UNITED STATES SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

For the fiscal year ended December 31, 2004
or

For the transition period from ___________ to _____________

Commission File Number 0-19289

STATE AUTO FINANCIAL CORPORATION

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

          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 þ     No o

          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.       o

          Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

          As of June 30, 2004, the last business day of the Registrant’s most recently completed second fiscal quarter, 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 $348,077,023.

DOCUMENTS INCORPORATED BY REFERENCE

1.	Portions of the Registrant’s Proxy Statement relating to the annual meeting of shareholders to be held May 11, 2005 (the “2005 Proxy Statement”), which will be filed within 120 days of December 31, 2004, are incorporated by reference into Part III of this Form 10-K.

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

Index to Form 10-K Annual Report for the year ended December 31, 2004

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

IMPORTANT INFORMATION REGARDING FORWARD-LOOKING STATEMENTS

          All statements, other than statements of historical facts, included in this Annual Report on Form 10-K (this “Form 10-K”) of State Auto Financial Corporation (“State Auto Financial” or “STFC”) or incorporated herein by reference, including, without limitation, statements regarding State Auto Financial’s future financial position, business strategy, budgets, projected costs, goals and plans and objectives of management for future operations, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements generally can be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “estimate,” “anticipate,” “project,” “believe” or “continue” or the negative thereof or variations thereon or similar terminology. Forward-looking statements speak only as the date the statements were made. Although State Auto Financial believes that the expectations reflected in forward-looking statements have a reasonable basis, it can give no assurance that these expectations will prove to be correct. Forward-looking statements are subject to risks and uncertainties that could cause actual events or results to differ materially from those expressed in or implied by the statements. For a discussion of the most significant risks and uncertainties that could cause State Auto Financial’s actual results to differ materially from those projected, see “Forward-Looking Statements; Certain Factors Affecting Future Results” in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Except to the limited extent required by applicable law, State Auto Financial undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

PART I

Item 1. Business

(a) General Development of Business

          State Auto Financial is an insurance holding company formed in 1990 and headquartered in Columbus, Ohio. STFC engages primarily in the property and casualty insurance business through its 100% owned subsidiaries, State Auto Property and Casualty Insurance Company (“State Auto P&C”), Milbank Insurance Company (“Milbank”), Farmers Casualty Insurance Company (“Farmers”), State Auto Insurance Company of Ohio (“SA Ohio”), and State Auto National Insurance Company (“SA National”). Farmers formerly owned 100% of the outstanding common shares of Mid-Plains Insurance Company (“Mid-Plains”), a property-casualty insurer. Mid-Plains was dissolved in December 2004 and its insurance liabilities were assumed by SA National pursuant to an assumption reinsurance agreement.

          Approximately 65% of State Auto Financial’s outstanding common shares are owned by State Automobile Mutual Insurance Company (“Mutual”), an Ohio mutual property and casualty insurance company organized in 1921. Mutual owns 100% of State Auto Florida Insurance Company (“SA Florida”) and State Auto Insurance Company of Wisconsin (“SA Wisconsin”), property-casualty insurers. Mutual also owns 100% of Meridian Insurance Group, Inc. (“MIGI”), an insurance holding company. MIGI owns 100% of Meridian Security Insurance Company (“Meridian Security”), a property-casualty insurer. In 2001, Mutual merged with Meridian Mutual Insurance Company (“Meridian Mutual”), with Mutual continuing as the surviving corporation, and in a substantially concurrent transaction Mutual acquired the outstanding shares of MIGI. MIGI is also a party to an affiliation agreement with Meridian Citizens Mutual Insurance Company (“Meridian Citizens Mutual”), a property-casualty insurer. Meridian Security and Meridian Citizens Mutual are hereafter referred to collectively as the “MIGI Insurers,” and together with MIGI, the “MIGI Companies.”

          STFC owns 100% of Stateco Financial Services, Inc. (“Stateco”), which provides investment management services to affiliated insurance companies. STFC also owns 100% of Strategic Insurance Software, Inc. (“S.I.S.”), a developer and seller of insurance-related software. 518 Property Management and Leasing, LLC (“518 PML”), whose members are State Auto P&C and Stateco, owns and leases real and personal property to affiliated companies. The results of the operations of S.I.S. and 518 PML are not material to the total operations of STFC.

          State Auto Financial, State Auto P&C, Milbank, Farmers, SA Ohio, SA National, Mid-Plains, Stateco, S.I.S., and 518 PML are hereafter referred to collectively as the “Company.”

          State Auto P&C has participated in a quota share reinsurance pooling arrangement with Mutual since 1987 (the “Pooling Arrangement”). At year end, the participants in the Pooling Arrangement were State Auto P&C, Mutual, Milbank, SA Wisconsin, Farmers, SA Ohio and SA Florida. As of January 1, 2005, Meridian Security and Meridian Citizens Mutual were added to the Pooling Arrangement. State Auto P&C, Mutual, Milbank, SA Wisconsin, Farmers, SA Ohio, SA Florida, Meridian Security (as of January 1, 2005) and Meridian Citizens Mutual (as of January 1, 2005) are hereafter referred to collectively as the “Pooled Companies.” State Auto P&C, Milbank, Farmers and SA Ohio are hereafter referred to collectively as the “STFC Pooled Companies.” See “Pooling Arrangement” in the “Narrative Description of Business.” The Pooled Companies and SA National are hereafter referred to as the “State Auto Group.”

          The insurers in the State Auto Group write a broad line of property and casualty insurance, such as standard personal and commercial automobile, nonstandard personal automobile, homeowners, commercial multi-peril, workers’ compensation, general liability and fire insurance, through approximately 22,500 independent insurance agents associated with approximately 3,250 agencies in 26 states. The State Auto Group’s insurance products are marketed primarily in the central and eastern parts of the United States, excluding New York, New Jersey and the New England States.

1

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

          The Company considers one of its key strengths to be its core values, which are to (i) fairly price and ethically sell useful insurance products, (ii) treat every transaction with absolute honesty and integrity, (iii) extend dignity and respect to everyone, (iv) encourage innovation, and (v) fully utilize every person’s talents. These core values are reflected in, among other things, the long-term strategic business plan adopted by the Boards of Directors of Mutual and STFC. This strategic business plan provides that the long-term goal of the State Auto Group is to continue to be a premier, independent property and casualty insurer by consistently performing in the top quartile of its peer group of companies. 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.

