State Auto Financial Corp
State Auto Property & Casualty Ins Co
Milbank Ins Co
Farmers Casualty Ins Co
State Auto Ins Co of Ohio
State Auto National Ins Co
Stateco Financial Services Inc
Strategic Insurance Software Inc
518 Property Management & Leasing LLC
State Automobile Mutual Ins Co
State Auto Ins Co of Wisconsin
State Auto Florida Ins Co
Meridian Security Ins Co
Meridian Citizens Mutual Ins Co
Beacon National Ins Co
Beacon Lloyds Ins Co
Patrons Mutual Ins Co of Connecticut
Litchfield Mutual Fire Ins Co
State Auto Financial Corporation
518 E. Broad Street
Columbus, OH 43215
www.StateAuto.com
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State Auto Financial Corporation
two thousand eight
Annual Report
StAte AUtO FINANCIAL COrPOrAtION (“StFC”) is a super-regional insurance holding company
headquartered in Columbus, Ohio. StFC is affiliated with State Automobile Mutual Insurance Company
(State Auto Mutual), which owns approximately 64% of StFC. StFC, State Auto Mutual and their insurance
subsidiaries and affiliates (State Auto) market their insurance products exclusively through independent
insurance agencies in 33 states. State Auto’s principal lines include personal and commercial auto,
homeowners, commercial multi-peril, fire and general liability insurance.
With a commitment to responsible cost-based pricing, conservative investments and sound underwriting
practices, StFC has achieved solid long-term financial performance since becoming a public company in
1991. Combined with providing outstanding customer service to policyholders and agents, State Auto
has earned the reputation as one of the strongest and best managed super-regional insurance groups in
the industry. State Auto has consistently received A.M. Best’s A+ (Superior) rating.
State Auto Financial Corporation is traded on the Nasdaq global Select Market System under the
symbol StFC.
Financial Highlights
2008
$ 1,126.0
87.4
(36.4)
4.9
$ 1,181.9
$
(31.1)
(0.78)
$
(0.78)
$
$
0.60
$ 19.23
$ 2,443.6
$ 761.0
($ in millions, except per share amounts)
2005
2006
2007
1,011.6
84.7
12.1
5.0
1,113.4
119.1
2.90
2.86
0.50
23.10
1,023.8
83.1
5.6
4.9
1,117.4
120.4
2.95
2.90
0.38
20.32
1,050.3
78.7
5.6
4.9
1,139.5
125.9
3.12
3.06
0.27
18.86
2004
1,006.8
71.8
7.6
6.2
1,092.4
110.0
2.76
2.70
0.17
16.42
2,337.9
935.5
2,255.1
834.2
2,274.9
763.5
2,168.4
658.2
(3.7)%
109.8
13.5%
92.8
15.1%
91.4
17.7%
90.1
18.3%
91.7
Earned premiums
Net investment income
Net realized investment (loss) gain
Other income
Total revenue
Net (loss) income
Basic (loss) earnings per share
Diluted (loss) earnings per share
Dividends paid per share
Book value per share
Total assets
Stockholders’ equity
Return on equity
Combined ratio
geographic Dispersion
Corporate Headquarters
Regional Headquarters
Western Region
Midwestern Region
Eastern Region
Southern Region
Central Region
Corporate Headquarters
Columbus, OH
regional offiCes
EastErn rEgiOn HEadquartErs
Hunt Valley, Md
regional President Charles Mcshane, 55
sOutHErn rEgiOn HEadquartErs
nashville, tn
regional President george Furlong, 55
CEntral rEgiOn HEadquartErs
Columbus, OH
regional President Kathy durso, 56
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MidWEstErn rEgiOn HEadquartErs
indianapolis, in
regional President Ben Blackmon, 47
WEstErn rEgiOn HEadquartErs
austin, tX
regional President gerald ladner, 49
FOrWArd-LOOkINg StAteMeNtS
this annual report contains forward-looking statements within the meaning of the Private securities litigation reform act of 1995. Please see “important
information regarding Forward-looking statements” preceding Part i of the Company’s annual report on Form 10-K for the fiscal year ended december 31,
2008, which is included with this annual report.
STATE AUTO FINANCIAL CORPORATION 2008 Annual Report
Dear Shareholders,
NET PREMIUMS
WRITTEN
(in billions)
“ Building a strong culture around performance has been, and will
0.75
continue to be, our highest priority.”
0.50
At State Auto, we measure short- and
are paying off. We enter 2009 with an
long-term financial success based on
0.25
increasing policy count run rate, increasing
maintaining underwriting profitability,
prices in personal lines and a leveling
growing book value and increasing
in business insurance pricing. All this
premium volume. We expect to do this
0.00
positions us for continued growth in 2009,
each and every year. We did not accomplish
notwithstanding a very difficult economic
all these important goals in 2008. The
climate, as we earn an ever-increasing
combination of unprecedented weather-
share of our agency partners’ production.
related catastrophes and the meltdown
in the capital markets produced both
an underwriting loss and a decline in
book value.
We received industry recognition as well.
Last year, we were recognized in a number
of significant ways, including:
25
• A first-ever “Top Ten” ranking in an Ease
In 2008 we experienced the worst
catastrophe year in our history, with
$156.1 million in losses accounting for
13.9 points on our loss ratio. Of the 37
catastrophe events identified by Property
Claim Services (PCS), we experienced
losses in 35 of these, the largest of which
was Hurricane Ike which ravaged our three
largest states—Ohio, Kentucky and Indiana.
In addition to the catastrophe losses, our
capital and book value suffered from the
precipitous decline in the financial markets.
20
15
10
5
0
of Doing Business Survey conducted
annually by Deep Customer Connections.
This survey includes 7,400 independent
agents and brokers who assess the
performance of over 250 property and
casualty insurance companies. We have
significantly improved our ranking over
the past two years and have improved
our performance substantially.
• Company of the Year in Ohio awarded
by the Independent Insurance Agents of
Ohio. Our home state includes a variety
Despite the catastrophe losses and book
of national and well-entrenched regional
value decline, we continued to produce
companies. We are very pleased to
profitable underwriting results and grow
have our associates recognized in such
the business. All non-property automobile
a significant way given the competitive
and casualty lines continue to perform
1500
landscape here in the Midwest.
well. Total premium volume increased
12.9 points, including 9.2 points from our
previously announced pooling change
and 3.7 points from organic growth. We
achieved the organic growth even with
our 2008 withdrawal from the Florida
personal lines market. New business
activity increased, led by our personal
insurance segment. Overall policy counts
were up with strong retention. Our
investments in new products and systems
• The CSC Connect Award recognizing
us for our innovation and collaboration
1000
in deploying a state-of-the-art
agency portal.
500
We also have made two significant
investments in the future success of
State Auto. The first: In 2008 we launched
0
a corporate-wide initiative that we call
Innovate SA to increase productivity,
reduce costs and enhance revenues.
STATE AUTO FINANCIAL CORPORATION 2008 Annual Report / page 1
$1.5
$1.0
$0.5
0
$0.75
$0.50
$0.25
’04
’05*
’06
’07 ’08*
*Pooling change year
DIVIDENDS PAID
(per share)
0
’04
’05
’06
’07 ’08
BOOK VALUE
(per share)
$25
$20
$15
$10
$5
0
’04
’05
’06
’07 ’08
INVESTMENT
PORTFOLIO
U.S.
Treasury
Securities
5.1%
Municipal
Bonds
74.7%
Corporates &
Other Invested
Assets
2.3%
Equity
Securities
7.1%
U.S.
Government
Agencies—
MBS
10.8%
BOND QUALITY
A
2.6%
Other
2.9%
Aa
38.9%
Aaa
55.6%
Innovate SA engaged our 2,000+
and his team have built a terrific company
associates in identifying, assessing and
which is very compatible with our strong
quantifying ideas that we believe will
underwriting culture. Over the next several
improve earnings over the next two to
years, our focus will be on the integration
three years. Over 2,000 ideas were
and assimilation of our businesses. This
submitted for review and analysis.
acquisition benefits State Auto Mutual’s
Approximately 500 were accepted for
policyholders by diversifying its sources
implementation over the next 24–36
of earnings and could benefit STFC
months. These ideas cover the gamut
and its shareholders at some point in
of our operations and are designed to
the future if we “pool” some or all of
significantly improve the productivity of
Rockhill’s businesses.
our core sales, underwriting and claims
operations, as well as reduce costs
associated with claim settlement and
eventually improve our loss ratio. These
ideas should also produce savings
in a wide array of expenses such as
procurement, benefits and commissions
on selected lines. Our associates also
identified a number of opportunities to
increase fees, prices and other premium
charges. Over the next few years, our goal
is to improve our expense ratio by as
much as three points and our loss ratio by
one point through the ideas generated by
Innovate SA.
Through Innovate SA and other corporate
initiatives, we have taken additional
steps to increase profitability and reduce
Lastly, I would like to comment on State
Auto’s greatest legacy and foundation
for the future: our people. The most
successful organizations are the ones
that have engaged, informed and focused
employees. Business and industry are
littered with famous names that failed
to link growth, profitability and employee
engagement. Whether it be arrogance,
incompetence or just bad luck, the result
is often failure. At State Auto, we have a
totally focused work force that:
• Remains aligned with our mission
and strategy
• Is accountable for individual and
team results
• Perseveres through adversity
headcount. Last year we offered a one-
• Aspires for success
time early retirement option and eliminated
almost 50 staff positions. Combined with
not replacing open positions, we will
• Analyzes risks and rewards
• Acts quickly and effectively
reduce our headcount by approximately
Building a strong culture around
150 positions by the end of the second
performance has been, and will continue
quarter of 2009, or just over 5% of our
to be, our highest priority. The people we
staff. These actions position us well for a
recruit, select, develop, recognize, reward
difficult economic climate in 2009 and
and communicate with on a day-to-day
improved earnings in 2010 and beyond.
basis are what will sustain our strong
Our second investment was through
our parent and largest shareholder,
State Auto Mutual. In early 2009, State
Auto Mutual completed the acquisition
of the Rockhill Insurance Group, a
specialty commercial insurance business
serving the excess and surplus, specialty
commercial, and workers’ compensation
performance over time. My thanks to them
for working through a difficult year and
positioning us for a more typical and robust
State Auto profit performance in the future.
RObERT P. RESTREPO JR.
Chairman of the Board, President
markets. Rockhill CEO Terry Younghanz
and Chief Executive Officer
STATE AUTO FINANCIAL CORPORATION 2008 Annual Report / page 2
Our Strategy
Growth…
Meeting the ultimate challenge in a down economy
There are essentially two ways to grow our company,
The second way to grow is either by STFC buying
or any property casualty company. One way is organic
companies directly or by State Auto Mutual’s acquisition
growth, where we obtain more of the business that
or affiliation with companies that are then added to the
is already out there. This is accomplished by working
State Auto pool. For example, we leveraged State Auto
with our independent agents to award us, rather
Mutual’s acquisition of the Beacon Insurance Group
than another company, their business. Organic
and affiliation with the Patrons Insurance Group by
growth is both art and science. Coming out of 2007,
adding the insurance businesses of both companies
we recognized the need to improve our product mix,
to the State Auto pool in 2008. These transactions,
pricing technology and service to agents, all things
along with adding State Auto Mutual’s middle market
we worked hard at in 2008. We believe that going into
business to the State Auto pool, added 9.2 points of
2009, our business and personal auto products are
sales growth in 2008. Adding partners to State Auto—
more attractive and our agents find us easier to do
such as Beacon or Patrons—requires research and
business with than ever before. As evidence of our
planning. Systems need to be meshed, people need
efforts, we grew organic sales 3.7% in 2008, even
to adjust to new colleagues and procedures, and
with the withdrawal of our personal lines business in
stakeholders need to be assured that the changes
the state of Florida.
make sense for them.
technoloGy…
You’re either getting better or buried
When we talk about being easier to do business
with, we’re really talking about improving our
with netXpressSM, our personal insurance real-time
rating tool. bizXpress allows our agents to provide
technologies: the ways that data are captured and
their customers a printed and accurate quote from
used to differentiate risk; the ways that coverages are
State Auto in an instant, positively impacting our growth.
underwritten and brought on board; the ways that
agents are enabled to quote the price of our products;
and the ways that claims are submitted, captured,
evaluated and processed. Our substantial investment in
technology is reflected in streamlined work processes
and the consolidation of facilities.
Our responsiveness received a tremendous boost when
we completed our bizXpressSM rollout for business
auto in 2008, building upon our previous successes
With our netXpress technology our agents delivered
over 850,000 home, auto and personal insurance
package quotes in 2008. We issued over 191,000 of
those quotes as policies. As our sales staff is now
fond of saying, “We get more hits when we get more
at bats.”
In 2008, more than 40,000 claims were initiated online
via StateAuto.com. Just two years ago, that number
STATE AUTO FINANCIAL CORPORATION 2008 Annual Report / page 3
was less than 10,000. We also received over 310,000
ways to use it. Our business and personal insurance
premium payments online in 2008 via our Pay Now
predictive modeling tools provide fast, consistent and
feature, compared to 189,000 in 2007. These are
accurate application of the law of large numbers to
testimonies to the rapid rise of the Internet as a
our data. For business insurance we quantify loss
transaction medium and our more efficient approach
tendencies associated with size of risk, loss frequency,
to claims handling and premium payment processing.
payment records and business experience, among
We expect increased utilization of these online portals
over the next several years. These conveniences
are appreciated by our policyholders, as well as by
other factors. Predictive modeling has given us
more price points for our CustomFit SM auto product
and will provide more pricing granularity in our new
our agents who can devote more time to counseling
homeowners product currently being developed. The
their customers.
The principles of pricing have not changed. We simply
have more data and more sophisticated and effective
end result is competitive and adequate pricing which
we believe ultimately translates to increased sales
and improved profitability over the long-term.
enterprise risk and capital ManaGeMent…
We are financially strong and positioned to grow
because we have aligned our strategy and risk appetite
When we put together this annual report, we asked
We do not buy municipal bonds in Cat-prone areas or
ourselves, “What will our stakeholders want to know
in the lowest rated states. We do not invest in securities
about State Auto in the context of this extraordinarily
which we don’t understand. Our historical results,
difficult year for financial markets and insurers?” We
even given the recent market turmoil, are proof of the
grew our business, but also experienced record
success of our investment policies and practices.
catastrophe losses. While we lost money in the
equity markets, our portfolio fared well relative to
market indices. We improved our products and are
implementing changes to our field structure that will
make us more efficient while enhancing our already
strong personal relationships with our agency partners.
We have enterprise risk and capital management
programs in place that are performing according
to design.
In 2007 we identified our Florida personal lines book
as a serious risk to our bottom line and pulled back
from that market. We continually examine hurricane
correlations in our coastal states as we refine our
appetite for storm loss risk.
Sound reserving practices help to assure the quality
and integrity of our balance sheet. In other words,
we are conservative and pragmatic in our approach to
assigning loss numbers to catastrophic or large loss
events that may take time to play out.
State Auto is a “risk aware” culture that supports
open communication and consideration of risk
factors. Management in all key areas of the company
participate in discussions to identify and assess the
key risks facing State Auto. We consistently implement
our risk management practices across business units
and geographies.
An ERM committee comprised of key senior
management regularly addresses risk-related topics.
And there is an open door to the CEO, COO, CFO and
director of enterprise risk management for people to
raise risk concerns.
Perhaps above all, we want to communicate that our
enterprise risk and capital management programs
were tested in 2008 and found strong.
STATE AUTO FINANCIAL CORPORATION 2008 Annual Report / page 4
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
È Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
‘ Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2008 or
For the transition period from
to
Commission File Number 000-19289
TM
STATE AUTO FINANCIAL CORPORATION
(Exact name of Registrant as specified in its charter)
Ohio
(State or other jurisdiction of
incorporation or organization)
31-1324304
(I.R.S. Employer Identification No.)
518 East Broad Street, Columbus, Ohio
(Address of principal executive offices)
43215-3976
(Zip Code)
Registrant’s telephone number, including area code:
(614) 464-5000
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Shares, without par value
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes ‘ No È
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the
Act. Yes ‘ No È
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required
to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes È No ‘
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein,
and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this Form 10-K. ‘
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer,
or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting
company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ‘
Non-accelerated filer ‘ (Do not check if a smaller reporting company)
Indicate by check mark whether
Accelerated filer È
Smaller reporting company ‘
is a shell company (as defined in Rule 12b-2 of
the Registrant
Act). Yes ‘ No È
the
As of June 30, 2008, the last business day of the Registrant’s most recently completed second fiscal quarter, the
aggregate market value (based on the closing sales price on that date) of the voting stock held by non-affiliates of the
Registrant was $336,814,989.
On March 6, 2009, the Registrant had 39,620,850 Common Shares outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s Proxy Statement relating to the annual meeting of stockholders to be held May 8, 2009 (the
“2009 Proxy Statement”), which will be filed within 120 days of December 31, 2008, are incorporated by reference into
Part III of this Form 10-K.
Index to Annual Report on Form 10-K for the year ended December 31, 2008
Form 10-K Item Description
Part I
1
Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Part II
Executive Officers of the Registrant . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1A Risk Factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1B Unresolved Staff Comments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2
3
4
5
6
7
Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Market for the Registrant’s Common Equity, Related Shareholder Matters and Issuer
Purchases of Equity Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Selected Consolidated Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Management’s Discussion and Analysis of Financial Condition and Results of
Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
7A Qualitative and Quantitative Disclosures about Market Risk . . . . . . . . . . . . . . . . . . . . . . . .
8
9
Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Reports of Independent Registered Public Accounting Firm . . . . . . . . . . . . . . . . . . . . . . . .
Changes in and Disagreements with Accountants on Accounting and Financial
Disclosures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
9A Controls and Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
9B Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Part III
10 Directors, Executive Officers and Corporate Governance . . . . . . . . . . . . . . . . . . . . . . . . . .
11
12
13
14
15
Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Certain Relationships and Related Transactions, and Director Independence . . . . . . . . . . .
Principal Accountant Fees and Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exhibits and Financial Statement Schedules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Part IV
Exhibits(1)
Consent of Independent Registered Public Accounting Firm . . . . . . . . . . . . . . . . . . . . . . .
Certifications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Page
2
14
15
25
25
26
26
27
29
30
85
86
86
129
129
129
130
130
130
131
131
131
144
145
146
(1)
The financial statement schedules noted at Item 15(a)(2) and the exhibits noted at Item 15(a)(3), other than
those exhibits identified in this Index, have been omitted from the reproduction of this form 10-K. For the
omitted schedules and exhibits, see our Annual Report on Form 10-K for the year ended December 31,
2008, as filed with the Securities and Exchange Commission, a copy of which is available on the SEC’s
website at www.sec.gov. Copies of omitted schedules and exhibits are also available on our website at
www.StateAuto.com under “SEC filings” or may be obtained by writing to James E. Duemey, Vice
President, State Auto Financial Corporation, 518 East Broad Street, Columbus, Ohio 43215.
IMPORTANT INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
All statements, other than statements of historical facts, included in this Annual Report on Form 10-K (this
“Form 10-K”) of State Auto Financial Corporation (“State Auto Financial” or “STFC”) or incorporated herein by
reference, including, without limitation, statements regarding State Auto Financial’s future financial position,
business strategy, budgets, projected costs, goals and plans and objectives of management for future operations,
are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements generally can be identified by the use of forward-looking terminology such as
“may,” “will,” “expect,” “intend,” “estimate,” “anticipate,” “project,” “believe” or “continue” or the negative
thereof or variations thereon or similar terminology. Forward-looking statements speak only as the date the
statements were made. Although State Auto Financial believes that the expectations reflected in forward-looking
statements have a reasonable basis, it can give no assurance that these expectations will prove to be correct.
Forward-looking statements are subject to risks and uncertainties that could cause actual events or results to
differ materially from those expressed in or implied by the statements. For a discussion of the most significant
risks and uncertainties that could cause State Auto Financial’s actual results to differ materially from those
projected, see “Risk Factors” in Item 1A of this Form 10-K. 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.
IMPORTANT DEFINED TERMS USED IN THIS FORM 10-K
As used in this Form 10-K, the following terms have the meanings ascribed below:
•
•
•
•
•
•
•
•
“State Auto Financial” or “STFC” refers to State Auto Financial Corporation;
“We,” “us,” “our” or the “Company” refers to STFC and its consolidated subsidiaries, namely State
Auto Property & Casualty Insurance Company (“State Auto P&C”), Milbank Insurance Company
(“Milbank”), Farmers Casualty Insurance Company (“Farmers”), State Auto Insurance Company of
Ohio (“SA Ohio”), State Auto National Insurance Company (“SA National”), Stateco Financial
Services, Inc. (“Stateco”), Strategic Insurance Software, Inc. (“S.I.S.”) and 518 Property Management
and Leasing, LLC (“518 PML”);
“State Auto Mutual” or “our parent company” refers to State Automobile Mutual Insurance Company,
which owns approximately 64% of STFC’s outstanding common shares;
The “Pooled Companies” or “our Pooled Companies” refer to State Auto P&C, Milbank, Farmers, SA
Ohio (referred to as the “STFC Pooled Companies”), State Auto Mutual, and certain subsidiaries and
affiliates of State Auto Mutual, namely State Auto Florida Insurance Company (“SA Florida”), State
Auto Insurance Company of Wisconsin (“SA Wisconsin”), Meridian Security Insurance Company
(“Meridian Security”) Meridian Citizens Mutual Insurance Company (“Meridian Citizens Mutual”),
Beacon National Insurance Company (“Beacon National”), Patrons Mutual Insurance Company of
Connecticut (“Patrons Mutual”), and Litchfield Fire Mutual Insurance Company (“Litchfield”), (State
Auto Mutual, SA Florida, SA Wisconsin, Meridian Security, Meridian Citizens Mutual, Beacon
National, Patrons Mutual and Litchfield are referred to as the “Mutual Pooled Companies”);
The “MIGI Insurers” refer to Meridian Security and Meridian Citizens Mutual, and the “MIGI
Companies” refer to the MIGI Insurers and Meridian Insurance Group, Inc. (“MIGI”);
The “Beacon Insurance Group” or “Beacon Group” refers to Beacon National and Beacon Lloyds
Insurance Company (“Beacon Lloyds”);
The “Patrons Insurance Group” or “Patrons Group” refers to Patrons Mutual and Litchfield; and
The “State Auto Group” refers to the Pooled Companies, SA National and Beacon Lloyds.
1
Item 1. Business
(a) General Development of Business
PART I
State Auto Financial is an Ohio domiciled super-regional property and casualty insurance holding company
incorporated in 1990. We are primarily engaged in writing both personal and business lines of insurance. State
Auto Financial owns 100% of State Auto P&C, Milbank, Farmers, SA Ohio, and SA National, each of which is a
property and casualty insurance company. Our operations are headquartered in Columbus, Ohio.
State Auto Financial owns 100% of Stateco, which provides investment management services to affiliated
insurance companies. State Auto Financial also owns 100% of S.I.S., a developer and seller of insurance-related
software. State Auto P&C and Stateco share ownership of 518 PML, which owns and leases property to affiliated
companies. The results of the operations of S.I.S. and 518 PML are not material to our total operations.
Our parent company is State Auto Mutual, an Ohio domiciled super-regional mutual property and casualty
insurance company organized in 1921. It owns approximately 64% of State Auto Financial’s outstanding
common shares. It also owns 100% of SA Florida and SA Wisconsin, each of which is a property and casualty
insurance company. It also owns 100% of MIGI, an insurance holding company. MIGI owns 100% of Meridian
Security, a property and casualty insurance company. MIGI is also a party to an affiliation agreement with
Meridian Citizens Mutual, a mutual property and casualty insurance company. MIGI also owns 100% of State
Auto Holdings, Inc., an insurance holding company, which owns 100% of the Beacon Insurance Group. The
Beacon Insurance Group was acquired in 2007, and is comprised of Beacon National and Beacon Lloyds, which
are affiliated through a trust agreement. In December 2007, State Auto Mutual completed its affiliation with the
Patrons Insurance Group, which is comprised of Patrons Mutual and Litchfield, both of which are mutual
property and casualty insurers.
State Auto P&C has participated in a quota share reinsurance pooling arrangement with State Auto Mutual
since 1987 (the “Pooling Arrangement”). Since January 1, 2005, the participants in the Pooling Arrangement
have been State Auto P&C, State Auto Mutual, Milbank, SA Wisconsin, Farmers, SA Ohio, SA Florida,
Meridian Security and Meridian Citizens Mutual. On January 1, 2008, Beacon National and the Patrons
Insurance Group became participants in the Pooling Arrangement. See “Narrative Description of Business—
Pooling Arrangement” in this Item 1 for further information regarding the Pooling Arrangement.
The State Auto Group markets a broad line of property and casualty insurance, such as standard personal
and commercial automobile, nonstandard personal automobile, homeowners and farmowners, commercial multi-
peril, workers’ compensation, commercial general
through independent
insurance agencies in 33 states. Our Pooled Companies and SA National are rated A+ (Superior) by the A.M.
Best Company.
liability and property insurance,
(b) Financial Information about Segments
Our significant reportable segments are personal insurance, business insurance (the “insurance segments”),
and investment operations. The three segments reflect the manner in which we manage our business and report
our results internally to our principal operating decision makers. See detailed discussion regarding our segments
at Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations—“Overview
Section” and Note 15 to our Consolidated Financial Statements included in Item 8 of this Form 10-K.
2
(c) Narrative Description of Business
Property and Casualty Insurance
Pooling Arrangement
Our Pooled Companies are parties to the “Pooling Arrangement.” In general, under
the Pooling
Arrangement, State Auto Mutual assumes premiums, losses and expenses from each of the remaining Pooled
Companies and in turn cedes to each of the Pooled Companies a specified portion of premiums, losses and
expenses based on each of the Pooled Companies’ respective pooling percentages. State Auto Mutual then retains
the balance of the pooled business. The participation percentage for the STFC Pooled Companies has remained at
80% since 2001. Prior to 2008, the Pooling Arrangement covered all property and casualty insurance written by
the Pooled Companies except State Auto Mutual’s voluntary assumed reinsurance, middle market business
insurance written by State Auto Mutual and Meridian Security and intercompany catastrophe reinsurance written
by State Auto P&C.
In 2008, we made the following changes to the Pooling Arrangement:
•
•
•
•
Added Beacon National to the pool with a participation percentage of 0.0%;
Added Patrons Mutual and Litchfield to the pool with participation percentages of 0.4% and 0.1%,
respectively;
Reduced State Auto Mutual’s participation percentage from 19.5% to 19.0% to accommodate the
participation percentages allocated to Patrons Mutual and Litchfield; and
Included State Auto middle market business insurance written by State Auto Mutual and Meridian
Security.
The following table sets forth a chronology of the participants and their participation percentages in the
Pooling Arrangement since January 1, 1997:
Year(1)
1997
1998
1999
2000 – 9/30/2001
10/1/2001 – 2002
2003 – 2004
1/1/2005 – 2007
1/1/2008 –current
State
Auto
Mutual
State
Auto
P&C Milbank
55.0
52.0
49.0
46.0
19.0
18.3
19.5
19.0
35.0
37.0
37.0
39.0
59.0
59.0
59.0
59.0
10.0
10.0(2)
10.0
10.0
17.0
17.0
17.0
17.0
SA
Wisconsin Farmers
SA
Ohio
SA
Florida
Meridian
Security
Meridian
Citizens
Mutual
Beacon
National
Patrons
Mutual
Litchfield
Mutual
N/A
1.0
1.0
1.0
1.0
1.0
0.0
0.0
N/A N/A N/A
N/A N/A N/A
3.0 N/A N/A
1.0 N/A
3.0
1.0 N/A
3.0
0.7
1.0
3.0
0.0
1.0
3.0
0.0
1.0
3.0
N/A
N/A
N/A
N/A
N/A
N/A
0.0
0.0
N/A
N/A
N/A
N/A
N/A
N/A
0.5
0.5
N/A
N/A
N/A
N/A
N/A
N/A
N/A
0.0
N/A
N/A
N/A
N/A
N/A
N/A
N/A
0.4
N/A
N/A
N/A
N/A
N/A
N/A
N/A
0.1
(1)
(2)
Time period is for the year ended December 31, unless otherwise noted.
In July 1998, Milbank became a 100% owned subsidiary of STFC. Previously, Milbank was a 100% owned subsidiary of State Auto
Mutual.
3
The following table sets forth a summary of the Pooling Arrangement participation percentages of STFC
and State Auto Mutual, aggregating their respective affiliates and 100% owned subsidiaries:
Year(1)
STFC
Pooled
Companies
State Auto
Mutual
Pooled
Companies
1997 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1/1/1998 – 6/30/1998 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
7/1/1998 – 12/31/1998 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2000 – 9/30/2001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
10/1/2001 – current
35
37
47
50
53
80
65
63
53
50
47
20
(1)
Time period is for the year ended December 31, unless otherwise noted.
It is not management’s intention to recommend an adjustment to the STFC Pooled Companies’ 80%
participation level
the Pooling
in the foreseeable future. Under applicable governance procedures,
Arrangement were to be amended, management would make recommendations to the independent committees of
the Board of Directors of both State Auto Mutual and STFC. The independent committees review and evaluate
such factors as they deem relevant and recommend any appropriate pooling change to the Board of Directors of
both State Auto Mutual and STFC. The Pooling Arrangement is terminable by any of our Pooled Companies at
any time by any party by giving twelve months notice to the other parties and their respective domiciliary
insurance departments. None of our Pooled Companies currently intends to terminate the Pooling Arrangement.
if
Under the terms of the Pooling Arrangement, all subject premiums, incurred losses, loss expenses and other
underwriting expenses are prorated among our Pooled Companies on the basis of their participation in the pool.
By spreading the underwriting risk the Pooling Arrangement is designed to produce more uniform and stable
underwriting results for each of our Pooled Companies than any one company would experience individually.
This has the effect of providing each of our Pooled Companies with a similar mix of pooled property and
casualty insurance business on a net basis.
Prior to July 1, 2008, the Pooling Arrangement excluded catastrophic losses and loss adjustment expenses
that were reinsured under our Catastrophe Assumption Agreement (defined below), as well as the premium for
such exposures. State Auto P&C reinsured each insurer in the State Auto Group for this layer of reinsurance in
the amount of $100.0 million in excess of $135.0 million. No losses were paid by State Auto P&C under the
Catastrophe Assumption Agreement in 2008, 2007 or 2006. The State Auto Group did not renew the Catastrophe
Assumption Agreement upon its expiration on July 1, 2008. See “Management’s Discussion and Analysis of
Financial Condition and Results of Operations—Reinsurance Arrangements” in this Item 7 for
further
information regarding the Catastrophe Assumption Agreement.
Our nonstandard automobile program written through SA National, provides insurance for private passenger
automobile risks which do not qualify for the standard or preferred automobile insurance market. Typically,
nonstandard risks have higher than average loss experience and an overall higher degree of risk than standard or
preferred automobile business. We do not include the business of SA National in the Pooling Arrangement.
Management Agreement
State Auto P&C provides the employees to perform all organizational, operational and management
functions for the State Auto Group and State Auto Mutual provides certain operating facilities, including our
corporate headquarters, for the State Auto Group through management and cost sharing agreements. In addition,
the insurance operations of the Patrons Group are conducted at facilities owned by Patrons Mutual and Litchfield.
4
Our primary management agreement, which we refer to as the 2005 Management Agreement, has a ten year term
and renews for an additional ten-year period unless terminated sooner in accordance with its terms. If the 2005
Management Agreement was terminated for any reason, we would have to relocate our facilities to continue our
operations. However, we do not currently anticipate the termination of the 2005 Management Agreement. See
“Properties” included in Item 2 of this Form 10-K.
Marketing
As of January 1, 2009, the State Auto Group marketed its products in 33 states through independent
insurance agencies. None of the companies in the State Auto Group has any contracts with managing general
agencies.
We view our independent insurance agents as our primary customers, because they are in a position to
recommend either our insurance products or those of a competitor to their customers. We strongly support the
independent agency system and believe its maintenance is essential to our present and future success. As such,
we continually develop programs and procedures to enhance our agency relationships, including the following:
regular travel by senior management and regional office staff to meet with agents, in person, in their home states;
training opportunities; incentives related to profit and growth; and an agent stock purchase plan. In addition, we
share the cost of approved advertising with selected agencies.
We actively help our agencies develop professional sales skills of their staffs. Our training programs include
both products and sales training conducted in our home office. Further, our training programs include disciplined
follow-up and coaching for an extended time. Other targeted training sessions are held in our branch office
locations from time to time, as well as in our agents’ offices.
We provide our agents with defined travel and cash incentives if they achieve certain sales and underwriting
profit levels. Further, we recognize our very top agencies—measured by consistent profitability, achievement of
written premium thresholds and growth—as Inner Circle Agencies. Inner Circle Agencies are rewarded with
additional trip and financial incentives, including additional contingent commissions and additional contributions
to their Inner Circle Agent Stock Purchase Plan, a part of our Agent Stock Purchase Plan described below.
To strengthen agency commitment
to producing profitable business and further develop our agency
relationships, we make available to our agents a stock purchase plan which provides them with the opportunity to
use their commission income to purchase our stock. Our transfer agent administers this stock purchase plan using
commission dollars assigned by the agents to purchase shares on the open market through a stockbroker.
We have made continuing efforts to use technology to make it easier for our agents to do business with us.
We offer internet-based (i) rating, (ii) policy application submission, (iii) execution of changes to policies for
certain products and (iv) claims submission. In addition, we provide our agents with the opportunity to maintain
policyholder records electronically, avoiding the expense of preparing and storing paper records. Software
developed by S.I.S. also enhances the ability of our agents and us to take advantage of electronic data
submission. We believe that, since agents and their customers realize better service and efficiency through
automation, they value their relationship with us. Automation can make it easier for an agent to do business with
us, which attracts prospective agents and enhances existing agencies’ relationships with us.
During 2008, the State Auto Group, received premiums on products marketed in Alabama, Arizona,
Arkansas, Colorado, Connecticut, Florida, Georgia, Illinois, Indiana, Iowa, Kansas, Kentucky, Maryland,
Massachusetts, Michigan, Minnesota, Mississippi, Missouri, North Carolina, North Dakota, Ohio, Oklahoma,
Pennsylvania, Rhode Island, South Carolina, South Dakota, Tennessee, Texas, Utah, Vermont, Virginia, West
Virginia and Wisconsin. During 2008, the eight states that contributed the greatest percentage of our direct
premiums written were as follows: Ohio (16.7%), Kentucky (9.9%), Indiana (6.6%), Tennessee (6.2%),
Pennsylvania (4.7%), Maryland (4.4%), Minnesota (4.4 %) and Arkansas (4.2%).
5
Claims
Our claims division emphasizes timely investigation of claims, settlement of meritorious claims for
equitable amounts, maintenance of adequate case reserves for claims, and control of external claims adjustment
expenses. Achievement of these goals supports our 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. Our claims division is responsible for reviewing the claim, obtaining
necessary documentation and establishing loss and expense reserves of certain claims. Generally, property or
casualty claims estimated to reach $150,000 or above are sent to our home office to be supervised by claims
division specialists. Branches with low volumes of large claims are assigned a lower dollar threshold for
referring claims to the home office. In territories in which there is not sufficient volume to justify having full-
time adjusters, we use independent appraisers and adjusters to evaluate and settle claims under the supervision of
claims division personnel.
We attempt to minimize claims adjusting costs by settling as many claims as possible through our 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.
Our claim representatives use third party, proprietary bodily injury evaluation software to help them value
bodily injury claims, except for the most severe injury cases. Our Claims Contact Centers allow us to improve
claims efficiency and economy by concentrating the handling of smaller, less complex claims in a centralized
environment. We provide claim service 24 hours a day, seven days a week, either through associates in our
Claims Contact Centers, which are located in Des Moines, Iowa and Columbus, Ohio, or, for a few overnight
hours, through a third party service provider.
Reserves
Loss reserves are management’s best estimates at a given point in time of what we expect to pay to settle all
losses incurred as of the end of the accounting period, 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 results of our
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.
We maintain 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 associated with 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 our reserving
practices, which take into account the type of risk, the circumstances surrounding each claim and applicable
policy provisions. The formula reserves are based on historical paid loss data for similar claims with provisions
for trend changes caused by inflation. Loss and loss expense reserves for incurred claims that have not yet been
reported are estimated based on many variables including historical and statistical information, changes in
exposure units, inflation, legal developments, storm loss estimates and economic conditions. Case and formula
basis loss reserves are reviewed on a regular basis. As new data becomes available, estimates are updated
resulting in adjustments to loss reserves. Generally, reported losses initially reserved on a formula basis which
have not settled after six months, are case reserved at that time. Although our management uses many resources
to calculate reserves, there is no precise method for determining the ultimate liability. We do not discount loss
6
reserves for financial statement purposes. For additional information regarding our reserves, see Item 7 of this
Form 10-K, “Management, Discussion and Analysis of Financial Condition and Results of Operations—Loss and
Loss Expense Reserves.”
The following table presents our one-year development information on changes in the reserve for loss and
loss expenses for each of the three years in the period ended December 31:
($ millions)
Beginning of Year:
Year Ended December 31
2008
2007
2006
Loss and loss expenses payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less: Reinsurance recoverable on losses and loss expenses payable(1) . . . . . . . . . . .
$658.3
11.2
674.5
13.5
Net losses and loss expenses payable(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Impact of pooling change, January 1, 2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
647.1
661.0
51.3 —
728.7
17.4
711.3
—
Provision for losses and loss expenses occurring:
Current year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Prior years(3)
874.0
(27.3)
645.5
(54.7)
659.3
(71.7)
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
846.7
590.8
587.6
Loss and loss expense payments for claims occurring during:
Current year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Prior years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
518.7
256.4
368.7
236.0
389.4
248.5
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
775.1
604.7
637.9
End of Year:
Net losses and loss expenses payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . .
Add: Reinsurance recoverable on losses and loss expenses payable(4)
770.0
21.2
647.1
11.2
661.0
13.5
Losses and loss expenses payable(5)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$791.2
658.3
674.5
(1)
(2)
(3)
(4)
(5)
Includes amounts due from affiliates of $1.2 million, $2.7 million, and $5.5 million at beginning of year 2008, 2007, and 2006,
respectively.
Includes net amounts assumed from affiliates of $257.2 million, $281.7 million, and $302.6 million at beginning of year 2008, 2007, and
2006, respectively.
This line item shows decreases in the current calendar year in the provision for losses and loss expenses attributable to claims occurring
in prior years. See discussion regarding the calendar year developments at Item 7 of this Form 10-K Management’s Discussion and
Analysis section at “2008 Compared to 2007—Loss and LAE” and “2007 Compared to 2006—Loss and LAE.”
Includes amounts due from affiliates of $0.6 million, $1.2 million, and $2.7 million at end of year 2008, 2007, and 2006, respectively.
Includes net amounts assumed from affiliates of $343.0 million, $257.2 million, and $281.7 million at end of year 2008, 2007, and 2006,
respectively.
The following table sets forth our development of reserves for losses and loss expenses from 1998 through
2008. “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 recoverable, for each year shown. This liability
represents the estimated amount of losses and loss expenses for claims incurred during the current year or incurred
during prior years that are unpaid at the balance sheet date, including losses incurred but not reported to us.
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, 2008, we have paid 103.1% of
the losses and loss expenses that had been incurred but not paid, as estimated at December 31, 1998.
The lower portion of the table shows the current estimate 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.
7
The amounts on the “cumulative redundancy (deficiency)” line represent the aggregate change in the
estimates over all prior years. For example, the 1998 calendar year reserve has developed a $48.3 million or
23.6% deficiency through December 31, 2008. This $48.3 million amount has been included in operating results
over the ten years and did not have a significant effect on income in any one year.
In evaluating the information in the table, it should be noted that each amount includes the effects of all
changes in amounts for prior periods. For example, the amount of the redundancy or deficiency evaluated at
December 31, 2000, on claims incurred in 1998 includes the cumulative redundancy or deficiency for years 1998,
1999 and 2000. Conditions and trends that have affected the development of the liability in the past may not
necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate future redundancies or
deficiencies based on this table.
In 1998, 1999, 2000 and 2001, the Pooling Arrangement was amended to increase our share of premiums,
losses and expenses. An amount of assets equal to the increase in net liabilities was transferred to us from our
parent company in 1998, 1999, 2000 and 2001 in conjunction with each year’s respective pooling change. In
2005, the MIGI Insurers were added to the pool and our share of their net liabilities and assets were transferred to
us from them. In 2008, Beacon National, the Patrons Insurance Group and State Auto Middle Market business
were added to the pool and accordingly net assets equal to the increase in net liabilities were transferred to us
from them. The amount of the assets transferred on the reserve liabilities assumed in 1998, 1999, 2000, 2001,
2005 and 2008 has been netted against and has reduced the cumulative amounts paid for years prior to 1998,
1999, 2000, 2001, 2005 and 2008, respectively.
8
($ millions)
Years Ended December 31
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Net liability for losses and loss
expenses payable . . . . . . . . .
Paid (cumulative) as of:
$205.0
$221.7
$236.7
$509.9
$592.1
$628.8
$ 655.9
$ 711.3
$ 661.0
$ 647.1
$ 770.0
One year later . . . . . . . . .
Two years later . . . . . . . .
Three years later . . . . . . .
Four years later . . . . . . . .
Five years later . . . . . . . .
Six years later . . . . . . . . .
Seven years later . . . . . . .
Eight years later . . . . . . . .
Nine years later . . . . . . . .
Ten years later . . . . . . . . .
5.9%
41.8%
35.4%
52.7%
43.0%
61.6%
79.9%
71.9%
62.1%
86.9%
95.5%
78.8%
96.1% 101.6%
86.3%
99.0% 107.0%
92.5%
94.9% 102.4% 112.2%
97.4% 106.0% 116.4%
100.3% 109.3%
103.1%
43.4%
65.3%
78.4%
84.4%
88.5%
92.3%
94.7%
41.2%
60.8%
71.4%
77.3%
82.3%
85.1%
36.7%
53.2%
63.3%
70.6%
74.3%
31.6%
48.4%
59.6%
66.1%
34.9%
51.1%
60.9%
34.9%
50.5%
31.7%
—
Net liability re-estimate as of:
One year later . . . . . . . . .
Two years later . . . . . . . .
Three years later . . . . . . .
Four years later . . . . . . . .
Five years later . . . . . . . .
Six years later . . . . . . . . .
Seven years later . . . . . . .
Eight years later . . . . . . . .
Nine years later . . . . . . . .
Ten years later . . . . . . . . .
96.6%
99.7%
97.5% 125.7% 102.4%
96.7% 119.1% 129.1% 105.1% 100.6%
98.8%
111.9% 120.3% 133.1% 106.9%
98.5%
111.5% 123.2% 136.1% 106.2%
98.8%
115.6% 126.7% 135.6% 107.1%
98.4%
118.5% 127.9% 138.2% 107.7%
120.0% 128.9% 140.1% 107.4%
121.5% 131.1% 139.5%
123.9% 130.6%
123.6%
Cumulative redundancy
96.5%
93.2%
91.0%
90.6%
89.8%
93.3%
87.6%
86.9%
86.2%
89.9%
86.4%
85.6%
91.7%
90.5%
95.8%
—
(deficiency) . . . . . . . . . . . . .
$ (48.3)
$ (67.8)
$ (93.5)
$ (37.6)
$
9.2
$ 63.8
$
90.7
$ 102.2
$
63.1
$
27.3
Cumulative redundancy
(deficiency) . . . . . . . . . . . . .
(23.6%)
(30.6%)
(39.5%)
(7.4%)
1.6%
10.2%
13.8%
14.4%
9.5%
4.2%
—
—
Gross* liability—end of
year . . . . . . . . . . . . . . . . . . .
Reinsurance recoverable . . . . .
Net liability—end of year . . . .
$414.2
$209.2
$205.0
$438.7
$217.0
$221.7
$457.2
$220.5
$236.7
$743.7
$233.8
$509.9
$862.4
$270.3
$592.1
$934.0
$305.2
$628.8
$1,006.4
$ 350.5
$ 655.9
$1,111.1
$ 399.8
$ 711.3
$1,032.7
$ 371.7
$ 661.0
$1,029.9
$ 382.8
$ 647.1
$1,198.6
$ 428.6
$ 770.0
Gross liability re-estimated—
latest
. . . . . . . . . . . . . . . . . .
117.4% 118.7% 125.0% 107.1%
98.9%
92.3%
89.3%
88.1%
92.1%
97.1%
Reinsurance recoverable
re-estimated—latest . . . . . . .
111.4% 106.5% 109.3% 106.6%
99.9%
97.5%
95.2%
92.4%
95.0%
99.3%
Net liability re-estimated—
latest
. . . . . . . . . . . . . . . . . .
123.6% 130.6% 139.5% 107.4%
98.4%
89.8%
86.2%
85.6%
90.5%
95.8%
—
—
—
*
Gross liability includes: Direct and assumed losses and loss expenses payable.
As the Pooling Arrangement provides for the right of offset, we have reported losses and loss expenses
payable ceded to our parent company as assets only in situations when net amounts ceded to our parent company
exceed that assumed. The following table provides a reconciliation of the reinsurance recoverable to the amount
reported in our consolidated financial statements at each balance sheet date:
$209.2
$217.0
$220.5
$233.8
$270.3
$305.2
$ 350.5
$ 399.8
$ 371.7
$ 382.8
$ 428.6
$197.7
$ 11.5
$206.3
$ 10.8
$212.6
7.9
$
$219.9
$ 13.9
$261.5
8.8
$
$291.0
$ 14.2
$ 324.6
25.9
$
$ 382.4
17.4
$
$ 358.2
13.5
$
$ 371.6
11.2
$
$ 407.4
21.2
$
Reinsurance recoverable . . . . .
Amount netted against
assumed from State Auto
Mutual . . . . . . . . . . . . . . . . .
Net reinsurance recoverable . .
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
9
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. See the detailed discussion of our reinsurance arrangements at Item 7 of this Form
10-K, “Management, Discussion and Analysis of Financial Condition and Liquidity and Capital Resources—
Reinsurance Arrangements.”
See “Narrative Description of Business—Regulation” of this Item 1 for a discussion of the Terrorism Risk
Insurance Act of 2002, and its successor, the Terrorism Risk Insurance Extension Act of 2005.
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 our 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 our 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 our holding company system, and require prior
notice and an opportunity to disapprove of certain “extraordinary” transactions, including, but not limited to,
extraordinary dividends to stockholders. Pursuant to these laws, all transactions within our holding company
system affecting any insurance subsidiary within 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 of our insurance
companies is subject to supervision and regulation in the states in which we transact 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.
We are required to file detailed annual reports with the supervisory agencies in each of the states in which
we do business, and our 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. Our insurance subsidiaries generally are restricted by the insurance laws of our respective states
of domicile as to the amount of dividends we may pay without the prior approval of our respective state
regulatory authorities. Generally, the maximum dividend that may be paid by an insurance subsidiary during any
year without prior regulatory approval is limited to the greater of a stated percentage of that subsidiary’s statutory
surplus as of a certain date, or adjusted net income of the subsidiary for the preceding year. Under current law at
10
December 31, 2008, adjusted for dividend payments made in the previous twelve-month period, a total of $34.8
million is available in 2009 for payment as a dividend from our insurance subsidiaries to STFC without prior
approval from our respective domiciliary state insurance departments. STFC received dividends of $39.0 million,
$50.0 million, and $0.0 million in 2008, 2007, and 2006, respectively, from its insurance subsidiaries.
Rates and Related Regulation. Except as discussed below, we are not aware of the adoption of any adverse
legislation or regulation in any state in which we conducted business during 2008 which would materially impact
our business.
In January 2007, the Florida legislature enacted new legislation which made fundamental changes to the
property and casualty insurance business in Florida. This legislation was intended to address the cost of
residential property insurance in Florida. After careful analysis of this legislation, we concluded that we could no
longer operate our personal lines on a profitable basis in that state. Accordingly, during the second quarter 2007,
we filed an application with the Florida Department of Insurance to withdraw from this state’s personal lines
insurance market effective January 1, 2008. As of January 1, 2009, all of our personal lines policies in Florida
have not been renewed. We continue to write commercial lines business in Florida. In 2007, we wrote $26.9
million of premium in Florida compared to $9.0 million in 2008, nearly all of which was business insurance.
Many of the states in which we operate have passed or are considering legislation restricting or banning the
use of “credit scoring” in the rating and risk selection process. The Fair and Accurate Credit Transactions Act,
passed by the U.S. Congress in 2003, directed the Federal Trade Commission (“FTC”) to consult with the Office
of Fair Housing and Equal Opportunity on, among other things, how the use of credit information may affect the
availability and affordability of property/casualty insurance, and whether the use of certain factors by credit
scoring systems could have a disparate impact on minorities. In July of 2007, the FTC released a report on credit
scoring and its impact on automobile insurance. The FTC concluded that credit-based scoring is an effective
predictor of risk with respect to the issuance of automobile insurance policies to consumers, but has little effect
as an indicator of racial or ethnic status of consumers. Despite the FTC’s conclusions, some consumer groups and
certain regulatory and legislative entities continue to resist the use of credit scoring in the rating and risk
selection process. In 2008, the FTC asked nine of the nation’s largest homeowners insurance companies to
provide information that the FTC says will allow it to determine how consumer credit data are used by the
companies in underwriting and rate setting in this line of business. The results of this study are not expected until
late in 2009 or early 2010, and its results could affect the future use of credit scoring. Banning or restricting this
practice or data mining would limit our ability, and the ability of other carriers, to take advantage of the
predictive value of this information.
In an attempt to make capital and surplus requirements more accurately reflect the underwriting risk of
different lines of insurance, as well as investment risks that attend insurers’ operations, the National Association
of
requirements. As of
December 31, 2008, each insurer affiliated with us was in compliance with its respective risk-based capital
requirements.
