 2001, the Company had fixed maturities with a fair
value of $1,051.4 million designated as available for sale compared to $653.3
million at December 31, 2000. During 2001, the Company continued its program to
increase its equity portfolio to enhance growth of statutory surplus over
Page 44
the long term. At December 31, 2001 and 2000, respectively, the equity portfolio
totaled $59.8 and $58.3 million, respectively.
The Company's current investment strategy does not rely on the use of
derivative financial instruments.
MARKET RISK
Investable assets comprise approximately 85% of the Company's total
assets. Of the total investable assets, 92.3% are invested in fixed maturities,
5.1% 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 laddered-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, 2001, the Company's
fixed maturity portfolio had an average maturity of 12.9 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. The average rating
of the fixed maturity portfolio is AA. 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. The Company has no exposure to foreign currency
exchange rate risk nor does it rely on the use of derivative financial
instruments. To provide the Company greater flexibility in order to manage its
market risk exposures, the Company has segregated a portion of its fixed
maturities as available for sale. Also, the Company does not maintain a trading
portfolio.
2001 was characterized by significant changes in the Company's
investment portfolio. These changes were the result of the financial market
environment as well as the Pooled Subsidiaries assumption through the Pooling
Arrangement of the former Meridian Mutual business on July 1, 2001 and the
October 1, 2001 change in the Pooled Subsidiaries pooling participation
percentages. The impact to the Company from the assumption of the Meridian
Mutual business as well as the October 1, 2001 pooling participation percentage
change, resulted in additional assets of $354 million, comprised primarily of
fixed maturity investments, being transferred to the Pooled Subsidiaries. These
transfers of assets are primarily responsible for the 51.1% increase in the
Company's investable assets at December 31, 2001 ($1,168.7 million in 2001
versus $772.2 million in 2000).
The equity markets declined in 2001, the first time since the 1973/1974
bear market in which the market declined two years in a row. For the year, the
Company's equity portfolio holds unrealized gains of $9.5 million at December
31, 2001, down $4.6 million from December 31, 2000.
The fixed maturity portfolio was impacted by the asset transfers
discussed above. While the interest rate environment did not change
significantly from 2000, the market did weaken a bit near the end
Page 45
of the year resulting in the Company experiencing a decline of $8.1 million in
its unrealized gains on its available for sale fixed maturity portfolio at
December 31, 2001.
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 asset backed securities. The table also presents the average
interest rate for each period presented.
PRINCIPAL AMOUNT MATURING IN:
(Dollars in thousands)
2002 2003 2004 2005 2006 Thereafter Total Fair Value
---- ---- ---- ---- ---- ---------- ----- ----------
Fixed interest
rate securities $ 55,498 17,428 24,334 31,913 46,135 866,916 1,042,224 $1,080,077
Average
Interest rate 5.2% 6.5% 5.5% 5.3% 5.8% 5.8% 5.8%
NEW ACCOUNTING STANDARDS
In June 2001, the Financial Accounting Standards Board issued
Statements of Financial Accounting Standards No. 141, Business Combinations, and
No. 142, Goodwill and Other Intangible Assets, effective for fiscal years
beginning after December 15, 2001. Under the new rules, goodwill will no longer
be amortized but will be subject to impairment tests in accordance with the
statements. Other intangible assets will continue to be amortized over their
useful lives. The Company will apply the new rules beginning in the first
quarter of 2002. The Company has determined that the adoption of the statements
will not have a material impact on the Company's financial position and results
of operations.
IMPACT OF SIGNIFICANT EXTERNAL FACTORS
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 relatively modest over the last several
years thereby allowing a better opportunity for 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.
The Company is also affected by court decisions. Premiums 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 Company
may also be adversely affected by regulatory actions on matters within the
jurisdiction of the various insurance departments where the Company does
business or has entities domiciled.
Page 46
The Company is not aware of any adverse legislation or regulation
that was adopted by any state where the Company did business during 2001 which
would present material obstacles to the Company's overall business. Several
states where the Company does business have passed or are considering more
strict regulation of the use credit scoring in rating and/or risk selection in
personal lines of business. This could have an adverse impact on the Company as
it has adopted credit scoring as an underwriting tool. Such regulation would
limit the Company's ability to take advantage of this tool.
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.
- In addition to the acquisition of the Meridian Insurers and
Mutual's merger with Meridian Mutual as discussed above,
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 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;
loss results of the Company acquired may be worse than
expected; 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.
- 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.
- The Company's operations are subject to changes occurring in
the legislative, regulatory and judicial environment. 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 Company, its affiliates, or the
insurance industry generally and judicial decisions affecting
claims, policy coverages and the general costs of doing
business. Many of these changes are beyond the Company's
control.
- 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,
Page 47
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. 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 and laws regulating underwriting "tools". These laws
may adversely affect the ability of the insurers in the State
Auto Group to earn a profit on their underwriting operations.
- The property and casualty insurance industry is highly
competitive. While prices have generally increased in some
lines, price competition continues to be intense. 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 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.
- 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.
Page 48
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, 2001 and 2000 and the
related consolidated statements of income, stockholders' equity and cash flows
for each of the three years in the period ended December 31, 2001. 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 conduct 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, 2001 and 2000,
and the consolidated results of their operations and their cash flows for each
of the three years in the period ended December 31, 2001, in conformity with
accounting principles generally accepted in the United States.
Columbus, Ohio /s/ Ernst & Young, LLP
February 26, 2002
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
CONSOLIDATED BALANCE SHEETS
- -------------------------------------------------------------------------------------------------------------------------
DECEMBER 31
2001 2000
---- ----
(dollars in thousands,
Assets except share data)
Fixed maturities:
Held to maturity, at amortized cost (fair value $28,672 and $40,225,
respectively)............................................................... $ 27,406 39,307
Available for sale, at fair value (amortized cost $1,042,539 and $636,302,
respectively)............................................................... 1,051,405 653,251
Equity securities, available for sale, at fair value (cost $50,361 and $44,220,
respectively)............................................................... 59,845 58,312
----------- -----------
Total investments................................................................ 1,138,656 750,870
Cash and cash equivalents........................................................ 30,016 21,305
Deferred policy acquisition costs................................................ 67,087 32,458
Accrued investment income and other assets....................................... 38,908 19,795
Due from affiliate............................................................... -- 1,405
Net prepaid pension expense...................................................... 43,344 37,738
Reinsurance recoverable on losses and loss expenses payable...................... 13,919 7,930
Prepaid reinsurance premiums..................................................... 4,955 11,575
Federal income taxes:
Current....................................................................... 1,549 --
Deferred...................................................................... 13,800 --
Property and equipment, at cost, net of accumulated depreciation of $3,351
and $2,785, respectively...................................................... 13,250 12,760
Goodwill......................................................................... 2,012 2,270
----------- -----------
Total assets..................................................................... $ 1,367,496 898,106
=========== ===========
Liabilities and Stockholders' Equity
Losses and loss expenses payable................................................. $ 523,860 244,583
Unearned premiums................................................................ 329,495 160,387
Note payable to affiliate........................................................ 45,500 45,500
Postretirement benefit liabilities............................................... 57,237 55,841
Federal income taxes:
Current....................................................................... -- 2,903
Deferred...................................................................... -- 1,490
Other liabilities................................................................ 5,059 1,343
Due to affiliates................................................................ 6,152 --
----------- -----------
Total liabilities................................................................ 967,303 512,047
----------- -----------
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; 43,045,320
and 42,625,723 shares issued, respectively, at stated value of $2.50
per share................................................................... 107,613 106,564
Less 4,108,230 and 4,071,012 treasury shares, respectively, at cost........... (47,613) (47,038)
Additional paid-in capital.................................................... 47,106 44,208
Accumulated other comprehensive income........................................ 12,030 20,317
Retained earnings............................................................. 281,057 262,008
----------- -----------
Total stockholders' equity....................................................... 400,193 386,059
----------- -----------
Total liabilities and stockholders' equity....................................... $ 1,367,496 898,106
=========== ===========
See accompanying notes to consolidated financial statements.
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
CONSOLIDATED STATEMENTS OF INCOME
- -----------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31
------------------------------
2001 2000 1999
---- ---- ----
(dollars in thousands,
except per share amount)
Earned premiums................................................. $ 555,207 397,967 392,058
Net investment income........................................... 47,375 38,915 34,262
Management services income from affiliates...................... 15,586 17,594 8,727
Net realized gains on investments............................... 1,962 5,255 2,555
Other income (includes $1,450, $1,546 and $1,676, respectively,
from affiliates)............................................. 3,142 3,043 3,269
--------- ------- -------
Total revenues.................................................. 623,272 462,774 440,871
--------- ------- -------
Losses and loss expenses........................................ 427,074 272,167 264,628
Acquisition and operating expenses.............................. 167,207 119,569 111,772
Interest expense to affiliate................................... 2,275 2,730 955
Other expenses.................................................. 8,740 6,864 6,531
--------- ------- -------
Total expenses.................................................. 605,296 401,330 383,886
--------- ------- -------
Income before federal income taxes.............................. 17,976 61,444 56,985
--------- ------- -------
Federal income tax expense (benefit):
Current...................................................... 7,699 14,408 12,136
Deferred..................................................... (10,338) (678) 2,033
--------- ------- -------
Total federal income taxes...................................... (2,639) 13,730 14,169
--------- ------- -------
Net income...................................................... $ 20,615 47,714 42,816
========= ======= =======
Earnings per common share:
Basic........................................................ $ 0.53 1.24 1.05
========= ======= =======
Diluted...................................................... $ 0.52 1.21 1.03
========= ======= =======
Dividends paid per common share................................. $ 0.13 0.12 0.11
========= ======= =======
See accompanying notes to consolidated financial statements
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, 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
====== ======== ======== ======== ======= ======= ======== ========
Net income 20,615 20,615
Unrealized losses, net of tax
and reclassification
adjustment (8,287) (8,287)
--------
Comprehensive income 12,328
--------
Issuance of common stock 419 1,049 1,604 2,653
Tax benefit from stock
options exercised 1,140 1,140
Treasury shares acquired on
stock option exercises 12 (187) (187)
Treasury shares acquired
under repurchase program 25 (388) (388)
Stock options granted 154 154
Cash dividends paid (1,566) (1,566)
------ -------- -------- -------- ------- ------- -------- --------
BALANCE-DECEMBER 31, 2001 43,045 $107,613 4,108 $(47,613) $47,106 $12,030 $281,057 $400,193
====== ======== ======== ======== ======= ======= ======== ========
See accompanying notes to consolidated financial statements.
