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, 2002
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
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)
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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:
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. _____
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
On June 28, 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 $208,937,312.
On March 21, 2003, the Registrant had 39,162,572 Common Shares outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the Registrant's Proxy Statement relating to the annual meeting of shareholders to be held May 23, 2003, which Proxy Statement will be filed within 120 days of December 31, 2002, are incorporated by reference in Part III, Items 10, 11, 12 and 13 of this report.
IMPORTANT INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
All statements, other than statements of historical facts, included in this Form 10-K of State Auto Financial 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 Item 7 "Forward-Looking Statements; Certain Factors Affecting Future Results." 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 Corporation ("State Auto Financial" or "STFC") 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 wholly-owned subsidiaries, State Auto Property and Casualty Insurance Company ("State Auto P&C"), Milbank Insurance Company ("Milbank"), Farmers Casualty Insurance Company ("Farmers Casualty"), State Auto Insurance Company of Ohio ("SA Ohio"), and State Auto National Insurance Company ("National"). Farmers Casualty owns 100% of the outstanding common shares of the property-casualty insurer, Mid-Plains Insurance Company ("Mid-Plains").
Approximately 67% 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 the outstanding common shares of property-casualty insurers, State Auto Florida Insurance Company ("SA Florida") and State Auto Insurance Company of Wisconsin ("SA Wisconsin"), formerly named Midwest Security Insurance Company. Mutual is also the sole owner of Meridian Insurance Group, Inc. ("MIGI"), an insurance holding company with two wholly-owned property and casualty insurance subsidiaries: Meridian Security Insurance Company ("Meridian Security") and Meridian Citizens Security Insurance Company ("Meridian Citizens"). 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. Another of MIGI's insurance subsidiaries, Insurance Company of Ohio ("ICO"), was dissolved effective January 15, 2003. MIGI is also a party to an affiliation agreement with the property-casualty insurer, Meridian Citizens Mutual Insurance Company ("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."
Another wholly-owned subsidiary of STFC is Stateco Financial Services, Inc. ("Stateco"), which provides investment management services to affiliated insurance companies. See "Investment Management Services" in the "Narrative Description of Business." STFC also owns Strategic Insurance Software, Inc. ("S.I.S."), a developer and seller of insurance-related software. The limited liability company, 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 operations of S.I.S. and 518 PML are insignificant to the total operations of STFC.
State Auto Financial and its subsidiaries, State Auto P&C, Milbank, Farmers Casualty, SA Ohio, National, Mid-Plains, Stateco, S.I.S., and 518 PML, are collectively referred to as the "Company."
State Auto P&C has participated in a quota share reinsurance pooling
arrangement with Mutual since 1987 (the "Pooling Arrangement"). The participants
in the Pooling Arrangement currently are State Auto P&C, Mutual, Milbank, SA
Wisconsin, Farmers Casualty, SA Ohio, and SA Florida, collectively referred to
hereafter as the "Pooled Companies." State Auto P&C, Milbank, Farmers Casualty
and SA Ohio are collectively referred to hereafter as the "Pooled Subsidiaries."
Effective January 1, 2003, the pooling percentages were modified as follows:
Mutual (18.3%), State Auto P&C (59%), Milbank (17%), SA Wisconsin (1%), Farmers
Casualty (3%), SA Ohio (1%) and becoming party to the agreement on this same
date, SA Florida (0.7%). 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."
The insurers in the State Auto Group write a broad line of property and casualty insurance, including standard personal and commercial automobile; nonstandard personal automobile; homeowners; commercial multi-peril; workers' compensation; general liability and fire insurance through approximately 22,300 independent insurance agents associated with approximately 3,500 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.
(b) FINANCIAL INFORMATION ABOUT SEGMENTS
The Company currently operates in four insurance segments. Prior to 2001, it operated in two segments: the standard insurance segment, consisting of the business operations of the Pooled Subsidiaries, and the nonstandard segment, consisting of the business operations of National and Mid-Plains. With the merger of Meridian Mutual into Mutual and the July 1, 2001, addition of the former Meridian Mutual business to the Pooling Arrangement (see "Pooling Arrangement" in "Narrative Description of Business"), the Company renamed the two existing insurance segments as the "State Auto Standard Segment" and the "State Auto Nonstandard Segment" and added two more insurance segments: the "Meridian Standard Segment," for the standard insurance business of the former Meridian Mutual, and the "Meridian Nonstandard Segment," for the nonstandard insurance business of the former Meridian Mutual. Financial information about all these segments is set forth in Note 15 to the Company's Consolidated Financial Statements, included in Item 8 "Financial Statements and Supplementary Data." 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 under the Reinsurance Pooling Agreement Amended and Restated as of January 1, 2000, as amended by the First, Second, Third and Fourth Amendments (the "2000 Pooling Agreement"). The Pooling Arrangement covers all the property and casualty insurance written by the parties, except voluntary assumed reinsurance written by Mutual and catastrophe inter-company reinsurance written by State Auto P&C. Under the terms of the Pooling Arrangement, each of the Pooled Subsidiaries, SA Wisconsin and SA Florida cede premiums, losses and expenses on all of their business to Mutual; in turn, Mutual cedes to each of the Pooled Subsidiaries, SA Wisconsin and SA Florida a specified portion of premiums, losses and expenses and Mutual retains the balance.
The following table sets forth a chronology of the participant changes that have occurred in the Pooling Arrangement since it became effective on January 1, 1987:
------------------ -------- ----------- --------- --------------- ----------- -------- ----------
State Farmers SA
Year *** Mutual Auto P&C Milbank SA Wisconsin Casualty SA Ohio Florida
------------------ -------- ----------- --------- --------------- ----------- -------- ----------
1987-1991 80% 20% N/A N/A N/A N/A N/A
------------------ -------- ----------- --------- --------------- ----------- -------- ----------
1992-1994 70 30 N/A N/A N/A N/A N/A
------------------ -------- ----------- --------- --------------- ----------- -------- ----------
1995-1997 55 35 10* N/A N/A N/A N/A
------------------ -------- ----------- --------- --------------- ----------- -------- ----------
1998 52 37 10** 1 N/A N/A N/A
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1999 49 37 10 1 3 N/A N/A
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2000-9/30/2001 46 39 10 1 3 1 N/A
------------------ -------- ----------- --------- --------------- ----------- -------- ----------
10/1/2001-2002 19 59 17 1 3 1 N/A
------------------ -------- ----------- --------- --------------- ----------- -------- ----------
2003 18.3 59 17 1 3 1 0.7
------------------ -------- ----------- --------- --------------- ----------- -------- ----------
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* At this time Milbank was a wholly owned subsidiary of Mutual
** In July, 1998 Milbank became a wholly owned subsidiary of STFC
*** Time period is for the year ended December 31, unless otherwise noted.
The following table sets forth a summary of the Pooling Arrangement participant percentages of STFC and Mutual, aggregating their respective wholly-owned subsidiaries:
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Mutual (in the
Year*** Pooled Subsidiaries aggregate)
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1987-1991 20% 80%
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1992-1994 30 70
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1995-1997 35 65
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1/1/1998-6/30/1998 37 63
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7/1/1998-12/31/1998 47 53
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1999 50 50
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2000 - 9/30/2001 53 47
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10/1/2001-2003 80 20
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*** Time period is for the year ended December 31, unless otherwise noted.
With the June 2001 merger of Meridian Mutual into Mutual, all insurance business written by Meridian Mutual legally became the business of Mutual and was included in the Pooling Arrangement effective July 1, 2001. Representing approximately 20% of the Pooled Companies' business, the former Meridian Mutual business is monitored as standard and nonstandard segments separate from the State Auto standard and nonstandard business. Over time, it is anticipated that the Meridian segments will decrease and eventually disappear as those segments are fully integrated over to the State Auto systems platform. See "Standard Insurance Segment" and "Nonstandard Insurance Segment" in "Narrative Description of Business."
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 Pooled Subsidiaries aggregate participation percentage in the foreseeable future. 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 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.
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 excluding catastrophic loss claims and loss adjustment expenses incurred by the parties in the amount of $100 million in excess of $120 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. See "Reinsurance" in the "Narrative Description of Business."
The direct business of the Meridian Insurers is not included in the Pooling Arrangement and to that extent is not included in the insurance operations of the Company. If State Auto P&C were required to pay catastrophe losses of the Meridian Insurers under the above referenced Catastrophe Assumption Agreement, those losses would impact the Company's results.
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. For the performance of its services under three of the management agreements, State Auto P&C is paid a quarterly management and operations services fee based on formulas outlined in the agreements, to the extent specified performance standards are achieved. 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. Pursuant to the 2000 Farmers Casualty 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 operation services performed by State Auto P&C's employees. Under the Management Services Agreement among State Auto P&C, MIGI and the Meridian Insurers (the "MIGI Management Agreement"), each of the Meridian Companies (other than ICO) pays State Auto P&C 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.
While there had been in place a fee under an agreement between State Auto P&C and Mutual (the "2000 Management Agreement"), as a result of the resolution of a disagreement with the Ohio Department of Insurance, the fee aspect of that agreement was terminated, effective October 1, 2001, and that arrangement continues as a pure cost sharing arrangement. 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 was eliminated effective October 1, 2001. Consequently, beginning with the first quarter 2002, the management and operations services segment is included in the "other" category for segment reporting as the results of this segment no longer meet the quantitative thresholds for separate presentation as a reportable segment.
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 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."
STANDARD INSURANCE SEGMENTS
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.
The following tables set forth the statutory loss and loss adjustment
expense ("LAE") ratios by line of insurance and the combined ratio for the
standard insurance segments of the Company's business. These tables were
prepared in accordance with accounting practices prescribed or permitted by
state insurance authorities, for the periods indicated. The loss & LAE ratio is
the ratio of incurred losses and loss adjustment expenses, without consideration
of salvage and subrogation recoverable, to net earned premiums ("loss & LAE
ratio"). The combined ratio is a traditional measure of underwriting
profitability. The combined ratio is the sum of (a) the loss & LAE 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 considered unprofitable. The combined ratio does
not reflect investment income or federal income taxes. The Company's operating
income depends on income from underwriting operations, investments and
management fees, although management fee income is substantially reduced after
October 1, 2001. See "Management Agreement" in the "Narrative Description of
Business."
The following table sets forth the aggregate statutory loss & LAE 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)
------------------------------------ --------------- ---------------------- --------------------
2002 2001 2000
---- ---- ----
------------------------------------ --------------- ---------------------- --------------------
Loss & LAE ratios:
------------------------------------ --------------- ---------------------- --------------------
Automobile - Personal......... 68.8% 69.7% 63.9%
------------------------------------ --------------- ---------------------- --------------------
Automobile - Commercial....... 66.5% 90.1% 81.7%
------------------------------------ --------------- ---------------------- --------------------
Homeowners and Farmowners..... 85.1% 85.8% 78.8%
------------------------------------ --------------- ---------------------- --------------------
Commercial multi-peril........ 89.9% 100.4% 63.0%
------------------------------------ --------------- ---------------------- --------------------
Workers' compensation......... 83.7% 105.2% 65.2%
------------------------------------ --------------- ---------------------- --------------------
Fire and allied lines......... 58.9% 62.9% 58.8%
------------------------------------ --------------- ---------------------- --------------------
Other commercial liability.... 77.7% 58.2% 80.7%
------------------------------------ --------------- ---------------------- --------------------
Other personal lines.......... 37.4% 42.5% 34.6%
------------------------------------ --------------- ---------------------- --------------------
Other commercial lines........ 19.3% 27.1% 9.7%
----- ----- ----
------------------------------------ --------------- ---------------------- --------------------
Total loss & LAE ratio.............. 72.5% 76.2% 67.6%
------------------------------------ --------------- ---------------------- --------------------
Expense ratio....................... 30.2% 28.3% 27.1%
----- ----- -----
------------------------------------ --------------- ---------------------- --------------------
Combined ratio...................... 102.7% 104.5% 94.7%
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(1) Reflects a combination of the loss experience of the Pooled Subsidiaries after giving effect to reinsurance and the 2000 Pooling Agreement.
The following tables provide the statutory loss and LAE 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)
------------------------------------ --------------------------------------------------------------
2002 2001 2000
---- ---- ----
------------------------------------ ------------------ ---------------------- --------------------
Loss & LAE ratios:
------------------------------------ ------------------ ---------------------- --------------------
Automobile - Personal ........ 67.5% 62.5% 63.9%
------------------------------------ ------------------ ---------------------- --------------------
Automobile - Commercial....... 63.5% 75.9% 81.7%
------------------------------------ ------------------ ---------------------- --------------------
Homeowners and Farmowners..... 81.1% 79.5% 78.8%
------------------------------------ ------------------ ---------------------- --------------------
Commercial multi-peril........ 80.8% 74.4% 63.0%
------------------------------------ ------------------ ---------------------- --------------------
Workers' compensation......... 84.4% 69.9% 65.2%
------------------------------------ ------------------ ---------------------- --------------------
Fire and allied lines......... 58.8% 62.8% 58.8%
------------------------------------ ------------------ ---------------------- --------------------
Other commercial liability.... 78.8% 54.5% 80.7%
------------------------------------ ------------------ ---------------------- --------------------
Other personal lines.......... 30.5% 44.1% 34.6%
------------------------------------ ------------------ ---------------------- --------------------
Other commercial lines........ 26.2% 27.8% 9.7%
----- ----- -----
------------------------------------ ------------------ ---------------------- --------------------
Total loss & LAE ratio............. 69.6% 66.3% 67.6%
------------------------------------ ------------------ ---------------------- --------------------
Expense ratio....................... 30.0% 28.4% 27.1%
----- ----- -----
------------------------------------ ------------------ ---------------------- --------------------
Combined ratio...................... 99.6% 94.7% 94.7%
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------------------------------------ ------------------ ---------------------- --------------------
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(1) Reflects a combination of the loss experience of the Pooled Subsidiaries after giving effect to reinsurance and the 2000 Pooling Agreement.
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Meridian Standard Segment Year Ended December 31(1)
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2002 2001
---- ----
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Loss & LAE ratios:
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Automobile - Personal ................... 75.1% 122.5%
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Automobile - Commercial.................. 76.5% 153.7%
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Homeowners and Farmowners................ 106.5% 136.3%
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Commercial multi-peril................... 107.5% 171.6%
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Workers' compensation.................... 82.7% 165.4%
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Fire and allied lines.................... 60.8% 66.9%
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Other commercial liability............... 50.0% 214.5%
----------------------------------------------- -------------------------- --------------------------
Other personal lines..................... 70.1% 27.1%
----- -----
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Total loss & LAE ratio......................... 85.5% 139.6%
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Expense ratio.................................. 31.3% 27.8%
----- -----
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Combined ratio................................. 116.8% 167.4%
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(1) Reflects the loss experience of the Meridian standard segment assumed by the Pooled Subsidiaries through the 2000 Pooling Agreement, beginning July 1, 2001.
NONSTANDARD INSURANCE SEGMENTS
The Company writes personal automobile insurance for nonstandard risks through National and Mid-Plains. National is licensed in 24 states and active in 19 of those states. Mid-Plains operates in Kansas and Iowa.
Existing nonstandard auto risks 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, and by the end of 2002 had been rolled out to all Meridian nonstandard states of operations. As a result of the Company's integration efforts that occurred within the Meridian nonstandard segment during 2001 and 2002, the Meridian nonstandard segment will be included in the State Auto nonstandard segment beginning with the first quarter of 2003.
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 for various reasons, such as an insured's poor loss experience, poor driving record, or history of late payments of premium. Nonstandard products are priced to account for the additional risk and expenses normally associated with this market.
The following table provides the statutory loss & LAE 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:
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Nonstandard Insurance Segments
Year Ended December 31(1)
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2002 2001 2000
---- ---- ----
------------------------------------------------ -------------------- ------------------- -----------------
Loss & LAE ratio:
------------------------------------------------ -------------------- ------------------- -----------------
Automobile................................. 79.0% 92.0% 81.4%
------------------------------------------------ -------------------- ------------------- -----------------
Expense ratio................................... 19.2% 21.7% 25.2%
----- ----- -----
------------------------------------------------ -------------------- ------------------- -----------------
Combined ratio.................................. 98.2% 113.7% 106.6%
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(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 and LAE ratios and combined ratios of National and Mid-Plains, which are engaged in the State Auto nonstandard segment of the business, and beginning July 1, 2001, the Meridian nonstandard segment, respectively:
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State Auto Nonstandard Segment
Year Ended December 31(1)
------------------------------------------------ ----------------------------------------------------------
2002 2001 2000
---- ---- ----
------------------------------------------------ -------------------- ------------------- -----------------
Loss & LAE ratio:
------------------------------------------------ -------------------- ------------------- -----------------
Automobile................................. 83.0% 77.9% 81.4%
------------------------------------------------ -------------------- ------------------- -----------------
Expense ratio................................... 18.3% 21.9% 25.2%
----- ----- -----
------------------------------------------------ -------------------- ------------------- -----------------
Combined ratio.................................. 101.3% 99.8% 106.6%
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(1) Reflects the combination of the loss experience of National and Mid-Plains.
------------------------------------------------- ----------------- ---------------------------
Meridian Nonstandard Segment
Year Ended December 31(1)
------------------------------------------------- ---------------------------------------------
2002 2001
---- ----
------------------------------------------------- ----------------- ---------------------------
Loss & LAE ratio:
------------------------------------------------- ----------------- ---------------------------
Automobile.................................. 48.7% 168.2%
------------------------------------------------- ----------------- ---------------------------
Expense ratio.................................... 31.9% 20.8%
----- -----
------------------------------------------------- ----------------- ---------------------------
Combined ratio................................... 80.6% 189.0%
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(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 22,300 insurance agents associated with approximately 3,500 independent insurance agencies. None of the companies in the State Auto Group has any contracts with managing general agencies.
National markets nonstandard products in 19 states exclusively through the Company's network of independent agents. Mid-Plains writes nonstandard auto insurance in Iowa and Kansas through the agency network of Farmers Casualty in those states, and the Mid-Plains business is processed on 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 has been introduced to these "former Meridian agents." 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; 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 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 attracts prospective agents and 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 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 broker.
The Company receives premiums on products marketed in Alabama, 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 2002, the seven states that contributed the greatest percentage of direct premiums written by the State Auto Group were: Ohio (18.3%), Kentucky (12.0%), Indiana (8.5%), Tennessee (6.8%), Minnesota (6.1%), Pennsylvania (5.3%), and South Carolina (4.1%).
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 $100,000 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 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 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 allows the Company to improve claims efficiency and economy by concentrating the handling of smaller, less complex claims in a centralized environment. The claims division also provides 24 hour, 7 days a week claim service through associates in its Contact Center.
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, 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 "Management's Discussion and Analysis" 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, 2002, there has been no adverse development of these reserves. In the event Mutual becomes financially impaired, and subject to regulatory restrictions, it may be unable to make any such reimbursement.
The following table presents one-year development information on changes in the reserve for loss and loss expenses of the Company for the three years ended December 31, 2002:
--------------------------------------------------------------- -----------------------------------------------------
Year Ended December 31
--------------------------------------------------------------- -----------------------------------------------------
2002 2001 2000
---- ---- ----
--------------------------------------------------------------- -----------------------------------------------------
(in thousands)
--------------------------------------------------------------- ----------------- ---------------- ------------------
Beginning of Year:
--------------------------------------------------------------- ----------------- ---------------- ------------------
Loss and loss expenses payable $523,860 $244,583 $232,489
--------------------------------------------------------------- ----------------- ---------------- ------------------
Less: Reinsurance recoverable on losses and loss
expenses payable(1) 13,919 7,930 10,807
------ ----- ------
--------------------------------------------------------------- ----------------- ---------------- ------------------
Net losses and loss expenses payable(2) $509,941 $236,653 $221,682
--------------------------------------------------------------- ----------------- ---------------- ------------------
Provision for losses and loss
--------------------------------------------------------------- ----------------- ---------------- ------------------
expenses occurring:
--------------------------------------------------------------- ----------------- ---------------- ------------------
Current year 641,060 366,348 277,805
--------------------------------------------------------------- ----------------- ---------------- ------------------
Prior years(3) 12,414 60,726 (5,638)
------ ------ ------
--------------------------------------------------------------- ----------------- ---------------- ------------------
Total 653,474 427,074 272,167
--------------------------------------------------------------- ----------------- ---------------- ------------------
Loss and loss expense payments
--------------------------------------------------------------- ----------------- ---------------- ------------------
for claims occurring during:
--------------------------------------------------------------- ----------------- ---------------- ------------------
Current year 349,733 240,508 164,620
--------------------------------------------------------------- ----------------- ---------------- ------------------
Prior years 221,549 144,862 104,871
------- ------- -------
--------------------------------------------------------------- ----------------- ---------------- ------------------
Total 572,282 385,370 269,491
--------------------------------------------------------------- ----------------- ---------------- ------------------
Impact of the addition of the former Meridian Mutual
--------------------------------------------------------------- ----------------- ---------------- ------------------
business to the Pooling Arrangement, effective
--------------------------------------------------------------- ----------------- ---------------- ------------------
7/1/01 - 75,575 -
--------------------------------------------------------------- ----------------- ---------------- ------------------
Impact of pooling change effective 10/1/01 and 1/1/00 (4) - 156,009 12,295
------- ------- ------
--------------------------------------------------------------- ----------------- ---------------- ------------------
End of Year:
--------------------------------------------------------------- ----------------- ---------------- ------------------
Net losses and loss expenses payable(1) 592,133 509,941 236,653
--------------------------------------------------------------- ----------------- ---------------- ------------------
Add: Reinsurance recoverable on losses and loss
expenses payable(2) 8,825 13,919 7,930
----- ------ -----
--------------------------------------------------------------- ----------------- ---------------- ------------------
Losses and loss expenses payable $600,958 $523,860 $244,583
======== ======== ========
--------------------------------------------------------------- ----------------- ---------------- ------------------
|
(1) Includes amounts due from affiliates of $4,286, $8,867 and $2,111, respectively.
(2) Includes net amounts assumed from affiliates of $303,959, $280,011 and $10,126, 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 increase of $12,414 in 2002 for claims occurring in prior years is well within normal expectations for reserve development and claim settlement uncertainty. The increase of $60,726 in 2001 for claims occurring in prior years is primarily the result of reserve strengthening 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 decrease in calendar year losses from prior years in 2000 of $5,638 is within a normal expectation of reserve variation.
(4) 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 and January 1, 2000, respectively. See "Pooling Arrangement" in "Narrative Description of Business."
The following table sets forth the development of reserves for losses and loss expenses from 1992 through 2002 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, 2002, the Company had paid 72.7% of the currently estimated losses and loss expenses that had been incurred, but not paid, as of December 31, 1992.
The amounts on the "cumulative redundancy (deficiency)" line represent the aggregate change in the estimates over all prior years. For example, the 1992 reserve has developed a $17,765 million redundancy through December 31, 2002. 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.
In 1992, 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 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.]
State Auto Financial Corp.
Years Ended December 31
------------------------------------------------------------------------------
1992 1993 1994 1995 1996
(Dollars in Thousands)
Net liability for losses
and loss expenses payable $119,044 $123,337 $126,743 $206,327 $199,480
Paid (cumulative)
as of:
One year later 41.3% 42.2% 1.5% 38.2% 39.4%
Two years later 60.9% 41.3% 29.1% 55.4% 54.1%
Three years later 60.6% 55.6% 44.5% 63.3% 65.0%
Four years later 68.0% 64.5% 51.0% 67.7% 73.2%
Five years later 71.9% 67.2% 54.6% 71.9% 69.8%
Six years later 72.5% 69.0% 58.8% 67.1% 74.6%
Seven years later 73.7% 72.1% 52.3% 69.3%
Eight years later 75.2% 67.0% 54.4%
Nine years later 71.5% 68.4%
Ten years later 72.7%
Net liability re-estimate
as of:
One year later 92.7% 93.7% 87.4% 87.0% 91.3%
Two years later 90.5% 90.0% 77.1% 86.4% 87.3%
Three years later 87.6% 85.0% 77.0% 83.2% 86.7%
Four years later 85.6% 86.3% 72.9% 81.6% 87.0%
Five years later 87.3% 82.8% 70.9% 81.3% 92.6%
Six years later 84.5% 81.6% 70.0% 83.6% 92.9%
Seven years later 83.0% 80.8% 72.6% 83.7%
Eight years later 82.0% 83.6% 72.8%
Nine years later 84.7% 83.8%
Ten years later 85.1%
Cumulative redundancy (deficiency) $17,765 $19,933 $34,440 $33,689 $14,196
Cumulative redundancy (deficiency) 14.9% 16.2% 27.2% 16.3% 7.1%
Gross* liability - end of year $224,771 $245,929 $277,783 $412,553 $410,658
Reinsurance recoverable $105,727 $122,591 $151,040 $206,226 $211,178
Net liability - end of year $119,044 $123,337 $126,743 $206,327 $199,480
Gross liability re-estimated - latest 96.4% 100.8% 93.2% 84.9% 93.3%
Reinsurance recoverable re-estimated - latest 109.1% 117.9% 110.3% 86.2% 93.7%
Net liability re-estimated - latest 85.1% 83.8% 72.8% 83.7% 92.9%
* Gross liability includes: Direct & assumed losses & loss expenses payable.
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 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:
|
Reinsurance recoverable $105,727 $122,591 $151,040 $206,226 $211,178 Amount netted against assumed from Mutual $99,096 $115,945 $142,680 $193,367 $194,839 Net reinsurance recoverable $6,631 $6,646 $8,360 $12,859 $16,339 |
State Auto Financial Corp.
Years Ended December 31
--------------------------------------------------------------------------------
1997 1998 1999 2000 2001 2002
(Dollars in Thousands)
Net liability for losses
and loss expenses payable $194,155 $205,034 $221,682 $236,653 $509,941 $592,133
Paid (cumulative)
as of:
One year later 32.7% 35.4% 41.8% 5.9% 43.4% ---
Two years later 54.6% 61.6% 43.0% 52.7%
Three years later 70.1% 62.1% 71.9%
Four years later 69.2% 78.8%
Five years later 77.1%
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Net liability re-estimate
as of:
One year later 93.0% 96.6% 97.5% 125.7% 102.4% ---
Two years later 92.0% 96.7% 119.1% 129.1%
Three years later 91.9% 111.9% 120.3%
Four years later 102.0% 111.5%
Five years later 101.4%
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Cumulative redundancy (deficiency) -$2,784 -$23,629 -$44,947 -$68,903 -$12,414 ---
Cumulative redundancy (deficiency) -1.4% -11.5% -20.3% -29.1% -2.4% ---
Gross* liability - end of year $402,718 $414,268 $438,748 $457,202 $743,710 $862,428
Reinsurance recoverable $208,563 $209,234 $217,065 $220,544 $233,769 $270,295
Net liability - end of year $194,155 $205,034 $221,682 $236,657 $509,941 $592,133
Gross liability re-estimated - latest 98.3% 107.2% 109.9% 114.6% 101.2%
Reinsurance recoverable re-estimated - latest 95.3% 102.9% 99.3% 99.0% 98.5%
Net liability re-estimated - latest 101.4% 111.5% 120.3% 129.1% 102.4%
|
Reinsurance recoverable $208,563 $209,234 $217,065 $220,544 $233,770 $270,295 Amount netted against assumed from Mutual $187,506 $196,818 $206,258 $212,614 $219,851 $261,470 Net reinsurance recoverable $21,057 $12,416 $10,807 $7,930 $13,919 $8,825 |
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"):
--------------------------------------------------------------------- ----------------- ------------------- ---------------------
2002 2001 2000
---- ---- ----
--------------------------------------------------------------------- ----------------- ------------------- ---------------------
(in thousands)
--------------------------------------------------------------------- -----------------------------------------------------------
GAAP losses and loss
expenses payable $600,958 $523,860 $244,583
--------------------------------------------------------------------- ----------------- ------------------- ---------------------
Less: ceded reinsurance recoverable
on losses and loss expenses payable 8,825 13,919 7,930
----- ------ -----
--------------------------------------------------------------------- ----------------- ------------------- ---------------------
Net losses and loss expenses payable 592,133 509,941 236,653
--------------------------------------------------------------------- ----------------- ------------------- ---------------------
Add: salvage and subrogation
recoverable 27,093 26,216 13,402
------ ------ ------
--------------------------------------------------------------------- ----------------- ------------------- ---------------------
STAT losses and loss
Expenses $619,226 $536,157 $250,055
======== ======== ========
--------------------------------------------------------------------- ----------------- ------------------- ---------------------
|
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 broker. Under the property per risk 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 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 motorists 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 $5.0 million of covered loss, and 95% of the excess over $5.0 million up to $10 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 million per loss occurrence.
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 $600,000 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 members of the State Auto Group combined retain the first $40 million of each property catastrophe occurrence that affects more than two individual risks. Eighty ($80) million dollars of traditional reinsurance is available above the $40 million retention with a co-participation of 5%.
In the event of a catastrophe loss in excess of $120.0 million for the State Auto Group, STFC has implemented a structured contingent financing agreement (the "Credit Agreement") with Bank One and other lenders (the "Lenders") to provide up to $100.0 million. Under the Credit Agreement, in the event of such a loss, STFC 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 the Lenders. STFC 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, SA Wisconsin, National, Farmers Casualty, Mid-Plains, SA Ohio, 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. STFC 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 is excluded from the Pooling Arrangement. In addition, STFC's obligation to repay the SPC has been secured by a Put Agreement among STFC, Mutual and the Lenders; under which, in the event of a default by STFC 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.
National has a reinsurance agreement with Mutual pursuant to which Mutual assumes up to $4,950,000 of each liability loss occurrence in excess of National's $50,000 of retention; and up to $450,000 of each catastrophe loss occurrence in excess of National's $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 assumes up to $450,000 of each liability loss occurrence in excess of Mid-Plains' $50,000 of retention.
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 loss and LAE ratio(the "Pool loss and LAE ratio") is between 70.75% and 80.00%, Mutual will reinsure certain of the 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%. Certain of the Pooled Companies would be responsible for its 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 a Pool loss and LAE ratio less than 69.25%, but more than 59.99%. This Stop Loss Reinsurance Arrangement will cease at the end of the fourth quarter, 2003.
See discussion regarding the federal Terrorism Risk Insurance Act of 2002 ("Terrorism Act") at Regulation section and Item 7 "Management's Discussion and Analysis" 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. Pursuant to these rules, a total of $35.3 million is available for payment to State Auto Financial as a dividend from State Auto P&C, Milbank, Farmers Casualty, SA Ohio and National during 2003 without prior approval from their domiciliary state insurance departments, under current law.
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 2002 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. Regulations or laws restricting the use of this information have an adverse impact on the Company because these laws impede the ability of the Company to make optimum use of credit scoring information. Such regulations would limit the ability of the Company, as well as the ability of all other insurance carriers operating in that jurisdiction, 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, 2002, 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 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 newly enacted 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.
Probably the most significant piece of legislation to affect the Company was not a state insurance law, but rather the federal Sarbanes-Oxley Act of 2002 ("Sarbanes Oxley"), which took effect in July 2002. While this law does not affect the Company's insurance operations, it has and will continue to have an effect on the Company. Sarbanes Oxley was the response of the Congress to the corporate scandals of the last two years. Sarbanes Oxley imposes significant new rules on the Company's corporate governance, its financial and reporting processes and its relationship with its independent auditor. Sarbanes Oxley will require the Company to increase the internal staff functions to ensure that it can demonstrate it is complying with these new legal requirements, which can be expected to have an adverse effect on the Company's expense ratio.
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. Prior to year-end 2002, the fixed maturity investments were classified as available for sale and carried at fair market value, or as held-to-maturity and carried at amortized cost according to the Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities." As of December 31, 2002, all fixed maturity investments have been classified as available for sale. Fixed maturities classified as available for sale totaled $1,216.7 million and $1,051.4 million at December 31, 2002 and December
31, 2001, respectively. Fixed maturities categorized as hold-to-maturity totaled $-0- and $27.4 million at December 31, 2002 and December 31, 2001, respectively.
At December 31, 2002 and 2001, respectively, the Company's equity portfolio totaled $53.7 million and $59.8 million.
The table below provides information about the quality and the scope of the Company's fixed maturity portfolio as of December 31, 2002:
-------------------------------- ------------------------ ------------- -------------------------- ---------------------------
Fair Market Value % of Quality* Amortized Cost Fair Market Value
Portfolio
-------------------------------- ------------------------ ------------- -------------------------- ---------------------------
Investment Grade -
Corporates and Municipals 72.0% AA+ $824,856 $876,333
-------------------------------- ------------------------ ------------- -------------------------- ---------------------------
U.S. Governments 2.8% AAA $31,207 $33,684
-------------------------------- ------------------------ ------------- -------------------------- ---------------------------
U.S. Government Agencies 25.2% AAA $293,271 $306,681
-------------------------------- ------------------------ ------------- -------------------------- ---------------------------
100.0% $1,149,334 $1,216,698
-------------------------------- ------------------------ ------------- -------------------------- ---------------------------
|
*As rated by Moody's Investors Service
The following table sets forth the Company's investment results for the periods indicated:
---------------------------------- --------------------------------------- ----------------------------- -------------------------
Year ended December 31
---------------------------------- -----------------------------------------------------------------------------------------------
2002 2001 2000
---- ---- ----
---------------------------------- --------------------------------------- ----------------------------- -------------------------
Average Invested Assets (1) $1,210,641 $870,864 $712,627
---------------------------------- --------------------------------------- ----------------------------- -------------------------
Net Investment Income (2) $59,691 $47,375 $38,915
---------------------------------- --------------------------------------- ----------------------------- -------------------------
Average Yield 4.9% 5.4% 5.5%
---------------------------------- --------------------------------------- ----------------------------- -------------------------
|
(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.
For additional discussion regarding the Company's investments, see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
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. Stateco has entered into an Investment Management Agreement with each of these entities, pursuant to which Stateco manages the investment portfolios of these companies and receives an investment management fee 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.
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.
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 are that mold claims will increase in the future. The Company believes that, under its insurance policies, the Company is not obligated to cover this kind of commonly occurring condition, particularly when remediation costs are extreme. Hence, to protect its current rate structure, the Company has filed mold limitations and exclusions on homeowner policies and certain commercial policies in all states that will accept such filings.
EMPLOYEES
As of March 13, 2003, the Company had 2,097 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.
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, as soon as reasonably practicable after STFC electronically files such material with the Securities and Exchange Commission.