Insurance Commissioners (“NAIC”) annually tests insurers’
risk-based capital
The property and casualty insurance industry is also affected by court decisions. In general, 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
unfavorably impact an insurer.
The Terrorism Risk Insurance Act of 2002 and its successor, the Terrorism Risk Insurance Extension Act of
2005 (collectively, the “Terrorism Acts”) require the federal government and the insurance industry to share in
11
insured losses up to $100 billion per year resulting from future terrorist attacks within the United States. Under
the Terrorism Acts, 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, we intend, subject to the approval of the state
regulators, to cover only such acts of terrorism that are not certified acts under the Terrorism Acts and that do not
arise out of nuclear, biological or chemical agents. In December 2007, The United States Congress extended the
Terrorism Acts through December 31, 2014. At the same time, Congress made modest changes to the Terrorism
Acts—for example, deleting the distinction between certified and non-certified (essentially foreign and domestic)
acts of terrorism. Lines of business covered, as well as certain important coverage features (such as loss triggers,
company deductibles and industry retentions) were not changed. We are evaluating these recent changes to the
Terrorism Acts and are taking actions to comply. Our current property reinsurance treaties exclude certified acts
of terrorism.
Investments
Our investment portfolio is managed to provide growth of statutory surplus to facilitate increased premium
writings over the long term while maintaining the ability to fund current insurance operations. The primary
objectives are to generate income, preserve capital and maintain liquidity. Our investment portfolio is managed
separately from that of our parent company and its subsidiaries, and investment results are not shared by our
Pooled Companies through the Pooling Arrangement. Stateco performs investment management services for us
and our parent company and its subsidiaries, although investment policies implemented by Stateco continue to be
set for each company through the Investment Committee of its respective Board of Directors.
Our 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) our liquidity requirements at any given time; and (f) our current federal income tax position and relative
spread between after tax yields on tax-exempt and taxable fixed maturity investments. We have investment
policy guidelines with respect to purchasing fixed maturity investments for our insurance subsidiaries which
preclude investments in bonds that are rated below investment grade by a recognized rating service. Our fixed
maturities portfolio is composed of high quality, investment grade issues, comprised almost entirely of debt
issues rated AAA or AA. As of December 31, 2008 and 2007, our bond portfolio had a fair value that totaled
$1,770.7 million and $1,745.4 million, respectively.
Our fixed maturity investments are classified as available-for-sale and carried at fair value, according to the
Financial Accounting Standards Board (“FASB”) Statement 115, “Accounting for Certain Investments in Debt
and Equity Securities” (“SFAS 115”). Our 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. Generally, investments in equity securities are selected based on their potential for appreciation as well as
ability to continue paying dividends. See Item 7 of this Form 10-K, “Management’s Discussion and Analysis of
Financial Condition and Results of Operations—2008 Compared to 2007—Investment Operations Segment—
Market Risks,” for a discussion regarding the market risks related to our investment portfolio.
At December 31, 2008 and 2007, our equity portfolio was classified as available-for-sale and carried at fair
value totaling $137.5 million and $254.2 million, respectively.
12
The following table sets forth our investment results for the periods indicated:
($ millions)
Year ended December 31
2007
2006
2008
Average Invested Assets(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net Investment Income(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Average Yield . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$2,127.6
87.4
4.1%
$1,987.1
84.7
4.3%
$1,891.6
83.1
4.4%
(1) Average of the aggregate invested assets at the beginning and end of each period, including interim quarter ends. Invested assets include
fixed maturities at amortized cost, equity securities and other invested assets at cost and cash equivalents.
(2) Net investment income is net of investment expenses and does not include realized or unrealized investment gains or losses or provision
for income taxes.
For additional discussion regarding our investments, see Item 7 of this Form 10-K, “Management’s
Discussion and Analysis of Financial Condition and Results of Operations—Investment Operations Segment.”
Competition
The property and casualty insurance industry is highly competitive. We compete with numerous insurance
companies, many of which are substantially larger and have considerably greater financial resources. In addition,
because our products are marketed exclusively through independent insurance agencies, most of which represent
more than one company, we face competition within each agency. See “Narrative Description of Business—
Marketing” in Item 1 and “Distribution System” and “Competition” in Item 1A of this Form 10-K. We compete
through underwriting criteria, appropriate pricing, quality service to our policyholders and our agents, and a fully
developed agency relations program.
Employees
As of February 28, 2009, we had 2,165 employees. Our employees are not covered by any collective
bargaining agreement. We consider the relationship with our employees to be excellent.
Available Information
Our website address is www.StateAuto.com. Through this website (found by clicking the “Investors” link,
then the “All SEC Filings” link), we make available, free of charge, our Annual Report on Form 10-K, Quarterly
Reports on Form 10-Q, Current Reports on Form 8-K, proxy and information statements and all amendments to
those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the
“Exchange Act”), as soon as reasonably practicable after we electronically file such material with the Securities
and Exchange Commission (the “SEC”). Also available on our website is information pertaining to our corporate
governance, including the charters of each of our standing committees of our Board of Directors, our corporate
governance guidelines, our employees’ code of business conduct and our directors’ ethical principles.
Any of the materials we file with the SEC may also be read and copied at the SEC’s Public Reference Room
at 100 F Street, NE, Washington, DC 20549. Information on the operation of the SEC’s Public Reference Room
may be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains a website that contains reports,
proxy and information statements, and other information regarding issuers that file electronically with the SEC at
www.sec.gov.
13
Executive Officers of the Registrant
Name of Executive Officer and
Position(s) with Company
Age(1)
Robert P. Restrepo, Jr.,
. . . . . .
58
Chairman, President and
Chief Executive Officer
Mark A. Blackburn, . . . . . . . . .
Executive Vice President
and Chief Operating Officer
57
Steven E. English,
. . . . . . . . . .
48
Vice President and
Chief Financial Officer
James E. Duemey,
. . . . . . . . . .
62
Vice President and
Investment Officer
Clyde H. Fitch, Jr.
. . . . . . . . . .
58
Senior Vice President and
Chief Sales Officer
Cynthia A. Powell, . . . . . . . . . .
Vice President and Treasurer
48
Lorraine M. Siegworth,
. . . . . .
41
Vice President
James A. Yano,
. . . . . . . . . . . .
57
Vice President, Secretary
and General Counsel
Principal Occupation(s)
During the Past Five Years
Chairman of
the Board and Chief Executive
Officer of STFC and State Auto Mutual, 2/06 to
present; President of STFC and State Auto
Mutual, 3/06 to present; Senior Vice President,
Insurance Operations, of Main Street America
a property and casualty insurance
Group,
company, 4/05 – 2/06; President and Chief
Executive Officer for two property and casualty
insurance subsidiaries of Allmerica Financial
Corporation (now known as Hanover Insurance
Group), 1998 – 2003.
Executive Vice President and Chief Operating
Officer of STFC and State Auto Mutual, 11/06 to
present; Senior Vice President of STFC and State
Auto Mutual, 03/01 to 11/06.
Vice President of STFC and State Auto Mutual,
05/06 to present; Chief Financial Officer of STFC
and State Auto Mutual, 12/06 to present;
Assistant Vice President of State Auto Mutual,
06/01 to 05/06.
Vice President and Investment Officer of State
Auto Mutual, 5/91 to present.
Senior Vice President and Chief Sales Officer of
STFC and State Auto Mutual, 11/07 to present.
Senior Vice President of Travelers Companies,
Inc. for more than five years prior to 11/07.
Treasurer of STFC and State Auto Mutual, 06/06
to present; Vice President of State Auto Mutual,
3/00 to present; Vice President of STFC, 5/00 to
present.
Vice President of STFC and State Auto Mutual,
11/06 to present; Vice President of Nationwide
Insurance or its affiliates, 09/00 to 03/06, most
recently serving as Vice President of Corporate
HR of Nationwide Insurance.
Vice President, Secretary and General Counsel of
STFC and State Auto Mutual 4/07 to present;
Senior Vice President, Secretary and General
Counsel of Abercrombie & Fitch Co. 5/05 to
3/07; Partner, law firm of Vorys, Sater, Seymour
and Pease LLP for more than five years prior.
An Executive Officer
of the Company Since(2)
2006
1999
2006
1991
2007
2000
2006
2007
(1) Age is as of March 5, 2009.
(2)
Each of the foregoing officers has been designated by our Board of Directors as an executive officer for purposes of Section 16 of the
Exchange Act.
14
Item 1A. Risk Factors
Statements contained in this Form 10-K may be “forward-looking” within the meaning of the Section 21E
of the Exchange Act. Such forward-looking statements are subject to certain risks and uncertainties that could
cause our operating results to differ materially from those projected. The following factors, among others, in
some cases have affected, and in the future could affect, our actual financial performance.
RESERVES
If our estimated liability for losses and loss expenses is incorrect, our reserves may be inadequate to cover
our ultimate liability for losses and loss expenses and may have to be increased.
We establish and carry, as a liability, reserves based on actuarial estimates of the amount to be paid in the
future to settle all claims incurred as of the end of the accounting period. We maintain loss reserves to cover our
estimated ultimate unpaid liability for losses and loss expenses with respect to reported and unreported claims
incurred as of the end of each accounting period. Reserves do not represent an exact calculation of liability, but
instead represent estimates, generally using actuarial projection techniques at a given accounting date. These
reserve estimates are expectations of what the ultimate settlement and administration of claims will cost based on
our assessment of facts and circumstances then known, review of historical settlement patterns, estimates of
trends in claims severity and frequency, legal theories of liability and other factors. Variables in the reserve
estimation process can be affected by both internal and external events, such as changes in claims handling
procedures, trends in loss costs, economic inflation, legal trends and legislative changes. Many of these items are
not directly quantifiable, particularly on a prospective basis. Additionally, there may be a significant reporting
lag between the occurrence of an insured event and the time a claim is actually reported to the insurer. We refine
reserve estimates in a regular ongoing process as historical loss experience develops and additional claims are
reported and settled. We record adjustments to reserves in the results of operations for the periods in which the
estimates are changed. In establishing reserves, we take into account estimated recoveries for reinsurance and
salvage and subrogation.
Because estimating reserves is an inherently uncertain process, currently established reserves may not be
adequate. If we conclude the estimates are incorrect and our reserves are inadequate, we are obligated to increase
our reserves. An increase in reserves results in an increase in losses and a reduction in our net income for the
period in which the deficiency in reserves is identified. Accordingly, an increase in reserves could have a
material adverse effect on our results of operations, liquidity and financial condition.
CATASTROPHE LOSSES AND GEOGRAPHIC CONCENTRATIONS
The occurrence of catastrophic events could materially reduce our profitability.
Our insurance operations expose us to claims arising out of catastrophic events. We have experienced, and
will in the future experience, catastrophe losses that may cause substantial volatility in our financial results for
any fiscal quarter or year and could materially reduce our profitability or harm our financial condition. Our
ability to write new business also could be affected. Catastrophes can be caused by various natural events,
including hurricanes, hailstorms, tornadoes, windstorms, earthquakes, severe winter weather and fires, none of
which are within our control. Catastrophe losses can vary widely and could significantly impact our results. The
frequency and severity of catastrophes are inherently unpredictable. Additionally, catastrophe losses incurred by
residual markets or pooling mechanisms (such as wind pools) in certain states could trigger assessments to the
Company. Such assessments could be material and may not be recoupable, depending on the applicable state
mechanism.
The magnitude of loss from a catastrophe is a function of the severity of the event and the total amount of
insured exposure in the affected area. Catastrophes to which we are exposed, including hurricanes, earthquakes
and other perils, may be severe and produce significant loss. We are also exposed to significant loss from less
15
severe catastrophes when they affect large geographic areas or areas that are heavily populated. Although
catastrophes can cause losses in a variety of our property and casualty lines, most of our catastrophe claims in the
past have related to homeowners, allied lines and commercial multi-peril coverages. The geographic distribution
of our business subjects us to catastrophe exposure from tornadoes, hailstorms and earthquakes in the Midwest as
well as catastrophe exposure from hurricanes affecting the Gulf Coast and Atlantic coast areas, including the
Southeast, Mid-Atlantic and Northeast regions. See “Narrative Description of Business – Regulation” in Item 1
of this Form 10-K for a discussion regarding our recent personal lines action with respect to Florida. In the last
three years, the largest catastrophe or series of catastrophes to affect STFC’s results of operations in any one year
travelled through the Midwest resulting in
were as follows: 2008 with losses from Hurricane Ike as it
approximately $44.1 million in pre-tax losses; 2007 with losses from a hail storm in early June causing $10.8
million in pre-tax losses; and 2006 with losses from hurricanes Katrina and Wilma resulting in approximately
$42.8 million in pre-tax losses.
We believe that increases in the value and geographic concentration of insured properties and the effects of
inflation could increase the severity of claims from catastrophic events in the future. In addition, states have from
time to time passed legislation that limits the ability of insurers to manage catastrophe risk, such as legislation
prohibiting insurers from withdrawing from catastrophe-prone areas. Although we attempt to reduce the impact
of catastrophes on our business by controlling concentrations of exposures in catastrophe prone areas and through
the purchase of reinsurance covering various categories of catastrophes, reinsurance may prove inadequate if a
major catastrophic loss exceeds the reinsurance limit, or an insurance subsidiary incurs a number of smaller
catastrophes that, individually, fall below the reinsurance retention level.
UNDERWRITING AND PRICING
Our financial results depend primarily on our ability to underwrite risks effectively and to charge
adequate rates to policyholders.
Our financial condition, cash flows and results of operations depend on our ability to underwrite and set
rates accurately for a full spectrum of risks, across a number of lines of insurance. Rate adequacy is necessary to
generate sufficient premium to pay losses, loss adjustment expenses and underwriting expenses and to earn a
profit.
Our ability to underwrite and set rates effectively is subject to a number of risks and uncertainties,
including, without limitation:
•
•
•
•
•
•
•
•
•
•
the availability of sufficient, reliable data;
our ability to conduct a complete and accurate analysis of available data;
our ability to timely recognize changes in trends and to project both the severity and frequency of
losses with reasonable accuracy;
uncertainties which are generally inherent in estimates and assumptions;
our ability to project changes in certain operating expense levels with reasonable certainty;
the development, selection and application of appropriate rating formulae or other pricing
methodologies;
our use of modeling tools to assist with correctly and consistently achieving the intended results in
underwriting and pricing ;
our ability to innovate with new pricing strategies, and the success of those innovations on
implementation;
our ability to secure regulatory approval of premium rates on an adequate and timely basis;
our ability to predict policyholder retention accurately;
16
•
•
•
•
•
•
•
•
unanticipated court decisions, legislation or regulatory action;
unanticipated changes in our claim settlement practices;
changing driving patterns for auto exposures; changing weather patterns for property exposures;
changes in the medical sector of the economy;
unanticipated changes in auto repair costs, auto parts prices and used car prices;
impact of inflation and other factors on cost of construction materials and labor;
our ability to monitor property concentration in catastrophe prone areas, such as hurricane, earthquake
and wind/hail regions; and
the general state of the economy in the states in which we operate.
Such risks may result in our rates being based on inadequate or inaccurate data or inappropriate assumptions
or methodologies, and may cause our estimates of future changes in the frequency or severity of claims to be
incorrect. As a result, we could under price risks, which would negatively affect our margins, or we could
overprice risks, which could reduce our volume and competitiveness. In either event, our operating results,
financial condition and cash flows could be materially adversely affected.
REINSURANCE
Reinsurance may not be available or adequate to protect us against losses.
We use reinsurance to help manage our exposure to insurance risks. The availability and cost of reinsurance
are subject to prevailing market conditions, which can affect our business volume and profitability. Although the
reinsurer is liable to us to the extent of the ceded reinsurance, we remain liable as the direct insurer on all risks
reinsured. Ceded reinsurance arrangements do not eliminate our obligation to pay claims. As a result, we are
subject to counterparty risk with respect to our ability to recover amounts due from reinsurers. Reinsurance may
not be adequate to protect us against losses and may not be available to us in the future at commercially
reasonable rates. In addition, the magnitude of losses in the reinsurance industry resulting from catastrophes may
adversely affect the financial strength of certain reinsurers, which may result in our inability to collect or recover
reinsurance. Reinsurers also may reserve their right to dispute coverage with respect to specific claims. With
respect to catastrophic or other loss, if we experience difficulty collecting from reinsurers or obtaining additional
reinsurance in the future, we will bear a greater portion of the total financial responsibility for such loss, which
could materially reduce our profitability or harm our financial condition.
CYCLICAL NATURE OF THE INDUSTRY
The property and casualty insurance industry is highly cyclical, which may cause fluctuations in our
operating results.
The property and casualty insurance industry, particularly business insurance, has been historically
characterized by periods of intense price competition due to excess underwriting capacity, as well as periods of
shortages of underwriting capacity that result in higher prices and more restrictive contract and/or coverage
terms. The periods of intense price competition may adversely affect our operating results, and the overall
cyclicality of the industry may cause fluctuations in our operating results. While we may adjust prices during
periods of intense competition, it remains our strategy to allow for acceptable profit levels and to decline
coverage in situations where pricing or risk would not result in acceptable returns. Accordingly, our commercial
lines business tends to contract during periods of severe competition and price declines and expand when market
pricing allows an acceptable return.
17
The personal lines businesses are characterized by an auto underwriting cycle of loss cost trends. Driving
patterns, inflation in the cost of auto repairs and medical care and increasing litigation of liability claims are
some of the more important factors that affect loss cost trends. Inflation in the cost of building materials and
labor costs and demand caused by weather-related catastrophic events affect personal lines homeowners loss cost
trends. Our Company and other personal lines insurers may be unable to increase premiums at the same pace as
coverage costs increase. Accordingly, profit margins generally decline in periods of increasing loss costs.
CURRENT ECONOMIC CONDITIONS
The current and future difficult economic conditions can adversely affect our business, results of
operations and financial condition.
The current economic slowdown and any further economic decline in future reporting periods could
adversely impact our business and results of operations. While the volatility of the current economic climate
makes it difficult for us to predict the complete impact of this slowdown on our business and results of
operations, our business may be impacted in a variety of ways.
The economy is causing consumers and businesses to decrease their spending, which may impact the
demand for our insurance products. For example, declining automotive sales and weaknesses in the housing
market generally impact the purchase of our personal auto and homeowners insurance products by consumers
and business insurance products by businesses involved in these industries. As unemployment rates rise, there
may be a tendency for the number of workers’ compensation claims to increase, as laid-off and unemployed
workers may seek workers’ compensation benefits to replace their lost health care benefits. Similarly, uninsured
and underinsured motorist claims may rise.
The volatility and weakness in the financial and capital markets have negatively impacted, and may
continue to negatively impact, the value of our investment portfolio.
We may be adversely affected by business difficulties, bankruptcies and impairments of other parties with
whom we do business, such as independent agents, reinsurers or banks, which increases our credit risk and other
counterparty risks.
In addition, departments of insurance, taxing authorities and other state and local agencies may seek to
impose or increase taxes, assessments and other revenue-generating fees in response to funding reductions
caused by the current economic downturn. These actions may increase the cost of doing business in these states.
In response to the current economic conditions,
the United States federal government and other
governmental and regulatory bodies have taken or are considering taking action to address such conditions
including, among other things, purchasing mortgage-backed and other securities from financial institutions,
investing directly in banks, thrifts and bank and savings and loan holding companies and increasing federal
spending to stimulate the economy. There can be no assurance as to what impact such actions will have on the
financial markets, current economic conditions or our Company.
Adverse capital and credit market conditions may negatively affect our ability to meet unexpected
liquidity needs or to obtain credit on acceptable terms.
The capital and credit markets have been experiencing significant volatility and disruption. In some cases,
the markets have negatively affected the availability of liquidity and credit capacity. In the event that we need
access to additional capital to pay our operating expenses, make payments on our indebtedness, pay for capital
expenditures or fund acquisitions, our ability to obtain such capital may be constrained and the cost of any such
capital may be significant. Our ability to obtain additional financing will depend on numerous factors, such as
market conditions, the general availability of credit, the overall availability of credit to our industry, our credit
18
ratings and credit capacity, as well as lenders’ perception of our long- or short-term financial prospects. Our
access to funds may also be constrained if regulatory authorities or rating agencies take negative actions. If
certain factors were to occur, our internal sources of liquidity may prove to be insufficient and we may not be
able to successfully obtain additional financing on satisfactory terms.
DISTRIBUTION SYSTEM
The independent agency system is the distribution system for our products. Use of this distribution system
may constrain our ability to grow at a comparable pace to our competitors that utilize multiple distribution
channels. In addition, consumers may prefer to purchase insurance products through alternative channels,
such as through the internet, rather than through agents.
We market our insurance products through independent, non-exclusive insurance agents, whereas some of
our competitors sell their insurance products through direct marketing techniques, the internet or “captive”
insurance agents who sell products exclusively for one insurance company. The State Auto Group has supported
the independent agency system as our sole distribution channel for the past 87 years. However, we recognize that
although the number of distribution locations has expanded, the number of independent agencies in the industry
has dramatically shrunk over the past several years due to agency purchases, consolidations, bankruptcies and
agent retirements. We also recognize that it will be progressively more difficult to expand the number of
independent agencies representing us. If we are unsuccessful in maintaining and increasing the number of
agencies in our independent agency distribution system, our sales and results of operations could be adversely
affected.
The agents that market and sell our products also sell products of our competitors. These agents may
recommend our competitors’ products over our products or may stop selling our products altogether. Our strategy
of not pursuing market share at prices that are not expected to produce an underwriting profit can have the effect
of making top line growth more difficult. When price competition is intense, this effect is exaggerated by the fact
our independent agent distribution force has products to sell from other carriers that may be more willing to
lower prices to grow top line sales. Consequently, we must remain focused on attracting and retaining productive
agents to market and sell our products. We compete for productive agents primarily on the basis of our financial
position, support services, ease of doing business, compensation and product features. Although we make efforts
to ensure we have strong relationships with our independent agents and to persuade them to promote and sell our
products, we may not be successful in these efforts. If we are unsuccessful in attracting and retaining these
agents, our sales and results of operations could be adversely affected.
In addition, consumers are increasingly using the internet and other alternative channels to purchase
insurance products. While our website provides a significant amount of information about our insurance
products, consumers cannot purchase insurance through our website. Instead, consumers must contact one of our
independent agents in order to purchase any of our insurance products or make changes to their existing policies.
This sole distribution system may place us at a disadvantage with consumers who prefer to purchase insurance
products online or through other alternative distributions channels.
REGULATION
Our business is heavily regulated, and changes in regulation may reduce our profitability and limit our
growth.
We are subject to extensive regulation in the states in which we conduct business. This regulation is
generally designed to protect the interests of policyholders, as opposed to stockholders and other investors, and
relates to authorization for lines of business, capital and surplus requirements,
limitations,
transactions with affiliates, dividend limitations (see “Narrative Description of
underwriting limitations,
Business-Regulation-Dividends” in Item 1) changes in control, premium rates and a variety of other financial and
investment
19
non-financial components of an insurance company’s business. The NAIC and state insurance regulators are
constantly reexamining existing laws and regulations, generally focusing on modifications to holding company
regulations, interpretations of existing laws and the development of new laws.
From time to time, some states in which we conduct business have considered or enacted laws that may alter
or increase state authority to regulate insurance companies and insurance holding companies. In other situations,
states in which we conduct business have considered or enacted laws that impact the competitive environment
and marketplace for property and casualty insurance. For example, in 2007, Florida enacted legislation that
required us to charge rates for homeowners insurance that we believed were inadequate to cover the related
underwriting risk. After careful analysis of this legislation, we concluded that we could no longer operate our
personal lines on a profitable basis in that state. Accordingly, during the second quarter 2007, we filed an
application with the Florida Department of Insurance to withdraw from this state’s personal lines insurance
market effective January 1, 2008. Non-renewals on our personal lines business occurred throughout 2008. We
continue to write commercial lines business in Florida.
Nearly all states require licensed insurers to participate in guaranty funds through assessments covering a
portion of insurance claims against impaired or insolvent insurers. An increase in the magnitude of impaired
companies could result in an increase in our share of such assessments. Residual market or pooling arrangements
exist in many states to provide certain types of insurance coverage to those that are otherwise unable to find
private insurers willing to insure them. Licensed insurers voluntarily writing such coverage are required to
participate in these residual markets or pooling mechanisms. Such participation exposes the Company to possible
to our results of operations. The potential availability of
assessments, some of which could be material
recoupments or premium rate increases, if applicable, may not offset such assessments in the financial statements
nor do so in the same fiscal periods.
Many of the states in which we operate have passed or are considering legislation restricting or banning the
use of credit scoring in rating and/or risk selection in personal lines of business. Similarly, several states are
considering restricting insurers’ rights to use loss history information maintained in various databases by
insurance support organizations. These tools help us price our products more fairly and enhance our ability to
compete for business that we believe will be profitable. Such regulations would limit our ability, as well as the
ability of all other insurance carriers operating in any affected jurisdiction, to take advantage of these tools.
Currently the federal government does not directly regulate the insurance business. However, in recent years
the state insurance regulatory framework has come under increased federal scrutiny. Congress and some federal
agencies from time to time investigate the current condition of insurance regulation in the United States to
determine whether to impose federal regulation or to allow an optional federal charter, similar to banks. In
addition, changes in federal legislation and administrative policies in several areas, including changes in the
Gramm-Leach-Bliley Act, financial services regulation and federal
the
insurance industry and us.
taxation, can significantly impact
We cannot predict with certainty the effect any enacted, proposed or future state or federal legislation or
NAIC initiatives may have on the conduct of our business. Furthermore, there can be no assurance that the
regulatory requirements applicable to our business will not become more stringent in the future or result in
materially higher costs than current requirements. Changes in the regulation of our business may reduce our
profitability, limit our growth or otherwise adversely affect our operations.
We could be adversely affected if our controls designed to assure compliance with guidelines, policies, and
legal and regulatory standards are ineffective. Our business is dependent on our ability to regularly engage in a
large number of insurance underwriting, claim processing and investment activities, many of which are
complex. These activities often are subject to internal guidelines and policies, as well as legal and regulatory
requirements. No matter how well designed and executed, control systems provide only reasonable assurance that
the system objectives will be met. If our controls are not effective, it could lead to financial loss, unexpected risk
exposures or damage to our reputation.
20
CLAIM AND COVERAGE DEVELOPMENTS
Developing claim and coverage issues in our industry are uncertain and may adversely affect our
insurance operations.
As industry practices and legislative, judicial and regulatory conditions change, unexpected and unintended
issues related to claims and coverage may develop. These issues could have an adverse effect on our business by
either extending coverage beyond our underwriting intent or by increasing the frequency or severity of claims.
The premiums we charge for our insurance products are based upon certain risk expectations. When legislative,
judicial or regulatory authorities expand the burden of risk beyond our expectations, the premiums we previously
charged or collected may no longer be sufficient to cover the risk, and we do not have the ability to retroactively
modify premium amounts. Furthermore, our reserve estimates do not take into consideration a major retroactive
expansion of coverage through legislative or regulatory actions or judicial interpretations.
In particular, court decisions have had, and are expected to continue to have, significant impact on the
property and casualty insurance industry. Court decisions may increase the level of risk which insurers are
expected to assume in a number of ways, such as by eliminating exclusions, increasing limits of coverage,
creating rights in claimants not intended by the insurer and interpreting applicable statutes expansively to create
obligations on insurers not originally considered when the statute was passed. In some cases, court decisions
have been applied retroactively. Court decisions have also negated legal reforms passed by state legislatures.
There is also a growing trend of plaintiffs targeting property and casualty insurers, including us, in
purported class action litigation relating to claim-handling and other practices, particularly with respect to the
handling of personal lines auto and homeowners claims.
Many of these issues are beyond our control. The effects of these and other unforeseen claims and coverage
issues are extremely hard to predict and could materially harm our business and results of operations.
TERRORISM
Terrorist attacks, and the threat of terrorist attacks, and ensuing events could have an adverse effect on
us.
Terrorism, both within the United States and abroad, and military and other actions and heightened security
measures in response to these types of threats, may cause loss of life, property damage, reduced economic
activity, and additional disruptions to commerce. Actual terrorist attacks could cause losses from insurance
claims related to the property and casualty insurance operations of the State Auto Group, as well as a decrease in
our stockholders’ equity, net income and/or revenue. The Terrorism Acts require the federal government and the
insurance industry to share in insured losses up to $100 billion per year resulting from certain future terrorist
attacks within the United States. Under the Terrorism Acts, we must offer our commercial policyholders
coverage against certified acts of terrorism. In December 2007, the United States Congress extended the
Terrorism Acts through December 31, 2014, and made some modest changes to the Terrorism Acts. We are
evaluating these changes to the Terrorism Act and are taking actions to comply. See “Narrative Description of
Business-Regulation” of this Item 1 for a discussion of the Terrorism Acts.
In addition, some of the assets in our investment portfolio may be adversely affected by declines in the
equity markets and economic activity caused by the continued threat of terrorism, ongoing military and other
actions and heightened security measures. We cannot predict at this time whether and the extent to which
industry sectors in which we maintain investments may suffer losses as a result of potentially decreased
commercial and economic activity, or how any such decrease might impact the ability of companies within the
affected industry sectors to pay interest or principal on their securities, or how the value of any underlying
collateral might be affected.
21
TECHNOLOGY AND AUTOMATION
Our development of business insurance lines automated underwriting tools may not be successful or the
benefits may not be realized. In addition our business success and profitability depend, in part, on effective
information technology systems and facilities. If we are unable to keep pace with the rapidly developing
technological advancements in the insurance industry, our ability to compete effectively could be impaired.
We are developing a business insurance agency portal (bizXpressSM) that will build upon the success we
believe we have achieved through our personal insurance agency portal (netXpressSM). Our bizXpress allows
agents to obtain business insurance quotes for applicants via the internet in real time. This technology enables our
agents to prepare a quote proposal and applications for their prospective customer at the point of sale.
While this represents a significant commitment of resources, we believe it is vitally important to our ability
to maintain our prospects in business insurance lines. Such automation was successfully put into production
for the business auto product during the first half of 2008. In 2009, we expect to complete work on an enhanced
Businessowners product and begin automation for workers compensation products. We cannot be sure that the
development of this technology will be completed within the projected 12-18 month timeframe, or that it will be
successful upon implementation. Additionally, because some of our competitors have already implemented or
may be implementing similar types of technology, we may be competitively disadvantaged. A challenge during
this development phase will be the utilization of today’s technology in face of a constantly changing
technological landscape. There can be no assurance that the development of today’s technology for tomorrow’s
use will not result in our being competitively disadvantaged, especially among the larger national carriers that
have greater financial and human resources than we.
We depend in large part on our technology systems and facilities for conducting business and processing
claims. Our business success is dependent on maintaining the effectiveness of existing technology systems and
facilities and on continuing to develop and enhance technology systems and facilities that support our business
processes and strategic initiatives in a cost effective manner. If we are unable to keep pace with the
advancements being made in technology, our ability to compete with other insurance companies who have
advanced technological capabilities will be negatively affected. Further, if we are unable to update or replace our
key legacy systems and facilities as they become obsolete or as emerging technology renders them competitively
inefficient, our competitive position and/or cost structure could be adversely affected.
INVESTMENTS
The performance of our investment portfolios is subject to investment risks.
Like other property and casualty insurance companies, we depend on income from our investment portfolio
for a portion of our revenues and earnings and are therefore subject to market risk and the risk that we will incur
losses due to adverse changes in equity, interest, commodity or foreign currency exchange rates and prices. Our
primary market risk exposures are to changes in interest rates and equity prices. Individual securities in our fixed-
income portfolio are subject to credit risk. Downgrades in the credit ratings of fixed maturities can have a
significant negative effect on the market valuation of such securities.
If the fixed-income or equity portfolios, or both, were to be impaired by market, sector or issuer-specific
conditions to a substantial degree, our liquidity, financial position and financial results could be materially
adversely affected. Under these circumstances, our income from these investments could be materially reduced,
and declines in the value of certain securities could further reduce our reported earnings and capital levels. A
decrease in value of our investment portfolio could also put our insurance subsidiaries at risk of failing to satisfy
regulatory minimum capital requirements. If we were not at that time able to supplement our subsidiaries’ capital
from STFC or by issuing debt or equity securities on acceptable terms, our business could be materially
adversely affected. Also, a decline in market rates could cause the investments in our pension plans to decrease
below the accumulated benefit obligation, resulting in additional expense and increasing required contributions to
the pension plan.
22
In addition, our investments are subject to risks inherent in the nation’s and world’s capital markets. The
functioning of those markets, the values of the investments held by us and our ability to liquidate investments on
favorable terms or short notice may be adversely affected if those markets are disrupted or otherwise affected by
local, national or international events, such as power outages, system failures, wars or terrorist attacks or by
recessions or depressions, a significant change in inflation expectations, a significant devaluation of
governmental or private sector credit, currencies or financial markets and other factors or events.
Changes in tax laws impacting marginal tax rates and/or the preferred tax treatment of municipal obligations
under current law, could adversely affect the market value of municipal obligations. Since 74.8%, at fair value, of
our investment portfolio at December 31, 2008 is invested in tax-exempt municipal obligations, any such
changes in tax law could adversely affect the value of the investment portfolio. Additionally, any such changes in
tax law could reduce the difference between tax-exempt interest rates and taxable rates.
EMPLOYEES
Our ability to attract, develop and retain talented employees, managers and executives, and to maintain
appropriate staffing levels, is critical to our success.
Our success depends on our ability to attract, develop and retain talented employees, including executives
and other key managers in a specialized industry. Our loss of certain key officers and employees or the failure to
attract and develop talented new executives and managers could have a materially adverse effect on our business.
In addition, we must forecast the changing business environments (for multiple business units and in many
geographic markets) with reasonable accuracy and adjust hiring programs and/or employment levels accordingly.
Our failure to recognize the need for such adjustments, or the failure or inability to react appropriately on a
timely basis, could lead either to over-staffing (which would adversely affect our cost structure) or under-staffing
(impairing our ability to service our ongoing and new business) in one or more business units or locations. In
either event, our financial results could be materially adversely affected.
BUSINESS CONTINUITY
Our business depends on the uninterrupted operation of our facilities, systems and business functions,
including our information technology and other business systems.
Our business is highly dependent upon our ability to perform, in an efficient and uninterrupted fashion,
necessary business functions, such as Internet support and 24-hour claims contact centers, processing new and
renewal business, and processing and paying claims. A shut-down of or inability to access one or more of our
facilities, a power outage, a pandemic, or a failure of one or more of our
information technology,
telecommunications or other systems could significantly impair our ability to perform such functions on a timely
basis. In addition, because our information technology and telecommunications systems interface with and
depend on third party systems, we could experience service denials if demand for such service exceeds capacity
or a third party system fails or experiences an interruption. If sustained or repeated, such a business interruption,
systems failure or service denial could result in a deterioration of our ability to write and process new and
renewal business, provide customer service, pay claims in a timely manner or perform other necessary corporate
functions. This could result in a materially adverse effect on our business results and liquidity.
A security breach of our computer systems could also interrupt or damage our operations or harm our
reputation. In addition, we could be subject to liability if confidential customer information is misappropriated
from our computer systems. Despite the implementation of security measures, including hiring an independent
firm to perform intrusion vulnerability testing of our computer infrastructure, these systems may be vulnerable to
physical break-ins, computer viruses, programming errors, attacks by third parties or similar disruptive problems.
Any well-publicized compromise of security could deter people from entering into transactions that involve
transmitting confidential information to our systems, which could have a material adverse effect on our business.
23
We have established a business continuity plan in an effort to ensure the continuation of core business
operations in the event that normal business operations could not be performed due to a catastrophic event. While
we continue to test and assess our business continuity plan to ensure it meets the needs of our core business
operations and addresses multiple business interruption events,
there is no assurance that core business
operations could be performed upon the occurrence of such an event.
ACQUISITIONS
Acquisitions subject us to a number of financial and operational risks.
Since going public in 1991, we and State Auto Mutual have acquired or affiliated with other insurance
companies, such as the MIGI Insurers, Milbank, Farmers, SA Wisconsin, and most recently the Beacon
Insurance Group and Patrons Insurance Group. It is anticipated that we and State Auto Mutual will continue to
pursue acquisitions or affiliations of other insurance companies in the future.
Acquisitions and affiliations involve numerous risks and uncertainties, such as:
•
•
•
•
•
•
•
obtaining necessary regulatory approvals may prove to be more difficult than anticipated;
integrating the business may prove to be more costly than anticipated;
integrating the 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);
loss results of the acquired or affiliated company or business may be worse than expected;
losses may develop differently than what we expected them to; and
retaining key employees of the acquired company or business may prove to be more difficult than
anticipated.
In addition, other companies in the insurance industry have similar acquisition and affiliation strategies.
Competition for target companies or businesses may intensify or we may not be able to complete such
acquisitions or affiliations on terms and conditions acceptable to us. Additionally, the costs of unsuccessful
acquisition and affiliation efforts may adversely affect our financial performance.
FINANCIAL STRENGTH RATINGS
A downgrade in our financial strength ratings may negatively affect our business.
Insurance companies are subject to financial strength ratings produced by external rating agencies. Higher
ratings generally indicate financial stability and a strong ability to pay claims. Ratings are assigned by rating
agencies to insurers based upon factors that they believe are relevant to policyholders and creditors. Ratings are
important to maintaining public confidence in our Company and in our ability to market our products. A
downgrade in our financial strength ratings could, among other things, negatively affect our ability to sell certain
insurance products, our relationships with agents, new sales and our ability to compete.
Although other agencies cover the property and casualty industry, we believe our ability to write business is
most influenced by our rating from A.M. Best. According to A.M. Best, its ratings are designed to assess an
insurer’s financial strength and ability to meet ongoing obligations to policyholders. Our Pooled Companies and
SA National currently have a rating from A.M. Best Company of A+ (Superior) (the second highest of A.M.
Best’s 15 ratings). We may not be able to maintain our current A.M. Best ratings.
24
CONTROL BY OUR PARENT COMPANY
Our parent company owns a significant interest in us and may exercise its control in a manner
detrimental to your interests.
As of December 31, 2008, our parent company owned approximately 64% of the voting power of our
Company. Therefore, State Auto Mutual has the power to direct our affairs and is able to determine the outcome
of substantially all matters required to be submitted to stockholders for approval, including the election of all our
directors. State Auto Mutual could exercise its control over us in a manner detrimental to the interests of other
STFC stockholders.
COMPETITION
Our industry is highly competitive, which could adversely affect our sales and profitability.
The property and casualty insurance business is highly competitive, and we compete with a large number of
other insurers. Many of our competitors have well-established national reputations, and substantially greater
financial, technical and operating resources and market share than we. We may not be able to effectively
compete, which could adversely affect our sales or profitability. We believe that competition in our lines of
business is based primarily on price, service, commission structure, product features, financial strength ratings,
reputation and name or brand recognition. Our competitors sell through various distribution channels, including
independent agents, captive agents and directly to the consumer. We compete not only for business insurance
customers and personal insurance customers, but also for independent agents to market and sell our products.
Some of our competitors offer a broader array of products, have more competitive pricing or have higher claims
paying ability ratings. In addition, other financial institutions are now able to offer services similar to our own as
a result of the Gramm-Leach-Bliley Act.
The increased transparency that arises from information available from the use of tools such as comparative
rater software, could work to our disadvantage. We may have difficulty differentiating our products or becoming
among the lowest cost providers. Expense efficiencies are important to maintaining and increasing our growth
and profitability. If we are unable to realize future expense efficiencies, it could affect our ability to establish
competitive pricing and could have a negative effect on new business growth and retention of existing
policyholders.
VOLATILITY OF OUR COMMON STOCK
The price of our common stock could be volatile.
limited to,
The trading price of our common stock may fluctuate substantially due to a variety of factors, certain of
which may not be related to our operating performance and are beyond our control. Such factors include, but are
not
the following: variations in our actual or anticipated operating results or changes in the
expectations of financial market analysts; investor perceptions of our Company and/or the property and casualty
industry; market conditions in the insurance industry and any significant volatility in the market; and major
catastrophic events.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
We share our operating facilities with State Auto Mutual pursuant to the terms of the 2005 Management
Agreement. Our corporate headquarters are located in Columbus, Ohio, in buildings owned by State Auto Mutual
25
that contain approximately 280,000 square feet of office space. Our Company and State Auto Mutual also own
and lease other office facilities in numerous locations throughout the State Auto Group’s geographical areas of
operation.
Item 3. Legal Proceedings
We are a party to a number of legal proceedings arising in the ordinary course of our insurance business.
Our Management believes that the ultimate resolution of these proceedings will not, individually or in the
aggregate, have a material, adverse effect on our financial condition.
Item 4. Submission of Matters to a Vote of Security Holders
None.
26
PART II
Item 5. Market for the Registrant’s Common Equity, Related Shareholder Matters, and Issuer Purchases
of Equity Securities
Market Information; Holders of Record
Our common shares are traded on the NASDAQ Global Select Market under the symbol STFC. As of
February 25, 2009, there were 1,448 stockholders of record of our common shares.
Market Price Ranges and Dividends Declared on Common Shares
Initial Public Offering—June 28, 1991 – $2.25(1). The following table provides information with respect to
the high and low sale prices of our common shares for each quarterly period for the past two years as reported by
NASDAQ, along with the amount of cash dividends declared by us with respect to our common shares for each
quarterly period for the past two years:
2008
High
Low
Dividend
First Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Second Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Third Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fourth Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$30.08
30.00
37.08
32.00
$23.29
23.91
21.83
17.38
$0.15
0.15
0.15
0.15
2007
High
Low
Dividend
First Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Second Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Third Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fourth Quarter
$35.22
34.00
32.25
32.38
$30.61
28.67
23.99
25.39
$0.10
0.10
0.15
0.15
(1) Adjusted for stock splits.
Additionally, see Item 7 of this Form 10-K, “Management’s Discussion and Analysis of Financial Condition
and Results of Operations—Liquidity and Capital Resources—Regulatory Considerations,” for additional
information regarding regulatory restrictions on the payment of dividends to State Auto Financial by its
insurance subsidiaries.
Purchases of Common Shares by the Company
On August 17, 2007, State Auto Financial announced that its board of directors had authorized the
repurchase, from time to time, of up to 4.0 million of its common shares, or approximately 10% of State Auto
Financial’s outstanding shares, over a period extending until December 31, 2009. State Auto Financial will
repurchase shares from State Auto Mutual in amounts that are proportional to the respective current ownership
percentages of State Auto Mutual, which is approximately 64%, and other shareholders.
27
Performance Graph
The line graph below compares the total return on $100 invested on December 31, 2003, in STFC’s shares,
the CRSP Total Return Index for the NASDAQ Stock Market (“NASDAQ Index”), and the CRSP Total Return
Index for NASDAQ insurance stocks (“NASDAQ Ins. Index”), with dividends reinvested.
s
r
a
l
l
o
D
200
150
100
50
0
Comparison of Cumulative Total Return
2003
2004
2005
2006
2007
2008
STFC
NASDAQ Index
NASDAQ Ins. Index
STFC . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
NASDAQ Index . . . . . . . . . . . . . . . . . . . . .
NASDAQ Ins. Index . . . . . . . . . . . . . . . . .
100.000
100.000
100.000
111.482
109.101
121.489
158.404
111.381
134.699
152.322
122.892
153.188
117.711
135.954
154.533
137.225
81.846
139.740
12/31/2003
12/31/2004
12/31/2005
12/31/2006
12/31/2007
12/31/2008
28
Item 6. Selected Consolidated Financial Data
(dollars and shares in millions, except per share data)
Statement of Income Data—
GAAP Basis:
Year ended December 31:
2008*
2007
2006
2005*
2004
Earned premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net (loss) income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Earned premium growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Return on average invested assets(1) . . . . . . . . . . . . . . . . . . . .
$1,126.0
$
87.4
$1,181.9
$ (31.1)
1,011.6
84.7
1,113.4
119.1
11.3% (1.2)
4.1%
4.3
1,023.8
83.1
1,117.4
120.4
(2.5)
4.4
1,050.3
78.7
1,139.5
125.9
4.3
4.3
1,006.8
71.8
1,092.4
110.0
4.8
4.5
Balance Sheet Data—
GAAP Basis:
Total investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total notes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . .
Common shares outstanding . . . . . . . . . . . . . . . . . . . . . . . . .
Return on average equity(2) . . . . . . . . . . . . . . . . . . . . . . . . . . .
Debt to capital ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,941.3
2,021.2
$2,443.6
2,337.9
$ 117.6
118.0
$ 761.0
935.5
39.6
40.5
(3.7)% 13.5
13.4% 11.2
1,937.9
2,255.1
118.4
834.2
41.0
15.1
12.4
1,879.9
2,274.9
118.7
763.5
40.5
17.7
13.5
1,699.1
2,168.4
164.5
658.2
40.1
18.3
20.0
Per Common Share Data—
GAAP Basis:
Basic EPS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Diluted EPS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash dividends per share . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Book value per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ (0.78)
$ (0.78)
$
0.60
$ 19.23
Common Share Price:
High . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Low . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Close at December 31 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Close price to basic EPS . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Close price to book value per share . . . . . . . . . . . . . . . . . . . .
$ 37.08
$ 17.38
$ 30.06
(38.54)
1.56
2.90
2.86
0.50
23.10
35.22
23.99
26.30
9.07
1.14
GAAP Ratios:(3)
Loss and LAE ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expense ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Combined ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Statutory Ratios:(3)
Loss and LAE ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expense ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Combined ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . .
Industry combined ratio(4)
Net premiums written to surplus(5) . . . . . . . . . . . . . . . . . . . . .
75.2% 58.4
34.6% 34.4
109.8% 92.8
74.8% 57.9
33.1% 33.2
107.9% 91.1
104.7% 95.6
1.1
1.6
2.95
2.90
0.38
20.32
39.94
28.40
34.68
11.76
1.71
57.4
34.0
91.4
56.8
32.9
89.7
92.4
1.2
3.12
3.06
0.27
18.86
38.15
24.30
36.46
11.69
1.93
58.4
31.7
90.1
58.4
31.6
90.0
101.2
1.5
2.76
2.70
0.17
16.42
31.83
22.12
25.85
9.37
1.57
61.5
30.2
91.7
61.6
30.6
92.2
98.9
1.6
(1)
Invested assets include investments and cash equivalents.
(2) Net income (loss) divided by average common stockholders’ equity.
(3) GAAP ratios are computed using earned premiums for both the loss and LAE ratio and the expense ratio, and include the effect of
eliminations in consolidation. The statutory expense ratio is computed using net written premiums. We use the statutory combined ratio
to compare our results to the industry statutory combined ratio as there is no industry GAAP combined ratio available.
The industry combined ratios are from A.M. Best. The 2008 industry combined ratio is an estimate.
(4)
(5) We use the statutory net premiums written to surplus ratio as there is no comparable GAAP measure. This ratio, also called the leverage
ratio, measures our statutory surplus available to absorb losses.
Reflects changes in Pooling Arrangements, effective January 1, 2008 and 2005.
*
29
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Capitalized terms used in this Item 7 and not otherwise defined have the meanings ascribed to such terms
under the caption “Important Defined Terms Used in this Form 10-K” which immediately precedes Part I of this
Form 10-K.
OVERVIEW
State Auto Financial is a property and casualty insurance holding company primarily engaged in writing
both personal and business lines of insurance. The State Auto Group markets a broad line of property and
casualty insurance products through independent agencies in 33 states.
State Auto Financial’s subsidiaries are State Auto P&C, Milbank, Farmers, SA Ohio and SA National, each
of which is a property and casualty insurance company; Stateco, which provides investment management
services to affiliated insurance companies; S.I.S., a developer and seller of insurance-related software; and 518
PML, which owns and leases property to affiliated companies. S.I.S. and 518 PML are not material to our total
operations.
State Auto Mutual owns approximately 64% of State Auto Financial’s outstanding common shares.
State Auto P&C, Milbank, Farmers and SA Ohio (“STFC Pooled Companies”) participate in a quota share
reinsurance pooling arrangement (the “Pooling Arrangement”) with State Auto Mutual, SA Florida, SA
Wisconsin, Meridian Security, Meridian Citizens Mutual, Beacon National, Patrons Mutual and Litchfield, which
together with STFC Pooled Companies are referred to as the “Pooled Companies.” The Pooled Companies
provide a broad line of property and casualty insurance, such as standard personal and commercial automobile,
homeowners and farmowners, commercial multi-peril, workers’ compensation, general liability and property
insurance. SA National, which is not included in the Pooling Arrangement, provides nonstandard personal
automobile insurance. Our Pooled Companies and SA National are rated A+ (Superior) by the A.M. Best
Company.
Under the Pooling Arrangement, State Auto Mutual assumes premiums, losses and expenses from each of
the remaining Pooled Companies and in turn cedes to each of the Pooled Companies a specified portion of
premiums, losses and expenses based on each of the Pooled Companies’ respective pooling percentages. State
Auto Mutual then retains the balance of the pooled business. The participation percentage for the STFC Pooled
Companies has remained at 80% since 2001. In general, the Pooling Arrangement covers all the property and
casualty insurance written by the Pooled Companies except State Auto Mutual’s voluntary assumed reinsurance.
As of January 1, 2008, the Pooling Arrangement was changed (the “Pooling Change”) to add Beacon
National, Patrons Mutual and Litchfield as participants and the middle market business written by companies in
the State Auto Group to the Pooling Arrangement (collectively referred to as the “New Pool Business”).
Concurrently with the addition of Patrons Mutual, Litchfield and Beacon National, the participating percentages
of certain participants were adjusted as presented in the table below; however the STFC Pooled Companies
continue to maintain an overall share of the pool at 80% and State Auto Mutual and its subsidiaries and affiliates
continue to maintain 20%. In conjunction with this modification,
the STFC Pooled Companies received
approximately $92.0 million in cash from State Auto Mutual and its subsidiaries and affiliates for net liabilities
assumed on this date.