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
-----------------------------------
2001 2000 1999
---- ---- ----
(in thousands)
Cash flows from operating activities:
Net income.................................................................... $ 20,615 47,714 42,816
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization, net.......................................... 3,036 3,548 3,257
Net realized gains on investments........................................... (1,962) (5,255) (2,555)
Changes in operating assets and liabilities:
Deferred policy acquisition costs......................................... (4,735) (1,756) (2,159)
Accrued investment income and other assets................................ (16,671) (2,480) 1,218
Net prepaid pension expense............................................... (5,606) (4,168) (2,116)
Postretirement benefit liabilities........................................ 1,396 3,746 654
Reinsurance recoverable on losses and loss
expenses payable and prepaid reinsurance premiums....................... (7,943) (763) (4,721)
Other liabilities and due to/from affiliates, net......................... 11,273 (7,106) 2,900
Losses and loss expenses payable.......................................... 47,693 (440) (7,099)
Unearned premiums......................................................... 21,919 6,817 4,031
Federal income taxes...................................................... (14,139) 1,093 1,290
Cash provided from adding the former Meridian Mutual Insurance
Company business to the reinsurance pool, effective 7/1/01................. 6,380 -- --
Cash provided from the change in the reinsurance pool
participation percentage 10/1/01, 1/1/00 and 1/1/99, respectively......... 2,197 18,617 11,419
Cash provided from transfer of employees, effective 1/1/00.................... -- 28,098 --
--------- ------ ------
Net cash provided by operating activities........................................ 63,453 87,665 48,935
--------- ------ ------
Cash flows from investing activities:
Purchase of fixed maturities - available for sale............................. (246,269) (187,724) (207,768)
Purchase of equity securities................................................. (16,437) (15,783) (25,567)
Maturities, calls and principal reductions of fixed maturities - held
to maturity................................................................. 11,612 4,600 11,776
Maturities, calls and principal reductions of fixed maturities - available
for sale.................................................................... 38,552 22,355 25,516
Sale of fixed maturities - available for sale................................. 149,043 71,530 113,671
Sale of equity securities..................................................... 9,301 16,158 17,369
Net cash acquired on acquisition of Farmers Casualty Insurance Company........ -- -- 11,568
Net additions of property and equipment....................................... (1,056) (2,066) (3,459)
--------- ------ ------
Net cash used in investing activities............................................ (55,254) (90,930) (56,894)
--------- ------ ------
Cash flows from financing activities:
Net proceeds from issuance of debt to affiliate............................... -- -- 45,500
Net proceeds from issuance of common stock.................................... 2,466 1,708 1,928
Payments to acquire treasury shares........................................... (388) (301) (46,199)
Payment of dividends.......................................................... (1,566) (1,397) (1,315)
--------- ------ ------
Net cash provided by (used in) financing activities.............................. 512 10 (86)
--------- ------ ------
Net increase (decrease) in cash and cash equivalents............................. 8,711 (3,255) (8,045)
--------- ------ ------
Cash and cash equivalents at beginning of year................................... 21,305 24,560 32,605
--------- ------ ------
Cash and cash equivalents at end of year......................................... $ 30,016 21,305 24,560
========= ====== ======
See accompanying notes to consolidated financial statements.
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.
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.
State Auto Financial, an Ohio corporation, is a majority-owned subsidiary
of State Automobile Mutual Insurance Company (Mutual), an Ohio corporation.
State Auto Financial and subsidiaries are referred to herein as "the Companies"
or "the Company." All significant intercompany 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 central 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 (SAICand
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, effectiveJanuary 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 pension and
postretirement 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 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,
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
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.
(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
---------------------------
2001 2000 1999
---- ---- ----
(dollars in thousands)
Balance, beginning of
year.................. $ 32,458 28,936 24,799
Acquisition costs
deferred.............. 143,651 101,305 96,578
Amortized to expense
during the year....... 109,022 97,783 92,441
--------- ------ ------
Balance, end
of year............... $ 67,087 32,458 28,936
========= ====== ======
(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. The Company
regularly reviews its investments based on current economic conditions, credit
loss experience and other factors. If there is a decline in an investment's fair
value that is determined to be other than temporary, it is treated as a realized
loss and the cost basis of the investment is reduced to its estimated fair
value.
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(f) 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 $1,863,657 and $1,605,000 at December
31, 2001 and 2000, respectively. See related goodwill discussion at note 1(n).
(g) 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 $26,216,000 and $13,403,000 at December 31, 2001 and 2000,
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. As such, losses and loss expenses payable
represent management's best estimate of the ultimate liability related to
reported and unreported claims.
(h) PREMIUM REVENUES
Premiums are recognized as earned using the monthly pro rata method over
the contract period.
(i) MANAGEMENT SERVICES INCOME
Management services income includes income for management and operations
services provided by State Auto P&C in 2001 and 2000 and executive insurance
management services provided in 1999 and income for investment management
services provided by Stateco. See note 6(d) regarding the Company's resolution
of its disagreement with the Ohio Department of Insurance (ODI) regarding its
recognition of management and operations service fee revenue paid by Mutual in
2001. Management and operations services income in 2001 and 2000, 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 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.
(j) 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 $186,000 and
$626,000 are included in accrued investment income and other assets at December
31, 2001 and 2000, respectively. Software amortization, included in other
expenses, was $440,000, $622,000 and $614,000 in 2001, 2000 and 1999,
respectively.
(k) 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.
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 and liabilities and are
measured using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse.
(l) CASH EQUIVALENTS
TheCompany considers all highly liquid debt instruments with a maturity of
three months or less to be cash equivalents.
(m) OTHER COMPREHENSIVE INCOME
Comprehensive income is defined as all changes in an enterprise's equity
during a period other than those
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
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 represents 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.
(n) NEW ACCOUNTING STANDARDS
In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 141, Business Combinations, and No. 142,
Goodwilll and Other Intangible Assets, effective for fiscal years beginning
after December 15, 2001. Under the new rules, goodwill will no longer be
amortized but will be subject to impairment tests in accordance with the
statements. Other intangible assets will continue to be amortized over their
useful lives. The Company will apply the new rules beginning in the first
quarter of 2002. The Company has determined that the adoption of the statements
will not have a material impact on the Company's financial position and results
of operations.
(2) INVESTMENTS
Realized and unrealized gains and losses are summarized as follows:
YEAR ENDED DECEMBER 31
---------------------------
2001 2000 1999
---- ---- ----
(in thousands)
Realized gains:
Fixed maturities available for sale................................... $ 3,072 791 1,336
Equity securities..................................................... 2,258 5,959 3,642
------- ------- -------
Total realized gains..................................................... 5,330 6,750 4,978
------- ------- -------
Realized losses:
Fixed maturities available for sale................................... 114 827 488
Equity securities..................................................... 3,254 668 1,896
Other................................................................. -- -- 39
------- ------- -------
Total realized losses.................................................... 3,368 1,495 2,423
------- ------- -------
Net realized gains on investments........................................ $ 1,962 5,255 2,555
======== ======= =======
Increase (decrease) in unrealized holding gains-- Equity securities...... $(4,608) (2,123) 3,252
Increase (decrease) in unrealized holding gains-- Fixed
maturities available for sale at fair value........................... (8,134) 33,195 (34,081)
Change in deferred unrealized gain....................................... (7) (55) (125)
Deferred federal income taxes thereon.................................... 4,462 (10,856) 10,834
------- ------- -------
Increase (decrease) in net unrealized holding gains or losses............ $(8,287) 20,161 (20,120)
======== ======= =======
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, 2001: COST HOLDING GAINS HOLDING LOSSES VALUE
---- ------------- -------------- -----
(in thousands)
U.S. Treasury securities and obligations of U.S.
government corporations and agencies.................... $ 2,015 73 -- 2,088
Obligations of states and political subdivisions........... 7,011 403 -- 7,414
Mortgage-backed securities: U.S. government agencies....... 18,380 790 -- 19,170
---------- -------- -------- ---------
Total...................................................... $ 27,406 1,266 -- 28,672
========== ======== ======== =========
AVAILABLE FOR SALE AT DECEMBER 31, 2001:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies.................... $ 60,623 2,051 286 62,388
Obligations of states and political subdivisions........... 831,865 12,799 9,014 835,650
Corporate securities....................................... 110,549 3,050 789 112,810
Mortgage-backed securities: U.S. government agencies....... 30,777 938 20 31,695
Mortgage-backed securities: Corporate...................... 8,725 139 2 8,862
---------- -------- -------- ---------
Total fixed maturities.................................. 1,042,539 18,977 10,111 1,051,405
Equity securities.......................................... 50,361 13,794 4,310 59,845
---------- -------- -------- ---------
Total...................................................... $1,092,900 32,771 14,421 1,111,250
========== ======== ======== =========
COST OR GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
HELD TO MATURITY AT DECEMBER 31, 2000: COST HOLDING GAINS HOLDING LOSSES VALUE
---- ------------- -------------- -----
(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: U.S. government agencies....... 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
========== ======== ======== =========
Deferred federal income taxes on the net unrealized holding gain for available
for sale investments was $6,478,000 and $10,940,000 at December 31, 2001 and
2000, respectively.