EXECUTIVE OFFICERS OF THE REGISTRANT
Name of Executive Officer Principal Occupation(s) An Executive Officer
and Position(s) with Company Age During the Past Five Years of the Company Since (1)
---------------------------- --- -------------------------- ------------------------
Robert H. Moone, 59 Chairman of the Board of STFC and Mutual, 1/1/01 to 1991
Chairman, President and present; Chief Executive Officer of STFC and Mutual, 5/99
Chief Executive Officer 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, 51 Senior Vice President of STFC and Mutual, 3/01 to 1999
Senior Vice President 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, 43 Senior Vice President of STFC and Mutual, 8/99 to 1994
Senior Vice President, present; Treasurer and Chief Financial Officer of STFC
Treasurer and Chief and Mutual, 4/97 to present; Vice President of STFC and
Financial Officer Mutual, 5/95 to 8/99
John R. Lowther, 52 Senior Vice President of STFC and Mutual, 3/01 to 1991
Senior Vice President, present; Secretary and General Counsel of STFC, 5/91 to
Secretary and present and of Mutual 8/89 to present; Vice President of
General Counsel STFC, 5/91 to 3/01 and of Mutual 8/89 to 3/01
James E. Duemey, 56 Vice President and Investment Officer of STFC and Mutual, 1991
Vice President 5/91 to present
and Investment Officer
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Name of Executive Officer Principal Occupation(s) An Executive Officer
and Position(s) with Company Age During the Past Five Years of the Company Since (1)
---------------------------- --- -------------------------- ------------------------
William D. Hansen, 37 Vice President of Mutual, 3/00 to present; Vice President 2000
Vice President of STFC, 5/00 to present; Assistant Vice President of
Mutual 5/95 to 3/00
Steven R. Hazelbaker 47 Vice President of Mutual 6/01 to present; Vice President 2001
Vice President of STFC 6/01 to present; CFO and Treasurer of MIGI and
Meridian Mutual 1994 to 6/01; Vice President of MIGI and
Meridian Mutual 1995 to 6/01
Noreen W. Johnson, 54 Vice President of STFC and Mutual, 3/98 to present; 1998
Vice President Assistant Vice President of Mutual, 3/97 to 3/98;
employee of Mutual since 9/92
Robert A. Lett, 63 Vice President of STFC, 3/98 to present; Vice President 1994
Vice President of Mutual, 2/88 to present
John B. Melvin, 53 Vice President of STFC, 3/98 to present; Vice President 1994
Vice President of Mutual, 11/93 to present; and prior thereto an officer
of Mutual
Cathy B. Miley, (2) 53 Vice President of STFC, 3/98 to present; Vice President 1995
Vice President of Mutual, 3/95 to present; Assistant Secretary of
Mutual, 8/92 to 3/95
Richard L. Miley, (2) 49 Vice President of STFC, 3/98 to present; Vice President 1995
Vice President of Mutual, 5/95 to present; Assistant Vice President of
Mutual, 8/87 to 5/95
John M. Petrucci, 44 Vice President of Mutual, 3/00 to present; Vice President 2000
Vice President of STFC, 5/00 to present; employee of Mutual since 9/96
Cynthia A. Powell, 42 Vice President of Mutual, 3/00 to present; Assistant Vice 2000
Vice President 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
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(1) 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 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 that are owned by Mutual, including a 6,600 square foot branch office in Cleveland, Ohio; a 29,000 square foot branch office in Cincinnati, Ohio; and a 205,000 square foot regional office in Indianapolis, Indiana. In addition, 518 PML owns and leases to Mutual regional office facilities in Nashville, Tennessee; Greer, South Carolina; and Des Moines, Iowa. Milbank owns an office facility in Milbank, South Dakota, where Company employees provide services to Milbank agents and policyholders. SA Wisconsin leases an office facility in Onalaska, Wisconsin, where Company employees service SA Wisconsin's agents and policyholders. Mutual also leases space in Columbus, Ohio for a regional office and leases a number of small offices throughout its operating area for the claims operations of Mutual and the Company.
ITEM 3. LEGAL PROCEEDINGS
The Company is a party to a number of lawsuits arising in the ordinary course of its insurance business. Management of the Company believes that the ultimate resolution of these lawsuits will not, individually or in the aggregate, have a material, adverse effect on the financial condition of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS
STOCK TRADING
Common shares are traded in the Nasdaq National Market System under the symbol STFC. As of March 8, 2003, there were 937 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:
------------------------------ ---------------------- ---------------------- -------------------
2001 HIGH LOW DIVIDEND
---- ---- --- --------
------------------------------ ---------------------- ---------------------- -------------------
First Quarter $17.688 $13.313 $0.0300
------------------------------ ---------------------- ---------------------- -------------------
Second Quarter $17.340 $12.833 $0.0300
------------------------------ ---------------------- ---------------------- -------------------
Third Quarter $17.800 $12.300 $0.0325
------------------------------ ---------------------- ---------------------- -------------------
Fourth Quarter $17.500 $13.100 $0.0325
------------------------------ ---------------------- ---------------------- -------------------
------------------------------ ---------------------- ---------------------- -------------------
2002
------------------------------ ---------------------- ---------------------- -------------------
First Quarter $17.250 $13.700 $0.0325
------------------------------ ---------------------- ---------------------- -------------------
Second Quarter $17.019 $14.330 $0.0325
------------------------------ ---------------------- ---------------------- -------------------
Third Quarter $16.820 $14.500 $0.0350
------------------------------ ---------------------- ---------------------- -------------------
Fourth Quarter $16.780 $12.670 $0.0350
------------------------------ ---------------------- ---------------------- -------------------
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(1) Adjusted for stock splits.
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 on the payment of dividends by the Company's insurance subsidiaries.
ITEM 6. SELECTED FINANCIAL DATA
"Selected Consolidated Financial Data" is as follows:
STATE AUTO FINANCIAL CORPORATION AND
SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company)
SELECTED CONSOLIDATED FINANCIAL DATA
YEAR ENDED DECEMBER 31
----------------------
2002 2001* 2000* 1999* 1998* 1997 1996 1995* 1994
---- ----- ----- ----- ----- ---- ---- ----- ----
STATEMENTS OF (Dollars in thousands, except per share data)
INCOME DATA:
Earned premiums $ 896,595 555,207 397,967 392,058 356,210 320,050 304,472 296,364 225,297
Net investment income $ 59,691 47,375 38,915 34,262 32,506 31,107 29,863 28,461 22,189
Management services
income $ 2,638 15,586 17,594 8,727 7,945 7,367 6,774 6,377 5,170
Net realized gains on
investments $ 5,909 1,962 5,255 2,555 2,925 3,043 2,788 1,758 1,595
Other income $ 2,646 3,142 3,043 3,269 2,473 1,409 1,200 525 147
---------------------------------------------------------------------------------------------------
Total revenues $ 967,479 623,272 462,774 440,871 402,059 362,976 345,097 333,485 254,398
---------------------------------------------------------------------------------------------------
Income before federal
income taxes $ 37,790 17,976 61,444 56,985 49,605 56,638 34,792 40,953 20,294
---------------------------------------------------------------------------------------------------
Net income $ 36,995 20,615 47,714 42,816 37,497 40,998 26,407 29,894 15,835
---------------------------------------------------------------------------------------------------
Earnings per common
share(1)(2):
Basic $ 0.95 0.53 1.24 1.05 0.89 0.99 0.64 0.73 0.39
---------------------------------------------------------------------------------------------------
Diluted $ 0.93 0.52 1.21 1.03 0.87 0.97 0.63 0.72 0.39
---------------------------------------------------------------------------------------------------
Cash dividends per
common share(1) $ 0.14 0.13 0.12 0.11 0.10 0.09 0.08 0.07 0.06
---------------------------------------------------------------------------------------------------
BALANCE SHEET DATA AT YEAR END:
Total investments $ 1,272,316 1,138,656 750,870 627,305 579,966 526,363 499,277 479,908 350,639
Total assets $ 1,592,995 1,367,496 898,106 759,945 717,520 664,384 605,385 579,194 487,282
Total notes payable $ 75,500 45,500 45,500 45,500 - - - - -
Total stockholders'
equity $ 463,769 400,193 386,059 317,687 340,824 297,258 247,619 225,763 175,852
Book value per
common share(1) $ 11.89 10.28 10.01 8.29 8.11 7.11 5.98 5.48 4.29
STATUTORY RATIOS:
Loss ratio 73.1 77.4 68.5 67.4 68.4 65.2 72.7 68.6 75.4
Expense ratio 29.2 27.8 27.0 29.5 29.4 28.9 27.3 31.0 28.2
Combined ratio 102.3 105.7 95.5 96.9 97.8 94.1 100.0 99.6 103.6
Industry combined ratio(3) 105.7 115.9 110.1 107.8 105.6 101.6 105.8 106.5 108.5
Ratio of net premiums
written to statutory
capital and surplus 2.62 1.81 1.32 1.47 1.63 1.71 1.91 2.12 1.77
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(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 2002 from A.M. Best.
* Reflects change in Pooling Arrangement, effective October 1, 2001, January 1, 2000, 1999, 1998 and 1995.
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 of Ohio, formerly State Auto Insurance Company ("SA Ohio"), provides personal and commercial insurance for the standard insurance market. State Auto National Insurance Company ("National") and Mid-Plains Insurance Company ("Mid-Plains") write personal automobile insurance for risks in the nonstandard insurance market. These insurance products are marketed through the independent agency system. 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."
Mutual's wholly-owned subsidiaries are State Auto Insurance Company of Wisconsin, formerly Midwest Security Insurance Company ("SA Wisconsin"), State Auto Florida Insurance Company ("SA Florida") and Meridian Insurance Group, Inc. ("MIGI"). MIGI's subsidiaries are Meridian Security Insurance Company ("Meridian Security"), Meridian Citizens Security Insurance Company ("Meridian Citizens") and Insurance Company of Ohio ("ICO"). ICO ceased insurance operations on October 1, 2002 and was dissolved on January 15, 2003. MIGI is also party to an affiliation agreement with Meridian Citizens Mutual Insurance Company ("Meridian Citizens Mutual"). Meridian Security, Meridian Citizens, ICO and Meridian Citizens Mutual are collectively referred herein as the "MIGI Insurers."
State Auto P&C provides employees to all insurance affiliates, including
Mutual and each of its 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, National, Milbank, and SA Ohio are
parties. After October 1, 2001, the 2000 Management Agreement became a pure cost
sharing agreement, but prior thereto, this agreement provided for a management
fee based on surplus which was paid by each managed company to State Auto P&C;
2) the "Midwest Management Agreement", to which State Auto P&C, Mutual and SA
Wisconsin are parties. This agreement provides for a management fee based on a
percentage of direct written premiums collected by the Company for the services
State Auto P&C provides; 3) the MIGI Management Agreement, effective July 1,
2002, to which State Auto P&C, Meridian Security, Meridian Citizens, and
Meridian Citizens Mutual are parties. This agreement provides 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 agreements also apportions the
actual costs of the services provided among the parties.
Effective January 1, 2002, all employees of MIGI became employees of State Auto P&C. In conjunction with this transaction, approximately $3.6 million in net plan benefit liabilities were transferred from MIGI to State Auto P&C.
State Auto P&C, Milbank, Farmers Casualty and SA Ohio (collectively the "Pooled Subsidiaries"), the insurance subsidiaries 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.
The following table sets forth a chronology of the participant changes that have occurred in the Pooling Arrangement since January 1, 1999:
---------------------------------------------------------------------------------------------
Pooled Subsidiaries
---------------------------------------------------------------------------------------------
State Farmers SA SA
----- ------- -- --
Year * Auto P&C Milbank Casualty SA Ohio Mutual Wisconsin Florida
---------------------------------------------------------------------------------------------
1999 37% 10% 3% N/A 49% 1% N/A
---------------------------------------------------------------------------------------------
2000-9/30/2001 39 10 3 1 46 1 N/A
---------------------------------------------------------------------------------------------
10/1/2001-2002 59 17 3 1 19 1 N/A
---------------------------------------------------------------------------------------------
Effective
1/1/2003 59 17 3 1 18.3 1 0.7
---------------------------------------------------------------------------------------------
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* Time period is for the year ended December 31, unless otherwise noted.
On January 1, 2003, the Pooling Arrangement was amended to add SA Florida as a participant. The Company's aggregate pooling participation percentage remained at 80%. At December 31, 2002, SA Florida had not commenced insurance operations; consequently, there was no impact on the Company's books at January 1, 2003 relating to the Pooling Arrangement amendment.
In discussing Results of Operations, State Auto P&C, Milbank, Farmers Casualty, SA Ohio, National, Mid-Plains, Mutual, SA Wisconsin, Meridian Security, Meridian Citizens, ICO and Meridian Citizens Mutual are referred to collectively as the "State Auto Insurance Companies." The Pooled Subsidiaries, Mutual and SA Wisconsin are collectively referred to below as the "Pooled Companies."
Non-insurance subsidiaries of the Company include Stateco Financial Services, Inc. ("Stateco"), which provides investment management services to affiliated companies and Strategic Insurance Software, Inc. ("S.I.S."), which 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") 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. The results of operations of S.I.S. and 518 PML are not material to the total operations of the Company.
The following is a summary of several transactions that occurred in the second half of 2001 that will assist in the discussion of the Company's current period financial results:
Effective June 1, 2001, Mutual merged with Meridian Mutual Insurance Company ("Meridian Mutual"), with Mutual continuing as the surviving corporation, and acquired MIGI. 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, which related to the additional net insurance liabilities assumed by the Pooled Subsidiaries on July 1, 2001. The business of 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. This former Meridian Mutual business assumed by the Pooled Subsidiaries comprises the Company's "Meridian standard" and "Meridian nonstandard" segments.
Effective October 1, 2001, the 2000 Management Agreement was amended to eliminate the management and operations services fee charged by State Auto P&C to participants to the agreement, including Mutual. As a result of the loss of this income, substantially all of State Auto P&C's services income was eliminated at that time. Consequently, beginning with the first quarter
2002, the management and operations services segment is included in the "all other" category for segment reporting, as the results of this segment no longer meet the quantitative thresholds for separate presentation as a reportable segment. See "Reportable Segments" included herein and footnote 15 regarding the Company's operating segments in the consolidated financial statements of the Company.
The Pooling Arrangement was amended, effective October 1, 2001, such that the Pooled Subsidiaries' aggregate participation was increased from 53% to 80%. 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.
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 quarterly statutory loss and loss adjustment expense ratio (the "Pool loss and LAE 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 Pool loss and LAE 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 Pool loss and LAE ratios less than 69.25%, but more than 59.99%.
As the former Meridian Mutual standard and nonstandard business continues to be written and processed through the Meridian underwriting and claims system platform, management has monitored this business as separate segments from the State Auto standard and nonstandard processed business. Monitoring of these segments separately has been necessary in order to facilitate the integration of the business as it migrates through new policies and renewals to the State Auto systems platform in which State Auto policies, pricing, underwriting, and claims philosophies are fully reflected. 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. 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." Due to the integration efforts that occurred within the Meridian nonstandard segment during 2001 and 2002, beginning with the first quarter of 2003, the Meridian nonstandard business will be included in the State Auto nonstandard segment.
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 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 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 that had initially been 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.
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 limit 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. These amounts are based on estimates, and accordingly, the actual realizable value may vary from the estimated realizable value.
At December 31, 2002, fixed maturity and equity security investments are classified as available for sale and carried at fair value. At December 31, 2001, fixed maturities are classified either 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 monitors its investment portfolio for declines in value that are other than temporary, an assessment which requires significant management judgment. Among the factors management considers are market conditions, the amount, timing and length of decline in fair value, and events impacting the issuer. When a security in the Company's investment portfolio has a decline in fair value which 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 herein.
RESULTS OF OPERATIONS
2002 COMPARED TO 2001
Net income for the Company increased by $16.4 million (79.5%) in 2002. Contributing to this increase was a 4.6 point improvement in the Company's GAAP combined ratio and, as more fully described above, changes made to the Company's participation in the Pooling Arrangement in the second half of 2001. Additionally, net investment income increased due to the Pooling Arrangement changes in 2001, which was offset by a decrease in the Company's management and operations service income.
Consolidated earned premiums increased by $341.4 million (61.5%) in 2002. This increase was the result of the addition of the former Meridian Mutual business to the Pooling Arrangement, effective July 1, 2001, a change in the Pooled Subsidiaries' aggregate pooling participation percentage from 53% to 80%, effective October 1, 2001 and total net internal growth of 16.3%. The addition of the former Meridian Mutual business and the pooling change increased consolidated earned premiums 45.2%. The internal growth of the State Auto standard segment's earned premiums increased consolidated earned premiums 15.1%. This increase was driven by growth in commercial lines of business due to a combination of rate changes as well as increased policy counts. Personal lines of business continued to experience sales increases over prior year due to changes in the marketplace that permitted rate increases, as well as the expansion of the new personal lines sales specialist position that contributed to increased policy counts. The internal growth of the State Auto nonstandard segment earned premiums increased consolidated earned premiums 5.4% due to a combination of rate changes and increased policy counts.
The internal decline of the Meridian standard and nonstandard segments decreased consolidated earned premiums 4.2%. This decrease was expected, given the corrective actions taken by management in both these segments, which actions included appropriate and necessary rate increases in almost every line of business. Additionally, one of the more significant actions taken within the Meridian standard segment was the discontinuance in late 2000 of the Group Advantage(R) Program which had generated substantial underwriting losses for Meridian Mutual. The last Group Advantage(R) policy on the books terminated January 2003. Regarding the Meridian nonstandard segment, in addition to taking significant corrective rate action, beginning in late 2001, the Company implemented an integration plan to write all new nonstandard auto business produced by the former Meridian Mutual agents through the State Auto nonstandard segment, specifically through National on the National system platform utilizing a more appropriate rating structure as well as credit scoring (as permitted by local law) and "point-of-sale" underwriting tools. The order of integration had been prioritized such that the states with the most need for profit improvement migrated to National first. All Meridian nonstandard auto new business is now being written through the State Auto nonstandard segment. The business that remains within the Meridian nonstandard segment is expected to decrease given this segment's historically low retention rate as well as the Company continuing to take appropriate rate increases. Fourth quarter 2002 earned premiums for the Meridian nonstandard segment comprised 0.5% of total consolidated earned premiums versus 1.8% in the same 2001 period. Consequently, beginning with the first quarter 2003, the Meridian nonstandard auto business will be included in the State Auto nonstandard segment category.
Net investment income increased by $12.3 million (26.0%) in 2002. Contributing to the increase over the previous year was an increase in invested assets due to a transfer of $354.6 million in cash and fixed maturity securities from Mutual to the Pooled Subsidiaries in the second half of 2001. This transfer was made in conjunction with the changes made to the Pooled Subsidiaries participation in the Pooling Arrangement, as more fully described above. Total cost of invested assets at December 31, 2002 and 2001, was $1,303.0 million and $1,150.3 million, respectively. Reflecting a decline in the interest rate environment, the investment yields, based on cash equivalents, fixed and equity securities at cost were 4.9% and 5.4% for the annual periods ending 2002 and 2001, respectively. 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 by $12.9 million (83.1%) in 2002. This decrease was attributable to the termination of the fee element of the 2000 Management Agreement. The service fee under the 2000 Management Agreement paid by Mutual in 2001 was $12.5 million. 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.
Consolidated losses and loss adjustment expenses, as a percentage of earned premiums (the "GAAP loss and LAE ratio"), were 72.9% and 76.9% for the years 2002 and 2001, respectively. Comparison of the overall results of 2002 with those of 2001 was affected by the addition of the former Meridian Mutual business to the Pooling Arrangement. Since the former Meridian Mutual business was added to the Pooling Arrangement effective July 1, 2001, it negatively impacted the loss results of the Company only in the second half of 2001. However, in 2002 the results of the former Meridian Mutual business were included in and negatively impacted the results of the Pooling Arrangement for the entire year. Comparison of the overall results of 2002 with those of 2001 is also affected by the reserve strengthening that occurred during the second half of 2001 with respect to the Meridian segments. While the Meridian standard business continues to produce loss results poorer than the State Auto book of business (see table of GAAP loss and LAE ratios operating segments below), management believes there has been improvement in the performance of the Meridian segments due to the continuing efforts to improve pricing and risk selection applicable to these segments during 2002.
During the quarters ended September 30, 2002 and June 30, 2002, the Pooled Companies produced a Pool loss and LAE ratio under the Stop Loss (described above) that exceeded the 70.75% threshold, thereby recovering from Mutual $2.4 million and $6.4 million in losses, respectively (total of $8.8 million for the year ended December 31, 2002). In the quarters ended December 31, 2002 and March 31, 2002, the Pooled Companies' Pool loss and LAE ratio was less than 69.25%, but more than 59.99%,
thereby ceding to Mutual, under the Stop Loss $1.0 million and $0.4 million in earned premiums, respectively (total of $1.4 million for the year ended December 31, 2002). The cession activity through the Stop Loss had the effect of lowering the GAAP loss and LAE ratio by 0.9 and 1.1 points in 2002 and 2001, respectively.
The year 2002 was the worst catastrophe year in the history of the Company on a dollar loss basis and third worst in terms of GAAP loss and LAE ratio points. During the second quarter of 2002, a series of tornadoes and hailstorms went through several of the Company's operating states, including an F4 tornado in La Plata, Maryland. This storm was the largest single catastrophe event for the Company in 2002, accounting for 3.1 GAAP loss and LAE ratio points. Overall, catastrophe losses in 2002 were 1.2 GAAP loss and LAE ratio points higher than in 2001.
For discussion purposes, the following table provides comparative GAAP loss and LAE ratios for the Company's insurance operating segments for the 2002 and 2001 periods, respectively, except for the Meridian segments for 2001, which is for the six month period ended December 31, 2001:
-----------------------------------------------
GAAP Loss and LAE Ratio 2002 2001
---- ----
-----------------------------------------------
State Auto standard segment 69.4 65.9
-----------------------------------------------
State Auto nonstandard segment 81.2 77.3
-----------------------------------------------
Meridian standard segment 85.9 139.3
-----------------------------------------------
Meridian nonstandard segment 51.9 168.2
-----------------------------------------------
Total GAAP Loss and LAE Ratio 72.9 76.9
==== ====
-----------------------------------------------
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The State Auto standard segment GAAP loss and LAE ratio increased in 2002 to 69.4 from 65.9 in 2001. Catastrophe losses represented 5.7 points of this segment's loss results for 2002 compared to 4.4 points for 2001. With the significant increase in new business policy count came an increase in claim submissions. While general inflation has been relatively modest for the past several years, price inflation on goods and services for which insurance pays, such as medical care and repairs to automobiles and buildings, exceeded the rate of overall inflation and adversely impacted the GAAP loss and LAE ratio. The Company has reacted to this inflationary trend by filing more aggressive, cost-based, rate increases. Also contributing to the current year deterioration in the GAAP loss and LAE ratio was restrictions on the use of credit scoring in some states where the Company does business. To the extent these limitations result in higher loss ratios, the actuarial rate indications will increase resulting in larger rate increases being sought. The Company is also reviewing its credit scoring models to ensure that the premium rate derived from the model continues to accurately reflect the loss experience associated with each particular credit score range.
Representing approximately 42% of this segment's business, personal automobile has over the last five years yielded loss results better than industry average and in fact, has produced combined ratios of less than 100.0%. While the current year results are expected again to better industry average, this line of business did experience deterioration in its current year loss ratio, specifically within the auto liability and no fault lines, which management believes is due at least in part to increasing rates of inflation applicable to the health care sector of the U.S. economy and an increased volume of new business, as noted above. Adverse loss results on workers' compensation, commercial multi peril and other liability lines of business, which collectively represents approximately 18.2% of this segment's business, also contributed to the current year loss result increase. The Company is taking substantial and necessary rate increases in rate per exposure across these lines of business. Workers' compensation continues to be one of the most volatile lines that the Company provides and for this reason the Company has always maintained a particularly conservative posture on pricing in this line.
The State Auto nonstandard segment GAAP loss and LAE ratio increased in 2002 to 81.2 from 77.3 in 2001. This segment experienced more volatility in 2002, especially in those states experiencing substantial premium growth due to policy count increases. As described above, contributing to this growth has been the addition of National's product to agents who wrote the former Meridian Mutual's nonstandard auto business. While nonstandard automobile tends to be a more volatile line of business than standard automobile, management continually monitors this segment's premium rate adequacy. Management has been paying particular attention to the adequacy of these rates in these growth states, as well as risks
written in certain agencies, and is reacting accordingly by increasing rates and working with those agencies regarding risk selection.
The Meridian standard segment GAAP loss and LAE ratio for 2002 was 85.9 compared to 139.3 for the six month period ended December 31, 2001. Comparison of the overall results of 2002 with those of 2001 is affected by the reserve strengthening that occurred during the second half of 2001 within this segment. Catastrophe losses represent approximately 7.0 points of this segment's loss results for both the 2002 and 2001 periods. While the Meridian standard business continues to produce loss results worse than the State Auto book of business, management believes there has been improvement in this segment due to the necessary and continued efforts that began in 2001, e.g. seeking adequate cost-based rates, re-underwriting commercial renewals to be certain that risks written are within the State Auto underwriting guidelines and discontinuing the Group Advantage(R) Program.
The Meridian non-standard segment GAAP loss ratio for 2002 was 51.9 compared to 168.2 for the six month period ended December 31, 2001. This segment was also significantly impacted by case reserve strengthening that occurred during the second half of 2001. Similar to the Meridian standard segment, largely contributing to the current year loss results has been the substantial rate increases the Company implemented in 2001 and 2002.
Acquisition and operating expenses, as a percentage of earned premiums (the "GAAP expense ratio"), were 29.5% and 30.1% for the years 2002 and 2001, respectively. Management continually focuses its attention on improving its GAAP expense ratio, which is especially critical during a period of substantial top line growth.
Interest expense relates to the $45.5 million line of credit agreement the Company entered into with Mutual in 1999 and the $15.0 million surplus note agreement entered into with an affiliate on September 30, 2002. See additional discussion in the "Liquidity and Capital Resources" section included herein.
The 2002 underwriting improvement, coupled with net investment income being largely comprised of tax-exempt income, produced an effective tax expense rate in 2002 of 2.1% versus an effective tax benefit of 15% in 2001. For additional clarification, see the reconciliation between actual federal income taxes and the amount computed at the statutory rate as detailed in footnote 8 in the notes to the Company's consolidated financial statements.
2001 COMPARED TO 2000
Net income for the Company decreased $27.1 million (56.8%) in 2001. Contributing to this decease was an increase in the Company's GAAP combined ratio to 107.0% from 98.4% 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.
Consolidated earned premiums increased $157.2 million (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. 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 a 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.
The investment yields, based on cash equivalents, fixed maturities 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 (11.4%) to $15.6 million for the year ended December 31, 2001. This decrease was attributable to the resolution of the disagreement between the Company and Ohio Department of Insurance regarding the recognition of the service fee paid by Mutual to State Auto P&C. The service fee under the 2000 Management Agreement paid by Mutual in 2001 was $12.5 million down from $14.5 million in 2000. 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 increased $154.9 million (56.9%) and as a percentage of earned premiums (the "GAAP loss and LAE 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 GAAP loss and LAE ratios for the Company's insurance operating segments for the 2001 and 2000 periods, respectively, except for the Meridian segments for 2001, which is for the six month period ended December 31, 2001:
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GAAP Loss and LAE Ratio 2001 2000
---- ----
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State Auto standard segment 65.9 67.4
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State Auto nonstandard segment 77.3 81.4
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Meridian standard segment 139.3 -
-----------------------------------------------
Meridian nonstandard segment 168.2 -
----- ----
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Total GAAP Loss and LAE Ratio 76.9 68.4
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The Company's State Auto standard segment reflected an improvement in its GAAP loss and LAE ratio in 2001 to 65.9 from 67.4 in 2000. This segment's largest line of business, automobile, reflected a 1.5 point improvement in 2001 from 2000. This segment's next largest line of business, homeowners, has experienced some deterioration in its GAAP loss and LAE 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 GAAP loss and LAE ratio in 2001 to 77.3 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.
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 "GAAP 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 a result of settlement of rate litigation with the North Carolina Department of Insurance. 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 benefit in 2001 of 15% versus an effective tax expense of 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 8 in the notes to the Company's consolidated financial statements.
REPORTABLE SEGMENTS
The Company's reportable segments are: State Auto standard insurance, State Auto nonstandard insurance, Meridian standard insurance, Meridian nonstandard insurance, and investment management services. The profits (losses) of these segments are monitored by management on an unconsolidated basis, as reflected in footnote 15, Reportable Segments, in the Company's consolidated financial statements 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 profit (loss) for the years ended 2002, 2001, and 2000, except for the Meridian segments for 2001, which is for the six month period ended December 31, 2001:
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2002 2001 2000
---- ---- ----
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(Dollars in thousands)
---------------------------------------------------------------------------------------
State Auto standard insurance $37,537 $45,664 $35,579
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State Auto nonstandard insurance 1,538 1,378 (116)
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Meridian standard insurance (15,376) (44,397) -
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Meridian nonstandard insurance 2,537 (5,933) -
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Investment management services 6,402 5,965 5,354
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All other 1,916 16,326 18,457
----- ------ ------
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Total segment profit $34,554 $19,003 $59,274
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The decrease in the Company's 2002 profit within the State Auto standard insurance segment is primarily due to an increase in this segment's current year loss experience as discussed at "2002 Compared to 2001" in "Results of Operations." Increased top line growth, as well as an increase in the State Auto nonstandard segment's net investment income, despite deterioration in its loss results, contributed positively to this segment's profit in 2002. Improvement in the Company's 2001 segment profit within the State Auto standard and nonstandard insurance segments was primarily due to an improvement in these segments' loss experience and management's response to premium rate inadequacy as discussed at "2001 Compared to 2000" in "Results of Operations." As discussed above, management continually monitors these segments' premium rate adequacy and seeks adequate cost-based rates.
Comparison of the segment profit (loss) results of 2002 with that of 2001 for the Meridian segments was affected by the reserve strengthening that occurred during the second half of 2001. While management recognizes that the Meridian standard business continues to produce loss results poorer than the State Auto standard segment, it believes its integration efforts that began in 2001, as discussed at "2001 Compared to 2000," has improved this segment's results.
The increase in segment profit of the investment management segment in 2002 and 2001 was the result of this segment providing its services to the Meridian Insurers beginning June 1, 2001. This segment's revenue is based on the average fair value of the portfolio of the companies managed, which is largely comprised of fixed maturities. During 2002 and 2001, the investment management segment profit increased as managed invested assets increased.
As discussed above, beginning with the first quarter of 2002, the management and operations services segment is now included in the "all other" category for segment reporting as the results of this segment no longer meet the quantitative thresholds for separate presentation as a reportable segment. All other segment profits, including management and operations services, decreased in 2002 and 2001. The termination of the service fee under the 2000 Management Agreement was due to the resolution of the disagreement between the Company and Ohio Department of Insurance regarding the service fee
paid by Mutual to the Company in 2001. See discussion at "2002 Compared to 2001" and "2001 Compared to 2000" in "Results of Operations." For additional information on the Company's reportable segments, see footnote 15 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 short and long-term cash requirements without the need to sell investments to meet fluctuations in claim payments.
Overall net cash provided by operating activities was $126.6 million in 2002, $63.5 million in 2001 and $87.7 million in 2000. The increase in 2002 is largely attributable to the prior year changes to the Pooled Subsidiaries participation in the Pooling Arrangement. In the second half of 2001, the Pooled Subsidiaries received cash of $8.6 million and fixed maturities of $346 million from Mutual as a result of adding the Meridian Mutual business to the Pooling Arrangement and changing the pooling participation percentage of the Pooled Subsidiaries from 53% to 80%. In 2000 there was a cash transfer of $18.6 million to the Pooled Subsidiaries in connection with the 2000 amended Pooling Arrangement, as well as a cash transfer of $28.1 million to State Auto P&C from Mutual relating to the net pension and post-retirement plan liabilities assumed by State Auto P&C relating to the transfer of employees of Mutual as of January 1, 2000. Prior to 2000, State Auto P&C provided only executive management services to all insurance affiliates. Absent the impact of these transactions in 2001 and 2000, net cash provided by operating activities was $54.9 million and $40.9 million, respectively. 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 significantly larger insurance segments is expected to result in more volatility going forward but will also provide opportunity for increased earnings and cash flows from operations.
Overall net cash used in investing activities was $85.6 million during 2002, $55.3 million in 2001 and $90.9 million during 2000. The respective year's investing activity was reflective of the cash flow generated from operations discussed above. During 2002 the Company experienced fluctuating activity within its fixed maturity portfolio. Call activity in 2002 continued in response to the declines in the interest rate environment. While the Company continued to focus its attention on improving the loss results of the Meridian book of business, which has put upward pressure on the Company's overall loss experience in recent years, the Company increased its sale activity of its fixed maturities in an effort to increase its taxable position in its investment portfolio. Monies generated from the call and sale activity have been reinvested at lower yielding rates.
Cash provided by financing activities consists of proceeds from issuance of debt and common stock and cash used to acquire treasury shares and pay dividends to shareholders. Overall net cash provided by financing activities was $25.0 million in 2002, $0.5 million in 2001 and $10,000 in 2000. Net cash provided by financing activities increased during 2002 primarily due to net proceeds from issuance of debt (see discussion below), partly offset by payments to re-purchase Company common shares. During 2001 net cash provided by financing activities increased due to an increase in net proceeds from issuance of common stock over 2000.
Mutual, whose ownership in State Auto Financial is approximately 67%, has waived its right to receipt of the dividends declared by State Auto Financial since 1994 in an effort to enhance the statutory surplus of the insurance subsidiaries of State Auto Financial for use in support of underwriting operations which in turn is expected to increase the statutory surplus of Mutual. In years before 2002, prior to the declaration of each dividend by State Auto Financial, Mutual's directors reviewed the facts and circumstances then present in deciding whether to waive such dividend. Beginning in 2002, the issue of the waiver of Mutual's dividend on its shares of State Auto Financial was referred to the Independent Committee of the board of directors of Mutual. It met and determined that it would review dividend waiver
decisions on an annual basis. For the year 2002, this committee of Mutual's board of directors decided to waive Mutual's dividends that might be declared by the board of directors of State Auto Financial for 2002 in order to take better advantage of the investment opportunity State Auto Financial represents for Mutual. In 2003, once again this matter was referred to the Independent Committee of the Mutual board which determined to waive Mutual's right to receipt of dividends declared by State Auto Financial for the year 2003.
Impacting cash provided by financing activities during 2002, 2001 and 2000 was State Auto Financial's Board of Directors' approving plans to repurchase shares of its common stock from the public. In March 2002, the Board of Directors of State Auto Financial approved a plan to repurchase up to 1.0 million shares of its common stock from the public over a period extending to December 31, 2003. During 2002, the Company repurchased 396,000 shares from the public for a total of $6.3 million. Impacting cash used in financing activities during 2001 and 2000 was a 2000 stock repurchase plan approved to purchase up to 1.0 million of State Auto Financial's common stock from the public ending December 31, 2001 (the "2000 Repurchase Plan"). In 2001 and 2000, the Company repurchased approximately 25,000 shares each year from the public for a total of $0.4 million and $0.3 million, respectively.
In conjunction with a 1999 Repurchase Plan, State Auto Financial entered into a line of credit agreement with Mutual for $45.5 million. The interest rate is adjustable annually on each January 1 to reflect adjustments in the then current prime lending rate as well as State Auto Financial's current financial position. The interest rate was 4.75%, 5.0% and 6.0% for 2002, 2001 and 2000, respectively. Beginning January 1, 2003, the interest rate on this credit agreement will be 4.25%. Commencing in 2001, principal is due upon demand, with final payment to be received on or prior to December 31, 2005
Effective September 30, 2002, Milbank entered into a $15.0 million surplus contribution note with Meridian Security. Subject to the condition described below and other terms of the note, the maturity date is September 30, 2012. The interest rate is equal to the U.S. Treasury ten-year note yield at September 30, 2002 plus 100 basis points (4.59%) and is adjustable October 1, 2007, to the then current U.S. Treasury ten-year note yield plus 100 basis points for the remaining term of the note. Interest is accrued, but all payments of principal or interest may be made only with the prior written approval of the South Dakota Director of Insurance, Milbank's domiciliary state. Interest is scheduled to be paid semiannually in arrears beginning March 30, 2003.
The purpose of this surplus contribution note was to lower Milbank's net written premium to statutory surplus ratio (the "leverage ratio"). The increase in Milbank's leverage ratio resulted from an unusual rate of written premium growth over the last eighteen months due to a combination of increased top line growth and an increase in the Company's pooling participation percentage, effective October 1, 2001 (Milbank's pooling percentage increased from 10% to 17%), as well as the addition of the former Meridian Mutual business to the Pooling Arrangement, effective July 1, 2001. Also affecting its leverage ratio had been the increased losses sustained by the Company during the period of transition of the former Meridian Mutual book of business. At December 31, 2002, Milbank's leverage ratio is 2.4 to 1.
Effective December 23, 2002, State Auto Financial entered into a 364 day $15.0 million term loan note agreement with a bank. Interest adjusts quarterly and accrues based on LIBOR plus 75 basis points (2.15% at December 31, 2002). Interest on the note is 2.15% through March 23, 2003 and 2.027% for the period March 24, 2003 through September 23, 2003. The purpose of this term loan note was to contribute additional capital to State Auto P&C to improve this company's leverage ratio. The reason for the increase in State Auto P&C's leverage ratio is similar to that of Milbank's, which is described above. State Auto P&C's pooling percentage increased from 39% to 59%, effective October 1, 2001. At December 31, 2002, State Auto P&C's leverage ratio is 2.6 to 1.