30
The following table presents the impact on our balance sheet on January 1, 2008, relating to the Pooling
Change:
($ millions)
Losses and loss expenses payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unearned premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred policy acquisition costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 51.3
53.6
(12.9)
Net cash received . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 92.0
The following table sets forth a chronology of the participants and participation percentages for the Pooling
Arrangement:
2008
2007 & 2006
STFC Pooled Companies:
State Auto P&C . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Milbank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Farmers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
SA Ohio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
59.0% 59.0%
17.0
3.0
1.0
17.0
3.0
1.0
Subtotal
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
80.0
80.0
Mutual Pooled Companies:
State Auto Mutual
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
SA Wisconsin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
SA Florida . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Meridian Security . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Meridian Citizens Mutual
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Beacon National . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Patrons Mutual . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Litchfield . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Subtotal
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
19.0
0.0
0.0
0.0
0.5
0.0
0.4
0.1
20.0
19.5
0.0
0.0
0.0
0.5
N/A
N/A
N/A
20.0
Reflecting the manner in which we manage our business and report our results internally to our principal
operating decision makers, our significant reportable segments are personal insurance, business insurance
(collectively the “insurance segments” or “our insurance segments”) and investment operations. The insurance
segments distribute their products through the independent agency system across 33 states. Each is managed
separately based on the type of customers served, products provided or services offered. The personal insurance
segment provides primarily personal auto (standard and nonstandard) and homeowners to the personal insurance
market. The business insurance segment provides primarily commercial auto, commercial multi-peril, fire and
allied lines, other and product liability and workers’ compensation insurance to small to medium sized businesses
within the commercial insurance market. The investment operations segment, managed by Stateco, provides
investment services for our Company’s invested assets.
We evaluate the performance of our insurance segments using industry financial measurements determined
based on Statutory Accounting Principles (“SAP”), and certain measures determined under Generally Accepted
Accounting Principles (“GAAP”). We evaluate our investment operations segment based on investment returns
of assets managed. Financial information about our segments is set forth in this Item 7 and in Note 15 to our
Consolidated Financial Statements included in Item 8 of this Form 10-K.
31
EXECUTIVE SUMMARY
The results of our operations from year-to-year and quarter-to-quarter are primarily driven by our ability to
generate revenue through selecting and pricing risks in a manner that permits premium growth without adversely
affecting underwriting profits, and disciplined investment strategy. We also recognize that our results will be
periodically impacted, sometimes significantly, by the occurrence of catastrophic events, which are generally
beyond our control.
•
•
•
Premium Growth/Underwriting Profitability: The property and casualty insurance industry is highly
cyclical. Our industry has been historically characterized by periods of intense price competition due to
excess underwriting capacity, as well as periods of shortages of underwriting capacity that result in
increased prices and more favorable underwriting terms. During periods of excess underwriting
capacity, some property and casualty insurers attempt to generate additional top line growth by setting
their prices at levels inappropriate for the risk underwritten. While in the short term this may result in
additional revenues, this action compromises their long term underwriting profitability. Our strategy is
to insure personal and small-to-medium business risks while adhering to disciplined and consistent
underwriting principles through all market cycles. Over the last several months the industry has been
moving from soft market conditions in which insurer competition has been intense and there has been
pressure to lower rates toward hard market conditions in which insurers tend to raise prices. We have
been monitoring this situation and have responded in ways consistent with our goals not to compromise
underwriting profitability and to protect the interests of our stakeholders.
Our underwriting principles include insistence on selecting and retaining business based on the merits
of each account and a dedication to cost-based pricing, where each line of business is priced to generate
a profit. It is our intention to set pricing levels so that no line of business, or classification within major
lines, subsidizes another line or classification. We are committed to achieving an underwriting profit
through all market cycles, even at the expense of periodic slowdowns in written and earned premiums.
We will not compromise underwriting profitability for top line growth. We believe that we can
implement periodic rate changes in most states and remain an attractive market to our policyholders
and independent agents by stressing the strengths we bring to the marketplace. These strengths include
stability, financial soundness, prompt and fair claims service, and technology which make it easier for
the agent to do business with the State Auto Group and provide substantial value to our customers. We
carefully monitor writing insurance in states that we believe present difficult legislative, judicial and/or
regulatory environments for the insurance industry.
Investment Strategy: We have a disciplined approach to our investment strategy that emphasizes the
quality of our fixed maturity portfolio, which comprised 91.3% of our total portfolio at fair value at
December 31, 2008, and includes primarily investment grade securities. The majority of our fixed
maturity portfolio is invested in municipal bonds to recognize the tax advantages available from
municipal bond income. In addition, we believe that our credit risk exposure is reduced by investing in
high quality municipal bonds that are diversified by issuer and state. Our internally managed equity
portfolio, which comprised 6.7% of our total portfolio at fair value at December 31, 2008, emphasizes
large-cap, dividend-paying companies selected based upon their potential for appreciation as well as
ability to continue paying dividends. During 2007, we began to diversify our equity portfolio and
utilize outside managers to invest in U.S. small-cap equities and international funds. Diversifying our
portfolio into small-cap equities and international funds was designed to achieve a greater total return
with reduced volatility. In 2008 almost all of the asset classes experienced a decline in fair value, and
our portfolio was not immune to this broad-based decline. We believe that in most market cycles
diversification of our portfolio will be beneficial to us and we plan to continue to maintain a diversified
portfolio.
Loss Reserves: We maintain reserves for the eventual payment of losses and loss expenses for both
reported claims and incurred claims that have not yet been reported. Loss reserves are management’s
best estimate at a given point in time of what we expect to pay to settle all claims incurred as of the end
of the accounting period, based on facts, circumstances and historical trends then known. Although
32
•
management uses many resources to calculate reserves, there is no precise method for determining the
ultimate liability. We do not discount loss reserves for financial statement purposes. Our objective is to
set reserves that are adequate such that the amounts originally recorded as reserves reasonably
approximate the ultimate liability for insured losses and loss expenses. We regularly review and adjust
loss reserves as appropriate.
Catastrophic Events: We are exposed to claims arising out of catastrophic events. Catastrophe losses
can and do cause substantial volatility in our financial results for any fiscal quarter or year.
Catastrophes can be caused by various natural events, including hurricanes, hailstorms, tornadoes,
windstorms, earthquakes, severe winter weather and fires, none of which are within our control. The
frequency and severity of catastrophes are inherently unpredictable. The magnitude of loss from a
catastrophe is a function of the severity of the event and the total amount of insured exposure in the
affected area. Catastrophes, to which we are exposed, including hurricanes, earthquakes and other
perils, may be severe and produce significant loss. We are also exposed to significant loss from less
severe catastrophes when they affect large geographic areas or areas that are heavily populated
Although catastrophes can cause losses in a variety of our property and casualty lines, most of our
catastrophe claims in the past have related to homeowners, allied lines and commercial multiple peril
coverages. We deploy specific strategies designed to mitigate our exposure to catastrophe losses, which
include obtaining reinsurance. We continually seek to diversify our business on a geographic basis. The
number of states we actively operate in has increased from 27 states in 2003 to 33 states as of
December 31, 2008. As we begin 2009, the concentration of our direct written premiums for our
property and casualty operations in our largest five states has decreased from 48% for the year ended
December 31, 2003, to approximately 44% at December 31, 2008. Our catastrophe management
strategies are designed to mitigate our exposure to earthquakes and hurricanes.
In addition to our adherence to our cost-based pricing, investment and catastrophe risk mitigation strategies
discussed above, our management focuses on several other key areas with the intention of continually improving
the results of our operations and financial results, including the following:
•
•
Claims Service: We believe an important element of our success is our focus on claims service. We
expect our claim service to be fair, fast and friendly. The role of the claims division is to deliver the
promise that we and the independent agent made to the insured. We have the capability of receiving
claims 24 hours a day, seven days a week. Claims may be reported to our Claims Contact Center, to the
policyholder’s independent agent or via the Internet at www.StateAuto.com. We make a pledge to our
policyholders to try and make contact with them within two hours of a claim being assigned to a claims
handler (except in catastrophe loss situations). In addition, we established internal claims catastrophe
teams to enhance our response to policyholders in these loss situations.
Independent Insurance Agent Network: We offer our products through over 3,330 agencies in 33
states. We believe the success of our independent
insurance agent network, which is our only
distribution channel, grows out of our commitment to promote and foster close working relationships
with our agents. We seek relationships with agencies where we will be one of their top three insurers,
measured on the basis of direct premiums written, for the type of business we desire. Our agents’
compensation package includes competitive commission rates and other sales inducements designed to
maintain and enhance relationships with existing independent agents as well as to attract new
independent agents. We provide our agents with a co-operative advertising program, sales training
programs, contingent commissions, travel incentives and agency recognition. We continually monitor
our agencies for compatibility with us, taking into account factors such as loss ratio, premium volume,
business profiles and relationship history. This allows us to be proactive in helping our agents grow
their book of business with us profitably and, thus, enhance the long-term value of our relationship.
Our senior management meets frequently with agents to encourage mutual growth and demonstrate our
commitment. We believe each of these elements creates a relationship that has resulted in our
independent insurance agents placing quality insurance business with us.
33
•
•
Technology: Our technology efforts are focused on making us as efficient and effective as possible.
Our personal insurance segment technology has leveraged past successes with our netXpressSM agency
portal by providing more integration with the systems our independent agents commonly use in their
offices. This integration of data directly into our netXpress portal eliminates the re-keying effort for our
agents and at the same time increases the quality of that data. We have also streamlined the way we
acquire outside information like motor vehicle reports and address-based information so that our
technology can provide fast and accurate quotes. Our independent agents have welcomed this
functionality and rewarded us with increased quote opportunities and submissions.
In 2008, our business insurance segment increased the functionality of our bizXpressSM portal, by
adding support for another line of business. Our independent agents who issue business auto policies
can now accurately quote and produce proposals for their clients. In addition, during 2008 our
independent agents benefited from the addition of more robust reports to analyze claims data for their
insureds. These reports are easily requested via the agent’s portal.
During the course of 2008, improvements in our project management, quality assurance, and IT
governance all improved our technology efficiency and effectiveness. These improvements help us
maximize the business results we ultimately receive from our technology investments.
Innovate SA: In the last two quarters of 2008, we launched a formal company-wide plan called
Innovate SA, which is intended to reduce expenses, enhance revenues and improve margins. Innovate
SA is comprised of various initiatives, including changes to our field structure, business processes and
product changes. Innovate SA began with an idea generation phase that involved our 2000+ associates
and was followed by an evaluation phase that was led by senior managers in our business units. The
idea generation and evaluation phases were completed for the most part in the fourth quarter of 2008,
and 480 separate actions have been approved for
implementation. Our expectation is that
implementation will take place over the next three fiscal years.
CRITICAL ACCOUNTING POLICIES
Our significant accounting policies are more fully described in Note 1 of the Notes to our Consolidated
Financial Statements included in Item 8 of this Form 10-K. In preparing the consolidated financial statements,
management is required to make estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the balance sheet, revenues and expenses for the period then ended and the financial
entries in the accompanying notes to the financial statements. Such estimates and assumptions could change in
the future, as more information becomes known which could impact the amounts reported and disclosed in this
Item 7. We have identified the policies and estimates described below as critical to our business operations and
the understanding of the results of our operations.
Investments
Our fixed maturity, equity security and certain other invested asset
investments are classified as
available-for-sale and carried at fair value. The unrealized holding gains or losses, net of applicable deferred
taxes, are shown as a separate component of stockholders’ equity as “accumulated other comprehensive loss,”
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.
We regularly monitor our investment portfolio for declines in value that are other-than-temporary impaired
(“OTTI”), an assessment which requires significant management judgment regarding the evidence known. Such
judgments could change in the future as more information becomes known which could negatively impact the
amounts reported herein. We consider many factors when assessing our investments for OTTI which include:
(1) the financial condition and near-term prospects of the issuer, including any specific events that may influence
the issuer’s operations; (2) the length of time and/or the depth of decline below cost; (3) our ability and intent to
hold the security through its near term recovery period; and (4) the ability of the fair value to recover to cost in
34
the near term. When a security in our investment portfolio has been determined to have a decline in fair value
that is other-than-temporary we adjust the cost basis of the security to fair value. This results in a charge to
earnings as a realized loss, which is not reversed for subsequent recoveries in fair value. Future increases or
decreases in fair value, if not other-than-temporary, are included in other comprehensive income or loss.
Fair Value Measurements
On January 1, 2008, we adopted SFAS No. 157, “Fair Value Measurements” (“SFAS 157”), which was
issued by the Financial Accounting Standards Board (“FASB”) in September 2006. For financial statement
elements currently required to be measured at fair value, SFAS 157 defines fair value, establishes a framework
for measuring fair value under GAAP and enhances disclosures about fair value measurements. The new
definition of fair value focuses on the price that would be received to sell the asset or paid to transfer the liability
(“exit price”) regardless of whether an observable liquid market price exists. An exit price valuation includes
margins for risk even if the margins are not observable.
SFAS 157 establishes a fair value hierarchy that categorizes the inputs to valuation techniques which are
used to measure fair value into three broad levels as defined below:
•
•
•
Level 1 includes observable inputs which reflect quoted prices for identical assets or liabilities in active
markets at the measurement date.
Level 2 includes observable inputs for assets or liabilities other than quoted prices included in Level 1
and it includes valuation techniques which use prices for similar assets and liabilities.
Level 3 includes unobservable inputs which reflect the reporting entity’s estimates of the assumptions
that market participants would use in pricing the asset or liability (including assumptions about risk).
Deferred Acquisition Costs
Acquisition costs, consisting of commissions, premium taxes and certain underwriting expenses relating to
the production of property and casualty business, are deferred and amortized over the same period in which the
related premiums are earned. The method followed for computing the acquisition costs limits the amount of such
deferred costs to their estimated realizable value. In determining estimated realizable value, the computation
gives effect to the premium to be earned, losses and loss expenses expected to be incurred, and certain other costs
expected to be incurred as premium is earned. These amounts are based on estimates, and accordingly, the actual
realizable value may vary from the estimated realizable value.
Losses and Loss Expenses Payable
Losses and loss expenses payable are management’s best estimates at a given point in time of what we
expect to pay to settle all claims incurred as of the end of the accounting period, based on known facts,
circumstances and historical trends. Reserves for reported losses are established on either a case-by-case or
formula basis depending on the type and circumstances of the loss. The case-by-case reserve amounts are
determined by claims adjusters based on our reserving practices, which take into account the type of risk, the
circumstances surrounding each claim and applicable policy provisions. The formula reserves are based on
historical data for similar claims with provision for trend changes caused by inflation. Case and formula basis
loss reserves are reviewed on a regular basis, and as new data becomes available, estimates are updated resulting
in adjustments to loss reserves. Generally, reported losses initially reserved on a formula basis and not settled
after six months are case reserved at that time.
Loss and loss expense reserves for incurred claims that have not yet been reported (“IBNR”) are estimated
based on many variables including historical and statistical information, inflation, legal developments, storm loss
estimates, and economic conditions. The process for calculating IBNR is to develop an estimate of the ultimate
35
losses incurred, and subtract all amounts already paid or held as formula or case reserves. Although we use many
internal and external resources, as well as multiple established methodologies to calculate IBNR, there is no
method for determining the exact ultimate liability. For a further discussion regarding our losses and loss expense
reserves and our reserving methods see “Other—Loss and Loss Expense Reserves” included in this Item 7.
Pension and Postretirement Benefit Obligations
Pension and postretirement benefit obligations are long term in nature and require management’s judgment
in estimating the factors used to determine these amounts. We review these factors annually, including the
discount rate and expected long term rate of return on plan assets. Because these obligations are based on
estimates which could change, the ultimate benefit obligation could be different from the amount estimated. For a
further discussion regarding our pension and postretirement benefit obligations see “Other—Employee Benefit
Plans” included in this Item 7.
Share-Based Compensation
We have share-based compensation plans which authorize the granting of various equity-based incentives
including stock options, restricted stock and restricted share units to employees and non-employee directors. The
expense for these equity-based incentives is based on their fair value at date of grant or each reporting date and
amortized over their vesting period. The fair value of each stock option granted is estimated on the date of grant
or each reporting date using the Black-Scholes closed-form pricing model. The pricing model requires
assumptions such as the expected life of the option and expected volatility of our stock over the expected life of
the option, which significantly impacts the assumed fair value. We use historical data to determine these
assumptions and if these assumptions change significantly for future grants, share-based compensation expense
will fluctuate in future periods.
Other
Other items that could have a significant
impact on the financial statements include the risks and
uncertainties listed in Item 1A of this Form 10-K under “Risk Factors.” Actual results could differ materially
using different estimates and assumptions, or if conditions are significantly different in the future.
36
RESULTS OF OPERATIONS
Summary
The following table summarizes certain key performance indicators used to manage our operations for the
years ended December 31, 2008, 2007 and 2006, respectively:
($ millions, except per share data)
2008
2007
2006
GAAP Basis:
Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net (loss) income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Book value per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Debt to capital ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loss and LAE ratio(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expense ratio(1)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Combined ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . .
Catastrophe Loss and LAE points(1)
Premium written growth(2) . . . . . . . . . . . . . . . . . . . . . . . . .
Premium earned growth . . . . . . . . . . . . . . . . . . . . . . . . . . .
Investment yield . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
SAP Basis:
Loss and LAE ratio(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expense ratio(3)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Combined ratio(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . .
Net premiums written to surplus(4)
$1,181.9
1,113.4
$ (31.1)
119.1
$ 761.0
935.5
$ 19.23
23.10
13.4
11.2
75.2
58.4
34.6
34.4
109.8
92.8
13.9%
3.7
18.2%
0.0
11.3% (1.2)
4.1%
4.3
1,117.4
120.4
834.2
20.32
12.4
57.4
34.0
91.4
8.9
(2.5)
(2.5)
4.4
74.8
33.1
107.9
1.6
57.9
33.2
91.1
1.1
56.8
32.9
89.7
1.2
(1)
(2)
(3)
See “2008 Compared to 2007” section below for definitions.
5.3 points of the increase for 2008 is related to the one-time $53.6 million transfer of unearned premium to us on January 1,
2008, in conjunction with the Pooling Change.
The “SAP Loss and LAE Ratio” is losses and loss expenses as a percentage of net earned premiums. The “SAP Expense
Ratio” is statutory underwriting expenses and miscellaneous expenses offset by miscellaneous income (“underwriting
expenses”) as a percentage of net written premiums. The “SAP Combined Ratio” is the sum of the SAP Loss and LAE Ratio
and the SAP Expense Ratio.
(4) We use the statutory net premiums written to surplus ratio because there is no comparable GAAP measure. This ratio, also
called the leverage ratio, measures our statutory surplus available to absorb losses.
2008 Compared to 2007
For 2008, we reported a pre-tax loss of $75.1 million compared to pre-tax income of $155.3 million for
2007. Our 2008 pre-tax loss was primarily driven by the following factors:
•
•
•
Catastrophe losses for 2008 were $156.1 million or 13.9 loss ratio points compared to $37.1 million or
3.7 loss ratio points for the same 2007 period. Hurricane Ike delivered tropical storm force winds to
Texas and three of our largest states-Ohio, Kentucky and Indiana, accounting for $44.1 million of
catastrophe losses or 3.9 loss ratio points. See the “Loss and Expenses” section included in this Item 7.
Our non-catastrophe losses for 2008 were $686.3 or 60.9 loss ratio points compared to $548.5 or 54.2
loss ratio points for the same 2007 period. All of our lines of business have contributed to this increase.
See the “Loss and LAE” section included in this Item 7.
During 2008, we recognized $39.3 million of OTTI on our investment portfolio compared to $1.9
million in 2007. See the “Investment Operations Segment” section included in this Item 7.
37
Insurance Segments
Insurance industry regulators require our insurance subsidiaries to report their financial condition and results
of operations using SAP. We use SAP financial results, along with industry standard financial measures
determined on a SAP basis and certain measures determined on a GAAP basis, to internally monitor the
performance of our insurance segments and reward our employees. The more common financial measures used
are Loss and LAE ratio, underwriting expense ratio, combined ratio, net premiums written and net premiums
earned. The combined ratio is the sum of the Loss and LAE ratio and the underwriting expense ratio. When the
combined ratio is less than 100%, the insurer is operating at an underwriting gain and when it is greater than
100%, the insurer is operating at an underwriting loss. Underwriting gain (loss) is determined by subtracting
from net earned premiums, losses and loss expenses and underwriting expenses.
One of the more significant differences between GAAP and SAP is that SAP requires all underwriting
expenses to be expensed immediately and not deferred over the same period that the premium is earned. In
converting SAP underwriting results to GAAP underwriting results, acquisition costs are deferred and amortized
over the periods the related written premiums are earned. For a discussion of deferred policy acquisition costs see
“Critical Accounting Policies—Deferred Acquisition Costs” section included in this Item 7. The “GAAP
combined ratio” is defined as the sum of the “GAAP Loss and LAE ratio” (loss and loss expenses as a percentage
of earned premiums) plus “GAAP expense ratio” (acquisition and operating expenses as a percentage of earned
premiums). All references to financial measures or components thereof in this discussion are calculated on a
GAAP basis, unless otherwise noted.
The following tables provide a summary of our insurance segments’ SAP underwriting (loss) gain and SAP
combined ratio for the years ended December 31, 2008 and 2007:
($ millions)
Written premiums . . . . . . . . . . . . . . . . .
Earned premiums . . . . . . . . . . . . . . . . .
Losses and loss expenses . . . . . . . . . . .
Underwriting expenses . . . . . . . . . . . . .
SAP underwriting loss and SAP
2008
%
Ratio
77.6
28.9
Business
$489.3
455.1
322.1
191.5
%
Ratio
70.8
39.1
Personal
$715.6
670.9
520.3
206.8
Total
$1,204.9
1,126.0
842.4
398.3
%
Ratio
74.8
33.1
combined ratio . . . . . . . . . . . . . . . . . .
$ (56.2)
106.5
$ (58.5)
109.9
$ (114.7)
107.9
($ millions)
Written premiums . . . . . . . . . . . . . . . . .
Earned premiums . . . . . . . . . . . . . . . . .
Losses and loss expenses . . . . . . . . . . .
Underwriting expenses . . . . . . . . . . . . .
SAP underwriting gain and SAP
2007
%
Ratio
62.1
29.9
Business
$404.7
402.0
207.2
154.2
%
Ratio
51.5
38.1
Total
$1,019.8
1,011.6
585.6
338.1
%
Ratio
57.9
33.2
Personal
$615.1
609.6
378.4
183.9
combined ratio . . . . . . . . . . . . . . . . . .
$ 47.3
92.0
$ 40.6
89.6
$
87.9
91.1
38
Revenue
We measure our top-line growth for our insurance segments based on net written premiums, which represent
the premiums on the policies we have issued for a period, net of reinsurance. Net written premiums provide us
with an indication of how well we are doing in terms of revenue growth before it is actually earned. Our policies
provide a fixed amount of coverage for a stated period of time, often referred to as “the policy term.” As such,
our written premiums are recognized as earned ratably over the policy term. The unearned portion of written
premiums, called unearned premiums, is reflected on our balance sheet as a liability and represents our obligation
to provide coverage for the unexpired terms of the policies.
The following table shows the reconciliation of the one-time impact on net written premiums for the year
ended December 31, 2008 with respect to the unearned premiums transferred to us on January 1, 2008, in
conjunction with the Pooling Change.
($ millions)
Net Written Premiums Reconciliation Table
Including
Pooling
Change
Pooling
Change
Impact
Excluding
Pooling
Change
Personal insurance segment:
Standard auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Nonstandard auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Homeowners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other personal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 406.7
42.2
234.2
32.5
Total personal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
715.6
Business insurance segment:
Commercial auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial multi-peril . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fire & allied lines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Product & other liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Workers’ compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
120.0
105.1
102.5
84.4
47.5
29.8
489.3
$ 7.9
—
14.4
2.5
24.8
10.0
6.1
5.7
3.9
2.0
1.1
28.8
$ 398.8
42.2
219.8
30.0
690.8
110.0
99.0
96.8
80.5
45.5
28.7
460.5
Total personal & business . . . . . . . . . . . . . . . . . . . . . . . . .
$1,204.9
$53.6
$1,151.3
Impacting both our written and earned premiums in 2008 were the following:
•
•
As of July 1, 2008, we terminated our State Auto P&C intercompany catastrophe reinsurance
agreement, which resulted in $1.4 million less net written and earned premiums within our property
lines for 2008 when compared to the same 2007 period.
Our third party excess of loss catastrophe reinsurance program, which renewed July 1, 2008 (coverage
period July 1, 2008 through June 30, 2009), incorporates a reinstatement provision should a loss
occurrence exceed our retention. Under this provision, our original reinsurance coverage limits are
automatically restored in consideration of an additional reinstatement premium (“Reinstatement
Premium”). The estimated direct ultimate loss resulting from Hurricane Ike exceeded our retention,
thereby causing two premium transactions to occur: 1) an acceleration of the recognition of the original
annual premium to the date of loss occurrence in proportion to the reinsurance coverage exhausted and
2) the recognition of the Reinstatement Premium from the date of the loss occurrence to the end of the
coverage period (June 30, 2009). Additionally, during the 2008 fourth quarter we entered into a
separate property catastrophe excess of loss reinsurance agreement (“Third Event Agreement”), which
provides additional coverage in excess of our retention through our remaining coverage period
39
(June 30, 2009). The incremental impact of the acceleration of the original annual premium plus the
recognition Reinstatement Premium plus the premium paid in connection with the Third Event
Agreement resulted in $3.5 million less net written and earned premiums within our property lines
when compared to the same 2007 period. The incremental impact has the most significant effect on our
property lines. See detailed discussion of our reinsurance programs in the “Liquidity and Capital
Resources—Reinsurance Arrangements” section included in this Item 7.
Personal Insurance Segment Revenue
Our personal insurance segment consists primarily of auto (standard and nonstandard) and homeowners’
products, with personal auto representing 38.3% of our total consolidated net written premium in 2008 and 2007.
Our strategy to grow our personal lines business includes introducing our products, enhanced systems and
easier-to-use technologies into new states. During 2008, we began introducing our personal lines products and
technologies into Texas through the independent agent distribution channel as a result of State Auto Mutual’s
acquisition of the Beacon Insurance Group in early 2007. In addition, future plans include leveraging our
relationship with the Patrons Insurance Group distribution channel
lines and
technologies into Connecticut.
to add upgraded product
During 2008, we continued to enhance our personal lines point of sale portal, netXpress. The additional
integration with the systems commonly used by our independent agents has resulted in an increase in the number
of quotes for personal auto and homeowners. In 2008, for the State Auto Group 840,000 quotes were handled on
netXpress with 196,000 of those quotes initiated from the integration mentioned above. In 2007, a total of
542,000 quotes were handled on netXpress.
We have also focused on improving our policyholders’ ease of doing business with respect to bill payment
and claim reporting and settlement. Utilization of
functionality via
www.StateAuto.com increased significantly. During 2008 for the State Auto Group, 310,000 payments
representing $117.0 million of premiums were made as compared to 189,000 payments and $76.0 million of
premium payments recorded in 2007.
“Pay Now”
electronic
the
The following table provides a summary of written and earned premium, net of reinsurance, by major
product line of business for our personal insurance segment for the years ended December 31, 2008 and 2007.
The one-time impact of the Pooling Change has been excluded from 2008 to present net written premiums on a
comparative basis (see Net Written Premium Reconciliation Table above):
($ millions)
Personal Insurance Segment:
2008
2007
%
Change
Net Written Premium
Standard auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Nonstandard auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Homeowners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other personal
$398.8
42.2
219.8
30.0
$361.5
42.7
187.7
23.2
Total personal
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$690.8
$615.1
Net Earned Premium
Standard auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Nonstandard auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Homeowners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other personal
$384.3
42.6
215.4
28.6
$357.3
42.9
186.5
22.9
Total personal
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$670.9
$609.6
10.3
(1.2)
17.1
29.3
12.3
7.6
(0.7)
15.5
24.9
10.1
40
In total, the personal insurance segment net written premium increased from 2007 by 12.3%, with 6.8% of
this increase attributed to the New Pool Business and 5.5% of this attributed to “Organic Growth.” We define
Organic Growth in this Form 10-K as premium growth excluding premium growth related to the New Pool
Business. Our Organic Growth for net written premiums has been impacted by our decision in 2007 to withdraw
our personal insurance products from Florida beginning January 1, 2008. The net written premium loss from this
action was $12.5 million for 2008.
Standard personal auto net written premiums increased 10.3% from 2007. The New Pool Business
contributed 3.9% for 2008, while Organic Growth increased 6.4% from 2007. The primary product contributing
to our increase in Organic Growth in standard personal auto is our CustomFitSM product which uses a
multivariate rating approach that broadens the underwriting and eligibility guidelines for new and existing
customers. Since introducing the first generation of the CustomFit product in 2005, we now offer this product in
most of our operating states and have seen significant improvement in our net written premiums production
trends for new business in these states. In late 2007, we began introducing the second generation of CustomFit
and during 2008 we continued migrating CustomFit states to the second generation product which increases the
number of pricing points significantly.
We believe independent agents value ease of doing business and make it an important factor in their choice
of insurance companies when quoting personal auto products to their customers. To assist in this area, in early
2007, we began implementing comparative rating tools which allow agents to receive rate quotes from multiple
insurance companies by entering the rating information only one time. To date, we have implemented 65
different integration points to our personal lines rating engine thus eliminating duplicate entry for agents. We
believe agents will quote and write more personal standard and nonstandard auto and homeowners insurance with
us as a result of a more efficient quoting process combined with more competitive rates resulting from the
ongoing introduction of CustomFit for standard auto and refined pricing for nonstandard auto.
Nonstandard auto net written premium decreased 1.2% from 2007. This decrease was due to tightening
underwriting controls and aggressive rate actions which contributed to a decline in our new business writings.
These actions were taken to drive an improvement in our underwriting results. See SAP Loss and LAE Ratios
Table in the “Losses and Expenses” section included in this Item 7.
Homeowners net written premium increased 17.1% from 2007. The New Pool Business contributed 12.4%
while Organic Growth increased 4.7% from 2007. We have undertaken new homeowners pricing and product
initiatives, such as various new home discounts that complement our CustomFit automobile rollout, in order to
improve our premium growth. During 2008, we experienced premium growth in most of our states.
Other personal net written premium increased 29.3% from 2007, with 11.2% coming from Organic Growth
and 18.1% from New Pool Business. Other personal includes primarily our farmowners line of business where
we expanded into four new states, which accounts for much of the Organic Growth in this line.
41
Business Insurance Segment Revenue
We focus our business insurance sales on small to medium sized exposures and offer a broad range of both
property and liability coverages such as commercial auto, commercial multi-peril, fire and allied lines, products
liability and workers’ compensation. The following table provides a summary of written and earned premium,
net of reinsurance, by major product line of business for our business insurance segment for the years ended
December 31, 2008 and 2007. The one-time impact of the Pooling Change has been excluded from 2008 to
present net written premiums on a comparative basis (see Net Written Premium Reconciliation Table above):
($ millions)
Business Insurance Segment:
2008
2007
%
Change
Net Written Premium
Commercial auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial multi-peril . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fire & allied lines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other & product liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Workers’ compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other commercial
$110.0
99.0
96.8
80.5
45.5
28.7
$ 95.8
86.6
84.0
75.6
36.1
26.6
Total business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$460.5
$404.7
Net Earned Premium
Commercial auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial multi-peril . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fire & allied lines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other & product liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Workers’ compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other commercial
$110.5
97.9
94.7
79.9
43.4
28.7
$ 96.9
86.8
83.4
75.5
33.4
26.0
Total business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$455.1
$402.0
14.8
14.3
15.2
6.5
26.0
7.9
13.8
14.0
12.8
13.5
5.8
29.9
10.4
13.2
The business insurance segment net written premium increased 13.8% from 2007. The New Pool Business
contributed 12.8%, while Organic Growth increased 1.0% from 2007. Business insurance continues to be
impacted by rate competition as well as ease of doing business issues. We are seeking to balance our traditional
underwriting discipline with new products and pricing tools that support the production of profitable new
business.
We continue to invest in products, processes and systems that we believe will increase our business
insurance writings. We have expanded our marketability by introducing new products, enhancing existing
products and broadening eligibility. For our property and liability business, we have also implemented a more
granular pricing process that we believe will help us price risks more accurately and improve account retention.
We are pursuing the same for our commercial auto and workers’ compensation lines of business. In addition, we
have broadened our property, liability, auto and workers’ compensation pricing ranges to better recognize the
spectrum of risks within our markets. This year, we introduced an enhanced Employment Practices Liability
product to agents in all states and added enhanced functionality for agents to perform more detailed loss analysis
on their existing book of business insurance policies. In addition, we introduced our workers’ compensation
products into West Virginia, which opened this market to private insurers after operating for years as a
“monopolistic” workers’ compensation state.
We also continue to improve our back office systems, such as enhancements to our insurance policy
administration system, to make it easier for agents to quote and submit business insurance policies to us. Our
system now allows transactions to be processed throughout the day using real-time and straight through
42
processing rather than in a large batch at night. In addition to the efficiency gains we have achieved for internal
employees, we have leveraged this real-time and straight through processing functionality with bizXpress. In
2008, we expanded our bizXpress functionality by giving agents the ability to quote business auto policies as
well as businessowners policies, a capability which we introduced to them in 2007.
We are working to expand the scope of this technology for new products and additional lines of business
including workers’ compensation. We believe this technology investment should better position us for revenue
growth opportunities in the future and start to drive efficiencies into our business model much like we have seen
through
in personal
processing technology. This has resulted in faster delivery of policies to our agents and their insureds for new
business and endorsements.
transactions in business insurance utilize the straight
insurance. The majority of all
Similar to our personal lines segment, we are leveraging our relationship with the agency distribution
channel as a result of State Auto Mutual’s acquisition of Beacon National in early 2007. During the fourth
quarter of 2007 we introduced our business product portfolio in Texas. In the fourth quarter of 2008, we began to
leverage our relationship with the Patrons Mutual and Litchfield agency distribution channel by completing all
filing and systems work to support the introduction of commercial property, liability, auto and workers’
compensation products, which we introduced to Connecticut agents early in 2009.
Loss and LAE
Our GAAP Loss and LAE ratio was 75.2% in 2008 compared to 58.4% in 2007. The increase in the GAAP
Loss and LAE Ratio was largely due to an increase in catastrophe storm losses. Our catastrophe losses, which
primarily impacted our property lines of business, accounted for 13.9 points of the Loss and LAE ratio in 2008
compared to only 3.7 points in 2007. Our non-catastrophe Loss and LAE ratio was 60.9% in 2008 compared to
54.2% in 2007. The increase in our non-catastrophe Loss and LAE ratio was driven mostly by bodily injury
claim severity in the personal and commercial auto lines. With auto lines representing a significant portion of our
earned premiums, this line of business contributed roughly 50% of the increase in our non-catastrophe ratio.
Losses and loss expenses for a calendar year represent the combined estimated ultimate liability for claims
occurring in the current calendar year along with any change in estimated ultimate liability for claims occurring
in prior years. The following table presents the provision for losses and loss expenses for those claims occurring
in 2008 and prior years, along with the GAAP Loss and LAE ratio for the years 2008 and 2007, respectively:
($ millions)
Provision for losses and loss expenses
occurring:
%
GAAP Loss
and LAE
%
GAAP Loss
and LAE
2007
2008
Current year
. . . . . . . . . . . . . . . . . . . . .
Prior years . . . . . . . . . . . . . . . . . . . . . . .
$874.0
(27.3)
Total losses and loss expenses . . .
$846.7
77.6
(2.4)
75.2
$645.5
(54.7)
$590.8
62.7
(4.3)
58.4
43
As shown above, the 2008 loss and loss expenses attributable to prior years totaled ($27.3) million. This
corresponded to a decrease, or favorable development, in the estimated ultimate liability for prior years’ claims.
A tabular presentation of the $27.3 million favorable development in 2008 by accident year is shown below.
($ millions)
Accident Year
1998 and prior . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Current year
development
of ultimate liability
Redundancy / (Deficiency)
$ 0.7
0.3
0.5
(0.1)
0.7
2.6
(0.2)
0.8
3.1
18.9
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$27.3
Emergence by accident year includes normal fluctuations due to the uncertainty associated with loss reserve
development and claim settlement. The favorable development of $27.3 million in 2008 came primarily from
accident year 2007. The more notable items contributing to the 2008 favorable development were:
•
•
•
Unallocated loss adjustment expenses (“ULAE”) were $13.7 million lower than anticipated in the
reserves at December 31, 2007. ULAE are those expenses or costs incurred in settling claims, such as
in-house processing costs, which cannot be associated with a specific claim.
Favorable catastrophe loss development of $6.4 million was primarily associated with the 2007
accident year. This development occurred primarily within our homeowners, fire & allied and
commercial multi-peril lines of business.
Non-catastrophe homeowners reserves developed $4.9 million lower than anticipated. Current loss
projections using more mature claim data resulted in lower expected average claim severity than prior
projections, primarily from losses occurring in 2007.
See discussion regarding the 2007 calendar year development at “2007 Compared to 2006—Losses and
Expenses” section included in this Item 7. See additional discussion regarding loss and loss expense reserves at
the “Other—Loss and Loss Expense Reserves” section included in this Item 7.
Catastrophe losses for 2008 totaled $156.1 million (13.9 loss ratio points) compared to $37.1 million (3.7
loss ratio points) for 2007. The discussion of catastrophe losses includes those which have been designated as
such by ISO’s Property Claim Services (“PCS”) unit, a nationally recognized industry service. PCS defines
catastrophes as events resulting in $25.0 million or more in insured losses industry wide and affecting significant
numbers of insureds and insurers. During 2008, we were impacted by losses from 35 of the 37 storms that were
classified as numbered catastrophes by PCS as compared to 18 of the 26 PCS 2007 classified storms. The losses
from these catastrophes have had a significant impact on both our personal and business insurance property lines.
44
The following tables provide our insurance segments’ SAP Loss and LAE ratios (“loss ratios”) by major
lines of business for 2008 and 2007 with the catastrophe (“cat”) and non-catastrophe (“non-cat”) impact shown
separately:
($ millions)
Earned
Premium
Cat Loss
& LAE
Non-Cat
Loss &
LAE
Statutory
Loss &
LAE
Cat
Ratio
Non-Cat
Ratio
Total Loss
and LAE
Ratio
2008 Statutory Loss and LAE Ratios
Personal insurance segment:
Standard auto . . . . . . . . . . . . . . . . . . . . . . . . . . .
Nonstandard auto . . . . . . . . . . . . . . . . . . . . . . . .
Homeowners . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other personal . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total personal . . . . . . . . . . . . . . . . . . .
670.9
105.8
414.5
520.3
15.8
$384.3
42.6
215.4
28.6
$8.2 $254.4
31.5
0.3
113.0
91.5
15.6
5.8
$262.6
31.8
204.5
21.4
2.1
0.7
42.5
20.6
66.2
74.0
52.5
54.1
61.7
Business insurance segment:
Commercial auto . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial multi-peril
. . . . . . . . . . . . . . . . . . .
Fire & allied lines . . . . . . . . . . . . . . . . . . . . . . . .
Other & product liability . . . . . . . . . . . . . . . . . .
Workers’ compensation . . . . . . . . . . . . . . . . . . .
Other commercial . . . . . . . . . . . . . . . . . . . . . . . .
Total business . . . . . . . . . . . . . . . . . . .
110.5
97.9
94.7
79.9
43.4
28.7
455.1
0.8
16.5
32.0
—
—
1.0
50.3
67.6
56.5
52.7
51.6
35.0
8.4
61.2
0.7
68.4
57.8
16.8
73.0
84.7
55.7
33.8
51.6 — 64.6
35.0 — 80.7
29.3
3.4
9.4
271.8
322.1
11.0
59.8
60.9
Total SAP personal and business . . . . $1,126.0 $156.1 $686.3
$842.4
13.9
($ millions)
2007 Statutory Loss and LAE Ratios
Personal insurance segment:
Standard auto . . . . . . . . . . . . . . . . . . . . . . . . . . .
Nonstandard auto . . . . . . . . . . . . . . . . . . . . . . . .
Homeowners . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other personal . . . . . . . . . . . . . . . . . . . . . . . . . . .
Earned
Premium
Cat Loss
& LAE
Non-Cat
Loss &
LAE
Statutory
Loss &
LAE
Cat
Ratio
Non-Cat
Ratio
Total Loss
and LAE
Ratio
$357.3
42.9
186.5
22.9
$2.3 $217.5
27.1
—
94.0
26.5
9.1
1.9
$219.8
60.8
0.7
27.1 — 63.2
50.4
14.2
120.5
40.3
7.9
11.0
Total personal . . . . . . . . . . . . . . . . . . .
609.6
30.7
347.7
378.4
5.0
57.1
Business insurance segment:
Commercial auto . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial multi-peril
. . . . . . . . . . . . . . . . . . .
Fire & allied lines . . . . . . . . . . . . . . . . . . . . . . . .
Other & product liability . . . . . . . . . . . . . . . . . .
Workers’ compensation . . . . . . . . . . . . . . . . . . .
Other commercial . . . . . . . . . . . . . . . . . . . . . . . .
96.9
86.8
83.4
75.5
33.4
26.0
Total business . . . . . . . . . . . . . . . . . . .
402.0
—
1.5
4.9
—
—
—
6.4
50.6
50.0
36.0
32.8
24.9
6.5
50.6 — 52.2
57.6
1.7
51.5
43.2
5.9
40.9
32.8 — 43.5
24.9 — 74.6
6.5 — 24.8
200.8
207.2
1.6
3.7
49.9
54.2
Total SAP personal and business . . . . $1,011.6
$37.1 $548.5
$585.6
The personal insurance segment non-cat loss ratio was 4.6 points higher in 2008 than in 2007. Standard and
non-standard auto’s SAP Loss and LAE Ratio increases were attributed primarily to an increase in the severity of
bodily injury claims and uninsured motorists’ claims as well as to an increase in claim frequency for these lines
of business. In addition, in 2008, competitive market conditions limited our ability to obtain price increases in
standard auto. As mentioned above, rate actions taken in our non-standard line of business in early 2008 will not
be fully realized until 2009. The non-cat ratio for homeowners remained relatively flat when compared to 2007.
45
68.3
74.7
95.0
74.7
77.5
61.9
74.6
89.5
64.6
80.7
32.7
70.8
74.8
61.5
63.2
64.6
48.2
62.1
52.2
59.3
49.1
43.5
74.6
24.8
51.5
57.9
The business insurance segment’s non-cat loss ratio for 2008 was 9.9 points higher than in 2007. The
intense competition in the business insurance segment continues to impact our ability to implement price
increases, and contributed significantly to the increase in our non-cat loss ratio. For commercial auto, rate
decreases were the primary drivers of the increase in our non-cat loss ratio. For other & products liability, the
increase in loss ratio was driven by development of losses from prior accident years and, to a lesser extent, rate
decreases. For fire & allied lines and workers’ compensation, the increase in loss ratio was primarily due to an
increase in the severity of current year claims.
Loss and loss expenses payable by major line of business as of December 31, 2008 and 2007 and at
January 1, 2008 as a result of the Pooling Change, are shown in the following table:
($ millions)
December 31,
2008
December 31,
2007
January 1,
2008(1)
$
Change(2)
Personal insurance segment:
Standard auto . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Nonstandard auto . . . . . . . . . . . . . . . . . . . . . . . . .
Homeowners . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . .
Other personal
Total personal . . . . . . . . . . . . . . . . . . . . . . . .
Business insurance segment:
Commercial auto . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial multi-peril
. . . . . . . . . . . . . . . . . . . .
Fire & allied lines . . . . . . . . . . . . . . . . . . . . . . . . .
Product & other liability . . . . . . . . . . . . . . . . . . . .
Workers’ compensation . . . . . . . . . . . . . . . . . . . .
Other business . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total business . . . . . . . . . . . . . . . . . . . . . . . .
Total losses and loss expenses payable, net
of reinsurance recoverable on losses and
loss expenses payable . . . . . . . . . . . . . . . .
$188.5
19.6
68.6
14.6
291.3
93.5
91.5
38.6
152.3
97.1
5.7
478.7
$169.1
18.3
53.4
8.9
249.7
77.8
78.8
20.3
130.1
85.5
4.9
397.4
$177.9
18.3
62.5
9.7
268.4
89.1
85.9
21.9
139.0
88.7
5.4
430.0
10.6
1.3
6.1
4.9
22.9
4.4
5.6
16.7
13.3
8.4
0.3
48.7
$770.0
$647.1
$698.4
71.6
(1)
The December 31, 2007 loss and loss expenses payable balance has been adjusted for comparative purposes to reflect the loss and
loss expenses payable assumed by us on January 1, 2008 from the Pooling Change.
(2) Calculated based on December 31, 2008 change from January 1, 2008.
As shown in the table above, there was a $71.6 million increase in total loss and loss expense reserves
during 2008. The increase relates primarily to higher levels of reserves for catastrophe losses largely related to
Hurricane Ike and an increase in reserves corresponding to our Organic Growth. We conduct periodic reviews of
loss development reports and make judgments in determining the reserves for ultimate losses and loss expenses
payable. Several factors are considered by us when 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 changes, anticipated inflation, current business
conditions, catastrophe developments, late reported claims, and other reasonableness tests.
The risks and uncertainties inherent in our 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. Our 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.
46
Acquisition and Operating Expenses
Our GAAP expense ratio was 34.6% in 2008 compared to 34.4% in 2007. The 2008 GAAP expense ratio
was negatively impacted by approximately 0.7 points related to our launching of Innovate SA, previously
discussed, and the actions we took to reduce headcount. In addition, during the 2008 fourth quarter we offered
eligible associates an early retirement option as well as reducing staff by almost 50 people. See “Other—Benefit
Plans” section included in this Item 7 for further discussion regarding our early retirement option. Combining the
early retirement option, 2008 reduction in staff and not replacing open positions, we plan to reduce our headcount
by approximately 150 positions by the end of the 2009 second quarter. The 2008 GAAP expense ratio was
positively impacted from 2007 by a decrease in our variable compensation programs for both our associates and
agents. These programs are directly related to our loss experience which, as previously discussed, was worse in
2008 when compared to 2007.
Investment Operations Segment
Our investment portfolio and the investment portfolios of other members of the State Auto Group are
managed by our subsidiary, Stateco. The Investment Committee (the “Committee”) of the Board of Directors
establishes the investment policies to be followed by Stateco.
At December 31, 2008, our investments in fixed maturities, equity securities and certain other invested
assets were held as available-for-sale and carried at fair value. The unrealized holding gains or losses, net of
applicable deferred taxes, are included as a separate component of stockholders’ equity as “accumulated other
comprehensive loss” and as such are not included in the determination of net income (loss).
Our primary investment objectives are to generate income, preserve capital and maintain adequate liquidity
for the payment of claims and expenses. Our current investment strategy does not rely on the use of derivative
financial instruments.
We have investment policy guidelines with respect to purchasing fixed maturity investments for our
insurance subsidiaries which preclude investments in bonds that are rated below investment grade by a
recognized rating service. For the insurance subsidiaries, the maximum investment in any single note or bond is
limited to 5.0% or less of statutory assets, other than obligations of the U.S. government or government agencies,
for which there is no limit. Our fixed maturity portfolio is composed of high quality, investment grade issues,
comprised almost entirely of debt issues rated AAA or AA. At December 31, 2008, fixed maturity investments
rated below investment grade accounted for less than 0.1% of our total available-for-sale investment portfolio. At
December 31, 2008 and 2007, our only investments in asset-backed securities were in federal agency pools
(Fannie Mae and Freddie Mac) and government guaranteed pools (Ginnie Mae).
Our internally managed equity portfolio invests in U.S. large-cap, dividend-paying companies across many
different industries selected based upon their potential for appreciation as well as ability to continue paying
dividends. This diversification across companies and industries reduces volatility in the value of the large-cap
equity portfolio. In addition, our investment policy guidelines limit the purchase of a specific stock to no more
than 2% of the market value of the stock at the time of purchase, and no single equity holding should exceed 5%
of the total equity portfolio.
Our externally managed equity portfolios invest in U.S. small-cap equities and international funds. These
managers are permitted to manage the portfolios according to their own respective portfolio objectives. In
selecting our outside investment managers we confirm that their portfolio objectives, including risk tolerance, are
acceptable to us. However, there may be slight differences in their objectives with respect to dividend payments
and other constraints that we apply to our large cap equity holdings.
Diversifying our portfolio into small-cap equities and international funds was designed to achieve a greater
total return with reduced volatility. In 2008 almost all asset classes experienced a decline in value and our
47
portfolio was not immune to this broad-based decline. We believe that in most market cycles, diversification of
the portfolio will be beneficial to us and we plan to continue to maintain a diversified portfolio.
The following table indicates our target asset allocation as approved by the Committee:
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Core fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Treasury inflation protected securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Large-cap equities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Small-cap equities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
International funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3.5 %
69.0
10.0
10.5
3.0
4.0
Total portfolio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
100.0%
Composition of Investment Portfolio
As funds become available, either through cash flow from operations, maturities or sales of investments, our
objective is to allocate funds to help us achieve our targeted asset allocations over the long term. The following
table provides a breakdown of our investment portfolio relative to our targeted allocated percentages at
December 31, 2008. As concerns began to arise in the market place in the last half of 2008 we took a more
conservative approach to preserve higher cash balances than our targeted allocation. As we observed markets
weakening, we began holding higher cash balances to avoid selling assets at depressed prices for any cash needs
that might arise in the course of business, which included settling the claim activity associated with the
catastrophes previously discussed. Consequently, cash balances at year-end were somewhat higher than the
target. Additionally, approximately $22.3 million is held at the holding company level for State Auto Financial
obligations and will remain in short-term funds. See “Liquidity and Capital Resources” included in this Item 7.