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, 2001, by contractual maturity,
are summarized as follows:
HELD TO MATURITY AVAILABLE FOR SALE
---------------- ------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
---- ----- ---- -----
(in thousands)
Due after 1 year or less.......................... $ 1,503 1,542 4,730 4,774
Due after 1 year through 5 years.................. 512 546 59,972 62,180
Due after 5 years through 10 years................ 7,011 7,414 187,667 191,815
Due after 10 years................................ -- -- 750,668 752,079
------- ------ --------- ---------
9,026 9,502 1,003,037 1,010,848
Mortgage-backed securities........................ 18,380 19,170 39,502 40,557
------- ------ --------- ---------
$27,406 28,672 1,042,539 1,051,405
======= ====== ========= =========
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 $27,666,000 and
$21,633,000 were on deposit with regulators as required by law or specific
escrow agreement at December 31, 2001 and 2000, respectively.
Components of net investment income are summarized as follows:
YEAR ENDED DECEMBER 31
-------------------------------------
2001 2000 1999
---- ---- ----
(in thousands)
Fixed maturities..................... $41,262 36,568 32,096
Equity securities...................... 996 848 678
Cash and cash equivalents.............. 5,756 1,926 1,707
----- ----- -----
Investment income.................... 48,014 39,342 34,481
------ ------ ------
Investment expenses.................. 639 427 219
----- ----- -----
Net investment income................ $47,375 38,915 34,262
======= ====== ======
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.
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
----------------------------------
2001 2000 1999
---- ---- ----
(in thousands)
Losses and loss expenses payable, net of reinsurance recoverables,
at beginning of year......................................................... $ 236,653 221,682 205,034
Incurred related to:
Current year................................................................. 366,348 277,805 271,507
Prior years.................................................................. 60,726 (5,638) (6,878)
--------- ------- -------
Total incurred.................................................................. 427,074 272,167 264,629
--------- ------- -------
Paid related to:
Current year................................................................. 240,508 164,620 168,512
Prior years.................................................................. 144,862 104,871 100,349
--------- ------- -------
Total paid...................................................................... 385,370 269,491 268,861
--------- ------- -------
Impact of adding the former Meridian Mutual Insurance Company to the
Pooling Arrangement, effective July 1, 2001 (note 6)......................... 75,575 -- --
--------- ------- -------
Impact of pooling change, October 1, 2001, January 1, 2000 and 1999,
respectively (note 6)....................................................... 156,009 12,295 7,633
--------- ------- -------
Impact of acquisition of Farmers Casualty and Mid-Plains,
January 1, 1999 (note 1(a)).................................................. -- -- 13,247
--------- ------- -------
Losses and loss expenses payable, net of reinsurance recoverables,
at end of year............................................................... $ 509,941 236,653 221,682
========= ======= =======
Losses and loss expenses incurred increased by $60,726,000 in 2001, and
decreased by $5,638,000 in 2000 and $6,878,000 in 1999, respectively, for claims
that had occurred in prior years. The increase of $60,726,000 in 2001, for
claims occurring in prior years, is the result of reserve strengthening that
occurred on the former Meridian Mutual Insurance Company (Meridian Mututal)
business in order to bring these claim reserves in line with historic State Auto
adequacy levels as well as the result of ongoing analysis of recent loss
development trends. See note 6(a) regarding discussion of the Meridian Mutual
business assumed by the Pooled Subsidiaries. The change in the incurred losses
related to prior years over the two year period ending December 31, 2000 has
resulted primarily from 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.
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
-----------
2001 2000
---- ----
(in thousands)
Losses and loss expenses payable:
Direct.......................................................... $ 240,012 229,422
Assumed......................................................... 3,837 5,035
Ceded........................................................... (7,742) (7,930)
-------- -------
Net losses and loss expenses payable......................... $236,107 226,527
======== =======
Unearned premiums:
Direct.......................................................... $ 189,800 159,173
Assumed......................................................... 1,107 1,214
Ceded .......................................................... (4,955) (3,131)
-------- -------
Net unearned premiums........................................ $ 185,952 157,256
======== =======
YEAR ENDED DECEMBER 31
----------------------
2001 2000 1999
---- ---- ----
(in thousands)
Written premiums:
Direct............................................ $ 501,250 439,623 436,150
Assumed........................................... 4,196 4,678 8,281
Ceded............................................. (15,447) (10,905) (11,216)
--------- ------- -------
Net written premiums........................... $ 489,999 433,396 433,215
========= ======= =======
Earned premiums:
Direct............................................ $ 472,766 432,318 429,577
Assumed........................................... 4,304 5,166 10,822
Ceded............................................. (13,623) (10,864) (13,698)
--------- ------- -------
Net earned premiums............................ $ 463,447 426,620 426,701
========= ======= =======
Losses and loss expenses incurred:
Direct............................................ $ 328,363 297,757 289,162
Assumed........................................... 3,054 3,726 10,803
Ceded............................................. (5,549) (2,165) (9,736)
--------- ------- -------
Net losses and loss expenses incurred.......... $ 325,868 299,318 290,229
========= ======= =======
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, SAIC (the Pooled Subsidiaries)
and Midwest Security participate in a quota share reinsurance pooling
arrangement (the Pooling Arrangement) with Mutual whereby the Pooled
Subsidiaries and Midwest Security 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 1998, State Auto P&C, Milbank and Midwest Security have participated
in the Pooling Arrangement with Mutual. 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 from 47% to 50%. In conjunction with this change in pool
participation, the Pooled Subsidiaries received cash from Mutual of $11.4
million, which related to the additional net insurance liabilities assumed by
the Pooled Subsidiaries on January 1, 1999. 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. In 2000, Mutual entered into an agreement with Meridian Mutual
Insurance Company (Meridian Mutual), an Indiana domiciled property and casualty
insurance company, pursuant to which Meridian Mutual would be merged with and
into Mutual, with Mutual continuing as the surviving corporation. The effective
date of the merger transaction was June 1, 2001. With the merging of Meridian
Mutual into Mutual, all insurance business that had been written by Meridian
Mutual became, legally, Mutual business. For the period June 1, 2001 through
June 30, 2001, the insurance business formerly known as the Meridian Mutual
business prior to the June 1 merger transaction was excluded from the Pooling
Arrangement. Effective July 1, 2001, the insurance business of the former
Meridian Mutual became part of the Pooling Arrangement, and the Pooled
Subsidiaries assumed 53% of the former Meridian Mutual business on this same
date. Concurrently, with this transaction, the Pooled Subsidiaries received cash
of $6.4 million and fixed maturities totaling $109.7 million from Mutual which
related to the additional net insurance liabilities assumed by the Pooled
Subsidiaries on July 1, 2001. As part of the resolution of the disagreement with
the ODI regarding the recognition of the service fee revenue paid by Mutual to
State Auto P&C (see note 6(d)), the Pooled Subsidiaries aggregate participation
in the Pooling Arrangement was increased to 80%, effective October 1, 2001. In
conjunction with this change in pool participation, the Pooled Subsidiaries
received cash of $2.2 million and fixed maturities totaling $236.3 million from
Mutual, which related to the additional net insurance liabilities assumed on
October 1, 2001. All parties that participate in the Pooling Arrangement have an
A. M. Best rating of A+ (Superior).
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
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
-----------------------
2001 2000
---- ----
(in thousands)
Losses and loss expenses payable:
Ceded.......................................................... $(219,851) (212,614)
Assumed........................................................ 499,862 222,740
--------- ------
Net assumed.................................................. $ 280,011 10,126
========= ======
Unearned premiums:
Ceded.......................................................... $(172,265) (149,854)
Assumed........................................................ 310,853 141,410
--------- ------
Net assumed (ceded).......................................... $ 138,588 (8,444)
========= ======
YEAR ENDED DECEMBER 31
----------------------
2001 2000 1999
---- ---- ----
(in thousands)
Written premiums:
Ceded............................................ $(448,331) (405,397) (403,679)
Assumed.......................................... 529,253 370,576 356,609
Earned premiums:
Ceded............................................ $(426,880) (399,057) (395,698)
Assumed.......................................... 515,619 367,275 358,700
Losses and loss expenses incurred:
Ceded............................................ $ (298,755) (277,340) (268,536)
Assumed.......................................... 406,138 250,189 242,935
Effective with the June 1, 2001 merger transaction of Meridian Mutual into
Mutual, Mutual also acquired all of the outstanding shares of Meridian Insurance
Group, Inc. (MIGI), an Indiana domiciled insurance holding company. MIGI's
wholly-owned insurance subsidiaries are Meridian Security Insurance Company, an
Indiana domiciled property and casualty insurer, Meridian Citizens Security
Insurance Company, an Indiana domiciled property and casualty insurer, and
Insurance Company of Ohio, an Ohio domiciled property and casualty insurer. MIGI
is also party to an affiliation agreement with Meridian Citizens Mutual
Insurance Company, an Indiana domiciled property and casualty insurer.
