2
Michael E. LaRocco
President, Chairman of
the board & Chief Executive officer
Dear
Shareholders,
In my 37-year insurance industry career,
2016 was the best bad year I’ve experienced.
Our financial results declined, and we failed
to meet our profit and growth goals.
We own the results and accept responsibility
for the performance. At the same time, we
made tremendous progress in turning
around State Auto. In 2016, we completed
much of our foundational work. We enter
2017 ready to deliver the results our
associates, shareholders, agents
and policyholders deserve.
1
3
"We strongly believe our
industry is at the cusp of
transformative changes."
A key building block was put in place in the third
commercial products. Some of these changes
quarter when we launched our new digital platform.
were launched immediately, while others will be
Choosing to become a digital insurance company
is a bold decision, but it reflects the reality of a
changing marketplace and consumer. Our industry
has been slow to adopt a digital approach to buying
and servicing our products, while our customers are
increasingly demanding change. With our digital
platform, new State Auto customers no longer
have to use paper or traditional means of payment.
delivered with the implementation of our new
digital technology. We’re very proud that we can
now offer our agents an auto product option based
on telematics, otherwise known as a usage-based
insurance product, that charges premium based on
how the vehicle is driven. This will also be offered
soon for commercial auto risks. On the homeowners
Using electronic signature and transfer of funds,
line, we now have discounts for smart homes,
they’re able to purchase and service their insurance
allowing us to reward customers who monitor their
products with the same seamless experience
home’s security, water flow, use of utilities and
they have come to expect from other best-in-class
e-commerce companies. The new platform is up
and running in five states for new auto and home
customers. We’ll complete our transformation to
the digital platform for our new auto and home
customers in all states where we do business
in 2017. For our new small business customers,
we’ll begin the change in the middle of 2017 and
complete it by early 2018.
more. We believe these new products will make
us more competitive while better positioning us to
make an underwriting profit.
We believe we made some hard but necessary
decisions to discontinue products that weren’t
core to our strategy. We finished our exit of large
commercial and large transportation business that
began in 2015. In 2016, we announced our planned
Launching the new digital technology was a major
exit of Specialty program business. These changes
step in the rebuilding of our foundation, but there
were many others.
PRODUCT STRATEGY
Our core products in personal and commercial
lines needed updating. Today, the combination
of publicly available data, analytics and talented
associates allow us to build products that better
were needed to allow us to use our resources
to focus on our core businesses of auto, home,
farm and ranch, small and mid-sized commercial,
workers’ compensation and excess and surplus
property and casualty. We enter 2017 not only with a
stronger operational foundation, but with a focused
product strategy. We have the right leaders in each
match rate with risk. During 2016, we rebuilt pricing
line and a crystal clear understanding that each line
and underwriting models for our personal and
must be profitable.
2
"We strongly believe our
industry is at the cusp of
transformative changes."
ONE TEAM. ONE GOAL.
diversity and inclusion; one that makes everyone
While we’ve invested heavily in updating our
feel welcome and respected as members of our
technology platform, we know a key to offering
team.
competitive products is a lower expense ratio. We’re
developing road maps to deliver a significantly
Let me close by sharing what I’m most proud of
improved cost structure. Whether it’s identifying
from 2016: our people. At State Auto, we
internal opportunities for cost reductions, retiring
understand our obligation to produce strong
legacy technology applications or consolidating real
financial results and take it very seriously. We
estate, we have clear plans for how we’ll become a
also feel a deep commitment to give back to our
more efficient company going forward.
communities and especially those less fortunate
We also restructured our compensation plan. Last
gave back selflessly. While they certainly did that
year we aligned as an organization behind a vision
through financial support, more impressive were
and a single goal: profitable growth. Our associates
the number of hours that they gave through
understand this and we approach everything as
volunteerism. I couldn’t be more proud.
than ourselves. Throughout 2016, our associates
One Team. Getting all of us aligned and working
together is critical in our effort to not only turn
2016 was the best bad year of my career –
around State Auto, but launch it forward to be an
a decline in financial results mixed with
industry leader. Compensation must support that
unprecedented foundational development.
approach. Our bonus compensation is now based
We strongly believe our industry is at the cusp of
simply on a combination of profit and growth. This
transformative changes. The foundation we’ve
direct match of pay and performance solidifies our
built will position us to take advantage of these
alignment as One Team. We simplified job titles and
changes as they occur. I’m more confident than
pay grades, eliminating unnecessary complexity
ever that State Auto is poised to emerge as an
and allowing for greater flexibility on hiring new
industry leader in profit, growth and exceeding the
associates and rewarding current ones. It’s critical
expectations of our customers and shareholders.
that we continue to attract and retain top talent in
order to meet our goals today and in the future, and
Best,
we have simplified our internal practices so that we
can compete and win in the tight talent market.
CULTURE
Finally, and most importantly, we continue to
emphasize the critical importance of our culture.
We cannot afford to lose one voice and must have
an environment in which all associates speak up,
offer their opinions and challenge one another
in a candid and productive manner. That can’t
happen unless our culture allows for all associates
to participate. We believe our culture is one of
Michael E. LaRocco
President, Chairman of
the board & Chief Executive officer
3
STFC Board
of Directors
Michael E . LaRocco
Michael E. LaRocco became president and chief
executive officer and was elected to the board in
May 2015. He became chairman of the board
in January 2016. LaRocco had been with Business
Insurance Direct LLC, an online seller of general
liability and property insurance to
small businesses, since December 2011.
Chairman of the Board
Investment and Finance Committee
Robe rt Bake r
Robert Baker has served as a senior marketing
executive at several of the nation’s premier
consumer products companies, including
Conagra, Kraft, and Procter & Gamble. He
currently serves as executive vice president of
DHR International, an executive recruiting firm.
Baker, a U.S. Air Force veteran, holds an
undergraduate degree from Tuskegee University
and an MBA from Columbia University.
Audit Committee
Compensation Committee (Chair)
David J. D’Antoni
David J. D’Antoni is a retired senior vice president
of Ashland Oil Inc. and president of Ashland
Chemical. D’Antoni is a graduate of Virginia
Polytechnic Institute, with a bachelor’s degree
in chemical engineering. He is also a graduate
of Harvard Business School’s Advanced
Management Program.
Audit Committee
Independent Committee
Investment and Finance Committee
Nominating and Governance Committee
4
6
Kym M. Hubbard
Kym M. Hubbard recently retired as global head of
investments, chief investment officer and treasurer
of Ernst & Young LLC. She has more than 30 years
of financial services experience, including roles
in private partnerships, insurance, government,
investment banking, capital markets, banking
and audit/public accounting. She is a graduate
of Bradley University.
Audit Committee
Independent Committee
Investment and Finance Committee
Michael J. Fiorile
Michael J. Fiorile is chairman and chief executive
officer of The Dispatch Printing Company. He
also serves as chairman of operating subsidiaries
Capitol Square Ltd. and Dispatch Broadcast Group,
which includes WBNS-TV, WBNS-AM/FM and Ohio
News Network in Columbus; and WTHR-TV and
WALV-CD in Indianapolis.
Nominating & Governance Committee (Chair)
Risk Committee (Chair)
Eile e n A. Mallesch
Eileen A. Mallesch was senior vice president and chief
financial officer of Nationwide Property and Casualty
Insurance Company. She also held leadership roles
with Genworth Life Insurance, GE Financial Employer
Services, Asea Brown Boveri and PepsiCo. She is a
graduate of the City University of New York and a
member of the American Institute of Certified Public
Accountants.
Audit Committee (Chair)
Compensation Committee
Independent Committee
5
7
Thomas E. Marke rt
Thomas E. Markert is CEO of Digital Tailwind,
a specialized digital marketing agency based in
Delray Beach, Fla. From 2008 to 2012, he served
as senior vice president of strategy and innovation
at Office Depot. He previously served as CEO of
Loyalty Worldwide at Ipsos and global chief
marketing and client service officer of ACNielsen.
Compensation Committee
Independent Committee (Chair)
Nominating and Governance Committee
Risk Committee
David R. Meuse
David R. Meuse is senior advisor of Stonehenge
Financial Holdings Inc. Prior to joining Stonehenge,
Meuse was chairman and chief executive officer
of Banc One Capital Holdings Corporation. Meuse
graduated from John Carroll University and
attended the Cleveland Marshall College of Law
and the Securities Industry Institute at the Wharton
School of Business.
Lead Director
Audit Committee
Independent Committee
Investment and Finance Committee (Chair)
S. Elain e Robe rts
S. Elaine Roberts is executive director of the
Columbus Airport Authority. She previously served
as executive director of the Rhode Island Airport
Corporation in Warwick, R.I., and deputy executive
director of the Indianapolis Airport Authority.
Roberts earned a master’s degree from the
University of Louisville and a law degree from
Indiana University.
Compensation Committee
Independent Committee
Nominating and Governance Committee
Risk Committee
6
8
Senior Leadership
Michael E. LaRocco
President, Chairman and CEO
Melissa A. Centers
SVP/General Counsel/Secretary
Jessica E. Clark
SVP/Director of Commercial &
Specialty Lines
Steven E. English
SVP/Chief Financial Officer
Kim A. Garland
SVP/Director of Standard Lines
John M. Petrucci
SVP/Customer Service
Suzanne M. Sinclair
SVP/Chief People Officer
´�
Elise D. Spriggs
SVP/External Relations
Paul M. Stachura
SVP/Chief Claims &
Risk Engineering (CARE) Officer
Gregory A. Tacchetti
SVP/Chief Information &
Strategy Officer
7
9
8
10
State Auto:
Serving customers &
the community
State Auto’s commitment to service doesn’t
associates volunteered their time to serve a number
end with our customers. Our communities have
of United Way agencies. More than 200 associates
benefited from the caring, generous spirit of State
took part in Community Service Day activities in
Auto associates since our founding. It’s a spirit
Columbus, Indianapolis, Baltimore, Nashville, Austin
that’s been renewed through not only words and
and other company locations.
dollars, but through the time and talents of our
In Columbus, agencies and programs were
people.
identified that help build pathways out of poverty.
Volunteers served Camp Oty’Okwa, a year-round
For more than 30 years, State Auto associates have
camp that focuses its attention on environmental
generously contributed to United Way through a
education and scientific research operated by Big
coordinated company wide campaign. In 2016,
Brothers Big Sisters of Central Ohio. Volunteers for
beyond pledging nearly $300,000 to United Way,
LifeCare Alliance packaged or delivered meals to
9
11
people no longer able to leave their homes. At the
Across the street from State Auto’s headquarters,
Habitat for Humanity ReStore, associate volunteers
cleaned, unloaded and organized furniture, home
goods and remodeling products for sale at discount
prices.
the Broad Street United Methodist Church provides
meals to those in need. Many of those meals
throughout the year are made and served by State
Auto associates. And a group of associates came
“We care a lot about our communities,” said State
together at the end of 2016 to provide a special
Auto Financial Corporation Chairman, President and
Christmas celebration for residents of Amethyst, a
CEO Mike LaRocco. “We certainly understand the
responsibility to make money and to be financially
strong. But quite frankly, we have an equal
obligation to give back. There are a lot of people
in the communities in which we live and work who
need our help.”
Columbus organization that provides transitional
housing for women recovering from addictions. The
children of those women received a meal, gifts, and
a visit from Santa Claus.
In our home state of Ohio, one out of six residents
In 1921, State Automobile Mutual Insurance
is “food insecure,” meaning they’re not sure where
their next meal is coming from. That’s why our
annual Operation Feed campaign is so important
not only to the central Ohio community, but to our
Company founder Bob Pein encouraged associates
and agents to “plant themselves firmly” in the
communities they serve. To this day, it’s a mission
associates, who provided more than 182,000 meals
we take seriously, not only because it’s part of who
to those in need in 2016 alone.
we are. It’s simply the right thing to do.
10
12
State Auto in the Community - 2016
$580,186
in gifts through the
State Auto Foundation
$44,573 in associate
donations to charitable
organizations matched
by State Auto
182,580 meals
provided through
donations to
Operation Feed
$435,297
donated by State Auto & State Auto
associates to United Way
2,388 hours donated through “Invest
a Day,” which offers associated paid time
off to volunteer in their communities
965 volunteer hours
donated to United
Way agencies during
Community Service Day
The State Auto Foundation
The State Auto Foundation focuses its resources on the areas of poverty, homelessness and education, particularly in underserved
areas. The Foundation has partnered with organizations like the American Heart Association, which delivers education to improve
health in our communities, and Homeport, which strives to create and preserve healthy, stable and affordable communities, one
neighborhood, one person at a time.
11
13
Financial Highlights
($ in millions, except per share amounts)
2016
2015
2014
2013
2012
1,291.9
Earned premiums
$
74.7
Net investment income
$
36.5
Net realized investment gains $
2.3
$
Other income
1,405.4
Total revenue
$
21.0
Net income
$
0.50
Basic earnings per share
$
0.50
Diluted earnings per share
$
0.40
Dividends paid per share
$
21.31
Book value per share
$
$ 2,959.4
Total assets
891.3
Stockholders’ equity
$
2.4%
Return on equity
106.2
Combined ratio
1,270.5
71.7
24.3
2.1
1,368.6
51.2
1.25
1.23
0.40
21.40
2,828.2
884.6
5.8%
101.5
1,074.1
74.7
20.7
3.2
1,172.7
107.4
2.63
2.60
0.40
21.32
2,766.6
872.9
13.0%
105.5
1,055.0
72.8
23.2
2.0
1,153.0
60.8
1.50
1.49
0.40
19.27
2,496.1
785.0
8.0%
101.8
1,042.1
75.4
29.0
3.6
1,150.1
10.7
0.26
0.26
0.55
18.22
2,477.4
737.2
1.5%
107.9
Investment Portfolio
Agency Bonds
6.2%
Corporate Bonds
17.2%
Net Premium Written (in billions)
Equities
14.7%
MBS
18.1%
Notes Receivable
2.7%
Other Invested Assets
1.7%
Taxable Muni Bonds
3.5%
Treasury Bonds
14.7%
2016
2015
2014
2013
2012
$1.3
$1.3
$1.2
$1.1
$1.1
Tax Exempt Bonds
21.2%
0
$0.3
$0.6
$0.9
$1.2
$1.5
Book Value (per share)
Dividend Paid (per share)
2016
2015
2014
2013
$21.31
$21.40
$21.32
$19.27
1.3
2012 $18.22
2016
2015
2014
2013
2012
$0.40
$0.40
$0.40
$0.40
$0.55
0
$5
$10
$15
$20
$25
0.0
$0.25
$0.50
$0.75
12
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2016 or
Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
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
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
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
No
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every
Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months
(or for such shorter period that the Registrant was required to submit and post such files). Yes
No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and
will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference
in Part III of this Form 10-K or any amendment to this Form 10-K.
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a
smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company”
in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Non-accelerated filer
(Do not check if a smaller reporting company)
Accelerated filer
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
As of June 30, 2016, 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
$344,055,419.
On February 24, 2017, the Registrant had 41,976,998 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 5, 2017 (the “2017
Proxy Statement”), which will be filed within 120 days of December 31, 2016, are incorporated by reference into Part III of this
Form 10-K.
Index to Annual Report on Form 10-K for the year ended December 31, 2016
Form 10-K
Part I
Item
1
Description
Business
1A
1B
2
3
4
5
6
7
7A
8
9
9A
9B
10
11
12
13
14
15
Part II
Part III
Part IV
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
Qualitative and Quantitative Disclosures about Market Risk
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
Page
9
16
17
29
29
29
29
30
32
32
77
77
78
128
128
128
129
129
129
129
130
131
144
3
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.
4
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
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”), and Stateco Financial Services, Inc. (“Stateco”).
Refers to State Automobile Mutual Insurance Company, which owns
approximately 61.9% of STFC’s outstanding common shares. State Auto
Mutual also owns Risk Evaluation & Design, LLC (“RED”), which previously
acted as a managing general underwriter exclusively for the benefit of our
Pooled Companies.
STFC Pooled Companies
Refers to State Auto P&C, Milbank, and SA Ohio.
Mutual Pooled Companies
Refers to State Auto Mutual, and certain subsidiaries and affiliates of State
Auto Mutual, namely, State Auto Insurance Company of Wisconsin (“SA
Wisconsin”), Meridian Security Insurance Company (“Meridian Security”),
Patrons Mutual Insurance Company of Connecticut (“Patrons Mutual”),
Rockhill Insurance Company (“RIC”), Plaza Insurance Company (“Plaza”),
American Compensation Insurance Company (“American Compensation”)
and Bloomington Compensation Insurance Company (“Bloomington
Compensation”).
Pooled Companies or our Pooled Companies Refers to the STFC Pooled Companies and the Mutual Pooled Companies.
Rockhill Insurance Group
Rockhill Insurers
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
Compensation.
to RIC, Plaza, American Compensation and Bloomington
State Auto Group
Refers to the Pooled Companies
5
Glossary of Selected Insurance and Accounting Terms
Accident year
Accounting standards codification or ASC
Admitted insurer
American Institute of Certified Public
Accountants or AICPA
Allocated loss adjustment expenses or ALAE
Book value per share
Catastrophe loss
Combined ratio
Debt to capital ratio
Deferred acquisition costs or DAC
Direct written premiums
The calendar year in which loss events occur, regardless of when the
losses are actually reported, booked or paid.
The Codification is the single source of authoritative nongovernmental
GAAP developed by the Financial Accounting Standards Board
(“FASB”).
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 AICPA represents the certified public accounting profession
nationally regarding rule-making and standard-setting, and serves as an
advocate before legislative bodies, public interest groups and other
professional organizations. The AICPA also monitors and enforces
compliance with the profession’s technical and ethical standards.
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 $25.0 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.
The ratio of notes payable to the sum of total stockholders’ equity and
notes payable.
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
Excess and surplus lines insurance
Expense ratio or underwriting expense ratio
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.
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.
6
Generally accepted accounting principles or
GAAP
Accounting practices used in the United States of America determined by
the FASB and American Institute of Certified Public Accountants
(“AICPA”).
Incurred but not reported reserves or IBNR
Loss adjustment expenses or LAE
Loss and LAE ratio or loss ratio
Loss reserves
Managing general underwriter or MGU
National Association of Insurance
Commissioners or NAIC
Net premiums written to surplus ratio or
leverage ratio
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.
For both SAP and GAAP, it is the ratio of incurred losses and LAE to
earned premiums.
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.
Non-admitted insurer or surplus lines carrier
Retail agent or retail agency
Return on average equity
Risk-based capital or RBC
Standard insurance
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.
7
Statutory accounting practices or SAP
Statutory surplus
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
Under SAP, earned premiums less loss and LAE and underwriting
expenses.
Unearned premiums
Wholesale broker
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.
8
Item 1. Business
PART I
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.
State Auto Mutual is an Ohio domiciled mutual property and casualty insurance company organized in 1921. It owns
approximately 61.9% of State Auto Financial’s outstanding common shares. State Auto Mutual’s other subsidiaries and affiliates
include SA Wisconsin, Meridian Security, Patrons Mutual and the Rockhill Insurers, each of which is a property and casualty
insurance company. 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
Our reportable insurance segments are 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
16 to our consolidated financial statements included in Item 8 of this Form 10-K.
Effective January 1, 2017, we completed the transition of our internal decision-making process to a product management
structure under which our principal operating decision makers assess performance and allocate resources based on the underwriting
results of individual products. Accordingly, beginning January 1, 2017, our reportable segments, and the products within each,
will be as follows:
• Personal Insurance Segment- personal auto, homeowners, farm & ranch and other personal
• Commercial Insurance Segment - commercial auto, small commercial package, middle market commercial,
workers’ compensation and other commercial
• Specialty Insurance Segment - E&S property, E&S casualty and programs
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, 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, homeowners, and farm & ranch.
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,
general liability, and workers’ compensation.
9
Marketing
We market our personal and business insurance through approximately 2,600 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 marketing with selected agencies.
We actively help our agencies develop the professional sales skills of their staff. Our training programs include both product
and sales training conducted in our corporate headquarters. Further, some of our training programs include disciplined follow-up
and coaching for an extended time. In addition, from time to time we provide targeted training sessions 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.
SPECIALTY INSURANCE
In contrast to standard insurance markets which are characterized by regulated products, uniform coverages and more
predictable exposures, specialty risks, due to the nature of the particular risk or activities of the insured, often do not lend themselves
to the strict, uniform underwriting criteria of standard insurers and require unique underwriting solutions. As a result, competition
in the specialty markets focuses on expertise, flexibility and customer service.
Because the specialty markets generally involve higher perceived insurance risks than those characteristic in the standard
markets, through our specialty insurance segment we offer commercial coverages that require specialized product underwriting,
claims handling and/or risk management services. We offer our specialty products through a distribution channel of retail agents
and wholesale brokers, including program administrators and other specialty sources. Our specialty insurance products are written
through our admitted and non-admitted insurers. Our units within the specialty insurance segment are Excess & Surplus (“E&S”)
property, Excess & Surplus (“E&S”) casualty and Programs.
Our E&S property unit markets and underwrites specialized property exposures, primarily in the Gulf, Southeast and West
regions of the United States with a focus on catastrophe exposed risks. Individual risk catastrophe modeling, specialized
underwriters, underwriting guidelines and specialized rating plans are leveraged. In addition, catastrophe portfolio exposure
management is utilized to produce the optimal portfolio of risk. Coverages offered by this unit are property and general liability.
Our E&S casualty unit markets and underwrites commercial exposures that have unique insurance requirements. This
includes difficult to place classes of commercial business, which may require customized rates and forms, along with customized
insurance programs for specialty niche and homogeneous groups of exposures. Coverages offered by this unit may include
commercial auto, healthcare, umbrella, property, and general liability.
Our Programs unit markets and distributes business through specialty program managers to whom we have outsourced
underwriting and policy administration. Program business typically consists of homogenous risks that require specialized
underwriting and claims expertise. Accordingly, our program managers have specialized underwriting expertise in the particular
risks covered by the program. Coverages offered through this unit include commercial auto, general liability, and property.
During the third quarter of 2016, management completed an evaluation of business written within the programs unit and
determined this business was not core to our strategy. As a result, we are exiting the programs business in order to further capitalize
on our expertise within the E&S casualty and E&S property segments of the specialty marketplace and we will stop writing program
business by the middle of 2017; however, exposure to the risks underlying this business will continue as the premiums are earned
through mid-2018.
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 State Auto Mutual 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 State Auto Mutual and all subsidiaries and affiliates. Investment policies and guidelines are
set for each company through the Investment Committee of its respective Board of Directors.
10
For additional discussion regarding our investments, including the market risks related to our investment portfolio, see Item 7
of this Form 10-K, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of
Operations—Investment Operations Segment.”
CLAIMS
Our claims and risk engineering (“CARE”) division supports our insurance segments through emphasis on timely
investigation of claims, settlement of meritorious claims for equitable amounts, maintenance of adequate case reserves for claims,
sharing of relevant information, 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 and focused on yielding 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. In areas where there is not a sufficient volume of claims to warrant
staff adjusters, we supplement our field staff with outside adjusters and appraisers who work under our direction.
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, when appropriate,
by settling disputes regarding automobile physical damage, bodily injury and property insurance claims through arbitration or
mediation.
In addition to our internal claims adjusters, we utilize third party claims administrators (“TPAs”) to investigate, process and
settle certain specialty insurance segment claims on our behalf As with our internal claims adjusters, claim settlement authority
is established for adjusters, supervisors and managers within each TPA. Claims handling and reporting guidelines are established
and provided to each TPA. Members of our internal claims staff perform periodic reviews of individual claim files produced by
each TPA for compliance with such established claims handling and reporting guidelines.
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
to defend our insureds, when appropriate.
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. The balance of the pooled premiums,
losses and expenses are retained by State Auto Mutual.
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.”
11
GEOGRAPHIC DISTRIBUTION
The following table sets forth the geographic distribution of our direct written premiums for the year ended December 31,
2016:
State
Ohio
Texas
Kentucky
California
Florida
Minnesota
Tennessee
Georgia
Indiana
Connecticut
Illinois
Maryland
Pennsylvania
North Carolina
South Carolina
All others (1)
Total
% of Total
8.9%
7.9
6.2
4.8
4.8
4.2
3.7
3.7
3.7
3.6
3.4
3.4
3.2
3.2
3.1
32.2
100.0%
No other single state accounted for 3.0% or more of the total direct
written premiums written in 2016.
(1)
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, renewed for an additional
ten-year period on January 1, 2015. If the 2005 Management Agreement was terminated for any reason, we would have to relocate
our facilities to continue our operations. See “Properties” included in Item 2 of this Form 10-K.
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 our estimate
of ultimate payments required to settle claims varies 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
12
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 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—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, 2016, 2015 and 2014:
($ millions)
Beginning of Year:
Year Ended December 31
2015
2014
2016
Loss and loss expenses payable
Less: Reinsurance recoverable on losses and loss expenses payable
Net losses and loss expenses payable(1)
Provision for losses and loss expenses occurring:
$
$ 1,053.0
5.9
1,047.1
Current year
Prior years(2)
Total
Loss and loss expense payments for claims occurring during:
Current year
Prior years
Total
End of Year:
915.4
27.0
942.4
417.8
393.7
811.5
$
983.2
9.6
973.6
852.8
10.0
862.8
421.5
367.8
789.3
Net losses and loss expenses payable
Add: Reinsurance recoverable on losses and loss expenses payable
Losses and loss expenses payable(3)
1,178.0
3.6
$ 1,181.6
1,047.1
5.9
$ 1,053.0
$
959.9
9.1
950.8
726.2
45.1
771.3
373.2
375.3
748.5
973.6
9.6
983.2
(1)
Includes net amounts assumed from affiliates of $532.4 million, $494.3 million, and $438.0 million at beginning of year 2016, 2015, and
2014, respectively.
(2) This line item shows changes 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.”
(3)
Includes net amounts assumed from affiliates of $630.9 million, $532.4 million, and $494.3 million at end of year 2016, 2015, and 2014,
respectively.
COMPETITION
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.
REGULATION
Most states, including all the domiciliary states of the State Auto Group, have enacted legislation that regulates insurance
holding company systems. Each insurance company in our holding company system is required to register with the insurance
supervisory agency of its state of domicile and furnish information concerning the operations of companies within our holding
company system that may materially affect the operations, management or financial condition of the insurers within the system.
Pursuant to these laws, the respective insurance departments may examine any members of the State Auto Group, at any time,
require disclosure of material transactions involving insurer members of our holding company system, and require prior notice
and an opportunity to disapprove of certain “extraordinary” transactions, including, but not limited to, extraordinary dividends to
13
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.
The Risk Management and Own Risk Solvency Assessment Model Act (“ORSA”), adopted by the NAIC in 2012, requires
insurers to incorporate a comprehensive enterprise risk management framework within company operations. Overall, ORSA is
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.
In 2016, the State Auto Group filed its ORSA Summary Report, supported by internal risk management materials, with the Ohio
Department of Insurance, our lead state regulator.
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, $84.4 million is available in 2017 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 $10.0 million and $15.0 million in 2016 and 2015, respectively, from its insurance subsidiaries. Additional information regarding
dividend restrictions can be found in this Item 7 and in Note 12 to our consolidated financial statements included in Item 8 of this
Form 10-K.
Rates and Related Regulation. Except as discussed below, we are not aware of the adoption of any material adverse legislation
or regulation in any state in which we conducted business during 2016 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. Some states are also becoming active in questioning the use of catastrophe modeling in
the pricing and underwriting areas. Regulation risk is realized when states do not approve or limit the amount of rate a company
can charge which may result in writing under-priced business. See “Risk Factors - Regulations” in Item 1A of this Form 10-K.
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, 2016, 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
14
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”), has been extended until 2020.
Under the Terrorism Acts, commercial property and casualty insurers like State Auto Group, in exchange for making terrorism
insurance available, may be entitled to be reimbursed by the Federal Government for a portion of their aggregate losses. As required
by the Terrorism Acts, we offer policyholders in specific lines of commercial insurance the option to elect terrorism coverage. In
order for a loss to be covered under the Terrorism Acts, the loss must meet the aggregate industry loss minimum and must be the
result of an act of terrorism as certified by the Secretary of the Treasury. For 2015, the aggregate industry loss minimum was
$100.0 million and, beginning in 2016, increases by $20.0 million annually to $200.0 million in 2020. The Terrorism Acts require
insurance carriers to retain 15% of any claims from a certified terrorist event in excess of the federally mandated deductible in
2015 subject to an annual industry-wide cap of $100.0 billion. This retention will increase, beginning on January 1, 2016, by 1%
each calendar year until it reaches 20% in 2020. The federally mandated deductible represents 20% of direct earned premium for
the covered lines of business of the prior year. Policyholders may choose to reject terrorism 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 commercial property reinsurance excludes certified
acts of foreign terrorism and loss due to nuclear, biological or chemical agents. Beginning in 2016, insurers participating in the
Terrorism Acts are required to provide information regarding insurance coverage for terrorism losses, including; (i) lines of business
with exposure to such losses; (ii) premiums earned on such coverage; (iii) geographical location of exposures; (iv) pricing of such
coverage; (v) the take-up rate for such coverage; and (vi) the amount of private reinsurance for acts of terrorism purchased. See
“Risk Factors-Terrorism” in Item 1A of this Form 10-K.
The Federal Insurance Office (“FIO”) was established in 2010 by the enactment of the Dodd-Frank Act. The FIO is a separate
office within the United States Department of Treasury. The primary objective of the FIO 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 FIO 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 FIO has no authority as a regulator or supervisor of insurance companies.
EMPLOYEES
As of February 24, 2017, we had approximately 2,020 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.
15
Executive Officers of the Registrant
Name of Executive Officer and
Position(s) with Company
Michael E. LaRocco,
Chairman, President and Chief
Executive Officer
(1)
Age
60
Steven E. English,
Senior Vice President, Chief
Financial Officer
Melissa A. Centers,
Senior Vice President, Secretary and
General Counsel
Jessica E. Clark,
Senior Vice President, Director of
Commercial and Specialty Lines
Kim B. Garland,
Senior Vice President, Director of
Standard Lines
John M. Petrucci,
Senior Vice President, Customer
Service
Elise D. Spriggs,
Senior Vice President, External
Relations
Paul M. Stachura,
Senior Vice President, Chief CARE
Officer
Gregory A. Tacchetti,
Senior Vice President, Chief
Information and Strategy Officer
Scott A. Jones,
Vice President, Chief Investment
Officer
Matthew S. Mrozek,
Vice President, Chief Actuarial
Officer
Matthew R. Pollak,
Vice President, Chief Accounting
Officer and Treasurer
56
45
45
51
58
46
59
48
52
48
51
Principal Occupation(s)
During the Past Five Years
President and Chief Executive Officer of STFC and State
Auto Mutual, 5/15 to present; Chairman of the Board of
STFC, 1/16 to present; chief executive officer of Business
Insurance Direct LLC, 10/11 to 4/15; chief executive officer
of AssureStart Insurance Agency LLC, 1/13 to 7/14; chief
executive officer of Fireman’s Fund Insurance Company, 3/08
to 7/11.
Senior Vice President of STFC and State Auto Mutual, 8/13
to present; Vice President of STFC and State Auto Mutual,
5/06 to 7/13; Chief Financial Officer of STFC and State Auto
Mutual, 12/06 to present.
Senior Vice President, Secretary and General Counsel of
STFC, 11/15 to present; General Counsel and Secretary of
State Auto Mutual, 11/15 to present; Assistant Secretary of
STFC and State Auto Mutual, 11/12 to 11/15; Associate
General Counsel of STFC and State Auto Mutual, 3/12 to
11/15; Assistant General Counsel of STFC and State Auto
Mutual, 6/10 to 3/12.
Senior Vice President, Director of Specialty Lines and Middle
Markets of STFC and State Auto Mutual, 8/15 to present;
Senior Vice President, Specialty Lines, of STFC and State
Auto Mutual, 8/13 to 7/15; Vice President, Specialty Lines of
STFC and State Auto Mutual, 1/11 to 7/13; Chief Operating
Officer of Rockhill Insurance Company, 11/08 to 1/11.
Senior Vice President of Standard Lines of STFC and State
Auto Mutual, 8/15 to present; chief product officer of
American Insurance Group, Inc.’s (“AIG”) consumer
division, 1/13 to 12/14; chief underwriting officer of AIG’s
global consumer insurance division, 12/12 to 1/13; president
and chief executive officer of United Guaranty Corporation
(“UGC”), an affiliate of AIG, 2/12 to 12/12; chief operating
officer of UGC, 6/09 to 12/12.
