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two thousand nine
State Auto Financial Corporation
Annual Report
State Auto Financial Corporation
State Auto Property & Casualty Insurance Company
Milbank Insurance Company
Farmers Casualty Insurance Company
State Auto Insurance Company of Ohio
State Auto National Insurance Company
Stateco Financial Services Inc.
518 Property Management & Leasing LLC
State Automobile Mutual Insurance Company
State Auto Insurance Company of Wisconsin
State Auto Florida Insurance Company
Meridian Security Insurance Company
Meridian Citizens Mutual Insurance Company
Beacon National Insurance Company
Beacon Lloyds Insurance Company
Patrons Mutual Insurance Company of Connecticut
Litchfield Mutual Fire Insurance Company
State Auto Financial Corporation
518 E. Broad Street
Columbus, OH 43215
www.StateAuto.com
181640_cover.indd 1
3/16/10 2:38:09 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 63.5% of STFC. STFC, State Auto Mutual and their
insurance subsidiaries and affiliates (State Auto) market their insurance products exclusively through
independent insurance agencies in 34 states and the District of Columbia. 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 Market System under the symbol STFC.
Financial Highlights
($ in millions, except per share amounts)
2009
2008
2007
2006
2005
Earned premiums
Net investment income
Net realized investment (loss) gain
Other income
Total revenue
Net income (loss)
Basic earnings (loss) per share
Diluted earnings (loss) per share
Dividends paid per share
Book value per share
Total assets
Stockholders’ equity
Return on equity
Combined ratio
$1,176.5
82.1
(5.2)
3.5
$1,256.9
1,126.0
87.4
(36.4)
4.9
1,181.9
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
(31.1)
(0.78)
(0.78)
0.60
19.23
2,443.6
761.0
2,337.9
935.5
2,255.1
834.2
%
(3.7)%
109.8
13.5%
92.8
15.1%
91.4
2,274.9
763.5
17.7
90.1
%
$
10.2
0.26
$
0.25
$
$
0.60
$ 21.33
$ 2,564.5
$ 849.4
1.3
105.8
Geographic Dispersion
Corporate Headquarters
Columbus, OH
regional oFFiCes
eastern region Headquarters
Western region Headquarters
BaltimOre Center
Hunt Valley, mD
regional President Charles mcShane, 56
auStin Center
austin, tX
regional President Gerald ladner, 50
soutHern region Headquarters
des Moines ClaiMs Center
West Des moines, ia
Harrisburg ClaiMs Center
Harrisburg, Pa
naSHVille Center
Goodlettsville, tn
regional President George Furlong, 56
Central region Headquarters
COlumBuS Center
Columbus, OH
regional President Kathy Durso, 57
MidWestern region Headquarters
inDianaPOliS Center
indianapolis, in
regional President Ben Blackmon, 48
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,
2009, which is included with this annual report.
STATE AUTO FINANCIAL CORPORATION 2009 Annual Report
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Dear
Shareholders,
In 2009, State Auto improved underwriting results, investment
performance, catastrophe management and premium growth. We
accomplished this in an environment of weak market pricing, a
tough economy, and uncertain regulatory and political climates.
We reported a modest profit with a combined ratio of 105.8% and
earnings per share of $0.25. While short of targets, results
rebounded in the second half of 2009 after a first half featuring
catastrophes and large fire losses. Benign weather and favorable
loss trends enabled a strong finish for State Auto in 2009. We are
well positioned for further improvement in 2010.
Throughout 2009, we also made substantial progress on initiatives
for underwriting profit, profitable growth, and quality risk and
capital management, all in support of our strategic plan. We are
confident that we have the plan, the progress, and the people to
favorably impact our return on equity. I’ll summarize 2009 progress
and our agenda for 2010.
People
Last year we strengthened an already terrific management team.
Steve Hunckler joined us in August to lead our claims organization
following John Melvin’s retirement. New faces and new initia-
tives had already made substantial improvements throughout 2009
under John Melvin’s leadership. We wish him the best in his
well-deserved retirement. Steve Hunckler brings a long history of
success in our industry. His leadership, inclusive management
style and strong technical background make him ideal to further
improve performance in our claims organization. This is criti-
cal to our ability to improve earnings and produce consistent
underwriting profits.
State Auto’s tradition of superb corporate governance was further
strengthened by the additions of Larry Adeleye as Director of
Treasury and Finance and Patrick Dukes as Chief Compliance
Officer.
We appointed five new Regional Presidents to head our restruc-
tured field operations. Reporting to Clyde Fitch, this team
includes Ben Blackmon, Kathy Durso, George Furlong, Gerald
Ladner and Charlie McShane. All these leaders have strong and
successful backgrounds in underwriting, sales and agency
development.
We restructured our IT organization under Doug Allen and
appointed David Russell as Enterprise Architect. David brings a
wealth of knowledge about State Auto’s systems and the needs of
our business. His background is a strong fit for this important role.
We consolidated personal insurance underwriting operations
from ten to two locations under Rick Holbein. We now have a
more productive platform for continued growth in personal
insurance.
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Unlike our personal insurance underwriting operations,
State Auto has room to improve the full-time employee
costs associated with producing business insurance
policies. The consolidation of operations, increased
sales and enhanced automation are the keys to driving
down the costs.
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State Auto Financial Corporation
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181640_4pager:Layout 1 3/17/10 9:23 PM Page 2
We also made important changes to our retirement programs
which will reduce balance sheet volatility and allow us
to remain competitive for talent.
Technology
Our enhanced personal insurance netXpress portal resulted in a
59% increase in new quotes. The more opportunities we get for
quotes, the more business we write. Our “batting average”
declined somewhat, but overall new business policy production
increased 28.5%. We are improving our business insurance
portal, bizXpress, to support BOP and commercial automobile.
Workers’ compensation and umbrella will follow in 2010.
We introduced a new portal for our bond business called Bond
Connect. Agents can now submit surety business seamlessly.
We completed construction of a new data center north of
Columbus. This investment will significantly improve our IT
infrastructure and provide us a secure and flexible platform for
growth well into the future.
Underwriting Profit
Our greatest challenge – and perhaps our industry’s – is achiev-
ing profit in the homeowners line. Last year, we implemented
remedies for this troubled line: an aggregate reinsurance catas-
trophe treaty which benefitted the homeowners line by 1.5
points; wind and hail deductibles in 14 states; price increases
of 4.7%; reduced commissions; aggressively upgraded insurance
to value; and a new product, Homeowners CustomFit®, which
integrates predictive modeling and by-peril pricing techniques
enabling both pricing precision and improved profitability.
We enhanced our commercial lines pricing sophistication
through predictive modeling techniques. Quest modeling
supports our property, liability and BOP lines (60% of our
business insurance premium). In the second half of 2009 we
saw incremental increases in these lines and going forward we
are counting on the pricing sophistication provided by Quest to
lead to improved margins for our product portfolio.
In claims, we formed dedicated teams for catastrophe claim
handling, large property losses, and automobile physical damage.
By expanding our staff counsel to eight offices, with three addi-
tional planned for 2010, we will substantially reduce legal fees.
Taken together, these actions will better manage claim in-
demnity costs, reduce expenses and enhance service response –
all components of lower loss ratios.
Profitable Growth
Our exceptional growth of 12.2% in personal insurance was
driven by our netXpress technology, top service and state
expansion. 35% of our new business came from states where
we had no presence three years ago – Texas, Arizona, Colorado
and Connecticut. We are well positioned for continued growth
in personal insurance given our products, pricing actions,
easy-to-use portals and geographic expansion.
In business insurance, new business production is suffering from
challenging economic and competitive climates. Premium bases
are shrinking as policyholders reduce vehicles, payrolls, sales
and property locations. Business insurance is a lagging indicator
of economic activity, so we don’t forecast much change in our
premium bases in 2010. We are continuing to strengthen price
even if it doesn’t immediately translate to premium growth. We
are rolling out our new BOP Choice product and expect to
have all states supported by mid-2010. This new product has
broader eligibility and leverages our investments in both our
portal, bizXpress, and Quest, our predictive modeling capability.
We entered the Write Your Own Program sponsored by the
federal National Flood Insurance Program. This is a source of
profitable, risk free premium and provides agents with another
product from the State Auto portfolio.
Strategic Roadmap
State Auto’s Strategic Roadmap
defines the company’s long-term
strategy for enhancing the inter-
ests of our policyholders and
shareholders. From efforts to
support our associates and agents
to investments in new products
and technology, each decision is
guided by the four pillars of our
strategy: rational growth, under-
writing profit, risk management
and capital management. This
slide is well-recognized by
virtually every State Auto associ-
ate; it’s a lead-in to periodic
discussions to introduce and
explain the company’s goals and
the roles that departments and
people play in their achievement.
Financial Strength l Reputation l Relationships l Reliability l Responsiveness
State Auto Financial Corporation
page 2
181640_4pager:Layout 1 3/17/10 9:23 PM Page 3
Enterprise Risk Management
We continue to work with our boards to identify and mitigate
risks both internal and external.
STFC has paid a dividend
in 74 straight quarters:
every quarter since its inception.
The dividend has
never been lowered.
State Auto’s overall
premium growth of
5.1% should exceed
industry results for
2009. Sales in the
personal insurance
lines were strong,
growing 12.2% for the
year. Our expansion
states of Arizona,
Colorado, Connecticut
and Texas performed
well. Business insur-
ance sales, on the
other hand, were
down 5.5%. We will
not force growth in
business insurance at
the expense of prof-
itability. Until the mar-
ket pricing firms and
the economy recovers,
we will rely on new
products, improving
technology and a
strong field staff to
stabilize the sales
trend.
We pay particular attention to geographic concentration and
wind and hail exposure. We modeled return rates and property
concentrations in every county within our 34 state footprint, and
we took the appropriate agency and underwriting actions in
counties with the greatest exposure.
Capital Management
Our number one goal remains preserving capital and enhancing
liquidity to maintain our A+ financial strength rating with A.M.
Best.
We continue to explore M&A opportunities, but find it a
challenging market. The gap between bid and ask is often too
great and opportunities to affiliate with mutual companies are
slim.
We maintained a very competitive dividend and took no action
to repurchase additional shares in 2009.
Going forward, our short term goals are to:
1. Strengthen prices in both our personal insurance and business
insurance lines We ended 2009 with annualized price increases
of 5% in personal insurance; pricing was virtually flat in busi-
ness insurance. Our 2010 plan anticipates both current and
prospective pricing action to yield additional premium increases
in 2010 and exceed anticipated loss cost increases, improving
our margins.
2. Improve sales management, particularly in business insurance
Our retention is sound despite the poor economy, but we need to
INVESTMENT PORTFOLIO
Municipal
Bonds
49.6%
U.S. Government
Agencies & Mortgage Backed
Securities 22.1%
Notes Receivable 3.2%
U.S. Treasury Securities 7.8%
Corporates &
Other Invested Assets 7.0%
Equity
Securities 10.3%
BOND QUALITY
Aaa
66.9%
Aa 27.0%
A 4.8%
Other 1.3%
Compared to 2008, STFC’s investment portfolio in 2009
held substantially fewer municipal bonds, and bonds rated Aaa
made up a larger portion of our portfolio. For the year, STFC’s
investment portfolio performed well relative to market indices and
contributed favorably to the company’s $2.10 growth in book value.
State Auto Financial Corporation
page 3
181640_4pager:Layout 1 3/17/10 9:23 PM Page 4
stimulate new business using our new products, improved
systems, and by continuing to recruit, develop and train our
field account executives.
3. Continue to implement claim initiatives to improve service,
loss ratio and loss adjustment expense results
4. Enhance underwriting productivity to reduce our underwriting
expense ratio Personal insurance is on target, but we have
opportunities in our business insurance operations. We expect
some improvement in our 2010 expense ratio despite ongoing
pressures driven by the economy and a continued soft market.
5. Integrate into our operations the Rockhill Insurance Group
Acquired by State Auto Mutual in February 2009, Rockhill
consists of specialty (admitted and non-admitted) property and
casualty programs and a workers’ compensation subsidiary,
RTW. In 2010 we will write new commercial specialty business
through another Rockhill subsidiary, Risk Evaluation and
Design or RED, which allows us to offer insurance coverages
for the alternative risk transfer market. The results will be
included in the State Auto pool.
6. Continue to grow our book value We remain focused on
underwriting profitabiliy and will continue our conservative
and stable investment and reserving practices.
Successful execution of our short and long term plans remains
largely dependent on the quality and engagement of associates
and agents at State Auto. We set expectations high over the
past two years. Our associates have dealt with new assignments,
changes in their benefit programs, poor catastrophe experience
and underwriting profitability, and an agency plant working hard
to preserve their business in a tough and uncertain economy.
Our agents have been pressured by customer concerns about the
cost of insurance and their business viability, a shrinking
premium base, eroding profit margins, soft pricing – and quite a
few changes from their partners at State Auto.
Through this, we remained task-focused, improved service
levels, rolled out new products and systems on time, exceeded
our production goals and maintained superior relationships.
This wasn’t easy, but our people have risen to the task. I’m
proud of them and privileged to lead such a talented group and
to be part of a team with such great prospects for the future.
RobeRt P. ReStRePo JR.
Chairman of the board, President
and Chief executive officer
15%
10%
5%
0%
-5%
State
Auto
ISO
Personal Lines Direct Written
Premium Growth Comparison
2007
0.4%
-0.1%
2008
12.9%
-0.1%
2009
12.7%
-0.6%
State Auto Personal Lines Direct Written
Premium Growth
Personal Lines Insurer Written Premium
Growth (2009 results through 3rd qtr.)
[Source: ISO]
Claims Performance
Comparison of survey results from State Auto insureds
who had submitted claims in 2008 and 2009 (4,000
respondents in each year). The overall rating percentage
represents those who answered “above average” or
“excellent” to the question, “How would you rate our
claims service.”
2008
2009
Were you treated in a fair manner?
97.0% 97.8%
Were you treated in a friendly and
courteous manner?
98.2% 98.7%
Was your claim handled in a
timely fashion?
95.6% 96.9%
How would you rate our
claims service?
92.6% 94.5%
State Auto has always been noted for its superior claims
service. This survey, which showed a slight year over year
improvement, demonstrates that the company’s territorial
reorganization and claims process automation is producing
the desired results.
State Auto Financial Corporation
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, 2009 or
For the transition period from
to
Commission File Number 000-19289
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 whether the Registrant has submitted electronically and posted on its corporate Web site, if any,
every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes ‘ 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, 2009, 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 $251,721,820.
On February 26, 2010, the Registrant had 39,871,374 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 7, 2010 (the
“2010 Proxy Statement”), which will be filed within 120 days of December 31, 2009, 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, 2009
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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Reserved . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
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
11
12
24
24
24
24
25
27
28
88
89
89
138
138
138
139
139
139
140
140
140
154
155
156
(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, 2009, 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 Lawrence A. Adeleye, Assistant 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”), and Stateco Financial
Services, Inc. (“Stateco”);
“State Auto Mutual” or “our parent company” refers to State Automobile Mutual Insurance Company,
which owns approximately 63.5% of STFC’s outstanding common shares;
The “Pooled Companies” or “our Pooled Companies” refer to State Auto P&C, Milbank, Farmers, SA Ohio,
effective January 1, 2010 SA National (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 Mutual Fire 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;
The “Rockhill Insurance Group” refers to Rockhill Holding Company, its insurance subsidiaries, namely
Rockhill Insurance Company, Plaza Insurance Company, American Compensation Insurance Company
and Bloomington Compensation Insurance Company, its subsidiary Risk Evaluation & Design, LLC
(“RED”), which acts as a managing general underwriter, and its other non-insurance subsidiaries; 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, and Stateco, which provides investment management services to
affiliated insurance companies. Our operations are headquartered in Columbus, Ohio.
Our parent company is State Auto Mutual, an Ohio domiciled super-regional mutual property and casualty
insurance company organized in 1921. It owns approximately 63.5% of State Auto Financial’s outstanding
common shares. State Auto Mutual also owns 100% of SA Florida and SA Wisconsin, each of which is a
property and casualty insurance company, and 100% of MIGI, a holding company which owns 100% of
Meridian Security, a property and casualty insurance company. MIGI is a party to an affiliation agreement with
Meridian Citizens Mutual, a mutual property and casualty insurance company. In 2007, MIGI acquired 100% of
the Beacon Insurance Group and State Auto Mutual affiliated with the Patrons Insurance Group. All of the
companies in the Beacon Insurance Group and Patrons Insurance Group are property and casualty insurers.
The State Auto Group markets a broad line of property and casualty insurance products through independent
insurance agencies primarily in the Midwestern, Southern, Southwestern, and Eastern states. Our products
include standard personal and commercial automobile, nonstandard personal automobile, homeowners and
farmowners, commercial multi-peril, workers’ compensation, commercial general
liability and property
insurance. Our Pooled Companies and SA National are rated A+ (Superior) by the A.M. Best Company.
(b) Financial Information about Segments
Our 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 of this Form 10-K “Management’s Discussion and Analysis of Financial Condition and Results of
Operations—Overview” and Note 16 to our Consolidated Financial Statements included in Item 8 of this
Form 10-K.
(c) Narrative Description of Business
Property and Casualty Insurance
Pooling Arrangement
Our Pooled Companies are parties to a quota share reinsurance agreement which we refer to as 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. See the detailed discussion of our Pooling
Arrangement at Item 7 of this Form 10-K, “Management’s Discussion and Analysis of Financial Condition and
Results of Operations—Pooling Arrangement.”
Management Agreement
Through various management and cost sharing agreements, State Auto P&C provides the employees to
perform all organizational, operational and management functions for the State Auto Group while State Auto
Mutual provides certain operating facilities, including our corporate headquarters.
2
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, 2010, the State Auto Group marketed its products in 34 states and the District of Columbia
through independent insurance agencies. Other than a managing general underwriting arrangement with our
affiliate RED, none of the companies in the State Auto Group has any contracts with managing general agencies.
See Item 7 of this Form 10-K, “Management’s Discussion and Analysis of Financial Condition and Results of
Operations—Overview.”
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; and incentives related to profit and growth. In addition, we share the cost of approved
advertising with selected agencies.
We actively help our agencies develop the 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 regional
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.
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. 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 2009, STFC received premiums on products marketed in Alabama, Arizona, Arkansas, Colorado,
Connecticut, Delaware, District of Columbia, 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 2009, the ten states that contributed the greatest percentage of our direct
premiums written were as follows: Ohio (15.8%), Kentucky (9.5%), Indiana (6.4%), Tennessee (6.3%), Texas
(5.1%), Pennsylvania (4.6%), Minnesota (4.5%), Maryland (4.3%), Arkansas (4.1%) and West Virginia (3.7%).
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.
3
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 $100,000 or above are sent to our home office to be supervised by claims
division specialists. Regions 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. See Item 7 of this Form 10-K, “Management’s Discussion and Analysis of Financial
Condition and Results of Operations—Acquisition and Operating Expenses.”
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 estimate 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 revise 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
reserves for financial statement purposes. For additional information regarding our reserves, see Item 7 of this
Form 10-K, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Loss
and LAE.”
4
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
2009
2008
2007
Loss and loss expenses payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less: Reinsurance recoverable on losses and loss expenses payable(1) . . . . . . . . . . .
$791.2
21.2
658.3
11.2
674.5
13.5
Net losses and loss expenses payable(2)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Impact of pooling change, January 1, 2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Provision for losses and loss expenses occurring:
770.0
—
661.0
647.1
51.3 —
Current year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Prior years(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
899.5
(56.2)
874.0
(27.3)
645.5
(54.7)
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
843.3
846.7
590.8
Loss and loss expense payments for claims occurring during:
Current year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Prior years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
524.8
269.1
518.7
256.4
368.7
236.0
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
793.9
775.1
604.7
End of Year:
Net losses and loss expenses payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . .
Add: Reinsurance recoverable on losses and loss expenses payable(4)
819.4
20.8
770.0
21.2
647.1
11.2
Losses and loss expenses payable(5) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$840.2
791.2
658.3
(1)
(2)
(3)
(4)
(5)
Includes amounts due from affiliates of $0.6 million, $1.2 million, and $2.7 million at beginning of year 2009, 2008, and 2007,
respectively.
Includes net amounts assumed from affiliates of $343.0 million, $257.2 million, and $281.7 million at beginning of year 2009, 2008, and
2007, 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 “2009 Compared to 2008—Loss and LAE” and “2008 Compared to 2007—Loss and LAE.”
Includes amounts due from affiliates of $0.1 million, $0.6 million, and $1.2 million at end of year 2009, 2008, and 2007, respectively.
Includes net amounts assumed from affiliates of $346.2 million, $343.0 million, and $257.2 million at end of year 2009, 2008, and 2007,
respectively.
The following table sets forth our development of reserves for losses and loss expenses from 1999 through
2009. “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, 2009, we have paid 110.8% of
the losses and loss expenses that had been incurred but not paid, as estimated at December 31, 1999.
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.
The amounts on the “cumulative redundancy (deficiency)” line represent the aggregate change in the
estimates over all prior years. For example, the year end 1999 reserve has developed $67.0 million or 30.2%
5
deficient through December 31, 2009. This $67.0 million amount has been included in operating results over the
ten years and did not have a significant effect on income in any one year.
In evaluating the information in the table, it should be noted that each amount includes the effects of all
changes in amounts for prior periods. For example, the amount of the redundancy or deficiency evaluated at
December 31, 2001, on claims incurred in 1999 includes the cumulative redundancy or deficiency for years 1999,
2000 and 2001. Conditions and trends that have affected the development of the liability in the past may not
necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate future redundancies or
deficiencies based on this table.
In 1999, 2000 and 2001, the Pooling Arrangement was amended to increase our share of premiums, losses
and expenses. An amount of assets equal to the increase in net liabilities was transferred to us from our parent
company in 1999, 2000 and 2001 in conjunction with each year’s respective pooling change. In 2005, the MIGI
Insurers were added to the pool and our share of their net liabilities and assets were transferred to us from them.
In 2008, Beacon National, the Patrons Insurance Group, State Auto middle market business and voluntary
assumed reinsurance from parties affiliated with State Auto Mutual were added to the pool and accordingly net
assets equal to the increase in net liabilities were transferred to us from them. The amount of the assets
transferred on the reserve liabilities assumed in 1999, 2000, 2001, 2005 and 2008 has been netted against and has
reduced the cumulative amounts paid for years prior to 1999, 2000, 2001, 2005 and 2008, respectively.
6
($ millions)
Years Ended December 31
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Net liability for losses and loss
expenses payable . . . . . . . . . . . . .
$221.7
$236.7
$509.9
$592.1
$628.8
$ 655.9
$ 711.3
$ 661.0
$ 647.1
$ 770.0
$ 819.4
Paid (cumulative) 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 . . . . . . . . . . . . .
5.9% 43.4% 41.2% 36.7%
41.8%
43.0% 52.7% 65.3% 60.8% 53.2%
71.9% 79.9% 78.4% 71.4% 63.3%
86.9% 95.5% 84.4% 77.3% 70.6%
96.1% 101.6% 88.5% 82.3% 74.3%
99.0% 107.0% 92.3% 85.1% 76.0%
102.4% 112.2% 94.7% 86.4%
106.0% 116.4% 95.9%
109.3% 117.9%
110.8%
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 . . . . . . . . . . . . .
97.5% 125.7% 102.4% 99.7% 96.5%
119.1% 129.1% 105.1% 100.6% 93.2%
120.3% 133.1% 106.9% 98.8% 91.0%
123.2% 136.1% 106.2% 98.5% 90.6%
126.7% 135.6% 107.1% 98.8% 89.8%
127.9% 138.2% 107.7% 98.4% 89.7%
128.9% 140.1% 107.4% 98.6%
131.1% 139.5% 107.6%
130.6% 139.6%
130.2%
Cumulative redundancy
31.6%
48.4%
59.6%
66.1%
69.2%
34.9%
51.1%
60.9%
66.0%
34.9%
50.5%
60.4%
31.7%
49.4%
34.9%
—
93.3%
87.6%
86.9%
86.2%
85.5%
89.9%
86.4%
85.6%
85.3%
91.7%
90.5%
88.8%
95.8%
93.7%
92.7%
—
(deficiency) . . . . . . . . . . . . . . . . .
$ (67.0)
$ (93.7)
$ (38.9)
$
8.5
$ 64.5
$
95.0
$ 104.9
$
73.8
$
40.7
$
56.2
Cumulative redundancy
(deficiency) . . . . . . . . . . . . . . . . .
(30.2%)
(39.6%)
(7.6%)
1.4% 10.3%
14.5%
14.5%
11.2%
6.3%
7.3%
—
—
. . . . .
Gross* liability—end of year
Reinsurance recoverable . . . . . . . . .
Net liability—end of year . . . . . . . .
$438.8
$217.1
$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
$1,293.2
$ 473.8
$ 819.4
Gross liability
re-estimated—latest . . . . . . . . . . .
118.3% 125.1% 107.7% 99.4% 92.6%
89.3%
88.4%
91.5%
96.1%
94.5%
Reinsurance recoverable
re-estimated—latest . . . . . . . . . . .
Net liability re-estimated—latest . . .
106.2% 109.5% 108.8% 101.3% 98.6%
130.2% 139.6% 107.6% 98.6% 89.8%
96.2%
85.5%
94.0%
85.3%
96.2%
88.8%
100.1%
93.7%
97.7%
92.7%
—
—
—
*
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:
Reinsurance recoverable . . . . . . . . .
Amount netted against assumed
$217.1
$220.5
$233.8
$270.3
$305.2
$350.5
$399.8
$371.7
$382.8
$428.6
$473.8
from State Auto Mutual . . . . . . . .
Net reinsurance recoverable . . . . . .
$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
$453.0
$ 20.8
Reinsurance
Members of the State Auto Group follow the customary industry practice of reinsuring a portion of their
exposures and paying to the reinsurers a portion of the premiums received. Insurance is ceded principally to
reduce net liability on individual risks or for individual loss occurrences, including catastrophic losses. Although
reinsurance does not legally discharge the individual members of the State Auto Group from primary liability for
the full amount of limits applicable under their policies, it does make the assuming reinsurer liable to the extent
of the reinsurance ceded. See the detailed discussion of our reinsurance arrangements at Item 7 of this
7
Form 10-K, “Management’s 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 applicable terrorism
acts.
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 state 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
December 31, 2009, adjusted for dividend payments made in the previous twelve-month period, a total of $68.2
million is available in 2010 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 $11.5 million,
$39.0 million, and $50.0 million in 2009, 2008, and 2007, respectively, from its insurance subsidiaries.
8
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 2009 which would materially impact
our business.
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 is used by the
companies in underwriting and rate setting in this line of business. We understand that the results of this data
intensive study are tentatively expected in late 2010, though no specific release date has been published by the
FTC. Upon release,
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.
the results of the study could affect
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, 2009, each insurer affiliated with us had adequate levels of capital as defined by the NAIC 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
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. Our current property reinsurance treaties
exclude certified acts of terrorism.
9
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.
For additional discussion regarding our investments, including the market risks related to our investment
portfolio, 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 26, 2010, we had 2,226 employees. Our employees are not covered by any collective
bargaining agreement. We consider the relationship with our employees to be very good.
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.
10
Executive Officers of the Registrant
Name of Executive Officer and
Position(s) with Company
Age(1)
Principal Occupation(s)
During the Past Five Years
Robert P. Restrepo, Jr.,
. . . . . .
59
Chairman, President and
Chief Executive Officer
Mark A. Blackburn, . . . . . . . . .