Collectively, the MIGIinsurer subsidiaries and affiliates are hereafter
collectively referred to as the "Meridian Insurers".
Mutual, State Auto P&C, Milbank, Midwest Security, Farmers Casualty, SAIC,
National, Mid Plains, and, effective June 1, 2001, the Meridian Insurers, are
participants in a 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,
Mid-Plains and the Meridian Insurers in the amount of $115 million excess of
$120 million. Effective November 2001, the catastrophe reinsurance program was
renegotiated whereby State Auto P&C assumed $100 million excess of $120 million.
Under this agreement, the Company has assumed from Mutual and its affiliate
premiums written and earned of $3,021,000, $3,129,000 and $2,355,000 for
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
2001, 2000 and 1999, 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 2001) up to $100 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 five-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 either purchase the preferred shares from the SPC
or repay the SPC for the loan(s) outstanding.
For the period October 1, 2001 through December 31, 2003, Mutual entered
into a stop loss reinsurance arrangement (Stop Loss) with the Pooled
Subsidiaries. Under the Stop Loss, Mutual has agreed to participate in the
Pooling Arrangement's quarterly underwriting losses and gains in the manner
described. If the Pooling Arrangement's statutory loss and loss adjustment
expense ratio (loss ratio) is between 70.75% and 80% (after the application of
all available reinsurance), Mutual will reinsure the Pooled Subsidiaries 27% of
the Pooling Arrangement's losses in excess of a loss ratio of 70.75% up to
80.00%. The Pooled Subsidiaries would be responsible for their share of the
Pooling Arrangement's losses over the 80% threshold. Also, Mutual will have the
right to participate in the profits of the Pooling Arrangement. Mutual will
assume 27% of the Pooling Arrangement's underwriting profits attributable to
loss ratios less than 69.25%, but more than 59.99%. During 2001, the Pooled
Subsidiaries ceded to Mutual, $6,177,000 under the Stop Loss, which has been
reflected in reinsurance recoverable on losses and loss expenses payable at
December 31, 2001, while no premium was assumed by Mutual under the Stop Loss.
(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 $123 million and $60 million
related to premium balances due to Mutual from agents and insureds at December
31, 2001 and 2000, respectively.
(c) NOTE PAYABLE
In 1999, 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(a). 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
2002 is 4.75% and in 2001 was 5.0%. Interest expense on the loan from Mutual was
$2,275,000, $2,730,000 and $955,000 in 2001, 2000 and 1999, respectively.
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(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 amount to $12,621,000 and $14,654,000 in 2001 and 2000,
respectively. 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 in
1999. Stateco provides Mutual and its affiliate investment management services.
Revenue related to these services amount to $2,965,000, $2,940,000 and
$3,099,000 in 2001, 2000, and 1999, respectively.
During early 2001, the ODI requested that Mutual file an analysis with the
ODI on a quarterly basis, starting with the quarter beginning January 1, 2001,
that justified the apportionment of the management and operation services 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 believed its accounting for such service fee was consistent with all
statutory accounting principles. On October 24, 2001, the board of directors of
the Company and Mutual and special committees thereof approved a resolution of
the disagreement between the Company and the ODI regarding the service fee paid
by Mutual to State Auto P&C. The disagreement with ODI was resolved and ODI
expressly did not take issue with Mutual's payment of the service fee to State
Auto P&C for the nine-month period ending September 30, 2001 which amounted to
$12.5 million, pre-tax, nor with Mutual's accounting for the service fee for
this same time period. The ODI also approved regulatory filings, effective
October 1, 2001, implementing a revised management agreement, changing the
Pooled Subsidiaries pooling participation percentages and implementing a stop
loss reinsurance arrangement. See note 6(a) regarding the change in the Pooled
Subsidiaries pooling participation percentages and the implementation of a stop
loss reinsurance arrangement.
Effective October 1, 2001, the management agreement between State Auto P&C
and certain affiliate companies, including Mutual, was amended to eliminate the
management and operations service fee charged by State Auto P&C. The management
agreement continues to allocate costs and apportion those costs among the
parties to the agreement in accordance with terms outlined therein. As a result
of the loss of the management and operations services income under this
management agreement, substantially all of State Auto P&C's services income has
been eliminated, effective October 1, 2001. See note 14. The management
agreement between State Auto P&C and Midwest Security was not affected by the
disagreement or resolution with the ODI.
(e) OTHER TRANSACTIONS
S.I.S. provides insurance software products and services to Mutual and its
affiliate. Revenue relating to these services amount to $692,000, $900,000 and
$1,109,000 in 2001, 2000 and 1999, respectively, and is included in other
income. 518 PML leases assets to Mutual and its affiliate. Revenue relating to
these services amount to $758,000, $646,000 and $567,000 in 2001, 2000 and 1999,
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, 2001, there has
been no adverse development of the liability.
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(7) FEDERAL INCOME TAXES
A reconciliation between actual federal income taxes (benefit) and the
amount computed at the indicated statutory rate is as follows:
YEAR ENDED DECEMBER 31
----------------------
2001 2000 1999
AMOUNT % AMOUNT % AMOUNT %
------ - ------ - ------ -
(in thousands)
Amount at statutory rate................................ $ 6,291 35 21,505 35 19,947 35
Tax-free interest and dividends received deduction...... (8,925) (50) (7,918) (13) (6,315) (11)
Other, net.............................................. (5) -- 143 -- 537 1
--------- --- ------ -- ------ --
Effective tax rate...................................... $ (2,639) (15) 13,730 22 14,169 25
========= === ====== == ====== ==
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
2001 2000
---- ----
(in thousands)
Deferred tax assets:
Unearned premiums not deductible.............................. $ 22,847 10,385
Losses and loss expenses payable discounting.................. 19,767 9,219
Postretirement benefit liabilities............................ 13,746 13,035
Other......................................................... 1,982 2,110
Alternative minimum tax credit................................ 1,410 --
-------- ------
Total deferred tax assets................................. 59,752 34,749
-------- ------
Deferred tax liabilities:
Deferral of policy acquisition costs.......................... 23,481 11,360
Net pension expense........................................... 13,993 12,628
Unrealized holding gain on investments........................ 6,478 10,940
Other......................................................... 2,000 1,311
-------- ------
Total deferred tax liabilities............................ 45,952 36,239
-------- ------
Net deferred tax assets (liabilities)..................... $ 13,800 (1,490)
======== ======
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 2001, 2000 and 1999 were $11,500,000,
$12,638,000 and $12,621,000, 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
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
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.
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
-----------
2001 2000
---- ----
(in thousands)
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of year....................................................... $ 87,093 44,016
Transfer in benefit obligation at beginning of year due to employee transfer.................. -- 39,586
Service cost.................................................................................. 3,537 3,339
Interest cost................................................................................. 6,750 6,728
Changes in plan provisions.................................................................... -- 1,205
Actuarial (gain) loss......................................................................... 9,145 (438)
Benefits paid................................................................................. (9,048) (7,343)
-------- ------
Benefit obligation at end of year............................................................. $ 97,477 87,093
-------- ------
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year................................................ $162,658 84,883
Transfer in plan assets at beginning of year due to employee transfer......................... -- 76,340
Actual return on plan assets.................................................................. (17,413) 8,778
Benefits paid................................................................................. (9,048) (7,343)
-------- ------
Fair value of plan assets at end of year...................................................... $136,197 162,658
-------- ------
Funded status................................................................................. $ 38,720 75,565
Unrecognized transition asset................................................................. (725) (846)
Unrecognized prior service cost............................................................... 2,263 2,470
Unrecognized net (gain) or loss............................................................... 3,086 (39,451)
-------- ------
Net prepaid pension expense................................................................... $ 43,344 37,738
======== ======
YEAR ENDED DECEMBER 31
----------------------
2001 2000 1999
---- ---- ----
(in thousands)
COMPONENTS OF NET PERIODIC BENEFIT
Service cost.................................................................... $ 3,537 3,339 2,047
Interest cost................................................................... 6,750 6,728 3,278
Expected return on plan assets.................................................. (14,633) (13,391) (6,125)
Amortization of prior service cost.............................................. 207 207 114
Amortization of transition asset................................................ (121) (121) (124)
Amortization of net (gain) or loss.............................................. (1,346) (930) 7
------- ------ ----
Net periodic benefit............................................................ $(5,606) (4,168) (803)
======= ====== ====
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
----------------------
2001 2000 1999
---- ---- ----
WEIGHTED-AVERAGE ASSUMPTIONS AS OF DECEMBER 31
Discount rate.................................................................... 7.50% 8.00% 8.00%
Expected long-term rate of return on assets...................................... 9.00% 9.00% 9.00%
Rates of increase in compensation levels......................................... 5.00% 5.00% 5.00%
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 2001 and 2000 net
periodic benefit was $4.0 million and $2.6 million, respectively.
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 $1,120,000, $890,000 and $852,000 for the years 2001,
2000 and 1999, 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.