Senior Vice President, Customer Service, 04/16 to present;
Senior Vice President, Service and Administration, 9/15 to
present; Vice President and Director of Sales of STFC and
State Auto Mutual, 3/00 to 9/15.
Senior Vice President, External and Government Affairs of
STFC and State Auto Mutual, 3/16 to present; vice president
and director of government relations, 7/11 to 6/15. Attorney,
Carpenter, Lipps & Leland LLP, 06/15 to 03/16
Senior Vice President and Chief Claims Officer of STFC and
State Auto Mutual, 9/15 to present; chief claims officer, of
QBE Holdings, Inc., 5/13 to 9/15; chief claims and risk
services officer of Fireman’s Fund Insurance Company, 5/05
to 4/13.
Senior Vice President and Chief Information and Strategy
Officer of STFC and State Auto Mutual, 8/15 to present; chief
executive officer of AssureStart Insurance Agency LLC, 7/14
to 12/14; chief operating officer of AssureStart Insurance
Agency LLC, 10/11 to 6/14; senior vice president and chief
administrative officer of Fireman’s Fund Insurance Company,
2008 to 10/11.
Vice President and Chief 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.
Vice President and Chief Actuarial Officer of STFC and State
Auto Mutual, 3/09 to present.
Vice President, Chief Accounting Officer and Treasurer of
STFC and State Auto Mutual, 4/13 to present; vice president,
corporate finance and accounting of American Safety
Insurance Holdings, Ltd. 2/10 to 4/13.
An Executive Officer
of the Company Since
2015
(2)
2006
2015
2011
2015
2015
2016
2015
2015
2012
2015
2013
(1) Age as of March 1, 2017.
(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 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, reputation, liquidity, capital resources, financial position or results of operations.
In that case, the market price of our stock could decline materially.
In the discussion below, we have organized risks according to categories of risk factors; however, many of the risks may
have correlations and ramifications in more than one category. For example, the timely availability of sufficient, reliable data and
information is included in Underwriting and Pricing, yet may also affect a number of risk factor categories. The categories, therefore,
should be viewed as a starting point for understanding the significant risks we face, not as a limitation on the potential impact of
risks.
The risk factors might affect, alter, or change actions we take in developing or executing our strategies, including, but not
limited to capital management. We employ a number of risk management approaches to reduce our exposure to risk, all of which
have inherent limitations. The failure of our risk management actions could have material adverse effects on our business, reputation,
liquidity, capital resources, financial position or results of operations.
The following list of risk factors is not exhaustive and others may exist or develop. This information should be carefully
considered together with the other information included in this report and in other reports and materials we file with the SEC, as
well as news releases and other information we publicly disseminate from time to time.
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, or changes in the report lag, between the occurrence of an insured
event and the time a claim is actually reported to us. 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 and adversely affect our liquidity and financial position.
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, fires and man-made events, 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
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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, commercial
property 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.
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 or refusing to enforce policy provisions such as hurricane deductibles. 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, such reinsurance may prove inadequate if a major catastrophic loss exceeds the reinsurance limit, or we incur 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. While we use 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 a potential emerging risk facing the
industry.
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 auto or other lines of business could be negatively affected.
A severe catastrophic event, pandemic or terrorist attack somewhere in the world may not result in material insurance losses
to us. However, our investment portfolio, reinsurers or the general economy could be negatively affected, resulting in a material
adverse effect on our business, liquidity, capital resources, financial position or results of operations.
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 timely 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 accuracy;
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•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
the development, selection and application of appropriate rating formula 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 company underwriting guidelines;
our ability to innovate with new product and/or 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 accurately predict consumer behavior, such as policyholder retention;
our ability to properly classify our new and renewal business;
unanticipated court decisions, legislation or regulatory action;
unanticipated changes or execution problems in our claim settlement practices, including our ability to recognize
and respond to fraudulent or inflated claims;
changing driving patterns for auto exposures including distracted driving; changing weather patterns (including those
which may be related to climate change) for property exposures;
technological innovations in automobiles, such as accident avoidance systems and advances leading to autonomous
cars;
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
risks, which would negatively affect our margins, or we could overprice risks, which could reduce our competitiveness. In either
event, our operating results, financial condition and cash flows could be materially adversely affected.
CREDIT AND FINANCIAL STRENGTH RATINGS
A downgrade in our financial strength ratings may negatively affect our business and reputation 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 rating 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.
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.
19
Depending on future results and developments, we may not be able to maintain our current ratings.
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; 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 STFC’s liquidity, including STFC’s 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.
If we are unable to effectively execute our top initiatives and projects, we may not meet organizational objectives due to
cost overruns, missed project milestones, defects and/or failing to deliver the desired business value.
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 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.
System implementations are complex processes requiring extensive planning and coordination among multiple stakeholder
groups. During 2016, we accelerated our business and technology plan to consolidate our policy administration and billing systems.
We have partnered with a third party specializing in providing core system software to the insurance industry. Introduction of the
new technology to our agents began in the fourth quarter of 2016. Initially, the technology will only be available for personal
lines new business in a limited number of states, with additional states being added in subsequent quarters. Additionally, we plan
on introducing the technology for certain small commercial product offerings beginning in the second quarter of 2017, again in a
limited number of states, with additional states and products being added in subsequent quarters. 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. Such risks are
also present in other key initiatives and projects planned for 2017 and beyond.
If we experience difficulties with outsourcing, or other third party relationships, our ability to conduct business might
be negatively impacted.
From time to time we may outsource certain other business, information technology or administrative functions, or otherwise
rely on certain third parties for the performance of such functions, for efficiency and cost saving purposes. If we fail to develop
and implement our sourcing strategies or our third party providers fail to perform as expected, we may experience operational
difficulties, increased costs, and a loss of business that may have a material adverse effect on our results of operations or financial
condition.
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VENDOR MANAGEMENT
Loss of key vendor relationships or failure of a vendor to perform as anticipated or to protect personal information of
our customers, claimants or employees could negatively affect our operations.
We rely on services and products provided by various vendors. In the event that one or more of our vendors becomes unable
to continue to provide products or services as anticipated, we may suffer operational impairment and financial loss. If one or more
of our vendors fail to protect personal information of our customers, claimants or employees, we may incur operational impairments,
or could be exposed to litigation, compliance costs or reputation damage.
CYBERSECURITY THREATS
Our highly automated and networked organization is subject to cyberterrorism and a variety of other cybersecurity 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 adverse effect
on our operations.
Our technology and telecommunications systems are highly integrated and connected with other networks. Cyberattacks
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. Cyberattacks 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 from a variety of sources 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.
While we take commercially reasonable measures to keep our systems and data secure, it is not possible to defend against
every risk posed by cybercrime. Increasing sophistication of cyber criminals and terrorists make keeping up with new threats
difficult and could result in a breach. Patching and other measures to protect existing systems and servers could be inadequate,
especially on systems that are being retired. Controls employed by our U.S., off-shore and cloud vendors could prove inadequate.
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. We maintain cyber liability insurance coverage to offset certain potential losses, subject to
policy limits, such as liability to others, costs of related crisis management, data extortion, applicable forensics and certain regulatory
defense costs, fines and penalties.
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.
21
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 address 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 reputation, financial position and results of operations.
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. There can be no assurance
that our use of reinsurance effectively meets our strategic business objectives. Reinsurance may not be adequate to protect us
against losses and may not be available to us in the future at commercially reasonable rates. The availability, policy conditions
and cost of reinsurance are subject to prevailing market conditions and loss experience, 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. 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.
CYCLICAL NATURE OF THE INDUSTRY
The property and casualty insurance industry is cyclical, which may cause fluctuations in our operating results.
The property and casualty insurance industry has been historically characterized by periods of intense price competition due
to excess underwriting capacity, as well as periods of shortages of underwriting capacity that result in higher prices and more
restrictive contract and/or coverage terms. The periods of intense price competition may adversely affect our operating results,
and the cyclical nature 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 expected returns. Accordingly, our 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, 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 products are influenced by a collection of loss cost trends. Driving patterns including behavioral changes
like distracted driving, along with 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 initially 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.
Economic conditions affect consumer behavior. For example, a decrease in gas prices may result in consumers driving more
miles, leading to a possible increase in auto claim frequency. Negative economic conditions may cause consumers and businesses
to decrease their spending, which may impact the demand for 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.
22
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 of 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.
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 method for our
personal and business insurance segments. Our exclusive use of such distribution 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 other means, such as 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 and the size of many agencies has grown, the number of individual
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 may become more difficult to expand the number of independent
agencies representing us. If we are unsuccessful in maintaining and increasing our agency representation, 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. When price competition is intense, our
premium production may be negatively impacted 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 partnering with 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, we may not be successful and 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 to purchase our insurance products or make
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changes to their policies. This single distribution system may place us at a disadvantage with consumers who prefer to purchase
insurance products online or through other alternative distribution channels.
Because our specialty insurance segment business is dependent upon wholesale brokers, managing general underwriters
and retail agents, we are exposed to certain risks arising out of these distribution channels that could cause our results to be
adversely affected.
We market and distribute our specialty insurance segment products through wholesale agents and managing general
underwriters to whom we have granted quoting and binding authority and who, in turn, sell our insurance products to insureds
through retail insurance brokers. While we have established and provided these wholesale agents and managing general underwriters
with pre-established underwriting guidelines, if they fail to comply with our underwriting guidelines and the terms of their
appointment, we could be bound on a particular risk or number of risks that were not anticipated when we developed the insurance
products. Such actions could adversely affect our results of operations.
Additionally, in any given period we may derive a significant portion of our business from a limited number of agents and
brokers and the loss of any of these relationships could have a significant impact on our ability to market our products and services.
Likewise, in certain jurisdictions, when the insured remits premium payments to our agent or broker in full, our premiums are
considered to have been paid in full, notwithstanding that we may or may not have actually received the premiums from the agent
or broker. Consequently, we assume a degree of credit risk associated with certain agents and brokers with whom we transact
business.
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 examining
laws and regulations, generally focusing on modifications to holding company regulations, interpreting existing laws and
developing 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.
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.
From time to time, some of the states in which we operate consider 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.
24
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
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 insurance we write, including
workers’ compensation, commercial and personal automobile and liability insurance. The enactment of the Patient Protection and
Affordable Care Act of 2010 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 regulation 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, including financial and regulatory reporting, are ineffective. Our business is dependent on our ability to
regularly engage in a large number of insurance underwriting, claim processing, personnel and human resources, and investment
activities, many of which are complex. These activities often are subject to internal guidelines and policies, as well as legal and
regulatory requirements. No matter how well designed and executed, control systems provide only reasonable assurance that the
system objectives will be met. If our controls are not effective, it could lead to financial loss, unexpected risk exposures or damage
to our reputation.
Tax legislation initiatives or challenges to our tax positions could adversely affect our results of operations and financial
condition.
We are subject to the tax laws and regulations of the 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 jurisdictions.
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.
25
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.
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. Other environmental
concerns could also create or affect potential liability exposures.
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. 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. We are required to participate in the Terrorism Acts as a
result of our commercial insurance business. In addition, 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 2016, over 90% of our commercial lines non-workers’ compensation policyholders
purchased terrorism coverage. Although the Terrorism Acts 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.
26
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 the extent to which industry sectors in which we maintain investments may suffer losses as a result
of potentially decreased commercial and economic activity, or how any such decrease might impact the ability of companies within
the affected industry sectors to pay interest or principal on their securities, or how the value of any underlying collateral might be
affected.
Furthermore, our reinsurers could experience significant losses as a result of terrorist attacks, potentially jeopardizing their
ability to pay losses ceded to them and reducing the availability of reinsurance. Our current commercial property reinsurance
excludes certified acts of foreign terrorism and loss due to nuclear, biological or chemical agents.
INVESTMENTS
The performance of our investment portfolios is subject to various investment risks, such as market, credit, concentration,
liquidity, and interest rate risks. Such risks could result in material adverse effects to our results of operations, cash flows and
financial position.
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.
EMPLOYEES
Our ability to attract, develop and retain talented employees, managers and executives, and to maintain appropriate
staffing levels, is critical to our success, as is our ability to effectively plan for the succession and transition of key executives
and subject matter experts.
Our success depends on our ability to attract, train, develop and retain talented, ethical, diverse employees, including
executives and other key managers in a specialized industry. The loss of certain key officers and employees or the failure to attract
27
and develop talented new executives and managers could have a materially adverse effect on our business. Effective succession
planning is important to assure the timely, competent replacement of retiring or transitioning senior executives and other departing
management talent and subject matter experts.
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. Other business units also focus on specialized technical or analytical skills.
Our success also depends on our ability to maintain and improve the effectiveness of our staff. Our ability to do so may be
impaired as a result of a variety of internal and external factors which affect employees and the employment marketplace, as well
as our ability to recognize and respond to changing trends and other circumstances that affect our employees. 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 business) in one or more business
units or locations. In either event, our financial results could be materially adversely affected.
CONTROL BY OUR PARENT COMPANY
State Auto Mutual owns a significant interest in us and may exercise its control in a manner detrimental to your interests.
As of December 31, 2016, State Auto Mutual owned approximately 61.9% 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 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.
Some of our competitors have well-established national reputations and brands supported by extensive media advertising. Some
of our competitors have substantially greater financial, technical and operating resources and market share than us. We may not
be able to effectively compete, which could adversely affect our sales and profitability. We believe that competition in our lines
of business is based primarily on price, service, commission structure, product features, technology, use of telematics, financial
strength ratings, producer relationships, reputation and name or brand recognition. Market developments such as usage-based auto
insurance or new entrants into the insurance marketplace 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. The competitive environment for certain lines of business, such as personal auto insurance, puts
pressure on achieving sustainable profit margins. 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.
28
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.
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. We 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 lawsuits in the ordinary course of our business arising out of or otherwise related to our insurance policies.
Additionally, from time to time we may be involved in lawsuits, including class actions, in the ordinary course of business but not
arising out of or otherwise related to our insurance policies. These lawsuits are in various stages of development. We generally
will contest these matters vigorously but may pursue settlement if appropriate. 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 position or cash flows.
Item 4. Mine Safety Disclosures
Not applicable.
29
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 24, 2017,
there were 1,164 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:
2016
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
2015
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
(1) Adjusted for stock splits.
High
Low
Dividend
$
$
$
$
22.83
22.22
24.35
27.42
High
24.80
25.70
27.37
25.69
$
17.84
18.69
20.76
19.54
0.10
0.10
0.10
0.10
Low
Dividend
$
20.36
20.63
21.55
20.01
0.10
0.10
0.10
0.10
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 information regarding regulatory restrictions on the payment
of dividends to State Auto Financial by its insurance subsidiaries.
30
Performance Graph
The line graph below compares the total return on $100.00 invested on December 31, 2011, 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.
STFC
NASDAQ Index
NASDAQ Ins. Index
12/31/2011
12/31/2012
12/31/2013
12/31/2014
12/31/2015
12/31/2016
100.00
100.00
100.00
92.85
116.71
123.33
134.87
163.60
161.75
143.73
187.86
178.82
151.97
201.21
194.41
201.34
219.26
228.72
31
Item 6. Selected Consolidated Financial Data
(dollars and shares in millions, except per share data)
Year ended December 31
Statement of Income Data — GAAP Basis:
Earned premiums
Net investment income
Total revenues
Net income
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)
Invested assets include investments and cash equivalents.
2016
2015
2014
2013
2012
$ 1,291.9
74.7
$
$ 1,405.4
21.0
$
1.7%
3.1%
$ 1,270.5
71.7
$
$ 1,368.6
51.2
$
18.3%
3.1%
$ 2,612.6
$ 2,959.4
122.1
$
891.3
$
41.8
2.4%
12.0%
$ 2,471.7
$ 2,828.2
100.5
$
884.6
$
41.3
5.8%
10.2%
1,074.1
74.7
1,172.7
107.4
1.8%
3.5%
2,357.9
2,766.6
100.5
872.9
40.9
13.0%
10.4%
1,055.0
72.8
1,153.0
60.8
1.2%
3.4%
2,251.3
2,496.1
100.5
785.0
40.7
8.0%
11.4%
1,042.1
75.4
1,150.1
10.7
(27.1)%
3.5 %
2,268.4
2,477.4
115.5
737.2
40.5
1.5 %
13.6 %
$
$
$
$
$
$
$
0.50
0.50
0.40
21.31
27.42
17.84
26.81
1.26
$
$
$
$
$
$
$
72.9%
33.3%
106.2%
73.1%
33.4%
106.5%
1.5
1.25
1.23
0.40
21.40
27.37
20.01
20.59
0.96
67.9
33.6
101.5
68.0
33.9
101.9
1.6
2.63
2.60
0.40
21.32
25.43
18.35
22.22
1.04
71.8
33.7
105.5
72.1
33.9
106.0
1.5
1.50
1.49
0.40
19.27
23.10
14.10
21.24
1.10
68.2
33.6
101.8
68.5
34.5
103.0
1.4
0.26
0.26
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
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.
32
Our reportable insurance segments are 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. 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 2016 is set forth in this Item 7 and in Note 16 to our consolidated financial
statements included in Item 8 of this Form 10-K.
EXECUTIVE SUMMARY
While we did not meet our profit or growth goals for 2016, our focus remains on achieving profitable growth for each of
our lines of business. During 2016, we completed most of the work to rebuild our foundation and implemented changes designed
to enable us to compete effectively in a rapidly changing industry.
Insurance Operations
Building on the efforts initiated in 2015 to address a number of issues impacting our underwriting results, in 2016, we
implemented a number of changes to improve our market competitiveness and underwriting profitability. Examples of changes
implemented include:
• Rebuilt pricing and underwriting models for our personal and commercial products
• Telematics, or usage-based insurance offerings for our personal and commercial auto products
• Discounts for smart home technology within our homeowners product
Personal insurance segment: During the first half of 2016, we increased the number of agency appointments for our personal
lines products and implemented pricing changes to improve our overall competitiveness. Increasing bodily injury severity trends
negatively impacted the insurance industry during 2016, and our personal auto results reflect the higher trends. We continued
efforts begun in 2015 to address the profitability of our personal auto business including the implementation of a number of rating
actions and improvements aimed at reducing underwriting and claims leakage. The actions we’ve taken began to show measurable
impact in 2016, as personal auto new business premiums and policy counts increased compared to 2015. In 2016, our homeowners
line was again profitable and new business increased both in policies-in-force and written premiums.
Business insurance segment: Our business insurance results improved in 2016 compared to 2015, reflecting our actions to
address issues that were negatively impacting underwriting results. The largest improvement came in our commercial auto line
of business which, like personal auto, has been impacted by increasing bodily injury severity trends. Throughout 2016, we took
a number of actions focused on improving commercial auto underwriting results, including identification and fixing of underwriting
gaps, better risk classifications, improving modeling capabilities and addressing rate needs. The combination of these actions and
our decision to exit our large account solutions impacted our ability to grow our business insurance net written premiums.
Specialty insurance segment - Growth in our specialty insurance segment was driven by increases in our E&S casualty and
programs units. Our E&S casualty unit continued to grow organically and programs net written premiums increased compared
to 2015 due to the addition of new programs during the latter half of 2015. Despite the continued competitiveness of the catastrophe-
exposed property marketplace, E&S property net written premiums remained flat compared to 2015, reflecting the addition of an
internal underwriting team during the third quarter of 2016. During 2016, we announced our decision to exit the traditional
programs business, enabling us to focus capital and resources on our E&S property and E&S casualty product lines.
Claims
Building upon the changes introduced late in 2015 to improve claim handling practices, philosophies, leadership and front
line personnel, we undertook a number of additional efforts during 2016 with the objective of improving overall claims efficiencies
and effectiveness. These were inclusive of, but not limited to (i) driving prompt and thorough investigations, (ii) minimizing the
utilization of external resources and building a larger State Auto field team, (iii) reinforcing the criticality of accurate and timely
reserving, (iv) reducing the time from opening to closing of each claim, and (v) identifying and investigating potential fraudulent
matters and aggressively defending claims through litigation as appropriate. These and other efforts were brought to bear across
all claims with particular emphasis on improving outcomes in the commercial and personal lines auto environment. Additionally,
whether it be the multitude of hail storms, tornadoes, Hurricane Matthew or the tragic wildfires surrounding Gatlinburg, Tennessee,
our CARE associates responded quickly, compassionately and equitably to all of our valued customers.
33
Technology
In the fourth quarter of 2016, we successfully launched our new technology platform in five states for auto and home,
providing our agents with cutting-edge, fully digital technology for underwriting and servicing new business policies. In addition
to only issuing policies digitally, insureds can only make premium payments electronically, further improving efficiencies and
eliminating the use of paper files. The new platform also incorporates new products and rates with advanced data analytics,
enhancing our analytical capabilities and providing us with data and knowledge to improve our ability to profitably underwrite
business across all of our lines of business. We expect to complete the roll-out of our new technology platform in our remaining
states for personal lines by the end of 2017 and plan to launch the same platform for small business and commercial auto by
mid-2017. Our workers compensation, umbrella and farm and ranch products will follow, most likely in 2018.
Culture
We continued to transform our culture throughout 2016, creating an environment in which every associate feels empowered
to speak up and be heard, and challenges one another candidly and respectfully. We believe our culture is one of diversity and
inclusion that makes everyone feel welcomed and respected as members of our team. We also share the deep commitment to
giving back to our communities, especially those less fortunate than our own, that’s been at the heart of our company since its
founding.
Moving forward
We remain a company focused on the property and casualty insurance business and are steadfast in our commitment to
distributing our products through independent agents. The insurance industry is undergoing significant and unprecedented change,
the pace of which can swiftly and dramatically change the manner in which property and casualty products are bought and sold.
We plan on being at the forefront of that change and our parent company, State Auto Mutual, has created State Auto Labs as a
vehicle for identifying, evaluating and investing in new technologies we believe will transform the property and casualty insurance
industry.
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 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.
The following table sets forth the participants and their participation percentages in the Pooling Arrangement. There were
no changes to the participants or to their participation percentages during 2016.
STFC Pooled Companies:
State Auto P&C
Milbank
SA Ohio
Total STFC Pooled Companies
State Auto Mutual Pooled Companies:
State Auto Mutual
SA Wisconsin
Meridian Security
Patrons Mutual
RIC
Plaza
American Compensation
Bloomington Compensation
Total State Auto Mutual Pooled Companies
51.0%
14.0
0.0
65.0
34.5
0.0
0.0
0.5
0.0
0.0
0.0
0.0
35.0%
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
34
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.
35
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, 2016, 2015 and 2014:
($ millions, except per share data)
2016
2015
2014
GAAP Basis:
Total revenues
Income before federal income taxes
Net income
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
Investment yield
SAP Basis:
Cat loss and ALAE ratio
Non-cat loss and ALAE ratio
ULAE ratio
Loss and LAE ratio
Expense ratio
Combined ratio
Net premiums written to surplus
$
$
$
$
$
1,405.4
19.2
21.0
891.3
21.31
$
$
$
$
$
1,368.6
67.3
51.2
884.6
21.40
$
$
$
$
$
1,172.7
26.8
107.4
872.9
21.32
2.4%
12.0%
6.3%
66.6%
72.9%
33.3%
5.8%
10.2%
4.0%
63.9%
67.9%
33.6%
106.2%
101.5%
1.6%
3.1%
6.3%
60.9%
5.9%
73.1%
33.4%
6.6%
3.1%
4.0%
57.7%
6.3%
68.0%
33.9%
13.0%
10.4%
3.0%
68.8%
71.8%
33.7%
105.5%
12.4%
3.5%
3.0%
62.6%
6.5%
72.1%
33.9%
106.5%
101.9%
106.0%
1.5
1.6
1.5
Our 2016 net income was $21.0 million compared to $51.2 million and $107.4 million in 2015 and 2014, respectively. Our
2014 net income included a non-cash income tax benefit of $82.6 million related to the reversal of a valuation allowance against
our net deferred tax assets.
The following highlights significant factors that impacted 2016 results as compared to 2015 and 2014:
•
•
•
Earned premiums in 2016 were $1,291.9 million compared to $1,270.5 million and $1,074.1 million in 2015 and
2014, respectively. Earned premium growth in 2016 was due to new business growth in the specialty insurance
segment. Earned premium growth in 2015 was due to (i) the termination of the HO QS Arrangement (as defined
below) and (ii) new business growth in workers’ compensation and the specialty insurance segment.
The SAP cat loss and ALAE ratio for 2016 was 6.3% compared to 4.0% and 3.0% for 2015 and 2014, respectively.
The 2016 cat loss ratio increased when compared to the same 2015 and 2014 periods primarily driven by an increase
in storm activity including wind and hail storms in Texas, Hurricane Matthew and wildfires in Tennessee.
The SAP non-catastrophe loss and ALAE ratio for 2016 was 60.9% compared to 57.7% and 62.6% for 2015 and
2014, respectively. The 2016 loss ratio increased compared to 2015 due primarily to higher severity in lines of
business with auto exposures. The 2014 loss ratios were impacted by strengthening RED reserves within the specialty
insurance segment by $96.7 million, which included the net cost of the ADC reinsurance agreement, as well as the
impact of the HO QS Arrangement, which increased our SAP non-catastrophe loss and ALAE ratio 3.4 points in
2014.
36
•
Net realized gains on investments were $36.5 million compared to $24.7 million and $20.7 million in 2015 and 2014,
respectively. Net realized gains in 2016 were impacted by the recognition of a $12.0 million gain from the redemption
of a limited partnership investment in international equities. 2015 net realized gains increased $4.0 million when
compared to 2014 partially driven by an increase in realized gains in the fixed income portfolio as a result of reducing
our TIPS position due to our inflation outlook.
37
Insurance Segments
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.
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 the “Critical Accounting Policies—Deferred Acquisition Costs” section included
in this Item 7.
The accounting for pension benefits also contributes to the difference between our GAAP loss and expense ratios and our
SAP loss and expense ratios. At January 1, 2013, we adopted new SAP pension guidance, which required the recognition of service
costs for non-vested participants. In accordance with GAAP, service costs related to non-vested participants were recognized over
a two year vesting period ending December 31, 2014. See the “Critical Accounting Policies – Pension and Postretirement Benefit
Obligations” section included in this Item 7.
Accounting for retroactive reinsurance agreements also contributes to the difference between our GAAP and SAP loss and
LAE ratios and expense ratios. In accordance with SAP, the amount paid for a retroactive reinsurance agreement is recognized
as other underwriting expense. Under GAAP, the amount recoverable for a retroactive reinsurance agreement is recorded as a
reduction to loss and loss expenses up to the amount paid for the reinsurance contract. Recoverable amounts in excess of the
amount paid for retroactive reinsurance coverage are deferred and amortized over the claim settlement period of the agreement.
The statutory loss and ALAE, and underwriting expenses within this Form 10-K have been adjusted to reflect the impact of a
retroactive reinsurance agreement. Accordingly, for the year ended December 31, 2015 we recognized a benefit of $5.9 million,
reflected as a reduction in SAP loss and ALAE. For the year ended December 31, 2014 we recognized an expense of $5.9 million,
reflected as an increase in SAP loss and ALAE. See the “Reinsurance Arrangements - Other Reinsurance Arrangements” 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 exclude the impact of the HO QS Arrangement cession for the year ended December 31, 2014 and exclude
the one-time impact of the unearned premium transfer associated with the termination of the HO QS Arrangement at December
31, 2014. We believe the use of these non-GAAP financial measures enable investors to (a) better understand the impact of the
reinsurance arrangement cession on our reported results for the year ended December 31, 2014, and (b) perform a meaningful
comparison of our results of operations for the years ended December 31, 2016, 2015 and 2014. We have also included
Reconciliation Tables 1-4 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 at the same time 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 line 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 expired on December 31, 2014. Upon expiration,
the Company recognized $89.5 million of unearned premium returned from the reinsurers. In accordance with the terms of the
HO QS Arrangement, the participating reinsurers’ margin was capped at 9.0%, with any excess returned to the State Auto Group
in the form of a profit commission. For the years ended December 31, 2016, 2015 and 2014, the Company recognized profit
38
commission of $1.9 million, $4.2 million, and $19.0 million, respectively, reflected as a reduction in acquisition and operating
expenses on the consolidated statements of income.
See “Liquidity and Capital Resources – Reinsurance Arrangements” included in this Item 7 for a more detailed discussion
of the HO QS Arrangement.
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, 2014.
GAAP HO QS Arrangement Cession -
Overall Results
As Reported
1,194.2
$
HO QS Cession
83.3
$
Pro Forma
without HO QS
Cession
$
1,277.5
1,074.1
175.6
1,249.7
$
32.3
739.0
771.3
361.9
(59.1)
3.0%
68.8%
71.8%
33.7%
105.5%
$
19.0
66.8
85.8
70.0
19.8
10.8%
38.1%
48.9%
39.8%
88.7%
51.3
805.8
857.1
431.9
(39.3)
4.1%
64.5%
68.6%
34.6%
103.2%
Reconciliation Table 1
($ millions)
December 31, 2014
Net written premiums
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) income
$
Cat loss and ALAE ratio
Non-cat loss and LAE ratio
Total Loss and LAE ratio
Expense ratio
Combined ratio
39
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, 2014.
Reconciliation Table 2
($ millions)
December 31, 2014
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 (loss) income
$
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—
Overall Results
As Reported
1,194.2
$
HO QS Cession
83.3
$
Pro Forma
without HO QS
Cession
$
1,277.5
1,074.1
175.6
1,249.7
$
32.3
672.8
705.1
69.4
774.5
405.4
(105.8)
3.0%
62.6%
65.6%
6.5%
72.1%
33.9%
106.0%
$
19.0
66.8
85.8
—
85.8
43.2
46.6
10.8%
38.1%
48.9%
—%
48.9%
51.9%
100.8%
51.3
739.6
790.9
69.4
860.3
448.6
(59.2)
4.1%
59.2%
63.3%
5.6%
68.9%
35.1%
104.0%
See additional pro forma reconciliation tables for the HO QS Arrangement cession on our homeowners line of business
at Reconciliation Tables 3-4.
40
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,
2016, 2015 and 2014:
($ millions)
Written premiums
Earned premiums
Cat loss and ALAE
Non-cat loss and ALAE
ULAE
Underwriting expenses
SAP underwriting loss and SAP
combined ratio
($ millions)
Written premiums
Earned premiums
Cat loss and ALAE
Non-cat loss and ALAE
ULAE
Underwriting expenses
SAP underwriting gain (loss)
and SAP combined ratio
($ millions)
Written premiums(1)
Earned premiums
Cat loss and ALAE
Non-cat loss and ALAE
ULAE
Underwriting expenses(2)
SAP underwriting loss and SAP
combined ratio
2016
Personal
%
Ratio
Business
%
Ratio
$
582.8
582.2
50.8
337.8
36.9
171.9
$
8.7
58.1
6.3
29.5
453.8
468.9
23.3
275.3
29.4
167.6
5.0
58.7
6.2
36.9
$
Specialty
256.7
240.8
7.5
173.7
9.4
92.9
%
Ratio
$
3.1
72.2
3.9
36.2
Total
1,293.3
1,291.9
81.6
786.8
75.7
432.4
%
Ratio
6.3
60.9
5.9
33.4
$
(15.2)
102.6
$
(26.7)
106.8
$
(42.7)
115.4
$
(84.6)
106.5
Personal
%
Ratio
Business
$
583.0
591.8
35.1
323.3
45.2
170.7
$
5.9
54.7
7.6
29.3
479.5
476.0
15.7
288.3
27.3
181.4
%
Ratio
2015
$
3.3
60.6
5.7
37.8
Specialty
%
Ratio
Total(3)
%
Ratio
211.0
202.7
0.3
121.1
8.0
79.2
$
1,273.5
1,270.5
51.1
732.7
80.5
431.3
0.2
59.7
4.0
37.5
4.0
57.7
6.3
33.9
$
17.5
97.5
$
(36.7)
107.4% $
(5.9)
101.4
$
(25.1)
101.9
Personal
%
Ratio
Business
$
532.1
451.4
13.9
260.9
43.5
144.8
$
3.1
57.8
9.6
27.2
473.1
459.9
16.5
242.6
20.9
184.5
%
Ratio
2014
$
3.6
52.8
4.5
39.0
Specialty
%
Ratio
Total(3)
%
Ratio
189.0
162.8
1.9
169.3
5.0
76.1
$
1,194.2
1,074.1
32.3
672.8
69.4
405.4
1.1
104.0
3.1
39.9
3.0
62.6
6.5
33.9
$
(11.7)
97.7
$
(4.6)
99.9
$
(89.5)
148.1
$
(105.8)
106.0
(1)
(2)
Includes $89.5 million of unearned premiums received by the STFC Pooled Companies on December 31, 2014 related to the expiration of the HO QS
Arrangement.
