State Auto Financial Corporation
2012 Annual Report
State Auto Financial Corporation
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Financial Highlights
($ in millions, except per share amounts)
2008
As Adjusted1 As Adjusted1 As Adjusted1 As Adjusted1
2012
2009
2010
2011
$1,042.1
1,126.0
Earned premiums
Net investment income 75.4
87.4
Net realized investment gain (loss) 29.0 37.0 14.9 (5.2) (36.4)
2.2 3.5 4.9
Other income
1,181.9
Total revenue
3.6
$1,150.1
2.5
1,533.7
1,176.5
82.1
1,257.2
80.8
1,428.8
85.4
1,256.9
1,355.1
Net income (loss)
$ 10.7
(160.7)
24.4
9.3
(32.9)
Basic earnings (loss) per share
Diluted earnings (loss) per share
Dividends paid per share
Book value per share
$ 0.26
(0.83)
0.23
0.61
(4.00)
$ 0.27
(0.83)
0.23
0.61
(4.00)
$ 0.55 0.60
0.60 0.60 0.60
$ 18.22 17.95 20.71 20.81 18.70
Total assets
Stockholders’ equity
Return on equity 1.5% (20.7)% 2.9% 1.2% (4.0)%
Combined ratio
116.5 104.6 105.9 110.1
$ 2,477.8
$ 737.2
107.9
2,422.7
740.1
2,544.0
828.9
2,764.4
723.8
2,701.4
831.2
1 We adopted, with retrospective application at Jan. 1, 2012, Accounting Standards Update 2010-26, “Accounting for Costs
Associated with Acquiring and Renewing Insurance Contracts.” All applicable prior period amounts have been adjusted to
conform to current period presentation.
BOOK VALUE
BOOK VALUE
(per share)
(per share)
DIVIDENDS PAID
DIVIDENDS PAID
(per share)
(per share)
INVESTMENT PORTFOLIO
INVESTMENT PORTFOLIO
Municipal
Bonds
35.3%
U.S. Government
Agencies and
MBS 22.1%
Corporate and Other
Invested Securities 17.7%
NET PREMIUMS
NET PREMIUMS
WRITTEN
WRITTEN
(in billions)
(in billions)
Equity
Securities 10.1%
1%
U.S. Treasury
U S Tre
Securities 11.7%
Notes
Receivable
3.1%
Cover photos: Company associates
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A solid plan to produce results
Dear
Shareholders,
It’s one thing to believe our strategies are taking hold. It’s yet
another to hear it from our customers and see it in our results.
That’s why I spent time during 2012 visiting with our pri-
mary customers: our independent agency and broker partners.
Joined by other members of our leadership team, I visited 87
agencies and brokers with the scale, expertise and market fo-
cus to offer us the greatest potential for profi t and production.
We wanted to understand each agency’s sales plan, share how
State Auto brings value to their agency and customers, and
identify where their goals and plans align well with State Auto’s
strategies and capabilities.
They’re highly sophisticated businesses, many ranking
among the top 100 agencies and brokers in the country. In my
40 years in the insurance industry, I’ve never seen independent
agencies better managed, more focused on marketing, more
responsive in their service capabilities and more resilient to
economic and pricing volatility.
What I heard from agents confi rms our belief that State
Auto is both well represented and well respected. They want
to do business with strong regional companies like us, and our
results demonstrate that they’re doing a lot more business with
State Auto. Many told me that they’ve long viewed State Auto
as primarily a personal lines and small business carrier. They’ve
now come to respect our middle market capabilities, our spe-
cialty product portfolio and our superior claim performance.
Among the agencies President, Chairman and CEO Bob Restrepo
visited in 2012 was the Ison Insurance Agency in West Liberty, Ky.,
where he met with agency staff including, from left, Jenni Ison, Ashley
Roseberry, John Ison, Amanda Frazier, Lisa Collins and Kate Kemplin.
Restrepo also viewed the considerable damage from a tornado that
struck just weeks before, destroying much of the city. State Auto part-
nered with the Ison Agency to restore peace of mind to our customers.
State Auto Financial Corporation
128596.indd 3
Robert P. Restrepo Jr.
President, Chairman of the Board and Chief Executive Offi cer
I’m also pleased to report progress on our goal to deliver
sustained earnings and growth in STFC’s book value. STFC
produced a 2012 profi t of $10.7 million or $0.27 per share and
a combined ratio of 107.9%. Book value per share increased
to $18.22, net of a $2.48 per share valuation allowance for
deferred tax assets. We’re focused on delivering consistent
profi table results that are necessary to restore these deferred
tax assets to our balance sheet.
We substantially improved performance versus our ca-
tastrophe driven loss of 2011. Improvement was driven by
better ex-catastrophe loss ratios, particularly for homeowners,
business insurance, and workers compensation. Production
in business insurance – new business, exposure growth, and
price – exceeded expectations and contributed to underwriting
and expense improvements.
Catastrophe losses were near our fi ve-year average and
we strengthened reserves related to RED, a managing general
agency we shut down mid-year. Setting aside RED’s impact,
our combined ratio was 102.3%1 or 5.6 points better than
reported.
We continue to segment our business into Personal Insur-
ance, Business Insurance, and Specialty Insurance.
Personal Insurance transition continues
Personal Auto is our largest and historically most profi t-
able line. While achieving mid-single digit price increases, we
recognize the need for even higher prices to absorb continued
growing industry wide severity in bodily injury. Auto remains
attractive, but we didn’t see expected improvement in 2012
because of this loss trend. We’re fi ling additional price increas-
es. While we expect improved margins with this pricing action,
it may dampen new business production. Physical damage
improved thanks to better weather and our continued focus on
claim performance.
Homeowners results improved signifi cantly. Following the
weather-related disasters of 2011, catastrophe experience
was better, but more importantly, the ex-catastrophe loss ratio
was 38.9%, an improvement of over ten points. We expect
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(cid:132) Our greatest opportunity is account sizes between
$25,000 (small accounts) and $100,000 (middle market).
This “bread and butter” business for most independent
agents is also the traditional strength for strong, regional
companies such as us.
(cid:132) Our middle market performance with distribution and trans-
portation accounts is recognized as a strength. We recog-
nize we’re less successful with middle market workers com-
pensation and will continue to avoid this volatile line.
(cid:132) Agents like our developing niche in the food industry we
call “Field to Fork.” Agencies like our capabilities in farm,
food manufacturing and processing, distribution and hos-
pitality/restaurants. We’re positioning ourselves to capitalize
on this profi table and growing market.
Balancing our traditional personal lines presence with more
commercial lines volume remains an important risk manage-
ment and business development priority.
Specialty Insurance is strong and growing
We continue to deliver strong underwriting profi t and
healthy growth in our Rockhill and RTW businesses. Rockhill
and RTW focus on niche opportunities where we can differen-
tiate ourselves, produce underwriting profi t, and respond to
market needs at the wholesale and retail level.
Rockhill’s excellent results were driven by specialty property
and environmental liability. Both programs benefi tted from fi rm-
ing pricing and a recovering economy. We’re beginning to see
growth in specialty liability and our Rockhill program business.
In workers compensation, we’ve leveraged RTW’s underwrit-
ing, pricing and claim capabilities in the debit mod business with
staff in key states to market our debit mod and small account
products to wholesale and retail agents. In 2013, we’ll introduce
“CompConnect” technology to enable rule-based underwriting
decisions, granular pricing, and ease of doing business.
Specialty includes a small but profi table surety business.
In 2012, we hired two regional marketing representatives and
lifted profi t and production. We’ll continue to hire surety profes-
sionals – either teams or individuals to allow us to achieve
scale and greater profi tability in this line.
Excellent results in Specialty Insurance were driven by the property line.
Colin Mayo, Rockhill Senior Vice President and Chief Property Offi cer,
leads the property team out of State Auto’s Atlanta offi ce. Pictured, left
to right: Sharon Hill, Judy Christy, LaTanya Wedlowe-Banks, Mike Bowler,
Colin Mayo, Michael Stokes, Jennifer Pruitt, Stacia Cunningham, Stephen
Christian, Heather Scarborough, Angela Willbanks.
State Auto Financial Corporation
3/21/13 5:08 PM
A multi-year effort to improve results in the homeowners line is paying off,
with STFC in a position to produce sustained acceptable results. Leading
the effort are, from left, Vice President/Standard Lines Product Manage-
ment Joyce Dallessio, Sales Financial Offi cer Lisa Pollard, Assistant Secre-
tary/Actuarial Product Management Director-Personal Lines Clay Jenkins,
and Vice President/Director of Personal Insurance Rick Holbein.
to achieve rate adequacy during 2013, positioning us for
sustained acceptable results. Our homeowners plans assume
the weather we’ve experienced over the past fi ve years will
continue. Our pricing actions, mandatory deductibles, insur-
ance-to-value programs, by-peril pricing and agency manage-
ment actions are paying off despite continued bad weather
forecasts. While we address and monitor the impact of our
remediation efforts, we’ll continue to leverage the homeowners
quota share reinsurance treaty, thereby minimizing or reducing
our capital risk.
Personal Insurance production will remain fl at as we reposi-
tion our geographic presence. In 2012, agency terminations
reduced our overall personal insurance policy count by almost
4.0%. Repositioning is diffi cult, but necessary. Sometimes
very good agents are in very exposed locations. Our fi eld force
ended some long-standing relationships, but they’ve done
what was necessary to improve our profi t potential and spread
of risk. The impact on our policy count and production levels
will continue through 2013 as terminated business runs off.
Business Insurance opportunities are clear
Commercial lines profi t and production improved signifi -
cantly. The loss ratio improved 9.5 points, driven by better
catastrophe experience and a 7.4 point improvement in our ex-
catastrophe loss ratio result. Production was up approximately
3.5%. We managed a mix of price increases, an improving
economy and targeted new business. We believe we’ll be able
to achieve price increases in the high single digits for 2013.
Agents are responding well to positive actions we’ve taken
in deploying our people, introducing new products, enhancing
our service and responsiveness, and relying on signifi cantly
improved claim service. State Auto’s value – depth and breadth
of product portfolio, underwriting capability, and most impor-
tantly, the reliability and responsiveness of our fi eld personnel –
is now more evident to agents focused on business insurance.
During my visits, I also learned that :
(cid:132) Our BOPChoice product is a big hit and promises to
reach its full potential in 2013 as we fully implement our
Business Insurance Evolution initiative that will advance
our sophistication in modeling, pricing, rules and process.
Page 2
128596.indd 4
(cid:132) The healthcare segment is an opportunity. We’re
developing a market program to leverage Rockhill’s
specialty liability focus, RTW’s success in healthcare, and
the profi table commercial property exposure we see in
highly protected, professionally run, modern buildings.
(cid:132) Workers compensation remains a niche opportunity
dependent on discipline and execution. Our strategy
focuses on targeted states, preferred classes of accounts,
premium size for small accounts (e.g. less than $25,000), or
RTW’s traditional “debit mod” business. We call our workers
compensation strategy a “niche within a niche” and our
focus is paying off with underwriting profi ts in the states,
classes and size of accounts we’re targeting.
Risk Management starts at the top
State Auto is in the risk business. In previous letters I’ve
detailed our plan to achieve greater scale, diversify our risk
portfolio, and minimize capital impact from catastrophic weath-
er events. Our active enterprise risk management process
looks at frequency and severity of all potential risks. In 2012,
we focused on:
(cid:132) Geographic diversifi cation – reducing our concentration in
the Midwest and Southeast
(cid:132) IT infrastructure – assuring that it stays reliable, respon-
sive and secure
(cid:132) Price adequacy – ensuring we respond quickly to loss
trends
(cid:132) Corporate governance – reinforcing the expectations of
shareholders and policyholders.
At State Auto, we’re proud to be a conservatively run com-
pany with a strong risk culture. We’re committed to:
(cid:132) Preserving and enhancing our fi nancial strength
(cid:132) Maintaining our long-term and trusted relationships with all
stakeholders
(cid:132) Protecting and enhancing the strong reputation we’ve
worked hard to earn
(cid:132) Being a reliable and trusted partner to agents and brokers
(cid:132) Developing and retaining responsive people, processes
and service capabilities.
Strong risk culture starts with the tone at the top. I’m
pleased with our progress in all dimensions with the signifi cant
exception of RED. This was a brief and disappointing relation-
ship from which we learned much. The experience is one we
will not repeat. We’ll continue to develop market and program
opportunities, but always with a focus on rigorous risk assess-
ment, monitoring and oversight regarding underwriting, pricing,
claims, regulatory compliance and technology. Equally impor-
tant, we’ll do business only with culturally compatible partners
that share similar values.
We’ve strengthened our risk management capability by
appointing Cindy Powell as Chief Risk Offi cer reporting di-
rectly to me. She’s developed an extensive knowledge of the
risks we face during her 23 years with company, including the
past six years as chief accounting offi cer. Cindy will build on
a solid enterprise risk management foundation and sharpen
our ability to operationalize and integrate risk management
capabilities into our capital management, product develop-
ment, pricing, claims and service capabilities.
State Auto’s risk management capability is even stronger following
the appointment of Cindy Powell as Chief Risk Offi cer. Cindy and
Vice President, Director of Corporate Enterprise Risk Management
Steve Hazelbaker will further integrate risk management capabilities
into our operations.
A solid plan to produce results
We expect to continue improving results for each of our
three insurance segments – Personal, Business and Specialty.
We believe our plan will enhance our risk management focus,
produce sustainable underwriting profi ts, and achieve mean-
ingful returns on equity. Our intense focus on underwriting and
claim discipline combined with achieving price adequacy will
help ensure that we achieve returns you expect and deserve.
We’ll deliver with a team of dedicated, highly engaged as-
sociates. Every day I’m impressed not only by the skills and
talents of our people, but by the degree to which our agents
and brokers truly like working with us. The quality of our
people remains our single greatest competitive advantage in
the marketplace. With their contributions, and your support,
we’re well positioned to restore our historically superior fi nan-
cial performance.
Robert P. Restrepo Jr.
President, Chairman of the Board and Chief Executive Offi cer
1Reconciliation of RED Underwriting Results to
As Reported Results
Year ended December 31, 2012
Pro Forma
As Reported RED without RED
0.7%
Cat Loss and ALAE ratio
Non-cat loss and LAE ratio 68.3% 122.1%
Loss and LAE ratio 74.7% 122.8%
39.0%
Expense ratio 33.2%
107.9% 161.8%
Combined ratio
7.0%
62.7%
69.7%
32.6%
102.3%
6.4%
State Auto Financial Corporation
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STFC Board of Directors
Standing from left:
Robert P. Restrepo Jr.
President, Chairman and CEO -
State Auto Financial Corporation
Thomas E. Markert
CEO, Digital Tailwind
David J. D’Antoni
Retired Senior Vice President -
Ashland Inc.
David R. Meuse
Principal -
Stonehenge Partners Corp.
Alexander B. Trevor
President and Director -
Nuvocom Inc.
S. Elaine Roberts
President and CEO -
Columbus Regional Airport Authority
Robert E. Baker
Executive Vice President
DHR International
Eileen A. Mallesch
CPA, Retired CFO
Paul S. WIlliams
Partner-
Major, Lindsey & Africa
Executives
Robert P. Restrepo Jr.
President, Chairman and
Chief Executive Offi cer
Steven E. English
Vice President
Chief Financial Offi cer
James A. Yano
Vice President
Secretary and General Counsel
Senior Offi cers
Douglas E. Allen
Vice President, Director of Information Technology
Joel E. Brown
Vice President, Standard Lines
Jessica E. Buss
Vice President, Specialty Lines
Karen L. Longshore
Vice President, Chief Technology Offi cer
Charles E. McShane Jr.
Vice President, Director of Business Insurance
Matthew S. Mrozek
Vice President, Chief Actuarial Offi cer
Joyce A. Dallessio
Vice President, Standard Lines Products Management
David W. Dalton
Vice President, Compliance Offi cer
Nancy D. Edwards
Vice President, Chief Security and Continuity Planning Offi cer
Paul E. Nordman
Vice President, Reinsurance
John M. Petrucci
Vice President, Director of Sales
Cynthia A. Powell
Vice President, Chief Risk Offi cer
Clyde H. Fitch
Senior Vice President, Chief Sales Offi cer
Steven R. Hazelbaker
Vice President,
Director of Corporate Enterprise Risk Management
Rick L. Holbein
Vice President, Director of Personal Insurance
Stephen P. Hunckler
Vice President, Chief Claims Offi cer
Scott A. Jones
Vice President, Chief Investment Offi cer
Timothy G. Reik
Vice President, Director of Specialty Administration
M. Jean Reynolds
Vice President,
Director of Planning and Expense Management
Lyle D. Rhodebeck
Vice President, Director of Operations
Lorraine M. Siegworth
Vice President,
Chief Strategy and Organization Effectiveness Offi cer
Larry E. Willeford
Vice President, Claims Field Director
Page 4
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State Auto Financial Corporation
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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, 2012 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)
518 East Broad Street, Columbus, Ohio
(Address of principal executive offices)
31-1324304
(I.R.S. Employer Identification No.)
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 È No ‘
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will
not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference
in Part III of this Form 10-K or any amendment to this Form 10-K. ‘
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a
smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in
Rule 12b-2 of the Exchange Act.
Large accelerated filer ‘
Non-accelerated filer ‘ (Do not check if a smaller reporting company)
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ‘ No È
As of June 30, 2012, 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
$212,461,602.
Accelerated filer È
Smaller reporting company ‘
On February 25, 2013, the Registrant had 40,518,650 Common Shares outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s Proxy Statement relating to the annual meeting of shareholders to be held May 3, 2013 (the “2013
Proxy Statement”), which will be filed within 120 days of December 31, 2012, are incorporated by reference into Part III of this
Form 10-K.
State Auto Financial Corporation
1
8596_FinC1.pdf
Index to Annual Report on Form 10-K for the year ended December 31, 2012
Form 10-K Item Description
Part I
1
Business
Executive Officers of the Registrant
Risk Factors
Unresolved Staff Comments
Properties
Legal Proceedings
Mine Safety Disclosures
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
1A
1B
2
3
4
5
6
7
7A
Qualitative and Quantitative Disclosures about Market Risk
8
9
9A
9B
10
11
12
13
14
15
Financial Statements and Supplementary Data
Reports of Independent Registered Public Accounting Firm
Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
Controls and Procedures
Other Information
Directors, Executive Officers and Corporate Governance
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 II
Part III
Part IV
Page
7
12
13
20
20
20
21
22
24
25
54
55
55
84
84
84
85
85
85
85
85
86
97
2
State Auto Financial Corporation
8596_FinC1.pdf
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.
8596_FinC1.pdf
State Auto Financial Corporation
3
IMPORTANT DEFINED TERMS USED IN THIS FORM 10-K
Glossary of Terms for State Auto Financial Corporation and Its Subsidiaries and Affiliates
State Auto Financial or STFC
Refers to our holding company, State Auto Financial Corporation.
We, us, our or the Company
State Auto Mutual or our parent company
STFC Pooled Companies
Mutual Pooled Companies
Refers to STFC and its consolidated subsidiaries, namely State Auto Property & Casualty
Insurance Company (“State Auto P&C”), Milbank Insurance Company (“Milbank”), State Auto
Insurance Company of Ohio (“SA Ohio”), Stateco Financial Services, Inc. (“Stateco”). STFC’s
former subsidiary Farmers Casualty Insurance Company (“Farmers”) was merged into State
Auto P&C as of the close of business on December 31, 2012. STFC’s former subsidiary
State Auto National Insurance Company (“SA National”) has been included through
December 31, 2010, the date of its sale to a third party.
Refers to State Automobile Mutual Insurance Company, which owns approximately 62% of
STFC’s outstanding common shares. State Auto Mutual also owns Risk Evaluation & Design,
LLC (“RED”), which acts as a managing general underwriter exclusively for the benefit of our
Pooled Companies.
Refers to State Auto P&C, Milbank, SA Ohio, and, from January 1, 2010 through December
31, 2010, SA National.
Refers to 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”), Litchfield Mutual Fire Insurance Company
(“Litchfield”) and, as of January 1, 2011, Rockhill Insurance Company (“RIC”), Plaza
Insurance Company (“Plaza”), American Compensation Insurance Company (“American
Compensation”) and Bloomington Compensation Insurance Company (“Bloomington
Compensation”). At the close of business on December 31, 2012, SA Florida and Beacon
National were merged into Meridian Security.
Pooled Companies or our Pooled Companies
Refers to the STFC Pooled Companies and the Mutual Pooled Companies.
MIGI Insurers
MIGI Companies
Refers to Meridian Security and Meridian Citizens Mutual.
Refers to the MIGI Insurers and Meridian Insurance Group, Inc. (“MIGI”).
Patrons Insurance Group or Patrons Group
Refers to Patrons Mutual and Litchfield.
Rockhill Insurance Group
Rockhill Insurers
State Auto Group
Refers to Rockhill Holding Company, its insurance subsidiaries, namely RIC, Plaza,
American Compensation and Bloomington Compensation, and its other non-insurance
subsidiaries, including RTW, Inc. (“RTW”), a holding company that owns 100% of American
Compensation and Bloomington Compensation.
Refers to RIC, Plaza, American Compensation and Bloomington Compensation.
Refers to the Pooled Companies and, through December 31, 2012, Beacon Lloyds Insurance
Company, which was dissolved as of the close of business on December 31, 2012.
4
State Auto Financial Corporation
8596_FinC1.pdf
Glossary of Selected Insurance and Accounting Terms
Accident year
Admitted insurer
Allocated loss adjustment expenses or ALAE
Book value per share
Catastrophe loss
Combined ratio
The calendar year in which loss events occur, regardless of when the losses are actually
reported, booked or paid.
An insurer licensed to transact insurance business within a state and subject to
comprehensive policy rate, form and market conduct regulation by that state’s insurance
regulatory authority.
The costs that can be related to a specific claim, which may include attorney fees, external
claims adjusters and investigation costs, among others.
Total common stockholders’ equity divided by the number of common shares outstanding.
Loss and ALAE from catastrophes, where catastrophes are defined as a severe loss caused
by various natural events, including hurricanes, hailstorms, tornadoes, windstorms,
earthquakes, severe winter weather and fires. Our catastrophe losses are those designated
by the Insurance Services Office (“ISO”) Property Claim Services (“PCS”). PCS defines a
catastrophe as an event that causes $25 million or more in industry insured property losses
and affects a significant number of property and casualty policyholders and insurers.
The sum of the loss and LAE ratio and the expense ratio. A combined ratio under 100%
generally indicates an underwriting profit. A combined ratio over 100% generally indicates an
underwriting loss.
Debt to capital ratio
The ratio of notes payable to the sum of total stockholders’ equity and notes payable.
Deferred acquisition costs or DAC
Direct written premiums
Expenses that vary with, and are primarily related to, the production of new and renewal
insurance business, and are deferred and amortized to achieve a matching of revenues and
expenses when reported in financial statements prepared in accordance with GAAP.
The amounts charged by an insurer to insureds in exchange for coverages provided in
accordance with the terms of an insurance contract. The amounts exclude the impact of all
reinsurance premiums, either assumed or ceded.
Duration
A measure of the sensitivity of a financial asset’s price to interest rate movements.
Earned premiums or premiums earned
The portion of written premiums that applies to the expired portion of the policy term. Earned
premiums are recognized as revenue under both SAP and GAAP.
Excess and surplus lines insurance
Expense ratio or underwriting expense ratio
Generally accepted accounting principles or
GAAP
Incurred but not reported reserves or IBNR
Loss adjustment expenses or LAE
Specialized property and liability coverages written by non-admitted insurers. These
coverages include exposures that do not fit within normal underwriting patterns, involve a
degree of risk that is not commensurate with standard rates and/or policy forms, or are not
written by admitted insurers because of general market conditions.
For SAP, it is the ratio of (i) the sum of statutory underwriting and miscellaneous expenses
incurred offset by miscellaneous income (collectively, “underwriting expenses”) to (ii) written
premiums. For GAAP, it is the ratio of acquisition and operating expenses incurred to earned
premiums.
Accounting practices used in the United States of America determined by the Financial
Accounting Standards Board (“FASB”) and American Institute of Certified Public Accountants
(“AICPA”).
Estimated losses and LAE that have been incurred but not yet reported to the insurer. This
includes amounts for unreported claims, development on known cases, and re-opened
claims.
The expenses of settling claims, including legal and other fees, and the portion of general
expenses allocated to claim settlement. LAE is comprised of ALAE and ULAE.
Loss and LAE ratio or loss ratio
For both SAP and GAAP, it is the ratio of incurred losses and LAE to earned premiums.
Loss reserves
Managing general underwriter or MGU
National Association of Insurance
Commissioners or NAIC
Net premiums written to surplus ratio or
leverage ratio
Liabilities established by insurers and reinsurers to reflect the estimated cost of claims
incurred that the insurer or reinsurer will ultimately be required to pay in respect of insurance
or reinsurance it has written. Reserves are established for losses and for LAE, and consist of
case reserves and IBNR reserves.
An independent insurance professional firm that acts as an intermediary between the insurer
and retail agents, much like a wholesaler. MGUs frequently have binding authority to issue
insurance policies on behalf of an insurer that fit into the underwriting guidelines provided by
that insurer. MGUs typically are compensated by an override commission on the insurance
coverages sold by their sub-agents.
An organization of the insurance commissioners or directors of all 50 states, the District of
Columbia and the five U.S. territories organized to promote consistency of regulatory
practices and statutory accounting standards throughout the United States.
A SAP calculation which measures statutory surplus available to absorb losses. This ratio is
calculated by dividing the net statutory premiums written for a rolling twelve month period by
the ending statutory surplus for the period. For example, a ratio of 1.5 means that for every
dollar of surplus, the insurer wrote $1.50 in premiums.
Net written premiums
Direct written premiums plus assumed reinsurance premiums less ceded reinsurance premiums.
State Auto Financial Corporation
5
8596_FinC1.pdf
Non-admitted insurer or surplus lines carrier
Retail agent or retail agency
Return on average equity
Risk-based capital or RBC
Standard insurance
Statutory accounting practices or SAP
Statutory surplus
An insurer that is not required to be licensed in a state but is allowed to do business in that
state subject to certain regulatory oversight by that state’s insurance regulatory authority.
Non-admitted insurers are not subject to most of the rate and form regulations imposed on
admitted insurers because they write specialized property and liability coverages, also known
as excess and surplus lines insurance, which allows them the flexibility to change coverages
offered and rates charged without time constraints and financial costs associated with the
filing process. As such, these insurers offer an opportunity for coverage for specialized
exposures that otherwise might not be insurable.
An independent insurance professional who represents, and acts as an intermediary for,
admitted insurers, generally recommending, marketing and selling insurance products and
services to insurance consumers.
The percent derived by dividing net income by average total stockholders’ equity.
A measure adopted by the NAIC and state regulatory authorities for determining the
minimum statutory capital and surplus requirements of insurers. Insurers having total
adjusted capital less than that required by the RBC calculation will be subject to varying
degrees of regulatory action depending on the level of capital inadequacy.
Insurance which is typically written by admitted insurers. Our personal and business
insurance segments are comprised of standard insurance.
The practices and procedures prescribed or permitted by state insurance regulatory
authorities in the United States for recording transactions and preparing financial statements.
Under SAP, the amount remaining after all liabilities, including loss reserves, are subtracted
from all admitted assets. Admitted assets are assets of an insurer prescribed or permitted by
a state to be recognized on the balance sheet prepared in accordance with SAP.
Unallocated loss adjustment expenses or ULAE
The costs incurred in settling claims, such as in-house processing costs, which cannot be
associated with a specific claim.
Underwriting gain or loss
Unearned premiums
Wholesale broker
Under SAP, earned premiums less loss and LAE and underwriting expenses.
The portion of written premiums that applies to the unexpired portion of the policy term.
Unearned premiums are not recognized as revenues under both SAP and GAAP.
An independent insurance professional who offers specialized insurance products and
serves as an intermediary between a retail agent and an insurer, while typically having no
contact with the insured. A wholesale broker may represent both admitted and non-admitted
insurers, and may offer both standard and excess and surplus lines insurance.
6
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P
A
R
T
I
PART I
Item 1. Business
State Auto Financial is an Ohio domiciled property and casualty
insurance holding company incorporated in 1990. We are engaged in
writing personal, business and specialty insurance. State Auto
Financial’s principal subsidiaries are State Auto P&C, Milbank and SA
Ohio, each of which is a property and casualty insurance company,
and Stateco, which provides investment management services to
affiliated insurance companies.
Our parent company is State Auto Mutual, an Ohio domiciled mutual
property and casualty insurance company organized in 1921. It owns
approximately 62% of State Auto Financial’s outstanding common
shares. State Auto Mutual’s other subsidiaries and affiliates include
SA Wisconsin, Meridian Security, Meridian Citizens Mutual, Patrons
Mutual, Litchfield and the Rockhill Insurers, each of which is a
property and casualty insurance company. In 2009, State Auto Mutual
acquired the Rockhill Insurance Group. State Auto Mutual and its
insurance subsidiaries and affiliates, along with State Auto Financial’s
insurance subsidiaries, pool their respective insurance business under
the Pooling Arrangement, as further described below.
The State Auto Group markets its insurance products throughout the
United States primarily through independent agencies, which include
retail agencies and wholesale brokers. All of the property and casualty
insurance companies in the State Auto Group are admitted insurers,
except for RIC, which is a non-admitted insurer. The operations of the
State Auto Group are headquartered in Columbus, Ohio.
Our Pooled Companies are rated A (Excellent) by the A.M. Best
Company (“A.M. Best”).
FINANCIAL INFORMATION ABOUT SEGMENTS
Since January 1, 2011, our reportable insurance segments have been
personal insurance, business insurance and specialty insurance
(collectively the “insurance segments”). These insurance segments
are aligned consistent with the reporting lines to our principal
operating decision makers. Our Investment operations is also a
reportable segment. See a 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 14 to our consolidated financial statements included in
Item 8 of this Form 10-K.
PERSONAL AND BUSINESS INSURANCE
Products offered in our personal and business insurance segments
are marketed exclusively through retail agents, but the segments are
managed separately from each other due to the differences in the
types of customers they serve or products they provide or services
they offer.
Products
Personal Insurance
In our personal insurance segment, we write standard insurance
covering personal exposures to individuals. The primary coverages
offered are personal auto and homeowners.
Business Insurance
In our business insurance segment, we write standard insurance
covering small-to-medium sized commercial exposures. We offer a
broad range of coverages which include commercial auto, commercial
multi-peril, business owners, fire & allied and general liability.
Marketing
We market our personal and business insurance through
approximately 2,900 retail agencies. We view our retail 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.
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 corporate headquarters. Further, our training
programs include disciplined follow-up and coaching for an extended
time. Other targeted training sessions are held in our regional
headquarters from time to time, as well as in our agents’ offices.
We provide our retail 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
incentives.
We have made continuing efforts to use technology to make it easier
for our retail 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.
Claims
Our claims division supports our personal and business insurance
segments through emphasis on 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.
We employ a specialized claims model that is skills-based which
attempts to yield a quality customer experience regardless of the type
and severity of the claim. We staff field adjusters in locations where
we have size, scale and density of claims whenever possible to
control file quality and enhance customer service. We supplement our
field staff with independent adjusters and appraisers in areas in which
there is not sufficient volume of claims to warrant staff adjusters.
Claim settlement authority levels are established for each adjuster,
supervisor and manager based on their level of expertise. 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 specialists for direct handling.
We minimize claim adjusting costs by settling as many claims as
possible through our claims staff and, if possible, by settling disputes
regarding automobile physical damage, bodily injury and property
insurance claims through arbitration or mediation when appropriate. In
addition, selected agents have authority to settle small first party
claims, which improves claims service.
State Auto Financial Corporation
7
8596_FinC1.pdf
Form 10-K, “Management’s Discussion and Analysis of Financial
Condition and Results of Operations—Investment Operations
Segment.”
POOLING ARRANGEMENT
Our Pooled Companies pool their respective insurance business in
accordance with 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 a specified portion of premiums, losses and expenses
based on each of the Pooled Companies’ respective pooling
percentages.
In 2011, we made two changes to the Pooling Arrangement. First, as
of January 1, 2011, we added the Rockhill Insurers to the pool with a
participation percentage of 0.0%. Second, at the close of business on
December 31, 2011, the Pooling Arrangement was amended to
reduce the overall participation percentage of the STFC Pooled
Companies from 80% to 65% and to include the pooling of applicable
balance sheet accounts such as accumulated other comprehensive
income related to employee benefit plans. 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.”
GEOGRAPHIC DISTRIBUTION
The following table sets forth the geographic distribution of our direct
written premiums for the year ended December 31, 2012:
State
Ohio
Texas
Kentucky
Indiana
Tennessee
Minnesota
Pennsylvania
Illinois
Michigan
Florida
Connecticut
Maryland
West Virginia
Arkansas
All others (1)
Total
% of Total
11.8%
8.8
7.3
5.2
5.0
4.6
3.9
3.5
3.4
3.4
3.3
3.2
3.1
3.1
30.4
100.0%
(1) No other single state accounted for 3.0% or more of the total direct written
premiums written in 2012.
MANAGEMENT AGREEMENT
Through various management and cost sharing agreements, State
Auto P&C provides 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.
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.
We have in-house counsel offices to defend and resolve claims which
are in litigation. These offices are strategically placed where we have
size, scale and density of legal cases to warrant their existence. We
also have a list of highly skilled panel counsel we retain for defending
our insureds when appropriate.
Our Claims Express 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 Express Centers, which are located in Des Moines, Iowa and
Columbus, Ohio, or for a few overnight hours, through a third party
service provider.
SPECIALTY INSURANCE
In our specialty insurance segment, we offer commercial coverages
that require specialized product underwriting, claims handling or risk
management services through a distribution channel of retail agents
and wholesale brokers, which may include program administrators
and other specialty sources. Our specialty insurance products are
written through our admitted and non-admitted insurers. Our specialty
insurance segment is organized into the following three units:
Our RED unit markets and underwrites small-to-medium commercial
exposures, offering property and casualty programs for customers
with common risk characteristics or coverage requirements. We may
also offer alternative forms of risk protection that include various forms
of self-insurance or high deductibles, some of which may utilize
captive insurance arrangements or risk retention groups. Coverages
offered by this unit include commercial auto, workers’ compensation,
general liability and property. We use approved external claim
services for claims notification, handling and settlement with
centralized management oversight by our home office team.
Our Rockhill unit markets and underwrites commercial exposures
which have unique insurance requirements, including difficult to place
classes of commercial business which may require customized rates
and forms, along with customized insurance programs for specialty
niche and homogenous groups of exposures. Coverages offered by
this unit may include commercial auto, property, bonds (fidelity and
surety) and general liability. Our Rockhill unit uses a combination of a
dedicated internal claims unit and also approved external claim
services for claims notification, handling and settlement with
centralized management oversight by our home office team.
Our Workers’ Compensation unit serves the small-to-medium account
and association business. This unit has a dedicated internal claims
team emphasizing managed care cost containment strategies
including focusing on the injured employee’s early return to work and
cost-effective quality care.
As of January 1, 2013, our units within the specialty insurance
segment will change from RED, Rockhill and Workers’ Compensation
to Property, Casualty, Workers’ Compensation and Programs.
INVESTMENT OPERATIONS
The primary objectives of our investment strategy are to maintain
adequate liquidity and capital to meet our responsibilities to
policyholders; grow surplus long term to support the growth of our
company; provide a consistent level of income; and manage
investment risk. Our investment portfolio is managed separately from
that of our parent company and its subsidiaries and affiliates, and
investment results are not shared through the Pooling Arrangement,
as described below. Stateco performs investment management
services for both us and our parent company and its subsidiaries and
affiliates. Investment policies and guidelines are 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
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State Auto Financial Corporation
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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 Form 10-K,
“Management’s Discussion and Analysis of Financial Condition and
Results of Operations—Liquidity and Capital Resources—
Reinsurance Arrangements.”
See “Regulation” in this Item 1 for a discussion of the Terrorism Acts.
LOSS RESERVES
We maintain reserves for the eventual payment of losses and LAE for
both reported claims and IBNR. 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 our estimate of the 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
loss reserves currently recorded.
Loss 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 reserves for IBNR claims 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 loss 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
loss reserves, see Item 7 of this Form 10-K, “Management’s
Discussion and Analysis of Financial Condition and Results of
Operations—Loss and LAE.”
The following table sets forth our one-year development information on changes in the loss reserve for the years ended December 31, 2012,
2011 and 2010:
P
A
R
T
I
Year Ended December 31
($ millions)
Beginning of Year:
Loss and loss expenses payable
Less: Reinsurance recoverable on losses and loss expenses payable
Net losses and loss expenses payable(1)
Impact of pooling change, January 1, 2011 and 2010
Provision for losses and loss expenses occurring:
Current year
Prior years(2)
Total
Loss and loss expense payments for claims occurring during:
Current year
Prior years
Total
Impact of pooling change, December 31, 2011
End of Year:
Net losses and loss expenses payable
Add: Reinsurance recoverable on losses and loss expenses payable
2012
2011
2010
$ 907.1
25.5
881.6
-
795.2
(16.9)
778.3
397.2
334.0
731.2
-
928.7
13.5
$ 893.0
18.8
874.2
124.1
1,213.3
(33.3)
1,180.0
724.2
369.1
1,093.3
(203.4)
881.6
25.5
840.2
20.8
819.4
(4.0)
954.2
(64.6)
889.6
543.9
286.9
830.8
-
874.2
18.8
893.0
Losses and loss expenses payable(3)
$ 942.2
$ 907.1
Includes net amounts assumed from affiliates of $376.8 million, $375.8 million, and $346.2 million at beginning of year 2012, 2011, and 2010, respectively.
(1)
(2) 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 “Results of Operations—
Loss and LAE Development.”
Includes net amounts assumed from affiliates of $435.1 million, $376.8 million, and $375.8 million at end of year 2012, 2011, and 2010, respectively.