Information regarding the funded status and net periodic benefit cost for
the Company's participation in the postretirement benefit plan is as follows:
2001 2000
---- ----
(in thousands)
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of year........................................................... $ 42,913 1,481
Transfer in benefit obligation at beginning of year due to employee transfer...................... -- 43,632
Service cost...................................................................................... 1,423 1,242
Interest cost..................................................................................... 3,356 3,205
Actuarial gain.................................................................................... 2,946 (5,247)
Employee contributions............................................................................ (2,080) (1,400)
-------- -----
Benefit obligation at end of year................................................................. $ 48,558 42,913
-------- -----
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year.................................................... $ 1,568 --
Transfer of plan assets at beginning of year due to employee transfer............................. -- 1,479
Expected return on assets......................................................................... 133 126
Gain (loss) on assets............................................................................. 67 (37)
-------- -----
Fair value of plan assets at end of year.......................................................... $ 1,768 1,568
-------- -----
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
DECEMBER 31
2001 2000
---- ----
(in thousands)
Funded status at end of year......................................... $(46,790) (41,345)
Unrecognized transition asset........................................ (38) (41)
Unrecognized gain.................................................... (8,700) (12,099)
-------- -------
Accrued postretirement benefit obligation at end of year............. $(55,528) (53,485)
======== =======
YEAR ENDED DECEMBER 31
2001 2000
---- ----
(in thousands)
COMPONENTS OF NET PERIODIC BENEFIT COST
Service cost......................................................... $ 1,423 1,242
Interest cost........................................................ 3,356 3,205
Expected return on assets............................................ (133) (126)
Amortization of unrecognized amounts................................. (523) (495)
-------- -----
Net periodic benefit cost............................................ $ 4,123 3,826
======== =====
An 8.0% weighted average discount rate was used for 2001 and 2000 to
determine the accumulated postretirement benefit obligation. An 8.5% weighted
average rate was used for 2001 and 2000 to determine the long-term rate of
return on plan assets.
Effective January 1, 2000, the postretirement benefit liability is carried
on the financial statements of the Company and the net periodic benefit cost is
allocated to affiliated companies based on allocations pursuant to intercompany
management agreements. The Company's share of the 2001 and 2000 net periodic
cost was $3.0 million and $2.6 million, respectively.
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 $7,464,000 and would increase the medical service
and interest cost by approximately $1,156,000.
The Company also has a supplemental executive retirement plan for which the
accrued obligation at December 31, 2001 and 2000 was $1,709,000 and $2,356,000,
respectively.
(9) STOCKHOLDERS' EQUITY
(a) 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 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. 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, 2001, State Auto Financial
repurchased 50,522 shares from the public. Repurchases during 2000 and 2001 were
funded through dividends from subidiaries.
On March 1, 2002, the State Auto Financial's Board of Directors approved a
plan to repurchase up to 1.0 million shares of common stock from the public over
a period extending to and through December 31, 2003.
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(b) DIVIDEND RESTRICTIONS AND STATUTORY FINANCIAL INFORMATION
State Auto P&C, Milbank, Farmers Casualty, SAIC and Nationalare subject to
regulations and restrictions under which payment of dividends from statutory
earned surplus can be made to State Auto Financial during the year without prior
approval of regulatory authorities. Pursuant to these rules, approximately $25.1
million is available for payment to State Auto Financial in 2002 without prior
approval.
Reconciliations of statutory capital and surplus and net income (loss), as
determined using statutory accounting practices, to the amounts included in the
accompanying consolidated financial statements are as follows:
DECEMBER 31
-----------
2001 2000
---- ----
(in thousands)
Statutory capital and surplus of insurance subsidiaries....................................... $ 317,983 325,532
Net assets of noninsurance parent and affiliates.............................................. (21,033) (25,744)
--------- -------
296,950 299,788
Increases (decreases):
Deferred policy acquisition costs.......................................................... 67,087 32,458
Losses and loss expenses payable........................................................... 26,216 13,403
Net prepaid pension expense................................................................ 43,344 37,738
Postretirement benefit liability........................................................... (19,708) (18,478)
Deferred federal income taxes.............................................................. (25,347) (1,854)
Excess of statutory loss liabilities over case basis amounts............................... -- 2,567
Fixed maturities at fair value............................................................. 8,979 17,250
Goodwill................................................................................... 2,012 2,270
Other, net................................................................................. 660 917
--------- -------
Stockholders' equity per accompanying consolidated
financial statements................................................................... $ 400,193 386,059
========= =======
YEAR ENDED DECEMBER 31
----------------------
2001 2000 1999
---- ---- ----
(in thousands)
Statutory net income (loss) of insurance subsidiaries........................ $ (39,773) 43,991 36,601
Net income of noninsurance parent and affiliates............................. 1,826 1,125 2,944
--------- ------ ------
(37,947) 45,116 39,545
Increases (decreases):
Deferred policy acquisition costs......................................... 34,629 3,522 3,407
Losses and loss expenses payable.......................................... 12,813 (103) 15
Net prepaid pension expense............................................... 1,131 640 2,578
Postretirement benefit expense............................................ (1,230) (1,150) --
Deferred federal income taxes............................................. 10,673 401 (2,265)
Goodwill amortization..................................................... (258) (258) (258)
Other, net................................................................ 804 (454) (206)
--------- ------ ------
Net income per accompanying consolidated
financial statements................................................... $ 20,615 47,714 42,816
========= ====== ======
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
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 changed, to some extent, prescribed statutory
insurance accounting practices and resulted 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 was reported as an adjustment to statutory surplus as of
January 1, 2001. The adoption of Codification, as of January 1, 2001, increased
statutory surplus of the insurance subsidiaries of State Auto Financial by
approximately $19.3 million.
(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 2001, 2000 and
1999 were $14,000, $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:
2001 2000 1999
---- ---- ----
(in thousands, except
per share figures)
Pro forma net earnings................................................................. $ 18,865 45,784 41,414
Pro forma net earnings per common share
Basic............................................................................. $ 0.49 1.19 1.02
Diluted........................................................................... $ 0.48 1.17 1.00
The fair value of options granted in 2001, 2000 and 1999 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:
2001 2000 1999
---- ---- ----
Fair value................................................................ $ 6.79 4.66 4.49
Dividend yield............................................................ .90% .90% .90%
Risk free interest rate................................................... 4.85% 6.51% 5.77%
Expected volatility factor................................................ .36 .34 .32
Expected life (years)..................................................... 6.7 7.2 5.7
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
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.
In May 2000, the Company's 1991 Stock Option Plan and 1991 Directors' Stock
Option Plan were replaced with the 2000 Stock Option Plan (Key Employee Plan)
and the 2000 Directors Stock Option Plan (Nonemployee Director Plan),
respectively, upon approval of shareholders at the 2000 annual meeting of
shareholders. 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
close of business on the date of 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 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, these options are
exercisable from 1 to 10 years from date of grant.
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, 2001, 1,803,000 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 2001, 2000 and 1999, respectively, were as follows: fair value
of $8.04, $10.91 and $4.02; dividend yield of .90% for all years; expected
volatility factor of .34, .32 and .30; risk-free interest rate of 5.16%, 5.19%
and 6.80%; and expected life of the option of 8.7, 9.0 and 9.7 years. Expense of
$140,000, $493,000 and $105,000 associated with this plan was recognized in
2001, 2000 and 1999, respectively.
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
A summary of the Company's stock option activity and related information
for these plans for the years ended December 31, 2001, 2000 and 1999, follows:
2001 2000 1999
---------------------------- ---------------------------- ----------------------------
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 2,852 $8.28 2,546 $7.76 2,272 $ 6.76
Granted 299 16.53 492 10.29 453 11.24
Exercised 315 4.39 (129) 4.32 (165) 3.34
Canceled (39) 10.16 (57) 11.15 (14) 10.52
----- ----- -----
Outstanding, end of year 2,797 8.70 2,852 8.28 2,546 7.76
===== ===== =====
A summary of information pertaining to options outstanding and exercisable as of
December 31, 2001 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 $5.00 521 1.2 $ 4.31 521 $ 4.31
$5.01 - $10.00 883 4.1 6.58 872 6.56
Greater than $10.01 1,393 7.8 13.45 980 12.93
----- -----
2,797 5.4 9.58 2,373 8.70
===== =====
(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
----------------------
2001 2000 1999
---- ---- ----
(in thousands, except per share data)
Numerator:
Net earnings for basic and diluted earnings per common share.............. $ 20,615 47,714 42,816
======== ====== ======
Denominator:
Weighted average shares for basic net earnings
per common share..................................................... 38,775 38,427 40,780
Effect of dilutive stock options.......................................... 906 693 746
-------- ------ ------
Adjusted weighted average shares for
diluted net earnings per common share .............................. 39,681 39,120 41,526
======== ====== ======
Basic net earnings per common share.......................................... $ 0.53 1.24 1.05
======== ====== ======
Diluted net earnings per common share........................................ $ 0.52 1.21 1.03
======== ====== ======
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(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, 2001
----------------------------
BEFORE-TAX TAX (EXPENSE) NET-OF-TAX
AMOUNT OR BENEFIT AMOUNT
------ ---------- ------
(in thousands)
Net unrealized holding losses on securities:
Unrealized holding losses arising during 2001............................. $(10,787) 3,775 (7,012)
Reclassification adjustments for gains realized in net income............. (1,962) 687 (1,275)
Net unrealized holding losses............................................. (12,749) 4,462 (8,287)
-------- ----- ------
Other comprehensive loss..................................................... $(12,749) 4,462 (8,287)
======== ===== ======
YEAR ENDED DECEMBER 31, 2001
----------------------------
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, 2001
----------------------------
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)
======== ====== ======
(14) REPORTABLE SEGMENTS
Prior to 2001 the Company had four reportable segments: standard insurance,
nonstandard insurance, investment management services and management and
operations services (prior to 2000, executive insurance management services).
The reportable segments are business units managed separately because of the
differences in products or service they offer and type of customer they serve.
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 central and eastern
United States, excluding New York, New Jersey, and the New England states,
through the independent insurance agency system.