Includes ceding commissions returned to reinsurers upon expiration of the HO QS Arrangement of $26.0 million and recognition of $19.0 of profit
commission.
(3) See Reconciliation Tables 3 and 4 for the impact of the HO QS Arrangement cession on our SAP underwriting results.
41
Personal Insurance Segment
The following table sets forth the net written premiums by major product line of business for our personal insurance segment
for the years ended December 31, 2016, 2015 and 2014.
Table 1
($ millions)
Net Written Premiums
Personal auto
Homeowners(1)
Other personal
Total personal
2016
2015
2014
$
$
333.8
213.9
35.1
582.8
$
$
334.4
215.8
32.8
583.0
$
$
354.4
146.4
31.3
532.1
(1) December 31, 2014 net written premiums include $89.5 million of unearned premiums received by the STFC
Pooled Companies on December 31, 2014 related to the expiration of the HO QS Arrangement.
The following table sets forth the SAP loss and ALAE ratios by major product line of business for our personal insurance
segment with the catastrophe and non-catastrophe impact shown separately for the years ended December 31, 2016, 2015 and
2014:
Table 2
($ millions)
Statutory Loss and LAE Ratios
2016
Personal auto
Homeowners
Other personal
Total personal
ULAE
Total Loss and LAE
2015
Personal auto
Homeowners
Other personal
Total personal
ULAE
Total Loss and LAE
2014
Personal auto
Homeowners
Other personal
Total personal
ULAE
Total Loss and LAE
Earned
Premium
Cat Loss
& ALAE
Non-Cat
Loss &
ALAE
Statutory
Loss &
LAE
Cat
loss
Ratio
Non-Cat
Loss &
ALAE Ratio
Total Loss
and LAE
Ratio
$
$
$
$
$
$
$
$
$
330.6
217.7
33.9
582.2
—
582.2
339.1
220.5
32.2
591.8
—
591.8
362.6
58.8
30.0
451.4
—
451.4
$
$
$
$
$
$
$
$
$
7.1
40.3
3.4
50.8
—
50.8
4.6
28.9
1.6
35.1
—
35.1
7.0
5.5
1.4
13.9
—
13.9
$
$
$
$
$
$
$
$
$
243.8
82.0
12.0
337.8
—
337.8
236.0
76.1
11.2
323.3
—
323.3
228.6
21.3
11.0
260.9
—
260.9
$
$
$
$
$
$
$
$
$
250.9
122.3
15.4
388.6
36.9
425.5
240.6
105.0
12.8
358.4
45.2
403.6
235.6
26.8
12.4
274.8
43.5
318.3
2.1
18.5
10.1
8.7
—
8.7
1.3
13.1
5.0
5.9
—
5.9
1.9
9.4
4.5
3.1
—
3.1
73.8
37.7
35.3
58.1
—
58.1
69.7
34.5
34.7
54.7
—
54.7
63.1
36.1
36.9
57.8
—
57.8
75.9
56.2
45.4
66.8
6.3
73.1
71.0
47.6
39.7
60.6
7.6
68.2
65.0
45.0
41.4
60.9
9.6
70.5
42
The personal insurance segment’s net written premiums for the year ended December 31, 2016 were flat when compared to
2015 (Table 1). While total policies in force continued to decline, new business policy counts were up, and personal auto and
homeowners new business premiums increased when compared to the same 2015 period. During 2016, we increased the number
of personal lines agency appointments and conducted pricing reviews designed to improve personal lines production.
The personal insurance segment’s net written premiums for the year ended December 31, 2015 increased 9.6% when compared
to 2014 (Table 1). Net written premiums for the year ended December 31, 2014 reflect the expiration of the HO QS Arrangement,
effective December 31, 2014, which resulted in a return of $89.5 million of unearned premium previously ceded under the
arrangement. Excluding the impact of the homeowners cession and the expiration of the HO QS Arrangement, net written premiums
for the year ended December 31, 2015 for the homeowners line of business and the personal insurance segment decreased 6.1%(1)
and 5.3%(1), respectively, when compared to 2014. In addition, personal auto net written premiums for the year ended December
31, 2015 decreased 5.6% when compared to 2014 (Table 1). The 2015 change was primarily the result of a reduction in personal
auto and homeowners new business policy counts when compared to 2014, primarily due to Company actions to improve
profitability.
(1)
For the year ended December 31, 2014, the following table sets forth the reconciliation of as reported net written premiums to pro forma net
written premiums that exclude the impact of the return of unearned premium associated with the termination of the HO QS Arrangement:
($ millions)
Net written premiums:
Homeowners
Homeowners cession
Return of ceded premium
Pro forma net written premiums
Personal insurance segment
Homeowners cession
Return of ceded premium
2015
2014
%
Change
$
215.8
$
$
$
—
—
215.8
583.0
—
—
$
$
146.4
172.8
(89.5)
229.7
532.1
172.8
(89.5)
47.4
(100.0)
(100.0)
(6.1)
9.6
(100.0)
(100.0)
(5.3)
Pro forma net written premiums
$
583.0
$
615.4
Throughout 2016, we continued the efforts that began in 2015 to improve the competitiveness and profitability of our personal
lines products. These efforts were focused on technology, pricing/rates and claims.
•
Technology - In October of 2016, we launched our new digital platform for our personal auto and homeowners products
in five states. The platform offers new products and coverages using new pricing models. In addition, the platform
incorporates advanced data analytics, and it gives our agents the ability to submit, rate, quote, bind, issue and bill policies
through a completely digital and integrated platform. During 2017, we plan on completing the rollout of this digital
platform to our remaining states.
• Pricing/Rates - As a result of the rate review process initiated in the fourth quarter of 2015, we revised our rate filings
in numerous states and implemented policy form changes designed to improve profitability.
• Claims - At the end of 2015, the claims department was re-aligned to create a dedicated personal auto team to improve
our (i) claims handling processes, (ii) vendor utilization, (iii) fraud awareness and referral, and (iv) integration of data/
metrics to expedite operational responses to identified trends.
The personal insurance segment’s SAP catastrophe loss ratio for the year ended December 31, 2016 was 8.7%, compared to
5.9% in 2015 and the pro forma SAP catastrophe loss ratio of 5.2% in 2014 (Table 2 and Reconciliation Table 4). Weather events
classified as catastrophes during 2016 were generally more severe than those experienced in 2015 and 2014. During 2016, we
were impacted by storms in Texas, primarily wind and hail, Hurricane Matthew and wildfires in Tennessee. These events accounted
for 2.4 points, or $13.7 million, of the cat loss ratio.
The personal insurance segment’s SAP non-catastrophe loss and ALAE ratio for the year ended December 31, 2016 was
58.1%, compared to 54.7% in 2015 and the pro forma SAP non-catastrophe loss and ALAE ratio of 52.3% in 2014 (Table 2 and
Reconciliation Table 4). The SAP non-catastrophe loss and ALAE ratio for the year ended December 31, 2016 increased 3.4
points, when compared to the same 2015 period (Table 2) primarily due to personal auto. Personal auto results for the year were
impacted by increasing level of bodily injury severity trends that resulted in increases in ultimate loss and ALAE estimates for
43
prior accident years, primarily 2014 and 2015, when compared to the same 2015 period. The personal auto current accident year
loss and ALAE estimates reflect the impact of continued increased bodily injury severity trends.
The personal insurance segment’s SAP non-catastrophe loss and ALAE ratio for the year ended December 31, 2015 was
54.7%, compared to pro forma SAP non-catastrophe loss and ALAE ratio of 52.3% in 2014 (Table 2 and Reconciliation Table
4). The 2.4 point increase in the 2015 ratio when compared to 2014 (Table 2 and Reconciliation Table 4) was due to a 6.6 point
increase in the personal auto ratio (Table 2), primarily attributable to increased bodily injury severity trends that resulted in higher
ultimate loss and LAE estimates for the current and prior accident years. The personal auto ratio increase was partially offset by
a decrease in the homeowners ratio of 3.1 points (Table 2 and Reconciliation Table 3) due to improvement in the 2015 accident
year.
The following tables set forth, on a SAP and pro forma basis, certain of our key performance indicators for the homeowners
line of business before and after the impact of the HO QS Arrangement cession for the year ended December 31, 2014:
Reconciliation Table 3
($ millions)
December 31, 2014
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
Reconciliation Table 4
($ millions)
December 31, 2014
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
58.8
$
175.6
$
234.4
$
5.5
21.3
26.8
9.4 %
36.1 %
45.5 %
$
19.0
66.8
85.8
10.8 %
38.1 %
48.9 %
24.5
88.1
112.6
10.5 %
37.6 %
48.1 %
SAP HO QS Arrangement Cession
– Personal Insurance Segment
As
Reported
HO QS
Cession
Pro-Forma
without
HO QS
Cession
451.4
$
175.6
$
627.0
13.9
260.9
274.8
$
3.1 %
57.8 %
60.9 %
$
19.0
66.8
85.8
10.8 %
38.1 %
48.9 %
32.9
327.7
360.6
5.2 %
52.3 %
57.5 %
$
$
$
$
Business Insurance Segment
As a result of changes to our reporting structure that occurred during late 2015, effective December 31, 2015, the workers’
compensation unit moved from the specialty insurance segment to the business insurance segment. Prior reporting periods have
been restated to conform to the new presentation.
44
The following table sets forth the net written premiums by major product line of business for our business insurance segment
for the years ended December 31, 2016, 2015 and 2014.
Table 3
($ millions)
Net Written Premiums
Commercial auto
Commercial multi-peril
Fire & allied lines
Other & product liability
Workers’ compensation
Other commercial
Total business
2016
2015
2014
$
$
85.9
117.1
73.0
69.5
92.0
16.3
453.8
$
$
102.5
119.9
73.6
73.9
92.8
16.8
479.5
$
$
101.8
121.4
76.9
71.4
83.9
17.7
473.1
45
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, 2016, 2015 and
2014:
Table 4
($ millions)
Statutory Loss and LAE Ratios
2016
Commercial auto
Commercial multi-peril
Fire & allied lines
Other & product liability
Workers’ compensation
Other commercial
Total business
ULAE
Total Loss and LAE
2015
Commercial auto
Commercial multi-peril
Fire & allied lines
Other & product liability
Workers’ compensation
Other commercial
Total business
ULAE
Total Loss and LAE
2014
Commercial auto
Commercial multi-peril
Fire & allied lines
Other & product liability
Workers’ compensation
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
$
$
$
$
$
$
$
$
$
94.8
119.2
73.5
71.0
93.8
16.6
468.9
—
468.9
101.6
120.0
74.9
73.1
89.3
17.1
476.0
—
476.0
98.5
118.0
77.4
70.2
78.1
17.7
459.9
—
459.9
$
$
$
$
$
$
$
$
$
0.9
12.8
9.5
—
—
0.1
23.3
—
23.3
0.6
8.3
6.8
—
—
—
15.7
—
15.7
0.8
7.0
8.7
—
—
—
16.5
—
16.5
$
$
$
$
$
$
$
$
$
74.1
63.9
30.6
42.4
58.4
5.9
275.3
—
275.3
83.8
73.4
26.8
45.4
54.6
4.3
288.3
—
288.3
56.6
68.1
34.1
32.6
45.9
5.3
242.6
—
242.6
$
$
$
$
$
$
$
$
$
75.0
76.7
40.1
42.4
58.4
6.0
298.6
29.4
328.0
84.4
81.7
33.6
45.4
54.6
4.3
304.0
27.3
331.3
57.4
75.1
42.8
32.6
45.9
5.3
259.1
20.9
280.0
1.0
10.8
12.8
—
—
0.6
5.0
—
5.0
0.6
6.9
9.1
—
—
0.1
3.3
—
3.3
0.8
6.0
11.3
—
—
(0.3)
3.6
—
3.6
78.2
53.6
41.6
59.7
62.3
35.2
58.7
—
58.7
82.4
61.2
35.8
62.1
61.1
25.3
60.6
—
60.6
57.5
57.6
44.0
46.5
58.8
30.3
52.8
—
52.8
79.2
64.4
54.4
59.7
62.3
35.8
63.7
6.2
69.9
83.0
68.1
44.9
62.1
61.1
25.4
63.9
5.7
69.6
58.3
63.6
55.3
46.5
58.8
30.0
56.4
4.5
60.9
Net written premiums for the business insurance segment for the year ended December 31, 2016 decreased 5.4% when
compared to 2015 (Table 3). The 2016 decrease was primarily due to (i) our decision to exit our large account business, (ii) rate
and underwriting actions to improve profitability in commercial auto, and (iii) changes made to our regional sales teams during
the first quarter of 2016, including staff reductions and reassignment of agency relationships among the remaining staff. Net
written premiums for the year ended December 31, 2015 increased 1.4% when compared to 2014 (Table 3) primarily due to growth
in mono-line workers’ compensation business.
Throughout 2016, we continued efforts that began in 2015 designed to improve the competitiveness and profitability of our
business insurance products. These efforts were focused on technology and underwriting improvements.
•
Technology - We anticipate introducing our new technology platform (as described in the personal insurance segment
discussion) for our business owners’ policy and small commercial auto products to our business insurance agents in the
second quarter of 2017.
46
• Underwriting Improvements - During 2016, we implemented a number of changes within our business insurance segment,
including (i) the decision to exit our large account solutions business; (ii) the restructuring of our regional sales teams;
(iii) redefining our underwriting appetite for commercial exposures; (iv) pricing reviews designed to improve commercial
auto profitability, and (v) expanding and strengthening relationships with our agency force.
The business insurance segment’s SAP catastrophe loss and ALAE ratio for 2016 was 5.0% compared to 3.3% and 3.6%
in 2015 and 2014, respectively (Table 4). The business insurance segment's SAP catastrophe loss ratio was impacted by the same
weather events described in the personal insurance segment discussion above. The improvement in 2015 when compared to 2014
was primarily due to fewer and less severe catastrophe events during the year ended 2015.
The business insurance segment’s SAP non-catastrophe loss and ALAE ratio for the year ended December 31, 2016 was
58.7% compared to 60.6% and 52.8% in 2015 and 2014, respectively (Table 4). The 1.9 point improvement in the 2016 ratio
when compared to 2015 (Table 4) was primarily due to commercial auto and commercial multi-peril lines ratio improvements of
4.2 points and 7.6 points, respectively (Table 4). The improvement in the commercial auto ratio was primarily due to less adverse
development of prior accident year losses as a result of revising our previous estimates for accident years 2014 and 2015, slightly
offset by increases in the current accident year loss and ALAE estimates that reflect the impact of increasing bodily injury severity
trends. Commercial multi-peril improved when compared to 2015 primarily as a result of underwriting actions taken to improve
production and profitability. Slightly offsetting the improvement was a 5.8 point increase in the fire & allied loss ratio when
compared to 2015 (Table 4) primarily due to three large fire losses that occurred during the second half of 2016.
The business insurance segment’s SAP non-catastrophe loss and ALAE ratio for the year ended December 31, 2015 increased
7.8 points when compared to 2014 (Table 4) primarily due to commercial auto, other & product liability and commercial multi-
peril lines ratio increases of 24.9 points, 15.6 points and 3.6 points, respectively (Table 4). The increase in the commercial auto
ratio was due to an increase in frequency and severity loss trends in third party liability and physical damage coverages when
compared to 2014. The elevated severity trends in third party liability coverages also contributed to adverse development of prior
accident year losses. The increase in the other & product liability ratio was primarily due to less favorable development of prior
accident year losses and an increase in the severity of losses during the current accident year when compared to 2014. The increase
in the commercial multi-peril ratio was due to an increase in the severity of losses during the current accident year when compared
to 2014. Partially offsetting these increases was an 8.2 point improvement in the fire & allied lines ratio when compared to 2014
(Table 4), due to fewer and less severe losses, and an elevated level of large fire losses during the first six months of 2014 as well
as the extreme cold weather during the first quarter of 2014.
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.
Certain business previously included in the programs unit has been reclassified to the E&S property unit. Prior reporting
periods have been restated to conform to the new presentation.
The following table sets forth the net written premiums by unit for our specialty insurance segment for the years ended
December 31, 2016, 2015 and 2014.
Table 5
($ millions)
Net Written Premiums
E&S property
E&S casualty
Programs
Total specialty
2016
2015
2014
$
$
44.4
99.6
112.7
256.7
$
$
44.5
70.5
96.0
211.0
$
$
51.7
60.9
76.4
189.0
47
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, 2016, 2015 and 2014:
Table 6
($ millions)
Statutory Loss and LAE Ratios
2016
E&S property
E&S casualty
Programs
Total specialty
ULAE
Total Loss and LAE
2015
E&S property
E&S casualty
Programs
Total specialty
ULAE
Total Loss and LAE
2014
E&S property
E&S casualty
Programs
Total specialty
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
$
$
$
$
$
$
$
$
$
40.4
91.0
109.4
240.8
—
240.8
49.4
64.0
89.3
202.7
—
202.7
49.0
48.6
65.2
162.8
—
162.8
$
$
$
$
$
$
$
$
$
6.9
0.1
0.5
7.5
—
7.5
0.1
—
0.2
0.3
—
0.3
1.9
—
—
1.9
—
1.9
$
$
$
$
$
$
$
$
$
13.5
65.3
94.9
173.7
—
173.7
6.9
41.2
73.0
121.1
—
121.1
9.0
20.0
140.3
169.3
—
169.3
$
$
$
$
$
$
$
$
$
20.4
65.4
95.4
181.2
9.4
190.6
7.0
41.2
73.2
121.4
8.0
129.4
10.9
20.0
140.3
171.2
5.0
176.2
17.0
0.1
0.5
3.1
—
3.1
0.3
—
0.2
0.2
—
0.2
3.9
—
—
1.1
—
1.1
33.5
71.8
86.7
72.2
—
72.2
13.8
64.4
81.8
59.7
—
59.7
18.3
41.3
215.2
104.0
—
104.0
50.5
71.9
87.2
75.3
3.9
79.2
14.1
64.4
82.0
59.9
4.0
63.9
22.2
41.3
215.2
105.1
3.1
108.2
Net written premiums for the specialty insurance segment for the year ended December 31, 2016 increased 21.7% when
compared to 2015 (Table 5). E&S casualty net written premiums increased 41.3% compared to 2015 primarily due to (i) continued
organic growth within our general liability and umbrella lines, which comprised the majority of the increase, (ii) changes to the
reinsurance treaty covering casualty risks within the specialty insurance segment, including an increase in our retention per loss
occurrence (see “Liquidity and Capital Resources – Reinsurance Arrangements" in this Item 7 for further information), and (iii)
the impact of the reinsurance correction recorded in the second quarter of 2015, which reduced E&S casualty net written premiums
by $7.2 million. Programs unit net written premiums increased 17.4% compared to 2015 due to new programs added during the
second half of 2015 and growth of existing programs. As discussed further below, during the third quarter of 2016, management
made the decision to exit the programs business. E&S property net written premiums were flat compared to the same 2015 period
as a result of continuing competitiveness of the catastrophe-exposed property market. During the fourth quarter of 2016, we hired
an internal E&S property underwriting team that we believe will strengthen our broker relationships and further diversify our book
of business with respect to (i) the mix between catastrophe and non-catastrophe and (ii) geographic spread of risk.
Net written premiums for the year ended December 31, 2015 increased 11.6% when compared to 2014 (Table 5). The
increase in premiums was primarily due to (i) the Partners General Agency acquisition in 2014, (ii) new programs added during
the second half of 2014, and (iii) growth in general liability and umbrella policies in the E&S casualty unit. Partially offsetting
the 2015 growth was a decline in the E&S property unit premiums due to continued intense competition within the catastrophe-
exposed property marketplace, which has contributed to less favorable pricing opportunities.
The specialty insurance segment’s SAP catastrophe loss and ALAE ratio for 2016 was 3.1% compared to 0.2% and 1.1%
in 2015 and 2014, respectively (Table 6). The 2016 SAP catastrophe loss ratio reflects the impact of Hurricane Matthew which
added 2.4 points, or $5.9 million, to the cat loss ratio.
The specialty insurance segment’s SAP non-catastrophe loss and ALAE ratio for the year ended December 31, 2016 was
72.2% compared to 59.7% and 104.0% in 2015 and 2014, respectively (Table 6). E&S property increased 19.7 points when
compared to 2015 (Table 6) primarily driven by increases in the ultimate loss and ALAE estimates for prior accident years for the
48
liability coverage of our Florida package business. E&S casualty increased 7.4 points when compared to 2015 (Table 6) driven
by (i) increases in the ultimate loss and ALAE estimates for the current and prior accident years for our healthcare line, which was
placed in run-off during the first quarter of 2016, and (ii) an increase in the ultimate loss and ALAE estimates for the current
accident year in our general liability line due to increased severity. Programs increased 4.9 points when compared to 2015 (Table
6) primarily driven by elevated severity trends within programs with commercial auto exposures which contributed to (i) higher
2016 accident year loss and ALAE ratios and (ii) adverse development of prior accident year losses.
During the third quarter of 2016, the Company’s management completed an evaluation of business written within the
programs unit due primarily to the unit’s poor underwriting results. As a result of the evaluation, management concluded that the
business generated by the programs unit was not core to our strategy and decided to exit the programs business. We will stop
writing program business by the middle of 2017; however, exposure to the risks underlying this business will continue as the
premiums are earned through mid-2018. Exiting the programs business allows us to focus on our E&S property and E&S casualty
books of business.
The specialty insurance segment’s SAP non-catastrophe loss and ALAE ratio for the year ended December 31, 2015 was
59.7% compared to 104.0% in 2014 (Table 6). The improvement in 2015 when compared to 2014 (Table 6) was due to RED
reserve strengthening during 2014.
The programs unit 2015 SAP non-catastrophe loss and ALAE ratio improved 133.4 points when compared to 2014 (Table
6) as a result of RED reserve strengthening in 2014 which added 148.3 points to the 2014 ratio. Excluding RED reserve
strengthening, the ratio increased 14.9 points when compared to pro forma 2014, primarily due to higher current accident year
losses due to increased severity in three programs with commercial auto exposures. In addition, prior accident year losses developed
adversely for certain programs, including those in runoff.
The E&S property unit’s 2015 SAP non-catastrophe loss and ALAE ratio improved 4.5 points when compared to 2014 (Table
6), primarily due to lower current year losses.
The E&S casualty unit’s 2015 SAP non-catastrophe loss and ALAE ratio increased 23.1 points, when compared to 2014
(Table 6), primarily due to (i) a shift in the business mix attributable to the Partners General Agency acquisition in the second
quarter of 2014, and (ii) adverse development of prior accident year losses during 2015 and favorable development of prior accident
year losses during 2014.
49
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 the 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, 2016, 2015 and 2014:
($ millions)
Provision for losses and loss expenses
occurring:
%
GAAP Loss
and LAE
Ratio
%
GAAP Loss
and LAE
Ratio
2015
2014
%
GAAP Loss
and LAE
Ratio
2016
Current year
Prior years
Total losses and loss expenses
$
$
915.4
27.0
942.4
70.8
2.1
72.9
$
$
852.8
10.0
862.8
67.1
0.8
67.9
$
$
726.2
45.1
771.3
67.6
4.2
71.8
As shown above, the 2016 loss and loss expenses attributable to prior years was $27.0 million, or an unfavorable
development in the estimated ultimate liability for prior years’ claims.
50
The following table sets forth a tabular presentation of the development of the ultimate liability of prior accident years by
line of business for the years ended December 31, 2016, 2015 and 2014:
($ millions)
2016
2015
2014
Redundancy /(Deficiency)
Non-cat loss and ALAE:
Personal insurance segment:
Personal auto
Homeowners
Other personal
Personal segment
Business insurance segment:
Commercial auto
Commercial multi-peril
Fire & allied lines
Other & product liability
Workers' compensation
Other commercial
Business segment
Specialty insurance segment:
E&S property
E&S casualty
Programs
Specialty segment
Cat loss and ALAE
ULAE
Total
$
$
(7.9)
(0.4)
0.5
(7.8)
(3.3)
(1.8)
(0.1)
4.5
4.2
0.4
3.9
(1.9)
(4.6)
(14.3)
(20.8)
1.4
(3.7)
$
(27.0)
$
$
(11.0)
1.6
—
(9.4)
(10.5)
(1.0)
1.3
3.8
5.1
0.9
(0.4)
5.2
(2.7)
(9.6)
(7.1)
0.7
6.2
(10.0)
$
2.7
2.9
0.8
6.4
5.3
(2.1)
1.2
11.9
5.6
0.4
22.3
3.9
3.1
(98.5)
(91.5)
5.2
12.5
(45.1)
For further information, see the discussion below and the "Personal Insurance Segment", "Business Insurance Segment"
and "Specialty Insurance Segment" sections of “Results of Operations – Insurance Segments” included in this Item 7.
51
The following table sets forth a tabular presentation of the development of the ultimate liability by accident year for the year
ended December 31, 2016:
($ millions)
Accident Year
2006 and prior
2007
2008
2009
2010
2011
2012
2013
2014
2015
Total
2016
Redundancy /(Deficiency)
(3.4)
$
3.3
1.7
(1.6)
0.5
1.7
1.9
(2.1)
(6.4)
(22.6)
(27.0)
$
While emergence by accident year includes normal fluctuations due to the uncertainty associated with loss reserve
development and claim settlement, the adverse development in 2016 resulted primarily from accident years 2015 and 2014. The
more notable items contributing to the 2016 development were as follows:
•
•
•
•
•
ULAE was $3.7 million higher than anticipated in the reserves at December 31, 2015.
Catastrophe reserves contributed $1.4 million of favorable development.
The personal insurance segment non-catastrophe loss and ALAE reserves contributed $7.8 million of the adverse
development, driven by personal auto which contributed $7.9 million of adverse development, primarily due to
higher than anticipated bodily injury severity from the prior two accident years.
The business insurance segment non-catastrophe loss and ALAE reserves contributed $3.9 million of favorable
development, driven by other & product liability and workers’ compensation of $4.5 million and $4.2 million ,
respectively. Favorable development in these lines was driven by lower than anticipated severity emerging from
multiple accident years. The favorable development was partially offset by adverse development in commercial
auto of $3.3 million, which was driven by higher than anticipated bodily injury severity from the prior two
accident years.
The specialty insurance segment non-catastrophe loss and ALAE reserves accounted for $20.8 million of adverse
development, which was driven by programs and E&S casualty with adverse development of $14.3 million and
$4.6 million, respectively. Programs adverse development was driven by higher than expected severity in
programs with commercial auto exposures. E&S casualty adverse development was driven by increased severity
from the healthcare line, which was placed in run-off in the first quarter of 2016.
52
The following table sets forth a tabular presentation of the development of the ultimate liability by accident year for the year
ended December 31, 2015:
($ millions)
Accident Year
2005 and prior
2006
2007
2008
2009
2010
2011
2012
2013
2014
Total
2015
Redundancy /(Deficiency)
1.1
$
(0.2)
(0.1)
1.8
2.0
3.4
(1.7)
(2.8)
(11.5)
(2.0)
(10.0)
$
While emergence by accident year includes normal fluctuations due to the uncertainty associated with loss reserve
development and claim settlement, the adverse development in 2015 resulted primarily from accident year 2013. The more notable
items contributing to the 2015 development were as follows:
•
•
•
•
ULAE was $6.2 million lower than anticipated in the reserves at December 31, 2014.
We experienced favorable catastrophe loss development of $0.7 million in 2015 related to catastrophe losses
primarily from accident year 2014.
In the personal and business insurance segments, the non-catastrophe loss and ALAE reserves contributed $9.8
million of unfavorable development. The personal insurance segment contributed $9.4 million of the adverse
development, due to higher than anticipated bodily injury severity trends from the 2014 and 2013 accident years
in personal auto. The business insurance segment contributed $0.4 million of unfavorable development, with
adverse development in commercial auto offset by favorable development in other & product liability and
workers’ compensation. Higher than anticipated bodily injury severity from the prior two accident years
contributed to the commercial auto development, while the favorable development in the other & product liability
and workers’ compensation lines was due to lower than anticipated severity emerging from multiple accident
years.
In the specialty insurance segment, the non-catastrophe loss and ALAE reserves accounted for $7.1 million of
adverse development, which was due to programs and E&S casualty with unfavorable development of $9.6
million and $2.7 million, respectively. Unfavorable development in programs was due to higher than expected
severity in programs with commercial auto exposure. Partially offsetting the unfavorable development was
favorable development of $5.2 million in the E&S property unit due to lower than anticipated severity emerging
from accident year 2014.
53
The following table sets forth a tabular presentation of the favorable development by accident year for the year ended
December 31, 2014:
($ millions)
Accident Year
2004 and prior
2005
2006
2007
2008
2009
2010
2011
2012
2013
Total
2014
Redundancy /(Deficiency)
1.4
$
0.3
0.5
0.5
1.3
3.9
(4.5)
(21.4)
(37.2)
10.1
(45.1)
$
The adverse development in 2014 resulted primarily from accident years 2012 and 2011. The more notable items contributing
to the 2014 development were as follows:
•
•
•
•
ULAE was $12.5 million lower than anticipated in the reserves at December 31, 2013.
We experienced favorable catastrophe loss development of $5.2 million in 2014 related to catastrophe losses
primarily from accident year 2013.
In the personal and business insurance segments, the non-catastrophe loss and ALAE reserves contributed $28.7
million of favorable development. The business insurance segment contributed $22.3 million of this favorable
development, due to other & product liability, workers' compensation and commercial auto. The favorable
development in these lines was due to lower than anticipated severity from accident years 2013 and prior. The
personal insurance segment contributed $6.4 million of this favorable development, primarily from accident
year 2013.
In the specialty insurance segment, the non-catastrophe loss and ALAE reserves accounted for $91.5 million of
adverse development related primarily to accident years 2011 and 2012, which was due to RED reserve
strengthening. Partially offsetting the unfavorable development of RED reserves was favorable development
in the E&S property and casualty units. Favorable development in these lines was due to better than anticipated
severity emerging primarily from the 2012 and 2013 accident years.
54
The following table sets forth loss and loss expenses payable by major line of business at December 31, 2016 and 2015:
($ 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
Workers’ compensation
Other business
Total business
Specialty insurance segment:
E&S property
E&S casualty
Programs
Total specialty
2016
2015
$
Change
$
$
192.6
49.4
9.1
251.1
103.3
123.6
19.8
171.0
185.6
2.6
605.9
29.8
137.4
153.8
321.0
$
182.1
37.2
7.7
227.0
97.1
109.1
17.4
161.2
167.3
1.5
553.6
21.4
96.6
148.5
266.5
10.5
12.2
1.4
24.1
6.2
14.5
2.4
9.8
18.3
1.1
52.3
8.4
40.8
5.3
54.5
Total losses and loss expenses payable net of reinsurance
recoverable on losses and loss expenses payable
$
1,178.0
$
1,047.1
$
130.9
The loss and loss expenses payable at December 31, 2016 increased $130.9 million from the loss and loss expenses payable
at December 31, 2015, primarily due to (i) exposure growth in workers' compensation and E&S casualty, (ii) increased bodily
injury severity trends which resulted in increases in ultimate loss and ALAE estimates for current and prior accident years in
personal auto, commercial auto and programs with auto exposures, and (iii) seasonality of weather-related catastrophe losses.
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. For a discussion of our
reserving methodologies, see “Critical Accounting Policies – Losses and Loss Expenses Payable” included in this Item 7.
Acquisition and Operating Expenses
Our GAAP expense ratio was 33.3% in 2016 compared to 33.6% and 33.7% in 2015 and 2014, respectively. Acquisition
and operating expenses for 2016 were flat compared to 2015 and pro forma 2014 (Reconciliation Table 1). The 2016 expense
ratio was impacted by an increase in technology investments offset by decreases in personnel costs and incentive compensation.
The 2015 expense ratio was impacted by management’s overall expense initiatives and organizational goals, during the fourth
quarter of 2015, we recognized $6.8 million of severance expenses for (i) an early retirement incentive offered to eligible employees
and (ii) headcount reductions within our underwriting, claims and information technology departments. The severance expenses
recognized during the fourth quarter of 2015 were offset by lower bonus and contingent commission expenses.
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, large-cap equities, MLP exchange traded funds,
mutual funds and small-cap equity funds, and outside investment managers to invest in small-cap equities and international funds.