We measure our investment portfolio allocation with fixed maturities at amortized cost and equities and other
invested assets at fair value.
($ millions)
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fixed maturities:
Core fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Treasury inflation protected securities . . . . . . . . . . . . . . . . . . . . . .
Total fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equities:
Large-cap equities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Small-cap equities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total equities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets:
International funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total other invested assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 150.5
1,703.2
77.9
1,781.1
130.2
7.3
137.5
28.8
2.9
31.7
% of
Total
7.2
81.1
3.7
84.8
6.2
0.3
6.5
1.4
0.1
1.5
Total portfolio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$2,100.8
100.0
48
The following table provides the composition of our available-for-sale investment portfolio at fair value at
December 31:
($ millions)
2008
2007
Fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . . .
$1,770.7
137.5
31.7
91.3
7.1
1.6
$1,745.4
254.2
19.8
86.4
12.6
1.0
Total investments, at fair value . . . . . . . . . .
$1,939.9
100.0% $2,019.4
100.0%
The amortized cost and fair value of fixed maturities at December 31, 2008, by contractual maturity, were as
follows:
($ millions)
Due in 1 year or less . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Due after 1 year through 5 years . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Due after 5 years through 10 years . . . . . . . . . . . . . . . . . . . . . . . . . .
Due after 10 years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
U.S. government agencies mortgage-backed securities . . . . . . . . . . .
Amortized
Cost
$
2.5
107.6
469.0
1,023.5
178.5
$
Fair
Value
2.5
111.2
482.5
994.2
180.3
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,781.1
$1,770.7
Expected maturities may differ from contractual maturities as issuers may have the right to call or prepay
the obligations with or without call or prepayment penalties.
At December 31, 2008, our equity portfolio consisted of approximately 71 different large-cap stocks and
335 small-cap stocks. The largest single position was 3.8% of the equity portfolio based on fair value and the top
ten positions account for 29.8% of the equity portfolio.
Since our equity portfolio consists primarily of large-cap value-oriented stocks, with a small allocation to
small-cap equities, when large-cap stocks and/or value-oriented stocks perform well our equity portfolio typically
performs well compared to benchmarks. Conversely, when growth stocks outperform value and/or small- to
mid-cap stocks outperform large-cap stocks, our equity portfolio does not perform as well compared to
benchmarks.
The chart below shows the industry sector breakdown of our large-cap equity portfolio versus the S&P 500
Index based on fair value as of December 31, 2008.
Industry Sector
Basic Materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Communications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Consumer Cyclical
Consumer Non-cyclical . . . . . . . . . . . . . . . . . . . . . . . . . . .
Energy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Financial
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Health Care . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Industrial
Technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity Portfolio
% of Fair Value
S&P 500 Index
% of Fair Value
2.2
4.1
18.4
14.9
6.6
9.4
5.1
23.8
15.5
—
2.9
3.8
8.4
13.0
13.4
13.1
14.9
11.0
15.3
4.2
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
100.0
100.0
49
Market Risk
Our 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 instruments; (d) general market interest
rates; (e) our liquidity requirements at any given time; and (f) our current federal income tax position and relative
spread between after tax yields on tax-exempt and taxable fixed maturity investments.
Our 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. Our fixed maturity securities are subject to interest
rate risk whereby the value of the securities varies as market interest rates change. We manage this risk by
closely monitoring the duration of the fixed maturity portfolio. The duration of the fixed maturity portfolio was
approximately 6.26 and 5.10 as of December 31, 2008 and 2007, respectively. The table below summarizes our
interest rate risk and shows the effects of a parallel change in interest rates on the fair value of the fixed maturity
portfolio (excluding other debt securities) as of December 31, 2008:
Fair value ($ millions) . . . . . . . . . . . . . . .
Change in interest rates (bps) . . . . . . . . .
Value as % of original value . . . . . . . . . .
$1,988.5
-200
112%
$1,881.8
-100
106%
$1,770.7
0
100%
$1,660.0
+100
$1,554.6
+200
94%
88%
This table summarizes only the effects that a parallel change in interest rates could have on the fixed
maturity portfolio. This change in rates would also change the value of our liabilities and possibly other financial
assets. We caution the reader that this analysis does not take into account nonparallel changes in interest rates. It
is likely that some rates would increase or decrease more than others depending upon market conditions at the
time of the change. This nonparallel change would alter the value of the fixed maturity portfolio. The analysis is
also limited in that it does not take into account any actions that might be taken by us in response to these
changes. As a result, the actual impact of a change in interest rates and the resulting fixed maturity values may
differ significantly from what is shown in the table.
We believe that the fixed maturity portfolio’s exposure to credit risk is minimal as greater than 98% of the
bonds we own are rated AA or better and the remaining bonds are rated A. We do not intend to change our
investment policy on the quality of our fixed maturity 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. We also manage liquidity risk by maintaining sufficient cash balances, owning
some agency and U.S. Treasury securities at all times, purchasing bonds of major issuers, and purchasing bonds
that are part of a medium or large issue. The fixed maturity portfolio does not have any direct exposure to either
exchange rate risk or commodity risk. We do not rely on the use of derivative financial instruments. To provide
us greater flexibility in order to manage our market risk exposures, we categorize our fixed maturities as
available-for-sale. We do not maintain a trading portfolio.
We have no direct exposure to Lehman Brothers Holdings Inc. or its subsidiaries, American International
Group Inc., and no exposure to the common or preferred shares of Federal Home Loan Mortgage Corporation
(“Freddie Mac”), or Federal National Mortgage Associations (“Fannie Mae”). Our exposure to Freddie Mac and
Fannie Mae is limited to senior debt issues and mortgage-backed pools, which amount to less than 4% of
invested assets, with no impairments anticipated as a result.
We have no asset-backed securities in our fixed maturity portfolio which may be labeled sub-prime
mortgage-backed securities. We only invest in conventional mortgage backed securities issued by a federal
agency or that are U.S. Government guaranteed. Specifically, approximately $180.3 million or 9.3% of our
available-for-sale investment portfolio as of December 31, 2008, were in either Ginnie Mae pools, which are
guaranteed by the full faith and credit of the U.S. Government, or Fannie Mae or Freddie Mac pools. In 2008
both Fannie Mae and Freddie Mac received additional U.S. Government backing when they were placed into
conservatorship.
50
Our fixed maturity investment portfolio at December 31, 2008 included securities issued by numerous
municipalities with a total carrying value of $1,451.0 million. Approximately $634.6 million or 44% of these
securities were enhanced by third-party insurance (the “Credit Enhancement”) for the payment of principal and
interest in the event of an issuer default. The downgrade of credit ratings of insurers of these securities could
result in a corresponding downgrade in the ratings of the securities to the underlying rating of the respective
security without giving effect to the benefit of the Credit Enhancement. Credit Enhancement is not a primary
consideration to us when purchasing a municipal security as we consider the underlying credit rating of the
security by Moody’s and S&P as a more important factor in our evaluation process. Of the total $1,451.0 million
of municipal securities in our investment portfolio at December 31, 2008, approximately 92% were rated AA or
better, without the benefit of a Credit Enhancement. We do not believe that a loss of a Credit Enhancement
would have a material adverse impact on our results of operations, financial position or liquidity, due to the
underlying strength of the issuers of the securities, as well as our ability and intent to hold the securities.
We believe our municipal bond portfolio (“Muni Portfolio”) is well diversified by issuer and state. No
single issuer comprises more than 4% of the portfolio and no more than 10% of the portfolio is concentrated in
any one state. We believe our Muni Portfolio is invested within the strongest sectors of the municipal bond
market. We have approximately 20% invested in securities which have been either pre-refunded or escrowed to
maturity bonds. Approximately 40% of our municipal bonds are general obligation bonds or other tax-backed
bonds. The majority of the remaining Muni Portfolio consists of revenue bonds. Our credit research is an
important part of our investment management process and we continually monitor all holdings for any signs of
deterioration. We believe that our municipal holdings will maintain their high credit quality and that the issuers
will be able to make all principal and interest payments as they come due.
As of December 31, 2008, our large-cap equity portfolio had a beta of 0.94 using the S&P 500 Index as a
benchmark. Beta estimates the degree the portfolio’s price will fluctuate based on a given movement in the
market index. The table below reflects what changes might occur in the value of the large-cap equity portfolio
given a change in the S&P 500 Index:
Fair value ($ millions)
. . . . . . . . . . . . . .
Change in S&P 500 Index . . . . . . . . . . .
Value as % of original value . . . . . . . . .
$154.7
$142.4
+20%
119%
+10%
109%
$130.2
0
100%
$118.0
$105.7
-10%
91%
-20%
81%
The above analysis is limited in that it does not take into account any actions that might be taken by us in
response to these changes. As a result, the actual impact of a change in equity market prices and the resulting
equity values may differ significantly from what is shown in the table. By investing in mostly large-cap issues we
hope to limit liquidity risk in the equity portfolio. The equity portfolio does not have any direct exposure to
exchange rate risk since we do not directly hold any foreign stocks. We constantly monitor the equity portfolio
holdings for any credit risk issues that may arise. We do not invest in any commodity futures or commodity
oriented mutual funds.
51
At December 31, 2008, we have two international funds, Fund 1 and Fund 2, which are included in other
invested assets available-for-sale. Fund 1 and Fund 2 had betas of 0.629 and 0.838, respectively, using the MSCI
EAFE Index as a benchmark. Beta estimates the degree the portfolio’s price will fluctuate based on a given
movement in the index. The tables below reflect what changes might occur in the values of Funds 1 and 2 given a
change in the MSCI EAFE Index:
Fund 1
Fair value ($ millions)
. . . . . . . . . . . . . . . . . . .
Change in MSCI EAFE Index . . . . . . . . . . . . .
Value as % of original value . . . . . . . . . . . . . .
Fund 2
Fair value ($ millions)
. . . . . . . . . . . . . . . . . . .
Change in MSCI EAFE Index . . . . . . . . . . . . .
Value as % of original value . . . . . . . . . . . . . .
$17.6
$16.6
$15.6
0
+20% +10%
113% 106% 100%
$15.4
$14.3
$13.2
0
+20% +10%
117% 108% 100%
$14.6
$13.6
-10% -20%
87%
94%
$12.1
$11.0
-10% -20%
83%
92%
The above analysis does not take into account any actions that might be taken by the portfolio managers in
response to these changes. As a result, the actual impact of a change in international equity market prices and the
resulting international equity values may differ significantly from what is shown in the tables above.
Investment Operations Revenue
Net investment income for 2008 was $87.4 million compared to $84.7 million in 2007. The growth in net
investment income is attributed to an increase in average invested assets, from $1,987.1 million at December 31,
2007 to $2,127.6 million at December 31, 2008, primarily due to the January 1, 2008 $92.0 million in cash
received in conjunction with the Pooling Change.
($ millions)
Gross investment income:
Year Ended December 31
2008
2007
Fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
Total gross investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less: Investment expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
79.1
5.5
4.9
89.5
2.1
87.4
$
$
75.3
5.7
5.5
86.5
1.8
84.7
Average invested assets (at cost) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Annualized investment yield . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Annualized investment yield, after tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net investment income, after tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Effective tax rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$2,127.6
4.1%
3.6%
76.6
12.4
$
$1,987.1
4.3
3.7
73.6
13.2
$
Our investment yield declined to 4.1% in 2008 from 4.3% in 2007 due to the following factors: we held
fewer large cap dividend paying stocks as we diversified into small cap stocks and international funds; and as the
financial markets began to weaken in the last half of 2008, we held higher levels of cash balances which earned
lower yields than in 2007.
52
Realized gains and losses on investments for the years ended December 31, 2008 and 2007, respectively, are
summarized as follows:
($ millions)
2008
2007
Realized
Gains
(Losses)
Proceeds
Received
on Sale
Realized
Gains
(Losses)
Proceeds
Received
On Sale
Realized gains:
Fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . .
Equity securities . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . .
$ 2.7
9.6
—
$164.6
41.0
—
Total realized gains . . . . . . . . . . . . . . . . . .
12.3
205.6
Realized losses:
Fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . .
Equity securities . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . .
Total realized losses . . . . . . . . . . . . . . . . .
—
(37.7)
(11.0)
(48.7)
—
26.0
—
26.0
$ 0.8
19.7
—
20.5
(1.3)
(7.1)
—
(8.4)
$ 82.5
76.2
—
158.7
72.7
30.8
—
103.5
Net realized (loss) gain on investments . . .
$(36.4)
$231.6
$12.1
$262.2
Equity sales were executed for various reasons in 2008, including the achievement of our price target and
generated $9.6 million in gains for that period. The $48.7 million of realized losses for 2008 include the
recognition of realized losses from sales activity of $9.4 million. We recognized realized losses on the sale of
certain equity positions within the consumer, manufacturing and financial services sectors due to announced
changes in business conditions which, in our opinion, greatly diminished future business prospects.
We regularly monitor our investment portfolio for declines in value that are OTTI, an assessment which
requires significant management judgment regarding the evidence known. Such judgments could change in the
future as more information becomes known which could negatively impact the amounts reported herein. We
consider many factors when assessing our investments for OTTI which include: (1) the financial condition of the
issuer, including any specific events that may influence the issuer’s operations; (2) the length of time and/or the
depth of decline below cost; (3) our ability and intent to hold the security through its near term recovery period;
and (4) the ability of the fair value to recover to cost in the near term. We recognized OTTI charges on our
externally managed small cap equity portfolio and a segment of our large cap portfolio where we are unable to
make the assertion regarding our intent to hold these securities that are currently valued below cost until recovery
in the near term. When a security in our investment portfolio has been determined to have a decline in fair value
that is other-than-temporary, we adjust the cost basis of the security to fair value. This results in a charge to
earnings as a realized loss, which is not reversed for subsequent recoveries in fair value. Future increases or
decreases in fair value, if not other-than-temporary, are included in other comprehensive income.
53
The $48.7 million of realized losses for 2008 include the recognition of OTTI in our available-for-sale
investment portfolio of $39.3 million. The following table provides a detailed breakdown by security type (and
by sector for the large cap portfolio) for the 2008 OTTI charges.
($ millions)
Equity Securities:
Large-cap equities:
Communications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Consumer Cyclical . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Consumer Noncyclical . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Energy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Financial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Industrial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Small-cap equities: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets:
International funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total OTTI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Number
of
positions
Total
impairment
2
6
1
2
6
2
4
3
26
530
2
558
$ (2.1)
(5.4)
(1.2)
(1.2)
(6.1)
(4.0)
(2.3)
(1.9)
(24.2)
(4.1)
(11.0)
$(39.3)
Gross Unrealized Investment Gains and Losses
A review of our investment portfolio at December 31, 2008, determined that there were no individual
investments with an unrealized holding loss that had a fair value significantly below cost continually for more
than one year.
The following table provides detailed information on our available-for-sale investment portfolio at fair value
for our gross unrealized gains and losses at December 31, 2008.
($ millions, except number of positions)
Investment Category:
Cost or
amortized
cost
Gross
unrealized
holding
gains
Number of
gain
positions
Gross
unrealized
holding
losses
Number of
loss
positions
Fair
Value
Fixed Maturities:
U.S. Treasury securities . . . . . . . . . . . . . . . . . . . . . $ 127.6
1,463.1
States and political subdivisions . . . . . . . . . . . . . . .
11.9
Corporate securities . . . . . . . . . . . . . . . . . . . . . . . . .
Mortgage-backed securities of U.S. Gov.
Agencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
178.5
Total fixed maturities . . . . . . . . . . . . . . . . . . .
1,781.1
Equity Securities:
Consumer
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Technologies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Pharmaceuticals . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Financial services . . . . . . . . . . . . . . . . . . . . . . . . . .
Manufacturing and other . . . . . . . . . . . . . . . . . . . . .
42.2
28.7
1.7
15.2
56.5
$ 4.2
21.4
0.1
4.0
29.7
3.0
0.3
0.3
0.6
2.5
Total equity securities . . . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . . . . .
144.3
6.7
32.4 —
Total investments . . . . . . . . . . . . . . . . . . . . . . $1,957.8
$36.4
42
288
7
42
379
71
58
8
70
158
365
—
744
$ (4.2)
(33.5)
(0.2)
(2.2)
(40.1)
(2.7)
(2.8)
—
(0.5)
(7.5)
(13.5)
(0.7)
$(54.3)
29
357
7
29
422
11
5
—
5
20
41
2
465
$ 127.6
1,451.0
11.8
180.3
1,770.7
42.5
26.2
2.0
15.3
51.5
137.5
31.7
$1,939.9
54
The following table presents a summary of our cumulative unrealized holding (loss) gain by investment
type, net of deferred taxes that were included as a component of accumulated comprehensive loss at
December 31, 2008 and December 31, 2007, respectively, and the change in unrealized holding gain (loss), net of
deferred tax, for the year ended December 31, 2008:
($ millions)
December 31,
2008
December 31,
2007
$
Change
Available-for-sale investments
Cumulative unrealized holding (loss) gain:
Fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cumulative unrealized holding (loss) gain . . . . . . . . . . . .
Deferred federal income tax asset (liability) . . . . . . . . . . . . . . .
Valuation allowance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$(10.4)
(6.8)
(0.7)
(17.9)
6.3
(2.6)
$ 22.5
44.0
0.3
66.8
(23.4)
—
$(32.9)
(50.8)
(1.0)
(84.7)
29.7
(2.6)
Cumulative unrealized holding (loss) gain, net of tax . . . .
$(14.2)
$ 43.4
$(57.6)
Fair Value Measurements
On January 1, 2008, we adopted SFAS No. 157, “Fair Value Measurements” (“SFAS 157”), which was
issued by the FASB in September 2006. For financial statement elements currently required to be measured at
fair value, SFAS 157 defines fair value, establishes a framework for measuring fair value under GAAP and
enhances disclosures about fair value measurements. The new definition of fair value focuses on the price that
would be received to sell the asset or paid to transfer the liability (“exit price”) regardless of whether an
observable liquid market price exists. An exit price valuation will include margins for risk even if they are not
observable.
SFAS 157 establishes a fair value hierarchy that categorizes the inputs to valuation techniques which are
used to measure fair value into three broad levels as defined below:
•
•
•
Level 1 includes observable inputs which reflect quoted prices for identical assets or liabilities in active
markets at the measurement date.
Level 2 includes observable inputs for assets or liabilities other than quoted prices included in Level 1
and it includes valuation techniques which use prices for similar assets and liabilities.
Level 3 includes unobservable inputs which reflect the reporting entity’s estimates of the assumptions
that market participants would use in pricing the asset or liability (including assumptions about risk).
The table below shows our investments measured at fair value by level at December 31, 2008:
($ millions)
Available-for-sale investments:
Fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . . .
Total
$1,770.7
137.5
31.7
Total available-for-sale investments . . . . . .
$1,939.9
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
$ —
137.5
2.9
$140.4
Significant
Other
Observable
Inputs
(Level 2)
$1,768.4
—
—
$1,768.4
Significant
Unobservable
Inputs
(Level 3)
$ 2.3
—
28.8
$31.1
55
As of December 31, 2008, Level 3 assets as a percentage of total assets were 1.3%, which we have
determined to be insignificant.
Other Income Statement Items
The effective tax rate for 2008 was a benefit of 58.6% compared to an expense rate of 23.3% for 2007.
Included in our 2008 loss before federal income taxes are tax-exempt earnings related to our investment portfolio
which is the significant contributing differential between the actual 58.6% and the expected statutory rate of
35.0%.
In 2008, a $3.1 million valuation allowance was established against our deferred tax asset to the extent we
could not demonstrate recoverability of the asset. The valuation allowance was allocated $0.5 million to deferred
tax expense associated with our OTTI realized investment losses recognized in the income statement and $2.6
the unrealized holding losses on equity securities recognized through accumulated other
million against
comprehensive loss, a component of equity. In the opinion of management, it is more likely than not that we will
realize the benefit of our net deferred tax asset. The $0.5 million portion of the valuation allowance reflected in
the income statement had the effect of decreasing the effective tax rate benefit by 0.7 percent. No valuation
allowance was held at December 31, 2007.
2007 Compared to 2006
Income before federal income tax decreased $6.4 million (4.0%) to $155.3 million from 2006. The most
significant factors contributing to this decrease related to a decline in our revenues, specifically our premiums,
and an increase in our loss and loss expenses. Our GAAP Loss and Loss Expense Ratio for 2007 was 58.4%
compared to 57.4% in 2006.
Insurance Segments
The following tables provide a summary of our insurance segments’ SAP underwriting gain and SAP
combined ratio for the years ended December 31, 2007 and 2006:
($ millions)
Written premiums . . . . . . . . . . . . . . . . . . . . .
Earned premiums . . . . . . . . . . . . . . . . . . . . .
Losses and loss expenses . . . . . . . . . . . . . . .
Underwriting expenses . . . . . . . . . . . . . . . . .
SAP underwriting gain and SAP
Personal
$615.1
609.6
378.4
183.9
%
Ratio
62.1
29.9
2007
Business
$404.7
402.0
207.2
154.2
%
Ratio
51.5
38.1
Total
$1,019.8
1,011.6
585.6
338.1
%
Ratio
57.9
33.2
combined ratio . . . . . . . . . . . . . . . . . . . . . .
$ 47.3
92.0
$ 40.6
89.6
$
87.9
91.1
($ millions)
Written premiums . . . . . . . . . . . . . . . . . . . . .
Earned premiums . . . . . . . . . . . . . . . . . . . . .
Losses and loss expenses . . . . . . . . . . . . . . .
Underwriting expenses . . . . . . . . . . . . . . . . .
SAP underwriting profit and SAP
Personal
$612.8
614.8
389.6
180.4
%
Ratio
63.4
29.4
2006
Business
$406.7
409.0
192.4
155.1
%
Ratio
47.0
38.1
Total
$1,019.5
1,023.8
582.0
335.5
%
Ratio
56.8
32.9
combined ratio . . . . . . . . . . . . . . . . . . . . . .
$ 44.8
92.8
$ 61.5
85.1
$ 106.3
89.7
56
Revenue
Personal Insurance Segment Revenue
Our personal insurance segment consists primarily of auto (standard and nonstandard) and homeowners’
products, with personal auto representing approximately 40% of our total consolidated net written premium in
2007 and 2006. The following table provides a summary of written and earned premium, net of reinsurance, by
major product line of business for our personal insurance segment for the years ended December 31, 2007 and
2006:
($ millions)
Personal Insurance Segment:
2007
2006
%
Change
Net Written Premium
Standard auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Nonstandard auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Homeowners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other personal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$361.5
42.7
187.7
23.2
$361.7
42.4
186.1
22.6
Total personal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$615.1
$612.8
Net Earned Premium
Standard auto
Nonstandard auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Homeowners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other personal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$357.3
42.9
186.5
22.9
$362.1
44.8
185.2
22.7
Total personal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$609.6
$614.8
(0.1)
0.7
0.9
2.7
0.4
(1.3)
(4.2)
0.7
0.9
(0.8)
In total, the personal insurance segment net written premium increased from 2006 by 0.4%. While a modest
increase, it does represent an improvement from 2006 which declined approximately 3.5% from 2005. In
particular, competition remains intense within the personal auto market, which is contributing to our overall
modest growth. It remains our strategy that rates be risk-based, reflecting the underlying loss and expense trends.
Net written premiums for our standard auto products decreased 0.1% in 2007 compared to 2006. The
competitive marketplace combined with some rate reductions in 2007 contributed to this result. However, we
have seen increasing new business production related to the introduction of our CustomFit product into new
states. CustomFit uses a multi-variate rating approach that broadens the underwriting eligibility for new
customers. In 2007, we began introducing the second generation of CustomFit, which further improves our rating
sophistication.
Net written premiums for nonstandard personal auto increased 0.7% in 2007 compared to 2006. This
represents a significant improvement compared to the 2006 premium result which declined 13.3% from 2005.
Targeted rate decreases coupled with the introduction of new discounts and an increased marketing effort
contributed to an increased level of new policy submissions, leading to an increase in premiums.
We believe independent agents value ease of doing business and make it an important factor in their choice
of insurance companies when quoting personal auto products to their customers. During 2007, we introduced in
17 states various “real time” comparative rating tools which can be used by our independent agents to prepare
comparative rate quotes from multiple insurance companies by entering the rating information once. We believe
our independent agents will quote and write more personal standard and nonstandard auto with us as a result of a
more efficient quoting process.
57
Homeowners’ net written premium increased 0.9% in 2007 compared to 2006. In 2007, we introduced a
home purchase discount and expanded our age of dwelling discounts to help attract new business which we
believe contributed favorably to increased new homeowners policy submission levels.
During 2007, we continued to enhance our personal lines point of sale portal, netXpress, by adding several
new integration options with a variety of third party tools used by our independent agents including a joint credit
ordering tool, integrated report ordering, and the comparative rating tools mentioned above. We also have added
a number of internal integration points through the use of web services technology. One example of this is real
time integration with our enterprise billing system to provide accurate installment information via netXpress. The
goal of these technology investments is to streamline quoting and policy issuance for our agents. We strive to be
their carrier of choice and ease of doing business is a major driver toward that goal.
We have also focused on improving our policyholders’ ease of doing business with respect to bill payment
and claim reporting and settlement. In 2006, we expanded our premium payment options to include credit and
debit card via www.stateauto.com. In 2007, we deployed an Interactive Voice Response (“IVR”) solution to
accept premium payments over the phone providing yet another option for policyholders. The IVR solution
provides a more efficient business process for our payment services department and is expected to drive better
policy retention results. During 2007, nearly 189,000 payments were made through self-service technologies
such as these representing over $76 million of premium payments.
Additionally, we recently completed several strategic initiatives to enhance our claims handling ability and
better manage major catastrophes. Field claims personnel are now equipped with mobile devices that permit
adjusting property claims at the loss site. We believe that our professional claims service backed by reliable
technology will continue to distinguish us from our competitors.
During the second quarter 2007, we filed an application with the Florida Department of Insurance to
withdraw from the state’s personal lines insurance market effective January 1, 2008. After a careful analysis of
recent regulatory changes in Florida, we concluded that we could no longer operate our personal lines on a
profitable basis in that state. Non-renewals on this business are in process. We will continue to write commercial
lines business in Florida. During 2007, we wrote $12.5 million of personal lines premium in Florida.
58
Business Insurance Segment Revenue
We focus our business insurance sales on small to medium sized exposures and offer a broad range of both
property and liability coverages such as commercial auto, commercial multi-peril, fire and allied lines, products
liability and workers’ compensation. The following table provides a summary of written and earned premium,
net of reinsurance, by major product line of business for our business insurance segment for the years ended
December 31, 2007 and 2006:
($ millions)
Business Insurance Segment:
2007
2006
%
Change
Net Written Premium
Commercial auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial multi-peril
Fire & allied lines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other & product liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Workers’ compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other commercial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 95.8
86.6
84.0
75.6
36.1
26.6
$ 98.7
87.8
83.1
77.2
34.3
25.6
Total business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$404.7
$406.7
Net Earned Premium
Commercial auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial multi-peril
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fire & allied lines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other & product liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Workers’ compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other commercial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 96.9
86.8
83.4
75.5
33.4
26.0
$100.3
87.5
84.2
77.5
33.8
25.7
Total business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$402.0
$409.0
(2.9)
(1.4)
1.1
(2.1)
5.2
3.9
(0.5)
(3.4)
(0.8)
(1.0)
(2.6)
(1.2)
1.2
(1.7)
The business insurance segment net written premium for 2007 decreased 0.5% from 2006. Business
insurance continues to be impacted by rate competition and ease of doing business issues. We are seeking to
balance our traditional underwriting discipline with new products and pricing tools that support the production of
profitable new business.
In 2007, we began offering our business products in two new states—Colorado and Texas—and increased
the number of business products offered in Arizona.
We also continue to enhance our back office systems which enable us to more effectively support our
independent agents. We recently implemented the technology to provide real time functionality in our business
insurance policy administration systems for quote and issuance transactions. Also known as straight through
processing (“STP”), our associates are now able to more effectively and accurately handle typical business
insurance processing. The policy service time has been greatly reduced as a result of this new technology.
To make it easier for our agents to submit business insurance accounts, in 2007, we introduced bizXpress,
our web-based quote and issuance system, to agents in all of our operating states except Florida. We currently
utilize bizXpress for businessowners policies. We are working to expand bizXpress functionality to our business
auto products in the first half of 2008, while we develop the same functionality for workers’ compensation
business for introduction at a later date. This has been a highly collaborative initiative that has included agent
focus group input throughout the project lifecycle. It also leverages the STP technology investment mentioned
above. We believe this technology investment should better position us for revenue growth opportunities in the
future and start to drive efficiencies into our business model much like we have seen in personal insurance.
59
Losses and Expenses
Our GAAP Loss and LAE ratio was 58.4% in 2007 compared to 57.4% in 2006. Loss results for the year
have been mixed. Our core auto (personal and business) and other and product liability lines continue to perform
well. On the property side, catastrophe losses for 2007 were lower than in 2006, but we experienced significantly
higher frequency of large fire losses within our personal and business lines during 2007.
The following table presents the provision for losses and loss expenses for those claims occurring in the
current calendar year and prior years, along with the GAAP Loss and LAE ratio for the years 2007 and 2006,
respectively:
($ millions)
%
GAAP Loss
and LAE
2006
%
GAAP Loss
and LAE
2007
Provision for losses and loss expenses occurring:
Current year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Prior years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$645.5
(54.7)
Total losses and loss expenses . . . . . . . . . . . . . . . . . . . . . . .
$590.8
62.7
(4.3)
58.4
$659.3
(71.7)
$587.6
64.4
(7.0)
57.4
A tabular presentation of the 2007 $54.7 million favorable development broken down by accident year is
shown below.
($ millions)
Accident year
1997 and prior
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1998 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Current year
development of ultimate
liability
Redundancy /(Deficiency)
$ (4.8)
(0.1)
0.2
0.2
1.8
1.1
4.3
2.3
20.2
29.5
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$54.7
Normal fluctuations and uncertainty associated with loss reserve development and claim settlement
contributed to favorable development in the respective calendar years. The favorable development of $54.7
million in 2007 came primarily from accident years 2005-2006. The more notable items contributing to the 2007
development are:
•
•
Favorable development at the product level is primarily from the auto liability and other liability lines,
where current loss projections using more mature claim data resulted in lower expected average claim
severities than past projections. The impact
is approximately $23.5 million for these two lines
combined.
Adjusting and other expense reserves accounted for approximately $11.8 million of prior year reserve
change. These expense reserves have a proportional relationship to the overall claim inventory and held
60
reserves by accident year, as they move up or down in relation to carried loss reserves. Since reserves
decreased for the prior accident years, the expense reserves declined in a similar fashion. (Allocated
loss adjustment expenses (“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. Unallocated loss
adjustment expenses (“ULAE”) are those costs incurred in settling claims, such as in-house processing
costs, for which no identification can be made to specific claims. “Adjusting and other expenses” are
the components of ALAE and ULAE that relate to costs other than defense, litigation, and medical cost
containment.)
• We hold ceded loss reserves in anticipation of transferring liabilities to reinsurers and other pools and
associations. Ceded loss reserves were above previously anticipated levels by approximately $10.0
million. Historically, we have had less ceded loss activity because our reinsurance retention levels are
generally high enough to exclude most claims. This favorable development occurred primarily in the
fire, auto liability and workers’ compensation lines.
•
•
Favorable catastrophe loss development of approximately $4.6 million is attributable to the 2006
accident year. This development occurred primarily within our homeowners, other personal and
commercial multi-peril lines of business.
The remaining favorable development is spread across several lines of business and is generally the
result of having fewer claims emerge and lower claim severity than anticipated in the estimates
developed as of December 31, 2006.
The following tables provide our insurance segments’ SAP Loss and LAE ratios (“loss ratios”) by major
line of business for 2007 and 2006 with the catastrophe (“Cat”) and non-catastrophe (“Non-Cat”) impact shown:
($ millions)
2007 Statutory Loss and LAE Ratios
Earned
Premium
Cat Loss
& LAE
Non-Cat
Loss &
LAE
Statutory
Loss &
LAE
Cat
Ratio
Non-Cat
Ratio
Total Loss
and LAE
Ratio
Personal insurance segment:
Standard auto . . . . . . . . . . . . . . . . . . . . . . . . .
Nonstandard auto . . . . . . . . . . . . . . . . . . . . . .
Homeowners . . . . . . . . . . . . . . . . . . . . . . . . . .
Other personal . . . . . . . . . . . . . . . . . . . . . . . . .
$ 357.3
42.9
186.5
22.9
$ 2.3
—
26.5
1.8
$217.4
27.1
94.0
9.2
$219.8
0.7
27.1 —
14.2
120.5
7.9
11.0
Total personal . . . . . . . . . . . . . . . . . . . . .
609.6
30.7
347.8
378.4
5.0
Business insurance segment:
Commercial auto . . . . . . . . . . . . . . . . . . . . . . .
Commercial multi-peril . . . . . . . . . . . . . . . . . .
Fire & allied lines . . . . . . . . . . . . . . . . . . . . . .
Other & product liability . . . . . . . . . . . . . . . . .
Workers’ compensation . . . . . . . . . . . . . . . . .
Other commercial . . . . . . . . . . . . . . . . . . . . . .
96.9
86.8
83.4
75.5
33.4
26.0
—
1.5
4.9
—
—
—
50.6
49.9
36.0
32.8
24.9
6.5
50.6 —
1.7
51.5
40.9
5.9
32.8 —
24.9 —
6.5 —
Total business . . . . . . . . . . . . . . . . . . . . .
Total SAP personal and business . . . . . .
402.0
$1,011.6
6.4
$37.1
200.8
$548.5
207.2
$585.6
1.6
3.7
60.9
63.2
50.4
40.3
57.0
52.2
57.5
43.2
43.5
74.6
24.8
49.9
54.2
61.5
63.2
64.6
48.2
62.1
52.2
59.3
49.1
43.5
74.6
24.8
51.5
57.9
61
Earned
Premium
Cat Loss
& LAE
Non-Cat
Loss &
LAE
Statutory
Loss &
LAE
Cat
Ratio
Non-Cat
Ratio
Total Loss
and LAE
Ratio
($ millions)
2006 Statutory Loss and LAE Ratios
Personal insurance segment:
Standard auto . . . . . . . . . . . . . . . . . . . . . . . . .
Nonstandard auto . . . . . . . . . . . . . . . . . . . . . .
Homeowners . . . . . . . . . . . . . . . . . . . . . . . . . .
Other personal . . . . . . . . . . . . . . . . . . . . . . . . .
$ 362.1
44.8
185.2
22.7
$ 6.5
0.3
59.7
6.4
$199.9
26.6
85.0
5.2
$206.4
26.9
114.7
11.6
1.8
0.7
32.2
28.3
11.9
Total personal . . . . . . . . . . . . . . . . . . . . .
614.8
72.9
316.6
389.6
Business insurance segment:
Commercial auto . . . . . . . . . . . . . . . . . . . . . . .
Commercial multi-peril . . . . . . . . . . . . . . . . . .
Fire & allied lines . . . . . . . . . . . . . . . . . . . . . .
Other & product liability . . . . . . . . . . . . . . . . .
Workers’ compensation . . . . . . . . . . . . . . . . .
Other commercial . . . . . . . . . . . . . . . . . . . . . .
100.3
87.5
84.2
77.5
33.8
25.7
0.3
1.1
16.1
—
—
0.2
40.1
41.4
33.0
29.1
19.4
11.7
0.3
40.4
1.3
42.5
19.2
49.1
29.1 —
19.4 —
0.6
11.9
Total business . . . . . . . . . . . . . . . . . . . . .
Total SAP personal and business . . . . . .
409.0
$1,023.8
17.7
$90.6
174.6
$491.3
192.4
$582.0
4.3
8.9
55.2
59.3
45.9
22.8
51.5
39.9
47.3
39.2
37.5
57.5
45.7
42.7
48.0
57.0
60.0
78.1
51.1
63.4
40.3
48.6
58.3
37.5
57.5
46.3
47.0
56.8
The personal insurance segment loss ratio was 1.3 points lower in 2007 than in 2006. Catastrophes
accounted for 5.0 loss ratio points in 2007 compared to 11.9 points in 2006. Excluding the impact of
catastrophes, the personal lines loss ratio in 2007 was 5.5 points higher than in 2006. The increase in both the
standard and nonstandard auto loss ratios can be attributed partially to rate reductions taken in 2006 and 2007.
The improvement in the homeowners loss ratio can be attributed primarily to the reduction of catastrophe losses.
In 2007, catastrophes added 14.2 points to the homeowners loss ratio compared to 32.2 points in 2006.
The business insurance segment’s loss ratio for 2007 was 4.5 points higher than in 2006. Catastrophes
accounted for 1.6 loss ratio points in 2007 compared to 4.3 points in 2006. Excluding the impact of catastrophes,
the business lines loss ratio in 2007 was 7.2 points higher than in 2006. The overall increase reflects rate
reductions in premium per exposure on business written in 2006 and 2007 and an increase in the number of large
property losses. Workers’ compensation, which represents approximately 9.0% of our business insurance
portfolio and less than 4.0% of our overall insurance segment portfolio, tends to be a more volatile line of
business due to its size and risks written. We do not write mono-line workers’ compensation, but make our
product available as part of the business package policy. The increase in the level of 2007 losses as compared to
2006 was driven largely by an increase in severity rather than frequency. We regularly monitor frequency and
severity trends, as well as the overall construction of our workers’ compensation book of business. In addition,
we promote the writing of the low-hazard risk types that have developed a consistent pattern of profitability.
Acquisition and operating expenses, as a percentage of earned premiums (“GAAP expense ratio”) were
34.4% in 2007 compared to 34.0% in 2006. The 2007 expense ratio was largely impacted by a lower premium
base in 2007 compared to 2006.
Investment Operations Segment
Our investment portfolio and the investment portfolios of State Auto Mutual, and its subsidiaries and
affiliates are managed by our subsidiary, Stateco. The Investment Committee of the Board of Directors of each of
our insurers sets investment policies to be followed by Stateco.
At December 31, 2007, our investments in fixed maturities, equity securities and certain other invested
assets were held as available-for-sale and carried at fair value. The unrealized holding gains or losses, net of
applicable deferred taxes, are included as a separate component of stockholders’ equity as “accumulated other
comprehensive loss” and as such are not included in the determination of net income.
62
Our primary investment objectives are to generate income, preserve capital and maintain adequate liquidity
for the payment of claims and expenses. Our current investment strategy does not rely on the use of derivative
financial instruments.
We have investment policy guidelines with respect to purchasing fixed maturity investments for our
insurance subsidiaries which preclude investments in bonds that are rated below investment grade by a
recognized rating service. For the insurance subsidiaries, the maximum investment in any single note or bond is
limited to 5.0% or less of statutory assets, other than obligations of the U.S. government or government agencies,
for which there is no limit. Our fixed maturity portfolio is composed of high quality, investment grade issues,
comprised almost entirely of debt issues rated AAA or AA. At December 31, 2007, we had no fixed maturity
investments rated below investment grade. Our only investments in asset-backed securities were in federal
agency pools (Fannie Mae and Freddie Mac) and government guaranteed pools (Ginnie Mae).
Our internally managed equity portfolio invests in U.S. large-cap, dividend-paying companies across many
different industries selected based upon their potential for appreciation as well as ability to continue paying
dividends. This diversification across companies and industries reduces volatility in the value of the large-cap
equity portfolio. In addition, our investment policy guidelines limit the purchase of a specific stock to no more
than 2% of the market value of the stock at the time of purchase, and no single equity holding should exceed 5%
of the total equity portfolio.
During the fourth quarter 2007, we began to diversify our equity portfolio and utilize outside money
managers to invest in U.S. small-cap equities and international funds. These managers are permitted to manage
the portfolios according to their own respective portfolio objectives. In selecting our outside money managers we
confirm that their portfolio objectives, including risk tolerance, are acceptable to us; however, there may be slight
differences in their objectives with respect to dividend payments and other constraints that we apply to our large
cap equity holdings. By further diversifying our portfolio into small-cap equities and international funds, we
hope to achieve a greater total return with reduced volatility.
In August 2007, we completed a portfolio diversification study with the objective to reduce the volatility of
the returns and improve our overall after-tax return while continuing to maintain a high-quality portfolio. Based
on this study, the Committee (defined below) approved the following target asset allocation:
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Core fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Treasury inflation protected securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Large-cap equities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Small-cap equities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
International funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3.5%
69.0
10.0
10.5
3.0
4.0
Total portfolio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
100.0%
63
Composition of Investment Portfolio
Beginning in the fourth quarter of 2007, we began investing funds as they became available moving toward
our targeted asset allocations over the next 12 to 18 months. The following table provides a breakdown of our
investments relative to our targeted allocated percentages provided above at December 31, 2007. We measure our
investment portfolio allocation with fixed maturities at amortized cost and equities and international funds at fair
value.
($ millions)
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Core fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Treasury inflation protected securities . . . . . . . . . . . . . . . . . . . . . . . . . .
Large-cap equities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Small-cap equities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
International funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
70.9
1,710.0
12.9
242.7
11.5
15.9
5.7
% of
Total
3.4
82.6
0.6
11.7
0.6
0.8
0.3
Total portfolio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$2,069.6
100.0
The following table provides the composition of our available-for-sale investment portfolio at December 31,
2007 and 2006, respectively:
($ millions)
2007
2006
Fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,745.4
254.2
19.8
86.4% $1,647.4
284.2
12.6
4.0
1.0
85.1
14.7
0.2
Total investments, at fair value . . . . . . . . . . . . . . . . . .
$2,019.4
100.0% $1,935.6
100.0
The amortized cost and fair value of fixed maturities at December 31, 2007, by contractual maturity, are as
follows:
($ millions)
Due in 1 year or less . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Due after 1 year through 5 years . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Due after 5 years through 10 years . . . . . . . . . . . . . . . . . . . . . . . . . . .
Due after 10 years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
U.S. government agencies mortgage- backed securities . . . . . . . . . .
Amortized
Cost
$
16.9
60.5
437.5
1,019.4
188.6
Fair
Value
$
16.9
62.5
451.1
1,025.5
189.4
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,722.9
$1,745.4
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.
At December 31, 2007, our equity portfolio consisted of approximately 80 different large-cap stocks and
325 small-cap stocks. The largest single position was 3.2% of the equity portfolio based on fair value and the top
ten positions were equal to approximately 25.1% of the equity portfolio.
Our equity portfolio consists primarily of large-cap value-oriented stocks, with a small allocation to
small-cap equities. Therefore, when large-cap stocks and/or value-oriented stocks perform well our equity
64
portfolio typically performs well compared to benchmarks. Conversely, when growth stocks outperform value
and/or small- to mid-cap stocks outperform large-cap stocks, our equity portfolio does not perform as well
compared to benchmarks.
The chart below shows the industry sector breakdown of our large-cap equity portfolio versus the S&P 500
Index based on fair value as of December 31, 2007.
Industry Sector
Basic Materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Communications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Consumer Cyclical
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Consumer Non-cyclical . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Energy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Financial
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Industrial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity Portfolio
% of Fair Value
S&P 500 Index
% of Fair Value
2.1
5.6
16.3
16.8
9.9
16.6
24.4
8.3
—
3.4
11.3
7.1
20.5
12.9
17.6
11.8
11.8
3.6
Total
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
100.0
100.0
In 2005, the Investment Committee of State Auto Financial’s Board of Directors (“the Committee”)
approved a targeted allocation of 70% tax-exempt fixed maturities, 15% taxable fixed maturities and 15%
equities. This reallocation effort would result in lower pre-tax investment yields but higher after tax investment
income than if we had continued under the then current allocation percentages.
In November 2006, the Committee approved a $50.0 million repositioning of the then-current taxable and
tax-exempt holdings to reach our targeted percentage at a quicker pace than if we just used new monies. Based
on this action, the sale of approximately $50.0 million of taxable securities was completed by December 31,
2006. Reinvestment into tax-exempt securities of the proceeds from these actions was completed during the first
quarter 2007.
During the Committee’s March 2007 meeting, the allocation status was reviewed and the Committee
approved an additional $100.0 million repositioning of the then-current taxable and tax-exempt holdings. Based
on this action, the sale of approximately $100.0 million of taxable securities was completed by March 31, 2007.
Reinvestment into tax-exempt securities of the proceeds from these actions was completed during the 2007
second quarter. After completion of the targeted rebalancing, we assessed the securities held and confirmed our
intent to hold the remaining securities until either recovery of fair value or maturity.
65
Investment Operations Revenue
Net investment income for 2007 was $84.7 million compared to $83.1 million in 2006. In 2007 our average
invested assets increased due to our insurance segments’ favorable underwriting cash flows. However, our
pre-tax return on investments declined slightly as provided in the table below due largely to rebalancing our fixed
maturity portfolio as described above toward tax-exempt bonds, which have a lower yield on a pre-tax basis.
After tax, our net investment income for 2007 was $73.6 million (13.2% effective tax rate) compared to $69.8
million (16.1% effective tax rate) for 2006.
($ millions)
Gross investment income:
Year Ended December 31
2007
2006
Fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
Total gross investment income . . . . . . . . . . . . . . . . . . . . . .
Less: Investment expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
75.3
5.7
5.5
86.5
1.8
84.7
$
$
73.6
5.1
6.1
84.8
1.7
83.1
Average invested assets (at cost) . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Annualized investment yield . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Annualized investment yield, after tax . . . . . . . . . . . . . . . . . . . . . . . .
$1,987.1
4.3%
3.7%
$1,891.6
4.4
3.7
Realized gains and losses on investments for the years ended December 31, 2007 and 2006, respectively are
summarized as follows:
($ millions)
Realized gains:
Fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . .
Equity securities . . . . . . . . . . . . . . . . . . . . . . . .
Total realized gains . . . . . . . . . . . . . . . . . .
Realized losses:
Fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . .
Equity securities . . . . . . . . . . . . . . . . . . . . . . . .
Total realized losses . . . . . . . . . . . . . . . . .
2007
2006
Realized
Gains
(Losses)
Proceeds
Received
on Sale
Realized
Gains
(Losses)
Proceeds
Received
On Sale
$ 0.8
19.7
20.5
(1.3)
(7.1)
(8.4)
$ 82.5
76.2
158.7
72.7
30.8
103.5
$ 1.8
15.6
17.4
$130.1
72.0
202.1
(4.8)
(7.0)
(11.7)
41.3
31.8
73.1
Net realized gains on investments . . . . . . .
$12.1
$262.2
$ 5.6
$275.2
Most of the realized gains in 2007 were derived from the equity segment of the portfolio. Equity sales were
executed for various reasons, including the achievement of our price target and raising funds within two of our
insurance subsidiaries to fund cash dividends to State Auto Financial. (See “Other Capital Transactions” section
below.) The realized gains on the fixed maturity portfolio were achieved by selling shorter-term tax-exempt
securities and subsequently reinvesting those funds into longer-term tax-exempt securities as well as selling
taxable securities to reinvest the proceeds into the tax-exempt securities as described above. For the year ended
December 31, 2007, realized losses of $1.3 million on the fixed maturities related primarily to selling taxable
securities to support our shift into tax-exempt securities. Realized losses of $7.1 million on equity securities
related primarily to the sale of equity positions where changes in government policy or business conditions, in
our opinion, greatly diminished future business prospects.
66
We regularly monitor our investment portfolio for declines in value that are OTTI, an assessment which
requires significant management judgment. Among the factors considered by management are the nature of the
investment, severity and length of decline in fair value, events impacting the issuer, overall market conditions,
and our intent and ability to hold securities until recovery. When a security in our investment portfolio has been
determined to have a decline in fair value that is OTTI, we adjust 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 OTTI, are included in other comprehensive income.
For the year ended December 31, 2007, we recognized $1.9 million OTTI compared to $5.4 million for the
same 2006 period. During 2007, we recognized no OTTI on our fixed maturity portfolio; however, we
recognized $1.9 million in realized losses related to OTTI within our equity portfolio. Of the $1.9 million in
realized losses, $1.1 million related to two equity positions within the consumer cyclical sector impacted by the
downturn in the housing industry. The remaining $0.8 million in realized losses was limited to our externally
managed U.S. small-cap portfolio for which we were unable to make the assertion regarding our intent to hold
particular securities that were currently valued below cost until recovery in the near term. The OTTI recognized
in 2007 were limited to these securities, based on specific facts and judgments related to these particular issuers.
The 2006 write-downs related primarily to our investment in certain subordinate income notes and principal
protected units representing purchased beneficial interests in securitized financial assets. We reduced the estimate
of future cash flows we expected to receive from these securities in light of actual default rates of the underlying
collateral securities exceeding the assumed defaults.
Gross Unrealized Investment Gains and Losses
A review of our investment portfolio at December 31, 2007 determined there were no individual
investments with an unrealized loss that had a fair value significantly below cost continually for more than one
year. There were also no individual material securities with an unrealized holding loss at December 31, 2007.
The following table provides detailed information on our available-for-sale investment portfolio for our
gross unrealized gains and losses at December 31, 2007:
($ millions, except number of positions)
Investment Category:
Cost or
amortized
cost
Gross
unrealized
holding
gains
Number
of
gain
positions
Gross
unrealized
holding
losses
Number
of
loss
positions
Fair
Value
Fixed Maturities:
U.S. Treasury securities . . . . . . . . . . . . . . . . . . . .
States and political subdivisions . . . . . . . . . . . . .
Corporate securities . . . . . . . . . . . . . . . . . . . . . . .
Mortgage-backed securities of U.S. Gov.
$
90.9
1,432.7
10.7
$ 2.2
23.6
0.3
Agencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
188.6
Total fixed maturities . . . . . . . . . . . . . . . . . .