(3)
The following table sets forth our development of loss reserves from
2002 through 2012. “Net liability for losses and loss expenses payable”
sets forth the estimated liability for unpaid losses and LAE recorded at
the balance sheet date, net of reinsurance recoverable, for each year
shown. This liability represents the estimated amount of losses and
LAE for claims incurred during the current year or incurred during prior
years that are unpaid at the balance sheet date, including IBNR.
The upper section of the table shows the cumulative amounts paid
with respect to the previously reported loss reserve as of the end of
each succeeding year. For example, through December 31, 2012, we
have paid 90.7% of the losses and LAE that had been incurred but not
paid, as estimated at December 31, 2002.
The lower portion of the table shows the current estimate of the
previously reported loss 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 2002 loss reserve has developed $11.9
million or 2.0% redundant through December 31, 2012. This $11.9
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.
State Auto Financial Corporation
9
8596_FinC1.pdf
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, 2004, on claims incurred in 2002 includes
the cumulative redundancy or deficiency for years 2002, 2003 and
2004. 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 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. In 2010, SA National and voluntary
assumed reinsurance from third parties unaffiliated with the Pooled
Companies that was assumed on or after January 1, 2009 by 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. As of
January 1, 2011, the Rockhill Insurers were added to the pool, and
accordingly net assets equal to the increase in net liabilities were
transferred to us from them. As of December 31, 2011, the overall
participation percentage of the STFC Pooled Companies was reduced
from 80% to 65%, and accordingly net assets equal to the decrease in
net liabilities were transferred by us to the Mutual Pooled Companies.
The amount of the assets transferred along with the reserve liabilities
assumed/ceded in, 2005, 2008, 2010 and 2011 has been netted
against and has reduced/increased the cumulative amounts paid for
years prior to, 2005, 2008, 2010 and 2011, respectively.
($ millions)
Net liability for losses and loss
expenses payable
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
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
Cumulative redundancy (deficiency)
Cumulative redundancy (deficiency)
Gross* liability—end of year
Reinsurance recoverable
Net liability—end of year
Gross liability re-estimated—latest
Reinsurance recoverable
re-estimated—latest
Net liability re-estimated— latest
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Years Ended December 31
$592.1
$628.8
$ 655.9
$ 711.3
$ 661.0
$ 647.1
$ 770.0
$ 819.4
$ 874.2
$ 881.6
$ 928.7
41.2% 36.7%
60.8% 53.2%
71.4% 63.3%
77.3% 70.6%
82.3% 74.3%
85.1% 76.0%
86.4% 78.4%
88.4% 79.6%
89.3% 81.3%
90.7%
99.7% 96.5%
100.6% 93.2%
98.8% 91.0%
98.5% 90.6%
98.8% 89.8%
98.4% 89.7%
98.6% 89.7%
98.6% 89.4%
98.1% 89.2%
98.0%
31.6%
48.4%
59.9%
66.1%
69.2%
72.3%
73.8%
75.6%
93.3%
87.6%
86.9%
86.2%
85.5%
85.2%
84.4%
84.2%
34.9%
51.1%
60.9%
66.0%
70.3%
72.7%
74.9%
89.9%
86.4%
85.6%
85.3%
84.7%
84.4%
84.2%
34.9%
50.5%
60.4%
67.8%
71.3%
74.3%
91.7%
90.5%
88.8%
87.4%
86.9%
86.7%
31.7%
49.4%
62.6%
69.1%
73.7%
95.8%
93.7%
91.9%
90.8%
90.2%
34.9%
53.2%
62.7%
68.5%
35.5%
53.2%
63.5%
40.8%
58.2%
37.9%
92.7%
89.5%
87.9%
87.1%
92.1%
89.1%
87.8%
96.2%
94.0%
98.1%
-
-
$ 11.9
$ 68.0
$ 103.5
$ 112.5
$
2.0% 10.8%
15.8%
15.8%
87.9
13.3%
$
63.4
$
9.8%
$
99.3
12.9%
99.9
12.2%
$
52.3
$
16.9
6.0%
1.9%
$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
$1,391.4
$ 517.2
$ 874.2
$1,411.9
$ 530.3
$ 881.6
98.9% 92.3%
88.1%
87.7%
89.6%
93.6%
89.8%
89.7%
97.5%
96.4%
-
-
$1,435.8
$ 507.1
$ 928.7
-
101.0% 98.6%
98.0% 89.2%
95.5%
84.2%
93.9%
84.2%
94.8%
86.7%
99.4%
90.2%
94.6%
87.1%
92.9%
87.8%
103.5%
94.0%
93.7%
98.1%
-
-
*
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 from State Auto
Mutual
Net reinsurance recoverable
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
$270.3
$305.2
$350.5
$399.8
$371.7
$382.8
$428.6
$473.8
$517.2
$530.3
$507.1
$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
$498.4
$ 18.8
$504.8
$ 25.5
$493.6
$ 13.5
December 31
COMPETITION
REGULATION
The property and casualty insurance industry is highly competitive. We
compete with numerous insurance companies, with varying size and
financial resources. We compete in the personal and business insurance
markets based on the following factors: price; product offerings and
innovation; underwriting criteria; quality of service to insureds,
relationships with our retail agents and wholesale brokers; prompt and
fair claims handling and settlement; financial stability; and technology,
making us a preferred business partner. In addition, because most of our
retail agents and wholesale brokers represent more than one insurer, we
face competition within each agency and broker.
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
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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 shareholders. 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,
$62.6 million is available in 2013 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 $20.0 million and $56.4 million in 2012 and 2011,
respectively, from its insurance subsidiaries.
Rates and Related Regulation. Except as discussed below, we are not
aware of the adoption of any adverse legislation or regulation in any
state in which we conducted business during 2012 which would
materially impact our business.
Many 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. In addition, the Fair and Accurate Credit
Transactions Act of 2003 directed certain federal agencies to consider
how the use of credit information may affect the availability and
affordability of property/casualty insurance and whether credit scoring
systems could have a disparate impact on minorities. A 2007 Federal
Trade Commission (“FTC”) report on automobile insurance concluded
that credit-based scoring is an effective predictor of risk, but has little
effect as an indicator of racial or ethnic status of consumers. Despite
these conclusions consumer groups and various government entities
continue to resist the use of credit scoring in the rating a risk selection
process. In 2008, the FTC asked nine of the largest homeowners
insurance companies to provide information to allow the FTC to
analyze how consumer credit data is used in underwriting and rate
setting. The FTC continues to analyze the information and expects to
issue a report in the future. Upon the release of the report the results
of the study could affect future use of credit scoring. Banning or
restricting this practice or data mining would limit our ability, and the
ability of other insurers, to take advantage of the predictive value of
this information.
In an attempt to make capital and surplus requirements more
accurately reflect the underwriting risk of different lines of insurance,
as well as investment risks that attend insurers’ operations, the NAIC
annually tests insurers’ risk-based capital requirements. As of
December 31, 2012, each of the Pooled Companies had adequate
levels of capital as defined by the NAIC with its respective risk-based
capital requirements.
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 successors, the
Terrorism Risk Insurance Extension Act of 2005 and the Terrorism
Risk Insurance Program Reauthorization Act of 2007 (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 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 (terrorism
coverage is mandatory for workers’ compensation). If the policyholder
rejects coverage for certified acts of terrorism, we will cover only such
acts of terrorism that are not certified acts under the Terrorism Acts
and continue to apply policy exclusions that may limit any coverage
from loss due to nuclear, biological or chemical agents. Our current
property reinsurance treaties exclude certified acts of terrorism. The
Terrorism Acts are due to expire in December 2014. It is uncertain
whether the Terrorism Acts will be extended, revised or allowed to
expire. See “Risk Factors-Terrorism” in Item 1A of this Form 10-K.
The Federal Insurance Office was established in 2010 by the enactment
of the Dodd-Frank Act. The Federal Insurance Office is a separate office
within the United States Department of Treasury. The primary objective
of the Federal Insurance Office is to monitor all aspects of the insurance
industry, including identifying issues or gaps in the regulation of insurers
that could contribute to a systemic crisis in the insurance industry or the
United States financial system. The Federal Insurance Office also
coordinates and develops federal policy on prudential aspects of
international insurance matters, including representing the United States
in the International Association of Insurance Supervisors, assists in
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negotiating certain international agreements, monitors access to
affordable insurance by traditionally underserved communities and
consumers, minorities, and low- and moderate-income persons, and
assists in the administration of the terrorism risk insurance program.
However, the Federal Insurance Office has no authority as a regulator or
supervisor of insurance companies.
EMPLOYEES
As of February 25, 2013, we had 2,423 employees. Our employees
are not covered by any collective bargaining agreement. We consider
the relationship with our employees to be 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.
Executive Officers of the Registrant
Name of Executive Officer and
Position(s) with Company
Age(1)
Principal Occupation(s)
During the Past Five Years
An Executive Officer
of the Company Since(2)
Robert P. Restrepo, Jr.,
Chairman, President and
Chief Executive Officer
Steven E. English,
Vice President and
Chief Financial Officer
Joel E. Brown,
Vice President,
Standard Lines
Jessica E. Buss,
Vice President,
Specialty Lines
Clyde H. Fitch, Jr.,
Senior Vice President and
Chief Sales Officer
Stephen P. Hunckler,
Vice President and Chief
Claims Officer
Scott A. Jones,
Vice President and
Chief Investment Officer
Cynthia A. Powell,
Vice President and
Chief Risk Officer
62
52
55
41
62
54
48
52
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.
Vice President of STFC and State Auto Mutual, 5/06 to present;
Chief Financial Officer of STFC and State Auto Mutual, 12/06 to
present.
Vice President, Standard Lines, of STFC and State Auto Mutual,
1/11 to present; Vice President, Personal Lines, and Regional
Vice President of STFC and State Auto Mutual, 1/01 to 1/11.
Vice President, Specialty Lines, of STFC and State Auto Mutual,
1/11 to present; Chief Operating Officer of Rockhill Insurance
Company, 11/08 to 1/11; Chief Financial Officer of Rockhill
Insurance Company, 11/05 to 11/08.
Senior Vice President and Chief Sales Officer of STFC and State
Auto Mutual, 11/07 to present.
Vice President and Chief Claims Officer of STFC and State Auto
Mutual, 8/09 to present; Chief Claims Officer of Balboa
Insurance Group 8/06 to 8/09.
Vice President and Investment Officer of STFC and State Auto
Mutual, 3/12 to present; Assistant Vice President of STFC and
State Auto Mutual, 8/09 to 3/12; Portfolio Manager of STFC and
State Auto Mutual for more than five years prior to 8/09.
Chief Risk Officer of STFC and State Auto Mutual, 6/12 to
present; Vice President of State Auto Mutual, 3/00 to present;
Vice President of STFC, 5/00 to present; Treasurer of STFC and
State Auto Mutual, 6/06 to 6/12.
2006
2006
2011
2011
2007
2011
2012
2000
Lorraine M. Siegworth,
45
Vice President of STFC and State Auto Mutual, 11/06 to present.
2006
Vice President, Chief Strategy and
Organization Effectiveness Officer
James A. Yano,
Vice President, Secretary and
General Counsel
Vice President, Secretary and General Counsel of STFC and
State Auto Mutual, 4/07 to present.
61
2007
(1) Age as of March 8, 2013.
(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.
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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. If any risks or uncertainties discussed below develop
into actual events, then such events could have a material adverse
effect on our business, liquidity, capital resources, financial position or
results of operations. In that case, the market price of our stock could
decline materially. The following list of risk factors is not exhaustive
and others may exist or develop.
RESERVES
If our estimated liability for losses and loss expenses is
incorrect, our loss reserves may be inadequate to cover our
ultimate liability for losses and loss expenses and may have to
be increased.
We establish loss 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. Loss reserves do not represent an exact
calculation of the liability, but instead represent estimates, generally
using actuarial projection techniques at a given accounting date. Our
loss 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
loss 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 loss
reserve estimates in a regular ongoing process as historical loss
experience develops and additional claims are reported and settled.
We record adjustments to loss reserves in the results of operations for
the periods in which the estimates are changed. In establishing loss
reserves, we take into account estimated recoveries for reinsurance,
salvage and subrogation.
Because estimating loss reserves is an inherently uncertain process,
currently established loss reserves may not be adequate. If we
conclude the estimates are incorrect and our loss reserves are
inadequate, we are obligated to increase them. An increase in loss
reserves results in an increase in losses, reducing our net income for
the period in which the deficiency is identified. Accordingly, an
increase in loss 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 us. Such assessments could be material
and may not be recoupable, depending on the applicable state
mechanism.
The magnitude of loss from a catastrophe is a function of the severity
of the event and the total amount of insured exposure in the affected
area. Accordingly, we can sustain significant losses from less severe
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
severe thunderstorms, tornadoes and hail, as well as earthquakes and
hurricanes affecting the United States. 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: in 2012, losses related
to wind and hail activity from a tornado in March, wind and hail activity
in Louisville, Kentucky, and St. Louis, Missouri, in April, and wind
activity from a storm in the Midwest and Mid-Atlantic states in June
resulted in approximately $50.5 million in pre-tax losses; in 2011,
losses arising from a hurricane, tornadoes, and wind and hail storms,
which impacted 32 of our operating states, including Hurricane Irene
and devastating tornadoes in Tuscaloosa, Alabama and Joplin,
Missouri, which resulted in approximately $130.6 million in pre-tax
losses; and in 2010, losses from a series of spring storms, including
wind and hail in northern Ohio, and floods in the Nashville, Tennessee
area, both which affected our auto physical damage results in both
personal and business insurance auto lines, which resulted in
approximately $22.2 million in pre-tax losses.
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. While we use
such modeling information in connection with our pricing and risk
management activities, there are limitations with respect to the models’
usefulness in predicting losses in any reporting period. Such limitations
are evidenced by the occurrence of significant variations in estimates
between models and modelers; material increases or decreases in
model results due to changes and refinements of the underlying data
elements and assumptions; and differences observed between the
results of actual event conditions and modeled expectations. Climate
change, to the extent it affects changes in weather patterns, could
impact the frequency or severity of weather events. Some industry
commentators have expressed concerns that hydraulic fracturing or
“fracking,” a process which involves drilling deep underground wells
and injecting water, chemicals and sand into the rock formations in
order to extract oil and gas, may cause seismic activity which, among
other things, may affect the frequency of earthquakes. We view
fracking as an emerging risk facing the industry.
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Our ongoing catastrophe management efforts could negatively impact
growth to the extent constraints on property exposures are deemed
necessary in certain territories. In addition, due to the potential impact
on cross-selling opportunities, new business growth in the auto lines
could be negatively affected.
risks, which would negatively affect our margins, or we could
overprice risks, which could reduce our premium reserves and
competitiveness. In either event, our operating results, financial
condition and cash flows could be materially adversely affected.
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 adequately 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 predictive modeling or other underwriting tools to assist
with correctly and consistently achieving the intended results in
underwriting and pricing;
• 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 and effectively implement such rate
changes;
• 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 and technological innovations in
automobiles 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; including healthcare
reform cost shifting and other factors;
• unanticipated changes in auto repair costs, auto parts prices and
used car prices;
• impact of inflation and other factors, such as demand surge on cost
of construction materials, labor and other expenditures;
• our ability to monitor and manage 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 underprice
DIVIDENDS
There can be no assurance that we will continue to pay cash
dividends consistent with current or past levels.
We have a history of consistently paying cash dividends to our
shareholders. In the fourth quarter of 2012, the Board of Directors of
State Auto Financial reduced the amount of dividends paid on our
common shares from $0.15 per share to $0.10 per share; 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 may 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.
TECHNOLOGY AND TELECOMMUNICATION SYSTEMS
Our business success and profitability depend, in part, on
effective information technology and telecommunication
systems. 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 and telecommunication
systems for conducting business and processing claims. Our business
success is dependent on maintaining the effectiveness of existing
technology and telecommunication systems and on their continued
development and enhancement to support our business processes
and strategic initiatives in a cost effective manner. We are developing
a new claims system which we expect to implement for most lines of
business during 2013. This initiative has involved a significant
commitment of resources. This new system is expected to add
functionality and increase our claims efficiency with improved file
quality; however, this system may not be implemented within the
planned time frame or budget, and the expected benefits of this
system may not be realized upon implementation.
During 2013, we will begin a multi-year business and technology
transition to consolidate all of our policy administration systems. The
transition is not expected to be complete for several years. For this
initiative, we are partnering with a third party which specializes in
providing core system software to the insurance industry. The new
technology platform is intended to provide us with quicker speed to
market, improve ease of doing business for our policyholders, agents
and brokers, lower our costs for maintenance and product
introductions and provide greater operational efficiency. However,
even with our best planning and efforts and the involvement of third
party expertise, there can be no assurance that the expected benefits
will be realized upon implementation or that the transition will be
completed within the planned time frame or budget.
An ongoing challenge during system development and enhancement
is the effective and efficient utilization of our current technology in
view of a constantly changing technological landscape. There can be
no assurance that the development of current technology for future
use will not result in our being competitively disadvantaged, especially
with those carriers that have greater resources. 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
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replace our key legacy technology and telecommunication systems as
they become obsolete or as emerging technology renders them
competitively inefficient, our competitive position and/or cost structure
could be adversely affected.
BUSINESS CONTINUITY
Our business depends on the uninterrupted operation of our
facilities, systems and business functions, including our
information technology, telecommunications and other business
systems. Our business continuity and disaster recovery plans
may not sufficiently address all contingencies.
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, receiving and processing
payment receipts and processing and paying claims. A shut-down of
or inability to access one or more of our facilities, power outages, a
major failure of the Internet, a pandemic, or a failure of one or more of
our information technology, telecommunications or other systems
could significantly impair our ability to perform such functions on a
timely basis. In addition, because our information technology and
telecommunications systems interface with and depend on third party
systems, we could experience service denials if demand for such
service exceeds capacity, or if our system or a third party system fails
or experiences an interruption. If sustained or repeated, such a
business interruption, systems failure or service denial could result in
a deterioration of our ability to write and process new and renewal
business, provide customer service, receive premium payments, 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 and may cause reputational damage.
We have established a business continuity plan that is designed to
continue our core business operations in the event that normal
business operations cannot be performed due to a catastrophic event.
While we continue to test and assess our business continuity plan to
meet the needs of our core business operations and addresses
multiple business interruption events, there is no assurance that we
will be able to perform our core business operations upon the
occurrence of such an event, which may result in a material adverse
effect on our financial position and results of operations.
CYBER-SECURITY THREATS
Our highly automated and networked organization is subject to
cyber-terrorism and a variety of other cyber-security threats.
These threats come in a variety of forms, such as viruses and
malicious software. Such threats can be difficult to prevent or
detect, and if experienced, could interrupt or damage our
operations, harm our reputation or have a material effect on our
operations.
Our technology and telecommunications systems are highly integrated
and connected with other networks. Cyber-attacks involving these
systems could be carried out remotely and from multiple sources and
could interrupt, damage or otherwise adversely affect the operations
of these critical systems. Cyber-attacks could result in the modification
or theft of data, the distribution of false information or the denial of
service to users. We obtain, utilize and maintain data concerning
individuals and organizations with which we have a business
relationship. Threats to data security can emerge and change in rapid
fashion, resulting in the ongoing need to expend resources to secure
our data in accordance with customer expectations and statutory and
regulatory requirements.
We could be subject to liability if confidential customer information is
misappropriated from our technology systems. Despite the
implementation of security measures, 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 and reputation.
We rely on services and products provided by many vendors. In the
event that one or more of our vendors fails to protect personal
information of our customers, claimants or employees, we may incur
operational impairments, or could be exposed to litigation, compliance
costs or reputational damage.
While we have not experienced material cyber-incidents to date, the
occurrence and effects of cyber-incidents may remain undetected for
an extended period. During 2012, we purchased cyber-liability
insurance coverage. Such coverage addresses certain potential
losses such as liability to others, costs of related crisis management,
data extortion, applicable forensics and certain regulatory defense
costs, fines and penalties.
REINSURANCE
Reinsurance may not be available, collectible or adequate to
protect us against losses, or may cause us to constrain the
amount of business we underwrite in certain lines of business
and locations.
We use reinsurance to help manage our exposure to insurance risks
and to manage our capital. 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.
As described in more detail elsewhere in this Form 10-K, we have
entered into a quota share reinsurance agreement covering our
homeowners line of business. Under this agreement, 75% of our
homeowners premium revenues, losses and ALAE are ceded to third
party reinsurers. The reduction in net written premiums may put
pressure on our expense ratios with respect to underwriting expenses
and ULAE. Consistent with our homeowners profitability plans, we
expect to constrain homeowners policy count growth in certain states
with geographic concentrations and/or unsatisfactory underwriting
results.
CYCLICAL NATURE OF THE INDUSTRY
The property and casualty insurance industry is highly cyclical,
which may cause fluctuations in our operating results.
The property and casualty insurance industry, particularly business
insurance, has been historically characterized by periods of intense
price competition due to excess underwriting capacity, as well as
periods of shortages of underwriting capacity that result in higher
prices and more restrictive contract and/or coverage terms. The
periods of intense price competition may adversely affect our
operating results, and the overall cyclicality of the industry may cause
fluctuations in our operating results. While we may adjust prices
during periods of intense competition, it remains our strategy to allow
for acceptable profit levels and to decline coverage in situations where
pricing or risk would not result in acceptable returns. Accordingly, our
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commercial and specialty lines of business tend to contract during
periods of severe competition and price declines and expand when
market pricing allows an acceptable return. This can cause volatility in
our premium revenues. Our specialty insurance segment markets and
underwrites commercial exposures through wholesale brokers,
program administrators and other specialty sources. The reaction of
these distribution channels to price competition may result in the
movement of business and volatility of premium revenues.
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. We 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
Economic conditions may adversely affect our business.
The current challenging national and global economy, as well as
negative economic conditions in the future, may adversely impact our
business and results of operations. While the volatility of the economic
climate makes it difficult for us to predict the overall impact of
economic conditions on our business and results of operations, our
business may be impacted in a variety of ways.
Negative economic conditions may cause 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. High levels of unemployment have a tendency to cause the
number of workers’ compensation claims to increase, as laid-off and
unemployed workers may seek workers’ compensation benefits to
replace their lost healthcare 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. Economic
strains on states and municipalities could result in downgrades or
defaults or certain municipal obligations.
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 response to economic conditions, the United States federal
government and other governmental and regulatory bodies have
taken action and may take 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.
In addition, government 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 experienced 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.
DISTRIBUTION SYSTEM
Our retail agents, who are part of the independent agency
distribution channel, are our sole distribution channel for our
personal and business insurance segments. Our exclusive use of
this distribution channel 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 in our personal and business
insurance segments exclusively through independent, non-exclusive
insurance agents and brokers, 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. Throughout its history, the State Auto Group
has supported the independent agency system as our distribution
channel. 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 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 retail 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 retail
agents and to persuade them to promote and sell our products, we
may not be successful in executing these efforts. If we are
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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 primary 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 shareholders and other
investors, and relates to authorization for lines of business, capital and
surplus requirements, investment limitations, underwriting limitations,
transactions with affiliates, dividend limitations (see “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.
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.
The Risk Management and Own Risk Solvency Assessment Model
Act (ORSA) calls for insurers to manage a comprehensive enterprise
risk management framework that is embedded within company
operations by January 2015. Overall, the ORSA is essentially an
internal assessment of the risks associated with an insurer’s business
and the sufficiency of capital resources to support those risks. Each
insurer’s ORSA process will be unique, reflecting its business,
strategy and approach to enterprise risk management. An ORSA
Summary Report, supported by internal risk management materials,
will be filed with state regulators. We are in the process of working
toward timely compliance with the ORSA guidelines and
requirements.
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 us to possible assessments, some of which
could be material to our results of operations. The potential availability
of 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 have considered 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. In February
2013, the Department of Housing and Urban Development finalized a
federal regulation introducing disparate- impact criteria to the sale of
homeowners insurance. Such regulation may have a negative effect
on our underwriting and pricing of homeowners insurance, as it puts in
jeopardy the use of longstanding, sound actuarial factors. We are
monitoring the impact of this recent legislation.
The Federal Insurance Office was established in 2010 by the
enactment of the Dodd-Frank Act. The Federal Insurance Office is a
separate office within the United States Department of Treasury. The
primary objective of the Federal Insurance Office is to monitor all
aspects of the insurance industry. The Federal Insurance Office also
coordinates and develops federal policy on prudential aspects of
international insurance matters, including representing the United
States in the International Association of Insurance Supervisors,
assists in negotiating certain international agreements, monitors
access to affordable insurance by traditionally underserved
communities and consumers, minorities, and low- and moderate-
income persons, and assists in the administration of the terrorism risk
insurance program. However, the Federal Insurance Office lacks
regulatory authority, and it is not clear how this federal office will
coordinate and interact with the NAIC or state insurance regulators.
Although we do not write health insurance, rules affecting health care
services can affect other insurance that we write, including workers’
compensation and commercial and personal automobile and liability
insurance. The enactment of the Patient Protection and Affordable
Care Act of 2010 (the “Healthcare Act”) and additional health care
reform legislation may have an impact on various aspects of our
business. In addition, we may be impacted as a business enterprise
by potential tax issues and changes in employee benefits. We will
continue to monitor and assess the impact of health care legislation or
regulations, or changing interpretations, at the federal or state levels.
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.
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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 United States
federal, state and local governments. Tax legislative initiatives by
these governmental bodies, including actions by departments of
insurance, taxing authorities and other state and local agencies, to
change the current tax structure or to increase taxes, assessments
and other revenue-generating fees may increase the cost of doing
business in those states.
For example, in February 2013, the Governor of Ohio issued a
proposed budget for Ohio for the 2014-2015 biennium known as House
Bill 59 (“HB 59”). Among other things, HB 59 proposes to broaden
Ohio’s sales tax base to provide for the taxation of nearly all services
and transfers of intangible property. HB 59 exempts certain services
considered to be necessities, which includes consumer insurance
transactions. However, insurance, financial and other services that we
receive or provide may be subject to sales tax. HB 59 does not provide
an exemption for services provided by affiliates. At this time, HB 59 is
only proposed and must proceed through an extensive legislative
process before it is approved and becomes law, and it may
dramatically change as it proceeds through this process.
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, United States 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.
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.
We have seen instances of political pressure exerted to force or
persuade insurers to provide extra-contractual coverage, such as
foregoing the use of deductibles. Such situations may, to some
degree, threaten the sanctity of the insurance contract.
There is also a growing trend of plaintiffs targeting property and
casualty insurers, including us, in putative 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 affect 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.
LITIGATION
We may suffer losses from litigation, which could materially and
adversely affect our operating results or cash flows and financial
condition.
As is typical in our industry, we face risks associated with litigation of
various types, including disputes relating to insurance claims under
our policies, as well as other general commercial and corporate
litigation. Litigation is subject to inherent uncertainties and in the event
of an unfavorable outcome in one or more litigation matters, the
ultimate liability may be in excess of amounts currently reserved and
may be material to our operating results or cash flows for a particular
quarter or annual period and to our financial condition.
TERRORISM
Terrorist attacks, and the threat of terrorist attacks, and ensuing
events could have an adverse effect on us.
Terrorism, both within the United States and abroad, and military and
other actions and heightened security measures in response to these
types of threats, may cause loss of life, property damage, reduced
economic activity, and additional disruptions to commerce. Actual
terrorist attacks could cause losses from insurance claims related to
the property and casualty insurance operations of the State Auto
Group, as well as a decrease in our stockholders’ equity, net income
and/or revenue.
The Terrorism Acts require the federal government and the insurance
industry to share the risk of insured losses on future acts of terrorism
that are certified by the U.S. Secretary of the Treasury. In connection
with the commercial insurance business we write, we are required to
participate. Under the Terrorism Acts, terrorism coverage is
mandatory for all primary workers compensation policies. Insureds
with non-workers compensation commercial policies, however, have
the option to accept or decline our terrorism coverage. In 2012, over
90% of our commercial lines non-workers compensation policyholders
purchased terrorism coverage. Under the Terrorism Acts, each
participating insurer is responsible for paying a deductible of specified
losses before federal assistance is available. This deductible is based
on 20% of the prior year’s applicable commercial lines premiums. For
losses above the deductible, the federal government will pay 85%, up
to an industry limit of $100 billion, and the insurer retains 15%.
Although the Terrorism Acts’ provisions will mitigate our exposure to a
large-scale terrorist attack, our deductible is substantial and losses
could have a material adverse effect on our results of operations,
financial condition and liquidity.
In December 2007, the United States Congress extended the
Terrorism Acts through December 31, 2014, and made some modest
changes to the Terrorism Acts. See “Regulation” in this Item 1 for a
discussion of the Terrorism Acts. It is uncertain beyond December 31,
2014 whether the Terrorism Acts will be renewed, revised or
terminated.
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
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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.
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, credit risk,
concentration risk, liquidity 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.
Continuation of the current low interest rate environment puts
downward pressure on investment income. 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. For example, budget strains on certain
states and local governments could negatively affect the credit quality
and ratings of their issued securities.
Our fixed income portfolio includes certain securities with call features
permitting them to be redeemed by the issuers prior to stated
maturity. Reinvestment risk exists with such securities as it may not
be possible to reinvest the proceeds from the called securities at
equivalent yields.
If the fixed income or equity portfolios, or both, were to be impaired by
market, sector or issuer-specific conditions to a substantial degree,
our liquidity, financial position and financial results could be materially
adversely affected. Under these circumstances, our income from
these investments could be materially reduced, and declines in the
value of certain securities could further reduce our reported earnings
and capital levels. A decrease in value of our investment portfolio
could also put our insurance subsidiaries at risk of failing to satisfy
regulatory minimum capital requirements. If we were not at that time
able to supplement our subsidiaries’ capital from STFC or by issuing
debt or equity securities on acceptable terms, our business could be
materially adversely affected. Also, a decline in market rates of fixed
income securities or a decline in the fair value of equity securities
could cause the investments in our pension plans to decrease,
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
significant portion 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.
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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. Talent management is a key consideration in our
specialty insurance segment, which requires specialized product
underwriting, claims handling and risk management services and
involves distribution through channels other than our retail agents.
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.
CREDIT AND FINANCIAL STRENGTH RATINGS
A downgrade in our financial strength ratings may negatively
affect our business and a downgrade in our credit rating could
negatively affect the cost and availability of debt financing.
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. The State Auto Group’s current financial
strength rating from A.M. Best is A (Excellent) with a stable outlook.
The State Auto Group’s current financial strength rating from Moody’s
is A3 with a negative outlook and from Standard & Poor’s BBB+ with a
negative outlook.
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. The State
Auto Group’s current credit rating from A.M. Best is bbb with a stable
outlook. The State Auto Group’s current credit ratings from Moody’s is
Baa3 with a negative outlook and from Standard & Poor’s BB+ with a
negative outlook.
Based on future results and developments, we may not be able to
maintain our current 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, 2012, our parent company owned approximately
62% 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
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shareholders 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 shareholders.
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 brands
supported by extensive media advertising. Many of our competitors
have 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, producer relationships, reputation and name or brand
recognition. Market developments such as usage-based auto
insurance could potentially result in reduced market share or adverse
selection. The growth in mobile communications and the prominence
of social media as a source of information for consumers are recent
examples of significant developments in the marketplace which may
adversely affect our competitive position. Social media, for example,
could be potentially utilized in a manner which negatively affects our
reputation with current or prospective policyholders and agents.
Our competitors sell through various distribution channels, including
independent agents, captive agents and directly to the consumer. We
compete not only for personal and business insurance customers, but
also for independent agents and brokers to market and sell our
products. Our specialty insurance segment faces competitors
attempting to sell their products through the distribution system of
wholesale brokers, program administrators and other specialty
sources. 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.
VOLATILITY OF OUR COMMON STOCK
The price of our common stock could be volatile.
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 limited to, the following: volatility and 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.
CHANGES IN ACCOUNTING STANDARDS
Changes in accounting standards issued by the FASB or other
standard-setting bodies may adversely affect our results of
operations and financial condition.
Our financial statements are prepared in accordance with GAAP.
FASB, AICPA and other accounting standard-setting bodies may
periodically issue changes to, interpretations of or guidance with
respect to GAAP. The adoption of such guidance may have an
adverse effect on our results of operations and financial position. See
Note 1 to our consolidated financial statements included in Item 8 of
this Form 10-K regarding adoption of recent accounting
pronouncements, such as our adoption, effective January 1, 2012, of
the updated guidance regarding the accounting for costs associated
with acquiring or renewing insurance contracts.
ACQUISITIONS
Acquisitions subject us to a number of financial and operational
risks.
Since going public in 1991, we and State Auto Mutual have acquired
or affiliated with other insurance companies, most recently the 2009
acquisition of the Rockhill Insurance Group by State Auto Mutual. It is
possible 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, such as the addition of the Rockhill Insurers in 2011.
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.
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 involved in numerous lawsuits arising in the ordinary course of
our business operations arising out of or otherwise related to our
insurance policies. Certain of these lawsuits allege extra-contractual
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damages. These lawsuits are in various stages of development. We
generally contest these matters vigorously but may pursue settlement
if appropriate. We consider all such litigation in establishing our loss
and loss adjustment expense reserves. Based on currently available
information, we do not believe it is reasonably possible that any such
lawsuit or related lawsuits will be material to our results of operations
or have a material adverse effect on our consolidated financial or cash
flow position.
Additionally, from time to time we may be involved in lawsuits arising
in the ordinary course of business but not arising out of or otherwise
related to our insurance policies. Based on currently available
information, we do not believe it is reasonably possible that any such
lawsuit or related lawsuits will be material to our results of operations
or have a material adverse effect on our consolidated financial or cash
flow position.
We accrue for a litigation-related liability when it is probable that such
a liability has been incurred and the amount can be reasonably
estimated. Based on currently available information known to us, we
believe that our reserves for litigation-related liabilities are
reasonable. Given the inherent uncertainty surrounding the ultimate
resolution of these legal proceedings, an adverse outcome could have
a material impact to our results of operations in a future period, though
in the opinion of management, none would likely have a material
adverse effect on our consolidated financial or cash flow position.
Additionally, we may be impacted by adverse regulatory actions and
adverse court decisions where insurance coverages are expanded
beyond the scope originally contemplated in our insurance policies.
We believe that the effects, if any, of such regulatory actions and
published court decisions are not likely to have a material adverse
effect on our financial or cash flow position.
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Item 4. Mine Safety Disclosures
None.
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State Auto Financial Corporation
21
PART II
Item 5. Market for the Registrant’s Common Equity,
Related Shareholder Matters, and Issuer
Purchases of Equity Securities
MARKET INFORMATION; HOLDERS OF RECORD
Our common shares are traded on the NASDAQ Global Select Market
under the symbol STFC. As of February 25, 2013, there were 1,233
shareholders 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
sets forth 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:
2012
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
2011
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
High
$ 16.00
14.79
16.91
16.88
High
$ 18.35
18.28
18.00
14.06
Low
Dividend
$ 12.21
12.82
12.49
13.93
$ 0.15
0.15
0.15
0.10
Low
Dividend
$ 14.90
15.16
11.83
10.09
$ 0.15
0.15
0.15
0.15
(1) Adjusted for stock splits.
On March 1, 2013, the Board of Directors of State Auto Financial
declared a cash dividend of $0.10 per share. The dividend is payable
on March 29, 2013, to shareholders of record on March 13, 2013.
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.
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Performance Graph
The line graph below compares the total return on $100.00 invested on December 31, 2007, 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
2007
2008
2009
2010
2011
2012
STFC
NASDAQ Index
NASDAQ Ins. Index
STFC
NASDAQ Index
NASDAQ Ins. Index
12/31/2007
12/31/2008
12/31/2009
12/31/2010
12/31/2011
12/31/2012
100.00
100.00
100.00
116.58
60.20
90.43
74.32
87.51
93.45
72.59
103.39
110.39
59.04
102.57
116.63
67.39
120.67
136.15
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Item 6. Selected Consolidated Financial Data
(dollars and shares in millions, except per share data)
2012
Year ended December 31
2011*
As Adjusted**
2010*
As Adjusted**
2009
As Adjusted**
2008*
As Adjusted**
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)
Balance Sheet Data— GAAP Basis:
Total investments
Total assets
Total notes payable
Total stockholders’ equity
Common shares outstanding
Return on average equity
Debt to capital ratio
Per Common Share Data— GAAP Basis:
Basic EPS
Diluted EPS
Cash dividends per share
Book value per share
Common Share Price:
High
Low
Close at December 31
Close price to book value per share
GAAP Ratios:
Loss and LAE ratio
Expense ratio
Combined ratio
Statutory Ratios:
Loss and LAE ratio
Expense ratio
Combined ratio
Net premiums written to surplus
$1,042.1
$
75.4
$1,150.1
10.7
$
(27.1)%
3.5%
$2,268.4
$2,477.8
$ 115.9
$ 737.2
40.5
1.5
13.6
0.26
$
0.27
$
$
0.55
$ 18.22
$ 16.91
$ 12.21
$ 14.94
0.82
74.7%
33.2%
107.9%
74.8%
33.6%
108.4%
1.7
$1,428.8
$
85.4
$1,553.7
$ (160.7)
13.6
3.6
$2,229.9
$2,764.4
$ 116.4
$ 723.8
40.3
(20.7)
13.9
$ (4.00)
$ (4.00)
$
0.60
$ 17.95
$ 18.35
$ 10.09
$ 13.59
0.76
$1,257.2
$
80.8
$1,355.1
24.4
$
6.9
3.6
$2,307.1
$2,701.4
$ 116.8
$ 831.2
40.1
2.9
12.3
0.61
$
0.61
$
$
0.60
$ 20.71
$ 20.38
$ 13.40
$ 17.42
0.84
$1,176.5
$
82.1
$1,256.9
9.3
$
4.5
3.9
$2,179.1
$2,544.0
$ 117.2
$ 828.9
39.8
1.2
12.4
0.23
$
0.23
$
$
0.60
$ 20.81
$ 30.25
$ 14.29
$ 18.50
0.89
$1,126.0
$
87.4
$1,181.9
$ (32.9)
11.3
4.1
$1,941.3
$2,422.7
$ 117.6
$ 740.1
39.5
(4.0)
13.7
$ (0.83)
$ (0.83)
$
0.60
$ 18.70
$ 37.08
$ 17.38
$ 30.06
1.61
82.6%
33.9%
116.5%
82.4%
33.9%
116.3%
2.1
70.8%
33.8%
104.6%
70.3%
32.9%
103.2%
1.7
71.7%
34.2%
105.9%
71.3%
33.5%
104.8%
1.5
75.2%
34.9%
110.1%
74.8%
33.1%
107.9%
1.6
Invested assets include investments and cash equivalents.