Executive Vice President
and Chief Operating Officer
58
Steven E. English,
. . . . . . . . . .
49
Vice President and Chief
Financial Officer
James E. Duemey,
. . . . . . . . . .
63
Vice President and
Investment Officer
Clyde H. Fitch, Jr., . . . . . . . . . .
Senior Vice President and
Chief Sales Officer
Cynthia A. Powell, . . . . . . . . . .
Vice President and Treasurer
59
49
Lorraine M. Siegworth,
. . . . . .
42
Vice President
James A. Yano,
. . . . . . . . . . . .
58
Vice President, Secretary
and General Counsel
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 Group, a
property and casualty insurance 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, 2010.
(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.
11
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, 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 developments 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, reducing 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 cause volatility in our results of operations and could
materially reduce our level of 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 level of profitability or harm our financial condition,
which in turn could adversely affect our ability to write new business. 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
losses from less severe
insured exposure in the affected area. Accordingly, we can sustain significant
12
catastrophes, such as localized windstorms, when they affect areas where our insured exposure is concentrated.
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. In the last three years, the largest catastrophe or series of catastrophes affecting STFC’s results of
operations in any one year were as follows: 2009 with losses from two winter storms in the South and Midwest
resulting in approximately $41.1 million in pre-tax losses; 2008 with losses from Hurricane Ike as it travelled
through the Midwest resulting in approximately $44.1 million in pre-tax losses; and 2007 with losses from a hail
storm in early June causing $10.8 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.
Along with others in the industry, we utilize catastrophe models developed by third party vendors to help
assess and manage our exposure to catastrophe losses. Such models assume various conditions and probability
scenarios and use historical information about catastrophic events, along with detailed information about our
business. There are limitations to the usefulness of such models and they do not necessarily accurately predict
future losses. Climate change, to the extent it affects changes in weather patterns, could impact the frequency or
severity of weather events. Our ongoing catastrophe management efforts could negatively impact growth to the
extent constraints on property exposures are deemed necessary in certain territories.
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;
13
•
•
•
•
•
•
•
•
•
•
•
•
our ability to establish and consistently follow appropriate underwriting guidelines;
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;
unanticipated court decisions, legislation or regulatory action;
unanticipated changes or execution problems in our claim settlement practices;
changing driving patterns for auto exposures; changing weather patterns (including those which may be
related to climate change) 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, labor and other expenditures;
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
14
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.
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.
ECONOMIC CONDITIONS
The current and future difficult economic conditions can adversely affect our business, results of
operations and financial condition.
Current economic conditions and any further economic declines 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 economic slowdowns on our business and results of operations,
our business may be impacted in a variety of ways.
The economy has caused a number of 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. Vacated homes and business properties pose
increased insurance industry risk.
Volatility and weakness in the financial and capital markets may 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, key vendors and suppliers, reinsurers or banks, which
increases our credit risk and other counterparty risks. Bankruptcies among our current business insurance
customers can negatively affect our retention. Reductions in new business start-ups may negatively affect the
number of future potential business insurance customers.
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 economic downturns. These actions may increase the cost of doing business in these states. Economic
strains on states and municipalities could result in downgrades or defaults of certain municipal obligations.
In response to economic conditions, the United States federal government and other governmental and
regulatory bodies have taken action and are considering taking additional actions to address such conditions.
There can be no assurance as to what impact such actions or future actions will have on the financial markets,
economic conditions or our Company.
15
In addition, the current stimulus spending and monetary policies or other factors may cause the rate of
inflation to increase in the future. Inflation can have a significant negative 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. Premium rates may prove to be inadequate due to low trend assumptions arising from the
use of historical data. Even when general inflation is relatively modest, price inflation on the goods and services
purchased by insurance companies in settling claims can steadily increase. Reserves may develop adversely and
become inadequate. Retentions and deductibles may be exhausted more quickly. Interest rate increases in an
inflationary environment could cause the values of our fixed income investments to decline.
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
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.
DIVIDENDS
Although we have a history of paying cash dividends, there can be no assurance that we will continue or
be able to pay cash dividends in the future.
We have a history of consistently paying cash dividends to our shareholders. However, the future payment
of cash dividends will depend upon a variety of factors, such as our results of operations, financial condition and
cash requirements, as well as the ability of our insurance subsidiaries to make distributions to STFC. State
insurance laws restrict the payment of dividends by insurance companies to their shareholders. In addition,
competitive pressures generally require insurance companies to maintain insurance financial strength ratings.
Such restrictions and other requirements and factors affect the ability of our insurance subsidiaries to make
dividend payments to STFC. Limits on the ability of our insurance subsidiaries to pay dividends could adversely
affect our liquidity, including our ability to pay cash dividends to shareholders.
DISTRIBUTION SYSTEM
The independent agency system is the primary 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 88 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 decade 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
16
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 executing 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 distribution 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
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.
investment
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.
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
17
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 taxation, or repeal of McCarran-Ferguson Act
(which largely exempts the insurance industry from the federal antitrust laws), could significantly impact the
insurance industry and us.
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. For example, concerns over climate change may prompt
federal, state or local laws intended to protect the environment. 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, personnel and human resources, 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.
Tax legislation initiatives or challenges to our tax positions could adversely affect our results of
operations and financial condition.
We are subject to the tax laws and regulations of the U.S. federal, state and local governments. From time to
time, various legislative initiatives may be proposed that could adversely affect our tax positions. There can be
no assurance that our effective tax rate or tax payments will not be adversely affected by these initiatives. In
addition, U.S. federal, state and local tax laws and regulations are extremely complex and subject to varying
interpretations. There can be no assurance that our tax positions will not be challenged by relevant tax authorities
or that we would be successful in any such challenge.
REALIZATION OF DEFERRED INCOME TAX ASSETS
If some or all of our deferred tax assets will not be realized, we will be required to establish a valuation
allowance against the deferred income tax asset, which could have a material adverse effect on our results of
operations and financial condition.
Deferred tax assets and liabilities represent the tax effect of the differences between the financial statement
carrying value of existing assets and liabilities and their respective tax basis. At December 31, 2009, we have net
deferred federal income tax assets of $75.9 million, consisting of deferred tax assets of $150.7 million and
deferred tax liabilities of $74.7 million. Deferred tax assets are reduced by a valuation allowance if, based on the
weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be
realized. At December 31, 2009, we held no valuation allowance on our net deferred tax assets.
18
The determination of the valuation allowance for deferred tax assets requires us to make certain judgments
and assumptions. In evaluating the ability to recover deferred tax assets, we consider all available evidence in
determining the realizability of the net deferred tax assets including loss carryback potential, past operating
results, existence of cumulative losses in the most recent years, projected performance of the business, future
taxable income, including the ability to generate capital gains, and prudent and feasible tax planning strategies. In
the event we determine that we most likely would not be able to realize all or part of our deferred tax assets in the
future, we would be required to establish a valuation allowance with a charge to earnings and/or other
comprehensive income in the period such determination is made. Our judgment and assumptions are subject to
change given the inherent uncertainty in predicting future performance or realizing tax planning strategies, which
is impacted by such things as severity and frequency of catastrophe losses, current premium rate environment,
investment market conditions, and planned loss and expense control initiatives that might not be realized.
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.
There are concerns that the focus on climate change and global warming could effect court decisions or
result in litigation, including potential matters arising from federal, state or local laws intended to protect the
environment.
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
19
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.
TECHNOLOGY AND AUTOMATION
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 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. An ongoing challenge during system development
and enhancement is the effective and efficient 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 those carriers that have greater
resources than we. 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 effectively execute and 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. Future increases in interest rates
could cause the values of our fixed income portfolios to decline, with the magnitude of the decline depending on
the duration of our portfolio. Individual securities in our fixed-income portfolio are subject to credit risk and
default. 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,
20
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 of fixed income securities or a decline in the fair value of
equity securities 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.
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 a majority of our
investment portfolio 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, train, develop and retain talented, diverse 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 execute and effectively 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 execute, 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
information technology,
facilities, a power outage, a pandemic, or a failure of one or more of our
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
21
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.
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 our parent State Auto Mutual have acquired or affiliated with other
insurance companies, most recently the 2009 acquisition of the Rockhill Insurance Group by State Auto Mutual.
It is anticipated that we and State Auto Mutual will continue to pursue acquisitions or affiliations of other
insurance companies in the future.
Insurance company acquisitions and affiliations involving State Auto Mutual generally do not have a
material financial impact on State Auto Financial unless and until the target insurers are added to our Pooling
Arrangement.
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. There is no assurance that any businesses
acquired in the future will be successfully integrated. Ineffective integration may adversely affect our results and
our ability to compete. Also, the acquired business may not perform as projected and anticipated cost savings and
other synergies may not be realized.
22
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 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.
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, 2009, our parent company owned approximately 63.5% 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 efficiently execute and 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.
23
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, some 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
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. Reserved
24
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 26, 2010, there were 1,384 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:
2009
High
Low
Dividend
First Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Second Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Third Quarter
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fourth Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$30.25
18.64
18.56
18.92
$14.29
14.75
15.62
15.54
$0.15
0.15
0.15
0.15
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
(1) Adjusted for stock splits.
On March 5, 2010, the Board of Directors of State Auto Financial declared a cash dividend of $0.15 per
share. The dividend is payable on March 31, 2010, to shareholders of record on March 15, 2010. 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. Under this program, which ended on December 31, 2009, State Auto Financial
repurchased 2,028,116 common shares at an average purchase price of $27.26 per share for a total of $55.3
million. These shares were purchased from the public and from State Auto Mutual in amounts that were
proportional to its ownership percentage in the Company, which was approximately 64%.
25
Performance Graph
The line graph below compares the total return on $100 invested on December 31, 2004, 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
2004
2005
2006
2007
2008
2009
STFC
NASDAQ Index
NASDAQ Ins. Index
STFC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
NASDAQ Index . . . . . . . . . . . . . . . . . . . . . .
NASDAQ Ins. Index . . . . . . . . . . . . . . . . . .
100.000
100.000
100.000
142.089
102.090
110.873
136.633
112.640
126.092
105.587
124.613
127.199
123.091
75.018
115.023
78.471
109.046
118.865
12/31/2004
12/31/2005
12/31/2006
12/31/2007
12/31/2008
12/31/2009
26
Item 6. Selected Consolidated Financial Data
(dollars and shares in millions, except per share data)
Year ended December 31:
2009
2008*
2007
2006
2005*
Statement of Income Data—
GAAP Basis:
Earned premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income (loss)
Earned premium growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . .
Return on average invested assets(1)
$1,176.5
1,126.0
$
82.1
87.4
$1,256.9
1,181.9
10.2
$
(31.1)
4.5% 11.3
3.9% 4.1
1,011.6
84.7
1,113.4
119.1
(1.2)
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
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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$2,179.1
1,941.3
$2,564.5
2,443.6
$ 117.2
117.6
$ 849.4
761.0
39.8
39.5
1.3% (3.7)
12.1% 13.4
2,021.2
2,337.9
118.0
935.5
40.5
13.5
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
Per Common Share Data—
GAAP Basis:
Basic EPS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Diluted EPS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash dividends per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Book value per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
0.26
$
0.25
0.60
$
$ 21.33
Common Share Price:
High . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Low . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Close at December 31 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Close price to basic EPS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Close price to book value per share . . . . . . . . . . . . . . . . . . . . .
$ 30.25
$ 14.29
$ 18.50
71.15
0.87
(0.78)
(0.78)
0.60
19.23
37.08
17.38
30.06
(38.54)
1.56
GAAP Ratios:(3)
Loss and LAE ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expense ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Combined ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Statutory Ratios:(3)
Loss and LAE ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expense ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Combined ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . .
Net premiums written to surplus(4)
71.7% 75.2
34.1% 34.6
105.8% 109.8
71.3% 74.8
33.5% 33.1
104.8% 107.9
1.6
1.5
2.90
2.86
0.50
23.10
35.22
23.99
26.30
9.07
1.14
58.4
34.4
92.8
57.9
33.2
91.1
1.1
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
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
1.5
(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.
(4) 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.
*
27
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. This discussion should be read in conjunction with the consolidated financial statements and notes
thereto included in Item 8 of this Form 10-K, and the “Narrative Description of Business” contained in Item 1 of
this Form 10-K.
OVERVIEW
State Auto Financial is a property and casualty insurance holding company. Our insurance subsidiaries are
part of the State Auto Group and Pooling Arrangement described below. State Auto Mutual owns approximately
63.5% of State Auto Financial’s outstanding common shares. Our Pooled Companies and SA National (which
joined the Pooling Arrangement on January 1, 2010) write personal and business insurance through independent
agencies primarily in Midwestern, Southern, Southwestern, and Eastern states. Our Pooled Companies and SA
National are rated A+ (Superior) by the A.M. Best Company.
State Auto Financial’s principal subsidiaries are State Auto P&C, Milbank, Farmers, SA Ohio and SA
National, each of which is a property and casualty insurance company, and Stateco, which provides investment
management services to affiliated insurance companies.
Our reportable segments are personal insurance, business insurance (collectively the “insurance segments”
or “our insurance segments”) and investment operations. These segments reflect the manner in which we manage
our business and report our results internally to our principal operating decision makers. 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 &
allied lines, other & 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 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 16 to our
Consolidated Financial Statements included in Item 8 of this Form 10-K.
Rockhill Insurance Group
In February 2009, State Auto Mutual completed its acquisition of the Rockhill Insurance Group. The
insurers in the Rockhill Insurance Group write specialty property and casualty insurance, with key product lines
that include commercial property, general liability for residential construction, commercial umbrella, surety,
program, professional and environmental. In addition, its subsidiary RED acts as a managing general underwriter
for a variety of property and casualty coverages in the alternative risk transfer market.
In 2010, the State Auto Group will write new commercial specialty business through RED, which will allow
the State Auto Group to offer insurance coverages for the alternative risk transfer market for business products
such as general liability, auto liability, workers’ compensation, property, inland marine, auto physical damage
and miscellaneous professional. The insurance coverages written by our Pooled Companies through RED are
subject to the Pooling Arrangement.
28
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.
•
•
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. In the current cycle, it appears that business
exposures are contracting due to reduced payrolls and inventories, resulting in price pressure. For
personal lines, it appears that rising claim costs are resulting in opportunities to establish more
favorable underwriting terms. We have been monitoring this situation for each of our lines of business
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 83.8% of our total portfolio at fair value at
December 31, 2009, 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. We regularly monitor the duration
of our fixed maturity portfolio. In our monitoring process we take into account market expectations
regarding future interest rates and inflation. Our internally managed equity portfolio, which comprised
8.6% of our total portfolio at fair value at December 31, 2009, emphasizes large-cap, dividend-paying
companies selected based upon their potential for appreciation as well as ability to continue paying
dividends. Since 2007, we have diversified our equity portfolio and utilized outside managers to invest
in U.S. small-cap equities and international equity funds. Diversifying our portfolio into small-cap
equities and international equity funds was designed to achieve a greater total return with reduced
volatility. In 2008, almost all asset classes experienced a decline in fair value, and our portfolio was not
immune to this broad-based decline. During 2009, as the stock market recovered above its 2008 level,
the fair value of our equity portfolio improved. 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.
29
•
•
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
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 and applying mandatory specific peril deductibles for some states. 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 34 states and the District of Columbia as of
December 31, 2009. As we begin 2010, 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 43% at December 31, 2009. Our management strategies are
designed to mitigate our exposure to catastrophes.
In addition to 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 contact them within two hours of a claim being assigned to a claims handler (except in
catastrophe loss situations). To enhance our response to policyholders in catastrophe loss situations, we
establish internal claims catastrophe teams.
Independent Insurance Agent Network: We believe the success of our independent insurance agent
network, which is our primary 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
30
•
•
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.
Technology: Our technology efforts are focused on making us as efficient and effective as possible.
During 2009, we continued our personal lines strategy of integrating external data directly into our
netXpressSM portal by significantly expanding the portfolio of third parties with whom we can extract
data. We also have taken advantage of industry-wide data standards and commonly used agent systems
to provide enhanced functionality to our agents, who have rewarded us with increased quote
opportunities and submissions. We also completed the production of a new homeowners product which
will be rolled out state by state in 2010 and 2011.
technology teams delivered a more sophisticated
In 2009, our business insurance segment
businessowners product to the marketplace. This new product will be rolled out to the majority of our
states in 2010. We also made further developments in our predictive modeling technology and
integrated these into our standard business flows so that we can use this new functionality when
underwriting the majority of our new and renewal business.
Project management and quality assurance efforts continue to mature and provide value. Investments in
enterprise architecture were also made to aid Information Technology Governance and to support our
ability to reach efficiency goals set by us. Construction of a new data center by State Auto Mutual was
completed in December 2009. This state of the art facility provides the State Auto Group a reliable
infrastructure designed to scale with the future business requirements of our Company. Migration of
computing activities to this facility will commence in 2010.
Innovate SA: In 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 were approved for implementation. The implementation of these actions began in 2009 and is
expected to continue through 2011.
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 in accumulated other comprehensive income
(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.
31
We regularly monitor our investment portfolio for declines in value that are other-than-temporary impaired
(“OTTI”), an assessment that 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 the following factors when assessing our equity securities and other
invested assets for OTTI: (1) the length of time and/or the significance of decline below cost; (2) our ability and
intent to hold these securities through their recovery periods; (3) the current financial condition of the issuer and
its future business prospects; and (4) the ability of the market value to recover to cost in the near term. We
recognize OTTI charges on our externally managed small-cap equity portfolio and a segment of our large-cap
portfolio, as 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 an equity security or other invested asset 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 accumulated
other comprehensive income (loss).
We also consider the following factors when assessing our fixed maturities investments for OTTI: (1) the
financial condition of the issuer including receipt of scheduled principal and interest cash flows; (2) our intent to
sell; and (3) if it is more likely than not that we will be required to sell the investments before recovery. When a
fixed maturity has been determined to have an other-than-temporary impairment, the impairment charge is
separated into an amount representing the credit loss, which is recognized in earnings as a realized loss, and the
amount related to non-credit factors, which is recognized in accumulated other comprehensive income (loss).
Future increases or decreases in fair value, if not other-than-temporary, are included in accumulated other
comprehensive income (loss).
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. Future changes in estimates, the most significant of which is
expected losses and loss adjustment expenses, that indicate a reduction in expected future profitability may result
in unrecoverable deferred policy acquisition costs. We have not recorded any significant changes in estimates for
the years ended December 31, 2009, 2008 and 2007, respectively.
Losses and Loss Expenses Payable
Our loss and loss expense payables are reserves which 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
32
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.
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
historical and statistical
legal developments, storm loss estimates and economic
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.
33
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
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. 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, 2009, was $882.5 million, within an
estimated range of $812.6 million to $901.5 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 other
loss and loss expenses payable tables included elsewhere within this Form 10-K.)
34
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
point of the range, $901.5 million, the reserve increase of $19.0 million corresponds to an after-tax decrease of
$12.4 million in net income. Likewise, should ultimate losses decline to a level corresponding to the low point of
the range, $812.6 million, the $69.9 million reserve decrease would add $45.4 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, 2009, 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 $68.8 million on reserves, or a $44.7 million reduction to net income, assuming a tax rate of 35%.
Inflation changes have much more impact on the longer tail commercial lines like other & product liability and
workers’ compensation, and much less impact on the shorter tail personal lines’ reserves.
In addition to establishing Loss and ALAE Reserves, as described above, we establish reserves for loss
adjustment expenses related to functions and costs that are not attributable to a specific claim, which is called
Unallocated Loss Adjustment Expense (“ULAE”). Historical patterns of paid ULAE relative to paid loss are
analyzed along with historical claim counts including claims opened, claims closed, and claims remaining open.
The product of this analysis is an estimate of the relationship, or ratio, between ULAE and loss underlying the
current loss reserves. This ratio is applied to the current outstanding loss reserves to estimate the required ULAE
reserve. Consequently, this component of the loss expense reserve has a proportional relationship to the overall
claim inventory and held loss reserves. The method assumes that the underlying claims process and mix of
business do not change materially over time.
35
The following table provides a reconciliation of MBE of our direct Loss and ALAE Reserve to our net loss
and loss expenses payable at December 31, 2009 and 2008, respectively. The STFC Pooled Companies net
additional share of transactions assumed from State Auto Mutual through the Pooling Arrangement for the years
ended December 31, 2009 and 2008, respectively, has been reflected in the table below as assumed by STFC
Pooled Companies:
($ millions)
Direct Loss and ALAE Reserve:
STFC Pooled Companies and SA National . . . . . . . . . . . . . . . . . . . . . . . . .
Assumed by STFC Pooled Companies . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total direct Loss and ALAE Reserve . . . . . . . . . . . . . . . . . . . . . . . . . .
Direct 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 . . . . . . . . . . . . . . . . . .
2009
2008
$488.0
394.5
882.5
440.5
411.3
851.8
26.6
24.5
51.1
(25.0)
(8.3)
(33.3)
(20.8)
4.4
(64.5)
24.9
24.3
49.2
(22.0)
(9.5)
(31.5)
(21.2)
4.8
(83.1)
Total losses and loss expenses payable, net of reinsurance
recoverable on losses and loss expenses payable of $20.8 in 2009
and $21.2 in 2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$819.4
770.0
The following tables present the loss and loss expenses payable by major line of business at December 31,
2009 and 2008, respectively:
($ in millions)
December 31, 2009
Personal insurance segment:
Standard auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Nonstandard auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Homeowners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other personal
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total personal
Business insurance segment:
Commercial auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial multi-peril
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fire & allied lines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other & product liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Workers’ compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total losses and loss expenses payable net of reinsurance recoverable
Ending
Loss &
ALAE
Case &
Formula
Ending
Loss &
ALAE
IBNR
Ending
ULAE
Bulk
Total
Reserves
$149.8
15.5
45.3
9.8
220.4
45.4
35.1
28.1
57.6
48.5
3.5
218.2
54.3
3.2
27.9
3.3
88.7
43.5
49.1
4.7
94.1
47.4
2.2
241.0
12.2
1.5
2.5
0.3
16.5
4.8
5.1
1.0
15.4
7.9
0.4
34.6
216.3
20.2
75.7
13.4
325.6
93.7
89.3
33.8
167.1
103.8
6.1
493.8
on losses and loss expenses payable . . . . . . . . . . . . . . . . . . . . . . . . . . .
$438.6
329.7
51.1
819.4
36
See discussion in “Results of Operations 2009 Compared to 2008-Loss and LAE” section included in this
Item 7.
($ in millions)
December 31, 2008
Ending
Loss &
ALAE
Case &
Formula
Ending
Loss &
ALAE
IBNR
Ending
ULAE
Bulk
Total
Reserves
Personal insurance segment:
Standard auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Nonstandard auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Homeowners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other personal
$133.5
15.1
44.0
9.7
Total personal
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
202.3
Business insurance segment:
Commercial auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial multi-peril
Fire & allied lines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other & product liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Workers’ compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
49.4
40.4
33.0
54.7
43.3
3.1
44.2
3.0
21.9
4.4
73.5
39.3
45.4
4.4
84.1
45.7
2.2
Total business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
223.9
221.1
10.8
1.5
2.7
0.5
15.5
4.8
5.7
1.1
13.6
8.1
0.4
33.7
188.5
19.6
68.6
14.6
291.3
93.5
91.5
38.5
152.4
97.1
5.7
478.7
Total losses and loss expenses payable net of reinsurance recoverable
on losses and loss expenses payable . . . . . . . . . . . . . . . . . . . . . . . . . . .
$426.2
294.6
49.2
770.0
See discussion in “Results of Operations 2008 Compared to 2007-Loss and LAE” 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 $2.0 million, and
environmental reserves are $8.6 million, for a total of $10.6 million, or 1.3% of net losses and loss expenses
payable. Asbestos reserves decreased $1.4 million and environmental reserves increased $0.9 million from 2008.
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.
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.
37
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,
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.
including changes in investment returns and interest rates,
To calculate the State Auto Group’s December 31, 2009 benefit obligation for each of the benefit plans, we
used a discount rate of 6.00% based on an evaluation of the expected future benefit cash flows of our benefit
plans used in conjunction with the Citigroup Pension Discount Curve at the measurement date. A lower discount
rate results in, all else being equal, a higher present value of the benefit obligation. To calculate our benefit
obligation at December 31, 2009 and net periodic benefit cost for the year ended December 31, 2010, a discount
rate of 6.00% and an expected long-term rate of return on plan assets of 8.00% were used. We selected an
expected long-term rate of return on our plan assets by considering the mix of investments and stability of
investment portfolio along with actual investment experience during the lifetime of the plans. Our assumptions
regarding the discount rate and expected return on plan assets could have an effect on the amounts related to our
benefit obligations and net periodic benefit cost depending on the degree of change between reporting periods.
The table below provides an illustration of variability with respect to the discount rate on our December 31,
2009, benefit obligation and 2010 expected net periodic benefit cost, along with the variability of the expected
return on plan assets to our 2010 expected net periodic benefit cost.
Holding all other assumptions constant, sensitivity to changes in any one of our key assumptions are as
follows:
($ millions)
Pension
Discount rate
Postretirement
Discount rate
-0.25%
6.00%
+0.25%
-0.25%
6.00%
+0.25%
Benefit obligation . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . .
Net periodic benefit cost
$259.3
13.8
250.0
12.7
241.3
11.7
$99.2
6.9
95.4
6.6
91.8
6.4
Net periodic benefit cost
. . . . . . . . . . . . . . . .
$ 13.3
12.7
12.2
$ 6.7
6.6
6.6
Expected return on plan assets
Expected return on plan assets
-0.25%
8.00%
+0.25%
-0.25%
8.00%
+0.25%
The accumulated benefit obligation (“ABO”) of a defined benefit pension 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 projected benefit obligation
(“PBO”) is the ABO plus a factor for future compensation levels. The ABO, which considers current
compensations level only, provides information about the obligation an employer would have if the plan were
discontinued at the measurement date. At December 31, 2009, the ABO and PBO were $225.4 million and
$250.0 million, respectively. At December 31, 2009 the fair value of the assets of our defined benefit pension
plan was $197.9 million, which resulted in an underfunded status within our balance sheet of $52.1 million. On a
cash flow basis, we target an annual contribution level that meets at least the targeted normal cost of the plan, as
defined by ERISA. Currently, we expect to make a cash contribution to the pension plan up to $15.0 million in
2010.
Our unfunded status on our pension plan decreased from $73.2 million at December 31, 2008, to $52.1
million at December 31, 2009. The factors influencing this decrease are as follows: (1) actual return on our plan
38
assets was a gain of $26.3 million compared to an expected return of $18.4 million for a net decrease to our
obligation and unrecognized actuarial
loss of approximately $7.9 million; and (2) our field and claim
restructuring in 2009 (discussed below) resulted in a plan curtailment gain which reduced our obligation and
unrecognized actuarial loss by approximately $2.2 million. Unrecognized gains and losses arise from additional
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.
Our unfunded status on our postretirement medical plan (“retiree med plan”) decreased from $109.1 million
at December 31, 2008 to $92.8 million at December 31, 2009. The factors influencing this decrease are as
follows: (1) a $5.9 million curtailment gain due to our field and claim restructuring which reduced our obligation
and unrecognized actuarial loss; and (2) additional unrecognized net actuarial gains and loss adjustments arising
from demographic changes and expected to actual claims experience, which at December 31, 2009 had the effect
of decreasing our obligation and unrecognized actuarial loss.