At December 31, 2002, National's leverage ratio is 4.4 to 1 compared to 2.0 to 1 at December 31, 2001. The increase in the 2002 leverage ratio is the result of this company's substantial current year net written premium growth. Management believes the leverage ratios for Milbank, State Auto P&C and National are higher than is optimal. Management is in the process of considering alternatives and developing a plan to improve these ratios. It is likely there will be a cost to the Company attendant to generating additional surplus within these three insurance subsidiaries, but no details are known at this time.
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, 2002, each of the State Auto Insurance Companies surpassed all standards established by the formula.
The State Auto Insurance Companies are participants in a catastrophe reinsurance program. The amount retained by the State Auto Insurance Companies is $40.0 million for each occurrence. For up to $80.0 million in losses, excess of $40.0 million, traditional reinsurance coverage is provided. State Auto P&C assumes catastrophe reinsurance from Mutual, Milbank, SA Wisconsin, Farmers Casualty, SA Ohio, National, Mid-Plains and the Meridian Insurers, in the amount of $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 has continued 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.
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, 2002, there has been no adverse development of the liability.
On March 7, 2003, the Board of Directors of State Auto Financial declared a quarterly cash dividend of $0.035 per common share, payable on March 31, 2003, to shareholders of record on March 17, 2003. This is the 47th 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 eleven consecutive years.
The maximum amount of dividends that may be paid to State Auto Financial during 2003 by its insurance subsidiaries without prior approval under current law is limited to $35.3 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.
As discussed above, there was particular emphasis throughout 2002 and 2001 on improving the former Meridian Mutual book of business, which is expected to continue in 2003. 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 subsidiaries. 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 may be sold due to changing investment strategies are categorized as available for sale and are carried at fair value. At December 31, 2002, the Company had no fixed maturity investments rated below investment grade, nor any mortgage loans. The following table provides information regarding the quality distribution of the Company's fixed maturity portfolio at December 31, 2002:
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Percentage Quality(1)
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Corporate and Municipal Bonds 72.0% AA+
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U.S. Governments 2.8% AAA
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U.S. Government Agencies 25.2% AAA
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Total 100.0%
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(1) As rated by Moody's Investors Service
Despite the volatility in the equity market during 2002, the Company continued its direction of moderately increasing its equity portfolio investments to enhance growth of statutory surplus over the long term. Gains and losses on the sale of equity securities are computed using the first-in, first-out method. The Company's current investment strategy does not rely on the use of derivative financial instruments.
At December 31, 2002 all investments in fixed maturity and equity securities were held as available for sale and therefore are carried at fair value. Other invested assets are comprised of limited liability partnership investments that are carried at fair value, and as presented in the table below, represent approximately 0.2% of the Company's overall investment portfolio. 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. Effective December 31, 2002, the Company transferred all of its investments previously classified as held to maturity to the available for sale category to align the investment portfolio with management's investment policy. For fixed maturities classified as held to maturity, unrealized holding gains or losses were not reflected in the accompanying consolidated financial statements; rather they were carried at amortized cost. Upon transfer of the held to maturity investments to available for sale at December 31, 2002, the held to maturity investments' amortized cost, fair value and net unrealized gain were $19.1 million, $20.4 million and $1.3 million, respectively, and therefore other comprehensive income of $0.8 million, net of deferred taxes, was recognized.
The following table provides the composition of the Company's investment portfolio at December 31, 2002 and 2001, respectively:
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(Dollars in thousands) 2002 2001
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% %
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Fixed maturities:
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Held to maturity, at amortized cost $ - - $ 27,406 2.4%
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Available for sale, at fair value 1,216,698 95.6% 1,051,405 92.3%
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Equity securities, at fair value 53,710 4.2% 59,845 5.3%
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Other invested assets, at fair value 1,908 0.2% - -
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Total investments $1,272,316 100.0% $1,138,656 100.0%
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The Company regularly monitors its investment portfolio for declines in value that are other than temporary, an assessment which requires significant management judgment. Among the factors that management considers are market conditions, the amount, timing and length of decline in fair value, and events impacting the issuer. When a security in the Company's investment portfolio has a decline in fair value which 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.
The Company reviewed its investments at December 31, 2002, and determined no other than temporary impairment exists in the gross unrealized holding losses, as provided in the table below, due to the evidence that exists indicating temporary impairment which includes, market conditions, amount, timing and length of decline, as well as events impacting the issuer, among other factors. The evaluation of investments for other than temporary impairment requires management to make judgments and estimates regarding the evidence known. Such judgments and estimates could change in the future as more information becomes known which could negatively impact the amounts reported herein. At December 31, 2002, there were no investments reflected in the table below with an unrealized holding loss that had a fair value significantly below cost continually for more than one year. There are no individually material securities with an unrealized holding loss at December 31, 2002.
The following table provides detailed information on the Company's investment portfolio for its gross unrealized gains and losses, adjusted for investments with other than temporary impairment at December 31, 2002:
------------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
Gross Gain Gross
December 31, 2002 Cost or unrealized number of unrealized Loss number
Investment Category amortized cost holding gains positions holding losses of positions Fair value
------------------------------------------------------------------------------------------------------------------------------------
Fixed Maturities
------------------------------------------------------------------------------------------------------------------------------------
U.S. Treasury securities & obligations $214,809 $11,016 75 $132 4 $225,693
------------------------------------------------------------------------------------------------------------------------------------
States & political subdivisions 696,191 41,574 357 444 12 737,321
------------------------------------------------------------------------------------------------------------------------------------
Corporate securities 128,631 10,453 58 72 4 139,012
------------------------------------------------------------------------------------------------------------------------------------
Mortgage-backed securities of U.S.
Gov. Agencies 109,703 4,969 54 - - 114,672
------- ----- -- - - -------
------------------------------------------------------------------------------------------------------------------------------------
Total fixed maturities 1,149,334 68,012 544 648 20 1,216,698
------------------------------------------------------------------------------------------------------------------------------------
Equity Securities
------------------------------------------------------------------------------------------------------------------------------------
Technologies 4,135 368 6 1,136 5 3,367
------------------------------------------------------------------------------------------------------------------------------------
Pharmaceuticals 6,716 930 4 479 2 7,167
------------------------------------------------------------------------------------------------------------------------------------
Financial services 16,194 1,565 10 2,194 14 15,565
------------------------------------------------------------------------------------------------------------------------------------
Manufacturing & other 28,792 3,285 15 4,466 25 27,611
------ ----- -- ----- -- ------
------------------------------------------------------------------------------------------------------------------------------------
Total equity securities 55,837 6,148 35 8,275 46 53,710
------ ----- -- ----- -- ------
------------------------------------------------------------------------------------------------------------------------------------
Other invested assets 1,857 51 1 - - 1,908
----- -- - - - -----
------------------------------------------------------------------------------------------------------------------------------------
Total $1,207,028 $74,211 580 $8,923 66 $1,272,316
========== ======= === ====== == ==========
------------------------------------------------------------------------------------------------------------------------------------
|
The amortized cost and fair value of fixed maturities at December 31, 2002, by contractual maturity, are summarized as follows:
-----------------------------------------------------------------------------------------------
Amortized Fair
(Dollars in thousands) Cost Value
-----------------------------------------------------------------------------------------------
Due after 1 year or less $ 5,363 $ 5,409
-----------------------------------------------------------------------------------------------
Due after 1 year through 5 years 40,173 43,368
-----------------------------------------------------------------------------------------------
Due after 5 years through 10 years 288,170 306,308
-----------------------------------------------------------------------------------------------
Due after 10 years 705,960 746,942
------- -------
-----------------------------------------------------------------------------------------------
Subtotal 1,039,666 1,102,027
-----------------------------------------------------------------------------------------------
Mortgage-backed securities 109,668 114,671
------- -------
-----------------------------------------------------------------------------------------------
Total $1,149,334 $1,216,698
========== ==========
-----------------------------------------------------------------------------------------------
|
Expected maturities may differ from contractual maturities as the issuers may have the right to call or prepay the obligations with or without call or prepayment penalties.
For 2002, included in realized losses of equity securities below, was $2,221,000 ($329,000 on equity securities sold and $1,892,000 on equity securities held at year end) recognized related to other than temporary impairment on 5 equity positions and none for 2001 and 2000. There were no individually material equity securities for which the Company recognized other than temporary impairments in 2002. There was no other than temporary impairment of fixed maturities for 2002, 2001 and 2000. The individual circumstances impacting the other than temporary impairments recognized in 2002 did not impact other investments.
The securities sold during 2002, were sold to either recognize the gain available, to dispose of the security because of the Company's opportunity to invest in securities with greater potential return considering capital preservation, and as discussed above, to reposition the taxable/tax-exempt fixed maturity position of the Company. Realized gains and losses are summarized as follows:
----------------------------------------------------------------------------------
(Dollars in thousands) Realized Fair Value at
-------- -------------
For the year ended December 31, 2002 Gains/Losses Sale
------------ ----
----------------------------------------------------------------------------------
Realized gains:
----------------------------------------------------------------------------------
Fixed maturities $12,661 $310,333
----------------------------------------------------------------------------------
Equity securities 2,047 8,059
----- -----
----------------------------------------------------------------------------------
Total realized gains 14,708 318,392
----------------------------------------------------------------------------------
----------------------------------------------------------------------------------
Realized losses:
----------------------------------------------------------------------------------
Fixed maturities 2,814 53,261
----------------------------------------------------------------------------------
Equity securities 5,985 4,657
----- -----
----------------------------------------------------------------------------------
Total realized losses 8,799 57,918
----- ------
----------------------------------------------------------------------------------
Net realized gains on investments $5,909 $376,310
====== ========
----------------------------------------------------------------------------------
|
MARKET RISK
Investable assets comprise approximately 85.9% of the Company's total assets. Of the total investable assets, 88.9% are invested in fixed maturities, 3.9% 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, 2002, the Company's fixed maturity portfolio had an average maturity of 15.2 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. As indicated in the table above, the fixed maturity portfolio is of high quality with all holdings in either Government obligations, municipal, or corporate obligations. 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 at December 31, 2002, is presented in tabular form above.
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 categorizes its fixed maturities as available for sale. Also, the Company does not maintain a trading portfolio.
The Company's investment portfolio grew 17.1% during 2002 to $1,368.3 million at December 31, 2002 from $1.168.7 million at December 31, 2001. This growth was generated primarily from cash flow provided by operations and an increase in the unrealized gains of fixed maturities, partly offset by a decline in the overall equity market.
The equity markets declined during 2002 and 2001, the first time since the 1973 and 1974 bear markets in which the market also declined two years in a row. During 2002, the Company's equity portfolio decreased $11.6 million to a cumulative unrealized loss of $2.1 million at December 31, 2002 from a cumulative unrealized gain position of $9.5 million at December 31, 2001.
During 2002 the fixed maturity fair values increased as the interest rate environment decreased. The Company's fixed maturity portfolio cumulative unrealized gains increased $58.5 million to $67.4 million at December 31, 2002 from $8.9 million in cumulative unrealized gains 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)
2003 2004 2005 2006 2007 Thereafter Total Fair Value
---- ---- ---- ---- ---- ---------- ----- ----------
Fixed interest
rate securities $14,544 5,783 8,302 21,605 8,653 1,079,266 1,138,153 $1,216,698
Average
Interest rate 5.56% 6.01% 6.17% 5.81% 5.89% 5.25% 5.31%
|
LOSSES AND LOSS EXPENSES PAYABLE
The Company's management conducts periodic reviews of loss development reports and makes judgments in determining the reserves for ultimate losses and loss expenses payable. Several factors are considered by management in estimating ultimate liabilities including consistency in relative case reserve adequacy, consistency in claims' settlement practices, recent legal developments, historical data, actuarial projections, accounting projections, exposure growth, current business conditions, catastrophe developments, late reported claims, entry errors, and other reasonableness tests.
Management's best estimate ("MBE") for National, Mid-Plains and the Pooled Subsidiaries share of the Pooled Companies loss and allocated loss adjustment expense reserve ("Loss and ALAE Reserve") at December 31, 2002, is $618,673,000 compared with an actuarial point estimate of $618,302,000 that is within a projected range of $593,156,000 to $644,692,000. The actuarial point estimate and MBE are not materially different. These values presented are on a direct basis, gross of salvage and subrogation recoverable, and before reinsurance, except for the Pooled Subsidiaries participation in the inter-company Pooling Arrangement. Therefore these values cannot be compared to other loss and loss expenses payable tables included elsewhere within the Company's Form 10-K. Ranges provide a quantification of the variability in the reserve projections, while the point estimates establish a mean, or expected value for the ultimate reserve. The MBE of loss reserves considers the Actuary's point estimate, or expected value, to be a reasonable and appropriate position within the range. The following table provides a reconciliation of MBE of the Company's direct Loss and ALAE Reserve to the Company's net loss and loss expenses payable at December 31, 2002. The Pooled Subsidiaries net additional share of transactions assumed from Mutual through the Pooling Arrangement has been reflected in the table below as Assumed by Pooled Subsidiaries:
-------------------------------------------------------------------------
Direct Loss and ALAE Reserve (1): (in thousands)
-------------------------------------------------------------------------
Pooled Subsidiaries, National and Mid-Plains $289,845
-------------------------------------------------------------------------
Assumed by Pooled Subsidiaries 328,828
--------
-------------------------------------------------------------------------
Total direct loss and ALAE reserve 618,673
--------
-------------------------------------------------------------------------
Direct unallocated loss adjustment expense ("ULAE") (1):
-------------------------------------------------------------------------
Pooled Subsidiaries, National and Mid-Plains 17,413
-------------------------------------------------------------------------
Assumed by Pooled Subsidiaries 14,689
--------
-------------------------------------------------------------------------
Total direct ULAE 32,102
--------
-------------------------------------------------------------------------
Direct salvage and subrogation recoverable:
-------------------------------------------------------------------------
Pooled Subsidiaries, National and Mid-Plains (13,538)
-------------------------------------------------------------------------
Assumed by Pooled Subsidiaries (13,555)
--------
-------------------------------------------------------------------------
Total direct salvage and subrogation recoverable (27,093)
--------
-------------------------------------------------------------------------
Reinsurance recoverable (8,825)
-------------------------------------------------------------------------
Assumed reinsurance 3,278
-------------------------------------------------------------------------
Reinsurance Assumed by Pooled Subsidiaries (26,002)
--------
-------------------------------------------------------------------------
Total losses and loss expenses payable, net of
reinsurance recoverable on losses and loss
expenses payable of $8,825 $592,133
========
-------------------------------------------------------------------------
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(1) ALAE are those costs that can be related to a specific claim, which may include attorney fees, external claims adjusters, and investigation costs, among others. ULAE are those costs incurred in settling claims, such as in-house processing costs, for which no identification can be made to specific claims. ALAE and ULAE comprise the loss expense portion of the total loss and loss expenses payable.
The risks and uncertainties inherent in the estimates include, but are not limited to, actual settlement experience different from historical data, trends, changes in business and economic conditions, court decisions creating unanticipated liabilities, ongoing interpretation of policy provisions by the courts, inconsistent decisions in lawsuits regarding coverage and additional information discovered before settlement of claims. 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 preceding paragraphs briefly describe certain factors management considers in estimating the ultimate liability for losses and loss expenses. With respect to the auto line of business, which represents almost half of the Company's total reserves, the most significant external variable is legal developments. As discussed in "Impact of Significant External Factors" below, court decisions have a significant impact on the property and casualty insurance industry. Some of these decisions have a more prospective effect as, for example, when contract provisions relating to third party coverages are construed in ways not anticipated by the Company. Other court decisions have more of a retroactive effect, in particular in the auto insurance line. Auto insurance tends to be a line of business more regulated by statutes; consequently, the courts tend to have more of an opportunity to construe these statutes and apply their interpretations to existing contracts. Uninsured motorists and underinsured motorists (collectively "UM") are statutory coverages in almost every state
where the Company does business. When courts construe UM statutes in a manner which is adverse to the Company and the industry, the effect of that decision is typically retroactive, because, legally speaking when the court interprets a statute it is as though the statute was always construed in that manner. This retroactive effect is exacerbated in UM cases (and other first party coverage cases) because the statute of limitations applicable to UM claims and other first party coverages can be as long as 15 years. Claims that had been closed or not even presented, going back as long as 15 years, can be re-born by an adverse court decision. The Company considers the impact of adverse court decisions of which it has become aware when it sets ultimate loss and LAE reserves for auto insurance as well as other lines to the extent those lines may be retroactively affected by such matters.
The effect of court decisions is also apparent in the commercial lines of coverages such as commercial multi-peril and other liability and products liability. Courts can expand coverage or void exclusions which can increase the Company's exposure to claims. Some of these third party claims may still be brought within the statute of limitations applicable to such third party claims and expose the Company to some retroactive liabilities. These liabilities are sought to be addressed by the ultimate loss and LAE reserve that is the Company's estimate of loss and loss expenses payable.
It is not feasible to quantify the impact of judicial decisions by the courts that may have retroactive effect because the Company cannot foresee, among the range of issues that are litigated every day in courts in each state in which the Company does business, which cases will be decided adversely and how such decisions will actually apply to the Company.
The following table presents the loss and loss expenses payable by major line of business at December 31, 2002 and 2001, respectively:
----------------------------------------------------------------------------------------
2002 2001 % Change
----------------------------------------------------------------------------------------
(Dollars in thousands)
----------------------------------------------------------------------------------------
Automobile - standard $254,579 $232,254 10%
----------------------------------------------------------------------------------------
Automobile - nonstandard 35,269 30,069 17%
----------------------------------------------------------------------------------------
Homeowners and farmowners 45,850 40,645 13%
----------------------------------------------------------------------------------------
Commercial multi-peril 77,018 58,161 32%
----------------------------------------------------------------------------------------
Workers compensation 77,801 72,726 7%
----------------------------------------------------------------------------------------
Fire and allied lines 14,416 11,370 27%
----------------------------------------------------------------------------------------
Other liability and products liability 80,539 60,154 34%
----------------------------------------------------------------------------------------
Other personal lines 1,033 779 33%
----------------------------------------------------------------------------------------
Other commercial lines 5,628 3,783 49%
----- -----
----------------------------------------------------------------------------------------
Total losses and loss expenses payable,
net of reinsurance recoverable on losses
and loss expenses payable of $8,825 and $592,133 $509,941 16%
$13,919, respectively ======== ========
----------------------------------------------------------------------------------------
|
Overall 2002 total net losses and loss expenses payable increased 16% from 2001. This increase is primarily driven by an increase in claim submissions, as the policy count base grew significantly during the year. As shown in the table, the "other commercial lines" payable percentage increase is greater than the average increase for all lines. We believe this is due to higher than average growth in commercial lines, and several unusually large claims incurred during 2002. Overall, management does not believe there is a significant change in the total book of business at December 31, 2002 compared to December 31, 2001.
Unlike 2001, where the Company's loss and loss expenses incurred increased by $60.7 million for claims that occurred in prior years primarily as the result of case reserve strengthening on Meridian claims, in 2002, loss and losses expenses incurred increased $12.4 million (2.4% of December 31, 2001
net loss and loss expense payable). The current year development of the prior years' ultimate liability does not reflect any changes in the Company's fundamental claims reserving practices.
A tabular presentation of the current year $12.4 million development broken down by accident year is shown below derived from the Company's 2001 and 2002, 10 year loss development tables, as presented in the Reserves section of the Company's Form 10-K, "Narrative Description of Business" section. The development is measured in dollars and as a percentage of the total December 31, 2001 net loss and loss expense payable:
--------------------------------------------------------
Current year Percentage of
development 12/31/2001
of ultimate total net loss
Accident liability and
Year redundancy loss expenses
(deficiency) payable
--------------------------------------------------------
(Dollars in
thousands)
--------------------------------------------------------
1992 and prior $(1,547) (0.30)%
--------------------------------------------------------
1993 1,210 0.24
--------------------------------------------------------
1994 (10) 0.00
--------------------------------------------------------
1995 188 0.04
--------------------------------------------------------
1996 (401) (0.08)
--------------------------------------------------------
1997 1,700 0.33
--------------------------------------------------------
1998 (434) (0.09)
--------------------------------------------------------
1999 (3,373) (0.66)
--------------------------------------------------------
2000 (5,509) (1.08)
--------------------------------------------------------
2001 (4,238) (0.83%)
------- -------
--------------------------------------------------------
Total ($12,414) (2.4%)
========= ======
--------------------------------------------------------
|
In management's opinion, the 2.4% current year development, given the breakdown by accident year, is well within normal expectations for reserve development and claim settlement uncertainty.
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 (Statements). 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. Effective January 1, 2002, the Company implemented the new rules in accordance with the Statements. As part of the implementation, the Company performed the requisite transitional impairment tests for goodwill. The adoption of the Statements did not materially impact the Company's financial position or 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 the limitations of modeling economic variables. General inflation, as measured by the CPI, has been relatively modest over the last several years, however price inflation on the goods and services purchased by insurance companies in settling claims has been steadily increasing. In particular, repair costs for homes, autos, and commercial buildings, and medical care costs, have risen over the last few years. We continue to adjust our pricing projections as loss cost trends change to ensure premiums keep pace with inflation in all 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 best 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.
After credit scoring, the industry's use of which has been limited to varying extents by certain state's laws, the next most predictive underwriting report available to insurers is previous loss information. Third party vendors obtain loss information from insurers based on the insured, the vehicle and/or the property location. As insurers write new business the database is accessed to analyze any loss experience of the insured, vehicle and/or property location. Many times insurer's premium rates will be adjusted to reflect the loss experience accessed from these databases. In some cases the overall acceptability of the insured's application in the standard market may be determined by these reports. During 2002, use of this loss information database product by the insurance industry as a predictive underwriting tool has been challenged by several west coast states and most recently in a few of the Company's states of operation. While it is too soon to determine states' reaction to the utilization of these database systems, any restrictive regulation of the full use of these underwriting reports could have an adverse impact on the Company as it has utilized these database systems for several years as an underwriting tool. Since such regulation is applicable to all companies writing business which utilize these reports the Company does not expect to suffer a competitive disadvantage.
Probably the most significant piece of legislation to affect the Company in 2002 was the Federal Sarbanes-Oxley Act of 2002,("Sarbanes Oxley") which took effect in July 2002. While this law does not affect the Company's insurance operations, it has and will continue to have an effect on the Company. Sarbarnes Oxley was the response of the Congress to the corporate scandals of the last two years. Sarbanes Oxley imposes significant new rules on the Company's corporate governance, its financial and reporting processes and its relationship with its independent auditor. Sarbanes Oxley will require the Company to incur additional costs through an increase in its internal staff functions to ensure that it adequately documents compliance with these new legal requirements.
The Terrorism Risk Insurance Act of 2002 (the "Terrorism Act") established a temporary federal program that provides for a system of shared public and private compensation for insured losses resulting from acts of terrorism committed by or on behalf of a foreign interest. In order for a loss to be covered under the Terrorism Act, it must be the result of an event that is certified as an act of terrorism by the U.S. Secretary of Treasury ("subject losses"). In the case of a war declared by Congress, only workers' compensation losses are covered by the Terrorism Act. The Terrorism Insurance Program (the "Program") generally requires that all commercial property casualty insurers licensed in the U.S. participate in the Program. The amount of compensation paid to participating insurers under the Program is 90% of subject losses, after an insurer deductible, subject to an annual cap that limits the amount of subject losses to $100 billion aggregate per program year. The Company's deductible under this federal Program is approximately $28.0 million for 2003, subject to final rules to be established by the U.S. Treasury. 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.
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 elsewhere in this Form 10-K, during the past several years, Mutual and the Company have acquired other insurance companies, such as Milbank, Farmers Casualty, and SA Wisconsin, 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, 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 of the Company's Form 10-K.
- 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 and unexpected challenges to the control of the Company by Mutual.
ITEM 7(a). QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
"Qualitative and Quantitative Disclosures About Market Risk" is included in Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" under Market Risk.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements, including the Notes to Consolidated Financial Statements and the Report of Independent Auditors are as follows:
Report of Independent Auditors
The Board of Directors and Stockholders
State Auto Financial Corporation
We have audited the accompanying consolidated balance sheets of State Auto Financial Corporation and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of State Auto Financial Corporation and subsidiaries at December 31, 2002 and 2001, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States.
Columbus, Ohio /s/ Ernst & Young, LLP February 21, 2003 |
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
CONSOLIDATED BALANCE SHEETS
DECEMBER 31
-----------
2002 2001
---- ----
(dollars in thousands,
ASSETS except share data)
Fixed maturities:
Held to maturity, at amortized cost (fair value $0 and $28,672, respectively) ............... $ -- 27,406
Available for sale, at fair value (amortized cost $1,149,334 and $1,042,539,
respectively) ............................................................................. 1,216,698 1,051,405
Equity securities, available for sale, at fair value (cost $55,837 and $50,361, respectively) 53,710 59,845
Other invested assets, at fair value (cost $1,857 and $0, respectively) ....................... 1,908 --
------------------------------
Total investments ............................................................................. 1,272,316 1,138,656
Cash and cash equivalents ..................................................................... 96,048 30,016
Deferred policy acquisition costs ............................................................. 77,886 67,087
Accrued investment income and other assets .................................................... 50,788 40,920
Due from affiliate ............................................................................ 14,210 --
Net prepaid pension expense ................................................................... 46,690 43,344
Reinsurance recoverable on losses and loss expenses payable (affiliate $4,286
and $8,867, respectively) ................................................................... 8,825 13,919
Prepaid reinsurance premiums (affiliate $3,997 and $2,200, respectively) ...................... 7,695 4,955
Current federal income taxes .................................................................. -- 1,549
Deferred federal income taxes ................................................................. 5,796 13,800
Property and equipment, at cost, net of accumulated depreciation of $3,915
and $3,351, respectively .................................................................... 12,741 13,250
------------------------------
Total assets .................................................................................. $1,592,995 1,367,496
==============================
LIABILITIES AND STOCKHOLDERS' EQUITY
Losses and loss expenses payable (affiliate $303,960 and $280,011, respectively)............... $ 600,958 523,860
Unearned premiums (affiliate $133,130 and $138,588, respectively) ............................. 377,990 329,495
Notes payable (affiliates $60,500 and $45,500, respectively) .................................. 75,500 45,500
Postretirement benefit liabilities ............................................................ 66,763 57,237
Current federal income taxes .................................................................. 745 --
Other liabilities ............................................................................. 7,270 5,059
Due to affiliates ............................................................................. -- 6,152
------------------------------
Total liabilities ............................................................................. 1,129,226 967,303
------------------------------
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; 43,525,774
and 43,045,320 shares issued, respectively, at stated value of $2.50 per share............. 108,815 107,613
Less 4,524,475 and 4,108,230 treasury shares, respectively, at cost ......................... (54,249) (47,613)
Additional paid-in capital .................................................................. 50,354 47,106
Accumulated other comprehensive income ...................................................... 42,512 12,030
Retained earnings ........................................................................... 316,337 281,057
------------------------------
Total stockholders' equity .................................................................... 463,769 400,193
------------------------------
Total liabilities and stockholders' equity .................................................... $1,592,995 1,367,496
==============================
|
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
----------------------
2002 2001 2000
---- ---- ----
(dollars in thousands,
except per share amount)
Earned premiums (ceded to affiliate $506,777, $432,168 and $402,560,
respectively) ..................................................................... $ 896,595 555,207 397,967
Net investment income ............................................................... 59,691 47,375 38,915
Management services income from affiliates ......................................... 2,638 15,586 17,594
Net realized gains on investments ................................................... 5,909 1,962 5,255
Other income (affiliates $602, $1,450, and $1,546, respectively) .................... 2,646 3,142 3,043
------------------------------------------
Total revenues ...................................................................... 967,479 623,272 462,774
------------------------------------------
Losses and loss expenses (ceded to affiliate $368,819, $303,931 and
$279,657, respectively) ........................................................... 653,474 427,074 272,167
Acquisition and operating expenses .................................................. 264,348 167,207 119,569
Interest expense to affiliates ...................................................... 2,333 2,275 2,730
Other expenses ...................................................................... 9,534 8,740 6,864
------------------------------------------
Total expenses ...................................................................... 929,689 605,296 401,330
------------------------------------------
Income before federal income taxes .................................................. 37,790 17,976 61,444
------------------------------------------
Federal income tax expense (benefit):
Current ........................................................................... 8,155 7,699 14,408
Deferred .......................................................................... (7,360) (10,338) (678)
------------------------------------------
Total federal income taxes .......................................................... 795 (2,639) 13,730
------------------------------------------
Net income .......................................................................... $ 36,995 20,615 47,714
===========================================
Earnings per common share:
Basic ............................................................................. $ 0.95 0.53 1.24
===========================================
Diluted ........................................................................... $ 0.93 0.52 1.21
===========================================
Dividends paid per common share ..................................................... $ 0.14 0.13 0.12
===========================================
|
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, 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
====== ======== ===== ======== ======= ======= ======== ========
Net income 36,995 36,995
Unrealized gains, net of tax
and reclassification
adjustment 30,482 30,482
--------
Comprehensive income 67,477
--------
Issuance of common stock 480 1,202 2,173 3,375
Tax benefit from stock
options exercised 910 910
Treasury shares acquired on
stock option exercises 20 (375) (375)
Treasury shares acquired
under repurchase program 396 (6,261) (6,261)
Stock options granted 165 165
Cash dividends paid (1,715) (1,715)
------ -------- ----- -------- ------- ------- -------- --------
BALANCE-DECEMBER 31, 2002 43,525 $108,815 4,524 ($54,249) $50,354 $42,512 $316,337 $463,769
====== ======== ===== ======== ======= ======= ======== ========
|
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
----------------------
2002 2001 2000
---- ---- ----
(in thousands)
Cash flows from operating activities:
Net income ....................................................................... $ 36,995 20,615 47,714
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization, net .............................................. 5,616 3,036 3,548
Net realized gains on investments ............................................... (5,909) (1,962) (5,255)
Changes in operating assets and liabilities:
Deferred policy acquisition costs .............................................. (10,798) (4,735) (1,756)
Accrued investment income and other assets ..................................... (10,054) (16,671) (2,480)
Net prepaid pension expense .................................................... (3,346) (5,606) (4,168)
Postretirement benefit liabilities ............................................. 9,526 1,396 3,746
Reinsurance recoverable on losses and loss
expenses payable and prepaid reinsurance premiums ............................. 2,353 (7,943) (763)
Other liabilities and due to/from affiliates, net .............................. (18,149) 11,273 (7,106)
Losses and loss expenses payable ............................................... 77,097 47,693 (440)
Unearned premiums .............................................................. 48,494 21,919 6,817
Federal income taxes ........................................................... (5,205) (14,139) 1,093
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 and 1/1/00, respectively ....................... -- 2,197 18,617
Cash provided from transfer of employees, effective 1/1/00 ....................... -- -- 28,098
----------------------------------------------
Net cash provided by operating activities ......................................... 126,620 63,453 87,665
----------------------------------------------
Cash flows from investing activities:
Purchase of fixed maturities - available for sale ................................ (507,626) (246,269) (187,724)
Purchase of equity securities .................................................... (22,130) (16,437) (15,783)
Purchase of other invested assets ................................................ (1,857) -- --
Maturities, calls and principal reductions of fixed maturities - held
to maturity ..................................................................... 8,238 11,612 4,600
Maturities, calls and principal reductions of fixed maturities - available
for sale ........................................................................ 61,509 38,552 22,355
Sale of fixed maturities - available for sale .................................... 363,594 149,043 71,530
Sale of equity securities ........................................................ 12,716 9,301 16,158
Net additions of property and equipment .......................................... (56) (1,056) (2,066)
----------------------------------------------
Net cash used in investing activities ............................................. (85,612) (55,254) (90,930)
----------------------------------------------
Cash flows from financing activities:
Net proceeds from issuance of debt ............................................... 30,000 -- --
Net proceeds from issuance of common stock ....................................... 3,000 2,466 1,708
Payments to acquire treasury shares .............................................. (6,261) (388) (301)
Payment of dividends ............................................................. (1,715) (1,566) (1,397)
----------------------------------------------
Net cash provided by financing activities ......................................... 25,024 512 10
----------------------------------------------
Net increase (decrease) in cash and cash equivalents .............................. 66,032 8,711 (3,255)
----------------------------------------------
Cash and cash equivalents at beginning of year .................................... 30,016 21,305 24,560
----------------------------------------------
Cash and cash equivalents at end of year .......................................... $ 96,048 30,016 21,305
==============================================
|
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 of Ohio (SA Ohio), an Ohio corporation
(formerly State Auto Insurance Company)
- 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.
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 SA Ohio, 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, SA Ohio, 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, SA Ohio, National and Mid-Plains are chartered and licensed as property and casualty insurers in the states of South Carolina, South Dakota, Iowa, Ohio (SA Ohio and National) and Iowa, respectively, and are licensed in various other states. As such, they are subject to the regulations of the applicable Departments of Insurance of their respective states of domicile (the Departments) and the regulations of each state in which they operate. These property and casualty insurance companies undergo periodic financial examination by the Departments and insurance regulatory agencies of the states that choose to participate.
Through State Auto P&C, effective January 1, 2000, the Company provides management and operation services under 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.
Through Stateco, the Company provides investment management services to affiliated companies.
The Company, through S.I.S., develops and sells software for the processing of insurance transactions, database management for insurance agents and electronic interfacing of information between insurance companies and agencies. S.I.S. sells services and products to affiliated companies and their agents and markets similar services and products to nonaffiliated insurers and their agencies.
518 PML, an Ohio limited liability company, was formed to engage in the business of owning and leasing real and personal property to affiliated companies.
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(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, SA Ohio, 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 amount of 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
----------------------
2002 2001 2000
---- ---- ----
(dollars in thousands)
Balance, beginning of
year .................. $ 67,087 32,458 28,936
Acquisition costs
deferred .............. 235,139 143,651 101,305
Amortized to expense
during the year ....... 224,340 109,022 97,783
----------------------------------------
Balance, end
of year ............... $ 77,886 67,087 32,458
========================================
|
(e) INVESTMENTS
At December 31, 2002 all investments in fixed maturity and equity securities are held as available for sale and therefore are carried at fair value. Other invested assets are comprised of limited liability partnership investments that 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. Effective December 31, 2002, the Company transferred all of its investments previously classified as held to maturity to the available for sale category to align the investment portfolio with management's investment policy. For fixed maturities classified as held to maturity, unrealized holding gains or losses were not reflected in the accompanying consolidated financial statements, rather they were carried at amortized cost. Upon transfer of the held to maturity investments to available for sale at December 31, 2002, the held to maturity investments' amortized cost, fair value and net unrealized gain were $19,095,000, $20,369,000 and $1,274,000, respectively, and therefore other comprehensive income of $828,000, net of deferred taxes of $446,000 was recognized. Gains and losses on the sale of equity securities are computed using the first-in, first-out method. The Company regularly monitors its investments that have fair value less than the carrying amount for signs of other than temporary impairment. Among the factors considered are market conditions, amount, timing and length of decline in fair market value and events impacting the issuer. When other than temporary impairment is recognized, the investment cost is written down to fair value and a realized loss is recorded. The cost is not adjusted for any subsequent recovery in fair value. For 2002, included in net realized gain on investments was $2,221,000 of realized losses recognized due to other than temporary impairments.
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 included in other assets was $2,012,000, net of $1,864,000 amortization at December 31, 2002 and 2001 which represents the excess of cost of acquisition over the fair value of the net assets acquired. See related goodwill discussion at note 1(n). 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 (Statements). Under the new rules, goodwill will no longer be amortized but will be subject to impairment tests in accordance with the Statements. The Company evaluated the goodwill and determined that there was no impairment at December 31, 2002.