Reflects changes in Pooling Arrangement, effective December 31, 2011, January 1, 2011, 2010 and 2008.
(1)
*
** As previously reported, we adopted with retrospective application at January 1, 2012 Accounting Standards Update 2010-26, “Accounting for Costs Associated
with Acquiring and Renewing Insurance Contracts.” All applicable prior period amounts have been adjusted to conform to current period presentation. See
“Critical Accounting Policies-Deferred Acquisition Costs” included in Item 7 of this Form 10-K.
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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 our
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. The State Auto Group
markets its insurance products throughout the United States primarily
through independent agencies, which include retail agencies and
brokers. Our Pooled Companies are rated A (Excellent) by A.M. Best.
State Auto Financial’s principal subsidiaries are State Auto P&C,
Milbank and SA Ohio, each of which is a property and casualty
insurance company, and Stateco, which provides investment
management services to affiliated insurance companies.
Since January 1, 2011, our reportable insurance segments have been
personal insurance, business insurance and specialty insurance.
These insurance segments are aligned with the reporting lines to our
principal operating decision makers. Investment operations is also a
reportable segment. As of January 1, 2013, our units within the
specialty insurance segment will change from RED, Rockhill and
Workers’ Compensation to Property, Casualty, Workers’
Compensation and Programs. See “Personal and Business
Insurance” and “Specialty Insurance” in Item 1 of this Form 10-K for
more information about our insurance segments.
We evaluate the performance of our insurance segments using
industry financial measurements determined under SAP and certain
measures determined under GAAP. We evaluate our investment
operations segment based on investment returns of assets managed.
Financial information about our segments for 2012 is set forth in this
Item 7 and in Note 14 to our consolidated financial statements
included in Item 8 of this Form 10-K. Prior period segment information
has been restated to conform to current period presentation.
EXECUTIVE SUMMARY
To deliver operating and financial results, we focus on our insurance
segments — personal insurance, business insurance and specialty
insurance, along with our investments operations segment. Underlying
these segments are performance disciplines that we believe are
critical to our success: underwriting profitability, risk management and
capital management.
Underwriting Profitability
While our goal is to consistently produce an underwriting profit, our
combined ratio has exceeded 100% for the last five years. This result
has largely been due to catastrophe and other weather-related losses
in our property lines of business. Significant efforts are being directed
toward returning to prior levels of underwriting profitability.
It is critical that we return our homeowners book of business to
underwriting profitability, as it is our second largest line of business
after personal auto. A multi-year effort to implement solutions includes
an aggressive insurance to value program that audits policy coverage
against the actual value of the property. We have also implemented
separate, mandatory wind and hail deductibles for properties in select
catastrophe prone states and by-peril rating for homeowners in the
majority of our states. By-peril rating calculates a separate premium
component for each peril and allows us to price more effectively for
weather risks, which is the leading cause of homeowners’ losses. Our
claim handling has become more specialized with the addition of
dedicated large and small property claim handlers and the formation of
a catastrophe claim team, lessening our dependency on independent
adjusters. We’re also continuing our efforts to diversify geographically.
Finally, we continue to aggressively address our rate needs in
homeowners, where we expect to achieve rate adequacy during 2013.
Pricing the property and casualty insurance product has become a
sophisticated science. To that end, we have made significant
investment in our actuarial and financial teams, adding depth and
talent to these important functions. We have also enhanced our
product management discipline, which uses objective analysis of
company results, competitor results and marketplace dynamics to
develop, monitor and communicate state strategies. Through product
management, we are attempting to capitalize on pricing segmentation,
risk selection, portfolio mix and competitive position to optimize profit
and growth. We are dedicated to cost-based pricing, with each line of
business priced to generate a profit.
We believe changes in our claim organization have positively
impacted claims efficiency, improved service and reduced costs. We
have reduced salvage yard vendor fees through negotiation with
vendors. A new auto physical damage unit has significantly reduced
independent adjuster expenses and improved claims file
administration on auto physical damage claims, while expansion of
our house counsel operation not only contributes to lower claim
expenses, but improves service. We believe that our claim
performance has been enhanced by our restructuring and business
process improvement efforts, and the claim organization will continue
to be a significant contributor to improving our ex-catastrophe loss and
expense ratio performance.
Risk Management
The focus of our enterprise risk management practices are to identify,
assess, manage and monitor the frequency and severity of all
potential risks. Numerous risks have been identified and are being
managed, including a variety of underwriting, operational, market,
credit and strategic risks. All of our business units play important roles
in risk identification and in the development and execution of risk
management strategies.
Catastrophes have been the onerous variable in our profitability
formula in recent years. We are committed to geographic diversity,
which means reducing our property risk concentrations in certain
geographic regions while at the same time expanding into new states
with new relationships. We believe geographic diversity is a classic
but effective way to spread risk and reduce volatility.
We strengthened our risk management capability in 2012 through the
appointment of a new chief risk officer who reports directly to our
CEO. Through this position, we will sharpen our ability to
operationalize and integrate risk management capabilities into our
capital management, product development, pricing, claims and
service capabilities.
Capital Management
Our number one goal remains to earn an appropriate risk adjusted
return for our shareholders while growing book value. Unprecedented
catastrophe losses in 2011, for both us and the insurance industry,
impacted our underwriting results and capital levels. In response, we
implemented several actions at the end of 2011 to strengthen capital,
improve our risk profile and begin restoring book value.
In addition to the HO QS Arrangement discussed elsewhere, members
of the State Auto Group pay a portion of the premiums received to
reinsurers in exchange for reinsuring a portion of our exposures.
Reinsurance reduces our net liability on individual risks or for individual
loss occurrences, including catastrophic losses. 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, based on
management’s best estimate at a given point in time. Although
management uses many resources to calculate reserves, there is not a
precise method for determining the ultimate liability. Our objective is to
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set reserves that will reasonably approximate the ultimate liability for
insured losses and loss expenses. We regularly review and adjust loss
reserves as appropriate.
comprehensive income (loss). Future increases or decreases in fair
value, if not other-than-temporary, are included in other
comprehensive income (loss).
Our investment operations segment maintains a disciplined
investment strategy by owning a well-diversified portfolio of
investment grade fixed income securities and equity securities. We
manage all of our fixed income securities internally. We manage our
U.S. large-cap equity portfolio internally and utilize outside managers
for our U.S. small-cap equities and international equity funds. We
believe that over the long term this diversified portfolio will provide us
with the best income and growth possibilities while protecting principal
and providing adequate liquidity to support our business operations.
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.
We regularly monitor our investment portfolio for declines in value that
are other-than-temporarily 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
other comprehensive income (loss).
We also consider the following factors when assessing our fixed
maturity 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 other
Deferred Acquisition Costs
As of January 1, 2012, we adopted retrospectively the FASB guidance
Accounting for Costs Associated with Acquiring or Renewing
Insurance Contracts. See “New Accounting Standards – Adoption of
Accounting Pronouncements — Accounting for Costs Associated with
Acquiring or Renewing Insurance Contracts” included in this Item 7
and in Note 1 of our consolidated financial statements included in
Item 8 of this Form 10-K for the impact of this adoption at January 1,
2010. The cumulative effect of this retrospective adoption of this
guidance reduced stockholders’ equity by $20.5 million, after-tax, at
January 1, 2010. All applicable prior period amounts have been
adjusted to conform to current period presentation. Acquisition costs,
consisting of commissions, premium taxes and certain underwriting
expenses related to the successful acquisition of acquiring or
renewing 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 premiums 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 acquisition costs.
Losses and Loss Expenses Payable
Our loss reserves reflect all unpaid amounts for claims that have been
reported, as well as for IBNR claims. Our loss reserves are not
discounted to present value.
Loss reserves 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. Loss reserves at the individual claim level are established on
either a case reserve basis or formula reserve basis depending on the
type and circumstances of the loss. The 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 changes caused by inflation. Case reserves and formula 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 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 determination of ultimate losses 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 reserves represent an estimate at a given point in time
based on many variables including historical and statistical
information, inflation, 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 reserves, there is no single method for determining
the exact ultimate liability.
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
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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 our loss reserves.
We use a number of different methodologies to estimate the IBNR
component of our loss reserves. Our loss reserves include amounts
related to short tail and long tail lines of business. “Tail” refers to the
time period between the occurrence of a loss and the settlement of
the claim. In general, the longer the time span between the incidence
of a loss and the settlement of the claim, the more the ultimate
settlement amount can vary. The reserving methods and strengths
and weaknesses of each are described below.
Short-Tail Business: For short-tail business, claims are typically
settled within five years, and the most common actuarial estimates are
based on techniques using link ratio projections of incurred losses,
paid losses, claim counts and claim severities. Each of these methods
is described below in detail. Separate projections are made for
catastrophes that are in the very early stages of development based
on specific information known through the reporting date.
Incurred Loss Development Method: The Incurred Loss
Development Method is probably the most common actuarial method
used in projecting indicated IBNR reserves. This method uses paid
loss experience as well as the outstanding estimates (formula and
case reserves) for claims that have been reported and are still open.
The underlying assumption of the Incurred Loss Development Method
is that case reserve adequacy remains consistent over time. This
method’s advantage is its responsiveness to changes in reported
losses, which is particularly valuable in the less mature accident
years. The disadvantage of the Incurred Loss Development Method is
that case reserve adequacy changes will distort the IBNR projections.
Paid Loss Development Method: The Paid Loss Development
Method uses calculations that are very similar to the Incurred Loss
Development Method. The key difference is that the data used in the
paid method exclude case reserve estimates, so only paid losses are
utilized. With this method, a payment pattern is estimated to project
ultimate settlement values for each accident year, with the underlying
assumption that claims are settled at a consistent rate over time.
Neither case reserves nor the rate at which claims are reported
(except to the extent that the reporting pattern influences the payment
pattern) is relevant to the results of this method. This method’s
advantage is the estimates of ultimate loss are independent of case
reserve adequacy and are unaffected by company changes in case
reserving philosophy. The disadvantages are that the paid method
does not use all of the available information, and in some cases the
liability payment patterns require the application of very large
development factors to relatively small payments in less mature
accident years.
Claim Counts and Severities Method: The Counts and Severities
Method calculations are very similar to the other methods. The
incurred claim counts reported to date are projected to an ultimate
number. Similarly, the incurred loss severities are projected to an
ultimate value. The ultimate incurred count is multiplied by the 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: For long-tail business, a material portion of
claims may not be settled within five years. 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 may 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 premiums, 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 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 loss
reserve projections. The primary determinant in estimating the loss
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 the STFC
Pooled Companies’ share of the Pooled Companies’ reserves at
December 31, 2012, was $932.2 million, within an estimated range of
$817.9 million to $968.6 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.)
The potential impact of the loss 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, $968.6 million, the
reserve increase of $36.4 million corresponds to an after-tax decrease
of $23.7 million in net income, assuming a tax rate of 35%. Likewise,
should ultimate losses decline to a level corresponding to the low
point of the range, $817.9 million, the $114.3 million reserve decrease
would add $74.3 million of after-tax net income. The loss reserve
range noted above represents a range of reasonably likely reserves,
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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 loss 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, 2012, 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 $100.8 million on reserves, or a $65.5 million reduction
to net income, assuming a tax rate of 35%. Inflation changes have
much more impact on the longer tail commercial lines like other &
product liability and workers’ compensation, and much less impact on
the shorter tail personal lines’ reserves.
In addition to establishing loss reserves, as described above, we
establish reserves for ULAE. Historical patterns of paid ULAE relative to
paid loss are analyzed along with historical claim counts including claims
opened, claims closed, and claims remaining open. The product of this
analysis is an estimate of the relationship, or ratio, between ULAE and
loss underlying the current loss reserves. This ratio is applied to the
current outstanding loss reserves to estimate the required ULAE reserve.
Consequently, this component of the loss expense reserve has a
proportional relationship to the overall claim inventory and held loss
reserves. The method assumes that the underlying claims process and
mix of business do not change materially over time.
The following table sets forth a reconciliation of MBE of our direct loss
and ALAE reserve to our net loss and loss expenses payable at
December 31, 2012 and 2011. The STFC Pooled Companies net
additional share of transactions assumed from State Auto Mutual
through the Pooling Arrangement for the years ended December 31,
2012 and 2011, respectively, has been reflected in the table below as
assumed by STFC Pooled Companies.
($ millions)
Direct loss and ALAE reserve:
STFC Pooled Companies
Assumed by STFC Pooled Companies
Total direct loss and ALAE reserve
Direct ULAE reserve:
STFC Pooled Companies
Assumed by STFC Pooled Companies
Total direct ULAE reserve
Direct salvage and subrogation recoverable:
STFC Pooled Companies
Assumed by STFC Pooled Companies
Total direct salvage and subrogation recoverable
Reinsurance recoverable
Assumed reinsurance
Reinsurance assumed by STFC Pooled Companies
2012
2011
$494.7
437.5
932.2
28.3
18.8
47.1
(23.6)
(2.1)
(25.7)
(13.5)
7.7
(19.1)
510.0
421.1
931.1
28.6
17.1
45.7
(20.9)
(4.6)
(25.5)
(25.5)
12.6
(56.8)
Total losses and loss expenses payable, net of reinsurance recoverable on losses and loss expenses
payable of $13.5 and $25.5 in 2012 and 2011, respectively
$928.7
881.6
The following tables set forth the loss and loss expenses payable by major line of business at December 31, 2012 and 2011:
December 31, 2012
($ millions)
Personal insurance segment:
Personal auto
Homeowners
Other personal
Total personal
Business insurance segment:
Commercial auto
Commercial multi-peril
Fire & allied lines
Other & product liability
Other commercial
Total business
Specialty insurance segment:
Total specialty
Total losses and loss expenses payable net of reinsurance recoverable on losses and loss
expenses payable
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Ending
Loss &
ALAE
Case &
Formula
Ending
Loss &
ALAE
IBNR
Ending
ULAE
Bulk
Total
Reserves
$126.4
22.1
7.8
156.3
38.2
38.6
18.6
53.1
2.0
49.9
10.3
2.3
62.5
35.5
37.2
2.3
91.4
0.8
150.5
167.2
9.8
2.2
0.2
12.2
3.7
4.6
0.6
15.1
0.1
24.1
186.1
34.6
10.3
231.0
77.4
80.4
21.5
159.6
2.9
341.8
150.4
194.2
11.3
355.9
$457.2
423.9
47.6
928.7
December 31, 2011
($ millions)
Personal insurance segment:
Personal auto
Homeowners
Other personal
Total personal
Business insurance segment:
Commercial auto
Commercial multi-peril
Fire & allied lines
Other & product liability
Other commercial
Total business
Specialty insurance segment:
Total specialty
Total losses and loss expenses payable net of reinsurance recoverable on losses and loss
Ending
Loss &
ALAE
Case &
Formula
Ending
Loss &
ALAE
IBNR
Ending
ULAE
Bulk
Total
Reserves
$133.9
47.1
7.9
188.9
38.5
32.6
21.4
58.5
2.5
52.3
22.2
3.0
77.5
34.8
36.7
2.2
85.3
1.0
153.5
160.0
9.7
2.6
0.3
12.6
3.6
4.2
0.7
14.8
0.1
23.4
195.9
71.9
11.2
279.0
76.9
73.5
24.3
158.6
3.6
336.9
104.4
151.6
9.7
265.7
$446.8
389.1
45.7
881.6
expenses payable
See discussion in “Results of Operations—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. 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.
Asbestos reserves are $1.4 million, and environmental reserves are
$7.0 million, for a total of $8.4 million, or 0.9% of net losses and loss
expenses payable. Asbestos reserves increased $0.2 million and
environmental reserves decreased $0.8 million from 2011.
Pension and Postretirement Benefit Obligations
Pension and postretirement benefit obligations are long-term in nature
and require management’s judgment in estimating the factors used to
determine these amounts. We review these factors annually, including
the discount rate and expected long-term rate of return on plan assets.
Because these obligations are based on estimates which could
change, the ultimate benefit obligation could be different from the
amount estimated.
The State Auto Group has a defined benefit pension plan covering
substantially all employees hired prior to January 1, 2010 and a
postretirement healthcare plan covering certain associates and
retirees (collectively “the benefit plans”). Several factors, which
attempt to anticipate future events, are used in calculating the
expense and liability related to the benefit plans. Key factors include
assumptions about the expected rates of return on plan assets,
discount rates, and health care cost trend rates. We consider market
conditions, including changes in investment returns and interest rates,
in making these assumptions. The actuarial assumptions used by us
($ millions)
Benefit obligation
Net periodic benefit cost (benefit)
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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.
To calculate the State Auto Group’s December 31, 2012 benefit
obligation for each of the benefit plans, we used a discount rate of
4.05% 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,
2012 and net periodic benefit cost for the year ended December 31,
2013, a discount rate of 4.05% and an expected long-term rate of
return on plan assets of 7.50% 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 a significant effect on the amounts related to our
benefit obligations and net periodic benefit cost depending on the
degree of change between reporting periods.
The following table sets forth an illustration of variability with respect
to the discount rate on our share of the State Auto Group’s
December 31, 2012 benefit obligation and expected net periodic
benefit cost for the year ending December 31, 2013, along with the
variability of the expected return on plan assets to our expected net
periodic benefit cost for the year ending December 31, 2013. Holding
all other assumptions constant, sensitivity to changes in any one of
our key assumptions are as follows:
Pension
Discount rate
Postretirement
Discount rate
-0.25% 4.05% +0.25%
-0.25% 4.05%
$255.9
$ 12.3
246.1
11.6
237.0
10.8
$ 25.6
$ (3.7)
25.1
(3.7)
+0.25%
24.6
(3.7)
Expected return on plan assets Expected return on plan assets
-0.25%
7.50%
+0.25%
-0.25%
7.50%
+0.25%
Net periodic benefit cost (benefit)
$12.0
11.6
11.2
$(3.7)
(3.7)
(3.7)
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State Auto Financial Corporation
29
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 compensation levels only, provides
information about the obligation an employer would have if the plan
were discontinued at the measurement date. At December 31, 2012,
our share of the State Auto Group’s ABO and PBO was $223.0 million
and $246.1 million, respectively. At December 31, 2012, STFC’s
share of the defined benefit pension plan’s fair value of the assets was
$162.2 million, which resulted in an underfunded status within our
balance sheet of $83.9 million. On a cash flow basis, we target an
annual contribution level that meets at least the targeted normal cost
plus any shortfall amortizations of the plan, as defined by ERISA.
Currently, we expect to make a cash contribution to the pension plan
up to $13.0 million in 2013.
The unfunded status on the pension plan and supplemental executive
retirement plan increased from $87.5 million at December 31, 2011, to
$89.7 million at December 31, 2012. Primarily influencing this
increase are actuarial gains and losses arising from factors that
include a decrease in the discount rate and expected to actual
demographic changes, such as retirement age, mortality, turnover,
and rate of compensation changes.
See Note 9, “Pension and Postretirement Benefit Plans,” to our
consolidated financial statements included in Item 8 of this Form 10-K
for further disclosures regarding our 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 bases. In
accordance with the FASB’s ASC Income Taxes Topic (“ASC 740”),
we periodically evaluate our deferred tax assets, which requires
significant judgment, to determine if they are realizable based upon
weighing all available evidence, both positive and negative, 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
making such judgments, significant weight is given to evidence that
can be objectively verified.
During 2011, we experienced a net loss driven by the magnitude of
record level catastrophe storm losses in the second quarter which
significantly exceeded our projections. We considered both positive
and negative evidence and concluded a valuation allowance should
be established. At December 31, 2012 and 2011, we recorded a
valuation allowance of $100.5 million and $103.3 million, respectively.
The deferred income tax asset remaining after recognition of the
valuation allowance represents a deferred tax asset on the gross
unrealized fixed maturity losses where we have concluded this portion
of the asset to be realizable due to our assertion that we have both
the ability and intent to hold these securities through recovery or
maturity.
The following table sets forth the components of our federal income
tax expense for the years ended December 31, 2012 and 2011:
($ millions)
Income (loss) before federal income taxes
Current tax benefit
Deferred tax benefit
Federal income tax benefit prior to valuation allowance
Valuation allowance
Total federal income tax (benefit) expense
Net income (loss)
2012
2011
As Adjusted
$10.6
(0.1)
(4.8)
(4.9)
4.8
(0.1)
$(112.1)
(6.4)
(48.3)
(54.7)
103.3
48.6
$10.7
$(160.7)
In future periods we will re-assess our judgments and assumptions
regarding the realization of our net deferred tax assets, but until such
time as the positive evidence exceeds the negative evidence we will
maintain a valuation allowance against our net deferred tax
assets. Until that time, as we report net earnings and generate taxable
income, we do not expect our consolidated statements of income to
reflect any federal income tax expense as we utilize our net operating
loss carryforward and release a corresponding amount of the net
deferred tax asset valuation allowance, unless we are in an
“exception” position as described by the intraperiod allocation
guidance included in ASC 740. ASC 740 requires all sources of other
income, including other comprehensive income, to be considered
when there is an expected loss from continuing operations for
purposes of determining the amount of tax benefit that results from a
loss from continuing operations and that should be allocated to
continuing operations when assessing the ability to realize deferred
tax assets. Alternatively, any reported losses will add to our net
operating loss carryforward position and be reserved against by
adding to the net deferred tax asset valuation allowance.
Based on ASC 740 intraperiod tax allocation guidelines, the following
sets forth the change in valuation allowance attributable to continuing
operations and other comprehensive income for the years ended
December 31, 2012 and 2011:
($ millions)
Continuing operations
Other comprehensive income
Change in valuation allowance
For the year ended
December 31
2012
For the year ended
December 31
2011
$ 4.8
(7.6)
$(2.8)
$103.3
-
$103.3
See Note 8, “Federal Income Taxes,” to our consolidated financial
statements included in Item 8 of this Form 10-K for further disclosures
regarding our income tax matters.
using different estimates and assumptions, or if conditions are
significantly different in the future.
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
POOLING ARRANGEMENT
The STFC Pooled Companies and the Mutual 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
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each of the 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.
In 2011, we made two changes to the Pooling Arrangement. First, as
of January 1, 2011, we added the Rockhill Insurers to the pool each
with a participation percentage of 0.0% (the “1.1.11 pool change”). In
conjunction with the 1.1.11 pool change, the STFC Pooled Companies
received $149.8 million ($69.1 million in cash and $80.7 million in
investment securities) from the Rockhill Insurers for net insurance
liabilities transferred on January 1, 2011. The following table sets forth
the impact on our balance sheet at January 1, 2011:
($ millions)
Increase/(Decrease)
Losses and loss expenses payable
Unearned premiums
Other liabilities
Less:
Deferred acquisition costs
Net cash and investment securities received
$124.1
34.1
(0.1)
8.3
$149.8
Second, at the close of business on December 31, 2011, the Pooling
Arrangement was amended to reduce the overall participation
percentage of the STFC Pooled Companies from 80% to 65% and to
include the pooling of applicable balance sheet accounts such as
accumulated other comprehensive income related to employee benefit
plans (the “12.31.11 pool change”). In conjunction with the 12.31.11
pool change, the STFC Pooled Companies paid $261.4 million in cash
to the Mutual Pooled Companies subsequent to year end for net
liabilities transferred on December 31, 2011. The following table sets
forth the impact on our balance sheet at December 31, 2011:
($ millions)
(Decrease)/Increase
Losses and loss expenses payable
Unearned premiums
Pension and postretirement liabilities
Other liabilities
Accumulated other comprehensive income
Less:
Deferred acquisition costs
Other assets
Net cash paid
$( 203.4)
(106.8)
(52.3)
27.6
59.1
(21.8)
7.4
$ (261.4)
In 2010, we made the following changes to the Pooling Arrangement
(the “2010 pool 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.
State Auto Financial sold its nonstandard automobile insurance
subsidiary, SA National, to a third party on December 31, 2010.
Concurrent with this sale, SA National’s participation in the Pooling
Arrangement was terminated, and we entered into a loss portfolio
transfer and a 100% quota share reinsurance agreement on
December 31, 2010 to assume liability for the pre- and post-closing
book of business of SA National, including providing policy and claims
service to SA National policyholders, until policies are renewed with
the third party purchaser on such purchaser’s systems during a
transition period of up to six months following effective date of sale.
The transition was completed as of June 30, 2011. However, we
continued to service policies that were written by us through June 30,
2011. The business assumed by us is subject to the Pooling
Arrangement.
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The following table sets forth the participants and their participation percentages in the Pooling Arrangement:
STFC Pooled Companies:
State Auto P&C(1)
Milbank
SA Ohio
SA National
Total STFC Pooled Companies
State Auto Mutual Pooled Companies:
State Auto Mutual
SA Wisconsin
Meridian Security(2)
Meridian Citizens Mutual
Patrons Mutual
Litchfield
RIC
Plaza
American Compensation
Bloomington Compensation
Total State Auto Mutual Pooled Companies
January 1,
2010 –
December 31,
2010
January 1,
2011 –
December 31,
2011
Close of
business December 31,
2011
December 31,
2012
62.0%
17.0
1.0
0.0
80.0
19.0
0.0
0.0
0.5
0.4
0.1
N/A
N/A
N/A
N/A
20.0
62.0%
17.0
1.0
N/A
80.0
19.0
0.0
0.0
0.5
0.4
0.1
0.0
0.0
0.0
0.0
20.0
51.0%
14.0
0.0
N/A
65.0
34.0
0.0
0.0
0.5
0.4
0.1
0.0
0.0
0.0
0.0
35.0
51.0%
14.0
0.0
N/A
65.0
34.0
0.0
0.0
0.5
0.4
0.1
0.0
0.0
0.0
0.0
35.0
8596_FinC1.pdf
State Auto Financial Corporation
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(1)
(2)
Includes the pooling participation percentage of Farmers which was
merged into State Auto P&C as of the close of business on December 31,
2012. Farmers’ pooling participation percentage was 3.0% from January 1,
2010 to December 31, 2011.
Includes the pooling participation percentages of SA Florida and Beacon
National, each of which was merged into Meridian Security as of the close
of business on December 31, 2012. Each of SA Florida’s and Beacon
National’s pooling participation percentage was 0.0% from January 1, 2010
to December 31, 2011.
We anticipate that the STFC Pooled Companies will maintain a 65%
participation percentage in the Pooling Arrangement for the
foreseeable future. However, under applicable governance procedures,
if the Pooling 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 subject to regulatory
approval by each participant’s respective domiciliary insurance
department. 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.
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.
RESULTS OF OPERATIONS
Summary
The following table sets forth certain key performance indicators we
use to monitor our operations for the years ended December 31,
2012, 2011 and 2010:
($ millions, except per share data)
GAAP Basis:
Total revenues
Net income (loss)
Stockholders’ equity
Book value per share
Return on average equity
Debt to capital ratio
Cat loss and ALAE ratio
Non-cat loss and LAE ratio
Loss and LAE ratio
Expense ratio
Combined ratio
Premiums written growth(1)
Investment yield
SAP Basis:
Cat loss and ALAE points
Non-cat loss and ALAE
ULAE
Loss and LAE ratio
Expense ratio
Combined ratio
Net premiums written to surplus
2012
2011
2010
As adjusted(2)
As adjusted(2)
$1,150.1
$
10.7
$ 737.2
$ 18.22
1.5
13.6
6.4
68.3
74.7
33.2
107.9
(17.8)%
3.5%
6.4
61.7
6.7
74.8
33.6
108.4
1.7
1,553.7
(160.7)
723.8
17.95
(20.7)
13.9
16.2
66.4
82.6
33.9
116.5
(2.9)
3.6
16.2
60.3
5.9
82.4
33.9
116.3
2.2
1,355.1
24.4
831.2
20.71
2.9
12.3
7.9
62.9
70.8
33.8
104.6
9.3
3.6
7.9
57.1
5.3
70.3
32.9
103.2
1.7
(1) Year 2011 includes (a) an increase of 2.6 points related to the one-time $34.1 million transfer of unearned premiums by the Rockhill Insurers in conjunction with
the 1.1.11 pool change (b) a decrease of 8.1 points related to the one-time $106.8 million transfer of unearned premiums to the Mutual Pooled Companies in
conjunction with the 12.31.11 pool change, and (c) a decrease of 8.0 points, related to the one-time transfer of $106.3 of unearned premiums on December 31,
2011 related to the HO QS Arrangement. Year 2010 includes a decrease of 0.2 points related to the one-time $1.4 million transfer of unearned premiums to the
Mutual Pooled Companies on January 1, 2010, in conjunction with the 2010 pool changes.
(2) As previously reported, we adopted with retrospective application at January 1, 2012 Accounting Standards Update 2010-26, “Accounting for Costs Associated
with Acquiring and Renewing Insurance Contracts,” All applicable prior period amounts have been adjusted to conform to current period presentation. See
“Critical Accounting Policies-Deferred Acquisition Costs” included in Item 7 of this Form 10-K.
2012 Summary
Our 2012 net income was $10.7 million compared to a net loss of
$160.7 million in 2011 and net income of $24.4 million in 2010. Our
2011 net loss included a non-cash charge of $103.3 million related to
a valuation allowance against our net deferred tax asset.
Our 2012 revenues were $1,150.1 million compared to revenues of
$1,553.7 million in 2011 and $1,355.1 million in 2010. Our 2012
expenses were $1,139.5 compared to expenses of $1,665.8 million in
2011 and $1,330.7 million in 2010. The decline in revenues from 2011
to 2012 is attributed to the HO QS Arrangement (discussed below)
and the 12.31.11 pool change (discussed above).
The following highlights significant factors that impacted 2012 results
as compared to 2011 and 2010:
• Earned premiums in 2012 were $1,042.1 million compared to
$1,428.8 million and $1,257.2 million in 2011 and 2010,
respectively. The HO QS Arrangement accounted for $166.2 million
and the 12.31.11 pool change contributed $267.9 million of this
decline. Excluding the impact of the HO QS Arrangement and
12.31.11 pool change, earned premium increased 4.1%(1). This
growth was driven by our business insurance and specialty
segments. The business segment growth was principally driven by
higher average new business premium, increased renewal pricing
and a recovering economy. Also contributing to this growth was our
termination of an umbrella quota share reinsurance arrangement as
of July 1, 2012. The specialty segment growth was principally driven
by the addition of new programs and increased rates in our Rockhill
unit.
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• Our 2012 results reflected a significant decrease in weather-related
catastrophe losses when compared to the same 2011 and 2010
results. Our 2012 catastrophe loss ratio was 6.4 loss ratio points
compared to 16.2 loss ratio points and 7.9 loss ratio points for 2011
and 2010, respectively. The HO QS Arrangement benefitted the
ratio by ceding catastrophe losses to our reinsurance partners. The
2011 results of our personal and business insurance segments
reflected a record level of weather-related catastrophe losses,
which impacted 32 of our operating states, including Hurricane
Irene and devastating tornadoes in Tuscaloosa, Alabama and
Joplin, Missouri.
• Our SAP non-catastrophe loss and ALAE ratio for 2012 was 61.7
loss ratio points compared to 60.3 loss ratio points and 57.1 loss
ratio points for the same 2011 and 2010 periods, respectively. Our
2012 non-catastrophe loss and ALAE ratio results were negatively
impacted by the strengthening of loss reserves in our RED unit
within our specialty insurance segment. The HO QS Arrangement
increased our SAP non-catastrophe loss and ALAE ratio 2.3 points
in 2012. Our 2011 non-catastrophe loss and ALAE ratio results
were also negatively impacted by a higher level of non-catastrophe
weather related losses, a higher number of large bodily injury claims
and an increase in workers’ compensation reserves on certain life
time disability claims.
• Net realized gains on investments were $28.8 million in 2012,
compared to $38.1 million and $11.0 million in 2011 and 2010,
respectively. The level of realized gains in 2011 was driven by
reducing our equity holdings to manage our risk parameters as well
as selling select securities in anticipation of the cash transfers in
connection with the 12.31.11 pool change and the HO QS
Arrangement.
(1) For the year ended December 31, 2012, the following table sets forth the
reconciliation of as reported earned premiums to pro forma earned
premiums that exclude the impact of the quota share reinsurance
agreement covering our homeowners book of business. For the year ended
December 31, 2011, the following table sets forth the reconciliation on a pro
forma basis which assumes that the 12.31.11 pool change from 80% to
65% was in effect as of January 1, 2011.
($ in millions)
Earned Premiums:
As reported earned premiums
HO QS Arrangement
Sub-total Excluding HO QS
Impact of 12.31.11 Pool Change
Pro forma earned premiums
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.
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 acquisition costs, see “Critical Accounting Policies—
Deferred Acquisition Costs” section included in this Item 7.
All references to financial measures or components thereof in this
discussion are calculated on a GAAP basis, unless otherwise noted.
Use of Non-GAAP Financial Measures
In the following discussion of the results of our insurance segments,
we sometimes refer to GAAP financial measures in the context of “as
reported” and to non-GAAP financial measures in the context of “pro
forma.” These pro forma, or non-GAAP financial measures, may
(i) exclude the impact of the HO QS Arrangement cession for the year
ended December 31, 2012, (ii) exclude the one-time impact of the
1.1.11 pool change for the year ended December 31, 2011,
(iii) exclude the impact of the 2010 pool changes, (iv) assumes the
12.31.11 pool change from an 80% to 65% participation percentage
had been in effect as of January 1, 2010, and (v) exclude the impact
of the RED underwriting results. We believe the use of these non-
For the year ended December 31
2012
2011
% Change
$1,042.1
166.2
1,208.3
-
1,428.8
-
1,428.8
267.9
(27.1)%
-
(15.4)%
-
$1,208.3
1,160.9
4.1%
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GAAP financial measures will enable investors to (a) better
understand the significance the reinsurance arrangement cession is
contributing to our reported results for the year ended December 31,
2012, and (b) perform a meaningful comparison of our results of
operations for the year ended December 31, 2012 and 2011. We have
also included Reconciliation Tables 1–7 and Tables 1–6 for readers to
better understand the use and calculation of these non-GAAP
financial measures.
Homeowners Quota Share Arrangement
To reduce risk and volatility, while providing us with additional
catastrophe reinsurance protection, the State Auto Group entered into
a quota share reinsurance agreement on December 31, 2011 with a
syndicate of unaffiliated reinsurers covering its homeowners book of
business (the “HO QS Arrangement”). Under the HO QS
Arrangement, the State Auto Group ceded to the reinsurers 75% of its
homeowners business under policies in force at December 31, 2011
and new and renewal policies thereafter issued during the term of the
agreement. The HO QS Arrangement is in effect until December 31,
2014. See “Liquidity and Capital Resources – Reinsurance
Arrangements” for a more detailed discussion of the HO QS
Arrangement. We believe the long term benefits of our homeowner
actions will be a more predictable and profitable book of homeowners
business with reduced risk to our capital base.
For 2012, our GAAP and SAP underwriting loss was $82.1 million and
$92.0 million, respectively. The HO QS Arrangement improved our
GAAP net underwriting loss by $6.0 million (or 0.7 points increase on
our GAAP combined ratio) (see Reconciliation Table 1), and our SAP
underwriting loss by $7.8 million (or 0.7 points increase on our SAP
combined ratio) (see Reconciliation Table 2).
8596_FinC1.pdf
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33
The following table sets forth, on a GAAP and pro forma basis, certain of our key performance indicators before and after the impact of the HO
QS Arrangement cession for the year ended December 31, 2012.
Reconciliation Table 1
For the year ended December 31, 2012
GAAP HO QS Arrangement Cession–Overall Results
($ millions)
Earned premiums
Losses and LAE incurred:
Cat loss and ALAE
Non-cat loss and LAE
Total Loss and LAE incurred
Acquisition and operating expenses
Net underwriting loss
Cat loss and ALAE ratio
Non-cat loss and LAE ratio
Total Loss and LAE ratio
Expense ratio
Combined ratio
As Reported
HO QS Cession
Pro Forma
without HO QS
Cession
$1,042.1
$166.2
$1,208.3
67.1
711.2
778.3
345.9
49.5
74.5
124.0
48.2
116.6
785.7
902.3
394.1
$ (82.1)
$ (6.0)
$ (88.1)
6.4%
68.3%
74.7%
33.2%
29.8%
44.8%
74.6%
29.0%
107.9%
103.6%
9.6%
65.0%
74.6%
32.6%
107.2%
The following table sets forth, on a SAP and pro forma basis, certain of our key performance indicators before and after the impact of the HO QS
Arrangement cession for the year ended December 31, 2012.
Reconciliation Table 2
For the year ended December 31, 2012
SAP HO QS Arrangement Cession–Overall Results
($ millions)
Net written premiums
Earned premiums
Losses and LAE incurred:
Cat loss and ALAE
Non-cat loss and ALAE
Total Loss and ALAE
ULAE
Total Loss and ALAE incurred
Underwriting expenses
Net underwriting loss
Cat loss and ALAE ratio
Non-cat loss and ALAE ratio
Total loss and ALAE ratio
ULAE ratio
Total loss and LAE ratio
Expense ratio
Combined ratio
As Reported
HO QS Cession
$1,055.3
1,042.1
67.1
643.0
710.1
68.9
779.0
355.1
$172.3
166.2
49.5
74.5
124.0
—
124.0
50.0
Pro Forma
without HO QS
Cession
$1,227.6
1,208.3
116.6
717.5
834.1
68.9
903.0
405.1
$ (92.0)
$ (7.8)
$ (99.8)
6.4%
61.7%
68.1%
6.7%
74.8%
33.6%
29.8%
44.8%
74.6%
0.0%
74.6%
29.0%
9.6%
59.4%
69.0%
5.7%
74.7%
33.0%
108.4%
103.6%
107.7%
See additional pro forma reconciliation tables for the HO QS Arrangement cession on our personal insurance segment’s SAP underwriting
results at Reconciliation Table 5 and our homeowners’ line of business at Reconciliation Table 6.