1,722.9
Equity Securities:
Consumer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Technologies . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Pharmaceuticals . . . . . . . . . . . . . . . . . . . . . . . . . .
Financial services . . . . . . . . . . . . . . . . . . . . . . . . .
Manufacturing and other . . . . . . . . . . . . . . . . . . .
Total equity securities . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . . .
65.3
24.7
8.4
35.6
76.2
210.2
19.6
2.6
28.7
18.1
5.4
0.6
7.9
15.4
47.4
0.3
Total investments . . . . . . . . . . . . . . . . . . . . .
$1,952.7
$76.4
34
469
11
23
537
78
71
9
79
149
386
2
925
$(0.1)
(4.3)
—
(1.8)
(6.2)
(1.7)
(0.3)
(0.2)
(0.7)
(0.5)
(3.4)
(0.1)
6
181
1
48
236
5
2
2
3
4
16
2
$
93.0
1,452.0
11.0
189.4
1,745.4
81.7
29.8
8.8
42.8
91.1
254.2
19.8
$(9.7)
254
$2,019.4
67
Other Income Statement Items
Interest expense on our debt was $7.6 million and $7.4 million for the years ended December 31, 2007 and
2006, respectively.
Our effective tax rate is largely affected by the amount of underwriting profit or loss and net realized
investment gains or losses that are taxed at approximately 35% relative to the amount of net investment income
at its effective tax rate. For the year ended December 31, 2007, the effective tax rate was 23.3% compared to
25.5% for the same 2006 period. As previously discussed, the effective tax rate on net investment income
declined to 13.2% for 2007 versus 16.1% for 2006.
LIQUIDITY AND CAPITAL RESOURCES
General
Liquidity refers to our ability to generate adequate amounts of cash to meet our short and long term needs.
Our primary sources of cash are premiums, investment income, investment sales and the maturity of fixed
income security investments. The significant outflows of cash are payments of claims, commissions, premium
taxes, operating expenses, income taxes, dividends, interest and principal payments on debt and investment
purchases. The cash outflows can vary due to uncertainties regarding settlement of large losses or catastrophe
events. As a result, we continually monitor our 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.
We maintain a portion of our investment portfolio in relatively short-term and highly liquid investments to
ensure the immediate availability of funds to pay claims and expenses. At December 31, 2008 and 2007, we had
$150.5 million and $70.9 million, respectively, in cash and cash equivalents, and $1,939.9 million and $2,019.4
million, respectively, of total available-for-sale investments at fair value. Included in our fixed maturities
available-for-sale at fair value are $56.0 million and $55.1 million of securities on deposit with insurance
regulators as required by law at December 31, 2008 and 2007, respectively. In addition, substantially all of our
fixed maturity and equity securities are traded on public markets. For a further discussion regarding investments
see “Investments Operations Segment” included in this Item 7.
Our insurance subsidiaries must have adequate liquidity to ensure that their cash obligations are met.
However, because the STFC Pooled Companies participate in the Pooling Arrangement, they do not have the
daily liquidity concerns normally associated with an insurance company. This is because under the terms of the
Pooling Arrangement, State Auto Mutual receives all premiums and pays all losses and expenses associated with
the insurance business produced by the pool participants and then settles the intercompany balances generated by
these transactions with the participating companies within 45 days following each quarter end.
When settling the intercompany balances, State Auto Mutual provides the pool participants with full credit
for the premiums written and net losses paid during the quarter and retains all receivable amounts from insureds
and agents and reinsurance recoverable on paid losses from unaffiliated reinsurers. Any receivable amounts that
are ultimately deemed to be uncollectible are charged-off by State Auto Mutual and allocated to the pool member
on the basis of pool participation. As a result, we have an off-balance sheet credit–risk related to the balances due
to State Auto Mutual from insureds, agents and reinsurers, which are offset by the unearned premium from the
respective policies. While the total amount due to State Auto Mutual from policyholders and agents is significant,
the individual amounts due are relatively small at the policyholder and agency level. Based on historical data,
this credit-risk exposure is not considered to be material to our financial position, though the impact to income on
a quarterly basis may be material. The State Auto Group mitigates its exposure to this credit risk through its
in-house collections unit for both personal and commercial accounts which is supplemented by third party
collection service providers. The amounts deemed uncollectible by State Auto Mutual and allocated to the STFC
Pooled Companies are included in Other Expenses in the accompanying consolidated Statements of Income.
68
The State Auto Group’s reliance on ceded reinsurance is not significant in comparison to the State Auto
Group’s total statutory surplus or our total financial position. To minimize the risk of reinsurer default, the State
Auto Group cedes only to third-party reinsurers who are rated A- or better by A.M. Best and also utilizes both
domestic and international markets to diversify its credit risk. We utilize reinsurance to limit our loss exposure
and contribute to our liquidity and capital resources. For a discussion of our reinsurance arrangements, see
“Reinsurance Arrangements” included in this Item 7.
Net cash provided by operating activities was $183.5 million, $121.6 million and $93.5 million for 2008,
2007 and 2006, respectively. Significant sources of operating cash flows are derived from underwriting
operations and net investment income. In addition, 2008 benefited from the $92.0 million of cash received by the
STFC Pooled Companies in connection with the Pooling Change. There is also a corresponding ongoing impact
of adding the New Pool Business which is reflected in the premiums, losses and expenses excluding the one-time
Pooling Change. In addition, losses were higher in 2008 than 2007 due to the increased level of catastrophes
previously discussed. The table below is a proforma of the direct method of our operating cash flows.
($ millions)
Net premium written . . . . . . . . . . . . . . . .
Investment income . . . . . . . . . . . . . . . . . .
Loss and LAE paid . . . . . . . . . . . . . . . . . .
Expense paid(1) . . . . . . . . . . . . . . . . . . . . .
Federal income tax . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2008
2007
$1,204.9
99.1
(719.5)
(387.8)
(18.2)
5.1
$1,019.8
96.7
(599.6)
(358.1)
(42.3)
5.1
Increase
(Decrease)
$ 185.1
2.4
(119.9)
(29.1)
24.1
0.1
One-Time
Pooling
Change
$ 53.6
—
53.3
(12.9)
—
—
Excluding
Pooling
Change
$ 131.5
2.4
(171.2)
(16.8)
24.1
0.1
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 183.5
$ 121.6
$ 61.9
$ 92.0
$ (30.1)
(1)
Expense paid includes interest paid during the year of $7.5 million in 2008 and $7.8 million in 2007
The positive net cash provided by operating activities in 2007 and 2006 was largely due to favorable
underwriting and investment income cash flows, offset by increases in cash paid on estimated federal income
taxes, interest expense and cash contributions to our defined benefit pension plan. Cash from operations in 2007
increased $28.2 million over 2006 primarily due to a reduction in claim payments from a lower level of
catastrophe losses in 2007 compared to 2006 offset partially by an increase in taxes paid.
Despite the increased level of catastrophe losses in 2008, we managed our cash flows through current
operational activity and maturities of investments, without a need to liquidate investments in the 2008 uncertain
market environment. See “Investment Operations Segment—Composition of Investment Portfolio” included in
this Item 7 for further discussion. However, should our written premium decline or paid losses increase
significantly or a combination thereof our cash flows from operations could be impacted requiring us to liquidate
investments at a loss.
During 2008, 2007 and 2006, as permitted by regulations of the Internal Revenue Service, we made cash
contributions of $12.0 million, $11.5 million and $10.0 million, respectively, to our defined benefit pension plan
on behalf of our employees. The actuarially determined contribution to our defined benefit pension plan ranges
from the minimum amount we would be required to contribute to the maximum amount that would be tax
deductible. Amounts contributed in excess of the minimum are deemed voluntary while amounts in excess of the
maximum would be subject to an excise tax and may not be deductible for tax purposes. Amounts paid in each of
these three years were within the minimum and maximum funding amounts that would be deductible for tax
purposes. The actuarially determined funding amount to the plan is generally not determined until the second
quarter with respect to the contribution year, though we currently expect to make a minimum cash contribution to
our defined benefit pension plan of approximately $15.0 million during 2009. For a further discussion regarding
our defined benefit pension plan, see “Employee Benefit Plans” included in this Item 7.
69
Net cash used in investing activities was $51.5 million, $86.1 million and $43.2 million for 2008, 2007 and
2006, respectively.
•
The decline in 2008 versus 2007 was principally the result of an increase in the accumulation of cash
for future claims settlements and intercompany payments to affiliates and to pay stockholder dividends.
The increase in 2007 versus 2006 was principally the result of:
•
•
a greater amount of cash and cash equivalents available to invest at the beginning of 2007 versus 2006
($73.4 million in 2007 compared to $28.7 million in 2006);
an increase in the level of cash provided from operations between the two years.
Our financing activities for 2008, 2007 and 2006 produced net cash outflows of $52.4 million, $38.0
million, and $5.6 million, respectively. The following contributed to the fluctuations between those years:
•
•
Dividends paid to shareholders totaled $23.9 million, $20.5 million and $15.4 million for 2008, 2007
and 2006, respectively. The increase in dividends paid between 2008, 2007 and 2006 was due to
increasing the amount of dividends paid per common share. Dividends paid per common share were
$0.60 in 2008, $0.50 in 2007 and $0.38 in 2006.
Cash used to repurchase common shares under our stock repurchase program was $33.2 million and
$22.1 million for 2008 and 2007, respectively. See “Other Capital Transactions” below.
Other Capital Transactions
On August 17, 2007, State Auto Financial’s board of directors authorized the repurchase, from time to time,
of up to 4.0 million of its common shares, or approximately 10% of State Auto Financial’s outstanding shares,
over a period extending to and through December 31, 2009. State Auto Financial will repurchase shares from
State Auto Mutual in amounts that are proportional to the respective current ownership percentages of State Auto
Mutual, which is approximately 64%, and other shareholders. For the year ended December 31, 2008 a total of
1,214,586 of common shares were purchased under this program at an average repurchase price of $27.25 per
share for a total of $33.2 million. Since inception through December 31, 2008, a total of 2,028,116 common
shares have been purchased under this program at an average purchase price of $27.26 per share for a total of
$55.3 million.
On November 7, 2008, the Board of Directors of State Auto Financial declared a cash dividend of $0.15 per
share. The dividend was payable on December 31, 2008, to shareholders of record on December 15, 2008. On
March 6, 2009, the Board of Directors of State Auto Financial declared a quarterly cash dividend of $0.15 per
share. The dividend is payable on March 31, 2009, to shareholders of record on March 17, 2009. This is the 71st
consecutive quarterly cash dividend declared by State Auto Financial’s Board since we had our initial public
offering of common stock on June 28, 1991.
To fund capital transactions and provide additional working capital to State Auto Financial, in 2008 State
Auto P&C, Milbank, Farmers, and State Auto National Insurance Company (“SA National”) declared cash
dividends of $14.0 million, $14.0 million, $4.0 million and $7.0 million, respectively. The cash transfer of
dividends was completed in 2008. The dividends from State Auto P&C, Milbank, Farmers and SA National were
paid from unassigned statutory surplus and were not considered to be extraordinary for regulatory purposes.
Other Events
On March 12, 2009, we issued a press release announcing preliminary estimates of the 2009 catastrophe
storm activity that hit our Midwest operating states. This press release disclosed our expectation that first quarter
2009 earnings will include between $38.0 and $42.0 million in pre-tax catastrophe losses related to late January
and early February storm activity. Over the past five years, we have experienced an average of $12.4 million in
catastrophe losses during the first quarter. While the 2009 January and February catastrophe storm losses will be
significant to our first quarter 2009 results, we do not expect these losses to have a significant impact on our
overall financial position.
70
Borrowing Arrangements
The following provides an overview of our borrowing arrangements during 2008 and outstanding at
December 31, 2008:
Credit Agreement
State Auto Financial has a credit agreement (“Credit Agreement”) with a syndicate of lenders which
provides for a $200.0 million five-year unsecured revolving credit facility (“Credit Facility”). The Credit Facility
is available for general corporate purposes. The Credit Facility provides for interest-only payments during its
term, with principal due in full at maturity. Interest is based on a London interbank market rate or a base rate plus
a calculated margin amount. The Credit Agreement contains certain covenants, including financial covenants that
require us to maintain a minimum net worth and not exceed a certain debt to capitalization ratio. As of
December 31, 2008, State Auto Financial had not made any borrowings and was in compliance with all of the
covenants under the Credit Agreement. We are currently evaluating whether we should amend or terminate this
agreement based on our needs and other options available for contingency funding. We believe our other sources
of cash are sufficient to fund our liquidity needs for the foreseeable future. We currently do not intend to
drawdown any funds under the Credit Facility.
Senior Notes
In 2003, State Auto Financial issued $100.0 million of unsecured Senior Notes due November 2013. The
Senior Notes bear interest at a fixed rate of 6.25% per annum, which is payable each May 15 and November 15.
The Senior Notes are general unsecured obligations ranking senior to all existing and future subordinated
indebtedness and equal with all existing and future senior indebtedness. The Senior Notes are not guaranteed by
any of our subsidiaries and thereby are effectively subordinated to all our subsidiaries’ existing and future
indebtedness. As of December 31, 2008, we were in compliance with all covenants related to the Senior Notes.
Trust Securities
State Auto Financial’s Delaware business trust subsidiary (the “Capital Trust”) issued $15.0 million
liquidation amount of capital securities in 2003, due 2033. In connection with the Capital Trust’s issuance of the
capital securities and the related purchase by State Auto Financial of all of the Capital Trust’s common securities
(liquidation amount of $0.5 million), State Auto Financial issued to the Capital Trust $15.5 million aggregate
principal amount of unsecured Floating Rate Junior Subordinated Debt Securities due 2033 (the “Subordinated
Debentures”). The sole assets of the Capital Trust are the Subordinated Debentures and any interest accrued
thereon. Interest on the Capital Trust’s capital and common securities is payable quarterly at a rate equal to the
three-month LIBOR rate plus 4.20%, adjusted quarterly. The applicable interest rates for the periods January
2006 through December 31, 2008 ranged from 6.38% to 9.78%.
Notes Payable Summary
The following summarized our notes payable at December 31, 2008:
($ millions)
Senior Notes due 2013: issued $100.0 million, November 2003 with fixed interest
Subordinated Debentures due 2033: issued $15.5 million, May 2003 with variable
Carrying
Value
Fair
Value
Interest
Rate
. .
$102.1
$ 86.9
6.25%
interest adjusting quarterly . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
15.5
15.5
6.38%
Total Notes Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$117.6
$102.4
71
Related to our notes payable, our primary market risk exposure is to the change in interest rates and our
credit rating. For a discussion regarding our credit ratings see “Credit and Financial Strength Ratings” included
in this Item 7. Based upon the notes payable carrying value at December 31, 2008, we had $15.5 million notes
payable with variable interest and $102.1 million notes payable with interest fixed at 6.25%, which equated to
approximately 13.1% variable interest debt and 86.9% fixed interest debt. Our decision to obtain fixed versus
variable interest rate debt is influenced primarily by the following factors: (a) current market interest rates
(b) anticipated future market interest rates (c) availability of fixed versus variable interest instruments and (d) our
currently existing notes payable fixed and variable interest rate position. See our contractual obligations table
included in “Contractual Obligations”.
Reinsurance Arrangements
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.
During 2007, the Beacon Insurance Group was added to the State Auto Group’s reinsurance programs
described below and as of January 1, 2008, the Patrons Group was added to these programs.
Each member of the State Auto Group is party to working reinsurance treaties for casualty, workers’
compensation and property lines with several reinsurers arranged through a reinsurance intermediary. These
agreements are described in more detail below. We have also secured other reinsurance to limit the net cost of
large loss events for certain types of coverage written in certain companies, including reinsurance covering
umbrella liability losses up to a limit of $10.0 million with a maximum of $0.6 million retention. The State Auto
Group also makes use of facultative reinsurance for unique risk situations. Facultative reinsurance provides for a
separate reinsurance agreement covering a particular risk or insurance policy. The State Auto Group also
participates in state insurance pools and associations. In general, these pools and associations are state sponsored
and/or operated, impose mandatory participation by insurers doing business in that state, and offer coverage for
hard-to-place risks at premium rates established by the state sponsor or operator, thereby transferring risk of loss
to the participating insurers in exchange for premiums which may not be commensurate with the risk assumed.
The casualty excess of loss reinsurance agreement provides 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 motorist and personal injury protection are covered by an arrangement that
provides for $10.0 million of coverage in excess of $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 workers’ compensation excess of loss reinsurance agreement provides that each company in the State
Auto Group is responsible for the first $2.0 million of covered loss. The reinsurers are responsible for 100% of
the excess over $2.0 million up to $10.0 million of covered loss. Net retentions under this agreement may be
submitted to the casualty excess of loss agreement, subject to a limit of $2.0 million per loss occurrence. The
rates for this reinsurance are negotiated annually.
In addition to the workers’ compensation reinsurance described above, each company in the State Auto
Group is party to an agreement which provides an additional layer of reinsurance for workers’ compensation
losses involving multiple workers. Subject to $10.0 million of retention, reinsurers are responsible for 100% of
the excess over $10.0 million up to $20.0 million of covered loss. This coverage is subject to a “Maximum Any
72
One Life” limitation of $10.0 million. This limitation means that losses associated with each worker may
contribute no more than $10.0 million to covered loss under this agreement. The rates for this reinsurance are
negotiated annually.
The property per risk excess of loss reinsurance agreement provides that each company in the State Auto
Group is responsible for the first $3.0 million of each covered loss. The reinsurers are responsible for 100% of
the excess over $3.0 million up to $20.0 million of covered loss. The rates for this reinsurance are negotiated
annually.
Members of the State Auto Group maintain a property catastrophe excess of loss reinsurance agreement
covering catastrophe related events affecting at least two risks. On July 1, 2008, concurrent with the renewal of
the agreement, we increased the limit of coverage by $20.0 million from $80.0 million to $100 million. The limit
of $100 million is structured in two layers. The first is $25.0 million excess of our retention, and the second is
$75 million excess of the first layer. On a combined basis, the members of the State Auto Group retain the first
$55.0 million of catastrophe loss, each occurrence, with a 5% co-participation on the next $100 million of
covered loss, each occurrence. The reinsurers are responsible for 95% of the excess over $55.0 million up to
$155.0 million of covered losses, each occurrence. Our companies are responsible for losses above $155.0
million. The rates for this reinsurance are negotiated annually.
The terms of the property catastrophe excess of loss reinsurance agreement described above provide that if
coverage is exhausted, coverage may be reinstated upon payment of an additional premium. By this
reinstatement provision, the property catastrophe reinsurance agreement effectively provides two sets of limits
that may be used to cover multiple events. In September 2008, Hurricane Ike produced losses to the members of
the State Auto Group that exceeded the $55.0 million retention layer, and were expected to exhaust the first $25.0
million layer of reinsurance coverage. On October 23, 2008, members of the State Auto Group entered into a
separate property catastrophe excess of loss reinsurance agreement (the “Third Event Agreement”) which
provided an additional $25.0 million of coverage in excess of our $55.0 million retention layer. Under the Third
Event Agreement, the members of the State Auto Group, on a combined basis, retain the first $55.0 million of
catastrophe loss, each occurrence, with a 5% co-participation on the next $25.0 million of covered loss, each
occurrence. The reinsurers are responsible for 95% of the excess over $55.0 million up to $80.0 million of
covered losses, each occurrence. The Third Event Agreement does not include a provision to reinstate coverage if
exhausted.
Prior to July 1, 2008, members of the State Auto Group participated in an intercompany catastrophe excess
of loss reinsurance agreement (the “Catastrophe Assumption Agreement”) under which State Auto P&C acted as
the catastrophe reinsurer for the State Auto Group. Under the Catastrophe Assumption Agreement State Auto
P&C was responsible for up to $100.0 million of covered losses in excess of the $135.0 million of covered losses
under the catastrophe reinsurance arrangement described above. The Catastrophe Assumption Agreement was
not renewed and expired on July 1, 2008. There had been no losses assumed under the Catastrophe Assumption
Agreement during 2008, 2007 and 2006.
As of January 1, 2009, members of the State Auto Group entered into a property catastrophe net aggregate
excess of loss reinsurance agreement (the “Catastrophe Aggregate Agreement”). This is a new agreement which
provides reinsurance coverage for certain catastrophic events, including certain events falling below the $55.0
million retention under the property catastrophe excess of loss reinsurance agreement previously described.
Events covered by the Catastrophe Aggregate Agreement must be PCS numbered catastrophes, excluding
earthquakes and named storms such as hurricanes and tropical storms. Individual occurrences are capped at $55.0
million and are subject to a $5.0 million franchise deductible, meaning occurrences producing losses totaling less
than $5.0 million are excluded. Subject to these limitations, qualifying losses from individual occurrences are
then aggregated over the course of the reinsurance term, January 1, 2009 through December 31, 2009. On an
aggregate basis, the members of the State Auto Group combined retain the first $80.0 million of covered loss,
with a 25% co-participation on the next $30.0 million of covered loss. The reinsurer is responsible for 75% of the
excess over $80.0 million up to $110.0 million of covered loss on an aggregate basis.
73
Contractual Obligations
Our significant contractual obligations as of December 31, 2008, were as follows:
($ millions)
Direct loss and reserves(1) . . . . . . . . . . . . . . . . . .
Notes payable(2):
Senior Notes due 2013:
issued $100.0, November 2003 with fixed
interest(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Subordinated Debentures due 2033:
issued $15.5, May 2003 with variable
interest(4) adjusting quarterly . . . . . . . . . . . . .
Due
1 year
or less
Due
1-3
years
Due
3-5
years
Due
after 5
years
Total
$ 851.8
$346.1
$286.4
$103.3
$116.0
$ 100.0
$ —
$ —
$100.0
$ —
15.5
—
—
—
15.5
Total notes payable . . . . . . . . . . . . . . . . . . .
$ 115.5
$ —
$ —
$100.0
$ 15.5
Interest payable (2):
Senior Notes due 2013: issued $100.0,
November 2003 with fixed interest(3) . . . . . . .
$
31.3
$
6.3
$ 12.5
$ 12.5
$ —
Subordinated Debentures due 2033:
issued $15.5, May 2003 with variable
interest(4) adjusting quarterly . . . . . . . . . . . . .
Total interest payable . . . . . . . . . . . . . . . . .
Postretirement benefits . . . . . . . . . . . . . . . . . . . .
Pension funding(5) . . . . . . . . . . . . . . . . . . . . . . . .
21.3
52.6
$
$
51.2
$ 178.6
0.9
7.2
3.9
7.3
$
$
$
1.7
1.7
17.0
$ 14.2
$
8.1
$ 38.4
$ 14.2
$
9.0
$ 50.1
$ 17.0
$ 30.2
$ 82.8
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,249.7
$364.5
$347.1
$276.6
$261.5
(2)
(1) We derived expected payment patterns separately for the direct loss and ALAE reserves. Amounts included the STFC Pooled
Companies net additional share of transactions assumed from State Auto Mutual through the Pooling Arrangement. For a
reconciliation of management’s best estimate, see “Loss and Loss Expense Reserves” included in this Item 7. These patterns were
applied to the December 31, 2008, loss and ALAE payable to generate estimated annual incremental loss and ALAE payments for
each subsequent calendar year. These amounts are based on historical payment patterns and do not represent actual contractual
obligations. The actual payment amounts and the related timing of those payments could differ significantly from these estimates.
For a discussion of these debt instruments, see “Liquidity and Capital Resources—Borrowing Arrangements” included in this
Item 7.
The Senior Notes bear interest at a fixed rate of 6.25% per annum, which is payable each May 15 and November 15.
Interest on the subordinated debentures was calculated using an interest rate equal to the three-month LIBOR rate at December 31,
2008 of 1.4250% plus 4.20%, or 5.6250%.
These amounts are estimates of ERISA minimum funding levels based on adjustments to prior year assumptions for our defined
benefit pension plan and do not represent an estimate of our expected contributions. Funding levels generally are not determined
until later in the year with respect to the contribution year. See Note 9, “Pension and Postretirement Benefits Plans” to our
Consolidated Financial Statements included in Item 8 of this Form 10-K for a tabular presentation of expected benefit payments
from the State Auto Group’s defined benefit pension plan.
(5)
(4)
(3)
Lease and other purchase obligations of State Auto Mutual are allocated to us through the Pooling
Arrangement.
Regulatory Considerations
At December 31, 2008, 2007 and 2006, each of our insurance subsidiaries was in compliance with statutory
requirements relating to capital adequacy.
The National Association of Insurance Commissioners (“NAIC”) utilizes a collection of analytical tools
designed to assist state insurance departments with an integrated approach to screening and analyzing the
74
financial condition of insurance companies operating in their respective states. One such set of analytical tools is
12 key financial ratios that are known in the insurance industry as the “IRIS” ratios. IRIS ratios are derived from
financial statements prepared on a statutory accounting basis, which are accounting practices prescribed or
permitted by the insurance department with regulatory authority over our insurance subsidiaries. A “defined
range” of results for each ratio has been established by the NAIC for solvency monitoring. While management
utilizes each of these IRIS ratios in monitoring our insurance companies’ operating performance on a statutory
accounting basis (each of our insurance subsidiaries operates within the defined range for the other measures),
the net written premium to statutory surplus ratio (the “leverage ratio”) is monitored to ensure that each of our
insurance subsidiaries continue to operate within the “defined range” of 3.0 to 1.0. The higher the leverage ratio,
the more risk a company bears in relation to statutory surplus available to absorb losses. In considering this
range, management also considers the distribution of net premiums between property and liability lines of
business. A company with a larger portion of net premiums from liability lines should generally maintain a lower
leverage ratio.
As shown below the leverage ratios increased from 2007 to 2008. Net written premiums increased primarily
due to a combination of increased Organic Growth and the impact of the Pooling Change along with our
insurance subsidiaries’ statutory surplus decreasing mostly due to underwriting losses coupled with realized and
unrealized losses on investments. The statutory leverage ratios for our insurance subsidiaries at December 31,
2008, 2007 and 2006 were as follows:
Statutory Leverage Ratios(1)
2008(2)
2007
2006
State Auto P&C . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Milbank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Farmers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
SA Ohio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
SA National . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Weighted Average . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1.7
1.6
1.4
1.1
0.6
1.6
1.2
1.2
1.0
1.0
0.6
1.1
1.2
1.2
1.1
1.0
0.6
1.2
(1) We use the statutory leverage ratio as there is no comparable GAAP measure.
(2)
Table excludes the one-time impact on net written premiums of $53.6 million that occurred in conjunction with the Pooling
Change.
Our insurance subsidiaries pay dividends to State Auto Financial which in turn may be used by State Auto
Financial to pay dividends to stockholders or to make principal and interest payments on debt. Individual states
limit the amount of dividends that our insurance subsidiaries domiciled in those states can pay without prior
approval. Under current law, at December 31, 2008 $73.8 million is available in 2009 for payment as a dividend
from our insurance subsidiaries to State Auto Financial, without prior approval from our respective domiciliary
state insurance departments. In 2008 and 2007, State Auto Financial received $39.0 million and $50.0 million,
respectively in dividends from its insurance subsidiaries and none in 2006. We are required to notify the
insurance subsidiaries’ applicable state insurance commissioner within five business days after declaration of all
such dividends and at least ten days prior to payment. Additionally, the domiciliary state commissioner of each
insurance 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 meet its financial needs. Such restrictions are not expected to limit the capacity of State Auto
Financial to meet its cash obligations.
State Auto Financial’s insurance subsidiaries are subject to regulation and supervision by the states in which
they do business. The NAIC has developed Risk-Based Capital (“RBC”) requirements. RBC attempts to relate an
individual insurance company’s statutory surplus to the risk inherent in its overall operations. RBC requires the
75
calculation of a ratio of total adjusted statutory capital to authorized control level. Insurers with a ratio below
200% are subject to different levels of regulatory intervention and action. At December 31, 2008, the ratio of
total adjusted statutory capital to authorized control level of State Auto Financial’s insurance subsidiaries ranged
from 699% to 1,902%.
Credit and Financial Strength Ratings
The following table summarizes our credit and insurance company financial strength ratings as of March 13,
2009:
STFC (credit rating) . . . . . . . . . . . . . . . . . . . . . . . .
STFC Pooled Companies (financial strength) . . . .
. . . . . . . . . . . . . .
SA National (financial strength)
a-
A+
A+
Baa2
A2
n/a
BBB
A
A
A.M. Best
Moody’s
Standard & Poor’s
We are reviewed regularly by the independent rating agencies listed in the table above. Ratings provide a
meaningful way for policyholders, agents, creditors and stockholders to compare us to our competitors. The
published credit ratings on State Auto Financial Senior Notes discussed above are opinions as to the ability of
State Auto Financial to meet its ongoing obligations under the terms of the Senior Notes. Generally, credit
ratings affect the cost, type and availability of debt financing. Higher rated securities receive more favorable
pricing and terms relative to lower rated securities at the time of issue. State Auto Financial’s Senior Notes have
been rated investment grade by each agency.
In February 2009 Moody’s lowered our credit rating from Baa1 to Baa2 due to Moody’s belief that the debt
incurred by State Auto Mutual in connection with its acquisition of Rockhill Holding Company will reduce the
ability of State Auto Mutual to offer contingent support to us. Contingent support had been the rationale for
narrower notching between our credit rating and insurance financial strength rating (two notches instead of the
customary three for U.S. insurance holding companies).
The published financial strength ratings on the insurance company subsidiaries of State Auto Financial are
opinions as to the ability of those companies to meet their ongoing obligations to their policyholders. The A.M.
Best financial strength ratings influence our ability to write insurance business as agents and policyholders
generally prefer higher rated companies. Lower rated companies may be required to compete for agents and
policyholders by offering higher commissions or lower premiums and expanded coverage, or a combination
thereof. State Auto Mutual has received A.M. Best’s A+ or higher rating every year since 1954. The STFC
Pooled Companies and the Mutual Pooled Companies are collectively assigned a pool rating by A.M. Best while
SA National is rated by A. M. Best as a part of the total group.
Our ratings are influenced by many factors including operating and financial performance, asset quality,
liquidity, financial leverage, exposure to catastrophe risks and operating leverage. Presently, our A.M. Best,
Moody’s and Standard & Poor’s ratings are assigned stable outlooks.
OTHER
Employee Benefit Plans
The State Auto Group has a defined benefit pension plan and a postretirement health care plan covering
substantially all employees (collectively “the benefit plans”). Several factors, which attempt to anticipate future
events, are used in calculating the expense and liability related to the benefit plans. Key factors include
assumptions about the expected rates of return on plan assets, discount rates, and health care cost trend rates. We
in making these
consider market conditions,
including changes in investment returns and interest rates,
76
assumptions. The actuarial assumptions used by us in determining benefit obligations may differ materially from
actual results due to changing market and economic conditions, higher or lower turnover and retirement rates or
longer or shorter life spans of participants. While we believe that the assumptions used are appropriate,
differences in actual experience or changes in assumptions may materially affect our financial position or results
of operations.
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension
and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R)” (“SFAS 158”)
which requires employers with defined benefit pension and other postretirement benefit plans, such as health
care, to recognize the funded status of its benefit plans on its balance sheet and measure the fair value of plan
assets and benefit obligations as of the date of the fiscal year-end balance sheet date thereby eliminating the use
of an earlier measurement date and to provide additional disclosures. Adopting SFAS 158 required us to
recognize the funded status (i.e. the difference between the fair value of plan assets and the benefit obligations)
on our balance sheet, with a corresponding adjustment to accumulated other comprehensive income, net of tax.
The adoption of SFAS 158 at December 31, 2006 had the impact of decreasing accumulated comprehensive
income by $63.9 million, net of tax.
Effective January 1, 2008, we adopted the measurement date requirement under transition alternative
method one, as defined in SFAS 158. This transition method resulted in a one-time adjustment that decreased
beginning retained earnings by $2.4 million, net of tax. The combined impact of the measurement date transition
and re-measurement of plan assets and obligations on January 1, 2008, increased beginning accumulated
comprehensive income by $3.5 million, net of tax. The discount rate used to re-measure our benefit plan
obligations at January 1, 2008 was 6.50% an increase of 0.25 points from the earlier measurement date of
September 30, 2007, which was used to report our benefit obligations on December 31, 2007.
To calculate the State Auto Group’s December 31, 2008 pension projected benefit obligation (“PBO”), we
used a discount rate of 6.0% based on an evaluation of the expected future benefit cash flows of our defined
benefit pension plan used in conjunction with the Citigroup Pension Discount Curve at the measurement date. A
lower discount rate results in, all else equal, a higher present value of the benefit obligation. We selected an
expected long-term rate of return on our plan assets of 9.0% by considering the mix of investments and stability
of investment portfolio along with actual investment experience during the lifetime of the plan. To calculate the
net periodic benefit cost for the year ended December 31, 2008, a discount rate of 6.5% and an expected long-
term rate of return on plan assets of 9.0% were used.
Our funding status on our pension plan went from a $2.1 million asset at January 1, 2008, to a $73.2 million
liability at December 31, 2008. The decline in interest rates over the course of the year and the difference
between expected and actual return on assets held by our pension plan had the effect of increasing our liability
and cumulative unrecognized actuarial loss, a component of accumulated comprehensive loss in our equity. The
factors influencing these increases are as follows: (1) the selected discount rate of 6.0% decreased 0.50 points
from the 6.50% rate used at January 1, 2008, which had the effect of increasing the 2008 PBO and related
unrecognized actuarial loss approximately $16.6 million, and (2) the actual return on our plan assets was a loss of
$40.9 million compared to an expected return of $19.4 million for a net increase to our liability and unrecognized
actuarial loss of approximately $60.3 million. In addition to the discount rate and expected to actual return on
plan assets, unrecognized gains and losses arise from several factors including expected to actual demographic
changes, such as retirement age, mortality, turnover, and rate of compensation increases. The cumulative
unrecognized actuarial loss is systematically recognized as an increase in net periodic cost over the average
future service period of active participants.
The accumulated benefit obligation (“ABO”) of a defined benefit plan represents the actuarial present value
of benefits attributed by the pension benefit formula to employee service rendered prior to the measurement date
and based on current and past compensation levels, while the PBO is the ABO plus a factor for future
compensation levels. The ABO, which considers current compensations level only, provides information about
77
the obligation an employer would have if the plan were discontinued at the date of measurement date. At
December 31, 2008, the ABO and PBO were $215.2 million and $245.9 million, respectively. At December 31,
2008 the fair value of the assets of our defined benefit pension plan was $172.7 million, which resulted in an
underfunding status within our balance sheet of $73.2 million. The State Auto Group has consistently targeted
contributions to our defined benefit pension plan with the objective of maintaining a fully funded status on an
ABO basis. Historically our plan assets have exceeded our ABO. Given the recent significant decline in the
pension plan’s asset we are reviewing the options available to us from a funding perspective. Currently we are
anticipating a minimum cash contribution in 2009 of $15.0 million.
Our unfunded status on our postretirement medical plan (“retiree med plan”) decreased from $118.2 million
at January 1, 2008 to $109.1 million at December 31, 2008. The factors influencing this decrease are as follows:
(1) In October 2008, we announced a substantive change to increase retiree cost sharing in the retiree med plan,
effective January 1, 2009. This change will allow us to decrease our overall company costs and continue to
provide a competitive retiree med plan for all associates and current retirees. The increase in the cost sharing will
be phased in over five years for current retirees and those associates who announced their retirement before
December 31, 2008 and retire in the first half of 2009. On October 1, 2008, this change reduced our PBO and
unrecognized prior service balance, a component of accumulated comprehensive loss in our equity, by $28.1
million. (2) Offsetting the cost share plan change is a combination of the following factors: (a) Key assumptions
used in determining the amount of the benefit obligation and related periodic cost are the discount rate and the
assumed health care cost trend rate. We decreased our selected discount rate by 0.50 points to 6.00% from the
6.50% rate used at January 1, 2008. We assume that the relative increase in health care costs will continue to rise
over the next several years. For 2008 the expected rate of increase in future health care costs was 10% for 2008,
trending down 1% per year to 5% thereafter. Changes to these two key assumptions, had the effect of increasing
our obligation and unrecognized actuarial loss at December 31, 2008. (b) Additional unrecognized net actuarial
gains or losses adjustments arising from demographic changes and expected to actual claims experience, which at
December 31, 2008 had the effect of increasing our obligation and unrecognized actuarial loss.
In October 2008, we offered an early retirement incentive option to retirement eligible associates. This early
retirement option is deemed a special termination benefit under SFAS No 88—“Employers’ Accounting for
Settlements and Curtailments of Define Benefit Pension Plans and for Termination Benefits. An employer
offering special termination benefits to employees must recognize a liability and an expense when the following
conditions are met: 1) the employees accept the offer, and 2) the amount can be reasonably estimated. We
recognized an expense of $1.9 million for the acceleration of certain plan benefits for those retirement eligible
associates who elected early retirement.
Loss and Loss Expense Reserves
Our loss and loss expense reserves reflect all unpaid amounts for claims that have been reported as well as
for claims that have been incurred but not reported (“IBNR”). Our loss and loss expense reserves are not
discounted to present value.
Losses and allocated loss expense reserves (“Loss and ALAE Reserve”) are management’s best estimates
(“MBE”) at a given point in time of what we expect to pay to settle all claims incurred as of that date based on
known facts, circumstances and historical trends. Reserves for reported losses are established on either a
case-by-case or formula basis depending on the type and circumstances of the loss. The case-by-case reserve
amounts are determined by claims adjusters based on our reserving practices, which take into account the type of
risk, the circumstances surrounding each claim and applicable policy provisions. The formula reserves are based
on historical data for similar claims with provision for trend changes caused by inflation. Case and formula basis
loss reserves are reviewed on a regular basis, and as new data becomes available, estimates are updated resulting
in adjustments to loss reserves. Generally, reported losses initially reserved on a formula basis and not settled
after six months are case reserved at that time. The process for calculating the IBNR component of the Loss and
ALAE Reserve is to develop an estimate of the ultimate losses and allocated loss expenses incurred, and subtract
all amounts already paid or held as case or formula reserves.
78
The ultimate determination of MBE integrates information and analysis provided by several disciplines
within our Company, including claims, actuarial and accounting. This assessment requires considerable judgment
in understanding how claims mature, which lines of business are the most volatile, and how trends change over
time. Loss and ALAE Reserves represent an estimate at a given point in time based on many variables including
legal developments, storm loss estimates, and economic
historical and statistical
conditions. Although we consider many different sources of information, as well as a number of actuarial
methodologies to estimate our Loss and ALAE Reserve, there is no single method for determining the exact
ultimate liability.
information,
inflation,
Our internal actuarial staff conducts quarterly reviews of projected loss development information to assist
management in making estimates of ultimate losses and loss expenses. Several factors are considered 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, and late reported claims. In addition,
reasonableness tests are performed on many of the assumptions underlying each reserving methodology, such as
claim frequency, claim severity and loss ratios. Nonetheless, changes which are not contemplated do occur over
time, and those changes are incorporated in subsequent valuations of the loss reserves.
We use a number of different methodologies to estimate the IBNR component of the Loss and ALAE
Reserves. Our reserves include amounts related to short tail and long tail lines of business. “Tail” refers to the
time period between the occurrence of a loss and the settlement of the claim. In general, the longer the time span
between the incidence of a loss and the settlement of the claim, the more the ultimate settlement amount can
vary. The reserving methods and strengths and weaknesses of each are described below.
Short-Tail Business: For short-tail business, claims are typically settled within five years, and the most
common actuarial estimates are based on techniques using link ratio projections of incurred losses, paid losses,
claim counts and claim severities. Each of these methods is described below in detail. Separate projections are
made for catastrophes that are in the very early stages of development based on specific information known
through the reporting date.
Incurred Loss Development Method: The Incurred Loss Development Method is probably the most
common actuarial method used in projecting indicated IBNR reserves. This method uses paid loss experience as
well as the outstanding estimates (formula and case reserves) for claims that have been reported and are still
open. The underlying assumption of the Incurred Loss Development Method is that case reserve adequacy
remains consistent over time. This method’s advantage is its responsiveness to changes in reported losses, which
is particularly valuable in the less mature accident years. The disadvantage of the Incurred Loss Development
Method is that case reserve adequacy changes will distort the IBNR projections.
Paid Loss Development Method: The Paid Loss Development Method uses calculations that are very
similar to the Incurred Loss Development Method. The key difference is that the data used in the paid method
exclude case reserve estimates, so only paid losses are utilized. With this method, a payment pattern is estimated
to project ultimate settlement values for each accident year, with the underlying assumption that claims are
settled at a consistent rate over time. Neither case reserves nor the rate at which claims are reported (except to the
extent that the reporting pattern influences the payment pattern) is relevant to the results of this method. This
method’s advantage is the estimates of ultimate loss are independent of case reserve adequacy and are unaffected
by company changes in case reserving philosophy. The disadvantages are that the paid method does not use all of
the available information, and in some cases the liability payment patterns require the application of very large
development factors to relatively small payments in less mature accident years.
Claim Counts and Severities Method: The Counts and Severities Method calculations are very similar to
the other methods. The incurred claim counts reported to date are projected to an ultimate number. Similarly, the
incurred loss severities are projected to an ultimate value. The ultimate incurred count is multiplied by the
79
ultimate incurred severity, for each accident year, to arrive at the ultimate incurred loss. Finally, as with the other
loss development methods, an estimate of the IBNR reserve is calculated by subtracting the reported losses from
the estimated ultimate losses.
Long-Tail Business: Reserve estimates for long-tail business use the same methods listed above along with
several other methods as determined by the actuary. For example, premium-based methods may be used in
developing ultimate loss estimates, including the Expected Loss Ratio, Bornhuetter-Ferguson, and Least-Squares
techniques as described below. We also use statistical models when the historical patterns can be reasonably
approximated.
Expected Loss Ratio Method: The Expected Loss Ratio Method generates indicated IBNR by multiplying
an expected loss ratio by earned premium, then subtracting incurred-to-date losses. For slower reporting lines of
business, new products, or data that is very immature, the actual claim data is often too limited or too volatile for
other projection methods. With this method the premiums are used as a measure of loss exposure, and the loss
ratios can be derived from pricing expectations.
Bornhuetter-Ferguson Method: The Bornhuetter-Ferguson Method is a weighted average of the Expected
Loss Ratio Method and the Incurred Loss Development Method, using the percentage of losses reported as the
weight. This method is particularly useful where there is a low volume of data in the current accident period, or
where the experience is volatile. In general, this method produces estimates that are very similar to the Incurred
Loss Development Method.
Least Square Loss Development Method: In the Least Squares Loss Development Method the statistical
technique of least squares regression is applied to a triangle of reported loss ratios to project the ultimate loss
ratio in each accident year. Using historical loss ratios puts the data for each time period on a more consistent
exposure basis, because premium levels are generally correlated with insured exposures. A by-product of the
regression function is an estimate of credibility for each stage of development. In cases where the regression
parameters fall outside of a reasonable range, the projection defaults to the incurred loss method.
Selection Process: In determining which reserving method to use for a particular line of business or
accident year, diagnostic tests of loss ratios and severity trends are considered, as well as the historic case reserve
adequacy and claim settlement rate. In general, the Incurred Loss Development Method is used if the projections
are stable, the data is credible, historic case reserve adequacy is consistent, and the loss ratios and loss severities
are reasonable. Other reserving methods are considered as well for particular lines of business or accident years,
along with supplemental information such as open claim counts and prior period development. For example, if
more than one method provides a reasonable projection, the actuary may select an average of those methods.
There is considerable judgment applied in the analysis of the historical patterns and in applying business
knowledge of our underwriting and claims functions.
Reserve ranges provide a quantification of the variability in the reserve projections. The primary
determinant in estimating the reserve range boundaries are the variances measured within the historical reserving
data for the various lines of business. Property lines typically have smaller variances, while liability lines can
experience significant variability. MBE of loss reserves considers the expected variation to establish an
appropriate position within a range. MBE Loss and ALAE Reserves for SA National and the STFC Pooled
Companies’ share of the Pooled Companies’ reserves at December 31, 2008 was $851.8 million, within a
projected range of $784.4 million to $869.0 million. (These values presented are on a direct basis, gross of
salvage and subrogation recoverable, and before reinsurance, except for the STFC Pooled Companies’
participation in the inter-company Pooling Arrangement. Therefore, these values cannot be compared to many of
the other loss and loss expenses payable tables included elsewhere within this Form 10-K.)
The potential impact of the reserve variability on net income can be illustrated using the range end points
and carried reserve amounts listed above. For example, if ultimate losses reach a level corresponding to the high
80
point of the range, $869.0 million, the reserve increase of $17.2 million corresponds to an after-tax decrease of
$11.2 million in net income. Likewise, should ultimate losses decline to a level corresponding to the low point of
the range, $784.4 million, the $67.4 million reserve decrease would add $43.8 million of after-tax net income.
The reserve range noted above represents a range of reasonably likely reserves, not a range of all possible
reserves. Therefore, the ultimate losses could reach levels corresponding to reserve amounts outside the range
provided.
An important assumption underlying the reserve estimation methods for the major casualty lines is that the
loss cost trends implicitly built into the loss and ALAE patterns will continue into the future. To estimate the
sensitivity of reserves to an unexpected change in inflation, projected calendar year payment patterns were
applied to the December 31, 2008, other & product liability Loss and ALAE Reserve to generate estimated
annual incremental loss and ALAE payments for each subsequent calendar year. Then, for purposes of sensitivity
testing, an additional annual loss cost trend of 10% was added to the trend implicitly embedded in the estimated
payment pattern, and revised incremental loss and ALAE payments were calculated. This type of inflationary
increase could arise from a variety of sources including tort
law changes, development of new medical
procedures, social inflation, and other inflationary changes in costs beyond assumed levels.
The estimated cumulative impact that this additional, unexpected 10% increase in the loss cost trend would
have on our results of operations over the lifetime of the underlying claims in other & product liability is an
increase of $61.8 million on reserves, or a $40.2 million reduction to net income, assuming a tax rate of 35%.
Inflation changes have much more impact on the longer tail commercial lines like other & product liability and
workers’ compensation, and much less impact on the shorter tail personal lines’ reserves.
In addition to establishing Loss and ALAE Reserves, as described above, we establish reserves for loss
adjustment expenses related to functions and costs that are not attributable to a specific claim, which is called
Unallocated Loss Adjustment Expense (“ULAE”). Historical patterns of paid ULAE relative to paid loss are
analyzed along with historical claim counts including claims opened, claims closed, and claims remaining open.
The product of this analysis is an estimate of the relationship, or ratio, between ULAE and loss underlying the
current loss reserves. This ratio is applied to the current outstanding loss reserves to estimate the required ULAE
reserve. Consequently, this component of the loss expense reserve has a proportional relationship to the overall
claim inventory and held loss reserves by accident year. The method assumes that the underlying claims process
and mix of business do not change materially over time.
81
The following table provides a reconciliation of MBE of our direct Loss and ALAE Reserve to our net loss
and loss expenses payable at December 31, 2008 and 2007, respectively. The STFC Pooled Companies net
additional share of transactions assumed from State Auto Mutual through the Pooling Arrangement for the years
ended December 31, 2008 and 2007, respectively, has been reflected in the table below as assumed by STFC
Pooled Companies:
($ millions)
Direct Loss and ALAE Reserve:
STFC Pooled Companies and SA National . . . . . . . . . . . . . . . . . . . . . . . . . . $440.5 $393.1
304.4
Assumed by STFC Pooled Companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total direct loss and ALAE reserve . . . . . . . . . . . . . . . . . . . . . . . . . . . .
697.5
411.3
851.8
2007
2008
Direct unallocated loss adjustment expense (“ULAE”)
STFC Pooled Companies and SA National . . . . . . . . . . . . . . . . . . . . . . . . . .
Assumed by STFC Pooled Companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total direct ULAE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Direct salvage and subrogation recoverable:
STFC Pooled Companies and SA National . . . . . . . . . . . . . . . . . . . . . . . . . .
Assumed by STFC Pooled Companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total direct salvage and subrogation recoverable . . . . . . . . . . . . . . . .
Reinsurance recoverable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Assumed reinsurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Reinsurance assumed by STFC Pooled Companies . . . . . . . . . . . . . . . . . . .
24.9
24.3
49.2
23.8
20.3
44.1
(22.0)
(9.5)
(31.5)
(21.2)
4.8
(83.1)
(20.9)
(8.4)
(29.3)
(11.2)
5.1
(59.1)
Total losses and loss expenses payable, net of reinsurance
recoverable on losses and loss expenses payable of $21.2 in 2008
and $11.2 in 2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $770.0 $647.1
The following tables present the loss and loss expenses payable by major line of business at December 31,
2008 and 2007, respectively:
($ in millions)
December 31, 2008
Personal insurance segment:
Standard auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Nonstandard auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Homeowners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other personal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total personal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Business insurance segment:
Commercial auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial multi-peril
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fire & allied lines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Product & other liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Workers’ compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total losses and loss expenses payable net of reinsurance
Ending
Loss &
ALAE
Case &
Formula
Ending
Loss &
ALAE
IBNR
Ending
ULAE
Bulk
Total
Reserves
$133.5
15.1
44.0
9.7
202.3
$ 44.2
3.0
21.9
4.4
73.5
$10.8
1.5
2.7
0.5
15.5
$188.5
19.6
68.6
14.6
291.3
49.4
40.4
33.0
54.7
43.3
3.1
223.9
39.3
45.4
4.4
84.1
45.7
2.2
221.1
4.8
5.7
1.1
13.6
8.1
0.4
33.7
93.5
91.5
38.5
152.4
97.1
5.7
478.7
recoverable on losses and loss expenses payable . . . . . . . . . . . . . .