Effective July 1, 2001, with the Pooled Subsidiaries assumption of the
former Meridian Mutual business through the Pooling Arrangement, as more fully
described in note 6(a), the Company's standard and nonstandard insurance
segments have been segregated into four reportable segments. While these
segments offer similar products and services and operate in the same
geographical locations within the United States, they differ within their
operating measures, more specifically within their loss and profitability
results. Consequently, the Company has defined the two insurance segments that
existed
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
prior to 2001 to be State Auto standard insurance and State Auto nonstandard
insurance and the former Meridian Mutual business assumed through the Pooling
Arrangement by the Pooled Subsidiaries to be Meridian standard insurance and
Meridian nonstandard insurance. Monitoring the performance of the Meridian
segments allows management to review the results of its integration efforts of
these segments while this business continues to be processed through the
Meridian systems platform. As this business begins to migrate through new and
renewal policy issuance on the State Auto systems platform where State Auto
policies, pricing and underwriting philosophies are fully integrated, it is
anticipated that the Meridian segments will decrease.
The investment management services segment manages the investment
portfolios of affiliated insurance companies. The management and operations
services segment provided employee services and managed the day-to-day
operations of all affiliated Companies. As a result of the loss of the
management and operations services income as described in note 6(d), the
management and operations service segment will be included in the all other
category for segment reporting beginning in the first quarter of 2002 as the
results for this segment will no longer meet the quantitative thresholds for
separate presentation as a reportable segment.
The Company evaluates performance of its reportable segments and allocates
resources thereon 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 monitors its assets for the insurance segments
on a legal entity basis, which for the Pooled Subsidiaries includes assets of
three of the four reportable insurance segments (State Auto standard insurance,
Meridian standard insurance and Meridian nonstandard insurance). 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.
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:
YEAR ENDED DECEMBER 31
----------------------
2001 2000 1999
---- ---- ----
(in thousands)
REVENUES FROM EXTERNAL CUSTOMERS:
State Auto standard insurance............................................... $ 485,059 406,602 392,557
State Auto nonstandard insurance............................................ 37,536 29,595 32,973
Meridian standard insurance................................................. 72,825 -- --
Meridian nonstandard insurance.............................................. 6,501 -- --
Investment management services.............................................. 3,466 3,360 3,371
Management and operations services.......................................... 12,621 14,654 5,628
All other................................................................... 3,152 3,227 3,537
--------- ------- -------
Total revenues from external customers......................................... 621,160 457,438 438,066
Intersegment revenues:
State Auto standard insurance............................................... 128 162 120
Investment management services.............................................. 3,553 2,884 2,575
Management and operations services.......................................... 3,706 4,303 1,451
All other................................................................... 1,800 1,744 1,676
--------- ------- -------
Total intersegment revenues.................................................... 9,187 9,093 5,822
--------- ------- -------
Total revenue.................................................................. 630,347 466,531 441,578
--------- ------- -------
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
----------------------
2001 2000 1999
---- ---- ----
(in thousands)
Reconciling items:
Intersegment revenues....................................................... (9,187) (9,093) (5,822)
Corporate revenues.......................................................... 150 81 250
Net realized gains on investment............................................ 1,962 5,255 2,555
--------- ------- -------
Total consolidated revenues.................................................... $ 623,272 462,774 440,871
========= ======= =======
SEGMENT PROFIT (LOSS):
State Auto standard insurance............................................... $ 45,664 35,579 41,146
State Auto nonstandard insurance............................................ 1,378 (116) 1,647
Meridian standard insurance................................................. (44,397) -- --
Meridian nonstandard insurance.............................................. (5,933) -- --
Investment management services.............................................. 5,965 5,354 5,191
Management and operations services.......................................... 15,322 17,552 6,330
All other................................................................... 1,004 905 1,238
--------- ------- -------
Total segment profit........................................................ 19,003 59,274 55,552
Reconciling items:
Corporate expenses.......................................................... (2,989) (3,085) (1,122)
Net realized gains on investments........................................... 1,962 5,255 2,555
--------- ------- -------
Total consolidated income before federal income taxes.......................... $ 17,976 61,444 56,985
========= ======= =======
NET INVESTMENT INCOME:
State Auto standard insurance............................................. $ 37,230 33,436 29,060
State Auto nonstandard insurance.......................................... 1,997 1,899 1,839
Meridian standard insurance............................................... 3,595 -- --
Meridian nonstandard insurance............................................ 338 -- --
Investment management services............................................ 318 360 272
All other................................................................. 193 244 268
--------- ------- -------
Total net investment income.................................................. 43,671 35,939 31,439
Reconciling items:
Corporate net investment income........................................... 150 81 249
Reclassification adjustments in consolidation............................. 3,554 2,895 2,574
--------- ------- -------
Total consolidated net investment income..................................... $ 47,375 38,915 34,262
========= ======= =======
DECEMBER 31
-----------
2001 2000
---- ----
(in thousands)
SEGMENT ASSETS:
Pooled Subsidiaries......................................................................... $1,261,689 850,080
State Auto nonstandard insurance............................................................ 67,043 48,811
Investment management services.............................................................. 8,698 6,879
All other................................................................................... 15,685 15,543
---------- -------
Total segment assets........................................................................ 1,353,115 921,313
Reconciling items:
Corporate assets............................................................................ 3,559 1,150
Reclassification adjustments in consolidation............................................... 10,822 (24,357)
---------- -------
Total consolidated assets...................................................................... $1,367,496 898,106
========== =======
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:
YEAR ENDED DECEMBER 31
----------------------
2001 2000 1999
---- ---- ----
(in thousands)
Earned premiums State Auto standard insurance:
Automobile................................................................... $237,401 203,967 204,155
Homeowners and farmowners.................................................... 77,105 67,247 63,666
Commercial multi-peril....................................................... 31,215 25,349 23,902
Workers' compensation........................................................ 15,365 10,628 10,764
Fire and allied.............................................................. 36,031 27,848 25,763
Other and products liability................................................. 21,875 21,924 20,052
Other lines.................................................................. 25,304 13,603 12,873
-------- ------- -------
Total State Auto standard insurance earned premiums............................. 444,296 370,566 361,175
Total State Auto nonstandard insurance earned premiums.......................... 35,256 27,401 30,883
-------- ------- -------
Meridian standard insurance:
Automobile................................................................... 36,402 -- --
Homeowners and farmowners.................................................... 9,536 -- --
Commercial multi-peril....................................................... 11,381 -- --
Workers' compensation........................................................ 8,660 -- --
Fire and allied.............................................................. 499 -- --
Other and products liability................................................. 519 -- --
Other lines.................................................................. 2,157 -- --
-------- ------- -------
Total Meridian standard insurance earned premiums............................... 69,154 -- --
Total Meridian nonstandard insurance earned premiums............................ 6,501 -- --
-------- ------- -------
Total earned permiums........................................................... 555,207 397,967 392,058
Investment management services.................................................. 2,965 2,940 3,099
Management and operations services.............................................. 12,621 14,654 4,908
Net investment income........................................................... 47,225 38,834 34,012
Other income.................................................................... 3,142 3,043 3,989
-------- ------- -------
Total revenues from external customers.......................................... $621,160 457,438 438,066
======== ======= =======
The standard insurance segments and the Meridian nonstandard insurance segment
participate in a reinsurance pooling agreement with other standard and
nonstandard insurance affiliates. For discussion regarding this arrangement and
these segments' 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.
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(15) QUARTERLY FINANCIAL DATA (UNAUDITED)
2001
----
FOR THREE MONTHS ENDED
----------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
--------- -------- ------------- ------------
(dollars in thousands, except per share amounts)
Total revenues............................................ $ 118,001 123,032 156,671 225,568
Income (loss) before federal income taxes................. 19,199 12,028 8,029 (21,280)
Net income (loss) ........................................ 14,540 9,433 7,276 (10,634)
Net earnings (loss) per common share (note 9a):
Basic................................................ 0.37 0.24 0.19 (0.27)
Diluted.............................................. 0.36 0.24 0.18 (0.27)
========= ======= ======= =======
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 income ............................................... 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
========= ======= ======= =======
(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
regulatory actions and 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 decicions are not expected to be material to the consolidated financial
statements.
Page 49
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, 2001, 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, 2001, 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, 2001, 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, 2001, 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, 2001 and 2000
Consolidated Statements of Income for
each of the three years in the
period ended December 31, 2001
Consolidated Statements of Stockholders'
Equity for each of the three years in the
period ended December 31, 2001
Consolidated Statements of Cash Flows
for each of the three years in the
period ended December 31, 2001
Notes to Consolidated Financial Statements
Page 50
(a)(2) LISTING OF FINANCIAL STATEMENT SCHEDULES
The following financial statement schedules of the Company for
the years 2001, 2000, and 1999, 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.
Page 51
(a)(3) LISTING OF EXHIBITS
Exhibit No. Description of Exhibit If incorporated by reference document
- ----------- ---------------------- with which Exhibit was previously filed
3(A)(1) State Auto Financial Corporation's Amended and Restated with SEC 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)* 1991 Stock Option Plan 1933 Act Registration Statement No.
33-40643 on Form S-1 (see Exhibit 10
(h) therein)
10(E)* 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(F)* 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
Page 52
Exhibit No. Description of Exhibit If incorporated by reference document
----------- ---------------------- with which Exhibit was previously filed
10(G) License Agreement between State Automobile Mutual with SEC 1933 Act Registration Statement No.