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Summary of Key Indicators of Insurance Segment Results
The following table sets forth certain key performance indicators for our insurance segments for the years ended December 31, 2012, 2011 and
2010:
($ millions)
Written premiums(1)
Earned premiums
Cat loss and ALAE
Non-cat loss and ALAE
ULAE
Underwriting expenses(2)
2012
Personal(1)
%
Ratio
Business
%
Ratio
Specialty
%
Ratio
$469.5
469.8
26.9
276.7
41.2
126.6
$349.4
327.2
37.8
165.7
19.0
147.0
5.7
58.9
8.8
27.0
$236.4
245.1
2.4
200.6
8.7
81.5
11.5
50.7
5.8
42.1
1.0
81.8
3.5
34.4
Total(2)
$1,055.3
1,042.1
67.1
643.0
68.9
355.1
%
Ratio
6.4
61.7
6.7
33.6
SAP underwriting loss and SAP combined ratio
$ (1.6)
100.4
$ (42.3)
110.1
$ (48.1)
120.7
$ (92.0) 108.4
($ millions)
Written premiums(3)
Earned premiums
Cat loss and ALAE
Non-cat loss and ALAE
ULAE
Underwriting expenses
2011
Personal
%
Ratio
Business
%
Ratio
Specialty
%
Ratio
$647.4
800.6
178.9
469.1
50.9
169.1
$341.7
379.0
51.6
220.2
24.6
153.5
$295.5
249.2
0.6
172.4
9.4
113.4
13.6
58.1
6.5
44.9
22.3
58.6
6.4
26.1
0.2
69.2
3.8
38.4
Total
$1,284.6
1,428.8
231.1
861.7
84.9
436.0
%
Ratio
16.2
60.3
5.9
33.9
SAP underwriting loss and SAP combined ratio
$ (67.4)
113.4
$ (70.9)
123.1
$ (46.6)
111.6
$ (184.9) 116.3
($ millions)
Written premiums(4)
Earned premiums
Cat loss and ALAE
Non-cat loss and ALAE
ULAE
Underwriting expenses
2010
Personal
%
Ratio
Business
%
Ratio
Specialty
%
Ratio
$819.9
798.5
74.0
454.7
40.7
238.4
$377.3
383.5
25.0
215.5
20.2
146.8
$126.3
75.2
-
46.9
6.2
50.6
6.5
56.2
5.3
38.9
9.3
56.9
5.1
29.1
-
62.5
8.2
40.0
Total
$1,323.5
1,257.2
99.0
717.1
67.1
435.8
%
Ratio
7.9
57.1
5.3
32.9
SAP underwriting loss and SAP combined ratio
$ (9.3)
100.4
$ (24.0)
106.9
$ (28.5)
110.7
$ (61.8) 103.2
(1) See Reconciliation Table 5 for the impact of the HO QS Arrangement cession on the SAP personal insurance segment’s SAP underwriting results.
(2) See Reconciliation Table 2 for the impact of the HO QS Arrangement cession on our SAP underwriting results.
(3)
Includes:
a. The one-time transfer of $34.1 million of unearned premiums by the Rockhill Insurers to our specialty insurance segment in conjunction with the 1.1.11 pool
change. In connection with this unearned premium transfer, we paid a one-time ceding commission of $8.3 million to the Rockhill Insurers.
b. The one-time transfer of $106.8 million of unearned premiums by the STFC Pooled Companies to the Mutual Pooled Companies in conjunction with the
12.31.11 pool change (transfer of $43.4 million, $35.6 million and $27.8 million, respectively, from our personal insurance, business insurance and specialty
insurance segments). In connection with this unearned premium transfer, we recognized a one-time ceding commission of $27.3 million from the Mutual
Pooled Companies ($9.1 million, $9.6 million and $8.6 million, respectively, to our personal insurance, business insurance and specialty insurance
segments).
The one-time transfer of $106.3 million of unearned premiums by the STFC Pooled Companies on December 31, 2011 related to the HO QS Arrangement
(from our personal insurance segment). In connection with this transfer we recognized a ceding commission of $30.8 million.
c.
d. Combined, these transactions impacted our personal insurance, business insurance and specialty insurance segments’ statutory expense ratio by (0.1)
points, 1.7 points and (0.9) points, respectively, and increased the total expense ratio by 0.7 points. See previous discussion regarding differences between
GAAP and SAP.
(4)
Includes the one-time transfer of $1.4 million of unearned premiums to the Mutual Pooled Companies on January 1, 2010, in conjunction with the 2010 pool
changes (transfer of $2.1 million of our personal insurance segment and receipt of $0.7 million for the Mutual Pooled Companies’ business insurance segment).
Revenue
We measure our top-line growth for our insurance segments based on net written premiums, which 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 term of the policies.
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35
The following table sets forth the reconciliation of the one-time impact on net written premiums for the year ended December 31, 2011, of the
unearned premiums transferred by the Rockhill Insurers to us on January 1, 2011, in conjunction with the 1.1.11 pool change and for the year
ended December 31, 2011, on a pro forma basis which assumes that the 12.31.11 pool change from an 80% to 65% participation percentage
had been in effect as of January 1, 2011:
Reconciliation Table 3
Net Written Premiums Reconciliation Table From 80% to Pro Forma 65%
Pro Forma
As Reported
2012 Net
Written
Premiums
As Reported
2011 Net
Written
Premiums
01.01.11
Pool
Change
Impact
2011
Net Written
Premiums
Excluding
01.01.11 Pool
Change
2011
Net Written
Premiums
Excluding
12.31.11
UEP Transfer
12.31.11
Pool
Change
Impact
Pro Forma
12/31/11
12.31.11
UEP Transfer
$
$ 383.6
56.5
29.4
$ 452.1
163.5
31.8
469.5
647.4
88.4
101.1
75.6
66.5
17.8
349.4
67.9
99.7
68.8
236.4
84.5
98.2
83.0
56.7
19.3
341.7
128.4
91.7
75.4
295.5
-
-
-
-
-
-
-
-
-
-
-
24.3
9.8
34.1
$ 452.1
163.5
31.8
647.4
$ (32.4)
(7.8)
(3.2)
(43.4)
$ 484.5
171.3
35.0
$ (90.8) $ 393.7
139.2
28.4
(32.1)
(6.6)
690.8
(129.5)
561.3
84.5
98.2
83.0
56.7
19.3
341.7
128.4
67.4
65.6
261.4
(8.5)
(10.3)
(8.9)
(5.9)
(2.0)
(35.6)
(13.2)
(8.3)
(6.3)
(27.8)
93.0
108.5
91.9
62.6
21.3
377.3
141.6
75.7
71.9
289.2
(17.5)
(20.4)
(17.2)
(11.7)
(4.0)
(70.8)
(26.5)
(14.2)
(13.5)
(54.2)
75.5
88.1
74.7
50.9
17.3
306.5
115.1
61.5
58.4
235.0
($ millions)
Personal insurance segment:
Personal auto
Homeowners
Other personal
Total personal
Business insurance segment:
Commercial auto
Commercial multi-peril
Fire & allied lines
Other & product liability
Other commercial
Total business
Specialty insurance segment:
RED
Rockhill
Workers’ compensation
Total specialty
Total net written premiums
$1,055.3
$1,284.6
$34.1
$1,250.5
$(106.8)
$1,357.3
$(254.5) $1,102.8
The following table sets forth the reconciliation of the one-time impact on net written premiums for the year ended December 31, 2010, of the
unearned premiums transferred to the Mutual Pooled Companies on January 1, 2010, in conjunction with the 2010 pool changes and for the
year ended December 31, 2010, on a pro forma basis which assumes that the 12.31.11 pool change from an 80% to 65% participation
percentage had been in effect as of January 1, 2010:
Reconciliation Table 4
Net Written Premiums Reconciliation Table From 80% to Pro Forma 65%
As Reported
2010 Net Written
Premiums
12.31.10
Pool
Change
Impact
Pro Forma
2010
Net Written
Premiums
Excluding
12.31.10 Pool
Change
12.31.11
Pool
Change
Impact
Pro Forma
12/31/10
$ 517.1
268.8
34.0
819.9
$(2.1)
-
-
(2.1)
$ 519.2
268.8
34.0
822.0
$ (97.3)
(50.4)
(6.4)
(154.1)
$ 421.9
218.4
27.6
667.9
95.4
98.4
95.3
66.1
22.1
377.3
83.9
3.5
38.9
126.3
-
-
-
-
-
-
0.7
-
-
0.7
95.4
98.4
95.3
66.1
22.1
377.3
83.2
3.5
38.9
125.6
(17.8)
(18.4)
(17.9)
(12.4)
(4.2)
(70.7)
(15.6)
(0.7)
(7.3)
(23.6)
77.6
80.0
77.4
53.7
17.9
306.6
67.6
2.8
31.6
102.0
$1,323.5
$(1.4)
$1,324.9
$(248.4)
$1,076.5
($ millions)
Personal insurance segment:
Personal auto
Homeowners
Other personal
Total personal
Business insurance segment:
Commercial auto
Commercial multi-peril
Fire & allied lines
Other & product liability
Other commercial
Total business
Specialty insurance segment:
RED
Rockhill
Workers’ compensation
Total specialty
Total net written premiums
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Personal Insurance Segment
The following table sets forth the net written premiums by major product line of business for our personal insurance segment for the year ended
December 31, 2012 and on a pro forma basis for the years ended December 31, 2011 and 2010 (see Reconciliation Tables 3 and 4).
Table 1
($ millions)
Personal Insurance Segment:
Net Written Premiums
Personal auto
Homeowners
Other personal
Total personal
2012
2011
2010
As Reported Pro Forma Pro Forma
$383.6
56.5
29.4
$469.5
393.7
139.2
28.4
561.3
421.9
218.4
27.6
667.9
The following table sets forth the SAP loss and ALAE ratios by major product line of business for our personal insurance segment with the
catastrophe and non-catastrophe impact shown separately for the years ended December 31, 2012, 2011 and 2010:
Table 2
($ millions)
Statutory Loss and LAE Ratios
2012
Personal auto
Homeowners
Other personal
Total personal
ULAE
Total Loss and LAE
2011
Personal auto
Homeowners
Other personal
Total personal
ULAE
Total Loss and LAE
2010
Personal auto
Homeowners
Other personal
Total personal
ULAE
Total Loss and LAE
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Earned
Premium
Cat Loss
& ALAE
Non-Cat
Loss &
ALAE
Statutory
Loss &
LAE
Cat
loss
Ratio
Non-Cat
loss
Ratio
Total Loss
and LAE
Ratio
$382.0
59.7
28.1
$469.8
-
$469.8
$492.6
272.7
35.3
$800.6
-
$800.6
$508.1
257.3
33.1
$798.5
-
$798.5
$ 10.7
8.5
7.7
$ 26.9
-
$ 26.9
$ 16.9
154.4
7.6
$178.9
-
$178.9
$
6.6
62.6
4.8
$ 74.0
-
$ 74.0
$242.5
23.2
11.0
$276.7
-
$276.7
$312.9
139.4
16.8
$469.1
-
$469.1
$308.1
133.5
13.1
$454.7
-
$454.7
$253.2
31.7
18.7
$303.6
41.2
$344.8
$329.8
293.8
24.4
$648.0
50.9
$698.9
$314.7
196.1
17.9
$528.7
40.7
$569.4
2.8
14.3
27.4
5.7
-
5.7
3.4
56.7
21.4
22.3
-
22.3
1.3
24.3
15.0
9.3
-
9.3
63.4
38.9
39.3
58.9
-
58.9
63.6
51.0
47.9
58.6
-
58.6
60.6
51.9
39.0
56.9
-
56.9
66.2
53.2
66.7
64.6
8.8
73.4
67.0
107.7
69.3
80.9
6.4
87.3
61.9
76.2
54.0
66.2
5.1
71.3
As reported personal insurance segment net written premiums for the
year ended December 31, 2012 decreased 27.5% compared to as
reported net written premiums for the same 2011 period (see
Reconciliation Table 3). As reported personal insurance segment net
written premiums for the year ended December 31, 2012 decreased
16.4% compared to pro forma net written premiums for the same 2011
period (see Table 1). This decrease in premiums was primarily due to
the following changes in our personal auto and homeowners lines of
business: (i) the reshaping of our geographic footprint; (ii) rate actions;
and (iii) the HO QS Arrangement. In our personal insurance segment,
the HO QS Arrangement decreased our SAP net underwriting loss by
$7.8 million and our SAP combined ratio by 0.8 points for the year
ended December 31, 2012 (see Reconciliation Table 5).
8596_FinC1.pdf
State Auto Financial Corporation
37
The following table sets forth, on a SAP and pro forma basis, certain of our key performance indicators for our personal insurance segment
before and after the impact of the HO QS Arrangement cession for the year ended December 31, 2012.
Reconciliation Table 5
For the year ended December 31, 2012
($ millions)
Net written premiums
Earned premiums
Losses and LAE Incurred:
Cat loss and ALAE
Non-cat loss and ALAE
Total Loss and ALAE
ULAE
Total Loss and LAE incurred
Underwriting expenses
Net underwriting gain
Cat loss and ALAE ratio
Non-cat loss and ALAE ratio
Total Loss and ALAE ratio
ULAE ratio
Total Loss and LAE ratio
Expense ratio
Combined ratio
SAP HO QS Arrangement
Cession–Personal Insurance
As
Reported
HO QS
Cession
Pro
Forma
without
HO QS
Cession
$469.5
469.8
$172.3
166.2
$641.8
636.0
26.9
276.7
303.6
41.2
344.8
126.6
49.5
74.5
124.0
-
124.0
50.0
76.4
351.2
427.6
41.2
468.8
176.6
$ (1.6)
$ (7.8)
$ (9.4)
5.7%
58.9%
64.6%
8.8%
73.4%
27.0%
29.8%
44.8%
74.6%
0.0%
74.6%
29.0%
12.0%
55.2%
67.2%
6.5%
73.7%
27.5%
100.4% 103.6% 101.2%
Our personal insurance segment’s SAP catastrophe loss and ALAE
ratio for 2012 was 5.7 loss ratio points compared to 22.3 loss ratio
points and 9.3 loss ratio points for 2011 and 2010, respectively (see
Table 2). Cessions under the HO QS Arrangement reduced our
personal insurance segment catastrophe losses by $49.5 million in
2012 (see Reconciliation Table 5). In 2012, our catastrophe losses
without the HO QS cession was $76.4 million. The majority of the
2012 catastrophe losses were primarily related to wind and hail
activity from a tornado, wind and hail activity in Louisville, Kentucky,
and St. Louis, Missouri and wind activity from a storm in the Midwest
and Mid-Atlantic states. In 2011, our catastrophe losses included
losses arising from Hurricane Irene and the tornadoes in Tuscaloosa,
Alabama and Joplin, Missouri, as well as other tornadoes and wind
and hail storms. A majority of the losses generated from these
catastrophes were concentrated in six states: Tennessee, Ohio,
Missouri, Texas, North Carolina and Alabama. The severity of these
storm losses was the highest in our history. During 2010, we were
impacted by losses from 30 of the 33 storms that were classified as
numbered catastrophes by PCS, including a series of spring storms
with wind and hail in northern Ohio and a rash of floods in the
Nashville, Tennessee area, both which affected our auto physical
damage results in both personal and business insurance auto lines.
As reported personal auto net written premiums for the year ended
December 31, 2012 decreased 15.2% compared to as reported net
written premiums for the same 2011 period (see Reconciliation Table
3). As reported personal auto net written premiums for the year ended
December 31, 2012 decreased 2.6% compared to pro forma net
written premiums for the same 2011 period (see Table 1). This
decrease in premiums was primarily due to (i) the reshaping of our
geographic footprint to de-emphasize the Midwest and Southeast and
to grow in areas less prone to wind damage, and (ii) actions taken in
our homeowners book of business (discussed below) which have
impacted our companion home/auto policies. Even with this decline in
overall personal auto net written premiums, we have continued to
achieve premium growth in several states such as Texas, Colorado,
Connecticut and Georgia. In addition, we have produced personal
auto premium growth in underpenetrated states, such as Illinois and
Michigan. We continue to aggressively address our rate needs in the
personal auto line of business and have filed rate increases in the
mid-single digit range to offset loss cost trends, primarily relating to
bodily injury claims. The personal auto SAP non-cat loss ratio for the
year ended December 31, 2012 improved slightly compared to this
ratio for the same 2011 period primarily due to the factors discussed
above.
As reported personal auto net written premiums for the year ended
December 31, 2011 decreased 12.6% compared to as reported net
written premiums for the same 2010 period (see Reconciliation Tables
3 and 4). Pro forma personal auto net written premiums for the year
ended December 31, 2011 decreased 6.7% compared to pro forma
net written premiums for the same 2010 period (see Table 1). This
decrease in premiums was primarily impacted by the sale of our
nonstandard automobile insurance subsidiary in 2010. The personal
auto SAP non-cat loss ratio for the year ended December 31, 2011
increased 3.0 points compared to this ratio for the same 2010 period.
The increase in this ratio was primarily due to increases in liability
claim frequency, including an increase in the number of large losses.
As reported homeowners net written premiums was $56.5 million for
the year ended December 31, 2012 compared to as reported net
written premiums of $163.5 million for the same 2011 period (see
Reconciliation Table 3). As reported homeowners net written
premiums decreased $82.7 million for the year ended December 31,
2012 compared to pro forma net written premiums for the same 2011
period (see Table 1). This decrease in premiums was primarily due to
the HO QS Arrangement. Net written premiums ceded under the HO
QS Arrangement were $172.3 million in 2012. For the year ended
December 31, 2012, homeowners net written premiums excluding the
impact of the HO QS Arrangement was $228.8 million (Reconciliation
Table 6) compared to $139.2 million in 2011 (Table 1). At
December 31, 2011 under the HO QS Arrangement, the State Auto
Group ceded 75% of its unearned premiums ($86.4 million pro forma)
in force to the reinsurers, which impacted our net written premiums by
the same amount.
As reported homeowners net written premiums for the year ended
December 31, 2011 decreased 39.2% compared to as reported net
written premiums for the same 2010 period (see Reconciliation Tables
3 and 4). Pro forma homeowners net written premiums for the year
ended December 31, 2011 decreased 36.3% compared to pro forma
38
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net written premiums for the same 2010 period (see Table 1). This
decrease in premiums was primarily due to the HO QS Arrangement.
During 2011 and 2010, we experienced declines in our policy counts
from our core states of Ohio, Kentucky, and Indiana but also
experienced policy count growth in states that we have either
expanded into or identified as profitable growth opportunities.
The following table sets forth, on a SAP and pro forma basis, certain of our key performance indicators for the homeowners’ line of business
before and after the impact of the HO QS Arrangement cession for the year ended December 31, 2012.
Reconciliation Table 6
For the year ended December 31, 2012
($ millions)
Net written premiums
Earned premiums
Losses and LAE incurred:
Cat loss and ALAE
Non-cat loss and ALAE
Total Loss and ALAE incurred
Cat loss and ALAE ratio
Non-cat loss and ALAE ratio
Total Loss and ALAE ratio
SAP HO QS Arrangement Cession–
Homeowners
As
Reported
HO QS
Cession
Pro-Forma
without HO
QS
Cession
$56.5
59.7
8.5
23.2
$172.3
166.2
$228.8
225.9
49.5
74.5
58.0
97.7
$31.7
$124.0
$155.7
14.3%
38.9%
53.2%
29.8%
44.8%
74.6%
25.7%
43.2%
68.9%
P
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For the year ended December 31, 2012, the HO QS Arrangement
improved our homeowners SAP loss and ALAE ratio by 15.7 points,
with catastrophe losses accounting for 11.4 points of this
improvement. In addition, we experienced improvement due to
favorable development from events that occurred prior to the inception
of the HO QS Arrangement. Events occurring on or prior to
December 31, 2011 are excluded from the HO QS Arrangement.
The homeowners SAP non-cat loss ratio for the year ended
December 31, 2012 was 38.9%, an improvement of 12.1 points
compared to the same 2011 period (see Table 2). Our non-
catastrophe loss ratio improved as a result of prior year rate actions
emerging in earned premiums. We continued to aggressively address
our rate needs in the homeowners’ book of business in 2012 receiving
regulatory approval to implement rate increases averaging
approximately 15% in 26 of 28 of the states we write homeowners
business in (“active states”) during 2012. In general, the most wind
and adverse weather-prone states are receiving higher rate and
deductible increases. The homeowners SAP non-cat loss ratio for the
year ended December 31, 2011 slightly declined 0.9 points from the
same 2010 period (see Table 2).
In addition to rate increases, we continue to utilize the following
additional strategies to improve our homeowners results.
• CustomFitSM homeowners: We have implemented the use of our
by-peril rating approach, CustomFit homeowners, in states that
represent approximately 80% of our homeowners’ premium and
86% of our five-year wind/hail losses. During 2012, our CustomFit
homeowners was operational in 20 of our 28 active states. During
2012, we developed a second generation CustomFit homeowners
product, which enhances our ability to model non-weather related
losses. This second generation of CustomFit homeowners was
deployed in 2 active states in late 2012.
• Evaluating, monitoring and terminating unprofitable agencies:
We are aggressively evaluating and monitoring unprofitable
agencies, which includes reviewing existing policies, implementing
tighter new business and renewal guidelines, and applying other
loss mitigation tools. In 2012, we terminated the personal lines
relationship with a significant number of agencies in our most
unprofitable homeowners states.
• Insurance to value: We continue to focus on insurance to value so
that our insureds maintain an amount of coverage sufficient to
replace their home and contents in the case of a total loss. Proper
insurance to value ensures that our premiums are commensurate
with our loss exposure.
• Wind and hail deductibles: We have implemented mandatory
wind and hail deductibles in all targeted catastrophe prone states.
We continue to evaluate the implementation of this loss mitigation
tool in other states based upon annual rate reviews.
Business Insurance Segment
The following table sets forth the net written premiums by major
product line of business for our business insurance segment for the
year ended December 31, 2012, and on a pro forma basis for the
years ended December 31, 2011 and 2010 (see Reconciliation Tables
3 and 4).
Table 3
($ millions)
Business Insurance Segment:
Net Written Premiums
Commercial auto
Commercial multi-peril
Fire & allied lines
Other & product liability
Other commercial
Total business
8596_FinC1.pdf
2012
2011
2010
As Reported Pro Forma Pro Forma
$ 88.4
101.1
75.6
66.5
17.8
$349.4
75.5
88.1
74.7
50.9
17.3
77.6
80.0
77.4
53.7
17.9
306.5
306.6
State Auto Financial Corporation
39
The following table sets forth the SAP loss and ALAE ratios by major product line of business for our business insurance segment with the
catastrophe and non-catastrophe impact shown separately for the years ended December 31, 2012, 2011 and 2010:
Table 4
($ millions)
Statutory Loss and LAE Ratios
2012
Business insurance segment:
Commercial auto
Commercial multi-peril
Fire & allied lines
Other & product liability
Other commercial
Total business
ULAE
Total Loss and LAE
2011
Business insurance segment:
Commercial auto
Commercial multi-peril
Fire & allied lines
Other & product liability
Other commercial
Total business
ULAE
Total Loss and LAE
2010
Business insurance segment:
Commercial auto
Commercial multi-peril
Fire & allied lines
Other & product liability
Other commercial
Total business
ULAE
Total Loss and LAE
Earned
Premium
Cat Loss
& ALAE
Non-Cat
Loss &
ALAE
Statutory
Loss &
LAE
Cat
loss
Ratio
Non-Cat
loss
Ratio
Total Loss
and LAE
Ratio
$ 81.4
94.3
74.5
59.3
17.7
$327.2
-
$327.2
$ 94.0
104.1
93.8
65.4
21.7
$379.0
-
$379.0
$ 98.6
95.6
97.7
69.0
22.6
$383.5
-
$383.5
$ 0.7
13.0
23.8
-
0.3
$37.8
-
$37.8
$ 2.7
21.6
26.7
-
0.6
$51.6
-
$51.6
$ 1.5
7.4
15.6
-
0.5
$25.0
-
$25.0
$ 51.6
52.8
22.9
33.6
4.8
$165.7
-
$165.7
$ 56.4
52.1
51.1
53.8
6.8
$220.2
-
$220.2
$ 55.8
46.5
51.0
54.0
8.2
$215.5
-
$215.5
$ 52.3
65.8
46.7
33.6
5.1
$203.5
19.0
$222.5
$ 59.1
73.7
77.8
53.8
7.4
$271.8
24.6
$296.4
$ 57.3
53.9
66.6
54.0
8.7
$240.5
20.2
$260.7
0.9
13.8
31.9
-
1.3
11.5
-
11.5
2.8
20.7
28.5
-
2.8
13.6
-
13.6
1.5
7.7
16.0
-
2.3
6.5
-
6.5
63.3
55.9
30.8
56.8
27.3
50.7
-
50.7
60.1
50.0
54.4
82.2
31.2
58.1
-
58.1
56.6
48.6
52.1
78.4
35.7
56.2
-
56.2
64.2
69.7
62.7
56.8
28.6
62.2
5.8
68.0
62.9
70.7
82.9
82.2
34.0
71.7
6.5
78.2
58.1
56.3
68.1
78.4
38.0
62.7
5.3
68.0
As reported business insurance segment net written premiums for the
year ended December 31, 2012 increased 2.3% compared to as
reported net written premiums for the same 2011 period (see
Reconciliation Table 3). As reported business insurance segment net
written premiums for the year ended December 31, 2012 increased by
14.0% compared to pro forma net written premiums for the same 2011
period (see Table 3). This increase in premiums was primarily due to
our (i) writing larger average premium new business accounts,
(ii) receiving modest pricing increases on renewal business, and
(iii) experiencing more growth on existing polices due to improved
economic conditions. Additionally, business insurance segment net
written premiums included $7.2 million of unearned premiums
transferred as the result of terminating an umbrella quota share
reinsurance arrangement as of July 1, 2012. For the year ended
December 31, 2011, written premiums of $13.5 million were ceded
under the umbrella treaty. For the year ended December 31, 2012, the
termination of this umbrella treaty accounted for 4.7 points of the
14.0% net written premium growth discussed above.
As reported business insurance segment net written premiums for the
year ended December 31, 2011 decreased 9.4% compared to as
reported net written premiums for the same 2010 period (see
Reconciliation Tables 3 and 4). Pro forma business insurance net written
premiums for the year ended December 31, 2011 were flat compared to
pro forma net written premiums for the same 2010 period (see Table 3).
The business insurance segment’s SAP non catastrophe loss and
ALAE ratio for 2012 was 50.7 loss ratio points compared to 58.1 loss
ratio points and 56.2 loss ratio points for 2011 and 2010, respectively
(see Table 4). The decrease from 2011 to 2012 was primarily due to
fewer large losses in our fire and allied and other & product liability
lines. The increase from 2010 to 2011 was primarily due to an
increase in weather-related losses in the fire & allied lines as well as
an increase in the number of large losses attributable to a more active
claims process whereby the ultimate liability was recognized earlier in
the case reserving process.
The business insurance segment’s catastrophe loss and ALAE ratio
for 2012 was 11.5 loss ratio points compared to 13.6 loss ratio points
and 6.5 loss ratio points for 2011 and 2010, respectively. We
experienced a higher level of catastrophe losses in 2012 and 2011 as
compared to 2010.
Our small accounts are a foundational element of our premium writings
and will continue as an important part of our future business plans.
Improved efficiency and reduced processing expense will be critical to
our success managing these accounts. Business Insurance Evolution
(BIE), introduced into two states in 2012, is an important tool providing
automated predictive price models and rules engines as part of our new
business and policy renewal process on our smaller accounts. BIE will
allow this process to move from being high touch (i.e. very manual), to
low or in many instances no touch processing. We intend to complete the
integration of BIE into our remaining states in 2013 in our largest lines of
business. We believe that over time the ability to price policies based on
predictive criteria and issuing them more efficiently will produce an
improvement in our loss ratio and expense ratio results, while increasing
agent satisfaction. We anticipate profit improvement in our smaller
account book of business beginning in 2014.
40
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P
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Our current book of business is mainly comprised of smaller
commercial accounts that are less than $5,000 in premium. Our goal
in 2013 is to write larger, more complex accounts in the premium
range of $25,000-$50,000. As these accounts are written frequently
by independent agents, we have developed strategies which we
believe will enable us to write a larger percentage of these accounts.
We believe writing a greater mix of larger accounts will improve our
expense ratio and provide value to our independent agencies.
Additionally, we are concentrating on accounts which produce
$100,000 or more in premium. These large accounts will typically
have over $3.0 million of payroll and more than $25.0 million in sales.
We believe our risk consulting and claims management will provide
value to our independent agents in writing these larger accounts.
Specialty Insurance Segment
In our specialty insurance segment, we offer commercial coverages
that require specialized product underwriting, claims handling or risk
management services through a distribution channel of retail agents
and wholesale brokers, which may include program administrators
and other specialty sources.
The following table sets forth the net written premiums by unit for our
specialty insurance segment for the year ended December 31, 2012
and on a pro forma basis for the years ended December 31, 2011 and
2010 (see Reconciliation Tables 3 and 4).
Table 5
($ millions)
Specialty Insurance Segment:
Net Written Premiums
RED
Rockhill
Workers’ compensation
Total specialty
2012
2011
2010
As Reported Pro Forma Pro Forma
$ 67.9
99.7
68.8
$236.4
115.1
61.5
58.4
235.0
67.6
2.8
31.6
102.0
As reported specialty insurance segment net written premiums for the
year ended December 31, 2012 decreased 20.0% compared to as
reported net written premiums for the same 2011 period (see
Reconciliation Table 3). As reported specialty insurance segment net
written premiums for the year ended December 31, 2012 increased by
0.6% compared to pro forma net written premiums for the same 2011
period (see Table 5). Pro Forma specialty insurance segment net
written premiums for the year ended December 31, 2011 increased
130.4% compared to the pro forma net written premiums for the same
2010 period (see Table 5).
For our Rockhill unit, as reported net written premiums for the year
ended December 31, 2012 increased 8.7% compared to as reported
net written premiums for the same 2011 period (see Reconciliation
Table 3), and as reported net written premiums for the year ended
December 31, 2012 increased 62.1% compared to pro forma net
written premiums for the same 2011 period (see Table 5). The
increase was impacted by the following.
• Growth driven by the addition of six new programs generated
through managing general underwriters. These new programs
accounted for $14.6 million of the premium growth for the year
ended December 31, 2012;
• Changes in the structure of two liability lines and all other perils
reinsurance programs made in 2011, which resulted in our retaining
additional written premium of $6.5 million for the year ended
December 31, 2012;
• Significant rate increases in our property business and increased
business opportunities through our excess and surplus channel for
catastrophe exposed businesses due to recent global catastrophe
events and recent industry catastrophe model changes. This
business is written on a non-admitted basis, which allows us to
underwrite unique insurance requirements using customized rates
and forms, and is subject to a separate catastrophe treaty with a net
retention of $9.75 million for each occurrence; and
• Exposure growth in our excess and surplus casualty lines, which we
believe was attributable to early signs of stabilization in pricing in
the commercial lines market and the strengthening of broker
relationships and marketing initiatives.
For our Rockhill unit, as reported net written premiums for the year
ended December 31, 2011 increased $88.2 million compared to as
reported net written premiums for the same 2010 period (see
Reconciliation Tables 3 and 4). The premium growth in our Rockhill
unit was primarily due to the addition of the Rockhill Insurers’ business
into the Pooling Arrangement in 2011.
For our workers’ compensation unit, as reported net written premiums
for the year ended December 31, 2012 decreased 8.8% compared to
as reported net written premiums for the same 2011 period (see
Reconciliation Table 3), and as reported net written premiums for the
year ended December 31, 2012 increased 17.8% compared to pro
forma net written premiums for the same 2011 period (see Table 5).
The premium growth in our workers’ compensation unit was driven by
increases in our mono-line product due primarily to state expansion
and a firming market place along with growth in our small account
workers’ compensation product written in conjunction with our
standard business products.
For our workers’ compensation unit, as reported net written premiums
for the year ended December 31, 2011 increased 93.8% compared to
as reported net written premiums for the same 2010 period (see
Reconciliation Tables 3 and 4). The net written premium growth in the
workers’ compensation unit was primarily due to the addition of the
Rockhill Insurers’ business into the Pooling Arrangement in 2011. Pro
forma workers’ compensation unit net written premiums for the year
ended December 31, 2011 increased 84.8% compared to pro forma
net written premiums for the same 2010 period (see Table 5).
For our RED unit, as reported net written premiums for the year ended
December 31, 2012 decreased 47.1% compared to as reported net
written premiums for the same 2011 period (see Reconciliation Table
3) and as reported net written premiums for the year ended
December 31, 2012 decreased 41.0% compared to pro forma net
written premiums for the same 2011 period (see Table 5). The
decrease in net written premiums was primarily due to the cancelation
of substantially all RED programs.
The specialty insurance segment produced net underwriting losses for
the year ended December 31, 2012, of $48.1 million (see
Reconciliation Table 7), due to the unprofitable performance of the
RED unit. In our specialty insurance segment, RED underwriting
results increased our SAP net underwriting loss by $49.3 million and
increased our SAP combined ratio by 26.2 points for the year ended
December 31, 2012 (see Reconciliation Table 7). The total specialty
insurance segment SAP non catastrophe loss and ALAE ratio for year
ended December 31, 2012 increased 12.6 points from the same 2011
period (see Table 6) primarily due to $30.5 million of loss and loss
expense reserve strengthening within our RED unit principally related
to a large commercial auto trucking program and a sizeable
State Auto Financial Corporation
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commercial restaurant program, which were cancelled in
2012. As previously disclosed, we have reorganized and
merged the operations of RED into the Rockhill unit’s program
division and have terminated or sent notice of termination
representing substantially all of the business written by the
former management team of RED. We will continue writing
program business through the Rockhill unit.
Reconciliation Table 7
For the year ended December 31, 2012
($ millions)
Net written premiums
Earned premiums
Losses and LAE incurred:
Cat loss and ALAE
Non-cat loss and ALAE
Total Loss and ALAE
ULAE
Total Loss and LAE incurred
Acquisition and operating expenses
Net underwriting loss
Cat loss and ALAE ratio
Non-cat loss and ALAE ratio
Total Loss and ALAE ratio
ULAE ratio
Total Loss and LAE ratio
Expense ratio
Combined ratio
The following table sets forth, on a SAP and pro forma basis,
certain of our key performance indicators for our specialty
insurance segment before and after the impact of the RED
underwriting results for the year ended December 31, 2012.
SAP Underwriting Results–
Specialty Insurance
As
Reported
RED
Pro Forma
without RED
$236.4
245.1
$ 67.9
97.9
$168.5
147.2
2.4
200.6
203.0
8.7
211.7
81.5
0.7
114.9
115.6
4.6
120.2
27.0
1.7
85.7
87.4
4.1
91.5
54.5
$ (48.1)
$ (49.3)
$
1.2
1.0%
0.7%
81.8% 117.4%
82.8% 118.1%
4.7%
3.5%
86.3% 122.8%
34.4%
39.8%
120.7% 162.6%
1.1%
58.3%
59.4%
2.8%
62.2%
32.3%
94.5%
The following table sets forth the SAP loss and LAE ratios for our specialty insurance segment with the catastrophe and non-catastrophe impact
shown separately for the years ended December 31, 2012, 2011 and 2010:
Table 6
($ millions)
Statutory Loss and LAE Ratios
Specialty insurance segment:
2012
ULAE
Total Loss and LAE
2011
ULAE
Total Loss and LAE
2010
ULAE
Total Loss and LAE
Earned
Premium
Cat Loss
&
ALAE
Non-Cat
Loss &
ALAE
Statutory
Loss &
LAE
Cat
loss
Ratio
Non-Cat
loss
Ratio
Total Loss
and LAE
Ratio
$245.1
-
$245.1
$249.2
-
$249.2
$ 75.2
-
$ 75.2
$2.4
-
$2.4
$0.6
-
$0.6
-
-
-
$200.6
-
$200.6
$172.4
-
$172.4
$ 46.9
-
$ 46.9
$203.0
8.7
$211.7
$173.0
9.4
$182.4
$ 46.9
6.2
$ 53.1
1.0
-
1.0
0.2
-
0.2
-
-
-
81.8
-
81.8
69.2
-
69.2
62.5
-
62.5
82.8
3.5
86.3
69.4
3.8
73.2
62.5
8.2
70.7
In the specialty insurance segment, the total SAP non-cat loss ratio for
year ended December 31, 2011 increased 6.7 points from the same
2010 period (see Table 6). The increase was primarily driven by an
increase in reserves of $5.4 million in certain life time disability claims
in the workers’ compensation line of business, nearly all of which are
from 2009 and prior years, with approximately 65% from accident
years 2006 and prior, as well as higher levels of losses in our RED
commercial auto line of business.
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Loss and LAE Development
Losses and loss expenses for a calendar year represent the combined estimated ultimate liability for claims occurring in the current calendar
year along with any change in estimated ultimate liability for claims occurring in prior years. The following table sets forth the provision for losses
and loss expenses for those claims occurring in the current and prior years, along with the GAAP loss and LAE ratio for the years ended
December 31, 2012, 2011 and 2010:
($ millions)
Provision for losses and loss expenses occurring:
Current year
Prior years
Total losses and loss expenses
%
GAAP Loss
and LAE
2011
%
GAAP Loss
and LAE
76.3
(1.6)
74.7
$1,213.3
(33.3)
$1,180.0
84.9
(2.3)
82.6
%
GAAP Loss
and LAE
75.9
(5.1)
70.8
2010
$954.2
(64.6)
$889.6
2012
$795.2
(16.9)
$778.3
As shown above, the 2012 loss and loss expenses attributable to prior
years totaled a decrease of $16.9 million, or favorable development, in
the estimated ultimate liability for prior years’ claims. The following
table sets forth a tabular presentation of the favorable development by
accident year for the year ended December 31, 2012:
As shown above, the 2011 loss and loss expenses attributable to prior
years totaled a decrease of $33.3 million, or favorable development, in
the estimated ultimate liability for prior years’ claims. The following
table sets forth a tabular presentation of the favorable development by
accident year for the year ended December 31, 2011:
($ millions)
Accident Year
2002 and prior
2003
2004
2005
2006
2007
2008
2009
2010
2011
Total
Current Year
Development
of Ultimate Liability
Redundancy/(Deficiency)
$ 0.9
0.2
0.3
-
(0.1)
2.4
2.3
4.9
8.0
(2.0)
($ millions)
Accident Year
2001 and prior
2002
2003
2004
2005
2006
2007
2008
2009
2010
$16.9
Total
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Current Year
Development
of Ultimate Liability
Redundancy/(Deficiency)
$ 1.8
0.7
(0.2)
2.5
(2.3)
0.9
4.2
5.1
11.6
9.0
$33.3
While emergence by accident year includes normal fluctuations due to
the uncertainty associated with loss reserve development and claim
settlement, the favorable development in 2012 came primarily from
the accident years 2010 and 2009. The more notable items
contributing to the 2012 favorable development were:
• ULAE was $6.3 million lower than anticipated in the reserves at
December 31, 2011.