See “2009 Compared to 2008—Acquisition and Operating Expenses” included in this Item 7 for a
discussion regarding the field and claim restructuring and Note 10, “Pension and Postretirement Benefit Plans” to
our Consolidated Financial Statements included in Item 8 of this Form 10-K for further disclosures regarding our
pension and postretirement benefit plans.
In November 2009, we announced to our employees a one-time election to select between two retirement
benefit options: to either continue participation in the existing pension plan with no changes; or to choose a new
“enhanced 401(k)” in which we will contribute 5% of the employee’s annual
income to his/her 401(k)
automatically. Under the enhanced 401(k) option, the employee’s existing accrued pension benefit would become
frozen as of June 30, 2010. Employees hired on, or after January 1, 2010, will not be eligible to participate in the
pension or postretirement health care benefit plans.
Deferred Income Taxes
Deferred income tax assets and liabilities represent the tax effect of the differences between the financial
statement carrying value of existing assets and liabilities and their respective tax basis. Deferred tax assets are
evaluated periodically by management to determine if they are realizable, requiring us to make certain judgments
and assumptions. In evaluating the ability to recover deferred tax assets, we consider all available evidence,
including loss carryback potential, past operating results, existence of cumulative losses in the most recent years,
projected performance of the business, future taxable income, including the ability to generate capital gains, and
prudent and feasible tax planning strategies. If, based on available information, it is more likely than not that the
deferred income tax asset will not be realized,
then a valuation allowance must be established with a
corresponding charge to net income and/or accumulated comprehensive income. No valuation allowance was
held by us at December 31, 2009.
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.
POOLING ARRANGEMENT
The STFC Pooled Companies and the Mutual Pooled Companies, referred to as the “Pooled Companies,”
participate in a quota share reinsurance pooling arrangement referred to as the “Pooling Arrangement.” 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
39
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 (the “2008 pooling changes”):
•
•
•
•
•
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;
Included State Auto middle market business insurance written by State Auto Mutual and Meridian
Security; and
Included voluntary assumed reinsurance from parties affiliated with State Auto Mutual.
In 2010, we made the following changes to the Pooling Arrangement (the “2010 pooling changes”):
•
•
Added SA National to the pool with a participation percentage of 0.0%; and
Included voluntary assumed reinsurance from third parties unaffiliated with the Pooled Companies that
was assumed on or after January 1, 2009 by State Auto Mutual.
In conjunction with the 2010 pooling changes, the STFC Pooled Companies will receive approximately $5.1
million in cash and/or investment securities from State Auto Mutual and its subsidiaries and affiliates, for net
insurance assets transferred on January 1, 2010. The following table presents the impact on our balance sheet on
January 1, 2010, relating to the 2010 pooling changes:
($ millions)
Losses and loss expenses payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unearned premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less:
Deferred policy acquisition costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ (4.0)
(1.4)
(0.2)
(10.3)
Net cash and/or investment securities to be received . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 5.1
40
The following table sets forth a chronology of the participants and their participation percentages in the
Pooling Arrangement since January 1, 2005:
2005 – 2007
2008 – 2009
2010
STFC Pooled Companies:
State Auto P&C . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Milbank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Farmers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
SA Ohio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
SA National
59.0%
17.0
3.0
1.0
N/A
59.0% 59.0%
17.0
3.0
1.0
N/A
17.0
3.0
1.0
0.0
Total STFC Pooled Companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
80.0
80.0
80.0
State Auto Mutual Pooled Companies:
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
State Auto Mutual
SA Wisconsin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
SA Florida . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Meridian Security . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Meridian Citizens Mutual
Beacon National . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Patrons Mutual . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Litchfield . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total State Auto Mutual Pooled Companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
19.5
0.0
0.0
0.0
0.5
N/A
N/A
N/A
20.0
19.0
0.0
0.0
0.0
0.5
0.0
0.4
0.1
20.0
19.0
0.0
0.0
0.0
0.5
0.0
0.4
0.1
20.0
It is not management’s intention to recommend an adjustment to the STFC Pooled Companies’ 80%
the Pooling
participation level
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 $135.0 million. No losses were paid by State Auto P&C under the
Catastrophe Assumption Agreement in 2008 or 2007. The State Auto Group did not renew the Catastrophe
Assumption Agreement upon its expiration on July 1, 2008.
41
RESULTS OF OPERATIONS
Summary
The following table summarizes certain key performance indicators used to manage our operations for the
years ended December 31, 2009, 2008 and 2007, respectively:
($ millions, except per share data)
2009
2008
2007
GAAP Basis:
Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Book value per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . .
Return on average equity(2)
Debt to capital ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loss and LAE ratio(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expense ratio(1)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Combined ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Catastrophe Loss and LAE points(1)
. . . . . . . . . . . . . . . . .
Premium written growth(3) . . . . . . . . . . . . . . . . . . . . . . . . .
Premium earned growth . . . . . . . . . . . . . . . . . . . . . . . . . . .
Investment yield . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
SAP Basis:
Loss and LAE ratio(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expense ratio(4)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Combined ratio(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . .
Net premiums written to surplus(5)
$1,256.9
$
10.2
$ 849.4
$ 21.33
1.3
12.1
71.7
34.1
105.8
1,181.9
(31.1)
761.0
19.23
(3.7)
13.4
75.2
34.6
109.8
7.7% 13.9
5.1% 18.2
4.5% 11.3
3.9%
4.1
71.3
33.5
104.8
1.5
74.8
33.1
107.9
1.6
1,113.4
119.1
935.5
23.10
13.5
11.2
58.4
34.4
92.8
3.7
0.0
(1.2)
4.3
57.9
33.2
91.1
1.1
(1)
See “2009 Compared to 2008” section below for definitions.
(2) Net income (loss) divided by average common stockholders’ equity.
(3)
(4)
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 2008 pooling changes.
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.
(5) 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.
2009 Compared to 2008
For 2009, we reported a pre-tax loss of $12.8 million compared to a pre-tax loss of $75.1 million for 2008.
Revenues increased to $1,256.9 million in 2009 from $1,181.9 million in 2008 while expenses increased to
$1,269.7 million in 2009 from $1,257.0 million in 2008. The following are significant factors that impacted 2009
results compared to 2008:
•
•
•
Earned premiums in 2009 were $1,176.5 million compared to $1,126.0 million in 2008. This growth
was driven by personal lines.
During 2009, we recognized $9.0 million of OTTI on our investment portfolio compared to $39.3
million in 2008. See the “Investment Operations Segment” section included in this Item 7.
Catastrophe losses for 2009 were $90.3 million or 7.7 loss ratio points compared to $156.1 million or
13.9 loss ratio points for the same 2008 period. In 2008 Hurricane Ike delivered tropical storm force
42
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 LAE” section included in this
Item 7.
•
Our non-catastrophe losses for 2009 were $753.0 million, or 64.0 loss ratio points, compared to $690.6
million, or 61.3 loss ratio points, for the same 2008 period. Several lines of business contributed to this
increase. See the “Loss and LAE” section included in this Item 7.
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).
Charges related to the restructuring of our field and claims operations, as well as those recorded due to the
North Carolina Beach Plan write-off, contributed to the difference between our GAAP expense ratio and our SAP
expense ratio. The restructuring differences relate mainly to the timing of the recognition of employee
termination benefits. SAP requires us to estimate and immediately recognize the entire estimated costs related to
severance, while GAAP requires similar estimated costs to be recognized ratably over the remaining service
period of the employees impacted. The write-off related to the North Carolina Beach Plan was included in the
other expense line item in the accompanying consolidated statements of income, and was therefore not included
in the computation of the GAAP expense ratio.
43
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 and SAP combined ratio for the years ended December 31, 2009 and 2008:
($ millions)
Written premiums . . . . . . . . . . . . . . .
Earned premiums . . . . . . . . . . . . . . .
Losses and loss expenses . . . . . . . . .
Underwriting expenses . . . . . . . . . . .
SAP underwriting loss and SAP
%
Ratio
75.7
30.6
Business
$435.3
443.7
283.7
168.4
2009
%
Ratio
64.0
38.7
Personal
$775.1
732.8
554.8
237.5
Total
$1,210.4
1,176.5
838.5
405.9
%
Ratio
71.3
33.5
combined ratio . . . . . . . . . . . . . . .
$ (59.5)
106.3
$ (8.4) 102.7
$ (67.9)
104.8
($ millions)
Written premiums(1)
. . . . . . . . . . . . .
Earned premiums . . . . . . . . . . . . . . .
Losses and loss expenses . . . . . . . . .
Underwriting expenses . . . . . . . . . . .
SAP underwriting loss and SAP
%
Ratio
77.6
28.9
Business
$489.3
455.1
322.1
191.5
2008
%
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
(1)
Includes the one-time transfer of $53.6 million of unearned premium to us on January 1, 2008, in conjunction with the 2008
pooling changes ($24.8 million for our personal insurance segment and $28.8 million for our business insurance segment).
Revenue
We measure our top-line growth for our insurance segments based on net written premiums, which represent
the premiums on the policies we have issued for a period, net of reinsurance. Net written premiums provide us
with an indication of how well we are doing in terms of revenue growth before it is actually earned. Our policies
provide a fixed amount of coverage for a stated period of time, often referred to as “the policy term.” As such,
our written premiums are recognized as earned ratably over the policy term. The unearned portion of written
premiums, called unearned premiums, is reflected on our balance sheet as a liability and represents our obligation
to provide coverage for the unexpired terms of the policy.
44
The following table shows the reconciliation of the one-time impact on net written premiums for the year
ended December 31, 2008, of the unearned premiums transferred to us on January 1, 2008, in conjunction with
the 2008 pooling changes.
($ millions)
Net Written Premiums Reconciliation Table
Excluding
Pooling
Including
Pooling
Change
Pooling
Change
Impact
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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other & product liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Workers’ compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other commercial
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
$1,151.3
Personal Insurance Segment Revenue
Our personal insurance segment consists primarily of auto (standard and nonstandard) and homeowners’
products, with personal auto representing 41% and 38% of our total consolidated net written premium in 2009
and 2008, respectively. Our strategy to grow our personal lines business includes introducing new products,
enhanced systems and easier-to-use technologies into all states. Since 2008, we have introduced personal lines
products into four new states.
During 2009, we continued to enhance our personal lines point of sale portal, netXpress. The additional
integration with the systems commonly used by our independent agents has resulted in an increase in the number
of quotes for personal auto and homeowners. In 2009, the State Auto Group received over 1.3 million personal
lines quotes through comparative raters, bridging solutions and our own proprietary rating system. This compares
favorably to less than 1.0 million quotes received in 2008.
45
The following table provides a summary of written and earned premium, net of reinsurance, by major
product line of business for our personal insurance segment for the years ended December 31, 2009 and 2008.
The one-time impact of the 2008 pooling changes has been excluded from 2008 to present net written premiums
on a comparative basis (see Net Written Premium Reconciliation Table above):
($ millions)
Personal Insurance Segment:
2009
2008
%
Change
Net Written Premium
Standard auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Nonstandard auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Homeowners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other personal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$460.4
37.7
245.2
31.8
$398.8
42.2
219.8
30.0
15.4
(10.7)
11.6
6.0
Total personal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$775.1
$690.8
12.2
Net Earned Premium
Standard auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Nonstandard auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Homeowners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other personal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$433.2
38.7
230.0
30.9
$384.3
42.6
215.4
28.6
Total personal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$732.8
$670.9
12.7
(9.2)
6.8
8.0
9.2
Standard personal auto net written premiums for the year ended December 31, 2009 increased 15.4% from
2008. The State Auto Group’s expansion of its operations within four of our newer states, Texas, Colorado, Arizona
and Connecticut, has contributed approximately 5% to our premium growth in standard personal auto. Recent rate
increases have also contributed to premium growth in 2009. We believe our new products and advanced technology
have strengthened our position with our independent agencies and make us attractive to prospective policyholders
looking for greater value in their insurance products. Our auto product, CustomFitSM, coupled with easier quote
capabilities, has resulted in a significant increase in new business quotes in 2009. While the number of new business
quotes is higher, our issue to quote ratio has remained relatively consistent with prior years.
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. 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 over 200 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 our new auto
product, CustomFit, for standard auto and refined pricing for nonstandard auto.
Nonstandard auto net written premium for the year ended December 31, 2009, decreased 10.7% from 2008. In
2008, we began increasing rates and tightening underwriting controls, and in 2009, we continued increasing rates
and began terminating certain agencies that failed to consistently perform to our expectations. These actions coupled
with the impact of general economic conditions have resulted in a reduction of nonstandard new business.
Homeowners net written premiums for the year ended December 31, 2009, increased 11.6% from 2008.
Approximately one-third of this premium growth was from rate increases, one-third was due to the expansion of
new business in Texas, Colorado, Arizona and Connecticut; and the remaining one-third was due to expansion in
our other states. We continue to aggressively address our rate needs in this line of business, and we are seeking
higher rates in 2010.
46
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. 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, 2009 and 2008. The one-time impact of the 2008 pooling changes has been excluded from 2008 to
present net written premiums on a comparative basis (see Net Written Premiums Reconciliation Table above):
($ millions)
Business Insurance Segment:
2009
2008
%
Change
Net Written Premium
Commercial auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial multi-peril . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fire & allied lines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other & product liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Workers’ compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other commercial
$100.3
94.5
99.3
72.4
43.3
25.5
$110.0
99.0
96.8
80.5
45.5
28.7
Total business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$435.3
$460.5
Net Earned Premium
Commercial auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial multi-peril . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fire & allied lines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other & product liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Workers’ compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other commercial
$106.2
95.2
97.6
74.8
43.2
26.7
$110.5
97.9
94.7
79.9
43.4
28.7
Total business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$443.7
$455.1
(8.8)
(4.5)
2.6
(10.1)
(4.8)
(11.1)
(5.5)
(3.9)
(2.8)
3.1
(6.4)
(0.5)
(7.0)
(2.5)
The business insurance segment net written premium decreased 5.5% for the year ended December 31,
2009, from 2008. Business insurance continues to be impacted by rate competition and general economic
conditions, as well as ease of doing business issues. Despite these factors, we strengthened our premium per
exposure in the second half of 2009 by re-evaluating and adjusting the application of debits and credits on our
renewal policies. We believe it will be difficult to generate measurable growth given the impact of the economy
on premium bases such as payrolls, sales and number of vehicles. However, 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. For our property and liability business, we have implemented a pricing process that we
believe will help us price risks at appropriate levels 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 improve our ability to recognize the spectrum of risks
within our markets.
We continue to enhance our insurance policy administration system to make it easier for our 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 processing rather than in large batch cycles at night. We have leveraged
to give agents the ability to quote
this functionality with bizXpressSM., our web-based quote system,
businessowners and commercial auto risks on-line.
47
We are working to expand the scope of bizXpress to add new products and 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 in
personal insurance. The majority of all transactions in business insurance utilize the straight-through processing
technology. This has resulted in faster delivery of policies to our agents and their insureds for new business and
endorsements.
We are also expanding the eligibility of our businessowners product to facilitate businesses with greater
liability exposures, such as artisan contractors, auto service garages, manufacturers and restaurants. While we
regularly insure these types of businesses through other insurance products, offering them in our businessowners
program leverages our bizXpress technology, simplifies agents’ rating and submission processes, and offers
broader base coverages for these types of risks. In late 2009, we implemented our enhanced businessowners
product in Utah and plan to introduce this product enhancement to other states within the first six months of
2010.
Similar to our personal lines segment, we are expanding our product offerings in our newer states of
operations. We are leveraging our relationship with the agency distribution channel as a result of State Auto
Mutual’s affiliation with the Patrons Insurance Group. We introduced our commercial package, auto and
workers’ compensation products in Connecticut in the first quarter of 2009. In the second quarter 2009, we made
these products available for risks with District of Columbia and Delaware locations.
Loss and LAE
Our GAAP Loss and LAE ratio was 71.7% in 2009 compared to 75.2% in 2008. The decrease in the GAAP
Loss and LAE ratio was due to a reduction in catastrophe storm losses offset partially by an increase in
non-catastrophe losses. Our catastrophe losses, which primarily impacted our property lines of business,
accounted for 7.7 points of the Loss and LAE ratio in 2009 compared to 13.9 points in 2008. Our non-catastrophe
Loss and LAE ratio was 64.0% in 2009 compared to 61.3% in 2008. The increase in our non-catastrophe Loss
and LAE ratio was driven mostly by personal lines auto and homeowners business.
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 2009 and prior years, along with the GAAP Loss and LAE ratio for the years 2009 and 2008, respectively:
($ millions)
Provision for losses and loss expenses
occurring:
%
GAAP Loss
and LAE
%
GAAP Loss
and LAE
2008
2009
Current year . . . . . . . . . . . . . . . . . . . . . . .
Prior years . . . . . . . . . . . . . . . . . . . . . . . .
$899.5
(56.2)
Total losses and loss expenses . . . . .
$843.3
76.5
(4.8)
71.7
$874.0
(27.3)
$846.7
77.6
(2.4)
75.2
48
As shown above, the 2009 loss and loss expenses attributable to prior years totaled $(56.2) million. This
corresponded to a decrease, or favorable development, in the estimated ultimate liability for prior years’ claims.
A tabular presentation of the favorable development in 2009 by accident year is shown below.
($ millions)
Accident Year
1999 and prior . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Current Year
Development
of Ultimate Liability
Redundancy / (Deficiency)
$ 0.8
(1.0)
(1.1)
0.6
1.4
3.6
(1.6)
8.0
3.1
42.4
Total
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$56.2
Emergence by accident year includes normal fluctuations due to the uncertainty associated with loss reserve
development and claim settlement. The favorable development in 2009 came primarily from accident year 2008.
The more notable items contributing to the 2009 favorable development were:
•
•
•
Unallocated loss adjustment expenses (“ULAE”) were $10.9 million lower than anticipated in the
reserves at December 31, 2008, with approximately 75% being attributable to the 2008 accident year.
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 $10.9 million was primarily associated with the 2008
accident year. This development occurred primarily within our homeowners, fire & allied and
commercial multi-peril lines of business.
Non-catastrophe reserves for the auto liability lines and other & product liability developed lower than
anticipated. Standard, nonstandard and commercial auto liability reserves developed $9.5 million lower
and other & product
than anticipated. This favorable
development, which was primarily associated with the 2008 accident year, was driven by lower than
anticipated tabular loss severity, as well as lower than anticipated loss frequency for other & product
liability.
liability developed $8.3 million lower
See discussion regarding the 2008 calendar year development at “2008 Compared to 2007—Loss and LAE”
section included in this Item 7. See additional discussion regarding loss and loss expense reserves at the “Critical
Accounting Policies—Losses and Loss Expenses Payable” section included in this Item 7.
Catastrophe losses for 2009 totaled $90.3 million (7.7 loss ratio points) compared to $156.1 million (13.9
loss ratio points) for 2008. Our losses include 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 2009, we were impacted by losses from 27 of the 28 storms that were classified as numbered catastrophes
by PCS as compared to 35 of the 37 PCS classified storms in 2008, one of which was Hurricane Ike. The losses
from these catastrophes have had a significant impact on both our personal and business insurance property lines.
49
As of January 1, 2009, members of the State Auto Group entered into a property catastrophe net aggregate
excess of loss reinsurance agreement (“Catastrophe Aggregate Agreement”). 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. 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 retain the first $80.0 million of the covered losses, with a
25% co-participation with the reinsurer 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. We experienced
six catastrophes during 2009 that met the minimum $5.0 million requirement and in aggregate exceeded the State
Auto Group’s $80.0 million retention level. STFC’s share of recoveries under the Catastrophe Aggregate
Agreement for the year ended December 31, 2009, was $8.2 million, benefitting our loss ratio by 0.7 points.
The following tables provide our insurance segments’ SAP Loss and LAE ratios (“loss ratios”) by major
lines of business for 2009 and 2008 with the catastrophe (“cat”) and non-catastrophe (“non-cat”) impact shown
separately:
($ millions)
2009 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
69.8
75.8
91.2
42.9
75.7
56.1
59.3
72.2
70.1
80.1
38.4
64.0
71.3
Personal insurance segment:
1.0
Standard auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 433.2 $ 4.5 $297.8 $302.3
29.4
0.5
Nonstandard auto . . . . . . . . . . . . . . . . . . . . . . . . . . .
209.8 28.3
Homeowners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
8.1
13.3
. . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other personal
38.7
230.0
30.9
29.1
144.9
10.7
0.3
64.9
2.6
Total personal
. . . . . . . . . . . . . . . . . . . . .
732.8
72.3
482.5
554.8
9.9
68.8
75.3
62.9
34.8
65.8
Business insurance segment:
Commercial auto . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial multi-peril
. . . . . . . . . . . . . . . . . . . . . .
Fire & allied lines . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other & product liability . . . . . . . . . . . . . . . . . . . . .
Workers’ compensation . . . . . . . . . . . . . . . . . . . . . .
Other commercial . . . . . . . . . . . . . . . . . . . . . . . . . . .
106.2
0.5
95.2
5.1
12.2
97.6
74.8 —
43.2 —
0.2
26.7
59.2
51.3
58.3
52.4
34.6
9.9
0.5
59.7
55.6
56.4
5.4
53.9
59.7
70.5 12.5
52.4 — 70.1
34.6 — 80.1
37.9
0.5
10.1
Total business . . . . . . . . . . . . . . . . . . . . . .
443.7
18.0
265.7
283.7
Total SAP personal and business . . . . . . . $1,176.5 $90.3 $748.2 $838.5
4.1
7.7
59.9
63.6
50
($ millions)
2008 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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 384.3 $
Nonstandard auto . . . . . . . . . . . . . . . . . . . . . . . . . . .
Homeowners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other personal
42.6
215.4
28.6
2.1
8.2 $254.4 $262.6
31.8
31.5
0.3
0.7
204.5 42.5
113.0
91.5
21.4 20.6
15.6
5.8
Total personal
. . . . . . . . . . . . . . . . . . . . .
670.9
105.8
414.5
520.3 15.8
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 . . . . . . . . . . . . . . . . . . . . . . . . . . .
0.8
110.5
16.5
97.9
32.0
94.7
79.9 —
43.4 —
1.0
28.7
67.6
56.5
52.7
51.6
35.0
8.4
61.2
68.4
0.7
57.8
73.0 16.8
55.7
84.7 33.8
51.6 — 64.6
35.0 — 80.7
29.3
3.4
9.4
Total business . . . . . . . . . . . . . . . . . . . . . .
455.1
50.3
271.8
322.1 11.0
Total SAP personal and business . . . . . . . $1,126.0 $156.1 $686.3 $842.4 13.9
59.8
60.9
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
The personal insurance segment non-cat loss ratio was 4.1 points higher in 2009 than in 2008. Standard
auto’s non-cat loss ratio increase was driven by an increase in frequency of physical damage, comprehensive and
collision coverage claims, while the nonstandard auto increase was caused by a rise in the overall severity of
claims. Previously, the intense price competition in the personal lines market had impeded our ability to take
appropriate rate increases. However, we believe price competition in the personal lines market is becoming less
intense, which has allowed us to recently implement rate increases, contributing some to our 2009 growth. We
intend to continue to seek price increases in the mid single-digit range in 2010. The increase in the non-cat
homeowners loss ratio was due primarily to experiencing more large fire losses and settling one threatened class
action claim. Settlement of the one class action claim increased the 2009 non-cat homeowners loss ratio by 3.2
points. We continue to seek homeowners rate increases in various states as appropriate for that state. However,
there is no assurance that the regulatory authorities will grant our requested rate increases. In addition to pricing
actions and the Aggregate Treaty implemented earlier this year, we have implemented mandatory wind and hail
deductibles in approximately one-third of our operating states and are in the process of strengthening our
insurance-to-value program. In addition, we introduced our new homeowner by-peril rated product in the fourth
quarter of 2009 and we will continue state by state deployment of this product throughout 2010 and 2011.
In total, the business insurance segment’s non-cat loss ratio for 2009 was comparable to 2008. However,
commercial auto and commercial multi-peril loss ratios decreased primarily due to a reduction in the number and
size of large losses when compared to 2008. The increase in the fire & allied lines loss ratio was the result of
more large fires in 2009. The increase in other & product liability was due primarily to an increase in the
estimate of internal claim handling expenses. Intense competition in the business insurance segment continues to
impact our ability to implement price increases where needed.
51
Loss and loss expenses payable by major line of business as of December 31, 2009 and 2008, respectively,
are shown in the following table:
($ millions)
Personal insurance segment:
Standard auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Nonstandard auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Homeowners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other personal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total personal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Business insurance segment:
Commercial auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial multi-peril . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fire & allied lines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other & product liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Workers’ compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total losses and loss expenses payable, net of reinsurance
recoverable on losses and loss expenses payable . . . . . .
December 31,
2009
December 31,
2008
$
Change
$216.3
20.2
75.7
13.4
325.6
93.7
89.3
33.8
167.1
103.8
6.1
493.8
$188.5
19.6
68.6
14.6
291.3
93.5
91.5
38.6
152.3
97.1
5.7
478.7
27.8
0.6
7.1
(1.2)
34.3
0.2
(2.2)
(4.8)
14.8
6.7
0.4
15.1
$819.4
$770.0
49.4
As shown in the table above, there was a $49.4 million increase in total loss and loss expense reserves
during 2009. The increase, driven by the personal insurance segment, was primarily due to growth in exposures
in our standard auto and homeowners business. We conduct quarterly 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.
Acquisition and Operating Expenses
Our GAAP expense ratio was 34.1% in 2009 compared to 34.6% in 2008. The decrease in the expense ratio
can be attributed principally to expenses being applied to a larger premium base in 2009 as compared to 2008,
and the inclusion of costs associated with launching our ISA initiative in 2008.
As a result of Innovate SA, in the second quarter of 2009, we initiated a plan to reorganize our field and
claims operations. We anticipate that reorganizing our field and claims operations will allow us to improve
service, streamline workflows and better deploy new technology solutions. Under our reorganization plan, the
existing field regions will be merged into five new regions, each with a regional headquarters, which we believe
will allow us to be more responsive to our agents. Each region will support personal insurance sales and business
52
insurance sales, underwriting, processing and administrative functions. Personal
processing and administrative functions will be consolidated into two operation centers.
insurance underwriting,
As part of the reorganization of our claims operations, we will expand our dedicated catastrophe team to
address both the urgency and special needs of catastrophe claim handling. Many large property losses, which
have been generally sent out to independent adjusters, will be handled in-house by large property specialist
adjusters strategically placed throughout our operating states. New contact center property claim teams will be
organized with redefined responsibilities including adjusting contents claims for larger fire losses and supporting
the dedicated catastrophe team. In addition, we expect to hire additional automobile and property appraisers to
rely less on outside property and auto appraisers. We believe this will allow us to take advantage of current
technology by having many of our property and auto appraisers work from their homes, providing better access
to policyholders. Casualty claims will continue to be handled in-house in fewer, larger units. We believe that
having more people in fewer locations will allow us to better train new casualty claim handlers, staff more
flexibly, and provide closer supervision on longer tail, third party claims.
Total restructuring charges, including employee termination benefits, benefit plan curtailment impact,
relocation packages, and costs associated with ceasing to use leased properties, are estimated to be approximately
$6.5 million through the fourth quarter 2010, the expected completion date for the reorganization. We recognized
restructuring costs totaling $4.8 million during the year ended December 31, 2009, which increased our GAAP
Loss and LAE and expense ratios 0.2 points each. See Note 9, “Restructuring Costs” to our Consolidated
Financial Statements included in Item 8 of this Form 10-K.