(b) Financial Information about Segments

          The Company currently operates in three segments: State Auto standard insurance, State Auto nonstandard insurance, and investment management services. Prior to 2003, it operated in the following four insurance segments: the State Auto standard insurance segment, consisting of the business operations of the STFC Pooled Companies; the State Auto nonstandard segment, consisting of the business operations of SA National and Mid-Plains; the Meridian standard segment, consisting of the standard insurance business of the former Meridian Mutual; and the Meridian nonstandard segment, consisting of the nonstandard business of the former Meridian Mutual. As of January 1, 2004 and January 1, 2003, the Meridian standard and nonstandard segments, respectively, were included in the State Auto standard and nonstandard segments because these Meridian segments no longer met the quantitative thresholds for separate presentation as reportable segments. Financial information about all these segments is set forth in Note 15 of the Notes to the Company’s Consolidated Financial Statements included in Item 8 of this Form 10-K. Additional information regarding the Company’s insurance and non-insurance segments is provided in “Narrative Description of Business.”

(c) Narrative Description of Business

Property and Casualty Insurance

Pooling Arrangement

          The Pooled Companies are parties to an intercompany Pooling Arrangement. The Pooling Arrangement was governed by the reinsurance pooling agreement known as the “2000 Pooling Agreement” prior to January 1, 2005, and by the reinsurance pooling agreement known as the “2005 Pooling Agreement” on and after that date. The Pooling Arrangement covers all the property and casualty insurance written by the parties, except voluntary assumed reinsurance written by Mutual, Mutual Middle Market Insurance (as defined in the 2005 Pooling Agreement) and intercompany catastrophe reinsurance written by State Auto P&C. Under the Pooling Arrangement each participant cedes premiums, losses and expenses on all of their business to Mutual, and Mutual in turn cedes to each participant a specified portion of premiums, losses and expenses based on each participant’s pooling percentage. Mutual then retains the balance of the pooled business. Mutual, SA Wisconsin, SA Florida, Meridian Security and Meridian Citizens Mutual are hereafter referred to collectively as the “Mutual Pooled Companies.”

          The following table sets forth a chronology of the participants and their participation percentage changes that have occurred in the Pooling Arrangement since January 1, 2000:

*

Time period is for the year ended December 31, unless otherwise noted.

2

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

          The following table sets forth a summary of the Pooling Arrangement participant percentages of STFC and Mutual, aggregating their respective 100% owned subsidiaries:

*

Time period is for the year ended December 31, unless otherwise noted.

          Prior to 2001, the pooling percentages were 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 changes made to the pooling percentages in 2001, it is not management’s current intention to recommend an adjustment to the STFC Pooled Companies aggregate participation percentage in the foreseeable future. Under revised procedures, management of each of the Pooled Companies would make recommendations to a standing independent committee of the Board of both 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 STFC. 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.

          Under the terms of the Pooling Arrangement, all premiums, incurred losses, loss expenses and other underwriting expenses are prorated among the companies party to the agreement on the basis of their participation in the pool. By spreading the underwriting risk among each of the participants, 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. One effect of the Pooling Arrangement is to provide each participant with an identical mix of pooled property and casualty insurance business on a net basis.

          The 2005 Pooling Agreement and the 2000 Pooling Agreement both contain a provision excluding catastrophic losses and loss adjustment expenses incurred by the parties in the amount of $100.0 million in excess of $120.0 million, as well as the premium for such exposures. State Auto P&C reinsures each insurer in the State Auto Group for this layer of reinsurance under a Catastrophe Assumption Agreement. No losses were paid by State Auto P&C under the Catastrophe Assumption Agreement in 2004, 2003 or 2002. See “Reinsurance” in the “Narrative Description of Business.”

          Prior to January 1, 2005, the direct business of the MIGI Insurers was not included in the Pooling Arrangement and to that extent was not included in the insurance operations of the Company for periods ending prior to January 1, 2005. If State Auto P&C had been required to pay catastrophe losses of the MIGI Insurers under the above referenced Catastrophe Assumption Agreement, those losses would have impacted the Company’s results.

          Also, excluded from both the 2000 Pooling Agreement and the 2005 Pooling Agreement is Mutual Middle Market Insurance. If State Auto P&C were required to pay catastrophe losses of the Mutual Middle Market Insurance under the above referenced Catastrophe Assumption Agreement, these losses would impact the Company’s results.

Nonstandard Auto Insurance

          The Company writes nonstandard auto insurance through SA National. See “Marketing” in “Narrative Description of Business.” This business is not part of the Pooling Arrangement. See also “Reportable Segments” in “Narrative Description of Business.”

Management Agreement

          State Auto P&C’s employees provide all organizational, operational and management functions for all insurance affiliates within the State Auto Group through management and cost sharing agreements. Through December 31, 2004, for the performance of its services under two of the management agreements, State Auto P&C was paid a quarterly management and operations services fee based on formulas outlined in the agreements. Under the “2000 Midwest Management Agreement” among State Auto P&C, Mutual and SA Wisconsin, SA Wisconsin pays 0.75% of direct written premium for management and operation services performed by employees of State Auto P&C. Under the “MIGI Management Agreement” among State Auto P&C, MIGI and the MIGI Insurers, each of the MIGI Companies paid State Auto P&C a management fee of 10% of all State Auto P&C’s employee-related costs in exchange for the services of those employees, in addition to reimbursing State Auto P&C for the actual costs of such services. Mutual provides facilities for all the insurance affiliates under management or cost sharing agreements, including the “2000 Management Agreement” to which State Auto P&C and Mutual are parties, among other affiliates. Subject to regulatory approval, the 2000 Management Agreement has been amended and restated as of January 1, 2005, known as the “2005 Management Agreement,” and the MIGI Companies and Farmers will become parties. The Company anticipates terminating

3

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

separate management agreements that had been in place among State Auto P&C and the MIGI Companies and Farmers, respectively, upon the 2005 Management Agreement taking effect.

          Each of the affiliated management and cost sharing agreements, except the MIGI Management Agreement, has a ten-year term and automatically renews for an additional ten-year period unless sooner terminated in accordance with its terms. If the 2005 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.