• We experienced favorable catastrophe loss development of $10.4
million in 2012 related to the higher level of catastrophe losses we
experienced in 2011.
• In the personal and business insurance segments, the non-
catastrophe loss and ALAE reserves accounted for $28.0 million of
favorable development related to the latest three accident years,
primarily in the personal auto liability, other & product liability, and
fire & allied lines with $10.5 million, $9.4 million and $5.1 million of
the favorable development, respectively. The favorable
development in these lines was driven by emergence of lower than
anticipated claim severity.
• In the specialty insurance segment, the non-catastrophe loss and
ALAE reserves accounted for $27.8 million of adverse development
related to the latest two accident years, which was driven by RED
reserve strengthening (discussed above).
While emergence by accident year includes normal fluctuations due to
the uncertainty associated with loss reserve development and claim
settlement, the favorable development in 2011 came primarily from
accident years 2009 and 2010. The more notable items contributing to
the 2011 favorable development were:
• ULAE was $7.6 million lower than anticipated in the reserves at
December 31, 2010.
• Favorable catastrophe loss development of $4.3 million was
primarily within our fire & allied lines, other personal, personal auto
and homeowners lines of business.
• In the personal and business insurance segments, the non-
catastrophe loss and ALAE reserves developed favorably by $28.1
million, primarily in the property lines. Homeowners, commercial
multi-peril and fire & allied lines reserves accounted for $14.2
million, $6.1 million and $4.9 million of the favorable development,
respectively. The favorable development in these lines was driven
by emergence of lower than anticipated claim severity, primarily
from accident year 2010 and, to a lesser extent, the past five
accident years in the commercial multi-peril line of business.
• In the specialty segment, the non-catastrophe loss and ALAE
reserves developed adversely by $6.7 million, which was driven by
greater than anticipated large losses in the commercial auto line of
business and reserve increases on certain life time disability claims
in the workers’ compensation line of business.
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43
As shown above, the 2010 loss and loss expenses attributable to prior
years totaled a decrease of $64.6 million, or favorable development, in
the estimated ultimate liability for prior years’ claims. The following
table sets forth a tabular presentation of the favorable development by
accident year for the year ended December 31, 2010:
($ millions)
Accident Year
2000 and prior
2001
2002
2003
2004
2005
2006
2007
2008
2009
Total
Current Year
Development
of Ultimate Liability
Redundancy/(Deficiency)
$ (0.5)
(0.2)
0.7
0.1
2.2
1.4
5.7
2.0
13.0
40.2
$64.6
The favorable development in 2010 came primarily from accident year
2009 and 2008. The more notable items contributing to the 2010
favorable development were:
• ULAE was $12.7 million lower than anticipated in the reserves at
December 31, 2009, with approximately 78% being attributable to
the 2009 accident year.
• Favorable catastrophe loss development of $3.3 million was
primarily associated with the 2009 accident year. This development
occurred primarily within our homeowners and commercial multi-
peril lines of business.
• Favorable development in the auto liability, homeowners and fire &
allied lines accounts for the majority of the development in the non-
catastrophe reserves, with the balance spread across multiple lines
of business. Standard, nonstandard and commercial auto liability
reserves developed favorably by $10.7 million. Homeowners and
fire & allied reserves developed lower than anticipated by $10.4
million and $9.0 million, respectively. The favorable development in
these lines of business was driven by emergence of lower than
anticipated claim severity, as well as lower than anticipated claim
frequency for fire & allied lines. The favorable development was
primarily associated with the 2009 and, to a lesser extent, 2008
accident years.
See additional discussion regarding loss and loss expense reserves at
the “Critical Accounting Policies – Losses and Loss Expenses
Payable” section included in this Item 7.
The following table sets forth loss and loss expenses payable by major line of business at December 31, 2012 and 2011:
($ millions)
Personal insurance segment:
Personal auto
Homeowners
Other personal
Total personal
Business insurance segment:
Commercial auto
Commercial multi-peril
Fire & allied lines
Other & product liability
Other business
Total business
Specialty insurance segment
Total losses and loss expenses payable net of reinsurance recoverable on losses and loss
expenses payable
December 31,
2012
December 31,
2011
$
Change
$186.1
34.6
10.3
231.0
77.4
80.4
21.5
159.6
2.9
341.8
355.9
$928.7
195.9
71.9
11.2
279.0
76.9
73.5
24.3
158.6
3.6
336.9
265.7
881.6
(9.8)
(37.3)
(0.9)
(48.0)
0.5
6.9
(2.8)
1.0
(0.7)
4.9
90.2
47.1
The loss and loss expenses payable at December 31, 2012 increased
$47.1 million from the loss and loss expenses payable at
December 31, 2011. This increase was primarily due to earned
premium growth in our specialty insurance segment and the
corresponding increase in claims activity, as well as the previously
mentioned loss and loss expense reserve strengthening with our RED
unit. Our homeowners line of business declined $37.3 million primarily
due to the ceding of reserves to unaffiliated reinsurers in connection
with the HO QS Arrangement. 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 33.2% in 2012 compared to 33.9% and
33.8% in 2011 and 2010, respectively.
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 its own personnel to invest in fixed maturities
and large-cap equities and outside investment managers to invest in
small-cap equities and international funds. The Investment Committee
(the “Committee”) of our Board of Directors establishes the investment
policies to be followed by Stateco. Our primary investment objectives
are to maintain adequate liquidity and capital to meet our
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responsibilities to policyholders, grow long term economic surplus to
increase our capital position, maintain a consistent level of income to
support operations and manage investment risk. 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, 2012, there were no fixed maturity investments rated
below investment grade in our available-for-sale investment portfolio.
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
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, 2012, 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 income (loss) and as such are not included in the
determination of net income (loss).
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Composition of Investment Portfolio
The following table sets forth the composition of our investment portfolio at carrying value at December 31, 2012 and 2011:
($ millions)
Cash and cash equivalents
Fixed maturities, at fair value:
Fixed maturities
Treasury inflation-protected securities
Total fixed maturities
Notes receivable from affiliate(1)
Equity securities, at fair value:
Large-cap securities
Small-cap securities
Total equity securities
Other invested assets, at fair value:
International instruments
Other invested assets
Total other invested assets, at fair value
Other invested assets, at cost
Total portfolio
December 31,
2012
% of
Total
December 31,
2011
$
59.0
2.5
$
356.0
1,674.1
231.0
1,905.1
70.0
174.2
54.2
228.4
59.0
5.4
64.4
0.5
72.0
9.9
81.9
3.0
7.5
2.3
9.8
2.6
0.2
2.8
0.0
1,674.5
260.4
1,934.9
70.0
122.1
45.2
167.3
52.6
4.6
57.2
0.5
% of
Total
13.8
64.8
10.1
74.9
2.7
4.7
1.7
6.4
2.0
0.2
2.2
0.0
$
2,327.4
100.0
$
2,585.9
100.0
(1)
In May 2009, we entered into two separate Credit Agreements with State Auto Mutual. Under these Credit Agreements, State Auto Mutual borrowed a total of
$70.0 million from us on an unsecured basis. Interest is payable semi-annually at a fixed annual interest rate of 7.00%. Principal is payable May 2019.
The following table sets forth the amortized cost and fair value of
available-for-sale fixed maturities by contractual maturity at
December 31, 2012:
Expected maturities may differ from contractual maturities as issuers
may have the right to call or prepay the obligations with or without call
or prepayment penalties.
($ 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
Total
Amortized
Cost
Fair
Value
$
47.3
286.8
463.4
601.6
$
47.9
306.9
502.9
647.7
377.1
399.7
$ 1,776.2
1,905.1
At December 31, 2012, our equity portfolio consisted of approximately
47 different large-cap stocks and 83 small-cap stocks. The largest
single position was 6.0% of the equity portfolio based on fair value,
and the top ten positions accounted for 28.1% of the equity portfolio.
At December 31, 2011, our equity portfolio consisted of approximately
51 different large-cap stocks and 72 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 22.5% 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
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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 4.05 and 3.71 as of
December 31, 2012 and 2011, respectively. The following table sets
forth our interest rate risk and the effects of a parallel change in
interest rates on the fair value of the available-for-sale fixed maturity
portfolio at December 31, 2012:
($ millions)
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-backed securities
Balance as of December 31, 2012
$
$
398.7
866.9
371.2
401.6
$
381.9
833.2
354.9
403.7
366.5
800.3
338.6
399.7
$
349.8
766.0
322.4
391.1
$
333.3
728.5
307.3
379.0
$ 2,038.4
$ 1,973.7
$ 1,905.1
$ 1,829.3
$ 1,748.1
This table summarizes only the effects that a parallel change in
interest rates could have on the fixed maturity portfolio. Changes in
rates would also change the value of our liabilities and possibly other
financial assets. We caution the reader that this analysis does not
take into account nonparallel changes in interest rates. It is likely that
some rates would increase or decrease more than others depending
upon market conditions at the time of the change. This nonparallel
change would alter the value of the fixed maturity portfolio. The
analysis is also limited in that it does not take into account any actions
that might be taken by us in response to these changes. As a result,
the actual impact of a change in interest rates and the resulting fixed
maturity values may differ significantly from what is shown in the table.
We believe that the fixed maturity portfolio’s exposure to credit risk is
minimal as approximately 81.3% 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 mortgage 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 $399.7 million or 21.0% of our fixed maturity available-
for-sale investment portfolio as of December 31, 2012, 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, 2012 included
obligations of states and political subdivisions with a total carrying value
of $800.3 million, with $266.6 million of these securities, or 33.3% of our
municipal securities portfolio (“Muni Portfolio”), 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 $800.3 million of
municipal securities in our investment portfolio at December 31, 2012,
88.8% were rated AA or better, without the benefit of a Credit
Enhancement. We do not believe that a loss of a Credit Enhancement
would have a material adverse impact on our results of operations,
financial position or liquidity, due to the underlying strength of the issuers
of the securities, as well as our ability and intent to hold the securities. In
addition, as of December 31, 2012, we had no direct investment in any
guarantor including any bond insurer.
The following table sets forth the credit ratings of our municipal
securities, excluding Credit Enhancements, based on ratings by
nationally recognized rating agencies at December 31, 2012:
Rating
($ millions)
AAA*
AA
A
Other
Total
Total fair
value
$270.6
440.3
82.5
6.9
%
33.8
55.0
10.3
0.9
$800.3
100.0
*
Our AAA rating category includes securities which have been either pre-
funded or escrowed to maturity.
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The following table sets forth the composition of the insurers providing
Credit Enhancements, along with the corresponding underlying credit
rating of the issuer of the security, at December 31, 2012:
tax exempt and taxable fixed income securities with lower rates of
return.
Monoline Insurer / Underlying Rating
($ millions)
Assured Guaranty Municipal Corp. (formerly FSA):
AAA
AA
A
AMBAC:
AAA
AA
A
FGIC:
AAA
AA
National Public Finance Guarantee (formerly MBIA):
AAA
AA
A
XLCA:
A
Total fair
value
$
44.7
82.6
12.3
139.6
25.8
26.3
6.1
58.2
3.3
0.3
3.6
10.8
48.7
3.3
62.8
2.4
Total municipal securities enhanced by third party
monoline insurers
$
266.6
We believe our Muni Portfolio is well diversified by issuer and state.
We have 14.8% 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 5.0% of the portfolio and no more than 10.0% 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.
28.8% 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, 2012, our large-cap equity portfolio had a beta of
1.05 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 following table sets forth what changes might
occur in the value of the large-cap equity portfolio given a change in
the S&P 500 Index at December 31, 2012:
Fair value ($ millions)
Change in S&P 500
Index
Value as % of
original value
$210.8
$192.5
$174.2
$155.9
$137.6
+20% +10%
0
-10%
-20%
121% 111% 100%
90%
79%
The above analysis is limited in that it does not take into account any
actions that might be taken by us in response to these changes. As a
result, the actual impact of a change in equity market prices and the
resulting equity values may differ significantly from what is shown in
the table. By investing in mostly large-cap issues we hope to limit
liquidity risk in the equity portfolio. The large-cap equity portfolio does
not have any direct exposure to exchange rate risk since we do not
directly hold any foreign stocks. We constantly monitor the equity
portfolio holdings for any credit risk issues that may arise. We do not
invest in any commodity futures or commodity oriented mutual funds.
At December 31, 2012, we have two international funds, Fund 1 and
Fund 2, which are included in other invested assets available-for-sale.
Fund 1 and Fund 2 had betas of 0.69 and 0.84, respectively, using the
MSCI EAFE Index as a benchmark. Beta estimates the degree the
portfolio’s price will fluctuate based on a given movement in the index.
The following tables set forth what changes might occur in the values
of Funds 1 and 2 given a change in the MSCI EAFE Index at
December 31, 2012:
Fund 1
Fair value ($ 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
$29.7
$27.9
$26.1
$24.3
$22.5
+20% +10%
-10% -20%
0
114% 107% 100% 93% 86%
$38.3
$35.6
$32.8
$30.0
$27.3
+20% +10%
-10% -20%
0
117% 108% 100% 92% 83%
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During 2012 and 2011, we experienced a high level of call activity with
respect to both our tax exempt and taxable bonds due to the low
interest rate environment. The proceeds from the call, maturity or sale
of securities within our Muni Portfolio have been reinvested into both
The above analysis does not take into account any actions that might
be taken by the portfolio managers in response to these changes. As
a result, the actual impact of a change in international equity market
prices and the resulting international equity values may differ
significantly from what is shown in the tables above.
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Investment Operations Revenue
The following table sets forth the components of net investment income for the years ended December 31, 2012, 2011 and 2010:
($ millions)
Gross investment income:
Fixed maturities
Equity securities
Other
Total gross investment income
Less: Investment expenses
Net investment income
Average invested assets (at cost)
Annualized investment yield
Annualized investment yield, after tax
Net investment income, after tax
Effective tax rate
Year Ended December 31
2012
2011
2010
$
$
$
$
66.9
4.9
5.6
77.4
2.0
75.4
2,173.4
3.5%
2.7%
58.0
23.0%
$
$
$
$
77.0
4.9
5.7
87.6
2.2
85.4
2,392.3
3.6%
2.8%
66.9
21.7%
$
$
$
$
71.7
5.4
5.8
82.9
2.1
80.8
2,235.7
3.6%
2.9%
65.7
18.7%
Our investment operations revenue for the year ended December 31,
2012 was primarily impacted by the following factors.
• A cash outflow of $336.9 million related to the settlement of the
12.31.11 pool change and the initial transfer of unearned premium
related to the HO QS Arrangement.
• Interest earned on our fixed maturity securities declined primarily due
to lower yields. As our higher yielding bonds mature or are called by
the issuers, the proceeds are being reinvested at a lower interest rate.
• The amortized cost value of our Treasury Inflation-Protected
Securities (“TIPS”) was $196.5 million for the year ended
December 31, 2012, compared to $231.4 million and $187.6 million
for the same 2011 and 2010 periods. The income earned on our
TIPS securities, which is dependent on changes in the CPI Index,
decreased by $3.5 million when compared to the same 2011 period
and increased by $6.6 million in 2011 when compared to the same
2010 period.
• During 2012 and 2011, we sold several of our equity securities for
several reasons, including managing our equity holdings to be
consistent with our investment policy, responding to negative
outlooks, achieving our price targets, as well as to accumulate cash
to be in a position to settle the transfers related to the 12.31.11 pool
change with the Mutual Pooled Companies in early 2012. In 2010,
to offset the decline in interest earned on our fixed maturity
securities and to improve yield and cash flows, we began to hold
additional high dividend paying equities.
The following table sets forth realized gains (losses) and the proceeds received on sale for our investment portfolio for the years ended
December 31, 2012, 2011 and 2010:
($ millions)
Realized gains:
Fixed maturities
Equity securities
Other invested assets
Total realized gains
Realized losses:
Equity securities:
Sales
OTTI
Fixed maturities:
OTTI
Other invested assets—OTTI
Total realized losses
2012
2011
2010
Realized
gains
(losses)
Proceeds
received
on sale
Realized
gains
(losses)
Proceeds
received
on sale
Realized
gains
(losses)
Proceeds
received
on sale
$
15.7
19.0
0.1
34.8
(2.6)
(3.2)
(0.2)
-
(6.0)
$
$
327.8
97.2
0.2
425.2
7.3
-
-
-
7.3
4.4
41.7
3.9
50.0
(5.3)
(6.6)
-
-
(11.9)
$
$
167.6
152.9
20.8
341.3
28.0
-
-
-
28.0
2.4
15.8
-
18.2
(3.1)
(3.6)
-
(0.5)
(7.2)
$
93.6
65.7
-
159.3
20.3
-
-
-
20.3
Net realized gain (loss) on investments
$
28.8
$
432.5
$
38.1
$
369.3
$
11.0
$
179.6
Equity sales were executed for various reasons in 2012, 2011 and
2010, including: (i) to accumulate cash for settlement of the transfers
related to the 12.31.11 pool change (ii) the achievement of our price
target, (iii) in response to negative outlook announcements or
changes in business conditions which in our opinion diminished the
future business prospects of certain securities and (iv) in order to
manage our equity holdings to be consistent with our investment
policy.
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 recognized OTTI on our fixed
maturity portfolio during 2012 of $0.2 million and did not recognize any
impairments on our fixed maturity portfolio during 2011 and 2010.
When a fixed maturity security has been determined to have an other-
than-temporary decline in fair value, the impairment charge is
separated into an amount representing the credit loss, which is
recognized in earnings, and the amount related to non-credit factors,
When an equity security or other invested asset has been determined
to have a decline in fair value that is other-than-temporary, we adjust
the cost basis of the security to fair value. See “Critical Accounting
Policies – Investments” included in this Item 7 for OTTI impairment
indicators. This results in a charge to earnings as a realized loss,
48
State Auto Financial Corporation
8596_FinC1.pdf
which is not reversed for subsequent recoveries in fair value. Future
increases or decreases in fair value, if not other-than-temporary, are
included in accumulated other comprehensive income (loss).
The following table sets forth the realized losses related to OTTI on our
investment portfolio recognized for the year ended December 31, 2012:
($ millions)
Equity Securities:
Small-cap securities
Bonds
Total OTTI
Number
of
positions
Total
impairment
38
1
39
$(3.2)
(0.2)
$(3.4)
Gross Unrealized Investment Gains and Losses
Based upon our review of our investment portfolio at December 31, 2012, we determined that there were no individual investments with an
unrealized holding loss that had a fair value significantly below cost continually for more than one year. The following table sets forth detailed
information on our available-for-sale investment portfolio by lot at fair value for our gross unrealized holding gains (losses) at December 31, 2012:
($ millions, except number of positions)
Fixed Maturities:
Cost or
amortized
cost
Gross
unrealized
holding
gains
Number of
gain
positions
Gross
unrealized
holding
losses
Number of
loss
positions
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
$
$ 328.2
750.4
320.5
securities
Total fixed maturities
Equity Securities:
Large-cap securities
Small-cap securities
Total equity securities
Other invested assets
377.1
1,776.2
152.6
43.6
196.2
49.0
38.3
50.3
19.2
24.0
131.8
25.0
10.6
35.6
15.4
Total available-for-sale investments
$ 2,021.4
$ 182.8
P
A
R
T
I
I
$
62
297
76
119
554
38
83
121
3
678
$
-
(0.4)
(1.1)
(1.4)
(2.9)
(3.4)
-
(3.4)
-
$
2
12
17
19
50
9
-
9
-
$
366.5
800.3
338.6
399.7
1,905.1
174.2
54.2
228.4
64.4
$
(6.3)
59
$ 2,197.9
The following table sets forth our unrealized holding gains by
investment type, net of deferred tax that was included as a component
of accumulated comprehensive income (loss) at December 31, 2012
and 2011, and the change in unrealized holding gains, net of deferred
tax, for the year ended December 31, 2012:
($ millions)
Available-for-sale investments
Unrealized gains:
Fixed maturities
Equity securities
Other invested assets
Unrealized gains
Deferred federal income tax liability (less valuation allowance)
Unrealized gains, net of tax
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, 2012.
December 31,
2012
December 31,
2011
$
Change
$
$
128.9
32.2
15.4
176.5
(52.5)
124.0
$
$
117.6
25.6
8.6
151.8
(53.1)
98.7
$ 11.3
6.6
6.8
24.7
0.6
$ 25.3
As of December 31, 2012, Level 3 assets as a percentage of total
assets were 0.3%, which we have determined to be insignificant.
Other Items
Income Taxes
For the year ended December 31, 2012, federal income tax benefit
was $0.1 million compared to tax expense of $48.6 million and less
than $0.1 million for the same 2011 and 2010 periods, respectively.
The effective tax rate for 2012 of 1.0% differs from the statutory rate of
35% principally because of the valuation allowance that was
established during 2011. A valuation allowance of $103.3 million was
held at December 31, 2011, with a corresponding charge to total tax
expense for the year ended December 31, 2011.
State Auto Financial Corporation
49
8596_FinC1.pdf
See “Critical Accounting Policies—Deferred Income Taxes” included
in this Item 7. 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 expense (benefit)
and the amount computed at the indicated statutory rate for the years
ended December 31, 2012, 2011 and 2010.
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.
Liquidity
Our insurance subsidiaries must have adequate liquidity to ensure that
their cash obligations are met. However, the STFC Pooled Companies
do not have the daily liquidity concerns normally associated with an
insurance company due to their participation in, and the terms of, the
Pooling Arrangement. 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
STFC Pooled Companies and the other pool participants, and then it
settles the intercompany balances generated by these transactions
with the pool participants within 45 days following each quarter end.
We believe this provides State Auto Mutual with sufficient liquidity to
pay losses and expenses of our insurance operations on a timely
basis. When settling the intercompany balances, State Auto Mutual
provides the pool participants with full credit for the premiums written
net of losses paid during the quarter, retaining 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 participant on the basis of its pooling percentage.
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 premiums 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 the other expenses line item in the accompanying
consolidated statements of income.
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 premiums 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 2012, 2011 or
2010, despite the increased level of catastrophe losses.
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, 2012 and
2011, we had $59.0 million and $356.0 million, respectively, in cash
and cash equivalents, and $2,197.9 million and $2,159.4 million,
respectively, of total available-for-sale investments. Included in our
fixed maturities available-for-sale were $10.0 million and $9.9 million
of securities on deposit with insurance regulators, as required by law,
at December 31, 2012 and 2011, 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.
Net cash used in operating activities was $285.6 million in 2012,
compared to net cash provided by operating activities during 2011 and
2010 of $43.0 million and $131.4 million, respectively. Net cash from
operations will vary from period to period if there are significant
changes in underwriting results, primarily a combination of the level of
premiums written and loss and loss expenses paid, changes in cash
flows from investment income or federal income tax activity. The
majority of the change between 2012 and 2011 was due to our
settlement payment of $261.4 million related to the 12.31.11 pool
change and our payment of $75.5 million related to our share of the
State Auto Group’s initial net unearned premium transfer under the HO
QS Arrangement. The lower level of net cash provided by operating
activities for the year ended December 31, 2011 compared to the same
2010 period was driven by the significant increase in the level of loss
and loss expenses paid due to the record level of catastrophe losses
that occurred in 2011 as compared to the same 2010 period. The 2011
and 2010 operational cash activity included cash inflows of
$69.1 million and $3.7 million, respectively, due to pooling changes.
Net cash provided by investing activities was $9.3 million and
$246.2 million for 2012 and 2011, respectively, compared to net cash
used in investing activities of $112.6 million in 2010. The following
factors significantly contributed to the fluctuations between those years:
• In early 2012 we continued to raise funds to complete the
settlement of amounts owed related to the 12.31.11 pool change
and the HO QS Arrangement.
• In 2011, we sold equity securities and certain fixed maturity
securities in order to accumulate cash to be in a position to settle
the transfers related to the 12.31.11 pool change with the Mutual
Pooled Companies in early 2012.
• Also in 2011, we had a cash inflow of $13.2 million, primarily related
to our sale of SA National, compared to a cash outflow of
$7.5 million in 2010. The amount paid in 2010 approximated SA
National’s cash position on that date.
Borrowing Arrangements
Credit Facility
State Auto Financial has a $100.0 million unsecured revolving credit
facility with a syndicate of lenders which matures in September 2016
(the “Credit Facility”). During the term of the Credit Facility, we have
the right to increase the total facility to a maximum amount of
$150.0 million, provided that no event of default has occurred and is
continuing. The Credit Facility is available for general corporate
purposes and provides for interest-only payments during its term, with
principal and interest due in full at maturity. Interest is based on
LIBOR or a base rate plus a calculated margin amount. The Credit
Facility includes certain covenants, including financial covenants that
require us to maintain a minimum net worth and not exceed a certain
debt to capitalization ratio. As of December 31, 2012, State Auto
Financial had not made any borrowings and was in compliance with
all of its covenants.
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
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State Auto Financial Corporation
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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.
In early 2013, State Auto P&C became a member of the Federal
Home Loan Bank of Cincinnati (“FHLB”). We intend to refinance the
Senior Notes with a secured borrowing with the FHLB.
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 $15.5 million aggregate principal amount of unsecured Floating
Rate Junior Subordinated Debt Securities due 2033 (the
“Subordinated Debentures”). The sole assets of the Capital Trust are
the Subordinated Debentures and any interest accrued thereon.
Interest on the Capital Trust’s capital and common securities is
payable quarterly at a rate equal to the three-month LIBOR rate plus
4.20%, adjusted quarterly. The applicable interest rates for
December 31, 2012 and 2011 were 4.51% and 4.73%, respectively.
Notes Payable Summary
The following table sets forth our notes payable at December 31, 2012:
($ 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 interest adjusting quarterly
Total notes payable
Carrying
Value
Fair
Value
$ 100.4
15.5
$ 100.3
15.5
$ 115.9
$ 115.8
Interest
Rate
6.25%
4.51%
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, 2012, we had $15.5 million notes
payable with variable interest and $100.4 million notes payable with
interest fixed at 6.25%, which equated to approximately 13.3%
variable interest debt and 86.7% fixed interest debt. Our decision to
obtain fixed versus variable interest rate debt is influenced primarily by
the following factors: (a) current market interest rates; (b) anticipated
future market interest rates; (c) availability of fixed versus variable
interest instruments; and (d) our currently existing notes payable fixed
and variable interest rate position. See our contractual obligations
table included in “Contractual Obligations” included in this Item 7.
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.
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
or Standard & Poor’s 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.
Homeowners Quota Share Reinsurance Arrangement
On December 31, 2011, the State Auto Group entered into the HO QS
Arrangement, which is a three-year quota share reinsurance
agreement covering our homeowners book of business. Under the HO
QS Arrangement, the State Auto Group cedes to reinsurers 75% of its
homeowners business under policies in force at the effective date and
new and renewal policies thereafter issued during the term of the
agreement. The HO QS Arrangement remains in place until
December 31, 2014. A reinsurer may terminate its participation in the
HO QS Arrangement upon the occurrence of certain events, including,
without limitation, if the policyholders’ surplus of the State Auto Group
is reduced by more than 25% from the amount of its surplus as of
September 30, 2011 or the State Auto Group is assigned an A.M.
Best rating below A-.
Under the HO QS Arrangement, the State Auto Group receives a
29.0% commission on all premiums ceded to the reinsurers during the
term of the agreement. Subject to the terms and conditions of the HO
QS Arrangement, the State Auto Group may receive a profit
commission.
P
A
R
T
I
I
The HO QS Arrangement provides the reinsurers with certain
contractual rights in the event of a “material adverse change,” as
defined in the agreement, occurs to the State Auto Group. For
example, the reinsurers may request the revision or renegotiation of
certain terms of the agreement if the State Auto Group’s homeowners
exposure growth exceeds specified levels or if the State Auto Group
makes significant underwriting, claim handling or business mix
changes that adversely impact the business reinsured under the
agreement. In the event the parties do not agree on revised terms, the
reinsurers may cancel the HO QS Arrangement. Under the material
adverse change provisions, the reinsurers may reduce the ceding
commission proportionally in the event the homeowners rate changes
implemented fall short of our pricing plan by more than certain
stipulated contractual amounts.
Under the HO QS Arrangement, the reinsurers have agreed to accept
75% of the State Auto Group’s subject homeowners net liability. The
liability of the reinsurers will not exceed any of the following:
$3.0 million as to any one risk with respect to property losses;
$2.0 million as to any one insured with respect to liability losses;
$55.0 million as to all losses arising from any one loss occurrence;
50% of the ceded net earned premium for the first contract year with
respect to all losses arising from all catastrophe loss occurrences
commencing during the first contact year, subject to an amount not to
exceed $181.0 million for the first contract year; 40% of the ceded net
earned premium for the second contract year with respect to all losses
arising from all catastrophe loss occurrences commencing during the
second contact year, subject to an amount not to exceed
$150.0 million for the second contract year; 30% of the ceded net
earned premium for the third contract year with respect to all losses
arising from all catastrophe loss occurrences commencing during the
third contract year, subject to an amount not to exceed $117.0 million
for the third contract year; or 34% of the ceded net earned premium
for the term of the agreement with respect to all losses arising from all
catastrophe loss occurrences commencing during the term of the
agreement, subject to an amount not to exceed $380.0 million for the
term of the contract. A “catastrophe loss occurrence” is defined as any
one loss occurrence which has been assigned a catastrophe number
by the ISO PCS. We believe this reinsurance arrangement reduces
risk and volatility in the homeowners line of business and to our
overall book of business while providing us with additional catastrophe
protection.
State Auto Financial Corporation
51
8596_FinC1.pdf
Other Reinsurance Arrangements
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 reinsurance intermediaries.
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. The State Auto Group also makes use of
facultative reinsurance for unique risk situations. 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.
Property Catastrophe
Members of the State Auto Group maintain a property catastrophe
excess of loss reinsurance agreement, covering catastrophe related
events affecting at least two risks. As of June 1, 2012, this property
catastrophe reinsurance agreement was revised to include property
business written through our specialty insurance segment. Under this
agreement, the State Auto Group retains the first $55.0 million of
catastrophe loss, each occurrence, with a 5% co-participation on the
next $245.0 million of covered loss, each occurrence. The reinsurers
are responsible for 95% of the excess over $55.0 million up to
$300.0 million of covered losses, each occurrence. Under this
agreement, the State Auto Group is responsible for losses above
$300.0 million.
For property policies underwritten by our Rockhill unit, the State Auto
Group also maintains a separate property catastrophe excess of loss
reinsurance agreement covering catastrophe related events affecting
at least two risks. Under this agreement, the State Auto Group retains
the first $15.0 million of catastrophe loss, each occurrence, and the
reinsurers are responsible for 100% of the excess over $15.0 million
up to $55.0 million of covered loss, each occurrence. The rates for this
reinsurance are negotiated annually.
Property Per Risk
As of July 1, 2012, the property per risk excess of loss reinsurance
agreement was revised to include the Rockhill unit’s property business.
This reinsurance agreement provides that the State Auto Group is
responsible for the first $1.0 million of each covered loss for business
written as Rockhill unit’s property business, and first $3.0 million of
each covered loss for other property business. The State Auto Group
also is responsible for an additional $2.0 million in aggregate retention
per treaty year for losses exceeding $3.0 million. 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.
For property policies underwritten by our Rockhill unit, the State Auto
Group also maintains a property surplus share agreement for wind-
only insurance products. This agreement provides for a proportional
share of losses on all coastal wind policies written with limits greater
than $5.0 million and up to $10.0 million of covered loss and all non
coastal wind policies written with limits greater than $10.0 million and
up to $16.0 million of covered loss. The reinsurers’ limit cannot
exceed more than $5.0 million on any one risk.
Casualty and Workers’ Compensation
As of July 1, 2012, the State Auto Group revised its casualty excess of
loss reinsurance agreement to include coverage for umbrella liability
and workers’ compensation losses. Under this agreement, each
company in the State Auto Group is responsible for the first $2.0 million
of workers’ compensation, umbrella, auto and other liability losses. The
reinsurance agreement provides coverage up to $10.0 million. Policies
underwritten by the Rockhill unit are not subject to this casualty excess
of loss reinsurance agreement. For workers’ compensation risks, the
State Auto Group also renewed a treaty that provides $1.0 million of
coverage in excess of $1.0 million retention, subject to an additional
$1.0 million in annual aggregate retention.
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 $30.0 million of
coverage in excess of $10.0 million retention for each loss
occurrence. This reinsurance sits above the $8.0 million excess of
$2.0 million arrangement. The rates for this reinsurance are
negotiated annually. Policies underwritten by the Rockhill unit are not
subject to this casualty excess of loss reinsurance agreement.
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 $30.0 million of covered loss. This coverage is subject to a
“Maximum Any One Life” limitation of $20.0 million. This limitation
means that losses associated with each worker may contribute no
more than $20.0 million to covered loss under this agreement. The
rates for this reinsurance are negotiated annually.
For liability policies written through our Rockhill unit, the State Auto
Group has a consolidated casualty treaty whereby it retains the first
$1.0 million of covered loss and the reinsurers are responsible for
87% of loss in excess of $1.0 million up to $11.0 million. The rates for
this reinsurance are negotiated annually.
As of October 1, 2011, the State Auto Group entered into a quota
share reinsurance agreement for Management & Professional Liability
arising out of certain classes of business underwritten in our Rockhill
unit. For any subject losses, the treaty pays 40% of 100%, up to 40%
of $10.0 million, or $4.0 million. The remaining loss amount was
covered by the consolidated casualty reinsurance agreement. As of
July 1, 2012, this reinsurance agreement was terminated.
Surety
As of November 1, 2012, the State Auto Group entered into a surety
excess of loss for business written by its surety underwriting unit.
Reinsurers under this treaty are responsible for the ultimate net loss
exceeding $1.0 million up to a reinsurer limit of $4.0 million. Total
amounts recoverable under this treaty may not exceed $12.0 million
during the one-year term of the agreement.
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Contractual Obligations
The following table sets forth our significant contractual obligations at December 31, 2012:
($ 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 notes payable
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
Total interest payable
Postretirement benefits
Pension funding(5)
Total
Due
1 year
or less
Due
1-3
years
Due
3-5
years
Due
after 5
years
Total
$
932.2
$ 386.0
$ 309.2
$ 111.7
$ 125.3
100.0
100.0
15.5
115.5
-
100.0
6.3
15.8
22.1
18.3
65.4
6.3
0.7
7.0
2.0
7.5
-
-
-
-
1.5
1.5
4.0
14.3
-
-
-
-
1.5
1.5
3.8
13.6
-
15.5
15.5
-
12.1
12.1
8.5
30.0
$ 1,153.5
$ 502.5
$ 329.0
$ 130.6
$ 191.4
(1) We derived expected payment patterns separately for the direct loss and ALAE reserves. Amounts included the STFC Pooled Companies net additional share
of transactions assumed from State Auto Mutual through the Pooling Arrangement. For a reconciliation of management’s best estimate, see “Critical Accounting
Policies—Losses and Loss Expenses Payable” included in this Item 7. These patterns were applied to the December 31, 2012, 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.
(2) For a discussion of these debt instruments, see “Liquidity and Capital Resources—Borrowing Arrangements” included in this Item 7.
(3) The Senior Notes bear interest at a fixed rate of 6.25% per annum, which is payable each May 15 and November 15.
(4)
Interest on the subordinated debentures was calculated using an interest rate equal to the three-month LIBOR rate at December 31, 2012 of 0.3105% plus
4.20%, or 4.5105%.
(5) These amounts are estimates of ERISA minimum funding levels based on adjustments to prior year assumptions for our defined benefit pension plan and do
not represent an estimate of our expected contributions. Funding levels generally are not determined until later in the year with respect to the contribution year.
See Note 9, “Pension and Postretirement Benefits Plans” to our consolidated financial statements included in Item 8 of this Form 10-K for a tabular presentation
of STFC’s share of expected benefit payments from the State Auto Group’s defined benefit pension plan.
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Lease and other purchase obligations of State Auto Mutual are
allocated to us through the Pooling Arrangement.
Regulatory Considerations
At December 31, 2012, 2011 and 2010, each of our insurance
subsidiaries was in compliance with statutory requirements relating to
capital adequacy.
The 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. 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 premiums written to
surplus or 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 following table sets forth the statutory leverage ratios for our insurance subsidiaries at December 31, 2012, 2011 and 2010:
Statutory Leverage Ratios
State Auto P&C
Milbank
SA Ohio
Weighted Average
2012
2011(1)
2010(1)
1.6
2.2
0.0
1.7
2.0
2.7
1.2
2.1
1.7
1.7
1.2
1.7
(1) Table excludes the one-time impact on net written premiums of $34.1 million, $106.8 million and $1.4 million occurred in conjunction with the 1.1.11 pool
change, the 12.31.11 pool change and 2010 pool changes, respectively.
Our insurance subsidiaries pay dividends to State Auto Financial
which in turn may be used by State Auto Financial to pay dividends to
shareholders 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, $62.6 million is available in 2013 for payment as a
dividend from our insurance subsidiaries to State Auto Financial,
without prior approval from our respective domiciliary state insurance
departments. State Auto Financial received $20.0 million and $56.4
million in dividends from its insurance subsidiaries in 2012 and 2010,
respectively. 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 Corporation
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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 requirements, which 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, 2012, the ratio of
total adjusted statutory capital to authorized control level of State Auto
Financial’s insurance subsidiaries ranged from 456.3% to 4,869.2%.