55
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 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 purchases of bonds that are rated below investment grade by a recognized rating service. Our fixed maturity
portfolio is composed of high quality, investment grade issues, comprised mostly of debt issues rated A or higher. We obtain
investment ratings from Moody’s, Standard & Poor’s and Fitch. If there is a split rating, we assign the lowest rating obtained. At
December 31, 2016, there were two fixed maturity investments rated below investment grade in our available-for-sale investment
portfolio. These securities are rated below investment grade due to a rating agency downgrade subsequent to the purchase of the
securities. Both securities are in the energy sector.
Our internally managed equity portfolio invests in U.S. large-cap companies across many different industries, selected based
upon their potential for appreciation. This diversification across companies and industries reduces volatility in the value of the
large-cap equity portfolio. Our investment policy guidelines limit the purchase of a specific stock to no more than 5.0% of the
market value of the stock at the time of purchase, and no individual company’s equity holding should exceed 5.0% of the total
equity portfolio. In addition, we also invest in dividend-paying exchange traded funds (“ETF”) and mutual funds which add to
the diversification of the portfolio by allowing us to invest in a large number of companies via one security.
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 when compare to how we manage our large-cap equity holdings.
At December 31, 2016, 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.
56
Composition of Investment Portfolio
The following table sets forth the composition of our investment portfolio at carrying value at December 31, 2016 and 2015:
% of
Total
2015
% of
Total
($ 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
Mutual and exchange traded funds
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
2016
$
51.1
1,947.5
161.8
2,109.3
70.0
139.0
79.1
164.7
382.8
1.9
$
58.1
73.1
6.1
79.2
2.6
5.2
3.0
6.2
14.4
1,856.7
144.0
2,000.7
70.0
161.7
69.6
79.3
310.6
35.7
9.4
45.1
5.4
$ 2,663.7
1.3
0.4
1.7
0.2
100.0
77.0
8.1
85.1
5.3
$ 2,529.8
2.3
73.4
5.7
79.1
2.8
6.4
2.8
3.1
12.3
3.0
0.3
3.3
0.2
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 $70.0 million from us on an unsecured basis. Interest is payable semi-annually at a fixed
annual interest rate of 7.00%. Principal is payable May 2019.
The following table sets forth the amortized cost and fair value of available-for-sale fixed maturities by contractual maturity
at December 31, 2016:
($ 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
$
74.4
$
552.7
280.2
574.9
613.7
75.2
557.8
282.9
582.1
611.3
$
2,095.9
$
2,109.3
Expected maturities may differ from contractual maturities as issuers may have the right to call or prepay the obligations
with or without call or prepayment penalties.
At December 31, 2016, our equity portfolio consisted of approximately 44 different large-cap stocks, 73 small-cap stocks
and 11 mutual and exchange traded funds. The largest single fund holding was 12.7% of the equity portfolio based on fair value
and the top ten positions accounted for 45.5% of the equity portfolio. At December 31, 2015, our equity portfolio consisted of
approximately 56 different large-cap stock, 69 small-cap stocks and nine mutual and exchange traded funds. The largest single
fund holding was 13.0% of the equity portfolio based on fair value, and the top ten positions accounted for 34.1% of the equity
portfolio.
57
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 4.45 and 4.85 as of December 31, 2016 and 2015,
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, 2016:
($ millions)
Fixed maturities:
-200 bps
Change
-100 bps
Change
Fair Value
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 mortgage-backed
securities
Balance as of December 31, 2016
$
$
438.6
697.3
487.0
662.0
2,284.9
$
$
422.1
671.3
468.8
637.4
2,199.6
$
$
404.7
643.7
449.6
611.3
2,109.3
$
$
386.0
613.8
428.8
583.0
2,011.6
$
$
366.7
583.3
407.4
553.9
1,911.3
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 66.8% of the bonds we
own are rated AA or better. We do not intend to change our investment policy or 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. We categorize our fixed maturities as
available-for-sale in order to provide us greater flexibility in managing our portfolio. We do not maintain a trading portfolio.
There are no mortgage backed securities in our fixed maturity portfolio which may be labeled sub-prime mortgage backed
securities. We invest only in mortgage backed securities issued by a federal agency or that are U.S. Government guaranteed.
Specifically, at December 31, 2016, approximately $611.3 million, or 29.0%, of our fixed maturity available-for-sale investment
portfolio was in either GNMA pools, which are guaranteed by the full faith and credit of the U.S. Government, or FNMA or Freddie
Mac pools.
At December 31, 2016, our fixed maturity investment portfolio included obligations of states and political subdivisions with
a total carrying value of $643.7 million, with $72.1 million of these securities, or 11.2% 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. At December 31,
2016, 66.9% of the total $643.7 million of municipal securities in our investment portfolio were rated AA or better, without the
benefit of a Credit Enhancement. We do not believe that a loss of a Credit Enhancement would have a material adverse impact on
our results of operations, financial position or liquidity, due to the underlying strength of the issuers of the securities, as well as
our ability and intent to hold the securities. In addition, at December 31, 2016, we had no direct investment in any guarantor
including any bond insurer.
58
The following table sets forth the credit ratings of our municipal securities, excluding Credit Enhancements, based on ratings
by nationally recognized rating agencies at December 31, 2016:
($ millions)
Rating
AAA
AA*
A
BBB
Total
Total fair
value
$
$
47.5
383.2
191.8
21.2
643.7
%
7.4
59.5
29.8
3.3
100.0
* Our AA rating category includes securities that have been either pre-
funded or escrowed to maturity.
We believe our Muni Portfolio is well diversified by issuer and state. We have 13.8% invested in securities which have been
either pre-refunded or escrowed to maturity bonds. No single issuer comprises more than 5.0% of our Muni Portfolio. For the
bonds that are not in the pre-refunded category, no more than 13.0% is concentrated in any one state. We believe our Muni Portfolio
is invested within the strongest sectors of the municipal bond market. Revenue bonds represent 54.6% of our Muni Portfolio and
state and local government general obligation bonds make up 17.5% of our Muni Portfolio. 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.
At December 31, 2016, our small-cap and large-cap equity portfolios had a beta of 0.81 and 1.07, respectively, using the
Russell 2000 and the S&P 500 Index as benchmarks, respectively. At December 31, 2016, our mutual and exchange traded funds
portfolio had a beta of 0.97 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 tables set forth what changes might occur in the value of the small-
cap and large-cap equity and mutual and exchange traded funds portfolios given a change in the S&P 500 Index at December 31,
2016:
Small-cap equity portfolio:
Fair value ($ millions)
Change in Russell 2000 Index
Value as % of original value
Large-cap equity portfolio:
Fair value ($ millions)
Change in S&P 500 Index
Value as % of original value
$
$
$
$
92.0
+20%
116%
168.7
+20%
121%
$
$
85.6
+10%
108%
153.9
+10%
111%
$
79.1
—
100%
$
72.7
-10%
92%
66.3
-20%
84%
139.0
—
100%
$
124.1
$
109.3
-10%
89%
-20%
79%
Mutual and exchange traded funds portfolio:
Fair value ($ millions)
Change in Russell 2000 Index
Value as % of original value
$
196.5
$
180.6
$
164.7
$
148.8
$
132.9
+20%
119%
+10%
110%
—
100%
-10%
90%
-20%
81%
The above analysis is limited in that it does not take into account any actions that might be taken by us in response to these
changes. As a result, the actual impact of a change in equity market prices and the resulting equity values may differ significantly
from what is shown in the table. By investing in mostly large-cap issues we hope to limit liquidity risk in the equity portfolio. The
small-cap and large-cap equity portfolios do 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.
59
At December 31, 2016, we have one international fund, Fund 1, which is included in other invested assets available-for-
sale. Fund 1 had a beta of 0.70 using the MSCI EAFE Index as a benchmark. The following table sets forth what changes might
occur in the value of Funds 1 given a change in the MSCI EAFE Index at December 31, 2016:
Fund 1:
Fair value ($ millions)
Change in MSCI EAFE Index
Value as % of original value
$
$
40.7
+20%
114%
$
38.2
+10%
107%
$
35.7
—
100%
$
33.2
-10%
93%
30.7
-20%
86%
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 value
may differ significantly from what is shown in the table above.
Investment Operations Revenue
The following table sets forth the components of net investment income for the years ended December 31, 2016, 2015 and
2014:
($ 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
2015
2014
2016
$
$
63.4
7.3
5.6
76.3
1.6
74.7
$
$
61.3
6.5
5.9
73.7
2.0
71.7
$
$
64.3
6.2
6.2
76.7
2.0
74.7
$ 2,443.0
$ 2,313.3
$ 2,153.7
3.1%
2.3%
55.7
25.5%
$
3.1%
2.4%
55.3
22.8%
$
3.5%
2.6%
57.0
23.7%
$
Our investment operations revenue for the year ended December 31, 2016 was primarily impacted by an increase of $1.8
million in Treasury Inflation-Protected Securities (“TIPS”) interest income and an increase in dividend income. Because TIPS
are dependent on changes in the Consumer Price Index, they are directly impacted by the change in the rate of inflation (as inflation
declines TIPS income decreases and vice versa). Interest earned on our fixed maturity securities in 2015 decreased primarily due
to a decrease of $3.3 million in TIPS income.
60
The following table sets forth realized gains (losses) and the proceeds received on sale for our investment portfolio for the
years ended December 31, 2016, 2015 and 2014:
($ millions)
2016
2015
2014
Realized gains:
Fixed maturities
Equity securities
Other invested assets
Total realized gains
Realized losses:
Equity securities:
Sales
OTTI
Fixed maturities:
OTTI
Total realized losses
Net realized gains on investments
Realized
gains
(losses)
Proceeds
received
on sale
Realized
gains
(losses)
Proceeds
received
on sale
Realized
gains
(losses)
Proceeds
received
on sale
$
$
$
$
$
2.8
29.2
12.1
44.1
$
$
(0.8) $
(4.5)
(2.3)
(7.6) $
$
36.5
211.6
147.0
0.8
359.4
6.0
—
—
6.0
365.4
$
$
$
$
$
4.6
29.6
0.2
34.4
$
$
(1.8) $
(7.9)
—
(9.7) $
$
24.7
180.7
135.1
0.7
316.5
9.7
—
—
9.7
326.2
$
$
$
$
$
3.1
21.3
0.1
24.5
$
$
(1.3) $
(2.5)
—
(3.8) $
$
20.7
159.9
89.2
0.1
249.2
10.4
—
—
10.4
259.6
Net realized gains increased $11.8 million and $15.8 million, respectively, when compared to the same 2015 and 2014
periods. During the fourth quarter of 2016, we redeemed a limited partnership investment in international equities that had been
classified as other invested assets. The redemption proceeds were reinvested in an international equity mutual fund classified as
an equity security. The Company recognized a gain of $12.0 million on the redemption. Out of the total proceeds related to this
redemption and reinvestment, $44.0 million was non-cash and therefore excluded from net cash used in investing activities in the
consolidated statements of cash flows. 2015 net realized gains increased $4.0 million when compared to 2014 partially driven by
an increase in realized gains in the fixed income portfolio 2015 as a result of reducing our TIPS position due to our inflation
outlook.
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, which is recognized in accumulated other comprehensive income. 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 $2.3 million of OTTI on our fixed maturity
portfolio for the year ended December 31, 2016. We did not recognize any impairments on our fixed maturity portfolio during
2015 or 2014.
When an equity security or other invested asset has been determined to have a decline in fair value that is other-than-
temporary, we adjust the cost basis of the security to fair value. See “Critical Accounting Policies – Investments” included in this
Item 7 for OTTI impairment indicators. This results in a charge to earnings as a realized loss, which is not reversed for subsequent
recoveries in fair value. Future increases or decreases in fair value, if not other-than-temporary, are included in accumulated other
comprehensive income (loss).
The following table sets forth the realized losses related to OTTI on our investment portfolio recognized for the years ended
December 31, 2016, 2015 and 2014:
($ millions)
2016
2015
2014
Number
of
positions
Total
impairment
Number
of
positions
Total
impairment
Number
of
positions
Total
impairment
Equity securities:
Large-cap securities
Small-cap securities
Fixed maturities
Total OTTI
1
41
—
42
$
$
(2.2)
(5.7)
—
(7.9)
1
33
—
34
$
$
(0.3)
(2.2)
—
(2.5)
2
28
1
31
$
$
(0.6)
(3.9)
(2.3)
(6.8)
61
Gross Unrealized Investment Gains and Losses
Based upon our review of our investment portfolio at December 31, 2016, 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, 2016:
($ millions, except number of positions)
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 mortgage-backed
securities
Total fixed maturities
Equity Securities:
Large-cap securities
Small-cap securities
Mutual and exchange traded funds
Total equity securities
Other invested assets
Total available-for-sale investments
Cost or
amortized
cost
Gross
unrealized
holding
gains
Number of
gain
positions
Gross
unrealized
holding
losses
Number of
loss
positions
Fair
value
$
401.9
$
8.9
22
$
(6.1)
30
$
404.7
634.6
445.7
613.7
2,095.9
108.9
57.2
157.0
323.1
25.5
$ 2,444.5
$
12.3
6.1
8.5
35.8
32.7
21.9
8.5
63.1
19.6
118.5
152
59
48
281
32
73
9
114
2
397
$
(3.2)
(2.2)
(10.9)
(22.4)
(2.6)
—
(0.8)
(3.4)
—
(25.8)
26
20
54
130
12
—
2
14
—
144
643.7
449.6
611.3
2,109.3
139.0
79.1
164.7
382.8
45.1
$ 2,537.2
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 at December 31, 2016 and 2015, and the change in unrealized holding gains,
net of deferred tax, for the year ended December 31, 2016:
($ millions)
Available-for-sale investments
Unrealized gains:
Fixed maturities
Equity securities
Other invested assets
Unrealized gains
Deferred federal income tax liability
Unrealized gains, net of tax
Fair Value Measurements
2016
2015
$
Change
$
$
13.4
59.7
19.6
92.7
(29.9)
62.8
$
$
27.8
45.4
28.2
101.4
(32.9)
68.5
$
$
(14.4)
14.3
(8.6)
(8.7)
3.0
(5.7)
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, 2016.
As of December 31, 2016, Level 3 assets as a percentage of total assets were 0.1%, which we have determined to be
insignificant.
62
Other Items
Income Taxes
For the year ended December 31, 2016, the federal income tax benefit was $1.8 million compared to an income tax expense
of $16.1 million for 2015 and an income tax benefit of $80.6 million for 2014. Income taxes for the year ended 2016 reflect the
impact of a correction of prior period deferred tax expense related to expired stock options. As a result of the correction, deferred
federal income tax expense and additional paid-in-capital were reduced by $1.6 million, respectively. The change from 2014 to
2015 was primarily due to the $82.6 million of deferred tax benefit resulting from the reversal of the valuation allowance against
net deferred tax assets at December 31, 2014, as well as greater taxable income in 2015.
See “Critical Accounting Policies — Income Taxes” included in this Item 7. See Note 9, “Federal Income Taxes” to our
consolidated financial statements included in Item 8 of this Form 10-K for a reconciliation between our actual federal income tax
(benefit) expense and the amount computed at the indicated statutory rate for the years ended December 31, 2016, 2015 and 2014.
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, as discussed
below, the STFC Pooled Companies do not have the day-to-day liquidity concerns normally associated with an insurance company
due to their participation in, and the terms of, the Pooling Arrangement. In addition, State Auto P&C’s $100.0 million credit facility
is available for general corporate purposes such as funding liquidity needs. See “Liquidity and Capital Resources – Borrowing
Arrangements - Credit Facility” included in this Item 7.
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 60 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 of the Pooling Arrangement, 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. This action was not
necessary in 2016, 2015 or 2014.
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, 2016 and 2015, we had $51.1 million and $58.1
million, respectively, in cash and cash equivalents, and $2,537.2 million and 2,396.4 million, respectively, of total available-for-
sale investments. Included in our fixed maturities available-for-sale were $9.2 million and $8.8 million, respectively, of securities
63
on deposit with insurance regulators, as required by law, at December 31, 2016 and 2015. In addition, substantially all of our fixed
maturity and equity securities are traded on public markets. For a further discussion regarding investments, see “Results of
Operations – Investments Operations Segment” included in this Item 7.
Net cash provided by operating activities was $113.5 million, $149.8 million and $75.6 million in 2016, 2015 and 2014,
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 change from 2016 compared to 2015 and 2014 was primarily due to the expiration of
the HO QS Arrangement at December 31, 2014, resulting in STFC receiving return premium of $63.5 million during the first
quarter of 2015.
Net cash used in investing was $127.6 million and $167.7 million and $56.5 million in 2016, 2015 and 2014, respectively.
The change from 2016 compared to 2015 and 2014 was primarily due to the reinvestment of proceeds received from the expiration
of the HO QS Arrangement along with the reduction of our average cash on hand balances through additional fixed income and
equity purchases.
Net cash provided by financing activities was $7.1 million in 2016 compared to net cash used in of $10.3 million, and $13.1
million in 2015 and 2014, respectively. The increase in 2016 when compared to 2015 and 2014 was primarily driven by proceeds
from the new term loan with the Federal Home Loan Bank of Cincinnati ("the "FHLB") in the principal amount of $21.5 million.
Borrowing Arrangements
Credit Facility
State Auto P&C has a credit facility (the “SPC Credit Facility”) with a syndicate of lenders that provides State Auto P&C
with a $100.0 million five-year revolving credit facility maturing in July 2018. During the term of the SPC Credit Facility, State
Auto P&C has the right to increase the total facility to a maximum amount of $150.0 million, provided that no event of default
has occurred. The SPC 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. All advances under the SPC Credit Facility are to be fully secured by a pledge of specific investment securities of State
Auto P&C. The SPC Credit Facility includes certain covenants and requirements, including financial requirements that State Auto
Financial maintain a minimum net worth and a certain debt to capitalization ratio. As of December 31, 2016, State Auto P&C
had not made any borrowings under the SPC Credit Facility and State Auto P&C and State Auto Financial were in compliance
with all covenants and requirements of the SPC Credit Facility.
FHLB Loan
In September 2016, State Auto P&C entered into a new term loan with the FHLB in the principal amount of $21.5 million
(the “2016 FHLB Loan”). The 2016 FHLB Loan is a five-year term loan and may be called (prepaid) after three years with no
prepayment penalty. The 2016 FHLB Loan provides for interest-only payments during its term, with principal due in full at
maturity. The interest rate is fixed over the term of the loan at 1.73%. The 2016 FHLB Loan is fully secured by a pledge of specific
investment securities of State Auto P&C. Proceeds from the loan were contributed to the pension plan to reduce the Company's
future pension costs. For the year ended December 31, 2016, the Company contributed $34.5 million to its pension plan.
In addition, State Auto P&C has outstanding an $85.0 million loan ("2013 FHLB Loan") from the FHLB. The 2013 FHLB
Loan is a 20-year term loan that may be currently called (prepaid) at any time with no prepayment penalty. The interest rate is
fixed over the term of the loan at 5.03%.
The 2013 and 2016 FHLB Loans are fully secured by a pledge of specific investment securities of State Auto P&C.
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 $15.5 million aggregate principal amount of unsecured Floating Rate Junior Subordinated
Debt Securities due 2033 (the “Subordinated Debentures”). The sole assets of the Capital Trust are the Subordinated Debentures
and any interest accrued thereon. Interest on the Capital Trust’s capital and common securities is payable quarterly at a rate equal
to the three-month LIBOR rate plus 4.20%, adjusted quarterly. The applicable interest rates for December 31, 2016 and 2015 were
5.13% and 4.61%, respectively.
64
Notes Payable Summary
The following table sets forth our notes payable at December 31, 2016:
($ millions)
Subordinated Debentures due 2033: issued $15.5 million, May 2003 with
variable interest adjusting quarterly
FHLB loan due 2033: issued $85.0 million, July 2013 with fixed interest
FHLB loan due 2021: issued $21.5 million , September 2016 with fixed
interest
Total notes payable
Carrying
Value
Fair
Value
Interest
Rate
$
$
15.2
85.4
21.5
122.1
$
$
15.2
85.6
21.0
121.8
5.13%
5.03%
1.73%
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 “Liquidity and Capital Resources – Credit and Financial Strength Ratings” included
in this Item 7. Based upon the notes payable carrying value at December 31, 2016, we had $15.2 million notes payable with
variable interest and $85.4 million and $21.5 million of notes payable with interest fixed at 5.03% and 1.73%, respectively, and,
which equated to approximately 12.4% variable interest debt and 87.6% 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 “Liquidity and Capital Resources –
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.
Expired Homeowners Quota Share Reinsurance Arrangement
On December 31, 2011, the State Auto Group entered into the HO QS Arrangement, which was a three-year quota share
reinsurance agreement covering our homeowners line of business. Under the HO QS Arrangement, the State Auto Group ceded
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 expired December 31, 2014.
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.
Adverse Development Cover
At December 31, 2014, the State Auto Group entered into an adverse development reinsurance agreement that provided
$40.0 million of coverage for adverse development in excess of carried reserves for the terminated RED restaurant program.
65
Property Catastrophe
Members of the State Auto Group maintain a property catastrophe excess of loss reinsurance agreement, covering property
catastrophe related events affecting at least two risks. As of June 1, 2016, this property catastrophe reinsurance agreement renewed.
Under this reinsurance agreement, we retain the first $55.0 million of catastrophe loss, each occurrence, with a 5.0% co-participation
on the next $285.0 million of covered loss, each occurrence. The reinsurers are responsible for 95.0% of the excess over $55.0
million up to $340.0 million of covered losses, each occurrence. Under this reinsurance agreement, the State Auto Group is
responsible for losses above $340.0 million.
The State Auto Group also maintains a separate property catastrophe excess of loss reinsurance agreement covering the
specialty insurance segment's E&S property and programs units catastrophe related events affecting at least two risks. Under this
reinsurance agreement, the State Auto Group retains the $30.0 million of catastrophe loss, each occurrence, with no co-participation
on the next $25.0 million of covered loss, each occurrence.
Property Per Risk
As of June 1, 2016, the State Auto Group renewed the property per risk excess of loss reinsurance agreement. This reinsurance
agreement provides that the State Auto Group is responsible for the first $3.0 million of losses, subject to an additional $2.0 million
annual aggregate deductible ("AAD"). Claims arising from named storms for E&S property are excluded from this treaty. The
reinsurers are responsible for 100.0% of the loss excess of the $3.0 million retention and $2.0 million AAD for property business
up to $20.0 million of covered loss.
Casualty and Workers’ Compensation
As of July 1, 2016, the State Auto Group renewed our casualty excess of loss reinsurance agreement. Under this reinsurance
agreement, the State Auto Group is responsible for the first $2.0 million of losses that involve workers' compensation, auto liability,
other liability and umbrella liability policies, subject to an additional $2.0 million AAD. This reinsurance agreement provides
coverage up to $10.0 million, except for umbrella policies which are covered for limits up to $15.0 million. E&S casualty and
programs units risks are not subject to this casualty excess of loss reinsurance agreement.
Also, certain unusual claim situations involving extra contractual obligations, excess of policy limits, LAE coverage and
multiple policy or coverage loss occurrences arising from bodily injury liability, property damage, uninsured motorist and personal
injury protection are covered by a Clash reinsurance agreement that provides for $30.0 million of coverage in excess of $10.0
million retention for each loss occurrence. This reinsurance coverage sits above the $8.0 million excess of $2.0 million arrangement.
Policies underwritten by the E&S casualty and programs units are not subject to this casualty excess of loss reinsurance agreement.
In addition, each company in the State Auto Group is party to a workers’ compensation catastrophe reinsurance agreement
that provides additional reinsurance coverage for workers’ compensation losses involving multiple workers. Subject to $10.0
million of retention, reinsurers are responsible for 100.0% of the excess over $10.0 million up to $30.0 million of covered loss.
For loss amounts over $30.0 million, the casualty excess of loss reinsurance agreement provides $20.0 million coverage in excess
of $30.0 million. Workers’ compensation catastrophe coverage is subject to a “Maximum Any One Life” limitation of $10.0 million.
This limitation means that losses associated with each worker may contribute no more than $10.0 million to covered loss under
these agreements.
As of July 1, 2016, the State Auto Group restructured its reinsurance coverage for E&S casualty and programs units casualty
risks. Under this reinsurance agreement, the State Auto Group is responsible for the first $2.0 million of losses. This reinsurance
agreement provides 100.0% coverage up to $9.0 million excess of $2.0 million for any one insured, all policies, and $14.0 million
excess of $11.0 million for Clash only coverage. This reinsurance arrangement is placed on a loss occurrence basis, while the
expired treaty was placed on a risk-attaching basis. As a result of this change, the 2015 reinsurance treaty was terminated on a
cut-off basis, resulting in the return of $5.1 million of ceded unearned premium from the reinsurers to the Company.
66
Contractual Obligations
The following table sets forth our significant contractual obligations at December 31, 2016:
($ millions)
Direct loss and ALAE reserves(1)
Notes payable(2):
Subordinated Debentures due 2033:
issued $15.5, May 2003 with variable interest(3) adjusting
quarterly
FHLB loan due 2033; issued $85.0 million, July 2013 with
fixed interest
FHLB loan due 2021: issued $21.5 million , September
2016 with fixed interest
Total notes payable
Interest payable (2):
Subordinated Debentures due 2033:
issued $15.5, May 2003 with variable interest(3) adjusting
quarterly
FHLB loan due 2021: issued $21.5 million , September
2016 with fixed interest
FHLB loan due 2033; issued $85.0 million, July 2013 with
fixed interest
Total interest payable
Postretirement benefits
Pension funding(4)
Total
Total
$ 1,178.0
Due
1 year
or less
Due
1-3
years
Due
3-5
years
Due
after 5
years
$
487.7
$
416.1
$
146.8
$
127.4
15.5
85.0
21.5
122.0
13.8
1.9
—
—
—
0.8
0.4
—
—
—
1.6
0.7
—
—
—
1.6
0.8
74.9
90.6
13.1
47.7
$ 1,451.4
$
4.3
5.5
1.5
4.3
499.0
$
8.6
10.9
2.9
8.9
438.8
$
8.6
11.0
2.7
9.2
169.7
$
15.5
85.0
21.5
122.0
9.8
—
53.4
63.2
6.0
25.3
343.9
(1)
(2)
(3)
(4)
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, 2016, loss and ALAE payable to generate estimated annual incremental loss and ALAE payments for each subsequent calendar year.
These amounts are based on historical payment patterns and do not represent actual contractual obligations. The actual payment amounts and the
related timing of those payments could differ significantly from these estimates.
For a discussion of these debt instruments, see “Liquidity and Capital Resources—Borrowing Arrangements” included in this Item 7.
Interest on the subordinated debentures was calculated using an interest rate equal to the three-month LIBOR rate at December 31, 2016 of 0.9307%
plus 4.20%, or 5.1307%.
These amounts are estimates of ERISA minimum funding levels based on adjustments to prior year assumptions for our defined benefit pension plan
and do not represent an estimate of our expected contributions. Funding levels generally are not determined until later in the year with respect to the
contribution year. See Note 10, “Pension and Postretirement Benefits Plans” to our consolidated financial statements included in Item 8 of this Form
10-K for a tabular presentation of STFC’s share of expected benefit payments from the State Auto Group’s defined benefit pension plan.
Leases and other purchase obligations of State Auto Mutual are allocated to us through the Pooling Arrangement.
Regulatory Considerations
At December 31, 2016, 2015 and 2014, 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.
67
The following table sets forth the statutory leverage ratios for our insurance subsidiaries at December 31, 2016, 2015 and
2014:
Statutory Leverage Ratios
State Auto P&C
Milbank
Weighted Average
2016
2015
2014
1.5
1.9
1.5
1.5
1.9
1.6
1.5
1.9
1.5
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. Under the
insurance regulations of Iowa and Ohio (the states of domicile), the maximum amount of dividends that the Company may pay
out of earned surplus to shareholders within a twelve month period without prior approval of the Department is limited to the
greater of 10% of the most recent year-end policyholders’ surplus or net income for the twelve month period ending the 31st day
of December of the previous year-end. Pursuant to these rules, $84.4 million is available for payment to State Auto Financial from
its insurance subsidiaries in 2015 without prior approval. State Auto Financial received dividends from its insurance subsidiaries
in the amount of $10.0 million, $15.0 million and $20.0 million in 2016, 2015 and 2014.
The Company’s insurance subsidiaries are subject to risk-based capital (“RBC”) requirements that have been adopted by
individual states. These requirements subject insurers having statutory capital less than that required by the RBC calculation to
varying degrees of regulatory action, depending on the level of capital inadequacy. The RBC formulas specify various weighting
factors to be applied to financial balances or various levels of activity based on the perceived degree of risk. Regulatory compliance
is determined by a ratio of total adjusted capital to authorized control level RBC. Generally no remedial action is required by an
insurance company if its adjusted statutory surplus exceeds 200% of the authorized level RBC. At December 31, 2016, the ratio
of total adjusted statutory capital to authorized control level of State Auto Financial’s insurance subsidiaries ranged from 438%
to 10,114%.
Credit and Financial Strength Ratings
As of February 26, 2016, the State Auto Group’s financial strength rating from A.M. Best was A- (Excellent) with a stable
outlook and its credit rating from A.M. Best was bbb- with a stable outlook.
The financial strength rating for the State Auto Group and expresses 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.
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.
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.
Our management considers how its overall strategy and decisions may influence the rating agencies’ evaluation of our credit
strength and capital position, which may in turn directly impact the credit and financial strength ratings assigned by those agencies.
In its decision-making process with respect to significant transactions, such as reinsurance, financing and investing activities, and
acquisitions, management takes into consideration the potential impact these decisions will have on our earnings volatility and
capital position.
68
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, has
been 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, historically medical care costs have risen at a higher
rate than general inflation over the last few years. Costs for building materials typically rise significantly following widespread
natural catastrophes, such as what the industry experienced in areas affected by Superstorm Sandy in 2012. 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.
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: (i) the length of time and/or the significance of
decline below cost; (ii) our ability and intent to hold these securities through their recovery periods; (iii) the current financial
condition of the issuer and its future business prospects; and (iv) 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, 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: (i) the financial condition
of the issuer including receipt of scheduled principal and interest cash flows; (ii) our intent to sell; and (iii) 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 comprehensive (loss)
income. Future increases or decreases in fair value, if not other-than-temporary, are included in other comprehensive (loss) income.
69
Deferred Acquisition Costs
Acquisition costs, consisting of net commissions (including ceding commissions), premium taxes and certain underwriting
expenses related to the successful acquisition or renewal of property and casualty business, are deferred and amortized over the
same period in which the related premiums are earned. Ceding commissions relating to reinsurance agreements reimburse us for
both deferrable and non-deferrable acquisition costs. To the extent these ceding commissions exceed the deferrable amount of
acquisition costs, the excess is reported as a deferred liability and is included in other liabilities in our consolidated balance sheet.
Excess ceding commissions are amortized in proportion to net revenue recognized on the underlying policies resulting in excess
ceding commissions being recognized as a reduction of acquisition and operating expenses.
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. Anticipated investment income is considered in determining whether a
premium deficiency exists.
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 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
70
(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 that 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. At December 31, 2016,
MBE of our direct loss and ALAE reserves for the STFC Pooled Companies’ share of the Pooled Companies’ reserves were
$1,180.7 million, within an estimated range of $1,010.7 million to $1,218.8 million.
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, $1,218.8
million, the reserve increase of $38.1 million corresponds to an after-tax decrease of $24.8 million in net income, assuming a tax
71
rate of 35%. Likewise, should ultimate losses decline to a level corresponding to the low point of the range, $1,010.7 million, the
$170.0 million reserve decrease would add $110.5 million of after-tax net income. The loss reserve range noted above represents
a range of reasonably likely reserves, not a range of all possible reserves. Therefore, the ultimate losses could reach levels
corresponding to reserve amounts outside the range provided.
An important assumption underlying the loss reserve estimation methods for 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, 2016, 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 $67.4 million on
reserves, or a $43.8 million reduction to net income, assuming a tax rate of 35%. Inflation changes have much more impact on
the longer tail commercial lines like other & product liability and workers’ compensation, and much less impact on the shorter
tail personal lines’ reserves.
In addition to establishing loss reserves, as described above, we establish reserves for ULAE. Historical patterns of paid
ULAE relative to paid loss are analyzed along with historical claim counts including claims opened, claims closed, and claims
remaining open. The product of this analysis is an estimate of the relationship, or ratio, between ULAE and loss underlying the
current loss reserves. This ratio is applied to the current outstanding loss reserves to estimate the required ULAE reserve.
Consequently, this component of the loss expense reserve has a proportional relationship to the overall claim inventory and held
loss reserves. The method assumes that the underlying claims process and mix of business do not change materially from period
to period.