$426.2
$294.6
$49.2
$770.0
82
Ending
Loss &
ALAE
Case &
Formula
Ending
Loss &
ALAE
IBNR
Ending
ULAE
Bulk
Total
Reserves
December 31, 2007
Personal insurance segment:
Standard auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Nonstandard auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Homeowners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other personal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$120.4
13.9
36.4
6.3
$ 37.5
3.0
15.3
2.3
$11.2
1.4
1.7
0.3
$169.1
18.3
53.4
8.9
Total personal
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
177.0
58.1
14.6
249.7
Business insurance segment:
Commercial auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial multi-peril . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fire & allied lines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Product & other liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Workers’ compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
44.8
37.8
18.7
46.0
38.3
2.0
28.9
36.9
1.0
71.7
39.4
2.4
Total business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total losses and loss expenses payable net of reinsurance recoverable
187.6
180.3
4.1
4.1
0.6
12.4
7.8
0.5
29.5
77.8
78.8
20.3
130.1
85.5
4.9
397.4
on losses and loss expenses payable . . . . . . . . . . . . . . . . . . . . . . . . . .
$364.6
$238.4
$44.1
$647.1
See discussion in “Results of Operations 2008 Compared to 2007-Losses and Expenses” section included in
this Item 7.
The property and casualty industry has experienced significant loss from claims related to asbestos,
environmental remediation, product liability, mold and other mass torts. Asbestos reserves are $3.4 million, and
environmental reserves are $7.7 million, for a total of $11.1 million, or 1.4% of net losses and loss expenses
payable. Asbestos reserves increased $0.2 million and environmental reserves decreased $0.2 million from 2007.
Because we have insured primarily product retailers and distributors, we do not expect to incur the same level of
liability, particularly related to asbestos, as companies that have insured manufacturing risks.
The risks and uncertainties inherent in the loss and loss expense reserve estimates include, but are not
limited to, actual settlement experience being different from historical data and 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. Our 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.
Impact of Inflation
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, we attempt to
anticipate increases from inflation subject to the limitations of modeling economic variables. Even when general
inflation, as measured by the Consumer Price Index, is relatively modest, as has been the case over the last
several years, price inflation on the goods and services purchased by insurance companies in settling claims can
steadily increase. For example, medical care costs have risen at a higher rate than general inflation over the last
few years. Costs for building materials typically rise dramatically following substantial, widespread natural
83
catastrophes, such as the industry experienced in Florida and adjacent states in 2004 in Mississippi and Alabama
in 2005, and more recently with Hurricane Katrina in 2006. We continue to adjust our pricing projections to
reflect current and anticipated changes in costs in all lines of business.
We consider inflation when estimating liabilities for losses and loss expenses, particularly for claims having
a long period between occurrence and final 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.
New Accounting Standards:
Adoption of Recent Accounting Pronouncements
In January 2009,
the Financial Accounting Standards Board (“FASB”) issued FSP EITF 99-20-1,
“Amendments to the Impairment and Interest Income Measurement Guidance of EITF Issue No. 99-20
Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests that
Continue to be held by a Transferor in Securitized Financial Assets.” This FSP was issued to achieve consistent
determination of whether an OTTI has occurred. This amendment aligns the impairment guidance with FAS 115
“Accounting for Certain Investments in Debt and Equity Securities” (“SFAS 115”). The FSP is effective for
interim and annual reporting periods ending after December 15, 2008. The Company adopted this guidance
effective December 31, 2008 and there was no impact on the Company’s financial statements.
In June 2007, the FASB issued EITF 06-11, “Accounting for Income Tax Benefits of Dividends on Share-
Based Payment Awards” (“EITF 06-11”). EITF 06-11 addresses how a company should recognize the income tax
benefit received on dividends that are (a) paid to employees holding equity-classified non-vested shares, equity-
classified non-vested share units, or equity-classified outstanding share options, and (b) charged to retained
earnings under FAS 123(R). The tax benefit received on dividends paid to employees associated with their share-
based awards should be recorded in additional paid-in capital until the award is settled through exercise (if the
award is an option) or vesting (if the award is non-vested stock). This will be effective for tax benefits of
dividends declared in fiscal years beginning after December 15, 2007. The Company adopted this guidance
effective January 1, 2008 and it did not have a material impact on the Company’s financial statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and
Financial Liabilities” (“SFAS 159”). SFAS 159 expands the standards under SFAS 157 (defined below) to
provide entities a one-time election to measure financial instruments and certain other items at fair value. SFAS
159 also amends SFAS No. 115 (defined below) to require a specific presentation of investments categorized as
available-for-sale. SFAS 159 was effective for the first year that begins after November 15, 2007. The Company
adopted this guidance effective January 1, 2008 and did not elect the fair value option for any of its eligible
assets or liabilities as of this date.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”), which
became effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal
years. SFAS 157 established a single authoritative definition of fair value, set out a framework for measuring fair
value, and required additional disclosures about fair-value measurements. The Statement imposed no new
requirements for additional fair-value measures in financial statements. The Company adopted the provisions of
SFAS 157 on January 1, 2008. The adoption of SFAS 157 did not require any adjustments to the Company’s
previously reported financial statements.
In September 2006, FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and
Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R)” (“SFAS 158”) that
than pensions
requires employers with defined benefit pension and postretirement benefit plans other
84
(collectively “benefit plans”) to recognize the funded status of their benefit plans in their balance sheet, measure
the fair value of plan assets and benefit obligations as of the date of the fiscal year-end balance sheet date thereby
eliminating the use of an earlier measurement date and provide additional disclosures. The new measurement
date requirement became effective for fiscal years ending after December 15, 2008. On December 31, 2006, the
Company adopted the recognition and disclosure provisions of SFAS 158, which had no effect on the Company’s
consolidated statement of income for year ended December 31, 2006. Adopting SFAS 158 required the Company
to recognize the funded status (i.e. the difference between the fair value of plan assets and the benefit obligations)
of its benefit plans in the December 31, 2006 balance sheet, with a corresponding adjustment
to other
comprehensive loss, net of tax of $63.9 million. At December 31, 2007 and 2006, the Company continued to use
the earlier measurement date of September 30. Effective January 1, 2008, the Company adopted the measurement
date requirement under transition alternative method one, as defined in SFAS 158. This transition method
resulted in a one-time adjustment that decreased beginning retained earnings by $2.4 million, net of tax. The
combined impact of the measurement date transition and re-measurement of plan assets and obligations on
January 1, 2008, increased beginning accumulated comprehensive income by $3.5 million, net of tax.
Pending Adoption of Accounting Pronouncements
On December 30, 2008, the FASB issued FSP FAS 132(R)-1, “Employers’ Disclosures about Postretirement
Benefit Plan Assets.” This FSP provides disclosures about the types of assets held in defined benefits and
postretirement benefit plans including employers’ investment strategies, major categories of plan assets,
concentrations of risk within plan assets, and valuation techniques used to measure the fair value of the plan
assets. The FSP includes disclosures about fair value measurements similar to those required by SFAS 157
(defined above). The FSP is effective for fiscal years ending after December 15, 2009 with early adoption
permitted.
Item 7A. Qualitative and Quantitative Disclosures about Market Risk
Qualitative and Quantitative Disclosures about Market Risk are included in Item 7 of this Form 10-K under
“2008 Compared to 2007—Investment Operations Segment—Market Risk.”
85
Item 8. Financial Statements and Supplementary Data
The Consolidated Financial Statements, including the Notes to Consolidated Financial Statements and the
Reports of Independent Registered Public Accounting Firm are as follows:
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of
State Auto Financial Corporation
We have audited the accompanying consolidated balance sheets of State Auto Financial Corporation and
subsidiaries as of December 31, 2008 and 2007, and the related consolidated statements of operations,
stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2008. 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 the standards of the Public Company Accounting Oversight
Board (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, 2008 and
2007, and the consolidated results of their operations and their cash flows for each of the three years in the period
ended December 31, 2008, in conformity with U.S. generally accepted accounting principles. 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.
As discussed in Note 1 to the consolidated financial statements, the Company changed its method of
accounting for defined benefit pension and other postretirement plans as of December 31, 2006, to adopt
Financial Accounting Standards Board Statement No. 158, “Employers’ Accounting for Defined Benefit Pension
and Other Postretirement Plans.”
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board
(United States), State Auto Financial Corporation’s internal control over financial reporting as of December 31,
2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission and our report dated March 12, 2009 expressed an
unqualified opinion thereon.
/s/ Ernst & Young LLP
Columbus, Ohio
March 12, 2009
86
Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting
The Board of Directors and Stockholders of
State Auto Financial Corporation
We have audited State Auto Financial Corporation’s internal control over financial reporting as of
December 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). State Auto Financial
Corporation’s management is responsible for maintaining effective internal control over financial reporting, and
for its assessment of the effectiveness of internal control over financial reporting included in the accompanying
Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an
opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance
about whether effective internal control over financial reporting was maintained in all material respects. Our
audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a
material weakness exists, testing and evaluating the design and operating effectiveness of internal control based
on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We
believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company’s internal control over financial reporting
includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable
assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that receipts and expenditures of the company are being made
only in accordance with authorizations of management and directors of the company; and (3) provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the
company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
In our opinion, State Auto Financial Corporation maintained, in all material respects, effective internal
control over financial reporting as of December 31, 2008, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board
(United States), the consolidated balance sheets of State Auto Financial Corporation as of December 31, 2008
and 2007, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of
the three years in the period ended December 31, 2008 of State Auto Financial Corporation and our report dated
March 12, 2009 expressed an unqualified opinion thereon.
Columbus, Ohio
March 12, 2009
/s/ Ernst & Young LLP
87
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Consolidated Balance Sheets
(in millions, except per share amounts)
Assets
December 31
2008
2007
Fixed maturities, available-for-sale, at fair value (amortized cost $1,781.1 and
$1,722.9, respectively) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,770.7
1,745.4
Equity securities, available-for-sale, at fair value (cost $144.3 and $210.2,
respectively) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
137.5
254.2
Other invested assets, available-for-sale, at fair value (cost $32.4 and $19.6,
respectively) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accrued investment income and other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred policy acquisition costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Pension asset
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Reinsurance recoverable on losses and loss expenses payable (affiliates $0.6 and $1.2,
respectively) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Prepaid reinsurance premiums (affiliates none) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Due from affiliate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Current federal income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net deferred federal income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Property and equipment, at cost, (net of accumulated depreciation of $6.2 and $5.6,
31.7
1.4
1,941.3
150.5
40.2
122.3
—
21.2
7.0
—
37.6
111.0
19.8
1.8
2,021.2
70.9
42.1
105.8
2.7
11.2
6.0
19.4
—
46.1
respectively) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
12.5
$2,443.6
12.5
2,337.9
Liabilities and Stockholders’ Equity
Losses and loss expenses payable (affiliates $343.0 and $257.2, respectively) . . . . . . .
Unearned premiums (affiliates $175.0 and $119.5, respectively) . . . . . . . . . . . . . . . . . .
Notes payable (affiliates $15.5 and $15.5, respectively) . . . . . . . . . . . . . . . . . . . . . . . . .
Postretirement and pension benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Due to affiliate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Current federal income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Stockholders’ equity:
Class A Preferred stock (nonvoting), without par value. Authorized 2.5 shares; none
issued . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Class B Preferred stock, without par value. Authorized 2.5 shares; none issued . . . . . .
Common stock, without par value. Authorized 100.0 shares; 46.3 and 46.0 shares
$ 791.2
515.1
117.6
187.7
15.9
—
55.1
1,682.6
658.3
436.0
118.0
125.2
—
7.8
57.1
1,402.4
—
—
—
—
issued, respectively, at stated value of $2.50 per share . . . . . . . . . . . . . . . . . . . . . . . .
Treasury stock, 6.8 and 5.5 shares, respectively, at cost . . . . . . . . . . . . . . . . . . . . . . . . .
Additional paid-in capital
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accumulated other comprehensive loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total liabilities and stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
115.9
(115.5)
109.0
(97.6)
749.2
761.0
$2,443.6
115.0
(81.0)
98.2
(3.3)
806.6
935.5
2,337.9
See accompanying notes to consolidated financial statements.
88
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Consolidated Statements of Income
($ millions, except per share amounts)
Year ended December 31
2008
2007
2006
Earned premiums (ceded to affiliate $700.9, $695.7 and $687.8, respectively) . . . $1,126.0
87.4
Net investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(36.4)
Net realized (loss) gain on investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4.9
. . . . . . . . . . . . . . . . . .
Other income (affiliates $3.1, $3.3 and $3.0, respectively)
1,011.6
84.7
12.1
5.0
1,023.8
83.1
5.6
4.9
Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,181.9
1,113.4
1,117.4
Losses and loss expenses (ceded to affiliate $514.6, $405.0 and $389.1,
respectively) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Acquisition and operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Interest expense (affiliates $1.2, $1.5 and $1.5, respectively)
. . . . . . . . . . . . . . . .
Other expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
846.7
389.8
7.3
13.2
Total expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,257.0
(Loss) income before federal income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Federal income tax (benefit) expense:
Current . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total federal tax (benefit) expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(75.1)
(26.4)
(17.6)
(44.0)
590.8
347.9
7.6
11.8
958.1
155.3
587.6
348.0
7.4
12.7
955.7
161.7
43.5
(7.3)
36.2
43.5
(2.2)
41.3
Net (loss) income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ (31.1)
119.1
120.4
(Loss) earnings per common share:
Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ (0.78)
Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ (0.78)
Dividends paid per common share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
0.60
2.90
2.86
0.50
2.95
2.90
0.38
See accompanying notes to consolidated financial statements.
89
45.1
0.6
45.7
(4.6)
(0.1)
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Consolidated Statements of Stockholders’ Equity
(in millions)
Common shares:
Year ended December 31
2008
2007
2006
Balance at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Issuance of shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Balance at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
46.0
0.3
46.3
45.7
0.3
46.0
Treasury shares:
Balance at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Shares acquired on stock option exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Shares acquired under repurchase program . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Balance at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(4.7)
(5.5)
(0.1) —
(1.2)
(6.8)
(0.8) —
(5.5)
(4.7)
Common stock:
Balance at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Issuance of shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Balance at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 115.0
0.9
115.9
114.3
0.7
115.0
112.8
1.5
114.3
Treasury stock:
Balance at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Shares acquired on stock option exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Shares acquired under repurchase program . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Balance at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ (81.0)
(1.3)
(33.2)
(115.5)
(56.8)
(1.3)
(58.1)
(0.8)
(22.1) —
(81.0)
(58.1)
Additional paid-in capital:
Balance at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Issuance of common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Tax benefit from stock options exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Stock options granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Balance at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 98.2
4.9
0.8
5.1
109.0
87.3
4.4
0.7
5.8
98.2
70.2
7.2
3.2
6.7
87.3
Accumulated other comprehensive (loss) income:
Balance at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Effect of changing benefit plan obligation measurement date pursuant to SFAS No. 158, net
of tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Balance at beginning of year, as adjusted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Change in unrealized (losses) gains on investments, net of tax and reclassification
adjustment
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amortization of gain on derivative used in cash flow hedge . . . . . . . . . . . . . . . . . . . . . . . . . . .
Change in unrecognized benefit plan obligations, net of tax and reclassification
adjustment
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accumulated other comprehensive (loss) income before SFAS No. 158 adoption . . . . . . . . . .
Cumulative effect of adoption of SFAS No. 158, net of tax . . . . . . . . . . . . . . . . . . . . . . . . . . .
Balance at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
(3.3)
(17.3)
34.3
3.5 —
0.2
(17.3)
—
34.3
(57.6)
(0.1)
(40.1)
(97.6)
—
(97.6)
(2.6)
(0.1)
12.4
(0.1)
16.7 —
(3.3)
46.6
— (63.9)
(17.3)
(3.3)
Retained earnings:
Balance at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Effect of changing benefit plan obligation measurement date pursuant to SFAS No. 158, net
of tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Balance at beginning of year, as adjusted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net (loss) income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash dividends paid (affiliates $15.3, $13.2 and $12.4, respectively) . . . . . . . . . . . . . . . . . . . .
Balance at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total stockholders’ equity at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 806.6
708.0
603.0
(2.4) —
804.2
708.0
(31.1) 119.1
(23.9)
(20.5)
749.2
806.6
—
603.0
120.4
(15.4)
708.0
$ 761.0
935.5
834.2
See accompanying notes to consolidated financial statements.
90
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Consolidated Statements of Cash Flows
($ millions)
Cash flows from operating activities:
Net (loss) income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
Depreciation and amortization, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Share-based compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net realized loss (gain) on investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Changes in operating assets and liabilities:
Deferred policy acquisition costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accrued investment income and other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Postretirement and pension benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Reinsurance recoverable on losses and loss expenses payable and prepaid
reinsurance premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other liabilities and due to/from affiliates, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Losses and loss expenses payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unearned premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Excess tax benefits on share-based awards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Federal income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash provided from adding Beacon National Insurance Company, Patrons Mutual
Insurance Company of Connecticut, Litchfield Mutual Fire Insurance Company
and State Auto Insurance Companies middle market business insurance to the
reinsurance pool, effective January 1, 2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash provided by operating activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash flows from investing activities:
Purchases of fixed maturities—available-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Purchases of equity securities—available-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Purchases of other invested assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Maturities, calls and pay downs of fixed maturities—available-for-sale . . . . . . . . . . .
Sales of fixed maturities—available-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Sales of equity securities—available-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Sales of other invested assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net additions of property and equipment
Net cash used in investing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash flows from financing activities:
Proceeds from issuance of common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Payments to acquire treasury shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Excess tax benefits on share-based awards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Payments of dividends (affiliates $15.3, $13.2 and $12.4, respectively) . . . . . . . . . . .
Change in securities lending collateral
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Change in securities lending obligation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash used in financing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net increase (decrease) in cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash and cash equivalents at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash and cash equivalents at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Year ended December 31
2008
2007
2006
$ (31.1)
119.1
120.4
10.6
5.5
36.4
(3.7)
1.1
7.3
(11.0)
33.2
81.6
25.5
0.4
(64.3)
11.0
6.0
(12.1)
(1.7)
1.0
7.3
2.3
4.0
(16.2)
7.2
0.4
(6.7)
9.6
7.0
(5.6)
2.0
1.6
6.2
4.0
(2.8)
(54.2)
(4.1)
(2.4)
11.8
92.0
183.5
—
121.6
—
93.5
(288.5)
(29.2)
(24.7)
58.7
164.6
67.0
1.1
(0.5)
(51.5)
(331.6)
(73.7)
(17.1)
73.1
155.2
107.0
1.8
(0.8)
(86.1)
(293.8)
(101.2)
(0.9)
76.0
171.4
103.8
1.7
(0.2)
(43.2)
4.4
(33.2)
0.3
(23.9)
—
—
(52.4)
79.6
70.9
$ 150.5
4.3
7.4
(22.1) —
2.4
(15.4)
99.0
(99.0)
(5.6)
44.7
28.7
73.4
0.3
(20.5)
—
—
(38.0)
(2.5)
73.4
70.9
Supplemental disclosures:
Interest paid (affiliates $1.2, $1.5 and $1.4, respectively)
. . . . . . . . . . . . . . . . . . . . . .
$
7.5
Federal income taxes paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 18.2
7.8
42.3
7.7
29.4
See accompanying notes to consolidated financial statements.
91
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 include State Auto Financial Corporation (“State Auto Financial”)
and its wholly-owned subsidiaries:
•
State Auto Property and Casualty Insurance Company (“State Auto P&C”), an Iowa corporation
• Milbank Insurance Company (“Milbank”), a South Dakota corporation
•
•
•
•
•
Farmers Casualty Insurance Company (“Farmers”), an Iowa corporation
State Auto Insurance Company of Ohio (“SA Ohio”), an Ohio corporation
State Auto National Insurance Company (“SA National”), an Ohio corporation
Stateco Financial Services, Inc. (“Stateco”), an Ohio corporation
Strategic Insurance Software, Inc. (“S.I.S.”), an Ohio corporation
The financial statements 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 (“State Auto 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 and SA Ohio, provides standard personal and
business insurance to its policyholders. The Company’s principal lines of insurance include personal and
commercial automobile, homeowners, commercial multi-peril, workers’ compensation, general liability and fire
insurance. SA National provides nonstandard automobile insurance. State Auto P&C, Milbank, Farmers, SA
Ohio and SA National operate primarily in the central and eastern United States, excluding New York and New
Jersey, through an independent insurance agency system. State Auto P&C, Milbank, Farmers, SA Ohio and SA
National are chartered and licensed property and casualty insurers. 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. A large portion of the Company’s revenues are derived from a reinsurance pooling agreement with
State Auto Mutual and its affiliates. The nature of the underlying policies and geographical distribution of State
Auto Mutual’s and its affiliates’ underwriting activity is similar to the Company.
Through State Auto P&C, the Company provides management and operation services under management
agreements for all insurance and non-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 insurance agencies and nonaffiliated insurers and
their agencies. S.I.S. also delivers services and sells products to affiliated entities.
92
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
518 PML, an Ohio limited liability company, was formed to engage in the business of owning and leasing
property to the Company’s affiliates.
c. Basis of Presentation
The consolidated financial statements have been prepared in conformity with U.S. generally accepted
accounting principles, which vary in certain respects from statutory-basis accounting principles followed by State
Auto P&C, Milbank, Farmers, SA Ohio and SA National 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 periods 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, current business conditions and assumptions about future conditions to
formulate estimates of the ultimate cost
to
uncertainties for various reasons. The Company’s results of operations and financial condition could be
materially impacted in future periods should the ultimate payments required to settle claims vary from the
amount of the liability currently provided.
to settle claims. These estimates by their nature are subject
Certain amounts in prior years’ financial statements and related footnotes have been reclassified to conform
to 2008 presentation. The December 31, 2007 amounts reflected on the consolidated balance sheets include a
reclassification of $0.5 million of other
invested assets. Such
invested assets at
reclassifications had no effect on the Company’s net income, stockholders’ equity or cash flows.
fair value to other
d. Investments
Investments in fixed maturities, equity securities and certain other invested assets are classified as
available-for-sale and, therefore, 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 a part of “accumulated
other comprehensive income (loss)” and, as such, are not included in the determination of net income (loss).
Realized gains and losses on the sales of investments are computed using the first-in, first-out method.
The Company regularly monitors its investments that have fair values less than cost or amortized cost for
signs of other–than-temporary impairment. Among the factors that management considers are market conditions,
the amount and length of decline in fair value, events impacting the issuer and the Company’s positive intent and
ability to hold the security until anticipated recovery or maturity. For declines in value that are not solely
attributable to interest rate movements, the Company considers positive evidence indicating that the cost of the
investment is recoverable within a reasonable period of time and evidence to the contrary in considering the
severity and duration of the impairment in relation to the anticipated market price recovery. When a decline in
fair value is deemed to be other-than-temporary, the investment cost is written down to fair value on the date the
determination is made and a realized loss is recorded. The cost is not adjusted for any subsequent recovery in fair
value.
93
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
e. Cash Equivalents
The Company considers all liquid debt instruments with a maturity of three months or less to be cash
equivalents. The carrying amounts reported approximate their fair value.
f. Deferred Policy Acquisition Costs
Acquisition costs, consisting of commissions, premium taxes and certain underwriting expenses that relate
to and vary with the production of new and renewal 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. These amounts are based on estimates and accordingly, the
actual realizable value may vary from the estimated realizable value. Net deferred policy acquisition costs for the
years ended December 31 are:
($ millions)
2008
2007
2006
Balance, beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . .
Effect of January 1, 2008 pooling change (Note 6)
. . . . . . . .
Acquisition costs deferred . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Acquisition costs amortized to expense . . . . . . . . . . . . . . . . .
$ 105.8
12.9
260.8
(257.2)
104.0
—
244.5
(242.7)
106.0
—
246.1
(248.1)
Balance, end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 122.3
105.8
104.0
g. Federal Income Taxes
The Company files a consolidated federal income tax return, and pursuant to a written tax sharing
agreement, each entity within the consolidated group pays or receives its share of federal income taxes based on
separate return calculations.
Income taxes are accounted for using the liability method. Under this method, deferred tax assets and
liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities
and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to
reverse.
Interest and penalties related to uncertain tax positions are recorded in the balance sheet as other liabilities,
and recognized in the income statement as other expenses.
h. Losses and Loss Expenses Payable
Losses and loss expenses payable are based on formula and case-basis estimates for reported claims and on
estimates, based on experience and perceived trends, for unreported claims and loss expenses. The liability for
unpaid losses and loss expenses, net of estimated salvage and subrogation recoverable of $31.5 million and $29.3
million at December 31, 2008 and 2007, respectively, has been established to cover the estimated ultimate cost to
settle insured losses. The amounts are 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 materially from such estimates.
The estimates are continually reviewed and adjusted as necessary; such adjustments are included in current
94
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
operations (see Note 4). Anticipated salvage and subrogation is 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.
i. Premiums
Premiums are recognized as earned in proportion to the insurance protection provided using the monthly pro
rata method over the contract period. Unearned premiums represent the portion of premiums written relative to
the unexpired terms of coverage.
j. Comprehensive (Loss) Income
Comprehensive (loss) 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 (loss) income includes
net income and other comprehensive (loss) income. Other comprehensive (loss) income includes all other
non-owner related changes to equity and includes net unrealized gains and losses on available-for-sale
investments, derivative instruments and unrecognized benefit plan obligations, adjusted for deferred federal
income taxes.
k. Share-Based Compensation
See Note 12—Share-Based Compensation regarding the Company’s adoption of SFAS 123(R) “Share-
Based Payment” (SFAS 123(R)) on January 1, 2006. The Company’s share-based compensation plans authorize
the granting of various equity-based incentives including stock options, restricted stock and restricted share units
to employees and non-employee directors and agents. The expense for these equity-based incentives is based on
their fair value at date of grant and amortized over their vesting period. The fair value of each stock option is
estimated on the date of grant using the Black-Scholes closed-form pricing model. The pricing model requires
assumptions such as the expected life of the option and expected volatility of the Company’s stock over the
expected life of the option, which significantly impacts the assumed fair value. The Company uses historical data
to determine these assumptions and if these assumptions change significantly for future grants, share-based
compensation expense will fluctuate in future periods.
l. New Accounting Standards
Adoption of Recent Accounting Pronouncements
In January 2009, the FASB issued FSP EITF 99-20-1, “Amendments to the Impairment and Interest Income
Measurement Guidance of EITF Issue No. 99-20, Recognition of Interest Income and Impairment on Purchased
Beneficial Interests and Beneficial Interests that Continue to be held by a Transferor in Securitized Financial
Assets.” This FSP was issued to achieve consistent determination of whether an other-than-temporary
impairment has occurred. This amendment aligns the impairment guidance with FAS 115, “Accounting for
Certain Investments in Debt and Equity Securities” (“SFAS 115”). The FSP is effective for interim and annual
reporting periods ending after December 15, 2008. The Company adopted this guidance effective December 31,
2008 and there was no material impact on the Company’s financial statements.
In June 2007, the FASB issued EITF 06-11, “Accounting for Income Tax Benefits of Dividends on Share-
Based Payment Awards” (“EITF 06-11”). EITF 06-11 addresses how a company should recognize the income tax
benefit received on dividends that are (a) paid to employees holding equity-classified non-vested shares, equity-
95
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
classified non-vested share units, or equity-classified outstanding share options, and (b) charged to retained
earnings under FAS 123(R). The tax benefit received on dividends paid to employees associated with their share-
based awards should be recorded in additional paid-in capital until the award is settled through exercise (if the
award is an option) or vesting (if the award is non-vested stock), effective for tax benefits of dividends declared
in fiscal years beginning after December 15, 2007. The Company adopted this guidance effective January 1, 2008
and it did not have a material impact on the Company’s financial statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and
Financial Liabilities” (“SFAS 159”). SFAS 159 expands the standards under SFAS 157 (defined below) to
provide entities a one-time election to measure financial instruments and certain other items at fair value. SFAS
159 also amends SFAS No. 115 (defined below) to require a specific presentation of investments categorized as
available-for-sale. SFAS 159 was effective for the first year that began after November 15, 2007. The Company
adopted this guidance effective January 1, 2008 and did not elect the fair value option for any of its eligible
assets or liabilities as of this date.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”), which
became effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal
years. SFAS 157 established a single authoritative definition of fair value, set out a framework for measuring fair
value, and required additional disclosures about fair-value measurements. The Statement imposed no new
requirements for additional fair-value measures in financial statements. The Company adopted the provisions of
SFAS 157 on January 1, 2008. The adoption of SFAS 157 did not require any adjustments to the Company’s
previously reported financial statements.
In September 2006,
issued SFAS No. 158,
the Financial Accounting Standards Board (“FASB”)
“Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB
Statements No. 87, 88, 106, and 132(R)” (“SFAS 158”) that requires employers with defined benefit pension and
postretirement benefit plans other than pensions (collectively “benefit plans”) to recognize the funded status of
their benefit plans in their balance sheets, measure the fair value of plan assets and benefit obligations as of the
date of the fiscal year-end balance sheet date thereby eliminating the use of an earlier measurement date and
provide additional disclosures. The new measurement date requirement became effective for fiscal years ending
after December 15, 2008. On December 31, 2006, the Company adopted the recognition and disclosure
provisions of SFAS 158, which had no effect on the Company’s consolidated statement of income for the year
ended December 31, 2006, and it will not affect the Company’s operating results in future periods. Adopting
SFAS 158 required the Company to recognize the funded status (i.e. the difference between the fair value of plan
assets and the benefit obligations) of its benefit plans in the December 31, 2006 balance sheet, with a
corresponding adjustment to other comprehensive loss, net of tax of $63.9 million. At December 31, 2007 and
2006, the Company continued to use its earlier measurement date of September 30. Effective January 1, 2008, the
Company adopted the measurement date requirement under transition alternative method one, as defined in
SFAS 158. This transition method resulted in a one-time adjustment that decreased beginning retained earnings
by $2.4 million, net of tax. The combined impact of the measurement date transition and re-measurement of plan
assets and obligations on January 1, 2008, increased beginning accumulated comprehensive income by $3.5
million, net of tax.
96
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
Pending Adoption of Accounting Pronouncements
On December 30, 2008 the FASB issued FSP FAS 132(R)-1, “Employers’ Disclosures about Postretirement
Benefit Plan Assets.” This FSP provides disclosures about the types of assets held in defined benefit and
postretirement benefit plans including employers’ investment strategies, major categories of plan assets,
concentrations of risk within plan assets, and valuation techniques used to measure the fair value of the plan
assets. The FSP includes disclosures about fair value measurements similar to those required by SFAS 157
(defined above). The FSP is effective for fiscal years ending after December 15, 2009 with early adoption
permitted.
2. Investments
The following tables summarize the cost or amortized cost of available-for-sale securities to fair value at
December 2008 and 2007:
($ millions)
Cost or
amortized
cost
Gross
unrealized
holding
gains
Gross
unrealized
holding
losses
Fair
Value
Available-for-sale at December 31, 2008:
U.S. treasury securities and obligations of U.S. government
agencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Obligations of states and political subdivisions . . . . . . . . . . . . . . . . . .
Corporate securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
U.S. government agencies mortgage-backed securities . . . . . . . . . . .
Total fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 127.6
1,463.1
11.9
178.5
1,781.1
144.3
32.4
$ 4.2
21.4
0.1
4.0
29.7
6.6
—
$ (4.2)
(33.5)
(0.2)
(2.2)
(40.1)
(13.4)
(0.7)
$ 127.6
1,451.0
11.8
180.3
1,770.7
137.5
31.7
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,957.8
$36.3
$(54.2)
$1,939.9
($ millions)
Cost or
amortized
cost
Gross
unrealized
holding
gains
Gross
unrealized
holding
losses
Fair
Value
Available-for-sale at December 31, 2007:
U.S. treasury securities and obligations of U.S. government
agencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Obligations of states and political subdivisions . . . . . . . . . . . . . . . . . .
Corporate securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
U.S. government agencies mortgage-backed securities . . . . . . . . . . .
Total fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
90.9
1,432.7
10.7
188.6
1,722.9
210.2
19.6
$ 2.2
23.6
0.3
2.6
28.7
47.4
0.3
$(0.1)
(4.3)
—
(1.8)
(6.2)
(3.4)
(0.1)
$
93.0
1,452.0
11.0
189.4
1,745.4
254.2
19.8
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,952.7
$76.4
$(9.7)
$2,019.4
97
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
At December 31, 2008 and 2007, there were no individual investments reflected in the tables below with an
unrealized holding loss that had a fair value significantly below cost continually for more than one year. There
are no individual material securities with an unrealized holding loss at December 31, 2008 and 2007. The
following tables reflect the Company’s gross unrealized losses and fair value on its investments, aggregated by
investment category and length of time for individual securities that have been in a continuous unrealized loss
position at December 31, 2008 and 2007:
At December 31, 2008
Less than 12 months
12 months or more
Total
Description of
Securities
($ millions)
Fair
Value
Unrealized
Losses
Number
of
Positions
Fair
Value
Unrealized
Losses
Number
of
Positions
Fair
Value
Unrealized
Losses
Number
of
Positions
U.S. treasury securities and
obligations of U.S.
government agencies . . . . $ 69.4
$ (4.2)
14
$ — $ —
— $
69.4
$ (4.2)
14
Obligations of states and
political subdivisions . . . .
Corporate securities . . . . . . .
U.S. government agencies
mortgage backed
securities . . . . . . . . . . . . .
Total fixed maturities . . . . . .
Equity securities . . . . . . . . . .
Other invested assets . . . . . .
Total temporarily
613.6
4.3
(18.0)
(0.2)
263
5
266.8
1.0
(15.5)
—
103
1
880.4
5.3
(33.5)
(0.2)
366
6
35.8
723.1
62.6
31.7
(1.1)
(23.5)
(12.0)
(0.7)
13
295
40
3
30.5
298.3
3.1
—
(1.1)
(16.6)
(1.4)
—
16
120
4
—
66.3
1,021.4
65.7
31.7
(2.2)
(40.1)
(13.4)
(0.7)
29
415
44
3
impaired
securities . . . . . . . . . $817.4
$(36.2)
338
$301.4
$(18.0)
124
$1.118.8
$(54.2)
462
At December 31, 2007
Less than 12 months
12 months or more
Total
Description of
Securities
($ millions)
Fair
Value
Unrealized
Losses
Number
of
Positions
Fair
Value
Unrealized
Losses
Number
of
Positions
Fair
Value
Unrealized
Losses
Number
of
Positions
U.S. treasury securities and
obligations of U.S.
government agencies . . . . $
Obligations of states and
5.4
$ —
2
$
6.5
$ (0.1)
4
$
11.9
$ (0.1)
6
political subdivisions . . . .
204.1
Corporate securities . . . . . . . —
U.S. government agencies
(1.8)
—
75
—
283.2
1.0
(2.5)
—
106
1
487.3
1.0
(4.3)
—
181
1
mortgage backed
securities . . . . . . . . . . . . .
Total fixed maturities . . . . . .
Equity securities . . . . . . . . . .
Other invested assets . . . . . .
Total temporarily
2.8
212.3
36.6
15.4
(0.1)
(1.9)
(3.4)
(0.1)
2
79
16
2
101.2
391.9
—
—
(1.7)
(4.3)
—
—
46
157
—
—
104.0
604.2
36.6
15.4
(1.8)
(6.2)
(3.4)
(0.1)
48
236
16
2
impaired
securities . . . . . . . . . $264.3
$ (5.4)
97
$391.9
$ (4.3)
157
$ 656.2
$ (9.7)
254
98
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 available-for-sale fixed maturities at December 31, 2008, by
contractual maturity, are summarized as follows:
($ millions)
Due in 1 year or less . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Due after 1 year through 5 years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Due after 5 years through 10 years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Due after 10 years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
U.S. government agencies mortgage-backed securities . . . . . . . . . . . . . . . . . . .
Amortized
cost
$
2.5
107.6
469.0
1,023.5
178.5
$
Fair
value
2.5
111.2
482.5
994.2
180.3
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,781.1
$1,770.7
Expected maturities may differ from contractual maturities because issuers may have the right to call or
prepay the obligations with or without call or prepayment penalties.
Fixed maturities with fair values of approximately $56.0 million and $55.1 million were on deposit with
insurance regulators as required by law at December 31, 2008 and 2007, respectively.
Components of net investment income for the year ended December 31 are summarized as follows:
($ millions)
Fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash and cash equivalents, and other . . . . . . . . . . . . . . . . . . . . . . . .
Investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Investment expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2008
$79.1
5.5
4.9
89.5
2.1
2007
75.3
5.7
5.5
86.5
1.8
2006
73.6
5.1
6.1
84.8
1.7
Net investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$87.4
84.7
83.1
The Company’s current investment strategy does not rely on the use of derivative financial instruments. See
Note 3 for additional fair value disclosures.
Realized losses recognized for the year ended December 31 related to other-than-temporary impairments on
the Company’s investment portfolio are summarized as follows:
($ millions)
2008
2007
2006
Fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ —
—
28.3
1.9
11.0 —
Total other-than-temporary impairments . . . . . . . . . . . . . . . . . .
$39.3
1.9
3.8
1.6
—
1.6
99
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
Realized losses related to other-than-temporary impairments on its fixed maturity portfolio in 2008 were
less than $0.1 million. The Company considers the following factors when assessing its investments for other-
than-temporary impairment: (1) the financial condition of the issuer; (2) the length of time and/or the
significance of decline below cost; and (3) its ability and intent to hold theses securities through their recovery
periods (4) the ability of the market value to recover to cost in the near term. The Company reviewed its
investments at December 31, 2008 and determined no additional other-than-temporary impairment exists in the
gross unrealized holding losses.
Proceeds on sales of available-for-sale securities in 2008, 2007, and 2006 were $231.6 million, $262.2
million and $275.2 million, respectively.
Realized and unrealized holding gains and losses for the years ended December 31 are summarized as
follows:
($ millions)
Realized gains:
2008
2007
2006
Fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 2.7
9.6
—
Total realized gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
12.3
Realized losses:
Fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total realized losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
—
37.7
11.0
48.7
0.8
19.7
—
20.5
1.3
7.1
—
8.4
Net realized (loss) gain on investments . . . . . . . . . . . . . . . . . . . . .
$(36.4)
$12.1
1.8
15.6
—
17.4
4.8
7.0
—
11.8
5.6
Change in unrealized holding (losses) gains:
(Decrease) increase in unrealized holding (losses) gains—fixed
maturity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$(32.9)
5.7
(3.2)
(Decrease) increase in unrealized holding (losses) gains—equity
securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(50.8)
(9.4)
22.6
(Decrease) increase in unrealized Holding (losses) gains—other
invested assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred federal income taxes (benefit) thereon . . . . . . . . . . . . . . . . . .
Valuation allowance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(0.9)
(0.3)
29.6
1.4
(2.6) —
(0.3)
(6.7)
—
(Decrease) increase in net unrealized holding (losses) gains . . . .
$(57.6)
(2.6)
12.4
There was a deferred federal tax benefit on the net unrealized holding losses at December 31, 2008 of $3.7
million, net of a valuation allowance of $2.6 million. There was a deferred federal tax liability on the net
unrealized holding gains at December 31, 2007 of $23.3 million.
100
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
3. Fair Value of Financial Instruments
Fair Value Measurements
On January 1, 2008, the Company adopted SFAS No. 157. For financial statement elements currently
required to be measured at fair value, SFAS 157 defines fair value, establishes a framework for measuring fair
value, and expands disclosures about fair value measurements. SFAS 157’s definition of fair value focuses on the
price that would be received to sell an asset or paid to transfer a liability (exit price) regardless of whether an
observable liquid market price exists. An exit price valuation will include margins for risk even if they are not
observable.
SFAS 157 establishes a fair value hierarchy that categorizes the inputs to valuation techniques that are used
to measure fair value into three levels:
Level 1 includes observable inputs which reflect quoted prices for identical assets or liabilities in active
markets at the measurement date.
Level 2 includes observable inputs for assets or liabilities other than quoted prices included in Level 1 and it
includes valuation techniques which use prices for similar assets and liabilities.
Level 3 includes unobservable inputs which reflect the reporting entity’s estimates of the assumptions that
market participants would use in pricing the asset or liability, including assumptions about risk.
Valuation of Available-for-Sale Investments
The Company utilizes a pricing service and employs other processes and control procedures in developing
its fair value estimates. The Company’s processes and control procedures are designed to ensure the values are
accurately recorded, that the data and the valuation methods utilized are appropriate and consistently applied and
that the assumptions are reasonable and representative of fair value.
For investments that have quoted market prices in active markets, the Company uses quoted market prices
as fair value and includes these prices in the amounts disclosed in Level 1 of the hierarchy. The Company
receives quoted market prices from a nationally recognized third party pricing service. When quoted market
prices are unavailable, the pricing service consolidates market transactions and other key valuation model inputs
from multiple sources and provides pricing information in the form of a single fair value for each security. The
fair value estimates provided from the pricing service are included in the amount disclosed in Level 2 of the
hierarchy. If market inputs are unavailable, then no fair value is provided by the pricing service. For these
securities, fair value is determined either by requesting brokers who are knowledgeable about these securities to
provide a quote; or the Company internally determines the fair values by employing widely accepted pricing
valuation models, and depending on the level of observable market inputs, renders the fair value estimate as
Level 2 or Level 3.
The following sections describe the valuation methods used by the Company for each type of financial
instrument it holds that are carried at fair value:
Fixed Maturities
The Company utilizes a pricing service and other procedures to estimate fair value measurements for
approximately 99% of its fixed maturities. The pricing service utilizes market quotations for fixed maturity
securities that have quoted prices in active markets. The pricing service prepares estimates of fair value using
101
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
proprietary pricing applications (matrix pricing) when quoted prices in active markets for identical assets are not
available. Most fixed maturities do not have a quoted price available since they do not trade on a daily basis.
Inputs to the applications include but are not limited to, market prices from recently completed transactions and
transactions of comparable securities, interest rate yield curves, credit spreads, and other market-observable
information. The pricing service will only produce an estimate of fair value if there is objectively verifiable
information to produce a valuation. If this information is not available, the Company would be required to
produce an estimate of fair value using some of the same methodologies as the pricing service. However, the
Company would also have to make assumptions for market-based inputs that are unavailable due to market
conditions.
The fair value estimates of most fixed maturity investments are determined by evaluations that are based on
observable market information rather than market quotes. All estimates of fair value for fixed maturities priced
by the pricing service are included in the amounts disclosed in Level 2 of the hierarchy.
The Company holds one fixed maturity security for which the Company estimates the fair value of this
security using the present value of the future cash flows. Due to the limited amount of observable market
information, the Company includes the fair value estimates for this security in Level 3.
Equities
The fair values of our equity securities are based on observable market quotations for identical assets and
are priced by the same pricing service discussed above. All equity securities are recorded using unadjusted
market quotes and have been disclosed in Level 1.
Other Invested Assets
Other invested assets managed by third party investment managers are based on values provided to the
Company by the custodians employed by these managers. Due to the significant unobservable inputs used in
these valuations, the Company includes the valuations in the amount disclosed in Level 3. The remainder of the
Company’s other invested assets consist primarily of holdings in publicly-traded mutual funds. The Company
believes that its estimates for these publicly-traded mutual funds reasonably reflect
their fair values and
consequently these securities have been disclosed in Level 1.
The table below summarizes the Company’s available-for-sale investments within the fair value hierarchy at
December 31, 2008:
Fair Value Measurements at December 31, 2008 Using
Available-for-sale investments:
Fixed maturities . . . . . . . . . . . . . . . . . . . . . . . .
Equity securities . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . .
Total
$1,770.7
137.5
31.7
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,939.9
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
—
137.5
2.9
140.4
1,768.4
—
—
1,768.4
2.3
—
28.8
31.1
102
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
For assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during
2008, a reconciliation of the beginning and ending balances, separately for each major category of assets is as
follows:
Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
Beginning balance, January 1, 2008 . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total gains or losses (realized) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Included in other comprehensive income (Total gains or losses
unrealized) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Purchases, issuances, and settlements . . . . . . . . . . . . . . . . . . . . . . . . . .
Transfers in and/or out of Level 3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fixed
maturities
$ 2.1
—
0.2
—
—
Ending balance, December 31, 2008 . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 2.3
Other
invested
assets
15.8
(11.0)
—
24.0
—
28.8
4. Losses and Loss Expenses Payable
Activity in the liability for losses and loss expenses for the year ended December 31 is summarized as
follows:
($ millions)
Losses and loss expenses payable, at beginning of year . . . . . . . . . . . . . . .
Less: reinsurance recoverable on losses and loss expenses payable . . . . . .
Net balance at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Impact of pooling change, January 1, 2008 (Note 6a)
. . . . . . . . . . . . . . . .
Incurred related to:
2008
2007
2006
$658.3
11.2
647.1
51.3
674.5
13.5
661.0
—
728.7
17.4
711.3
—
Current year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Prior years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
874.0
(27.3)
645.5
(54.7)
659.3
(71.7)
Total incurred . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Paid related to:
Current year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Prior years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net balance at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Plus: reinsurance recoverable on losses and loss expenses payable . . . . . .
846.7
590.8
587.6
518.7
256.4
775.1
770.0
21.2
368.7
236.0
604.7
647.1
11.2
389.4
248.5
637.9
661.0
13.5
Losses and loss expenses payable, at end of year (affiliate $343.0,
$257.2 and $281.7, respectively) . . . . . . . . . . . . . . . . . . . . . . . . . . .
$791.2
658.3
674.5
The Company recorded favorable loss and loss expense reserve development in 2008, 2007, and 2006 of
$27.3 million, $54.7 million and $71.7 million, respectively. Approximately half of the 2008 favorable
development is attributable to loss adjustment expense being lower than anticipated. The remainder is primarily
103
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
attributable to favorable emergence of catastrophe losses as well as non-catastrophe homeowners losses, where
claims severity emerged lower than anticipated. The favorable development in 2007 was primarily due to auto
liability and other liability losses being approximately $23.5 million less than anticipated as revised loss
loss
projections using more mature claim data resulted in lower claim severity than in past projections,
adjustment expenses being approximately $11.8 million lower than anticipated in proportion to losses and ceded
losses being above previously anticipated levels by approximately $10.0 million. The favorable development in
2006 was largely due to ceded reserves being above previously anticipated levels by $23.7 million, auto liability
losses being $24.7 million less than anticipated as revised loss projections using more mature claim data resulted
in lower average claim severities than in past projections, and loss adjustment expenses emerging $13.5 million
lower than anticipated previously.
5. Reinsurance
In the ordinary course of business, the Company assumes and cedes reinsurance with other insurers and
reinsurers and is a member in various pools and associations. See Note 6a for discussion of reinsurance with
affiliates. The voluntary arrangements provide greater diversification of business and limit the maximum net loss
potential arising from large risks and catastrophes. Most of the ceded reinsurance is effected under reinsurance
contracts known as treaties; the remainder is by negotiation on individual risks. Although the ceding of
reinsurance does not discharge the original insurer from its primary liability to its policyholder, the insurance
company that assumes the coverage assumes the related liability.
Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated
with the reinsured business. The recoverability of these assets depends on the reinsurers’ ability to perform under
the reinsurance agreements. The Company evaluates and monitors the financial condition and concentrations of
credit risk associated with its reinsurers under voluntary reinsurance arrangements to minimize its exposure to
significant losses from reinsurer insolvencies. The Company has reported ceded losses and loss expenses payable
and prepaid reinsurance premiums with other insurers and reinsurers as assets. All reinsurance contracts provide
for indemnification against loss or liability relating to insurance risk and have been accounted for as reinsurance.
Prior to the reinsurance transaction with State Auto Mutual under the Pooling Arrangement, as discussed in
Note 6a, the effect of the Company’s external reinsurance on its balance sheets and income statements is
summarized as follows:
($ millions)
Losses and loss expenses payable:
December 31
2008
2007
Direct
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Ceded . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$443.3
4.8
(20.6)
396.0
5.1
(10.1)
Net losses and loss expenses payable . . . . . . . . . . . . . . . . . . . . .
$427.5
391.0
Unearned premiums:
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Direct
Assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Ceded . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$339.0
1.0
(7.0)
315.3
1.2
(6.0)
Net unearned premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$333.0
310.5
104
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
($ millions)
Written premiums:
Year ended December 31
2008
2007
2006
Direct . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Ceded . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$784.1
5.5
(22.5)
757.4
6.5
(18.8)
748.8
7.1
(17.7)
Net written premiums . . . . . . . . . . . . . . . . . . . . . . . . .
$767.1
745.1
738.2
Earned premiums:
Direct . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Ceded . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$759.4
5.6
(21.5)
751.0
6.5
(18.8)
743.1
7.1
(17.6)
Net earned premiums . . . . . . . . . . . . . . . . . . . . . . . . . .
$743.5
738.7
732.6
Losses and loss expenses incurred:
Direct . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Ceded . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$563.8
2.7
(15.8)
438.5
2.0
(2.9)
415.0
10.8
(3.5)
Net losses and loss expenses incurred . . . . . . . . . . . . .
$550.7
437.6
422.3
6. Transactions with Affiliates
a. Reinsurance
Prior to 2008, State Auto P&C, Milbank, Farmers Casualty, and State Auto Ohio (“the STFC Pooled
Companies”) participated in a quota share reinsurance pooling arrangement (“the Pooling Arrangement”) with
State Auto Mutual and its subsidiaries and affiliates, State Auto Insurance Company of Wisconsin (“State Auto
Wisconsin”), State Auto Florida Insurance Company (“State Auto Florida”), Meridian Citizens Mutual Insurance
Company (“Meridian Citizens Mutual”) and Meridian Security Insurance Company (“Meridian Security”).
Effective January 1, 2008, the Pooling Arrangement was amended to add Beacon National Insurance Company
(“Beacon”), Patrons Mutual Insurance Company of Connecticut (“Patrons”), Litchfield Mutual Fire Insurance
Company (“Litchfield”) and the middle market business written by State Auto Mutual and Meridian Security.