Investment Operations Segment
Our investment portfolio and the investment portfolios of other members of the State Auto Group are
managed by our subsidiary, Stateco. Stateco utilizes outside investment managers to invest in small-cap equities
and international funds. The Investment Committee (the “Committee”) of the Board of Directors establishes the
investment policies to be followed by Stateco. 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.
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. 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, 2009, there were no fixed maturity
investments rated below investment grade in our available-for-sale investment portfolio. At December 31, 2009
and 2008, 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.
53
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 equity funds was designed to achieve a
greater total return with reduced volatility. 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.
At December 31, 2009, 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).
Composition of Investment Portfolio
The following table provides the composition of our investment portfolio at carrying value at December 31:
($ millions)
Cash and cash equivalents . . . . . . . . . . . . . .
Fixed maturities, at fair value:
Fixed maturities . . . . . . . . . . . . . . . . . .
Treasury inflation protected
securities . . . . . . . . . . . . . . . . . . . . . .
Total fixed maturities . . . . . . . . . .
Notes receivable from affiliate . . . . . . . . . . .
Equities, at fair value:
Large-cap equities . . . . . . . . . . . . . . . . .
Small-cap equities . . . . . . . . . . . . . . . . .
Total equities . . . . . . . . . . . . . . . .
Other invested assets, at fair value:
International instruments . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . .
Total other invested assets, at fair
value . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . .
Other invested assets, at cost
December 31,
2009
% of
Total
December 31,
2008
$
90.3
4.0
$ 150.5
1,691.8
140.0
1,831.8
70.0
196.1
28.0
224.1
48.3
4.0
52.3
0.9
74.5
6.2
80.7
3.1
8.6
1.2
9.8
2.1
0.2
2.3
0.1
1,694.9
75.8
1,770.7
—
130.2
7.3
137.5
28.8
2.9
31.7
1.4
% of
Total
7.2
81.0
3.7
84.7
—
6.2
0.3
6.5
1.4
0.1
1.5
0.1
Total portfolio . . . . . . . . . . . . . . . . . . . . . . . .
$2,269.4
100.0
$2,091.8
100.0
In May 2009, two of State Auto Financial’s subsidiaries, State Auto P&C and Milbank, entered into separate
Credit Agreements with State Auto Mutual. Under these Credit Agreements, State Auto Mutual borrowed a total
of $70.0 million from State Auto P&C and Milbank ($50.0 million and $20.0 million, respectively) on an
unsecured basis. Interest is payable semi-annually at a fixed annual interest rate of 7.00%. Principal is payable
May 2019.
54
The amortized cost and fair value of unaffiliated fixed maturities at December 31, 2009, by contractual
maturity, were as follows:
($ 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 residential mortgage-backed securities . .
Amortized
Cost
Fair
Value
$
17.2
263.2
506.5
705.8
295.4
$
17.4
268.9
523.7
721.2
300.6
Total
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,788.1
$1,831.8
Expected maturities may differ from contractual maturities as issuers may have the right to call or prepay
the obligations with or without call or prepayment penalties.
At December 31, 2009, our equity portfolio consisted of approximately 67 different large-cap stocks and 76
small-cap stocks. The largest single position was 2.9% of the equity portfolio based on fair value and the top ten
positions account for 22.6% of the equity portfolio. Since our equity portfolio consists primarily of large-cap
value-oriented stocks, with a small allocation to small-cap equities, when large-cap stocks and/or value-oriented
stocks perform well our equity portfolio typically performs well compared to benchmarks. Conversely, when
growth stocks outperform value and/or small- to mid-cap stocks outperform large-cap stocks, our equity portfolio
does not perform as well compared to benchmarks.
Market Risk
Our primary market risk exposures are to changes in market prices for equity securities and changes in
interest rates and credit ratings for fixed maturity securities. Our fixed maturity securities are subject to interest
rate risk whereby the value of the securities varies as market interest rates change. We manage this risk by
closely monitoring the duration of the fixed maturity portfolio. The duration of the fixed maturity portfolio was
approximately 4.99 and 6.26 as of December 31, 2009 and 2008, respectively. The table below summarizes our
interest rate risk and shows the effects of a parallel change in interest rates on the fair value of the fixed maturity
portfolio (excluding other debt securities) as of December 31, 2009:
($ millions)
Description of securities
Fixed maturities:
Fair Value
-200 bps
Change
-100 bps
Change
Actual
+100 bps
Change
+200 bps
Change
U.S. treasury securities and obligations of U.S.
government agencies . . . . . . . . . . . . . . . . . . . . . . .
Obligations of states and political subdivisions . . . .
Corporate securities . . . . . . . . . . . . . . . . . . . . . . . . . .
U.S. government agencies residential mortgage-
$ 372.5
1,197.2
110.6
$ 363.4
1,141.6
104.9
$ 352.9
1,078.6
99.7
$ 341.2
1,010.7
94.5
$ 329.6
945.0
89.9
backed securities . . . . . . . . . . . . . . . . . . . . . . . . . .
313.4
308.6
300.6
289.7
277.2
Balance as of December 31, 2009 . . . . . . . . . . . . . . . . . . .
$1,993.7
$1,918.5
$1,831.8
$1,736.1
$1,641.7
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
55
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 approximately 94% of
the bonds we own are rated AA or better. 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 asset-backed securities in our fixed maturity portfolio which may be labeled sub-prime
mortgage-backed securities. We invest only in conventional mortgage backed securities issued by a federal
agency or that are U.S. Government guaranteed. Specifically, approximately $300.6 million or 14.3% of our
available-for-sale investment portfolio as of December 31, 2009, 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.
Our fixed maturity investment portfolio at December 31, 2009 included obligations of states and political
subdivisions with a total carrying value of $1,078.6 million. $531.3 million of these securities, or 49.3% of our
municipal securities portfolio (“Muni Portfolio”), were enhanced by third-party monoline insurers (a “Credit
Enhancement”) for the payment of principal and interest in the event of an issuer default. A Credit Enhancement
is not a primary consideration to us when purchasing a municipal security, as we consider the underlying credit
quality of the security as the primary rating factor in our evaluation process. Of the total $1,078.6 million of
municipal securities in our investment portfolio at December 31, 2009, 89.6% were rated AA or better, without
the benefit of a Credit Enhancement. We do not believe that a loss of a Credit Enhancement would have a
material adverse impact on our results of operations, financial position or liquidity, due to the underlying strength
of the issuers of the securities, as well as our ability and intent to hold the securities. In addition, as of
December 31, 2009, we had no direct investment in any guarantor including any bond insurer.
The following table details the credit ratings of our municipal securities, excluding Credit Enhancements,
based on ratings by nationally recognized rating agencies.
($ millions)
Rating
AAA* . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
AA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total fair
value
$ 330.6
636.3
108.5
3.2
%
30.6
59.0
10.1
0.3
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,078.6
100.0
*
Our AAA rating category includes securities which have been either pre-funded or escrowed to maturity.
56
The following table shows the composition of the insurers providing Credit Enhancements at December 31,
2009, along with the corresponding underlying credit rating of the issuer of the security.
($ millions)
Monoline Insurer / Underlying Rating
Assured Guaranty Municipal Corp. (formerly FSA):
AAA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
AA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
AMBAC:
AAA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
AA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
FGIC:
AAA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
AA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
National Public Finance Guarantee (formerly MBIA):
AAA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
AA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total fair
value
$ 27.8
193.3
28.4
1.1
250.6
7.7
80.5
42.8
2.1
133.1
26.5
3.5
30.0
13.4
87.8
7.5
108.7
XLCA:
A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
8.9
Total municipal securities enhanced by third-party monoline insurers . . . . . . . . . .
$531.3
We believe our Muni Portfolio is well diversified by issuer and state. We have 18.5% invested in securities
which have been either pre-refunded or escrowed to maturity bonds. Within the non pre-refunded and escrowed
to maturity portfolio, no single issuer comprises more than 5% of the portfolio and no more than 10% of the
portfolio is concentrated in any one state. We believe our Muni Portfolio is invested within the strongest sectors
of the municipal bond market. 41.1% of our municipal bonds are general obligation bonds or other tax-backed
bonds. The majority of the remaining Muni Portfolio consists of revenue bonds. Our credit research is an
important part of our investment management process, and we continually monitor all holdings for any signs of
deterioration. We believe that our municipal holdings will maintain their high credit quality and that the issuers
will be able to make all principal and interest payments as they come due.
As of December 31, 2009, our large-cap equity portfolio had a beta of 0.96 using the S&P 500 Index as a
benchmark. Beta estimates the degree the portfolio’s price will fluctuate based on a given movement in the
market index. The table below reflects what changes might occur in the value of the large-cap equity portfolio
given a change in the S&P 500 Index:
Fair value ($ millions) . . . . . . . . . . . . . . . . . . . . . .
Change in S&P 500 Index . . . . . . . . . . . . . . . . . . .
Value as % of original value . . . . . . . . . . . . . . . . .
$233.6
$214.8
+20%
119%
+10%
110%
$196.1
0
100%
$177.2
$158.4
-10%
90%
-20%
81%
57
The above analysis is limited in that it does not take into account any actions that might be taken by us in
response to these changes. As a result, the actual impact of a change in equity market prices and the resulting
equity values may differ significantly from what is shown in the table. By investing in mostly large-cap issues we
hope to limit liquidity risk in the equity portfolio. The large-cap equity portfolio does not have any direct
exposure to exchange rate risk since we do not directly hold any foreign stocks. We constantly monitor the equity
portfolio holdings for any credit risk issues that may arise. We do not invest in any commodity futures or
commodity oriented mutual funds.
At December 31, 2009, we have two international funds, Fund 1 and Fund 2, which are included in other
invested assets available-for-sale. Fund 1 and Fund 2 had betas of 0.684 and 0.849, respectively, using the MSCI
EAFE Index as a benchmark. Beta estimates the degree the portfolio’s price will fluctuate based on a given
movement in the index. The tables below reflect what changes might occur in the values of Funds 1 and 2 given a
change in the MSCI EAFE Index:
Fund 1
Fair value ($ 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 . . . . . . . . . . . . . .
$29.0
$27.2
$25.5
0
+20% +10%
114% 107% 100%
$26.7
$24.7
$22.8
0
+20% +10%
117% 108% 100%
$23.8
$22.0
-10% -20%
86%
93%
$20.9
$18.9
-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 2009 was $82.1 million compared to $87.4 million in 2008. The decline in net
investment income is attributed to a reduction in the average invested assets and the investment yield. Average
invested assets decreased from $2,127.6 million at December 31, 2008 to $2,117.0 million at December 31, 2009.
Our investment yield declined to 3.9% in 2009 from 4.1% in 2008 due to the following factors.
•
Our Treasury Inflation Protection Securities (“TIPS”) holdings, at amortized cost, increased to $137.0
million from $77.9 million, respectively. The income earned on our TIPS securities, which is
dependent on changes in the CPI Index, declined compared to 2008.
• We held fewer large-cap dividend paying stocks in 2009 than in 2008.
•
•
Dividend payouts were reduced on certain equity holdings.
On average, we held higher levels of cash balances, which earned lower yields. Average short-term
yields were 240 basis points lower in 2009 than in 2008.
58
($ millions)
Gross investment income:
Year Ended December 31
2009
2008
Fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
Total gross investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less: Investment expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
75.7
3.5
4.9
84.1
2.0
82.1
$
$
79.4
5.0
5.1
89.5
2.1
87.4
Average invested assets (at cost) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Annualized investment yield . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Annualized investment yield, after tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net investment income, after tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Effective tax rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$2,117.0
$2,127.6
3.9%
3.3%
70.5
14.1
$
4.1%
3.6%
76.6
12.4
$
Realized gains and losses on investments for the years ended December 31, 2009 and 2008, respectively, are
summarized as follows:
($ millions)
Realized gains:
Fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . .
Equity securities . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . .
Total realized gains . . . . . . . . . . . . . . . . . .
Realized losses:
Fixed maturities—Sales . . . . . . . . . . . . . . . . . . .
Equity securities:
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
OTTI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets—OTTI . . . . . . . . . . . . . . .
2009
2008
Realized
gains
(losses)
Proceeds
received
on sale
Realized
gains
(losses)
Proceeds
received
on sale
$ 5.9
4.8
—
10.7
$322.2
19.2
—
341.4
$ 2.7
9.6
—
$164.6
41.0
—
12.3
205.6
—
(6.9)
(9.0)
—
1.6
14.8
—
—
16.4
—
(9.4)
(28.3)
(11.0)
(48.7)
—
26.0
—
—
26.0
Total realized losses . . . . . . . . . . . . . . . . . .
(15.9)
Net realized gain (loss) on investments . . . . . . .
$ (5.2)
$357.8
$(36.4)
$231.6
During 2009, we sold fixed maturities, which resulted in realized gains on certain municipal bonds, and
replaced them with taxable bonds. Equity sales were executed for various reasons in 2009, including the
achievement of our price target. We recognized realized losses on the sale of certain equity securities in response
to negative earnings or negative outlook announcements and changes in business conditions which in our opinion
diminished their future business prospects.
When a fixed maturity has been determined to have a decline in fair value, the impairment charge is
separated into an amount representing the credit loss, which is recognized in earnings, and the amount related to
non-credit factors, which is recognized in accumulated other comprehensive income (loss). See “Critical
Accounting Policies—Investments” included in this Item 7 for OTTI impairment indicators. Future increases or
decreases in fair value, if not other-than-temporary, are included in accumulated other comprehensive income
(loss). We did not recognize OTTI on our fixed maturity portfolio during 2009. In 2008, we recognized realized
losses that were less than $0.1 million.
59
When an equity security or other invested asset has been determined to have a decline in fair value that is
other-than-temporary, we adjust the cost basis of the security to fair value. See “Critical Accounting Policies –
Investments” included in this Item 7 for OTTI impairment indicators. This results in a charge to earnings as a
realized loss, which is not reversed for subsequent recoveries in fair value. Future increases or decreases in fair
value, if not other-than-temporary, are included in accumulated other comprehensive income (loss).
The following table provides a detailed breakdown by security type for the 2009 OTTI charges.
($ millions)
Equity Securities:
Number
of
positions
Total
impairment
Large-cap equities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Small-cap equities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total OTTI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
12
267
279
$7.8
1.2
$9.0
Gross Unrealized Investment Gains and Losses
Based upon our review of our investment portfolio at December 31, 2009, we determined that there were no
individual investments with an unrealized holding loss that had a fair value significantly below cost continually
for more than one year. The following table provides detailed information on our available-for-sale investment
portfolio by lot at fair value for our gross unrealized gains and losses at December 31, 2009.
($ millions, except number of positions)
Cost or
amortized
cost
Gross
unrealized
holding
gains
Number of
gain
positions
Gross
unrealized
holding
losses
Number of
loss
positions
Fixed Maturities:
U.S. treasury securities and obligations of
U.S. government agencies . . . . . . . . . .
Obligations of state and political
subdivisions . . . . . . . . . . . . . . . . . . . . .
Corporate securities . . . . . . . . . . . . . . . . .
U.S. government agencies residential
$ 348.4
$ 5.9
1,046.9
97.4
mortgage-backed securities . . . . . . . . .
295.4
Total fixed maturities . . . . . . . . . . . .
1,788.1
Equity Securities:
Large-cap equity securities . . . . . . . . . . . .
Small-cap equity securities . . . . . . . . . . . .
Total equity securities . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . .
164.7
25.0
189.7
44.1
33.2
2.4
6.4
47.9
31.6
3.0
34.6
8.2
Total available-for-sale investments . . . . . . . . .
$2,021.9
$90.7
60
58
428
46
82
614
60
67
127
4
745
$(1.4)
(1.5)
(0.1)
(1.2)
(4.2)
(0.2)
—
(0.2)
—
$(4.4)
53
48
10
25
136
—
6
6
—
142
Fair value
$ 352.9
1,078.6
99.7
300.6
1,831.8
196.1
28.0
224.1
52.3
$2,108.2
The following table presents a summary of our unrealized gains (losses) by investment type, net of deferred
tax that was included as a component of accumulated comprehensive loss at December 31, 2009 and 2008,
respectively, and the change in unrealized gains (losses), net of deferred tax, for the year ended December 31,
2009:
($ millions)
Available-for-sale investments
Unrealized gains (losses):
December 31,
2009
December 31,
2008
$
Change
Fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unrealized gains (losses) . . . . . . . . . . . . . . . . . . . . .
Deferred federal income tax (liability) asset
. . . . . . . . . .
Valuation allowance . . . . . . . . . . . . . . . . . . . . . . . . .
$ 43.7
34.4
8.2
86.3
(30.2)
—
$(10.4)
(6.8)
(0.7)
(17.9)
6.3
(2.6)
$ 54.1
41.2
8.9
104.2
(36.5)
2.6
Unrealized gains (losses), net of tax . . . . . . . . . . . . . . . . . . . . .
$ 56.1
$(14.2)
$ 70.3
At December 31, 2009, we determined a valuation allowance against our capital deferred tax items was not
needed because our unrealized losses at December 31, 2008, had shifted to an unrealized gain. In the first quarter
of 2009, we reversed the $3.1 million valuation allowance that we established at December 31, 2008, benefitting
accumulated other comprehensive loss by $2.6 million and deferred tax expense by $0.5 million.
Fair Value Measurements
We primarily use one independent nationally recognized pricing service in developing fair value estimates.
We obtain one price per security, and our processes and control procedures are designed to ensure the value is
accurately recorded on an unadjusted basis. Through discussions with the pricing service, we gain an
understanding of the methodologies used to price the different types of securities, that the data and the valuation
methods utilized are appropriate and consistently applied, and that
the assumptions are reasonable and
representative of fair value. To validate the reasonableness of the valuations obtained from the pricing service,
we compare to other fair value pricing information gathered from other independent pricing sources. See Note 3,
“Fair Value of Financial Instruments” to our Consolidated Financial Statements included in Item 8 of this Form
10-K for a presentation of our available-for-sale investments within the fair value hierarchy at December 31,
2009.
As of December 31, 2009, Level 3 assets as a percentage of total assets were 0.1%, which we have
determined to be insignificant.
Other Income Statement Items
Included in other expenses was a $6.5 million charge related to a write-off of our equity interest in the
accumulated surplus of the North Carolina Beach Plan, a mandatory reinsurance underwriting association. This
charge was the result of recent legislation intended to reform the funding mechanism of the North Carolina
Beach Plan which called into question our rights to the equity interest either in form of future distributions or
credits.
The effective tax rate for 2009 was a benefit of 180.0% compared to a benefit of 58.6% for 2008. Included
in our 2009 and 2008 loss before federal income taxes were tax-exempt earnings related to our investment
portfolio, which significantly contributed to the difference between the actual rates of 180.0% and 58.6%,
61
respectively, and the expected statutory rate of 35.0%. See Note 8, “Federal Income Taxes” to our Consolidated
Financial Statements included in Item 8 of this Form 10-K for a reconciliation between our actual federal income
tax benefit and the amount computed at the indicated statutory rate for the years ended December 31, 2009 and
2008.
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 LAE” 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 $1.9
million in 2007. See the “Investment Operations Segment” section included in this Item 7.
Insurance Segments
The following tables provide a summary of our insurance segments’ SAP underwriting (loss) gain and SAP
combined ratio for the years ended December 31, 2008 and 2007:
($ millions)
Written premiums . . . . . . . . . . . . . . . . . .
Earned premiums . . . . . . . . . . . . . . . . . .
Losses and loss expenses . . . . . . . . . . . .
Underwriting expenses . . . . . . . . . . . . . .
SAP underwriting loss and SAP
Personal
$715.6
670.9
520.3
206.8
%
Ratio
77.6
28.9
Business
$489.3
455.1
322.1
191.5
2008
%
Ratio
70.8
39.1
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 combined
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
ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 47.3
92.0
$ 40.6
89.6
$
87.9
91.1
62
Revenue
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 2008 pooling changes.
($ 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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other & product 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
(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.
63
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 $76.0 million of
premium payments recorded in 2007.
“Pay Now”
electronic
the
The following table provides a summary of written and earned premium, net of reinsurance, by major
product line of business for our personal insurance segment for the years ended December 31, 2008 and 2007.
The one-time impact of the 2008 pooling changes has been excluded from 2008 to present net written premiums
on a comparative basis (see Net Written Premium Reconciliation Table above):
($ 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
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.
64
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 LAE” 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.
65
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 & allied lines, other &
product 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 2008 pooling changes 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.
66
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
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
in personal
through
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
67
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 additional discussion regarding loss and loss expense reserves at the “Critical Accounting Policies –
Losses and Loss Expenses Payable” 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 $25.0 million or more in insured losses industry wide and affecting significant
numbers of insureds and insurers. During 2008, we were impacted by losses from 35 of the 37 storms that were
classified as numbered catastrophes by PCS as compared to 18 of the 26 PCS 2007 classified storms. The losses
from these catastrophes have had a significant impact on both our personal and business insurance property lines.
68
The following tables provide our insurance segments’ SAP Loss and LAE ratios (“loss ratios”) by major
lines of business for 2008 and 2007 with the catastrophe (“cat”) and non-catastrophe (“non-cat”) impact shown
separately:
($ millions)
2008 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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 384.3 $
Nonstandard auto . . . . . . . . . . . . . . . . . . . . . . . . . . .
Homeowners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other personal
42.6
215.4
28.6
2.1
8.2 $254.4 $262.6
0.7
31.8
31.5
0.3
204.5 42.5
113.0
91.5
21.4 20.6
15.6
5.8
Total personal
. . . . . . . . . . . . . . . . . . . . .
670.9
105.8
414.5
520.3 15.8
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 . . . . . . . . . . . . . . . . . . . . . . . . . . .
0.8
110.5
16.5
97.9
94.7
32.0
79.9 —
43.4 —
1.0
28.7
67.6
56.5
52.7
51.6
35.0
8.4
61.2
68.4
0.7
57.8
73.0 16.8
84.7 33.8
55.7
51.6 — 64.6
35.0 — 80.7
29.3
3.4
9.4
Total business . . . . . . . . . . . . . . . . . . . . . .
455.1
50.3
271.8
322.1 11.0
Total SAP personal and business . . . . . . . $1,126.0 $156.1 $686.3 $842.4 13.9
59.8
60.9
68.3
74.7
95.0
74.7
77.5
61.9
74.6
89.5
64.6
80.7
32.7
70.8
74.8
($ 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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 357.3 $
Nonstandard auto . . . . . . . . . . . . . . . . . . . . . . . . . . .
Homeowners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other personal
42.9 —
26.5
186.5
1.9
22.9
2.3 $217.5 $219.8
27.1
94.0
9.1
0.7
60.8
27.1 — 63.2
50.4
120.5 14.2
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 —
1.5
86.8
4.9
83.4
75.5 —
33.4 —
26.0 —
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
Total business . . . . . . . . . . . . . . . . . . . . . .
402.0
6.4
200.8
207.2
Total SAP personal and business . . . . . . . $1,011.6 $ 37.1 $548.5 $585.6
1.6
3.7
49.9
54.2
61.5
63.2
64.6
48.2
62.1
52.2
59.3
49.1
43.5
74.6
24.8
51.5
57.9
The personal insurance segment non-cat loss ratio was 4.6 points higher in 2008 than in 2007. Standard and
non-standard auto’s SAP Loss and LAE ratio increases were attributed primarily to an increase in the severity of
bodily injury claims and uninsured motorists’ claims as well as to an increase in claim frequency for these lines
of business. In addition, in 2008, competitive market conditions limited our ability to obtain price increases in
standard auto. As mentioned above, rate actions taken in our non-standard line of business in early 2008 will not
be fully realized until 2009. The non-cat ratio for homeowners remained relatively flat when compared to 2007.
69
The business insurance segment’s non-cat loss ratio for 2008 was 9.9 points higher than in 2007. The
intense competition in the business insurance segment continues to impact our ability to implement price
increases, and contributed significantly to the increase in our non-cat loss ratio. For commercial auto, rate
decreases were the primary drivers of the increase in our non-cat loss ratio. For other & product liability, the
increase in loss ratio was driven by development of losses from prior accident years and, to a lesser extent, rate
decreases. For fire & allied lines and workers’ compensation, the increase in loss ratio was primarily due to an
increase in the severity of current year claims.
Loss and loss expenses payable by major line of business as of December 31, 2008 and 2007 and at
January 1, 2008 as a result of the 2008 pooling changes, are shown in the following table:
($ 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 . . . . . . . . . . . . . . . . . . . . . . . . . .
Other & product 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 2008 pooling changes.
(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.
70
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. 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
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.
71
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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$2,100.8
100.0
72
The following table provides the composition of our available-for-sale investment portfolio at fair value at
December 31:
($ millions)
2008
2007
Fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total investments, at fair value . . . . . . . . . . . . . . . . . . .
$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
$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 residential 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
73
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 $92.0 million in cash
received in conjunction with the 2008 pooling changes.
($ 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.
Realized gains and losses on investments for the years ended December 31, 2008 and 2007, respectively, are
summarized as follows:
($ millions)
Realized gains:
2008
Realized
gains
(losses)
Proceeds
received
on sale
2007
Realized
gains
(losses)
Proceeds
received
on sale
Fixed maturities . . . . . . . . . . . . . . . . . . . . . .
Equity securities . . . . . . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . .
$ 2.7
9.6
—
$164.6
41.0
—
$ 0.8
19.7
—
$ 82.5
76.2
—
Total realized gains . . . . . . . . . . . . . . .
12.3
205.6
20.5
158.7
Realized losses:
Fixed maturities—Sales . . . . . . . . . . . . . . . .
Equity securities:
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . .
OTTI . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets—OTTI . . . . . . . . . . . .
Total realized losses . . . . . . . . . . . . . . .
—
(9.4)
(28.3)
(11.0)
(48.7)
—
26.0
—
—
26.0
(1.3)
72.7
(5.2)
(1.9)
—
(8.4)
30.8
—
—
103.5
Net realized gain (loss) on investments . . . . . . . .
$(36.4)
$231.6
$12.1
$262.2
74
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.
When an equity security or other invested asset 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. See “Critical Accounting Policies—
Investments” included in this Item 7 for OTTI impairment indicators. 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 accumulated other comprehensive income (loss).
When a fixed maturity has been determined to have a decline in fair value, the impairment charge is
separated into an amount representing the credit loss, which is recognized in earnings, and the amount related to
non-credit factors, which is recognized in accumulated other comprehensive income (loss). See “Critical
Accounting Policies—Investments” included in this Item 7 for OTTI impairment indicators. Future increases or
decreases in fair value, if not other-than-temporary, are included in accumulated other comprehensive income
(loss). In 2008, we recognized realized losses that were less than $0.1 million.
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 securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Small-cap securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets:
International funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total OTTI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Number
of
positions
Total
impairment
26
530
556
2
558
(24.2)
(4.1)
(28.3)
(11.0)
$(39.3)
Gross Unrealized Investment Gains and Losses
A review of our investment portfolio at December 31, 2008, determined that there were no individual
investments with an unrealized holding loss that had a fair value significantly below cost continually for more
than one year.
75
The following table provides detailed information on our available-for-sale investment portfolio at fair value
for our gross unrealized gains and losses at December 31, 2008.
($ millions, except number of positions)
Investment Category:
Fixed maturities:
Cost or
amortized
cost
Gross
unrealized
holding
gains
Number of
gain
positions
Gross
unrealized
holding
losses
Number of
loss
positions
U.S. treasury securities . . . . . . . . . . . . . . .