(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 $27,093,000 and $26,216,000 at December 31, 2002 and 2001, 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 employees 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, to the extent certain operational ratios were achieved, was recognized quarterly based on a percentage of the three year average of each managed company's adjusted surplus or equity. State Auto Insurance Company of Wisconsin (SA Wisconsin), formerly Midwest Security Insurance Company, a wholly-owned subsidiary of Mutual, is an exception to this, calculating its fee based on a percentage of quarterly direct premiums written. Effective July 1, 2002, the Meridian Insurers, defined below, pay State Auto P&C a predetermined percentage of their allocated share of 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. 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 software license fees on a straight-line basis over the license agreement term specified in the contract. Cash payments received at the signing of the license agreement are deferred and recognized as revenue on a straight-line basis over the agreement term, typically three years. Service fees are also recognized as revenue on a straight-line basis over the license agreement term specified in the contract. Other fees are recognized as revenue upon substantial performance by the Company and customer acceptance. 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 $225,000 and $186,000 are included in accrued investment income and other assets at December 31, 2002 and 2001, respectively. Software amortization, included in other expenses, was $186,000, $440,000 and $622,000 in 2002, 2001 and 2000 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
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
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
The Company 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 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, equity securities and other invested assets.
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 14.
(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, Goodwill and Other Intangible Assets, effective for fiscal years beginning after December 15, 2001 (Statements). 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. Effective January 1, 2002, the Company implemented the new rules in accordance with the Statements. As part of the implementation, the Company performed the requisite transitional impairment tests for goodwill. The adoption of the Statements did not materially impact the Company's financial position or results of operations.
(o) RECLASSIFICATIONS
Certain items in the 2001 and 2000 consolidated financial statements have been reclassified to conform to the 2002 presentation.
(2) INVESTMENTS
Realized and unrealized gains and losses are summarized as follows:
YEAR ENDED DECEMBER 31
----------------------
2002 2001 2000
---- ---- ----
(in thousands)
Realized gains:
Fixed maturities available for sale ................................................. $ 12,661 3,072 791
Equity securities ................................................................... 2,047 2,258 5,959
--------------------------------------
Total realized gains .................................................................. 14,708 5,330 6,750
--------------------------------------
Realized losses:
Fixed maturities available for sale ................................................. 2,814 114 827
Equity securities ................................................................... 5,985 3,254 668
--------------------------------------
Total realized losses ................................................................. 8,799 3,368 1,495
--------------------------------------
Net realized gains on investments ..................................................... $ 5,909 1,962 5,255
======================================
Increase (decrease) in unrealized holding gains -- Equity securities .................. $ (11,611) (4,608) (2,123)
Increase (decrease) in unrealized holding gains -- Fixed
maturities available for sale at fair value ......................................... 58,491 (8,134) 33,195
Increase in unrealized holding gains - Other invested assets .......................... 51 -- --
Change in deferred unrealized gain .................................................... (35) (7) (55)
Deferred federal income taxes thereon ................................................. (16,414) 4,462 (10,856)
--------------------------------------
Increase (decrease) in net unrealized holding gains or losses ......................... $ 30,482 (8,287) 20,161
======================================
|
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
See footnote 1(e) regarding investments. The Company's investments are summarized as follows:
COST OR GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
AVAILABLE FOR SALE AT DECEMBER 31, 2002: COST HOLDING GAINS HOLDING LOSSES VALUE
---- ------------- -------------- -----
(in thousands)
U.S. Treasury securities and obligations of U.S.
government agencies and authorities ........................ $ 214,809 11,016 132 225,693
Obligations of states and political subdivisions ............. 696,191 41,574 444 737,321
Corporate securities ......................................... 128,631 10,453 72 139,012
Mortgage-backed securities: U.S. government agencies ......... 109,703 4,969 -- 114,672
--------------------------------------------------------------
Total fixed maturities ..................................... 1,149,334 68,012 648 1,216,698
Equity securities ............................................ 55,837 6,148 8,275 53,710
Other invested assets ........................................ 1,857 51 -- 1,908
--------------------------------------------------------------
Total ........................................................ $ 1,207,028 74,211 8,923 1,272,316
==============================================================
|
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 agencies and authorities ........................ $ 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 agencies and authorities ........................ $ 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
==============================================================
|
Deferred federal income taxes on the net unrealized holding gain for available for sale investments was $22,891,000 and $6,478,000 at December 31, 2002 and 2001, 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 at December 31, 2002, by contractual maturity, are summarized as follows:
AVAILABLE FOR SALE
------------------
AMORTIZED FAIR
COST VALUE
---- -----
(in thousands)
Due after 1 year or less .................................... $ 5,363 5,409
Due after 1 year through 5 years ............................ 40,173 43,368
Due after 5 years through 10 years .......................... 288,170 306,308
Due after 10 years .......................................... 705,960 746,942
----------------------------
1,039,666 1,102,027
Mortgage-backed securities .................................. 109,668 114,671
----------------------------
$ 1,149,334 1,216,698
============================
|
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 $45,256,000 and $27,666,000 were on deposit with regulators as required by law or specific escrow agreement at December 31, 2002 and 2001, respectively.
Components of net investment income are summarized as follows:
YEAR ENDED DECEMBER 31
----------------------
2002 2001 2000
---- ---- ----
(in thousands)
Fixed maturities ......................................................... $58,225 41,262 36,568
Equity securities ........................................................ 1,146 996 848
Cash and cash equivalents ................................................ 1,204 5,756 1,926
-------------------------------------------
Investment income ........................................................ 60,575 48,014 39,342
-------------------------------------------
Investment expenses ...................................................... 884 639 427
-------------------------------------------
Net investment income .................................................... $59,691 47,375 38,915
===========================================
|
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. The fair value of other invested assets is based on Generally Accepted Accounting Principles equity.
CASH AND CASH EQUIVALENTS: The carrying amounts reported in the balance sheets for these instruments approximate their fair value, because of their short-term nature.
NOTES PAYABLE: The carrying amounts reported in the balance sheets for these instruments approximate their fair value because their interest rates adjust regularly.
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
----------------------
2002 2001 2000
---- ---- ----
(in thousands)
Losses and loss expenses payable, at beginning of year .......................... $523,860 244,583 232,489
Less: reinsurance recoverable on losses and loss expenses payable ............... 13,919 7,930 10,807
-------------------------------------------
Net balance at beginning of year ................................................ 509,941 236,653 221,682
===========================================
Incurred related to:
Current year .................................................................. 641,060 366,348 277,805
Prior years ................................................................... 12,414 60,726 (5,638)
-------------------------------------------
Total incurred .................................................................. 653,474 427,074 272,167
-------------------------------------------
Paid related to:
Current year .................................................................. 349,733 240,508 164,620
Prior years ................................................................... 221,549 144,862 104,871
-------------------------------------------
Total paid ...................................................................... 571,282 385,370 269,491
-------------------------------------------
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 and January 1, 2000,
respectively (note 6) ......................................................... -- 156,009 12,295
-------------------------------------------
Net balance at end of year ...................................................... 592,133 509,941 236,653
Plus reinsurance recoverable on losses and loss expenses payable ................ 8,825 13,919 7,930
-------------------------------------------
Losses and loss expenses payable, at end of year (affiliate
$303,959, $280,011 and $10,126, respectively) ................................. $600,958 523,860 244,583
===========================================
|
The increase of $12,414,000 in 2002 for claims occurring in prior years is well within normal expectations for reserve development and claim settlement uncertainty. The increase of $60,726,000 in 2001 for claims occurring in prior years is primarily the result of reserve strengthening on the former Meridian Mutual Insurance Company (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 decrease in calendar year losses from prior years in 2000 of $5,638,000 is within normal expectation of reserve variation.
(5) REINSURANCE
In the ordinary course of business, the Company assumes and cedes reinsurance with other insurers and reinsurers and is a member 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.
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
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
-----------
2002 2001
---- ----
(in thousands)
Losses and loss expenses payable:
Direct ................................................................................................ $293,720 240,012
Assumed ............................................................................................... 3,278 3,837
Ceded ................................................................................................. (4,540) (5,048)
----------------------
Net losses and loss expenses payable ................................................................ $292,458 238,801
======================
Unearned premiums:
Direct ................................................................................................ $243,811 189,800
Assumed ............................................................................................... 1,049 1,107
Ceded ................................................................................................. (3,699) (2,755)
----------------------
Net unearned premiums ............................................................................... $241,161 188,152
======================
|
YEAR ENDED DECEMBER 31
----------------------
2002 2001 2000
---- ---- ----
(in thousands)
Written premiums:
Direct ............................................................................ $ 631,342 501,250 439,623
Assumed ........................................................................... 3,876 4,196 4,678
Ceded ............................................................................. (12,203) (9,152) (7,340)
------------------------------------------
Net written premiums ............................................................ $ 623,015 496,294 436,961
==========================================
Earned premiums:
Direct ............................................................................ $ 577,803 472,766 432,318
Assumed ........................................................................... 3,934 4,304 5,166
Ceded ............................................................................. (11,260) (8,335) (7,360)
------------------------------------------
Net earned premiums ............................................................. $ 570,477 468,735 430,124
==========================================
Losses and loss expenses incurred:
Direct ............................................................................ $ 413,359 328,363 297,757
Assumed ........................................................................... 2,383 3,054 3,726
Ceded ............................................................................. (1,945) (1,550) 152
------------------------------------------
Net losses and loss expenses incurred ........................................... $ 412,382 329,867 301,635
==========================================
|
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, SA Ohio (the Pooled Subsidiaries) and SA Wisconsin participate in a quota share reinsurance pooling arrangement (the Pooling Arrangement) with Mutual whereby the Pooled Subsidiaries and SA Wisconsin 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.
Effective December 31, 1999 State Auto P&C, Milbank, SA Wisconsin and Farmers
participation in the Pooling Arrangement was 50%. Effective January 1, 2000, the
Pooling Arrangement was amended to make SA Ohio 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).
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:
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
DECEMBER 31
-----------
2002 2001
---- ----
(in thousands)
Losses and loss expenses payable:
Ceded .................................................................................... $ (261,470) (219,851)
Assumed .................................................................................. 565,430 499,862
-----------------------------
Net assumed ............................................................................ $ 303,960 280,011
=============================
Unearned premiums:
Ceded .................................................................................... $ (212,077) (172,265)
Assumed .................................................................................. 345,207 310,853
-----------------------------
Net assumed ............................................................................ $ 133,130 138,588
=============================
|
YEAR ENDED DECEMBER 31
----------------------
2002 2001 2000
---- ---- ----
(in thousands)
Written premiums:
Ceded .................................................................... $ (534,377) (448,331) (405,397)
Assumed .................................................................. 864,830 529,253 370,576
Earned premiums:
Ceded .................................................................... $ (495,036) (426,880) (399,057)
Assumed .................................................................. 829,981 515,619 367,275
Losses and loss expenses incurred:
Ceded .................................................................... $ (353,602) (298,755) (277,340)
Assumed .................................................................. 609,910 406,138 250,189
|
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, (Meridian Security), 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 MIGI insurer subsidiaries and affiliate are hereafter collectively referred to as the "Meridian Insurers".
Mutual, State Auto P&C, Milbank, SA Wisconsin, Farmers Casualty, SA Ohio, 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, SA Wisconsin, Farmers Casualty, SA Ohio, National, Mid-Plains and the Meridian Insurers in the amount of $115 million excess of $120 million. Effective November 2002, 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 $2,914,000, $3,021,000 and $3,129,000 for 2002, 2001 and 2000, 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 2002) up to $100 million for
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
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 2002 and 2001, the Pooled Subsidiaries ceded to Mutual, $8,769,000 and $6,177,000 in losses, respectively, and $1,442,000 and $0, respectively, in premiums under the Stop Loss. At December 31, 2001, the $6,177,000 recovery under the stop loss has been reflected in reinsurance recoverable on losses and loss expenses payable.
National and Mid-Plains each have ceding reinsurance agreements with Mutual, that include excess of loss and quota share coverages. Through Mutual's participation in the Pooling Arrangement, the effects of these agreements with National and Mid-Plains are indirectly subject to the Pooling Arrangement between Mutual and the pooled subsididaries.
The following provides a summary of the ceding reinsurance transactions on the Company's balance sheets and income statement for the reinsurance agreements between National and Mutual and Mid-Plains and Mutual:
DECEMBER 31
-----------
2002 2001
---- ----
(in thousands)
Losses and loss
expenses payable $4,285 2,694
Unearned premiums $3,996 2,200
|
YEAR ENDED DECEMBER 31
----------------------
2002 2001 2000
---- ---- ----
(in thousands)
Written premiums $ 12,097 6,295 3,565
Earned premiums $ 10,299 5,288 3,504
Losses and loss
expenses incurred $ 7,862 3,999 2,317
|
(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 $167 million and $123 million related to premium balances due to Mutual from agents and insureds at December 31, 2002 and 2001, respectively, which is collateralized by the unearned premium from the respective policies.
(c) NOTES 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. See related footnote at note 10(a). Principal payment is due on demand after December 31, 2000, with final payment to be received on or prior to December 31,
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
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, 2001 and 2000 is 4.75%, 5.0% and 6.0%, respectively. Interest rate for the year 2003 will be 4.25%. Interest expense on the loan from Mutual was $2,161,000, $2,275,000 and $2,730,000 in 2002, 2001 and 2000, respectively. Total interest expense paid to affiliates during 2002, 2001 and 2000 was $2,333,000, $2,275,000 and $2,730,000, respectively.
Effective September 30, 2002, Milbank, entered into a $15.0 million surplus contribution note agreement with Meridian Security. This note was funded with cash during the fourth quarter of 2002. Subject to the condition described below and the other terms of the note, the maturity date is September 30, 2012. The interest rate is equal to the U.S. Treasury ten-year note yield at September 30, 2002 plus 100 basis points (total 4.59%) and is adjustable October 1, 2007 to the then current U.S. Treasury ten-year note yield plus 100 basis points for the remaining term of the note. Interest is accrued, but all payments of principal or interest may be made only with the prior written approval of the South Dakota Director of Insurance. Interest is scheduled to be paid semiannually in arrears starting March 30, 2003. Interest expense on the loan was $172,000 in 2002.
(d) MANAGEMENT SERVICES
Effective January 1, 2000, State Auto P&C began providing management and operation services to Mutual and its insurance affiliates. Revenue relating to these services amount to $553,000, $12,621,000 and $14,654,000 in 2002, 2001 and 2000, respectively. Stateco provides Mutual and its affiliate investment management services. Revenue related to these services amount to $2,085,000, $2,965,000 and $2,940,000 in 2002, 2001, and 2000, 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 15. The management agreement between State Auto P&C and SA Wisconsin 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 $225,000, $692,000 and $900,000 in 2002, 2001 and 2000, respectively, and is included in other income. 518 PML leases assets to Mutual and its affiliate. Revenue relating to these services amount to $376,000, $758,000 and $646,000 in 2002, 2001 and 2000, 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, 2002, 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) NOTE PAYABLE TO BANK
Effective December 21, 2002 State Auto Financial entered into a $15,000,000 term loan note agreement with a bank that matures December 21, 2003. Interest adjusts quarterly and accrues at LIBOR plus 75 basis points (2.15% at December 31, 2002) and is payable quarterly. This note agreement has various covenants including financial ratio covenants.
(8) 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
----------------------
2002 2001 2000
AMOUNT % AMOUNT % AMOUNT %
------ -- ------ -- ------ --
(in thousands)
Amount at statutory rate ..................................... $ 13,227 35 6,291 35 21,505 35
Tax-free interest and dividends received deduction............ (11,888) (32) (8,925) (50) (7,918) (13)
Other, net.................................................... (544) (1) (5) -- 143 --
------------------------------------------------
Effective tax rate............................................ $ 795 2 (2,639) (15) 13,730 22
================================================
|
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
-----------
2002 2001
---- ----
(in thousands)
Deferred tax assets:
Unearned premiums not deductible ...................$ 25,927 $22,847
Losses and loss expenses payable discounting ....... 21,626 19,767
Postretirement benefit liabilities ................. 16,438 13,746
Other .............................................. 5,658 1,982
Alternative minimum tax credit ..................... 3,439 1,410
--------------------------
Total deferred tax assets ........................ 73,088 59,752
==========================
Deferred tax liabilities:
Deferral of policy acquisition costs ............... 27,260 23,481
Net pension expense ................................ 15,583 13,993
Unrealized holding gain on investments ............. 22,891 6,478
Other .............................................. 1,558 2,000
--------------------------
Total deferred tax liabilities ................... 67,292 45,952
--------------------------
Net deferred tax assets ..........................$ 5,796 $13,800
==========================
|
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 2002, 2001 and 2000 were $6,000,000 $11,500,000 and $12,638,000, respectively.
(9) (a) PENSION BENEFIT PLANS
Effective January 1, 2002, employees of MIGI, a subsidiary of the former Meridian Mutual, became employees of State Auto P&C. In conjunction with this transaction approximately $3.6 million in net plan benefit liabilities were transferred from MIGI to 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 agree-
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
ments effective on that same date. See related discussion at Note (1)(b). Pursuant to the new management agreements, the Company paid cash of approximately $14.6 million to Mutual, equal to the net prepaid pension asset received.
The assets of the defined benefit pension plan are represented primarily by U.S. government and agency obligations, bonds, and common stocks. The Company's policy is to fund pension costs in accordance with the requirements of the Employee Retirement Income Security Act of 1974. Benefits are determined by applying factors specified in the plan to a participant's defined average annual compensation.
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.
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
--------
2002 2001
---- ----
(in thousands)
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of year ................................................... $ 97,477 87,093
Transfer in benefit obligation at beginning of year due to employee transfer .............. 31,440 --
Service cost .............................................................................. 5,541 3,537
Interest cost ............................................................................. 9,399 6,750
Actuarial loss ............................................................................ 15,111 9,145
Benefits paid ............................................................................. (8,901) (9,048)
----------------------------------
Benefit obligation at end of year ......................................................... $150,067 97,477
----------------------------------
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year ............................................ $136,197 162,658
Transfer in plan assets at beginning of year due to employee transfer ..................... 31,320 --
Actual return on plan assets .............................................................. (8,057) (17,413)
Benefits paid ............................................................................. (8,901) (9,048)
----------------------------------
Fair value of plan assets at end of year .................................................. $150,559 136,197
----------------------------------
Funded status ............................................................................. 492 38,720
Unrecognized transition asset ............................................................. (5,511) (725)
Unrecognized prior service cost ........................................................... 2,963 2,263
Unrecognized net loss ..................................................................... 48,746 3,086
----------------------------------
Net prepaid pension expense ............................................................... 46,690 43,344
==================================
|
YEAR ENDED DECEMBER 31
----------------------
2002 2001 2000
(in thousands)
COMPONENTS OF NET PERIODIC BENEFIT
Service cost ..................................... $ 5,541 3,537 3,339
Interest cost .................................... 9,399 6,750 6,728
Expected return on plan assets ................... (16,724) (14,633) (13,391)
Amortization of prior service cost ............... 280 207 207
Amortization of transition asset ................. (633) (121) (121)
Amortization of net gain ......................... -- (1,346) (930)
---------------------------------------------------------
Net periodic benefit ............................. $(2,137) (5,606) (4,168)
=========================================================
|
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
----------------------
2002 2001 2000
---- ---- ----
WEIGHTED-AVERAGE ASSUMPTIONS AS OF DECEMBER 31
Discount rate ........................................................... 6.75% 7.5% 8.0%
Expected long-term rate of return on assets ............................. 9.0 % 9.0% 9.0%
Rates of increase in compensation levels ................................ 5.0 % 5.0% 5.0%
|
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 2002, 2001 and 2000 net periodic benefit was $2.0 million, $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 $1,964,000, $1,120,000 and $890,000 for the years 2002, 2001 and 2000, 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. 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:
DECEMBER 31
-----------
2002 2001
---- ----
(in thousands)
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of year .................................................. $48,558 42,913
Transfer in benefit obligation at beginning of year due to employee transfer ............. 8,235 --
Service cost ............................................................................. 2,400 1,423
Interest cost ............................................................................ 4,179 3,356
Actuarial gain ........................................................................... 9,336 2,946
Employee contributions ................................................................... (1,509) (2,080)
---------------------------------
Benefit obligation at end of year ........................................................ $71,199 48,558
---------------------------------
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year ........................................... $ 1,768 1,568
Expected return on assets ................................................................ 150 133
Gain (loss) on assets .................................................................... (22) 67
---------------------------------
Fair value of plan assets at end of year ................................................. $ 1,896 1,768
---------------------------------
|
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
DECEMBER 31
-----------
2002 2001
---- ----
(in thousands)
Funded status at end of year ......................................... $(69,303) (46,790)
Unrecognized transition asset ........................................ (34) (38)
Unrecognized prior service cost ...................................... 5,073 --
Unrecognized loss (gain) ............................................. 110 (8,700)
---------------------------------
Accrued postretirement benefit obligation at end of year ............. $(64,154) (55,528)
==================================
|
YEAR ENDED DECEMBER 31
----------------------
2002 2001
---- ----
(in thousands)
COMPONENTS OF NET PERIODIC BENEFIT COST
Service cost ............................................................. $ 2,400 1,423
Interest cost ............................................................ 4,179 3,356
Expected return on assets ................................................ (150) (133)
Amortization of unrecognized amounts ..................................... 183 (523)
---------------------------------------
Net periodic benefit cost ................................................ $ 6,612 4,123
======================================
|
A 6.75%, 7.5% and 8.0% weighted average discount rate was used for 2002, 2001 and 2000, respectively to determine the accumulated postretirement benefit obligation. A 9.0%, 8.5% and 8.5% weighted average rate was used for 2002, 2001 and 2000, respectively 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 2002, 2001 and 2000 net periodic cost was $5.6 million, $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 $10.7 million and would increase the medical service and interest cost by approximately $1.5 million.
The Company also has a supplemental executive retirement plan for which the accrued obligation at December 31, 2002 and 2001 was $2,609,000 and $ 1,709,000, respectively.
(10) STOCKHOLDERS' EQUITY
(a) TREASURY SHARES
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. Through December 31, 2002, State Auto Financial repurchased 395,924 shares from the public. Repurchases during 2002 were funded through dividends from subsidiaries.
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.
(b) DIVIDEND RESTRICTIONS AND STATUTORY FINANCIAL INFORMATION
State Auto P&C, Milbank, Farmers Casualty, SA Ohio and National are 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 $35.3 million is available for payment to State Auto Financial in 2003 without prior approval. Reconciliations of statutory capital and surplus and
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
net income (loss), as determined using statutory accounting practices, to the amounts included in the accompanying consolidated financial statements are as follows:
DECEMBER 31
-----------
2002 2001
---- ----
(in thousands)
Statutory capital and surplus of insurance subsidiaries ...................... $359,289 317,983
Net assets of noninsurance parent and affiliates ............................. (44,060) (21,033)
-----------------------------------
315,229 296,950
Increases (decreases):
Deferred policy acquisition costs .................................... 77,886 67,087
Losses and loss expenses payable ..................................... 27,093 26,216
Net prepaid pension expense .......................................... 46,690 43,344
Postretirement benefit liability ..................................... (21,968) (19,708)
Deferred federal income taxes ........................................ (36,964) (25,347)
Fixed maturities at fair value ....................................... 67,281 8,979
Surplus note ......................................................... (15,000) --
Other, net ........................................................... 3,522 2,672
-----------------------------------
Stockholders' equity per accompanying consolidated
financial statements ...............................................$ 463,769 400,193
===================================
|
YEAR ENDED DECEMBER 31
----------------------
2002 2001 2000
---- ---- ----
(in thousands)
Statutory net income (loss) of insurance subsidiaries ............. $17,027 (39,773) 43,991
Net income of noninsurance parent and affiliates .................. 2,461 1,826 1,125
--------------------------------------------------------
19,488 (37,947) 45,116
Increases (decreases):
Deferred policy acquisition costs ............................... 10,776 34,629 3,522
Losses and loss expenses payable ................................ 907 12,813 (103)
Net prepaid pension expense ..................................... 506 1,131 640
Postretirement benefit expense .................................. (2,260) (1,230) (1,150)
Deferred federal income taxes ................................... 7,671 10,673 401
Other, net ...................................................... (93) 546 (712)
--------------------------------------------------------
Net income per accompanying consolidated
financial statements .......................................... $36,995 20,615 47,714
========================================================
|
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.
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(11) 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.
(12) 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. Compensation cost charged against operations in 2002, 2001 and 2000 were $0, $14,000 and $31,000, 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:
2002 2001 2000
---- ---- ----
(in thousands, except
per share figures)
Pro forma net earnings ............................................ $35,568 18,865 45,784
Pro forma net earnings per common share
Basic .......................................................... $ 0.91 0.49 1.19
Diluted ........................................................ $ 0.89 0.48 1.17
|
The fair value of options granted in 2002, 2001 and 2000 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:
2002 2001 2000
---- ---- ----
Fair value ................................. $6.09 6.79 4.66
Dividend yield ............................. .94% .90% .90%
Risk free interest rate .................... 4.20% 4.85% 6.51%
Expected volatility factor ................. .33 .36 .34
Expected life (years) ...................... 6.8 6.7 7.2
|
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 for 2002 and 4,200 shares for 2003) shares of common stock following each annual meeting of
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
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, 2002 and 2001, 1,919,000 and 1,803,000, respectively 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 2002, 2001 and 2000, respectively, were as follows: fair value of $7.55, $8.04 and $10.91; dividend yield of .87%, .90% and .90%; expected volatility factor of .36, .34 and .32; risk-free interest rate of 4.50%, 5.16% and 5.19%; and expected life of the option of 8.1, 8.7 and 9.0 years. Expense of $165,000, $140,000 and $493,000 associated with this plan was recognized in 2002, 2001 and 2000, respectively.
A summary of the Company's stock option activity and related information for these plans for the years ended December 31, 2002, 2001 and 2000, follows:
2002 2001 2000
-----------------------------------------------------------------------------------------------
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 2,797 $9.58 2,852 $8.28 2,546 $7.76
Granted 356 16.00 299 16.53 492 10.29
Exercised 362 5.11 315 4.39 (129) 4.32
Canceled -- -- (39) 10.16 (57) 11.15
------- -------- --------
Outstanding, end of year 2,791 10.98 2,797 9.58 2,852 8.28
======= ======== ========
|
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 information pertaining to options outstanding and exercisable as
of December 31, 2002 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 $5.00 266 .4 $4.36 266 $4.36
$5.01 - $10.00 791 3.1 6.61 791 6.61
Greater than $10.01 1,734 7.4 13.99 1,140 13.27
------- -------
2,791 5.5 10.98 2,197 9.80
------- -------
|
(13) 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
----------------------
2002 2001 2000
---- ---- ----
(in thousands, except per share data)
Numerator:
Net earnings for basic and diluted earnings per common share $36,995 20,615 47,714
----------------------------------------------------
Denominator:
Weighted average shares for basic net earnings
per common share ................................................... 38,984 38,775 38,427
Effect of dilutive stock options ..................................... 759 906 693
----------------------------------------------------
Adjusted weighted average shares for
diluted net earnings per common share .............................. 39,743 39,681 39,120
----------------------------------------------------
Basic net earnings per common share .................................... $0.95 0.53 1.24
----------------------------------------------------
Diluted net earnings per common share .................................. $0.93 0.52 1.21
----------------------------------------------------
|
The following options to purchase shares of common stock were not included in the computation of diluted earnings per share because the exercise price of the options was greater than the average market price:
YEAR ENDED DECEMBER 31
----------------------
2002 2001 2000
---- ---- ----
(in thousands)
Number of options................................................................911 562 656
--------------------------------------
|
(14) OTHER COMPREHENSIVE INCOME
The related federal income tax effects of each component of other comprehensive income (loss) are as follows:
YEAR ENDED DECEMBER 31, 2002
----------------------------
BEFORE-TAX TAX (EXPENSE) NET-OF-TAX
AMOUNT OR BENEFIT AMOUNT
------ ---------- ------
( in thousands)
Net unrealized holding gains on securities:
Unrealized holding gains arising during 2002 ........................... $52,805 (18,482) 34,323
Reclassification adjustments for gains realized in net income .......... 5,909 (2,068) 3,841
-----------------------------------------------------
Net unrealized holding gains ........................................... 46,896 (16,414) 30,482
-----------------------------------------------------
Other comprehensive income ............................................... $46,896 (16,414) 30,482
=====================================================
|
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
----------------------------
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, 2000
----------------------------
BEFORE-TAX TAX (EXPENSE) NET-OF-TAX
AMOUNT OR BENEFIT AMOUNT
------ ---------- ------
( in thousands)
Net unrealized holding gains on securities:
Unrealized holding gains arising during 2000 ............................. $36,272 (12,695) 23,577
Reclassification adjustments for gains realized in net income ............ (5,255) 1,839 (3,416)
---------------------------------------------------
Net unrealized holding gains ............................................. 31,017 (10,856) 20,161
---------------------------------------------------
Other comprehensive income ................................................. $31,017 (10,856) 20,161
===================================================
|
(15) REPORTABLE SEGMENTS
Prior to 2001 the Company had four reportable segments: standard insurance, nonstandard insurance, investment management services and management and operations 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 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. With the transition, during 2002, of the Meridian nonstandard segment to the State Auto systems platform, begining with the first quarter 2003, this segment will be included in the State Auto nonstandard segment.
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The investment management services segment manages the investment portfolios of affiliated insurance 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 is now in the all other category for segment reporting beginning with the first quarter of 2002 as the results for this segment no longer meet the quantitative thresholds for separate presentation as a reportable segment. The segment disclosures for the year ended December 31, 2001 and 2000 have been restated to reflect this change.
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 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; management and operations services segment, an insurance software development and resale segment, and a property management and leasing segment. The insurance software development and resale segment and property management and leasing segment have never met the quantitative thresholds for individual presentation as reportable segments.
The following provides financial information regarding the Company's reportable segments. The 2001 financial information for the Meridian standard and nonstandard segments reflects the business assumed by the pooled subsidiaries, beginning July 1, 2001:
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
----------------------
2002 2001 2000
---- ---- ----
(in thousands)
REVENUES FROM EXTERNAL CUSTOMERS:
State Auto standard insurance .................................. $720,278 485,059 406,602
State Auto nonstandard insurance ............................... 67,575 37,536 29,595
Meridian standard insurance .................................... 159,060 72,825 --
Meridian nonstandard insurance ................................. 9,043 6,501 --
Investment management services ................................. 2,469 3,466 3,360
All other ...................................................... 3,120 15,773 17,881
------------------------------------------------------------
Total revenues from external customers ........................... 961,545 621,160 457,438
Intersegment revenues:
State Auto standard insurance .................................. 120 128 162
Investment management services ................................. 5,019 3,553 2,884
All other ...................................................... 2,141 5,506 6,047
------------------------------------------------------------
Total intersegment revenues ...................................... 7,280 9,187 9,093
------------------------------------------------------------
Total revenue .................................................... 968,825 630,347 466,531
------------------------------------------------------------
Reconciling items:
Intersegment revenues .......................................... (7,280) (9,187) (9,093)
Corporate revenues ............................................. 25 150 81
Net realized gains on investment ............................... 5,909 1,962 5,255
------------------------------------------------------------
Total consolidated revenues ...................................... $967,479 623,272 462,774
============================================================
SEGMENT PROFIT (LOSS):
State Auto standard insurance .................................. $37,537 45,664 35,579
State Auto nonstandard insurance ............................... 1,538 1,378 (116)
Meridian standard insurance .................................... (15,376) (44,397) --
Meridian nonstandard insurance ................................. 2,537 (5,933) --
Investment management services ................................. 6,402 5,965 5,354
All other ...................................................... 1,916 16,326 18,457
------------------------------------------------------------
Total segment profit ............................................. 34,554 19,003 59,274
Reconciling items:
Corporate expenses ............................................. (2,673) (2,989) (3,085)
Net realized gains on investments .............................. 5,909 1,962 5,255
------------------------------------------------------------
Total consolidated income before federal income taxes ............ $37,790 17,976 61,444
============================================================
NET INVESTMENT INCOME:
State Auto standard insurance .................................. $42,223 37,230 33,436
State Auto nonstandard insurance ............................... 2,228 1,997 1,899
Meridian standard insurance .................................... 9,322 3,595 --
Meridian nonstandard insurance ................................. 531 338 --
Investment management services ................................. 125 318 360
All other ...................................................... 180 193 244
------------------------------------------------------------
Total net investment income ...................................... 54,609 43,671 35,939
Reconciling items:
Corporate net investment income ................................ 25 150 81
Reclassification adjustments in consolidation .................. 5,057 3,554 2,895
------------------------------------------------------------
Total consolidated net investment income ......................... $59,691 47,375 38,915
============================================================
|
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
DECEMBER 31
-----------
2002 2001
---- ----
(in thousands)
SEGMENT ASSETS:
Standard insurance ..................................... $1,468,482 1,261,689
Nonstandard insurance .................................. 98,886 67,043
Investment management services ......................... 4,744 8,698
All other .............................................. 12,539 15,685
------------------------------------
Total segment assets ..................................... 1,584,651 1,353,115
Reconciling items:
Corporate assets ....................................... 833 3,559
Reclassification adjustments in consolidation .......... 7,511 10,822
------------------------------------
Total consolidated assets ................................ $1,592,995 1,367,496
====================================
|
Revenues from external customers include the following products and services:
YEAR ENDED DECEMBER 31
----------------------
2002 2001 2000
---- ---- ----
(in thousands)
Earned premiums
State Auto standard insurance:
Automobile ...................................................... $356,137 237,401 203,967
Homeowners and farmowners ....................................... 112,350 77,105 67,247
Commercial multi-peril .......................................... 50,305 31,215 25,349
Workers' compensation ........................................... 23,236 15,365 10,628
Fire and allied ................................................. 57,310 36,031 27,848
Other liability and products liability .......................... 49,233 21,875 21,924
Other lines ..................................................... 24,604 25,304 13,603
-------------------------------------------------------
Total State Auto standard insurance earned premiums ............... 673,175 444,296 370,566
Total State Auto nonstandard insurance earned premiums ............ 65,022 35,256 27,401
-------------------------------------------------------
Meridian standard insurance:
Automobile ...................................................... 79,212 36,402 --
Homeowners and farmowners ....................................... 21,159 9,536 --
Commercial multi-peril .......................................... 25,942 11,381 --
Workers' compensation ........................................... 16,081 8,660 --
Fire and allied ................................................. 1,095 499 --
Other liability and products liability .......................... 1,834 519 --
Other lines ..................................................... 4,542 2,157 --
-------------------------------------------------------
Total Meridian standard insurance earned premiums ................. 149,865 69,154 --
Total Meridian nonstandard insurance earned premiums .............. 8,533 6,501 --
-------------------------------------------------------
Total earned permiums ............................................. 896,595 555,207 397,967
Investment management services .................................... 2,469 2,965 2,940
Net investment income ............................................. 59,666 47,225 38,834
Other income ...................................................... 2,815 15,763 17,697
-------------------------------------------------------
Total revenues from external customers ............................ $961,545 621,160 457,438
=======================================================
|
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
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.
(16) QUARTERLY FINANCIAL DATA (UNAUDITED)
2002
----
FOR THREE MONTHS ENDED
----------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
--------- -------- ------------- ------------
(dollars in thousands, except per share amounts)
Total revenues ......................................... $229,959 236,223 246,962 254,335
Income (loss) before federal income taxes .............. 17,301 (6,751) 5,128 22,112
Net income (loss) ...................................... 13,165 (1,385) 5,885 19,330
Net earnings (loss) per common share (note 10a):
Basic ................................................ 0.34 (0.04) 0.15 0.50
Diluted .............................................. 0.33 (0.04) 0.15 0.49
--------------------------------------------------------------
|
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 10a):
Basic.................................................... 0.37 0.24 0.19 (0.27)
Diluted ................................................. 0.36 0.24 0.18 (0.27)
----------------------------------------------------------------
|
(17) 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.
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, 2002, 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, 2002, and is hereby incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information required under this Item will be contained in the Company's proxy statement to be filed within 120 days of December 31, 2002, 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, 2002, and is hereby incorporated herein by reference.