Reportable Segments

          See Note 15, Reportable Segments of the Notes to the Company’s Consolidated Financial Statements included in Item 8 of this Form 10-K, and Item 7 of this Form 10-K.

Marketing

          The State Auto Group markets its products in 26 states through approximately 22,500 insurance agents associated with approximately 3,250 independent insurance agencies. None of the companies in the State Auto Group has any contracts with managing general agencies.

          SA National markets nonstandard products in 21 states exclusively through the Company’s network of independent agents. Mid-Plains wrote nonstandard auto insurance in Iowa and Kansas through the agency network of Farmers in those states. In December 2004, Mid-Plains was dissolved and its insurance liabilities were assumed by SA National. See “Nonstandard Auto 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; travel incentives related to profit and growth; and an agent stock purchase 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 conducted in the Company’s home office. Further, the training programs include disciplined follow-up and coaching for an extended time. Other targeted training sessions are held in the Company’s branch office locations from time to time.

          The Company has made continuing efforts to use technology to make it easier for its agents to do business with the Company. The Company offers internet-based rating, policy application submission and execution of endorsements for certain products. In addition, the Company provides its agents with the opportunity to maintain policyholder records electronically, avoiding the expense of preparing and storing paper records. Software developed by S.I.S. also enhances the ability of the Company and its agents to take advantage of electronic data submission. 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 attracts prospective agents and enhances the existing agencies’ relationships 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 – measured by consistent profitability, achievement of written premium thresholds and growth — as Inner Circle Agencies. Inner Circle Agencies are rewarded with additional trip and financial incentives, including additional profit sharing bonus and additional contributions to their Inner Circle Agent Stock Purchase Plan, a 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 stockbroker. The Company also makes available to certain top performing agents the opportunity to vest grants of options in the Company’s common shares provided the participants meet performance targets described in the Agent Stock Option Plan.

          The Company receives premiums on products marketed in Alabama, Arkansas, Florida, Georgia, Illinois, Indiana, Iowa, Kansas, Kentucky, Maryland, Michigan, Minnesota, Mississippi, Missouri, North Carolina, North Dakota, Ohio, Oklahoma, Pennsylvania, South Carolina, South Dakota, Tennessee, Utah, Virginia, West Virginia and Wisconsin. During 2004, the seven states that contributed the greatest percentage of the Company’s direct premiums written were as follows: Ohio (18.6%), Kentucky (11.5%), Tennessee (6.9%), Minnesota (6.4%), Pennsylvania (5.2%), Maryland (4.7%) and Indiana (4.2%).

4

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

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. The claims division is responsible for reviewing the claim, obtaining necessary documentation and establishing loss and expense reserves of certain claims. Generally, property or casualty claims estimated to reach $150,000 or above are sent to the home office to be supervised by claims division specialists. Branches with small volumes of large claims report claims to the home office at a lower dollar threshold. 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 adjusting 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.

          Claim representatives use third party, proprietary bodily injury evaluation software to help them value bodily injury claims, except for the most severe injury cases. This software continues to be a valuable tool for the Company. The Claims Contact Centers allow the Company to improve claims efficiency and economy by concentrating the handling of smaller, less complex claims in a centralized environment. The Company provides 24 hour, seven days a week claim service, either through associates in the Claims Contact Centers, which are located in Des Moines, Iowa and Columbus, Ohio, or, for a few overnight hours, through a third party service provider.

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. 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’s results of operations and financial condition could be impacted, perhaps significantly, in the future if the ultimate payments required to settle claims vary from the liability currently recorded.

          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, litigation and in-house claims processing costs from such losses.

          Reserves for reported losses are initially 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, changes in exposure units, inflation, legal developments, storm loss estimates, and economic conditions. Case and formula basis loss reserves are reviewed on a regular basis. As new data becomes available, estimates are updated resulting in adjustments to loss reserves. Generally, reported losses initially reserved on a formula basis which have not settled after six months, are case reserved at that time. 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. Additional information regarding the Company’s reserves is included in Item 7 of this Form 10-K in the Losses and Loss Expenses Payable section included therein.

          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, 2004, 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.

5

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

          The following table presents one-year development information on changes in the reserve for loss and loss expenses of the Company for each of the three years in the period ended December 31, 2004:

(1)		Includes amounts due from affiliates of $5.7 million, $4.3 million, and $8.9 million, respectively.
(2)		Includes net amounts assumed from affiliates of $303.9 million, $304.0 million and $280.0 million, respectively.
(3)		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 decrease of $22.2 million and $1.8 million in 2004 and 2003, respectively, and the increase of $12.4 million in 2002 for claims occurring in prior years is well within normal expectations for reserve development and claim settlement uncertainty.
(4)		Includes amounts due from affiliates of $5.7 million for 2004 and 2003 and $4.3 million for 2002.
(5)		Includes net amounts assumed from affiliates of $296.9 million, $303.9 million, and $304.0 million, respectively.

          The following table sets forth the development of reserves for losses and loss expenses from 1994 through 2004 for the Company. “Net liability for losses and loss expenses payable” sets forth the estimated liability for unpaid losses and loss expenses recorded at the balance sheet date, net of reinsurance recoverables, for each of the indicated years. This liability represents the estimated amount of losses and loss expenses for claims arising in the current and all prior years that are unpaid at the balance sheet date, including losses incurred but not reported to the Company.

          The lower portion of the table shows the re-estimated amounts of the previously reported reserve based on experience as of the end of each succeeding year. The estimate is increased or decreased as more information becomes known about the claims incurred.

          The upper section of the table shows the cumulative amounts paid with respect to the previously reported reserve as of the end of each succeeding year. For example, through December 31, 2004, the Company had paid 68.8% of the currently estimated losses and loss expenses that had been incurred, but not paid, as of December 31, 1995.

          The amounts on the “cumulative redundancy (deficiency)” line represent the aggregate change in the estimates over all prior years. For example, the 1995 calendar year reserve has developed a $33.0 million or 16.0% redundancy through December 31, 2004. That amount has been included in operations over the ten years and did not have a significant effect on income in 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 1997, but incurred in 1994, will be included in the cumulative redundancy amount for years 1994, 1995 and 1996. 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.