Insurance Company and Policy Management Systems 33-40643 on Form S-1 (see Exhibit 10 (k)
Corporation dated December 28, 1984 therein)
10(H) 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(I)* 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(J)* 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(K)* 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(L)* 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(M) Amended and Restated SERP of State Auto Mutual Form 10-K Annual Report for the year
effective as of January 1, 1994 ended December 31, 1997 (see Exhibit
10(HH) therein)
10(N) Credit Agreement dated as of June 1, 1999 between Form 10-Q for the period ended June 30,
State Auto Financial Corporation and State Automobile 1999 (see Exhibit 10(LL) therein)
Mutual Insurance Company
10(O) Reinsurance Pooling Agreement amended and restated as Form 10-K Annual Report for the year
of January 1, 2000 by and among State Automobile ended December 31, 1999 (see Exhibit
Mutual Insurance Company, State Auto Property and 10(W) therein)
Casualty Insurance Company, Milbank Insurance Company,
Midwest Security Insurance Company, Farmers Casualty
Insurance Company and State Auto Insurance Company
10(P) 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
- ---------------------------------
*Constitutes either a management contract or a compensatory plan or arrangement
required to be filed as an Exhibit
Page 53
Exhibit No. Description of Exhibit
- ----------- ----------------------
If incorporated by reference document
with which Exhibit was previously filed
10(Q) Property Catastrophe Overlying Excess of Loss with SEC Form 10-K Annual Report for the year
Reinsurance contract issued to State Automobile ended December 31, 1999 (see Exhibit
Mutual Insurance Company, State Auto National 10(Y) therein)
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(R) 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(S) 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(T) 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(U)* Employment Agreement and Executive Agreement between Form 10-K Annual Report for the year
State Auto Financial Corporation and Robert H. Moone ended December 31, 2000 (see Exhibit
10(BB) therein)
10(V)* Form of Executive Agreement between State Auto Form 10-K Annual Report for the year
Financial Corporation and certain executive ended December 31, 2000 (see Exhibit
officers 10(CC) therein)
10(W) First Amendment to the Reinsurance Pooling Agreement Form 10-K Annual Report for the year
Amended and Restated as of January 1, 2000 by and ended December 31, 2000 (see Exhibit
among State Auto Property and Casualty Insurance 10(DD) therein)
Company, State Automobile Mutual Insurance Company,
Milbank Insurance Company, Midwest Security Insurance
Company, Farmers Casualty Insurance Company and State
Auto Insurance Company
10(X) Addendum No. 1 of the Property Catastrophe Overlying Form 10-K Annual Report for the year
Excess of Loss Reinsurance Contract by and among ended December 31, 2000 (see Exhibit
State Auto Property and Casualty Insurance Company, 10(EE) therein)
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
- ---------------------------------
*Constitutes either a management contract or a compensatory plan or arrangement
required to be filed as an Exhibit
Page 54
10(Y)* 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(Z)* 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)
10(AA)* First Amendment to 2000 Directors Stock Option Plan Form 10-Q for the period ended March 31,
2001 (see Exhibit 10(HH) therein)
10(BB)* Second Amendment to the Reinsurance Pooling Agreement Form 10-Q for the period ended June 30,
Amended and Restated as of January 1, 2000, by the 2001 (see Exhibit 10(II) therein)
State Automobile 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(CC)* Second Amendment to 1991 Directors Stock Option Plan Form 10-Q for the period ended September
30, 2001 (see Exhibit 10(JJ) therein)
10(DD)* Second Amendment to 2000 Directors Stock Option Plan Form 10-Q for the period ended September
30, 2001 (see Exhibit 10(KK) therein)
10(EE)* Third Amendment to 2000 Directors Stock Option Plan Included herein
10(FF) Third Amendment to State Auto Reinsurance Pooling Included herein
Agreement, Amended and Restated as of January 1, 2000
10(GG) Stop Loss Reinsurance Agreement dated October 1, 2001 Included herein
among inter alia Mutual and State Auto P&C
10(HH) Amendment No. 2 to the Management and Operations Included herein
Agreement dated January 1, 2000 among, inter alia,
Mutual and State Auto P&C
10(II) $100,000,000 Credit Agreement among SAF Funding Included herein
Corporation, as Borrower, the Lenders and Bank One,
NA as Agent dated as of November 16, 2001
10(JJ) Put Agreement among State Automobile Mutual Insurance Included herein
Company, State Auto Financial Corporation and Bank
One, NA as Agent dated as of November 16, 2001
10(KK) Standby Purchase Agreement between State Auto Included herein
Financial Corporation and SAF Funding Corporation
dated as of November 16, 2001
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,
Harris, Jr., Paul W. Huesman, George R. Manser, and 1997 (see Exhibit 24(C) therein)
David J. D'Antoni
- ---------------------------------
*Constitutes either a management contract or a compensatory plan or arrangement
required to be filed as an Exhibit
Page 55
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 Form 10-K Annual Report for the year
ended December 31, 2000 (See Exhibit
24(D) therein)
24(E) Power of Attorney - Ramon L. Humke Included herein
(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, 2001.
(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.
Page 56
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: March 29, 2002 /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, March 29, 2002
- --------------------------- Senior Vice President, Treasurer
Steven J. Johnston (principal financial officer
and principal accounting
officer)
John R. Lowther* Secretary and Director March 29, 2002
- ---------------------------
John R. Lowther
Urlin G. Harris, Jr.* Director March 29, 2002
- ---------------------------
Urlin G. Harris, Jr.
David J. D'Antoni* Director March 29, 2002
- ---------------------------
David J. D'Antoni
Paul W. Huesman* Director March 29, 2002
- ---------------------------
Paul W. Huesman
William J. Lhota* Director March 29, 2002
- ---------------------------
William J. Lhota
George R. Manser* Director March 29, 2002
- ---------------------------
George R. Manser
Ramon L. Humke* Director March 29, 2002
- ---------------------------
Ramon L. Humke
Richard K. Smith* Director March 29, 2002
- ---------------------------
Richard K. Smith
Page 57
/s/Robert H. Moone Chairman, President and March 29, 2002
- --------------------------- Chief Executive Officer
Robert H. Moone (principal executive officer)
Page 58
*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 March 29, 2002
- ---------------------------
Steven J. Johnston
Attorney in Fact
Item 14(c)
Exhibit Index
(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.
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)* 1991 Stock Option Plan 1933 Act Registration Statement No.
33-40643 on Form S-1 (see Exhibit 10
(h) therein)
10(E)* 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(F)* 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
Page 2
If incorporated by reference document
Exhibit No. Description of Exhibit with which Exhibit was previously filed with SEC
- ----------- ---------------------- ------------------------------------------------
10(G) 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 (k)
Corporation dated December 28, 1984 therein)
10(H) 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(I)* 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(J)* 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(K)* 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(L)* 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(M) Amended and Restated SERP of State Auto Mutual Form 10-K Annual Report for the year
effective as of January 1, 1994 ended December 31, 1997 (see Exhibit
10(HH) therein)
10(N) Credit Agreement dated as of June 1, 1999 between Form 10-Q for the period ended June 30,
State Auto Financial Corporation and State Automobile 1999 (see Exhibit 10(LL) therein)
Mutual Insurance Company
10(O) Reinsurance Pooling Agreement amended and restated as Form 10-K Annual Report for the year
of January 1, 2000 by and among State Automobile ended December 31, 1999 (see Exhibit
Mutual Insurance Company, State Auto Property and 10(W) therein)
Casualty Insurance Company, Milbank Insurance Company,
Midwest Security Insurance Company, Farmers Casualty
Insurance Company and State Auto Insurance Company
10(P) 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
- ---------------------------------
*Constitutes either a management contract or a compensatory plan or arrangement
required to be filed as an Exhibit
Page 3
If incorporated by reference document
Exhibit No. Description of Exhibit with which Exhibit was previously filed with SEC
- ----------- ---------------------- ------------------------------------------------
10(Q) Property Catastrophe Overlying Excess of Loss Form 10-K Annual Report for the year
Reinsurance contract issued to State Automobile ended December 31, 1999 (see Exhibit
Mutual Insurance Company, State Auto National 10(Y) therein)
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(R) 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(S) 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(T) 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(U)* Employment Agreement and Executive Agreement between Form 10-K Annual Report for the year
State Auto Financial Corporation and Robert H. Moone ended December 31, 2000 (see Exhibit
10(BB) therein)
10(V)* Form of Executive Agreement between State Auto Form 10-K Annual Report for the year
Financial Corporation and certain executive ended December 31, 2000 (see Exhibit
officers 10(CC) therein)
10(W) First Amendment to the Reinsurance Pooling Agreement Form 10-K Annual Report for the year
Amended and Restated as of January 1, 2000 by and ended December 31, 2000 (see Exhibit
among State Auto Property and Casualty Insurance 10(DD) therein)
Company, State Automobile Mutual Insurance Company,
Milbank Insurance Company, Midwest Security Insurance
Company, Farmers Casualty Insurance Company and State
Auto Insurance Company
10(X) Addendum No. 1 of the Property Catastrophe Overlying Form 10-K Annual Report for the year
Excess of Loss Reinsurance Contract by and among ended December 31, 2000 (see Exhibit
State Auto Property and Casualty Insurance Company, 10(EE) therein)
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
- ---------------------------------
*Constitutes either a management contract or a compensatory plan or arrangement
required to be filed as an Exhibit
Page 4
10(Y)* 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(Z)* 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)