ITEM 14. CONTROLS AND PROCEDURES
(a) Within the 90 days prior to the date of filing of this report, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's periodic filings with the Securities and Exchange Commission.
(b) There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls subsequent to the date the evaluation described in (a), above, was carried out.
PART IV
ITEM 15. 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, 2002 and 2001 Consolidated Statements of Income for each of the three years in the period ended December 31, 2002 Consolidated Statements of Stockholders' Equity for each of the three years in the period ended December 31, 2002 Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2002 Notes to Consolidated Financial Statements
(a)(2) LISTING OF FINANCIAL STATEMENT SCHEDULES
The following financial statement schedules of the Company for the years 2002, 2001, and 2000, 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. 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.
(a)(3) LISTING OF EXHIBITS
If incorporated by reference document with
Exhibit No. Description of Exhibit which Exhibit was previously filed with SEC
----------- ---------------------- -------------------------------------------
3(A)(1) State Auto Financial Corporation's Amended and Restated 1933 Act Registration Statement No. 33-40643
Articles of Incorporation 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. 33-89400
Amended and Restated Articles of Incorporation 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 ended
Amendment to the Amended and Restated Articles of December 31, 1998 (see Exhibit 3(A)(3)
Incorporation as of June 2, 1998 therein)
3(B) State Auto Financial Corporation's Amended and Restated 1933 Act Registration Statement No. 33-40643
Code of Regulations 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 ended
Articles of Incorporation, and Articles 1, 3, 5 and 9 of December 31, 1992 (see Exhibit 3(A) and 3(B)
the Company's Amended and Restated Code of Regulations therein)
10(A) Guaranty Agreement between State Automobile Mutual 1933 Act Registration Statement No. 33-40643
Insurance Company and State Auto Property and Casualty on Form S-1 (see Exhibit 10 (d) therein)
Insurance Company dated as of May 16, 1991
10(B) Form of Indemnification Agreement between State Auto 1933 Act Registration Statement No. 33-40643
Financial Corporation and each of its directors 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)
10(G) License Agreement between State Automobile Mutual 1933 Act Registration Statement No. 33-40643
Insurance Company and Policy Management Systems on Form S-1 (see Exhibit 10 (k) therein)
Corporation dated December 28, 1984
10(H) Investment Management Agreement between Stateco Form 10-K Annual Report for the year ended
Financial Services, Inc. and State Automobile Mutual December 31, 1992 (see Exhibit 10 (N)
Insurance Company, effective April 1, 1993 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 No.
Non-Qualified Incentive Deferred Compensation Plan 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 ended
Plan 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 ended
effective as of January 1, 1994 December 31, 1997 (see Exhibit 10(HH)
therein)
10(N) Credit Agreement dated as of June 1, 1999 between State Form 10-Q for the period ended June 30, 1999
Auto Financial Corporation and State Automobile Mutual (see Exhibit 10(LL) therein)
Insurance Company
|
* Constitutes either a management contract or a compensatory plan or arrangement required to be filed as an Exhibit.
If incorporated by reference document with
Exhibit No. Description of Exhibit which Exhibit was previously filed with SEC
----------- ---------------------- -------------------------------------------
10(O) Reinsurance Pooling Agreement amended and restated as Form 10-K Annual Report for the year ended
of January 1, 2000 by and among State Automobile Mutual December 31, 1999 (see Exhibit 10(W) therein)
Insurance Company, State Auto Property and Casualty
Insurance Company, Milbank Insurance Company, Midwest
Security Insurance Company (n/k/a State Auto Insurance
Company of Wisconsin), Farmers Casualty Insurance
Company and State Auto Insurance Company (n/k/a State
Auto Insurance Company of Ohio)
10(P) Management and Operations Agreement as of January 1, Form 10-K Annual Report for the year ended
2000 among State Automobile Mutual Insurance Company, December 31, 1999 (see Exhibit 10(X) therein)
State Auto Financial Corporation, State Auto Property
and Casualty Insurance Company, State Auto National
Insurance Company, Milbank Insurance Company, State
Auto Insurance Company (n/k/a State Auto Insurance
Company of Ohio), Stateco Financial Services, Inc.,
Strategic Insurance Software, Inc., 518 Property
Management and Leasing, LLC
10(Q) Property Catastrophe Overlying Excess of Loss Form 10-K Annual Report for the year ended
Reinsurance contract issued to State Automobile Mutual December 31, 1999 (see Exhibit 10(Y) therein)
Insurance Company, State Auto National Insurance
Company, Milbank Insurance Company, Midwest Security
Insurance Company (n/k/a State Auto Insurance Company
of Wisconsin), 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 ended
Agreement effective January 1, 2000 among State December 31, 1999 (see Exhibit 10(Z) therein)
Automobile Mutual Insurance Company, State Auto
Financial Corporation, State Auto Property and Casualty
Insurance Company, State Auto National Insurance
Company, Milbank Insurance Company, State Auto
Insurance Company (n/k/a State Auto Insurance Company
of Ohio), 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 ended
dated November 1, 1999 between State Auto Financial December 31, 1999 (see Exhibit 10(AA)
Corporation and State Automobile Mutual Insurance 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 ended
State Auto Financial Corporation and Robert H. Moone 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 ended
Financial Corporation and certain executive officers December 31, 2000 (see Exhibit 10(CC)
therein)
10(W) First Amendment to the Reinsurance Pooling Agreement Form 10-K Annual Report for the year ended
Amended and Restated as of January 1, 2000 by and among December 31, 2000 (see Exhibit 10(DD)
State Auto Property and Casualty Insurance Company, therein)
State Automobile Mutual Insurance Company, Milbank
Insurance Company, Midwest Security Insurance Company
(n/k/a State Auto Insurance Company of Wisconsin),
Farmers Casualty Insurance Company and State Auto
Insurance Company (n/k/a State Auto Insurance Company
of Ohio)
10(X) Addendum No. 1 of the Property Catastrophe Overlying Form 10-K Annual Report for the year ended
Excess of Loss Reinsurance Contract by and among State December 31, 2000 (see Exhibit 10(EE)
Auto Property and Casualty Insurance Company, State therein)
Automobile Mutual Insurance Company, State Auto
National Insurance Company, Milbank Insurance Company,
Midwest Security Insurance Company (n/k/a State Auto
Insurance Company of Wisconsin), Farmers Casualty
Insurance Company, Mid-Plains Insurance Company and
State Auto Insurance Company (n/k/a State Auto
Insurance Company of Ohio) dated November 17, 2000
|
* Constitutes either a management contract or a compensatory plan or arrangement required to be filed as an Exhibit.
If incorporated by reference document with
Exhibit No. Description of Exhibit which Exhibit was previously filed with SEC
----------- ---------------------- -------------------------------------------
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, 2001
Amended and Restated as of January 1, 2000, by the (see Exhibit 10(II) therein)
State Automobile Mutual Insurance Company, State Auto
Property and Casualty Insurance Company, Milbank
Insurance Company, Midwest Security Insurance Company
(n/k/a State Auto Insurance Company of Wisconsin),
Farmers Casualty Insurance Company and State Auto
Insurance Company (n/k/a State Auto Insurance Company
of Ohio)
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 Form 10-K Annual Report for the year ended
December 31, 2001 (see Exhibit 10(EE)
therein)
10(FF) Third Amendment to State Auto Reinsurance Pooling Form 10-K Annual Report for the year ended
Agreement, Amended and Restated as of January 1, 2000 December 31, 2001 (see Exhibit 10(FF)
therein)
10(GG) Stop Loss Reinsurance Agreement dated October 1, 2001 Form 10-K Annual Report for the year ended
among inter alia Mutual and State Auto P&C December 31, 2001 (see Exhibit 10(GG)
therein)
10(HH) Amendment No. 2 to the Management and Operations Form 10-K Annual Report for the year ended
Agreement dated January 1, 2000 among, inter alia, December 31, 2001 (see Exhibit 10(HH)
Mutual and State Auto P&C therein)
10(II) $100,000,000 Amended and Restated Credit Agreement Form 10-K Annual Report for the year ended
among SAF Funding Corporation, as Borrower, the Lenders December 31, 2001 (see Exhibit 10(II)
and Bank One, NA as Agent dated as of November 16, 2001 therein)
10(JJ) Amended and Restated Put Agreement among State Form 10-K Annual Report for the year ended
Automobile Mutual Insurance Company, State Auto December 31, 2001 (see Exhibit 10(JJ)
Financial Corporation and Bank One, NA as Agent dated therein)
as of November 16, 2001
10(KK) Amended and Restated Standby Purchase Agreement between Form 10-K Annual Report for the year ended
State Auto Financial Corporation and SAF Funding December 31, 2001 (see Exhibit 10(KK)
Corporation dated as of November 16, 2001 therein)
10(LL) Amendment No. 3 to Management and Operations Agreement Form 10-Q for the period ended June 30, 2002
effective January 1, 2002, among State Automobile (see Exhibit 10(LL) therein)
Mutual Insurance Company, State Auto Financial
Corporation, State Auto Property and Casualty Insurance
Company, State Auto National Insurance Company, Milbank
Insurance Company, State Auto Insurance Company,
Stateco Financial Services, Inc., Strategic Insurance
Software, Inc., and 518 Property Management and
Leasing, LLC
10(MM) Surplus Contribution Note from Milbank Insurance Form 10-Q for the period ended September 30,
Company to Meridian Security Insurance Company dated as 2002 (see Exhibit 10(MM) therein)
of September 30, 2002
|
* Constitutes either a management contract or a compensatory plan or arrangement required to be filed as an Exhibit.
If incorporated by reference document with
Exhibit No. Description of Exhibit which Exhibit was previously filed with SEC
----------- ---------------------- -------------------------------------------
10(NN) Management Services Agreement as of July 1, 2002 by and Form 10-Q for the period ended September 30,
among State Auto Property and Casualty Insurance 2002 (see Exhibit 10(NN) therein)
Company, Meridian Insurance Group, Inc., Meridian
Security Insurance Company, Meridian Citizens Mutual
Insurance Company and Meridian Citizens Security
Insurance Company
10(OO) Cost Sharing Agreement among State Auto Property and Included herein
Casualty Insurance Company, State Automobile Mutual
Insurance Company, and State Auto Florida Insurance
Company effective January 1, 2003
10(PP) Amendment No. 1 to Put Agreement and Waiver among State Included herein
Automobile Mutual Insurance Company, State Auto
Financial Corporation and Bank One, NA dated as of
August 28, 2002
10(QQ) Amendment No. 1 to Amended and Restated Credit Included herein
Agreement among SAF Funding Corporation, the Lenders
and Bank One, NA dated as of November 14, 2002
10(RR) Amendment No. 2 to Amended and Restated Put Agreement Included herein
and Waiver among State Automobile Mutual Insurance
Company, State Auto Financial Corporation and Bank One,
NA dated as of November 14, 2002
10(SS) Amendment No. 1 to Amended and Restated Standby Included herein
Purchase Agreement between State Auto Financial
Corporation and SAF Funding Corporation
10(TT) Fourth Amendment to State Auto Reinsurance Pooling Included herein
Agreement, Amended and Restated as of January 1, 2000
10(UU)* Fourth Amendment to 2000 Directors Stock Option Plan Included herein
10(VV) Term Loan Note from State Auto Financial Corporation to Included herein
KeyBank National Association dated as of December 23,
2002
21 List of Subsidiaries of State Auto Financial Corporation Included herein
23 Consent of Independent Auditors Included herein
24(A) Powers of Attorney - William J. Lhota, Urlin G. Harris, Form 10-Q for the period ended June 30, 1997
Jr., Paul W. Huesman, George R. Manser, and David J. (see Exhibit 24(C) therein)
D'Antoni
24(B) Power of Attorney - John R. Lowther Form 10-Q for the period ended March 31,
1998 (see Exhibit 24(D) therein)
24(C) Power of Attorney - Robert H. Moone Form 10-K Annual Report for the year ended
December 31, 1998 (see Exhibit 24(E) therein)
24(D) Power of Attorney - Richard K. Smith Form 10-K Annual Report for the year ended
December 31, 2000 (See Exhibit 24(D) therein)
24(E) Power of Attorney - S. Elaine Roberts Included herein
99.1 CEO certification required by Section 906 of Included herein
Sarbanes-Oxley Act of 2002
99.2 CFO certification required by Section 906 of Included herein
Sarbanes-Oxley Act of 2002
|
*Constitutes either a management contract or a compensatory plan or arrangement required to be filed as an Exhibit
The Company did not file any Form 8-K current reports during the fourth quarter of the Company's fiscal year ended December 31, 2002.
(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 and certifications.
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 28, 2003 /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/Robert H. Moone Chairman, President and March 28, 2003
-------------------------- Chief Executive Officer
Robert H. Moone (principal executive officer)
/s/Steven J. Johnston Chief Financial Officer, March 28, 2003
-------------------------- Senior Vice President, and Treasurer
Steven J. Johnston (principal financial officer
and principal accounting officer)
John R. Lowther* Senior Vice President, General Counsel, March 28, 2003
-------------------------- and Secretary and Director
John R. Lowther
David J. D'Antoni* Director March 28, 2003
--------------------------
David J. D'Antoni
Urlin G. Harris, Jr.* Director March 28, 2003
--------------------------
Urlin G. Harris, Jr.
Paul W. Huesman* Director March 28, 2003
--------------------------
Paul W. Huesman
William J. Lhota* Director March 28, 2003
--------------------------
William J. Lhota
George R. Manser* Director March 28, 2003
--------------------------
George R. Manser
S. Elaine Roberts* Director March 28, 2003
--------------------------
S. Elaine Roberts
Richard K. Smith* Director March 28, 2003
--------------------------
Richard K. Smith
|
*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 28, 2003 Steven J. Johnston Attorney in Fact |
CERTIFICATION
I, Robert H. Moone, certify that:
1. I have reviewed this annual report on Form 10-K of State Auto Financial Corporation;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
(c) Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
(a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 28, 2003 /s/ Robert H. Moone
----------------------------
Robert H. Moone
Chief Executive Officer
(Principal Executive Officer)
|
CERTIFICATION
I, Steven J. Johnston, certify that:
1. I have reviewed this annual report on Form 10-K of State Auto Financial Corporation;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
(c) Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
(a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 28, 2003 /s/ Steven J. Johnston
---------------------------------
Steven J. Johnston
Treasurer and Chief Financial Officer
(Principal Financial Officer)
|
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
SCHEDULE I - SUMMARY OF INVESTMENTS - OTHER THAN
INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 2002
Column A Column B Column C Column D
-------- -------- -------- --------
Amount at
Available for Sale which shown
in the
Type of Investments Cost(1) Value balance sheet
------------------- ------- ----- -------------
(in thousands)
Fixed maturities:
Bonds:
United States Government and
government agencies and authorities $324,512 $340,365 $340,365
States, municipalities and
political subdivisions 696,191 737,321 737,321
Public utilities 6,631 7,601 7,601
All other corporate bonds 122,000 131,411 131,411
---------------------- ----------------------- ----------------------
Total fixed maturities 1,149,334 1,216,698 1,216,698
---------------------- ----------------------- ----------------------
Equity securities:
Common stocks:
Public utilities 1,300 1,299 1,299
Banks, trust and insurance companies 16,835 15,565 15,565
Industrial, miscellaneous and all
other 39,594 36,846 36,846
---------------------- ----------------------- ----------------------
Total equity securities 57,729 53,710 53,710
---------------------- ----------------------- ----------------------
Other long-term investments 1,857 xxxxxx 1,908
---------------------- ----------------------
Total investments $ 1,208,920 xxxxxx $ 1,272,316
====================== ======================
|
(1) Original cost of equity securities and, as to fixed maturities, original cost reduced by repayments and adjusted for amortization of premiums or accrual of discounts.
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEETS
December 31
------------------------------------------
ASSETS 2002 2001
---- ----
(in thousands)
Investments in common stock of subsidiaries
(equity method) $519,893 $440,826
Cash 93 2,005
Real estate 389 408
Other assets 740 887
Federal income tax benefit 3,744 2,907
------------------ -------------------
Total assets $524,859 $447,033
================== ===================
LIABILITIES AND STOCKHOLDERS' EQUITY
Notes payable (affiliate $45,500 at December 31, 2002 and 2001) $60,500 $45,500
Due to affiliates 173 734
Accrued expenses 417 606
------------------ -------------------
Total liabilities 61,090 46,840
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, respectively; issued - -
43,525,774 and 43,045,320 shares
issued and outstanding, respectively, at stated value of
$2.50 per share 108,814 107,613
Less 4,524,475 and 4,108,230 treasury shaes, respectively, at cost (54,249) (47,613)
Additional paid-in capital 50,354 47,106
Accumulated other comprehensive income 42,535 12,075
Retained earnings 316,315 281,012
------------------ -------------------
Total stockholders' equity 463,769 400,193
------------------ -------------------
Total liabilities and stockholders' equity $524,859 $447,033
================== ===================
|
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONTINUED
CONDENSED STATEMENTS OF INCOME
Year ended December 31
--------------------------------------------------------------
2002 2001 2000
---- ---- ----
(in thousands)
Investment income $25 $150 $81
Rental income 37 38 37
Net realized gains on investments - - -
------------------- ------------------ ------------------
Total revenue 62 188 118
------------------- ------------------ ------------------
Interest expense to affiliate 2,161 2,275 2,730
Total operating expenses 1,653 1,889 1,859
------------------- ------------------ ------------------
Loss before federal income taxes (3,752) (3,976) (4,471)
Federal income tax benefit (1,313) (1,383) (1,573)
--------------------------------------------------------------
Net loss before equity in undistributed
net earnings of subsidiaries (2,439) (2,593) (2,898)
Equity in undistributed net earnings of subsidiaries 39,457 23,208 50,612
------------------- ------------------ ------------------
Net Income $37,018 $20,615 $47,714
=================== ================== ==================
|
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONTINUED
CONDENSED STATEMENTS OF CASH FLOWS
Year Ended December 31
--------------------------------------------------------------
2002 2001 2000
---- ---- ----
(in thousands)
Cash flows from operating activities:
Net income $37,018 $20,615 $47,714
------------------ ------------------- -------------------
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation and amortization, net 183 157 484
Equity in undistributed earnings of subsidiaries (39,457) (23,208) (50,612)
Changes in operating assets and liabilities:
Change in accrued expenses and due to affiliates (751) 788 60
Change in other assets 148 (328) (19)
Change in federal income taxes 74 178 (721)
------------------ ------------------- -------------------
Net cash used in operating activities (2,785) (1,798) (3,094)
------------------ ------------------- -------------------
Cash flows from investing activities:
Capitalization of subsidiary (21,514) (9,001) -
Dividends received from subsidiaries 12,364 11,701 3,025
------------------ ------------------- -------------------
Net cash provided by (used in) investing activities (9,150) 2,700 3,025
------------------ ------------------- -------------------
Cash flows from financing activities:
Proceeds from issuance of debt to bank 15,000 - -
Net proceeds from sale of common stock 2,999 2,466 1,707
Payments to acquire treasury stock (6,261) (388) (300)
Payment of dividends (1,715) (1,566) (1,397)
------------------ ------------------- -------------------
Net cash provided by financing activities 10,023 512 10
------------------ ------------------- -------------------
Net increase (decrease) in cash and invested cash (1,912) 1,414 (59)
------------------ ------------------- -------------------
Cash and cash equivalents at beginning of year 2,005 591 650
------------------ ------------------- -------------------
Cash and cash equivalents at end of year $93 $2,005 $591
================== =================== ===================
Supplemental Disclosures:
Federal income taxes received $1,386 $1,561 $852
================== =================== ===================
|
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONTINUED
NOTE 1 - 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 subsidiaries 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 2 - 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. Through December 31, 2002, State Auto Financial repurchased 395,924 shares from the public. Repurchases during 2002 were funded through dividends from subsidiaries.
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. Repurchases during 2001 and 2000 were funded through dividends from subsidiaries.
NOTE 3 - NOTES PAYABLE
In conjunction with the May 1999 stock repurchase plan, State Auto Financial entered into a line of credit agreement with Mutual for $45.5 million, at an interest rate of 6.0%. The interest rate adjusts each January 1 based on a formula set forth in the note. During 2002 and 2001 the interest rate was 4.75% and 5.0%, respectively, and adjusts to 4.25% in 2003. 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.
Effective December 23, 2002, State Auto Financial entered into a 364 day $15.0 million term loan note agreement with a bank. Interest adjusts quarterly and accrues based on LIBOR plus 75 basis points (2.15% at December 31, 2002). Interest on the note is 2.15% through March 23, 2003 and 2.027% for the period March 24, 2003 through September 23, 2003.
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(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, 2002
State Auto standard insurance segment $65,374 $373,103 $299,115 - $673,175
State Auto nonstandard insurance segment 4,224 60,102 25,087 - 65,022
Meridian standard insurance segment 8,207 159,186 53,010 - 149,865
Meridian nonstandard insurance segment 81 8,567 778 - 8,533
-------------- ---------------- -------------- -------------- -------------
Total 77,886 600,958 377,990 - 896,595
============== ================ ============== ============== =============
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
============== ================ ============== ============== =============
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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, 2002
State Auto standard insurance segment $42,223 $467,263 $178,761 $28,187 $722,599
State Auto nonstandard insurance segment 2,228 53,986 10,358 742 76,422
Meridian standard insurance segment 9,322 128,072 34,978 9,991 137,944
Meridian nonstandard insurance segment 531 4,153 243 1,088 5,879
Investment management services 125 - - - -
All other 180 - - - -
Corporate 25 - - - -
Reclassification adjustments in consolidation 5,057 - - - -
-------------- ---------------- -------------- -------------- -------------
Total 59,691 653,474 224,340 40,008 942,844
============== ================ ============== ============== =============
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
============== ================ ============== ============== =============
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STATE AUTO FINANCIAL CORPORATION
SCHEDULE IV - REINSURANCE
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(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 12-31-02
property-casualty earned premiums $577,803 $11,260 $506,777 $3,934 $832,895 $896,595 0.4%
Year ended 12-31-01
property-casualty earned premiums $472,766 $8,335 $432,168 $4,304 $518,640 $555,207 0.8%
Year ended 12-31-00
property-casualty earned premiums $432,318 $7,360 $402,561 $5,166 $370,404 $397,967 1.3%
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(a)(3) LISTING OF EXHIBITS
If incorporated by reference document with
Exhibit No. Description of Exhibit which Exhibit was previously filed with SEC
----------- ---------------------- -------------------------------------------
3(A)(1) State Auto Financial Corporation's Amended and Restated 1933 Act Registration Statement No. 33-40643
Articles of Incorporation 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. 33-89400
Amended and Restated Articles of Incorporation 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 ended
Amendment to the Amended and Restated Articles of December 31, 1998 (see Exhibit 3(A)(3)
Incorporation as of June 2, 1998 therein)
3(B) State Auto Financial Corporation's Amended and Restated 1933 Act Registration Statement No. 33-40643
Code of Regulations 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 ended
Articles of Incorporation, and Articles 1, 3, 5 and 9 of December 31, 1992 (see Exhibit 3(A) and 3(B)
the Company's Amended and Restated Code of Regulations therein)
10(A) Guaranty Agreement between State Automobile Mutual 1933 Act Registration Statement No. 33-40643
Insurance Company and State Auto Property and Casualty on Form S-1 (see Exhibit 10 (d) therein)
Insurance Company dated as of May 16, 1991
10(B) Form of Indemnification Agreement between State Auto 1933 Act Registration Statement No. 33-40643
Financial Corporation and each of its directors 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)
10(G) License Agreement between State Automobile Mutual 1933 Act Registration Statement No. 33-40643
Insurance Company and Policy Management Systems on Form S-1 (see Exhibit 10 (k) therein)
Corporation dated December 28, 1984
10(H) Investment Management Agreement between Stateco Form 10-K Annual Report for the year ended
Financial Services, Inc. and State Automobile Mutual December 31, 1992 (see Exhibit 10 (N)
Insurance Company, effective April 1, 1993 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 No.
Non-Qualified Incentive Deferred Compensation Plan 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 ended
Plan 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 ended
effective as of January 1, 1994 December 31, 1997 (see Exhibit 10(HH)
therein)
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* Constitutes either a management contract or a compensatory plan or arrangement required to be filed as an Exhibit.
If incorporated by reference document with
Exhibit No. Description of Exhibit which Exhibit was previously filed with SEC
----------- ---------------------- -------------------------------------------
10(N) Credit Agreement dated as of June 1, 1999 between State Form 10-Q for the period ended June 30, 1999
Auto Financial Corporation and State Automobile Mutual (see Exhibit 10(LL) therein)
Insurance Company
10(O) Reinsurance Pooling Agreement amended and restated as Form 10-K Annual Report for the year ended
of January 1, 2000 by and among State Automobile Mutual December 31, 1999 (see Exhibit 10(W) therein)
Insurance Company, State Auto Property and Casualty
Insurance Company, Milbank Insurance Company, Midwest
Security Insurance Company (n/k/a State Auto Insurance
Company of Wisconsin), Farmers Casualty Insurance
Company and State Auto Insurance Company (n/k/a State
Auto Insurance Company of Ohio)
10(P) Management and Operations Agreement as of January 1, Form 10-K Annual Report for the year ended
2000 among State Automobile Mutual Insurance Company, December 31, 1999 (see Exhibit 10(X) therein)
State Auto Financial Corporation, State Auto Property
and Casualty Insurance Company, State Auto National
Insurance Company, Milbank Insurance Company, State
Auto Insurance Company (n/k/a State Auto Insurance
Company of Ohio), Stateco Financial Services, Inc.,
Strategic Insurance Software, Inc., 518 Property
Management and Leasing, LLC
10(Q) Property Catastrophe Overlying Excess of Loss Form 10-K Annual Report for the year
Reinsurance contract issued to State Automobile Mutual ended December 31, 1999 (see Exhibit
Insurance Company, State Auto National Insurance 10(Y) therein)
Company, Milbank Insurance Company, Midwest Security
Insurance Company (n/k/a State Auto Insurance Company
of Wisconsin), 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 (n/k/a State Auto Insurance Company
of Ohio), 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 officers ended December 31, 2000 (see Exhibit
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 among ended December 31, 2000 (see Exhibit
State Auto Property and Casualty Insurance Company, 10(DD) therein)
State Automobile Mutual Insurance Company, Milbank
Insurance Company, Midwest Security Insurance Company
(n/k/a State Auto Insurance Company of Wisconsin),
Farmers Casualty Insurance Company and State Auto
Insurance Company (n/k/a State Auto Insurance Company
of Ohio)
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* Constitutes either a management contract or a compensatory plan or arrangement required to be filed as an Exhibit.
If incorporated by reference document with
Exhibit No. Description of Exhibit which Exhibit was previously filed with SEC
----------- ---------------------- -------------------------------------------
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 State ended December 31, 2000 (see Exhibit
Auto Property and Casualty Insurance Company, State 10(EE) therein)
Automobile Mutual Insurance Company, State Auto
National Insurance Company, Milbank Insurance Company,
Midwest Security Insurance Company (n/k/a State Auto
Insurance Company of Wisconsin), Farmers Casualty
Insurance Company, Mid-Plains Insurance Company and
State Auto Insurance Company (n/k/a State Auto
Insurance Company of Ohio) dated November 17, 2000
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
(n/k/a State Auto Insurance Company of Wisconsin),
Farmers Casualty Insurance Company and State Auto
Insurance Company (n/k/a State Auto Insurance Company
of Ohio)
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 Form 10-K Annual Report for the year
ended December 31, 2001 (see Exhibit
10(EE) therein)
10(FF) Third Amendment to State Auto Reinsurance Pooling Form 10-K Annual Report for the year
Agreement, Amended and Restated as of January 1, 2000 ended December 31, 2001 (see Exhibit
10(FF) therein)
10(GG) Stop Loss Reinsurance Agreement dated October 1, 2001 Form 10-K Annual Report for the year
among inter alia Mutual and State Auto P&C ended December 31, 2001 (see Exhibit
10(GG) therein)
10(HH) Amendment No. 2 to the Management and Operations Form 10-K Annual Report for the year
Agreement dated January 1, 2000 among, inter alia, ended December 31, 2001 (see Exhibit
Mutual and State Auto P&C 10(HH) therein)
10(II) $100,000,000 Amended and Restated Credit Agreement Form 10-K Annual Report for the year
among SAF Funding Corporation, as Borrower, the ended December 31, 2001 (see Exhibit
Lenders and Bank One, NA as Agent dated as of 10(II) therein)
November 16, 2001
10(JJ) Amended and Restated Put Agreement among State Form 10-K Annual Report for the year
Automobile Mutual Insurance Company, State Auto ended December 31, 2001 (see Exhibit
Financial Corporation and Bank One, NA as Agent dated 10(JJ) therein)
as of November 16, 2001
10(KK) Amended and Restated Standby Purchase Agreement Form 10-K Annual Report for the year
between State Auto Financial Corporation and SAF ended December 31, 2001 (see Exhibit
Funding Corporation dated as of November 16, 2001 10(KK) therein)
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* Constitutes either a management contract or a compensatory plan or arrangement required to be filed as an Exhibit.
If incorporated by reference document with
Exhibit No. Description of Exhibit which Exhibit was previously filed with SEC
----------- ---------------------- -------------------------------------------
10(LL) Amendment No. 3 to Management and Operations Form 10-Q for the period ended June 30,
Agreement effective January 1, 2002, among State 2002 (see Exhibit 10(LL) therein)
Automobile Mutual Insurance Company, State Auto
Financial Corporation, State Auto Property and
Casualty Insurance Company, State Auto National
Insurance Company, Milbank Insurance Company, State
Auto Insurance Company, Stateco Financial Services,
Inc., Strategic Insurance Software, Inc., and 518
Property Management and Leasing, LLC
10(MM) Surplus Contribution Note from Milbank Insurance Form 10-Q for the period ended September
Company to Meridian Security Insurance Company dated 30, 2002 (see Exhibit 10(MM) therein)
as of September 30, 2002
10(NN) Management Services Agreement as of July 1, 2002 by Form 10-Q for the period ended September
and among State Auto Property and Casualty Insurance 30, 2002 (see Exhibit 10(NN) therein)
Company, Meridian Insurance Group, Inc., Meridian
Security Insurance Company, Meridian Citizens Mutual
Insurance Company and Meridian Citizens Security
Insurance Company
10(OO) Cost Sharing Agreement among State Auto Property and Included herein
Casualty Insurance Company, State Automobile Mutual
Insurance Company, and State Auto Florida Insurance
Company effective January 1, 2003
10(PP) Amendment No. 1 to Put Agreement and Waiver among Included herein
State Automobile Mutual Insurance Company, State Auto
Financial Corporation and Bank One, NA dated as of
August 28, 2002
10(QQ) Amendment No. 1 to Amended and Restated Credit Included herein
Agreement among SAF Funding Corporation, the Lenders
and Bank One, NA dated as of November 14, 2002
10(RR) Amendment No. 2 to Amended and Restated Put Agreement Included herein
and Waiver among State Automobile Mutual Insurance
Company, State Auto Financial Corporation and Bank
One, NA dated as of November 14, 2002
10(SS) Amendment No. 1 to Amended and Restated Standby Included herein
Purchase Agreement between State Auto Financial
Corporation and SAF Funding Corporation
10(TT) Fourth Amendment to State Auto Reinsurance Pooling Included herein
Agreement, Amended and Restated as of January 1, 2000
10(UU)* Fourth Amendment to 2000 Directors Stock Option Plan Included herein
10(VV) Term Loan Note from State Auto Financial Corporation Included herein
to KeyBank National Association dated as of December
23, 2002
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
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)
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* Constitutes either a management contract or a compensatory plan or arrangement required to be filed as an Exhibit.
If incorporated by reference document with
Exhibit No. Description of Exhibit which Exhibit was previously filed with SEC
----------- ---------------------- -------------------------------------------
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 - S. Elaine Roberts Included herein
99.1 CEO certification required by Section 906 of Included herein
Sarbanes-Oxley Act of 2002
99.2 CFO certification required by Section 906 of Included herein
Sarbanes-Oxley Act of 2002
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*Constitutes either a management contract or a compensatory plan or arrangement required to be filed as an Exhibit
Exhibit 10(OO)
Cost Sharing Agreement
Among
State Auto Property and Casualty Insurance Company, State Automobile Mutual Insurance Company
And State Auto Florida Insurance Company
Effective
January 1, 2003
COST SHARING AGREEMENT
THIS AGREEMENT, made as of this _____ day of ___________, 2002, by and among State Auto Property and Casualty Insurance Company ("State Auto P&C"), State Automobile Mutual Insurance Company ("Mutual"), and State Auto Florida Insurance Company ("SAFIC"), is effective January 1, 2003.
WHEREAS, State Auto P&C desires to make available to SAFIC and SAFIC desires to obtain from State Auto P&C the services of State Auto P&C through its executive, managerial, administrative and other employees and human resources; and
WHEREAS, Mutual desires to make available to SAFIC its data processing and other equipment and facilities, including office space, all of which may be used jointly by SAFIC and Mutual; and
WHEREAS it is expected that effective January 1, 2003, SAFIC will participate in the Reinsurance Pooling Agreement, Amended and Restated as of January 1, 2000, as subsequently amended, (the "State Auto Pooling Agreement" or the "State Auto Pool" or the "State Auto Pooling Arrangement"), with State Auto P&C and State Auto Mutual and certain other affiliates; and
WHEREAS, it is necessary to provide for the allocation and apportionment of the expenses of SAFIC.
NOW, THEREFORE, in consideration of the premises and the mutual promises contained herein, AND INTENDING TO BE LEGALLY BOUND HEREBY, the parties hereto agree as follows:
1. State Auto P&C, through its employees, shall operate, administer, and manage the day-to-day business operations of and otherwise perform Management and Operations Services (as defined below) for SAFIC in accordance with the underwriting, claims and any other reasonable guidelines of such companies which may be in effect or established from time to time by the board of directors of SAFIC. The management and administration of such company's business operations by State Auto P&C shall include, without limitation, appointment and termination of agencies, underwriting of insurance risks, investigation and settlement of claims and arrangement of reinsurance, as well as every other business operation that supports or attends the performance of those services or other business functions of SAFIC. State Auto P&C shall use the same degree of care in acting on behalf of such insurer as it uses in connection with the conduct of its insurance business operations. For the purposes of this agreement it is understood and agreed that Management and Operations Services means all services, including without limitation, executive, managerial, supervisory, administrative, technical, professional, and clerical services, necessary or appropriate in the operation of the respective businesses of SAFIC. Any of State Auto P&C's employees may also serve as directors or officers of SAFIC, notwithstanding that such persons may also be officers or directors of State Auto P&C. State Auto P&C shall have the right to continue using for its business operations all of its employees provided to the other party hereunder. To the extent reasonably possible, SAFIC shall jointly utilize State Auto P&C's employees in a cooperative manner and consistent with the best business interests and needs of SAFIC and State Auto P&C. State Auto P&C shall direct its employees, in performing such services for SAFIC, to use their best efforts to promote the general interests and economic welfare of SAFIC in the same manner as such employees provide services to their direct employer. Nothing contained in this Agreement shall impair the
authority and responsibility of the Board of Directors of SAFIC to exercise managerial control as provided in said company's Articles of Incorporation.
2. Mutual shall provide to SAFIC, as is reasonably required by SAFIC in connection with the SAFIC's business operations, Mutual's equipment and facilities owned or leased by Mutual from time to time in the course of its business operations. Mutual shall have the right to continue using for its business operations all of its equipment and facilities provided to SAFIC hereunder. To the extent reasonably possible, SAFIC shall jointly utilize Mutual's equipment and facilities in a cooperative manner and consistent with the best business interests and needs of SAFIC and Mutual.