In conjunction with the Pooling Arrangement amendment, the STFC Pooled Companies received $92.0
million in cash, for additional net insurance liabilities assumed on January 1, 2008. The following table presents
the impact on the Company’s balance sheet on January 1, 2008, relative to the additional net insurance liabilities
assumed on this date.
($ millions)
Losses and loss expenses payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unearned premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred policy acquisition costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 51.3
53.6
(12.9)
Net cash received . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 92.0
105
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
In general, under the Pooling Arrangement, the STFC Pooled Companies, State Auto Wisconsin, State Auto
Florida, Meridian Citizens Mutual, Meridian Security, Beacon, Patrons and Litchfield cede to State Auto Mutual
all of their insurance business and assume from State Auto Mutual an amount equal to their respective
participation percentages in the Pooling Arrangement. The STFC Pooled Companies’ pooling participation
percentage remained at 80% under the amended Pooling Arrangement effective January 1, 2008. 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.
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 State Auto
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 State Auto Mutual as assets only in situations when net
amounts ceded to State Auto Mutual exceed net amounts assumed. All parties that participate in the Pooling
Arrangement have an A.M. Best rating of A+ (Superior).
The following provides a summary of the reinsurance transactions on the Company’s balance sheets and
income statements for the Pooling Arrangement between the STFC Pooled Companies and State Auto Mutual:
($ millions)
Losses and loss expenses payable:
December 31
2008
2007
Ceded . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$(407.3)
750.3
(371.6)
628.8
Net assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 343.0
257.2
Unearned premiums:
Ceded . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$(321.6)
496.6
(298.6)
418.1
Net assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 175.0
119.5
($ millions)
Written premiums:
Year ended December 31
2008
2007
2006
Ceded . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ (724.9)
1,107.4
(702.3)
973.9
(695.7)
974.1
Earned premiums:
Ceded . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ (700.9)
1,081.7
(695.7)
965.5
(687.6)
976.0
Losses and loss expenses incurred:
Ceded . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ (514.6)
810.6
(405.6)
558.2
(388.4)
554.4
The pool participants and State Auto National are collectively referred to as the “State Auto Group.”
106
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
Until June 30, 2008, State Auto P&C assumed catastrophe reinsurance from the State Auto Group in the
amount of $100.0 million excess of $135.0 million in exchange for a premium paid by each reinsured company.
Under this agreement, the Company had assumed from State Auto Mutual and its affiliates premiums written and
earned of $1.7 million, $3.1 million and $3.0 million for 2008, 2007 and 2006, respectively. There have been no
losses assumed under this agreement. The catastrophe reinsurance program with State Auto P&C had been
excluded from the Pooling Arrangement.
The following provides a summary of the ceded reinsurance transactions on the Company’s balance sheet
and income statement related to a terminated reinsurance agreement that is in run-off between State Auto
National and State Auto Mutual:
($ millions)
2008
2007
Balance sheet:
Losses and loss expenses payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$0.5
1.1
($ millions)
2008
2007
2006
Income statement:
Earned premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Losses and loss expenses incurred . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$—
$—
—
(0.6)
0.2
0.7
Intercompany Balances
Pursuant to the Pooling Arrangement, State Auto Mutual receives all premiums and pays all losses and
expenses associated with the insurance business produced by the pool participants and then settles the
intercompany balances generated by these transactions with the participating companies on a quarterly basis
within 45 days following each quarter end. No interest is paid on this balance. When settling the intercompany
balances, State Auto Mutual provides the pool participants with full credit for the premiums written and net
losses paid during the quarter and retains all receivable amounts from insureds and agents and reinsurance
recoverable on paid losses from unaffiliated reinsurers. Any receivable amounts that are ultimately deemed to be
uncollectible are charged-off by State Auto Mutual and allocated to the pool member on the basis of pool
participation. As a result, the Company has an off-balance sheet credit–risk related to the balances due to State
Auto Mutual from insurers, agents and reinsurers, which are offset by the unearned premium from the respective
policies. The Company’s share of the premium balances due to State Auto Mutual from agents and insureds at
December 31, 2008 and 2007 is approximately $296.8 million and $266.9 million, respectively.
b. Notes Payable
In May 2003, State Auto Financial formed a Delaware business trust (the “Capital Trust) that issued $15.0
million mandatorily redeemable preferred capital securities to a third party and $0.5 million of its common
securities representing all outstanding common securities to State Auto Financial (collectively, the capital and
common securities are referred to as the “Trust Securities”). The Capital Trust loaned $15.5 million in proceeds
from the issuance of its Trust Securities to State Auto Financial in the form of a Floating Rate Junior
Subordinated Debt Securities due in 2033 (the “Subordinated Debentures”). The Subordinated Debentures are the
Capital Trust’s only assets along with any interest accrued thereon. Interest on the Trust Securities are payable
quarterly at a rate equal
to the three-month LIBOR rate plus 4.20% adjusted quarterly (total 6.38% at
December 31, 2008). Prior to May 2008, the interest rate could not exceed 12.5% per annum. The interest rate
and interest payment dates on the Subordinated Debentures are the same as the interest rate and interest payment
107
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
dates on the Trust Securities, thereby payments from the Subordinated Debentures finance the distributions paid
on the Trust Securities. State Auto Financial has the right to redeem the Subordinated Debentures, in whole or in
part, on or after May 23, 2008. In accordance with FASB Interpretation No. 46(R), (and related amendments and
interpretations) “Consolidation of Variable Interest Entities,” State Auto Financial determined that the business
trust is a variable interest entity for which it is not the primary beneficiary and therefore, does not consolidate the
Capital Trust with the Company. State Auto Financial has unconditionally and irrevocably guaranteed payment
of any required distributions on the capital securities, the redemption price when the capital securities are
redeemed, and any amounts due if the Capital Trust is liquidated or terminated. State Auto Financial’s equity
interest in the Capital Trust is included in other invested assets.
c. Management Services
Stateco provides State Auto Mutual and its affiliates investment management services. Investment
management income is recognized quarterly based on a percentage of the average fair value of investable assets
and the equity portfolio performance of each company managed. Revenue related to these services amounted to
$2.5 million, $2.8 million and $2.5 million in 2008, 2007 and 2006, respectively, and is included in other income
(affiliates).
7. Notes Payable and Credit Facility
In 2003, State Auto Financial issued $100.0 million of unsecured Senior Notes due November 2013. The
Senior Notes bear interest at a fixed rate of 6.25% per annum, which is payable each May 15 and November 15.
The Senior Notes are general unsecured obligations ranking senior to all existing and future subordinated
indebtedness and equal with all existing and future senior indebtedness. The Senior Notes are not guaranteed by
any of State Auto Financial’s subsidiaries and thereby are effectively subordinated to all subsidiaries’ existing
and future indebtedness. As of December 31, 2008, State Auto Financial was in compliance with all covenants
related to the Senior Notes. State Auto Financial incurred $1.5 million in issuance costs related to the Senior
Notes, which is recorded in other assets and is being amortized into interest expense ($0.1 million each for 2008,
2007 and 2008) as the underlying interest expense is recognized on the Senior Notes.
State Auto Financial has a credit agreement (“Credit Agreement”) with a syndicate of lenders which
provides for a $200.0 million five-year unsecured revolving credit facility (“Credit Facility”). During the term of
the Credit Facility, the Company has the right to increase the total facility to a maximum total facility amount of
$250.0 million, provided that no event of default has occurred and is continuing. The Credit Facility will be
available for general corporate purposes, including working capital, acquisitions and liquidity purposes. The
Credit Facility provides for interest-only payments during its term, with principal due in full at maturity. Interest
is based on either a London interbank market rate or a base rate plus a calculated margin amount. The Credit
Agreement contains certain covenants, including financial covenants that require the Company to maintain a
minimum net worth and not exceed a certain debt to capitalization ratio. As of December 31, 2008, State Auto
Financial had not made any borrowings and was in compliance with all of the covenants under the Credit
Agreement. State Auto Financial incurred $0.5 million in issuance costs related to the Credit Agreement, which
is recorded in other assets and is being amortized into expense ($0.1 million for 2008 and 2007) over the life of
the Credit Agreement.
See discussion of affiliate notes payable at Note 6b. The carrying amount of the Trust Securities note
(defined in Note 6b) in the consolidated balance sheets approximates its fair value as the interest rate adjusts
quarterly. The $100.0 million, 6.25% Senior Notes have a fair value of $86.9 million and $103.6 million at
108
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
December 31, 2008 and 2007, respectively. The fair value of the Senior Notes is based on the quoted market
price at December 31, 2008 and 2007, respectively. Notes payable at December 31 consisted of the following:
($ millions, except interest rates)
Senior Notes due 2013: issued $100.0, November 2003
. . . . . . . . . . . . . . . . . . . . . . . . . . . .
with fixed interest
Affiliate subordinated debentures due 2033: issued
$15.5, May 2003 with variable interest (see Note
6b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Carrying
Value
2008
Fair
Value
Interest
Rate
Carrying
Value
2007
Fair
Value
Interest
Rate
$102.1
$ 86.9
6.25% $102.5
$103.6
6.25%
15.5
15.5
6.38
15.5
15.5
9.32
Total Notes Payable . . . . . . . . . . . . . . . . . . . . . . . .
$117.6
$102.4
$118.0
$119.1
8. Federal Income Taxes
The reconciliation between actual federal income tax expense (benefit) and the amount computed at the
indicated statutory rate for the year ended December 31 is summarized as follows:
($ millions)
Amount at statutory rate . . . . . . . . . . . . . . . . . . . . .
Tax-free interest and dividends received
deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other, net
Valuation allowance . . . . . . . . . . . . . . . . . . . . . . . .
Federal income tax (benefit) expense and
2008
$(26.3)
(19.7)
1.5
0.5
%
35
26
(2)
(1)
2007
$ 54.4
%
35
2006
$ 56.6
%
35
(18.5)
(12)
(15.7)
(10)
0.3 —
—
—
0.4 —
—
—
effective rate . . . . . . . . . . . . . . . . . . . . . . . .
$(44.0)
58
$ 36.2
23
$ 41.3
25
109
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
The tax effects of temporary differences that give rise to significant portions of deferred tax assets and
deferred tax liabilities as of December 31 are presented below:
($ millions)
Deferred tax assets:
2008
2007
Unearned premiums not currently deductible . . . . . . . . . . . . . . . . . .
Losses and loss expenses payable discounting . . . . . . . . . . . . . . . . . .
Postretirement and pension benefits . . . . . . . . . . . . . . . . . . . . . . . . . .
Unrealized holding losses on investments . . . . . . . . . . . . . . . . . . . . .
Realized loss on other-than-temporary impairment . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 35.3
22.0
64.2
6.3
14.9
14.2
29.6
20.1
42.4
—
2.1
12.2
Deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Valuation allowance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
156.9
106.4
(3.1) —
Total deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
153.8
106.4
Deferred tax liabilities:
Deferral of policy acquisition costs . . . . . . . . . . . . . . . . . . . . . . . . . .
Unrealized holding gains on investments . . . . . . . . . . . . . . . . . . . . . .
Total deferred tax liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . .
42.8
—
42.8
Net deferred federal income taxes . . . . . . . . . . . . . . . . . . . . . . .
$111.0
37.0
23.3
60.3
46.1
At December 31, 2008, the Company established a valuation allowance of $3.1 million for the portion of the
deferred tax asset that management believes will not be realized. The valuation allowance was allocated $0.5
million to deferred tax expense associated with realized investment losses recognized in the income statement
and $2.6 million against the unrealized holding losses on equity securities recognized through accumulated other
comprehensive loss, a component of equity. In the opinion of management, it is more likely than not that the
Company will realize the benefits of the net deferred tax assets. No valuation allowance was held at
December 31, 2007.
At December 31, 2008, the Company carried no balance for uncertain tax positions.
The Company had no accrual for the payment of interest and penalties at December 31, 2008 or 2007.
The Company is currently not under audit by either the Internal Revenue Service or any state jurisdiction for
income tax purposes and all prior audits have been settled. Tax years 2005 through 2007 remain open for audit
for federal income tax purposes.
9. Pension and Postretirement Benefit Plans
The Company, through its employees of State Auto P&C, provides management and operation services
under management agreements for all insurance and non-insurance affiliates. The annual periodic costs related to
the Company’s benefit plans are allocated to affiliated companies based on allocations pursuant to intercompany
management agreements.
The Company provides a defined benefit pension plan for its eligible employees. Substantially all Company
employees become eligible to participate the year after becoming 20 years of age and vest with 5 years of
110
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
credited service or attained age 65. 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.
In addition to the defined benefit pension plan, the Company provides a postretirement benefit plan
including certain health care and life insurance benefits for its eligible retired employees. Substantially all of the
Company’s employees may become eligible for these postretirement 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. The defined
benefit pension and postretirement benefit plans are referred to herein as “the benefit plans.”
On December 31, 2006, the Company adopted the recognition and disclosure provisions of SFAS 158. The
adjustment, a decrease of $63.9 million, net of tax, to accumulated other comprehensive loss at adoption
represents the net unrecognized actuarial losses, unrecognized prior service costs, and unrecognized transition
assets remaining from the initial adoption of SFAS 87 and SFAS 106, all of which were previously netted against
the plans’ funded status in the Company’s balance sheet pursuant to the provisions of SFAS 87 and SFAS 106.
These amounts are being subsequently recognized as net periodic cost pursuant to the Company’s historical
accounting policy for amortizing such amounts. Further, actuarial gains and losses that arise in subsequent
periods and are not recognized as net periodic cost in the same periods will be recognized as a component of
other comprehensive income. Those amounts will be subsequently recognized as a component of net periodic
cost on the same basis as the amounts recognized in accumulated other comprehensive income at adoption of
SFAS 158.
Effective January 1, 2008, the Company adopted the measurement date requirement under transition
alternative method one, as defined in SFAS 158, moving from a September 30 measurement date to a
December 31 date for measuring its benefit plan obligations. This transition method resulted in a one-time
adjustment that decreased beginning retained earnings by $2.4 million, net of tax. The combined impact of the
measurement date transition and re-measurement of plan assets and obligations on January 1, 2008, increased
beginning accumulated comprehensive income by $3.5 million, net of tax.
111
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
Information regarding the Company’s pension and postretirement benefit plans’ change in benefit
obligation, plan assets and funded status as of December 31 are as follows:
($ millions)
Pension
2008
2007
Postretirement
2008
2007
Change in benefit obligation:
Benefit obligation at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
SFAS No. 158 measurement date transition . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Service cost
Interest cost
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Plan amendments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Special termination benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Actuarial (gain) loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Benefits paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$217.3
213.4
(4.7) —
8.9
9.0
13.5
12.5
—
—
2.0 —
24.5
(15.6)
(5.6)
(12.0)
123.0
122.7
(2.4) —
4.8
5.6
7.3
7.3
(28.1) —
—
(9.7)
(2.9)
0.4
9.3
(2.7)
Benefit obligation at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$245.9
217.3
111.6
123.0
Change in plan assets:
Fair value of plan assets at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . .
SFAS No. 158 measurement date transition . . . . . . . . . . . . . . . . . . . . . . . . . . .
Employer contribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Actual return on plan assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Benefits paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$220.0
2.3
197.3
(5.4) —
0.1
12.0
—
11.5
(38.3)
0.1
23.2
(12.0) —
(15.6)
Fair value of plan assets at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . .
$172.7
220.0
Contribution received during fourth quarter . . . . . . . . . . . . . . . . . . . . . . . . . . .
Supplemental executive retirement plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
—
—
—
—
2.5
—
(5.4)
2.2
—
—
0.1
—
2.3
(0.2)
(4.3)
Funded status at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ (73.2)
2.7
(114.5)
(125.2)
Accumulated benefit obligation—end of year . . . . . . . . . . . . . . . . . . . . . . . . . .
$215.2
194.3
No assets are expected to be returned during the fiscal year-ended December 31, 2008. The Company had
no additional minimum liability included in other comprehensive income for the pension plan for 2006 (prior to
adoption of SFAS 158).
Included in accumulated other comprehensive losses are the following amounts that have not been
recognized in net periodic cost:
($ millions)
December 31
2008
2007
Transition asset . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Prior service (benefit) cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net actuarial loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ (1.6)
(22.9)
159.0
(2.4)
5.7
75.7
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$134.5
79.0
112
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
The amount of amortization expected to be recognized during the fiscal year ending December 31, 2009 for
the State Auto Group is as follows:
($ millions)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Transition asset
Prior service cost
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net actuarial loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2009
$(0.6)
(1.4)
6.0
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 4.0
Information regarding the State Auto Group’s pension and postretirement benefit plans’ components of net
periodic cost for the year ended December 31 is as follows:
($ millions)
Pension
Postretirement
2008
2007
2006
2008
2007
2006
Components of net periodic cost:
Service cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Interest cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expected return on plan assets . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . .
Amortization of transition asset
Amortization of prior service cost . . . . . . . . . . . . . . . . . . . . . . . . .
Amortization of net actuarial loss . . . . . . . . . . . . . . . . . . . . . . . . .
Net periodic cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Special termination benefit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 8.9
13.5
(19.4)
(0.6)
0.4
2.7
$ 9.0
12.5
(17.8)
(0.6)
0.4
3.9
5.5
2.0
7.4
—
Net periodic cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 7.5
$ 7.4
4.9
6.2
(0.2)
4.8
7.3
(0.2)
5.6
7.3
(0.2)
10.0
11.7
(17.0)
(0.6) — — —
0.5
0.4
0.6
2.9
(0.1)
—
0.5
0.8
7.4
—
7.4
11.8
14.0
12.0
0.3 — —
12.1
14.0
12.0
In October 2008, the Company announced a substantive change to increase retiree cost sharing within the
postretirement medical plan, effective January 1, 2009. This change reduced the Company’s postretirement
benefit obligation by $28.1 million. In addition, the Company offered an early retirement incentive option to
retirement eligible associates. This early retirement option is deemed a special termination cost under SFAS No
88—“Employers’ Accounting for Settlements and Curtailments of Define Benefit Pension Plans and for
Termination Benefits.” At December 31, 2008 the Company recorded a $1.9 million expense to reflect its share
of the special termination benefit.
113
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
The following benefit payments, which reflect expected future service, are expected to be paid:
($ millions)
Pension
Postretirement
2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2012 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2014 - 2018 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 9.9
10.4
10.9
11.8
12.8
80.8
$ 3.9
4.0
4.2
4.4
4.7
30.2
The Company’s share of the 2008, 2007, and 2006 net periodic costs for the defined benefit plan were $7.4
million, $7.4 million, and $7.4 million, respectively. For postretirement benefits other than pensions, the
Company’s share of the 2008, 2007 and 2006 net periodic costs were $11.3 million, $11.6 million and $10.3
million, respectively. The Company’s gross benefit payments for 2008 post retirement benefits were $3.8
million, including the prescription drug benefits. The Company’s subsidy related to Medicare Prescription Drug
Improvement and Modernization Act of 2003 was $0.2 million for 2008 and estimates future annual subsidies to
be approximately $0.4 million.
Summarized in the following table are the weighted average assumptions used to determine the Company’s
benefit obligations for the year ended December 31:
Pension
2008
2007
Postretirement
2008
2007
Benefit obligations weighted-average assumptions:
Discount rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Rates of increase in compensation levels . . . . . . . . . . . . . . . . . . . . . . . .
6.00% 6.25% 6.00% 6.25%
4.00
4.00 —
—
Summarized in the following table are the weighted average assumptions used to determine the Company’s
net periodic cost:
Pension
Postretirement
2008
2007
2006
2008
2007
2006
Weighted-average assumptions:
Discount rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expected long-term rate of return on assets . . . . . . . . .
Rates of increase in compensation levels . . . . . . . . . . .
6.50% 6.00% 5.75% 6.50% 6.00% 5.75%
9.00
4.00
9.00
9.00
5.00 —
9.00
—
9.00
—
9.00
4.00
The Company’s benefit plan obligations are long-term in nature and consequently the investment strategies
have a long-term time horizon. In establishing the long-term rate of return assumption on plan assets,
management, along with its pension consulting actuary, reviews the historical performance of the plan assets and
the stability in the mix of the investment portfolio. The expected inflation rate and expected real rates of return of
applicable asset classes are then determined to assist in setting appropriate assumptions.
114
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
The assumed health care cost trend rates used for the year ended December 31 are as follows:
Assumed health care cost trend rates:
Health care cost trend rate assumed for the next year . . . . . . . . . . . . . . . . .
Rate to which the cost trend rate is assumed to decline (the ultimate trend
rate) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Year that the rate reaches the ultimate trend rate . . . . . . . . . . . . . . . . . . . . .
Postretirement
2008
2007
2006
10.00% 10.00% 10.00%
5.00% 5.00% 5.00%
2013
2011
2012
The assumed health care cost trend rates have a significant effect on the amounts reported for the
postretirement plan. A one percentage point change in assumed health care cost trend rates would have the
following effects for the year ended December 31, 2008:
($ millions)
Postretirement
Increase
(Decrease)
One percentage point change:
Effect on total service and interest cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Effect on accumulated postretirement benefit obligation . . . . . . . . . . . . . . . . . . .
$ 2.5
18.9
$ (1.9)
(15.1)
The Company’s benefit plans’ weighted average asset allocations by asset category at
the plans’
measurement date of December 31 are as follows:
Pension
2008
2007
Postretirement
2008
2007
Asset Category:
Fixed maturity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
U.S. large cap equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
U.S. small cap equities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
International . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
55.0% 37.9% 100.0% 100.0%
27.3
9.5
8.2
40.3
12.4
9.4
—
—
—
—
—
—
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
100.0
100.0
100.0
100.0
115
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
The benefit plan’s investment policy objective is to preserve the investment principal while generating
income and appreciation in fair value to meet the benefit plans’ obligations. The benefit plans’ investment
strategy and risk tolerance is balanced between meeting cash obligation requirements and a long term relatively
high risk tolerance. Since the nature and timing of the benefit plans’ liabilities and cash requirements are
predictable, the liquidity requirements are somewhat moderate. During 2007, the following asset allocation
targets, as a percentage of total fair value, were approved. Management is in the process of moving towards these
allocation targets as funds become available.
Asset
Allocation
Target
(0 to 100%)
Asset Category:
Fixed maturity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
U.S. large cap equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
U.S. small/mid cap equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Treasury inflation protected securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
International . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
23
43
14
10
10
The actuarially prepared funding amount to the pension plan ranges from the minimum amount the
Company would be required to contribute to the maximum amount that would be deductible for tax purposes.
Contributed amounts in excess of the minimum amounts are deemed voluntary. Amounts in excess of the
maximum amount would be subject to an excise tax and may not be deductible for tax purposes. This range is
generally not determined until the second quarter with respect to the contribution year. The Company expects to
contribute approximately $15.0 million during 2009 to its pension plan, depending on the actuarially calculated
funding requirements of such plan. Postretirement and SERP plan payments are deductible for tax purposes when
paid.
The Company maintains a defined contribution plan that covers substantially all employees of the Company.
The Company matches the first 2% of contributions of participants’ salary at the rate of 75 cents for each dollar
contributed. Participant contributions of 3% to 6% are matched at a rate of 50 cents for each dollar contributed.
The Company’s share of the expense under the plan totaled $3.1 million, $2.6 million and $2.5 million for the
years 2008, 2007 and 2006, respectively.
10. Stockholders’ Equity
a. Treasury Shares
On August 17, 2007, State Auto Financial’s board of directors authorized a plan to repurchase, from time to
time, up to 4.0 million of its common shares, or approximately 10% of State Auto Financial’s outstanding shares,
over a period extending to and through December 31, 2009 (the “Repurchase Plan”). Under the Repurchase Plan,
State Auto Financial may repurchase shares from State Auto Mutual in amounts that are proportional to the
respective current ownership percentages of State Auto Mutual, which is approximately 64%, and other
shareholders. State Auto Financial’s total share repurchase activity in 2008 and 2007 was approximately
1.2 million and 0.8 million common shares, respectively. Since inception through December 31, 2008, a total of
2.0 million common shares have been purchased under this program at an average repurchase price of $27.26 per
share for a total cost of $55.3 million.
116
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
b. Dividend Restrictions and Statutory Financial Information
State Auto P&C, Milbank, Farmers, SA Ohio and SA 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, at December 31, 2008, adjusted for
dividend payments made in the previous twelve-month period, approximately $34.8 million is available for
payment to State Auto Financial from its insurance subsidiaries in 2009 without prior approval. In 2008 State
Auto Financial received dividends of $39.0 million from its insurance subsidiaries, $50.0 million in 2007, and
none in 2006.
Reconciliations of statutory capital and surplus and net income, as determined using statutory accounting
principles, to the amounts included in the accompanying consolidated financial statements as of December 31 are
as follows:
($ millions)
2008
2007
Statutory capital and surplus of insurance subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net liabilities of non-insurance parent and affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$738.0
(73.1)
916.4
(59.5)
Increases (decreases):
Deferred policy acquisition costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Postretirement and pension benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred federal income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fixed maturities at fair value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
664.9
856.9
122.3
(23.9)
2.3
(11.3)
6.7
105.8
(22.1)
(33.6)
22.5
6.0
Stockholders’ equity per accompanying consolidated financial statements . . . . . . . . . . . . . . . . .
$761.0
935.5
($ millions)
Year ended December 31
2008
2007
2006
Statutory net (loss) income of insurance subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net (loss) income of non-insurance parent and affiliates . . . . . . . . . . . . . . . . . . . . . . . . .
$(49.8) 129.5
0.5
(0.6)
140.1
(0.1)
Increases (decreases):
Deferred policy acquisition costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Postretirement and pension benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred federal income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Share-based compensation expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
16.5
(10.3)
16.1
(4.6)
1.6
1.7
(12.0)
5.4
(5.5)
(0.5)
(2.0)
(11.8)
0.3
(6.5)
0.4
Net (loss) income per accompanying consolidated financial statements . . . . . . . . . . . . .
$(31.1) 119.1
120.4
(50.4) 130.0
140.0
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.
117
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
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. Share-Based Compensation
The Company maintains share-based compensation plans for key employees and outside, or non-employee,
directors. The share-based compensation plan for key employees is the Amended and Restated Equity Incentive
Compensation Plan (the “Equity Plan”). The stock-based compensation plan for outside directors is the Outside
Directors Restricted Share Unit Plan (the “RSU Plan”).
Equity Plan
The Equity Plan provides for the award of qualified and nonqualified stock options, restricted shares,
performance shares, performance units and other stock-based awards. The Company has reserved 3.5 million
common shares under the Equity Plan. As of December 31, 2008, a total of 0.7 million common shares are
available for issuance under the Equity Plan. The Equity Plan provides that (i) no more than 33% of the common
shares authorized for issuance under the Equity Plan may be granted in the form of awards other than stock
options, (ii) the maximum number of common shares subject to awards of stock options, restricted shares and
performance shares that may be granted in any calendar year is equal to 1.5% of the total number of common
shares of the Company outstanding as of December 31 of the prior year, and (iii) the maximum number of
common shares subject to awards of stock options, restricted shares and performance shares that may be granted
in any calendar year to any one individual is 250,000 shares. The Equity Plan automatically terminates on July 1,
2010.
The Equity Plan provides that qualified stock options may be granted at an option price not less than the fair
market value of the common shares at the date of grant and that nonqualified stock options may be granted at any
price determined by the Compensation Committee of the Board of Directors. Options granted generally vest over
a three-year period, with one-third of the options vesting on each anniversary of the grant date, and must be
exercised no later than ten years from the date of grant. Stock options granted under the Equity Plan for 2008,
2007 and 2006 were 0.4 million, 0.4 million and 0.3 million, respectively.
The Equity Plan provides for the granting of restricted shares subject to a vesting schedule based on the
employee’s continued employment (“Restriction Period”), for which vesting is generally on the third anniversary
after the date of grant. The Company recognizes compensation expense based on the number of restricted shares
granted at the then grant date fair value over the Restriction Period.
A summary of the status of the Company’s non-vested restricted shares and changes for the year ended
December 31 is as follows:
Outstanding, beginning of year . . . . . . . . . . . . . . . . . .
Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2008
2007
2006
Weighted
Average
Grant
Date Fair
Value
Weighted
Average
Grant
Date Fair
Value
Shares
Weighted
Average
Grant
Date Fair
Value
Shares
$30.46
10,500
— 32,000
$31.94
29.98
— $ —
31.94
10,500
Shares
42,500
—
Outstanding, end of year . . . . . . . . . . . . . . . . . . . . . . .
42,500
$30.46
42,500
$30.46
10,500
$31.94
118
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
As of December 31, 2008, there was $0.6 million of total unrecognized compensation cost related to
non-vested restricted share compensation arrangements. The remaining cost is expected to be recognized over a
period of 1.75 years. No shares vested during the years ended December 31, 2008 and 2007.
Employee Stock Purchase Plan
The Company also has a broad-based employee stock purchase plan, 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 shares. The purchase price of the common shares is 85%
of the lower of its beginning-of-interval or end-of-interval market price. The Company has reserved 3.4 million
common shares under this plan. As of December 31, 2008, a total of 2.5 million common shares have been
purchased under this plan. This plan remains in effect until terminated by the board of directors.
Outside Directors Plan
The RSU Plan is an unfunded deferred compensation plan which provides each outside director with an
award of 1,400 restricted share units (the “RSU award”) following each annual meeting of shareholders,
however, the amount of the award may change from year to year, based on the provision described below. The
RSU awards are fully vested upon grant. RSU awards are not common shares of the Company and, as such, no
participant has any rights as a holder of common shares under the RSU Plan. RSU awards represent the right to
receive an amount, payable in cash or common shares of the Company, as previously elected by the outside
director, equal to the value of a specified number of common shares of the Company at the end of the restricted
period. Such election may be changed within the constraints set forth in the RSU Plan. The restricted period for
the RSU awards begins on the date of grant and expires on the date the outside director retires from or otherwise
terminates service as a director of the Company. During the restricted period, outside directors are credited with
dividends, equivalent in value to those declared and paid on the Company’s common shares, on all RSU awards
granted to them. At the end of the restricted period, outside directors receive distributions of their RSU awards
either (i) in a single lump sum payment, or (ii) in annual installment payments over a five- or ten-year period, as
previously elected by the outside director. The administrative committee for the RSU Plan (currently the
Company’s Compensation Committee) retains the right to increase the annual number of RSU awards granted to
each outside director to as many as 5,000 or to decrease such annual number to not less than 500, without seeking
shareholder approval, if such increase or decrease is deemed appropriate by the administrative committee to
maintain director compensation at appropriate levels. The RSU Plan automatically terminates on May 31, 2015.
The Company accounts for the RSU Plan as a liability plan. There were 11,200 RSUs granted in both 2008 and
2007 and 9,800 RSUs granted in 2006.
During 2008 and 2007, common shares valued at approximately $87,000 and $9,000, respectively, were
distributed by the Company under the RSU Plan.
Agent Stock Option Plan
The Company had a stock option incentive plan for certain designated independent insurance agencies
(“Agent Stock Option Plan”) that represent the Company and its affiliates. The Agent Stock Option Plan expired
May 2008. The plan provided 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 the date of grant or a portion thereof in the first calendar year in which an agency
commences participation under the plan. Options granted under this plan have a ten-year term. Options granted
for the years 2008, 2007 and 2006 were 15,208, 15,862 and 16,452, respectively.
119
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
Stock Options
The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes closed-
form pricing model. The following tables present the weighted-average assumptions used in the option pricing
model for options granted to employees and non-employees (independent insurance agencies) during 2008, 2007,
and 2006. The expected life of the options for employees represents the period of time the options are expected to
be outstanding and is based on historical trends. For non-employees the expected life of the option approximates
the remaining contractual term of the option. The expected stock price volatility is based on the historical
volatility of the Company’s stock for a period approximating the expected life and the expected dividend yield is
based on the Company’s most recent period’s dividend payout. The risk-free interest rate is based on the U.S.
Treasury yield curve in effect at the time of grant and has a term approximating the expected life of the option.
The fair value of the options granted under the Agent Stock Option Plan was estimated at the reporting date
or vesting date using the Black-Scholes option-pricing model. The weighted average fair value and related
assumptions are as follows:
Fair value per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Dividend yield . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Risk free interest rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expected volatility factor
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expected life in years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2008
$10.54
2007
7.10
2006
16.61
2.00% 2.28% 1.15%
2.3% 3.9%
4.7%
37.3% 33.8% 34.7%
8.5
8.5
8.4
The fair value of share-based awards granted to employees was 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:
2008
2007
2006
Fair value per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expected dividend yield . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Risk free interest rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expected volatility factor
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expected life in years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
12.41
10.82
$7.92
2.31% 1.46% 1.12%
3.1% 4.5%
5.1%
33.2% 33.4% 32.4%
6.9
6.4
6.4
A summary of the Company’s total stock option activity and related information for these plans for the
years ended December 31, follows:
(millions, except per share amounts)
2008
2007
2006
Weighted-
Average
Exercise
Price
Options
Weighted-
Average
Exercise
Price
Options
Options
Outstanding, beginning of year . . . . . . . . . . . . . . . . .
Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Canceled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . —
2.7
0.4
(0.3)
$23.78
25.80
15.13
29.37 —
2.4
0.4
(0.1)
$22.09
29.55
15.48
31.91 —
2.6
0.3
(0.5)
Outstanding, end of year . . . . . . . . . . . . . . . . . . . . . .
2.8
$24.84
2.7
$23.78
2.4
Weighted-
Average
Exercise
Price
$18.76
33.49
12.35
27.14
$22.09
120
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
Intrinsic value for stock options is defined as the difference between the current market value and the grant
price. For the years ended December 31, 2008, 2007 and 2006, the total intrinsic value of stock options exercised
was $3.3 million, $2.6 million and $11.9 million, respectively. The tax benefit for tax deductions from share-
based awards totaled $0.8 million, $0.7 million and $3.2 million for the years ended December 31, 2008, 2007
and 2006, respectively.
A summary of information pertaining to the total options outstanding and exercisable as of December 31,
2008 follows:
(millions, except per share amounts)
Options Outstanding
Options Exercisable
Weighted-
Average
Remaining
Contractual Life
Weighted-
Average
Exercise
Price
Number
Weighted-
Average
Exercise
Price
Number
Range of Exercise Prices:
Less than $10.00 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . —
0.9
$10.01 – $20.00 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1.2
$20.01 – $30.00 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
0.7
Greater than $30.01 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2.8
1.0
2.9
7.7
6.1
5.8
$ 9.13 —
0.9
15.64
0.5
27.20
0.6
32.04
$24.84
2.0
$ 9.13
15.63
27.18
31.92
$23.56
Aggregate intrinsic value for total options outstanding at December 31, 2008 is $20.4 million. Aggregate
intrinsic value for total options exercisable at December 31, 2008 is $16.2 million.
Compensation expense recognized during 2008, 2007 and 2006 was $5.5 million, $6.0 million and $7.0
million, respectively. Share-based compensation is recognized as a component of loss and loss adjustment
expense and acquisition and operating expense in a manner consistent with other employee compensation. As of
December 31, 2008, there was $4.2 million of total unrecognized compensation cost related to option-based
compensation arrangements granted under the plans. The remaining cost is expected to be recognized over a
period of three years.
121
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
13. Net (Loss) Earnings Per Common Share
The following table sets forth the compilation of basic and diluted net (loss) earnings per common share for
the year ended December 31:
($ millions, except per share amounts)
2008
2007
2006
Numerator:
Net (loss) earnings for basic net earnings per common
share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Effect of dilutive share-based awards . . . . . . . . . . . . . . . . .
$(31.1)
—
119.1
0.1
120.4
—
Adjusted net (loss) earnings for dilutive net (loss)
earnings per common share . . . . . . . . . . . . . . . . . . .
$(31.1)
119.2
120.4
Denominator:
Weighted average shares for basic net earnings per
common share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Effect of dilutive share-based awards . . . . . . . . . . . . . . . . .
39.7
—
Adjusted weighted average shares for diluted net
(loss) earnings per common share . . . . . . . . . . . . . .
39.7
Basic net (loss) earnings per common share . . . . . . . . . . . . . . . .
Diluted net (loss) earnings per common share . . . . . . . . . . . . . . .
$(0.78)
$(0.78)
41.0
0.6
41.6
2.90
2.86
40.9
0.7
41.6
2.95
2.90
The following options to purchase shares of common stock were not included in the computation of diluted
earnings per share because the exercise price of the options was greater than the average market price or their
inclusion would have been antidilutive for the year ended December 31:
(in millions)
2008
2007
2006
Number of options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1.5
0.7
0.3
122
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
14. Comprehensive (Loss) Income
A reconciliation of each component of comprehensive (loss) income and the related federal income tax
effect for the year ended December 31 is as follows:
($ millions)
2008:
Before-Tax
Amount
Tax
(Expense)
or Benefit
Net-of-Tax
Amount
Net (loss) income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other comprehensive loss:
$ (75.1)
44.0
(31.1)
(121.0)
36.4
(84.6)
(0.1)
39.8
(12.8)
27.0
—
(81.2)
23.6
(57.6)
(0.1)
(63.6)
22.0
(41.6)
(0.6)
2.7
0.3
(61.2)
0.2
(1.0)
(0.1)
21.1
48.1
92.1
(0.4)
1.7
0.2
(40.1)
(97.8)
(128.9)
Net unrealized holding losses on investments:
Unrealized holding losses arising during the year . . . . . . . . . . . . . . . . . . . .
Reclassification adjustments for losses realized in net income (loss) . . . . .
Amortization of gain on derivative used in cash flow hedge . . . . . . . . . . . . . .
Net unrecognized benefit plan obligations:
Net actuarial gain (loss) arising during period . . . . . . . . . . . . . . . . . . . . . . .
Reclassification adjustments for amortization to net income (loss):
Transition asset . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net actuarial loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Prior service cost
Other comprehensive loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(145.9)
Comprehensive loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$(221.0)
123
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
2007:
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other comprehensive income:
Net unrealized holding losses on investments:
Unrealized holding gain arising during the year . . . . . . . . . . . . . . . . . . . . .
Reclassification adjustments for losses realized in net income . . . . . . . . . .
Amortization of gain on derivative used in cash flow hedge . . . . . . . . . . . .
Net unrecognized benefit plan obligations:
Net actuarial gain arising during period . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Reclassification adjustments for amortization to net income:
Transition asset . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net actuarial loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Prior service cost
Other comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Before-Tax
Amount
Tax
(Expense)
or Benefit
Net-of-Tax
Amount
$155.3
(36.2)
119.1
8.1
(12.1)
(4.0)
(0.1)
(2.8)
4.2
1.4
—
5.3
(7.9)
(2.6)
(0.1)
20.6
(6.9)
13.7
(0.6)
4.7
0.9
25.6
21.5
0.2
(1.9)
(0.3)
(8.9)
(7.5)
(0.4)
2.8
0.6
16.7
14.0
Comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$176.8
(43.7)
133.1
2006:
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other comprehensive loss:
Net unrealized holding gains on investments:
Unrealized holding gain arising during the year . . . . . . . . . . . . . . . . . . . . .
Reclassification adjustments for losses realized in net income . . . . . . . . . .
Amortization of gain on derivative used in cash flow hedge . . . . . . . . . . . .
Other comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$161.7
(41.3)
120.4
24.7
(5.6)
19.1
(0.1)
19.0
(8.7)
2.0
(6.7)
—
(6.7)
16.0
(3.6)
12.4
(0.1)
12.3
Comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$180.7
(48.0)
132.7
124
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
15. Reportable Segments
The Company has three significant reportable segments: personal
insurance, business insurance, and
investment operations. The reportable insurance segments are business units managed separately because of the
differences in the type of customers they serve or products they provide or services they offer. The insurance
segments operate primarily in the central and eastern United States, excluding New York and New Jersey,
distributing products through the independent insurance agency system. The personal insurance segment provides
primarily personal auto (standard and nonstandard) and homeowners to the personal insurance market. The
business insurance segment provides primarily commercial auto, commercial multi-peril, fire and allied lines,
other and product liability and workers’ compensation insurance to small to medium sized businesses within the
commercial insurance market. The investment operations segment, managed by Stateco, provides investment
services.
The Company evaluates the performance of its insurance segments using industry financial measurements
based on Statutory Accounting Principles (“SAP”), which include loss and loss adjustment expense ratios,
underwriting expense ratios, combined ratios, statutory underwriting gain (loss), net premiums earned and net
written premiums. One of the most significant differences between SAP and GAAP is that SAP requires all
underwriting expenses to be expensed immediately and not deferred and amortized over the same period the
premium is earned. The investment operations segment is evaluated based on investment returns of assets
managed by Stateco.
Asset information by segment is not reported for the insurance segments because the Company does not
produce such information internally.
125
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
The following provides financial information regarding the Company’s reportable segments for the year
ended December 31:
($ millions)
Revenues from external customers:
Insurance segments
2008
2007
2006
Personal insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Business insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 670.9
455.1
609.6
402.0
614.8
409.0
Total insurance segments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,126.0
1,011.6
1,023.8
Investment operations segment
Net investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net realized (loss) gain on investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total investment operations segment . . . . . . . . . . . . . . . . . . . . . . . . . . . .
All other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
87.4
(36.4)
51.0
4.9
84.7
12.1
96.8
5.0
83.1
5.6
88.7
4.9
Total revenues from external sources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Intersegment revenues: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,181.9
9.7
1,113.4
9.4
1,117.4
9.0
Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,191.6
1,122.8
1,126.4
Reconciling items:
Eliminate intersegment revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(9.7)
(9.4)
(9.0)
Total consolidated revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,181.9
1,113.4
1,117.4
Segment (loss) income before federal income tax:
Insurance segments:
Personal insurance SAP underwriting (loss) gain . . . . . . . . . . . . . . . . . . . . . .
Business insurance SAP underwriting (loss) gain . . . . . . . . . . . . . . . . . . . . . .
$ (56.1)
(58.5)
Total insurance segments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(114.6)
Investment operations segment:
Net investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net realized (loss) gain on investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total investment operations segment . . . . . . . . . . . . . . . . . . . . . . . . . . . .
All other segments (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
87.4
(36.4)
51.0
(1.9)
47.3
40.6
87.9
84.7
12.1
96.8
(2.6)
44.9
61.5
106.4
83.1
5.6
88.7
(2.3)
Reconciling items:
GAAP adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Interest expense on corporate debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Corporate expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(0.1)
(7.3)
(2.2)
(17.3)
(7.6)
(1.9)
(21.7)
(7.4)
(2.0)
Total consolidated (loss) income before federal income taxes . . . . . . . .
$ (75.1)
155.3
161.7
126
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
($ millions)
Segment assets:
December 31
2008
2007
Investment operations segment
. . . . . . . . . . . . . . . . . . . . . . . . .
$2,091.8
$2,092.1
Total segment assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2,091.8
2,092.1
Reconciling items:
Corporate assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
351.8
245.8
Total consolidated assets . . . . . . . . . . . . . . . . . . . . . . . . . .
$2,443.6
$2,337.9
Assets attributed to the Investment Operations segment include the “Total investments” and “Cash and cash
equivalent” categories from the balance sheet. All other assets are corporate assets and are not assigned to a
segment.
Revenues from external sources for reportable segments include the following products and services for the
year ended December 31:
($ millions)
Earned premiums:
Personal insurance:
2008
2007
2006
Standard auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Nonstandard auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Homeowners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other personal
$ 384.3
42.6
215.4
28.6
Total personal insurance earned premiums . . . . . . . . . . . .
670.9
Business insurance:
Commercial auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial multi-peril
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fire & allied lines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other & product liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Workers compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total business insurance earned premiums . . . . . . . . . . . .
110.5
97.9
94.7
79.9
43.4
28.7
455.1
357.3
42.9
186.5
22.9
609.6
96.9
86.8
83.4
75.5
33.4
26.0
402.0
362.1
44.8
185.2
22.7
614.8
100.3
87.5
84.2
77.5
33.8
25.7
409.0
Total earned premiums . . . . . . . . . . . . . . . . . . . . . . . .
1,126.0
1,011.6
1,023.8
Investment operations:
Net investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net realized (loss) gain on investments . . . . . . . . . . . . . . . . . . .
Total investment operations . . . . . . . . . . . . . . . . . . . . . . . .
87.4
(36.4)
51.0
84.7
12.1
96.8
83.1
5.6
88.7
Total revenues from significant reportable
segments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,177.0
1,108.4
1,112.5
127
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
16. Quarterly Financial Data (unaudited)
($ millions, except per share amounts)
2008
For three months ended
March 31
June 30
September 30 December 31
Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(Loss) income before federal income taxes . . . . . . . . . . . . . . . . . .
Net (loss) income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(Loss) earnings per common share:
$301.0
(15.0)
(12.5)
307.0
(24.2)
(3.3)
Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ (0.31)
$ (0.31)
(0.08)
(0.08)
300.6
(30.2)
(14.7)
(0.37)
(0.37)
273.3
(5.7)
(0.6)
(0.02)
(0.02)
2007
For three months ended
March 31
June 30
September 30
December 31
Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income before federal income taxes . . . . . . . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net earnings per common share:
$275.5
40.9
30.9
Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 0.75
$ 0.74
278.7
28.8
23.3
0.57
0.56
280.9
28.6
23.2
0.56
0.55
278.3
57.0
41.7
1.02
1.01
17. Contingencies
The Company’s insurance subsidiaries are involved in a number of lawsuits, and may become involved in
other potential litigation, arising in the ordinary course of business. Generally, the involvement of an insurance
subsidiary in a lawsuit involves defending third-party claims brought against its insureds (in its role as liability
insurer) or as a principal of surety bonds and defending policy coverage claims brought against the insurance
subsidiary. All lawsuits relating to such insurance claims are considered by the Company in establishing the
Company’s loss and loss adjustment expense reserves.
In accordance with the provisions of SFAS No. 5, “Accounting for Contingencies,” the Company accrues
for a litigation-related liability other than insurance claims when it is probable that such a liability has been
incurred and the amount of the loss can be reasonably estimated. Based on currently available information known
to the Company, the Company believes that its reserves for these litigation-related liabilities are reasonable and
that the ultimate outcomes of any pending matters are not likely to have a material adverse effect on its
consolidated financial position or results of operations.
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 their insurance
policies. The Company believes that the effects, if any, of such regulatory actions and published court decisions
are not likely to have a material adverse effect on its financial position or results from operations.
128
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
Management’s Annual Report on Internal Control Over Financial Reporting
Our management’s annual report on internal control over financial reporting required by Item 308(a) of
Regulation S-K follows. The attestation report of our independent registered public accounting firm required by
Item 308(b) of Regulation S-K is found under the caption “Report of the Independent Registered Public
Accounting Firm” in Item 8 of this Form 10-K.
The following report is provided by our management on the Company’s internal control over financial
reporting (as defined in Rule 13a-15(f) of the Exchange Act):
1. Our management
is responsible for establishing and maintaining adequate internal control over
financial reporting for the Company.
2. Our management has used the Committee Of Sponsoring Organizations of the Treadway Commission
(COSO) framework to evaluate the effectiveness of our internal control over financial reporting. Our
management believes that the COSO framework is a suitable framework for its evaluation of our
internal control over financial reporting because it is free from bias, permits reasonably qualitative and
quantitative measurements of our internal controls, is sufficiently complete so that those relevant
factors that would alter a conclusion about the effectiveness of our internal controls are not omitted and
is relevant to an evaluation of internal control over financial reporting.
3. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even
those systems determined to be effective can only provide reasonable assurance with respect to
financial reporting.
4. Our management has assessed the effectiveness of our internal control over financial reporting as of
December 31, 2008, and has concluded that such internal control over financial reporting is effective.
There are no material weaknesses in our internal control over financial reporting that have been
identified by our management.
Disclosure Controls and Procedures
We carried out an evaluation, under the supervision and with the participation of our management, including
our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)). Based upon that evaluation, our
Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this
report, our disclosure controls and procedures were 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.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting that occurred during our most
recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
Item 9B. Other information
None.
129
PART III
Item 10. Directors, Executive Officers and Corporate Governance
Information regarding our directors required by Items 401(a) and (d)-(f) of Regulation S-K will be found
under the caption “Proposal One: Election of Directors” in our 2009 Proxy Statement, which information is
incorporated herein by reference. Information regarding our executive officers required by Items 401(b) and (d)-
(f) of Regulation S-K is found under the caption “Executive Officers of the Registrant” at the end of Item 1 of
our Form 10-K, which information is also incorporated by reference into this Item 10.
a
We have
separately-designated standing Audit Committee
established in accordance with
Section 3(a)(58)(A) of the Exchange Act. As of March 3, 2009, the members of our Audit Committee were
Richard K. Smith, David J. D’Antoni, David R. Meuse, Thomas E. Markert and Paul S. Williams. Mr. Smith is
Chairman of our Audit Committee. Our Board of Directors has determined that Mr. Smith is an “audit committee
financial expert,” as that term is defined in Item 407(d)(5) of Regulation S-K, and “independent,” as that term is
defined in Rule 10A-3 of the Exchange Act.
Information regarding the filing of reports of ownership under Section 16(a) of the Exchange Act by our
officers and directors and persons owning more than 10% of a registered class of our equity securities required
by Item 405 of Regulation S-K will be found under the caption “Section 16(a) Beneficial Ownership Reporting
Compliance” in our 2009 Proxy Statement, which information is incorporated herein by reference.
Information concerning the procedures by which stockholders may recommend nominees to our Board of
Directors will be found under the caption “Corporate Governance—Nomination of Directors” in our 2009 Proxy
Statement. There has been no material change to the nomination procedures previously disclosed by the
Company in its proxy statement for its 2008 annual meeting of stockholders.