6

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

          In 1995, 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 1995, 1998, 1999, 2000 and 2001 in conjunction with each year’s respective pooling change. The amount of the assets transferred from Mutual in 1995, 1998, 1999, 2000 and 2001 has been netted against and has reduced the cumulative amounts paid for years prior to 1995, 1998, 1999, 2000 and 2001, respectively.

[See table on following page.]

7

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

As the Pooling Arrangement provides for the right of offset, the Company has reported losses and loss expenses payable ceded to Mutual as assets only in situations when net amounts ceded to Mutual exceed that assumed. The following table provides a reconciliation of the reinsurance recoverable to the amount reported in the Company’s consolidated financial statements at each balance sheet date:

8

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

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. Insurance is ceded principally to reduce net liability on individual risks or for individual loss occurrences, including catastrophic losses. 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, casualty and workers compensation lines with several reinsurers arranged through a reinsurance intermediary. Under the property per risk excess of loss treaty, each member is responsible for the first $2.0 million of each covered loss, and the reinsurers are responsible for 100% of the excess over $2.0 million up to $10.0 million of covered loss. 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 82.5% of the excess over $2.0 million up to $5.0 million of covered loss. Also, certain unusual claim situations involving bodily injury liability, property damage, uninsured motorist and personal injury protection are covered by an arrangement that provides for $10.0 million of coverage in excess of 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.

          The terms of the workers compensation excess of loss program provide that each company in the State Auto Group is responsible for the first $2.0 million of covered loss. The reinsurers are responsible for 100% of the excess over $2.0 million up to $10.0 million of covered loss. Net retentions under this contract may be submitted to the casualty excess of loss program, subject to a limit of $2.0 million per loss occurrence. The rates for this reinsurance are negotiated annually.

          In addition to the workers compensation reinsurance program described above, as of July 1, 2004, each company in the State Auto Group became party to an agreement which provides an additional layer of excess of loss reinsurance for workers compensation losses involving multiple workers. Subject to $10.0 million of retention, reinsurers are responsible for 100% of the excess over $10.0 million up to $20.0 million of covered loss. This coverage is subject to a “Maximum Any One Life” limit of $10.0 million. The rates for this reinsurance are negotiated annually.

          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 $10.0 million above a maximum $0.6 million retention. The State Auto Group also makes use of facultative reinsurance for unique risk situations and participates in involuntary pools and associations in certain states.

          The State Auto Group participates in an intercompany catastrophe reinsurance program. Under this program, the members of the State Auto Group, on a combined basis, retain the first $40.0 million of catastrophe losses that affect at least two individual risks. For catastrophe losses incurred by the State Auto Group up to $80.0 million, in excess of $40.0 million, traditional reinsurance coverage is provided with a co-participation of 5%. For catastrophe losses incurred by the State Auto Group up to $100.0 million, in excess of $120.0 million, in exchange for a premium paid by each reinsured company, State Auto P&C acts as the catastrophe reinsurer for the State Auto Group under the terms of an intercompany catastrophe reinsurance agreement. There have been no losses assumed under this agreement.

          To provide funding if the State Auto Group were to incur catastrophe losses in excess of $120.0 million, State Auto Financial has a structured contingent financing arrangement in place 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, thereby preserving the statutory surplus of State Auto P&C. State Auto P&C would use the contributed capital to pay its direct catastrophe losses and losses assumed under the intercompany catastrophe reinsurance agreement. State Auto Financial is obligated to repay SPC (which would repay the Lenders) by redeeming the preferred shares in ten semi-annual installments. 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 SPC or repay SPC for the loan(s) outstanding. This funding arrangement, if exercised, would have the impact of adding up to $100.0 million of additional debt to the Company while providing needed cash to pay claims, while at the same time preserving the investment portfolio of the Company in the short term.

          SA National has a reinsurance agreement with Mutual pursuant to which Mutual assumes up to $4.9 million of each liability loss occurrence in excess of SA National’s $50,000 of retention; and up to $0.5 million of each catastrophe loss occurrence in excess of SA National’s $50,000 of retention. Mutual further provides SA National with an 8.5% quota share within the $50,000 retention on liability coverages, and a 20% quota share on physical damage coverages. In connection with its dissolution in December 2004, Mid-Plains entered into an assumption reinsurance agreement with SA National for all Mid-Plains’ property and casualty insurance policy liabilities.

9

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

          See the discussion regarding the federal Terrorism Risk Insurance Act of 2002 (the “Terrorism Act”) in the Regulation section and in Item 7 of this Form 10-K in the Other External Factors section included therein.

Regulation

          Most states, including all the domiciliary states of the State Auto Group, have enacted legislation that regulates insurance holding company systems. 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 any members of the State Auto Group, 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 to shareholders. Pursuant to these laws, all transactions within the holding company system affecting any members of the State Auto Group 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. The insurance laws of all the domiciliary states of the State Auto Group provide that no person may acquire direct or indirect control of a domestic insurer without obtaining the prior written approval of the state insurance commissioner for such acquisition.

          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. 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. STFC’s insurance subsidiaries generally are restricted by the insurance laws of their respective states of domicile as to the amount of dividends they may pay to STFC without the prior approval of the respective state regulatory authorities. Generally, the maximum dividend that may be paid by an insurance subsidiary during any year without prior regulatory approval is limited to the greater of a stated percentage of that subsidiary’s statutory surplus as of a certain date, or adjusted net income of the subsidiary, for the preceding year. Under current law, a total of $94.7 million is available for payment to State Auto Financial as a dividend from State Auto P&C, Milbank, Farmers, SA Ohio and SA National during 2005 without prior approval from their respective domiciliary state insurance departments.

          Rate and Related Regulation. In general, the Company is not aware of the adoption of any adverse legislation or regulation by any state where the Company did business during 2004 which would present material obstacles to the Company’s overall business. However, 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. Similarly, several states are considering restricting insurers’ rights to use loss history information maintained in various databases by insurance support organizations. These tools help the Company price its products more fairly and enhance its ability to compete for business that it believes will be profitable. Such regulations would limit the ability of the Company, as well as the ability of all other insurance carriers operating in any affected jurisdiction, to take advantage of these tools.