72
The following table sets forth a reconciliation of MBE of our direct loss and LAE reserve to our net losses and loss expenses
payable at December 31, 2016 and 2015. The STFC Pooled Companies net additional share of transactions assumed from State
Auto Mutual through the Pooling Arrangement for the years ended December 31, 2016 and 2015, respectively, has been reflected
in the table below as assumed by STFC Pooled Companies.
($ 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
2016
2015
$
536.9
643.8
1,180.7
508.1
529.1
1,037.2
31.3
32.2
63.5
(22.5)
(4.5)
(27.0)
(3.6)
5.1
(40.7)
27.9
25.5
53.4
(20.4)
(4.3)
(24.7)
(5.9)
5.0
(17.9)
Total losses and loss expenses payable, net of reinsurance recoverable on losses and
loss expenses payable of $3.6 million and $5.9 million in 2016 and 2015, respectively
$ 1,178.0
1,047.1
The following tables set forth the net losses and loss expenses payable by major line of business at December 31, 2016
and 2015:
($ millions)
December 31, 2016
Personal insurance segment:
Personal auto
Homeowners
Other personal
Total personal
Business insurance segment:
Commercial auto
Commercial multi-peril
Fire & allied lines
Other & product liability
Workers’ compensation
Other commercial
Total business
Specialty insurance segment:
E&S property
E&S casualty
Programs
Total specialty
Total losses and loss expenses payable net of reinsurance
recoverable on losses and loss expenses payable
Ending
Loss &
ALAE
Case &
Formula
Ending
Loss &
ALAE
IBNR
Ending
ULAE
Bulk
Total
Reserves
60.2
14.1
1.7
76.0
48.9
59.4
4.0
108.9
106.0
1.2
328.4
16.2
99.5
82.6
198.3
602.7
10.8
2.8
0.2
13.8
4.1
6.9
0.8
14.1
11.6
0.1
37.6
1.6
7.7
3.1
12.4
63.8
192.6
49.4
9.1
251.1
103.3
123.6
19.8
171.0
185.6
2.6
605.9
29.8
137.4
153.8
321.0
1,178.0
$
121.6
32.5
7.2
161.3
50.3
57.3
15.0
48.0
68.0
1.3
239.9
12.0
30.2
68.1
110.3
$
511.5
73
($ millions)
December 31, 2015
Personal insurance segment:
Personal auto
Homeowners
Other personal
Total personal
Business insurance segment:
Commercial auto
Commercial multi-peril
Fire & allied lines
Other & product liability
Workers’ compensation
Other commercial
Total business
Specialty insurance segment:
E&S property
E&S casualty
Programs
Total specialty
Total losses and loss expenses payable net of reinsurance
recoverable on losses and loss expenses payable
Ending
Loss &
ALAE
Case &
Formula
Ending
Loss &
ALAE
IBNR
Ending
ULAE
Bulk
Total
Reserves
$
113.0
25.1
5.4
143.5
54.9
51.4
15.2
53.7
59.2
0.8
235.2
6.5
18.5
75.5
100.5
$
479.2
59.2
10.1
2.1
71.4
38.6
51.6
1.7
94.1
99.7
0.6
286.3
12.5
72.6
71.3
156.4
514.1
9.9
2.0
0.2
12.1
3.6
6.1
0.5
13.4
8.4
0.1
32.1
2.4
5.5
1.7
9.6
182.1
37.2
7.7
227.0
97.1
109.1
17.4
161.2
167.3
1.5
553.6
21.4
96.6
148.5
266.5
53.8
1,047.1
See discussion in “Results of Operations—Loss and LAE Development” 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 $1.1 million, and environmental reserves are $15.1 million, for a total of $16.2 million, or 1.4% of
net losses and loss expenses payable. Asbestos reserves decreased $0.1 million and environmental reserves increased $3.8 million
from 2015.
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 in determining benefit obligations may differ materially from actual results due to changing market and
economic conditions, higher or lower turnover and retirement rates, or longer or shorter life spans of participants. While we believe
that the assumptions used are appropriate, differences in actual experience or changes in assumptions may materially affect our
financial position or results of operations.
In October 2014, the Retirement Plans Experience Committee of the Society of Actuaries released reports summarizing
updated statistics and analysis for actuaries to consider in the selection of the mortality assumptions used in the valuation of benefit
plans, including new mortality tables that reflect updated mortality rates observed during 2004 through 2008. Previously, the
pension plan valuation utilized a mortality table required to be used for purposes of minimum funding requirements under ERISA.
For the December 31, 2014 valuation, the RP-2014 mortality table was used as a baseline for the mortality assumption and the
74
MP-2014 improvement scale with indefinite improvement was used to project future mortality rates. For the December 31, 2016
and 2015 valuations, the Adjusted RP-2014 mortality table was used as a baseline for the mortality assumption and to project
future mortality rates. The January 1, 2017 and 2016 actuarial reports of the benefit plans included these revised mortality
assumptions.
To calculate the State Auto Group’s December 31, 2016 benefit obligation for each of the benefit plans, we used a discount
rate of 4.00% based on an evaluation of the expected future benefit cash flows of our benefit plans used in conjunction with the
Citigroup Pension Discount Curve at the measurement date. A lower discount rate results in, all else being equal, a higher present
value of the benefit obligation. To calculate our benefit obligation at December 31, 2016 and net periodic benefit cost for the year
ended December 31, 2017, a discount rate of 4.00% and an expected long-term rate of return on plan assets of 7.00% were used.
We selected an expected long-term rate of return on our plan assets by considering the mix of investments and stability of investment
portfolio along with actual investment experience during the lifetime of the plans. Our assumptions regarding the discount rate
and expected return on plan assets could have 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.
As a result of revised mortality assumptions and the change in the discount rate, the benefit plan’s liability increased $2.9
million for the year ended December 31, 2016 and decreased $6.5 million for the year ended December 31, 2015.
The following table sets forth an illustration of variability with respect to the discount rate on our share of the State Auto
Group’s December 31, 2016 benefit obligation and expected net periodic benefit cost for the year ending December 31, 2017,
along with the variability of the expected return on plan assets to our expected net periodic benefit cost for the year ending
December 31, 2017. Holding all other assumptions constant, sensitivity to changes in any one of our key assumptions are as
follows:
($ millions)
Benefit obligation
Net periodic benefit cost (benefit)
Net periodic benefit cost
$
$
$
Pension
Discount rate
Postretirement
Discount rate
3.75%
4.00%
4.25%
3.75%
4.00%
4.25%
295.3
8.5
284.4
7.5
274.2
6.6
$
$
18.4
(4.7)
18.8
(4.6)
19.3
(4.5)
Expected return on plan assets
6.75%
7.00%
7.25%
8.1
7.5
6.9
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, 2016, our share of the State Auto Group’s ABO and
PBO was $267.5 million and $284.5 million, respectively. At December 31, 2016, STFC’s share of the defined benefit pension
plan’s fair value of the assets was $235.7 million, which resulted in an underfunded status within our balance sheet of $48.8 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 2017.
The unfunded status on the pension plan and supplemental executive retirement plan decreased from $83.7 million at
December 31, 2015, to $55.6 million at December 31, 2016. Primarily influencing the change from year to year are actuarial gains
and losses arising from factors that include (i) changes in the discount rate, (ii) expected to actual demographic changes, such as
retirement age, mortality, turnover, rate of compensation changes, and (iii) changes in returns on our plan assets.
See Note 10, “Pension and Postretirement Benefit Plans,” to our consolidated financial statements included in Item 8 of this
Form 10-K for further disclosures regarding our benefit plans.
Income Taxes
For 2016, we recognized a federal income tax benefit of $1.8 million compared to federal income tax expense of $16.1
million for 2015 and a federal income tax benefit of $80.6 million for 2014. Income taxes for the year ended 2016 reflect the
impact of a correction of prior period deferred tax expense related to expired stock options. As a result of the correction, deferred
federal income tax expense and additional paid-in-capital were reduced by $1.6 million, respectively. The income tax benefit in
75
2014 was primarily due to the reversal of our deferred tax asset valuation allowance, which resulted in an income tax benefit of
$82.6 million.
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. During 2011, we experienced a net loss due to the magnitude
of record level catastrophe storm losses in the second quarter that significantly exceeded our projections. We considered both
positive and negative evidence and concluded that a valuation allowance should be established.
In accordance with the FASB’s ASC 740, Income Taxes (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 our historical and anticipated future taxable income. In making such judgments, significant weight is given to
evidence that can be objectively verified.
At December 31, 2014, consistent with the above process, we evaluated the need for a valuation allowance against our net
deferred tax assets and determined that it was more likely than not that our deferred tax asset would be realized. As a result, in
accordance with the guidance in ASC 740, we reversed our deferred tax asset valuation allowance and recognized an $82.6 million
federal income tax benefit in the fourth quarter of 2014.
The principal positive evidence that led us to determine at December 31, 2014 that the valuation allowance against our net
deferred tax assets was no longer necessary included (i) three consecutive years of pre-tax income; (ii) cumulative three-year pre-
tax income of $98.7 million through December 31, 2014; and (iii) expected future pre-tax income. Since the establishment of the
valuation allowance in the second quarter of 2011, our homeowners line underwriting results, a key contributor to the initial
establishment of the valuation allowance, have significantly improved. The improvement in our homeowners underwriting results
is attributable to actions undertaken by management, including rate increases, deductible expansion, and changes in the geographic
mix, among others. See the “Results of Operations – Insurance Segments – Personal Insurance Segment” discussion included in
this Item 7 for further information. Since 2011, underwriting results have also been impacted by our RED underwriting results,
which included reserve strengthening in 2012, 2013 and 2014. Due to the actions taken in 2014, including the reserve strengthening
and the placement of the ADC reinsurance agreement, which provides $40.0 million of adverse development cover over carried
Loss and LAE reserves for the RED restaurant program, along with the fact that the RED program business has been terminated
and is in run-off, future underwriting results are not expected to be materially impacted by RED underwriting results. See the
“Results of Operations – Insurance Segments – Specialty Insurance Segment” discussion included in this Item 7 for further
information.
Management anticipates generating taxable income over the next three years that will allow for the realization of all of our
net operating loss (“NOL”) carryforwards prior to the end of 2019. The NOL carryforwards do not begin to expire until 2030 and
will not fully expire until 2036.
The following table sets forth the components of our federal income tax expense for the years ended December 31, 2016,
2015 and 2014:
($ millions)
Income before federal income taxes
Current tax (benefit) expense
Deferred tax (benefit) expense
Valuation allowance
Total federal income tax (benefit) expense
Net income
2016
2015
2014
$
19.2
$
67.3
$
26.8
(1.7)
(0.1)
(1.8)
—
(1.8)
21.0
$
2.9
13.2
16.1
—
16.1
51.2
$
0.1
1.9
2.0
(82.6)
(80.6)
107.4
$
See Note 9, “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.
Other
Other items that could have a significant impact on the financial statements include the risks and uncertainties listed in
Item 1A of this Form 10-K under “Risk Factors.” Actual results could differ materially using different estimates and assumptions,
or if conditions are significantly different in the future.
76
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.”
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:
77
The Board of Directors and Stockholders of State Auto Financial Corporation
Report of Independent Registered Public Accounting Firm
We have audited the accompanying consolidated balance sheets of State Auto Financial Corporation and subsidiaries as of
December 31, 2016 and 2015, 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, 2016. 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, 2016 and 2015, and the consolidated results of their
operations and their cash flows for each of the three years in the period ended December 31, 2016, 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.
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, 2016, based on
criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (2013 framework) and our report dated March 1, 2017 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Columbus, Ohio
March 1, 2017
78
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, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (2013 framework) (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, 2016 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, 2016 and 2015, 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, 2016, and our report dated March 1, 2017, expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Columbus, Ohio
March 1, 2017
79
December 31
2016
2015
$
$
2,109.3
382.8
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Consolidated Balance Sheets
($ and shares in millions, except per share amounts)
Assets
Fixed maturities, available-for-sale, at fair value (amortized cost $2,095.9 and $1,972.9,
respectively)
Equity securities, available-for-sale, at fair value (cost $323.1 and $265.2, respectively)
Other invested assets, available-for-sale, at fair value (cost $25.5 and $56.9,
respectively)
Other invested assets
Notes receivable from affiliate
Total investments
Cash and cash equivalents
Accrued investment income and other assets
Deferred policy acquisition costs (affiliated net assumed $50.7 and $49.3, respectively)
Reinsurance recoverable on losses and loss expenses payable
Prepaid reinsurance premiums
Due from affiliate
Current federal income taxes
Net deferred federal income taxes
Property and equipment, at cost (net of accumulated depreciation of $6.6 and $6.3,
respectively)
Total assets
Liabilities and Stockholders’ Equity
Losses and loss expenses payable (affiliated net assumed $630.9 and $532.4,
respectively)
Unearned premiums (affiliated net assumed $220.9 and $214.2, respectively)
Notes payable (affiliates $15.2 and $15.2, respectively)
Postretirement and pension benefits (affiliated net ceded $40.1 and $56.0, respectively)
Due to affiliate
Other liabilities (affiliated net assumed $11.0 and affiliated net ceded $8.4, respectively)
$
$
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; 48.6 and 48.1 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 (affiliated net ceded $53.7 and $56.7,
respectively)
Retained earnings
Total stockholders’ equity
Total liabilities and stockholders’ equity
See accompanying notes to consolidated financial statements.
80
45.1
5.4
70.0
2,612.6
51.1
40.0
129.8
3.6
6.1
—
6.7
102.1
7.4
2,959.4
$
1,181.6
617.8
122.1
74.4
2.4
69.8
2,068.1
—
—
121.6
(116.5)
159.9
32.5
693.8
891.3
2,959.4
$
$
2,000.7
310.6
85.1
5.3
70.0
2,471.7
58.1
35.7
129.1
5.9
6.8
5.9
4.9
102.5
7.6
2,828.2
1,053.0
616.3
100.5
104.0
—
69.8
1,943.6
—
—
120.4
(116.3)
153.5
37.6
689.4
884.6
2,828.2
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Consolidated Statements of Income
($ millions, except per share amounts)
Year ended December 31
2015
2014
2016
Earned premiums (affiliated net assumed $472.0, $437.6 and $212.4, respectively)
Net investment income (affiliates $4.9, $4.9 and $4.9, respectively)
Net realized gain on investments:
$
1,291.9
74.7
$
1,270.5
71.7
$
1,074.1
74.7
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 $2.3, $2.1 and $1.9, respectively)
Total revenues
Losses and loss expenses (affiliated net assumed $383.8, $293.3 and $250.8,
respectively)
Acquisition and operating expenses (affiliated net assumed $285.8, $248.6 and
$156.9, respectively)
Interest expense (affiliates $0.8, $0.7 and $0.7, respectively)
Other expenses
Total expenses
Income before federal income taxes
Federal income tax (benefit) expense:
Current
Deferred
Total federal income tax (benefit) expense
Net income
Earnings per common share:
Basic
Diluted
Dividends paid per common share
See accompanying notes to consolidated financial statements.
(6.8)
—
43.3
36.5
2.3
1,405.4
(7.9)
—
32.2
24.3
2.1
1,368.6
(2.5)
—
23.2
20.7
3.2
1,172.7
942.4
862.8
771.3
430.4
5.5
7.9
1,386.2
19.2
426.8
5.4
6.3
1,301.3
67.3
(1.7)
(0.1)
(1.8)
21.0
0.50
0.50
0.40
$
$
$
$
2.9
13.2
16.1
51.2
1.25
1.23
0.40
$
$
$
$
$
$
$
$
361.9
5.4
7.3
1,145.9
26.8
0.1
(80.7)
(80.6)
107.4
2.63
2.60
0.40
81
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Consolidated Statements of Comprehensive Income
($ millions)
Net income
Other comprehensive loss, net of tax:
Net change in unrealized holding gains (losses) on investments:
Unrealized holding gains (losses) arising during year
Reclassification adjustments for gains realized in net income
Income tax benefit (expense)
Total change in net unrealized holding gains (losses) on investments
Net unrecognized benefit plan obligations:
Net actuarial (loss) gain arising during period
Reclassification adjustments for amortization to statements of income:
Negative prior service cost
Net actuarial loss
Income tax (expense) benefit
Total net unrecognized benefit plan obligations
Other comprehensive loss
Comprehensive income
See accompanying notes to consolidated financial statements.
Year ended December 31
2015
2014
2016
$
21.0
$
51.2
$
107.4
27.8
(36.5)
3.0
(5.7)
(3.0)
(5.5)
9.4
(0.3)
0.6
(5.1)
15.9
$
(39.2)
(24.7)
22.4
(41.5)
5.3
(5.4)
11.5
(4.0)
7.4
(34.1)
17.1
$
59.8
(20.7)
(13.7)
25.4
(54.4)
(5.5)
6.9
18.5
(34.5)
(9.1)
98.3
$
82
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Consolidated Statements of Stockholders’ Equity
Year ended December 31
2015
2014
2016
48.1
0.5
48.6
(6.8)
(6.8)
47.7
0.4
48.1
(6.8)
(6.8)
47.5
0.2
47.7
(6.8)
(6.8)
120.4
1.2
121.6
$
$
119.3
1.1
120.4
$
$
118.8
0.5
119.3
(116.3)
(0.2)
(116.5) $
(116.0)
(0.3)
(116.3) $
(115.9)
(0.1)
(116.0)
153.5
6.8
(3.0)
2.6
159.9
37.6
(5.7)
0.6
32.5
689.4
21.0
(16.6)
693.8
891.3
$
$
$
$
$
$
143.2
5.2
0.3
4.8
153.5
71.7
(41.5)
7.4
37.6
654.7
51.2
(16.5)
689.4
884.6
$
$
$
$
$
$
137.5
2.9
—
2.8
143.2
80.8
25.4
(34.5)
71.7
563.8
107.4
(16.5)
654.7
872.9
$
$
$
$
$
$
$
$
$
$
$
(in millions)
Common shares:
Balance at beginning of year
Issuance of shares
Balance at end of year
Treasury shares:
Balance at beginning of year
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 and vested restricted shares
Balance at end of year
Additional paid-in capital:
Balance at beginning of year
Issuance of common stock
Tax (expense) benefit from stock option exercises
Stock options granted
Balance at end of year
Accumulated other comprehensive income:
Balance at beginning of year
Change in unrealized holding gains (losses) on investments, net of tax
Change in unrecognized benefit plan obligations, net of tax and
reclassification adjustments
Balance at end of year
Retained earnings:
Balance at beginning of year
Net income
Cash dividends paid (affiliates $10.4, $10.4 and $10.2, respectively)
Balance at end of year
Total stockholders’ equity at end of year
See accompanying notes to consolidated financial statements.
83
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Consolidated Statements of Cash Flows
($ millions)
Cash flows from operating activities:
Net income
Year ended December 31
2015
2014
2016
$
21.0
$
51.2
$
107.4
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization, net
Share-based compensation
Net realized gain on investments
Changes in operating assets and liabilities:
Deferred policy acquisition benefits
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 expense on share-based awards
Federal income taxes
Cash provided from December 31, 2014 unearned premium transfer related
to the homeowners quota-share reinsurance arrangement
Net cash provided by operating activities
Cash flows from investing activities:
Purchases of fixed maturities available-for-sale
Purchases of equity securities available-for-sale
Purchases of other invested assets
Maturities, calls and pay downs of fixed maturities available-for-sale
Sales of fixed maturities available-for-sale
Sales of equity securities available-for-sale
Sales of other invested assets available-for-sale
Net disposals of property and equipment
Net cash used in investing activities
Cash flows from financing activities:
Proceeds from issuance of common stock
Payments to acquire treasury stock
Payments of dividends (affiliates $10.4, $10.4 and $10.2, respectively)
Excess tax expense on share-based awards
Proceeds from long-term debt
Net cash provided by (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 $0.8, $0.7 and $0.7, respectively)
Federal income taxes paid
See accompanying notes to consolidated financial statements.
84
$
$
$
$
$
$
$
$
14.6
3.7
(36.5)
(0.7)
(4.5)
(28.8)
3.0
7.3
128.6
1.5
(0.2)
4.5
15.7
4.5
(24.3)
(2.6)
(2.4)
(6.0)
3.0
(39.9)
69.8
3.9
(0.3)
13.7
—
113.5
$
63.5
149.8
$
(589.3) $
(143.1)
(1.5)
240.9
211.6
153.0
0.8
—
(127.6) $
2.2
(0.2)
(16.6)
0.2
21.5
7.1
(7.0)
58.1
51.1
$
$
$
(573.9) $
(154.0)
(6.9)
241.0
180.7
144.8
0.7
(0.1)
(167.7) $
$
6.2
(0.3)
(16.5)
0.3
—
(10.3) $
(28.2)
86.3
58.1
$
5.4
$
— $
5.3
6.4
$
$
11.7
3.6
(20.7)
(29.7)
0.2
(7.3)
(1.9)
(50.8)
23.3
121.4
—
(81.6)
—
75.6
(431.4)
(119.0)
(1.8)
232.4
163.5
99.2
0.6
—
(56.5)
3.5
(0.1)
(16.5)
—
—
(13.1)
6.0
80.3
86.3
5.2
1.0
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies
a. Principles of Consolidation
The consolidated financial statements include State Auto Financial Corporation (“State Auto Financial”), 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
• 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 only members are State Auto P&C and Stateco.
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 intercompany balances
and transactions have been eliminated in consolidation.
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.
Through Stateco, the Company provides investment management services to affiliated companies.
518 PML owns and leases property to the Company’s affiliates.
c. Basis of Presentation
The consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles
(“GAAP”), which vary in certain respects from statutory accounting practices (“SAP”) followed by State Auto P&C, Milbank and
SA Ohio that are prescribed or permitted by the Departments.
The Company’s insurance subsidiaries, domiciled in Ohio and Iowa, are required to prepare statutory basis financial
statements in accordance with the accounting practices prescribed or permitted by the insurance departments of the states of
domicile. Prescribed statutory accounting practices are those practices that are incorporated directly or by reference in state laws,
regulations, and general administrative rules applicable to all insurance enterprises domiciled in a particular state. The Ohio and
Iowa Departments of Insurance require insurers domiciled in their respective states to prepare statutory financial statements in
accordance with National Association of Insurance Commissioners’ (“NAIC”) statutory accounting practices. Permitted statutory
accounting practices are those practices that differ either from state-prescribed statutory accounting practices or NAIC statutory
85
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
accounting practices. The Company’s insurance subsidiaries do not apply any statutory accounting practices that would be
considered a prescribed statutory accounting practice that differs from NAIC statutory accounting practices.
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 assets will not be realized, then a valuation allowance must be established with a corresponding
charge to net income and/or other comprehensive loss. 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 loss and, as such, are not included in the
determination of net income. Realized gains and losses on the sales of investments are computed using the first-in, first-out method.
The Company views gross unrealized losses on fixed maturities and equity securities as being temporary since it is its
assessment that these securities will recover in the near term, allowing the Company to realize the anticipated long-term economic
value. 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 security 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.
Future increases or decreases in fair value, if not other-than-temporary, are included in other comprehensive income.
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.
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 net commissions (including ceding commissions), premium taxes and certain underwriting
expenses related to the successful acquisition or renewal of property and casualty business, are deferred and amortized over the
same period in which the related premiums are earned. Ceding commissions relating to reinsurance agreements reimburse us for
both deferrable and non-deferrable acquisition costs. Excess ceding commissions are amortized in proportion to net revenue
86
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
recognized on the underlying policies resulting in excess ceding commissions being recognized as a reduction of acquisition and
operating expenses.
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. Anticipated investment income is considered in determining whether a
premium deficiency exists.
The following table sets forth net deferred acquisition costs for the years ended December 31, 2016, 2015 and 2014:
($ millions)
Balance, beginning of year
Acquisition costs deferred
Acquisition costs amortized to expense
Balance, end of year
2016
2015
2014
$
$
129.1
291.0
(290.3)
129.8
$
$
126.5
285.6
(283.0)
129.1
$
$
96.8
251.5
(221.8)
126.5
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. 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.
h. Losses and Loss Expenses Payable
Losses and loss expenses payable are based on formula and case-basis estimates for reported claims and on estimates, based
on experience and perceived trends, for unreported claims and loss expenses. The liability for unpaid losses and loss expenses,
net of estimated salvage and subrogation recoverable of $27.0 million and $24.7 million at December 31, 2016 and 2015,
respectively, has been established to cover the estimated ultimate cost to settle insured losses. The amounts are based on estimates
of future rates of inflation and other factors, and accordingly, there can be no assurance that the ultimate liability will not vary
materially from such estimates. The estimates are continually reviewed and adjusted as necessary; such adjustments are included
in current operations (see Note 4). Anticipated salvage and subrogation is estimated using historical experience. As such, losses
and loss expenses payable represent management’s best estimate of the ultimate liability related to reported and unreported claims.
i. Premiums
Premiums are recognized as earned prorata over the policy period. Unearned premiums represent the portion of premiums
written relative to the unexpired terms of coverage.
j. Comprehensive Income
Comprehensive income is defined as all changes in an enterprise’s equity during a period other than those resulting from
investments by owners and distributions to owners. Comprehensive income includes net income and other comprehensive (loss)
income. Other comprehensive (loss) income includes all other non-owner related changes to equity and includes net unrealized
gains and losses on available-for-sale investments and unrecognized benefit plan obligations, adjusted for deferred federal income
taxes.
87
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
k. New Accounting Standards
Adoption of Recent Accounting Pronouncements
Simplifying the Presentation of Debt Issuance Costs
The amendments in this guidance simplify the presentation of debt issuance costs by requiring them to be presented in the
balance sheet as a direct deduction from the carrying amount of the related recognized debt liability, consistent with debt discounts.
The Company adopted this guidance at January 1, 2016 on a retrospective basis and it resulted in a $0.3 million decrease to notes
payable and accrued investment income and other assets at December 31, 2015 and 2014, respectively.
Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent)
The amendments in this guidance remove the requirement to categorize within the fair value hierarchy all investments for
which fair value is measured using the net asset value per share practical expedient. The amendments also remove the requirement
to make certain disclosures for all investments that are eligible to be measured at fair value using the net asset value per share
practical expedient. Rather, those disclosures are limited to investments for which the entity has elected to measure the fair value
using that practical expedient. The amendments in this update are effective for public business entities for fiscal years beginning
after December 15, 2015, and interim periods within those fiscal years and should be applied retrospectively to all periods presented.
The Company adopted this guidance at January 1, 2016. The new guidance affects disclosures only and it did not impact the
Company’s results of operations or consolidated financial position.
Disclosures about Short-Duration Contracts
The amendments in this guidance require expanded disclosures for insurance entities that issue short-duration contracts. The
expanded disclosures are designed to provide additional insight into an insurance entity’s significant estimates made in measuring
the liability for unpaid claims and claim adjustment expenses. The disclosures include information about incurred and paid claims
development by accident year, on a net basis after reinsurance, for the number of years claims incurred typically remain outstanding,
not to exceed ten years. Each period presented in the disclosure about claims development that precedes the current reporting
period is considered required supplementary information. The expanded disclosures also include information about significant
changes in methodologies and assumptions, a reconciliation of incurred and paid claims development to the carrying amount of
the liability for unpaid claims and claim adjustment expenses, the total amount of incurred but not reported liabilities plus expected
development, the incidence of claims including the methodology used to determine the incidence of claims, and claim duration.
The guidance is effective for annual periods beginning after December 15, 2015, and interim periods beginning after December
15, 2016, and is to be applied retrospectively. The Company adopted this guidance at December 31, 2016. The new guidance
affects disclosures only and it did not impact the Company’s results of operations or consolidated financial position.
Pending Adoption of Recent Accounting Pronouncements
Revenue from Contracts with Customers
In May 2014, the FASB issued guidance that requires an entity to recognize revenue to depict the transfer of promised goods
or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those
goods and services. Insurance contracts do not fall within the scope of this new guidance. The guidance is effective for annual
reporting periods beginning after December 15, 2017, with early adoption permitted. The guidance has not yet been adopted;
however, there is not expected to be a material impact on the Company’s results of operations and consolidated financial position.
Financial Instruments - Overall: Recognition and Measurement of Financial Assets and Financial Liabilities
In January 2016, the FASB issued guidance to improve certain aspects of recognition, measurement, presentation, and
disclosure of financial instruments. Specifically the guidance (i) requires equity investments, including equity securities and
limited partnership interests, that are not accounted for under the equity method of accounting or result in consolidation to be
measured at fair value with changes in fair value recognized in earnings, (ii) simplifies the impairment assessment of equity
investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, (iii) eliminates
the requirement to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed
for financial instruments measured at amortized cost, (iv) requires the use of the exit price notion when measuring the fair value
of financial instruments for disclosure purposes, (v) requires an entity to present separately in other comprehensive income the
portion of the total change in fair value of a liability resulting from a change in the instrument-specific credit risk when the entity
has elected to measure the liability at fair value in accordance with the fair value option, (vi) requires separate presentation of
88
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
financial assets and liabilities by measurement category and form on the balance sheet or the notes to the financial statements, and
(vii) clarifies that the need for a valuation allowance on a deferred tax asset related to an available for sale security should be
evaluated with other deferred tax assets. The guidance is effective beginning January 1, 2018 and the Company is currently
evaluating the impact on its results of operations and consolidated financial position.
Leases
In February 2016, the FASB issued guidance that amended previous guidance on lease accounting. The new guidance
requires the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous
GAAP. The guidance is effective beginning January 1, 2019 and the Company is currently evaluating the impact on its results of
operations and consolidated financial position; however, it is not expected to have a material impact on the Company’s results of
operations, consolidated financial position or cash flows.
Improvements to Employee Share-Based Payment Accounting
In March 2016, the FASB issued guidance that simplifies the accounting for share-based payment award transactions
including: income tax consequences, classification of awards as either equity or liabilities, classification of excess tax benefits,
and classification on the statement of cash flows. The guidance is effective beginning January 1, 2017 and it is not expected to
have a material impact on the Company’s results of operations, consolidated financial position or cash flows.
Measurement of Credit Losses on Financial Instruments
In June 2016, the FASB issued guidance that amended previous guidance on the impairment of financial instruments by
adding an impairment model that allows an entity to recognize expected credit losses as an allowance rather than impairing as
they are incurred. The new guidance is intended to reduce complexity of credit impairment models and result in a more timely
recognition of expected credit losses. The measurement of credit losses for available-for-sale debt securities measured at fair value
is not affected except that credit losses recognized are limited to the amount by which fair value is below amortized cost and the
carrying value adjustment is recognized through an allowance and not as a direct write-down. The guidance is effective beginning
January 1, 2020 and the Company is currently evaluating the impact on its results of operations and consolidated financial position.
Statement of Cash Flows - Classification of Certain Cash Receipts and Cash Payments
In August 2016, the FASB issued guidance that addresses eight specific cash flow issues with the objective of reducing
existing diversity in practice. The new guidance is effective beginning January 1, 2018 and it is not expected to have a material
impact on the Company's cash flows.