Credit and Financial Strength Ratings
The following table sets forth our credit and insurance company financial strength ratings as of February 25, 2013:
State Auto Financial (credit rating)
State Auto Group (financial strength)
A.M. Best
Moody’s
Standard & Poor’s
bbb
stable outlook
A
stable outlook
Baa3
negative outlook
A3
negative outlook
BB+
negative outlook
BBB+
negative outlook
We are reviewed regularly by the independent rating agencies,
including those rating agencies listed in the table above. We believe
that these ratings provide a meaningful way for policyholders, agents,
creditors, shareholders and others to compare us to our competitors.
Our ratings are influenced by many factors, including operating and
financial performance, asset quality, liquidity, financial leverage,
exposure to catastrophe risks and operating leverage.
The credit ratings set forth above relate to the Senior Notes issued by
State Auto Financial and express the opinion of the rating agency 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.
The financial strength ratings set forth above relate to the State Auto
Group and express the opinion of the rating agency as to the ability of
the State Auto Group to meet its ongoing obligations to policyholders.
The A.M. Best financial strength rating influences our ability to write
insurance business as agents and policyholders generally prefer
higher rated companies. Lower rated companies may be required to
compete for agents and policyholders by offering higher commissions
or lower premiums and expanded coverage, or a combination thereof.
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 widespread
natural catastrophes, such as the industry experienced in 2008 with
Hurricane Ike. 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
Accounting for Costs Associated with Acquiring or Renewing
Insurance Contracts
In October 2010, the FASB issued updated guidance to address
diversity in practice for the accounting of costs associated with
acquiring or renewing insurance contracts. This guidance modifies the
definition of acquisition costs to specify that a cost be directly related
to the successful acquisition of a new or renewal insurance contract in
order to be deferred. This guidance was effective for fiscal years
beginning after December 15, 2011. The Company adopted this
guidance, with retrospective application, at January 1, 2012. The
cumulative effect of the retrospective adoption of this guidance
reduced stockholders’ equity by $20.5 million, after-tax, at January 1,
2010. See Note 1 of our consolidated financial statements included in
Item 8 of this Form 10-K.
Amendments to Achieve Common Fair Value Measurement and
Disclosure Requirements in U.S. GAAP and IFRS
The amendments in this guidance result in common fair value
measurement and disclosure requirements in GAAP and International
Financial Reporting Standards (“IFRS”). Consequently, the
amendments in the guidance change the wording used to describe
many of the requirements in GAAP for measuring fair value and for
disclosing information about fair value measurements. For many of
the requirements, the FASB does not intend for the amendments in
the guidance to result in a change in the application of the
requirements in the Fair Value Measurements Topic. The guidance
also clarifies the FASB’s intent about the application of existing fair
value measurement requirements as well as changes to a particular
principle or requirement for measuring fair value or for disclosing
information about fair value measurements. This guidance was
effective on a prospective basis for fiscal years and interim periods
beginning after December 15, 2011. The Company’s adoption of this
guidance at January 1, 2012 did not have a material impact on its
consolidated financial statements.
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 “Results of Operations—
Investment Operations Segment—Market Risk.”
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Item 8. Financial Statements and Supplementary Data
Our consolidated financial statements, including the notes thereto,
and the reports of Ernst & Young LLP on our consolidated financial
statements and our internal controls over financial reporting 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,
2012 and 2011, and the related consolidated statements of income,
comprehensive income (loss), stockholders’ equity, and cash flows for
each of the three years in the period ended December 31, 2012. 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,
2012 and 2011, and the consolidated results of their operations and
their cash flows for each of the three years in the period ended
December 31, 2012, 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 deferred acquisition
costs in 2012.
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, 2012, 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 8, 2013, expressed an unqualified opinion
thereon.
/s/ Ernst & Young LLP
Columbus, Ohio
March 8, 2013
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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, 2012,
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, 2012, 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, 2012 and 2011, and the related
consolidated statements of income, comprehensive income,
stockholders’ equity, and cash flows for each of the three years in the
period ended December 31, 2012, and our report dated March 8,
2013, expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Columbus, Ohio
March 8, 2013
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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
2012
2011
As adjusted
(see Note 1)
Fixed maturities, available-for-sale, at fair value (amortized cost $1,776.2 and $1,817.3, respectively)
Equity securities, available-for-sale, at fair value (cost $196.2 and $141.7, respectively)
Other invested assets, available-for-sale, at fair value (cost $49.0 and $48.6, respectively)
Other invested assets
Notes receivable from affiliate
Total investments
$
$
1,905.1
228.4
64.4
0.5
70.0
2,268.4
Cash and cash equivalents
Accrued investment income and other assets
Deferred policy acquisition costs
Reinsurance recoverable on losses and loss expenses payable
Prepaid reinsurance premiums
Current federal income taxes
Net deferred federal income taxes
Property and equipment, at cost (net of accumulated depreciation of $5.6 and $7.5, respectively)
Total assets
Liabilities and Stockholders’ Equity
Losses and loss expenses payable (affiliates $435.1 and $376.8, respectively)
Unearned premiums (affiliates $81.9 and $98.4, respectively)
Notes payable (affiliates $15.5 and $15.5, respectively)
Postretirement and pension benefits
Due to affiliate
Other liabilities
Total liabilities
Stockholders’ equity:
Class A Preferred stock (nonvoting), without par value. Authorized 2.5 shares; none issued
Class B Preferred stock, without par value. Authorized 2.5 shares; none issued
Common stock, without par value. Authorized 100.0 shares; 47.3 and 47.1 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 income
Retained earnings
Total stockholders’ equity
Total liabilities and stockholders’ equity
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1,934.9
167.3
57.2
0.5
70.0
2,229.9
356.0
30.2
91.7
25.5
7.9
12.3
0.5
10.4
59.0
31.5
91.7
13.5
3.9
-
1.0
8.8
$
2,477.8
$
2,764.4
$
942.2
481.6
115.9
113.0
8.6
79.3
$
907.1
470.2
116.4
112.8
349.4
84.7
1,740.6
2,040.6
-
-
118.1
(115.8)
131.6
84.2
519.1
737.2
-
-
117.8
(115.8)
127.3
63.8
530.7
723.8
$
2,477.8
$
2,764.4
See accompanying notes to consolidated financial statements.
State Auto Financial Corporation
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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 $809.2, $803.6 and $818.8, respectively)
Net investment income (affiliates $4.9, $4.9 and $4.9, respectively)
Net realized 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 gain on investments
Other income (affiliates $3.6, $2.5 and $2.2, respectively)
Total revenues
Losses and loss expenses (ceded to affiliate $575.7, $701.0 and $579.1, respectively)
Acquisition and operating expenses
Interest expense (affiliates $0.7, $0.7 and $0.7, respectively)
Postretirement benefit curtailment gain
Other expenses
Total expenses
Income (loss) 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
Year ended December 31
2012
2011
As adjusted
(see Note 1)
2010
As adjusted
(see Note 1)
$
1,042.1
75.4
$
1,428.8
85.4
$
1,257.2
80.8
(3.4)
-
32.4
29.0
3.6
1,150.1
778.3
345.9
7.0
-
8.3
1,139.5
10.6
(0.1)
-
(0.1)
10.7
0.26
0.27
0.55
$
$
$
$
(6.6)
-
43.6
37.0
2.5
1,553.7
1,180.0
485.0
7.1
(14.9)
8.6
1,665.8
(112.1)
(7.0)
55.6
48.6
(160.7)
(4.00)
(4.00)
0.60
$
$
$
$
(4.1)
-
19.0
14.9
2.2
1,355.1
889.6
424.5
7.1
-
9.5
1,330.7
24.4
7.7
(7.7)
-
24.4
0.61
0.62
0.60
$
$
$
$
See accompanying notes to consolidated financial statements.
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STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Consolidated Statements of Comprehensive Income (Loss)
($ millions)
Net income (loss)
Other comprehensive income (loss), net of tax:
Net unrealized holding gains on investments:
Unrealized holding gains arising during year
Reclassification adjustments for gains realized in net income (loss)
Income tax benefit (expense)
Total net unrealized holding gains on investments
Amortization of gain on derivative used in cash flow hedge
Net unrecognized benefit plan obligations:
Net actuarial loss arising during period
Negative plan amendment gain on postretirement healthcare benefit plan
Reclassification adjustments for amortization to statements of income:
Transition asset
Negative prior service cost
Net actuarial loss
Effect of December 31, 2011 pooling change
Income tax (benefit) expense
Total net unrecognized benefit plan obligations
Other comprehensive income (loss)
Comprehensive income (loss)
Year ended December 31
2012
2011
As adjusted
(see Note 1)
2010
As adjusted
(see Note 1)
$
10.7
$
(160.7)
$
24.4
53.5
(28.8)
0.6
25.3
(0.1)
(7.4)
-
-
(5.2)
7.8
-
-
(4.8)
20.4
31.1
$
80.2
(38.1)
(14.7)
27.4
(0.1)
(69.8)
93.8
(0.3)
(19.0)
7.2
59.1
(26.6)
44.4
71.7
34.9
(11.5)
(8.2)
15.2
(0.1)
(33.9)
-
(0.8)
(3.0)
6.8
-
10.8
(20.1)
(5.0)
$
(89.0)
$
19.4
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See accompanying notes to consolidated financial statements.
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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:
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
Balance at end of year
Common stock:
Balance at beginning of year
Issuance of shares
Balance at end of year
Treasury stock:
Balance at beginning of year
Shares acquired on stock option exercises
Balance at end of year
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
Accumulated other comprehensive income (loss):
Balance at beginning of year
Change in unrealized gains on investments, net of tax
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
Retained earnings:
Balance at beginning of year
Effect of adopting deferred acquisition costs (Note 1)
Net income (loss)
Cash dividends paid (affiliates $13.9, $15.2 and $15.2, respectively)
Balance at end of year
Total stockholders’ equity at end of year
Year ended December 31
2012
47.1
0.2
47.3
(6.8)
-
(6.8)
117.8
0.3
118.1
(115.8)
-
(115.8)
127.3
1.3
-
3.0
131.6
63.8
25.3
(0.1)
(4.8)
84.2
530.7
-
10.7
(22.3)
519.1
737.2
$
$
$
$
$
$
2011
As adjusted
(see Note 1)
2010
As adjusted
(see Note 1)
46.9
0.2
47.1
(6.8)
-
(6.8)
117.3
0.5
117.8
(115.8)
-
(115.8)
122.1
2.2
-
3.0
127.3
(7.9)
27.4
(0.1)
44.4
63.8
715.5
-
(160.7)
(24.1)
530.7
723.8
$
$
$
$
$
$
46.6
0.3
46.9
(6.8)
-
(6.8)
116.6
0.7
117.3
(115.7)
(0.1)
(115.8)
115.8
2.6
0.3
3.4
122.1
(2.9)
15.2
(0.1)
(20.1)
(7.9)
735.6
(20.5)
24.4
(24.0)
715.5
831.2
$
$
$
$
$
$
See accompanying notes to consolidated financial statements.
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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 to net cash (used in) provided by operating
activities:
Depreciation and amortization, net
Share-based compensation
Net realized gain on investments
Changes in operating assets and liabilities:
Deferred acquisition costs (benefit)
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 used in December 31, 2011 unearned premium transfer related to the homeowners
quota-share reinsurance arrangement
Cash (used in) provided from pooling changes, December 31, 2011, January 1, 2011
and 2010 (Note 6a)
Net cash (used in) 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 available-for-sale
Sale of subsidiary
Net additions of property and equipment
Net cash provided by (used in) investing activities
Cash flows from financing activities:
Proceeds from issuance of common stock
Payments of dividends (affiliates $13.9, $15.2 and $15.2, 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
Supplemental disclosures:
Interest paid (affiliates $0.7, $0.7 and $0.7, respectively)
Federal income taxes (received) paid
P
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Year ended December 31
2012
2011
As adjusted
2010
As adjusted
(see Note 1)
(see Note 1)
$
10.7
$
(160.7)
$
24.4
7.1
3.5
(29.0)
-
(1.4)
(4.6)
16.0
(9.8)
35.1
11.4
-
12.3
(75.5)
(261.4)
(285.6)
(540.4)
(143.0)
(1.1)
257.0
332.8
101.8
0.7
-
1.5
9.3
1.6
(22.3)
(20.7)
(297.0)
356.0
59.0
7.0
(12.4)
$
$
$
5.3
3.2
(37.0)
7.9
0.8
(9.9)
(7.0)
97.6
93.0
(70.2)
-
50.9
-
69.1
43.0
(369.7)
(92.6)
(1.2)
327.2
167.6
180.9
20.8
13.2
-
246.2
2.6
(24.1)
(21.5)
267.7
88.3
356.0
7.0
(2.3)
$
$
$
8.8
3.7
(14.9)
(23.1)
2.3
5.6
1.5
1.2
56.8
67.6
0.3
(6.5)
-
3.7
131.4
(546.2)
(87.4)
(21.2)
369.3
93.6
86.0
0.9
(7.5)
(0.1)
(112.6)
3.2
(24.0)
(20.8)
(2.0)
90.3
88.3
7.0
6.2
$
$
$
See accompanying notes to consolidated financial statements.
State Auto Financial Corporation
61
8596_FinC1.pdf
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
Through Stateco, the Company provides investment management
services to affiliated companies.
518 PML owns and leases property to the Company’s affiliates.
a. Principles of Consolidation
c. Basis of Presentation
The consolidated financial statements include State Auto Financial
Corporation (“State Auto Financial”), an Ohio corporation, and the
following wholly owned subsidiaries of State Auto Financial:
• State Auto Property and Casualty Insurance Company (“State Auto
P&C”), an Iowa corporation
The consolidated financial statements have been prepared in
conformity with U.S. generally accepted accounting principles
(“GAAP”), which vary in certain respects from statutory accounting
practices (“SAP”) followed by State Auto P&C, Milbank and SA Ohio
that are prescribed or permitted by the Departments.
• Milbank Insurance Company (“Milbank”), an Iowa corporation
• State Auto Insurance Company of Ohio (“SA Ohio”), an Ohio
corporation
• Stateco Financial Services, Inc. (“Stateco”), an Ohio corporation
The consolidated financial statements also include the operations and
financial position of 518 Property Management and Leasing, LLC
(“518 PML”), an Ohio limited liability company whose members are
State Auto P&C and Stateco. The consolidated financials include the
assets and liabilities, as well as, the operations of Farmers Casualty
Insurance Company, which was merged with State Auto P&C at the
close of business December 31, 2012. The consolidated financial
statements also include the operations of State Auto National
Insurance Company (“SA National”), an Ohio corporation and a wholly
owned subsidiary of State Auto Financial through December 31, 2010,
the date SA National was sold to a third party.
State Auto Financial is a majority-owned subsidiary of State
Automobile Mutual Insurance Company (“State Auto Mutual”), an Ohio
corporation. State Auto Financial and its subsidiaries are referred to
herein as the “Company.” All significant intercompany balances and
transactions have been eliminated in consolidation.
On December 31, 2010, State Auto Financial sold SA National to a
third party for $14.0 million. In 2010, SA National wrote approximately
$37.0 million in direct written premium, with 80% (or approximately
$30.0 million) retained by the Company under the Pooling
Arrangement (see Note 6). Included in net realized gain (loss) on
investments for the year ended December 31, 2010 was a $3.9 million
net gain on the sale of SA National.
b. Description of Business
The Company markets its insurance products throughout the United
States primarily through independent agencies, which include retail
agencies and wholesale brokers. The Company’s principal lines of
insurance include personal and commercial automobile, homeowners,
commercial multi-peril, workers’ compensation, general liability and
fire insurance. State Auto P&C, Milbank and SA Ohio 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 underwriting activity and geographic distribution
of State Auto Mutual and its affiliates is generally the same as the
underwriting activity and geographic distribution of the Company.
Through the employees of State Auto P&C, the Company provides
management and operation services under management agreements
for all of its insurance and non-insurance affiliates.
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 and the realization of deferred tax assets. In
connection with the determination of losses and loss expenses
payable, management uses historical data, current business
conditions and assumptions about future conditions to formulate
estimates of the ultimate cost to settle claims. Deferred tax assets are
evaluated periodically by management to determine if they are
realizable, requiring management to make certain judgments and
assumptions. In evaluating the ability to recover deferred tax assets,
management considers 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 other comprehensive income. These estimates by their
nature are subject to uncertainties for various reasons.
d. Investments
Investments in fixed maturities, equity securities and certain other
invested assets are classified as available-for-sale and 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
income (loss) and, as such, are not included in the determination of
net income (loss). Realized gains and losses on the sales of
investments are computed using the first-in, first-out method.
The Company regularly monitors its investments that have fair values
less than cost or amortized cost for signs of other-than-temporary
impairment, 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. 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, and intent to sell including 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 other comprehensive income (loss).
Future increases or decreases in fair value, if not other-than-
temporary, are included in other comprehensive income (loss).
62
State Auto Financial Corporation
8596_FinC1.pdf
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
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
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 other comprehensive
income (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 Acquisition Costs
Acquisition costs, consisting of commissions, premium taxes and
certain underwriting expenses related to the successful acquisition or
renewing 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 acquisition costs. See 1.k New Accounting
Standards below.
The following table sets forth net deferred acquisition costs for the years ended December 31, 2012, 2011 and 2010:
($ millions)
Balance, beginning of year
Effect of January 1, 2011 and 2010 pooling changes
Acquisition costs deferred
Acquisition costs amortized to expense
Effect of December 31, 2011 pooling change
Balance, end of year
$
2012
91.7
-
213.1
(213.1)
-
2011
As adjusted
2010
As adjusted
$
118.5
8.3
266.6
(274.4)
(27.3)
$
95.6
(0.2)
236.9
(213.8)
-
$
91.7
$
91.7
$
118.5
P
A
R
T
I
I
g. Federal Income Taxes
The Company files a consolidated federal income tax return. 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 other comprehensive income (loss). Deferred tax
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.
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 prorata over the policy 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.
h. Losses and Loss Expenses Payable
k. New Accounting Standards
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 $25.7 million and
$25.5 million at December 31, 2012 and 2011, 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
Adoption of Recent Accounting Pronouncements
Accounting for Costs Associated with Acquiring or Renewing
Insurance Contracts
In October 2010, the Financial Accounting Standards Board (“FASB”)
issued updated guidance to address diversity in practice for the
accounting of costs associated with acquiring or renewing insurance
contracts. This guidance modifies the definition of acquisition costs to
specify that a cost be directly related to the successful acquisition of a
State Auto Financial Corporation
63
8596_FinC1.pdf
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
new or renewal insurance contract in order to be deferred. The Company
adopted this guidance, with retrospective application, at January 1, 2012.
The cumulative effect of this retrospective adoption reduced
stockholders’
equity by $20.5 million, after-tax, at January 1, 2010. Previously reported
financial information has been revised to reflect the effect of the
Company’s adoption of this accounting standard.
The effect of adoption of this new guidance on the Company’s consolidated balance sheet as of December 31, 2011, 2010 and 2009 was as
follows:
($ in millions)
December 31, 2011:
Deferred policy acquisition costs
Other liabilities
Net deferred federal income taxes
Retained earnings
Stockholders’ equity
December 31, 2010:
Deferred policy acquisition costs
Net deferred federal income taxes
Retained earnings
Stockholders’ equity
December 31, 2009:
Retained earnings
Stockholders’ equity
As
Previously
Reported
Effect of
Change
As
Adjusted
$ 118.1
76.6
0.5
565.2
758.3
$ (26.4)
8.1
-
(34.5)
(34.5)
$ 91.7
84.7
0.5
530.7
723.8
$ 150.2
(86.3)
736.1
851.8
$ (31.7)
(11.1)
(20.6)
(20.6)
$ 118.5
(97.4)
715.5
831.2
$ 735.6
849.4
$ (20.5)
(20.5)
$ 715.1
828.9
This adoption did not have any impact on cash flows from operating activities on the Company’s consolidated statements of cash flows.
The effect of adoption of this new guidance on the consolidated statements of income and comprehensive income (loss) for the years ended
December 31, 2011 and 2010 was as follows:
($ in millions, except per share amounts)
Acquisition and operating expenses
Income tax expense
Net loss
Comprehensive loss
Loss per share:
Basic
Diluted
($ in millions, except per share amounts)
Acquisition and operating expenses
Income tax expense
Net income
Comprehensive income
Earnings per share:
Basic
Diluted
For the Year Ended
December 31, 2011
As
Previously
Reported
$ 482.2
37.5
(146.8)
(75.1)
Effect of
Change
As
Adjusted
$
2.8
11.1
(13.9)
(13.9)
$ 485.0
48.6
(160.7)
(89.0)
$ (3.65)
$ (3.65)
$ (0.35)
$ (0.35)
$ (4.00)
$ (4.00)
For the Year Ended
December 31, 2010
As
Previously
Reported
$ 424.4
-
24.5
19.5
Effect of
Change
As
Adjusted
$ 0.1
-
(0.1)
(0.1)
$ 424.5
-
24.4
19.4
$
$
0.61
0.62
$
$
-
-
$ 0.61
$ 0.62
Amendments to Achieve Common Fair Value Measurement and
Disclosure Requirements in U.S. GAAP and IFRS
The amendments in this guidance result in common fair value
measurement and disclosure requirements in GAAP and International
Financial Reporting Standards. Consequently, the amendments in the
guidance change the wording used to describe many of the
requirements in GAAP for measuring fair value and for disclosing
information about fair value measurements. For many of the
requirements, the FASB does not intend for the amendments in the
guidance to result in a change in the application of the requirements in
the Fair Value Measurements Topic. The guidance also clarifies the
FASB’s intent about the application of existing fair value measurement
requirements as well as changes to a particular principle or
requirement for measuring fair value or for disclosing information
about fair value measurements. The Company adopted this guidance
at January 1, 2012 and it did not have a material impact on the
consolidated financial statements.
64
State Auto Financial Corporation
8596_FinC1.pdf
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Pending Adoption of Accounting Pronouncements
Reporting of Amounts Reclassified Out of Accumulated Other
Comprehensive Income
The amendments in this guidance result in additional disclosure
requirements under GAAP and do not change the current
requirements for reporting net income or other comprehensive income
in financial statements. The new guidance requires an entity to
present, either in a single note, or, parenthetically on the face of the
statement where net income is presented, the effects of significant
amounts reclassified from each component of accumulated other
comprehensive income by the respective line items of net income,
only, if the amount reclassified is required under GAAP to be
reclassified to net income in its entirety in the same reporting period. If
a component is not required to be reclassified to net income in its
entirety, the entity would, instead, cross-reference it to the related
disclosure required under GAAP. This guidance is effective
prospectively for fiscal years and interim periods beginning after
December 15, 2012, early adoption is permitted. The Company
adopted this guidance at January 1, 2013, and it did not have a
material impact on the consolidated financial statements.
2. INVESTMENTS
The following tables set forth the cost or amortized cost and fair value of available-for-sale securities by lot at December 31, 2012 and 2011:
($ millions)
At December 31, 2012:
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 securities
Total fixed maturities
Equity securities:
Large-cap securities
Small-cap securities
Total equity securities
Other invested assets
Total available-for-sale securities
($ millions)
At December 31, 2011:
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 securities
Total fixed maturities
Equity securities:
Large-cap securities
Small-cap securities
Total equity securities
Other invested assets
Total available-for-sale securities
P
A
R
T
I
I
Cost or
amortized
cost
Gross
unrealized
holding
gains
Gross
unrealized
holding
losses
$
$
328.2
750.4
320.5
377.1
$
38.3
50.3
19.2
24.0
1,776.2
131.8
152.6
43.6
196.2
49.0
25.0
10.6
35.6
15.4
$ 2,021.4
$ 182.8
$
-
(0.4)
(1.1)
(1.4)
(2.9)
(3.4)
-
(3.4)
-
(6.3)
Fair
value
$
366.5
800.3
338.6
399.7
1,905.1
174.2
54.2
228.4
64.4
$ 2,197.9
Cost or
amortized
cost
Gross
unrealized
holding
gains
Gross
unrealized
holding
losses
$
$
433.8
761.3
231.4
390.8
$
35.0
50.0
13.7
20.3
1,817.3
119.0
106.4
35.3
141.7
48.6
18.9
9.9
28.8
8.6
$ 2,007.6
$ 156.4
$
(0.1)
(0.1)
(0.3)
(0.9)
(1.4)
(3.2)
-
(3.2)
-
(4.6)
Fair
value
$
468.7
811.2
244.8
410.2
1,934.9
122.1
45.2
167.3
57.2
$ 2,159.4
8596_FinC1.pdf
State Auto Financial Corporation
65
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
The following tables set forth 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, 2012 and 2011:
Less than 12 months
12 months or more
Total
Fair
value
Unrealized
losses
Number
of
positions
Fair
value
Unrealized
losses
Number
of
positions
Fair
value
Unrealized
losses
Number
of
positions
$
7.0
$
-
47.4
80.4
23.3
158.1
23.7
(0.4)
(1.1)
(0.3)
(1.8)
(2.1)
2
12
17
6
37
4
41
$
$
-
-
-
-
-
-
34.8
34.8
8.9
(1.1)
(1.1)
(1.3)
$ 43.7
$
(2.4)
-
-
-
13
13
5
18
$
7.0
$
-
47.4
80.4
58.1
192.9
32.6
(0.4)
(1.1)
(1.4)
(2.9)
(3.4)
$ 225.5
$
(6.3)
2
12
17
19
50
9
59
Less than 12 months
12 months or more
Total
Fair
value
Unrealized
losses
Number
of
positions
Fair
value
Unrealized
losses
Number
of
positions
Fair
value
Unrealized
losses
Number
of
positions
securities
$ 181.8
$
(3.9)
($ millions, except # of positions)
At December 31, 2012:
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 securities
Total fixed maturities
Large-cap equity securities :
Total temporarily impaired
($ millions, except # of positions)
At December 31, 2011:
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 securities
Total fixed maturities
Large-cap equity securities
Total temporarily impaired
$
5.0
$
-
8.9
23.0
18.3
55.2
19.3
(0.1)
(0.3)
(0.1)
(0.5)
(3.0)
1
4
9
4
18
9
27
$
9.0
$
(0.1)
2.1
-
35.3
46.4
2.7
-
-
(0.8)
(0.9)
(0.2)
$ 49.1
$
(1.1)
3
1
-
13
17
1
18
$ 14.0
$
(0.1)
11.0
23.0
53.6
101.6
22.0
(0.1)
(0.3)
(0.9)
(1.4)
(3.2)
$ 123.6
$
(4.6)
4
5
9
17
35
10
45
securities
$ 74.5
$
(3.5)
The following table sets forth the realized losses related to other-than-
temporary impairments on the Company’s investment portfolio
recognized for the years ended December 31, 2012, 2011 and 2010:
The following table sets forth the amortized cost and fair value of
available-for-sale fixed maturities by contractual maturity at
December 31, 2012:
($ millions)
2012
2011
2010
Equity securities:
Large-cap securities
Small-cap securities
Fixed maturities
Other invested assets
$
-
(3.2)
(0.2)
-
$ (1.0)
(5.6)
-
-
$ (0.3)
(3.3)
-
(0.5)
Total other-than-temporary
impairments
$ (3.4)
$ (6.6)
$ (4.1)
($ 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
$
47.3
286.8
463.4
601.6
377.1
$
47.9
306.9
502.9
647.7
399.7
Total
$ 1,776.2
$ 1,905.1
The Company reviewed its investments at December 31, 2012, and
determined no additional other-than-temporary impairment exists in
the gross unrealized holding losses.
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.
66
State Auto Financial Corporation
8596_FinC1.pdf
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Fixed maturities with fair values of approximately $10.0 million and
$9.9 million were on deposit with insurance regulators as required by
law at December 31, 2012 and 2011, respectively.
The following table sets forth the components of net investment
income for the years ended December 31, 2012, 2011 and 2010:
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 2012, 2011 and
2010 were $435.3 million, $369.3 million and $180.5 million,
respectively.
($ millions)
Fixed maturities
Equity securities
Cash and cash equivalents, and
other
Investment income
Investment expenses
2012
2011
2010
$ 66.9
4.9
$ 77.0
4.9
$ 71.7
5.4
5.6
77.4
2.0
5.7
87.6
2.2
5.8
82.9
2.1
Net investment income
$ 75.4
$ 85.4
$ 80.8
The following table sets forth the realized and unrealized holding gains (losses) on the Company’s investment portfolio for the years ended
December 31, 2012, 2011 and 2010:
($ millions)
Realized gains:
Fixed maturities
Equity securities
Other invested assets
Total realized gains
Realized losses:
Equity securities:
Sales
OTTI
Fixed maturities—OTTI
Other invested assets—OTTI
Total realized losses
Net realized gain (loss) on investments
Change in unrealized holding gains (losses), net of tax:
Fixed maturities
Equity securities
Other invested assets
Deferred federal income liability thereon
Valuation allowance
Change in net unrealized holding gains, net of tax
P
A
R
T
I
I
2012
2011
2010
$
$
$
$
15.7
19.0
0.1
34.8
(2.6)
(3.2)
(0.2)
-
(6.0)
28.8
11.3
6.6
6.8
(8.6)
9.2
25.3
$
$
$
$
$
$
4.4
41.7
3.9
50.0
(5.3)
(6.6)
-
-
(11.9)
38.1
79.2
(30.4)
(6.7)
(14.7)
-
$
27.4
$
2.4
15.8
-
18.2
(3.1)
(3.6)
-
(0.5)
(7.2)
11.0
(5.3)
21.6
7.1
(8.2)
-
15.2
There was a deferred federal income tax liability on the net unrealized
holding gains at December 31, 2012 and 2011 of $52.5 million, net of
a valuation allowance of $9.2 million, and $53.1 million, respectively.
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. The Company’s
processes and control procedures are designed to ensure the price is
accurately recorded on an unadjusted basis. Through discussions with
the pricing service, the Company obtains 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, the Company compares
the valuations received to other fair value pricing from other
independent pricing sources. At December 31, 2012 and 2011, the
Company did not adjust any of the prices received from the pricing
service.
Transfers between levels may occur due to changes in the availability
of market observable inputs. Transfers in and out of levels are
reported as having occurred at the beginning of the quarter in which
the transfer occurred. There were no transfers between levels during
the years ended December 31, 2012 and 2011.
8596_FinC1.pdf
State Auto Financial Corporation
67
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
The following sections describe the valuation methods used by the
Company for each type of financial instrument carried at fair value.
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.
The fixed maturity portfolio pricing obtained from the pricing service is
reviewed for reasonableness. Regularly, samples of security prices
are referred back to the pricing service for more detailed explanation
as to how the pricing service arrived at that particular price. The
explanations are reviewed for reasonableness by the portfolio
manager or investment officer. Additionally, the prices and
assumptions are verified against an alternative pricing source for
reasonableness and accuracy. Any discrepancies with the pricing are
returned to the pricing service for further explanation and if necessary,
adjustments are made. To date, the Company has not identified any
significant discrepancies in the pricing provided by its third party
pricing service. Investments valued using these inputs include U.S.
treasury securities and obligations of U.S. government agencies,
obligations of states and political subdivisions, corporate securities
(except for two securities discussed below), and U.S. government
agencies residential mortgage-backed securities. 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. If
market inputs are unavailable, then no fair value is provided by the
pricing service. For these securities, fair value is determined either by
requesting brokers who are knowledgeable about these securities to
provide a quote; or the Company internally determines the fair values
by employing widely accepted pricing valuation models, and
depending on the level of observable market inputs, renders the fair
value estimate as Level 2 or Level 3.
The Company estimates the fair values of two fixed maturity corporate
securities using the present value of the future cash flows and broker
quotes. Due to the limited amount of observable market information
for both of these securities, the Company includes the fair value
estimates 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 had
a fair value of $59.0 million and $52.6 million at December 31, 2012
and 2011, respectively, which was determined using each fund’s net
asset value. 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. The funds are
disclosed in 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 remainder of the Company’s other invested assets consist of
holdings in publicly-traded mutual funds. The Company believes that
its prices for these publicly-traded mutual funds based on an
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 set forth the Company’s available-for-sale investments within the fair value hierarchy at December 31, 2012 and 2011:
Quoted prices
in active
markets for
identical
assets
(Level 1)
Significant
other
observable
inputs
(Level 2)
Significant
unobservable
inputs
(Level 3)
Total
$
366.5
800.3
338.6
399.7
1,905.1
174.2
54.2
228.4
64.4
$ 2,197.9
$
$
-
-
-
-
-
174.2
54.2
228.4
5.4
233.8
$
$
366.5
800.3
330.1
399.7
1,896.6
-
-
-
59.0
-
-
8.5
-
8.5
-
-
-
-
$ 1,955.6
$
8.5
($ millions)
At December 31, 2012:
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 securities
Total fixed maturities
Equity securities:
Large-cap securities
Small-cap securities
Total equity securities
Other invested assets
Total available-for-sale investments
68
State Auto Financial Corporation
8596_FinC1.pdf
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
($ millions)
At December 31, 2011:
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 securities
Total fixed maturities
Equity securities:
Large-cap securities
Small-cap securities
Total equity securities
Other invested assets
Total available-for-sale investments
Quoted prices
in active
markets for
identical
assets
(Level 1)
Significant
other
observable
inputs
(Level 2)
Significant
unobservable
inputs
(Level 3)
Total
$
468.7
811.2
244.8
410.2
1,934.9
122.1
45.2
167.3
57.2
$ 2,159.4
$
$
-
-
-
-
-
122.1
45.2
167.3
4.6
171.9
$
$
468.7
811.2
241.9
410.2
1,932.0
-
-
-
52.6
-
-
2.9
-
2.9
-
-
-
-
$ 1,984.6
$
2.9
For assets measured at fair value on a recurring basis using
significant unobservable inputs (Level 3), the following tables set forth
a reconciliation of the beginning and ending balances for 2012 and
2011, separately for each major category of assets:
($ millions)
Balance at January 1, 2012
Total realized gains (losses)—included in earnings
Total unrealized gains (losses)—included in other
Fixed
maturities
$
2.9
(0.2)
comprehensive income
Purchases
Sales
Transfers into Level 3
Transfers out of Level 3
Balance at December 31, 2012
$
-
5.8
-
-
-
8.5
($ millions)
Balance at January 1, 2011
Total realized gains (losses)—included in earnings
Total unrealized gains (losses)—included in other
comprehensive income
Purchases
Sales
Transfers into Level 3
Transfers out of Level 3
Balance at December 31, 2011
P
A
R
T
I
I
Fixed
maturities
$
2.7
-
-
0.6
(0.4)
-
-
$
2.9
Financial Instruments Disclosed, But Not Carried, At Fair Value
Notes Receivable from Affiliates
In May 2009, the Company entered into two separate credit agreements with State Auto Mutual pursuant to which it loaned State Auto Mutual a
total of $70.0 million. The Company estimates the fair value of the notes receivable from affiliate using market quotations for U.S. treasury
securities with similar maturity dates and applies an appropriate credit spread. Consequently this has been placed in Level 2 of the fair value
hierarchy.
($ millions, except interest rates)
Notes receivable from affiliate
Notes Payable
December 31, 2012
Fair
value
Carrying
value
Interest
rate
December 31, 2011
Fair
value
Carrying
value
Interest
rate
$ 70.0
$ 78.3
7.00% $ 70.0
$ 77.5
7.00%
Included in notes payable are Senior Notes and Subordinated Debentures. The fair value of the Senior Notes is based on the observable market
price and has been disclosed in Level 2. The carrying amount of the Subordinated Debentures approximates its fair value as the interest rate
adjusts quarterly and has been disclosed in Level 3.
($ 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
Total notes payable
December 31, 2012
December 31, 2011
Carrying
value
Fair
Value
Interest
rate
Carrying
value
Fair
value
Interest
rate
$ 100.4
$ 100.3
6.25% $ 100.9
$ 100.3
6.25%
15.5
15.5
4.51
15.5
15.5
4.73
$ 115.9
$ 115.8
$ 116.4
$ 115.8
State Auto Financial Corporation
69
8596_FinC1.pdf
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
The following table sets forth the Company’s assets and liabilities within the fair value hierarchy at December 31, 2012:
($ millions)
At December 31, 2012:
Assets:
Notes receivable from affiliate
Liabilities:
Senior Notes
Affiliate Subordinated Debentures
Total liabilities
4. LOSSES AND LOSS EXPENSES PAYABLE
Quoted prices
in active
markets for
identical
assets
(Level 1)
Significant
other
observable
inputs
(Level 2)
Significant
unobservable
inputs
(Level 3)
Total
$
78.3
$
100.3
15.5
$ 115.8
$
-
-
-
-
$
78.3
$
-
100.3
-
$ 100.3
$
-
15.5
15.5
The following table sets forth the activity in the liability for losses and loss expenses for the years ended December 31, 2012, 2011 and 2010:
($ millions)
Losses and loss expenses payable, at beginning of year
Less: reinsurance recoverable on losses and loss expenses payable
$
Net balance at beginning of year
Impact of pooling changes, January 1, 2010 and 2011 (Note 6a)
Incurred related to:
Current year
Prior years
Total incurred
Paid related to:
Current year
Prior years
Total paid
Impact of pooling change, December 31, 2011 (Note 6a)
Net balance at end of year
Plus: reinsurance recoverable on losses and loss expenses payable
2012
907.1
25.5
881.6
-
795.2
(16.9)
778.3
397.2
334.0
731.2
-
928.7
13.5
$
2011
893.0
18.8
874.2
124.1
1,213.3
(33.3)
1,180.0
724.2
369.1
1,093.3
(203.4)
881.6
25.5
$
2010
840.2
20.8
819.4
(4.0)
954.2
(64.6)
889.6
543.9
286.9
830.8
-
874.2
18.8
Losses and loss expenses payable, at end of year (affiliates $435.1, $376.8 and $375.8,
respectively)
$
942.2
$
907.1
$
893.0
The Company recorded favorable development related to prior years
loss and loss expense reserves in 2012, 2011 and 2010 of
$16.9 million, $33.3 million and $64.6 million, respectively. Favorable
development of unallocated loss adjustment expenses contributed
approximately $6.3 million of the 2012 development, while $10.4 million
was attributable to favorable development on catastrophe reserves
from accident year 2011. The personal and business insurance
segments non-catastrophe loss and ALAE reserves accounted for
$28.0 million of favorable development related to the latest three
accident years, primarily in the personal auto liability, other & product
liability, and fire & allied lines with $10.5 million, $9.4 million and
$5.1 million of favorable development, respectively. The favorable
development in these lines was driven by emergence of lower than
anticipated claim severity. The specialty insurance segment
non-catastrophe loss and ALAE reserves accounted for $27.8 million of
adverse development related to the latest two accident years, which
was driven by RED reserve strengthening.