3. It is understood and agreed that Mutual shall act as the common paymaster of the employees of State Auto P&C providing services to SAFIC and that it shall also act as the common agent on behalf of SAFIC. Utilizing the employees of State Auto P&C, Mutual shall act as agent for SAFIC and to the extent necessary for the purposes of its business, in collecting and disbursing funds due to SAFIC, and in paying expenses and other operating costs of the facilities used by SAFIC except for those expenses paid directly by SAFIC from its own accounts. Other than those direct expenses which are allocable under the State Auto Pooling Agreement, as set forth in paragraph 4 below, SAFIC is responsible for its own direct expenses incurred in the operations of its business and it agrees to reimburse Mutual for any of such expenses which Mutual may have incurred as the common agent of such company. Because the State Auto Companies operate utilizing employees of one employer, State Auto P&C, and the facilities and equipment of one common agent and common paymaster, Mutual, the non-direct expenses incurred by Mutual and State Auto P&C for the benefit of SAFIC shall be apportioned to SAFIC, in accordance with the provisions of this Agreement and reimbursed to Mutual and State Auto P&C by SAFIC in accordance with the provisions of this Agreement.
4. It is understood and agreed that the direct and indirect expenses of the insurance business operations of SAFIC, including but not limited to underwriting expenses, losses and loss adjustment expenses, will be apportioned to it in accordance with the State Auto Pooling Agreement. All other expenses of SAFIC which are not otherwise allocable or apportionable under the State Auto Pooling Agreement will be apportioned to SAFIC in accordance with all applicable statutory accounting principles including, without limitation, SSAP #70. The books, accounts, and records shall be so maintained as to clearly and accurately disclose the nature and details of the transactions including such accounting information as is necessary to support the expenses apportioned to the respective parties.
5. All amounts due under this Agreement shall be due and payable by the respective company within forty-five days after the end of each calendar quarter. The amounts due from SAFIC hereunder shall be reviewed by State Auto P&C and Mutual on a semi-annual or annual basis as appropriate to reasonably verify such amounts. Any resulting adjustments shall be settled between the parties or credited to future payment periods as may be determined by State Auto P&C and Mutual.
6.(a) Funds representing premiums belonging to SAFIC but held by State Auto P&C
or Mutual on behalf of SAFIC shall be held by either State Auto P&C or Mutual,
as the case may be, in a fiduciary capacity, in one or more trust accounts, as
and to the extent required by Florida law.
(b) SAFIC shall retain such right to access books and records maintained by
State Auto P&C or Mutual as is necessary to 1) ensure SAFIC performs its
contractual obligations to its
insureds, subject to the proprietary rights of State Auto P&C and Mutual in
their respective property; and 2) to verify the accuracy of calculations by
State Auto P&C and Mutual of the payments due from SAFIC hereunder.
(c) State Auto P&C or Mutual shall provide a written notice approved by SAFIC
to SAFIC insureds advising them of the relationship among State Auto P&C, Mutual
and SAFIC as contemplated by this agreement.
7. Any notices to be given hereunder shall be in writing and shall be deemed effective when delivered in person or by facsimile or, if mailed, two days after mailing first class prepaid, to the address of the principal office of the party to which the notice is being given.
8. This Agreement may not be assigned by any party without the prior written consent of the other party. The provisions of this Agreement shall bind and inure to the benefit of the parties and their respective successors and permitted assigns.
9. This Agreement sets forth the entire agreement between the parties with respect to the subject matter hereof and supersedes all prior or contemporaneous agreements with respect thereto. Any modifications or amendments to this Agreement must be in writing and signed by the parties to be bound.
10. This Agreement shall be governed by and construed in accordance with the laws of the State of Florida both as to execution and performance.
11. This Agreement shall remain in force for a period of five years unless terminated prior thereto as provided herein. Any party to this Agreement may terminate this Agreement by giving written notice to the other party, stating a date certain not less than 90 days hence on which such termination will become effective. The Agreement may be renewed for additional five-year terms by the written consent of all the parties hereto.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written.
(THIS SPACE INTENTIONALLY LEFT BLANK)
STATE AUTO PROPERTY AND CASUALTY INSURANCE COMPANY
By: /s/ Robert H. Moone
-------------------
Title: President
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STATE AUTOMOBILE MUTUAL INSURANCE COMPANY
By: /s/ Robert H. Moone
-------------------
Title: President
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STATE AUTO FLORIDA INSURANCE COMPANY
By: /s/ Robert H. Moone
-------------------
Title: President
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Exhibit 10(PP)
Amendment No. 1 to Put Agreement and Waiver Among State Automobile Mutual Insurance Company State Auto Financial Corporation and Bank One, NA
Dated as of August 28, 2002
AMENDMENT NO. 1 TO PUT AGREEMENT AND WAIVER
This Amendment (this "Amendment") is entered into as of August 28, 2002 by and among State Automobile Mutual Insurance Company, a mutual insurance company duly organized and validly existing under the laws of the State of Ohio ("State Auto Mutual"), State Auto Financial Corporation, a corporation duly organized and validly existing under the laws of the State of Ohio ("State Auto Financial" and, together with State Auto Mutual, the "State Auto Obligors"), and Bank One, NA, as agent (in such capacity, together with its successors in such capacity, the "Agent") for the Lenders party to the Credit Agreement referred to below.
RECITALS
A. The State Auto Obligors and the Agent are parties to an Amended and Restated Put Agreement dated as of November 16, 2001 (the "Put Agreement").
B. The State Auto Obligors and the Agent desire to amend the Put Agreement on the terms and conditions set forth below.
C. Additionally, the State Auto Obligors have requested a waiver of, and the Agent wishes to waive, certain provisions of the Put Agreement on the terms and conditions set forth below.
NOW, THEREFORE, in consideration of the mutual execution hereof and other good and valuable consideration, the parties hereto agree as follows:
1. Waiver. The undersigned Agent hereby waives any breach of Section 4.10(c) of the Put Agreement arising solely out of the failure of State Auto Mutual to prevent the Premium to Surplus Ratio of State Auto P&C to exceed 2.50 to 1 during the fiscal quarter of State Auto P&C ended June 30, 2002.
2. Amendments to Put Agreement. Upon the satisfaction of each of the conditions set forth in Section 4 below, the Put Agreement shall be amended as follows:
(a) Article I of the Put Agreement shall be amended by adding the following definition thereto in alphabetical order:
"State Auto Pool" shall mean, collectively, State Auto Mutual, State Auto P&C, Milbank, Midwest Security, Farmers Casualty and State Auto Insurance.
(b) The definition of "Midwest Security" in Article I of the Put Agreement shall be amended and restated to read as follows:
"Midwest Security" means State Auto Insurance Company of Wisconsin (formerly known as Midwest Security Insurance Company), a Wisconsin domiciled property and casualty insurance company.
(c) The definition of "State Auto Insurance" in Article I of the Put Agreement shall be amended and restated to read as follows:
"State Auto Insurance" means State Auto Insurance Company, an Ohio corporation to be renamed State Auto Insurance Company of Ohio.
(d) Section 4.10(c) of the Put Agreement shall be amended and restated in its entirety to read as follows:
(c) Premium to Surplus. State Auto Mutual will not permit its Premium to Surplus Ratio at any time to exceed (i) 2.00 to 1, at any time prior to the occurrence of a catastrophe giving rise to Loans being outstanding under the Credit Agreement (provided that no Loans are outstanding at such time) and (ii) 2.50 to 1, at any time during the period from and including the date of occurrence of a catastrophe giving rise to Loans being outstanding under the Credit Agreement to but excluding the date all Loans shall have been required to be repaid in full pursuant to the terms of the Credit Agreement. State Auto Mutual will not permit the Premium to Surplus Ratio of State Auto P&C to exceed (x) 2.75 to 1 at any time prior to the occurrence of a catastrophe giving rise to Loans being outstanding under the Credit Agreement (provided that no Loans are outstanding at such time) and (y) 3.00 to 1, at any time during the period from and including the date of occurrence of a catastrophe giving rise to Loans being outstanding under the Credit Agreement to but excluding the date all Loans shall have been required to be repaid in full pursuant to the terms of the Credit Agreement. State Auto Mutual will not permit the Premium to Surplus Ratio of the State Auto Pool to exceed (x) 2.00 to 1 at any time prior to the occurrence of a catastrophe giving rise to Loans being outstanding under the Credit Agreement (provided that no Loans are outstanding at such time) and (y) 2.50 to 1 at any time during the period from and including the date of occurrence of a catastrophe giving rise to Loans being outstanding under the Credit Agreement to but excluding the date all Loans shall have been required to be repaid in full pursuant to the terms of the Credit Agreement.
3. Representations and Warranties of State Auto Obligors. Each State Auto Obligor represents and warrants that:
(a) The execution, delivery and performance by such State Auto Obligor of this Amendment have been duly authorized by all necessary corporate action and that this Amendment is a legal, valid and binding obligation of such State Auto Obligor enforceable against such State Auto Obligor in accordance with its terms, except as the enforcement thereof may be subject to the effect of any applicable bankruptcy, insolvency, reorganization, moratorium or similar law affecting creditors' rights generally;
(b) Each of the representations and warranties contained in the Put Agreement is true and correct in all material respects on and as of the date hereof as if made on the date hereof except to the extent any such representation or warranty is stated to relate
solely to an earlier date, in which case such representation or warranty was true and correct on and as of such earlier date;
(c) After giving effect to this Amendment, no Put Event has occurred and is continuing.
4. Effective Date. Section 2 of this Amendment shall become effective as of July 1, 2002 upon satisfaction of the following conditions:
(a) Executed Amendment. Receipt by the Agent of duly executed counterparts hereof by State Auto Obligors and the Agent.
(b) Fees. The receipt by the Agent of the amendment fee referenced in Section 6(b) below.
(c) Miscellaneous. Receipt by the Agent of such other documents, certificates, instruments and opinions as may reasonably be requested in advance of the date hereof by it.
5. Reference to and Effect Upon the Put Agreement.
(a) Except as specifically amended above, the Put Agreement shall remain in full force and effect and is hereby ratified and confirmed.
(b) The execution, delivery and effectiveness of this Amendment shall not operate as a waiver of any right, power or remedy of the Agent or any Lender under the Put Agreement or any Loan Document, nor constitute a waiver of any provision of the Put Agreement or any Loan Document, except as specifically set forth herein. Upon the effectiveness of this Amendment, each reference in the Put Agreement to "this Agreement", "hereunder", "hereof", "herein" or words of similar import shall mean and be a reference to the Put Agreement as amended hereby.
6. Costs and Expenses.
(a) Each State Auto Obligor hereby affirms its joint and several obligation under Section 5.3 of the Put Agreement to reimburse the Agent for all costs, internal charges and out-of-pocket expenses paid or incurred by the Agent in connection with the preparation, negotiation, execution and delivery of this Amendment, including but not limited to the reasonable attorneys' fees and time charges of attorneys for the Agent with respect thereto.
(b) The State Auto Obligors hereby jointly and severally agree that, contemporaneously herewith, the State Auto Obligors shall pay to the Agent for the ratable benefit of the Lenders party hereto an amendment fee in an amount equal to $3,000 for each Lender that executes this Amendment on or before August 28, 2002.
7. GOVERNING LAW. THIS AMENDMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE INTERNAL LAWS (AS OPPOSED TO
CONFLICTS OF LAWS PROVISIONS) OF THE STATE OF ILLINOIS BUT GIVING EFFECT TO FEDERAL LAWS APPLICABLE TO NATIONAL BANKS.
8. Headings. Section headings in this Amendment are included herein for convenience of reference only and shall not constitute a part of this Amendment for any other purposes.
9. Counterparts. This Amendment may be executed in any number of counterparts, each of which when so executed shall be deemed an original but all such counterparts shall constitute one and the same instrument.
[signature pages follow]
IN WITNESS WHEREOF, the parties have executed this Amendment as of the date and year first above written.
STATE AUTOMOBILE MUTUAL INSURANCE COMPANY
By: /s/ Steven J. Johnston
---------------------------------------
Title: Senior Vice President
------------------------------------
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STATE AUTO FINANCIAL CORPORATION
By: /s/ Steven J. Johnston
---------------------------------------
Title: Senior Vice President
------------------------------------
|
BANK ONE, NA, as Agent
By: /s/ Cynthia Priest
---------------------------------------
Title: Director
------------------------------------
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Exhibit 10(QQ)
Amendment No. 1 to Amended and Restated Credit Agreement Among SAF Funding Corporation, the Lenders and Bank One, NA
Dated as of November 14, 2002
AMENDMENT NO. 1 TO AMENDED AND RESTATED CREDIT AGREEMENT
This Amendment (this "AMENDMENT") is entered into as of November 14, 2002 by and among SAF Funding Corporation, a Delaware corporation (the "BORROWER"), Bank One, NA, individually and as agent ("AGENT"), and the other financial institutions signatory hereto.
RECITALS
A. The Borrower, the Agent and the Lenders are party to that certain Credit Agreement dated as of November 19, 1999 (as amended and restated by that certain Amended and Restated Credit Agreement dated as of November 16, 2001, the "CREDIT AGREEMENT"). Unless otherwise specified herein, capitalized terms used in this Amendment shall have the meanings ascribed to them by the Credit Agreement;
B. The Borrower has requested an extension of the Commitment Termination Date, and each of the Lenders have approved such extension request in accordance with the terms of the Credit Agreement; and
C. Firstar Bank, NA ("FIRSTAR") has notified the Agent of its desire to terminate its Commitment on the current Commitment Termination Date (as defined in the Credit Agreement).
NOW, THEREFORE, in consideration of the mutual execution hereof and other good and valuable consideration, the parties hereto agree as follows:
1. AMENDMENT TO CREDIT AGREEMENT. Upon the "Effective Date" (as defined below), the Credit Agreement shall be amended as follows:
(a) The definition of "Commitment Termination Date" set forth in Article I of the Credit Agreement is amended in its entirety to read as follows:
"COMMITMENT TERMINATION DATE" means November 12, 2003 or any earlier date on which the Aggregate Commitment is reduced to zero or otherwise terminated pursuant to the terms hereof.
(b) The definition of "Company Pledge Agreement" set forth in Article I of the Credit Agreement is amended in its entirety to read as follows:
"COMPANY PLEDGE AGREEMENT" shall mean a Pledge and Security Agreement dated as of November 19, 1999 between the Borrower and the Agent, as the same shall be modified and supplemented and in effect from time to time.
(c) The definition of "Parent Pledge Agreement" set forth in Article I of the Credit Agreement is amended in its entirety to read as follows:
"PARENT PLEDGE AGREEMENT" shall mean a Pledge and Security Agreement dated as of November 19, 1999 between the Parent and the Agent, as the same shall be modified and supplemented and in effect from time to time.
(d) Schedule 1 to the Credit Agreement is deleted in its entirety, and SCHEDULE 1 attached hereto and made a part hereof is substituted in its place.
2. TERMINATION OF FIRSTAR COMMITMENT. The Commitment of Firstar shall be terminated and of no further force and effect from and after the Effective Date.
3. REPRESENTATIONS AND WARRANTIES OF THE BORROWER. The Borrower represents and warrants that:
(a) The execution, delivery and performance by the Borrower of this Amendment have been duly authorized by all necessary corporate action and that this Amendment is a legal, valid and binding obligation of the Borrower enforceable against the Borrower in accordance with its terms, except as the enforcement thereof may be subject to the effect of any applicable bankruptcy, insolvency, reorganization, moratorium or similar law affecting creditors' rights generally;
(b) Each of the representations and warranties contained in the Credit Agreement is true and correct in all material respects on and as of the date hereof as if made on the date hereof except to the extent any such representation or warranty is stated to relate solely to an earlier date, in which case such representation or warranty was true and correct on and as of such earlier date;
(c) After giving effect to this Amendment, no Default or Unmatured Default has occurred and is continuing.
4. EFFECTIVE DATE. Sections 1 and 2 of this Amendment shall become effective upon:
(a) the execution and delivery hereof by the Borrower, the Agent and all the Lenders;
(b) the execution and delivery of Amendment No. 2 to Put Agreement, a copy of which is attached hereto as EXHIBIT A (the "PUT AGREEMENT AMENDMENT"), by the State Auto Obligors and the Agent;
(c) the execution and delivery of Amendment No. 1 to Standby Purchase Agreement by State Auto Financial and the Borrower;
(d) the Borrower's repayment to Firstar in full of all Obligations outstanding and due to Firstar on the Effective Date;
(e) a certificate, signed by the chief financial officer of the Borrower, stating that (i) on the Effective Date no Default or Unmatured Default has occurred and is continuing and (ii) no amendments or modifications have been made to the articles or certificate of incorporation or by-laws of the Borrower or the Parent since November 16, 2001 (or, if any amendments or modifications have been made, attaching a copy thereof to such certificate);
(f) copies of the resolutions of the board of directors of the Borrower authorizing the transactions contemplated hereby, certified as of the date hereof by the Secretary or an Assistant Secretary of the Borrower; and
(g) a certificate of the Secretary or an Assistant Secretary of the Borrower, dated as of the date hereof, certifying the names and true signatures of the officers of the Borrower authorized to execute, deliver and perform this Amendment.
The date upon which such events have occurred is the "Effective Date."
5. REFERENCE TO AND EFFECT UPON THE CREDIT AGREEMENT.
(a) Except as specifically amended above, the Credit Agreement and the other Loan Documents shall remain in full force and effect and are hereby ratified and confirmed.
(b) The execution, delivery and effectiveness of this Amendment shall not operate as a waiver of any right, power or remedy of the Agent or any Lender under the Credit Agreement or any Loan Document, nor constitute a waiver of any provision of the Credit Agreement or any Loan Document, except as specifically set forth herein. Upon the effectiveness of this Amendment, each reference in the Credit Agreement to "this Agreement", "hereunder", "hereof", "herein" or words of similar import shall mean and be a reference to the Credit Agreement as amended hereby.
6. CONSENT TO PUT AGREEMENT AMENDMENT. By their signatures below, each of the undersigned Lenders hereby consents to the execution of the Put Agreement Amendment.
7. COSTS AND EXPENSES. The Borrower hereby affirms its obligation under
Section 9.6 of the Credit Agreement to reimburse the Agent for all reasonable
costs, internal charges and out-of-pocket expenses paid or incurred by the Agent
in connection with the preparation, negotiation, execution and delivery of this
Amendment, including but not limited to the attorneys' fees and time charges of
attorneys for the Agent with respect thereto.
8. GOVERNING LAW. THIS AMENDMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE INTERNAL LAWS (AS OPPOSED TO CONFLICTS OF LAWS PROVISIONS) OF THE STATE OF ILLINOIS BUT GIVING EFFECT TO FEDERAL LAWS APPLICABLE TO NATIONAL BANKS.
9. HEADINGS. Section headings in this Amendment are included herein for convenience of reference only and shall not constitute a part of this Amendment for any other purposes.
10. COUNTERPARTS. This Amendment may be executed in any number of counterparts, each of which when so executed shall be deemed an original but all such counterparts shall constitute one and the same instrument.
[signature pages follow]
IN WITNESS WHEREOF, the parties have executed this Amendment as of the date and year first above written.
SAF FUNDING CORPORATION
BANK ONE, NA, as Agent and as a Lender
By: /s/ Cynthia Priest
-------------------------------------
Title: Director
----------------------------------
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KEYBANK NATIONAL ASSOCIATION, as a Lender
By: /s/ Mary K. Young
-------------------------------------
Title: Vice President
----------------------------------
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THE HUNTINGTON NATIONAL BANK, as a Lender
By: /s/ Nancy Cracoiice
------------------------------------
Title: Vice President
---------------------------------
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NATIONAL CITY BANK, as a Lender
By: /s/ Rick Marriotti
------------------------------------
Title: Vice President
---------------------------------
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FIFTH THIRD BANK, as a Lender
By: /s/ John K. Beardslee
------------------------------------
Title: Vice President
---------------------------------
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PARK NATIONAL BANK, as a Lender
By: /s/ Thomas Button
------------------------------------
Title: Vice President
---------------------------------
|
SCHEDULE 1
COMMITMENTS
Lender Commitment
------ ----------
Bank One, NA $20,000,000
Keybank National Association $20,000,000
The Huntington National Bank $20,000,000
National City Bank $17,000,000
Fifth Third Bank $15,000,000
Park National Bank $8,000,000
Aggregate Commitment $100,000,000
|
Exhibit 10(RR)
Amendment No. 2 to
Amended and Restated Put Agreement and Waiver
Among
State Automobile Mutual Insurance Company, State Auto Financial Corporation, and Bank One, NA
Dated as of November 14, 2002
AMENDMENT NO. 2 TO AMENDED AND RESTATED
PUT AGREEMENT AND WAIVER
This Amendment (this "AMENDMENT") is entered into as of November 14, 2002 by and among State Automobile Mutual Insurance Company, a mutual insurance company duly organized and validly existing under the laws of the State of Ohio ("STATE AUTO MUTUAL"), State Auto Financial Corporation, a corporation duly organized and validly existing under the laws of the State of Ohio ("STATE AUTO FINANCIAL" and, together with State Auto Mutual, the "STATE AUTO OBLIGORS"), and Bank One, NA, as agent (in such capacity, together with its successors in such capacity, the "AGENT") for the Lenders party to the Credit Agreement referred to below.
RECITALS
A. The State Auto Obligors and the Agent are parties to a Put Agreement
dated as of November 19, 1999 (as amended and restated by that certain Amended
and Restated Put Agreement dated as of November 16, 2001 and as amended by
Amendment No. 1 to Put Agreement and Waiver dated as of August 28, 2002, the
"PUT AGREEMENT").
B. The State Auto Obligors and the Agent desire to amend the Put Agreement on the terms and conditions set forth below.
C. Additionally, the State Auto Obligors have requested a waiver of, and the Agent wishes to waive, certain provisions of the Put Agreement on the terms and conditions set forth below.
NOW, THEREFORE, in consideration of the mutual execution hereof and other good and valuable consideration, the parties hereto agree as follows:
1. WAIVER. The undersigned Agent hereby waives any breach of Section 4.10(c) of the Put Agreement arising solely out of the failure of State Auto Mutual to prevent the Premium to Surplus Ratio of State Auto P&C to exceed 2.75 to 1 during the fiscal quarter of State Auto P&C ended September 30, 2002.
2. AMENDMENTS TO PUT AGREEMENT. Upon the satisfaction of each of the conditions set forth in SECTION 4 below, the Put Agreement shall be amended as follows:
(a) Section 4.10(a) of the Put Agreement shall be amended and restated to read as follows:
(a) STATUTORY SURPLUS. State Auto Mutual will not permit its Statutory Surplus at any time to be less than (a) $637,000,000, at any time prior to the occurrence of a catastrophe giving rise to Loans being outstanding under the Credit Agreement (PROVIDED that no Loans are outstanding at such time) and (b) $600,000,000, at any time during the period from and including the date of occurrence of a catastrophe giving rise to Loans being outstanding under the Credit Agreement to but excluding the date all Loans shall have been required to
be repaid in full pursuant to the terms of the Credit Agreement. State Auto Mutual will not permit the Statutory Surplus of State Auto P&C to be less than (a) the sum of $180,000,000 plus 85% of the net available proceeds raised from a surplus note issuance by State Auto P&C at any time prior to the occurrence of a catastrophe giving rise to Loans being outstanding under the Credit Agreement (PROVIDED that no Loans are outstanding at such time) and (b) $170,000,000 plus 80% of the net available proceeds raised from a surplus note issuance by State auto P&C at any time during the period from and including the date of occurrence of a catastrophe giving rise to Loans being outstanding under the Credit Agreement to but excluding the date all Loans shall have been required to be repaid in full pursuant to the terms of the Credit Agreement.
(b) Section 4.20(b) of the Put Agreement shall be amended and restated to read as follows:
(b) a certificate of a senior officer of State Auto Mutual, dated such date, to the effect that (i) the "Probable Maximum Loss" (as defined below) of the State Auto Obligors for the 250-year return period shall not exceed (x) $100,000,000 for earthquake peril, (y) $75,000,000 for hurricane peril and (z) $130,000,000 for thunderstorm peril and (ii) attached thereto is a true, correct and complete copy of the report prepared by the applicable Modelling Firm (as defined below) in connection with the calculation referred to in the definition of "Probable Maximum Loss" below. For purposes of this clause (b), "PROBABLE MAXIMUM LOSS" shall mean, for any date, the "probable maximum loss" as most recently calculated prior to such date by Risk Management Solutions, Inc., Applied Insurance Research, EQECAT Inc., Tillinghast (a Towers Perrin Company) or another independent modelling firm satisfactory to the Agent (each, a "MODELLING FIRM") and "THUNDERSTORM PERIL" shall mean peril caused by lightning, straight line wind, rain, hail and/or tornado.
3. REPRESENTATIONS AND WARRANTIES OF STATE AUTO OBLIGORS. Each State Auto Obligor represents and warrants that:
(a) The execution, delivery and performance by such State Auto Obligor of this Amendment have been duly authorized by all necessary corporate action and that this Amendment is a legal, valid and binding obligation of such State Auto Obligor enforceable against such State Auto Obligor in accordance with its terms, except as the enforcement thereof may be subject to the effect of any applicable bankruptcy, insolvency, reorganization, moratorium or similar law affecting creditors' rights generally;
(b) Each of the representations and warranties contained in the Put Agreement is true and correct in all material respects on and as of the date hereof as if made on the date hereof except to the extent any such representation or warranty is stated to relate solely to an earlier date, in which case such representation or warranty was true and correct on and as of such earlier date;
(c) No Put Event has occurred and is continuing.
4. EFFECTIVE DATE. SECTION 2 of this Amendment shall become effective as of November 14, 2002 upon satisfaction of the following conditions:
(a) EXECUTED AMENDMENT. Receipt by the Agent of duly executed counterparts hereof by State Auto Obligors and the Agent.
(b) OTHER. Satisfaction of the conditions to effectiveness set forth in
Section 3 of that certain Amendment No. 1 to Amended and Restated Credit
Agreement among the Borrower, the Agent and the financial institutions signatory
thereto.
5. REFERENCE TO AND EFFECT UPON THE PUT AGREEMENT.
(a) Except as specifically amended above, the Put Agreement shall remain in full force and effect and is hereby ratified and confirmed.
(b) The execution, delivery and effectiveness of this Amendment shall not operate as a waiver of any right, power or remedy of the Agent or any Lender under the Put Agreement or any Loan Document, nor constitute a waiver of any provision of the Put Agreement or any Loan Document, except as specifically set forth herein. Upon the effectiveness of this Amendment, each reference in the Put Agreement to "this Agreement", "hereunder", "hereof", "herein" or words of similar import shall mean and be a reference to the Put Agreement as amended hereby.
6. COSTS AND EXPENSES. Each State Auto Obligor hereby affirms its joint and several obligation under Section 5.3 of the Put Agreement to reimburse the Agent for all costs, internal charges and out-of-pocket expenses paid or incurred by the Agent in connection with the preparation, negotiation, execution and delivery of this Amendment, including but not limited to the reasonable attorneys' fees and time charges of attorneys for the Agent with respect thereto.
7. GOVERNING LAW. THIS AMENDMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE INTERNAL LAWS (AS OPPOSED TO CONFLICTS OF LAWS PROVISIONS) OF THE STATE OF ILLINOIS BUT GIVING EFFECT TO FEDERAL LAWS APPLICABLE TO NATIONAL BANKS.
8. HEADINGS. Section headings in this Amendment are included herein for convenience of reference only and shall not constitute a part of this Amendment for any other purposes.
9. COUNTERPARTS. This Amendment may be executed in any number of counterparts, each of which when so executed shall be deemed an original but all such counterparts shall constitute one and the same instrument.
[signature pages follow]
IN WITNESS WHEREOF, the parties have executed this Amendment as of the date and year first above written.
STATE AUTOMOBILE MUTUAL INSURANCE
COMPANY
By: /s/ Steven J. Johnston
------------------------------------
Title: Senior Vice President
---------------------------------
|
STATE AUTO FINANCIAL CORPORATION
By: /s/ Steven J. Johnston
------------------------------------
Title: Senior Vice President
---------------------------------
|
BANK ONE, NA, as Agent
By: /s/ Cynthia Priest
------------------------------------
Title: Director
---------------------------------
|
Exhibit 10(SS)
Amendment No. 1 to Amended and Restated
Standby Purchase Agreement
Between
State Auto Financial Corporation and
SAF Funding Corporation
AMENDMENT NO. 1 TO AMENDED AND RESTATED
STANDBY PURCHASE AGREEMENT
This Amendment (this "AMENDMENT") is entered into as of November 14, 2002 by and between State Auto Financial Corporation, a corporation duly organized and validly existing under the laws of the State of Ohio ("STATE AUTO FINANCIAL"), and SAF Funding Corporation, a Delaware corporation (the "COMPANY").
RECITALS
A. State Auto Financial and the Company are parties to a Standby Purchase Agreement dated as of November 19, 1999 (as amended and restated by that certain Amended and Restated Standby Purchase Agreement dated as of November 16, 2001, the "STANDBY PURCHASE AGREEMENT").
B. State Auto Financial and the Company desire to amend the Standby Purchase Agreement on the terms and conditions set forth below.
NOW, THEREFORE, in consideration of the mutual execution hereof and other good and valuable consideration, the parties hereto agree as follows:
1. AMENDMENTS TO STANDBY PURCHASE AGREEMENT. Upon the satisfaction of each of the conditions set forth in SECTION 4 below, the Standby Purchase Agreement shall be amended as follows:
(a) The definition of "Company Pledge Agreement" in Article I of the Standby Purchase Agreement shall be amended and restated to read as follows:
"COMPANY PLEDGE AGREEMENT" shall mean the Pledge and Security Agreement dated as of November 19, 1999, among the Company and the Agent, as modified and supplemented and in effect from time to time.
(b) The definition of "Purchase Commitment Termination Date" shall be amended and restated to read as follows:
"PURCHASE COMMITMENT TERMINATION DATE" shall mean
November 12, 2003; PROVIDED, that if the "Commitment
Termination Date" under the Credit Agreement is extended as
provided therein, the Purchase Commitment Termination Date
shall, automatically and without any action on the part of
State Auto Financial or the Company, be extended to the date
to which said "Commitment Termination Date" has been so
extended.
2. REPRESENTATIONS AND WARRANTIES OF STATE AUTO OBLIGORS. Each of the Company and State Auto Financial represents and warrants that:
(a) The execution, delivery and performance by such Person of this Amendment have been duly authorized by all necessary corporate action and that this Amendment is a legal, valid and binding obligation of such Person enforceable against such Person in accordance with its terms, except as the enforcement thereof may be subject to the effect of any applicable bankruptcy, insolvency, reorganization, moratorium or similar law affecting creditors' rights generally; and
(b) Each of the representations and warranties contained in the Standby Purchase Agreement is true and correct in all material respects on and as of the date hereof as if made on the date hereof except to the extent any such representation or warranty is stated to relate solely to an earlier date, in which case such representation or warranty was true and correct on and as of such earlier date.
3. EFFECTIVE DATE. SECTION 1 of this Amendment shall become effective as of November 14, 2002 upon satisfaction of the following conditions:
(a) EXECUTED AMENDMENT. Receipt by the Agent of duly executed counterparts hereof by the Company and State Auto Financial.
(b) OTHER. Satisfaction of the conditions to effectiveness set forth in Section 3 of that certain Amendment No. 1 to Amended and Restated Credit Agreement among the Company, the Agent and the financial institutions signatory thereto.
4. REFERENCE TO AND EFFECT UPON THE STANDBY PURCHASE AGREEMENT.
(a) Except as specifically amended above, the Standby Purchase Agreement shall remain in full force and effect and is hereby ratified and confirmed.
(b) The execution, delivery and effectiveness of this Amendment shall not operate as a waiver of any right, power or remedy of the Agent or any Lender under the Standby Purchase Agreement or any Loan Document, nor constitute a waiver of any provision of the Standby Purchase Agreement or any Loan Document, except as specifically set forth herein. Upon the effectiveness of this Amendment, each reference in the Standby Purchase Agreement to "this Agreement", "hereunder", "hereof", "herein" or words of similar import shall mean and be a reference to the Standby Purchase Agreement as amended hereby.
5. GOVERNING LAW. THIS AMENDMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE INTERNAL LAWS (AS OPPOSED TO CONFLICTS OF LAWS PROVISIONS) OF THE STATE OF ILLINOIS BUT GIVING EFFECT TO FEDERAL LAWS APPLICABLE TO NATIONAL BANKS.
6. HEADINGS. Section headings in this Amendment are included herein for convenience of reference only and shall not constitute a part of this Amendment for any other purposes.
7. COUNTERPARTS. This Amendment may be executed in any number of counterparts, each of which when so executed shall be deemed an original but all such counterparts shall constitute one and the same instrument.
[signature pages follow]
IN WITNESS WHEREOF, the parties have executed this Amendment as of the date and year first above written.
STATE AUTOMOBILE FINANCIAL
CORPORATION
By: /s/ Steven J. Johnston
--------------------------------
Title: Senior Vice President
-----------------------------
|
SAF FUNDING CORPORATION
By: /s/ Jill A. Gordon
--------------------------------
Title: Vice President
-----------------------------
|
Exhibit 10(TT)
Fourth Amendment to State Auto Reinsurance Pooling Agreement, Amended and Restated as of
January 1, 2000
FOURTH AMENDMENT TO THE
REINSURANCE POOLING AGREEMENT
AMENDED AND RESTATED AS OF
JANUARY 1, 2000
This Fourth Amendment (this "Fourth Amendment") to the Reinsurance Pooling
Agreement, Amended and Restated as of January 1, 2000 as heretofore amended (the
"2000 Pooling Agreement") by and among State Automobile Mutual Insurance Company
("State Auto Mutual"), State Auto Property and Casualty Insurance Company
("State Auto P&C"), Milbank Insurance Company ("Milbank"), State Auto Insurance
Company of Wisconsin (formerly known as Midwest Security Insurance Company)
("State Auto Wisconsin"), Farmers Casualty Insurance Company ("Farmers
Casualty") and State Auto Insurance Company of Ohio (formerly known as State
Auto Insurance Company) ("State Auto Ohio") (collectively, the "Pooled
Companies") is made this ___ day of ______2002, but is effective as of 12:01
a.m. Columbus, Ohio time January 1, 2003.
BACKGROUND INFORMATION
State Auto Florida Insurance Company ("SAFIC" or "State Auto Florida") which was incorporated in December 2001 as a Florida domiciled corporation, has received a certificate of authority dated August 1, 2002, from the Florida Department of Insurance licensing SAFIC as a property casualty insurer in the state of Florida.
SAFIC is a wholly owned subsidiary of State Auto Mutual and it desires that SAFIC become a participant in the 2000 Pooling Agreement.
The Independent Committee of the Board of Directors of State Auto Mutual has approved the addition of State Auto Florida to the 2000 Pooling Agreement at the pooling percentage indicated.
The purpose of this Fourth Amendment is to add State Auto Florida as a party to the 2000 Pooling Agreement at the Respective Percentage indicated below and to amend the Respective Percentage (as defined in the 2000 Pooling Agreement) of State Auto Mutual, as indicated below and to make other conforming amendments to the 2000 Pooling Agreement.
STATEMENT OF AGREEMENT
In consideration of the mutual covenants set forth herein and INTENDING TO BE LEGALLY BOUND HEREBY, the Pooled Companies agree to amend the 2000 Pooling Agreement as follows:
1. Capitalized terms used in this Fourth Amendment (including the Background Information) which are not otherwise defined herein shall be
defined as in the 2000 Pooling Agreement, and those definitions shall apply in this Fourth Amendment.
2. State Auto Florida is hereby made a party to the 2000 Pooling Agreement and as such is hereby designated a Pooled Company and it hereby accepts all the terms and provisions of the 2000 Pooling Agreement, as amended by the First Amendment, the Second Amendment, the Third Amendment, heretofore adopted by the parties and this Fourth Amendment.
3. The following sentence is hereby added to the first paragraph under Background Information: In addition to the foregoing management agreements, State Auto Florida has entered into a management agreement with State Auto P&C and State Auto Mutual to be effective January 1, 2003, pursuant to which State Auto Florida's business operations will be conducted in a manner similar to that described for the other Pooled Companies.