89
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
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,
2016 and 2015:
($ millions)
December 31, 2016
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 mortgage-backed securities
Total fixed maturities
Equity securities:
Large-cap securities
Small-cap securities
Mutual and exchange traded funds
Total equity securities
Other invested assets
Total available-for-sale securities
($ millions)
December 31, 2015
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 mortgage-backed securities
Total fixed maturities
Equity securities:
Large-cap securities
Small-cap securities
Mutual and exchange traded funds
Total equity securities
Other invested assets
Total available-for-sale securities
Cost or
amortized
cost
Gross
unrealized
holding
gains
Gross
unrealized
holding
losses
Fair
value
$
401.9
634.6
445.7
613.7
2,095.9
108.9
57.2
157.0
323.1
25.5
$ 2,444.5
Cost or
amortized
cost
$
219.8
804.0
500.3
448.8
1,972.9
136.3
53.3
75.6
265.2
56.9
$ 2,295.0
$
$
$
$
8.9
12.3
6.1
8.5
35.8
32.7
21.9
8.5
63.1
19.6
118.5
Gross
unrealized
holding
gains
6.6
22.5
5.8
11.5
46.4
29.4
16.5
4.8
50.7
28.3
125.4
$
$
$
$
(6.1) $
(3.2)
(2.2)
(10.9)
(22.4)
404.7
643.7
449.6
611.3
2,109.3
(2.6)
—
(0.8)
(3.4)
—
139.0
79.1
164.7
382.8
45.1
(25.8) $ 2,537.2
Gross
unrealized
holding
losses
Fair
value
(2.0) $
(1.7)
(11.7)
(3.2)
(18.6)
224.4
824.8
494.4
457.1
2,000.7
(4.0)
161.7
(0.2)
69.6
(1.1)
79.3
(5.3)
310.6
(0.1)
85.1
(24.0) $ 2,396.4
90
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
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, 2016 and 2015:
($ millions, except # of positions)
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
December 31, 2016
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 mortgage-
backed securities
Total fixed maturities
Large-cap equity securities
Mutual and exchange traded funds
Total equity securities
December 31, 2015
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 mortgage-
backed securities
Total fixed maturities
Large-cap equity securities
Small-cap equity securities
Mutual and exchange traded funds
Total equity securities
Other invested assets
$ 229.1
$
(6.1)
30
$
— $
178.9
102.9
341.7
852.6
9.1
29.9
39.0
(3.2)
(1.4)
(10.1)
(20.8)
(0.9)
(0.8)
(1.7)
26
16
43
115
7
2
9
—
29.4
20.5
49.9
8.8
—
8.8
—
—
(0.8)
(0.8)
(1.6)
(1.7)
—
(1.7)
(3.3)
— $ 229.1
$
(6.1)
—
4
11
15
5
—
5
20
178.9
132.3
362.2
902.5
17.9
29.9
47.8
(3.2)
(2.2)
(10.9)
(22.4)
(2.6)
(0.8)
(3.4)
$ 950.3
$
(25.8)
30
26
20
54
130
12
2
14
144
Total temporarily impaired securities
$ 891.6
$
(22.5)
124
$
58.7
$
($ millions, except # of positions)
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
$
68.6
$
(1.6)
15
$
13.5
$
(0.4)
4
$
82.1
$
(2.0)
137.5
246.9
132.2
585.2
46.0
3.4
19.8
69.2
8.1
(1.7)
(5.3)
(2.3)
(10.9)
(4.0)
(0.2)
(1.1)
(5.3)
(0.1)
16
36
18
85
20
1
4
25
1
—
63.9
33.0
110.4
—
—
—
—
—
—
(6.4)
(0.9)
(7.7)
—
—
—
—
—
137.5
310.8
165.2
695.6
46.0
3.4
19.8
69.2
8.1
(1.7)
(11.7)
(3.2)
(18.6)
(4.0)
(0.2)
(1.1)
(5.3)
(0.1)
—
11
11
26
—
—
—
—
—
26
19
16
47
29
111
20
1
4
25
1
Total temporarily impaired securities
$ 662.5
$
(16.3)
111
$ 110.4
$
(7.7)
$ 772.9
$
(24.0)
137
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, 2016, 2015 and 2014:
($ millions)
Equity securities:
Large-cap securities
Small-cap securities
Fixed maturities
Total other-than-temporary impairments
2016
2015
2014
$
$
(0.6) $
(3.9)
(2.3)
(6.8) $
(2.2) $
(5.7)
—
(7.9) $
(0.3)
(2.2)
—
(2.5)
The Company reviewed its investments at December 31, 2016, and determined that no additional other-than-temporary
impairment exists in the gross unrealized holding losses.
91
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
The following table sets forth the amortized cost and fair value of available-for-sale fixed maturities by contractual maturity
at December 31, 2016:
($ millions)
Due in 1 year or less
Due after 1 year through 5 years
Due after 5 years through 10 years
Due after 10 years
U.S. government agencies mortgage-backed securities
Total
Amortized
cost
Fair
value
$
$
74.4
552.7
280.2
574.9
613.7
2,095.9
$
$
75.2
557.8
282.9
582.1
611.3
2,109.3
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.
At December 31, 2016, State Auto P&C had fixed maturity securities, with a carrying value of approximately $106.5 million,
that were pledged as collateral for the FHLB Loan (as defined in Note 8). In accordance with the terms of the FHLB Loan, State
Auto P&C retains all rights regarding these securities, which are included in the “U.S. government agencies mortgage-backed
securities” classification of the Company’s fixed maturity securities portfolio.
Fixed maturities with fair values of approximately $9.2 million and $8.8 million were on deposit with insurance regulators
as required by law at December 31, 2016 and 2015, respectively.
The following table sets forth the components of net investment income for the years ended December 31, 2016, 2015 and
2014:
($ millions)
Fixed maturities
Equity securities
Cash and cash equivalents, and other
Investment income
Investment expenses
Net investment income
2016
2015
2014
$
$
63.4
7.3
5.6
76.3
1.6
74.7
$
$
61.3
6.5
5.9
73.7
2.0
71.7
$
$
64.3
6.2
6.2
76.7
2.0
74.7
The Company’s current investment strategy does not rely on the use of derivative financial instruments.
Proceeds on sales of available-for-sale securities in 2016, 2015 and 2014 were $365.4 million, $326.2 million and $263.3
million, respectively.
92
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
The following table sets forth the realized and unrealized holding gains (losses) on the Company’s investment portfolio for
the years ended December 31, 2016, 2015 and 2014:
($ millions)
Realized gains:
Fixed maturities
Equity securities
Other invested assets
Total realized gains
Realized losses:
Equity securities:
Sales
OTTI
Fixed maturities:
OTTI
Total realized losses
Net realized gains on investments
Change in unrealized holding gains (losses), net of tax:
Fixed maturities
Equity securities
Other invested assets
Deferred federal income tax
Change in unrealized holding gains (losses), net of tax
2016
2015
2014
$
$
$
$
2.8
29.2
12.1
44.1
(0.8)
(4.5)
(2.3)
(7.6)
36.5
$
$
(14.4) $
14.3
(8.6)
3.0
(5.7) $
4.6
29.6
0.2
34.4
(1.8)
(7.9)
—
(9.7)
24.7
$
$
(32.8) $
(29.5)
(1.6)
22.4
(41.5) $
3.1
21.3
0.1
24.5
(1.3)
(2.5)
—
(3.8)
20.7
34.5
6.2
(1.6)
(13.7)
25.4
During the fourth quarter of 2016, the Company redeemed a limited partnership investment in international equities that had
been classified as other invested assets. The redemption proceeds were reinvested in an international equity mutual fund classified
as an equity security. The Company recognized a gain of $12.0 million on the redemption. Out of the total proceeds related to
this redemption and reinvestment, $44.0 million was non-cash and therefore excluded from net cash used in investing activities
in the consolidated statements of cash flows.
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, 2016 and 2015, the Company did not adjust any
of the prices received from the pricing service.
93
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
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, 2016 and 2015.
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 a security discussed below), and U.S.
government agencies 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 holds one fixed maturity corporate security included in Level 3 and estimates its fair value using the present
value of the future cash flows.
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 is one international fund (“the fund”) that invests in equity securities of foreign issuers and
is managed by third party investment managers. The fund had a fair value of $35.7 million and $33.3 million at December 31,
2016 and 2015, respectively, which was determined using the fund’s net asset value. The Company employs procedures to assess
the reasonableness of the fair value of the fund including obtaining and reviewing the fund’s audited financial statements. There
is no unfunded commitment related to the fund. The Company may not sell its investment in the fund; however, the Company may
redeem all or a portion of its investment in the fund at net asset value per share with the appropriate prior written notice.
At December 31, 2015, the Company held another international fund that was managed by third party investment managers.
During the fourth quarter of 2016, the Company redeemed its investment in the fund. At December 31, 2015, the fund had a fair
value of $43.7 million.
In accordance with Accounting Standard Codification 820-10, since the investments are measured at fair value using the net
asset value per share practical expedient they have not been classified in the fair value hierarchy. Fair values presented here are
intended to permit reconciliation of the fair value hierarchy to the amounts presented in the consolidated balance sheets.
The remainder of the Company’s other invested assets consist of holdings in publicly-traded mutual funds. The Company
believes that its prices for these publicly-traded mutual funds, based on an observable market price for an identical asset in an
active market, reflect their fair values and consequently these securities have been disclosed in Level 1.
94
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
The following tables set forth the Company’s available-for-sale investments within the fair value hierarchy at December 31,
2016 and 2015:
($ millions)
December 31, 2016
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 mortgage-backed securities
Total fixed maturities
Equity securities:
Large-cap securities
Small-cap securities
Mutual and exchange traded funds
Total equity securities
Other invested assets
Total available-for-sale investments
($ millions)
December 31, 2015
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 mortgage-backed securities
Total fixed maturities
Equity securities:
Large-cap securities
Small-cap securities
Mutual and exchange traded funds
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
$
$
$
$
404.7
643.7
449.6
611.3
2,109.3
139.0
79.1
164.7
382.8
9.4
2,501.5
$
$
— $
—
—
—
—
139.0
79.1
164.7
382.8
9.4
392.2
$
404.7
643.7
446.1
611.3
2,105.8
—
—
—
—
—
2,105.8
Quoted prices
in active
markets for
identical
assets
(Level 1)
Significant
other
observable
inputs
(Level 2)
Total
224.4
824.8
494.4
457.1
2,000.7
161.7
69.6
79.3
310.6
8.1
2,319.4
$
$
— $
—
—
—
—
161.7
69.6
79.3
310.6
8.1
318.7
$
224.4
824.8
491.1
457.1
1,997.4
—
—
—
—
—
1,997.4
$
$
$
$
—
—
3.5
—
3.5
—
—
—
—
—
3.5
Significant
unobservable
inputs
(Level 3)
—
—
3.3
—
3.3
—
—
—
—
—
3.3
95
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
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 2016 and 2015, separately for each major category of assets:
($ millions)
Balance at January 1, 2016
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, 2016
($ millions)
Balance at January 1, 2015
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, 2015
Fixed
maturities
3.3
—
—
0.2
—
—
—
3.5
Fixed
maturities
9.4
—
(0.2)
—
(5.9)
—
—
3.3
$
$
$
$
96
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
Financial Instruments Disclosed, But Not Carried, At Fair Value
Other Invested Assets
Included in other invested assets are common stock of the Federal Home Loan Bank of Cincinnati (the “FHLB”), and the
Trust Securities (as defined in Note 7b). The Trust Securities and FHLB common stock are carried at cost, which approximates
fair value. The fair value of the FHLB common stock at December 31, 2016 was $4.9 million and the fair value of the Trust
Securities were $0.5 million. Both investments have been placed in Level 3 of the fair value hierarchy.
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 $70.0 million. The Company estimates the fair value of the notes receivable from affiliates using
market quotations for U.S. treasury securities with similar maturity dates and applies an appropriate credit spread. This has been
placed in Level 2 of the fair value hierarchy.
($ millions, except interest rates)
December 31, 2016
Fair
value
Carrying
value
Interest
rate
Carrying
value
December 31, 2015
Fair
value
Interest
rate
Notes receivable from affiliate
$
70.0
$
75.7
7.00% $
70.0
$
74.1
7.00%
Notes Payable
Included in notes payable are the FHLB Loans, consisting of the 2013 FHLB Loan and the 2016 FHLB Loan (as defined in
Note 8) and Subordinated Debentures. The Company estimates the fair value of the FHLB Loans by discounting cash flows using
a borrowing rate currently available to the Company for a loan with similar terms. The FHLB Loans have been placed in Level 3
of the fair value hierarchy. 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)
December 31, 2016
Fair
Value
Carrying
value
Interest
rate
Carrying
value
December 31, 2015
Fair
value
Interest
rate
FHLB Loan due 2021:, issued $21.5,
September 2016 with fixed interest
FHLB Loan due 2033:, issued $85.0,
July 2013 with fixed interest
Affiliate Subordinated Debentures due
2033: issued $15.5, May 2003 with
variable interest
Total notes payable
$
21.5
$
21.0
1.73% $
— $
—
—%
85.4
85.6
5.03%
85.3
85.5
5.03%
15.2
122.1
$
15.2
121.8
$
5.13%
15.2
100.5
$
15.2
100.7
$
4.61%
97
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
4. Losses and Loss Expenses Payable
The following table sets forth the activity in the liability for losses and loss expenses for the years ended December 31:
($ 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
Incurred related to:
Current year
Prior years
Total incurred
Paid related to:
Current year
Prior years
Total paid
Net balance at end of year
Plus: reinsurance recoverable on losses and loss expenses payable
Losses and loss expenses payable, at end of year (affiliates $630.9, $532.4, and
$494.3, respectively)
2016
2015
2014
$
$
1,053.0
5.9
1,047.1
915.4
27.0
942.4
417.8
393.7
811.5
1,178.0
3.6
$
983.2
9.6
973.6
852.8
10.0
862.8
421.5
367.8
789.3
1,047.1
5.9
959.9
9.1
950.8
726.2
45.1
771.3
373.2
375.3
748.5
973.6
9.6
$
1,181.6
$
1,053.0
$
983.2
The Company recorded adverse development related to prior years’ loss and loss expense reserves in 2016, 2015 and 2014
of $27.0 million and $10.0 million, and $45.1 million, respectively. Unallocated loss adjustment expenses contributed $3.7 million
of the adverse development and catastrophe reserves contributed $1.4 million of favorable development in 2016. The personal
insurance segment non-catastrophe loss and ALAE reserves accounted for $7.8 million of the adverse development in 2016, driven
by personal auto which contributed $7.9 million of adverse development, primarily due to higher than anticipated bodily injury
severity from the prior two accident years. The business insurance segment non-catastrophe loss and ALAE reserves contributed
$3.9 million of favorable development in 2016, driven by other & product liability and workers’ compensation of $4.5 million and
$4.2 million, respectively. Favorable development in these lines was driven by lower than anticipated severity emerging from
multiple accident years. The favorable development was partially offset by adverse development in commercial auto of $3.3
million, which was driven by higher than anticipated bodily injury severity from the prior two accident years. The specialty
insurance segment non-catastrophe loss and ALAE reserves accounted for $20.8 million of adverse development in 2016, which
was driven by programs and E&S casualty with adverse development of $14.3 million and $4.6 million, respectively. Programs
adverse development was driven by higher than expected severity in programs with commercial auto exposures. E&S casualty
adverse development was driven by increased severity from the healthcare line, which was placed in run-off in the first quarter of
2016.
Favorable development of unallocated loss adjustment expenses and catastrophe reserves were approximately $6.2 million
and $0.7 million, respectively, of the 2015 development. The personal and business insurance segments non-catastrophe loss and
ALAE reserves contributed $9.8 million of adverse development. The personal insurance segment contributed $9.4 million of the
adverse development, driven by personal auto which developed unfavorably by $11.0 million, primarily due to higher than
anticipated bodily injury severity from the prior two accident years. The business insurance segment contributed $0.4 million of
adverse development, driven by commercial auto which developed unfavorably by $10.5 million, also due to higher than anticipated
bodily injury severity from the prior two accident years. The adverse development was partially offset by favorable development
in workers’ compensation and other & product liability of $5.1 million and $3.8 million, respectively. Favorable development in
these lines was driven by lower than anticipated severity emerging from multiple accident years. The specialty insurance segment
non-catastrophe loss and ALAE reserves accounted for $7.1 million of adverse development, which was driven by programs and
E&S casualty with adverse development of $9.7 million and $2.7 million, respectively. Adverse development in programs was
driven by higher than expected severity in programs with commercial auto exposures. Somewhat offsetting the adverse development
was favorable development of $5.3 million in the E&S property unit driven by lower than anticipated severity emerging from
accident year 2014.
Favorable development of unallocated loss adjustment expenses contributed approximately $12.5 million of the 2014
development, while favorable development of catastrophe reserves was approximately $5.2 million, which was slightly lower than
2013. The personal and business insurance segments non-catastrophe loss and ALAE reserves accounted for $28.7 million of
98
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
favorable development. The personal insurance segment contributed $6.4 million of favorable development, primarily from
accident year 2013. The business insurance segment contributed $22.3 million of favorable development, driven by the other &
product liability, workers’ compensation and commercial auto lines with $11.9 million, $5.6 million and $5.3 million of favorable
development, respectively. The favorable development in these lines was driven by the emergence of lower than anticipated claim
severity from accident years 2013 and prior. Somewhat offsetting the favorable development was adverse development of $2.1
million in the commercial multi-peril line, driven by third party liability coverage. The specialty insurance segment non-catastrophe
loss and ALAE reserves accounted for $91.5 million of adverse development, driven by RED reserve strengthening of $96.7 million
related to a large restaurant program and a commercial auto trucking program. Somewhat offsetting the adverse development was
favorable development of $3.9 million in the E&S property unit and $3.1 million in the E&S casualty unit. Favorable development
in these lines was driven by better than anticipated severity emerging from the 2012 and 2013 accident years.
5. Short-Duration Insurance Contracts
The following tables set forth:
•
•
•
•
undiscounted, incurred and paid claims and allocated claim adjustment expenses by accident year, on a net basis after
reinsurance;
the sum of IBNR claims liabilities + expected development on reported claims ("IBNR+") included within the incurred
claims development tables, for each accident year, for the most recent reporting period; and
cumulative claim frequency information for each accident year;
average annual percentage payout of incurred claims by age, net of reinsurance.
The above information is provided for each of our reportable insurance segments and then is further disaggregated between
short and long-tail where "tail" refers to the time period between the occurrence of a loss and the settlement of the claims. See
Note 16 for discussion of our reportable segments. The personal insurance segment generally only consists of short-tail business,
whereas the business and specialty insurance segments have both short and long-tail business. We believe our disaggregated
groupings have homogeneous risk characteristics with similar development patterns and are generally subject to similar trends.
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 in the "Losses and Loss Expenses Payable" section of "Critical Accounting Policies" included
in Item 7 of this Form10-K. Separate projections are made for catastrophes that are in the very early stages of development based
on specific information known through the reporting date.
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 in the "Losses and Loss Expenses Payable" section of "Critical
Accounting Policies" included in Item 7 of this Form10-K. Statistical models may also be used when the historical patterns can
be reasonably approximated.
Cumulative Claim Frequency: Cumulative claim frequency is defined as the cumulative number of reported claims
("reported claims"). Reported claims include claims that do not result in a liability (e.g. those below a deductible). Reported
claims disclosed in the tables below are for the State Auto Group and have not been pooled (see Note 7a for additional information
regarding the Pooling Arrangement).
99
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
Personal Insurance Segment - Short-Tail
($ in millions except number of claims)
Incurred Losses and Allocated Loss Adjustment Expenses, Net of Reinsurance
As of December 31, 2016
Accident
Year
2012
2013
2014
2015
2016
For the Years Ended December 31,
2012*(1)
2013*(1)
2014*(1)
2015*
2016
IBNR+
$
305.3
$
307.6
$
306.7
$
308.9
$
308.6
$
288.6
283.3
271.2
287.9
272.8
337.2
287.6
275.2
343.6
366.4
Total $
1,581.4
0.9
2.8
4.0
20.3
44.9
Reported
Claims (2)
212,774
189,392
171,772
151,130
137,561
* Supplementary information and unaudited
(1) Allocated claim adjustment expenses, net of reinsurance, for accident years 2012, 2013 and 2014 were impacted by the HO
QS Arrangement. See Note 6 for a more detailed discussion of the HO QS Arrangement.
(2) Personal insurance segment - short-tail is an aggregation of the homeowners and personal auto product lines. Homeowners
reported claims are counted by claimant and personal auto claims are counted by coverage.
($ in millions)
Cumulative Paid Losses and Allocated Loss Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
Accident Year
2012*(1)
2013*(1)
2014*(1)
2015*
2016
$
193.8
$
260.2
$
176.0
2012
2013
2014
2015
2016
285.1
$
298.1
$
236.9
172.5
265.4
226.3
214.9
Total $
All outstanding liabilities before 2012, net of reinsurance
Losses and allocated loss adjustment expenses payable, net of reinsurance $
304.5
277.2
252.1
288.9
230.8
1,353.5
0.5
228.4
* Supplementary information and unaudited
(1) Cumulative paid claims for accident years 2012, 2013 and 2014 were impacted by the HO QS Arrangement. See Note 6
for a more detailed discussion of the HO QS Arrangement.
100
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
Business Insurance Segment - Short-Tail
($ in millions except number of claims)
Incurred Losses and Allocated Loss Adjustment Expenses, Net of Reinsurance
As of December 31, 2016
For the Years Ended December 31,
Accident
Year
2012
2013
2014
2015
2016
2012*
2013*
2014*
2015*
2016
IBNR+
$
170.3
$
170.5
$
168.1
$
170.9
$
169.1
$
170.0
168.7
181.0
175.2
183.9
189.1
Total $
176.8
185.6
191.0
186.8
909.3
3.7
6.4
15.0
31.2
49.8
Reported
Claims(1)
33,897
33,131
32,253
30,445
25,340
* Supplementary information and unaudited
(1) Business insurance segment - short-tail is an aggregation of the commercial auto, commercial-multi peril and fire & allied
product lines. Commercial auto reported claims are counted by coverage, and commercial multi-peril and fire & allied claims
are counted by claimant.
($ in millions)
Cumulative Paid Losses and Allocated Loss Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
Accident Year
2012*
2013*
2014*
2015*
2016
2012
2013
2014
2015
2016
$
91.9
$
128.0
$
145.8
$
156.8
$
79.4
126.2
92.9
146.0
131.3
90.4
Total $
All outstanding liabilities before 2012, net of reinsurance
Losses and allocated loss adjustment expenses payable, net of reinsurance $
* Supplementary information and unaudited
161.8
158.4
150.5
130.0
87.7
688.4
14.0
234.9
101
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
Business Insurance Segment - Long-Tail
The change in incurred losses and loss adjustment expenses for prior accident years was caused by lower than expected loss
emergence during 2016 in our other & product liability and workers’ compensation lines of business. The unanticipated emergence
in the other & product liability line was driven by much lower than expected severity in accident years 2013 and 2015. The
unanticipated emergence in the workers’ compensation line was driven by lower than expected severity in accident year 2014.
($ in millions except number of claims)
Incurred Losses and Allocated Loss Adjustment Expenses, Net of Reinsurance
As of December 31, 2016
For the Years Ended December 31,
Accident
Year
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2007*
2008*
2009*
2010*
2011*
2012*
2013*
2014*
2015*
2016
IBNR+
$ 73.4
$ 73.3
$ 74.1
$ 73.2
$ 71.9
$ 71.9
$ 72.5
$ 72.4
$ 73.0
$ 73.3
$
86.1
79.1
90.2
75.6
92.0
85.3
75.0
87.4
93.5
86.9
75.4
86.0
86.7
86.4
92.8
75.3
85.0
82.2
80.9
85.5
92.6
74.9
83.1
82.0
77.5
80.2
88.2
96.1
74.2
82.4
79.5
76.1
78.0
88.2
96.6
108.9
73.4
82.3
78.9
75.3
77.6
84.9
95.2
106.2
109.5
Total
$ 856.6
2.7
4.0
5.8
7.2
9.0
12.2
19.7
27.3
45.5
65.6
Reported
Claims(1)
8,072
9,577
10,086
10,644
17,390
17,321
16,646
16,501
15,783
8,548
* Supplementary information and unaudited
(1) Business insurance segment-long-tail is an aggregation of the other & product liability and workers' compensation product lines.
Other & product liability reported claims are counted by claimant and workers' compensation reported claims are counted by a
combination of claimant and coverage.
102
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
($ in millions)
Accident
Year
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
Cumulative Paid Losses and Allocated Loss Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
2007*
2008*
2009*
2010*
2011*
2012*
2013*
2014*
2015*
2016
$
12.7
$
$
28.7
14.3
$
43.0
34.7
15.2
$
50.3
43.9
34.9
12.9
$
57.6
51.6
48.2
33.0
16.4
$
61.4
56.4
60.2
46.3
33.9
15.3
$
64.0
61.3
66.2
54.2
46.4
32.6
16.3
$
65.7
64.0
70.3
63.3
53.9
43.7
36.7
15.8
$
68.1
65.0
72.1
65.8
60.7
51.8
50.1
37.6
17.3
68.6
66.0
74.1
67.6
63.6
57.3
57.2
53.9
38.6
15.4
$ 562.3
All outstanding liabilities before 2007, net of reinsurance
36.6
Losses and allocated loss adjustment expenses payable, net of reinsurance
$ 330.9
* Supplementary information and unaudited
103
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
Specialty Insurance Segment - Short-Tail
The change in incurred losses and loss adjustment expenses for prior accident years was caused by greater than expected
loss emergence during 2016 in our Programs line of business. The unanticipated emergence in the Programs line was driven by
higher than expected severity in accident year 2015 for programs with commercial auto exposure. The changes in incurred losses
and loss adjustment expenses for accident years 2012 and 2013 for the years ended December 31, 2013, 2014 and 2015 are primarily
attributable to our Programs line of business, including RED.
($ in millions except number of claims)
Incurred Losses and Allocated Loss Adjustment Expenses, Net of Reinsurance
As of December 31, 2016
Accident
Year
2012
2013
2014
2015
2016
For the Years Ended December 31,
2012*
2013*
2014*
2015*
2016
IBNR+
$
108.6
$
115.6
$
164.8
$
162.8
$
163.7
$
70.9
82.9
55.7
85.0
56.9
75.5
90.9
58.6
85.4
99.3
Total $
497.9
9.0
6.7
7.8
21.6
48.8
Reported
Claims(1)
9,697
7,680
7,657
7,666
5,754
* Supplementary information and unaudited
(1) Specialty insurance segment-short-tail is an aggregation of the E&S property and Programs product lines. E&S property and
Programs reported claims are counted by claimant.
($ in millions)
Cumulative Paid Losses and Allocated Loss Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
Accident Year
2012*
2013*
2014*
2015*
2016
$
25.4
$
$
59.8
18.2
94.7
37.7
22.0
2012
2013
2014
2015
2016
$
122.9
$
142.5
55.5
34.9
24.0
Total $
72.0
44.0
48.2
25.2
331.9
12.9
178.9
All outstanding liabilities before 2012, net of reinsurance
Losses and allocated loss adjustment expenses payable, net of reinsurance $
* Supplementary information and unaudited
104
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
Specialty Insurance Segment - Long-Tail
The change in incurred loss and loss adjustment expenses for prior accident years was caused by greater than expected loss
emergence during 2016, driven by higher than anticipated severity in accident years 2014 and 2015 for our healthcare product.
($ in millions except number of claims)
Incurred Losses and Allocated Loss Adjustment Expenses, Net of Reinsurance
As of December 31, 2016
For the Years Ended December 31,
2007*
2008*
2009*
2010*
2011*
2012*
2013*
2014*
2015*
2016
IBNR+
Reported
Claims(1)
$
9.7
$
$
9.2
6.4
9.4
6.7
10.3
$
9.0
6.7
11.0
11.2
$
8.8
6.8
10.0
10.9
11.9
$
8.5
6.1
10.4
9.9
10.7
16.7
$
8.4
6.0
11.0
9.7
10.7
16.7
20.1
$
8.3
5.8
11.0
9.8
10.2
15.4
18.9
23.3
$
8.3
6.0
10.6
9.9
10.1
17.6
17.9
25.2
38.6
$
$
4.1
4.9
12.4
10.3
10.9
17.4
16.5
27.1
45.0
60.8
2.4
1.6
2.0
2.2
2.2
3.0
4.9
9.5
22.8
47.6
Total
$ 209.4
1,101
1,502
1,429
1,169
911
862
936
1,044
1,409
1,401
Accident
Year
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
* Supplementary information and unaudited
(1) Specialty insurance segment-long-tail consists of the E&S casualty product line. E&S casualty reported claims are counted by
claimant.
105
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
($ in millions)
Accident
Year
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
Cumulative Paid Losses and Allocated Loss Adjustment Expenses, Net of Reinsurance
For the Years Ended December 31,
2007*
2008*
2009*
2010*
2011*
2012*
2013*
2014*
2015*
2016
$
— $
$
0.1
0.1
$
0.6
0.3
0.2
$
0.1
0.8
2.4
0.8
$
0.5
1.3
4.9
2.2
0.9
$
1.3
1.7
7.2
5.2
3.0
0.9
$
1.3
2.1
8.6
6.5
5.2
4.0
1.1
$
1.5
2.4
9.4
7.7
6.6
7.3
3.7
1.2
$
1.5
2.8
9.2
7.6
7.1
10.3
6.7
7.2
2.7
1.6
3.0
10.0
8.1
7.9
12.5
9.1
12.5
11.0
6.0
$
81.7
* Supplementary information and unaudited
All outstanding liabilities before 2007, net of reinsurance
2.0
Losses and allocated loss adjustment expenses payable, net of reinsurance
$ 129.7
106
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
The following table sets forth the reconciliation of the claims development tables to the balance sheet losses and loss expenses
payable, with separate disclosure of unallocated loss adjustment expenses, net of reinsurance ("ULAE") and reinsurance recoverable
on losses and loss expenses payable, for the years ended December 31:
($ in millions)
2016
2015
2014
Net losses and allocated loss adjustment expenses payable:
Personal Insurance Segment
Short-tail
Other personal
Business Insurance Segment
Short-tail
Long-tail
Other business
Specialty Insurance Segment
Short-tail
Long-tail
Net losses and loss expenses payable
ULAE
Reinsurance recoverable on losses and loss expenses payable
$
228.4
$
207.4
$
8.9
7.5
234.9
330.9
2.5
178.9
129.7
1,114.2
63.8
3.6
213.5
306.6
1.4
165.8
91.1
993.3
53.8
5.9
183.1
7.5
183.9
285.6
2.4
195.3
65.4
923.2
50.4
9.6
Total losses and loss expenses payable
$
1,181.6
$
1,053.0
$
983.2
The following table sets forth the historical average annual payout of incurred losses and allocated loss adjustment expenses
(claims duration) for short-duration contracts, based on the disaggregated information in the paid loss development tables, net of
reinsurance:
Average Annual Percentage Payout of Incurred Claims by Age, Net of Reinsurance
Years
Segment
1*
2*
3*
4*
5*
6*
7*
8*
9*
10*
Personal Insurance:
Short-tail
62.4% 21.0% 9.1%
4.2%
2.1%
N/A
N/A
N/A
N/A
N/A
Business Insurance:
Short-tail
48.7% 22.3% 10.7%
6.8%
Long-tail
17.9% 23.5% 16.1% 10.5%
3.0%
8.6%
N/A
N/A
4.8% 2.9%
Specialty Insurance:
Short-tail
Long-tail
25.3% 23.2% 18.8% 17.7% 11.9%
N/A
N/A
5.3% 14.5% 18.5% 10.6%
9.6%
8.1% 2.4%
N/A
2.0%
N/A
6.3%
N/A
2.4%
N/A
2.8%
N/A
0.7%
N/A
2.2%
* Supplementary information and unaudited
6. 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 7a for discussion of reinsurance with affiliates. The voluntary arrangements
provide greater diversification of business and limit the maximum net loss potential arising from large risks and catastrophes. Most
of the ceded reinsurance is effected under reinsurance contracts known as treaties; the remainder is by negotiation on individual
risks. Although the ceding of reinsurance does not discharge the original insurer from its primary liability to its policyholder, the
insurance company that assumes the coverage assumes the related liability.
107
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
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 was a three-
year quota share agreement covering its homeowners line of business. Under the arrangement, the State Auto Group ceded 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 expired on December 31, 2014. The Company received $89.5 million
of unearned premiums related to the expiration of this arrangement. Subject to the terms and conditions of the arrangement, the
participating reinsurers’ margin was capped at 9.0%, with any excess returned to the Company in the form of profit commission.
For the years ended December 31, 2016, 2015 and 2014, the Company recognized profit commission of $1.9 million, $4.2 million,
and $19.0 million, respectively, reflected as a reduction in acquisition and operating expenses on the consolidated statements of
income. The amount of ceding commission earned was limited to the amount of deferred acquisition costs that would have been
deferred if not for entering in the arrangement. As a result of the expiration of the HO QS Arrangement, the Company recognized
$8.1 million of excess ceding commission that had previously been deferred, reflected as a reduction in acquisition and operating
expenses on the consolidated statements of income for the year ended December 31, 2014.