          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 National Association of Insurance Commissioners (“NAIC”) annually tests insurers’ risk-based capital requirements. As of December 31, 2004, each insurer affiliated with the Company surpassed all standards tested by the formula applying risk-based capital requirements.

          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, expanding the terms of the contract, 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

10

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

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 Terrorism Act requires the federal government and the insurance industry to share in insured losses up to $100 billion per year resulting from future terrorist attacks within the United States. Under the Terrorism Act, commercial property and casualty insurers must offer their commercial policyholders coverage against certified acts of terrorism, but the policyholders may choose to reject this coverage. If the policyholder rejects coverage for certified acts of terrorism, the Company intends, subject to the approval of the state regulators, to cover only such acts of terrorism that are not certified acts under the Terrorism Act and that do not arise out of nuclear, biological or chemical agents. The requirement for insurers to make certain coverage available under the Terrorism Act originally extended through December 2004, but Congress has extended it through the end of 2005. The Terrorism Act will terminate on December 31, 2005, unless Congress acts to extend it again. The Company has advocated the extension of this statute. If the statute is allowed to sunset, the foregoing description would become inapplicable. The Company’s current property reinsurance treaties exclude certified acts of terrorism. If the Terrorism Act expires, those treaties will likely be revised to exclude acts of terrorism as defined within the treaties. Likewise, if the Terrorism Act expires, the Company will pursue changes to its direct commercial policies to exclude acts of terrorism as defined within its policies.

          An area of regulatory focus that arose late in 2004, and which likely will continue to receive additional focus in 2005, is “producer compensation arrangements.” The New York Attorney General has undertaken investigations and initiated lawsuits involving allegations of improper compensation arrangements between brokers and insurance companies. These actions have led several state insurance departments to undertake their own surveys or inquiries into the activities of their domestic insurers with respect to producer compensation arrangements in their respective states. Two state insurance departments have delivered inquiries to the Company, and the Company has responded to each of the inquiries. It is the Company’s understanding that these inquiries are part of an overall fact-finding process initiated by these state insurance departments, and that similar inquiries were made to a number of other domestic insurers in these states. The inquiries did not indicate or imply that the Company had done anything improper with respect to its compensation arrangements with its agents. Because these inquiries are in their early stages of fact finding, it cannot be predicted as to the next phase of inquiry or what, if any, legislation or rules may be proposed to address producer compensation arrangements in those states where the Company has domestic insurers. The improper producer compensation arrangements generally involve insurance brokers, which are persons retained and compensated by the insurance customer. The Company markets its insurance products through independent insurance agents who have been appointed to act on the Company’s behalf, and the Company, not the insurance customer, compensates these agents pursuant to contractual arrangements. Under its agency agreements, the Company’s compensation arrangements with its agencies consist of commissions paid for the sale of the Company’s insurance products, usually based upon a percentage of the premium paid by the insurance customer, and a “contingent commission.” This “contingent commission” is based upon the underwriting profit generated by that agency’s book of business placed with the State Auto Group. Like many other sales organizations, the Company also offers sales incentives to its agencies. The Company believes that its agent compensation arrangements are in compliance with all laws and consistent with good business practices.

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 subsidiaries, and investment results are not shared by 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.

          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 Item 7 of this Form 10-K.

          The Company’s fixed maturity investments are classified as available for sale and carried at fair market value, according to the Statement of Financial Accounting Standards (SFAS) No. 115, “Accounting for Certain Investments in Debt and Equity Securities.”

          The Company’s Investment Policy and Guidelines permit investment in debt issues rated A or better by two major rating services. The Company’s fixed maturities portfolio is composed of high quality, investment grade issues, comprised almost entirely of debt issues rated AAA or AA. As of December 31, 2004 and 2003, the bond portfolio had a fair market value that totaled $1,502.1 million and $1,427.9 million, respectively.

11

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

          At December 31, 2004 and 2003, respectively, the Company’s equity portfolio is classified as available for sale and carried at fair market value that totaled $193.6 million and $139.3 million, respectively.

          The following table sets forth the Company’s investment results for the periods indicated:

(1)		Average of the aggregate invested assets at the beginning and end of each period, including interim quarter ends. Invested assets include fixed maturities at amortized cost, equity securities at cost, other invested assets 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.

          For additional discussion regarding the Company’s investments, see Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Competition

          The property and casualty insurance industry is highly competitive. 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, quality service to the policyholder and the agent, and a fully developed agency relations program.

Employees

          As of March 4, 2005, the Company had 2,029 employees. Employees of the Company are not covered by any collective bargaining agreement. Management of the Company considers its relationship with its employees to be excellent.

Available Information

          STFC’s internet website address is www.stfc.com. Through this internet website (found under the “SEC Filings” link), STFC makes available, free of charge, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”), as soon as reasonably practicable after STFC electronically files such material with the Securities and Exchange Commission (the “SEC”). Also available on its website is information pertaining to the Company’s corporate governance, including the charters of each the standing committees of the Company’s Board of Directors, the Company’s corporate governance guidelines and the Company’s code of business conduct. For a free copy of the Form 10-K, write to Terrence L. Bowshier, Vice President, State Auto Financial Corporation, 518 East Broad Street, Columbus, Ohio 43215.

          Any of the materials the Company files with the SEC may also be read and copied at the SEC’s Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. Information on the operation of the SEC’s Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov.

12

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

Executive Officers of the Registrant

(1)		Age is as of March 4, 2005.
(2)		Each of the foregoing officers has been designated by the Company’s Board of Directors as an executive officer for purposes of Section 16 of the Exchange Act.
(3)		Richard L. Miley and Cathy B. Miley are husband and wife.

13

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

Item 2. Properties

          The Company shares its operating facilities with Mutual pursuant to the terms of the 2000 Management Agreement, and subject to regulatory approval, the 2005 Management Agreement. The Company’s corporate headquarters are located in Columbus, Ohio, in buildings owned by Mutual that contain approximately 280,000 square feet of office space. The Company and Mutual also own or lease other office facilities in numerous locations throughout the State Auto Group’s geographical areas of operation.

Item 3. Legal Proceedings

Insurance Business

          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.