Favorable development on prior years loss adjustment expense
reserves contributed approximately $7.6 million of the 2011
development, while $4.3 million was attributable to favorable
development on catastrophe reserves. The personal and business
insurance segments non-catastrophe loss and ALAE reserves
accounted for $28.1 million of favorable development in 2011,
primarily in the homeowners, commercial multi-peril and fire & allied
lines with $14.2 million, $6.1 million and $4.9 million of favorable
development, respectively. The favorable development in these lines
was driven by emergence of lower than anticipated claim severity,
primarily from accident years 2010 and 2009 as well as, to a lesser
extent, the past five accident years in the commercial multi-peril line of
business. The specialty insurance segment non-catastrophe loss and
ALAE reserves accounted for $6.7 million of adverse development in
2011, which was driven by greater than anticipated large losses in the
commercial auto line of business and reserve increases on certain life
time disability claims in the workers’ compensation line of business.
Favorable prior years development of loss adjustment expenses
contributed approximately $12.7 million of the 2010 development. Of
the remaining favorable development in 2010, $10.7 million,
$10.4 million and $9.0 million was attributable to auto liability, both
personal and commercial, homeowners and fire & allied lines,
respectively. The favorable development in these lines was driven by
emergence of lower than anticipated claim severity, as well as lower
than anticipated claim frequency for fire & allied lines. Much of the
favorable development was attributable to the 2009 and, to a lesser
extent, 2008 accident years.
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
70
State Auto Financial Corporation
8596_FinC1.pdf
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
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.
On December 31, 2011, the State Auto Group entered into the
Homeowners Quota Share Arrangement, which is a three-year quota
share agreement covering its homeowners book of business. Under
this arrangement, the State Auto Group cedes to reinsurers 75% of its
homeowners business under policies in force at the effective date and
new and renewal policies thereafter issued during the term of the
agreement. The arrangement remains in place until December 31,
2014. A reinsurer may terminate its participation in the arrangement
upon the occurrence of certain events, including, without limitation, the
following: the policyholders’ surplus of the State Auto Group has been
reduced by more than 25% from the amount of its surplus as of
September 30, 2011; or the State Auto Group has been assigned an
A.M. Best’s rating below A-. As of December 31, 2012 the State Auto
Group was in compliance with the terms of the arrangement. Under
the arrangement, the State Auto Group will receive a 29.0%
commission on all premiums ceded to the reinsurers during the term
of the agreement. Subject to the terms and conditions of the
arrangement, the State Auto Group may receive a profit commission.
On December 31, 2011 the Company transferred $106.3 million of
unearned premium related to this arrangement. The amount of ceding
commission is limited to the amount of deferred acquisition costs that
would have been deferred if not for entering in the arrangement. The
Company has recorded $8.4 million and $9.4 million of excess ceding
commission as a deferred liability on the consolidated balance sheet
at December 31, 2012 and 2011, respectively.
The following table sets forth the effect of the Company’s external
reinsurance on its balance sheets at December 31, 2012 and 2011,
prior to the reinsurance transaction with State Auto Mutual under the
Pooling Arrangement, as discussed in Note 6a:
($ millions)
Losses and loss expenses payable:
Direct
Assumed
Ceded
December 31
2012
2011
$ 499.4
7.7
(13.5)
$ 517.7
12.6
(25.5)
P
A
R
T
I
I
Net losses and loss expenses payable
$ 493.6
504.8
Unearned premiums:
Direct
Assumed
Ceded
$ 398.7
1.0
(3.9)
370.7
1.1
(7.9)
Net unearned premiums
$ 395.8
$ 363.9
The following table sets forth the effect of the Company’s external reinsurance on its income statements for the years ended December 31,
2012, 2011 and 2010, prior to the reinsurance transaction with State Auto Mutual under the Pooling Arrangement, as discussed in Note 6a:
($ millions)
Written premiums:
Direct
Assumed
Ceded
Net written premiums
Earned premiums:
Direct
Assumed
Ceded
Net earned premiums
Losses and loss expenses incurred:
Direct
Assumed
Ceded
Net losses and loss expenses incurred
$
575.7
8596_FinC1.pdf
Year ended December 31
2012
2011
2010
$
$
$
$
$
860.1
4.0
(24.3)
839.8
833.3
4.1
(28.2)
809.2
578.5
3.6
(6.4)
$
814.4
8.7
(26.9)
796.2
812.1
18.2
(26.7)
803.6
716.2
12.6
(25.8)
703.0
$
852.8
3.4
(27.3)
828.9
842.1
3.5
(26.8)
818.8
589.2
2.4
(6.1)
585.5
State Auto Financial Corporation
71
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
6. TRANSACTIONS WITH AFFILIATES
a. Reinsurance
The insurance subsidiaries of State Auto Financial participate 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”), Meridian Citizens Mutual Insurance Company (“Meridian
Citizens Mutual”), Meridian Security Insurance Company (“Meridian
Security”) which includes State Auto Florida Insurance Company and
Beacon National Insurance Company as these companies were
merged with Meridian Security at the close of business on
December 31, 2012, Patrons Mutual Insurance Company of
Connecticut (“Patrons Mutual”) and Litchfield Mutual Fire Insurance
Company (“Litchfield”). State Auto P&C, Milbank and SA Ohio are
referred to as the “STFC Pooled Companies,” and State Auto Mutual,
SA Wisconsin, Meridian Citizens Mutual, Meridian Security, Patrons
Mutual and Litchfield are referred to as the “Mutual Pooled
Companies.” The STFC Pooled Companies, the Mutual Pooled
Companies, including the Rockhill Insurers (defined below), are
collectively referred to as the “State Auto Group.”
As of January 1, 2011, the Pooling Arrangement was amended to add
Rockhill Insurance Company (“Rockhill”), Plaza Insurance Company
(“Plaza”), American Compensation Insurance Company (“American
Compensation”) and Bloomington Compensation Insurance Company
(“Bloomington Compensation”) to the pool. Rockhill, Plaza, American
Compensation and Bloomington Compensation are referred to as the
“Rockhill Insurers.” In conjunction with this amendment, the STFC
Pooled Companies received $149.8 million ($69.1 million in cash and
$80.7 million in investment securities) from the Rockhill Insurers for
net insurance liabilities transferred on January 1, 2011. The following
table sets forth the impact on the Company’s balance sheet at
January 1, 2011, relating to this amendment:
($ millions)
Losses and loss expenses payable
Unearned premiums
Other liabilities
Less:
Deferred acquisition costs
(Decrease)/
Increase
$ 124.1
34.1
(0.1)
8.3
Net cash and investment securities received
$ 149.8
On December 31, 2011, the Pooling Arrangement was amended to
reduce the overall participation percentage of the STFC Pooled
Companies from 80% to 65% and to include the pooling of applicable
balance sheet accounts such as applicable accumulated other
comprehensive income related to employee benefit plans. In
conjunction with this amendment, the STFC Pooled Companies paid
$261.4 million in cash to the Mutual Pooled Companies in the first
quarter 2012 for the net liabilities transferred on December 31, 2011.
The following table sets forth the impact on the Company’s balance
sheet at December 31, 2011, relating to this amendment:
As of January 1, 2010, the Pooling Arrangement was amended to add
SA National to the pool and to include voluntary assumed reinsurance
from third parties unaffiliated with the pool participants that was
assumed on or after January 1, 2010. In conjunction with this
amendment, the STFC Pooled Companies received $3.7 million in
cash for net insurance assets transferred on January 1, 2010. The
following table sets forth the impact on the Company’s balance sheet
at January 1, 2010, relating to this amendment:
($ millions)
Losses and loss expenses payable
Unearned premiums
Other liabilities
Less:
Deferred acquisition costs
Other assets
Net cash received
(Decrease)/
Increase
$
(4.0)
(1.4)
(0.6)
(0.2)
(9.5)
$
3.7
In general, under the Pooling Arrangement, the STFC Pooled
Companies and the Mutual Pooled Companies other than State Auto
Mutual 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. 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
(Excellent).
The following table sets forth the reinsurance transactions on the
Company’s balance sheets for the Pooling Arrangement between the
STFC Pooled Companies and State Auto Mutual at December 31,
2012 and 2011:
($ millions)
Losses and loss expenses payable:
Ceded
Assumed
Net assumed
Unearned premiums:
December 31
2012
2011
$
$
$
$
(493.6)
928.7
435.1
(395.8)
477.7
81.9
$
$
$
$
(504.8)
881.6
376.8
(363.9)
462.3
98.4
($ millions)
Losses and loss expenses payable
Unearned premiums
Pension and postretirement liabilities
Other liabilities
Accumulated other comprehensive income
Less:
Deferred acquisition costs
Other assets
Net cash paid
(Decrease)/
Increase
Ceded
Assumed
Net assumed
$ (203.4)
(106.8)
(52.3)
22.1
59.1
(27.3)
7.4
$ (261.4)
72
State Auto Financial Corporation
8596_FinC1.pdf
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
The following table sets forth the reinsurance transactions on the Company’s income statements for the Pooling Arrangement between the
STFC Pooled Companies and State Auto Mutual for the years ended December 31, 2012, 2011 and 2010:
($ millions)
Written premiums:
Ceded
Assumed
Earned premiums:
Ceded
Assumed
Losses and loss expenses incurred:
Ceded
Assumed
Year ended December 31
2012
2011
2010
$
$
$
(839.9)
1,055.3
(809.2)
1,042.1
(575.7)
779.4
$
$
$
(796.2)
1,284.6
(803.6)
1,428.8
(701.0)
1,177.7
$
$
$
(828.9)
1,323.5
(818.8)
1,257.2
(579.1)
883.2
Intercompany Balances
c. Notes Receivable
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,
2012 and 2011 is approximately $269.3 million and $268.5 million,
respectively.
b. Notes Payable
In May 2003, State Auto Financial formed a Delaware business trust
(the “Capital Trust”) to issue $15.0 million of mandatorily redeemable
preferred capital securities to a third party and $0.5 million of common
securities to State Auto Financial (the capital and common securities
are collectively referred to as the “Trust Securities”). The Capital Trust
loaned $15.5 million, the 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 and interest accrued
thereon are the Capital Trust’s only assets. Interest on the Trust
Securities are payable quarterly at a rate equal to the three-month
LIBOR rate plus 4.20% adjusted quarterly (total 4.51% at
December 31, 2012). Because 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, 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 2008.
State Auto Financial has unconditionally and irrevocably guaranteed
payment of any required distributions on the capital securities, the
redemption price when the capital securities are to be 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. 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.
See Note 7.
In May 2009, the Company entered into two separate credit
agreements with State Auto Mutual pursuant to which it loaned State
Auto Mutual a total of $70.0 million. Interest is payable semi-annually
at a fixed annual interest rate of 7.00%, with the principal payable in
May 2019. There is no prepayment penalty, and no collateral was
given as security for the payment of this loan.
Under these agreements, State Auto Financial earned interest of $4.9
million for each of the three years ended December 31, 2012, 2011
and 2010, respectively. See Note 3 for the notes receivable fair value
discussion.
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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
$2.9 million, $1.9 million and $1.6 million in 2012, 2011 and 2010,
respectively, and is included in other income (affiliates) on the
consolidated statements of income.
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. See Note 3 for the
Senior Notes fair value discussion.
State Auto Financial has a $100.0 million unsecured revolving credit
facility with a syndicate of lenders which matures in September 2016
(the “Credit Facility”). During the term of the Credit Facility, State Auto
Financial has the right to increase the total facility to a maximum
amount of $150.0 million, provided that no event of default has
occurred and is continuing. The Credit Facility is available for general
corporate purposes and provides for interest-only payments during its
term, with principal and interest due in full at maturity. Interest is
based on LIBOR or a base rate plus a calculated margin amount. The
Credit Facility includes certain covenants, including financial
covenants that require the Company to maintain a minimum net worth
and not exceed a certain debt to capitalization ratio. As of
December 31, 2012, the Company had not made any borrowings and
was in compliance with all covenants related to the Credit Facility.
State Auto Financial Corporation
73
8596_FinC1.pdf
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
8. FEDERAL INCOME TAXES
The following table sets forth the reconciliation between actual federal income tax expense (benefit) and the amount computed at the indicated
statutory rate for the years ended December 31, 2012, 2011 and 2010:
($ millions)
2012
2011
2010
As adjusted % As adjusted %
Amount at statutory rate
Tax-exempt interest and dividends received deduction
Patient Protection and Affordable Care Act, Medicare Part D exemption repeal
Other, net
Valuation allowance
Federal income tax (benefit) expense and effective rate
$ 3.7
(9.1)
-
0.5
4.8
$ (0.1)
$
(39.2)
(10.8)
-
(4.7)
103.3
$
35
10
-
4
(92)
8.5
(12.9)
4.4
-
-
(1)
$
48.6
(43) $
-
35
(53)
18
-
-
-
%
35
(85)
-
4
45
The following table sets forth the tax effects of temporary differences that give rise to significant portions of deferred tax assets and deferred tax
liabilities at December 31, 2012 and 2011:
($ millions)
Deferred tax assets:
Unearned premiums not currently deductible
Losses and loss expenses payable discounting
Postretirement and pension benefits
Realized loss on other-than-temporary impairment
Other liabilities
Net operating loss carryforward
Tax credit carryforward
Other
Total deferred tax assets
Deferred tax liabilities:
Deferral of policy acquisition costs
Net unrealized holding gains on investments
Total deferred tax liabilities
Total net deferred tax assets before valuation allowance
Less valuation allowance
Net deferred federal 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 bases. The
Company periodically evaluates its deferred tax assets, which
requires significant judgment, to determine if they are realizable based
upon weighing all available evidence, both positive and negative,
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
making such judgments, significant weight is given to evidence that
can be objectively verified.
During 2011, the Company determined that a valuation allowance
should be established due to the magnitude of the catastrophe losses
from unprecedented storms experienced industry wide. At December
31, 2012 and 2011, the Company recorded a valuation allowance of
$100.5 million and $103.3 million, respectively. The deferred income
tax asset remaining after recognition of the valuation allowance
represents a deferred tax asset on the gross unrealized fixed maturity
losses where management determined this portion of the asset to be
realizable due to management’s assertion that it has both the ability
and intent to hold these securities through recovery or maturity.
In future periods the Company will re-assess its judgments and
assumptions regarding the realization of its net deferred tax assets,
but until such time the positive evidence exceeds the negative
74
State Auto Financial Corporation
8596_FinC1.pdf
December 31,
2012
December 31,
2011
As adjusted
$
$
33.4
25.2
39.4
7.5
14.5
66.5
0.9
7.9
195.3
32.1
61.7
93.8
101.5
100.5
1.0
$
$
32.4
25.0
39.4
11.4
14.9
56.0
0.7
9.2
189.0
32.1
53.1
85.2
103.8
103.3
0.5
evidence the Company will maintain a valuation allowance against its
net deferred tax assets.
At December 31, 2012, $52.0 million of the Company’s net operating
loss carryforwards, if not used will expire in 2031 with the remaining
expiring in 2032.
At December 31, 2012, the Company carried no balance for uncertain
tax positions. The Company had no accrual for the payment of interest
and penalties at December 31, 2012 or 2011.
State Auto Financial and its subsidiaries file a consolidated U.S.
federal income tax return. State Auto Financial 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 2009. The federal income tax audit for
the 2008 and 2009 returns was concluded in 2012 with an additional
refund of $1.1 million.
9. PENSION AND POSTRETIREMENT BENEFIT PLANS
The Company, through the 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 including the Pooling Arrangement for
insurance subsidiaries and affiliates party to this agreement.
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
The Company provides a defined benefit pension plan for its eligible
employees. Substantially all Company employees hired prior to
January 1, 2010 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.
The Company also provides a postretirement benefit plan including
certain health care and life insurance benefits for certain eligible
retired employees. On November 4, 2011, the postretirement benefit
plan was amended to change eligibility requirements for participation
of employees and certain retirees, resulting in a $93.8 million negative
plan amendment. In addition, a curtailment gain resulted and the
Company’s portion recognized was $14.9 million.
The defined benefit pension and postretirement benefit plans are
referred to herein as “the benefit plans.”
The following table sets forth information regarding the pension and postretirement benefit plans’ change in benefit obligation, plan assets and
funded status at December 31, 2012 and 2011:
($ millions)
Change in benefit obligation:
Benefit obligation at beginning of year
Plan amendments
Service cost
Interest cost
Actuarial loss (gain)
Benefits paid
Impact of pooling change, December 31, 2011
The Company’s portion of benefit obligation at end of year
Change in plan assets available for plan benefits:
Fair value of plan assets available for plan benefits at beginning of year
Employer contribution
Actual return on plan assets
Benefits paid
Impact of pooling change, December 31, 2011
The Company’s portion of fair value of plan assets at end of year
Supplemental executive retirement plan
Funded status at end of year
Accumulated benefit obligation end of year
Pension
Postretirement
2012
2011
2012
2011
$
$
$
$
$
$
229.6
-
7.8
9.9
10.6
(11.8)
-
246.1
147.7
13.0
13.3
(11.8)
-
162.2
(5.8)
(89.7)
223.0
$
$
$
$
$
$
282.8
-
10.5
15.2
52.5
(16.0)
(115.4)
229.6
219.6
15.0
8.6
(16.0)
(79.5)
147.7
(5.6)
(87.5)
207.1
$
$
$
$
$
27.1
-
-
1.1
(1.6)
(1.5)
-
25.1
1.8
-
-
-
-
1.8
-
(23.3)
$
$
$
$
$
119.4
(93.8)
5.2
5.7
7.4
(2.3)
(14.5)
27.1
2.7
-
0.1
-
(1.0)
1.8
-
(25.3)
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No assets are expected to be returned during the fiscal year ending
December 31, 2012.
The following table sets forth the Company’s share of amortization
expected to be recognized for the year ending December 31, 2013:
The following table sets forth the Company’s share of the amounts
included in accumulated other comprehensive income (loss) that have
not been recognized in net periodic cost at December 31, 2012 and
2011:
($ millions)
Prior service benefit
Net actuarial loss
Total
($ millions)
Prior service benefit
Net actuarial loss
Total
December 31
2012
(75.6)
135.7
60.1
$
$
2011
(80.9)
136.2
55.3
$
$
2013
$
$
(5.3)
9.0
3.7
The following table sets forth information regarding the Company’s share of pension and postretirement benefit plans’ components of net
periodic cost for the years ended December 31, 2012, 2011 and 2010:
($ millions)
Components of net periodic cost:
Service cost
Interest cost
Expected return on plan assets
Amortization of prior service cost (benefit)
Amortization of net actuarial loss
Net periodic cost (benefit)
Curtailment gain
Net periodic cost (benefit)
8596_FinC1.pdf
$
2012
7.8
9.9
(11.7)
0.3
6.7
13.0
-
Pension
2011
$
8.5
12.3
(14.6)
0.3
7.0
13.5
-
Postretirement
2010
2012
2011
2010
$
8.7
12.0
(13.9)
0.3
7.7
14.8
-
$
-
1.1
(0.1)
(5.5)
1.1
(3.4)
-
$
4.1
5.1
(0.2)
(2.1)
0.3
7.2
-
$
3.7
5.0
(0.2)
(1.4)
0.1
7.2
(1.6)
$ 13.0
$ 13.5
$ 14.8
$ (3.4)
$
7.2
$
5.6
State Auto Financial Corporation
75
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
The following table sets forth the Company’s share of the benefit payments, which reflect expected future service, expected to be paid:
($ millions)
2013
2014
2015
2016
2017
2018 – 2022
Pension Postretirement
$ 8.5
8.8
9.2
9.7
10.2
62.8
$2.0
2.0
2.0
1.9
1.9
8.5
The postretirement plan’s gross benefit payments for 2012 were
$2.7 million, including the prescription drug benefits. The
postretirement plan’s subsidy related to Medicare Prescription Drug
Improvement and Modernization Act of 2003 was $0.5 million for 2012
and estimates future annual subsidies to be approximately $0.3
million.
The following table sets forth the weighted average assumptions used to determine the benefit plans’ obligations at December 31, 2012 and
2011:
Benefit obligations weighted-average assumptions:
Discount rate
Rates of increase in compensation levels
Pension
Postretirement
2012
2011
2012
2011
4.05%
4.00
4.40%
4.00
4.05%
-
4.40%
-
The following table sets forth the weighted average assumptions used to determine the benefit plans’ net periodic cost for the years ended
December 31, 2012, 2011 and 2010:
Weighted-average assumptions:
Discount rate
Expected long-term rate of return on assets
Rates of increase in compensation levels
Pension
Postretirement
2012
2011
2010
2012
2011
2010
4.40%
7.50
4.00
5.50%
8.00
4.00
6.00%/
5.75%(2)
8.00
4.00
4.40%
7.50
-
5.50%/
4.75%(1)
8.00
-
6.00%
8.00
-
(1) Due to the curtailment resulting from the postretirement benefit plan amendment, the expense was remeasured at November 1, 2011, using discount rate of
4.75%.
(2) Due to the curtailment resulting from the employee one-time pension benefit election, the expense was remeasured at May 31, 2010, using discount rate of
5.75%.
The benefit plans’ obligations are long-term in nature and
consequently the investment strategies have a long-term time horizon.
In establishing the long-term rate of return assumption on plan assets,
management, along with its pension consulting actuary, reviews the
historical performance of the plan assets and the stability in the mix of
the investment portfolio. The expected inflation rate and expected real
rates of return of applicable asset classes are then determined to
assist in setting appropriate assumptions.
The following table sets forth the assumed health care cost trend rates used for the years ended December 31, 2012, 2011 and 2010:
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
2012
2011
2010
10.00%
5.00%
2017
10.00%
5.00%
2016
10.00%
5.00%
2015
The assumed health care cost trend rates have a significant effect on the amounts reported for the postretirement plan. The following table sets
forth the effects of a one percentage point change in assumed health care cost trend rates for the year ended December 31, 2012:
($ millions)
One percentage point change:
Effect on total service and interest cost
Effect on accumulated postretirement benefit obligation
Postretirement
Increase
(Decrease)
$0.1
3.2
$(0.1)
(2.8)
76
State Auto Financial Corporation
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STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
The benefit plans’ investment policy objective is to preserve the
investment principal while generating income and appreciation in fair
value to meet the benefit plans’ obligations. The benefit plans’
investment strategy and risk tolerance is balanced between meeting
cash obligation requirements and a long-term relatively high risk
tolerance. Since the nature and timing of the benefit plans’ liabilities
and cash requirements are predictable, the liquidity requirements are
somewhat moderate. One of the goals of diversifying the benefit
plans’ portfolio among different asset classes is the elimination of
concentration of risk in one asset class. Management has investment
policy guidelines with respect to limiting the ownership in any single
debt or equity issuer, and the international private equity investments
are composed of numerous securities to reduce our exposure to a
single issuer. The following table sets forth the asset allocation
targets, as a percentage of total fair value, which are used as a guide
by management when allocating funds as they become available.
Asset Category:
Fixed maturity
U.S. large-cap equity
U.S. small-cap equity
International equity
Emerging market equity
Total
Asset
allocation
target
(0 to 100%)
36%
33
14
12
5
100%
See Note 3 for the valuation methods used by the Company for each
type of financial instrument the plans hold that are carried at fair value.
There were no transfers between level categorizations during the
years ended December 31, 2012 and 2011.
The following tables set forth the Company’s share of pension plan’s available-for-sale securities within the fair value hierarchy at December 31,
2012 and 2011:
($ millions)
At December 31, 2012:
Fixed maturities:
U.S. treasury securities and obligations of U.S. government agencies
Corporate securities
U.S. government agencies mortgage-backed securities
Total fixed maturities
Equity securities:
Large-cap securities
Small-cap securities
Total equity securities
International instruments
Short-term money market funds
Total pension plan investments
($ millions)
At December 31, 2011:
Fixed maturities:
U.S. treasury securities and obligations of U.S. government agencies
Corporate securities
U.S. government agencies mortgage-backed securities
Total fixed maturities
Equity securities:
Large-cap securities
Small-cap securities
Total equity securities
International instruments
Short-term money market funds
Total pension plan investments
Quoted prices
in active
markets for
identical assets
(Level 1)
Significant
other
observable
inputs
(Level 2)
Significant
unobservable
inputs
(Level 3)
P
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I
-
-
-
-
60.8
24.1
84.9
-
4.1
89.0
30.4
7.4
13.9
51.7
-
-
-
20.0
-
71.7
-
-
-
-
-
-
-
-
-
-
Quoted prices
in active
markets for
identical assets
(Level 1)
Significant
other
observable
inputs
(Level 2)
Significant
unobservable
inputs
(Level 3)
-
-
-
-
51.5
20.7
72.2
-
3.8
76.0
25.2
10.9
17.8
53.9
-
-
-
15.9
-
69.8
-
-
-
-
-
-
-
-
-
-
Total
$ 30.4
7.4
13.9
51.7
60.8
24.1
84.9
20.0
4.1
$160.7
Total
$ 25.2
10.9
17.8
53.9
51.5
20.7
72.2
15.9
3.8
$145.8
8596_FinC1.pdf
State Auto Financial Corporation
77
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
The following tables set forth the Company’s share of the postretirement plan’s available-for-sale securities within the fair value hierarchy at
December 31, 2012 and 2011:
($ millions)
At December 31, 2012:
Fixed maturities:
U.S. treasury securities and obligations of U.S. government agencies
Corporate securities
Total fixed maturities
Equity securities:
Large-cap securities
Total equity securities
Short-term money market funds
Total postretirement plan investments
($ millions)
At December 31, 2011:
Fixed maturities:
U.S. treasury securities and obligations of U.S. government agencies
Corporate securities
Total fixed maturities
Short-term money market funds
Total postretirement plan investments
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. The Company’s share of expected contributions during
2013 is approximately $13.0 million.
Quoted prices
in active
markets for
identical assets
(Level 1)
Significant
other
observable
inputs
(Level 2)
Significant
unobservable
inputs
(Level 3)
-
-
-
0.7
0.7
0.5
1.2
0.5
0.2
0.7
-
-
-
0.7
-
-
-
-
-
-
-
Quoted prices
in active
markets for
identical assets
(Level 1)
Significant
other
observable
inputs
(Level 2)
Significant
unobservable
inputs
(Level 3)
-
-
-
0.2
0.2
1.4
0.2
1.6
-
1.6
-
-
-
-
-
Total
$0.5
0.2
0.7
0.7
0.7
0.5
$1.9
Total
$1.4
0.2
1.6
0.2
$1.8
The Company’s share of the expense under the plan totaled $4.5
million, $4.8 million and $3.3 million for 2012, 2011 and 2010,
respectively.
10. STOCKHOLDERS’ EQUITY
a. Dividend Restrictions and Statutory Financial
Information
The Company maintains a defined contribution plan that covers
substantially all employees of the Company. 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. In
addition, the Company contributes a percentage of the employee’s
annual income for those employees hired on or after January 1, 2010,
and for those employees hired prior to January 1, 2010 who chose to
freeze their existing accrued pension benefit effective June 30, 2010.
State Auto P&C, Milbank and SA Ohio are subject to regulations and
restrictions under which payment of dividends from statutory surplus
can be made to State Auto Financial during the year without prior
approval of regulatory authorities. Pursuant to these rules,
approximately $62.6 million is available for payment to State Auto
Financial from its insurance subsidiaries in 2013 without prior
approval. State Auto Financial received dividends from its insurance
subsidiaries in the amount of $20.0 million, $0 and $56.4 million in
2012, 2011 and 2010, respectively.
The following tables set forth reconciliations of statutory capital and surplus and net income, as determined using SAP, to the amounts included
in the accompanying consolidated financial statements:
($ millions)
Statutory capital and surplus of insurance subsidiaries
Net liabilities of non-insurance parent and affiliates
Increases (decreases):
Deferred acquisition costs
Postretirement and pension benefits
Deferred federal income taxes
Fixed maturities at fair value
Other, net
Stockholders’ equity per accompanying consolidated financial statements
78
State Auto Financial Corporation
8596_FinC1.pdf
2012
2011
As adjusted
$630.1
(74.8)
555.3
91.7
6.6
(38.0)
128.5
(6.9)
$737.2
622.3
(74.2)
548.1
91.7
4.6
(33.4)
117.0
(4.2)
723.8
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
($ millions)
Statutory net income (loss) of insurance subsidiaries
Net income of non-insurance parent and affiliates
(Decreases) increases:
Deferred acquisition costs
Postretirement and pension benefits
Deferred federal income taxes
Share-based compensation expense
Other, net
Year ended December 31
2012
2011
2010
As adjusted
As adjusted
$ 5.5
0.2
5.7
-
5.3
(3.3)
(2.7)
5.7
(64.6)
1.9
(62.7)
(26.8)
(2.5)
(59.5)
(2.9)
(6.3)
16.9
2.3
19.2
22.8
(18.4)
4.7
(3.0)
(0.9)
24.4
Net income(loss) per accompanying consolidated financial statements
$10.7
(160.7)
11. PREFERRED STOCK
Equity Plan
P
A
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T
I
I
State Auto Financial has two authorized 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.
The Class A preferred stock is not entitled to voting rights until, for any
period, dividends are in arrears in the amount of six or more quarterly
dividends.
12. SHARE-BASED COMPENSATION
The Company maintains share-based compensation plans for key
employees and outside, or non-employee, directors. The share-based
compensation plan for key employees is the State Auto Financial
Corporation 2009 Equity Compensation Plan (the “Equity Plan”). This
plan replaced the previous equity plan which expired 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 the 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.
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,
2012, a total of 0.5 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
2012, 2011 and 2010 were 0.3 million, 0.6 million and 0.6 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.
The following table sets forth the status of the Company’s non-vested and vested restricted shares and changes for the years ended
December 31, 2012, 2011 and 2010:
Outstanding, beginning of year
Granted
Vested
Outstanding, end of year
8596_FinC1.pdf
2012
2011
2010
Weighted
Average
Grant
Date Fair
Value
$17.92
13.53
-
$16.21
Weighted
Average
Grant
Date Fair
Value
$18.78
17.03
-
$17.92
Weighted
Average
Grant
Date Fair
Value
$29.98
18.78
29.98
$18.78
Shares
32,000
17,180
(32,000)
17,180
Shares
17,180
16,707
-
33,887
Shares
33,887
21,526
-
55,413
State Auto Financial Corporation
79
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
As of December 31, 2012, there was $0.3 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 2.25 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, 2012, a total of 3.0 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
currently provides each outside director with an award of 1,400
restricted share units (the “RSU award”) following each annual
meeting of shareholders. The amount of the award may change from
year to year, based on the provision described below. The RSU
awards are fully vested upon grant. RSU awards are not common
shares of the Company and, as such, no participant has any rights as
a holder of common shares under the RSU Plan. RSU awards
represent the right to receive an amount, payable in cash or common
shares of the Company, as previously elected by the outside director,
equal to the value of a specified number of common shares of the
Company at the end of the restricted period. Such election may be
changed within the constraints set forth in the RSU Plan. The
restricted period for the RSU awards begins on the date of grant and
expires on the date the outside director retires from or otherwise
terminates service as a director of the Company. During the restricted
period, outside directors are credited with dividends, equivalent in
value to those declared and paid on the Company’s common shares,
on all RSU awards granted to them. At the end of the restricted
period, outside directors receive distributions of their RSU awards
either (i) in a single lump sum payment, or (ii) in annual installment
payments over a five- or ten-year period, as previously elected by the
outside director. The administrative committee for the RSU Plan
(currently the Company’s Compensation Committee) retains the right
to increase the annual number of RSU awards granted to each
outside director to as many as 5,000 or to decrease such annual
number to not less than 500, without seeking shareholder approval, if
such increase or decrease is deemed appropriate by the
administrative committee to maintain director compensation at
appropriate levels. The RSU Plan automatically terminates on May 31,
2015. The Company accounts for the RSU Plan as a liability plan.
There were 26,480 RSUs, 23,928 RSUs, and 24,268 RSUs granted in
2012, 2011 and 2010, respectively.
During 2012 and 2011, common shares valued at approximately
$39,000 and $30,000, respectively, were distributed by the Company
under the RSU Plan.
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 2012, 2011
and 2010. 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 share-based awards granted to employees was estimated at the date of grant using the Black-Scholes option-pricing model.
The following table sets forth the weighted average fair values and related assumptions for options granted for the years ended December 31,
2012, 2011 and 2010:
Fair value per share
Expected dividend yield
Risk free interest rate
Expected volatility factor
Expected life in years
2012
$ 3.46
4.41%
1.10%
41.50%
5.4
2011
$ 4.69
3.51%
2.50%
34.90%
6.3
2010
$ 5.40
3.28%
2.50%
36.80%
6.1
The following table sets forth the Company’s total stock option activity and related information for these plans for the years ended December 31,
2012, 2011 and 2010:
(millions, except per share amounts)
2012
2011
2010
Outstanding, beginning of year
Granted
Exercised
Canceled
Outstanding, end of year
Weighted-
Average
Exercise
Price
$22.79
13.54
14.49
17.95
$22.25
Weighted-
Average
Exercise
Price
$23.53
16.98
16.40
18.94
$22.79
Options
3.4
0.6
-
(0.2)
3.8
Options
3.8
0.4
-
(0.3)
3.9
Weighted-
Average
Exercise
Price
$24.02
18.74
14.54
24.73
$23.53
Options
3.1
0.6
(0.2)
(0.1)
3.4
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, 2012, 2011 and 2010, the total
intrinsic value of stock options exercised was $0, $0.1 million
and $1.4 million, respectively. The tax benefit for tax
deductions from share-based awards totaled $0 for the years
ended December 31, 2012 and 2011 and $0.3 million for the
year ended December 31, 2010.
80
State Auto Financial Corporation
8596_FinC1.pdf
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
The following table sets forth information pertaining to the total options outstanding and exercisable at December 31, 2012:
(Options in millions)
Range of Exercise Prices:
$10.01 – $20.00
$20.01 – $30.00
Greater than $30.00
Options Outstanding
Options Exercisable
Weighted-
Average
Remaining
Contractual Life
Weighted-
Average
Exercise
Price
Number
Weighted-
Average
Exercise
Price
6.3
3.8
2.4
4.9
$16.66
27.17
32.11
$22.25
1.1
1.1
0.7
2.9
$17.23
27.26
32.11
$24.29
Number
2.1
1.1
0.7
3.9
Aggregate intrinsic value for total options outstanding at
December 31, 2012 was $3.4 million. Aggregate intrinsic value for
total options exercisable at December 31, 2012 was $0.1 million.
Compensation expense recognized during 2012, 2011 and 2010 was
$3.5 million, $3.2 million and $3.7 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, 2012, there was $2.2 million of total unrecognized
compensation cost related to option-based compensation
arrangements granted under the plans. The remaining cost is
expected to be recognized over a period of three years.
13. NET EARNINGS (LOSS) PER COMMON SHARE
The following table sets forth the compilation of basic and diluted net (loss) earnings per common share for the years ended December 31,
2012, 2011 and 2010:
P
A
R
T
I
I
(millions, except per share amounts)
Numerator:
Net earnings (loss) for basic net earnings per common share
Effect of dilutive share-based awards
Adjusted net earnings (loss) for dilutive net (loss) earnings per common share
Denominator:
Weighted average shares for basic net earnings (loss) per common share
Effect of dilutive share-based awards
Adjusted weighted average shares for diluted net earnings(loss) per common share
Basic net earnings (loss) per common share
Diluted net earnings (loss) per common share
2012
2011
2010
As adjusted As adjusted
$10.7
0.3
$11.0
40.4
0.1
40.5
$0.26
$0.27
(160.7)
-
(160.7)
40.1
0.1
40.2
(4.00)
(4.00)
24.4
0.2
24.6
40.0
0.1
40.1
0.61
0.62
The following table sets forth the options to purchase shares of common stock that were not included in the computation of diluted earnings
(loss) 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 years ended December 31, 2012, 2011 and 2010:
(in millions)
Number of options
14. REPORTABLE SEGMENTS
Effective January 1, 2011, the Company had four reportable
segments: personal insurance, business insurance, specialty
insurance (the “insurance segments”) and investment operations. The
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 personal insurance segment
provides primarily personal automobile and homeowners to the
personal insurance market. The business insurance segment provides
primarily commercial automobile, commercial multi-peril, fire & allied
and general liability insurance covering small-to-medium sized
commercial exposures in the business insurance market. The
specialty insurance segment provides commercial coverages,
including workers’ compensation, that require specialized product
2012
3.7
2011
3.3
2010
2.7
underwriting, claims handling or risk management services through a
distribution channel of retail agents and wholesale brokers, which may
include program administrators and other specialty sources. The
investment operations segment, managed by Stateco, provides
investment services.
Due to internal changes which occurred in 2010, that included
realigning the internal organization to be more strategic in the
personal, business and specialty insurance markets, along with
changes to the Pooling Arrangement as of January, 1, 2011 (see
Note 6), the Company changed its reportable insurance segments
from personal and business insurance to the three insurance
segments described above. No changes were made to the investment
operations segment. Prior reporting periods have been restated to
conform to the new insurance segment presentation.
8596_FinC1.pdf
State Auto Financial Corporation
81
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
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.