4. Section 1c. of the 2000 Pooling Agreement is hereby amended in its entirety to read as follows:
"Respective Percentage" shall be
As to State Auto Ohio 1%
As to Farmers Casualty 3%
As to State Auto Wisconsin 1%
As to Milbank 17%
As to State Auto P&C 59%
As to State Auto Mutual 18.3%
As to State Auto Florida 0.7%
|
5. Section 2, CESSION, is amended by the addition of the following subsection (f):
(f) State Auto Florida Cession: State Auto Mutual hereby reinsures and assumes and State Auto Florida hereby cedes and transfers to State Auto Mutual all Net Liabilities incurred under or in connection with all contracts and policies of insurance issued by State Auto Florida outstanding and in force as of and subsequent to 12:01 a.m. EST, January 1, 2003. Such liabilities shall include State Auto Florida's reserves for unearned premiums, outstanding losses and loss expenses (including unreported losses) and all other outstanding underwriting and administrative expenses as evidenced by State Auto Florida's books and records at the close of business on December 31, 2002, but shall not include intercompany balances, liabilities incurred in connection with the investment transactions of State Auto Florida, liabilities for dividends to stockholders declared and unpaid, other liabilities not incurred in
connection with underwriting operations and liabilities arising out of the State Auto Mutual Reinsurance Book. It is further agreed that State Auto Mutual shall receive the Net Premiums for said contracts and policies.
6. Section 3, ASSETS TRANSFER TO STATE AUTO MUTUAL, is amended by the addition of the following subsection (f):
(f) State Auto Florida: In consideration of the agreements herein contained, State Auto Florida hereby agrees that there has been or will be assigned and transferred to State Auto Mutual an amount, in cash or other assets, equal to the aggregate of all liabilities of State Auto Florida assumed by State Auto Mutual under paragraph 2(f) hereof, less a ceding commission equal to the sum of the acquisition expenses associated with the unearned premium reserves which are transferred as provided herein. There shall be included among the assets assigned and transferred to State Auto Mutual by State Auto Florida all of the right, title and interest of State Auto Florida in and to all assets relative to the underwriting operations of State Auto Florida due or that may become due as evidenced by its books and records at the close of business on December 31, 2002, not including investments, accrued investment income, intercompany balances and bank deposits.
7. Section 4, ASSUMPTION OF REINSURANCE, is hereby amended by the addition of the following subsection (f):
(f) State Auto Florida: State Auto Florida hereby reinsures and assumes and State Auto Mutual hereby cedes and transfers to State Auto Florida its Respective Percentage of all Net Liabilities under all contracts and policies of insurance, (including those ceded by State Auto Florida and reinsured by State Auto Mutual as provided in paragraph 2(f)), on which State Auto Mutual is subject to liability and which are outstanding and in force on or after the effective date of the Fourth Amendment.
Such liabilities shall include reserves for unearned premiums, outstanding losses (including unreported losses) and loss expenses and all other underwriting and administrative expenses, but shall not include intercompany balances, liabilities for federal income taxes, liabilities incurred in connection with investment transactions, liabilities for dividends to stockholders declared and unpaid, other liabilities not incurred in connection with underwriting operations and liabilities arising out of the State Auto Mutual Reinsurance Book.
8. Section 5, ASSET TRANSFER BY STATE AUTO MUTUAL, is hereby amended by the addition of the following subsection (f):
(f) State Auto Florida: In consideration of the agreements herein contained, State Auto Mutual hereby agrees that there has been or will be assigned and transferred to State Auto Florida an amount, in cash or other assets, equal to the aggregate of all liabilities of State Auto Mutual assumed by State Auto Florida under paragraph 4(f) hereof, less a ceding commission equal to the sum of the acquisition expenses associated with the unearned premium reserves which are transferred as provided herein. There shall be included among the assets assigned and transferred to State Auto Florida by State Auto Mutual all of the right, title and interest of State Auto Mutual in and to all assets relative to the underwriting operations of State Auto Mutual, due or that may become due, as evidenced by its books and records at the close of business on December 31, 2002, not including investments, accrued investment income, intercompany balances and bank deposits.
9. Section 6, PREMIUM COLLECTION AND PAYMENT OF LOSSES, is hereby amended by the addition of the following:
As of the effective date of this Fourth Amendment, and pursuant to the terms of the Management Agreement in place between State Auto Florida, State Auto P&C, and State Auto Mutual, State Auto Florida hereby authorizes and empowers State Auto Mutual to collect and receive all premiums and to take charge of, adjust and administer the payment of all losses with respect to any and all contracts and policies of insurance previously or thereafter issued by State Auto Florida and to reinsure or terminate all such contracts and policies, and in all respects to act as though said contracts and policies were issued by State Auto Mutual. State Auto Mutual agrees to administer the payment of all losses and loss adjustment expenses in connection with such contracts and policies. None of the foregoing is intended to affect or impair the direct obligation of State Auto Florida to its insureds under policies issued by State Auto Florida.
10. Section 7, PREMIUM PAYABLE BY STATE AUTO MUTUAL, is amended by the addition of the following subsection (f):
(f) State Auto Florida: Commencing with the effective date of this Fourth Amendment, State Auto Mutual hereby agrees to pay State Auto Florida its Respective Percentage of the Net Premiums written by the parties hereto. Similarly, commencing with the effective date of this Fourth Amendment, all losses, loss expenses, underwriting expenses, and administrative expenses chargeable to underwriting of the parties hereto (except for losses, loss expenses, underwriting expenses and administrative expenses chargeable to the State Auto Mutual Reinsurance Book), including policyholder dividends, less all losses and expenses recovered and recoverable under reinsurance ceded to reinsurers other
than the parties hereto, (except for the State Auto P&C Catastrophe Assumption Agreement) shall be prorated among the parties on the basis of the Respective Percentage of each. Accounts shall be rendered at quarterly intervals and shall be settled within sixty (60) days thereafter.
11. Section 9, GENERAL STATEMENT OF INTENT, is amended by the addition of the following subsection (h):
(h) State Auto Florida shall be liable as a reinsurer to State Auto Mutual, State Auto P&C, Milbank, State Auto Wisconsin, Farmers Casualty and State Auto Ohio on the policies and contracts of State Auto Mutual, State Auto P&C, Milbank, State Auto Wisconsin, Farmers Casualty, and State Auto Ohio respectively, issued and in force at 12:01 a.m., EST, January 1, 2003 or on which there were, at that time, unsettled claims or losses, and on policies and contracts thereafter issued by State Auto Mutual, State Auto P&C, Milbank, State Auto Wisconsin, Farmers Casualty, and State Auto Ohio to the extent of State Auto Florida's Respective Percentage. Premiums, losses, loss expenses, underwriting expenses and administrative expenses chargeable to the State Auto Mutual Reinsurance Book from and after 12:01 a.m. EST January 1, 2000 are excluded from the scope of the 2000 Pooling Agreement.
Subsection (g) of Section 9 is deleted and replaced by the following:
(g) The parties hereto shall, on and after 12:01 a.m.,
Columbus, Ohio time, January 1, 2003, participate on the basis
of 18.3% for State Auto Mutual, 59% for State Auto P&C, 17%
for Milbank, 1% for State Auto Wisconsin, 3% for Farmers
Casualty, 1% for State Auto Ohio and 0.7% for State Auto
Florida in all of the underwriting operations of each of the
seven parties hereto. Premiums, losses, loss expenses,
underwriting expenses and administrative expenses chargeable
to the State Auto Mutual Reinsurance Book from and after 12:01
a.m. EST January 1, 2000 are excluded from the scope of the
2000 Pooling Agreement.
12. Section 11, LIABILITIES EXCLUDED, is deleted and replaced by the following:
In addition to the liabilities set forth in paragraphs 2(a),
2(b), 2(c), 2(d), 2(e), 2(f) and 10 above, this Agreement
shall not apply to the investment operation or liabilities for
federal income tax or other liabilities excluded by this
Agreement.
13. Section 13, METHODS AND PROCEDURES, is deleted and replaced by the following:
The president of State Auto Mutual, State Auto P&C, Milbank, State Auto Wisconsin, Farmers Casualty, State Auto Ohio and State Auto Florida or
any officer of any of these companies designated by said president, shall determine the methods and procedures, including accounting transactions, by which the terms of this Agreement shall be performed by and on behalf of the parties hereto.
14. Section 14, AMENDMENTS, is deleted and replaced by the following:
This Agreement may be modified from time to time, so as to adapt its provisions to the varying conditions of the business of the Pooled Companies, by a mutual agreement in writing of the parties hereto, subject to ratification by the Board of Directors of each party and with the approval of the insurance regulatory officials from the State of Ohio, the State of South Carolina, the State of South Dakota, the State of Wisconsin, the State of Iowa, and the State of Florida, as required by law.
15. Section 18, ARBITRATION, is deleted and replaced by the following:
In the event of any dispute hereafter arising with respect to this Agreement, State Auto Mutual, State Auto P&C, Milbank, State Auto Wisconsin, Farmers Casualty, State Auto Ohio and State Auto Florida hereby agree that such dispute shall, upon the request of the one of the parties, be submitted to arbitration. One arbitrator shall be chosen by each party and those arbitrators shall then select an umpire who shall hear and decide the issues to be arbitrated. If one party fails to name an arbitrator within thirty (30) days after receipt of a written request to do so, the party initiating the arbitration may choose the arbitrators. The decision of the umpire shall be final and binding on the parties. Each party shall bear the expense of its arbitrator and the cost of the umpire shall be shared equally. The arbitration shall take place at Columbus, Ohio or such other location upon which the parties may mutually agree.
16. The Fourth Amendment is effective as of 12:01 a.m. Columbus, Ohio time January 1, 2003, provided that it is not disapproved by any insurance regulator with jurisdiction over any party to the 2000 Pooling Agreement, as amended heretofore and hereby. If the Fourth Amendment is disapproved as indicated, the Fourth Amendment shall be deemed null and void and shall not be deemed to have amended the 2000 Pooling Agreement in any manner whatsoever. This Fourth Amendment shall terminate when the 2000 Pooling Agreement terminates, absent the earlier termination hereof by the written consent of all parties hereto.
Except as expressly amended hereby, the 2000 Pooling Agreement shall continue in full force and effect for the balance of the term thereof.
IN WITNESS WHEREOF, by their signatures hereon the parties hereto hereby agree to the foregoing Fourth Amendment as of the foregoing effective date and time.
State Automobile Mutual Insurance Company
By: /s/ Robert H. Moone
---------------------------------
Robert H. Moone, President
|
State Auto Property and Casualty Insurance Company
By: /s/ Robert H. Moone
---------------------------------
Robert H. Moone, President
|
Milbank Insurance Company
By: /s/ Robert H. Moone
---------------------------------
Robert H. Moone, President
|
State Auto Insurance Company of Wisconsin
By: /s/ Robert H. Moone
---------------------------------
Robert H. Moone, President
|
Farmers Casualty Insurance Company
By: /s/ Robert H. Moone
---------------------------------
Robert H. Moone, President
|
State Auto Insurance Company of Ohio
By: /s/ Robert H. Moone
---------------------------------
Robert H. Moone, President
|
State Auto Florida Insurance Company
By: /s/ Robert H. Moone
---------------------------------
Robert H. Moone, President
|
Exhibit 10(UU)
Fourth Amendment to 2000 Directors Stock Option Plan
FOURTH AMENDMENT
TO
STATE AUTO FINANCIAL CORPORATION
2000 DIRECTORS STOCK OPTION PLAN
The State Auto Financial Corporation 2000 Directors Stock Option Plan (the "Plan"), as heretofore amended, is hereby further amended in the following particulars:
1. Section 3. Stock Options. Subsection (a) Grant and Eligibility is hereby deleted in its entirety and replaced by the following:
(a) Grant and Eligibility. All directors of the Company who are not full-time employees of the Company or its Parent or Subsidiary corporations and who are in compliance with the Company's stock ownership guidelines as applicable to such directors are eligible to be granted Awards under the Plan. Promptly following each annual meeting of the shareholders of the Company on or after the effective date of the Plan, each person who is then a director of the Company and not a full-time employee of the Company or its Parent or Subsidiary corporations shall be granted an Option to purchase 4,200 shares of Stock.
2. The effective date of this Fourth Amendment is December 1, 2002 and this Fourth Amendment shall be deemed to be a part of the Plan as of such date. In the event of any inconsistencies between the provisions of the Plan and this Fourth Amendment, the provisions of this Fourth Amendment shall control. Except as previously modified by the First, Second and Third Amendments and as modified by this Fourth Amendment, the Plan shall continue in full force and effect.
The Fourth Amendment was approved and adopted by the Board of Directors of State Auto Financial Corporation on March 7, 2003 and recommended for approval by the Shareholders at the 2003 Annual Meeting of the Shareholders.
Exhibit 10(VV)
Term Loan Note from
State Auto Financial Corporation to
KeyBank National Association
Dated as of
December 23, 2002
TERM LOAN NOTE
$15,000,000 Cleveland, Ohio As of December 23, 2002
FOR VALUE RECEIVED, the undersigned, STATE AUTO FINANCIAL CORPORATION, an Ohio corporation (the "Borrower"), promises to pay to the order of KEYBANK NATIONAL ASSOCIATION (hereinafter called the "Bank", which term shall include any subsequent holder hereof) at 127 Public Square, Cleveland, Ohio 44114 or such other place as the Bank may from time to time designate in writing the sum of Fifteen Million Dollars ($15,000,000) (hereinafter called the "Principal Sum"), together with interest as hereinafter provided, and payable at the time(s) and in the manner(s) hereinafter provided. The Borrower agrees that the advance of the Principal Sum and all payments of principal and interest will be evidenced by entries made by the Bank into its electronic data processing system and/or internal memoranda maintained by the Bank. The Borrower further agrees that the sum or sums shown on the most recent printout from the Bank's electronic data processing system and/or such memoranda shall be rebuttably presumptive evidence of the amount of the Principal Sum and of the amount of any accrued interest.
1. INTEREST.
(a) RATES. The Principal Sum shall be comprised of, at the option of the Borrower, Base Rate Portions and LIBOR Portions. Interest will accrue on the unpaid balance of the Principal Sum until paid (i) as to the Base Rate Portions, at a variable rate of interest per annum equal to the Base Rate, and (ii) as to each LIBOR Portion, at a rate per annum equal to the sum of the Adjusted LIBOR for the Interest Period of such LIBOR Portion, PLUS Seventy-five (75) Basis Points.
(b) COMPUTATIONS OF INTEREST AND FEES. All interest shall be calculated on the basis of a 360-day year for the actual number of days that the Principal Sum or any part thereof remains unpaid. (including the day of advance but excluding the day of payment). Each determination by the Bank of an interest rate hereunder shall be conclusive and binding for all purposes, absent manifest error.
(c) PAYMENT NOT ON BANKING DAY. Whenever any payment hereunder shall be stated to be due on a day other than a Banking Day, such payment shall be made on the next succeeding Banking Day, except that, if such extension would cause payment of interest on or principal of a LIBOR Portion to be made in the next following calendar month, such payment shall be made on the immediately preceding Banking Day. Any such extension or reduction of time shall in such case be included in the computation of payment of interest.
2. PROCEDURES FOR RATE DESIGNATION.
(a) RATE CONVERSION AND CONTINUATION. Prior to the advance of the Principal Sum to the Borrower, the Borrower delivered to the Bank an initial borrowing request in which the Borrower designated the Types of Portions of such advance that are, respectively, Base Rate Portion and LIBOR Portions. From and after such advance, but subject to the terms and conditions of this Note, the Borrower shall have the right to cause a Rate Conversion or Rate Continuation in respect of any Portion then outstanding, upon request delivered by the Borrower to the Bank not later than 12:00 noon (Cleveland, Ohio time) (i) on the day that is the Banking Day on which the Borrower desires to convert any LIBOR Portion into a Base Rate Portion, and (ii) on the day that is three (3) Banking Days prior to the Banking
Page 1 of 18 Pages
Day on which the Borrower desires to (A) convert any Base Rate Portion into
a LIBOR Portion for a given Interest Period, (B) continue any LIBOR Portion as
a LIBOR Portion for an additional Interest Period of the same duration, or
(C) convert any LIBOR Portion having a particular Interest Period into a
LIBOR Portion having a different permissible Interest Period.
(b) CERTAIN LIMITATIONS AND REQUIREMENTS. Each such Rate Conversion or Rate Continuation shall be subject to the following:
(i) If less than all the outstanding principal amount of a Portion is converted or continued, the principal amount of such Portion converted or continued shall, in the case of LIBOR Portions, not be less than Five Hundred Thousand Dollars ($500,000) or additional increments of One Hundred Thousand Dollars ($100,000) in excess thereof;
(ii) Each Rate Conversion or Rate Continuation shall be effected by the Bank by applying the proceeds of the Portion resulting from such Rate Conversion or Rate Continuation to the Portion being converted or continued, as the case may be, and the accrued interest on any such Portion (or portion thereof) being converted or continued shall be paid to the Bank at the time of such Rate Conversion or Rate Continuation;
(iii) LIBOR Portions may not be converted or continued at a time other than the end of the Interest Period applicable thereto unless the Borrower shall pay, upon demand, any amounts due to the Bank pursuant to Section 4(b) hereof;
(iv) No Portion may be converted into or continued as a LIBOR Portion less than one month prior to the Stated Maturity Date;
(v) The Borrower shall not request a LIBOR Portion if, after giving effect to such request, there would be outstanding more than four (4) LIBOR Portions;
(vi) Without limiting any other right or remedy of the Bank then available to the Bank, upon and during the continuance of an Event of Default, the Borrower may not convert or continue any Portion into a LIBOR Portion; and
(vii) Any LIBOR Portion that cannot be converted into or continued as a LIBOR Portion by reason of any of the foregoing limitations shall be automatically converted at the end of the Interest Period in effect for such LIBOR Portion into a Base Rate Portion.
Each such request for a conversion or continuation (a "Rate Conversion/ Continuation Request") shall be transmitted by the Borrower to the Bank in writing by a medium acceptable to the Bank prior to the effective date of the Rate Conversion or Rate Continuation requested, in the form specified by the Bank from time to time, setting forth (A) the identity and amount of the Portion that the Borrower requests to be converted or continued, (B) the Type of Portion into which such outstanding Portion is to be converted or continued, (C) if such notice requests a Rate Conversion, the date of the Rate Conversion (which shall be a Banking Day) and (D) in the case of a Portion being converted into or continued as a LIBOR Portion, the Interest Period for such LIBOR Portion. The Borrower may make Rate Conversion/Continuation Requests telephonically so long as written confirmation of such Rate Conversion or Rate Continuation is received by the Bank by 1:00 p.m. (Cleveland, Ohio time) on the same day of such telephonic Rate Conversion/Continuation Request. The Bank may rely on such telephonic Rate Conversion/Continuation Request to the same extent that the Bank may rely on a written Rate Conversion/Continuation Request. Each Rate Conversion/Continuation Request, whether telephonic or written, shall be irrevocable and binding on the Borrower and subject to the breakage compensation provisions of Section 4(b) hereof.
Page 2 of 18 Pages
The Borrower shall bear all risks related to its giving any Rate Conversion/Continuation Request telephonically or by such other method of transmission as the Borrower shall elect.
3. PAYMENTS.
(a) Subject to the provisions of the Section 10 hereof, the Principal Sum shall be due and payable in full on the Stated Maturity Date.
(b) Interest accrued on Base Rate Portions and LIBOR Portions shall be due and payable:
(i) as to Base Rate Portions, quarterly, in arrears, on the last day of each calendar quarter (in respect of the quarter then ending), commencing with December 31, 2002, and at maturity (whether by reason of acceleration or otherwise), and
(ii) as to each LIBOR Portion, (A) on the last day of the Interest Period of such LIBOR Portion, (B) if such Interest Period has a duration of more than three months, three months after the first day of such Interest Period and (C) on the earlier date on which such LIBOR Portion shall be converted to a Base Rate Portion or to a LIBOR Portion of a different Interest Period or paid in full and at maturity (whether by reason of acceleration or otherwise).
4. PREPAYMENT.
(a) PERMITTED PREPAYMENTS. Except for breakage compensation under
Section 4(b) hereof, the Borrower may prepay, without penalty or premium, not
later than 12:00 noon (Cleveland, Ohio time): (i) in the case of any LIBOR
Portion, upon at least three (3) Banking Days' notice to the Bank prior to the
date fixed for such prepayment; and (ii) in the case of any Base Rate Portion,
upon notice to the Bank not later than 12:00 noon (Cleveland, Ohio time) on the
date fixed for such prepayment, in each case stating the proposed date and
aggregate principal amount of the prepayment, and, upon such notice, shall
prepay the outstanding aggregate principal amount of such Portion in whole or in
part, together with accrued interest to the date of such prepayment on the
principal amount prepaid; provided, however, that (1) each partial prepayment of
a LIBOR Portion shall be in a principal amount of Five Hundred Thousand Dollars
($500,000) or additional increments of One Hundred Thousand Dollars ($100,000)
in excess thereof, and (2) each prepayment of a Base Rate Portion shall be in an
aggregate principal amount of One Hundred Thousand Dollars ($100,000) or
additional increments of Fifty Thousand Dollars ($50,000) in excess thereof. Any
prepayment of any LIBOR Portion made pursuant to this paragraph on other than
the last day of the Interest Period applicable thereto shall obligate the
Borrower to pay breakage compensation pursuant to Section 4(b) hereof.
(b) BREAKAGE COMPENSATION FOR LIBOR PORTIONS. The Borrower shall compensate the Bank, upon its written request (which request shall set forth the detailed basis for requesting and the method of calculating such compensation), for all reasonable losses (including loss of profits), expenses and liabilities (including, without limitation, any loss, expense or liability incurred by reason of the liquidation or reemployment of deposits or other funds required by the Bank to fund its LIBOR Portions) which the Bank may sustain: (i) if for any reason (other than a default by the Bank), a conversion or continuation in respect of a LIBOR Portion does not occur on a date specified therefor in a Rate Conversion/Continuation Request (whether or not rescinded or withdrawn by or on behalf of the Borrower), or (ii) if any repayment, prepayment, Rate Continuation, Rate Conversion of any LIBOR Portion, or any portion thereof, occurs on a date which is not the last day of the Interest Period of such LIBOR Portion; or (iii) if any prepayment of any LIBOR Portion is not made on any date specified in a notice of prepayment given
Page 3 of 18 Pages
by the Borrower; or (iv) as a consequence of any other default by the Borrower to repay any LIBOR Portion when required by the terms of this Note.
5. RESERVES; TAXES; INDEMNITIES.
(a) RESERVES OR DEPOSIT REQUIREMENTS. If at any time any Law, treaty or regulation (including, without limitation, Regulation D of the Board of Governors of the Federal Reserve System) or the interpretation thereof by any governmental authority charged with the administration thereof or any central bank or other fiscal, monetary or other authority shall impose (whether or not having the force of Law), modify or deem applicable any reserve and/or special deposit requirement (other than reserves included in the Reserve Percentage, the effect of which is reflected in the interest rate(s) of the LIBOR Portion(s) in question) against assets held by, or deposits in or for the amount of any loans by, the Bank, and the result of the foregoing is to increase the cost (whether by incurring a cost or adding to a cost) to the Bank of making or maintaining hereunder LIBOR Portions or to reduce the amount of principal or interest received by the Bank with respect to such LIBOR Portions, then upon demand by the Bank the Borrower shall pay to the Bank from time to time on each date on which interest otherwise is due with respect to such Portions, as additional consideration hereunder, additional amounts sufficient to fully compensate and indemnify the Bank for such increased cost or reduced amount, assuming (which assumption the Bank need not corroborate) such additional cost or reduced amount was allocable to such LIBOR Portions. A certificate as to the increased cost or reduced amount as a result of any event mentioned in this Section 5(a), setting forth the calculations therefor, shall be promptly submitted by the Bank to the Borrower and shall, in the absence of manifest error, be conclusive and binding as to the amount thereof. Notwithstanding any other provision of this Note, after any such demand for compensation by the Bank, the Borrower, upon at least three (3) Banking Days' prior written notice to the Bank, may prepay the affected LIBOR Portions in full or convert all LIBOR Portions to Base Rate Portions regardless of the Interest Period of any thereof. Any such prepayment or conversion shall entitle the Bank to the breakage compensation provided for in Section 4(b) hereof.
(b) IMPOSITION OF TAXES. In the event that by reason of any Law,
regulation or requirement or in the interpretation thereof by an official
authority, or the imposition of any requirement of any central bank whether or
not having the force of Law, the Bank shall, with respect to this Note, be
subjected to any tax, levy, impost, charge, fee, duty, deduction or withholding
of any kind whatsoever (other than any tax imposed upon the total net income of
the Bank) and if any such measures or any other similar measure shall result in
an increase in the cost to the Bank of making or maintaining any LIBOR Portion
or in a reduction in the amount of principal, interest or commitment fee
receivable by the Bank in respect thereof, then the Bank shall promptly notify
the Borrower in writing stating the reasons therefor. The Borrower shall
thereafter pay to the Bank upon demand from time to time on each date on which
interest otherwise is due with respect to such LIBOR Portions, as additional
consideration hereunder, such additional amounts as will fully compensate the
Bank for such increased cost or reduced amount. A certificate as to any such
increased cost or reduced amount, setting forth the calculations therefor, shall
be submitted by the Bank to the Borrower and shall be rebuttably presumptive
evidence of the amount thereof. Notwithstanding any other provision of this
Note, after any such demand for compensation by the Bank, the Borrower, upon at
least three (3) Banking Days prior written notice to the Bank, may prepay the
affected LIBOR Portions in full or convert all LIBOR Portions to Base Rate
Portions regardless of the Interest Period of any thereof. Any such prepayment
or conversion shall entitle the Bank to breakage compensation provided for in
Section 4(b) hereof.
(c) EURODOLLAR DEPOSIT UNAVAILABLE OR INTEREST RATE UNASCERTAINABLE. In respect of any LIBOR Portion, in the event that the Bank shall have determined that, by reason of circumstances affecting the London interbank market for dollar deposits, adequate and reasonable means do not exist for
Page 4 of 18 Pages
ascertaining the LIBOR applicable to the Interest Period thereof, the Bank shall promptly give notice of such determination to the Borrower and (i) any notice of conversion or continuation of existing Portions to LIBOR Portions previously given by the Borrower and not yet converted or continued, as the case may be, shall be deemed a notice to make a Base Rate Portion, and (ii) the Borrower shall be obligated either to prepay or to convert any outstanding LIBOR Portions on the last day of the then current Interest Period or Periods with respect thereto. Any such prepayment or conversion shall entitle the Bank to breakage compensation provided for in Section 4(b) hereof.
(d) CHANGES IN LAW RENDERING LIBOR PORTIONS UNLAWFUL. If at any time
any new Law, treaty or regulation, or any change in any existing Law, treaty or
regulation, or any interpretation thereof by any governmental or other
regulatory authority charged with the administration thereof, shall make it
unlawful for the Bank to fund any LIBOR Portions which it is committed to make
hereunder with moneys obtained in the Eurodollar market, the commitment of the
Bank to fund LIBOR Portions shall, upon the happening of such event, forthwith
be suspended for the duration of such illegality, and the Bank shall by written
notice to the Borrower declare that its commitment with respect to such Portions
has been so suspended. If and when such illegality ceases to exist, such
suspension shall cease and the Bank shall similarly notify the Borrower. If any
such change shall make it unlawful for the Bank to continue in effect the
funding in the applicable Eurodollar market of any LIBOR Portion previously made
by it hereunder, the Bank shall, upon the happening of such event, notify the
Borrower thereof in writing stating the reasons therefor, and the Borrower
shall, on the earlier of (i) the last day of the then current Interest Period or
(ii) if required by such Law, regulation or interpretation, on such date as
shall be specified in such notice, either convert all LIBOR Portions to Base
Rate Portions to the extent permissible under this Note or prepay all LIBOR
Portions to the Bank in full. Any such prepayment or conversion shall entitle
the Bank to breakage compensation as provided in Section 4(b) hereof.
(e) CAPITAL ADEQUACY. If the Bank shall have determined, that, whether in effect at the date of this Note or hereafter in effect, any applicable Law, rule, regulation or guideline regarding capital adequacy, or any change therein, or any change in the interpretation or administration thereof by any governmental authority, central bank or comparable agency charged with the interpretation or administration thereof, or compliance by the Bank (or its Lending Office) with any request or directive regarding capital adequacy (whether or not having the force of Law) of any such authority, central bank or comparable agency, has or would have the effect of reducing the rate of return on the Bank's capital allocated to the transactions contemplated by this Note (or the capital of its holding company) as a consequence of its obligations hereunder to a level below that which the Bank (or its holding company) could have achieved but for such adoption, change or compliance (taking into consideration the Bank's policies or the policies of its holding company with respect to capital adequacy) by an amount deemed by the Bank to be material, then from time to time, within 15 days after demand by the Bank, the Borrower shall pay to the Bank such additional amount or amounts as will compensate the Bank (or its holding company) for such reduction. The Bank will designate a different lending office if such designation will avoid the need for, or reduce the amount of, such compensation and will not, in the judgment of the Bank, be otherwise disadvantageous to the Bank. A certificate of the Bank claiming compensation under this section and setting forth the additional amount or amounts to be paid to it hereunder shall be conclusive in the absence of manifest error. In determining such amount, the Bank may use any reasonable averaging and attribution methods. Failure on the part of the Bank to demand compensation for any reduction in return on capital with respect to any period shall not constitute a waiver of the Bank's rights to demand compensation for any reduction in return on capital in such period or in any other period. The protection of this Section 5(e) shall be available to the Bank regardless of any possible contention of the invalidity or inapplicability of the Law, regulation or other condition which shall have been imposed.
Page 5 of 18 Pages
6. REPRESENTATIONS AND WARRANTIES. The Borrower hereby represents and warrants to the Bank as follows:
(a) EXISTENCE; SUBSIDIARIES. The Borrower is a corporation, duly organized and validly existing and in good standing under the Laws of the State of Ohio and is duly qualified and authorized to do business wherever it owns any real estate or personal property or transacts any substantial business. The Borrower has no Subsidiaries, other than those listed on Schedule 6(a) hereto. Each such Subsidiary is duly organized and validly existing and in good standing under the laws of the state of its formation and is duly qualified and authorized to do business wherever it owns any real estate or personal property or transacts any substantial business.
(b) POWER, AUTHORIZATION AND CONSENT. The execution, delivery and performance by the Borrower of this Note (i) are within the Borrower's legal power and authority, (ii) have been duly authorized by all necessary or proper action of the Borrower, (iii) do not require the consent or approval of any governmental body, agency, authority or any other Person which has not been obtained, (iv) will not violate (A) any provision of Law applicable to the Borrower, (B) any provision of the Borrower's articles of incorporation or code of regulations (or equivalent documents otherwise named), or (C) any material agreement or material indenture by which the Borrower or its property is bound, or (v) will not result in the creation or imposition of any lien or encumbrance on any property or assets of the Borrower.
(c) LITIGATION; PROCEEDINGS. No action, suit, investigation or proceeding is now pending or, to the knowledge of the Borrower, threatened, against the Borrower, at Law, in equity or otherwise, before any court, board, commission, agency or instrumentality of any federal, state, local or foreign government or of any agency or subdivision thereof, or before any arbitrator or panel of arbitrators, which, if determined adversely to the Borrower, has a reasonable probability of causing or resulting in a material adverse effect on the condition of the Borrower, financial or otherwise.
(d) FINANCIAL CONDITION. The financial statements of the Borrower for the Fiscal Year ending December 31, 2001 and for the Fiscal Quarter ending September 30, 2002, previously delivered to the Bank, are true and complete (including, without limiting the generality of the foregoing, a disclosure of all material contingent liabilities), have been prepared in accordance with GAAP applied on a basis consistent and fairly present its then financial condition and operations for the periods then ending. There has been no material change in the Borrower's financial condition, properties or business since either such date.
(e) LAWFUL OPERATIONS. The operations of the businesses of the Borrower and its Subsidiaries are in compliance with all requirements imposed by Law or regulation, whether federal, state or local, except where the noncompliance with any such Laws could not be reasonably expected to result in a material adverse effect the Borrower's financial condition, properties or business or its ability to perform its obligations hereunder.
(f) REGULATION G/REGULATION U/REGULATION X COMPLIANCE. The Borrower is not engaged principally, or as one of its important activities, in the business of extending credit for the purpose of purchasing or carrying "margin stock", (as defined by Regulation U of the Board of Governors of the Federal Reserve System of the United States (as amended from time to time)) and all official rulings and interpretations thereunder or thereof, and at no time shall more than 25% of the value of the assets of the Borrower that are subject to any "arrangement" (as such term is used in section 221.2(g) of Regulation U) be represented by "margin stock". No part of the proceeds of the Principal Sum will be used, whether directly or indirectly, and whether immediately, incidentally or ultimately, (i) to purchase or to extend credit to others for the purpose of purchasing "margin stock" or to carry or to extend credit to others for the purpose of carrying stock which will be "margin stock" or (ii) for any purpose that entails a violation
Page 6 of 18 Pages
of, or is inconsistent with, the provisions of the Regulations of the Board of Governors of the Federal Reserve System of the United States, including Regulation G, U or X.
7. FINANCIAL REPORTING.
(a) QUARTERLY FINANCIAL STATEMENTS. The Borrower shall furnish to the Bank promptly, and in any case within sixty (60) days after the end of each of the first three (3) Fiscal Quarters of each Fiscal Year, an unaudited Consolidated balance sheet of the Borrower as at the end of that period and the related unaudited Consolidated statements of income and cash flows, all prepared in accordance with GAAP and otherwise in form and detail satisfactory to the Bank.
(b) ANNUAL FINANCIAL STATEMENTS. The Borrower shall furnish to the Bank promptly, and in any case within ninety (90) days after the end of each Fiscal Year, the Consolidated balance sheets of the Borrower and its Subsidiaries as at the end of such Fiscal Year and the related Consolidated statement of income, of shareholders' equity and of cash flows for such Fiscal Year, in each case setting forth comparative figures for the preceding Fiscal Year, all in reasonable detail and accompanied by the opinion with respect to such Consolidated financial statements of independent public accountants of recognized national standing selected by the Borrower and satisfactory to the Bank, which opinion shall be unqualified and shall state that such accountants audited such Consolidated financial statements in accordance with generally accepted auditing standards, that such accountants believe that such audit provides a reasonable basis for their opinion, and that in their opinion such Consolidated financial statements present fairly, in all material respects, the Consolidated financial position of the Borrower and its Subsidiaries as at the end of such Fiscal Year and the Consolidated results of their operations and cash flows for such Fiscal Year in conformity with generally accepted auditing standards.
(c) OFFICER'S CERTIFICATES. The Borrower shall furnish to the Bank
concurrently with the financial statements delivered in connection with clause
(a) and (b) above, a certificate of the chief financial officer of the Borrower,
in form and content specified by the Bank, (A) certifying that (1) to his or her
knowledge and belief, those financial statements fairly present in all material
respects the financial condition and results of operations of the Borrower
(subject, in the case of interim financial statements, to routine year-end audit
adjustments) and (2) no Event of Default or Incipient Default then exists or if
any does, a brief description thereof and of the Borrower's intentions in
respect thereof, and (B) setting forth the calculations necessary to determine
whether or not the Borrower and its Subsidiaries are in compliance with
financial covenants in Section 8 hereof.
(d) QUARTERLY STATUTORY STATEMENTS. The Borrower shall cause each Insurance Subsidiary to furnish to the Bank promptly, and in any case within forty-five (45) days after the end of each of the first three (3) fiscal quarters of such Insurance Subsidiary's fiscal year, its quarterly Statutory Statement for such quarterly fiscal period, together with the opinion thereon of a senior financial officer of such Insurance Subsidiary stating that such Statutory Statement presents the financial condition of such Insurance Subsidiary for the fiscal period in accordance with SAP.