Minority Shareholder Litigation—Ohio

          As previously reported, on October 16, 2003, State Auto Financial, Mutual, and their respective directors filed a complaint against Gregory M. Shepard and his company in the Common Pleas Court of Franklin County, Ohio (the “Court”), seeking (1) declaratory relief that neither State Auto Financial, Mutual, nor their respective directors and officers violated any fiduciary duties to Mr. Shepard, his company, or State Auto Financial’s minority shareholders in responding to a tender offer commenced by Mr. Shepard and his company for State Auto Financial’s common shares (the “Shepard tender offer”); (2) declaratory relief that neither State Auto Financial nor its directors and officers have an obligation to call a meeting of shareholders under Ohio’s Control Share Acquisition statute with respect to the Shepard tender offer; and (3) compensatory damages in favor of State Auto Financial and Mutual from Mr. Shepard and his company for knowingly making misrepresentations in connection with their control bid in violation of Ohio law. Also as previously reported, on December 19, 2003, Mr. Shepard and his company filed a counterclaim against State Auto Financial, Mutual, and their respective directors seeking (1) a declaratory judgment requiring State Auto Financial to call a meeting of shareholders under Ohio’s Control Share Acquisition statute with respect to the Shepard tender offer; (2) injunctive relief to enjoin State Auto Financial, Mutual, and their respective directors and employees from taking actions that would have the effect of impeding or interfering with the Shepard tender offer; and (3) compensatory damages from Mutual, Mutual’s directors, and State Auto Financial’s directors for the alleged breach of their fiduciary duties. Mr. Shepard and his company announced the termination of the Shepard tender offer on May 10, 2004.

          On May 13, 2004, the Court entered an order (1) dismissing with prejudice all counterclaims of Mr. Shepard and his company against State Auto Financial, Mutual, and their respective directors, and (2) dismissing without prejudice all claims for declaratory relief against Mr. Shepard and his company. The only remaining claim before the Court was for compensatory damages brought by State Auto Financial and Mutual against Mr. Shepard and his company for knowingly making misrepresentations in connection with their control bid in violation of Ohio law. In January 2005, the Court granted a motion for summary judgment in favor of Mr. Shepard and his company and entered an order dismissing State Auto Financial’s and Mutual’s claim for damages against Mr. Shepard and his company. State Auto Financial and Mutual did not appeal the Court’s order. Therefore, this litigation has been concluded.

Minority Shareholder Litigation—Indiana

          On July 27, 2001, Mr. Shepard and American Union Insurance Company (“AUIC”), an Illinois insurance company owned by Mr. Shepard and his brother, Tracy Shepard, filed a complaint against State Auto Financial, Mutual, MIGI, and MIGI’s former directors in the United States District Court for the Southern District of Indiana (the “Court”). The factual basis for this suit arises from the circumstances surrounding the merger of MIGI with and into a wholly owned subsidiary of Mutual (the “Merger”), which was effective June 1, 2001. In their complaint, Mr. Shepard and AUIC alleged claims of (1) breach of fiduciary duty against the former MIGI directors for entering into the Merger; (2) breach of contract against State Auto Financial and Mutual with respect to a confidentiality agreement, dated September 29, 2000, between State Auto Financial and AUIC; and (3) tortuous interference against MIGI and one of its former directors with respect to such confidentiality agreement. On December 3, 2003, the Court granted the request of Mr. Shepard and AUIC to voluntarily dismiss the claims of breach of fiduciary duty and tortuous interference against MIGI and its former directors. Thus, the only remaining claim in this suit is for breach of the confidentiality agreement against State Auto Financial and Mutual. Mr. Shepard and AUIC are seeking compensatory damages in this suit, which they allege exceed $25.0 million based on an expert witness’ report provided to State Auto Financial and Mutual by Mr. Shepard’s counsel in April 2004. As of March 4, 2005, discovery is substantially concluded and the trial is currently scheduled to occur in October of 2005. State Auto Financial and Mutual have filed a motion for summary judgment seeking the dismissal of all claims against them. As of March 4, 2005, the Court has not ruled on this motion.

14

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

Item 4. Submission of Matters to a Vote of Security Holders

          Not applicable.

PART II

Item 5.	Market for the Registrant’s Common Equity, Related Shareholder Matters, and Issuer Purchases of Equity Securities

Market Information; Holders of Record

          The Company’s common shares are traded in the NASDAQ National Market System under the symbol STFC. As of March 4, 2005, there were 898 shareholders of record of the Company’s common shares.

Market Price Ranges and Dividends Declared on Common Shares⁽¹⁾

          Initial Public Offering — June 28, 1991, $2.25⁽¹⁾. The following table provides information with respect to the high and low sale prices of the Company’s common shares for each quarterly period for the past two years as reported by NASDAQ, along with the amount of cash dividends declared by the Company with respect to its common shares for each quarterly period for the past two years:

          Additionally, see Liquidity and Capital Resources section of included in Item 7 of this Form 10-K for a discussion of regulatory restrictions on the payment of dividends by the Company’s insurance subsidiaries.

Purchases of Common Shares by the Company

          The following table provides information with respect to purchases made by the Company of its common shares during the fourth quarter 2004:

15

Item 6. Selected Consolidated Financial Data

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

          State Auto Financial Corporation (“State Auto Financial” or “STFC”) and its 100% owned subsidiaries are collectively referred to as the “Company.” The Company is a member of the State Auto Group (defined below). The State Auto Group writes personal and commercial insurance through approximately 22,500 independent insurance agents associated with approximately 3,250 agencies in 26 states. The State Auto Group operates primarily in the central and eastern United States, excluding New York, New Jersey, and the New England states. State Auto Financial is a majority-owned subsidiary of State Automobile Mutual Insurance Company (“Mutual”), an Ohio domiciled property and casualty insurer and member of the State Auto Group. Mutual is one of only 15 companies in the United States that have received A.M. Best’s A+ or higher rating every year since 1954.