States and political subdivisions . . . . . . . .
Corporate securities . . . . . . . . . . . . . . . . .
U.S. government agencies residential
$ 127.6
1,463.1
11.9
$ 4.2
21.4
0.1
mortgage-backed securities . . . . . . . . .
178.5
Total fixed maturities . . . . . . . . . . . .
1,781.1
Equity securities:
Large-cap securities . . . . . . . . . . . . . . . . .
Small-cap securities . . . . . . . . . . . . . . . . .
Total equity securities . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . .
137.5
6.8
144.3
32.4
4.0
29.7
6.1
0.5
6.6
—
Total investments . . . . . . . . . . . . . . . . . . . . . . .
$1,957.8
$36.3
42
288
7
42
379
32
333
365
—
744
$ (4.2)
(33.5)
(0.2)
(2.2)
(40.1)
(13.4)
—
(13.4)
(0.7)
29
357
7
29
422
41
—
41
2
Fair Value
$ 127.6
1,451.0
11.8
180.3
1,770.7
130.2
7.3
137.5
31.7
$(54.2)
465
$1,939.9
The following table presents a summary of our cumulative unrealized holding (loss) gain by investment
type, net of deferred taxes that were included as a component of accumulated comprehensive loss at
December 31, 2008 and December 31, 2007, respectively, and the change in unrealized holding gain (loss), net of
deferred tax, for the year ended December 31, 2008:
($ 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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cumulative unrealized holding (loss) gain, net of
$(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)
tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$(14.2)
$ 43.4
$(57.6)
Fair Value Measurements
We primarily use one independent nationally recognized pricing service in developing fair value estimates.
We obtain one price per security, and our processes and control procedures are designed to ensure the value is
accurately recorded on an unadjusted basis. Through discussions with the pricing service, we gain an
understanding of the methodologies used to price the different types of securities, that the data and the valuation
the assumptions are reasonable and
methods utilized are appropriate and consistently applied, and that
representative of fair value. To validate the reasonableness of the valuations obtained from the pricing service,
76
we compare to other fair value pricing information gathered from other independent pricing sources. See Note 3,
“Fair Value of Financial Instruments” to our Consolidated Financial Statements included in Item 8 of this
Form 10-K for a presentation of our available-for-sale investments within the fair value hierarchy at
December 31, 2008.
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
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 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.
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 may 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, 2009 and 2008, we had
$90.3 million and $150.5 million, respectively, in cash and cash equivalents, and $2,108.2 million and $1,939.9
million, respectively, of total available-for-sale investments at fair value. Included in our fixed maturities
available-for-sale at fair value are $56.9 million and $56.0 million of securities on deposit with insurance
regulators as required by law at December 31, 2009 and 2008, 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.
77
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.
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 $110.5 million, $183.5 million and $121.6 million for 2009,
2008 and 2007, respectively. Net cash from operations may vary from year to year if there are significant
changes in underwriting results from the previous four quarters, investment income or federal income taxes.
Below are the primary factors that contributed to the variance in operating cash flows for these years:
•
Each quarter we settle our intercompany account from the previous quarter with State Auto Mutual,
who acts as our cash administrator. We receive our premiums and pay our losses and expenses through
this account. In quarters where premiums exceed losses and expenses, we receive money. In quarters
where losses and expenses exceed premiums, we pay money. We received $0.3 million, $24.7 million
and $82.9 million through this account for the years ended December 31, 2009, 2008 and 2007,
respectively. The variability between years was primarily driven by the level of catastrophe losses and
the timing of their settlement;
• We received a federal income tax refund of $38.1 million in 2009 compared to federal income tax
payments of $18.2 million and $42.3 million in 2008 and 2007, respectively; and
•
Cash from operations in 2008 included $92.0 million due to the 2008 pooling change.
We generally manage our cash flows through current operational activity and maturing investments, without
a need to liquidate any of our other investments. 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 losses. This action was not necessary in 2009 or 2008 despite the increased level of
catastrophe losses.
During 2009, 2008 and 2007, as permitted by regulations of the Internal Revenue Service, we made cash
contributions of $15.0 million, $12.0 million and $11.5 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
78
quarter with respect to the contribution year, though we currently expect to make a minimum cash contribution to
our defined benefit pension plan up to approximately $15.0 million during 2010. For a further discussion
regarding our defined benefit pension plan, see “Other—Employee Benefit Plans” included in this Item 7.
Net cash used in investing activities was $150.2 million, $51.5 million and $86.1 million for 2009, 2008 and
2007, respectively. The following contributed to the fluctuations between those years:
•
•
In the last half of 2008, as markets began to weaken, we took a conservative approach to investing. We
maintained higher cash balances to avoid selling assets at depressed prices for any cash needs, such as
paying the claims associated with the high level of catastrophes occurring during the second half of the
year. During 2009, as markets improved and claim activity settled into lower levels than 2008, we
began reinvesting as opportunities arose.
The decline in cash used in investing activities in 2008 versus 2007 was primarily the result of an
increase in the accumulation of cash for future claims settlements and intercompany payments to
affiliates and to pay shareholder dividends.
Our financing activities for 2009, 2008 and 2007 produced net cash outflows of $20.5 million, $52.4
million, and $38.0 million, respectively. The following contributed to the fluctuations between those years:
•
•
Dividends paid to shareholders totaled $23.8 million, $23.9 million and $20.5 million for 2009, 2008
and 2007, respectively. The increase in dividends paid between 2008 and 2007 was due to increasing
the amount of dividends paid per common share. Dividends paid per common share were $0.60 in
2009, $0.60 in 2008 and $0.50 in 2007.
Cash used to repurchase common shares under our stock repurchase program was $33.2 million and
$22.1 million for 2008 and 2007, respectively. No shares were repurchased in 2009. 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 the Company’s outstanding shares. This
program ended on December 31, 2009. State Auto Financial repurchased shares from State Auto Mutual in
amounts that were proportional to its ownership percentages of State Auto Mutual, which was approximately
64%, and other shareholders. There were no shares repurchased for the year ended December 31, 2009. 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. For the lifetime of the program, a total
of 2,028,116 common shares were purchased at an average purchase price of $27.26 per share for a total of $55.3
million.
On November 6, 2009, the Board of Directors of State Auto Financial declared a cash dividend of $0.15 per
share. The dividend was payable on December 31, 2009, to shareholders of record on December 14, 2009. On
March 5, 2010, the Board of Directors of State Auto Financial declared a cash dividend of $0.15 per share. The
dividend is payable on March 31, 2010, to shareholders of record on March 15, 2010. This is the 75th 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 working capital to State Auto Financial, in 2009 Stateco, SA
National and State Auto P&C declared cash dividends of $5.0 million, $6.5 million and $5.0 million,
respectively. The cash transfers of dividends were completed in 2009. The dividends from SA National and State
Auto P&C were paid from unassigned statutory surplus and were not considered to be extraordinary for
regulatory purposes.
79
Borrowing Arrangements
Credit Agreement
State Auto Financial has a credit facility (the “Credit Facility”) with a syndicate of financial institutions.
The Credit Facility provides for a $100.0 million unsecured revolving credit facility maturing in July 2012. The
Credit Facility is available for general corporate purposes. The Credit Facility provides for interest-only
payments during its term, with principal and interest 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 Facility includes certain
covenants, including financial covenants that require State Auto Financial to maintain a minimum net worth and
not exceed a certain debt to capitalization ratio. As of December 31, 2009, State Auto Financial had not made
any borrowings and was in compliance with all covenants related to the Credit Facility.
Senior Notes
State Auto Financial has outstanding $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 State Auto Financial’s
subsidiaries’ existing and future indebtedness.
Subordinated Debentures
State Auto Financial’s Delaware business trust subsidiary (the “Capital Trust”) has outstanding $15.0
million liquidation amount of capital securities, 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 has issued to the Capital Trust $15.5 million aggregate
principal amount of unsecured Floating Rate Junior Subordinated Debt Securities due 2033 (the “Subordinated
Debentures”). The sole assets of the Capital Trust are the Subordinated Debentures and any interest accrued
thereon. Interest on the Capital Trust’s capital and common securities is payable quarterly at a rate equal to the
three-month LIBOR rate plus 4.20%, adjusted quarterly. The applicable interest rates for December 31, 2009 and
2008 were 4.46% and 6.38%, respectively.
Notes Payable Summary
The following summarized our notes payable at December 31, 2009:
($ 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
$101.7
$101.8
6.25%
interest adjusting quarterly . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
15.5
15.5
4.46%
Total Notes Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$117.2
$117.3
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, 2009, we had $15.5 million notes
payable with variable interest and $101.7 million notes payable with interest fixed at 6.25%, which equated to
approximately 13.2% variable interest debt and 86.8% fixed interest debt. Our decision to obtain fixed versus
80
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.
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
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, as well as an additional $2.0 million in
aggregate retention per treaty year. 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.
81
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 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.
Members of the State Auto Group also maintain a property catastrophe net aggregate excess of loss
reinsurance agreement (the “Catastrophe Aggregate Agreement”). The agreement, which was reviewed and
renewed as of January 1, 2010, provides reinsurance coverage on an annual basis for certain qualifying
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, 2010 through December 31, 2010. On an aggregate basis the members of the
State Auto Group combined retain the first $90.0 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 $90.0 million up to $120.0
million of covered loss on an aggregate basis. The rates for this reinsurance are negotiated annually. Prior to
January 1, 2010 the aggregate retention under this agreement was $80.0 million.
Contractual Obligations
Our significant contractual obligations as of December 31, 2009, were as follows:
($ millions)
Direct Loss and ALAE 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 . . . . . . . . . . . . . .
Total
$ 882.5
Due
1 year
or less
$357.0
Due
1-3
years
$300.4
Due
3-5
years
$107.9
Due
after 5
years
$117.2
$ 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)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Subordinated Debentures due 2033:
issued $15.5, May 2003 with variable
interest(4) adjusting quarterly . . . . . . . . . . . . . .
$
25.1
$
6.3
$ 12.5
$
6.3
$ —
16.2
0.7
1.4
1.4
12.7
Total interest payable . . . . . . . . . . . . . . . . .
Postretirement benefits . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . .
Pension funding(5)
41.3
$
$
46.8
$ 113.1
7.0
$
$
3.7
$ —
$ 13.9
$
7.7
$ 41.0
7.7
$
$
8.3
$ 38.8
$ 12.7
$ 27.1
$ 33.3
Total
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,199.2
$367.7
$363.0
$262.7
$205.8
(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
82
(2)
(3)
(4)
(5)
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, 2009, 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,
2009 of 0.2506% plus 4.20%, or 4.4506%.
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 10, “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.
Lease and other purchase obligations of State Auto Mutual are allocated to us through the Pooling
Arrangement.
Regulatory Considerations
At December 31, 2009, 2008 and 2007, 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
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.
The leverage ratios decreased slightly in 2009. While premiums grew 5.1%, surplus increased 8.0%. The
increase in surplus was driven by unrealized holding gains on investments and net investment income. The
statutory leverage ratios for our insurance subsidiaries at December 31, 2009, 2008 and 2007 were as follows:
Statutory Leverage Ratios(1)
2009
2008(2)
2007
State Auto P&C . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Milbank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Farmers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
SA Ohio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
SA National . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Weighted Average . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1.6
1.6
1.4
1.1
0.6
1.5
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) 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 2008
pooling changes.
83
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, 2009 $68.2 million is available in 2010 for payment as a dividend
from our insurance subsidiaries to State Auto Financial, without prior approval from our respective domiciliary
state insurance departments. In 2009, 2008 and 2007, State Auto Financial received $11.5 million, $39.0 million
and $50.0 million, respectively in dividends from its insurance subsidiaries. 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
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, 2009, the ratio of
total adjusted statutory capital to authorized control level of State Auto Financial’s insurance subsidiaries ranged
from 707% to 2,265%.
Credit and Financial Strength Ratings
The following table summarizes our credit and insurance company financial strength ratings as of
February 25, 2010:
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
84
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
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
catastrophes, such as the industry experienced in Florida and other 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
Fair Value Measurements and Disclosures—Investments in Certain Entities That Calculate Net Asset Value per
Share
In September 2009, the Financial Accounting Standards Board (“FASB”) issued new guidance on the fair
value measurements and disclosures of investments in certain entities that calculate net asset value per share (or
its equivalent). The new guidance, which is now part of the FASB Accounting Standards Codification (“ASC”)
Topic Fair Value Measurements and Disclosures, permits, as a practical expedient, a reporting entity to estimate
the fair value of an investment within its scope using net asset value per share of the investment (or its
equivalent) without adjustment, as long as the net asset value is calculated as of the reporting entity’s
measurement date in a manner consistent with the measurement principles of FASB ASC Topic Financial
Services—Investment Companies. The new guidance also requires certain disclosures about the attributes of
investments measured at net asset value, such as the nature of any restrictions on the investor’s ability to redeem
its investment at the measurement date or any unfunded capital commitments. The new guidance was effective
on a prospective basis for the first reporting period, including interim periods, ending after December 15, 2009.
The adoption of this new guidance effective December 31, 2009 had no effect on our consolidated financial
statements. The disclosures required by this new guidance are provided in Note 3 of the accompanying financial
statements.
85
Employers’ Disclosures about Postretirement Benefit Plan Assets
In December 2008, the FASB issued new guidance on the disclosure of pension or other postretirement
benefit plan assets. The new guidance, which is now part of the FASB ASC Topic Compensation—Retirement
Benefits, requires an employer to provide certain disclosures about plan assets of its defined benefit pension or
other postretirement plans. The required disclosures include the investment policies and strategies of the plans,
the fair value of the major categories of plan assets, the inputs and valuation techniques used to develop fair
value measurements and a description of significant concentrations of risk in plan assets. The new guidance was
effective on a prospective basis for fiscal years ending after December 15, 2009, and the required disclosures are
provided in Note 10 of the accompanying financial statements.
Accounting Standards Codification
In June 2009, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 168, The FASB
Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles—a
replacement of FASB Statement No. 162 (“the Codification”). The Codification reorganized existing U.S.
accounting and reporting standards issued by the FASB and other related private sector standard setters into a
single source of authoritative accounting principles arranged by topic. The Codification supersedes all existing
U.S. accounting standards; all other accounting literature not included in the Codification (other than Securities
and Exchange Commission guidance for publicly-traded companies) is considered non-authoritative. The
Codification was effective on a prospective basis for interim and annual reporting periods ending after
September 15, 2009. The adoption of the Codification changed our references to U.S. GAAP accounting
standards but did not impact our consolidated financial statements.
Subsequent Events
In May 2009, the FASB issued new guidance for accounting for subsequent events. The new guidance,
which is now part of the FASB ASC Topic Subsequent Events, establishes general standards of accounting for
and disclosure of events that occur after the balance sheet date but before financial statements are issued or are
available to be issued. Specifically, the new guidance sets forth the period after the balance sheet date during
which management of a reporting entity should evaluate events or transactions that may occur for potential
recognition or disclosure in the financial statements. The new guidance was effective on a prospective basis for
interim or annual periods ending after June 15, 2009. The adoption of this new guidance effective June 30, 2009
had no effect on our consolidated financial statements. The disclosures required by this new guidance are
provided in Note 19 of the accompanying financial statements.
Other-Than-Temporary Impairments
In April 2009, the FASB issued new guidance for the accounting for other-than-temporary impairments.
Under the new guidance, which is now part of the FASB ASC Topic Investments—Debt and Equity Securities,
the indicators used in considering an impairment of a debt security to be other-than-temporary have been
modified, from management asserting it has both the intent and the ability to hold an impaired security for a
period of time sufficient for anticipated recovery in fair value to management asserting that (a) it does not have
the intent to sell the security and (b) it is more likely than not it will not have to sell the security before recovery.
Additionally, this new guidance requires that other-than-temporary impairments on debt securities due to credit
be recognized in earnings while non-credit other-than-temporary impairments be recognized in other
comprehensive income. This new guidance also requires companies to disclose major security types for both debt
and equity securities and to provide meaningful disclosure about individually significant unrealized losses and all
such disclosures are required to be included in both interim and annual periods. This new guidance was effective
for interim and annual reporting periods ending after June 15, 2009. The adoption of this new guidance effective
April 1, 2009 did not have a material effect on our consolidated financial statements. The disclosures required by
this new guidance are provided in Note 2 of the accompanying financial statements.
86
Additional Fair Value Measurement Guidance
In April 2009, the FASB issued new guidance for determining when a transaction is not orderly and for
estimating fair value when there has been a significant decrease in the volume and level of activity for an asset or
liability. The new guidance, which is now part of the FASB ASC Topic Fair Value Measurements and
Disclosures, requires disclosure of the inputs and valuation techniques used, as well as any changes in valuation
techniques and inputs used during the period, to measure fair value in interim and annual periods. In addition, the
presentation of the fair value hierarchy is required to be presented by major security type as described in the
FASB ASC Topic Investments—Debt and Equity Securities. The provisions of the new guidance were effective
for interim periods ending after June 15, 2009. The adoption of this new guidance effective April 1, 2009 did not
have a material effect on our consolidated financial statements. The disclosures required by this new guidance
are provided in Note 3 of the accompanying financial statements.
Disclosures about Fair Value of Financial Instruments
In April 2009, the FASB issued new guidance related to the disclosure of the fair value of financial
instruments. The new guidance, which is now part of the FASB ASC Topic Financial Instruments, requires
disclosure of the fair value of financial instruments whether recognized or not recognized on the balance sheet in
interim and annual financial statements. The provisions of the new guidance were effective for interim periods
ending after June 15, 2009. We adopted this new guidance effective April 1, 2009. The disclosures required by
this new guidance are provided in Notes 6 and 7 of the accompanying financial statements.
Pending Adoption of Accounting Pronouncements
Amendments to Accounting for Variable Interest Entities
In June 2009, the FASB issued revised guidance on the accounting for variable interest entities. The revised
guidance, which was issued as SFAS No. 167, Amendments to FASB Interpretation No. 46(R), has not yet been
adopted into the Codification. The revised guidance reflects the elimination of the concept of a qualifying
special-purpose entity and replaces the quantitative-based risks and rewards calculation of the previous guidance
for determining which company, if any, has a controlling financial interest in a variable interest entity. The
revised guidance requires an analysis of whether a company has: (1) the power to direct the activities of a
variable interest entity that most significantly impact the entity’s economic performance and (2) the obligation to
absorb the losses that could potentially be significant to the entity or the right to receive benefits from the entity
that could potentially be significant to the entity. An entity is required to be re-evaluated as a variable interest
entity when the holders of the equity investment at risk, as a group, lose the power from voting rights or similar
rights to direct the activities that most significantly impact the entity’s economic performance. Additional
disclosures are required about a company’s involvement in variable interest entities and an ongoing assessment
of whether a company is the primary beneficiary. The new guidance is effective on a prospective basis at the start
of our first fiscal year beginning after November 15, 2009. The provisions of the new guidance are not expected
to have a material impact on our consolidated financial statements.
Improving Disclosures about Fair Value Measurements
In January 2010,
the FASB issued guidance to improve the disclosures related to fair value
measurements. The new guidance requires expanded fair value disclosures, including the reasons for significant
transfers between Level 1 and Level 2 and the amount of significant transfers into each level disclosed separately
from transfers out of each level. For Level 3 fair value measurements, information in the reconciliation of
recurring Level 3 measurements about purchases, sales, issuances and settlements shall be presented separately
on a gross basis, rather than as one net number. In addition, clarification is provided about existing disclosure
requirements, such as presenting fair value measurement disclosures for each class of assets and liabilities that
are determined based on their nature and risk characteristics and their placement in the fair value hierarchy (that
is, Level 1, 2, or 3), as opposed to each major category of assets and liabilities, as required in the previous
87
guidance. Disclosures about the valuation techniques and inputs used to measure fair value for both recurring and
nonrecurring fair value measurements will be required for fair value measurement that fall in either Level 2 or
Level 3. The new guidance is effective for interim and annual reporting periods beginning after December 15,
2009. The expanded disclosures will be included in our Quarterly Report on Form 10-Q for the quarter ended
March 31, 2010.
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
“2009 Compared to 2008—Investment Operations Segment—Market Risk.”
88
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, 2009 and 2008, and the related consolidated statements of income, stockholders’
equity, and cash flows for each of the three years in the period ended December 31, 2009. 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, 2009 and
2008, and the consolidated results of their operations and their cash flows for each of the three years in the period
ended December 31, 2009, 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 other-than-temporary impairments of investments in fixed maturity securities in 2009.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board
(United States), State Auto Financial Corporation and subsidiaries’ internal control over financial reporting as of
December 31, 2009, 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 5, 2010,
expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Columbus, Ohio
March 5, 2010
89
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 and subsidiaries’ internal control over financial reporting
as of December 31, 2009, 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 and subsidiaries maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2009, 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 and subsidiaries as of
December 31, 2009 and 2008, and the related consolidated statements of income, stockholders’ equity, and cash
flows for each of the three years in the period ended December 31, 2009, and our report dated March 5, 2010,
expressed an unqualified opinion thereon.
Columbus, Ohio
March 5, 2010
/s/ Ernst & Young LLP
90
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
2009
2008
Fixed maturities, available-for-sale, at fair value (amortized cost $1,788.1 and
$1,781.1, respectively)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,831.8
1,770.7
Equity securities, available-for-sale, at fair value (cost $189.7 and $144.3,
respectively)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
224.1
137.5
Other invested assets, available-for-sale, at fair value (cost $44.1 and $32.4,
respectively)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Notes receivable from affiliate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
52.3
0.9
70.0
31.7
1.4
—
2,179.1
1,941.3
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accrued investment income and other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred policy acquisition costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Reinsurance recoverable on losses and loss expenses payable (affiliates $0.1 and $0.6,
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 $6.7 and $6.2,
respectively)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
90.3
35.1
127.3
20.8
7.2
7.7
9.1
75.9
12.0
150.5
40.2
122.3
21.2
7.0
—
37.6
111.0
12.5
$2,564.5
2,443.6
Liabilities and Stockholders’ Equity
Losses and loss expenses payable (affiliates $346.2 and $343.0, respectively) . . . . . . . .
Unearned premiums (affiliates $180.7 and $175.0, respectively)
. . . . . . . . . . . . . . . . . .
Notes payable (affiliates $15.5 and $15.5, respectively)
. . . . . . . . . . . . . . . . . . . . . . . . .
Postretirement and pension benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Due to affiliate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 840.2
547.0
117.2
150.4
—
60.3
791.2
515.1
117.6
187.7
15.9
55.1
1,715.1
1,682.6
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; 46.6 and 46.3 shares
—
—
—
—
issued, respectively, at stated value of $2.50 per share . . . . . . . . . . . . . . . . . . . . . . . . .
Treasury stock, 6.8 and 6.8 shares, respectively, at cost . . . . . . . . . . . . . . . . . . . . . . . . . .
Additional paid-in capital
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accumulated other comprehensive loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total liabilities and stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
116.6
(115.7)
115.8
(2.9)
735.6
115.9
(115.5)
109.0
(97.6)
749.2
849.4
761.0
$2,564.5
2,443.6
See accompanying notes to consolidated financial statements.
91
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Consolidated Statements of Income
($ millions, except per share amounts)
Earned premiums (ceded to affiliate $742.6, $700.9 and $695.7, respectively) . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net investment income (affiliate $3.1 in 2009)
Net realized (loss) gain on investments:
Total other-than-temporary impairment losses . . . . . . . . . . . . . . . . . . . . .
Portion of loss recognized in other comprehensive income . . . . . . . . . . .
Other net realized investment gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total net realized (loss) gain on investments . . . . . . . . . . . . . . . . . . . . . . . . . .
Other income (affiliates $2.2, $3.1 and $3.3, respectively) . . . . . . . . . . . . . . . . . . .
Year ended December 31
2009
2008
2007
$1,176.5
82.1
1,126.0
87.4
1,011.6
84.7
(9.0)
—
3.8
(5.2)
3.5
(39.3)
—
2.9
(36.4)
4.9
(1.9)
—
14.0
12.1
5.0
Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,256.9
1,181.9
1,113.4
Losses and loss expenses (ceded to affiliate $544.9, $514.6 and $405.0,
respectively)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Acquisition and operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Interest expense (affiliates $0.8, $1.2 and $1.5, respectively) . . . . . . . . . . . . . . . . .
Other expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
843.3
400.9
7.6
17.9
846.7
389.8
7.3
13.2
Total expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,269.7
1,257.0
590.8
347.9
7.6
11.8
958.1
155.3
(12.8)
(75.1)
(9.5)
(13.5)
(23.0)
(26.4)
(17.6)
(44.0)
43.5
(7.3)
36.2
10.2
(31.1)
119.1
0.26
0.25
0.60
(0.78)
(0.78)
0.60
2.90
2.86
0.50
$
$
$
$
(Loss) income before federal income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Federal income tax (benefit) expense:
Current . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total federal income tax (benefit) expense . . . . . . . . . . . . . . . . . . . . . . .
Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Earnings (loss) per common share:
Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Dividends paid per common share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
See accompanying notes to consolidated financial statements.
92
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
2009
2008
2007
Balance at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Issuance of shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Balance at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Treasury shares:
Balance at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Shares acquired on stock option exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Shares acquired under repurchase program . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Balance at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
46.3
0.3
46.6
(6.8)
—
—
(6.8)
46.0
0.3
46.3
45.7
0.3
46.0
(4.7)
(5.5)
(0.1) —
(1.2)
(6.8)
(0.8)
(5.5)
Common stock:
Balance at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Issuance of shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Balance at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 115.9
0.7
116.6
115.0
0.9
115.9
114.3
0.7
115.0
Treasury stock:
Balance at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Shares acquired on stock option exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Shares acquired under repurchase program . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Balance at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$(115.5)
(0.2)
—
(115.7)
(81.0)
(1.3)
(33.2)
(115.5)
(58.1)
(0.8)
(22.1)
(81.0)
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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 109.0
2.8
0.2
3.8
115.8
98.2
4.9
0.8
5.1
109.0
87.3
4.4
0.7
5.8
98.2
Accumulated other comprehensive (loss) income:
Balance at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Effect of changing benefit plan obligation measurement date, net of tax . . . . . . . .
Balance at beginning of year, as adjusted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Change in unrealized gains (losses) 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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Balance at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ (97.6)
—
(97.6)
(17.3)
(3.3)
3.5 —
0.2
(17.3)
70.3
(0.1)
24.5
(2.9)
(57.6)
(0.1)
(40.1)
(97.6)
(2.6)
(0.1)
16.7
(3.3)
Retained earnings:
Balance at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Effect of changing benefit plan obligation measurement date, net of tax . . . . . . . .
Balance at beginning of year, as adjusted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash dividends paid (affiliates $15.2, $15.3 and $13.2, respectively) . . . . . . . . . .
Balance at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total stockholders’ equity at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 749.2
—
749.2
10.2
(23.8)
735.6
$ 849.4
806.6
708.0
(2.4) —
804.2
708.0
(31.1) 119.1
(20.5)
(23.9)
806.6
749.2
935.5
761.0
See accompanying notes to consolidated financial statements.
93
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 income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Adjustments to reconcile net income (loss) 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 pooling change, January 1, 2008 (Note 6a) . . . . . . . . . . . . . .