The following table sets forth the effect of the Company’s external reinsurance on its balance sheets at December 31, 2016
and 2015, prior to the reinsurance transaction with State Auto Mutual under the Pooling Arrangement, as discussed in Note 7a:
($ millions)
Losses and loss expenses payable:
Direct
Assumed
Ceded
Net losses and loss expenses payable
Unearned premiums:
Direct
Assumed
Ceded
Net unearned premiums
2016
2015
$
$
$
$
545.7
5.0
(3.6)
547.1
395.6
1.3
(6.1)
390.8
$
$
$
$
515.6
5.0
(5.9)
514.7
400.9
1.2
(6.8)
395.3
108
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
The following table sets forth the effect of the Company’s external reinsurance on its income statements for the years ended
December 31, 2016, 2015 and 2014, prior to the reinsurance transaction with State Auto Mutual under the Pooling Arrangement,
as discussed in Note 7a:
($ 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
7. Transactions with Affiliates
a. Reinsurance
2016
2015
2014
$
$
$
$
$
$
835.4
5.0
(24.9)
815.5
840.6
4.9
(25.6)
819.9
559.1
3.9
(4.4)
558.6
$
$
$
$
$
$
854.1
4.7
(35.4)
823.4
863.1
4.5
(34.7)
832.9
569.0
3.4
(2.9)
569.5
$
$
$
$
$
$
880.6
4.4
(26.8)
858.2
882.6
4.4
(25.3)
861.7
525.6
2.9
(8.0)
520.5
The insurance subsidiaries of State Auto Financial, including State Auto Property & Casualty Insurance Company (“State
Auto P&C”), Milbank Insurance Company and State Auto Insurance Company of Ohio (collectively referred to as the “STFC
Pooled Companies”) 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, Meridian Security Insurance Company,
Patrons Mutual Insurance Company of Connecticut, Rockhill Insurance Company, Plaza Insurance Company, American
Compensation Insurance Company and Bloomington Compensation Insurance Company, (collectively referred to as the “Mutual
Pooled Companies”). State Auto P&C, Milbank and SA Ohio are referred to as the “STFC Pooled Companies,” State Auto Mutual,
SA Wisconsin, Meridian Security and Patrons Mutual are referred to as the “Mutual Pooled Companies,” and RIC, Plaza, American
Compensation and Bloomington Compensation are referred to as the “Rockhill Insurers.” The STFC Pooled Companies, the
Mutual Pooled Companies and the Rockhill Insurers are collectively referred to as the “State Auto Group.”
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).
109
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
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, 2016 and 2015:
($ millions)
Assets
Deferred policy acquisition costs:
Ceded
Assumed
Net assumed
Liabilities and Stockholders’ Equity
Losses and loss expenses payable:
Ceded
Assumed
Net assumed
Unearned premiums:
Ceded
Assumed
Net assumed
Pension and postretirement benefits:
Ceded
Assumed
Net ceded
Other liabilities:
Ceded
Assumed
Net assumed (ceded)
Stockholders’ Equity
Accumulated other comprehensive income:
Ceded
Assumed
Net ceded
2016
2015
(79.1) $
129.8
50.7
$
(79.8)
129.1
49.3
(547.1) $
1,178.0
630.9
$
(514.7)
1,047.1
532.4
(390.8) $
611.7
220.9
$
(114.5) $
74.4
(40.1) $
(42.9) $
53.9
11.0
$
(395.3)
609.5
214.2
(160.0)
104.0
(56.0)
(63.8)
55.4
(8.4)
(153.5) $
99.8
(53.7) $
(162.0)
105.3
(56.7)
$
$
$
$
$
$
$
$
$
$
$
$
110
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
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, 2016, 2015 and 2014:
($ millions)
Written premiums:
Ceded
Assumed
Net assumed
Earned premiums:
Ceded
Assumed
Net assumed
Losses and loss expenses incurred:
Ceded
Assumed
Net assumed
Acquisition and operating expenses:
Ceded
Assumed
Net assumed
2016
2015
2014
$
$
$
$
$
$
$
(815.5) $
1,293.3
477.8
$
(823.4) $
1,273.5
450.1
$
(819.9) $
1,291.9
472.0
$
(832.9) $
1,270.5
437.6
$
(560.3) $
944.1
383.8
$
(148.5)
434.3
285.8
$
(570.9) $
864.2
293.3
$
(183.9)
432.5
248.6
$
(858.2)
1,194.2
336.0
(861.7)
1,074.1
212.4
(523.6)
774.4
250.8
(215.4)
372.3
156.9
Intercompany Balances
Pursuant to the Pooling Arrangement, State Auto Mutual receives all premiums and pays all losses and expenses associated
with the insurance business produced by the pool participants and then settles the intercompany balances generated by these
transactions with the participating companies on a quarterly basis within 60 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, 2016 and 2015 is approximately $310.5 million and $294.7 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 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 is payable quarterly at a rate equal to the three-month LIBOR rate plus 4.20% adjusted
quarterly (total 5.13% at December 31, 2016). 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 810, 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.
111
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
c. Notes Receivable
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, the Company earned interest of $4.9 million for each of the three years ended December 31, 2016,
2015 and 2014, respectively. See Note 3 for the notes receivable fair value discussion.
d. Management Services
Stateco provides State Auto Mutual and its affiliates investment management services. Investment management income is
recognized quarterly based on a percentage of the average fair value of investable assets and the equity portfolio performance of
each company managed. Revenue related to these services amounted to $1.9 million, $1.8 million and $1.5 million in 2016, 2015
and 2014, respectively, and is included in other income (affiliates) on the consolidated statements of income.
8. Notes Payable and Credit Facility
FHLB Loans
State Auto Financial’s subsidiary, State Auto P&C, is a member of the Federal Home Loan Bank of Cincinnati (the “FHLB”)
and in September 2016 entered into a new term loan with the FHLB in the principal amount of $21.5 million (the “2016 FHLB
Loan”). The 2016 FHLB Loan is a five-year term loan and may be called (prepaid) after three years with no prepayment penalty.
The 2016 FHLB Loan provides for interest-only payments during its term, with principal due in full at maturity. The interest rate
is fixed over the term of the loan at 1.73%. The 2016 FHLB Loan is fully secured by a pledge of specific investment securities of
State Auto P&C. State Auto P&C has a term loan with the FHLB in the principal amount of $85.0 million (the “2013 FHLB
Loan”). The 2013 FHLB Loan is a 20-year term loan and is callable after three years with no prepayment penalty thereafter. The
2013 FHLB Loan provides for interest-only payments during its term, with principal due in full at maturity. The interest rate is
fixed over the term of the loan at 5.03%. The 2013 FHLB Loan is fully secured by a pledge of specific investment securities of
State Auto P&C.
Credit Facility
State Auto P&C has a credit facility (the “SPC Credit Facility”) with a syndicate of lenders that provides State Auto P&C
with a $100.0 million five-year revolving credit facility maturing in July 2018. During the term of the SPC Credit Facility, State
Auto P&C has the right to increase the total facility to a maximum amount of $150.0 million, provided that no event of default
has occurred and is continuing. The SPC Credit Facility is available for general corporate purposes and provides for interest-only
payments during its term, with principal and interest due in full at maturity. Interest is based on the London Interbank Offered
Rate (“LIBOR”) or a base rate plus a calculated margin amount. All advances under the SPC Credit Facility are to be fully secured
by a pledge of specific investment securities of State Auto P&C. The SPC Credit Facility includes certain requirements, including
financial requirements that State Auto Financial maintain a minimum net worth and a certain debt to capitalization ratio.
As of December 31, 2016, State Auto P&C had not made any borrowings and both State Auto P&C and State Auto Financial
were in compliance with all covenants and requirements of the SPC Credit Facility.
112
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
9. Federal Income Taxes
The following table sets forth the reconciliation between actual federal income tax (benefit) expense and the amount computed
at the indicated statutory rate for the years ended December 31, 2016, 2015 and 2014:
($ millions)
Amount at statutory rate
Tax-exempt interest and dividends received deduction
Other, net
Valuation allowance
Federal income tax (benefit) expense and effective rate $
$
2016
2015
2014
6.7
(7.1)
(1.4)
—
(1.8)
35.0 % $
(37.2)
(7.2)
—
(9.4)% $
23.5
(8.7)
1.3
—
16.1
35.0% $
(13.0)
1.9
—
9.4
(8.5)
1.1
(82.6)
23.9% $ (80.6)
35.0 %
(31.5)
4.1
(308.1)
(300.5)%
Income taxes for the year ended December 31, 2016 reflect the impact of a correction of prior period deferred tax expense
related to expired stock options. As a result of the correction, deferred federal income tax expense (“other, net” above) and
additional paid-in-capital were reduced by $1.6 million, respectively.
The following table sets forth the tax effects of temporary differences that give rise to significant portions of deferred tax
assets and deferred tax liabilities at December 31, 2016 and 2015:
($ 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
Net deferred federal income taxes
2016
2015
$
$
42.6
19.7
26.1
4.0
16.6
58.9
3.3
8.8
180.0
45.4
32.5
77.9
102.1
$
$
42.5
19.3
36.4
12.3
21.3
41.8
4.8
4.9
183.3
45.2
35.6
80.8
102.5
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. As part of its assessment of the appropriateness of the
deferred tax asset valuation allowance at December 31, 2014, management considered the following positive evidence: (i) three-
year cumulative pre-tax income of $98.7 million, (ii) three consecutive years of pre-tax income, (iii) the expiration of the HO QS
Arrangement under which we ceded 75% of our homeowners line underwriting results to the participating reinsurers, (iv) the
actions the Company took (including reserve strengthening and entering into an ADC reinsurance agreement protecting against
the risk of further adverse development for one of the programs) with respect to the terminated RED program business, which
significantly reduced the Company’s reported financial results since 2011, (v) more adequate pricing, which has contributed to
improved underwriting margins, and (vi) profitable growth within the specialty insurance segment, excluding the terminated RED
program business. Management concluded that this positive evidence outweighed available negative evidence and further
113
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
concluded that a valuation allowance against the Company’s net deferred tax assets was no longer appropriate. As a result, the
valuation allowance was reversed at December 31, 2014. With the reversal of the valuation allowance at December 31, 2014, the
Company recorded an income tax benefit of $82.6 million.
At December 31, 2016, the tax benefit of the net operating loss (“NOL”) carryforward was $58.9 million. The NOL
carryforwards do not begin to expire until 2030 and will not fully expire until 2036.
At December 31, 2016, the Company carried no balance for uncertain tax positions. The Company had no accrual for the
payment of interest and penalties at December 31, 2016 or 2015.
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 2013. The Company has no current U.S. federal or state and local income tax
examinations on-going at this time.
10. 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.
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 attaining 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 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, 2016 and 2015:
($ millions)
Change in benefit obligation:
Benefit obligation at beginning of year
Service cost
Interest cost
Actuarial loss (gain)
Benefits paid
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
$
$
$
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
2016
2015
2016
2015
281.3
6.1
11.6
4.5
(19.0)
284.5
$
$
292.5
7.7
11.1
(17.6)
(12.4)
281.3
$
$
$
204.4
34.5
15.8
(19.0)
235.7
(6.8)
(55.6) $
267.5
$
$
$
205.1
13.0
(1.3)
(12.4)
204.4
(6.8)
(83.7) $
263.1
$
20.3
—
0.8
(0.9)
(1.4)
18.8
$
$
— $
—
—
—
— $
—
(18.8) $
23.9
—
0.9
(3.3)
(1.2)
20.3
0.3
—
—
(0.3)
—
—
(20.3)
No assets are expected to be returned during the fiscal year ending December 31, 2016.
114
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
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, 2016 and 2015:
($ millions)
Prior service benefit
Net actuarial loss
Total
2016
2015
$
$
(54.1) $
118.5
64.4
$
(59.5)
125.1
65.6
The following table sets forth the Company’s share of amortization expected to be recognized for the year ending
December 31, 2017:
($ millions)
Prior service benefit
Net actuarial loss
Total
2017
(5.5)
8.0
2.5
$
$
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, 2016, 2015 and 2014:
($ millions)
Components of net periodic cost:
Service cost
Interest cost
Expected return on plan assets
Amortization of:
Prior service benefit
Net actuarial loss
Net periodic cost (benefit)
2016
Pension
2015
2014
2016
Postretirement
2015
2014
$
$
6.2
11.9
(15.1)
—
9.2
12.2
$
$
7.9
11.3
(13.8)
—
10.9
16.3
$
$
5.2
11.1
(12.6)
—
6.3
10.0
$
$
— $
0.9
—
(5.5)
0.2
(4.4) $
— $
1.1
—
(5.4)
0.6
(3.7) $
—
1.1
—
(5.5)
0.6
(3.8)
The following table sets forth the Company’s share of the benefit payments, which reflect expected future service, expected
to be paid:
($ millions)
2017
2018
2019
2020
2021
2022-2026
$
Pension
11.3
11.8
12.0
12.5
13.1
76.8
Postretirement
1.5
$
1.4
1.4
1.4
1.4
6.0
The postretirement plan’s gross benefit payments for 2016 were $1.4 million, including the prescription drug benefits. The
postretirement plan’s subsidy related to Medicare Prescription Drug Improvement and Modernization Act of 2003 was $0.3 million
for 2016 and estimates future annual subsidies to be approximately $0.3 million.
115
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
The following table sets forth the weighted average assumptions used to determine the benefit plans’ obligations at
December 31, 2016 and 2015:
Benefit obligations weighted-average assumptions:
Discount rate
Rates of increase in compensation levels
Pension
Postretirement
2016
2015
2016
2015
4.00%
3.50
4.20%
3.50
4.00%
—
4.20%
—
The following table sets forth the weighted average assumptions used to determine the benefit plans’ net periodic cost for
the years ended December 31, 2016, 2015 and 2014:
Weighted-average assumptions:
Discount rate
Expected long-term rate of return on assets
Rates of increase in compensation levels
2016
Pension
2015
2014
2016
Postretirement
2015
2014
4.20% 3.85%
7.00
3.50
7.00
3.50
4.85%
7.00
3.50
4.20%
—
—
3.85%
—
—
4.85%
—
—
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, 2016, 2015
and 2014:
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
2016
Postretirement
2015
2014
6.50%
3.90%
2075
6.50%
3.80%
2076
6.00%
3.80%
2075
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, 2016:
($ millions)
Postretirement
Increase
(Decrease)
One percentage point change:
Effect on total service and interest cost
Effect on accumulated postretirement benefit obligation
$
$
0.1
2.8
0.1
2.4
116
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
The pension plan’s investment policy objective is to preserve the investment principal while generating income and
appreciation in fair value to meet the pension plan’s obligations. The pension plan’s investment strategy and risk tolerance is
balanced between meeting cash obligation requirements and a long-term relatively high risk tolerance takes into account the
predictable cash requirements, nature of the plan’s liabilities and the plan’s long term time horizon. 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 also has investment policy guidelines with respect to limiting the ownership in any single debt or equity
issuer. The international fund investments are also 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%)
49.0%
26.0
11.0
10.0
4.0
100.0%
Effective January 1, 2014, the Investment Committee approved a change to a liability driven investment (LDI) for the
pension plan assets. The primary goal of the LDI strategy is to shift the asset allocation to more closely align with the plan liability,
thereby reducing the volatility of the funded status. The implementation of the LDI strategy will occur over a period of time and
the actual asset allocation at any point in time is dependent upon the funded status and the level of interest rates. This glide path
helps to balance interest rate risk, curve steepness risk, and credit spread risk, as incremental changes are made to the allocation
over time. The new allocation strategy reduces exposure to equity holdings and increases exposure to long duration fixed maturity
holdings. This change will result in lower volatility for the plan assets. By moving more of the plan’s assets to long duration fixed
income, the duration of the assets will increase to more closely match the duration of the plan’s liabilities.
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, 2016 and 2015.
Included in the pension plan’s available-for-sale securities is an international fund (“the fund”) that invests in equity securities
of foreign issuers and is managed by third party investment managers. The fund had a fair value of $31.3 million and $18.6 million
at December 31, 2016 and 2015, respectively, which was determined using the fund’s net asset value. In accordance with Accounting
Standard Codification 820-10, since this investment is measured at fair value using the net asset value per share practical expedient
this has not been classified in the table below.
117
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
The following tables set forth the Company’s share of pension plan’s available-for-sale securities within the fair value
hierarchy at December 31, 2016 and 2015:
($ millions)
December 31, 2016
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
Short-term fixed maturities
Total pension plan investments
($ millions)
December 31, 2015
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
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)
Total
$
$
$
$
$
60.4
48.0
— $
—
$
60.4
48.0
4.6
113.0
59.6
26.3
85.9
2.0
200.9
Total
51.0
38.9
6.4
96.3
59.0
22.3
81.3
177.6
$
$
$
—
—
59.6
26.3
85.9
—
85.9
$
4.6
113.0
—
—
—
2.0
115.0
Quoted prices
in active
markets for
identical
assets
(Level 1)
Significant
other
observable
inputs
(Level 2)
— $
—
—
—
59.0
22.3
81.3
81.3
$
51.0
38.9
6.4
96.3
—
—
—
96.3
$
$
$
—
—
—
—
—
—
—
—
—
Significant
unobservable
inputs
(Level 3)
—
—
—
—
—
—
—
—
During 2015, the postretirement plan assets were sold in order to pay retiree medical costs.
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 2017 is approximately $13.0 million.
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. The Company’s share
of the expense under the plan totaled $6.3 million, $5.1 million and $5.1 million for 2016, 2015 and 2014, respectively.
118
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
11. Other Comprehensive Income and Accumulated Other Comprehensive Income
The following tables set forth the changes in the Company’s accumulated other comprehensive income component (AOCI),
net of tax, for the years ended December 31, 2016, 2015 and 2014:
($ millions)
Beginning balance at January 1, 2016
Other comprehensive income before reclassifications
Amounts reclassified from AOCI (a)
Net current period other comprehensive income
Ending balance at December 31, 2016
Beginning balance at January 1, 2015
Other comprehensive income before reclassifications
Amounts reclassified from AOCI (a)
Net current period other comprehensive income
Ending balance at December 31, 2015
Beginning balance at January 1, 2014
Other comprehensive income before reclassifications
Amounts reclassified from AOCI (a)
Net current period other comprehensive income
Ending balance at December 31, 2014
(a) See separate table below for details about these reclassifications
Unrealized Gains
and Losses on
Available-for-Sale
Securities
Benefit Plan
Items
Total
$
$
$
$
$
$
68.5
18.0
(23.7)
(5.7)
62.8
110.0
(25.4)
(16.1)
(41.5)
68.5
84.6
38.9
(13.5)
25.4
110.0
$
$
$
$
$
$
(30.9) $
(3.0)
3.6
0.6
(30.3) $
(38.3) $
5.3
2.1
7.4
(30.9) $
(3.8) $
(54.4)
19.9
(34.5)
(38.3) $
37.6
15.0
(20.1)
(5.1)
32.5
71.7
(20.1)
(14.0)
(34.1)
37.6
80.8
(15.5)
6.4
(9.1)
71.7
The following tables set forth the reclassifications out of accumulated other comprehensive income, by component, to the
Company’s consolidated statement of income for the years ended December 31, 2016, 2015 and 2014:
($ millions)
Details about Accumulated Other
Comprehensive Income Components
December 31
2015
2016
2014
Affected line item in the Condensed
Consolidated Statements of Income
Unrealized gains on available for sale
securities
Amortization of benefit plan items:
Negative prior service costs
Net loss
Total reclassifications for the period
$ 36.5
36.5
(12.8)
23.7
$ 24.7
24.7
(8.6)
16.1
$ 20.7 Realized gain on sale of securities
20.7 Total before tax
(7.2) Tax expense
13.5 Net of tax
5.5
(9.4)
(3.9)
0.3
(3.6)
$ 20.1
5.4
(11.5)
(6.1)
4.0
(2.1)
$ 14.0
(a)
(a)
5.5
(6.9)
(1.4) Total before tax
(18.5) Tax benefit (expense)
(19.9) Net of tax
$ (6.4)
(a) These accumulated other comprehensive income components are included in the computation of net periodic pension cost (see pension
and postretirement benefit plans footnote for additional details).
12. Stockholders’ Equity
a. Dividend Restrictions and Statutory Financial Information
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. Under the
119
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
insurance regulations of Iowa and Ohio (the states of domicile), the maximum amount of dividends that the Company may pay
out of earned surplus to shareholders within a twelve month period without prior approval of the Department is limited to the
greater of 10% of the most recent year-end policyholders’ surplus or net income for the twelve month period ending the 31st day
of December of the previous year-end. Pursuant to these rules, approximately $84.4 million is available for payment to State Auto
Financial from its insurance subsidiaries in 2016 without prior approval. State Auto Financial received dividends from its insurance
subsidiaries in the amount of $10.0 million, $15.0 million and $20.0 million in 2016, 2015 and 2014, respectively.
The Company’s insurance subsidiaries are subject to risk-based capital (“RBC”) requirements that have been adopted by
individual states. These requirements subject insurers having statutory capital less than that required by the RBC calculation to
varying degrees of regulatory action, depending on the level of capital inadequacy. The RBC formulas specify various weighting
factors to be applied to financial balances or various levels of activity based on the perceived degree of risk. Regulatory compliance
is determined by a ratio of total adjusted capital to authorized control level RBC. Generally no remedial action is required by an
insurance company if its adjusted statutory surplus exceeds 200% of the authorized level RBC. As of December 31, 2016, each
of the Company’s insurance subsidiaries maintained adjusted statutory surplus in excess of 400% of the authorized control level
RBC.
The following tables set forth reconciliations of statutory capital and surplus and net income, as determined using SAP, to
the amounts included in the accompanying consolidated financial statements:
($ 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
$
2016
2015
$
844.4
(84.9)
759.5
129.8
22.7
(49.1)
13.5
14.9
891.3
$
814.3
(80.2)
734.1
129.1
23.2
(41.6)
27.9
11.9
884.6
($ millions)
Statutory net income (loss) of insurance subsidiaries
Net loss of non-insurance parent and affiliates
$
Increases (decreases):
Deferred acquisition costs
Postretirement and pension benefits
Deferred federal income taxes
Share-based compensation expense
Other, net
Net income per accompanying consolidated financial statements
$
13. Preferred Stock
Year ended December 31
2015
2014
2016
22.7
(3.0)
19.7
0.7
4.4
(5.4)
—
1.6
21.0
$
$
$
65.4
(4.1)
61.3
2.5
4.2
(12.2)
(0.1)
(4.5)
51.2
$
(17.5)
(5.3)
(22.8)
29.7
10.6
79.3
(0.5)
11.1
107.4
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.
120
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
14. 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”). 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.
Equity Plan
The Equity Plan provides for the award of qualified and nonqualified stock options, restricted shares, performance shares,
performance units and other stock-based awards. The Company has reserved 5.0 million common shares under the Equity Plan.
As of December 31, 2016, a total of 2.4 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 2016, 2015 and 2014 were 0.2 million, 0.3 million and 0.2 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, 2016, 2015 and 2014:
2016
2015
2014
Weighted
Average
Grant
Date Fair
Value
22.19
21.55
21.93
21.91
22.04
Shares
111,084
45,252
(33,414)
(15,625)
107,297
$
$
Weighted
Average
Grant
Date Fair
Value
19.06
22.83
16.88
21.92
22.19
Shares
76,472
74,020
(35,859)
(3,549)
111,084
$
$
Weighted
Average
Grant
Date Fair
Value
15.06
21.23
17.08
21.23
19.06
Shares
38,233
56,178
(16,892)
(1,047)
76,472
$
$
Outstanding, beginning of year
Granted
Vested
Canceled
Outstanding, end of year
As of December 31, 2016, there was $0.9 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.
121
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
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 3.7 million common shares under this plan. As of December 31, 2016, a total of 3.4
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 six months after the date of
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 cash or common share 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 10,000 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, 2026. The Company
accounts for the RSU Plan as a liability plan. There were 22,832 RSUs, 26,184 RSUs, and 25,960 RSUs granted in 2016, 2015
and 2014, respectively.
During 2016 and 2015, common shares valued at approximately $753,000 and $567,000, 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 during 2016, 2015 and 2014. 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, 2016, 2015 and 2014:
Fair value per share
Expected dividend yield
Risk free interest rate
Expected volatility factor
Expected life in years
$
2016
2015
2014
$
6.75
1.87%
1.30%
36.27%
5.3
$
7.69
1.75%
1.60%
36.61%
6.0
7.28
1.86%
1.65%
39.23%
5.7
122
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
The following table sets forth the Company’s total activity and related information for these plans for the years ended
December 31, 2016, 2015 and 2014:
(millions, except per share amounts)
2016
2015
2014
Outstanding, beginning of year
Granted
Exercised
Canceled
Outstanding, end of year
Weighted-
Average
Exercise
Price
Options
Weighted-
Average
Exercise
Price
Options
Weighted-
Average
Exercise
Price
Options
3.4
0.3
(0.4)
(0.5)
2.8
$
$
21.44
21.47
17.55
29.81
20.67
3.7
0.4
(0.3)
(0.4)
3.4
$
$
21.29
22.87
16.56
25.18
21.44
3.9
0.3
(0.1)
(0.4)
3.7
$
$
22.01
21.20
16.43
30.21
21.29
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, 2016, 2015 and 2014, the total intrinsic value of stock options exercised was $3.0 million, $2.6 million
and $0.5 million, respectively. The tax benefit for tax deductions from share-based awards totaled $1.4 million, $0.3 million and
$0 for the years ended December 31, 2016, 2015 and 2014, respectively. In addition, income taxes for the year ended December
31, 2016 reflect the impact of a $1.6 million correction of prior period deferred tax expense related to expired stock options. See
Note 9 for additional information.
The following table sets forth information pertaining to the total options outstanding and exercisable at December 31, 2016:
(Options in millions)
Options Outstanding
Options Exercisable
Range of Exercise Prices:
$10.01 – $20.00
$20.01 – $30.00
Weighted-
Average
Remaining
Contractual Life
Weighted-
Average
Exercise
Price
Number
Number
Weighted-
Average
Exercise
Price
1.4
1.4
2.8
4.1
3.6
3.8
$
$
16.44
24.57
20.67
1.3
0.9
2.2
$
$
16.46
25.96
20.53
Aggregate intrinsic value for total options outstanding at December 31, 2016 was $25.3 million. Aggregate intrinsic value
for total options exercisable at December 31, 2016 was $14.9 million.
Compensation expense recognized during 2016, 2015 and 2014 was $3.7 million, $4.5 million and $3.6 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, 2016, 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 2.25 years.
123
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
15. Net Earnings Per Common Share
The following table sets forth the compilation of basic and diluted net earnings per common share for the years ended
December 31, 2016, 2015 and 2014:
(millions, except per share amounts)
Numerator:
Net earnings for basic net earnings per common share
Adjusted net earnings for dilutive net earnings per common share
Denominator:
Weighted average shares for basic net earnings per common share
Effect of dilutive share-based awards
Adjusted weighted average shares for diluted net earnings per
common share
Basic net earnings per common share
Diluted net earnings per common share
2016
2015
2014
$
$
$
$
21.0
21.0
$
$
51.2
51.2
$
$
107.4
107.4
41.6
0.4
42.0
0.50
0.50
$
$
41.1
0.5
41.6
1.25
1.23
$
$
40.8
0.4
41.2
2.63
2.60
The following table sets forth the options to purchase shares of common stock and the restricted share units (“RSU award”)
provided to each outside director of the Company, that were not included in the computation of diluted earnings per common share
because the exercise price of the options, or awards, was greater than the average market price or their inclusion would have been
antidilutive for the years ended December 31, 2016, 2015 and 2014:
(millions)
Total number of antidilutive options and awards
2016
2015
2014
1.2
1.5
1.8
16. Reportable Segments
The Company has 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 primarily provides personal automobile and homeowners to the personal insurance market.
The business insurance segment primarily provides commercial automobile, commercial multi-peril, fire & allied, general liability
and workers’ compensation insurance covering small-to-medium sized commercial exposures in the business insurance market.
The specialty insurance segment provides 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 investment operations segment, managed by Stateco, provides investment services.
The Company evaluates the performance of its insurance segments using industry financial measurements based on SAP,
which include loss and loss adjustment expense ratios, underwriting expense ratios, combined ratios, statutory underwriting gain
(loss), net premiums earned and net written premiums. One of the most significant differences between SAP and GAAP is that
SAP requires all underwriting expenses to be expensed immediately and not deferred and amortized over the same period the
premium is earned.
The accounting for pension benefits also contributes to the difference between our GAAP loss and expense ratios and our
SAP loss and expense ratios. At January 1, 2013, we adopted new SAP pension guidance, which required the recognition of service
costs for non-vested participants. In accordance with GAAP, service costs related to non-vested participants was recognized over
the two year vesting period ended December 31, 2014.
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.
Effective January 1, 2017, the Company completed the transition of its internal decision-making process to a product
management structure under which its principal operating decision makers assess performance and allocate resources based on
124
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
the underwriting results of individual products. Accordingly, beginning January 1, 2017, the Company’s reportable segments, and
the products within each, will be as follows:
• Personal Insurance Segment- personal auto, homeowners, farm & ranch and other personal
• Commercial Insurance Segment - commercial auto, small commercial package, middle market commercial,
workers’ compensation and other commercial
• Specialty Insurance Segment - E&S property, E&S casualty and programs
The following table sets forth financial information regarding the Company’s reportable segments for the years ended
December 31, 2016, 2015 and 2014:
$
$
$
($ 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) gain
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
Reconciling items:
GAAP adjustments
Interest expense on corporate debt
Corporate expenses
Total reconciling items
Total consolidated income before federal income taxes
$
$
125
2016
2015
2014
$
582.2
468.9
240.8
1,291.9
74.7
36.5
111.2
1,403.1
2.3
1,405.4
5.8
1,411.2
591.8
476.0
202.7
1,270.5
71.7
24.7
96.4
1,366.9
1.7
1,368.6
5.6
1,374.2
(5.8)
1,405.4
$
(5.6)
1,368.6
$
$
$
(15.2) $
(26.7)
(42.7)
(84.6)
74.7
36.5
111.2
0.4
2.0
(5.5)
(4.3)
(7.8) $
19.2
$
17.5
(36.7)
(5.9)
(25.1)
71.7
24.7
96.4
(0.1)
4.2
(5.4)
(2.7)
(3.9) $
$
67.3
451.4
459.9
162.8
1,074.1
74.7
20.7
95.4
1,169.5
3.2
1,172.7
5.1
1,177.8
(5.1)
1,172.7
(11.7)
(4.6)
(89.5)
(105.8)
74.7
20.7
95.4
—
45.8
(5.4)
(3.2)
37.2
26.8
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
The following table sets forth financial information regarding the Company’s reportable segments at December 31, 2016
and 2015:
($ millions)
Segment assets:
Investment operations segment
Total segment assets
Reconciling items:
Corporate assets
Total consolidated assets
2016
2015
$
$
2,663.7
2,663.7
295.7
2,959.4
$
$
2,529.8
2,529.8
298.4
2,828.2
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.
17. Quarterly Financial Data (unaudited)
The following tables set forth quarterly financial data for 2016 and 2015:
2016
For three months ended
June 30
September 30
352.8
$
7.4
10.1
December 31
364.9
$
33.1
32.5
348.5
(25.1)
(24.6)
(0.59) $
(0.59) $
0.24
0.24
$
$
0.78
0.77
2015
For three months ended
June 30
337.4
3.4
2.7
September 30
349.7
$
29.9
20.7
$
December 31
346.6
0.8
3.1
0.06
0.06
$
$
0.50
0.50
$
$
0.08
0.07
($ millions, except per share amounts)
Total revenues
Income (loss) before federal income taxes
Net income (loss)
Earnings (loss) per common share:
Basic
Diluted
Total revenues
Income before federal income taxes
Net income
Earnings per common share:
Basic
Diluted
March 31
339.2
3.8
3.0
0.07
0.07
March 31
334.9
33.2
24.7
0.60
0.60
$
$
$
$
$
$
$
$
$
$
$
$
126
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
18. Contingencies
In accordance with the Contingencies Topic of the Financial Accounting Standards Board’s Accounting Standards
Codification, 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. The Company reviews all litigation on an ongoing basis when making accrual and
disclosure decisions. For certain legal proceedings, the Company cannot reasonably estimate losses or a range of loss, if any,
particularly for proceedings that are in their early stages of development or where the plaintiffs seek indeterminate damages. Various
factors, including, but not limited to, the outcome of potentially lengthy discovery and the resolution of important factual questions,
may need to be determined before probability can be established or before a loss or range of loss can be reasonably estimated. If
the loss contingency in question is not both probable and reasonably estimable, the Company does not establish an accrual and
the matter will continue to be monitored for any developments that would make the loss contingency both probable and reasonably
estimable. Based on currently available information known to the Company, it believes that its reserves for litigation-related
liabilities are reasonable. However, in the event that a legal proceeding results in a substantial judgment against, or settlement by,
the Company, there can be no assurance that any resulting liability or financial commitment would not have a material adverse
effect on the financial condition, results of operations or cash flows of the consolidated financial statements of the Company.
The Company is involved in lawsuits in the ordinary course of its business arising out of or otherwise related to its insurance
policies. Additionally, from time to time the Company may be involved in lawsuits, including class actions, in the ordinary course
of business but not arising out of or otherwise related to its insurance policies. These lawsuits are in various stages of
development. The Company generally will contest these matters vigorously but may pursue settlement if appropriate. 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 position or cash flows.