          State Auto Financial provides personal and commercial insurance to the standard insurance market through the following 100% owned insurance subsidiaries, collectively referred to as the “STFC Pooled Companies”:

	•	State Auto Property and Casualty Insurance Company (“State Auto P&C”)
	•	Milbank Insurance Company (“Milbank”)
	•	Farmers Casualty Insurance Company (“Farmers”) and
	•	State Auto Insurance Company of Ohio (“SA Ohio”).
		The STFC Pooled Companies’ principal lines of business include:

	•	Personal and commercial automobile
	•	Homeowners
	•	Commercial multi-peril
	•	Workers’ compensation
	•	General liability
	•	Fire

          State Auto Financial also provides personal automobile insurance to the nonstandard insurance market through State Auto National Insurance Company (“SA National”), a 100% owned insurance subsidiary. State Auto Financial also provided nonstandard automobile insurance through Mid-Plains Insurance Company (“Mid-Plains”), a 100% owned subsidiary of Farmers. As of December 1, 2004, SA National and Mid-Plains entered into an assumption reinsurance agreement whereby SA National assumed all outstanding insurance claim liabilities of Mid-Plains on this date. Mid-Plains was dissolved on December 29, 2004.

          The companies below are collectively referred to as the “Affiliates.” The Company and the Affiliates are collectively referred to as the “State Auto Group.”

		Mutual and its 100% owned subsidiaries:
	•	State Auto Insurance Company of Wisconsin (“SA Wisconsin”)
	•	State Auto Florida Insurance Company (“SA Florida”)
	•	Meridian Insurance Group, Inc. (“MIGI”) and its 100% owned subsidiary:

	o	Meridian Security Insurance Company (“Meridian Security”)
	o	Through an affiliation agreement with MIGI:

•

Meridian Citizens Mutual Insurance Company (“Meridian Citizens Mutual”).

          Meridian Security and Meridian Citizens Mutual are collectively referred to as the “Meridian Insurers.”

          The STFC Pooled Companies participate in a quota share reinsurance pooling arrangement (the “Pooling Arrangement”) with Mutual, SA Wisconsin and SA Florida (collectively the “Mutual Pooled Companies”). The Pooling Arrangement provides that the STFC Pooled Companies and the Mutual Pooled Companies 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. The participation percentage for the STFC Pooled Companies has remained at 80% since October 1, 2001. The STFC Pooled Companies and Mutual Pooled Companies are collectively referred to as the “Pooled Companies.”

          As of July 1, 2004, the Pooling Arrangement was amended to exclude certain middle market business written by Mutual.

          As of January 1, 2005, the Pooling Arrangement was amended to add the Meridian Insurers as participants. In conjunction with this amendment, the STFC Pooled Companies received $54.0 million in cash from the Meridian Insurers which related to the additional net insurance liabilities assumed on January 1, 2005.

17

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

Management’s Discussion and Analysis of Financial Condition and Results of Operations, Continued

          The following table sets forth a chronology of the participant and participant percentage changes that have occurred in the Pooling Arrangement since January 1, 2002:

(1)

Time period is for the year ended December 31, unless otherwise noted.

          State Auto P&C provides employees to the Company and the Affiliates. This is contractually provided for under the following management and/or cost sharing agreements: 1) the “2000 Management Agreement” to which State Auto P&C, Mutual, Milbank, SA Ohio and SA National are parties; and 2) the “Midwest Management Agreement” to which State Auto P&C, Mutual and SA Wisconsin are parties. During 2004, there also existed the following management and/or cost sharing agreements: (A) the “MIGI Management Agreement” to which State Auto P&C, MIGI, the Meridian Insurers and an insurance company sold by Meridian Security in October 2004, were parties; and (B) the “Farmers Management Agreement” to which Mutual, State Auto P&C, Farmers and Mid-Plains were parties. The Midwest Management Agreement provides for a management fee based on a percentage of SA Wisconsin’s direct written premiums collected by the Company for the services State Auto P&C provides. The MIGI Management Agreement provided for a management fee equal to a percentage of the allocable employee expenses attributable to the operations of these companies paid to the Company for the services State Auto P&C provides. Each of the foregoing management or cost sharing agreements also apportions or apportioned among the parties the actual costs of the services provided.

          Subject to regulatory approval, the 2000 Management Agreement has been amended and restated as of January 1, 2005, as the “2005 Management Agreement,” and Meridian Security, Meridian Citizens Mutual and Farmers will become parties. As of this same date, the MIGI Management Agreement and the Farmers Management Agreement will be terminated.

		100% owned non-insurance subsidiaries (direct and indirect) of State Auto Financial include:
	•	Stateco Financial Services, Inc. (“Stateco”)
	•	Strategic Insurance Software, Inc. (“S.I.S.”)
	•	518 Property Management and Leasing, LLC (“518 PML”)

          Stateco provides investment management services to the Company and Affiliates, which comprise the Company’s investment management services segment. S.I.S. 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 insurance agencies and nonaffiliated insurers. It also delivers its services and sells its products to the Affiliates. 518 PML is engaged in the business of owning and leasing real and personal property to the Affiliates. The members of 518 PML are State Auto P&C and Stateco. The results of operations of S.I.S. and 518 PML are not material to the total operations of the Company.

Significant Transactions Summary

          The following is a summary of significant transactions that occurred during 2002 through 2004 that will assist in the discussion of the Company’s current period financial results:

          For the period October 1, 2001 through December 31, 2003, Mutual entered into a stop loss reinsurance arrangement (the “Stop Loss”) with the STFC Pooled Companies. Under the Stop Loss, Mutual agreed to participate in the Pooling Arrangement’s quarterly underwriting losses and gains in the manner described. If the Pooling Arrangement’s quarterly statutory loss and loss adjustment expense ratio (the “Pool loss and LAE ratio”) was between 70.75% and 80.00% (after the application of all available reinsurance), Mutual reinsured the STFC Pooled Companies 27% of the Pooling Arrangement’s losses in excess of a Pool loss and LAE ratio of 70.75% up to 80.00%. The STFC Pooled Companies were responsible for their share of the Pooling Arrangement’s losses over the 80.00% threshold. Also, Mutual had the right to participate in the profits of the Pooling Arrangement. Mutual assumed 27% of the Pooling Arrangement’s underwriting profits attributable to Pool loss and LAE ratios less than 69.25%, but more than 59.99%. The Stop Loss arrangement expired at December 31, 2003, and was not renewed.