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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Note to affiliate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
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 $15.2, $15.3 and $13.2, respectively)
Net cash used in financing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net (decrease) increase 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
2009
2008
2007
$ 10.2
(31.1)
119.1
11.8
3.7
5.2
(5.0)
4.7
1.8
0.3
(18.2)
49.0
31.9
0.1
15.0
—
10.6
5.5
36.4
(3.7)
1.1
7.3
(11.0)
33.2
81.6
25.5
0.4
(64.3)
92.0
11.0
6.0
(12.1)
(1.7)
1.0
7.3
2.3
4.0
(16.2)
7.2
0.4
(6.7)
—
110.5
183.5
121.6
(494.7)
(90.4)
(13.0)
159.0
323.8
34.0
1.2
(288.5)
(29.2)
(24.7)
58.7
164.6
67.0
1.1
(70.0) —
(0.1)
(0.5)
(331.6)
(73.7)
(17.1)
73.1
155.2
107.0
1.8
—
(0.8)
(150.2)
(51.5)
(86.1)
3.3
—
—
(23.8)
(20.5)
(60.2)
150.5
4.4
(33.2)
0.3
(23.9)
4.3
(22.1)
0.3
(20.5)
(52.4)
(38.0)
79.6
70.9
$ 90.3
150.5
(2.5)
73.4
70.9
7.8
42.3
Supplemental disclosures:
Interest paid (affiliates $0.8, $1.2 and $1.5, respectively) . . . . . . . . . . . . . . . . . . .
$
7.1
7.5
Federal income taxes (received) paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ (38.1)
18.2
See accompanying notes to consolidated financial statements.
94
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
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.
During 2009, the assets of Strategic Insurance Software, Inc., a wholly-owned subsidiary of State Auto
Financial and a developer and seller of insurance-related software, were sold to a third party. The assets and
operation of this subsidiary were not material to the Company’s total operations.
95
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 (“GAAP”), which vary in certain respects from statutory-basis accounting principles
(“SAP”) 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
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 and losses, net of
applicable deferred income taxes, are shown as a separate component of stockholders’ equity as a part of
accumulated other comprehensive 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.
that requires significant management
The Company regularly monitors its investments that have fair values less than cost or amortized cost for
signs of other-than-temporary impairment, an assessment
judgment
regarding the evidence known. Such judgments could change in the future as more information becomes known,
which could negatively impact the amounts reported. Among the factors that management considers for fixed
maturity securities are the financial condition of the issuer including receipt of scheduled principal and interest
cash flows, intent to sell, and if it is more likely than not that the Company will be required to sell the
investments before recovery. When a fixed maturity has been determined to have an other-than-temporary
impairment, the impairment charge is separated into an amount representing the credit loss, which is recognized
in earnings as a realized loss, and the amount related to non-credit factors, which is recognized in accumulated
other comprehensive loss. Future increases or decreases in fair value, if not other-than-temporary, are included in
accumulated other comprehensive loss.
Among the factors that management considers for equity securities and other invested assets are the length
of time and/or the significance of decline below cost, the Company’s ability and intent to hold these securities
through their recovery periods, the current financial condition of the issuer and its future business prospects, and
96
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
the ability of the market value to recover to cost in the near term. When an equity security or other invested asset
has been determined to have a decline in fair value that is other-than-temporary, the cost basis of the security is
adjusted 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
accumulated other comprehensive loss.
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 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. Future changes in estimates, the most significant of which is
expected losses and loss adjustment expenses, that indicate a reduction in expected future profitability may result
in unrecoverable deferred policy acquisition costs. The Company has not recorded any significant changes in
estimates for the years ended December 31, 2009, 2008 and 2007, respectively.
Net deferred policy acquisition costs for the years ended December 31 are:
($ millions)
2009
2008
2007
Balance, beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Effect of January 1, 2008 pooling change (Note 6) . . . . . . . . .
Acquisition costs deferred . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Acquisition costs amortized to expense . . . . . . . . . . . . . . . . . .
$ 122.3
—
282.5
(277.5)
105.8
12.9
260.8
(257.2)
104.0
—
244.5
(242.7)
Balance, end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 127.3
122.3
105.8
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.
The Company recognizes deferred income tax assets and liabilities for the expected future tax effects
attributable to temporary differences between the financial statement and tax return bases of assets and liabilities,
based on enacted tax rates and other provisions of the tax law. The effect of a change in tax laws or rates on
deferred tax assets and liabilities is recognized in income in the period in which such change is enacted. Deferred
tax assets and liabilities include provisions for unrealized investment gains and losses as well as the net funded
status of pension and other postretirement benefit obligations with the changes for each period included in the
respective components of accumulated other comprehensive income (loss) in stockholders’ equity. Deferred tax
97
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
assets are reduced by a valuation allowance if it is more likely than not that all or some portion of the deferred
tax assets will not be realized.
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 $33.3 million and $31.5
million at December 31, 2009 and 2008, 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
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 Income (Loss)
Comprehensive income (loss) is defined as all changes in an enterprise’s equity during a period other than
those resulting from investments by owners and distributions to owners. Comprehensive income (loss) includes
net income (loss) and other comprehensive income (loss). Other comprehensive income (loss) 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. New Accounting Standards
Adoption of Recent Accounting Pronouncements
Fair Value Measurements and Disclosures—Investments in Certain Entities That Calculate Net Asset Value per
Share
In September 2009, the Financial Accounting Standards Board (“FASB”) issued new guidance on the fair
value measurements and disclosures of investments in certain entities that calculate net asset value per share (or
its equivalent). The new guidance, which is now part of the FASB Accounting Standards Codification (“ASC”)
Topic Fair Value Measurements and Disclosures, permits, as a practical expedient, a reporting entity to estimate
the fair value of an investment within its scope using net asset value per share of the investment (or its
equivalent) without adjustment, as long as the net asset value is calculated as of the reporting entity’s
measurement date in a manner consistent with the measurement principles of FASB ASC Topic Financial
98
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
Services—Investment Companies. The new guidance also requires certain disclosures about the attributes of
investments measured at net asset value, such as the nature of any restrictions on the investor’s ability to redeem
its investment at the measurement date or any unfunded capital commitments. The new guidance was effective
on a prospective basis for the first reporting period, including interim periods, ending after December 15, 2009.
The Company adopted this new guidance effective December 31, 2009, and determined it had no effect on the
Company’s consolidated financial statements. The disclosures required by this new guidance are provided in
Note 3.
Employers’ Disclosures about Postretirement Benefit Plan Assets
In December 2008, the FASB issued new guidance on the disclosure of pension or other postretirement
benefit plan assets. The new guidance, which is now part of the FASB ASC Topic Compensation—Retirement
Benefits, requires an employer to provide certain disclosures about plan assets of its defined benefit pension or
other postretirement plans. The required disclosures include the investment policies and strategies of the plans,
the fair value of the major categories of plan assets, the inputs and valuation techniques used to develop fair
value measurements and a description of significant concentrations of risk in plan assets. The new guidance was
effective on a prospective basis for fiscal years ending after December 15, 2009. The Company adopted this new
guidance effective December 31, 2009, and the required disclosures are provided in Note 10.
Accounting Standards Codification
In June 2009, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 168, The FASB
Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles—a
replacement of FASB Statement No. 162 (“the Codification”). The Codification reorganized existing U.S.
accounting and reporting standards issued by the FASB and other related private sector standard setters into a
single source of authoritative accounting principles arranged by topic. The Codification supersedes all existing
U.S. accounting standards; all other accounting literature not included in the Codification (other than Securities
and Exchange Commission guidance for publicly-traded companies) is considered non-authoritative. The
Codification was effective on a prospective basis for interim and annual reporting periods ending after
September 15, 2009. The adoption of the Codification changed the Company’s references to U.S. GAAP
accounting standards but did not impact the Company’s consolidated financial statements.
Subsequent Events
In May 2009, the FASB issued new guidance for accounting for subsequent events. The new guidance,
which is now part of the FASB ASC Topic Subsequent Events, establishes general standards of accounting for
and disclosure of events that occur after the balance sheet date but before financial statements are issued or are
available to be issued. Specifically, the new guidance sets forth the period after the balance sheet date during
which management of a reporting entity should evaluate events or transactions that may occur for potential
recognition or disclosure in the financial statements. The new guidance was effective on a prospective basis for
interim or annual periods ending after June 15, 2009. The Company adopted this new guidance effective June 30,
2009, and determined it had no effect on the Company’s consolidated financial statements. The disclosures
required by this new guidance are provided in Note 19.
Other-Than-Temporary Impairments
In April 2009, the FASB issued new guidance for the accounting for other-than-temporary impairments.
Under the new guidance, which is now part of the FASB ASC Topic Investments—Debt and Equity Securities,
99
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
the indicators used in considering an impairment of a debt security to be other-than-temporary have been
modified, from management asserting it has both the intent and the ability to hold an impaired security for a
period of time sufficient for anticipated recovery in fair value to management asserting that (a) it does not have
the intent to sell the security and (b) it is more likely than not it will not have to sell the security before recovery.
Additionally, this new guidance requires that other-than-temporary impairments on debt securities due to credit
be recognized in earnings while non-credit other-than-temporary impairments be recognized in other
comprehensive income. This new guidance also requires companies to disclose major security types for both debt
and equity securities and to provide meaningful disclosure about individually significant unrealized losses and all
such disclosures are required to be included in both interim and annual periods. This new guidance was effective
for interim and annual reporting periods ending after June 15, 2009. The Company adopted this new guidance
effective April 1, 2009, and determined it did not have a material effect on the Company’s consolidated financial
statements. The disclosures required by this new guidance are provided in Note 2.
Additional Fair Value Measurement Guidance
In April 2009, the FASB issued new guidance for determining when a transaction is not orderly and for
estimating fair value when there has been a significant decrease in the volume and level of activity for an asset or
liability. The new guidance, which is now part of the FASB ASC Topic Fair Value Measurements and
Disclosures, requires disclosure of the inputs and valuation techniques used, as well as any changes in valuation
techniques and inputs used during the period, to measure fair value in interim and annual periods. In addition, the
presentation of the fair value hierarchy is required to be presented by major security type as described in the
FASB ASC Topic Investments – Debt and Equity Securities. The provisions of the new guidance were effective
for interim periods ending after June 15, 2009. The Company adopted this new guidance effective April 1, 2009,
and determined it did not have a material effect on the Company’s consolidated financial statements. The
disclosures required by this new guidance are provided in Note 3.
Disclosures about Fair Value of Financial Instruments
In April 2009, the FASB issued new guidance related to the disclosure of the fair value of financial
instruments. The new guidance, which is now part of the FASB ASC Topic Financial Instruments, requires
disclosure of the fair value of financial instruments whether recognized or not recognized on the balance sheet in
interim and annual financial statements. The provisions of the new guidance were effective for interim periods
ending after June 15, 2009. The Company adopted this new guidance effective April 1, 2009. The disclosures
required by this new guidance are provided in Notes 6 and 7.
Pending Adoption of Accounting Pronouncements
Amendments to Accounting for Variable Interest Entities
In June 2009, the FASB issued revised guidance on the accounting for variable interest entities. The revised
guidance, which was issued as SFAS No. 167, Amendments to FASB Interpretation No. 46(R), has not yet been
adopted into the Codification. The revised guidance reflects the elimination of the concept of a qualifying
special-purpose entity and replaces the quantitative-based risks and rewards calculation of the previous guidance
for determining which company, if any, has a controlling financial interest in a variable interest entity. The
revised guidance requires an analysis of whether a company has: (1) the power to direct the activities of a
variable interest entity that most significantly impact the entity’s economic performance and (2) the obligation to
absorb the losses that could potentially be significant to the entity or the right to receive benefits from the entity
100
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
that could potentially be significant to the entity. An entity is required to be re-evaluated as a variable interest
entity when the holders of the equity investment at risk, as a group, lose the power from voting rights or similar
rights to direct the activities that most significantly impact the entity’s economic performance. Additional
disclosures are required about a company’s involvement in variable interest entities and an ongoing assessment
of whether a company is the primary beneficiary. The new guidance is effective on a prospective basis at the start
of the Company’s first fiscal year beginning after November 15, 2009. The provisions of the new guidance are
not expected to have a material impact on the Company’s consolidated financial statements.
Improving Disclosures about Fair Value Measurements
In January 2010, the FASB issued guidance to improve the disclosures related to fair value measurements. The
new guidance requires expanded fair value disclosures, including the reasons for significant transfers between Level
1 and Level 2 and the amount of significant transfers into each level disclosed separately from transfers out of each
level. For Level 3 fair value measurements, information in the reconciliation of recurring Level 3 measurements
about purchases, sales, issuances and settlements shall be presented separately on a gross basis, rather than as one
net number. In addition, clarification is provided about existing disclosure requirements, such as presenting fair
value measurement disclosures for each class of assets and liabilities that are determined based on their nature and
risk characteristics and their placement in the fair value hierarchy (that is, Level 1, 2, or 3), as opposed to each
major category of assets and liabilities, as required in the previous guidance. Disclosures about the valuation
techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements will
be required for fair value measurement that fall in either Level 2 or Level 3. The new guidance is effective for
interim and annual reporting periods beginning after December 15, 2009. The expanded disclosures will be included
in the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2010
2. Investments
The following tables summarize the cost or amortized cost and fair value of available-for-sale securities by
lot at December 31, 2009 and 2008:
($ millions)
At December 31, 2009:
Fixed maturities:
Cost or
amortized
cost
Gross
unrealized
holding
gains
Gross
unrealized
holding
losses
Fair
value
U.S. treasury securities and obligations of U.S. government
agencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Obligations of states and political subdivisions . . . . . . . . . . . . .
Corporate securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
U.S. government agencies residential mortgage-backed
$ 348.4
1,046.9
97.4
securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
295.4
1,788.1
Equity securities:
Large-cap equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Small-cap equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total available-for-sale securities . . . . . . . . . . . . . . . . . . . . . . . . . . .
164.7
25.0
189.7
44.1
$2,021.9
$ 5.9
33.2
2.4
6.4
47.9
31.6
3.0
34.6
8.2
$90.7
$(1.4)
(1.5)
(0.1)
(1.2)
(4.2)
(0.2)
—
(0.2)
—
$(4.4)
$ 352.9
1,078.6
99.7
300.6
1,831.8
196.1
28.0
224.1
52.3
$2,108.2
101
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
($ millions)
At December 31, 2008:
Fixed maturities:
Cost or
amortized
cost
Gross
unrealized
holding
gains
Gross
unrealized
holding
losses
Fair
value
U.S. treasury securities and obligations of U.S. government
agencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Obligations of states and political subdivisions . . . . . . . . . . . . . . .
Corporate securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
U.S. government agencies residential mortgage-backed
$ 127.6
1,463.1
11.9
securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
178.5
Total fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,781.1
Equity securities:
Large-cap equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Small-cap equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
137.5
6.8
144.3
32.4
4.2
21.4
0.1
4.0
29.7
6.1
0.5
6.6
—
(4.2)
(33.5)
(0.2)
127.6
1,451.0
11.8
(2.2)
180.3
(40.1)
1,770.7
(13.4)
—
(13.4)
(0.7)
130.2
7.3
137.5
31.7
Total available-for-sale securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,957.8
36.3
(54.2)
1,939.9
The following tables reflect the Company’s gross unrealized losses and fair value on its investments by lot,
aggregated by investment category and length of time for individual securities that have been in a continuous
unrealized loss position at December 31, 2009 and 2008:
($ millions, except # of positions)
Less than 12 months
12 months or more
Total
At December 31, 2009:
Fixed maturities:
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 . . . . . $121.9
$(1.4)
53
$ — $—
— $121.9
$(1.4)
92.6
15.5
(1.0)
(0.1)
39
26.0
10 —
(0.5)
—
9
—
118.6
15.5
(1.5)
(0.1)
53
48
10
Obligations of states and
political subdivisions . . . . .
Corporate securities . . . . . . . .
U.S. government agencies
residential mortgage-
backed securities . . . . . . . .
Total fixed maturities . . .
Large-cap equity securities . . . . . .
Total temporarily impaired
52.8
282.8
14.9
(0.4)
(2.9)
(0.2)
14
22.0
116
48.0
6 —
(0.8)
(1.3)
—
11
20
—
74.8
330.8
14.9
(1.2)
(4.2)
(0.2)
25
136
6
securities . . . . . . . . . . . . . . . . . . $297.7
$(3.1)
122
$48.0
$(1.3)
20
$345.7
$(4.4)
142
102
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
($ millions, except # of positions)
Less than 12 months
12 months or more
Total
At December 31, 2008:
Fixed maturities:
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
residential mortgage-
backed securities . . . . . .
Total fixed
maturities . . . . . . .
Large-cap equity securities . . . .
Other invested assets . . . . . . . .
Total temporarily impaired
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
(1.1)
13
30.5
(1.1)
16
66.3
(2.2)
29
723.1
62.6
31.7
(23.5)
(12.0)
(0.7)
295
40
3
298.3
3.1
—
(16.6)
(1.4)
—
120
4
—
1,021.4
65.7
31.7
(40.1)
(13.4)
(0.7)
415
44
3
securities . . . . . . . . . . . . . . . . $817.4 $(36.2)
338
$301.4 $(18.0)
124
$1,118.8 $(54.2)
462
Realized losses recognized for the year ended December 31 related to other-than-temporary impairments on
the Company’s investment portfolio are summarized as follows:
($ millions)
Equity securities:
Large-cap securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Small-cap securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total other-than-temporary impairments . . . . . . . . . . . . . .
2009
2008
2007
$ 7.8
1.2
—
$ 9.0
1.1
24.2
0.8
4.1
11.0 —
39.3
1.9
The Company did not recognize other-than-temporary impairments on its fixed maturity securities in 2009
or 2007, and the realized losses related to other-than-temporary impairments of fixed maturity securities in 2008
were less than $0.1 million. The Company reviewed its investments at December 31, 2009, and determined no
additional other-than-temporary impairment exists in the gross unrealized holding losses.
103
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
The amortized cost and fair value of available-for-sale fixed maturities at December 31, 2009, by
contractual maturity, are summarized as follows:
($ millions)
Amortized
cost
Fair value
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 residential mortgage-backed securities . . . . . . . . . . .
$
17.2
263.2
506.5
705.8
295.4
17.4
268.9
523.7
721.2
300.6
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,788.1
1,831.8
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 $56.9 million and $56.0 million were on deposit with
insurance regulators as required by law at December 31, 2009 and 2008, respectively.
Components of net investment income for the year ended December 31 are summarized as follows:
($ millions)
Fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash and cash equivalents, and other . . . . . . . . . . . . . . . . . . . . . . . . .
Investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Investment expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2009
$75.7
3.5
4.9
84.1
2.0
Net investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$82.1
2008
79.4
5.0
5.1
89.5
2.1
87.4
2007
75.2
5.8
5.5
86.5
1.8
84.7
The Company’s current investment strategy does not rely on the use of derivative financial instruments.
Proceeds on sales of available-for-sale securities in 2009, 2008 and 2007 were $357.8 million, $231.6
million and $262.2 million, respectively.
104
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
Realized and unrealized holding gains and losses for the years ended December 31 are summarized as
follows:
($ millions)
Realized gains:
2009
2008
2007
Fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 5.9
4.8
—
2.7
9.6
—
Total realized gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
10.7
12.3
0.8
19.7
—
20.5
Realized losses:
Fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
—
(15.9)
—
—
(37.7)
(11.0) —
(1.3)
(7.1)
Total realized losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(15.9)
(48.7)
(8.4)
Net realized gain (loss) on investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ (5.2)
(36.4)
12.1
Change in unrealized holding gains (losses):
Fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred federal income tax (liability) asset thereon . . . . . . . . . . . . . . .
Valuation allowance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 54.1
41.2
8.9
(36.5)
2.6
5.7
(32.9)
(9.4)
(50.8)
(0.3)
(0.9)
29.6
1.4
(2.6) —
Change in net unrealized holding gains (losses) . . . . . . . . . . . . . . . . . . . . . . .
$ 70.3
(57.6)
(2.6)
There was a deferred federal income tax liability on the net unrealized holding gains at December 31, 2009,
of $30.2 million. There was a net deferred federal income tax asset on the net unrealized holding losses at
December 31, 2008, of $3.7 million, net of a valuation allowance of $2.6 million.
3. Fair Value of Financial Instruments
Below is the fair value hierarchy that categorizes into three levels the inputs to valuation techniques that are
used to measure fair value:
•
•
•
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 Company utilizes one nationally recognized pricing service to estimate the majority of its available for
sale investment portfolio’s fair value. The Company obtains one price per security and the processes and control
procedures employed by the Company are designed to ensure the value is accurately recorded on an unadjusted
basis. Through discussions with the pricing service, the Company gains an understanding of the methodologies
105
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
used to price the different types of securities, that the data and the valuation methods utilized are appropriate and
consistently applied, and that the assumptions are reasonable and representative of fair value. To validate the
reasonableness of the valuations obtained from the pricing service, the Company compares to other fair value
pricing information gathered from other independent pricing sources. At December 31, 2009, the Company did
not adjust any of the prices received from the pricing service.
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 to estimate fair value measurements for approximately 99.9% of its
fixed maturities. The fair value estimate of the Company’s fixed maturity investments are determined by
evaluations that are based on observable market information rather than market quotes. Inputs to the evaluations
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. All
unadjusted estimates of fair value for fixed maturities priced by the pricing service are included in the amounts
disclosed in Level 2 of the hierarchy. At December 31, 2009, the pricing service provided all valuations for the
fixed maturity securities, except for one fixed maturity security discussed below.
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 value of each equity security is based on an observable market price for an identical asset in an
active market and is priced by the same pricing service discussed above. All equity securities are recorded using
unadjusted market prices and have been disclosed in Level 1.
Other Invested Assets
Included in other invested assets are two international private equity funds (“the funds”) that invest in equity
securities of foreign issuers and are managed by third party investment managers. The funds have a fair value of
$48.3 million at December 31, 2009, which has been determined using the net asset value per share of the
investments. The Company employs procedures to assess the reasonableness of the fair value of the funds
including obtaining and reviewing each fund’s audited financial statements. There are no unfunded commitments
related to the funds. The Company may not sell its investment in the funds; however, the Company may redeem
all or a portion of its investment in the funds at net asset value per share with the appropriate prior written notice.
As of October 1, 2009, the Company adopted the FASB’s new guidance related to fair value measurements and
disclosures of investments in certain entities that calculate net asset value per share (or its equivalent). This new
guidance classifies the fair value measurements of the funds as a Level 2 within the hierarchy due to the
Company’s ability to redeem its investment in the funds at net asset value per share at the measurement date. The
funds, which have historically been classified as a Level 3, were transferred out of Level 3 and into Level 2 as of
October 1, 2009.
The remainder of the Company’s other invested assets consist primarily of holdings in publicly-traded
mutual funds. The Company believes that its prices for these publicly-traded mutual funds based on an
106
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
observable market price for an identical asset in an active market reflect their fair values and consequently these
securities have been disclosed in Level 1.
The following tables reflect the Company’s available-for-sale investments within the fair value hierarchy at
December 31, 2009 and 2008:
($ millions)
At December 31, 2009:
Fixed maturities:
U.S. treasury securities and obligations of U.S. government
agencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Obligations of states and political subdivisions . . . . . . . . . . .
Corporate securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
U.S. government agencies residential mortgage-backed
Total
$ 352.9
1,078.6
99.7
securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . .
300.6
1,831.8
Equity securities:
Large-cap equity securities . . . . . . . . . . . . . . . . . . . . . . . . . .
Small-cap equity securities . . . . . . . . . . . . . . . . . . . . . . . . . .
Total equity securities . . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total available-for-sale investments . . . . . . . . . . . . . . . . . . . . . . .
196.1
28.0
224.1
52.3
$2,108.2
($ millions)
At December 31, 2008:
Fixed maturities:
U.S. treasury securities and obligations of U.S. government
agencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Obligations of states and political subdivisions . . . . . . . . . . .
Corporate securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
U.S. government agencies residential mortgage-backed
Total
$ 127.6
1,451.0
11.8
securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . .
180.3
1,770.7
Equity securities:
Large-cap equity securities . . . . . . . . . . . . . . . . . . . . . . . . . .
Small-cap equity securities . . . . . . . . . . . . . . . . . . . . . . . . . .
Total equity securities . . . . . . . . . . . . . . . . . . . . . . . . . .
Other invested assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total available-for-sale investments . . . . . . . . . . . . . . . . . . . . . . .
130.2
7.3
137.5
31.7
$1,939.9
Quoted prices
in active
markets for
identical assets
(Level 1)
Significant
other
observable
inputs
(Level 2)
Significant
unobservable
inputs
(Level 3)
—
—
—
—
—
196.1
28.0
224.1
4.0
228.1
352.9
1,078.6
97.4
300.6
1,829.5
—
—
—
48.3
1,877.8
—
—
2.3
—
2.3
—
—
—
—
2.3
Quoted prices
in active
markets for
identical assets
(Level 1)
Significant
other
observable
inputs
(Level 2)
Significant
unobservable
inputs
(Level 3)
—
—
—
—
—
130.2
7.3
137.5
2.9
140.4
127.6
1,451.0
9.5
180.3
1,768.4
—
—
—
—
1,768.4
—
—
2.3
—
2.3
—
—
—
28.8
31.1
107
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
For assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3), a
reconciliation of the beginning and ending balances for 2009 and 2008, separately for each major category of
assets, is as follows:
($ millions)
Balance at January 1, 2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total realized gains and losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Included in other comprehensive loss—total gains or losses unrealized . . . .
Purchases, issuances, and settlements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Transfers in and/or (out) of Level 3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Balance at December 31, 2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
($ millions)
Balance at January 1, 2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total realized gains and losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Included in other comprehensive loss—total gains or losses unrealized . . . .
Purchases, issuances, and settlements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Transfers in and/or (out) of Level 3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Balance at December 31, 2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fixed
maturities
$ 2.3
—
—
—
—
$ 2.3
Fixed
maturities
$ 2.1
—
0.2
—
—
$ 2.3
Other
invested
assets
28.8
5.7
0.9
1.9
(37.3)
—
Other
invested
assets
15.8
(11.0)
—
24.0
—
28.8
Below is a summary of the carrying value and fair value of financial instruments at December 31, 2009:
($ millions)
Assets:
Carrying
value
Fair
value
Reference
Fixed maturities, available-for-sale, at fair value . . . . . . . . . . . . . . . . . .
Equity securities, available-for-sale, at fair value . . . . . . . . . . . . . . . . . .
Other invested assets, available-for-sale, at fair value . . . . . . . . . . . . . .
Notes receivable from affiliate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,831.8
224.1
52.3
70.0
$1,831.8
224.1
52.3
69.9
See above
See above
See above
See Note 6
Liabilities:
Notes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Pension plan assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Postretirement plan assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
117.2
117.3
See Note 7
See Note 10
See Note 10
108
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
4. Losses and Loss Expenses Payable
Activity in the liability for losses and loss expenses for the year ended December 31 is summarized as
follows:
($ millions)
2009
2008
2007
Losses and loss expenses payable, at beginning of year . . . . . . . . . . . . . . .
Less: reinsurance recoverable on losses and loss expenses payable . . . . . .
$791.2
21.2
Net balance at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . .
770.0
Impact of pooling change, January 1, 2008 (Note 6a)
. . . . . . . . . . . . . . . .
—
658.3
11.2
647.1
51.3
674.5
13.5
661.0
—
Incurred related to:
Current year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Prior years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
899.5
(56.2)
874.0
(27.3)
645.5
(54.7)
Total incurred . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
843.3
846.7
590.8
Paid related to:
Current year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Prior years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net balance at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Plus: reinsurance recoverable on losses and loss expenses payable . . . . . .