Our Board of Directors has adopted a code of ethics that applies to our principal executive officer, principal
financial officer, principal accounting officer, controller, and persons performing similar functions. This code of
ethics has been posted on our website at www.StateAuto.com under “Investor Relations” then “Corporate
Governance.” Any amendment (other than any technical, administrative or other non-substantive amendment) to,
or waiver from, a provision of this code will be posted on our website described above within four business days
following its occurrence.
Item 11. Executive Compensation
Our 2009 Proxy Statement will contain information regarding the following matters: information regarding
executive compensation required by Item 402 of Regulation S-K will be found under the captions “Board of
Directors and Board Committees—Compensation of Directors and Director Compensation Table” and
“Compensation Discussion and Analysis”; information required by Item 407(e)(4) of Regulation S-K will be
found under the caption “Compensation Committee Interlocks and Insider Participation”; information required
by Item 407(e)(5) of Regulation S-K will be found under the caption “Compensation Committee Report”. This
information is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
Information regarding security ownership of certain beneficial owners and management required by
Item 403 of Regulation S-K will be found under the caption “Proposal One: Election of Directors” and “Principal
Holders of Voting Securities” in our 2009 Proxy Statement, which information is incorporated herein by
reference.
Information regarding equity compensation plan information required by Item 201(d) of Regulation S-K
will be found under the caption “Equity Compensation Plan Information” in our 2009 Proxy Statement, which
information is incorporated herein by reference.
130
Item 13. Certain Relationships and Related Transactions, and Director Independence
Information regarding certain relationships and related transactions required by Item 404 of Regulation S-K
will be found under the caption “Related Party Transactions” in our 2009 Proxy Statement, which information is
incorporated herein by reference.
Information regarding the independence of our directors required by Item 407(a) of Regulation S-K will be
found under the caption “Corporate Governance – Director Independence” in our 2009 Proxy Statement, which is
incorporated herein by reference.
Item 14. Principal Accountant Fees and Services
Information regarding principal accountant fees and services required by Item 9(e) of Schedule 14A will be
found under the caption “Independent Registered Public Accounting Firm” in our 2009 Proxy Statement, which
information is incorporated herein by reference.
Item 15. Exhibits and Financial Statement Schedules
(a)(1) LISTING OF FINANCIAL STATEMENTS
PART IV
The following consolidated financial statements of the Company are filed as part of this Form 10-K and are
included in Item 8:
Reports of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2008 and 2007
Consolidated Statements of Income for each of the three years in the period ended
December 31, 2008
Consolidated Statements of Stockholders’ Equity for each of the three years in the period ended
December 31, 2008
Consolidated Statements of Cash Flows for each of the three years in the period ended
December 31, 2008
Notes to Consolidated Financial Statements
(a)(2) LISTING OF FINANCIAL STATEMENT SCHEDULES
The following financial statement schedules of the Company for the years 2008, 2007 and 2006 are included
in Item 14(d) following the signatures and should be read in conjunction with our consolidated financial
statements contained in our Form 10-K.
Schedule
Number
I.
II.
III.
IV.
Summary of Investments—Other Than Investments in Related Parties
Schedule
Condensed Financial Information of Registrant
Supplementary Insurance Information
Reinsurance
All other schedules and footnotes are omitted because they are not applicable or the required
information is included in the consolidated financial statements or notes thereto.
131
(a)(3) LISTING OF EXHIBITS
Exhibit
No.
3.01
3.02
3.03
3.04
10.01
10.02
10.03*
10.04*
10.05*
10.06*
10.07*
10.08*
10.09*
10.10*
10.11*
Description of Exhibit
If incorporated by reference document with which Exhibit was
previously filed with SEC
State Auto Financial Corporation’s Amended
and Restated Articles of Incorporation
1933 Act Registration Statement No. 33-40643
on Form S-1 (see Exhibit 3(a) therein)
State Auto Financial Corporation’s Amendment
to the Amended and Restated Articles of
Incorporation
State Auto Financial Corporation Certificate of
Amendment
to the Amended and Restated
Articles of Incorporation as of June 2, 1998
1933 Act Registration Statement No. 33-89400
on Form S-8 (see Exhibit 4(b) therein)
Form 10-K Annual Report for the year ended
December 31, 1998 (see Exhibit 3(A)(3) therein)
State Auto Financial Corporation’s Amended
and Restated Code of Regulations
1933 Act Registration Statement No. 33-40643
on Form S-1 (see Exhibit 3(b) therein)
Guaranty Agreement between State Automobile
Insurance Company and State Auto
Mutual
Property and Casualty Insurance Company dated
as of May 16, 1991
Indemnification Agreement between
Form of
State Auto Financial Corporation and each of its
directors
1933 Act Registration Statement No. 33-40643
on Form S-1 (see Exhibit 10 (d) therein)
Form 8-K Current Report filed on November 20,
2008 (see Exhibit 99.1 therein)
1991 Stock Option Plan of State Auto Financial
Corporation
1933 Act Registration Statement No. 33-40643
on Form S-1 (see Exhibit 10 (h) therein)
Amendment Number 1 to the 1991 Stock Option
Plan of State Auto Financial Corporation
1933 Act Registration Statement No. 33-89400
on Form S-8 (see Exhibit 4 (a) therein)
Amendment Number 2 to the 1991 Stock Option
Plan of State Auto Financial Corporation
Form 10-K Annual Report for the year ended
December 31, 1996 (see Exhibit 10(DD) therein)
Amendment Number 3 to 1991 Stock Option
Plan (effective January 1, 2001) of State Auto
Financial Corporation
Amendment Number 4 to 1991 Stock Option
Plan (effective March, 7, 2008) of State Auto
Financial Corporation
Form 10-Q Quarterly Report for the period ended
September 30, 2003 (see 10.01) therein)
Form 8-K Current Report filed on March 13,
2008 (see Exhibit 10.1 therein)
1991 Directors’ Stock Option Plan of State Auto
Financial Corporation
1933 Act Registration Statement No. 33-40643
on Form S-1 (see Exhibit 10 (i) therein)
Amendment Number 1 to the 1991 Directors’
Stock Option Plan of State Auto Financial
Corporation
Form 10-K Annual Report for the year ended
December 31, 1996 (see Exhibit 10(EE) therein)
Second Amendment
to 1991 Directors’ Stock
Option Plan of State Auto Financial Corporation
Form 10-Q Quarterly Report for the period ended
September 30, 2001 (see Exhibit 10(JJ) therein)
Third Amendment to the 1991 Directors’ Stock
Option Plan (effective March 7, 2008) of State
Auto Financial Corporation
Form 8-K Current Report filed on March 13,
2008 (see Exhibit 10.2 therein)
132
Exhibit
No.
10.12*
10.13*
10.14*
10.15*
10.16*
10.17*
10.18*
10.19
10.20
10.21
10.22
10.23
10.24
Description of Exhibit
If incorporated by reference document with which Exhibit was
previously filed with SEC
2000 Directors Stock Option Plan of State Auto
Financial Corporation
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)
First Amendment
to 2000 Directors Stock
Option Plan of State Auto Financial Corporation
Form 10-Q Quarterly Report for the period ended
March 31, 2001 (see Exhibit 10(HH) therein)
Second Amendment
to 2000 Directors Stock
Option Plan of State Auto Financial Corporation
Form 10-Q Quarterly Report for the period ended
September 30, 2001 (see Exhibit 10(KK) therein)
to 2000 Directors Stock
Third Amendment
Option Plan of State Auto Financial Corporation
Form 10-K Annual Report for the year ended
December 31, 2001 (see Exhibit 10(EE) therein)
Fourth Amendment
to 2000 Directors Stock
Option Plan of State Auto Financial Corporation
Form 10-K Annual Report for year ended 12-31-
02 (see Exhibit 10(UU) therein)
to 2000 Directors Stock
Fifth Amendment
Option Plan of State Auto Financial Corporation
Form 10-Q Quarterly Report for the period ended
June 30, 2005 (see Exhibit 10.66 therein)
Form 8-K Current Report filed on March 13,
2008 (see Exhibit 10.3 therein)
Form 10-K Annual Report for the year ended
December 31, 1992 (see Exhibit 10 (N) therein)
Form 10-K Annual Report for the year ended
December 31, 2005 (see Exhibit 10.17 therein)
Form 10-K Annual Report for the year ended
December 31, 2005 (see Exhibit 10.18 therein)
Form 10-K Annual Report for the year ended
December 31, 2005 (see Exhibit 10.19 therein)
Form 10-K Annual Report for the year ended
December 31, 2005 (see Exhibit 10.20 therein)
Form 10-Q Quarterly Report for the period ended
March 31, 2007 (see Exhibit 10.63 therein)
Sixth Amendment to the 2000 Directors Stock
Option Plan (effective March 7, 2008) of State
Auto Financial Corporation
Investment Management Agreement between
and State
Stateco Financial Services,
Company,
Automobile Mutual
effective April 1, 1993
Inc.
Insurance
Investment Management Agreement between
Stateco Financial Services, Inc. and Meridian
Security Insurance Company, effective June 1,
2001
Investment Management Agreement between
Stateco Financial Services, Inc. and State Auto
Florida Insurance Company effective April 1,
2002
Investment Management Agreement between
Stateco Financial Services, Inc. and Midwest
Security Insurance Company effective January 1,
1997
Investment Management Agreement between
Stateco Financial Services, Inc. and Meridian
Citizens Mutual Insurance Company effective
June 1, 2001
dated
Investment Management Agreement
March 29, 2007, between Stateco Financial
Services, Inc. and Beacon National Insurance
Company, First Preferred Insurance Company,
Petrolia Insurance Company and Beacon Lloyds
Insurance Company
133
Exhibit
No.
10.25
10.26
10.27
10.28
10.29
10.30
10.31
Description of Exhibit
If incorporated by reference document with which Exhibit was
previously filed with SEC
Form 10-K Annual Report for the year ended
December 31, 2007 (see Exhibit 10.22 therein)
Form 10-K Annual Report for the year ended
December 31, 2007 (see Exhibit 10.23 therein)
Form 10-K Annual Report for year ended 12-31-
02 (see Exhibit 10(OO) therein)
Included herein
Included herein
Form 10-K Annual Report for the year ended
December 31, 2005 (see Exhibit 10.45 therein)
Form 10-Q Quarterly Report for the period ended
March 31, 2005 (see Exhibit10.56 therein)
Amended and Restated Investment Management
Agreement dated as of December 31, 2007,
Inc. and
among Stateco Financial Services,
Patrons Mutual
of
Connecticut, Patrons Fire Insurance Company of
Rhode Island, and Provision State Insurance
Company
Company
Insurance
Amended and Restated Investment Management
Agreement dated as of December 31, 2007,
between Stateco Financial Services, Inc. and
Litchfield Mutual Fire Insurance Company
Cost Sharing Agreement among State Auto
Property and Casualty Insurance Company, State
Insurance Company, and
Automobile Mutual
State Auto Florida Insurance Company effective
January 1, 2003
Cost Sharing Agreement among State Auto
Property and Casualty Insurance Company, State
Insurance Company, and
Automobile Mutual
Columbus Marketing,
(n/k/a BroadStreet
Capital Partners, Inc.) effective January 1, 2003
Inc.
Renewal of Cost Sharing Agreement among
State Auto Property & Casualty Insurance
Company, State Automobile Mutual Insurance
Company and BroadStreet Capital Partners, Inc.
effective March 31, 2008
Security
Insurance
Midwest
Company
Management Agreement amended and restated
as of January 1, 2000 by and among State
Automobile Mutual Insurance Company, State
Auto Property and Casualty Insurance Company
and Midwest Security Insurance Company (nka
State Auto Insurance Company of Wisconsin
Management
and Operations Agreement,
Amended and Restated as of January 1, 2005 by
and among State Automobile Mutual Insurance
Company, State Auto Financial Corporation,
State Auto Property and Casualty Insurance
Insurance
Company, State Auto National
Company, Milbank
Company,
State Auto Insurance Company of Ohio,
Meridian Security Insurance Company, Meridian
Citizens Mutual Insurance Company, Meridian
Insurance Group,
Farmers Casualty
Inc.,
Insurance Company, Stateco Financial Services,
Inc., Strategic Insurance Software, Inc., and 518
Property Management and Leasing, LLC
Insurance
134
Exhibit
No.
10.32
10.33
Description of Exhibit
If incorporated by reference document with which Exhibit was
previously filed with SEC
Form 10-Q Quarterly Report for the period ended
June 30, 2007 (see Exhibit 66.67 therein)
Form 8-K Current Report filed on January 27,
2009 (see Exhibit 10.1 therein)
and
Operations
First Amendment, made as of April 1, 2007, to
Management
Agreement
Amended and Restated as of January 1, 2005, by
and among State 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 of Ohio, Meridian Security Insurance
Company, Meridian Citizens Mutual Insurance
Inc.,
Company, Meridian Insurance Group,
Farmers Casualty Insurance Company, Stateco
Financial Services,
Insurance
Software, Inc., 518 Property Management and
Leasing, LLC, State Auto Florida Insurance
Company, Beacon National Insurance Company,
Beacon Lloyds, Inc., Beacon Lloyds Insurance
Company, First Preferred Insurance Company,
and Petrolia Insurance Company
Inc., Strategic
2005,
among
State Auto
to the Management
Second Amendment dated as of December 31,
2008,
and Operations
Agreement, Amended and Restated as of January
Financial
1,
Corporation, State Automobile Mutual Insurance
Company, State Auto Property & Casualty
Insurance Company, State Auto National
Insurance
Company, Milbank
Insurance
Company, State Auto Insurance Company of
Ohio, Meridian Security Insurance Company,
Meridian Citizens Mutual Insurance Company,
Inc., Farmers
Meridian
Casualty Insurance Company, Stateco Financial
Services, Inc., Strategic Insurance Software, Inc.,
518 Property Management and Leasing, LLC,
State Auto Florida Insurance Company, Beacon
National Insurance Company, Beacon Lloyds,
Inc., Beacon Lloyds Insurance Company, Patrons
Mutual
Insurance Company of Connecticut,
Litchfield Mutual Fire Insurance Company, and
Provision State Insurance Company
Insurance Group,
Form 10-K Annual Report for the year ended
December 31, 2007 (see Exhibit 10.28 therein)
10.34
Inter-Company Expense Agreement (dated as of
June 18, 2001),
including First Amendment
(dated as of September 30, 2002) and Second
Amendment (dated as of December 14, 2007),
thereto, among Patrons Fire Insurance Company
of Rhode Island, Patrons Mutual
Insurance
Company of Connecticut, State Automobile
Insurance Company and State Auto
Mutual
Property & Casualty Insurance Company
135
Exhibit
No.
10.35
10.36
10.37
10.38
10.39
Description of Exhibit
If incorporated by reference document with which Exhibit was
previously filed with SEC
Form 10-K Annual Report for the year ended
December 31, 2007 (see Exhibit 10.29 therein)
Form 10-K Annual Report for the year ended
December 31, 2007 (see Exhibit 10.30 therein)
Form 10-K Annual Report for the year ended
December 31, 2007 (see Exhibit 10.31 therein)
Form 10-K Annual Report for the year ended
December 31, 2007 (see Exhibit 10.32 therein)
Form 10-K Annual Report for the year ended
December 31, 2007 (see Exhibit 10.34 therein)
Inter-Company Expense Agreement (dated as of
January 12, 2001), including First Amendment
(dated as of September 30, 2002) and Second
Amendment (dated as of December 14, 2007)
thereto among Litchfield Mutual Fire Insurance
Company, Patrons Mutual Insurance Company
of Connecticut, State Automobile Mutual
Insurance Company and State Auto Property &
Casualty Insurance Company
Inter-Company Expense Agreement (dated as of
including First Amendment
June 18, 2001),
(dated as of December 14, 2007) thereto among
Provision State Insurance Company, Patrons
Mutual
Insurance Company of Connecticut,
State Automobile Mutual Insurance Company
and State Auto Property and Casualty Insurance
Company
Management Services Agreement (dated as of
August 30, 1996), including First Amendment
(dated as of December 14, 2007) thereto among
Patrons Fire Insurance Company of Rhode
Island, Patrons Mutual Insurance Company of
Connecticut, State Automobile Mutual Insurance
Company and State Auto Property & Casualty
Insurance Company
Management Services Agreement (dated as of
August 26, 1998), including First Amendment
(dated as of December 14, 2007) thereto among
Litchfield Mutual Fire Insurance Company,
of
Patrons Mutual
Connecticut, State Automobile Mutual Insurance
Company and State Auto Property & Casualty
Insurance Company
Company
Insurance
Property Catastrophe Overlying Excess of Loss
Reinsurance Contract (effective July 1, 2007)
among State Automobile Mutual
Insurance
Company, Milbank Insurance Company, State
Auto National Insurance Company, State Auto
Insurance Company of Wisconsin, Farmers
Casualty
Insurance Company, State Auto
Insurance Company of Ohio, Meridian Security
Insurance Company, Meridian Citizens Mutual
Insurance Company,
Florida
Insurance Company, Beacon National Insurance
Company, First Preferred Insurance Company,
Petrolia Insurance Company, Beacon Lloyds
Insurance Company and State Auto Property and
Casualty Insurance Company
State Auto
136
Exhibit
No.
10.40
10.41
10.42
Description of Exhibit
If incorporated by reference document with which Exhibit was
previously filed with SEC
Form 10-K Annual Report for the year ended
December 31, 2007 (see Exhibit 10.35 therein)
Farmers
Casualty
Endorsement No. 1 to the Property Catastrophe
Overlying Excess of Loss Reinsurance Contract
(effective July 1, 2007) among State Automobile
Mutual Insurance Company, Milbank Insurance
Company, State Auto National
Insurance
Company, State Auto Insurance Company of
Insurance
Wisconsin,
Company, State Auto Insurance Company of
Ohio, Meridian Security Insurance Company,
Meridian Citizens Mutual Insurance Company,
State Auto Florida Insurance Company, Beacon
Insurance Company, First Preferred
National
Insurance
Insurance
Company, Beacon Lloyds Insurance Company,
of
Patrons Mutual
Connecticut, Litchfield Mutual Fire Insurance
Company, Patrons Fire Insurance Company of
Rhode
Insurance
Provision
Company and State Auto Property and Casualty
Insurance Company
Company,
Company
Insurance
Petrolia
Island,
State
Form 10-K Annual Report for the year ended
December 31, 2004 (see Exhibit 10.55 therein)
Reinsurance Pooling Agreement Amended and
Restated as of January 1, 2005 by and among
State Automobile Mutual Insurance Company,
State Auto Property and Casualty Insurance
Company, Milbank Insurance Company, State
Auto Insurance Company of Wisconsin,
Farmers Casualty Insurance Company, State
Auto Insurance Company of Ohio, State Auto
Florida Insurance Company, Meridian Security
Insurance Company, and Meridian Citizens
Mutual Insurance Company
Form 10-Q Quarterly Report for the period ended
June 30, 2007 (see Exhibit 10.66 therein)
First Amendment
to the Reinsurance Pooling
Agreement Amended and Restated as of January
1, 2005 by and among State Automobile Mutual
Insurance Company, State Auto Property and
Casualty Insurance Company, Milbank Insurance
Company, State Auto Insurance Company of
Wisconsin,
Insurance
Company, State Auto Insurance Company of
Ohio, State Auto Florida Insurance Company,
Meridian Security Insurance Company, and
Meridian Citizens Mutual Insurance Company,
made as of April 1, 2007
Casualty
Farmers
137
Exhibit
No.
10.43
10.44
10.45
10.46
10.47
10.48
10.49
Description of Exhibit
If incorporated by reference document with which Exhibit was
previously filed with SEC
Form 10-K Annual Report for the year ended
December 31, 2007 (see Exhibit 10.38 therein)
Included herein
Reinsurance Pooling Agreement Amended and
Restated as of January 1, 2008 by and among
State Automobile Mutual Insurance Company,
State Auto Property and Casualty Insurance
Company, Milbank Insurance Company, State
Auto Insurance Company of Wisconsin, Farmers
Insurance Company, State Auto
Casualty
Insurance Company of Ohio, State Auto Florida
Insurance
Security
Company, Meridian
Insurance Company, Meridian Citizens Mutual
Insurance Company, Patrons Mutual Insurance
Company of Connecticut, Litchfield Mutual Fire
Insurance Company
and Beacon National
Insurance Company
First Amendment effective as of July 1, 2008 to
Reinsurance Pooling Agreement Amended and
Restated as of January 1, 2008 by and among
State Automobile Mutual Insurance Company,
State Auto Property & Casualty Insurance
Company, Milbank Insurance Company, State
Auto Insurance Company of Wisconsin, Farmers
Casualty
Insurance Company, State Auto
Insurance Company of Ohio, State Auto Florida
Insurance
Security
Company, Meridian
Insurance Company, Meridian Citizens Mutual
Insurance Company, Patrons Mutual Insurance
Company of Connecticut, Litchfield Mutual Fire
Insurance Company
and Beacon National
Insurance Company
Amended and Restated Declaration of Trust of
STFC Capital Trust I, dated as of May 22, 2003
Form 10-Q Quarterly Report for the period ended
June 30, 2003 (see 10(XX) therein)
Form 10-Q Quarterly Report for the period ended
June 30, 2003 (see 10(YY) therein)
Securities Act Registration Statement on Form S-
4 (File No. 333-111507)(see Exhibit 4.01 therein)
Securities Act Registration Statement on Form S-
4 (File No. 333-111507)(see Exhibit 4.02 therein)
Form 8-K Current Report filed on July 17, 2007
(see Exhibit 10.1 therein)
Indenture dated as of May 22, 2003, for Floating
Rate Junior Subordinated Debt Securities Due
2033
Indenture dated as of November 13, 2003,
among State Auto Financial Corporation, as
Issuer, and Fifth Third Bank, as Trustee,
regarding 6 1⁄4% Senior Note due 2013
Form of 6 1⁄4% Senior Note due 2013 (Exchange
Note)
Credit Agreement dated as of July 12, 2007,
among State Auto Financial Corporation, as
borrower, a syndicate of financial institutions, as
lenders, and KeyBank National Association, as
Administrative Agent, Lead Arranger, Sole Book
Runner and Swingline Lender
138
Exhibit
No.
10.50*
10.51*
10.52*
10.53*
10.54*
10.55*
10.56*
10.57*
10.58*
Description of Exhibit
If incorporated by reference document with which Exhibit was
previously filed with SEC
Form 10-K Annual Report for the year ended
December 31, 2005 (see Exhibit 10.26 therein)
Included herein
Form 10-K Annual Report for the year ended
December 31, 2006 (see Exhibit 10.24 therein)
Included herein
Included herein
Form 10-Q Quarterly Report for the period ended
September 30, 2007 (see Exhibit 10.69 therein)
Included herein
Form 10-Q Quarterly Report for the period ended
September 30, 2007 (see Exhibit 10.70 therein)
Form 10-Q Quarterly Report for the period ended
March 31, 2007 (see Exhibit 10.61 therein)
Employment Agreement dated as of March 2,
2006, among State Auto Financial Corporation,
State Auto Property and Casualty Insurance
Company, State Automobile Mutual Insurance
Company and Robert P. Restrepo, Jr.
Second Amendment effective as of January 1,
2009,
to Employment Agreement dated as of
March 2, 2006, among State Auto Financial
Corporation, State Auto Property & Casualty
Insurance Company, State Automobile Mutual
Insurance Company and Robert P. Restrepo, Jr.
Amendment to Employment Agreement dated as
of January 24, 2007, among State Auto Financial
Corporation, State Auto Property and Casualty
Insurance Company, State Automobile Mutual
Insurance Company and Robert P. Restrepo, Jr.
Employment Agreement effective as of March 1,
2009, among State Auto Financial Corporation,
State Auto Property & Casualty Insurance
Company, State Automobile Mutual Insurance
Company and Robert P. Restrepo, Jr.
Executive Agreement effective as of March 1,
2009, among State Auto Financial Corporation,
State Automobile Mutual Insurance Company
and Robert P. Restrepo, Jr.
Employment Agreement dated as of October 4,
2007, among State Auto Financial Corporation,
State Auto Property and Casualty Insurance
Company, State Automobile Mutual Insurance
Company and Mark A. Blackburn
effective
Amendment
January 1, 2009 to
Employment Agreement dated as of October 4,
2007, among State Auto Financial Corporation,
State Auto Property & Casualty Insurance
Company, State Automobile Mutual Insurance
Company and Mark A. Blackburn
Amended and Restated Executive Agreement
dated as of October 4, 2007, among State Auto
Financial Corporation, State Automobile Mutual
Insurance Company and Mark A. Blackburn
Retention Agreement dated as of February 9,
2004, between State Auto Property & Casualty
Insurance Company and Steven E. English
139
Exhibit
No.
10.59*
10.60*
10.61*
10.62*
10.63*
10.64*
10.65*
10.66*
10.67*
Description of Exhibit
If incorporated by reference document with which Exhibit was
previously filed with SEC
Form 8-K Current Report filed on May 9, 2008
(see Exhibit 99.1 therein)
Included herein
Included herein
Form 10-Q Quarterly Report for the period ended
June 30, 2005 (see Exhibit 10.60 therein)
Included herein
Form 10-K Annual Report for the year ended
December 31, 2005 (see Exhibit 10.49 therein)
Form 10-Q Quarterly Report for the period ended
September 30, 2007 (see Exhibit 10.71 therein)
Included herein
Form 10-Q Quarterly Report for the period ended
June 30, 2005 (see Exhibit 10.62 therein)
Executive Change of Control Agreement entered
into as of May 5, 2008, and effective April 25,
2008, among State Auto Financial Corporation,
State Auto Property & Casualty Insurance
Company, State Automobile Mutual Insurance
Company and Steven E. English
Executive Change
of Control Agreement
effective April 25, 2008, among State Auto
Financial Corporation, State Auto Property &
Casualty Insurance Company, State Automobile
Mutual Insurance Company and Clyde H. Fitch
Executive Change
of Control Agreement
effective April 25, 2008, among State Auto
Financial Corporation, State Auto Property &
Casualty Insurance Company, State Automobile
Mutual Insurance Company and James A. Yano
Amended
Incentive
and Restated Equity
Compensation Plan of State Auto Financial
Corporation
Amendment Number 1 to the Amended and
Restated Equity Incentive Compensation Plan of
State Auto Financial Corporation (amendment
effective August 15, 2008)
Restricted Share Award Agreement under the
Incentive
and Restated Equity
Amended
Compensation Plan dated as of March 2, 2006
between State Auto Financial Corporation and
Robert P. Restrepo, Jr.
Restricted Stock Agreement under the Amended
and Restated Equity Incentive Compensation
Plan dated as of October 4, 2007, between State
Auto Financial Corporation and Mark A.
Blackburn
Restricted Stock Agreement under the Amended
and Restated Equity Incentive Compensation
Plan dated as of November 5, 2007, between
State Auto Financial Corporation and Clyde H.
Fitch
Form of Non-Qualified Stock Option Agreement
the Amended and Restated Equity
under
Incentive Compensation Plan of State Auto
Financial Corporation
140
Exhibit
No.
10.68*
10.69*
10.70*
10.71*
10.72*
10.73*
10.74*
10.75*
10.76*
10.77*
10.78*
10.79*
10.80*
Description of Exhibit
If incorporated by reference document with which Exhibit was
previously filed with SEC
Non-Qualified Stock Option Agreement under
the Amended and Restated Equity Incentive
Compensation Plan of State Auto Financial
Corporation dated March 2, 2006 between State
Auto Financial Corporation and Robert P.
Restrepo, Jr.
Incentive Stock Option Agreement
Form of
under
the Amended and Restated Equity
Incentive Compensation Plan of State Auto
Financial Corporation
Form 10-K Annual Report for the year ended
December 31, 2005 (see Exhibit 10.51 therein)
Form 10-Q Quarterly Report for the period ended
June 30, 2005 (see Exhibit 10.63 therein)
Outside Directors Restricted Share Unit Plan of
State Auto Financial Corporation
Form 10-Q Quarterly Report for the period ended
June 30, 2005 (see Exhibit 10.61 therein)
First Amendment
to the Outside Directors
Restricted Share Unit Plan of State Auto
Financial Corporation
Second Amendment
to the Outside Directors
Restricted Share Unit Plan of State Auto
Financial Corporation
Third Amendment
to the Outside Directors
Restricted Share Unit Plan of State Auto
Financial Corporation
Form of Restricted Share Unit Agreement for the
Outside Directors Restricted Share Unit Plan of
State Auto Financial Corporation
Form of Designation of Beneficiary for
the
Outside Directors Restricted Share Unit Plan of
State Auto Financial Corporation
Supplemental Retirement Plan for Executive
Employees of State Auto Insurance Companies
(Restatement) effective as of January 1, 1994
Amendment No. 1, effective as of January 1,
to Supplemental Retirement Plan for
2008,
Executive Employees of State Auto Insurance
Companies
Amendment No. 2 effective as of January 1,
2009 to the Supplemental Retirement Plan for
Executive Employees of State Auto Insurance
Companies
State Auto Financial Corporation Supplemental
Executive Retirement Plan, effective January 1,
2007
Form of Designation of Distribution Election for
Corporation
the
Supplemental Executive Retirement Plan
Financial
State
Auto
141
Form 10-K Annual Report for the year ended
December 31, 2005 (see Exhibit 10.54 therein)
Included herein
Included herein
Form 10-Q Quarterly Report for the period ended
June 30, 2005 (see Exhibit 10.64 therein)
Form 10-Q Quarterly Report for the period ended
June 30, 2005 (see Exhibit 10.65 therein)
Form 10-K Annual Report for the year ended
December 31, 1997 (see Exhibit 10(HH) therein)
Form 10-Q Quarterly Report for the period ended
June 30, 2008 (see Exhibit 10.01 therein)
Form 10-Q Quarterly Report for the period ended
September 30, 2008 (see Exhibit 10.01 therein)
Form 10-Q Quarterly Report for the period ended
September 30, 2007 (see Exhibit 10.72 therein)
Form 10-Q Quarterly Report for the period ended
September 30, 2007 (see Exhibit 10.73 therein)
Exhibit
No.
10.81*
10.82*
10.83*
10.84*
10.85*
10.86*
10.87*
10.88*
10.89*
10.90*
Description of Exhibit
If incorporated by reference document with which Exhibit was
previously filed with SEC
Form 10-K Annual Report for the year ended
December 31, 2005 (see Exhibit 10.58 therein)
Form 10-K Annual Report for the year ended
December 31, 2005 (see Exhibit 10.59 therein)
Form 10-Q Quarterly Report for the period ended
September 30, 2008 (see Exhibit 10.02 therein)
Included herein
Form 10-K Annual Report for the year ended
December 31, 2005 (see Exhibit 10.60 therein)
State Auto Insurance Companies Amended and
Restated Directors Deferred Compensation Plan
(amended and restated as of March 1, 2001)
First Amendment to the State Auto Insurance
Companies Amended and Restated Directors
(amendment
Plan
Deferred Compensation
effective as of December 1, 2005)
Second Amendment to the State Auto Insurance
Companies Amended and Restated Directors
(amendment
Deferred Compensation
effective as of January 1, 2009)
Plan
Third Amendment to the State Auto Insurance
Companies Amended and Restated Directors
(amendment
Deferred Compensation
effective as of January 1, 2009)
Plan
Agreement of Assignment and Assumption dated
as of March 1, 2001, among State Auto Financial
Corporation, State Automobile Mutual Insurance
Company, State Auto Property and Casualty
Insurance Company, and Midwest Security
Insurance Company (nka State Auto Insurance
regarding the State
Company of Wisconsin)
Auto
and
Restated Directors Deferred Compensation Plan
Insurance Companies Amended
Form of State Auto Insurance Companies
Directors Deferred Compensation Agreement
Form 10-K Annual Report for the year ended
December 31, 2005 (see Exhibit 10.61 therein)
Form 10-K Annual Report for the year ended
December 31, 2005 (see Exhibit 10.62 therein)
Form 10-K Annual Report for the year ended
December 31, 2005 (see Exhibit 10.63 therein)
Form 10-Q Quarterly Report for the period ended
September 30, 2008 (see Exhibit 10.03 therein)
Form 10-K Annual Report for the year ended
December 31, 2005 (see Exhibit 10.64 therein)
State Auto Property & Casualty Insurance
Company’s Amended and Restated Incentive
Deferred Compensation Plan (amended and
restated as of March 1, 2001)
First Amendment to the State Auto Property &
Casualty Insurance Company’s Amended and
Restated Incentive Deferred Compensation Plan
(amendment effective as of November 22, 2002)
Second Amendment to the State Auto Property
& Casualty Insurance Company’s Amended and
Restated Incentive Deferred Compensation Plan
(amendment effective as of January 1, 2009)
Agreement of Assignment and Assumption dated
as of March 1, 2001, among State Auto Financial
Corporation, State Automobile Mutual Insurance
Company, and State Auto Property and Casualty
Insurance Company regarding the State Auto
Property & Casualty Insurance Company’s
Amended and Restated Incentive Deferred
Compensation Plan
142
Exhibit
No.
10.91*
10.92*
10.93*
10.94*
10.95*
10.96*
21.01
23.01
24.01
24.02
31.01
31.02
32.01
32.02
Description of Exhibit
If incorporated by reference document with which Exhibit was
previously filed with SEC
Form of State Auto Property & Casualty
Insurance
Incentive Deferred
Compensation Agreement
Company’s
Form 10-K Annual Report for the year ended
December 31, 2005 (see Exhibit 10.65 therein)
State Auto Financial Corporation Leadership
Bonus Plan
Form 10-Q Quarterly Report for the period ended
June 30, 2007 (see Exhibit 10.64 therein)
to the State Auto Financial
First Amendment
Corporation Leadership Bonus Plan (amendment
effective as of January 1, 2009)
Form 10-Q Quarterly Report for the period ended
September 30, 2008 (see Exhibit 10.04 therein)
State Auto Financial Corporation Long-Term
Incentive Plan
Form 10-Q Quarterly Report for the period ended
June 30, 2007 (see Exhibit 10.65 therein)
First Amendment
Corporation
Long-Term
(amendment effective as of January 1, 2008)
to the State Auto Financial
Plan
Incentive
Form 8-K Current Report filed on March 13,
2008 (see Exhibit 10.5 therein)
Second Amendment to the State Auto Financial
Corporation
Plan
Long-Term
(amendment effective as of January 1, 2009)
Incentive
Form 10-Q Quarterly Report for the period ended
September 30, 2008 (see Exhibit 10.05 therein)
List of Subsidiaries of State Auto Financial
Corporation
Form 10-K Annual Report for the year ended
December 31, 2007 (see Exhibit 21.01 therein)
Consent of
Accounting Firm
Independent Registered Public
Included herein
Powers of Attorney—Robert P. Restrepo, Jr.,
David J. D’Antoni, David R. Meuse, S. Elaine
Roberts, Richard K. Smith, Alexander B. Trevor
and Paul S. Williams
Form 10-K Annual Report for the year ended
December 31, 2007 (see Exhibit 24.01 therein)
Powers of Attorney—Robert E. Baker and
Thomas E. Markert
Form 10-Q Quarterly Report for the period ended
March 31, 2008 (see Exhibit 24.01 therein)
CEO certification required by Section 302 of
Sarbanes-Oxley Act of 2002
Included herein
CFO certification required by Section 302 of
Sarbanes-Oxley Act of 2002
Included herein
CEO certification required by Section 906 of
Sarbanes-Oxley Act of 2002
Included herein
CFO certification required by Section 906 of
Sarbanes-Oxley Act of 2002
Included herein
*
Constitutes either a management contract or a compensatory plan or arrangement required to be filed as an Exhibit.
(b) EXHIBITS
The exhibits included with this Form 10-K, as indicated in Item 15(a) (3), have been separately filed.
(c) FINANCIAL STATEMENT SCHEDULES
Our financial statement schedules included with this Form 10-K, as indicated in Item 15(a) (2), follow the
signatures to this Form 10-K.
143
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.
SIGNATURES
Dated: March 13, 2009
STATE AUTO FINANCIAL CORPORATION
/s/ ROBERT P. RESTREPO, JR.
Robert P. Restrepo, Jr.
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 P. RESTREPO, JR.
Robert P. Restrepo, Jr.
/s/ STEVEN E. ENGLISH
Steven E. English
/s/ CYNTHIA A. POWELL
Cynthia A. Powell
DAVID J. D’ANTONI*
David J. D’Antoni
ROBERT E. BAKER*
Robert E. Baker
THOMAS E. MARKERT*
Thomas E. Markert
DAVID R. MEUSE*
David R. Meuse
S. ELAINE ROBERTS*
S. Elaine Roberts
RICHARD K. SMITH*
Richard K. Smith
ALEXANDER B. TREVOR*
Alexander B. Trevor
PAUL S. WILLIAMS*
Paul S. Williams
Chairman, President and Chief
Executive Officer (principal
executive officer)
March 13, 2009
Vice President and Chief Financial
Officer (principal financial officer)
March 13, 2009
Vice President and Treasurer
(principal accounting officer)
Director
Director
Director
Director
Director
Director
Director
Director
March 13, 2009
March 13, 2009
March 13, 2009
March 13, 2009
March 13, 2009
March 13, 2009
March 13, 2009
March 13, 2009
March 13, 2009
*
Steven E. English 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 E. ENGLISH
Attorney in Fact
March 13, 2009
Steven E. English
144
Consent of Independent Registered Public Accounting Firm
We consent to the incorporation by reference in the following Registration Statements and related Prospectuses
of State Auto Financial Corporation of our reports dated March 12, 2009, with respect to the consolidated
financial statements and schedules of State Auto Financial Corporation and the effectiveness of internal control
over financial reporting of State Auto Financial Corporation, included in this Annual Report (Form 10-K) for the
year ended December 31, 2008.
EXHIBIT 23.01
Form
S-8
S-8
S-8
S-8
S-8
S-8
S-3
S-3
S-4
S-8
Registration
Number
33-44667
33-89400
1991 Stock Option Plan
Description
33-44666
1991 Directors’ Stock Option Plan
1991 Employee Stock Purchase and Dividend Reinvestment Plan
33-41423
333-05755
333-147333
333-56336
State Auto Insurance Companies Capital Accumulation Plan
333-43882
2000 Directors’ Stock Option Plan
333-43880
2000 Stock Option Plan
333-41849 Monthly Stock Purchase Plan for Independent Agents
333-90529
333-111507
1998 State Auto Agents’ Stock Option Plan
6 1⁄4% Senior Notes due 2013
333-127172
2005 Outside Directors Restricted Share Unit Plan
/s/ Ernst & Young LLP
Columbus, Ohio
March 12, 2009
145
CERTIFICATION
I, Robert P. Restrepo, Jr., certify that:
1.
I have reviewed this Form 10-K of State Auto Financial Corporation;
EXHIBIT 31.01
2. Based on my knowledge, this 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 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 report;
4.
The registrant’s other certifying officer and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and
internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for
the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, 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 report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over
to provide reasonable assurance
financial reporting to be designed under our supervision,
regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in
this report our conclusions about the effectiveness of the disclosure controls and procedures, as of
the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that
occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in
the case of an annual report) that has materially affected, or is reasonably likely to materially
affect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of
internal control over financial reporting, to the registrant’s auditors and the audit committee of the
registrant’s board of directors:
(a) All significant deficiencies and material weaknesses in the design or operation of internal control
over financial reporting which are reasonably likely to adversely affect the registrant’s ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant’s internal control over financial reporting.
Date: March 13, 2009
/s/ Robert P. Restrepo, Jr.
Robert P. Restrepo, Jr.,
Chief Executive Officer
(Principal executive officer)
146
CERTIFICATION
I, Steven E. English, certify that:
1.
I have reviewed this Form 10-K of State Auto Financial Corporation;
EXHIBIT 31.02
2. Based on my knowledge, this 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 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 report;
4.
The registrant’s other certifying officer and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and
internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for
the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, 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 report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over
financial reporting to be designed under our supervision,
to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in
this report our conclusions about the effectiveness of the disclosure controls and procedures, as of
the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that
occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in
the case of an annual report) that has materially affected, or is reasonably likely to materially
affect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of
internal control over financial reporting, to the registrant’s auditors and the audit committee of the
registrant’s board of directors:
(a) All significant deficiencies and material weaknesses in the design or operation of internal control
over financial reporting which are reasonably likely to adversely affect the registrant’s ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant’s internal control over financial reporting.
Date: March 13, 2009
/s/ Steven E. English
Steven E. English,
Chief Financial Officer
(Principal Financial Officer)
147
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906
OF THE SARBANES-OXLEY ACT OF 2002
EXHIBIT 32.01
In connection with the Annual Report of State Auto Financial Corporation (the “Company”) on Form 10-K
for the period ended December 31, 2008, as filed with the Securities and Exchange Commission on the date
hereof (the “Report”), I, Robert P. Restrepo, Jr., Chief Executive Officer of the Company, certify, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 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.
/s/ Robert P. Restrepo, Jr.
Robert P. Restrepo, Jr.
Chief Executive Officer
March 13, 2009
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.
148
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906
OF THE SARBANES-OXLEY ACT OF 2002
EXHIBIT 32.02
In connection with the Annual Report of State Auto Financial Corporation (the “Company”) on Form 10-K
for the period ended December 31, 2008, as filed with the Securities and Exchange Commission on the date
hereof (the “Report”), I, Steven E. English, Chief Financial Officer of the Company, certify, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 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.
/s/ Steven E. English
Steven E. English
Chief Financial Officer
March 13, 2009
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.
149
Shareholder Information
DOUGLAS E. ALLEN, 51
Vice President
JOEL E. BROWN, 51
Vice President
DAVID W. DALTON, 50
Vice President
JAMES E. DUEMEY, 62
Vice President,
NANCY D. EDWARDS, 56
Vice President
STEVEN R. HAZELBAKER, 53
Vice President
TERRENCE P. HIGERD, 64
Vice President
JOHN B. MELVIN, 59
Vice President
CATHY B. MILEY, 59
Vice President
RICHARD L. MILEY, 55
Vice President
PAUL E. NORDMAN, 51
Vice President
JOHN M. PETRUCCI, 50
Vice President
M. JEAN REYNOLDS, 53
Vice President
LORRAINE M. SIEGWORTH, 42
Vice President
LARRY D. WILLIAMS, 61
Vice President
CORPORATE INFORMATION
CORPORATE HEADQUARTERS
State Auto Financial Corporation
518 E. Broad Street
Columbus, OH 43215
Phone (614) 464-5000
www.StateAuto.com
ANNUAL MEETING
10 a.m. Friday, May 8, 2009,
Corporate Headquarters
SHAREHOLDER INQUIRIES
James E. Duemey
Director of Investor Relations
State Auto Financial Corporation
518 E. Broad Street
Columbus, OH 43215
Phone (614) 464-5373
Fax (614) 464-5325
E-mail: Jim.Duemey@StateAuto.com
INDEPENDENT AUDITORS
Ernst & Young LLP
1100 Huntington Center
41 South High Street
Columbus, OH 43215
LEGAL COUNSEL
Baker & Hostetler LLP
65 E. State Street
Columbus, OH 43215
SEC FILINGS
This report and other filings with the Securities
and Exchange Commission are also available free
of charge on the company’s Web site maintained
at www.StateAuto.com.
TRANSFER AGENT/REGISTRAR
National City Bank
Shareholder Services Operations—LOC 5352
P.O. Box 92301
Cleveland, OH 44101-4301
Phone (800) 622-6757
E-mail: shareholder.inquiries@nationalcity.com
STOCK TRADING
Common shares are traded in the NASDAQ
Global Select National Market System under
the symbol STFC. As of February 26, 2009,
there were 1,448 stockholders of record of the
Company’s common shares.
MARKET PRICE RANGE AND DIVIDENDS,
COMMON STOCK
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 and cash dividends paid per share are:
2008
High
Low
Dividend
First Qtr.
Second Qtr.
Third Qtr.
Fourth Qtr.
$30.08
30.00
37.08
32.00
$23.29
23.91
21.83
17.38
$0.15
0.15
0.15
0.15
2007
High
Low
Dividend
First Qtr.
Second Qtr.
Third Qtr.
Fourth Qtr.
$35.22
34.00
32.25
32.38
$30.61
28.67
23.99
25.39
$0.10
0.10
0.15
0.15
(1) Adjusted for stock splits.
DIRECTORS
ROBERT P. RESTREPO JR.
President and CEO
State Auto Insurance Companies
Term expires in 2009
ROBERT E. BAKER
President
Puroast Coffee Inc.
Term expires in 2010
DAVID J. D’ANTONI
Retired Senior Vice President
Ashland Inc.
Term expires in 2011
THOMAS E. MARKERT
Senior Vice President
Office Depot
Term expires in 2010
DAVID R. MEUSE
Principal
Stonehenge Financial Holdings Inc.
Term expires in 2011
S. ELAINE ROBERTS
President and CEO
Columbus Regional Airport Authority
Term expires in 2011
RICHARD K. SMITH
Retired Audit Partner
KPMG Peat Marwick
Term expires in 2009
ALEXANDER B. TREVOR
President
Nuvocom Inc.
Term expires in 2010
PAUL S. WILLIAMS
Managing Director
Major, Lindsay and Africa
Term expires in 2009
SENIOR OFFICERS
ROBERT P. RESTREPO JR., 58
Chairman of the Board,
President and CEO
MARK A. BLACKBURN, 57
Executive Vice President, COO
CLYDE H. FITCH JR., 58
Senior Vice President
STEVEN E. ENGLISH, 48
Vice President, CFO
JAMES A. YANO, 57
Vice President, Secretary,
General Counsel
CYNTHIA A. POWELL, 48
Vice President, Chief
Accounting Officer, Treasurer
STATE AUTO FINANCIAL CORPORATION 2008 Annual Report
77260 3-21313_STFC FN.indd 1
77260 3-21313_STFC FN.indd 1
3/24/09 12:29:12 PM
3/24/09 12:29:12 PM
StAte AUtO FINANCIAL COrPOrAtION (“StFC”) is a super-regional insurance holding company
headquartered in Columbus, Ohio. StFC is affiliated with State Automobile Mutual Insurance Company
(State Auto Mutual), which owns approximately 64% of StFC. StFC, State Auto Mutual and their insurance
subsidiaries and affiliates (State Auto) market their insurance products exclusively through independent
insurance agencies in 33 states. State Auto’s principal lines include personal and commercial auto,
homeowners, commercial multi-peril, fire and general liability insurance.
With a commitment to responsible cost-based pricing, conservative investments and sound underwriting
practices, StFC has achieved solid long-term financial performance since becoming a public company in
1991. Combined with providing outstanding customer service to policyholders and agents, State Auto
has earned the reputation as one of the strongest and best managed super-regional insurance groups in
the industry. State Auto has consistently received A.M. Best’s A+ (Superior) rating.
State Auto Financial Corporation is traded on the Nasdaq global Select Market System under the
symbol StFC.
Financial Highlights
2008
$ 1,126.0
87.4
(36.4)
4.9
$ 1,181.9
$
(31.1)
(0.78)
$
(0.78)
$
$
0.60
$ 19.23
$ 2,443.6
$ 761.0
($ in millions, except per share amounts)
2005
2006
2007
1,011.6
84.7
12.1
5.0
1,113.4
119.1
2.90
2.86
0.50
23.10
1,023.8
83.1
5.6
4.9
1,117.4
120.4
2.95
2.90
0.38
20.32
1,050.3
78.7
5.6
4.9
1,139.5
125.9
3.12
3.06
0.27
18.86
2004
1,006.8
71.8
7.6
6.2
1,092.4
110.0
2.76
2.70
0.17
16.42
2,337.9
935.5
2,255.1
834.2
2,274.9
763.5
2,168.4
658.2
(3.7)%
109.8
13.5%
92.8
15.1%
91.4
17.7%
90.1
18.3%
91.7
Earned premiums
Net investment income
Net realized investment (loss) gain
Other income
Total revenue
Net (loss) income
Basic (loss) earnings per share
Diluted (loss) earnings per share
Dividends paid per share
Book value per share
Total assets
Stockholders’ equity
Return on equity
Combined ratio
geographic Dispersion
Corporate Headquarters
Regional Headquarters
Western Region
Midwestern Region
Eastern Region
Southern Region
Central Region
Corporate Headquarters
Columbus, OH
regional offiCes
EastErn rEgiOn HEadquartErs
Hunt Valley, Md
regional President Charles Mcshane, 55
sOutHErn rEgiOn HEadquartErs
nashville, tn
regional President george Furlong, 55
CEntral rEgiOn HEadquartErs
Columbus, OH
regional President Kathy durso, 56
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MidWEstErn rEgiOn HEadquartErs
indianapolis, in
regional President Ben Blackmon, 47
WEstErn rEgiOn HEadquartErs
austin, tX
regional President gerald ladner, 49
FOrWArd-LOOkINg StAteMeNtS
this annual report contains forward-looking statements within the meaning of the Private securities litigation reform act of 1995. Please see “important
information regarding Forward-looking statements” preceding Part i of the Company’s annual report on Form 10-K for the fiscal year ended december 31,
2008, which is included with this annual report.
STATE AUTO FINANCIAL CORPORATION 2008 Annual Report
State Auto Financial Corp
State Auto Property & Casualty Ins Co
Milbank Ins Co
Farmers Casualty Ins Co
State Auto Ins Co of Ohio
State Auto National Ins Co
Stateco Financial Services Inc
Strategic Insurance Software Inc
518 Property Management & Leasing LLC
State Automobile Mutual Ins Co
State Auto Ins Co of Wisconsin
State Auto Florida Ins Co
Meridian Security Ins Co
Meridian Citizens Mutual Ins Co
Beacon National Ins Co
Beacon Lloyds Ins Co
Patrons Mutual Ins Co of Connecticut
Litchfield Mutual Fire Ins Co
State Auto Financial Corporation
518 E. Broad Street
Columbus, OH 43215
www.StateAuto.com
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State Auto Financial Corporation
two thousand eight
Annual Report