          On November 13, 2003 State Auto Financial issued $100.0 million unsecured 6.25% senior notes. State Auto Financial used the proceeds from these debt instruments to contribute additional paid-in capital to its insurance subsidiaries as follows: $39.0 million to State Auto P&C, $30.0 million to SA National and $15.0 million to Milbank. Milbank used the $15.0 million additional paid-in capital contribution to repay its $15.0 million surplus note with Meridian Security. State Auto Financial also used these proceeds to repay $15.0 million of its bank debt and invested the remaining amount in fixed maturity and equity securities.

18

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

Management’s Discussion and Analysis of Financial Condition and Results of Operations, Continued

Critical Accounting Policies

          The Company’s significant accounting policies are more fully described in Note 15 of the Notes to the Company’s Consolidated Financial Statements included in Item 8 of this Form 10-K. 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 claimants, based on known facts, circumstances and historical trends. 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 by claims adjusters 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 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. Generally, reported losses initially reserved on a formula basis and not settled after six months, are case reserved at that time. Although management uses many internal and external resources, as well as multiple established methodologies to calculate reserves, there is no method for determining the exact 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 for computing the 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 expected 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.

          Pension and postretirement benefit obligations are long term in nature and require management judgment in estimating the factors used to determine these amounts. Management, along with its defined benefit consulting actuary, reviews these factors, including the discount rate and expected long term rate of return on plan assets among other factors. Because these obligations are based upon management estimates which could change given available information, the ultimate benefit obligation could be different from the amount estimated.

          Fixed maturity and equity security investments are classified as available for sale and 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. Investment income is recognized when earned, and capital gains and losses are recognized when investments are sold.

          The Company regularly monitors its investment portfolio for declines in value that are other than temporary, an assessment that requires significant management judgment. Among the factors management considers are the nature of the investment, severity and length of decline in fair value, events impacting the issuer, and overall market conditions. When a security in the Company’s investment portfolio has been determined to have a decline in fair value that is other than temporary, the Company adjusts the cost basis of the security to fair value. This results in a charge to earnings as a realized loss, which is not changed for subsequent recoveries in fair value. Future increases or decreases in fair value, if not other than temporary, are included in other comprehensive income.

          See a discussion of other factors that may have an impact on management’s best estimates at “Impact of Significant External Factors” included in this Item 7.

Note on Reportable Segments

          In June 2001, Mutual merged with Meridian Mutual Insurance Company (“Meridian Mutual”), with Mutual continuing as the surviving corporation. With the 2001 merger, all insurance business written by Meridian Mutual legally became the business of Mutual and was included in the Pooling Arrangement as of July 1, 2001. Due to the integration efforts by management of the Meridian book of business, on January 1, 2004, the Meridian Standard segment was included in the State Auto Standard segment; likewise, on January 1, 2003, the Meridian Nonstandard segment was included in the State Auto Nonstandard segment as these Meridian segments no longer met the quantitative thresholds for separate presentation as reportable segments. The 2003 and 2002 disclosures in this Item 7 have been revised to reflect this change. See Note 15 of the Notes to the Company’s Consolidated Financial Statements included in Item 8 regarding the Company’s operating segments in the consolidated financial statements of the Company.

19

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

Management’s Discussion and Analysis of Financial Condition and Results of Operations, Continued

Results of Operations

Summary

          The following table summarizes certain key performance indicators used to manage the operations of the Company for the years ended December 31, 2004, 2003, and 2002, respectively:

(1)		Definition follows
(2)		The Company uses the statutory net premiums written to surplus ratio because there is no comparable GAAP measure. This ratio, also called the leverage ratio, measures the Company’s statutory surplus available to absorb losses.

          The Company’s reportable segments are State Auto standard insurance, State Auto nonstandard insurance, and investment management services. The profits of these segments are monitored by management on an unconsolidated basis and therefore do not reflect adjustments for transactions with other segments or realized gains or losses on sales of investments.

          The following table reflects segment profits for the years ended December 31, 2004, 2003, and 2002, respectively:

          The reader is referred to the complete disclosure on reportable segments in Note 15, Reportable Segments, of the Notes to the Company’s Consolidated Financial Statements included in Item 8 of this Form 10-K.

          The investment management services segment reflects management of the investment portfolios of affiliate companies. Its significant source of segment profit is the fee generated from providing this service. The relative stable improvement in profit over the years is attributable to the combined growth of the investment portfolios managed along with fair value improvement. This segment’s revenue is based on the average fair value of the portfolios managed.

          A necessary discipline of a successful property and casualty insurance company is to produce an underwriting profit. When underwriting is not profitable, premiums are inadequate to pay for insurance losses and related acquisition and operating expenses. When an insurance company operates at an underwriting loss, net investment income may enable an insurance company to produce income. However, if an underwriting loss persists over an extended period of time, the insurance company puts itself at risk as a going concern. The Company has consistently focused on this underwriting objective and therefore views its underwriting results as a critical component of its overall performance.

          The Company monitors the profitability of its insurance segments by utilizing certain components of segment profit that are characteristic within the property and casualty insurance industry, namely underwriting profit and combined ratio. Underwriting profit under Statutory Accounting Principles (“SAP”) is determined by subtracting from earned premiums, losses and loss expenses and net underwriting expenses incurred. SAP requires

20

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

Management’s Discussion and Analysis of Financial Condition and Results of Operations, Continued

all underwriting expenses to be expensed immediately and not deferred over the same period that the premium is earned. Generally Accepted Accounting Principles (“GAAP”), however, permits the recognition of acquisition costs as the premiums are earned. In converting SAP underwriting results to GAAP underwriting results, acquisition costs are deferred through the capitalization of deferred policy acquisition costs and amortized over the periods the related premiums written are earned. See the discussion of deferred policy acquisition costs under “Critical Accounting Policies” included in this Item 7. The “GAAP Combined Ratio” is defined as the sum of the “GAAP loss and LAE ratio” (loss and loss expenses, as a percentage of earned premiums) plus “GAAP expense ratio” (acquisition and operating expenses, as a percentage of earned premiums). When the combined ratio is greater than 100%, the insurer is operating at an underwriting loss. When the combined ratio is less than 100%, the insurer is operating at an underwriting profit.

          The following tables provide a reconciliation to the insurance segments’ GAAP net underwriting profit (loss), GAAP Combined Ratio along with related segment net investment income, for the years 2004, 2003 and 2002, respectively. The tabular information provided does not reflect adjustments for transactions with other segments.