524.8
269.1
793.9
819.4
20.8
518.7
256.4
775.1
770.0
21.2
368.7
236.0
604.7
647.1
11.2
Losses and loss expenses payable, at end of year (affiliate $346.2, $343.0
and $257.2, respectively) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$840.2
791.2
658.3
The Company recorded favorable loss and loss expense reserve development in 2009, 2008, and 2007 of
$56.2 million, $27.3 million and $54.7 million, respectively. The favorable development in 2009 is the result of
subsequent reserve reviews using more mature claim data. Favorable development in 2009 of loss adjustment
expense and catastrophe losses contributed approximately $10.9 million each. Of the remaining favorable
development
in 2009, $9.5 million and $8.3 million is attributable to auto liability, both personal and
commercial, and other & product liability, respectively. The favorable development in those lines is driven by
emergence of lower than anticipated claim severity, as well as lower than anticipated claim frequency for other &
product liability. Approximately half of the 2008 favorable development is attributable to loss adjustment
expense being lower than anticipated. The remainder is primarily 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 projections using more mature claim data
resulted in lower claim severity than in past projections, loss adjustment expenses being approximately $11.8
million lower than anticipated in proportion to losses and ceded losses being above previously anticipated levels
by approximately $10.0 million.
5. Reinsurance
In the ordinary course of business, the Company assumes and cedes reinsurance with other insurers and
reinsurers and is a member in various pools and associations. See Note 6a for discussion of reinsurance with
affiliates. The voluntary arrangements provide greater diversification of business and limit the maximum net loss
109
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
potential arising from large risks and catastrophes. Most of the ceded reinsurance is effected under reinsurance
contracts known as treaties; the remainder is by negotiation on individual risks. Although the ceding of
reinsurance does not discharge the original insurer from its primary liability to its policyholder, the insurance
company that assumes the coverage assumes the related liability.
Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated
with the reinsured business. The recoverability of these assets depends on the reinsurers’ ability to perform under
the reinsurance agreements. The Company evaluates and monitors the financial condition and concentrations of
credit risk associated with its reinsurers under voluntary reinsurance arrangements to minimize its exposure to
significant losses from reinsurer insolvencies. The Company has reported ceded losses and loss expenses payable
and prepaid reinsurance premiums with other insurers and reinsurers as assets. All reinsurance contracts provide
for indemnification against loss or liability relating to insurance risk and have been accounted for as reinsurance.
Prior to the reinsurance transaction with State Auto Mutual under the Pooling Arrangement, as discussed in
Note 6a, the effect of the Company’s external reinsurance on its balance sheets and income statements is
summarized as follows:
($ millions)
Losses and loss expenses payable:
December 31
2009
2008
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Direct
Assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Ceded . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$489.6
4.4
(20.8)
443.3
4.8
(20.6)
Net losses and loss expenses payable . . . . . . . . . . . . . . . . . . . . .
$473.2
427.5
Unearned premiums:
Direct
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Ceded . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$365.3
1.0
(7.2)
339.0
1.1
(7.0)
Net unearned premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$359.1
333.1
110
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
($ millions)
Written premiums:
Year ended December 31
2009
2008
2007
Direct . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Ceded . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$830.3
4.9
(26.7)
784.1
5.5
(22.5)
757.4
6.5
(18.8)
Net written premiums . . . . . . . . . . . . . . . . . . . . . . . . .
$808.5
767.1
745.1
Earned premiums:
Direct . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Ceded . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$802.8
5.0
(26.5)
759.4
5.6
(21.5)
751.0
6.5
(18.8)
Net earned premiums . . . . . . . . . . . . . . . . . . . . . . . . . .
$781.3
743.5
738.7
Losses and loss expenses incurred:
Direct . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Ceded . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$587.0
2.7
(10.7)
563.8
2.7
(15.8)
438.5
2.0
(2.9)
Net losses and loss expenses incurred . . . . . . . . . . . . .
$579.0
550.7
437.6
6. Transactions with Affiliates
a. Reinsurance
Prior to 2008, State Auto P&C, Milbank, Farmers, and SA 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 (“SA Wisconsin”), State
Auto Florida Insurance Company (“SA 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 National”),
Patrons Mutual Insurance Company of Connecticut (“Patrons Mutual”), Litchfield Mutual Fire Insurance
Company (“Litchfield”) and the middle market business written by State Auto Mutual and Meridian Security.
In conjunction with the January 1, 2008 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
111
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, SA Wisconsin, SA Florida,
Meridian Citizens Mutual, Meridian Security, Beacon National, Patrons Mutual 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
2009
2008
Ceded . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$(453.0)
799.2
(407.3)
750.3
Net assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 346.2
343.0
Unearned premiums:
Ceded . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$(348.7)
529.4
(321.6)
496.6
Net assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 180.7
175.0
($ millions)
Written premiums:
Year ended December 31
2009
2008
2007
Ceded . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ (770.8)
1,172.7
(724.9)
1,107.4
(702.3)
973.9
Earned premiums:
Ceded . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ (742.6)
1,137.8
(700.9)
1,081.7
(695.7)
965.5
Losses and loss expenses incurred:
Ceded . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Assumed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ (545.0)
809.2
(514.6)
810.6
(405.6)
558.2
112
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
The pool participants, SA National and Beacon Lloyds Insurance Company (“Beacon Lloyds”) are
collectively referred to as the “State Auto Group.”
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 and $3.1 million for 2008 and 2007, 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.
Ceded losses and loss expenses payable related to the terminated reinsurance agreement that is in run-off
between SA National and State Auto Mutual were $0.1 million and $0.5 million at December 31, 2009 and 2008,
respectively. Ceded losses and loss expenses incurred related to the terminated reinsurance agreement were $0.1
million and $0.6 million for 2009 and 2007, respectively. There was no impact to the 2008 income statement.
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 members 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, 2009 and 2008 is approximately $320.2 million and $296.8 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 4.46% at
December 31, 2009). 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
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 the Consolidation Topic of the FASB ASC, 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
113
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
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. Notes Receivable
In May 2009, State Auto Financial’s subsidiaries State Auto P&C and Milbank entered into separate credit
agreements with State Auto Mutual, in which $70.0 million ($50.0 million and $20.0 million, respectively) was
loaned to State Auto Mutual for ten years. Interest is due semi-annually at a fixed annual interest rate of 7.00%,
with the principal due May 2019. There is no prepayment penalty, and there was no collateral given in exchange
for the notes.
Under these agreements, State Auto Financial earned interest of $3.1 million for the year December 31,
2009. Interest income is included in net investment income on the condensed consolidated statements of income.
The Company estimates the fair value of the notes receivable from affiliate using market quotations for U.S.
treasury securities with similar maturity dates and applies an appropriate credit spread. Notes receivable at
December 31, 2009, consisted of the following:
($ millions, except interest rate)
Carrying
value
Fair
value
Interest
rate
Notes receivable from affiliate . . . . . . . . . . . . . . . . . . . . . . . . .
$70.0
$69.9
7.00%
d. 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
$1.6 million, $2.5 million and $2.8 million in 2009, 2008 and 2007, 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. 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 2009, 2008
and 2007) as the underlying interest expense is recognized on the Senior Notes.
State Auto Financial has a credit facility (the “Credit Facility”) with a syndicate of financial institutions. On
April 1, 2009, the Credit Facility was amended as follows:
•
The maximum amount which may be borrowed by State Auto Financial was reduced from $200.0
million to $100.0 million;
114
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 loans that may be advanced from State Auto Financial and its subsidiaries to State Auto
Mutual and its subsidiaries (that are not State Auto Financial or its subsidiaries) was increased from
$50.0 million to $75.0 million;
The definition of net worth was modified to exclude accumulated other comprehensive income (loss);
and
State Auto Financial’s minimum net worth covenant was modified.
As amended, the Credit Facility provides for a $100.0 million unsecured revolving credit facility maturing
in July 2012. 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 Facility includes 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, 2009, the Company had not made any
borrowings and was in compliance with all covenants related to the Credit Facility. State Auto Financial incurred
$0.5 million in issuance costs related to the Credit Facility, which is recorded in other assets and is being
amortized into expense ($0.1 million for 2009, 2008 and 2007) over the life of the Credit Facility.
See discussion of affiliate notes payable at Note 6b. The carrying amount of the Subordinated Debentures in
the consolidated balance sheets approximates its fair value as the interest rate adjusts quarterly. The fair value of
the Senior Notes is based on the quoted market price at December 31, 2009 and 2008, respectively. Notes
payable at December 31 consisted of the following:
($ 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) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total notes payable . . . . . . . . . . . . . . . . . . . . . . . . .
Carrying
value
2009
Fair
value
Interest
rate
Carrying
value
2008
Fair
value
Interest
rate
$101.7
$101.8
6.25% $102.1
$ 86.9
6.25%
15.5
15.5
4.46
15.5
15.5
6.38
$117.2
$117.3
$117.6
$102.4
8. Federal Income Taxes
The reconciliation between actual federal income tax expense (benefit) and the amount computed at the
indicated statutory rate for the year ended December 31 is summarized as follows:
($ millions)
Amount at statutory rate . . . . . . . . . . . . . . . . . . . . .
Tax-free interest and dividends received
deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other, net
Valuation allowance . . . . . . . . . . . . . . . . . . . . . . . .
Federal income tax (benefit) expense and
2009
$ (4.5)
(16.9)
(1.1)
(0.5)
%
35
133
8
4
2008
$(26.3)
(19.7)
1.5
0.5
%
35
26
(2)
(1)
2007
$ 54.4
%
35
(18.5)
(12)
0.3 —
—
—
effective rate . . . . . . . . . . . . . . . . . . . . . . . .
$(23.0)
180
$(44.0)
58
$ 36.2
23
115
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:
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
. . . . . . . . . . . . . .
Employee compensation and benefits . . . . . . . . . . . . . . . . . . . . . . . . .
Asset valuation allowance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Valuation allowance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred tax liabilities:
Deferral of policy acquisition costs . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unrealized holding gains on investments . . . . . . . . . . . . . . . . . . . . . .
Total deferred tax liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2009
2008
$ 37.9
23.7
52.5
—
14.4
5.1
3.5
13.5
150.6
—
150.6
44.5
30.2
74.7
35.3
22.0
64.2
6.3
14.9
2.1
1.0
11.1
156.9
(3.1)
153.8
42.8
—
42.8
Net deferred federal income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 75.9
111.0
If the Company determines it is more likely than not that any of its deferred tax assets will not result in
future tax benefits, a valuation allowance must be established for the portion of these assets that are not expected
to be realized. Although realization of deferred tax assets is not assured, based upon a review of all available
evidence, both positive and negative, including the Company’s historical and anticipated future taxable income,
the Company’s management concluded that it is more likely than not that the net deferred income tax assets will
be realized. No valuation allowance was held at December 31, 2009. At December 31, 2008, the Company
established a valuation allowance of $3.1 million for the portion of the deferred tax asset that management
believed would 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.
At December 31, 2009, the Company carried no balance for uncertain tax positions.
The Company had no accrual for the payment of interest and penalties at December 31, 2009 or 2008.
The Company files a consolidated U.S. federal income tax return. The Company and its subsidiaries also file
in various state jurisdictions. The Company is no longer subject to U.S. federal or state and local income tax
examinations by tax authorities for years before 2006. The Internal Revenue Service commenced a limited scope
examination of the Company’s U.S. income tax return for 2008 in the first quarter of 2010 that is anticipated to
be completed by the end of 2010.
116
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
9. Restructuring Costs
In June 2009, the Company initiated a plan to restructure its field and claims operations. Restructuring charges,
including employee termination benefits, relocation packages, and costs associated with ceasing to use leased
properties, related to this reorganization have been recognized in accordance with the Exit or Disposal Cost
Obligations Topic of the FASB ASC. Consideration of this restructuring resulted in a curtailment of the Company’s
pension and postretirement benefit plans as of June 30, 2009, due to the elimination of expected years of future
services of those impacted employees. The Company recognized restructuring costs totaling $4.8 million during the
year ended December 31, 2009, and anticipates additional charges of approximately $1.7 million through the fourth
quarter 2010, the expected completion date of the restructuring. These charges are included in losses and loss
expenses and acquisition and operating expenses on the condensed consolidated statements of income.
Total cumulative estimated costs to be incurred and costs incurred through December 31, 2009, are as
follows:
($ millions)
Total
cumulative
estimated costs
to be incurred
Costs incurred
through
December 31,
2009
Employee termination benefits . . . . . . . . . . . . . . . . . . . . . . . . .
Relocation costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Lease termination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Benefit plan curtailment
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 6.3
2.7
0.4
(2.9)
$ 6.5
4.5
1.4
0.2
(1.3)
4.8
These costs are allocated to the Company’s insurance segments as follows:
($ millions)
Total
cumulative
estimated costs
to be incurred
Costs incurred
through
December 31,
2009
Personal insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Business insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$3.1
3.4
$6.5
2.5
2.3
4.8
Activity for the year ended December 31, 2009, was as follows:
($ millions)
Balance of
liability at
December 31,
2008
Employee termination benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Relocation costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Lease termination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Benefit plan curtailment (non-cash item) . . . . . . . . . . . . . . . . . . . . .
Total
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$—
—
—
—
$—
Costs
incurred
Amounts
paid
0.6
4.5
1.4
1.4
0.2
0.1
(1.3) —
4.8
2.1
Balance of
liability at
December 31,
2009
3.9
—
0.1
—
4.0
117
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
10. 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
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.”
Effective January 1, 2008, the Company adopted the measurement date requirement under transition
alternative method one, as defined in SFAS No. 158 (codified in the Compensation—Retirement Benefits Topic
of the FASB ASC), 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 $3.5 million, net of tax.
118
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
Information regarding the Company’s pension and postretirement benefit plans’ change in benefit
obligation, plan assets and funded status as of December 31 are as follows:
($ millions)
Pension
2009
2008
Postretirement
2009
2008
Change in benefit obligation:
Benefit obligation at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Business combination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Curtailment
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Plan amendments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
SFAS No. 158 measurement date transition . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Special termination benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Service cost
Interest cost
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Actuarial (gain) loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Benefits paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
111.6
123.0
—
—
(5.9) —
(0.9)
$245.9
217.3
3.5 —
(2.2) —
—
—
(4.7) —
—
2.0 —
—
4.9
10.2
8.9
6.5
14.5
13.5
(18.3)
(1.9)
24.5
(2.5)
(20.0)
(15.6)
(28.1)
(2.4)
0.4
4.8
7.3
9.3
(2.7)
Benefit obligation at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$250.0
245.9
95.4
111.6
Change in plan assets:
Fair value of plan assets at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . .
Business combination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
SFAS No. 158 measurement date transition . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Employer contribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Actual return on plan assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Benefits paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$172.7
220.0
3.9 —
—
15.0
26.3
(20.0)
2.5
—
(5.4) —
12.0 —
0.1
(38.3)
(15.6) —
Fair value of plan assets at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$197.9
172.7
2.6
2.3
—
0.1
—
0.1
—
2.5
Supplemental executive retirement plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
—
—
(5.5)
(5.4)
Funded status at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ (52.1)
(73.2)
(98.3)
(114.5)
Accumulated benefit obligation—end of year . . . . . . . . . . . . . . . . . . . . . . . . . . .
$225.4
215.2
No assets are expected to be returned during the fiscal year-ended December 31, 2010.
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 $28.1 million as of December 31, 2008.
119
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
Included in accumulated other comprehensive losses are the following amounts that have not been
recognized in net periodic cost:
($ millions)
December 31
2009
2008
Transition asset . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Prior service benefit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net actuarial loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ (0.9)
(21.1)
117.6
(1.6)
(22.9)
159.0
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 95.6
134.5
The amount of amortization expected to be recognized during the fiscal year ending December 31, 2010 for
the State Auto Group is as follows:
($ millions)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Transition asset
Prior service benefit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net actuarial loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2010
$(0.6)
(1.3)
5.7
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 3.8
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
2009
2008
2007
2009
2008
2007
Components of net periodic cost:
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Service cost
Interest cost
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expected return on plan assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amortization of transition asset . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amortization of prior service cost (benefit)
. . . . . . . . . . . . . . . . . . . .
Amortization of net actuarial loss . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 10.2
14.5
(18.4)
(0.7)
0.4
5.1
8.9
13.5
(19.4)
(0.6)
0.4
2.7
5.6
7.3
(0.2)
4.9
6.5
(0.2)
4.8
7.3
(0.2)
9.0
12.5
(17.8)
(0.6) — — —
0.5
0.4
0.8
3.9
(1.6)
0.1 —
(0.1)
Net periodic cost
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
11.1
5.5
7.4
9.7
11.8 14.0
Cost of special termination benefit
. . . . . . . . . . . . . . . . . . . . . . .
Curtailment loss (gain) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
—
0.3 —
2.0 — —
0.3 —
— (1.7) — —
Net periodic cost
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 11.4
7.5
7.4
8.0
12.1
14.0
120
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
2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2012 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2015 – 2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$10.2
10.6
11.6
12.6
13.5
85.7
$ 3.7
3.8
3.9
4.0
4.3
27.1
The Company’s share of the 2009, 2008 and 2007 net periodic costs for the defined benefit plan were $11.4
million, $7.4 million, and $7.4 million, respectively. For postretirement benefits other than pensions, the
Company’s share of the 2009, 2008 and 2007 net periodic costs were $5.5 million, $11.3 million and $11.6
million, respectively. The Company’s gross benefit payments for 2009 postretirement benefits were $2.8 million,
including the prescription drug benefits. The Company’s subsidy related to Medicare Prescription Drug
Improvement and Modernization Act of 2003 was $0.3 million for 2009 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
2009
2008
Postretirement
2009
2008
Benefit obligations weighted-average assumptions:
Discount rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Rates of increase in compensation levels . . . . . . . . . . . . . . . . . . . . . . . .
6.00% 6.00% 6.00% 6.00%
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
2009
2008
2007
2009
2008
2007
Weighted-average assumptions:
Discount rate . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expected long-term rate of return on assets . . .
Rates of increase in compensation levels . . . . .
6.00%/
6.25%* 6.50% 6.00%
9.00/
8.00*
4.00
9.00
4.00
9.00
4.00
6.00%/
6.25%* 6.50% 6.00%
9.00/
8.00*
—
9.00
—
9.00
—
*
Due to the curtailment resulting from the restructuring, the expense was remeasured at June 30, 2009, using discount rate of 6.25%
and expected long-term rate of return on assets of 8.00%.
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,
121
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
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.
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
2009
2008
2007
10.00% 10.00% 10.00%
5.00% 5.00% 5.00%
2014
2013
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, 2010:
($ millions)
Postretirement
Increase
(Decrease)
One percentage point change:
Effect on total service and interest cost
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Effect on accumulated postretirement benefit obligation . . . . . . . . . . . . . . . . . . . .
$ 2.1
16.4
$ (1.7)
(13.2)
The benefit plans’ 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. One of the goals of diversifying the benefit plans’ portfolio among
different asset classes is the elimination of concentration of risk in one asset class. Management has investment
policy guidelines with respect to limiting the ownership in any single debt or equity issuer, and the international
private equity investments are composed of numerous securities to reduce our exposure to a single issuer.
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
122
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
See Note 3 for the valuation methods used by the Company for each type of financial instrument the plans
hold that are carried at fair value.
The table below reflects the pension plan’s assets within the fair value hierarchy at December 31, 2009:
($ millions)
Quoted
prices in
active
markets
for
identical
assets
(Level 1)
Total
Significant
other
observable
inputs
(Level 2)
Significant
unobservable
inputs
(Level 3)
Fixed maturities:
U.S. treasury securities and obligations of U.S. government
agencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Corporate securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
U.S. government agencies mortgage-backed securities: . . . . . . . .
$ 35.0 —
12.8 —
28.2 —
Total fixed maturities
Equity securities:
Large-cap equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Small-cap equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Mutual fund—other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
International instruments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Short-term money market funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
76.0 —
68.6
68.6
24.9
24.9
0.2 —
93.7
93.5
23.3 —
3.0
3.0
Total pension plan investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$196.0
96.5
35.0
12.8
28.2
76.0
—
—
—
—
23.3
—
99.3
—
—
—
—
—
—
0.2
0.2
—
—
0.2
For assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3), a
reconciliation of the beginning and ending balances, separately for each major category of assets, is as follows:
($ millions)
Mutual
fund – other
International
instruments
Beginning balance, January 1, 2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Actual return on plan assets:
Relating to assets still held at December 31, 2009 . . . . . . . . . . . . . . . . .
Relating to assets sold during 2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Purchases, sales, issuances and settlements . . . . . . . . . . . . . . . . . . . . . .
Transfers in and/or out of Level 3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$—
(0.1)
—
0.3
—
Ending balance, December 31, 2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 0.2
22.5
4.2
1.6
(5.0)
(23.3)
—
123
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
The table below reflects the postretirement plan’s assets within the fair value hierarchy at December 31,
2009:
($ millions)
Quoted
prices in
active
markets
for
identical
assets
(Level 1)
Total
Significant
other
observable
inputs
(Level 2)
Significant
unobservable
inputs
(Level 3)
Fixed maturities:
U.S. treasury securities and obligations of U.S. government
agencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Corporate securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$2.1 —
0.3 —
Total fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Short-term money market funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2.4 —
0.2
0.2
Total postretirement plan investments . . . . . . . . . . . . . . . . . . . . . . . . . . .
$2.6
0.2
2.1
0.3
2.4
—
2.4
—
—
—
—
—
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 up to $15.0 million during 2010 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.
Effective January 1, 2008, the Company matches the first 1% of contributions of participants’ salary at the rate of
one dollar for each dollar contributed. Participant contributions of 2% to 6% are matched at a rate of 50 cents for
each dollar contributed. Prior to January 1, 2008, the Company matched the first 2% of contributions of
participants’ salary at the rate of 75 cents for each dollar contributed. Participant contributions of 3% to 6% were
matched at a rate of 50 cents for each dollar contributed. The Company’s share of the expense under the plan
totaled $3.3 million, $3.1 million and $2.6 million for the years 2009, 2008 and 2007, respectively.
11. 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
(the “Repurchase Plan”). This program ended on December 31, 2009. Under the Repurchase Plan, State Auto
Financial repurchased shares from State Auto Mutual in amounts that were proportional to the respective current
ownership percentages of State Auto Mutual, which was approximately 64%, and other shareholders. State Auto
Financial did not repurchase any shares in 2009 and had total share repurchase activity in 2008 of approximately
1.2 million common shares. For the lifetime of the Repurchase Plan, approximately 2.0 million common shares
were purchased at an average repurchase price of $27.26 per share for a total cost of $55.3 million.
124
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, 2009, adjusted for
dividend payments made in the previous twelve-month period, approximately $68.2 million is available for
payment to State Auto Financial from its insurance subsidiaries in 2010 without prior approval. In 2009 State
Auto Financial received dividends of $11.5 million from its insurance subsidiaries, $39.0 million in 2008, and
$50.0 million in 2007.
Reconciliations of statutory capital and surplus and net income, as determined using SAP, to the amounts
included in the accompanying consolidated financial statements as of December 31 are as follows:
($ millions)
2009
2008
Statutory capital and surplus of insurance subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net liabilities of non-insurance parent and affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$796.7
(82.1)
738.0
(73.1)
Increases (decreases):
Deferred policy acquisition costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Postretirement and pension benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred federal income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fixed maturities at fair value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
714.6
664.9
127.3
(14.6)
(26.6)
43.6
5.1
122.3
(23.9)
2.3
(11.3)
6.7
Stockholders’ equity per accompanying consolidated financial statements . . . . . . . . . . . . . . . . . .
$849.4
761.0
($ millions)
Year ended December 31
2009
2008
2007
Statutory net income (loss) of insurance subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net (loss) income of non-insurance parent and affiliates . . . . . . . . . . . . . . . . . . . . . . . . .
$ 9.2
(0.5)
(49.8) 129.5
0.5
(0.6)
Increases (decreases):
Deferred policy acquisition costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Postretirement and pension benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred federal income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Share-based compensation expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
5.0
(12.0)
12.5
(3.5)
(0.5)
16.5
(10.3)
16.1
(4.6)
1.6
1.7
(12.0)
5.4
(5.5)
(0.5)
Net income (loss) per accompanying consolidated financial statements . . . . . . . . . . . . .
$ 10.2
(31.1) 119.1
8.7
(50.4) 130.0
12. 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.
125
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.
13. 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 State Auto Financial Corporation 2009
Equity Compensation Plan (the “Equity Plan”). This plan replaced the previous equity plan which was due to
expire on July 1, 2010. The stock-based compensation plan for outside directors is the Outside Directors
Restricted Share Unit Plan (the “RSU Plan”).
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.
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 2.0 million
common shares under the Equity Plan. As of December 31, 2009, a total of 2.0 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 May 8,
2019.
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 2009,
2008 and 2007 were 0.4 million, 0.4 million and 0.4 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.
126
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
A summary of the status of the Company’s non-vested and vested restricted shares and changes for the year
ended December 31 is as follows:
Outstanding, beginning of year . . . . . . . . . . . . . . . . . .
Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Vested . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2009
2008
2007
Weighted
Average
Grant
Date Fair
Value
$30.46
—
31.94
Shares
42,500
—
(10,500)
Weighted
Average
Grant
Date Fair
Value
Shares
$30.46
10,500
— 32,000
—
—
Weighted
Average
Grant
Date Fair
Value
$31.94
29.98
—
Shares
42,500
—
—
Outstanding, end of year . . . . . . . . . . . . . . . . . . . . . . .
32,000
$29.98
42,500
$30.46
42,500
$30.46
As of December 31, 2009, there was $0.2 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 0.75 years.
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, 2009, a total of 2.6 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
127
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
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 14,800 RSUs granted in 2009 and 11,200
RSUs granted in both 2008 and 2007.
During 2009 and 2008, common shares valued at approximately $5,300 and $87,000, 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 and 2007 were 15,208 and 15,862, respectively.
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 2009, 2008,
and 2007. 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
2007
$10.54
$7.10
2.00% 2.28%
2.3%
3.9%
37.3% 33.8%
8.5
8.5
128
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
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:
2009
2008
2007
Fair value per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expected dividend yield . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Risk free interest rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expected volatility factor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expected life in years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
7.92
10.82
$4.56
3.84% 2.31% 1.46%
2.0% 3.1%
4.5%
42.6% 33.2% 33.4%
6.0
6.9
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)
2009
2008
2007
Weighted-
Average
Exercise
Price
Weighted-
Average
Exercise
Price
Options
Options
Options
Outstanding, beginning of year . . . . . . . . . . . . . . . . . .
Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Canceled . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . —
2.8
0.4
(0.1)
$24.84
14.65
13.68
25.38 —
2.7
0.4
(0.3)
$23.78
25.80
15.13
29.37 —
2.4
0.4
(0.1)
Outstanding, end of year . . . . . . . . . . . . . . . . . . . . . . .
3.1
$24.02
2.8
$24.84
2.7
Weighted-
Average
Exercise
Price
$22.09
29.55
15.48
31.91
$23.78
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, 2009, 2008 and 2007, the total intrinsic value of stock options exercised
was $0.6 million, $3.3 million and $2.6 million, respectively. The tax benefit for tax deductions from share-based
awards totaled $0.2 million, $0.8 million and $0.7 million for the years ended December 31, 2009, 2008 and
2007, respectively.