10(AA)* First Amendment to 2000 Directors Stock Option Plan Form 10-Q for the period ended March 31,
2001 (see Exhibit 10(HH) therein)
10(BB)* Second Amendment to the Reinsurance Pooling Agreement Form 10-Q for the period ended June 30,
Amended and Restated as of January 1, 2000, by the 2001 (see Exhibit 10(II) therein)
State Automobile 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(CC)* Second Amendment to 1991 Directors Stock Option Plan Form 10-Q for the period ended September
30, 2001 (see Exhibit 10(JJ) therein)
10(DD)* Second Amendment to 2000 Directors Stock Option Plan Form 10-Q for the period ended September
30, 2001 (see Exhibit 10(KK) therein)
10(EE)* Third Amendment to 2000 Directors Stock Option Plan Included herein
10(FF) Third Amendment to State Auto Reinsurance Pooling Included herein
Agreement, Amended and Restated as of January 1, 2000
10(GG) Stop Loss Reinsurance Agreement dated October 1, 2001 Included herein
among inter alia Mutual and State Auto P&C
10(HH) Amendment No. 2 to the Management and Operations Included herein
Agreement dated January 1, 2000 among, inter alia,
Mutual and State Auto P&C
10(II) $100,000,000 Credit Agreement among SAF Funding Included herein
Corporation, as Borrower, the Lenders and Bank One,
NA as Agent dated as of November 16, 2001
10(JJ) Put Agreement among State Automobile Mutual Insurance Included herein
Company, State Auto Financial Corporation and Bank
One, NA as Agent dated as of November 16, 2001
10(KK) Standby Purchase Agreement between State Auto Included herein
Financial Corporation and SAF Funding Corporation
dated as of November 16, 2001
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,
Harris, Jr., Paul W. Huesman, George R. Manser, and 1997 (see Exhibit 24(C) therein)
David J. D'Antoni
- ---------------------------------
*Constitutes either a management contract or a compensatory plan or arrangement
required to be filed as an Exhibit
Page 5
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 Form 10-K Annual Report for the year
ended December 31, 2000 (See Exhibit
24(D) therein)
24(E) Power of Attorney - Ramon L. Humke Included herein
Item 14(d)
Financial Statement Schedules
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
SCHEDULE I(a) - SUMMARY OF INVESTMENTS - OTHER THAN
INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 2001
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 $20,395 $21,258 $20,395
States, municipalities and
political subdivisions 7,011 7,414 7,011
-------------- ---------------- -------------------
Total fixed maturities - held to maturity $27,406 $28,672 $27,406
============== ================ ===================
SCHEDULE I(b) - SUMMARY OF INVESTMENTS - OTHER THAN
INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 2001
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 $91,400 $94,083 $94,083
States, municipalities and
political subdivisions 831,865 836,650 836,650
Public utilities 18,018 18,350 18,350
All other corporate bonds 101,256 102,322 102,322
---------------- ---------------- -------------------
Total fixed maturities $1,042,539 $1,051,405 $1,051,405
---------------- ---------------- -------------------
Equity securities:
Public utilities 10,178 11,572 11,572
Banks, trust and insurance companies 1,415 2,278 2,278
Industrial, miscellaneous and all
other 38,768 45,995 45,995
---------------- ---------------- -------------------
Total equity securities 50,361 59,845 59,845
---------------- ---------------- -------------------
Total investments - available for sale $1,092,900 $1,111,250 $1,111,250
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEETS
December 31
-----------------------------------
ASSETS 2001 2000
---- ----
(dollars in thousands)
Investments in common stock of subsidiaries
(equity method) $440,826 $428,591
Cash 2,005 591
Real estate 408 425
Other assets 887 559
Federal income tax benefit 2,907 1,945
--------------- ----------------
Total assets $447,033 $432,111
=============== ================
LIABILITIES AND STOCKHOLDERS' EQUITY
Note payable to affiliate $45,500 $45,500
Due to affiliates 734 102
Accrued expenses 606 450
--------------- ----------------
Total liabilities 46,840 46,052
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; 43,045,320 and 42,625,723 shares
issued, respectively, at stated value of $2.50 per share 107,613 106,564
Less 4,108,230 and 4,017,012 treasury shares, respectively, at cost (47,613) (47,038)
Additional paid-in capital 47,106 44,208
Accumulated other comprehensive income 12,075 20,367
Retained earnings 281,012 261,958
--------------- ----------------
Total stockholders' equity 400,193 386,059
--------------- ----------------
Total liabilities and stockholders' equity $447,033 $432,111
=============== ================
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONTINUED
CONDENSED STATEMENTS OF INCOME
Year ended December 31
---------------------------------------------------
2001 2000 1999
---- ---- ----
(in thousands)
Investment income $150 $81 $249
Rental income 38 37 37
Net realized gains on investments - - 1
---------------- --------------- ----------------
Total revenue 188 118 287
---------------- --------------- ----------------
Interest expense to affiliate 2,275 2,730 955
Total operating expenses 1,889 1,859 1,176
---------------- --------------- ----------------
Loss before federal income taxes (3,976) (4,471) (1,844)
Federal income tax benefit (1,383) (1,573) (645)
---------------------------------------------------
Net loss before equity in undistributed
net earnings of subsidiaries (2,593) (2,898) (1,199)
Equity in undistributed net earnings of subsidiaries 23,208 50,612 44,015
---------------- --------------- ----------------
Net Income $20,615 $47,714 $42,816
================ =============== ================
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONTINUED
CONDENSED STATEMENTS OF CASH FLOWS
Year Ended December 31
---------------------------------------------------
2001 2000 1999
---- ---- ----
(in thousands)
Cash flows from operating activities:
Net income $20,615 $47,714 $42,816
---------------- ---------------- ----------------
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation and amortization, net 157 484 102
Equity in undistributed earnings of subsidiaries (23,208) (50,612) (43,957)
Changes in operating assets and liabilities:
Change in accrued expenses and due to affiliates 788 60 125
Change in other assets (328) (19) 185
Change in federal income taxes 178 (721) (387)
---------------- ---------------- ----------------
Net cash used in operating activities (1,798) (3,094) (1,116)
---------------- ---------------- ----------------
Cash flows from investing activities:
Capitalization of subsidiary (9,001) - (12,030)
Dividends received from subsidiaries 11,701 3,025 12,663
Additions to real estate - - (1)
---------------- ---------------- ----------------
Net cash provided by investing activities 2,700 3,025 632
---------------- ---------------- ----------------
Cash flows from financing activities:
Proceeds from issuance of debt to affiliate - - 45,500
Net proceeds from sale of common stock 2,466 1,707 1,928
Payments to acquire treasury stock (388) (300) (46,199)
Payment of dividends (1,566) (1,397) (1,315)
---------------- ---------------- ----------------
Net cash provided by (used in) financing activities 512 10 (86)
---------------- ---------------- ----------------
Net increase (decrease) in cash and invested cash 1,414 (59) (570)
---------------- ---------------- ----------------
Cash and cash equivalents at beginning of year 591 650 1,220
---------------- ---------------- ----------------
Cash and cash equivalents at end of year $2,005 $591 $650
================ ================ ================
Supplemental Disclosures:
Federal income taxes received $1,561 $852 $517
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
On March 1, 2002, the Board of Directors of State Auto Financial approved a plan
to repurchase up to 1.0 million shares of its common stock over a period
extending to and through December 31, 2003.
During 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, 2001 State Auto Financial
repurchased 50,522 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 Mutal 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 Finanical 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 was 5.0% and adjusts to 4.75% in 2002.
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.
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(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, 2001
State Auto standard insurance segment $54,129 $344,746 $244,421 - $444,296
State Auto nonstandard insurance segment 2,310 19,011 15,903 - 35,256
Meridian standard insurance segment 10,363 145,654 65,461 - 69,154
Meridian nonstandard insurance segment 285 14,449 3,710 - 6,501
------------ ------------------- --------------- ---------------- -------------
Total 67,087 523,860 329,495 - 555,207
============ =================== =============== ================ =============
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 $361,175
Nonstandard insurance segment 30,883
-------------
Total 392,058
=============
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, 2001
State Auto standard insurance segment $37,230 $292,917 $96,127 $42,597 $462,931
State Auto nonstandard insurance segment 1,997 27,243 6,164 1,063 41,540
Meridian standard insurance segment 3,595 95,979 6,551 12,309 64,526
Meridian nonstandard insurance segment 338 10,935 180 2,216 4,944
Investment management services 318 - - - -
All other 193 - - - -
Corporate 150 - - - -
Reclassification adjustments in consolidation 3,554 - - - -
------------ ------------------- --------------- ---------------- -------------
Total 47,375 427,074 109,022 58,185 573,941
============ =================== =============== ================ =============
Year ended December 31, 2000
Standard insurance segment $33,436 $250,071 $92,955 $20,527 $373,867
Nonstandard insurance segment 1,899 22,096 4,828 1,259 27,837
Investment management services 360 - - - -
All other 244 - - - -
Corporate 81 - - - -
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 $17,465 $359,084
Nonstandard insurance segment 1,839 22,219 5,832 1,866 29,416
Investment management services 272 - - - -
All other 268 - - - -
Corporate 249 - - - -
Reclassification adjustments in consolidation 2,574 - - - -
------------ ------------------- --------------- ---------------- -------------
Total 34,262 264,628 92,441 19,331 388,500
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
SCHEDULE IV - REINSURANCE
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(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 12-31-01
property-casualty earned premiums $472,767 $13,623 $426,880 $4,304 $518,639 $555,207 0.8%
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%
- --------------
(1) These columns include the effect of intercompany pooling.
(2) Calculated as earned premiums assumed from outside companies to net amount.