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 results of
operations or have a material adverse effect on its consolidated financial position or cash flows.
127
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Companies)
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
Not applicable.
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) 2013
framework to evaluate the effectiveness of our internal control over financial reporting. Our management believes that
the COSO 2013 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,
2016, 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 report 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
Not applicable.
128
Item 10. Directors, Executive Officers and Corporate Governance
PART III
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 the 2017 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 this Form 10-K, which information is also incorporated by reference
into this Item 10.
We have a separately-designated standing Audit Committee established in accordance with Section 3(a)(58)(A) of the
Exchange Act. As of March 1, 2017, the members of our Audit Committee were Eileen A. Mallesch, Robert E. Baker, David R.
Meuse, David J. D’Antoni and Kym M. Hubbard. 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 “Ownership of Equity Securities of the Company—Section 16(a) Beneficial Ownership Reporting
Compliance” in the 2017 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 and Board of Directors—Nomination of Directors” in the 2017 Proxy Statement.
There has been no material change to the nomination procedures previously disclosed in the proxy statement for our 2017 annual
meeting of shareholders.
Our Board of Directors has adopted a code of ethics that applies to our principal executive officer, principal financial officer,
principal accounting officer, controller, and persons performing similar functions. This code of ethics has been posted on our
website at www.StateAuto.com under “Investor Relations” then “Corporate Governance.” Any amendment (other than any
technical, administrative or other non-substantive amendment) to, or waiver from, a provision of this code will be posted on our
website described above within four business days following its occurrence.
Item 11. Executive Compensation
The 2017 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 “Corporate Governance and Board of
Directors—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
Matters—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 Matters—Compensation Committee Report of the Fiscal Year
Ended December 31, 2016” This information is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information regarding security ownership of certain beneficial owners and management required by Item 403 of Regulation
S-K will be found under the caption “Ownership of Equity Securities of the Company” in the 2017 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 and Burn Rate” in the 2017 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 the 2017 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 and Board of Directors—Directors—Director Independence” in the 2017 Proxy Statement, which
is incorporated herein by reference.
129
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 “Audit Committee Matters—Independent Registered Public Accounting Firm’s Audit and Other Services Fees” in our
2017 Proxy Statement, which information is incorporated herein by reference.
130
Item 15. Exhibits and Financial Statement Schedules
(a)(1) LISTING OF FINANCIAL STATEMENTS
PART IV
The following consolidated financial statements of the Company are filed as part of this Form 10-K and are included in
Item 8:
Reports of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2016 and 2015
Consolidated Statements of Income for each of the three years in the period ended December 31, 2016
Consolidated Statements of Comprehensive Income for each of the three years in the period ended December 31, 2016
Consolidated Statements of Stockholders’ Equity for each of the three years in the period ended December 31, 2016
Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2016
Notes to Consolidated Financial Statements
(a)(2) LISTING OF FINANCIAL STATEMENT SCHEDULES
The following financial statement schedules of the Company for the years 2016, 2015 and 2014 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
Schedule
Condensed Financial Information of Registrant
Supplementary Insurance Information
Reinsurance
Valuation and Qualifying Accounts
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.
(a)(3) LISTING OF EXHIBITS
Exhibit
No.
Description of Exhibit
If incorporated by reference document with which Exhibit was
previously filed with SEC
3.01
3.02
3.03
3.04
3.05
State Auto Financial Corporation’s Amended and
Restated Articles of Incorporation
Form 10-K Annual Report for the year ended
December 31, 2012 (see Exhibit 3.01 therein)
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
Form 10-K Annual Report for the year ended
December 31, 2012 (see Exhibit 3.04 therein)
First Amendment
to State Auto Financial
Corporation’s Amended and Restated Code of
Regulations
Form 10-Q Quarterly Report for the period ended
September 30, 2010 (see Exhibit 3.05 therein)
131
Exhibit
No.
3.06
10.01*
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
Description of Exhibit
Second Amendment
to State Auto Financial
Corporation’s Amended and Restated Code of
Regulations
2000 Directors Stock Option Plan of State Auto
Financial Corporation
If incorporated by reference document with which Exhibit was
previously filed with SEC
Form 10-Q Quarterly Report for the period ended
June 30, 2016 (see Exhibit 3.01 therein)
Definitive Proxy Statement on Form DEF 14A, File
No. 000-19289, for Annual Meeting of Shareholders
held on May 26, 2000 (see Appendix B therein)
First Amendment to 2000 Directors Stock Option
Plan of State Auto Financial Corporation
Form 10-Q Quarterly Report for the period ended
March 31, 2001 (see Exhibit 10(HH) therein)
Second Amendment to 2000 Directors Stock Option
Plan of State Auto Financial Corporation
Form 10-Q Quarterly Report for the period ended
September 30, 2001 (see Exhibit 10(KK) therein)
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
December 31, 2002 (see Exhibit 10(UU) therein)
for year ended
Fifth Amendment to 2000 Directors Stock Option
Plan of State Auto Financial Corporation
Form 10-Q Quarterly Report for the period ended
June 30, 2005 (see Exhibit 10.66 therein)
Sixth Amendment to the 2000 Directors Stock Option
Plan (effective March 7, 2008) of State Auto Financial
Corporation
Investment Management Agreement between Stateco
Financial Services, Inc. and State Automobile Mutual
Insurance Company, effective April 1, 1993
Form 8-K Current Report filed on March 13, 2008
(see Exhibit 10.3 therein)
Form 10-K Annual Report for the year ended
December 31, 1992 (see Exhibit 10 (N) therein)
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 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
Investment Management Agreement between Stateco
Financial Services, Inc. and Meridian Citizens
Mutual Insurance Company effective June 1, 2001
Form 10-K Annual Report for the year ended
December 31, 2012 (see Exhibit 10.09 therein)
Form 10-K Annual Report for the year ended
December 31, 2012 (see Exhibit 10.10 therein)
Form 10-K Annual Report for the year ended
December 31, 2005 (see Exhibit 10.17 therein)
Form 10-K Annual Report for the year ended
December 31, 2012 (see Exhibit 10.12 therein)
Form 10-K Annual Report for the year ended
December 31, 2005 (see Exhibit 10.19 therein)
Form 10-K Annual Report for the year ended
December 31, 2012 (see Exhibit 10.15 therein)
Form 10-K Annual Report for the year ended
December 31, 2005 (see Exhibit 10.20 therein)
132
If incorporated by reference document with which Exhibit was
previously filed with SEC
Form 10-K Annual Report for the year ended
December 31, 2012 (see Exhibit 10.17 therein)
Form 10-K Annual Report for the year ended
December 31, 2007 (see Exhibit 10.22 therein)
Form 10-K Annual Report for year ended December
31, 2010 (see Exhibit 10.26 therein)
Form 10-K Annual Report for the year ended
December 31, 2012 (see Exhibit 10.22 therein)
Form 10-K Annual Report for year ended December
31, 2010 (see Exhibit 10.27 therein)
Form 10-K Annual Report for the year ended
December 31, 2012 (see Exhibit 10.24 therein)
Form 10-K Annual Report for year ended December
31, 2010 (see Exhibit 10.28) therein)
Form 10-K Annual Report for the year ended
December 31, 2012 (see Exhibit 10.26 therein)
Form 10-K Annual Report for the year ended
December 31, 2005 (see Exhibit 10.45 therein)
Form 10-Q Quarterly Report for the period ended
March 31, 2005 (see Exhibit10.56 therein)
Exhibit
No.
10.16
10.17
10.18
10.19
10.20
10.21
10.22
10.23
10.24
10.25
Description of Exhibit
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
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
Investment Management Agreement between Stateco
Financial Services, Inc. and Plaza Insurance
Company effective October 1, 2010
Amended and Restated Exhibit A to the Investment
Management Agreement between Stateco Financial
Services, Inc. and Plaza Insurance Company,
effective January 1, 2013
Investment Management Agreement between Stateco
Financial Services, Inc. and Rockhill Insurance
Company effective October 1, 2010
Amended and Restated Exhibit A to the Investment
Management Agreement between Stateco Financial
Services, Inc. and Rockhill Insurance Company,
effective January 1, 2013
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
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)
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
133
If incorporated by reference document with which Exhibit was
previously filed with SEC
Form 10-Q Quarterly Report for the period ended
June 30, 2007 (see Exhibit 66.67 therein)
Form 8-K Current Report filed on January 27, 2009
(see Exhibit 10.1 therein)
Form 10-K Annual Report
December 31, 2010 (see Exhibit 10.36 therein)
for year ended
Exhibit
No.
10.26
10.27
10.28
Description of Exhibit
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
134
If incorporated by reference document with which Exhibit was
previously filed with SEC
Form 10-Q Quarterly Report for the period ended
June 30, 2015 (see Exhibit10.01 therein)
Form 10-Q Quarterly Report for the period ended
September 30, 2009 (see Exhibit 10.01 therein)
Form 10-K Annual Report for the year ended
December 31, 2012 (see Exhibit 10.35 therein)
Form 8-K Current Report filed on November 25, 2009
(see Exhibit 10.1 therein)
Form 8-K Current Report filed on January 7, 2011
(see Exhibit 10.2 therein)
Exhibit
No.
10.29
10.30
10.31
10.32
10.33
Description of Exhibit
Management and Operations Agreement, Amended
and Restated as of January 1, 2015 by and among State
Automobile Mutual Insurance Company, State Auto
Financial Corporation, State Auto Property and
Casualty Insurance Company, State Auto Insurance
Company of Ohio, Meridian Security Insurance
Company, Patrons Mutual Insurance Company,
Stateco Financial Services, Inc., 518 Property
Management and Leasing, LLC, State Auto Holdings,
Inc., Facilitators, Inc., CDC Holding, Inc., Partners
General Insurance Agency, LLC, and Network E&S
Brokers, LLC
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.
to
Amended and Restated Appendix B , effective as of
January 1, 2013,
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
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.
135
If incorporated by reference document with which Exhibit was
previously filed with SEC
Form 10-K Annual Report for the year ended
December 31, 2012 (see Exhibit 10.38 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-Q Quarterly Report for the period ended
March 31, 2013 (see Exhibit 10.1 therein)
Exhibit
No.
10.34
10.35
10.36
10.37
Description of Exhibit
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 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
Second Amendment, effective March 31, 2013, 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, State Auto Insurance Company of
Ohio, Meridian Security
Insurance Company,
Meridian Citizens Mutual Insurance Company,
Patrons Mutual Insurance Company of Connecticut,
Rockhill Insurance Company, Plaza Insurance
Company, American Compensation
Insurance
Company and Bloomington Compensation Insurance
Company
136
Exhibit
No.
10.38
10.39
10.40
10.41
10.42
10.43
10.44
10.45*
10.46*
10.47*
Description of Exhibit
Third Amendment, effective July 1, 2014, 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, State Auto Insurance Company of
Ohio, Meridian Security Insurance Company, Patrons
Mutual Insurance Company of Connecticut, Rockhill
Insurance Company, Plaza Insurance Company,
American Compensation Insurance Company and
Bloomington Compensation Insurance Company
Homeowners Quota Share Reinsurance Contract
Insurance
between State Automobile Mutual
Company (on behalf of
insurance
itself and
subsidiaries and affiliates now under its ownership,
control or management,
insurance
subsidiaries of State Auto Financial Corporation) and
a syndicate of reinsurers effective December 31, 2011
at 11:59 p.m.
including
If incorporated by reference document with which Exhibit was
previously filed with SEC
Form 10-Q Quarterly Report for the period ended
September 30, 2014 (see Exhibit 10.01 therein)
Form 10-K Annual Report
December 31, 2011 (see Exhibit 10.46 therein)
for year ended
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)
Credit Agreement dated as of May 19, 2009, between
State Automobile Mutual Insurance Company, as
borrower, and Milbank Insurance Company, as lender
Form 8-K Current Report filed on May 26, 2009 (see
Exhibit 10.1 therein)
Form 8-K Current Report filed on May 13, 2009 (see
Exhibit 10.1 therein)
Form 8-K Current Report filed on September 30,
2011 (see Exhibit 10.1 therein)
Form 10-K Annual Report
December 31, 2011 (see Exhibit 10.61 therein)
for year ended
Form 10- Quarterly Report for the period ended
March 31, 2015 (see Exhibit 10.01 therein)
Form 10-Q Quarterly Report for the period ended
September 30, 2014 (see Exhibit 10.02 therein)
Credit Agreement dated as of May 8, 2009, between
State Automobile Mutual Insurance Company, as
borrower, and State Auto Property & Casualty, as
lender
Credit Agreement dated as of July 26, 2013, among
State Auto Property & Casualty, 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.
including Amendment
Employment Agreement (dated as of November 17,
2008),
to Employment
Agreement (dated as of November 30, 2010), among
Rockhill Holding Company, State Automobile
Mutual Insurance Company and Jessica E. Buss
Employment Agreement, dated as of March 27, 2015,
commencing as of April 27, 2015, among State Auto
Financial Corporation, State Auto Property &
Casualty Insurance Company, State Automobile
Mutual Insurance Company and Michael E. LaRocco
Executive Change of Control Agreement dated as of
October 27, 2014, among State Auto Financial
Corporation, State Auto Property & Casualty
Insurance Company, State Automobile Mutual
Insurance Company and Steven E. English
137
Exhibit
No.
10.48*
10.49*
10.50*
10.51*
10.52*
10.53*
10.54*
10.55*
10.56*
10.57*
10.58*
10.59*
10.60*
10.61*
10.62*
Description of Exhibit
Executive Change of Control Agreement dated as of
October 27, 2014, among State Auto Financial
Corporation, State Auto Property & Casualty
Insurance Company, State Automobile Mutual
Insurance Company and Jessica E. Buss
Executive Change of Control Agreement dated as of
March 27, 2015 among State Auto Financial
Corporation, State Auto Property & Casualty
Insurance Company, State Automobile Mutual
Insurance Company and Michael E. LaRocco
Executive Change of Control Agreement dated as of
March 27, 2015 among State Auto Financial
Corporation, State Auto Property & Casualty
Insurance Company, State Automobile Mutual
Insurance Company and Kim B. Garland
Executive Change of Control Agreement dated as of
December 1, 2015 among State Auto Financial
Corporation, State Auto Property & Casualty
Insurance Company, State Automobile Mutual
Insurance Company and Paul M. Stachura
If incorporated by reference document with which Exhibit was
previously filed with SEC
Form 10-Q Quarterly Report for the period ended
September 30, 2014 (see Exhibit 10.05 therein)
Form 10-Q Quarterly Report for the period ended
March 31, 2015 (see Exhibit 10.02 therein)
Form 10-Q Quarterly Report for the period ended
June 30, 2016 (see Exhibit 10.04 therein)
Included herein
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)
Officer Indemnification Agreement dated as of May
8, 2009, between State Auto Financial Corporation
and Steven E. English
Incentive
and Restated Equity
Amended
Compensation Plan of State Auto Financial
Corporation
Amendment Number 1 to the Amended and Restated
Equity Incentive Compensation Plan of State Auto
Financial Corporation (amendment effective August
15, 2008)
Form of Non-Qualified Stock Option Agreement
under the Amended and Restated Equity Incentive
Compensation Plan of State Auto Financial
Corporation
Form of Incentive Stock Option Agreement under the
Amended
Incentive
and Restated Equity
Compensation Plan of State Auto Financial
Corporation
Form 8-K Current Report filed on May 13, 2009 (see
Exhibit 10.3 therein)
Form 10-Q Quarterly Report for the period ended
June 30, 2005 (see Exhibit 10.60 therein)
Form 10-K Annual Report for the year ended
December 31, 2008 (see Exhibit 10.63 therein)
Form 10-Q Quarterly Report for the period ended
June 30, 2005 (see Exhibit 10.62 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
Amendment No. 2 to the 2009 Equity Incentive
Compensation Plan of State Auto Financial
Corporation
Amendment No. 3 to the 2009 Equity Incentive
Compensation Plan of State Auto Financial
Corporation
Amendment No. 4 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)
Form 10-Q Quarterly Report for the period ended
September 30, 2013 (see Exhibit 10.01 therein)
Form 10-K Annual Report for the year ended
December 31, 2014 (see Exhibit 10.69 therein)
Form 10-Q Quarterly Report for the period ended
June 30, 2016 (see Exhibit 10.01 therein)
138
Exhibit
No.
10.63*
10.64*
10.65*
10.66*
10.67*
10.68*
10.69*
10.70*
10.71*
10.72*
10.73*
10.74*
10.75*
Description of Exhibit
Restricted Stock Agreement under the 2009 Equity
Incentive Compensation Plan dated as of March 6,
2014 between State Auto Financial Corporation and
Steven E. English
Restricted Stock Agreement under the 2009 Equity
Incentive Compensation Plan dated as of March 5,
2015 between State Auto Financial Corporation and
Steven E. English
Restricted Stock Agreement under the 2009 Equity
Incentive Compensation Plan dated as of March 6,
2014 between State Auto Financial Corporation and
Jessica E. Buss
Restricted Stock Agreement under the 2009 Equity
Incentive Compensation Plan dated as of March 5,
2015 between State Auto Financial Corporation and
Jessica E. Buss
Restricted Stock Agreement under the 2009 Equity
Incentive Compensation Plan dated as of May 7,
2015 between State Auto Financial Corporation and
Michael E. LaRocco
Restricted Stock Agreement under the 2009 Equity
Incentive Compensation Plan dated as of March 3,
2016 between State Auto Financial Corporation and
Michael E. LaRocco
Restricted Stock Agreement under the 2009 Equity
Incentive Compensation Plan dated as of March 3,
2016 between State Auto Financial Corporation and
Steven E. English
Restricted Stock Agreement under the 2009 Equity
Incentive Compensation Plan dated as of March 3,
2016 between State Auto Financial Corporation and
Jessica E. Clark
Restricted Stock Agreement under the 2009 Equity
Incentive Compensation Plan dated as of August 24,
2015 between State Auto Financial Corporation and
Kim B. Garland
Restricted Stock Agreement under the 2009 Equity
Incentive Compensation Plan dated as of August 24,
2015 between State Auto Financial Corporation and
Kim B. Garland
Restricted Stock Agreement under the 2009 Equity
Incentive Compensation Plan dated as of March 3,
2016 between State Auto Financial Corporation and
Kim B. Garland
Restricted Stock Agreement under the 2009 Equity
Incentive Compensation Plan dated as of September
9, 2015 between State Auto Financial Corporation
and Paul M. Stachura
Restricted Stock Agreement under the 2009 Equity
Incentive Compensation Plan dated as of September
9, 2015 between State Auto Financial Corporation
and Paul M. Stachura
139
If incorporated by reference document with which Exhibit was
previously filed with SEC
Form 10-Q Quarterly Report for the period ended
March 31, 2014 (see Exhibit 10.02 therein)
Form 8-K Current Report filed on May 13, 2015 (see
Exhibit 10.02 therein)
Form 10-Q Quarterly Report for the period ended
March 31, 2014 (see Exhibit 10.04 therein)
Form 8-K Current Report filed on May 13, 2015 (see
Exhibit 10.03 therein)
Form 8-K Current Report filed on May 13, 2015 (see
Exhibit 10.06 therein)
Form 10-Q Quarterly Report for the period ended
March 31, 2016 (see Exhibit 10.01 therein)
Form 10-Q Quarterly Report for the period ended
March 31, 2016 (see Exhibit 10.02 therein)
Form 10-Q Quarterly Report for the period ended
March 31, 2016 (see Exhibit 10.03 therein)
Form 10-Q Quarterly Report for the period ended
March 31, 2016 (see Exhibit 10.04 therein)
Form 10-Q Quarterly Report for the period ended
March 31, 2016 (see Exhibit 10.05 therein)
Form 10-Q Quarterly Report for the period ended
March 31, 2016 (see Exhibit 10.06 therein)
Included herein
Included herein
Exhibit
No.
10.76*
10.77*
10.78*
10.79*
10.80*
10.81*
10.82*
10.83*
10.84*
10.85*
10.86*
10.87*
10.88*
10.89*
10.90*
10.91*
Description of Exhibit
If incorporated by reference document with which Exhibit was
previously filed with SEC
Restricted Stock Agreement under the 2009 Equity
Incentive Compensation Plan dated as of March 3,
2016 between State Auto Financial Corporation and
Paul M. Stachura
Included herein
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
the Outside Directors
Restricted Share Unit Plan of State Auto Financial
Corporation
to
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
the Outside Directors
Restricted Share Unit Plan of State Auto Financial
Corporation effective November 1, 2010
to
Outside Directors Restricted Share Unit Plan of State
Auto Financial Corporation
Form of Restricted Share Unit Agreement for the
Outside Directors Restricted Share Unit Plan of State
Auto Financial Corporation
Form of Designation of Beneficiary for the Outside
Directors Restricted Share Unit Plan of State Auto
Financial Corporation
Supplemental Retirement Plan
for Executive
Employees of State Auto Insurance Companies
effective as of May 1, 2010
First Amendment to the Supplemental Retirement
Plan for Executive Employees of State Auto
effective
Companies (amendment
Insurance
December 1, 2010)
Form 10-K Annual Report
December 31, 2010 (see Exhibit 10.89 therein)
for year ended
Form 10-Q Quarterly Report for the period ended
June 30, 2016 (see Exhibit 10.02 therein)
Form 10-Q Quarterly Report for the period ended
June 30, 2005 (see Exhibit 10.64 therein)
Form 10-Q Quarterly Report for the period ended
June 30, 2005 (see Exhibit 10.65 therein)
Form 10-Q Quarterly Report for the period ended
June 30, 2010 (see Exhibit 10.01 therein)
Form 10-K Annual Report
December 31, 2010 (see Exhibit 10.96 therein)
for year ended
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 of Designation of Distribution Election for the
State Auto Financial Corporation Supplemental
Executive Retirement Plan
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)
Form 10-K Annual Report
December 31, 2010 (see Exhibit 10.98 therein)
for year ended
Form 10-Q Quarterly Report for the period ended
September 30, 2007 (see Exhibit 10.73 therein)
Form 10-K Annual Report for the year ended
December 31, 2005 (see Exhibit 10.58 therein)
Form 10-K Annual Report for the year ended
December 31, 2005 (see Exhibit 10.59 therein)
140
Exhibit
No.
10.92*
10.93*
10.94*
10.95*
10.96*
10.97*
10.98*
10.99*
10.100*
10.101*
10.102*
10.103*
10.104*
10.105*
If incorporated by reference document with which Exhibit was
previously filed with SEC
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)
Description of Exhibit
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 of State Auto Insurance Companies Directors
Deferred Compensation Agreement
Form 10-K Annual Report for the year ended
December 31, 2005 (see Exhibit 10.61 therein)
State Auto Property & Casualty Insurance Company
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)
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
December 31, 2011 (see Exhibit 10.109 therein)
for year ended
State Auto Financial Corporation Leadership Bonus
Plan
Form 10-Q Quarterly Report for the period ended
June 30, 2007 (see Exhibit 10.64 therein)
First Amendment to the State Auto Financial
Corporation Leadership Bonus Plan (amendment
effective as of January 1, 2009)
Second Amendment to the State Auto Financial
Corporation Leadership Bonus Plan (amendment
effective as of January 1, 2012)
Third Amendment to the State Auto Financial
Corporation Leadership Bonus Plan (amendment
effective as of January 1, 2015)
Form 10-Q Quarterly Report for the period ended
September 30, 2008 (see Exhibit 10.04 therein)
Form 8K Current Report filed on May 10, 2012 (see
Exhibit 10.2 therein)
Form 10-Q Quarterly Report for the period ended
September 30, 2015 (see Exhibit 10.02 therein)
141
Exhibit
No.
10.106*
10.107*
10.108*
10.109*
10.110*
10.111*
10.112*
10.113*
10.114*
10.115*
Description of Exhibit
Fourth Amendment to the State Auto Financial
Corporation Leadership Bonus Plan (amendment
effective as of January 1, 2015)
If incorporated by reference document with which Exhibit was
previously filed with SEC
Form 10-K Annual Report
December 31, 2015 (see Exhibit 10.99 therein)
for year ended
State Auto Financial Corporation Long-Term
Incentive Plan
Form 10-Q Quarterly Report for the period ended
June 30, 2007 (see Exhibit 10.65 therein)
First Amendment 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)
Fourth Amendment to the State Auto Financial
Corporation Long-Term Incentive Plan (amendment
effective as of August 8, 2014)
Blanket Security Agreement effective February 15,
2013 between State Auto Property & Casualty
Insurance Company and Federal Home Loan Bank
of Cincinnati
Insurance Company Member Addendum to Blanket
Security Agreement effective February 15, 2013
between State Auto Property & Casualty Insurance
Company and Federal Home Loan Bank of
Cincinnati
Application for Callable Advance signed July 10,
2013 by State Auto Property & Casualty Insurance
Company with respect to Blanket Security
Agreement effective February 15, 2013 between
State Auto Property & Casualty Insurance
Company and Federal Home Loan Bank of
Cincinnati
Application for Callable Advance signed September
2, 2016 by State Auto Property & Casualty
Insurance Company with respect to Blanket
Security Agreement effective February 15, 2013
between State Auto Property & Casualty Insurance
Company and Federal Home Loan Bank of
Cincinnati
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 10-Q Quarterly Report for the period ended
September 30, 2015 (see Exhibit 10.01 therein)
Form 10-Q Quarterly Report for the period ended
June 30, 2013 (see Exhibit 10.02 therein)
Form 10-Q Quarterly Report for the period ended
June 30, 2013 (see Exhibit 10.03 therein)
Form 10-Q Quarterly Report for the period ended
June 30, 2013 (see Exhibit 10.04 therein)
Form 10-Q Quarterly Report for the period ended
September 30, 2016 (see Exhibit 10.01 therein)
10.116*
State Auto Financial Corporation One Team Incentive
Plan
Form 10-Q Quarterly Report for the period ended
June 30, 2016 (see Exhibit 10.03 therein)
21.01
23.01
24.01
List of Subsidiaries of State Auto Financial
Corporation
Included herein
Consent
Accounting Firm
of
Independent Registered Public
Powers of Attorney-David J. D’Antoni, Robert E.
Baker, Michael J. Fiorile, Kym M. Hubbard, Eileen
A. Mallesch, Thomas E. Markert, David R. Meuse
and S. Elaine Roberts
Included herein
Included herein
31.01
CEO certification required by Section 302 of
Sarbanes-Oxley Act of 2002
Included herein
142
Exhibit
No.
31.02
32.01
32.02
101.INS
Description of Exhibit
If incorporated by reference document with which Exhibit was
previously filed with SEC
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
The instance document does not appear in the
interactive data file because its XBRL tags are
embedded within
101.SCH
XBRL Taxonomy Extension Schema Document
Included herein
101.CAL
XBRL Taxonomy Extension Calculation Linkbase
Document
Included herein
101.DEF
XBRL Taxonomy Definition Linkbase Document
Included herein
101.LAB
101.PRE
XBRL Taxonomy Extension Label Linkbase
Document
Included herein
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.
(b) EXHIBITS
The exhibits included with this Form 10-K, as indicated in Item 15(a)(3), have been separately filed.
(c) FINANCIAL STATEMENT SCHEDULES
Our financial statement schedules included with this Form 10-K, as indicated in Item 15(a)(2), follow the signatures to this
Form 10-K.
143
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SIGNATURES
Dated: March 1, 2017
STATE AUTO FINANCIAL CORPORATION
/s/ Michael E. LaRocco
Michael E. LaRocco
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
/s/ Michael E. LaRocco
Michael E. LaRocco
Chairman, President and Chief Executive Officer
(principal executive officer)
Date
March 1, 2017
March 1, 2017
/s/ Steven E. English
Steven E. English
/s/ Matthew R. Pollak
Matthew R. Pollak
David J. D’Antoni
David J. D’Antoni
Robert E. Baker*
Robert E. Baker
Michael J. Fiorile*
Michael J. Fiorile
Kym M. Hubbard*
Kym M. Hubbard
Eileen A. Mallesch*
Eileen A. Mallesch
Thomas E. Markert*
Thomas E. Markert
David R. Meuse*
David R. Meuse
S. Elaine Roberts*
S. Elaine Roberts
Senior Vice President and Chief Financial Officer
(principal financial officer)
Vice President, Treasurer and Chief Accounting Officer
(principal accounting officer)
March 1, 2017
Director
Director
Director
Director
Director
Director
Director
Director
March 1, 2017
March 1, 2017
March 1, 2017
March 1, 2017
March 1, 2017
March 1, 2017
March 1, 2017
March 1, 2017
*
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
Steven E. English
Attorney in Fact
March 1, 2017
144
EXHIBIT 21.01
List of Subsidiaries of
State Auto Financial Corporation
State Auto Property and Casualty Insurance Company, an Iowa corporation
Stateco Financial Services, Inc., an Ohio corporation
Milbank Insurance Company, an Iowa corporation
State Auto Insurance Company of Ohio, an Ohio corporation
518 Property Management and Leasing, LLC, an Ohio limited liability company
EXHIBIT 23.01
Consent of Independent Registered Public Accounting Firm
We consent to the incorporation by reference in the following Registration Statements:
For
m
Registration
Number
S-8
33-44667
1991 Stock Option Plan
33-89400
Description
S-8
S-8
S-8
S-8
S-8
S-3
S-3
S-8
S-8
33-44666
1991 Directors’ Stock Option Plan
33-41423
1991 Employee Stock Purchase and Dividend Reinvestment Plan
333-05755
333-147333
333-206148
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
333-209878
333-90529
1998 State Auto Agents’ Stock Option Plan
333-127172
2005 Outside Directors Restricted Share Unit Plan
333-165364
State Auto Financial Corporation 2009 Equity Incentive Compensation Plan
333-192158
333-214472
S-8
333-165366
333-170568
State Auto Property & Casualty Insurance Company Amended and Restated Incentive Deferred Compensation
Plan
S-8
S-8
333-170564
State Auto Insurance Companies Amended and Restated Directors Deferred Compensation Plan, and
333-214471 Outside Directors Restricted Share Unit Plan of State Auto Financial Corporation
of our reports dated March 1, 2017, 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, 2016.
/s/ Ernst & Young LLP
Columbus, Ohio
March 1, 2017
I, Michael E. LaRocco, certify that:
CERTIFICATION
EXHIBIT 31.01
1.
2.
3.
4.
I have reviewed this Form 10-K of State Auto Financial Corporation;
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;
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;
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 1, 2017
/s/ Michael E. LaRocco
Michael E. LaRocco, Chief Executive Officer
Chief Executive Officer
(Principal Executive Officer)
I, Steven E. English, certify that:
CERTIFICATION
EXHIBIT 31.02
1.
2.
3.
4.
I have reviewed this Form 10-K of State Auto Financial Corporation;
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;
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;
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 1, 2017
/s/ Steven E. English
Steven E. English,
Chief Financial Officer
(Principal Financial Officer)
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, 2016, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Michael E.
LaRocco, 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/ Michael E. LaRocco
Michael E. LaRocco
Chief Executive Officer
March 1, 2017
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.
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, 2016, 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 1, 2017
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.
Corporate Information
ANNUAL MEETING
11 a.m. ET Friday, May 5, 2017,
at Corporate Headquarters
SHAREHOLDER INQUIRIES
Tara Shull
Investor Relations and Finance Director
State Auto Financial Corporation
518 E. Broad St.
Columbus, Ohio 43215
Phone (614) 917-4478
Fax (614) 887-1793
Tara.Shull@StateAuto.com
INDEPENDENT AUDITORS
Ernst & Young LLP
800 Yard St., Ste. 200
Grandview Heights, Ohio 43212
LEGAL COUNSEL
Baker & Hostetler LLP
65 E. State St., Ste. 2100
Columbus, Ohio 43215
SEC FILINGS
This report and other filings 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/investor
STOCK TRADING
Common shares are traded in the Nasdaq Global Select
National Market System under the symbol STFC. As of
Feb. 24, 2017, there were 1,164 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:
High
2016
$27.42
Fourth Quarter
Third Quarter
24.35
Second Quarter 22.22
22.83
First Quarter
2015
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
High
$25.69
27.37
25.70
24.80
Low
$19.54
20.76
18.69
17.84
Low
$20.01
21.55
20.63
20.36
Dividend
$0.10
0.10
0.10
0.10
Dividend
$0.10
0.10
0.10
0.10
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 state-
ments 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, 2016,
which is included with this Annual Report.
0.0
$0.25
$0.50
$0.75
State Auto Financial
Corporation Annual Report
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
Patrons Mutual Insurance Company of Connecticut
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