The following table sets forth financial information regarding the Company’s reportable segments for the years ended December 31, 2012, 2011
and 2010:
($ millions)
Revenues from external sources:
Insurance segments
Personal insurance
Business insurance
Specialty insurance
Total insurance segments
Investment operations segment
Net investment income
Net realized capital gains
Total investment operations segment
Total revenue from reportable segments
All other
Total revenues from external sources
Intersegment revenues
Total revenues
Reconciling items:
Eliminate intersegment revenues
Total consolidated revenue
Segment loss before federal income tax:
Insurance segments:
Personal insurance SAP underwriting loss
Business insurance SAP underwriting loss
Specialty insurance SAP underwriting loss
Total insurance segments
Investment operations segment:
Net investment income
Net realized capital gains
Total investment operations segment
All other segments income (loss)
Reconciling items:
GAAP adjustments
Interest expense on corporate debt
Corporate expenses
2012
2011
2010
As adjusted
As adjusted
$ 469.8
327.2
245.1
1,042.1
75.4
28.8
104.2
1,146.3
3.8
1,150.1
9.5
1,159.6
800.6
379.0
249.2
798.5
383.5
75.2
1,428.8
1,257.2
85.4
38.1
123.5
1,552.3
1.4
1,553.7
10.5
1,564.2
80.8
11.0
91.8
1,349.0
6.1
1,355.1
9.8
1,364.9
(9.5)
(10.5)
(9.8)
$1,150.1
1,553.7
1,355.1
$
(1.6)
(42.3)
(48.1)
(92.0)
75.4
28.8
104.2
2.0
7.2
(7.0)
(3.8)
(67.4)
(70.9)
(46.6)
(184.9)
85.4
38.1
123.5
(0.5)
(40.7)
(7.1)
(2.4)
(9.3)
(24.0)
(28.5)
(61.8)
80.8
11.0
91.8
0.3
(0.1)
(7.1)
1.3
24.4
Total consolidated income (loss) before federal income taxes
$
10.6
(112.1)
The following table sets forth financial information regarding the Company’s reportable segments at December 31, 2012 and 2011:
($ millions)
Segment assets:
Investment operations segment
Total segment assets
Reconciling items:
Corporate assets
Total consolidated assets
December 31
2012
2011
As adjusted
$2,327.4
$2,585.9
2,327.4
2,585.9
150.4
178.5
$2,477.8
$2,764.4
Assets attributed to the investment operations segment include the
total investments and cash and cash equivalent categories from the
balance sheet. All other assets are corporate assets and are not
assigned to a segment.
82
State Auto Financial Corporation
8596_FinC1.pdf
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
15. QUARTERLY FINANCIAL DATA (UNAUDITED)
The following tables set forth quarterly financial data for 2012 and 2011:
($ millions, except per share amounts)
Total revenues
(Loss) income before federal income taxes
Net (loss) income
Earnings (loss) per common share:
Basic
Diluted
Total revenues
Income (loss) before federal income taxes
Net income (loss)
Earnings (loss) per common share:
Basic
Diluted
16. CONTINGENCIES
The Company is involved in numerous lawsuits arising in the ordinary
course of our business operations arising out of or otherwise related
to its insurance policies. Certain of these lawsuits allege extra-
contractual damages. These lawsuits are in various stages of
development. The Company will generally contest these matters
vigorously but may pursue settlement if appropriate. The Company
considers all such litigation in establishing its loss and loss adjustment
expense reserves. Based on currently available information, the
Company does not believe it is reasonably possible that any such
lawsuit or related lawsuits will be material to its results of operations or
have a material adverse effect on its consolidated financial or cash
flow positions.
Additionally, from time to time the Company may be involved in
lawsuits arising in the ordinary course of business but not arising out
of or otherwise related to its insurance policies. Based on currently
available information, the Company does not believe it is reasonably
possible that any such lawsuit or related lawsuits will be material to its
2012
For three months ended
March 31
June 30
September 30
December 31
$280.3
(2.0)
(2.0)
$ (0.05)
$ (0.05)
286.7
(2.7)
(2.7)
(0.07)
(0.07)
286.4
(5.6)
(5.5)
(0.14)
(0.14)
296.7
20.9
20.9
0.52
0.51
2011
For three months ended
March 31
June 30
September 30
December 31
As adjusted
As adjusted
As adjusted
As adjusted
$380.2
15.6
12.8
$ 0.32
$ 0.32
384.4
(139.3)
(214.1)
(5.33)
(5.33)
388.0
(52.0)
(58.7)
(1.46)
(1.46)
401.1
63.6
99.3
2.47
2.46
P
A
R
T
I
I
results of operations or have a material adverse effect on its
consolidated financial or cash flow position.
In accordance with the Contingencies Topic of the FASB ASC, the
Company accrues for a litigation-related liability when it is probable
that such a liability has been incurred and the amount can be
reasonably estimated. Based on currently available information known
to the Company, the Company believes that its reserves for litigation-
related liabilities are reasonable. Given the inherent uncertainty
surrounding the ultimate resolution of these legal proceedings, an
adverse outcome could have a material impact to the Company’s
results of operations in a future period, though in the opinion of the
Company’s management, none would likely have a material adverse
effect on its consolidated financial or cash flow position.
Additionally, the Company may be impacted by adverse regulatory
actions and adverse court decisions where insurance coverages are
expanded beyond the scope originally contemplated in its 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 or its cash flow position.
8596_FinC1.pdf
State Auto Financial Corporation
83
Item 9. Changes in and Disagreements with
Accountants on Accounting and Financial
Disclosure
None.
Item 9A. Controls and Procedures
MANAGEMENT’S ANNUAL REPORT ON INTERNAL CONTROL OVER
FINANCIAL REPORTING
Our management’s annual report on internal control over financial
reporting required by Item 308(a) of Regulation S-K follows. The
attestation report of our independent registered public accounting firm
required by Item 308(b) of Regulation S-K is found under the caption
“Report of the Independent Registered Public Accounting Firm 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,
2012, 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.
84
State Auto Financial Corporation
8596_FinC1.pdf
PART III
Item 11. Executive Compensation
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 2013 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.
Our 2013 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.
We have a separately-designated standing Audit Committee
established in accordance with Section 3(a)(58)(A) of the Exchange
Act. As of March 8, 2013, the members of our Audit Committee were
Eileen A. Mallesch, Alexander B. Trevor, David R. Meuse, Thomas E.
Markert and Paul S. Williams. Ms. Mallesch is Chairperson of our
Audit Committee. Our Board of Directors has determined that
Ms. Mallesch 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 2013 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
2013 Proxy Statement. There has been no material change to the
nomination procedures previously disclosed in the proxy statement for
our 2013 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 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 2013 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 2013 Proxy Statement,
which information is incorporated herein by reference.
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 2013 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 2013 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 2013 Proxy
Statement, which information is incorporated herein by reference.
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PART IV
Item 15. Exhibits and Financial Statement Schedules
(A)(1) LISTING OF FINANCIAL STATEMENTS
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, 2012 and 2011
Consolidated Statements of Income for each of the three years in the period ended December 31, 2012
Consolidated Statements of Comprehensive Income (Loss) for each of the three years in the period ended December 31, 2012
Consolidated Statements of Stockholders’ Equity for each of the three years in the period ended December 31, 2012
Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2012
Notes to Consolidated Financial Statements
(A)(2) LISTING OF FINANCIAL STATEMENT SCHEDULES
The following financial statement schedules of the Company for the years 2012, 2011 and 2010 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.
V.
Summary of Investments—Other Than Investments in Related Parties
Condensed Financial Information of Registrant
Supplementary Insurance Information
Reinsurance
Valuation and Qualifying Accounts
Schedule
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.
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(A)(3) LISTING OF EXHIBITS
Exhibit
No.
3.01
3.02
3.03
3.04
3.05
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
Included herein
State Auto Financial Corporation’s Amendment to the Amended
and Restated Articles of Incorporation
1933 Act Registration Statement No. 33-89400 on Form S-8
(see Exhibit 4(b) therein)
State Auto Financial Corporation Certificate of Amendment to
the Amended and Restated Articles of Incorporation as of
June 2, 1998
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
Included herein
First Amendment to State Auto Financial Corporation’s
Amended and Restated Code of Regulations as of May 7, 2010
Form 10-Q Quarterly Report for the period ended
September 30, 2010 (see Exhibit 3.05 therein)
10.01*
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)
10.02*
10.03*
10.04*
10.05*
10.06*
10.07*
10.08
10.09
10.10
10.11
10.12
10.13
10.14
10.15
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)
Fourth Amendment to 2000 Directors Stock 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
Form 8-K Current Report filed on March 13, 2008 (see
Exhibit 10.3 therein)
Investment Management Agreement between Stateco Financial
Services, Inc. and State Automobile Mutual Insurance
Company, effective April 1, 1993
First Amendment to the Investment Management Agreement
between Stateco Financial Services, Inc. and State Automobile
Mutual Insurance Company, effective January 1, 2013
Amended and Restated Exhibit A to the Investment
Management Agreement between Stateco Financial Services,
Inc. and State Automobile Mutual Insurance Company, effective
January 1, 2013
Investment Management Agreement between Stateco Financial
Services, Inc. and Meridian Security Insurance Company,
effective June 1, 2001
Amended and Restated Exhibit A to the Investment
Management Agreement between Stateco Financial Services,
Inc. and Meridian Security Insurance Company, effective
January 1, 2013
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
Amended and Restated Exhibit A to the Investment
Management Agreement between Stateco Financial Services,
Inc. and Midwest Security Insurance Company, effective
January 1, 2013
Form 10-K Annual Report for the year ended December 31,
1992 (see Exhibit 10 (N) therein)
Included herein
Included herein
Form 10-K Annual Report for the year ended December 31,
2005 (see Exhibit 10.17 therein)
Included herein
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)
Included herein
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Exhibit
No.
10.16
10.17
10.18
10.19
10.20
10.21
10.22
10.23
10.24
10.25
10.26
10.27
10.28
10.29
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 Meridian Citizens Mutual Insurance Company
effective June 1, 2001
Amended and Restated Exhibit A to the Investment
Management Agreement between Stateco Financial Services,
Inc. and Meridian Citizens Mutual Insurance Company, effective
January 1, 2013
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
Amended and Restated Investment Management Agreement
dated as of December 31, 2007, among Stateco Financial
Services, Inc. and Patrons Mutual Insurance Company of
Connecticut, Patrons Fire Insurance Company of Rhode Island,
and Provision State Insurance Company
Amended and Restated Investment Management Agreement
dated as of December 31, 2007, between Stateco Financial
Services, Inc. and Litchfield Mutual Fire Insurance Company
Investment Management Agreement between Stateco Financial
Services, Inc. and Plaza Insurance Company effective
October 1, 2010
Form 10-K Annual Report for the year ended December 31,
2005 (see Exhibit 10.20 therein)
Included herein
Form 10-Q Quarterly Report for the period ended March 31,
2007 (see Exhibit 10.63 therein)
Form 10-K Annual Report for the year ended December 31,
2007 (see Exhibit 10.22 therein)
Form 10-K Annual Report for the year ended December 31,
2007 (see Exhibit 10.23 therein)
Form 10-K Annual Report for year ended December 31, 2010
(see Exhibit 10.26 therein)
Amended and Restated Exhibit A to the Investment
Management Agreement between Stateco Financial Services,
Inc. and Plaza Insurance Company, effective January 1, 2013
Included herein
Investment Management Agreement between Stateco Financial
Services, Inc. and Rockhill Insurance Company effective
October 1, 2010
Form 10-K Annual Report for year ended December 31, 2010
(see Exhibit 10.27 therein)
Amended and Restated Exhibit A to the Investment
Management Agreement between Stateco Financial Services,
Inc. and Rockhill Insurance Company, effective January 1, 2013
Included herein
Investment Management Agreement between Stateco Financial
Services, Inc. and American Compensation Insurance Company
and Bloomington Compensation Insurance Company effective
October 1, 2010
Amended and Restated Exhibit A to the Investment
Management Agreement between Stateco Financial Services,
Inc. and American Compensation Insurance Company and
Bloomington Compensation Insurance Company, effective
January 1, 2013
Cost Sharing Agreement among State Auto Property and
Casualty Insurance Company, State Automobile Mutual
Insurance Company, and State Auto Florida Insurance
Company effective January 1, 2003
Renewal of Cost Sharing Agreement among State Auto
Property & Casualty Insurance Company, State Automobile
Mutual Insurance Company and BroadStreet Capital Partners,
Inc. effective March 31, 2008
Midwest Security Insurance Company Management Agreement
amended and restated as of January 1, 2000 by and among
State Automobile Mutual Insurance Company, State Auto
Property and Casualty Insurance Company and Midwest
Security Insurance Company (nka State Auto Insurance
Company of Wisconsin)
Form 10-K Annual Report for year ended December 31, 2010
(see Exhibit 10.28) therein)
Included herein
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 10.29 therein)
Form 10-K Annual Report for the year ended December 31,
2005 (see Exhibit 10.45 therein)
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Description of Exhibit
If incorporated by reference document with which Exhibit was
previously filed with SEC
Management and Operations Agreement, Amended and
Restated as of January 1, 2005 by and among State Automobile
Mutual Insurance Company, State Auto Financial Corporation,
State Auto Property and Casualty Insurance 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, Inc.,
Strategic Insurance Software, Inc., and 518 Property
Management and Leasing, LLC
First Amendment, made as of April 1, 2007, to Management and
Operations Agreement Amended and Restated as of January 1,
2005, by and among State Automobile Mutual Insurance
Company, State Auto Financial Corporation, State Auto
Property and Casualty Insurance 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, 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, First Preferred Insurance Company, and
Petrolia Insurance Company
Second Amendment dated as of December 31, 2008, to the
Management 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 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, 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
Third Amendment, effective as of December 31, 2010, to the
Management 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 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, 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 and Litchfield Mutual
Fire Insurance Company
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.
Form 10-Q Quarterly Report for the period ended March 31,
2005 (see Exhibit10.56 therein)
Form 10-Q Quarterly Report for the period ended June 30, 2007
(see Exhibit 66.67 therein)
Form 8-K Current Report filed on January 27, 2009 (see Exhibit
10.1 therein)
Form 10-K Annual Report for year ended December 31, 2010
(see Exhibit 10.36 therein)
Form 10-Q Quarterly Report for the period ended September
30, 2009 (see Exhibit 10.01 therein)
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Exhibit
No.
10.30
10.31
10.32
10.33
10.34
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Exhibit
No.
10.35
10.36
10.37
10.38
10.39
10.40
Description of Exhibit
If incorporated by reference document with which Exhibit was
previously filed with SEC
Included herein
Form 8-K Current Report filed on November 25, 2009 (see
Exhibit 10.1 therein)
Form 8-K Current Report filed on February 16, 2010 (see
Exhibit 10.3 therein)
Form 8-K Current Report filed on January 7, 2011 (see
Exhibit 10.2 therein)
Included herein
Form 8-K Current Report filed on February 16, 2010 (see
Exhibit 10.1 therein)
Amended and Restated Appendix B , effective as of January 1,
2013, to the Consulting Service 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 Insurance Company, and Risk Evaluation
and Design, LLC
Management and Operations Agreement, 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 Insurance Company, Rockhill
Insurance Company, Plaza Insurance Company, American
Compensation Insurance Company, Bloomington
Compensation Insurance Company, Rockhill 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
Amended and Restated Management and Operations
Agreement, effective as of January 1, 2011, by and among
State Auto Property & Casualty Insurance Company, State
Automobile Mutual Insurance Company, Rockhill Insurance
Company, Plaza Insurance Company, American Compensation
Insurance Company, Bloomington Compensation Insurance
Company, Rockhill Holding Company, National Environmental
Coverage Corporation of the South, LLC, National
Environmental Coverage Corporation, RTW, Inc., Rockhill
Insurance Services, LLC and Rockhill Underwriting
Management, LLC.
First Amendment, effective as of January 1, 2013, to Amended
and Restated Management and Operations Agreement,
effective as of January 1, 2011 by and among State Auto
Property & Casualty Insurance Company, State Automobile
Mutual Insurance Company, Rockhill Insurance Company,
Plaza Insurance Company, American Compensation Insurance
Company, Bloomington Compensation Insurance Company,
Rockhill Holding Company, National Environmental Coverage
Corporation of the South, LLC, National Environmental
Coverage Corporation, RTW, Inc., Rockhill Insurance Services,
LLC and Rockhill Underwriting Management, LLC.
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 Insurance
Company, State Auto Florida Insurance Company, Meridian
Security Insurance Company, Meridian Citizens Mutual
Insurance Company, Patrons Mutual Insurance Company of
Connecticut, Litchfield Mutual Fire Insurance Company, and
Beacon National Insurance Company
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Exhibit
No.
10.41
10.42
10.43
10.44
10.45
10.46
10.47
10.48
Description of Exhibit
If incorporated by reference document with which Exhibit was
previously filed with SEC
First Amendment, effective December 31, 2010, to Reinsurance
Pooling Agreement Amended and Restated as of January 1,
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 Florida Insurance
Company, Meridian Security Insurance Company, Meridian
Citizens Mutual Insurance Company, Patrons Mutual Insurance
Company of Connecticut, Litchfield Mutual Fire Insurance
Company, and Beacon National Insurance Company
Reinsurance Pooling Agreement Amended and Restated as of
January 1, 2011, entered into as of January 3, 2011, 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
Company, Meridian Security Insurance Company, Meridian
Citizens Mutual Insurance Company, Patrons Mutual Insurance
Company of Connecticut, Litchfield Mutual Fire Insurance
Company, Beacon National Insurance Company, Rockhill
Insurance Company, Plaza Insurance Company, American
Compensation Insurance Company and Bloomington
Compensation Insurance Company
First Amendment, effective December 31, 2011, to Reinsurance
Pooling Agreement Amended and Restated as of January 1,
2011 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
Company, Meridian Security Insurance Company, Meridian
Citizens Mutual Insurance Company, Patrons Mutual Insurance
Company of Connecticut, Litchfield Mutual Fire Insurance
Company, Beacon National Insurance Company, Rockhill
Insurance Company, Plaza Insurance Company, American
Compensation Insurance Company and Bloomington
Compensation Insurance Company
Homeowners Quota Share Reinsurance Contract between
State Automobile Mutual Insurance Company (on behalf of itself
and insurance subsidiaries and affiliates now under its
ownership, control or management, including insurance
subsidiaries of State Auto Financial Corporation) and a
syndicate of reinsurers effective December 31, 2011 at
11:59 p.m.
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 10-K Annual Report for year ended December 31, 2010
(see Exhibit 10.49 therein)
Form 8-K Current Report filed on January 7, 2011 (see
Exhibit 10.1 therein)
Form 10-K Annual Report for year ended December 31, 2011
(see Exhibit 10.45 therein)
Form 10-K Annual Report for year ended December 31, 2011
(see Exhibit 10.46 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)
Indenture dated as of May 22, 2003, for Floating Rate Junior
Subordinated Debt Securities Due 2033
Form 10-Q Quarterly Report for the period ended June 30, 2003
(see 10(YY) therein)
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
Securities Act Registration Statement on Form S-4
(File No. 333-111507)(see Exhibit 4.01 therein)
10.49
Form of 6 1⁄4% Senior Note due 2013 (Exchange Note)
10.50
Credit Agreement dated as of May 19, 2009, between State
Automobile Mutual Insurance Company, as borrower, and
Milbank Insurance Company, as lender
Securities Act Registration Statement on Form S-4
(File No. 333-111507)(see Exhibit 4.02 therein)
Form 8-K Current Report filed on May 26, 2009 (see
Exhibit 10.1 therein)
State Auto Financial Corporation
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No.
10.51
10.52
10.53*
10.54*
10.55*
10.56*
10.57*
10.58*
10.59*
10.60*
10.61*
10.62*
10.63*
10.64*
10.65*
10.66*
Description of Exhibit
If incorporated by reference document with which Exhibit was
previously filed with SEC
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
Credit Agreement dated as of September 29, 2011, among
State Auto Financial Corporation, as borrower, a syndicate of
financial institutions, as the lenders party thereto, KeyBank
National Association, as Administrative Agent, Lead Arranger,
Sole Book Runner and Swingline Lender, and JPMorgan Chase
Bank, N.A. and PNC BANK, National Association, as Co-
Documentation Agents.
Employment Agreement, dated as of December 20, 2011,
commencing as of January 1, 2012, among State Auto Financial
Corporation, State Auto Property & Casualty Insurance
Company, State Automobile Mutual Insurance Company and
Robert P. Restrepo, Jr.
Executive Agreement dated as of December 20, 2011, among
State Auto Financial Corporation, State Automobile Mutual
Insurance Company and Robert P. Restrepo, Jr.
Employment Agreement (dated as of November 17, 2008),
including Amendment to Employment Agreement (dated as of
November 30, 2010), among Rockhill Holding Company, State
Automobile Mutual Insurance Company and Jessica E. Buss
Executive Change of Control Agreement dated as of October
28, 2011, 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 dated as of
October 28, 2011, among State Auto Financial Corporation,
State Auto Property & Casualty Insurance Company, State
Automobile Mutual Insurance Company and Clyde H. Fitch, Jr
Executive Change of Control Agreement dated as of
October 28, 2011, among State Auto Financial Corporation,
State Auto Property & Casualty Insurance Company, State
Automobile Mutual Insurance Company and James A. Yano
Executive Change of Control Agreement dated as of
October 28, 2011, among State Auto Financial Corporation,
State Auto Property & Casualty Insurance Company, State
Automobile Mutual Insurance Company and Jessica E. Buss
Form 8-K Current Report filed on May 13, 2009 (see
Exhibit 10.1 therein)
Form 8-K Current Report filed on September 30, 2011 (see
Exhibit 10.1 therein)
Form 10-K Annual Report for year ended December 31, 2011
(see Exhibit 10.55 therein)
Form 10-K Annual Report for year ended December 31, 2011
(see Exhibit 10.57 therein)
Form 10-K Annual Report for year ended December 31, 2011
(see Exhibit 10.61 therein)
Form 10-Q Quarterly Report for the period ended
September 30, 2011 (see Exhibit 10.1 therein)
Form 10-Q Quarterly Report for the period ended
September 30, 2011 (see Exhibit 10.2 therein)
Form 10-Q Quarterly Report for the period ended
September 30, 2011 (see Exhibit 10.3 therein)
Form 10-K Annual Report for year ended December 31, 2011
(see Exhibit 10.75 therein)
Form of Indemnification Agreement between State Auto
Financial Corporation and each of its directors
Form 8-K Current Report filed on November 20, 2008 (see
Exhibit 99.1 therein)
Indemnification Agreement dated as of November 14, 2008,
between State Auto Financial Corporation and Robert P.
Restrepo, Jr.
Officer Indemnification Agreement dated as of May 8, 2009,
between State Auto Financial Corporation and Steven E.
English
Officer Indemnification Agreement dated as of May 8, 2009,
between State Auto Financial Corporation and Clyde H. Fitch,
Jr.
Form 8-K Current Report filed on May 13, 2009 (see
Exhibit 10.2 therein)
Form 8-K Current Report filed on May 13, 2009 (see
Exhibit 10.3 therein)
Form 8-K Current Report filed on May 13, 2009 (see
Exhibit 10.5 therein)
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 10.6 therein)
Amended and Restated Equity Incentive Compensation Plan of
State Auto Financial Corporation
Form 10-Q Quarterly Report for the period ended June 30, 2005
(see Exhibit 10.60 therein)
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 10.63 therein)
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Exhibit
No.
10.67*
10.68*
10.69*
10.70*
10.71*
10.72*
10.73*
10.74*
10.75*
10.76*
10.77*
10.78*
10.79*
10.80*
10.81*
10.82*
10.83*
10.84*
10.85*
10.86*
Description of Exhibit
If incorporated by reference document with which Exhibit was
previously filed with SEC
Restricted Share Award Agreement under the Amended and
Restated Equity Incentive 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 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.
Form of Incentive Stock Option Agreement 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-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)
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)
Amendment No. 1 to the 2009 Equity Incentive Compensation
Plan of State Auto Financial Corporation
Form 10-Q Quarterly Report for the period ended June 30, 2011
(see Exhibit 10.01 therein)
Restricted Stock Agreement under the 2009 Equity Incentive
Compensation Plan dated as of March 4, 2010 between State
Auto Financial Corporation and Robert P. Restrepo, Jr.
Restricted Stock Agreement under the 2009 Equity Incentive
Compensation Plan dated March 3, 2011, between State Auto
Financial Corporation and Robert P. Restrepo, Jr.
Restricted Stock Agreement under the 2009 Equity Incentive
Compensation Plan dated March 1, 2012, between State Auto
Financial Corporation and Robert P. Restrepo Jr.
Form 10-Q Quarterly Report for the period ended March 31,
2010 (see Exhibit 10.01 therein)
Form 10-Q Quarterly Report for the period ended March 31,
2011 (see Exhibit 10.01 therein)
Form 8-K Current Report filed on May 10, 2012 (see Exhibit
10.1 therein)
Outside Directors Restricted Share Unit Plan of State Auto
Financial Corporation
Form 10-Q Quarterly Report for the period ended June 30, 2005
(see Exhibit 10.61 therein)
First Amendment to the Outside Directors Restricted Share Unit
Plan of State Auto Financial Corporation
Form 10-K Annual Report for the year ended December 31,
2005 (see Exhibit 10.54 therein)
Second Amendment to the Outside Directors Restricted Share
Unit Plan of State Auto Financial Corporation
Form 10-K Annual Report for the year ended December 31,
2008 (see Exhibit 10.72 therein)
Third Amendment to the Outside Directors Restricted Share
Unit Plan of State Auto Financial Corporation
Form 10-K Annual Report for the year ended December 31,
2008 (see Exhibit 10.73 therein)
Fourth Amendment to the Outside Directors Restricted Share
Unit Plan of State Auto Financial Corporation effective
November 1, 2010
Form of Restricted Share Unit Agreement for the Outside
Directors Restricted Share Unit Plan of State Auto Financial
Corporation
Form 10-K Annual Report for year ended December 31, 2010
(see Exhibit 10.89 therein)
Form 10-Q Quarterly Report for the period ended June 30, 2005
(see Exhibit 10.64 therein)
Form of Designation of Beneficiary for the 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 10.65 therein)
Supplemental Retirement Plan for Executive Employees of
State Auto Insurance Companies (Restatement) effective as of
January 1, 1994
Form 10-K Annual Report for the year ended December 31,
1997 (see Exhibit 10(HH) therein)
Amendment No. 1, effective as of January 1, 2008, to
Supplemental Retirement Plan for 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
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)
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Exhibit
No.
10.87*
10.88*
10.89*
10.90*
10.91*
10.92*
10.93*
10.94*
10.95*
10.96*
10.97*
10.98*
Description of Exhibit
If incorporated by reference document with which Exhibit was
previously filed with SEC
Supplemental Retirement Plan for Executive Employees of
State Auto Insurance Companies effective as of May 1, 2010
Form 10-Q Quarterly Report for the period ended June 30, 2010
(see Exhibit 10.01 therein)
First Amendment to the Supplemental Retirement Plan for
Executive Employees of State Auto Insurance
Companies (amendment effective December 1, 2010)
Form 10-K Annual Report for year ended December 31, 2010
(see Exhibit 10.96 therein)
State Auto Financial Corporation Supplemental Executive
Retirement Plan, effective January 1, 2007
Form 10-Q Quarterly Report for the period ended
September 30, 2007 (see Exhibit 10.72 therein)
First Amendment to the State Auto Financial Corporation
Supplemental Executive Retirement Plan effective December 1,
2010
Form 10-K Annual Report for year ended December 31, 2010
(see Exhibit 10.98 therein)
Form of Designation of Distribution Election for the State Auto
Financial Corporation Supplemental Executive Retirement Plan
Form 10-Q Quarterly Report for the period ended
September 30, 2007 (see Exhibit 10.73 therein)
State Auto Insurance Companies Amended and Restated
Directors Deferred Compensation Plan (amended and restated
as of March 1, 2001)
First Amendment to the State Auto Insurance Companies
Amended and Restated Directors Deferred Compensation Plan
(amendment effective as of December 1, 2005)
Second Amendment to the State Auto Insurance Companies
Amended and Restated Directors Deferred Compensation Plan
(amendment effective as of January 1, 2009)
Third Amendment to the State Auto Insurance Companies
Amended and Restated Directors Deferred Compensation Plan
(amendment effective as of January 1, 2009)
Fourth Amendment to the State Auto Insurance Companies
Amended and Restated Directors Deferred Compensation Plan
effective November 1, 2010
Fifth Amendment to the State Auto Insurance Companies
Amended and Restated Directors Deferred Compensation Plan
effective January 1, 2012
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 Company of
Wisconsin) regarding the State Auto Insurance Companies
Amended and Restated Directors Deferred Compensation Plan
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)
Form 10-K Annual Report for the year ended December 31,
2008 (see Exhibit 10.84 therein)
1933 Act Registration Statement No. 333-170564 on Form S-8
(see Exhibit 4(j) therein)
Form 10-Q Quarterly Report for the period ended
September 30, 2012 (see Exhibit 10.1 therein)
Form 10-K Annual Report for the year ended December 31,
2005 (see Exhibit 10.60 therein)
10.99*
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)
10.100*
10.101*
10.102*
10.103*
State Auto Property & Casualty Insurance Company
Amended and Restated Incentive Deferred Compensation Plan
effective as of March 1, 2010
First Amendment to the State Auto Property & Casualty
Insurance Company Amended and Restated Incentive Deferred
Compensation Plan (amendment effective July 1, 2010)
Second Amendment to the State Auto Property & Casualty
Insurance Company Amended and Restated Incentive Deferred
Compensation Plan (amendment effective November 1, 2010)
Third Amendment to the State Auto Property & Casualty
Insurance Company Amended and Restated Incentive Deferred
Compensation Plan (amendment effective January 1, 2011)
10.104*
State Auto Financial Corporation Leadership Bonus Plan
1933 Act Registration Statement No. 333-165366 on Form S-8
(see Exhibit 4(e) therein)
Form 10-Q Quarterly Report for the period ended June 30, 2010
(see Exhibit 10.02 therein)
1933 Act Registration Statement No. 333-170568 on Form S-8
(see Exhibit 4(h) therein)
Form 10-K Annual Report for year ended December 31, 2011
(see Exhibit 10.109 therein)
Form 10-Q Quarterly Report for the period ended June 30, 2007
(see Exhibit 10.64 therein)
10.105*
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)
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Exhibit
No.
10.106*
Description of Exhibit
If incorporated by reference document with which Exhibit was
previously filed with SEC
Second Amendment to the State Auto Financial Corporation
Leadership Bonus Plan (amendment effective as of January 1,
2012)
Form 8K Current Report filed on May 10, 2012 (see
Exhibit 10.2 therein)
10.107*
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)
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 May 10, 2012 (see
Exhibit 10.3 therein)
Form 8-K Current Report filed on November 25, 2009 (see
Exhibit 10.1 therein)
First Amendment to the State Auto Financial Corporation
Long-Term Incentive Plan (amendment effective as of
January 1, 2008)
Second Amendment to the State Auto Financial Corporation
Long-Term Incentive Plan (amendment effective as of
January 1, 2009)
Third Amendment to the State Auto Financial Corporation
Long-Term Incentive Plan (amendment effective as of
January 1, 2012)
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 Insurance
Company, and Risk Evaluation and Design, LLC
10.108*
10.109*
10.110*
10.111*
21.01
23.01
24.01
List of Subsidiaries of State Auto Financial Corporation
Included herein
Consent of Independent Registered Public Accounting Firm
Included herein
Powers of Attorney—Robert P. Restrepo, Jr., David J.
D’Antoni, David R. Meuse, S. Elaine Roberts, Alexander B.
Trevor and Paul S. Williams
Form 10-K Annual Report for the year ended December 31,
2007 (see Exhibit 24.01 therein)
24.02
Powers of Attorney—Robert E. Baker and Thomas E. Markert
24.03
Power of Attorney—Eileen A. Mallesch
Form 10-Q Quarterly Report for the period ended March 31,
2008 (see Exhibit 24.01 therein)
Form 10-K Annual Report for year ended December 31, 2010
(see Exhibit 24.03 therein)
31.01
31.02
32.01
32.02
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
101.INS**
XBRL Instance Document
101.SCH** XBRL Taxonomy Extension Schema Document
Included herein
Included herein
101.CAL** XBRL Taxonomy Extension Calculation Linkbase Document
Included herein
101.DEF** XBRL Taxonomy Definition Linkbase Document
Included herein
101.LAB** XBRL Taxonomy Extension Label Linkbase Document
Included herein
101.PRE** XBRL Taxonomy Extension Presentation Linkbase Document
Included herein
*
**
Constitutes either a management contract or a compensatory plan or arrangement required to be filed as an Exhibit.
The XBRL related information in Exhibit 101 shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or
otherwise subject to liability of that section and shall not be incorporated by reference into any filing or other document pursuant to the Securities Act of 1933, as
amended, except as shall be expressly set forth by specific reference in such filing or document.
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State Auto Financial Corporation
95
(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.
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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 8, 2013
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.
Chairman, President and Chief Executive Officer
(principal executive officer)
March 8, 2013
/S/ STEVEN E. ENGLISH
Steven E. English
Vice President and Chief Financial Officer
(principal financial officer)
March 8, 2013
/S/ PETER J. LOVE
Peter J. Love
Controller
(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
EILEEN A. MALLESCH*
Eileen A. Mallesch
ALEXANDER B. TREVOR*
Alexander B. Trevor
PAUL S. WILLIAMS*
Paul S. Williams
Director
Director
Director
Director
Director
Director
Director
Director
March 8, 2013
March 8, 2013
March 8, 2013
March 8, 2013
March 8, 2013
March 8, 2013
March 8, 2013
March 8, 2013
March 8, 2013
*
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 8, 2013
Steven E. English
State Auto Financial Corporation
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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 8, 2013, 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, 2012.
EXHIBIT 23.01
Form
S-8
S-8
S-8
S-8
S-8
S-8
S-3
S-3
S-4
S-8
S-8
S-8
S-8
Registration
Number
Description
33-44667
1991 Stock Option Plan
33-89400
33-44666
1991 Directors’ Stock Option Plan
33-41423
1991 Employee Stock Purchase and Dividend Reinvestment Plan
333-05755
333-147333
333-56336
State Auto Insurance Companies Retirement Savings 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
333-165364
State Auto Financial Corporation 2009 Equity Incentive Compensation Plan
333-165366
333-170568
State Auto Property & Casualty Insurance Company Amended and Restated Incentive Deferred
Compensation Plan
333-170564
State Auto Insurance Companies Amended and Restated Directors Deferred Compensation Plan
/s/ Ernst & Young LLP
Columbus, Ohio
March 8, 2013
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EXHIBIT 31.01
I, Robert P. Restrepo, Jr., certify that:
1.
I have reviewed this Form 10-K of State Auto Financial Corporation;
CERTIFICATION
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 8, 2013
/s/ Robert P. Restrepo, Jr.
Robert P. Restrepo, Jr.,
Chief Executive Officer
(Principal Executive Officer)
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EXHIBIT 31.02
I, Steven E. English, certify that:
1.
I have reviewed this Form 10-K of State Auto Financial Corporation;
CERTIFICATION
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 8, 2013
/s/ Steven E. English
Steven E. English,
Chief Financial Officer
(Principal Financial Officer)
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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, 2012, 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 8, 2013
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.
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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, 2012, 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 8, 2013
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.
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Corporate Information
ANNUAL MEETING
10 a.m. Friday, May 3, 2013, at Corporate Headquarters
SHAREHOLDER INQUIRIES
Larry Adeleye
Assistant Vice President, Treasury and Finance Director
State Auto Financial Corporation
518 E. Broad St.
Columbus, Ohio 43215
Phone (614) 917-5108
FAX (614) 887-1074
Larry.Adeleye@StateAuto.com
INDEPENDENT AUDITORS
Ernst & Young LLP
Huntington Center
41 S. High St., Ste. 1100
Columbus, Ohio 43215
LEGAL COUNSEL
Baker & Hostetler LLP
65 E. State St., Ste. 2100
Columbus, Ohio 43215
SEC FILINGS
This report and other fi lings with the Securities and
Exchange Commission are available free of charge
on the Company’s website at StateAuto.com.
TRANSFER AGENT/REGISTRAR
Computershare
P.O. Box 43078
Providence, R.I. 02940
Phone (800) 622-6757
www.computershare.com/us/contact/Pages/default.aspx
STOCK TRADING
Common shares are traded in the Nasdaq Global Select
National Market System under the symbol STFC. As of
Feb. 25, 2013, there were 1,233 shareholders of the
Company’s common shares.
MARKET PRICE RANGE,COMMON STOCK
Initial Public Offering – June 28, 1991, $2.25
The high and low sale prices for each quarterly period
for the past two years as reported by Nasdaq and cash
dividends paid per share are:
2012
High
Fourth Quarter $16.88
Third Quarter
16.91
Second Quarter 14.79
16.00
First Quarter
2011
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
High
$14.06
18.00
18.28
18.35
Low
$13.93
12.49
12.82
12.21
Low
$10.09
11.83
15.16
14.90
Dividend
$0.10
0.15
0.15
0.15
Dividend
$0.15
0.15
0.15
0.15
CORPORATE HEADQUARTERS
State Auto Financial Corporation
518 E. Broad St.
Columbus, Ohio 43215
StateAuto.com
(614) 464-5000
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 Dec. 31, 2012, which is
included with this Annual Report.
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State Auto Financial Corporation
State Auto Property & Casualty Insurance Company
Milbank Insurance Company
State Auto Insurance Company of Ohio
Stateco Financial Services Inc.
518 Property Management & Leasing LLC
State Automobile Mutual Insurance Company
State Auto Insurance Company of Wisconsin
Meridian Security Insurance Company
Meridian Citizens Mutual Insurance Company
Patrons Mutual Insurance Company of Connecticut
Litchfield Mutual Fire Insurance Company
Rockhill Insurance Company
Plaza Insurance Company
American Compensation Insurance Company
Bloomington Compensation Insurance Company
STATE AUTO FINANCIAL CORPORATION
518 E. BROAD ST.
COLUMBUS, OHIO 43215
STATEAUTO.COM
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