(e) ANNUAL STATUTORY STATEMENTS AND CERTIFICATE OF VALUATION ACTUARY. The Borrower shall cause each Insurance Subsidiary to furnish to the Bank promptly, and in any case within ninety (90) days after the end of each fiscal year of such Insurance Subsidiary, (i) its annual Statutory Statement for such annual fiscal period, together with the opinion thereon of a senior financial officer of such Insurance Subsidiary stating that such Statutory Statement presents the financial condition of such Insurance Subsidiary for the fiscal period in accordance with SAP and (ii) a certificate of a valuation actuary affirming the adequacy of reserves taken by such Insurance Subsidiary in respect of future policyholder benefits at the end of such fiscal year.
Page 7 of 18 Pages
(f) CERTIFICATE OF AUDITORS. The Borrower shall cause each Insurance Subsidiary to furnish to the Bank promptly, and in any case within one hundred eighty (180) days after the end of each fiscal year of such Insurance Subsidiary, the opinion with respect to the most recent Statutory Statement of each Insurance Subsidiary of independent public accountants of recognized national standing selected by such Insurance Subsidiary and satisfactory to the Bank, which opinion shall be shall state that such accountants audited such Statutory Statement, that such accountants believe that such Statutory Statement presents fairly, in all material respects, the financial position of such Insurance Subsidiary for the period covered by such Statutory Statement in conformity with SAP.
(g) NOTICE OF DEFAULT. Immediately upon becoming aware of the existence of an Event of Default or Incipient Default, the Borrower shall deliver to the Bank a written notice specifying the nature and period of existence thereof and what action the Borrower is taking or propose to take in respect thereof.
(h) OTHER INFORMATION. Promptly upon receipt of a request therefor from the Bank, the Borrower shall prepare and deliver to the Bank such other information with respect to the business, property and financial condition of the Borrower and its Subsidiaries, in form and content reasonably satisfactory to the Bank, as the Bank may from time to time designate, including, but not limited to, those reports and information required under the Put Agreement among State Automobile Mutual Insurance Company, the Borrower and Bank One, NA, As Agent, dated as of November 16, 2001, as amended (the "Put Agreement").
(i) FISCAL YEAR. The Borrower shall not change its Fiscal Year.
8. FINANCIAL COVENANTS.
(a) FIXED CHARGE COVERAGE. The Borrower shall not suffer or permit, as of the end of any Fiscal Quarter, the Fixed Charge Coverage Ratio to be less than 1.00 to 1.
(b) STATE AUTO PROPERTY AND CASUALTY INSURANCE COMPANY. The Borrower shall not suffer or permit its Subsidiary, State Auto Property and Casualty Insurance Company:
(i) At any time, to have a Statutory Surplus of less than Two Hundred Two Million Dollars ($202,000,000);
(ii) As at the end of any of its fiscal years, to have a Risk-Based Capital Ratio of less than 3.00 to 1; or
(iii) At any time, to have a Premium to Surplus Ratio of more than 2.75 to 1.
9. OTHER COVENANTS. The Borrower shall perform each and all of the following agreements until all indebtedness evidenced hereby is paid in full:
(a) CORPORATE EXISTENCE. The Borrower shall maintain, and cause each of its Subsidiaries to maintain, (i) its corporate existence and (ii) its good standing in the jurisdiction of its incorporation or organization and its qualification in each other jurisdiction in which the failure so to do would have a material adverse effect on its financial condition, business, operations or property.
Page 8 of 18 Pages
(b) INSURANCE AUTHORIZATIONS. The Borrower shall cause each of its Insurance Subsidiaries to remain authorized to issue policies of insurance and in good standing under the regulations and other requirements of its Applicable Insurance Regulatory Authority, provided that it is understood and agreed that the Borrower shall be permitted to cause Mid-Plains Insurance Company to merge with and into Farmers Casualty Insurance Company, with Farmers Casualty Insurance Company being the survivor, should it determine that such a transaction serves the Borrower's business interests.
(c) RECORDS. The Borrower shall (a) at all times maintain true and complete records and books of account and, without limiting the generality of the foregoing, maintain appropriate reserves for possible losses and liabilities, all in accordance with GAAP and (b) at all reasonable times and upon reasonable prior notice permit the Bank to examine its books and records and to make excerpts therefrom and transcripts thereof; provided, however, that if an Event of Default shall have occurred and be continuing, no such prior notice shall be required.
(d) INDEBTEDNESS. The Borrower shall not create, incur or suffer to exist any Indebtedness of any kind, other than:
(i) the Indebtedness of the Borrower under this Note,
(ii) any other Indebtedness existing on the date hereof and listed on Schedule 9(d) hereof, and
(iii) Indebtedness subordinated to the Borrower's obligations hereunder in a writing satisfactory to the Bank.
(e) LIENS. The Borrower shall not (a) acquire any property subject to any consignment, lease, land contract or other title retention contract (this section shall not apply to true leases, consignments, tolling or other possessory agreements in respect of the property of others whereby the Borrower does not have legal or beneficial title to such property and which, pursuant to GAAP, are not required to be capitalized), (b) sell or otherwise transfer any receivables or other accounts, whether with or without recourse, or (c) suffer or permit any property now owned or hereafter acquired by it to be or become encumbered by any mortgage, security interest, financing statement or lien of any kind or nature, other than:
(i) any lien for a tax, assessment or governmental charge or levy which is not yet due and payable or which is being contested in good faith and as to which the Borrower shall have made appropriate reserves,
(ii) any lien securing only its workers' compensation, unemployment insurance and similar obligations,
(iii) any mechanics, carrier's or similar common law or statutory lien incurred in the normal course of business,
(iv) any transfer of a check or other medium of payment for deposit or collection through normal banking channels or any similar transaction in the normal course of business,
(v) easements, restrictions, minor title irregularities and similar matters having no adverse effect as a practical matter on the ownership or use of any Borrower's real property, and
Page 9 of 18 Pages
(vi) any other liens existing on the date hereof which are identified on Schedule 9(e) hereto.
(f) MERGER. The Borrower shall not merge or consolidate with or into, or enter into any merger agreement with any other entity, or lease, sell or transfer all or substantially all its property, assets and business to any other entity.
(g) USE OF PROCEEDS. The Borrower shall use the proceeds of the Principal Sum for the purpose of providing additional capital to its Subsidiary, State Auto Property and Casualty Insurance Company.
(h) MOST FAVORED COVENANT STATUS. If the Borrower at any time after the date hereof, issues or guarantees any unsecured Indebtedness for money borrowed or represented by bonds, notes, debentures or similar securities in an aggregate amount exceeding $25,000,000, to any lender or group of lenders acting in concert with one another, or one or more institutional investors, pursuant to a loan agreement, credit agreement, note purchase agreement, indenture, guaranty or other similar instrument, which agreement, indenture, guaranty or instrument, includes affirmative or negative business or financial covenants (or any events of default or other type of restriction which would have the practical effect of any affirmative or negative business or financial covenant, including, without limitation, any "put" or mandatory prepayment of such Indebtedness upon the occurrence of a "change of control") which are applicable to the Borrower, other than those set forth herein, the Borrower shall promptly so notify the Bank and, if the Bank shall so request by written notice to the Borrower, the Borrowers and the Bank shall promptly amend this Note to incorporate some or all of such provisions, in the discretion of the Bank, into this Note.
10. DEFAULT. The occurrence of any one or more of the following events shall constitute an "Event of Default":
(a) PAYMENT. (i) If the Borrower shall fail to pay any portion of the Principal Sum when due and payable or declared due and payable; or (ii) if the Borrower shall fail to pay any portion of the interest or other sum evidenced hereby when due and payable or declared due and payable or within five (5) days thereafter.
(b) COVENANT. If the Borrower shall fail or omit to perform, observe or satisfy any of the warranties, covenants, agreements or conditions contained in this Note;
(c) CROSS DEFAULT. If (i) there shall occur a "Put Event" under the Put Agreement, or there shall occur a "Default" under the Credit Agreement, or (ii) the Borrower, after any applicable notice or grace period or both, (A) defaults in the payment of any principal or interest due and owing upon any other Indebtedness or in excess of Five Million Dollars ($5,000,000) in aggregate principal amount or (B) defaults in the performance of any other agreement, term or condition contained in any promissory note, agreement or other instrument under which such Indebtedness or Indebtednesses in excess of Five Million Dollars ($5,000,000) in the aggregate are evidenced, created, constituted, secured or governed which default causes, or permits the holder(s) of such Indebtedness or Indebtednesses the right to cause, the acceleration of the maturity thereof;
(d) INSOLVENCY. If the Borrower shall become insolvent or suspend business (other than a temporary work stoppage as a result of a strike, lockout or other similar labor problem) or shall file a voluntary petition in bankruptcy, or shall file a voluntary petition or an answer admitting the jurisdiction
Page 10 of 18 Pages
of the court and the material allegations of, or shall consent to, any involuntary petition pursuant to or purporting to be pursuant to any bankruptcy, reorganization or insolvency law of any jurisdiction, or shall make an assignment for the benefit of creditors, or shall apply for or consent to the appointment of any receiver or trustee of, or of a substantial part of, the property of the Borrower;
(e) INVOLUNTARY PROCEEDINGS. If an order shall be entered (without the
application, approval or consent of the Borrower) and shall not be dismissed or
stayed within thirty (30) days from its entry pursuant to or purporting to be
pursuant to any bankruptcy, reorganization or insolvency law of any jurisdiction
(i) approving an involuntary petition seeking reorganization; or (ii) approving
an involuntary petition seeking an arrangement with creditors of the Borrower;
(f) CHANGE OF CONTROL. A majority interest of the equity ownership of the Borrower shall be sold, transferred, conveyed or otherwise disposed of or the control or management of the Borrower shall materially change;
(g) JUDGMENTS. Final judgment for the payment of money in excess of $1,000,000 shall be rendered against the Borrower, and the same shall remain undischarged for a period of thirty (30) days during which execution shall not be effectively stayed;
(h) WARRANTIES. If any representation, warranty or statement made in or pursuant to this Note or any other related document or any other material information furnished by the Borrower to the Bank shall be false or erroneous in any material respect when furnished or made or deemed furnished or made hereunder;
(i) TERMINATION OF PLAN OR CREATION OF WITHDRAWAL LIABILITY. If (a) any
Reportable Event (as defined in Title IV of the Employee Retirement Income
Security Act of 1974, as amended, except actions of general applicability by the
Secretary of Labor under Section 110 of such Act) occurs and the Bank, in its
sole determination, deem such Reportable Event to constitute grounds (i) for the
termination of any Plan by the Pension Benefit Guaranty Corporation or (ii) for
the appointment by the appropriate United States district court of a trustee to
administer any Plan and such Reportable Event shall not have been fully
corrected or remedied to the full satisfaction of the Bank within thirty (30)
days after giving of written notice of such determination to the Borrower by the
Bank or (b) any Plan shall be terminated within the meaning of Title IV of ERISA
(other than a Standard Termination, as that term is defined in Section 4041(b)
of ERISA), or (c) a trustee shall be appointed by the appropriate United States
district court to administer any Plan, or (d) the Pension Benefit Guaranty
Corporation shall institute proceedings to terminate any Plan or to appoint a
trustee to administer any Plan or (e) there occurs a withdrawal by the Borrower
or any Subsidiary from a multi-employer plan which results or may result in a
withdrawal liability in an amount that is material in relation to the business,
operations, affairs, financial condition, assets, or properties of the Borrower
and its Subsidiaries taken as a whole; or
(j) CREDIT AGREEMENT DRAW. SAF Funding Corporation shall issue a "Borrowing Notice" under the Credit Agreement or otherwise shall receive an "Advance" thereunder.
11. REMEDIES.
(a) OPTIONAL ACCELERATION. Upon the occurrence of an Event of Default described in any one or more of subparagraphs (a), (b), (c), (f), (g), (h), (i) or (j) of Section 10 hereof, and at any time thereafter, if any such Event of Default shall then be continuing, the entire Principal Sum and all interest and other sums evidenced hereby shall, at the option of the Bank and without demand, notice, or legal
Page 11 of 18 Pages
process of any kind be declared, and immediately shall become, due and payable; and the Bank may exercise such rights and remedies as are available to it hereunder, at law or in equity.
(b) AUTOMATIC ACCELERATION. Upon the occurrence of an Event of Default described in either of subparagraphs (d) or (e) of Section 10 hereof, the entire Principal Sum and all interest and other sums evidenced hereby shall automatically without any action by the Bank, and without demand, notice or legal process of any kind, be declared, and immediately shall become, due and payable; and the Bank may exercise such rights and remedies as are available to it hereunder, at law or in equity.
(c) OFFSETS. If there shall occur or exist any Event of Default, the Bank shall have the right at any time to set off against, and to appropriate and apply toward the payment of, any and all indebtedness then owing by the Borrower to the Bank, whether or not the same shall then have matured, any and all deposit balances and all other indebtedness then held or owing by that Bank to or for the credit or account of the Borrower, all without notice to or demand upon the Borrower or any other person, all such notices and demands being hereby expressly waived by the Borrower.
(d) DEFAULT INTEREST. If any principal, interest or other sum due under this Note shall not be paid when due, or if the Principal Sum shall not be paid at maturity, whether such maturity occurs by reason of lapse of time or by operation of any provision of acceleration of maturity herein contained (and without waiving any Event of Default resulting therefrom or limiting any right or remedy of the Bank), the Principal Sum and the unpaid interest thereon and any other sum due hereunder shall bear interest, payable on demand, at the Increased Rate. The Borrower acknowledges that this calculation will result in the accrual of interest on interest, and the Borrower expressly consents and agrees to this provision. In addition, notwithstanding anything to the contrary contained in this Note, upon and during the continuance of an Event of Default, but without waiving such Event of Default or limiting any right or remedy of the Bank in respect thereof, all of the Principal Sum and the unpaid interest thereon and any other sum due hereunder shall bear interest at the Increased Rate.
(e) LATE CHARGE. Any installment or other payment of interest not paid within three (3) days after the date on which such payment or installment is due shall be subject to a late charge equal to five percent (5%) of the amount of the installment or payment; provided that the charging and payment thereof shall not be deemed to waive any Event of Default occurring by reason of such failure to pay.
12. GENERAL PROVISIONS.
(a) CERTAIN WAIVERS. The Borrower hereby waives presentment, notice of dishonor, protest, notice of protest, and diligence in bringing suit against the Borrower, and consents that without discharging the Borrower the time of payment may be extended an unlimited number of times before or after maturity without notice.
(b) AMENDMENTS. No amendment, modification, termination, or waiver of any provision of this Note, nor consent to any variance therefrom, shall be effective unless the same shall be in writing and signed by the Bank (and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given).
(c) CAPTIONS. The captions used herein are for reference only and shall not be deemed a part of this Note. If any of the terms or provisions of this Note shall be deemed unenforceable, the enforceability of the remaining terms and provisions shall not be affected. This Note shall be governed by and construed in accordance with the law of the State of Ohio.
Page 12 of 18 Pages
(d) BANK EXPENSE; INDEMNIFICATION. The Borrower agrees to pay to the Bank on demand all costs and expenses (including, without limitation, attorneys' fees) paid or incurred to prepare and negotiate this Note and related documents, to modify this Note or any related document, to obtain payment of the indebtedness evidenced hereby, enforce the provisions of this Note, or to defend any claims made or threatened against the Bank arising out of the transactions contemplated hereby (including without limitation, preparations for and consultations concerning any such matters). The Borrower agrees to indemnify the Bank and its directors, officers, employees and agents from, and hold each harmless against, any and all losses, liabilities, claims, damages or expenses incurred in connection with the loan evidenced hereby, the administration and enforcement thereof and all transactions incident thereto, except by reason of the gross negligence or willful misconduct of the Lender.
(e) NOTICES. All notices, requests, demands and other communications provided for hereunder shall be in writing and addressed to the following address (or at such other address as may be specified by such party to the other party in writing):
To the Bank: KeyBank National Association
127 Public Square
Cleveland, Ohio 44114
Attention: Large Corporate
Telecopy: 216.689.4981
To the Borrower: State Auto Financial Corporation
518 East Broad Street
Columbus, Ohio 43215
Attention: Scott Jones
Telecopy: 614.719.0740.
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All notices, statements, requests, demands and other communications provided for hereunder shall be deemed to be given or made when delivered party (including, without limitation, delivery by facsimile transmission) or forty-eight (48) hours after being deposited in the mails with postage prepaid by registered or certified mail, addressed as aforesaid, except that notices from the Borrower to the Bank pursuant to any of the provisions hereof shall not be effective until received by the Bank.
(f) GOVERNING LAW; BINDING EFFECT. This Note and any other related documents shall be governed by and construed in accordance with the Laws of the State of Ohio and the respective rights and obligations of the Borrower and the Bank shall be governed by Ohio Law. This Note shall bind the Borrower and its successors and assigns and shall inure to the benefit of the Bank and its successors and assigns, including, without limitation, any subsequent holder of this Note.
13. CERTAIN DEFINITIONS. As used in this Note, the following terms shall have the following meanings:
"ADJUSTED LIBOR" shall mean a rate per annum equal to the quotient obtained (rounded upwards, if necessary, to the nearest 1/100th of 1%) by DIVIDING (i) the applicable LIBOR rate by (ii) 1.00 MINUS the Reserve Percentage, and which Adjusted LIBOR shall be automatically adjusted on and as of the effective date of any change in the Reserve Percentage.
"BANKING DAY" shall mean a day of the year on which banks are not required or authorized to close in Cleveland, Ohio and New York, New York; provided, however, that, when used in connection with a LIBOR Loan, "Banking Day" shall mean any such day on which banks are open for dealings in or quoting deposit rates for dollar deposits in the London interbank market.
Page 13 of 18 Pages
"BASE RATE" shall mean, at any time, the higher of (i) the per annum rate equal to the Fed Funds Rate, PLUS one hundred fifty Basis Points at such time and (ii) the Prime Rate at such time.
"BASE RATE PORTION" shall mean those Portions of the Principal Sum on which the Borrower shall pay interest at a rate based on the Base Rate.
"BASIS POINT" shall mean one one-hundredth of one percent (0.01%).
"BORROWER" shall have the meaning assigned to such term in the first paragraph of this Note.
"CONSOLIDATED" shall mean the Borrower and its Subsidiaries, taken as a whole in accordance with GAAP.
"CREDIT AGREEMENT" shall mean the Amended and Restated Credit Agreement among SAF Funding Corporation, as borrower, certain "Lender" parties thereto, Bank One, NA, as agent, the Bank, as syndication agent, and National City Bank, as documentation agent, dated November 16, 2001, as amended.
"EUROCURRENCY LIABILITIES" has the meaning assigned to that term in Regulation D of the Board of Governors of the Federal Reserve System, as in effect from time to time.
"FED FUNDS RATE" shall mean, for any period, a fluctuating interest rate per annum equal for each day during such period to the weighted average of the rates on overnight Federal funds transactions with members of the Federal Reserve System arranged by federal funds brokers, as published for such day (or, if such day is not a Banking Day, for the next preceding Banking Day) by the Federal Reserve Bank of New York, or, if such rate is not so published for any day which is a Banking Day, the average of the quotations for such day on such transactions received by the Bank from three (3) federal funds brokers of recognized standing selected by it.
"FISCAL QUARTER" shall mean any of the four consecutive three-month fiscal accounting periods collectively forming a Fiscal Year of the Borrower, consistent with the Borrower's past practice.
"FISCAL YEAR" shall mean the Borrower's regular annual accounting period which shall end December 31, 2002, in respect of the Borrower's current annual accounting period, and which thereafter shall end on December 31 of each succeeding calendar year.
"FIXED CHARGE COVERAGE RATIO" means the ratio of (a) the sum of (i) the
greater of (A) 10% of the aggregate amount of statutory capital and surplus of
each Insurance Subsidiary as of the most recently ended calendar year
(determined without duplication in accordance with SAP) or (B) the aggregate net
income earned by each Insurance Subsidiary for the most recently ended four
Fiscal Quarters (determined without duplication in accordance with SAP), PLUS
(ii) cash on hand at the Borrower at the end of the most recently ended Fiscal
Quarter, PLUS (iii) the aggregate net income of each Subsidiary (other than
Insurance Subsidiaries) for the most recently ended four Fiscal Quarters
(determined without duplication in accordance with GAAP) to (b) the sum of (i)
interest payments on the Borrower's Consolidated Indebtedness for the most
recent four quarters, PLUS (ii) scheduled principal amortization payments on the
Borrower's Consolidated Indebtedness for the four Fiscal Quarters following the
date of determination.
"INCIPIENT DEFAULT" shall mean an event, condition or thing which constitutes, or which with the lapse of any applicable grace period or the giving of notice or both would constitute, any
Page 14 of 18 Pages
Event of Default and which has not been appropriately waived by the Lenders in writing or fully corrected prior to becoming an actual Event of Default.
"INCREASED RATE" shall mean, at any time and from time to time, (i) as to each Portion then outstanding, a rate of interest per annum which is Two Hundred (200) Basis Points in excess of the rate of interest otherwise accruing on such Portion at such time, and (ii) as to other obligations of the Borrower hereunder, Two Hundred (200) Basis Points in excess of the Base Rate.
"INDEBTEDNESS" means, with respect to any person or entity ("Person"),
without duplication, (i) all indebtedness for money borrowed of such Person;
(ii) all bonds, notes, debentures and similar debt securities of such Person;
(iii) the deferred purchase price of capital assets or services which in
accordance with GAAP would be shown on the liability side of the balance sheet
of such Person; (iv) the face amount of all letters of credit issued for the
account of such Person and, without duplication, all drafts drawn thereunder;
(v) all obligations, contingent or otherwise, of such Person in respect of
bankers' acceptances; (vi) all Indebtedness of a second Person secured by any
lien on any property owned by such first Person, whether or not such
Indebtedness has been assumed; (vii) all capitalized lease obligations of such
Person and all Indebtedness of such Person secured by purchase money liens;
(viii) the present value, determined on the basis of the implicit interest rate,
of all basic rental obligations under all "synthetic" leases (i.e. leases
accounted for by the lessee as operating leases under which the lessee is the
"owner" of the leased property for Federal income tax purposes); (ix) all
obligations of such Person to pay a specified purchase price for goods or
services whether or not delivered or accepted, i.e., take-or-pay and similar
obligations; (x) all net obligations of such Person under any so-called `hedge',
`swap', `collar', `cap' or similar interest rate or currency fluctuation
protection agreements; (xi) the full outstanding balance of trade receivables,
notes or other instruments sold with full recourse (and the portion thereof
subject to potential recourse, if sold with limited recourse), other than in any
such case any thereof sold solely for purposes of collection of delinquent
accounts; (xii) the stated value, or liquidation value if higher, of all
redeemable stock (or membership interest or other equity interest) of such
Person; and (xiii) all guaranty and other secondary obligations of such Person;
provided that (a) neither trade payables nor other similar accrued expenses, in
each case arising in the ordinary course of business, unless evidenced by a
note, shall constitute Indebtedness; and (b) the Indebtedness of any Person
shall in any event include (without duplication) the Indebtedness of any other
entity (including any general partnership in which such Person is a general
partner) to the extent such Person is liable thereon as a result of such
Person's ownership interest in or other relationship with such entity, except to
the extent the terms of such Indebtedness provide expressly that such Person is
not liable thereon.
"INSURANCE SUBSIDIARY" shall mean State Auto Property and Casualty Company, Milbank Insurance Company, State Auto National Insurance Company, State Auto Insurance Company, Farmers Casualty Insurance Company, Mid-Plains Insurance Company and, at any time, each other Subsidiary engaged in the insurance underwriting business at such time.
"INTEREST PERIOD" shall mean, for each LIBOR Portion, the period commencing on the date on which such Portion is advanced by the Bank or the date of the Rate Conversion or Rate Continuation of any Portion into a LIBOR Portion and ending on the numerically corresponding day of the period selected by the Borrower pursuant to the provisions hereof and each subsequent period commencing on the last day of the immediately preceding Interest Period in respect of such Portion and ending on the last day of the period selected by the Borrower pursuant to the provisions hereof. The duration of each such Interest Period shall be one (1), two (2), three (3) or six (6) months, in each case as the Borrower may select, upon delivery to the Bank of a Rate Conversion/Continuation Request therefor; provided, however, that:
(i) no Interest Period may end on a date later than the Stated Maturity Date;
Page 15 of 18 Pages
(ii) if there is no such numerically corresponding day in the month that is such, as the case may be, first, second, third or sixth month after the commencement of an Interest Period, such Interest Period shall end on the last day of such month; and
(iii) whenever the last day of any Interest Period in respect of a LIBOR Portion would otherwise occur on a day other than a Banking Day, the last day of such Interest Period shall be extended to occur on the next succeeding Banking Day; provided, however, that if such extension would cause the last day of such Interest Period to occur in the next following calendar month, the last day of such Interest Period shall occur on the immediately preceding Banking Day.
"LAW" shall mean any law, treaty, regulation, statute or ordinance, common law, civil law, or any case precedent, ruling, requirement, directive or request having the force of law of any foreign or domestic governmental authority, agency or tribunal.
"LIBOR" shall mean, with respect to any LIBOR Loan for any Interest Period, the per annum rate of interest, determined by the Agent in accordance with its usual procedures (which determination shall be conclusive and binding absent manifest error) as of approximately 11:00 A.M. (London time) two (2) Banking Days prior to the beginning of such Interest Period pertaining to such LIBOR Loan, appearing on page 3750 of the Dow Jones Telerate Service (or any successor to or substitute page of such Service, or any successor to or substitute for such Service providing rate quotations comparable to those currently provided on such page of such Service, as determined by the Agent from time to time for purposes of providing quotations of interest rates applicable to dollar deposits in the London interbank market) as the rate in the London interbank market for dollar deposits in immediately available funds with a maturity comparable to such Interest Period. In the event that such a rate quotation is not available for any reason, then the rate shall be the rate, determined by the Agent as of approximately 11:00 A.M. (London time) two (2) Banking Days prior to the beginning of such Interest Period pertaining to such LIBOR Loan, to be the average (rounded upwards, if necessary, to the nearest one sixteenth of one percent (1/16th of 1%)) of the per annum rates of interest at which dollar deposits in immediately available funds approximately equal in principal amount to such LIBOR Loan and for a maturity comparable to the Interest Period are offered to KeyBank by prime banks in the London interbank market.
"LIBOR PORTIONS" shall mean those Portions of the Principal Sum on which the Borrower shall pay interest at a rate based on LIBOR.
"NAIC" shall mean the National Association of Insurance Commissioners and any successor thereto.
"PERSON" shall mean an individual, partnership, limited liability company, corporation (including a business trust), joint stock company, trust, unincorporated association, joint venture or other entity, or a government or any political subdivision or agency thereof.
"PLAN" shall mean any employee pension benefit plan subject to Title IV of the Employee Retirement Income Security Act of 1974, as amended, established or maintained by Holdings, any Subsidiary, or any member of the Controlled Group, or any such Plan to which the Borrower, any Subsidiary, or any member of the Controlled Group is required to contribute on behalf of any of its employees (other than a Multi-Employer Plan, as that term is defined in Section 414(f) of the Code).
"PREMIUM TO SURPLUS RATIO" shall mean, with respect to any Person as at any date of determination thereof, the ratio (determined with respect to such Person and its Subsidiaries in accordance with SAP) of (a) net premiums written during the four consecutive calendar quarters ending on or most
Page 16 of 18 Pages
recently ended prior to such date of determination to (b) Statutory Surplus as at the last day of the calendar quarters ending on or most recently ended prior to such date of determination.
"PRIME RATE" shall mean that interest rate established from time to time by the Bank as its so-called "prime" rate (or equivalent rate otherwise named), whether or not such rate is publicly announced; the Prime Rate may not necessarily be the lowest interest rate charged by the Bank for commercial or other extensions of credit.
"PRINCIPAL SUM" shall have the meaning assigned to such term in the first paragraph of this Note.
"PUT AGREEMENT" shall have the meaning assigned to such term in Section 7(h) hereof.
"RATE CONTINUATION" shall mean a continuation of a LIBOR Portion having a particular Interest Period as a LIBOR Portion having an Interest Period of the same duration pursuant to the provisions of Section 2(a) hereof.
"RATE CONVERSION" refers to a conversion of a Portion of one Type into a Portion of another Type and, with respect to a LIBOR Portion, from one permissible Interest Period to another permissible Interest Period pursuant to the provisions of Section 2(a) hereof.
"RATE CONVERSION/CONTINUATION REQUEST" shall have the meaning assigned to such term in Section 2(b) hereof.
"RESERVE PERCENTAGE" shall mean for any day that percentage (expressed as a decimal) which is in effect on such day, as prescribed by the Board of Governors of the Federal Reserve System (or any successor) for determining the maximum reserve requirement (including, without limitation, all basic, supplemental, marginal and other reserves and taking into account any transitional adjustments or other scheduled changes in reserve requirements) for a member bank of the Federal Reserve System in Cleveland, Ohio, in respect of "Eurocurrency Liabilities".
"RISK-BASED CAPITAL RATIO" shall mean, with respect to any Person as at any date of determination thereof, the ratio of (a) total Adjusted Capital (as defined by the NAIC) for such Person as at such date of determination to (b) Authorized Control Level Risk-Based Capital (as defined by the NAIC) for such Person as at such date of determination.
"SAP" shall mean, with respect to any Insurance Subsidiary, the accounting procedures and practices prescribed or permitted by the Applicable Insurance Regulatory Authority, applied on a basis consistent with those that are to be used in making the calculations for purposes of determining compliance with this Note.
"STATED MATURITY DATE" shall mean December __, 2003.
"STATUTORY STATEMENT" shall mean as to any Insurance Subsidiary a statement of the condition and affairs of such Insurance Subsidiary, prepared in accordance with SAP and filed with the Applicable Insurance Regulatory Authority.
"STATUTORY SURPLUS" shall mean, as at any date for any Insurance Subsidiary, the aggregate amount of surplus as regards policyholders (determined without duplication in accordance with SAP) of such Insurance Subsidiary.
Page 17 of 18 Pages
"SUBSIDIARY" shall mean an existing or future corporation, limited liability company or other entity more than fifty percent (50%) of the outstanding capital stock, membership interest or other equity interests or voting power, or both, of which is (or upon the exercise of all outstanding warrants, options and other rights would be) directly or indirectly owned at the time in question by the Borrower or by any Subsidiary of the Borrower.
"TERM" shall mean the period of time commencing on the date of this Note and ending on the Stated Maturity Date or such other date on which the Principal Sum and all other sums owing hereunder shall have been paid and satisfied in full.
"TYPE" shall mean, when used in respect of any Portion, LIBOR or Base Rate, as applicable to such Portion.
14. WAIVER OF JURY TRIAL.
THE BORROWER AND, BY ITS ACCEPTANCE OF THIS NOTE, THE BANK HEREBY IRREVOCABLY AGREE TO WAIVE THEIR RESPECTIVE RIGHTS TO A JURY TRIAL OF ANY CLAIM OR CAUSE OF ACTION BASED UPON OR ARISING OUT OF THIS NOTE OR ANY OTHER RELATED DOCUMENT OR ANY DEALINGS BETWEEN THEM RELATING TO THE SUBJECT MATTER OF THIS NOTE OR ANY OTHER RELATED DOCUMENT AND THE RELATIONSHIPS THEREBY ESTABLISHED. The scope of this waiver is intended to be all-encompassing of any and all disputes that may be filed in any court and that relate to the subject matter of this transaction, including, without limitation, contract claims, tort claims, breach of duty claims, and all other statutory and common law claims. THIS WAIVER SHALL APPLY TO ANY SUBSEQUENT AMENDMENTS, RENEWALS, SUPPLEMENTS OR MODIFICATIONS OF THIS NOTE. In the event of litigation, this provision may be filed as a written consent to a trial by the court.
IN WITNESS WHEREOF, the Borrower has hereunto set its hands as of the date first above written.
STATE AUTO FINANCIAL CORPORATION
By /s/ Steven J. Johnston
----------------------
_________________, its Sr. Vice President
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Page 18 of 18 Pages
Exhibit 21
List of Subsidiaries of State Auto Financial Corporation
Exhibit 21
List of Subsidiaries of
State Auto Financial Corporation
State Auto Property and Casualty Insurance Company, a South Carolina corporation
State Auto National Insurance Company, an Ohio corporation
Stateco Financial Services, Inc., an Ohio corporation
Strategic Insurance Software, Inc., an Ohio corporation
Milbank Insurance Company, a South Dakota corporation
Farmers Casualty Insurance Company, an Iowa corporation
Mid-Plains Insurance Company, an Iowa corporation
State Auto Insurance Company of Ohio (formerly known as State Auto Insurance Company), an Ohio corporation
518 Property Management and Leasing, LLC, an Ohio limited liability company
Exhibit 23
Consent of Independent Auditors
Exhibit 23
Consent of Independent Auditors
We consent to the incorporation by reference in the following Registration Statements and related prospectuses of State Auto Financial Corporation of our report dated February 21, 2003, with respect to the consolidated financial statements and schedules of State Auto Financial Corporation and subsidiaries included in this Annual Report (Form 10-K) for the year ended December 31, 2002.
Registration
Form Number(s) Description
----------------------------------------------------------------------------------------
S-8 33-44667 1991 Stock Option Plan
33-89400
S-8 33-44666 1991 Directors' Stock Option Plan
S-8 33-41423 1991 Employee Stock Purchase and Dividend Reinvestment Plan
333-05755
S-8 333-56336 State Auto Insurance Companies Capital Accumulation Plan
S-8 333-43882 2000 Directors' Stock Option Plan
S-8 333-43880 2000 Stock Option Plan
S-3 333-41849 Monthly Stock Purchase Plan for Independent Agents
S-3 333-90529 1998 State Auto Agents' Stock Option Plan
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Columbus, Ohio /s/ Ernst & Young, LLP March 25, 2003 |
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, 2002 and 2001, and the
related consolidated statements of income, stockholders' equity and cash flows
for each of the three years in the period ended December 31, 2002. Our audits
also included the financial statement schedules listed in the Index at Item
15(a)(2). These financial statements and schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and schedules based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of State Auto Financial Corporation and subsidiaries at December 31, 2002 and 2001, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
Columbus, Ohio /s/ Ernst & Young, LLP February 21, 2003 |
Exhibit 24(E)
Power of Attorney
S. Elaine Roberts
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned director or officer of State Auto Financial Corporation, an Ohio corporation (the "Company"), hereby constitutes and appoints Robert H. Moone, John R. Lowther, and Steven J. Johnston and each of them, my true and lawful attorney-in-fact and agents, with full power to act without the other, with full power of substitution and resubstitution, for me and in my name, place and stead, in my capacity as director or officer of the Company, to execute the Company's Form 10-K Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Company's fiscal year ended December 31, 2002, for each fiscal year thereafter and any amendments thereto, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full powers and authority to do and perform each and every act and thing requisite and necessary to be done, as fully to all intents and purposes as I might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them or their or his substitute or substitutes may lawfully do or cause to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has hereunto set his hand as of the 7th day of March 2003.
Signature Position(s) with the Company
--------- ----------------------------
/s/ Elaine Roberts Director
-------------------------- ---------------------------
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Exhibit 99.1
CEO certification required by Section 906
Of
Sarbanes-Oxley Act of 2002
EXHIBIT 99.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of State Auto Financial Corporation (the "Company") on Form 10-K for the period ending December 31, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Robert H. Moone, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.
A signed original of this written statement required by Section 906 has been provided to State Auto Financial Corporation and will be retained by State Auto Financial Corporation and furnished to the Securities and Exchange Commission or its staff upon request.
/s/ Robert H. Moone
----------------------------
Robert H. Moone
Chief Executive Officer
March 28, 2003
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Exhibit 99.2
CFO certification required by Section 906
Of
Sarbanes-Oxley Act of 2002
EXHIBIT 99.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of State Auto Financial Corporation (the "Company") on Form 10-K for the period ending December 31, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Steven J. Johnston, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.
A signed original of this written statement required by Section 906 has been provided to State Auto Financial Corporation and will be retained by State Auto Financial Corporation and furnished to the Securities and Exchange Commission or its staff upon request.
/s/ Steven J. Johnston
--------------------------------
Steven J. Johnston
Chief Financial Officer
March 28, 2003
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