A summary of information pertaining to the total options outstanding and exercisable as of December 31,
2009 follows:
(Options in millions)
Range of Exercise Prices:
$10.01 – $20.00 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$20.01 – $30.00 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Greater than $30.01 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
129
Options Outstanding
Options Exercisable
Weighted-
Average
Remaining
Contractual Life
Weighted-
Average
Exercise
Price
Number
Number
1.1
1.2
0.8
3.1
4.4
6.8
5.1
5.5
$15.70
27.21
31.72
$24.02
0.8
0.8
0.7
2.3
Weighted-
Average
Exercise
Price
$16.14
27.34
32.10
$24.98
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
Aggregate intrinsic value for total options outstanding at December 31, 2009, is $5.4 million. Aggregate
intrinsic value for total options exercisable at December 31, 2009, is $2.4 million.
Compensation expense recognized during 2009, 2008 and 2007 was $3.7 million, $5.5 million and $6.0
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, 2009, there was $2.5 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.
14. Net Earnings (Loss) Per Common Share
The following table sets forth the compilation of basic and diluted net earnings (loss) per common share for
the year ended December 31:
(millions, except per share amounts)
2009
2008
2007
Numerator:
Net earnings (loss) for basic net earnings per common
share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Effect of dilutive share-based awards . . . . . . . . . . . . . . . . . . .
$10.2
—
(31.1)
—
119.1
0.1
Adjusted net earnings (loss) for dilutive net earnings
(loss) per common share . . . . . . . . . . . . . . . . . . . . . . .
$10.2
(31.1)
119.2
Denominator:
Weighted average shares for basic net earnings per common
share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Effect of dilutive share-based awards . . . . . . . . . . . . . . . . . . .
39.7
0.1
39.7
—
Adjusted weighted average shares for diluted net
earnings (loss) per common share . . . . . . . . . . . . . . .
39.8
39.7
Basic net earnings (loss) per common share . . . . . . . . . . . . . . . . . .
Diluted net earnings (loss) per common share . . . . . . . . . . . . . . . .
$0.26
$0.25
(0.78)
(0.78)
41.0
0.6
41.6
2.90
2.86
The following options to purchase shares of common stock were not included in the computation of diluted
earnings per share because the exercise price of the options was greater than the average market price or their
inclusion would have been antidilutive for the year ended December 31:
(in millions)
2009
2008
2007
Number of options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2.1
1.5
0.7
130
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
15. Comprehensive Income (Loss)
A reconciliation of each component of comprehensive income (loss) and the related federal income tax
effect for the year ended December 31 is as follows:
($ millions)
2009:
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other comprehensive income:
Net unrealized holding gains on investments:
Unrealized holding gains arising during the year . . . . . . . . . . . . . . . . . . . . .
Reclassification adjustments for gains 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
$ (12.8)
23.0
10.2
99.0
5.2
104.2
(0.1)
(32.1)
(1.8)
(33.9)
—
66.9
3.4
70.3
(0.1)
37.3
(13.8)
23.5
(0.7)
5.2
(2.7)
39.1
143.2
0.2
(2.1)
1.1
(14.6)
(48.5)
(25.5)
(0.5)
3.1
(1.6)
24.5
94.7
104.9
Comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$130.4
131
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
2008:
Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other comprehensive loss:
Net unrealized holding losses on investments:
Unrealized holding losses arising during the year
. . . . . . . . . . . . . . . . . . . .
Reclassification adjustments for gains realized in net loss . . . . . . . . . . . . . .
Amortization of gain on derivative used in cash flow hedge . . . . . . . . . . . .
Net unrecognized benefit plan obligations:
Net actuarial loss arising during period . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Reclassification adjustments for amortization to net loss:
Transition asset . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net actuarial loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Prior service cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Before-Tax
Amount
Tax
(Expense)
or Benefit
Net-of-Tax
Amount
$ (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)
Other comprehensive loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(145.9)
Comprehensive loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$(221.0)
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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 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
132
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
16. Reportable Segments
The Company has three 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 Midwestern, Southern, Southwestern, and Eastern 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 & allied lines,
other & 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 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.
133
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 sources:
Insurance segments
2009
2008
2007
Personal insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Business insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 732.8
443.7
670.9
455.1
609.6
402.0
Total insurance segments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,176.5
1,126.0
1,011.6
Investment operations segment
Net investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net realized (loss) gain on investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total investment operations segment
. . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total revenue from reportable segments . . . . . . . . . . . . . . . . . . . . . .
All other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total revenues from external sources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Intersegment revenues: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
82.1
(5.2)
76.9
87.4
(36.4)
51.0
84.7
12.1
96.8
1,253.4
3.5
1,256.9
9.6
1,177.0
4.9
1,181.9
9.7
1,108.4
5.0
1,113.4
9.4
Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,266.5
1,191.6
1,122.8
Reconciling items:
Eliminate intersegment revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(9.6)
(9.7)
(9.4)
Total consolidated revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,256.9
1,181.9
1,113.4
Segment (loss) income before federal income tax:
Insurance segments:
Personal insurance SAP underwriting (loss) gain . . . . . . . . . . . . . . . . . . . . . . .
Business insurance SAP underwriting (loss) gain . . . . . . . . . . . . . . . . . . . . . .
$ (59.5)
(8.4)
(56.1)
(58.5)
Total insurance segments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(67.9)
(114.6)
Investment operations segment:
Net investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net realized (loss) gain on investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total investment operations segment
. . . . . . . . . . . . . . . . . . . . . . . . . . . .
All other segments (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Reconciling items:
GAAP adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Interest expense on corporate debt
Corporate expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
82.1
(5.2)
76.9
(1.1)
(11.5)
(7.6)
(1.6)
47.3
40.6
87.9
84.7
12.1
96.8
(2.6)
87.4
(36.4)
51.0
(1.9)
(0.1)
(7.3)
(2.2)
(17.3)
(7.6)
(1.9)
Total consolidated (loss) income before federal income taxes . . . . . . . . .
$ (12.8)
(75.1)
155.3
134
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
2009
2008
Investment operations segment . . . . . . . . . . . . . . . . . . . . . . . . . .
$2,269.4
$2,091.8
Total segment assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2,269.4
2,091.8
Reconciling items:
Corporate assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
295.1
351.8
Total consolidated assets . . . . . . . . . . . . . . . . . . . . . . . . . .
$2,564.5
$2,443.6
Assets attributed to the investment operations segment include the total investments and cash and cash
equivalent categories from the balance sheet. All other assets are corporate assets and are not assigned to a
segment.
Revenues from external sources for reportable segments include the following products and services for the
year ended December 31:
($ millions)
Earned premiums:
Personal insurance:
2009
2008
2007
Standard auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Nonstandard auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Homeowners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other personal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 433.2
38.7
230.0
30.9
Total personal insurance earned premiums . . . . . . . . . . . .
732.8
Business insurance:
Commercial auto . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Commercial multi-peril . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fire & allied lines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other & product liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Workers’ compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other commercial
Total business insurance earned premiums . . . . . . . . . . . .
106.2
95.2
97.6
74.8
43.2
26.7
443.7
384.3
42.6
215.4
28.6
670.9
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
Total earned premiums . . . . . . . . . . . . . . . . . . . . . . . .
1,176.5
1,126.0
1,011.6
Investment operations:
Net investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net realized (loss) gain on investments . . . . . . . . . . . . . . . . . . .
Total investment operations . . . . . . . . . . . . . . . . . . . . . . . .
82.1
(5.2)
76.9
87.4
(36.4)
51.0
84.7
12.1
96.8
Total revenues from reportable segments . . . . . . . . . .
$1,253.4
1,177.0
1,108.4
135
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
17. Quarterly Financial Data (unaudited)
($ millions, except per share amounts)
2009
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:
$294.0
(30.9)
(14.0)
316.9
(11.7)
(3.2)
Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ (0.35)
$ (0.35)
(0.08)
(0.08)
324.5
13.7
13.0
0.33
0.33
321.5
16.1
14.4
0.36
0.36
2008
For three months ended
March 31
June 30
September 30
December 31
Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(Loss) before federal income taxes . . . . . . . . . . . . . . . . . . . . . . . . .
Net (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(Loss) 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)
18. 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 Contingencies Topic of the FASB ASC, 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.
136
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
19. Subsequent Events
Effective January 1, 2010, the Pooling Arrangement, described in Note 6a, was further amended to add SA
National to the pool with a participation percentage of 0.0% and to include voluntary assumed reinsurance from
third parties unaffiliated with the Pooled Companies that was assumed on or after January 1, 2009.
In conjunction with the January 1, 2010, Pooling Arrangement amendment, the STFC Pooled Companies
will receive approximately $5.1 million in cash and/or investment securities from State Auto Mutual and its
subsidiaries and affiliates, for net insurance assets transferred on January 1, 2010. The following table presents
an estimate of the impact on the Company’s balance sheet at January 1, 2010, relating to the Pooling
Arrangement amendment:
($ millions)
Losses and loss expenses payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unearned premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less:
Deferred policy acquisition costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ (4.0)
(1.4)
(0.2)
(10.3)
Net cash and/or investment securities to be received . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 5.1
137
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 as of December 31, 2009,
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 on Internal Control over Financial Reporting” 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, 2009, and has concluded that such internal control over financial reporting was effective.
5.
Ernst & Young LLP, the independent registered public accounting firm that audited the consolidated
financial statements included in this Form 10-K, has issued their attestation on the Company’s internal
control over financial reporting, which is included herein.
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.
138
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 2010 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 5, 2010, 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 2010 Proxy Statement, which information is incorporated herein by reference.
Information concerning the procedures by which shareholders may recommend nominees to our Board of
Directors will be found under the caption “Corporate Governance—Nomination of Directors” in our 2010 Proxy
Statement. There has been no material change to the nomination procedures previously disclosed in the proxy
statement for our 2009 annual meeting of shareholders.
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 2010 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 Outside Directors and Outside 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 2010 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 2010 Proxy Statement, which
information is incorporated herein by reference.
139
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 2010 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 2010 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 2010 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, 2009 and 2008
Consolidated Statements of Income for each of the three years in the period ended
December 31, 2009
Consolidated Statements of Stockholders’ Equity for each of the three years in the period ended
December 31, 2009
Consolidated Statements of Cash Flows for each of the three years in the period ended
December 31, 2009
Notes to Consolidated Financial Statements
(a)(2) LISTING OF FINANCIAL STATEMENT SCHEDULES
The following financial statement schedules of the Company for the years 2009, 2008 and 2007 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.
140
(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*
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
Form of
Indemnification Agreement between
State Auto Financial Corporation and each of its
directors
Indemnification Agreement
of
November 14, 2008, between State Auto
Financial Corporation and Robert P. Restrepo, Jr.
dated
as
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)
Form 8-K Current Report filed on May 13, 2009
(see Exhibit 10.2 therein)
Officer Indemnification Agreement dated as of
May 8, 2009, between State Auto Financial
Corporation and Steven E. English
Form 8-K Current Report filed on May 13, 2009
(see Exhibit 10.3 therein)
Indemnification Agreement
of
November 14, 2008, between State Automobile
Mutual
Insurance Company and Mark A.
Blackburn
dated
as
Form 8-K Current Report filed on May 13, 2009
(see Exhibit 10.4 therein)
Officer Indemnification Agreement dated as of
May 8, 2009, between State Auto Financial
Corporation and Clyde H. Fitch, Jr.
Officer Indemnification Agreement dated as of
May 8, 2009, between State Auto Financial
Corporation and James A. Yano
Form 8-K Current Report filed on May 13, 2009
(see Exhibit 10.5 therein)
Form 8-K Current Report filed on May 13, 2009
(see Exhibit 10.6 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)
141
Exhibit
No.
10.11*
10.12*
10.13*
10.14*
10.15*
10.16*
Description of Exhibit
If incorporated by reference document with which Exhibit was
previously filed with SEC
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 Exhibit 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)
10.17*
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)
10.18*
10.19*
10.20*
10.21*
10.22*
10.23*
10.24
10.25
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)
Third Amendment
to 2000 Directors Stock
Option Plan of State Auto Financial Corporation
Form 10-K Annual Report for the year ended
December 31, 2001 (see Exhibit 10(EE) therein)
to 2000 Directors Stock
Fourth Amendment
Option Plan of State Auto Financial Corporation
Form 10-K Annual Report for year ended
December 31, 2002 (see Exhibit 10(UU) therein)
Fifth Amendment
to 2000 Directors Stock
Option Plan of State Auto Financial Corporation
Form 10-Q Quarterly Report for the period ended
June 30, 2005 (see Exhibit 10.66 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,
Automobile Mutual
Company,
effective April 1, 1993
Inc.
Insurance
Investment Management Agreement between
Stateco Financial Services, Inc. and Meridian
Security Insurance Company, effective June 1,
2001
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)
142
Exhibit
No.
10.26
10.27
10.28
10.29
10.30
10.31
10.32
10.33
10.34
Description of Exhibit
If incorporated by reference document with which Exhibit was
previously filed with SEC
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
Investment Management Agreement dated 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
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)
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
Form 10-K Annual Report for the year ended
December 31, 2007 (see Exhibit 10.22 therein)
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
effective
BroadStreet Capital Partners,
March 31, 2008
Inc.
143
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
December 31, 2002 (see Exhibit 10(OO) therein)
Form 10-K Annual Report for the year ended
December 31, 2008 (see Exhibit 10.28 therein)
Form 10-K Annual Report for the year ended
December 31, 2008 (see Exhibit 10.29 therein)
Exhibit
No.
10.35
10.36
10.37
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 10.45 therein)
Form 10-Q Quarterly Report for the period ended
March 31, 2005 (see Exhibit 10.56 therein)
Form 10-Q Quarterly Report for the period ended
June 30, 2007 (see Exhibit 66.67 therein)
Security
Insurance
Midwest
Company
Management Agreement amended and restated as
January 1, 2000 by and among State
of
Automobile Mutual Insurance Company, State
Auto Property and Casualty Insurance Company
and Midwest Security Insurance Company (nka
State Auto Insurance Company of Wisconsin)
and
Operations
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
Company, Meridian Insurance Group,
Inc.,
Farmers Casualty Insurance Company, Stateco
Insurance
Financial Services,
Software, Inc., and 518 Property Management and
Leasing, LLC
Inc., Strategic
and
Operations
First Amendment, made as of April 1, 2007, to
Agreement
Management
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
Company, Meridian Insurance Group,
Inc.,
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
144
Exhibit
No.
10.38
10.39
10.40
10.41
Description of Exhibit
If incorporated by reference document with which Exhibit was
previously filed with SEC
Form 8-K Current Report filed on January 27,
2009 (see Exhibit 10.1 therein)
to the Management
Second Amendment dated as of December 31,
2008,
and Operations
Agreement, Amended and Restated as of January
1, 2005, among State Auto Financial Corporation,
State Automobile Mutual Insurance Company,
State Auto Property & Casualty Insurance
Insurance
State Auto National
Company,
Company, Milbank Insurance Company, State
Auto Insurance Company of Ohio, Meridian
Security Insurance Company, Meridian Citizens
Mutual Insurance Company, Meridian Insurance
Insurance
Group,
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
Farmers Casualty
Inc.,
Form 10-Q Quarterly Report for the period ended
September 30, 2009 (see Exhibit 10.01 therein)
Form 8-K Current Report filed on November 25,
2009 (see Exhibit 10.1 therein)
Form 10-K Annual Report for the year ended
December 31, 2007 (see Exhibit 10.28 therein)
Consulting Services Agreement dated as of
November 1, 2009, by and between State
Automobile Mutual Insurance Company, State
Auto Property & Casualty Insurance Company,
Meridian Security Insurance Company, Meridian
Citizens Mutual
Insurance Company, Farmers
Casualty Insurance Company, Milbank Insurance
Company, and RTW, Inc.
Underwriting Management Agreement effective
as of November 20, 2009, by and between
Rockhill Insurance Company, Plaza Insurance
Company, American Compensation Insurance
Company, Bloomington Compensation Insurance
Company, State Automobile Mutual Insurance
Company, State Auto Property & Casualty
Insurance Company, Meridian Security Insurance
Company, Milbank Insurance Company, Farmers
Casualty
and Risk
Evaluation and Design, LLC
Insurance Company,
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
145
Exhibit
No.
10.42
10.43
10.44
10.45
10.46
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 8-K Current Report filed on February 16,
2010 (see Exhibit 10.3 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,
Patrons Mutual
of
Connecticut, State Automobile Mutual Insurance
Company and State Auto Property & Casualty
Insurance Company
Company
Insurance
Insurance
and Operations Agreement,
Management
effective as of January 1, 2010, entered into as of
February 10, 2010, by and among State Auto
Property & Casualty Insurance Company, State
Automobile Mutual
Company,
Rockhill Insurance Company, Plaza Insurance
Company, American Compensation Insurance
Compensation
Company,
Insurance
Holding
Company, National Environmental Coverage
Corporation of
the South, LLC, National
Environmental Coverage Corporation, RTW,
Inc., Rockhill Insurance Services, LLC, Rockhill
Underwriting Management, LLC and Risk
Evaluation and Design, LLC
Bloomington
Company,
Rockhill
146
Exhibit
No.
10.47
10.48
10.49
10.50
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, 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
Security
Company, Meridian
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)
Form 10-K Annual Report for the year ended
December 31, 2007 (see Exhibit 10.38 therein)
Form 10-K Annual Report for the year ended
December 31, 2008 (see Exhibit 10.44 therein)
to the Reinsurance Pooling
First Amendment
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
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
147
Exhibit
No.
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
Reinsurance Pooling Agreement, Amended and
Restated effective as of January 1, 2010, entered
into as of February 10, 2010, 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 National
Florida
Insurance Company,
Security
Company, Meridian
Insurance
Insurance Company, Meridian Citizens Mutual
Insurance Company, Patrons Mutual Insurance
Company of Connecticut, Litchfield Mutual Fire
Insurance Company,
and Beacon National
Insurance Company
State Auto
Commutation and Release Agreement, effective
as of January 1, 2010, entered into as of
February 10, 2010, between State Automobile
Mutual
Insurance Company and State Auto
National Insurance Company.
Form 8-K Current Report filed on February 16,
2010 (see Exhibit 10.1 therein)
Form 8-K Current Report filed on February 16,
2010 (see Exhibit 10.2 therein)
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)
Form 8-K Current Report filed on April 7, 2009
(see Exhibit 99.1 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
First Amendment, dated as of March 27, 2009
and effective as of April 1, 2009, to the Credit
Agreement, dated as of July 12, 2007, by and
among State Auto Financial Corporation, as
borrower, the financial institution parties thereto,
as lenders, and KeyBank National Association,
as administrative agent, swingline lender and
lender.
148
Exhibit
No.
10.59
10.60
10.61*
10.62*
10.63*
10.64*
10.65*
10.66*
10.67*
10.68*
Description of Exhibit
If incorporated by reference document with which Exhibit was
previously filed with SEC
Credit Agreement dated as of May 19, 2009,
between State Automobile Mutual
Insurance
Company, as borrower, and Milbank Insurance
Company, as lender
Credit Agreement dated as of May 8, 2009,
between State Automobile Mutual
Insurance
Company, as borrower, and State Auto Property
& Casualty Insurance Company, as lender
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
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
149
Form 8-K Current Report filed on May 26, 2009
(see Exhibit 10.1 therein)
Form 8-K Current Report filed on May 13, 2009
(see Exhibit 10.1 therein)
Form 10-K Annual Report for the year ended
December 31, 2008 (see Exhibit 10.53 therein)
Form 10-K Annual Report for the year ended
December 31, 2008 (see Exhibit 10.54 therein)
Form 10-Q Quarterly Report for the period ended
September 30, 2007 (see Exhibit 10.69 therein)
Form 10-K Annual Report for the year ended
December 31, 2008 (see Exhibit 10.56 therein)
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)
Form 8-K Current Report filed on May 9, 2008
(see Exhibit 99.1 therein)
Form 10-K Annual Report for the year ended
December 31, 2008 (see Exhibit 10.60 therein)
Exhibit
No.
10.69*
10.70*
10.71*
10.72*
10.73*
10.74*
10.75*
10.76*
10.77*
10.78*
Description of Exhibit
If incorporated by reference document with which Exhibit was
previously filed with SEC
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)
Form 10-K Annual Report for the year ended
December 31, 2008 (see Exhibit 10.61 therein)
Form 10-Q Quarterly Report for the period ended
June 30, 2005 (see Exhibit 10.60 therein)
Form 10-K Annual Report for the year ended
December 31, 2008 (see Exhibit 10.63 therein)
2009 Equity Incentive Compensation Plan of
State Auto Financial Corporation.
Form 8-K Current Report filed on May 13, 2009
(see Exhibit 10.7 therein)
Restricted Share Award Agreement under the
Amended
Incentive
and Restated Equity
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
under
the Amended and Restated Equity
Incentive Compensation Plan of State Auto
Financial Corporation
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 10.49 therein)
Form 10-Q Quarterly Report for the period ended
September 30, 2007 (see Exhibit 10.71 therein)
Form 10-K Annual Report for the year ended
December 31, 2008 (see Exhibit 10.66 therein)
Form 10-Q Quarterly Report for the period ended
June 30, 2005 (see Exhibit 10.62 therein)
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)
10.79*
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)
150
Exhibit
No.
10.80*
10.81*
10.82*
10.83*
10.84*
10.85*
10.86*
10.87*
10.88*
10.89*
10.90*
10.91*
10.92*
Description of Exhibit
If incorporated by reference document with which Exhibit was
previously filed with SEC
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
the
Form of Designation of Beneficiary for
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
Auto
State
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
151
Form 10-K Annual Report for the year ended
December 31, 2005 (see Exhibit 10.54 therein)
Form 10-K Annual Report for the year ended
December 31, 2008 (see Exhibit 10.72 therein)
Form 10-K Annual Report for the year ended
December 31, 2008 (see Exhibit 10.73 therein)
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)
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)
Exhibit
No.
10.93*
10.94*
10.95*
10.96*
10.97*
10.98*
10.99*
10.100*
10.101*
10.102*
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, 2008 (see Exhibit 10.84 therein)
Form 10-K Annual Report for the year ended
December 31, 2005 (see Exhibit 10.60 therein)
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)
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
Form of State Auto Property & Casualty
Incentive Deferred
Insurance
Compensation Agreement
Company’s
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)
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)
First Amendment
to the State Auto Financial
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)
10.103*
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)
152
Exhibit
No.
10.104*
10.105*
10.106
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 8-K Current Report filed on March 13,
2008 (see Exhibit 10.5 therein)
Form 10-Q Quarterly Report for the period ended
September 30, 2008 (see Exhibit 10.05 therein)
Form 8-K Current Report filed on November 25,
2009 (see Exhibit 10.1 therein)
First Amendment
Corporation
Long-Term
(amendment effective as of January 1, 2008)
to the State Auto Financial
Plan
Incentive
Second Amendment to the State Auto Financial
Corporation
Plan
Long-Term
(amendment effective as of January 1, 2009)
Incentive
Bloomington
Underwriting Management Agreement effective
as of November 20, 2009, by and between
Rockhill Insurance Company, Plaza Insurance
Company, American Compensation Insurance
Company,
Compensation
Insurance Company, State Automobile Mutual
Insurance Company, State Auto Property &
Casualty Insurance Company, Meridian Security
Insurance
Company, Milbank
Insurance
Company,
Insurance
Casualty
Farmers
Company, and Risk Evaluation and Design, LLC
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.
153
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 5, 2010
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
Chairman, President and Chief
Executive Officer
(principal executive officer)
Vice President and Chief Financial
Officer
(principal financial officer)
/s/ CYNTHIA A. POWELL
Cynthia A. Powell
Vice President and Treasurer
(principal accounting officer)
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
Director
Director
Director
Director
Director
Director
Director
Director
March 5, 2010
March 5, 2010
March 5, 2010
March 5, 2010
March 5, 2010
March 5, 2010
March 5, 2010
March 5, 2010
March 5, 2010
March 5, 2010
March 5, 2010
*
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 5, 2010
Steven E. English
154
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 5, 2010, with respect to the
consolidated financial statements and schedules of State Auto Financial Corporation and subsidiaries, and the
effectiveness of internal control over financial reporting of State Auto Financial Corporation and subsidiaries,
included in this Annual Report (Form 10-K) for the year ended December 31, 2009.
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 5, 2010
155
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 5, 2010
/s/ Robert P. Restrepo, Jr.
Robert P. Restrepo, Jr.,
Chief Executive Officer
(Principal Executive Officer)
156
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 5, 2010
/s/ Steven E. English
Steven E. English,
Chief Financial Officer
(Principal Financial Officer)
157
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, 2009, 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 5, 2010
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.
158
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, 2009, 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 5, 2010
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.
159
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 63.5% of STFC. STFC, State Auto Mutual and their
insurance subsidiaries and affiliates (State Auto) market their insurance products exclusively through
independent insurance agencies in 34 states and the District of Columbia. 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 Market System under the symbol STFC.
Financial Highlights
($ in millions, except per share amounts)
2009
2008
2007
2006
2005
Earned premiums
Net investment income
Net realized investment (loss) gain
Other income
Total revenue
Net income (loss)
Basic earnings (loss) per share
Diluted earnings (loss) per share
Dividends paid per share
Book value per share
Total assets
Stockholders’ equity
Return on equity
Combined ratio
$1,176.5
82.1
(5.2)
3.5
$1,256.9
1,126.0
87.4
(36.4)
4.9
1,181.9
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
(31.1)
(0.78)
(0.78)
0.60
19.23
2,443.6
761.0
2,337.9
935.5
2,255.1
834.2
%
(3.7)%
109.8
13.5%
92.8
15.1%
91.4
2,274.9
763.5
17.7
90.1
%
$
10.2
0.26
$
0.25
$
$
0.60
$ 21.33
$ 2,564.5
$ 849.4
1.3
105.8
Geographic Dispersion
Corporate Headquarters
Columbus, OH
regional oFFiCes
eastern region Headquarters
Western region Headquarters
BaltimOre Center
Hunt Valley, mD
regional President Charles mcShane, 56
auStin Center
austin, tX
regional President Gerald ladner, 50
soutHern region Headquarters
des Moines ClaiMs Center
West Des moines, ia
Harrisburg ClaiMs Center
Harrisburg, Pa
naSHVille Center
Goodlettsville, tn
regional President George Furlong, 56
Central region Headquarters
COlumBuS Center
Columbus, OH
regional President Kathy Durso, 57
MidWestern region Headquarters
inDianaPOliS Center
indianapolis, in
regional President Ben Blackmon, 48
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,
2009, which is included with this annual report.
STATE AUTO FINANCIAL CORPORATION 2009 Annual Report
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State Auto Financial Corporation
Annual Report
State Auto Financial Corporation
State Auto Property & Casualty Insurance Company
Milbank Insurance Company
Farmers Casualty Insurance Company
State Auto Insurance Company of Ohio
State Auto National Insurance Company
Stateco Financial Services Inc.
518 Property Management & Leasing LLC
State Automobile Mutual Insurance Company
State Auto Insurance Company of Wisconsin
State Auto Florida Insurance Company
Meridian Security Insurance Company
Meridian Citizens Mutual Insurance Company
Beacon National Insurance Company
Beacon Lloyds Insurance Company
Patrons Mutual Insurance Company of Connecticut
Litchfield Mutual Fire Insurance Company
State Auto Financial Corporation
518 E. Broad Street
Columbus, OH 43215
www.StateAuto.com
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